Q&A Hero

Q: Under IFRS, operating lease treatment could be required if the leased asset is so specialized that significant modifications would be needed for another party to use it.

Q: Under IFRS, an indicator that could lead to a lease being classified as a finance lease is if the lessee cancels the lease, the lessor's losses will be borne by the lessee.

Q: The FASB and the IASB are working on a joint project which will ultimately result in all leases being treated as capital leases.

Q: For tax purposes lessees prefer operating leases.

Q: With a leveraged lease, the lessor must treat the lease as a direct financing lease.

Q: It is possible that the lessee and the lessor could both treat the same lease as a capital lease.

Q: The current ratio will be lower over the lease term when the lessee treats the lease as a capital lease rather than an operating lease.

Q: If a company sells an asset for a profit of $175,000 and immediately leases it back with a capital lease, the gain on the sale is recognized immediately as an ordinary gain.

Q: The lessor does not have any asset recorded in its financial statements for a lease classified as a sales-type lease.

Q: The lessor's lease Gross investment in leased asset balance is the same at the end of the lease term whether the residual value is guaranteed or unguaranteed.

Q: The gross profit earned by the lessor is the same whether the residual value is guaranteed or unguaranteed.

Q: The lessor recognizes both gross profit and interest income during the first year of the lease term when the lease is classified as a sales-type lease.

Q: Gross Investment in Leased Asset is classified on a lessor's balance sheet as a current asset.

Q: For a lessor using the operating lease method of recording a lease, the net effect on income is recognized evenly throughout the term of the lease, if the lessor uses straight-line depreciation.

Q: Current GAAP defines lessors' treatment of leases according to Type I and Type II characteristics. Type I characteristics are linked to the critical event criteria for revenue recognition.

Q: When a lease meets one of the Type I criteria and both of the Type II criteria, the lessor must treat the lease as a capital lease.

Q: For a lessee, the current ratio deteriorates with a capitalized lease.

Q: Managers in lessee companies prefer that leases be treated as capital leases.

Q: The amount charged to expense over the life of a lease is the same for operating and capital leases.

Q: Residual value guarantees protect lessors against lessees who abuse leased assets.

Q: A lessee's minimum lease payments includes the present value of a residual value guarantee.

Q: A lessee will record a leased asset at the lower of the present value of the minimum lease payments or the leased asset's fair value when the lease is a capital lease.

Q: If a lease contains a residual value guarantee, the lessee must add that guaranteed amount to the present value of the minimum lease payments.

Q: Executory costs paid by the lessee associated with a capital lease are recorded as a component of the lease liability.

Q: The annual expense associated with a capital lease decreases over the term of the lease.

Q: Executory costs of a lease are treated as operating expenses by the lessee.

Q: If a lease agreement contains a bargain purchase option, the lessee must depreciate the leased asset over the asset's useful life rather than over the lease term.

Q: The lessee must depreciate a leased asset over the lease term assuming that any one of the four lease criteria applicable to the lessee are met.

Q: A lessee must use the incremental borrowing rate to value a capital lease.

Q: GAAP establishes specific criteria for the treatment of leases. One of the criteria states that the lessee must capitalize a lease if the lease agreement contains a bargain purchase option.

Q: GAAP established specific criteria for the treatment of leases. One of the criteria states that the lessee must capitalize a lease if the present value of the minimum lease payments is greater than or equal to 75% of the leased asset's fair value.

Q: GAAP establishes specific criteria for the treatment of leases. For a lessee, if any of the criteria are met, the lease must be treated as an operating lease.

Q: Treating a lease as an operating lease rather than a capital lease results in an increase in the asset turnover ratio.

Q: Loan covenants are one reason lessees prefer operating lease treatment.

Q: If a lessee mistakenly treats a capital lease as an operating lease, both assets and liabilities would be understated at the inception of the lease.

Q: Operating leases are financial statement examples of off -balance sheet financing.

Q: When accounting for an operating lease, interest expense is recognized over the lease term by the lessee.

Q: When accounting for an operating lease, a liability is recognized when the lease is signed by the lessee.

Q: Refer to the 2003 IBM financial statement excerpts presented on the subsequent pages to answer these questions. All questions relate to fiscal year 2003 unless stated otherwise. Required: 1. Explain the risks that IBM is trying to manage with its derivatives. 2. Explain how the gains and losses on the fair value hedges affect net income and other comprehensive income during 2003. Give specific accounts and amounts where possible. 3. Explain how the gains and losses on non-hedge/other derivatives affect net income and other comprehensive income during 2003. Give specific accounts and amounts where possible. 4. Explain how the gains and losses on the cash flow hedges affect net income and other comprehensive income during 2003. Give specific accounts and amounts where possible. 5. Was it a good idea for IBM to enter into its cash flow hedges?

Q: On January 1, 2011, Hitchcock Corporation entered into a 5-year interest rate swap agreement. The agreement called for the company to make payments based on an 8% fixed notional amount of $500,000 and to receive interest based on a floating interest rate. The contract called for cash settlement of the net interest amount at the end of each year. The floating rate was to be reset at each cash settlement date. Thus, the floating rate for determining each end of year payment is the rate as of the end of the prior year. Market (LIBOR) interest rates were 8% at January 1, 2011, 6.5% at December 31, 2011, and 9% at December 31, 2012. The fair value of the swap is as follows: Requirements: 1. Complete the following table to show the amounts appearing in Hitchcock's financial statements related to the swap for the years ended December 31, 2011 and December 31, 2012. There may be zeros in several of the cells. Indicate debits and credits by putting parentheses around credits. Show your work within the table. 2. Complete the following table to show the amounts appearing in Hitchcock's statement of comprehensive income related to the swap and the hedged item for the years ended December 31, 2011 and December 31, 2012, assuming that the interest rate swap is being used as a perfectly effective cash flow hedge for a $500,000 variable rate note payable issued by Hitchcock. There may be zeros in multiple cells. Indicate debits and credits by placing parentheses around the credits. Show your work within the table. 3. Complete the following table to show the amounts appearing in Hitchcock's statement of comprehensive income related to the swap and the hedged item for the years ended December 31, 2011 and December 31, 2012, assuming that the interest rate swap is being used as a perfectly effective fair value hedge for a $500,000 investment in a fixed rate note. The note is classified as an available-for-sale security. There may be zeros in multiple cells. Indicate debits and credits by placing parentheses around the credits. Show your work within the table.

Q: On December 15, 2011, The International Company received and accepted an order to deliver goods to a foreign customer on February 1, 2012 in exchange for 3 million euros. International must deliver the goods on February 1, 2012 and the foreign customer is required to pay for the goods at the time of delivery. On December 15, 2011, International agreed to a forward contract to deliver 3 million euros to the Speculative Bank on February 1, 2012 in exchange for $2,730,000. The forward rate as of December 31, 2011 was $.915; the spot rate as of February 1, 2012 was $.904. Requirement: Prepare the necessary journal entries on December 31, 2011 and February 1, 2012 assuming that the forward contract is being used as a fair value hedge.

Q: The Hockey Supply Company acquires its inventory from a Canadian supplier. As a result, the company purchases call options in order to hedge its foreign currency risk. On December 1, 2011, Hockey Supply Company made a commitment to purchase inventory during February 2012; the payment of one million Canadian dollars is due at the time of the inventory purchase. The company immediately purchased a call option on one million Canadian dollars at a strike price of $.98 per Canadian dollar; the call option cost $5,200. The call option is considered to be a fair value hedge. As of December 31, 2011, the spot rate was .975 U.S. dollars per Canadian dollar, and the fair value of the call option was $1,300. Hockey Supply Company purchased the inventory on February 5, 2012. The spot rate at the time of purchase was .99 U.S dollars per Canadian dollar and the fair value of the call option was $8,900. Requirement: Prepare the necessary journal entries for December 1, 2011, December 31, 2011, and February 5, 2012.

Q: On July 1, 2012, The Wings Corporation paid $460,000 plus accrued interest to retire bonds with a maturity value of $500,000. The bonds had a book value of $475,131 on January 1, 2012. The stated interest rate is 8% with interest payments being made annually on December 31; the bonds were issued at a time when the market interest rate was 10%. Requirement: Determine the gain or loss on the bond retirement.

Q: On January 1, 2011, when the market rate of interest was 12%, Habs Company issued five-year bonds with a maturity value of $750,000. The bonds have a 10% stated rate and pay interest semi-annually on July 1 and December 31. Requirements: 1. Calculate the bond discount as of the date of issue. 2. Calculate the bond discount balance as of January 1, 2012.

Q: The following information pertains to a bond issue of the Atomic Corporation: Maturity value: $1,000,000 Maturity date: January 31, 2015 Stated interest rate: 8% Interest payments are made annually on December 31st Date of issue: January 1, 2011 The bond is dated January 1, 2011 Effective (market) interest rate: 10% Requirements: 1. At what price were the bonds issued? 2. Using the effective interest method, prepare an amortization schedule showing annual interest expense, annual discount or premium amortization, and carrying value through December 31, 2013. 3. Prepare the necessary journal entries on January 1, 2011 and December 31, 2012. 4. How should the bonds be shown on Atomic's December 31, 2011 balance sheet?

Q: On January 1, 2012, Sharp Company issued bonds with a face value of $500,000. The bonds mature in ten years and have a stated rate of 8%. Requirements: 1. Determine the selling price of the bonds if the market rate of interest was 10%. 2. Determine the selling price of the bonds if the market rate of interest was 6%.

Q: On January 1, 2012 when the effective interest rate was 12%, Philips Co. issued bonds with a maturity value of $200,000. The stated rate of interest is 12% and the bonds pay interest semi-annually. Philips Co. paid $2,000 in bond issue costs on this date. If Philips Co. uses IFRS, the effective interest rate will be A. slightly lower than 12%. B. slightly higher than 12%. C. 12%. D. Cannot be determined based on the information provided.

Q: Losses must be disclosed if they are A. remote and estimable. B. reasonably possible and estimable. C. probable and reasonably estimable. D. reasonably possible but not estimable.

Q: Losses must be accrued if they are A. remote and estimable. B. reasonably possible and estimable. C. probable and reasonably estimable. D. probable and not estimable.

Q: Which one of the following contingencies requires financial statement disclosure? A. A lawsuit that the firm's attorneys believe will be dropped. B. A lawsuit that the firm's attorneys believe will probably be settled for $75,000. C. A reasonably possible loss on a lawsuit that the firm's attorneys cannot estimate the loss. D. A reasonably possible loss on a lawsuit that the firm's attorneys believe will be settled for $100,000.

Q: A contingent liability that is probable and can be reasonably estimated will immediately result in A. an increase in both liabilities and stockholders' equity. B. an increase in liabilities and a decrease in net income. C. an increase in liabilities without any need for financial statement disclosure. D. an increase in liabilities and a decrease in assets.

Q: Which one of the following contingencies must be accrued on the balance sheet? A. The likely loss on a lawsuit that the firm's attorneys believe will be dropped. B. The probable loss on a lawsuit that the firm's attorneys believe will be settled for $50,000. C. The reasonably possible loss on a lawsuit that the firm's attorneys believe will be dropped. D. The reasonably possible loss on a lawsuit that the firm's attorneys believe will be settled for $50,000.

Q: A hedge of the exposure to changes in the fair market value of an existing asset or liability or a firm commitment is a/an A. fair value hedge. B. cash flow hedge. C. foreign currency exposure hedge. D. marked-to-market hedge.

Q: Which of the following statements does not accurately describe the accounting for derivatives? A. The holding gain resulting from a fair value hedge that qualifies for hedge accounting is recognized in net income along with the offsetting loss on the hedged item. B. The holding loss resulting from a cash flow hedge that qualifies for hedge accounting is recognized in net income during the year of the loss. C. Management must be able to describe its hedging strategy in order to meet the GAAP criteria to qualify for hedge accounting. D. Derivatives that fail to meet the GAAP criteria for hedge accounting are accounted for as speculative investments.

Q: A hedged item can be any of the following except: A. an anticipated (forecasted) transaction. B. an existing asset or liability on the company's books. C. a past transaction. D. a firm commitment.

Q: Which of the following statements does not properly describe GAAP accounting for derivatives? A. Derivatives are reported within the balance sheet at fair value. B. Speculative investments in derivative contracts can increase earnings volatility. C. Changes in the fair value of a derivative must be included in net income when they occur. D. A derivative's unrealized holding gain or loss for a particular year is not a component of that year's income from operations.

Q: On December 1, 2011 a company bought a call option costing $100,000 as a speculative investment. The call option gave the company the right to purchase 100,000 barrels of oil for $110 per barrel during April 2012. As of December 31, 2011 the call option had a value of $125,000. The company liquidated the call option on April 15, 2012 in exchange for $175,000. Which of the following accurately describes GAAP accounting for this call option? A. The realized gain applicable to the year ending December 31, 2011 is $25,000. B. The realized gain recognized on April 15, 2012 is $75,000. C. The unrealized gain recognized on April 15, 2012 is $50,000. D. The call option will be reported on the December 31, 2011 balance sheet at $125,000 and a $25,000 unrealized gain will be reported as a component of income from continuing operations for the year ending December 31, 2011.

Q: A derivative instrument that gives the holder the right but not the obligation to do something is a/an A. future contract. B. swap contract. C. performance contract. D. options contract.

Q: All of the statements below are true of futures contracts except that futures contracts A. result in predictable cash flows. B. eliminate downside risk and upside potential. C. eliminate downside risk while allowing for upside potential. D. result in predictable gross profits.

Q: A variation of a forward contract that is traded daily in a market with many buyers and sellers and does not have a predetermined settlement date is a/an A. futures contract. B. swap contract. C. performance contract. D. options contract.

Q: When two parties agree to the sale of some asset or commodity on some specified future date at a price specified today it is a/an A. forward contract. B. swap contract. C. performance contract. D. options contract.

Q: On February 1, 2012, Hills Company had 10,000 pounds of inventory costing $1.50 per pound; the market value per pound was $1.95 on this date. Hills entered into a futures contract to sell the 10,000 pounds of inventory during May 2012 at $2.25 per pound. Which of the following statements does not accurately describe the impact of this futures contract? A. Hills has foregone the benefit of additional profits (the upside potential) if the price per pound exceeds $2.25 during the month of May. B. Hills has eliminated the risk of reduced profits (the downside potential) if the price per pound is less than $1.95 during the month of May. C. Hills' gross profit in May will be $3,000 regardless of the actual price per pound in May. D. The value of the futures contract decreases as the market price per pound of inventory increases.

Q: Investors need to review transactions involving swaps carefully to ensure that there is an underlying A. loss. B. gain. C. rationale. D. economic benefit.

Q: Some financial analysts contend that reporting debt at amortized historical cost rather than current market value A. makes it more difficult to manipulate accounting numbers. B. makes it easier to manipulate accounting numbers. C. has no impact on the accounting numbers. D. makes it impossible to manipulate the accounting numbers.

Q: When interest rates have increasedand bonds are retired before maturity, market value is A. below book value generating an accounting gain. B. below book value generating an accounting loss. C. above book value generating an accounting gain. D. above book value generating an accounting loss.

Q: A bond with a $750,000 maturity value is immediately retired for $745,000 plus accrued interest. The discount on bonds payable (bond discount) at the retirement date is $25,500. Which of the following statements is correct? A. The gain on the debt extinguishment is $5,000. B. The loss on the debt extinguishment is $20,500. C. The gain on the debt extinguishment is $30,500. D. The gain or loss on the debt extinguishment can't be determined without knowing the dollar amount of the accrued interest.

Q: Which of the following is not an accurate description of the controversies surrounding the fair value option? A. Advocates argue that accounting-induced volatility is eliminated and financial statement transparency is improved. B. Proponents argue that opportunities are enhanced for companies to manipulate their earnings and balance sheet. C. Proponents argue that companies that can use the fair value option in situations where there is not necessarily a relationship between the financial assets and liabilities which promotes the opportunity to manage earnings. D. Advocates argue that financial reporting is more accurate and transparent for those companies in financial distress.

Q: On January 1, 2011, Ross Corporation issued bonds with a maturity value of $200,000; the bond's stated rate of interest equaled the market interest rate on the issue date. On December 31, 2011, the market value of the bonds was $188,926; on December 31, 2012, the market value of the bonds was $191,325. Which of the following correctly describes Ross Corporation's financial reporting if Ross elects to measure the bond liability using the fair value option? A. For the year ending December 31, 2011, Ross will report an unrealized holding loss of $11,074 in its income statement. B. For the year ending December 31, 2012, Ross will report an unrealized holding gain of $8,675 in its income statement. C. For the year ending December 31, 2012, Ross will report an unrealized holding loss of $8,675 in its income statement. D. For the year ending December 31, 2012, Ross will report an unrealized holding loss of $2,399 in its income statement.

Q: Which of the following statements is not accurate with respect to the reporting requirements regarding the fair value option? A. Firms may elect the fair value option for a single eligible instrument without electing it for other identical instruments. B. Once the choice is made to adopt the fair value option, the decision is irrevocable. C. Financial statement disclosures must include management's rationale for electing the fair value option. D. The fair value option is not available for security investments that are accounted for using the equity method.

Q: Dot Company issued $200,000 of bonds on January 1, 2011 with interest payable each year. The bonds had a stated rate of 8%. The bonds were set up as floating-rate debt with the rated pegged to LIBOR plus 3%. Interestexpense for year one if LIBOR is 7% will be which one of the following? A. $6,000 B. $14,000 C. $16,000 D. $20,000

Q: When market rates of interest decrease, the use of floating-rate debt benefits A. investors. B. issuing companies. C. all parties. D. no one.

Q: Which of the following statements with respect to floating-rate debt is incorrect? A. If the market rate of interest increases, the market value of the floating-rate debt will remain the same. B. If the market rate of interest decreases, the cash interest payment required by the issuing company would decrease. C. If the market rate of interest increases, the investors benefit while the issuing corporation does not benefit. D. If the market rate of interest decreases, both the issuing company and the investors benefit.

Q: The market value of floating-rate debt of $200,000 will A. rise by $2,000 with a 1% rise in interest rates. B. fall by $2,000 with a 1% fall in interest rates. C. remain unchanged with a change in interest rates. D. will rise in the short run and fall in the long run with a change in interest rates.

Q: Floating-rate debt is the most common method for lenders to protect themselves from losses that arise as a result of A. increases in the market interest rate. B. decreases in the market interest rate. C. increases in the stated interest rate on bonds. D. decreases in the stated rate on bonds.

Q: When a bond is sold at a premium the A. effective interest rate is less than the stated rate. B. effective interest rate is greater than the stated rate. C. effective interest rate relative to the stated rate is not known. D. interest expense during the life of the bond exceeds the amount of cash interest payments during the life of the bond.

Q: Which of the following statements is not correct regarding amortization when using the effective interest method (basis)? A. Amortization of discount on bonds payable (bond discount) increases in later years relative to earlier years of a bond's life. B. Amortization of premium on bonds payable (bond premium) increases in later years relative to earlier years of a bond's life. C. Amortization of both premium on bonds payable (bond premium) and discount on bonds payable (bond discount) decreases in later years relative to earlier years of a bonds life. D. Amortization of discount on bonds payable (bond discount) results in an increase in interest expense and in an increase in the bond's carrying value.

Q: When a bond is sold at a discount the effective interest rate is A. equal to the stated rate. B. above the stated rate. C. below the stated rate. D. equal to the stated rate for a period of time and then above the stated rate for a period of time.

Q: Which of the following statements is correct? A. Amortization of discount on bonds payable (bond discount) results in an increase in a bond's carrying value. B. Amortization of discount on bonds payable (bond discount) results in a decrease in bond interest expense. C. Amortization of premium on bonds payable (bond premium) results in an increase in a bond's carrying value. D. Amortization of premium on bonds payable (bond premium) results in an increase in bond interest expense.

Q: On January 1, 2011 when the effective interest rate was 14%, a company issued bonds with a maturity value of $1,000,000. The stated rate of interest is 12%, the bonds pay interest semi-annually and sold for $893,640. The amount of bond discount amortized on July 1, 2011 is approximately A. $1,000 B. $2,555 C. $2,000 D. $5,110

Q: A bond with a maturity value of $700,000 was initially issued for $715,000. The bond has a ten-year life and a stated interest rate of 10%. The total interest expense over the life of the bond is A. $700,000 B. $715,000 C. $685,000 D. not determinable without knowing the bond's effective yield.