Problem 1 -

Alvarado Company sells a machine for $7,400 with a 12-month warranty agreement that requires the company to replace all defective parts and to provide the repair labor at no cost to the customers. With sales being made evenly throughout the year, the company sells 600 machines in 2017 (warranty expense is incurred half in 2017 and half in 2018). As a result of product testing, the company estimates that the warranty cost is $390 per machine ($170 parts and $220 labor).

Instructions - Assuming that actual warranty costs are incurred exactly as estimated, what journal entries would be made relative to the following facts?

(a) Sale of machinery and warranty expense incurred in 2017.

(b) Warranty accrual on December 31, 2017.

(c) Warranty costs incurred in 2018.

(d) What amount, if any, is disclosed in the balance sheet as a liability for future warranty costs as of December 31, 2017?

Problem 2 - WRITING (Loss Contingencies: Entries and Essays) Polska Corporation, in preparation of its December 31, 2017, financial statements, is attempting to determine the proper accounting treatment for each of the following situations.

1. As a result of uninsured accidents during the year, personal injury suits for $350,000 and $60,000 have been filed against the company. It is the judgment of Polska's legal counsel that an unfavorable outcome is unlikely in the $60,000 case but that an unfavorable verdict approximating $250,000 will probably result in the $350,000 case.

2. Polska owns a subsidiary in a foreign country that has a book value of $5,725,000 and an estimated fair value of $9,500,000. The foreign government has communicated to Polska its intention to expropriate the assets and business of all foreign investors. On the basis of settlements other firms have received from this same country, Polska expects to receive 40% of the fair value of its properties as final settlement.

3. Polska's chemical product division consisting of five plants is uninsurable because of the special risk of injury to employees and losses due to fire and explosion. The year 2017 is considered one of the safest (luckiest) in the division's history because no loss due to injury or casualty was suffered. Having suffered an average of three casualties a year during the rest of the past decade (ranging from $60,000 to $700,000), management is certain that next year the company will probably not be so fortunate.

Instructions -

(a) Prepare the journal entries that should be recorded as of December 31, 2017, to recognize each of the situations above.

(b) Indicate what should be reported relative to each situation in the financial statements and accompanying notes. Explain why.

Problem 3 -

Dumars Corporation reports in the current liability section of its balance sheet at December 31, 2017 (its year-end), short-term obligations of $15,000,000, which includes the current portion of 12% long-term debt in the amount of $10,000,000 (matures in March 2018). Management has stated its intention to refinance the 12% debt whereby no portion of it will mature during 2018. The date of issuance of the financial statements is March 25, 2018.

Instructions -

(a) Is management's intent enough to support long-term classification of the obligation in this situation?

(b) Assume that Dumars Corporation issues $13,000,000 of 10-year debentures to the public in January 2018 and that management intends to use the proceeds to liquidate the $10,000,000 debt maturing in March 2018. Furthermore, assume that the debt maturing in March 2018 is paid from these proceeds prior to the issuance of the financial statements. Will this have any impact on the balance sheet classification at December 31, 2017? Explain your answer.

(c) Assume that Dumars Corporation issues common stock to the public in January and that management intends to entirely liquidate the $10,000,000 debt maturing in March 2018 with the proceeds of this equity securities issue. In light of these events, should the $10,000,000 debt maturing in March 2018 be included in current liabilities at December 31, 2017?

(d) Assume that Dumars Corporation, on February 15, 2018, entered into a financing agreement with a commercial bank that permits Dumars Corporation to borrow at any time through 2019 up to $15,000,000 at the bank's prime rate of interest. Borrowings under the financing agreement mature three years after the date of the loan. The agreement is not cancelable except for violation of a provision with which compliance is objectively determinable. No violation of any provision exists at the date of issuance of the financial statements. Assume further that the current portion of long-term debt does not mature until August 2018. In addition, management intends to refinance the $10,000,000 obligation under the terms of the financial agreement with the bank, which is expected to be financially capable of honoring the agreement.

(1) Given these facts, should the $10,000,000 be classified as current on the balance sheet at December 31, 2017?

(2) Is disclosure of the refinancing method required?

Problem 4 -

(Bond Theory: Balance Sheet Presentations, Interest Rate, Premium) On January 1, 2017, Nichols Company issued for $1,085,800 its 20-year, 11% bonds that have a maturity value of $1,000,000 and pay interest semiannually on January 1 and July 1. The following are three presentations of the long-term liability section of the balance sheet that might be used for these bonds at the issue date.

1. Bonds payable (maturing January 1, 2037)                                                   $1,000,000

Unamortized premium on bonds payable                                                          $85,800

Total bond liability                                                                                          $1,085,800

2. Bonds payable-principal (face value $1,000,000 maturing January 1, 2037)     $142,050 (a)

Bonds payable-interest (semiannual payment $55,000)                                     $943,750 (b)

Total bond liability                                                                                          $1,085,800

3. Bonds payable-principal (maturing January 1, 2037)                                      $1,000,000

Bonds payable-interest ($55,000 per/Period for 40/Priod)                                  $2,200,000

Total bond liability                                                                                           $3,200,000

(a): The present value of $1,000,000 due at the end of 40 (6-month) periods at the yield rate of 5% per period.

(b): The present value of $55,000 per period for 40 (6-month) periods at the yield rate of 5% per period.

Instructions

(a) Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds.

(b) Explain why investors would pay $1,085,800 for bonds that have a maturity value of only $1,000,000.

(c) Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose:

(1) The coupon or nominal rate.

(2) The effective or yield rate at date of issue.

(d) If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of issue be affected by an increase or a decrease in the market rate of interest?

Problem 5 -

Matt Ryan Corporation is interested in building its own soda can manufacturing plant adjacent to its existing plant in Partyville, Kansas. The objective would be to ensure a steady supply of cans at a stable price and to minimize transportation costs. However, the company has been experiencing some financial problems and has been reluctant to borrow any additional cash to fund the project. The company is not concerned with the cash flow problems of making payments, but rather with the impact of adding additional long-term debt to its balance sheet. The president of Ryan, Andy Newlin, approached the president of the Aluminum Can Company (ACC), its major supplier, to see if some agreement could be reached. ACC was anxious to work out an arrangement, since it seemed inevitable that Ryan would begin its own can production. The Aluminum Can Company could not afford to lose the account. After some discussion, a two-part plan was worked out. First, ACC was to construct the plant on Ryan's land adjacent to the existing plant. Second, Ryan would sign a 20-year purchase agreement. Under the purchase agreement, Ryan would express its intention to buy all of its cans from ACC, paying a unit price which at normal capacity would cover labor and material, an operating management fee, and the debt service requirements on the plant. The expected unit price, if transportation costs are taken into consideration, is lower than current market. If Ryan did not take enough production in any one year and if the excess cans could not be sold at a high enough price on the open market, Ryan agrees to make up any cash shortfall so that ACC could make the payments on its debt. The bank will be willing to make a 20-year loan for the plant, taking the plant and the purchase agreement as collateral. At the end of 20 years, the plant is to become the property of Ryan.

Instructions -

(a) What are project financing arrangements using special-purpose entities?

(b) What are take-or-pay contracts?

(c) Should Ryan record the plant as an asset together with the related obligation?

(d) If not, should Ryan record an asset relating to the future commitment?

(e) What is meant by off-balance-sheet financing?

Problem 6 -

Part 1: Capital leases and operating leases are the two classifications of leases described in FASB pronouncements from the standpoint of the lessee.

Instructions

(a) Describe how a capital lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease, assuming the lease transfers ownership of the property to the lessee by the end of the lease.

(b) Describe how an operating lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease, assuming equal monthly payments are made by the lessee at the beginning of each month of the lease. Describe the change in accounting, if any, when rental payments are not made on a straight-line basis.

Do not discuss the criteria for distinguishing between capital leases and operating leases.

Part 2: Sales-type leases and direct-financing leases are two of the classifications of leases described in FASB pronouncements from the standpoint of the lessor.

Instructions

Compare and contrast a sales-type lease with a direct-financing lease as follows.

(a) Lease receivable.

(b) Recognition of interest revenue.

(c) Manufacturer's or dealer's profit.

Do not discuss the criteria for distinguishing between the leases described above and operating leases.