Solutions manual for advanced accounting 10th edition fischer cheng taylor1

www.elsolucionario.net www.elsolucionario.net To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com www.elsolucionario.net CHAPTER UNDERSTANDING THE ISSUES (a) Value Analysis: Price paid $ Fair value of net assets Goodwill $ Current assets (fair value) $ Land (fair value) Building & equipment (fair value) Customer list (fair value) Liabilities (fair value) Goodwill Total $ By accepting cash in exchange for the net assets of the company, the seller would have to recognize an immediate taxable gain However, if the seller were to accept common stock of another corporation instead, the seller could construct the transaction as a tax-free reorganization The seller could then account for the transaction as a tax-free exchange The seller would not pay taxes until the shares received were sold Identifiable assets (fair value) Deferred tax liability ($200,000 × 40%) Net assets Goodwill Price paid Net assets Goodwill $600,000 (80,000) $520,000 $850,000 (520,000) $330,000 (b) Value Analysis: Price paid $ Fair value of net assets Gain $ Current assets (fair value) $ Land (fair value) Building & equipment (fair value) Customer list (fair value) Liabilities (fair value) Gain Total $ 800,000 520,000 280,000 120,000 80,000 400,000 20,000 (100,000) 280,000 800,000 450,000 520,000 (70,000) 120,000 80,000 400,000 20,000 (100,000) (70,000) 450,000 The 20X1 financial statements would be revised as they are included in the 20X2 – 20X1 comparative statements The 20X2 statements would be based on the new values The adjustments would be: (a) The net assets and goodwill will be recorded at their full fair value on the books of the parent on the date of acquisition (b) The net assets will be “marked up” to fair value, and goodwill will be recorded at the end of the fiscal year when the consolidated financial statements are prepared through the use of a consolidated worksheet (a) The equipment and building will be restated at $180,000 and $550,000 on the comparative 20X1 and 20X2 balance sheets (b) Originally, depreciation on the equipment was $40,000 ($200,000/5) per year It will be recalculated as $36,000 ($180,000/5) per year The adjustment for 20X1 is for a half year 20X1 depreciation expense and accumulated depreciation will be restated at $18,000 instead of $20,000 for the half year Depreciation expense for 20X2 will be $36,000 Puncho will record the net assets at their fair value of $800,000 on its books Also, Puncho will record goodwill of $100,000 ($900,000 – $800,000) resulting from the excess of the price paid over the fair value Semos will record the removal of its net assets at their book values Semos will record a gain on the sale of business of $500,000 ($900,000 – $400,000) www.elsolucionario.net (a) Horizontal combination—both are marine engine manufacturers (b) Vertical combination—manufacturer buys distribution outlets (c) Conglomerate—unrelated businesses To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com (c) Originally, depreciation on the building was $25,000 ($500,000/20) per year It will be recalculated as $27,500 ($550,000/20) per year The adjustment for 20X1 is for a half year 20X1 depreciation expense and accumulated depreciation will be restated at $13,750 instead of $12,500 for the half year Depreciation expense for 20X2 will be $27,500 (d) Goodwill is reduced $30,000 on the comparative 20X1 and 20X2 balance sheets Fair value of operating unit Book value including goodwill Goodwill is impaired Fair value of operating unit Fair value of net identifiable assets Recalculated goodwill Existing goodwill Goodwill impairment loss $ $1,200,000 1,250,000 $1,200,000 1,120,000 80,000 200,000 120,000 (a) An estimated liability should have been recorded on the purchase date Any difference between that estimate and the $100,000 paid would be recorded as a gain or loss on the liability already recorded (b) Even though the issuance is based on performance and suggests additional goodwill, no adjustment is made if additional stock is issued In this case, the paid-in capital in excess of par account is reduced for the par value of the additional shares to be issued The fair value of the stock originally issued is being devalued The entry would take the following form: Paid-In Capital in Excess of Par 10,000 Common Stock ($1 par) 10,000 (c) This agreement is also settled by issuing shares The price is not changed The paid-in capital in excess of par account is reduced for the par value of the additional shares to be issued The fair value of the stock originally issued is being devalued The entry would take the following form: Paid-In Capital in Excess of Par 5,000 Common Stock ($1 par) 5,000 www.elsolucionario.net www.elsolucionario.net To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ch 1—Exercises www.elsolucionario.net EXERCISES EXERCISE 1-1 (1) Current Assets Land Building Equipment Goodwill Liabilities Cash 100,000 75,000 300,000 275,000 152,000 Expenses (acquisition costs) Cash 15,000 (2) Cash Liabilities Accumulated Depreciation—Building Accumulated Depreciation—Equipment Current Assets Land Building Equipment Gain on Sale of Business 800,000 100,000 200,000 100,000 102,000 800,000 80,000 50,000 450,000 300,000 320,000 Note: Seller does not receive the acquisition costs (3) Investment in Crow Company Cash Expenses (acquisition costs) Cash 800,000 800,000 15,000 Note: At year-end, Crow would be consolidated with Bart, as explained in Chapter 15,000 www.elsolucionario.net 15,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ch 1–Exercises www.elsolucionario.net EXERCISE 1-2 Cash Inventory Equipment Land Buildings Goodwill* Discount on Bonds Payable Current Liabilities Bonds Payable Common Stock Paid-In Capital in Excess of Par 100,000 250,000 220,000 180,000 300,000 640,000 140,000 Acquisition Expense Paid-In Capital in Excess of Par Cash 25,000 10,000 35,000 $1,200,000 $100,000 250,000 220,000 180,000 300,000 (80,000) (410,000) $ 560,000 640,000 www.elsolucionario.net *Total consideration: Common stock (60,000 shares × $20) Less fair value of net assets acquired: Cash Inventory Equipment Land Buildings Current liabilities Bonds payable Value of net identifiable assets acquired Excess of total cost over fair value of net assets (goodwill) 80,000 550,000 300,000 900,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ch 1–Exercises www.elsolucionario.net EXERCISE 1-3 Accounts Receivable Inventory Equipment for Resale Land Building R&D Project Customer List Goodwill* Current Liabilities Bonds Payable Warranty Liability Common Stock Paid-In Capital in Excess of Par 80,000 200,000 30,000 100,000 1,400,000 $1,500,000 $ 100,000 210,000 72,000 (80,000) (200,000) 200,000 450,000 90,000 210,650 (30,000) $ www.elsolucionario.net *Total consideration: Common stock (100,000 shares × $15) Less fair value of net assets acquired: Accounts receivable Inventory Equipment for resale ($80,000 less 10%) Current liabilities Bonds payable Land Building R&D project Customer list ($100,000 payment discounted years at 20%) Estimated liability under warranty Value of net identifiable assets acquired Excess of total cost over fair value of net assets (goodwill) 100,000 210,000 72,000 200,000 450,000 90,000 210,650 477,350 1,022,650 477,350 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ch 1–Exercises www.elsolucionario.net EXERCISE 1-4 Accounts Receivable Inventory Equipment Brand-Name Copyright Cash Current Liabilities Mortgage Payable Gain on Acquisition* Acquisition Expense Cash 160,000 80,000 250,000 35,000 25,000 25,000 $160,000 $ 200,000 270,000 40,000 15,000 (80,000) (250,000) $ 195,000 (35,000) www.elsolucionario.net *Total consideration: Cash Less fair value of net assets acquired: Accounts receivable Inventory Equipment Brand-name copyright Current liabilities Mortgage payable Value of net identifiable assets acquired Excess of total fair value over cost of net assets (gain) 200,000 270,000 40,000 15,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ch 1–Exercises www.elsolucionario.net EXERCISE 1-5 (1) Adjustments: Final value of manufacturing plant Provisional value of manufacturing plant Total increase $70,000 60,000 $10,000 Adjustment for half year $5,000 Journal Entries: Plant Assets Goodwill 100,000 Retained Earnings (increase depreciation for half year) Plant Assets (because they are shown net of depreciation) (2) 100,000 5,000 5,000 Balance Sheet December 31, 20X1 (revised) Current assets Equipment (net) Plant assets (net) Goodwill Total assets $ 300,000 Current liabilities 600,000 Bonds payable 1,695,000 Common stock ($1 par) 200,000 Paid-in capital in excess of par Retained earnings $2,795,000 Total liabilities and equity $ 300,000 500,000 50,000 1,300,000 645,000 $2,795, Summary Income Statement For Year Ended December 31, 20X1 (revised) Sales revenue Cost of goods sold Gross profit Operating expenses Depreciation expense Net income www.elsolucionario.net Depreciation adjustment: Depreciation on final cost ($700,000/10 years) Depreciation based on provisional cost ($600,000/10 years) Annual increase in depreciation $700,000 600,000 $100,000 $800,000 520,000 $280,000 $150,000 85,000 $ 235,000 45,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ch 1–Exercises www.elsolucionario.net EXERCISE 1-6 Machine = $200,000 Deferred tax liability = $16,800 In this tax-free exchange, depreciation on $56,000 [($200,000 appraised value) – ($144,000* net book value)] of the machine’s value is not deductible on future tax returns The additional tax to be paid as a result of Lewison’s inability to deduct the excess value assigned to the machine is $16,800 ($56,000 × 30%) Goodwill = $800,000 – ($700,000 – $16,800) = $116,800 EXERCISE 1-7 Current Assets Equipment Building Deferred Tax Asset Goodwill* Current Liabilities Cash 100,000 200,000 270,000 120,000 270,000 60,000 900,000 Price paid Less fair value of net assets: Current assets Equipment Building Recorded (current) liabilities Excess $100,000 200,000 270,000 (60,000) $ *Tax loss carryforward consideration: Deferred tax asset ($400,000 × 30%) = the value of the remaining carryforward Goodwill $ $ 900,000 www.elsolucionario.net *$180,000/10 yrs × prior years = $36,000 accumulated depreciation $180,000 – $36,000 = $144,000 net book value 510,000 390,000 (120,000) 270,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Ch 1–Exercises www.elsolucionario.net EXERCISE 1-8 (1) Liabilities 40,000 Loss on Contingent Payment 20,000 Cash 60,000 × (average income of $55,000* – $25,000) less $40,000 liability already recorded *($50,000 + $60,000)/2 = $55,000 (2) Shares issued = $60,000/$5 per share = 12,000 shares Since the contingency is settled in shares, goodwill is not increased and cash is not changed The entry to record the 12,000 additional shares issued is as follows: Paid-In Capital in Excess of Par Common Stock ($1 par) 12,000 (3) Paid-In Capital in Excess of Par Common Stock ($1 par) 50,000 50,000 ÷ $200,000 $4 50,000 EXERCISE 1-9 (1) Purchase price Fair value of net assets other than goodwill Goodwill $600,000 400,000 $200,000 The estimated value of the unit exceeds $600,000, confirming goodwill (2) (a) Estimated fair value of business unit Book value of Anton net assets, including goodwill $520,000 $500,000 No impairment exists (b) Estimated fair value of business unit Book value of Anton net assets, including goodwill $400,000 $450,000 Goodwill is impaired Estimated fair value of business units Fair value of net assets, excluding goodwill Remeasured amount of goodwill Existing goodwill Impairment loss $ $400,000 340,000 60,000 200,000 $140,000 www.elsolucionario.net Deficiency [($6 – $4) × 100,000 shares] Divide by fair value Added number of shares 12,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Exercises www.elsolucionario.net Exercise 6, Concluded May During May June Inventory of Soybean Meal Cash To record purchase at $1.63 per pound 489,000 Inventory of Food Inventory of Soybean Meal To record use of meal to make food 489,000 Cost of Sales Other Comprehensive Income Inventory of Food To record sale of one-half of the food and the reclassification of other comprehensive income 240,000 4,500 489,000 489,000 244,500 Assumed sales value Cost of sales Assumed gross profit Gain (loss) excluded from effectiveness Net effect on earnings Without the With the Hedge Hedge $ 300,000 $ 300,000 (244,500) $ 55,500 $ 60,000 (300) $ 55,500 $ 59,700 If the forecasted purchase had not been hedged, there would have been a $4,200 decrease in earnings 483 www.elsolucionario.net (2) The net effect on earnings with and without the cash flow hedge is as follows: (240,00 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com www.elsolucionario.net Derivatives Module—Exercises (1) Quarter Quarter Quarter Quarter (a) Loan Balance Interest at at Beginning of Original Quarter Rate (4.5%) $120,000,000* $1,350,000 116,250,000 1,307,813 112,500,000 1,265,625 108,750,000 1,223,438 $5,146,876 (b) Interest Received from Counterparty at Rate (4.2%) $1,260,000 1,220,625 1,181,250 1,141,875 $4,803,750 (c) Interest Paid to Counterparty Rate Amount 4.25% $1,275,000 4.35 1,264,219 3.85 1,082,813 3.65 992,344 $4,614,376 *$150,000 – ($3,750,000 × quarters) = $120,000,000 (2) Quarter Quarter Quarter Quarter (b) Interest Loan Balance Received from at Beginning of Counterparty Quarter at Rate (4.2%) $105,000,000* $1,102,500 101,250,000 1,063,125 97,500,000 1,023,750 93,750,000 984,375 $4,173,750 (a) Interest Paid to Counterparty Rate Amount 3.55% $ 931,875 3.55 898,594 3.55 865,313 3.55 832,031 $3,527,813 (c) Net Payment $170,625 164,531 158,438 152,344 $645,938 *$150,000 – ($3,750,000 × 12 quarters) = $105,000,000 (3) Using the LIBOR rate of 3.55%, the net present value of the net payments at the beginning of the second year of the swap is $632,120 [the net present value of the four net payments ($170,625; $164,531; $158,438; $152,344) discounted at 3.55%/4] (4) As the floating rate decreases relative to the receive fixed rate, the value of the swap increases If the spread between the receive fixed and pay floating begins to decrease, the value of the swap will decrease The value of the swap is also influenced by the amount of time remaining on the swap In essence, the value of the swap reflects the present value of the anticipated net payment over the remaining term of the swap 484 www.elsolucionario.net EXERCISE To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net PROBLEMS PROBLEM M-1 (1) The use of derivatives for speculative purposes is prohibited Derivatives are used to manage market risk from changes in foreign exchange rates, commodity prices, compensation liabilities, and interest rates (3) A cash flow hedge is used to establish fixed prices or rates when future cash flows could vary due to changes in prices or rates The interest rate swaps that are used as cash flow hedges are designed to hedge against the adverse effects of variability in cash flows associated with existing debt that has variable interest rates or with forecasted transactions, as is the case with the treasury lock agreements related to the anticipated fixed rate note issuance to finance the acquisition of York A fair value hedge is used to offset changes in the fair value of items with fixed prices or rates The interest rate swaps that qualify as fair value hedges are not hedging against variability in cash flows but rather hedging against changes in the value of fixed rate debt The company hedged both its fixed rate 5% notes maturing in November 2006 and its 6.3% notes maturing in February 2008 In both cases, the company received a fixed dollar rate of interest and paid interest based on a floating rate of LIBOR plus basis points (4) The hedge of the 6.3% notes requires the company to pay a fixed rate of 6.3% Anticipating that variable or floating rates would result in lower interest expense, the company agreed to pay to a counterparty a floating rate of LIBOR plus 283.5 basis points in exchange for a fixed rate of 6.3% The rate is reset every three months Regarding the impact on earnings, the gain or loss on the swap would be recorded as a change in the value of the swap and an offsetting gain or loss would be recorded as an adjustment to the basis of the debt Therefore, the net effect would be zero However, the fixed interest expense on the debt would be adjusted (increased or decreased) to reflect the settlement of interest rate differences If the floating rate paid were less than the fixed rate received, the company would experience a decrease in interest expense 485 www.elsolucionario.net (2) The hedging activity that has an impact on other comprehensive income is that which is associated with cash flow hedges Some of the hedges are used with respect to the variability in future cash flows attributable to changes in foreign currency exchange rates or commodity price changes In addition, the company uses interest rate swaps and treasury lock agreements as cash flow hedges To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net PROBLEM M-2 Corn Futures Number of bushels Spot price per bushel Futures price per bushel Fair value of contract (a) Change in above fair value (b) Change in spot rates: At beginning of period At end of period Change September September 30 1,000,000 $2.5000 $2.5100 $— Wheat Futures Number of bushels Spot price per bushel Futures price per bushel Fair value of contract (a) Change in above fair value (b) Change in spot rates: At beginning of period At end of period Change 30 32,000 32,000 1,000,000 $2.5680 $2.5700 1,000,000 $2.5685 $2.5710 $ $ 60,000 28,000 $2,538,000 2,568,000 $ 30,000 $ (6,000) September September 30 $ $ 61,000 1,000 $2,568,000 2,568,500 $ 500 (2,000) $ October 31 November 2,000,000 $3.5480 $3.5520 2,000,000 $3.5700 $3.5710 2,000,000 $3.5700 $3.5705 62,000 62,000 $ 100,000 $ 38,000 $ $ $7,030,000 7,096,000 $ 66,000 $7,096,000 7,140,000 $ 44,000 $7,140,000 7,140,000 $ — 2,000,000 $3.5150 $3.5210 (a) – (b) = Change in spot-forward difference Sept $ $ $ $— November 1,000,000 $2.5380 $2.5420 $2,500,000 2,538,000 $ 38,000 (a) – (b) = Change in spot-forward difference October 31 $ $ $ (4,000) $ 99,000 (1,000) (6,000) $ Memo entry to record the acquisition of the futures contract Margin Account Cash To record margin account deposit 70,000 Futures Contract—Corn Futures Contract—Wheat Unrealized Hedging Loss Other Comprehensive Income To record change in value of contract and include in earnings change in time value excluded from hedge effectiveness 32,000 62,000 10,000 486 70,000 104,000 500 www.elsolucionario.net (1) (1,000) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net Problem M-2, Concluded Nov Futures Contract—Corn Futures Contract—Wheat Unrealized Hedging Loss Other Comprehensive Income To record change in value of contract and include in earnings change in time value excluded from hedge effectiveness 28,000 38,000 8,000 Futures Contract—Corn Unrealized Hedging Loss Futures Contract—Wheat Other Comprehensive Income To record change in value of contract and include in earnings change in time value excluded from hedge effectiveness 1,000 500 Cash Futures Contract—Corn Futures Contract—Wheat Margin Account To record settlement of futures and return of margin account 21 Other Comprehensive Income Cost of Sales—Corn Cost of Sales—Wheat To adjust cost of sales for the recognition of gains on futures contracts 74,000 1,000 500 230,000 61,000 99,000 70,000 178,500 68,500 110,000 (2) Factors that might cause the futures contracts to not be highly effective include the following: a Changes in the price of wheat and corn may not correlate as highly with the change in the price of flour due to costs associated with producing flour b The CBT prices reflect delivery of commodities at a location that is different than the location of commodities used to make flour that is used by CBBI c The quality of the commodities traded on the CBT may be different than the quality of the commodities used to make the flour acquired by CBBI d The quantity of flour used by CBBI and therefore the equivalent amount of corn and wheat may be greater than the notional amount of the futures contracts Therefore, some of the cash flows would not be hedged 487 www.elsolucionario.net Oct 31 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net PROBLEM M-3 September Futures Contract June 15 420,000 $ 2.09 $ 2.10 June 30 420,000 $ 2.075 $ 2.08 September 420,000 $ 2.12 $ $ Intrinsic value (change in spot rates) Time value (spot-forward difference) or change in contract value less change in intrinsic value 8,400 — 8,400 (8,400) 6,300 (6,300) 2,100 (Note A) (2,100) Note A: The contract expires in September; at that time, the spot/future rate is greater than the contracted future rate Therefore, the contract has no value at its expiration date As a result of the above hedging activity, the following account balances would result: 2nd Quarter Income statement accounts: Gain (loss) on inventory change Gain (loss) on futures due to: Change in intrinsic value Change in time value Total income statement values Balance sheet asset accounts: Increase (decrease) in inventory Increase (decrease) in futures contract 488 $ $ $ $ (6,300) 3rd Quarter $ 6,300 6,300 2,100 2,100 $ (6,300) (2,100) (2,100) $ (6,300) 8,400 $ 6,300 (8,400) www.elsolucionario.net Number of gallons Spot price per gallon Future price per gallon Fair value of contract: (original futures price vs current futures price × notional amount) Current-period gain (loss) in: Value of contract To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net Problem M-3, Concluded Wheat Futures June 15 Number of bushels 630,000 Spot price per bushel $ 2.12 Future price per bushel $ 2.15 Fair value of contract: (original futures price vs current futures price × notional amount) Current-period gain (loss) in: Value of contract June 30 630,000 $ 2.146 $ 2.18 July 31 630,000 $ 2.169 $ 2.20 $ 18,900 $ 31,500 Intrinsic value (change in spot rates) Time value (spot-forward difference) or change in contract value less change in intrinsic value 18,900 12,600 16,380 14,490 2,520 (1,890) As a result of the above hedging activity, the following account balances would result: 2nd Quarter Income statement accounts: Gain (loss) on inventory change $ Gain (loss) on firm commitment (13,104) 16,380 Change in time value 2,520 Increase (decrease) in firm commit- $ $ 2,520 (13,104) (3,276) ment Increase (decrease) in futures con- $ (3,276) Gain (loss) on futures due to: Change in intrinsic value Total income statement values Balance sheet asset accounts: Increase (decrease) in inventory 3rd Quarter 18,900 (11,592) (Note B) (2,898) (Note C) 14,490 $ $ (Note D) (1,890) (Note D) (1,890) (11,592) (Note B) (2,898) (Note C) 12,600 tract Note B: This represents the impact of the hedge on existing inventory (12/15 of the change in intrinsic value) Note C: This represents the impact of the hedge on the firm sales commitment (3/15 of the change in intrinsic value) Note D: This represents the change in value traceable to both hedges 489 www.elsolucionario.net October Futures Contract To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net www.elsolucionario.net 490 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com www.elsolucionario.net Derivatives Module—Problems PROBLEM M-4 Date December 31, 20X7 March 31, 20X8 June 30, 20X8 September 30, 20X8 December 31, 20X8 Totals Payment $1,136,408 1,136,408 1,136,408 1,136,408 $4,545,632 (2) Date June 30, 20X8 September 30, 20X8 December 31, 20X8 Totals (3) Date March 31, 20X8 June 30, 20X8 September 30, 20X8 December 31, 20X8 Totals (4) Date September 30, 20X8 December 31, 20X8 Totals Payment $115,000 108,750 $223,750 Interest Quarterly Rate Amount 1.25% 1.25 1.25 1.25 $157,383 145,145 132,754 120,208 $555,490 Interest Quarterly Rate Amount 1.1500% 1.0875 $115,000 108,750 $223,750 Balance at Beginning of Quarter $12,590,619 11,611,594 10,620,331 9,616,677 Pay Floating Rate 1.1875% 1.1625 1.1000 1.0375 Balance at Beginning of Quarter $10,000,000 10,000,000 Pay Receive Floating Rate Fixed Rate 1.1500% 1.1250% 1.0875 1.1250 3,750 Receive Fixed Rate 1.1875% 1.1875(2,903) 1.1875(9,293) 1.1875 Principal $ 979,025 991,263 1,003,654 1,016,200 $3,990,142 Principal $ $ — — — Balance $10,000,000 10,000,000 10,000,000 Net Swap Interest $ — 145,145 132,754 (14,425) $(26,621) Stated Interest on Note $157,383 142,242 123,461 120,208 $555,490 Net Interest Expense $157,383 Net Swap Interest $(2,500) Stated Interest on Note* $122,500 116,250 $238,750 Net Interest Income $120,000 120,000 $240,000 $ 1,250 *$10,000,000 x (2.90% + 2.0%)/4 = $122,500; $10,000,000 x (2.65% + 2.0%)/4 = $116,250 491 Balance $12,590,619 11,611,594 10,620,331 9,616,677 8,600,477 105,783 $528,869 www.elsolucionario.net (1) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com www.elsolucionario.net Derivatives Module—Problems (5) Pay floating rate interest per quarter ($10,000,000 × 1.0875%) Receive fixed rate interest per quarter ($10,000,000 × 1.1250%) Difference per quarter $108,750 112,500 $ 3,750 Number of quarters remaining Net present value of difference = quarters, i = 1.0875% $ 14,601 (6) In addition to the risk that the interest income on the note would decline due to falling variable interest rates, there is now a concern due to changing currency exchange rates If the interest income is to be received in euros and the euros are exchanged into dollars, it is possible that the number of dollars received could decline over time This would be the case if the euro weakened relative to the dollar 492 www.elsolucionario.net Problem M-4, Concluded To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net PROBLEM M-5 July 10 31 Aug 31 Sept 10 15 Sept July 31 100,000 $5.00 $5.14 $14,000 $9,000 $23,000 August 31 100,000 $5.00 $5.35 $35,000 $2,000 $37,000 Investment in Call Option Cash To record payment of option premium (100,000 × $0.20) 20,000 Investment in Call Option Unrealized Loss on Hedge ($10,000 – $9,000) Other Comprehensive Income ($10,000 – $14,000) To record change in value of the option The change in time value is excluded from assessment of hedge effectiveness 3,000 1,000 Investment in Call Option Unrealized Loss on Hedge Other Comprehensive Income To record change in value of option 14,000 7,000 Unrealized Loss on Hedge Other Comprehensive Income Investment in Call Option To record change in value of the option 1,000 3,000 Cash Investment in Call Option To record net settlement of option 33,000 Inventory of Silver Accounts Payable (or Cash) To record purchase of inventory (100,000 × $5.33) 533,000 Accounts Receivable Plating Revenues To record sales 225,000 Cost of Sales Other Inventoriable Costs Inventory of Silver (15,000 × $5.33) To recognize cost of sales 184,950 493 Sept 10 100,000 $5.00 $5.32 $32,000 $1,000 $33,000 20,000 4,000 21,000 4,000 33,000 533,000 225,000 105,000 79,950 www.elsolucionario.net Notional amount in troy ounces Strike price Spot price Intrinsic value (if strike is < spot) Time value Total value July 10 100,000 $5.00 $5.10 $10,000 $10,000 $20,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net Problem M-5, Concluded Oct Other Comprehensive Income Cost of Sales To adjust cost of sales [(15,000 divided by 100,000) × $22,000 of OCI] 3,300 Accounts Receivable Plating Revenues To record sales 750,000 Cost of Sales Other Inventoriable Costs Inventory of Silver (50,000 × $5.33) To recognize cost of sales 616,500 Other Comprehensive Income Cost of Sales To adjust cost of sales [(50,000 divided by 100,000) × $22,000 of OCI] 11,000 3,300 750,000 350,000 266,500 11,000 PROBLEM M-6 July a Call Option A Unrealized gain (loss) on commitment: 10,000 × ($45 – $46) 10,000 × ($45 – $44) 10,000 × ($45 – $46.50) Less: Previously recognized gain (loss) (10,000) Net unrealized gain (loss) Unrealized gain (loss) on hedge Change in time value excluded from effectiveness: Time value of $2,000 at beg vs $2,400 at end Time value of $2,400 at beg vs $1,000 at end Time value of $1,000 at beg vs $1,000 at end Net gain (loss) August $(10,000) $ Total $(15,000) $(10,000) 10,000 (15,000) 20,000 15,000 $(25,000) 15,000 10,000 10,000 $(10,000) 10,000 $ (10,000) 400 400 (1,400) (1,400) $ 400 $ 8,600 b Call Option B (hedge not effective—does not qualify for special hedge accounting) Unrealized gain (loss) on option: ($900 – $1,100) $ (200) ($600 – $900) $ (300) ($200 – $600) Net gain (loss) $ (200) $ (300) 494 September $(10,000) $ $ $ www.elsolucionario.net Sept (400) (400) $ $ (200) (300) (400) (900) (1,000) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net Problem M-6, Concluded c Put Option C Sales revenue Cost of sales Adjustment to cost of sales—Intrinsic value at 7/1 of $0 versus intrinsic value at 9/10 of $12,500 [10,000 × ($30 – $28.75)] Gross profit on sales Change in time value excluded from effectiveness: Time value of $500 at beg vs $600 at end Time value of $600 at beg vs $200 at end Time value of $200 at beg vs $100 at end Net gain (loss) d Futures Contract D Change in time value excluded from effectiveness: [($9.94 – $9.95) vs ($9.90 – $9.92) × 10,000] [($9.90 – $9.92) vs ($9.87 – $9.89) × 10,000] [($9.87 – $9.89) vs ($9.84 – $9.85) × 10,000] Net gain (loss) e Interest Rate Swap Variable interest income: (6.8% × $10,000,000 × 1/12 year) (6.8% × $10,000,000 × 1/12 year) (6.7% × $10,000,000 × 1/12 year) Settlement of fixed variable difference: [(7% – 6.8%) × $10,000,000 × 1/12 year] [(7% – 6.7%) × $10,000,000 × 1/12 year] Net interest income 58,333 $ 495 August September $ $ $ 287,500 (200,000) 12,500 100,000 100 $ 100 $ 100 $ 100 $ Total $ (400) $ (400) $ 56,667 $ (100) 99,900 $ $ $ (100) (100) $ 100 (400) (100) $ 55,833 $ 2,500 58,334 $ 12,500 100,000 99,600 100 (100) $ 56,667 $ 1,667 $ 56,667 173,334 $ 287,500 (200,000) www.elsolucionario.net July 56,667 56,667 55,833 1,667 2,500 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net PROBLEM M-7 Interest Expense Cash To record interest expense [(7% + 1%) × $20,000,000 × 1/2 year] Interest Rate Swap Asset Other Comprehensive Income To record change in the value of the swap 20X3 June 30 Dec 31 800,000 800,000 27,990 27,990 Interest Expense Cash To record interest expense [(7.1% + 1%) × $20,000,000 × 1/2 year] 810,000 Cash Other Comprehensive Income Interest Rate Swap Asset To record settlement of the swap [(7.1% – 7.0%) × $20,000,000 × 1/2 year] and the change in the value of the swap 10,000 37,001 Other Comprehensive Income Interest Expense To reclassify other comprehensive income to earnings 10,000 Interest Expense Cash To record interest expense [(6.9% + 1%) × $20,000,000 × 1/2 year] 790,000 Other Comprehensive Income Cash Interest Rate Swap Asset To record settlement of the swap [(6.9% – 7.0%) × $20,000,000 × 1/2 year] and the change in value of the swap 10,331 Interest Expense Other Comprehensive Income To reclassify other comprehensive income to earnings 10,000 496 810,000 47,001 10,000 790,000 10,000 331 10,000 www.elsolucionario.net (1) 20X2 Dec 31 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Derivatives Module—Problems www.elsolucionario.net Problem M-7, Concluded 20X4 June 30 Interest Expense Cash To record interest expense [(6.8% + 1%) × $20,000,000 × 1/2 year] 780,000 Interest Rate Swap Asset Other Comprehensive Income Cash 19,342 658 Interest Expense Other Comprehensive Income To reclassify other comprehensive income to earnings 20,000 780,000 20,000 20,000 Dec 31, 20X2 Effective interest rate: Without a hedge With a hedge Interest expense: Without a hedge With a hedge Difference Six-Month Period Ending June 30, Dec 31, 20X3 20X3 8.0% 8.0 $ 8.1% 8.0 $800,000 800,000 $ 7.9% 8.0 June 30, 20X4 Total 7.8% 8.0 $810,000 $790,000 $780,000 $3,180,000 800,000 800,000 800,000 3,200,00 10,000 $(10,000) $(20,000) $ (20,000 Unfortunately, in retrospect, the company would have been better off not to have engaged in an interest rate swap The swap resulted in an additional decrease in earnings of $20,000 (3) The LIBOR rate on December 31, 20X3, would have had to be 7% This would have resulted in an 8% (7% + 1%) variable interest rate for the final 6-month period If that were the case, then total interest expense would have been $3,200,000 whether or not there was a hedge 497 www.elsolucionario.net (2) Impact on Earnings of the Interest Rate Swap ... adjustment for 20X1 is for a half year 20X1 depreciation expense and accumulated depreciation will be restated at $18,000 instead of $20,000 for the half year Depreciation expense for 20X2 will... adjustment for 20X1 is for a half year 20X1 depreciation expense and accumulated depreciation will be restated at $13,750 instead of $12,500 for the half year Depreciation expense for 20X2 will... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com www.elsolucionario.net Ch 1–Problems Problem 1-10, Concluded Worksheet for Pro Forma Income Statement For the Year