You are auditing the December 31, 2014, financial statements

of Hockney, Inc., manufacturer of novelties and party favors.During your inspection of the company

garage, you discovered that a used automobile not listed in theequipment subsidiary ledger is parked

there. You ask Stacy Reeder, plant manager, about the vehicle,and she tells you that the company did not

list the automobile because the company was only leasing it. Thelease agreement was entered into on

January 1, 2014, with Crown New and Used Cars.

You decide to review the lease agreement to ensure that thelease should be afforded operating lease

treatment, and you discover the following lease terms.

1. Noncancelable term of 4 years.

2. Rental of $3,240 per year (at the end ofeach year). (The present value at 8% per year is $10,731.)

3. Estimated residual value after 4 years is$1,100. (The present value at 8% per year is $809.) Hockney

guarantees the residual value of $1,100.

4. Estimated economic life of the automobile is5 years.

5. Hockneyâs incremental borrowing rate is 8%per year.

Instructions

You are a senior auditor writing a memo to your supervisor, theaudit partner in charge of this audit, to

discuss the above situation. Be sure to include (a) why youinspected the lease agreement, (b) what you

determined about the lease, and (c) how you advised your clientto account for this lease. Explain every

journal entry that you believe is necessary to record this leaseproperly on the clientâs books. (It is also

necessary to include the fact that you communicated thisinformation to your client.)

Question

You are auditing the December 31, 2014, financial statements

of Hockney, Inc., manufacturer of novelties and party favors.During your inspection of the company

garage, you discovered that a used automobile not listed in theequipment subsidiary ledger is parked

there. You ask Stacy Reeder, plant manager, about the vehicle,and she tells you that the company did not

list the automobile because the company was only leasing it. Thelease agreement was entered into on

January 1, 2014, with Crown New and Used Cars.

You decide to review the lease agreement to ensure that thelease should be afforded operating lease

treatment, and you discover the following lease terms.

1. Noncancelable term of 4 years.

2. Rental of $3,240 per year (at the end ofeach year). (The present value at 8% per year is $10,731.)

3. Estimated residual value after 4 years is$1,100. (The present value at 8% per year is $809.) Hockney

guarantees the residual value of $1,100.

4. Estimated economic life of the automobile is5 years.

5. Hockneyâs incremental borrowing rate is 8%per year.

Instructions

You are a senior auditor writing a memo to your supervisor, theaudit partner in charge of this audit, to

discuss the above situation. Be sure to include (a) why youinspected the lease agreement, (b) what you

determined about the lease, and (c) how you advised your clientto account for this lease. Explain every

journal entry that you believe is necessary to record this leaseproperly on the clientâs books. (It is also

necessary to include the fact that you communicated thisinformation to your client.)

12	. On 1/1/14, ABC Corporation purchased, as a held-to-maturity investment, $200,000 of the 8%, 5-year bonds of Intuit Corporation for $177,824,
	which provides an 11% return. Prepare ABC's 12/31/14 journal entry to reflect the receipt of annual interest and discount amortization.
	Assume the bond investment pays interest annually on 12/31 each year and that effective interest amortization is used.
	Note: Notice that a discount account is not used for this investment. Therefore, for purposes of this adjusting entry, amortize the discount directly to the
	investment account.


13.	ABC Corporation prepares an aging schedule on 12/31/14 that estimates total uncollectible accounts at $25,000. Assuming that the allowance method is used,
	prepare the entry to record bad debt expense.


14	On 1/1/14, ABC Corporation signed a 5-year noncancelable lease for a delivery vehicle. The terms of the lease called for ABC to Corporation to make
	annual payments of $10,503 at the beginning of each year, starting January 1, 2014. The delivery vehicle has an estimated useful life of 6 years and a $7,000
	unguaranteed residual value. The delivery vehicle reverts back to the lessor at the end of the lease term. ABC Corporation uses the straight-line method
	of depreciation for the delivery vehicle. ABC Corporation's incremental borrowing rate is 10%, and the Lessor's implicit rate is unknown. No entries have yet
	been made concerning this lease arrangement. After determining the type of lease arrangement (capital or operating), prepare the necessary multiple-part journal
	entry for 2014 for ABC Corporation. (Hints: You will need to compute the present value of the minimum lease payments and 4 separate sub-entries for
	this lease transaction. Also, for Statement of Cash Flow purposes, the principal portion of lease payments are correctly categorized as a financing activity.)


15	ABC Corporation provides a defined benefit pension plan for its employees. A combination adjusting entry should be made to correctly account for this type of pension
	plan given the following items of information for the 2014 plan year, including the recording of pension expense and the employer's contribution to the pension plan in 2014.
	Note: Use the summary entry method as demonstrated and discussed in the chapter lectures on pension accounting to prepare the adjusting entry.

	Pension asset/liability (January 1)		$0
	Actual return on plan assets		$40,000
	Expected return on plan assets		$20,000
	Contributions (funding) in 2014		$37,000
	Fair value of plan assets (December 31)		$75,000
	Settlement rate		10%
	Projected benefit obligation (January 1)		$0
	Service cost		$60,000
	Benefits paid in 2014		$0
	*For purposes of financial statement presentation, consider Pension Expense as an operating item and any resulting Pension Asset/Liability as long-term in nature.

16	On December 31, 2014, ABC Corporation issued 1,000 shares of restricted stock to its Chief Financial Officer. ABC stock had a fair value (closing market price) of
	$10 per share on December 31, 2014. Additional information is as follows:
		a. The service period related to the restricted stock is 2 years.
		b. Vesting occurs if the CFO stays with the company for a two-year period.
		c. The par value of the common stock is $3 per share.
	Make the appropriate accounting entry as of the grant date, 12/31/14. Note: use the alternative method as described in your textbook for deferred compensation.

	Do this step after preparing the Income Statement except for the Income taxes line: (You need to calculate Income Before Income Taxes in order to calcualte total Income Tax Expense)
17	Corporate taxes are due in four estimated quarterly payments on April 15, June 15, September 15, and December 15.
	However, for the purposes of this ABC illustration, we will assume that estimates are not paid, and that the tax is paid in full
	on the return's March 15, 2015 due date.
	ABC's income tax rate is 40%. The entire year's income tax expense was estimated at the beginning of 2014 to be $69,600,
	so January through November income tax expense recognized amounts to $63,800 (11/12 months).
	Since we are assuming estimates are not made during the year, the balance in Income taxes payable represents
	tax accrued for January through November. Assume no deferred tax assets or deferred tax liabilities.
	Based on the income before income taxes figure from the income statement, record December's income tax expense
	so that the entire year's total tax expense is correct.

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