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51. Nan Chen works for a firm that offers a benefit plan that guarantees her an annual payment in retirement equal to her average salary over her last 3 years of full-time employment multiplied by 3% for each of her years of full-time employment, as long as she has reached age 62. The most appropriate term for Nan’s retirement plan is a: A. salary-based plan. B. defined benefit plan. C. years-of-service plan.

Ans: B. A plan where the company guarantees a specific benefit amount upon retirement is referred to as a defined benefit plan.

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52. Which of the following statements about the treatment of leases on the lessor’s financial statements is least accurate? A. If the present value of the payments on a finance lease is greater than the carrying value of the asset, the lease is a sales-type lease on the books of the lessor. B. In a direct financing lease, the lessor recognizes gross profit at the lease inception, while in a sales-type lease it does not. C. To be a finance lease for the lessor, collectability must be reasonably certain and the lessor must have substantially completed performance.

Ans: B. When the PV of the lease payments is greater than the carrying value of an asset, the lessor records an immediate gross profit on sale equal to the excess of the PV over the carrying value, and the lease is termed a sales-type lease, not a direct financing lease.

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53. Compared to an operating lease, a capital lease will have what effects on operating income (earnings before interest and taxes) and net income in the first year? A. Both will be lower. B. Both will be higher. C. One will be lower and one will be higher.

Ans: C. With an operating lease, the entire lease payment (rent expense) is subtracted from operating income. With a capital lease, only depreciation is subtracted from operating income, so operating income is higher with a ca[ital lease. Net income in the first year is lower with a capital lease because the sum of depreciation (operating expense) and interest (non-operating expense) is greater than the lease payment.

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54. If the balance sheets of a firm reporting under U.S.GAAP and a firm reporting under IFRS show equal pension liabilities, it is most likely that: A. both firms’ defined contribution plans are underfunded. B. the funded status of the U.S.GAAP firm’s pension is equal to its pension liability. C. the IFRS firm’s pension is underfunded by a greater amount than the U.S.GAAP firm’s pension.

Ans: B. Under U.S.GAAP, the asset or liability reported on the balance sheet for a defined benefit pension plan reflects the funded status of the plan. Under IFRS, the balance sheet asset or liability does not include prior service costs or actuarial gains and losses. The net effect of these differences on funded status can be positive or negative. Defined contribution plans do not represent future obligations of the firm and, therefore, do not appear on the balance sheet.

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55. A company issues $10 million in 8% annual-pay, 5-year bonds, when the market rate is 8.25%. the initial balance sheet liability and liability one year from the date of issue are closest to: initial liability liability one year later A. $9,900,837 $9,917,656 B. $10,000,000 $9,975,000 C. $10,099,163 $10,082,344

Ans: A. PMT = 800,000; FV = 10,000,000; N = 5; I/Y = 8.25; CPT → PV = $9,900,837 Interest expense = 9,900,836.51 x 0.0825 = $816,819.01 Year-end adjustment = 816,819.01 – 800,000 = $16,819.01 Year-end debt = $9,900,836.51 + $16,819.01 = $9,917,655.52 Note: sine this is a discount bond, we know the initial liability will be less than the face value, so we really didn’t have to do any calculations to answer this question.

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56. Which of the following is correct regarding the impact of convertible bonds on a company’s financial statements and ratios: A. The issuance of convertible bonds by a company results in a decrease in both its debt-to-equity and its interest coverage ratios. B. The conversion of convertible bonds into common equity results in an increase in the company’s debt-to-equity ratio and an increase in the interest coverage ratio. C. When there is a conversion of convertible debt into common equity, even if the market price exceeds the conversion price, no gain or loss may be reported on the financial statements.

Ans: C. The conversion of convertible debt into common equity uses the additional paid-in capital account as a balancing account. No gain or loss is recorded when convertible bonds are converted into common equity. A is incorrect. The issuance of convertible bonds by a company results in a increased, not decreased, debt-to-equity ratio (convertible bonds are debt until they are converted) and a decreased interest coverage ratio due to the higher interest associated with the increased debt. B is incorrect. The conversion of convertible bonds into common equity results in lower debt and higher equity balances, as well as lower interest expense in the future due to the reduced debt. The reduced debt and increased equity result in a lower debt-to-equity ratio. The decrease in interest expense results in an increased interest coverage ratio.

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57. For the lessee, during the later years of a finance lease: A. the debt-to-equity ratio will increase compared to the initial years. B. a higher net profit (margin) will be obtained versus an operating lease. C. a high asset turnover ratio will be obtained versus the operating lease.

Ans: B. In the later years of a finance lease, the net profit (margin) will be greater than the net profit (margin) reported with an operating lease. Although rent expense is normally constant throughout the term of an operating lease, interest expense declines in a finance lease as the lease obligation is reduced while depreciation expense remains constant. This leads to lower total expenses in the later years of a finance lease versus an operating lease and a higher reported net profit (margin). A is incorrect. Through the passage of time, the lease obligation with a finance lease is reduced leading to a lower debt-to-equity ratio compared to the early years. C is incorrect. Although the asset turnover ratio rises over time as the leased asset is depreciated with a finance lease, the asset turnover remains higher with an operating lease since the leased asset is never recorded with an operating lease.