Costs and Expenses Flashcards
On October 1 of the prior year, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1 of the prior year. Fleur’s prior-year financial statements reported interest payable and interest expense on the note for three months at 16%. All amounts due on the note were paid February 1 of the current year. As a result of Fleur’s accounting treatment of the note, interest, and merchandise, which of the following items was reported correctly?
The cost of the merchandise purchased (and sold by the end of the year) should have been based on the present value of the note used to pay for them, not the face amount. Since the note paid a higher rate of interest than what was required as a yield, the note would have a premium, a higher value than face.
Thus, the note’s present value was higher than its face amount, and the higher value should have been added to purchase cost and moved to cost of goods sold. The lower value that was used for purchase cost understated the cost of goods sold. If cost of goods sold was understated, then net income was wrong and retained earnings was not correct.
Interest payable, however, is based on the face amount of the note and the stated payment rate, so it is correct.
HINT: IN OTHER WORDS, the interest expense is based on PV of note x interest, not the face amount of note. However, the interest payable is based on face amount of note
On January 1, 20X1, Sip Co. signed a 5-year contract enabling it to use a patented manufacturing process beginning in 20X1. A royalty is payable for each product produced, subject to a minimum annual fee. Any royalties in excess of the minimum will be paid annually. On the contract date, Sip prepaid a sum equal to two years’ minimum annual fees. In 20X1, only minimum fees were incurred. The royalty prepayment should be reported in Sip’s December 31, 20X1, financial statements as:
The prepayment on January 1, 20X1, represented the minimum annual fees for 20X1 and 20X2. On December 31, 20X1, the 20X1 fee is an expense and the payment for the 20X2 fee is a current asset (prepaid fee).
Which Depreciation Method does not use salvage value?
DDB Salvage value is not used in the depreciation formula, but the plant asset cannot be depreciated below its salvage value.
what is the times earned interest ratio?
The times interest earned ratio is income before interest expenses and taxes divided by interest expense. In this question, that would be the operating income prior to either of those expenses, or $900,000 divided by the interest expense of $100,000, giving an answer of 9.0 to 1
