Financial Accounting

ACT 421 (Section:1)

Assignment for Final Assessment
Questions: (Marks: 8+8+4=20)

1. “Sylvan Inc. entered into a non-cancelable lease arrangement with Breton Leasing
Corporation for a certain machine. Breton’s primary business is leasing; it is not a
manufacturer or dealer. Sylvan will lease the machine for a period of 3 years, which is
50% of the machine’s economic life. Breton will take possession of the machine at the end
of the initial 3-year lease and lease it to another, smaller company that does not need the
most current version of the machine. Sylvan does not guarantee any residual value for the
machine and will not purchase the machine at the end of the lease term. Sylvan’s
incremental borrowing rate is 10%, and the implicit rate in the lease is 9%. Sylvan has no
way of knowing the implicit rate used by Breton. Using either rate, the present value of
the minimum lease payments is between 90% and 100% of the fair value of the machine at
the date of the lease agreement. Sylvan has agreed to pay all executory costs directly, and
no allowance for these costs is included in the lease payments. Breton is reasonably
certain that Sylvan will pay all lease payments. Because Sylvan has agreed to pay all
executory costs, there are no important uncertainties regarding costs to be incurred by
Breton. Assume that no indirect costs are involved.

Requirement
(a) With respect to Sylvan (the lessee), answer the following:
i. What type of lease has been entered into? Explain the reason for your answer.
ii. How should Sylvan compute the appropriate amount to be recorded for the lease or asset
acquired?
iii. What accounts will be created or affected by this transaction, and how will the lease or
asset and other costs related to the transaction be matched with earnings?
iv. What disclosures must Sylvan make regarding this leased asset?

(b) With respect to Breton (the lessor), answer the following.

i. What type of leasing arrangement has been entered into? Explain the reason for your
answer.
ii. How should this lease be recorded by Breton, and how are the appropriate amounts
determined?
iii. How should Breton determine the appropriate amount of earnings to be recognized from
each lease payment?
iv. What disclosures must Breton make regarding this lease?
 2. (a)What are the major advantages of notes to the financial statements? What types of
items are usually reported in notes?

(b) Presented below are three independent situations-

Situation 1: A company offers a one-year warranty for the product that it manufactures. A
history of warranty claims has been compiled, and the probable amounts of claims related to
sales for a given period can be determined.

Situation 2: Subsequent to the date of a set of financial statements but prior to the issuance of
the financial statements, a company enters into a contract that will probably result in a significant
loss to the company. The amount of the loss can be reasonably estimated.

Situation 3: A company has adopted a policy of recording self-insurance for any possible losses
resulting from injury to others by the company’s vehicles. The premium for an insurance policy
for the same risk from an independent insurance company would have an annual cost of $4,000.
During the period covered by the financial statements, there were no accidents involving the
company’s vehicles that resulted in injury to others.
Requirement
Discuss the accrual or type of disclosure necessary (if any) and the reason(s) why such disclosure
is appropriate for each of the three independent sets of facts above.

3. State how (cumulative or retrospective or prospective) each of the following items is

reflected in the financial statements?
i. Change from FIFO to LIFO method for inventory valuation purposes.
ii. Litigation won in current year, related to prior period.
iii. Change in the reliability of certain receivables.
iv. Write-off of receivables.
v. Change from the percentage-of-completion to the Completed-contract method for
reporting net income.