Three problems accounting
I. (Liability Errors) You are the independent auditor engaged to audit Millay Corporation's December 31, 2014, financial statements. Millay manufactures household appliances. During the course of your audit, you discovered the following contingent liabilities.
1. Millay began production of a new dishwasher in June 2014 and, by December 31, 2014, sold 120,000 to various retailers for $500 each. Each dishwasher is under a one-year warranty. The company estimates that its warranty expense per dishwasher will amount to $25. At year-end, the company had already paid out $1,000,000 in warranty expenses. Millay's income statement shows warranty expenses of $1,000,000 for 2014. Millay accounts for warranty costs on the accrual basis.
As presented, these contingencies are not reported in accordance with GAAP, which may create problems in issuing a favorable audit report. You feel the need to note these problems in the work papers.
Instructions
Heading each page with the name of the company, balance sheet date, and a brief description of the problem, write a brief narrative for above issues in the form of a memorandum to be incorporated in the audit work papers. Explain what led to the discovery of each problem, what the problem really is, and what you advised your client to do (along with any appropriate journal entries) in order to bring these contingencies in accordance with GAAP.
II. (Stock Transactions-Lump Sum) Seles Corporation's charter authorized issuance of 100,000 shares of $10 par value common stock and 50,000 shares of $50 preferred stock. The following transactions involving the issuance of shares of stock were completed. Each transaction is independent of the others.
1. Issued a $10,000, 9% bond payable at par and gave as a bonus one share of preferred stock, which at that time was selling for $106 a share.
2. Issued 500 shares of common stock for equipment. The equipment had been appraised at $7,100; the seller's book value was $6,200. The most recent market price of the common stock is $16 a share.
3. Issued 375 shares of common and 100 shares of preferred for a lump sum amounting to $10,800. The common had been selling at $14 and the preferred at $65.
4. Issued 200 shares of common and 50 shares of preferred for equipment. The common had a fair value of $16 per share; the equipment has a fair value of $6,500.
Instructions
Record the transactions listed above in journal entry form.
III. (Lessee Computations and Entries; Capital Lease with Guaranteed Residual Value) Pat Delaney Company leases an automobile with a fair value of $8,725 from John Simon Motors, Inc., on the following terms:
1. Noncancelable term of 50 months.
2. Rental of $200 per month (at end of each month). (The present value at 1% per month is $7,840.)
3. Estimated residual value after 50 months is $1,180. (The present value at 1% per month is $715.) Delaney Company guarantees the residual value of $1,180.
4. Estimated economic life of the automobile is 60 months.
5. Delaney Company's incremental borrowing rate is 12% a year (1% a month). Simon's implicit rate is unknown.
Instructions
(a) What is the nature of this lease to Delaney Company?
(b) What is the present value of the minimum lease payments?
(c) Record the lease on Delaney Company's books at the date of inception.
(d) Record the first month's depreciation on Delaney Company's books (assume straight-line).
(e) Record the first month's lease payment.