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    Johnson Corp, Felner Industries, Terry Transport, Tax, Bond

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    Question 1

    Johnson Corp on Thursday extended the warranty on its video game console and said it will take a charge of more than $1 billion to pay for "anticipated costs." Under the new warranty, Johnson will pay for shipping and repairs for three years, worldwide, for consoles afflicted with what gamers call "the red ring of death." Previously, the warranty expired after a year for U.S. customers and two years for Europeans. The charge will be $1.05 billion to $1.15 billion for the quarter ended June 30. Johnson reports its fourth-quarter results July 19.

    a) Why must Johnson report this charge of over $1 billion entirely in one quarter, the last quarter of the company's fiscal year ended June 30, 2007?

    b) When the announcement was made, analyst Richard Johnson stated that either a high number of consoles will fail or the company is being overly conservative in its warranty estimate. From an accounting standpoint, what will Johnson do in the future if the estimate of future repairs is overly conservative (too high)?

    Question 2

    On August 31, 2008, Felner Industries issued $25 million of its 30-year, 6% convertible bonds dated August 31, priced to yield 5%. The bonds are convertible at the option of the investors into 1,500,000 shares of Felner's common stock. Felner records interest expense at the effective rate. On August 31, 2011, investors in Felner's convertible bonds tendered 20% of the bonds for conversion into common stock that had a market value of $20 per share on the date of the conversion. On January 1, 2010, Felner Industries issued $40 million of its 20-year, 7% bonds dated January 1 at a price to yield 8%. On December 31, 2011, the bonds were extinguished early through acquisition in the open market by Felner for $40.5 million.

    a) Using the book value method, would recording the conversion of the 6% convertible bonds into common stock affect earnings? If so, by how much? Would earnings be affected if the market value method is used? If so, by how much?

    b) Were the 7% bonds issued at face value, at a discount, or at a premium? Explain.

    Question 3

    Terry Transport leases much of its aircraft, land, facilities, and equipment. A portion of those leases are part of sale and leaseback arrangements. An excerpt from Terry's 2009 disclosure notes describes the company's handling of gains from those arrangements:

    Deferred Gains:
    Gains on the sale and leaseback of aircraft and other property and equipment are deferred and amortized ratably over the life of the lease as a reduction of rent expense.

    a) Based on the information provided in the disclosure note, determine whether the leases in the leaseback portion of the arrangements are considered by Terry Transport to be capital leases or operating leases. Explain.

    Question 4

    Smith Co. began operations in 2011 and reported $225,000 in income before income taxes for the year. Smith's 2011 tax depreciation exceeded its book depreciation by $25,000. Smith also had nondeductible book expenses of $10,000 related to permanent differences. Smith's tax rate for 2011 was 40%, and the enacted rate for years after 2011 is 35%. In its December 31, 2011, balance sheet, what amount of deferred income tax liability should Smith report? Show calculation.

    a. $ 8,750
    b. $10,000
    c. $12,250
    d. $14,000

    Question 5

    On January 2, 2011, Carter Co. issued at par $10,000 of 4% bonds convertible in total into 1,000 shares of Carter's common stock. No bonds were converted during 2011.

    Throughout 2011, Carter had 1,000 shares of common stock outstanding. Carter's 2011 net income was $1,000. Carter's income tax rate is 50%. No potential common shares other than the convertible bonds were outstanding during 2011. Carter's diluted earnings per share for 2011 would be (Show calculation)

    a. $0.50
    b. $0.60
    c. $0.70
    d. $1.00

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    Solution Summary

    Your responses are in word and supported by an Excel spreadsheet for the bond amortization problem.