4-Describe the different reporting results and make the necessary adjusting entries to conform the financial statements to the new lease rules compliance for 2012.

5-In answering the following parts, keep in mind companies usually prefer to report higher net income and higher cash from operating activities (although accounting research has identified exceptions to this).

A.Prepare an income statement under the new lease rules for 2012.

B.Prepare balance sheet under the new lease rules on December 31, 2012.

C.Prepare a cash flow statement under the new lease rules for 2012.

6-Compute the following ratios for 2012, under both the current GAAP reporting lease rules and the new lease rules :

Current Ratio

Quick Ratio

Cash Ratio

Times Interest Earned

Debt to Capital Ratio

Debt to Shareholder Equity Ratio

Case Study: Treatment of Leases-Current VS. New Lease Requirements and the Impact on Financial Ratios CASE DESCRIPTION After decades of continuous controversy since the package of FASB 13, there has been a major change in Lease Accounting effective for the period ending after December 15, 2018.The changes are dramatic and effectively capitalizes all non-cancellable lease terms greater than one year. The liability created by the lease will now become a balance sheet debt item, This case study focuses on the differences in the treatment of leases between the current lease pronouncements and the upcoming new lease rules under US GAAP, and the impact of these differences on financial statements and selected financial ratios. Students will take GAAP financial statements under the present lease requirements and prepare a balance sheet, cash flow statement and income statement reflecting the new lease rules. This case study is suitable for use at both the undergraduate and graduate levels. It may be used in an Intermediate Accounting II, Accounting Theory, Financial Statement Analysis or an International Accounting class, as well as an Investment Finance course. The case can be offered as an individual case study or as a group project. JEL: M4, M41, M42, M48, M49 KEYWORDS: US GAAP, IFRS, Capital Lease, Operating Lease, Financing Lease, Ratios. CASE INFORMATION ACE Corporation (ACE), a publically traded NASDAQ company (symbol ACE), is a manufacturer of electrical automobiles. It is based in Detroit, Michigan and the company has been operating since 1996. The company sells their electrical automobiles to auto manufacturers as well as the retail market on a worldwide basis. Its major clients are Ford, General Motors and Toyota. ACE has captured about 10 percent of the world market of the electrical automobile sales. Its stock sells at 25 US Dollars per share, and its 52-week price range is between 19.75 and 27.15 US Dollars, with a market cap of 10.6 billion dollars. Their financial statements presented below for the year ending December 31, 2012 has been prepared using GAAP. The controller would like to see the effect of the proposed new of lease rules on the financial statements; you have been assigned this task. In particular, the controller would like to see the impact of these changes on balance sheet, income statement, cash flow statement and selected financial ratios. Table 1 US GAAP Balance Sheet for ACE Corp. at 12/31/2012 and 12/31/2011 ACE Corporation Balance Sheet (in 000 except par value) As of December 31, 2012 and 2011 2012 2011 ASSETS Current Assets Cash Accounts Receivable (net) Inventory (FIFO) Total Current Assets Noncurrent Assets Security Available for Sale Property, Plant and Equipment $ 10,000 100,000 less Accumulated Depreciation (30,000) $ 33,000 25,000 50,000 108,000 $ 19,000 17,000 21,000 57,000 0 $136,00 0 (28,000) 80,000 Intangible Assets Trademark Goodwill Total Noncurrent Assets Total Assets 5,000 7,000 LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Current liabilities Accounts payable Accrued interest Accrued operating expenses Income taxes payable Total current liabilities Noncurrent Liabilities Deferred income taxes $ 5,000 Bonds Payable 45,000 Total noncurrent liabilities Total Liabilities SHAREHOLDERS' EQUITY Common stock ($1 par) 20,000 Additional paid in capital 30,000 Retained earnings 60,000 Total Shareholders' Equity Total Liabilities and Shareholders' Equity 108,000 7,000 7,000 12,000 $200,000 14,000 $179,000 $ 18,000 2,000 13,000 7,000 40,000 $ 17,000 2,000 19,000 6,000 44,000 $ 4,000 45,000 50,000 90,000 49,000 93,000 18,000 17,000 51,000 110,000 $200,000 Table 1 shows the Balance Sheet of Ace Corporation for the years ended 12/31/12 and 12/31/11presented under US GAAP reporting. Note that the presentation is based on the order of liquidity-most liquid items followed by less liquid items. Table 2 ACE Corp. US GAAP Income Statement for the year ended December 31, 2012 ACE Corporation Income Statement (in 000, except per share data) For the Year Ended December 31, 2012 86,000 $179,000 Sales Cost of goods sold Gross profit Selling and administrative expenses $ 31,000 Amortization and depreciation expense 10,000 Interest expense 4,000 Income before taxes Income tax expense Income before extraordinary item Extraordinary loss from hurricane (net of $6,000 tax savings) Net Income Earnings per share: Earnings per share from continuing operations Extraordinary loss per share Earnings per share $270,000 (175,000) 95,000 (45,000) 50,000 (15,000) 35,000 (14,000) $ 21,000 $1.75 (.70) $1.05 Table 2 presents a statement of income for the year ended 12/31/12 prepared under US GAAP reporting. Also included is the earnings per share amount which is derived by taking net income and divided by the number of common shares outstanding. Table 3 ACE Corp. US GAAP Cash Flow Statement for the year ended December 31, 2012 ACE Corporation Cash Flow Statement (in 000) For the Year Ended December 31, 2012 Cash from Operating Activities Net income Adjustments for noncash items: Loss from hurricane Depreciation expense Amortization expense Increase in accounts receivable Increase in inventory Increase in accounts payable Change in accrued operating expenses Change in income taxes payable Increase in deferred income taxes Net Cash from Operating Activities Cash from Investing Activities $21,000 $14,000 8,000 2,000 (8,000) (29,000) 1,000 (6,000) 7,000 1,000 (10,000) 11,000 Insurance proceeds Purchase securities available for sale Net Cash from Investing Activities Cash from Financing Activities Issue common stock Pay dividends Net Cash from Financing activities Net increase in cash Cash December 31, 2011 Cash December 31, 2012 Additional supplemental disclosure: Cash paid for income taxes Cash paid for interest $10,000 (10,000) -0- $15,000 (12,000) 3,000 $14,000 19,000 $33,000 $ 7,000 $ 4,000 Table 3 presents the Statement of Cash Flows for Ace Corp. for the year ended 12/31/12 under US GAAP. The cash flow presented is the indirect method. Alternatively, the Direct method-not presented here is also the other acceptable cash flow statement under both US GAAP and IFRS. The Direct Method is illustrated in the solution for question 5C where the Direct Method is presented in the solution under IFRS. ADDITIONAL INFORMATION 1. ACE entered into a noncancelable lease on January 2, 2012 with the following terms: A ACE leased specialized machinery manufactured by the lessor, Bell Corp., which enables ACE to manufacture their electric cars in a much more efficient manner. This machinery does not have a resale market and was made specifically for ACE to meet its specifications. B The lease term is for 3 years with an annual lease payment of $10,000. Payment is due on December 31 of each year, with the first payment due on December 31, 2012. At the end of the lease term, ownership reverts to the lessor. There is no option for ACE to buy the equipment. C The lessee will pay all executor costs of $1,500/year which in included in 2102 selling and administration expenses. D The estimated useful life of the lease is 49 months (4 1/12 years.) E The fair market value of the equipment is $30,000 on January 1, 2012. F The implicit rate of Bell Corp. is 6 percent, and the lessee, ACE, knows this. G ACE's incremental borrowing rate is 7 percent. 2. ACE Corporation did not sell any plant assets; however plant assets with a cost of $36,000 and accumulated depreciation of $6,000 were destroyed in a hurricane. Insurance proceeds of $10,000 were collected by the company. 3. Two million shares of common stock were issued at the beginning of 2012. 4. Securities available for sale were purchased on December 31, 2012. 5. Cash dividends were paid during 2012. 6. ACE's bonds payable have several covenants that involve net income and cash from operating activities. The controller is especially concerned that IFRS treatment of leases does not violate those covenants. She is concerned that renegotiating the debt covenants will be costly to ACE. QUESTIONS 45- Describe the different reporting results and make the necessary adjusting entries to conform the financial statements to the new lease rules compliance for 2012. In answering the following parts, keep in mind companies usually prefer to report higher net income and higher cash from operating activities (although accounting research has identified exceptions to this). A Prepare an income statement under the new lease rules for 2012. B Prepare balance sheet under the new lease rules on December 31, 2012. C Prepare a cash flow statement under the new lease rules for 2012. 6- Compute the following ratios for 2012, under both the current GAAP reporting lease rules and the new lease rules: Current Ratio Quick Ratio Cash Ratio Times Interest Earned Debt to Capital Ratio Debt to Shareholder Equity Ratio