On January 2, 2014, Wareham Company leased equipment from Dean, Inc. Lease payments are $7,000 payable annually, with the first of 8 annual payments made on January 2, 2014. Wareham will return the equipment to Dean at the end of the lease term. The lease is noncancellable and Wareham does not have the option to buy the equipment at the end of the lease term. Additional facts: ? The equipment has a $40,000 carrying value on Dean? books; its current sales price (i.e., its fair value) is $70,000. Its estimated economic life is 10 years on January 2, 2014. ? The interest rate implicit in the lease, which is known by Wareham, is 4%. Wareham?s incremental borrowing rate is 5%. ? Wareham uses the straight-line method of depreciation for all equipment.

Question 1 (10 points)Capital Lease. Complete parts 1 and 2 given the information provided. On January 2, 2014, Wareham Company leased equipment from Dean, Inc. Lease payments are $7,000 payable annually, with the first of 8 annual payments made on January 2, 2014. Wareham will return the equipment to Dean at the end of the lease term. The lease is noncancellable and Wareham does not have the option to buy the equipment at the end of the lease term. Additional facts: The equipment has a $40,000 carrying value on Dean' books; its current sales price (i.e., its fair value) is $70,000. Its estimated economic life is 10 years on January 2, 2014. The interest rate implicit in the lease, which is known by Wareham, is 4%. Wareham's incremental borrowing rate is 5%. Wareham uses the straight-line method of depreciation for all equipment. Part I (2 points). This lease is a capital lease. Why is this lease a capital lease? List all of the reasons that this is a capital lease. There are anywhere from one to four reasons. Although there is a lot of space below, please be brief. Capital leases are agreements that we identify as being formulated outwardly as leases, but which are in reality essentially installment purchases. 1. The agreement specifies that ownership of the asset transfers to the lessee. 2. The agreement contains a bargain purchase option. 3. The noncancelable lease term is equal to 75% or more of the expected economic life of the asset. 4. The present value of the \"minimum lease payments\" 5 is equal to or greater than 90% of the fair value of the asset. 1 Part II. 0.5 points each; 8 points total. This part of the question requires you to fill in the correct dollar amounts in the shaded cells below. Note that the two journal entries for September 30, 2014 require you to assume that Wareham is closing the books on that date to prepare an interim financial statement. They had not closed the books or made accruals in 2014 prior to that date. The answer to one of the items below is \"0,\" and the rest are all non-zero numbers. Debit January 2, 2014 Leased equipment Capital lease liability January 2, 2014 Capital lease liability Interest expense Cash December 31, 2014 Depreciation expense Accumulated depreciation December 31, 2014 Interest expense Interest payable January 2, 2015 Capital lease liability Interest payable Cash September 30, 2015 Interest expense Interest payable Fill in the blanks below (read dates carefully): Book value of leased equipment as of 12/31/15 Current portion of long-term debt related to lease on 12/31/17 2 Credit Questions 2-4 are based on the following: Clarence Company is a large Corporation. The following applies to its investments and bonds. Fiscal year. Clarence Company's fiscal year end is December 31 (12/31). The accounting year just ended for Clarence Company is the fiscal year ending December 31, 2008 (12/31/08). Investments. Clarence's Chief Financial Officer loves to invest, so he uses Clarence's money to invest in shares of other companies' stock. On 1/1/2007, Clarence purchased 1,000 shares of Llama Corporation. During fiscal 2008, Clarence purchased 1,000 shares of Goat Corporation. The Llama shares were purchased for $10.50 per share and the Goat shares were purchased for $7.20 per share. At the end of fiscal 2007, the fair market value of Llama was $10.90/share. At the end of fiscal 2008, the shares of Llama and Goat were worth $10.50 and $7.20 per share, respectively. Llama Corporation declared and paid cash dividends of $0.75 per share in both 2007 and 2008; Goat Corporation declared and paid a cash dividend of $0.50 per share in fiscal 2008. 6% Bonds. On July 1, 2007, Clarence issued 800 bonds. The bonds are 6% stated (face, coupon) rate, 10-year, non-convertible, callable bonds (each bond has a face value of $1,000 and they were issued at 107.7214). The bonds pay interest annually on July 1. The bond issue price was based on an effective interest rate of 5%. The bonds are callable anytime at 96 plus accrued interest. 5.5% Convertible bonds. In 2005, Clarence issued, at face value, $1,000,000 of 5.5%, 8-year, convertible, non-callable bonds (that is, it issued 1,000 bonds that each have a face value of $1,000). Each bond can be converted anytime by the bondholder into 24 shares of common stock. The bonds were issued on January 1, 2005 and pay interest annually on January 1. The effective interest method is used to amortize all bond discount or premium. 3 1. 10 points This question refers to the bonds that have a stated interest rate of 6%. a. What is total interest expense on these bonds for fiscal 2008 (year ended 12/31/08)? b. What is the carrying value of these bonds as of 12/31/08? For parts c and d, assume that the bonds are retired on December 31, 2009. c. How much gain or loss will Clarence recognize on the retirement? Please provide a dollar amount and state whether it is a gain or loss. d. How much cash will Clarence have to pay the bondholders on that date? If there is more than one item that affects cash flows, list each separately and, for each, provide a dollar amount. If the amounts are not zero, for each, indicate whether it is a cash inflow or outflow and whether it would appear as an operating, investing, or financing activity in the cash flow statement. 2. 8 points 4 a. What is the effect of the investment in Goat Company on net income and comprehensive income in fiscal 2008 under each of the following classifications for investments. If not zero, you must provide an amount and a sign (+ for increase income, - for decrease income). Available for Sale Trading Effect on net income Effect on other comprehensive income b. c. 4. 5 If the investment in Llama is accounted for as an available-for-sale security, what is its value in the assets section of the balance sheet as of 12/31/08? If the investment in Llama is accounted for as a trading security, what is its value in the assets section of the balance sheet as of 12/31/08? 2 points If all of the convertible bonds were converted into common stock on January 1, 2009 when the fair market value of the stock was $55/share (after all entries to record interest expense were properly recorded), what would be the effect on net income? You must indicate increase, decrease, or no effect and, if increase or decrease, indicate a dollar amount. 6