Accounting for Lawyers s1

1 ACCOUNTING FOR LAWYERS Professor Bradford

December 14, 2005 9:00 a.m. 4 Hours

INSTRUCTIONS (PLEASE READ BEFORE PROCEEDING!)

1. This is a partially open book exam. You may use the casebook, the Bradford & Ames book, the handouts I distributed, and any materials, such as notes or outlines, prepared exclusively by you. You may also use a calculator. You may not use any other materials and you may not consult with or communicate with any other person during this exam. If you have any other books, notes, briefcases, book bags, or other items, you must bring them to the front of this room. You may not take any of these items to the special purpose rooms.

2. You have four hours (4:00) to complete the exam. The time at which the exam ends will be posted on the board. Writing anything after time is called is an Honor Code violation. You may not even finish a word or sentence.

3. If you finish the exam more than five minutes early, you may turn in your answers in the Dean's Office. Otherwise, you must turn in your answers in this room—regardless of where you take the exam.

4. This exam has eleven (11) pages, including the instructions. The page numbers appear on the top right-hand corner of each page. Please check to be sure that this copy has all the pages.

5. The exam consists of five (5) questions. The recommended time for each question is as follows:

Question One…………………..….25 Minutes Question Two……………..………75 Minutes Question Three……….…….…….35 Minutes Question Four………………….…35 Minutes Question Five…………………..…30 Minutes

An additional 40 minutes is not allocated to any particular question and is yours to use as you choose. Each question will be weighted in accordance with its recommended time.

CONTINUE TO THE NEXT PAGE. 2

6. You may take the exam in this room or in a designated special purpose room (typing or overflow room) posted on the board. If you decide to take the exam in a special purpose room, remember that (1) time will be called only in this room, and (2) when time is called, you must either be present in this room or have already turned in your answers.

7. Do not spend all of your time writing. THINK AND ORGANIZE YOUR ANSWERS BEFORE WRITING. Be clear. Be concise. Be organized.

8. Please write legibly. I can=t give you credit for what I can=t read.

9. If the answer involves a calculation, please show your work so I can see how you calculated the answer. If I cannot see how you calculated the answer, you will not receive full credit.

10. If you believe that additional facts are necessary to answer a question, state exactly what those facts are and how they would affect your answer. If you believe that a question is ambiguous or unclear, note the ambiguity or lack of clarity and indicate how it affects your answer.

11. The questions may be answered in blue books, on lined notebook paper, or typed on typing paper if you type your exam. Please write or type on only one side of each page. Double- space if you type. BE SURE TO WRITE YOUR EXAM IDENTIFICATION NUMBER ON EACH BLUE BOOK OR PIECE OF PAPER THAT YOU USE. If you are not using blue books, please staple your pages together in order. Do not put your name on any materials you turn in.

12. The Honor Code is in effect.

13. Good luck and have a pleasant holiday.

DO NOT TURN THIS PAGE UNTIL YOU ARE GIVEN THE SIGNAL TO START. 3 Question One (25 Minutes)

You are the trial attorney for Nell. Nell was injured in an assault by Snidely Whiplash. Snidely’s attorney has just offered a structured settlement that would pay your client $10,000 a year at the first of each year, beginning now, for the first five years and $20,000 a year for the five years after that. In other words, Nell would receive the following payments:

Now $10,000 Dec. 14, 2006 $10,000 Dec. 14, 2007 $10,000 Dec. 14, 2008 $10,000 Dec. 14, 2009 $10,000

Dec. 14, 2010 $20,000 Dec. 14, 2011 $20,000 Dec. 14, 2012 $20,000 Dec. 14, 2013 $20,000 Dec. 14, 2014 $20,000

What is the present value of this structured settlement to Nell? Assume that Nell can earn a 5% return on any money she invests and that the settlement is guaranteed: there is no risk that Nell will not receive the payments. Ignore any attorneys’ fees involved in concluding the settlement. 4 Question Two (75 Minutes)

Paula’s Pork Rinds, Inc. is a corporation that buys pork rinds from wholesalers and sells them to local stores. Paula’s has been in business for several years; the company’s balance sheet as of October 31, 2005 appears below:

Paula's Pork Rinds, Inc. Balance Sheet As of October 31, 2005

Assets Liabilities and Shareholders' Equity

$30,00 Cash 0 Liabilities Accounts Receivable $27,000 Accounts Payable $6,430 Less: Allowance for $23,40 Doubtful Accounts $3,600 0 Prepaid Expenses $1,300 Shareholders' Equity Equipment $6,000 Common Stock $900 Less: Accumulated Depreciation $2,970 $3,030 Additional Paid-In Capital $34,000 Inventory (800 cases) $8,000 Retained Earnings $24,400

$65,73 Total Liabilities and Total Assets 0 Shareholders' Equity $65,730

The following events occurred in November:

Date Transaction

Nov. 2 Sold 150 cases of pork rinds to Lo-Vee for $2,250 cash.

Nov. 5 Super Savor paid $5,000 on its account owed to Paula's. Super Savor's debt was 15 days old.

Nov. 7 Sold 75 cases of pork rinds to Food Queen for $1,000 cash. Food Queen took the pork rinds at the time of payment. Agreed that Food Queen can return the pork rinds and get its money back if it doesn’t 5

resell them before their expiration date.

Nov. 9 Ordered 50 cases of pork rinds from Oink, Inc. for a price of $600. Paula’s did not pay at the time of the order.

Nov. 10 Mal-Mart unexpectedly paid $2,000 that it has owed to Paula's for the last ten months.

Nov. 15 Paid salaries of $5,000 for the first half of November.

Nov. 20 Lo-Vee returned 20 cases of the pork rinds purchased on Nov. 2 for a $300 cash credit. Paula's has not yet paid this credit.

Nov. 24 Costsaver paid $3,000 for pork rinds. Paula’s has not yet delivered the pork rinds to Costsaver.

Nov. 25 Delivered 180 cases of pork rinds to Jumbo Mart, for which Jumbo Mart has agreed to pay $2,500. Jumbo Mart has not yet paid.

Nov. 26 Oink, Inc. delivered the 50 cases of pork rinds Paula's had previously ordered on November 9. Paula's has not yet paid Oink for these pork rinds.

Nov. 27 Returned 20 of the cases of pork rinds purchased from Oink, Inc. when Paula’s discovered that their expiration date had passed. Oink has agreed to a $240 credit against the money owed.

Nov. 28 Paid December rent of $1,500. This is higher than the November rent of $1,300, which Paula’s paid in October, because the lease includes utilities and has a cost escalation clause that increases the rent when utility costs increase.

Nov. 30 Learned that this month’s phone bill is $200. Paula’s has not yet paid it.

Nov. 30 Calculated that it owes salaries of $5,000 to employees for the second half of November. Paula’s has not yet paid those salaries. 6

Nov. 30 Purchased a used packaging machine from Machinery, Inc. for 1,000 shares of Paula’s common stock (par value = $.10/share). The machine had a book value on Machinery's balance sheet of $5,000. Its fair market value is $8,000.

Other Information that Might (or Might Not) Be Useful:

1. A count at the end of the month revealed that Paula’s has 400 cases of pork rinds in stock.

2. Paula’s uses the average cost method of valuing its inventory.

3. Pork rinds have no carbohydrates.

4. Paula’s uses the 150% declining balance depreciation method. The salvage value of the machinery shown on its October 31 balance sheet is $3,000. Its total expected useful life when acquired was 60 months. Its remaining useful life, including November, is 33 months.

5. Nearly $1 billion worth of pork rinds are sold in the United States every year.

6. Paula’s ages its accounts receivable. Based on past experience, it assumes that 95% of accounts one month old or less will be paid, 80% of accounts 1-6 months old and 50% of accounts greater than 6 months old. Of the accounts receivable shown on the October balance sheet, $22,000 were one month old or less at the time, none were 1-6 months old, and $5,000 were greater than 6 months old.

7. Not a single U.S. law firm offers free pork rinds as a year-end bonus to associates.

8. Paula’s pays a flat 10% income tax on its net income.

Prepare all necessary journal entries for Paula’s for the month of November. Post those entries to T-accounts. (Don’t forget to enter the initial balances.) Prepare a November income statement and a balance sheet as of the end of November for Paula’s.

7 Question Three (35 Minutes)

Buyer Corporation is a Delaware corporation. Seller General Partnership is a Delaware limited partnership. Buyer has agreed to buy all of Seller’s assets and assume all of its liabilities for a cash price of $350,000. Buyer will borrow the $350,000 from a bank at the time of closing and sign a note agreeing to pay the principal plus 5% interest in annual installments over a ten- year period.

Buyer’s and Seller’s balance sheets as of immediately before the transaction appear on the following two pages. Prepare a balance sheet for Buyer Corporation immediately after the purchase is completed.

Things you might (or might not) need to know:

1. Seller’s Inventory has a fair market value of $150,000. Seller’s Equipment has a fair market value of $110,000. 2. Seller General Partnership uses the FIFO method of inventory valuation and the double- declining-balance method of depreciation. 3. Buyer’s Equipment has a fair market value of $100,000. Buyer’s Building has a fair market value of $270,000. Buyer’s Land has a fair market value of $250,000. Buyer’s Inventory has a fair market value of $80,000. 4. Buyer Corporation uses the LIFO method of inventory valuation and the straight-line depreciation method. 8

Buyer Corporation Balance Sheet As of December 14, 2005

Assets Liabilities and Shareholders' Equity

Cash $100,000 Liabilities Accounts Receivable $60,000 Accounts Payable $20,000 Less: Allowance for Note Payable $50,000 Doubtful Accounts $5,000 $55,000

Inventory $60,000 Total Liabilities $70,000 Equipment $95,000 Less: Accumulated Shareholders' Equity Depreciation $15,000 $80,000 Capital Stock $5,000 Building $300,000 Additional Paid-In Capital $70,000 Less: Accumulated Retained Earnings $530,000 Depreciation $50,000 $250,000

Land $130,000 Total Shareholders' Equity $605,000

Total Liabilities and Total Assets $675,000 Shareholders' Equity $675,000 9

Seller General Partnership Balance Sheet As of December 14, 2005

Liabilities and Assets Partners' Equity

Cash $65,000 Liabilities Accounts Receivable $15,000 Accounts Payable $30,000 Less: Allowance for Doubtful Accounts $2,000 $13,000

Inventory $120,000 Partners' Equity $258,000 Equipment $100,000 Less: Accumulated Depreciation $10,000 $90,000

Total Liabilities and Total Assets $288,000 Partners' Equity $288,000 10 Question Four (35 Minutes)

Bailey Machinery Corporation is a large public company that makes industrial machinery for manufacturers. Bailey’s fiscal year ends on December 1. On November 15 of this year, Bailey hadn’t met its sales target for the year. Billy Bailey, Bailey’s Vice President for Finance, informed the board of directors that it would probably fall short of the sales target by about half a million dollars. He also indicated that Bailey’s stock price would probably drop significantly if it didn’t meet the sales target.

On November 16, Bailey entered into a contract with Mr. Potter, Bailey’s largest shareholder (owning 10% of its stock) and a member of Bailey’s board of directors. Potter agreed to buy two large machines from Bailey for a total of $500,000 cash. This is a bargain price; these machines usually sell for about $300,000 each.

Potter intends to resell the machines, but the contract is not contingent on resale. It is, however, subject to the unconditional money back guarantee that Bailey gives all its customers. Over the years, the return rate on Bailey’s contracts has been pretty consistent at 2%.

The contract provides that, when Potter resells the machines, Bailey will visit the ultimate customer’s site and do a final tune-up of the machines. Bailey usually sells its machines directly to the ultimate user, not for resale, but it always does this final tune-up for its customers. The final tune-up costs approximately $1,000 per machine.

The machines were delivered to Potter on November 30. Potter has not yet paid for the machines, nor has he resold them.

Discuss how Bailey should account for this transaction. 11

Question Five (30 Minutes)

You are an attorney in Lincoln, Nebraska. One of your clients is Husker Corporation, a publicly traded corporation. You just received a signed letter from Husker asking you to provide information to its auditor on all loss contingencies of which you’re aware. The letter does not identify any specific contingencies. The letter expressly waives any attorney-client privilege or right of confidentiality Husker might have.

You have only handled one matter for Husker, a contract dispute concerning a guaranty Husker provided Wolverine Corporation. Wolverine claims Husker is liable for a $1.5 million debt owed to Wolverine by L’il Red, Inc. (LRI). Husker admits it gave a guaranty to Wolverine of some of the debt of LRI, and does not dispute the amount of the debt LRI owes Wolverine, but contends the guaranty doesn’t cover this particular debt.

You have been negotiating with Wolverine’s attorney for about three months now, but the two sides have made very little progress. Two weeks ago, Wolverine’s attorney threatened to sue, but no lawsuit has been filed. You think Husker has a colorable claim and might win, but believe Husker is reasonably likely to lose. If Husker loses, the amount of liability will be $1.5 million. Both sides concede that, under the terms of the guaranty, Wolverine is not entitled to interest or attorneys’ fees.

Discuss how you should respond to the audit request.