Name (Print/Capital Letters) __Answer Key_______________________________

UIN ____________________________________________

University of Illinois at Chicago

ACTG 500: Introduction to Financial Accounting
Fall 2009
Midterm Examination

Instructions—READ CAREFULLY!

1. This exam is closed book, closed notes. You are only allowed to use an
electronic calculator and a single-sided, letter-size (A4) “cheat sheet.”
Consulting other students or materials and the use of PDAs, laptops, cell
phones or other electronic/communication devices are strictly prohibited.
2. No questions of any kind are permitted during the exam. Make
appropriate assumptions, where needed, and write them on the exam.
3. You have 150 minutes to complete the exam from the time I start it.
4. The exam consists of 3 parts and has 12 pages, including the cover sheet
and a scratch page provided for additional calculations. Please check your
exam for completeness and let me know if any pages are missing.
5. Use only the paper provided with the exam. All pages, even if blank, must
be returned with the exam.
6. Please write your name on the “cheat sheet” and submit it with the exam.
7. Where applicable, show your work and supporting calculations, not just
the final answer. This will help you earn partial credit.
8. If you finish early, check your work to avoid careless errors. When you are
ready to leave, bring your exam to the front of the room. Please leave the
room quietly so that other are not disturbed.
9. When I call time, stop writing immediately and place your writing
instrument on the desk. Failure to do so will cost you 30 points.

DECLARATION OF ACADEMIC INTEGRITY

I hereby declare that this examination represents my individual effort, that I have
understood the above instructions and agree to abide by them, and that I have neither
cheated on this examination nor have I assisted anyone else in cheating.

I understand that if I break the above pledge, I am subject to any penalty that the
Department of Accounting, College of Business Administration and/or the University of
Illinois deems appropriate including, but not limited to, failing this course.

Signed: __________________________________

Dated: ___________________________________
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Part 1: Multiple Choice Questions (3 point each, Total = 30 points)

For each question, place an ‘X’ in the box next to the correct answer.

1. An accrual of wages expense would produce what effect on the balance sheet?

X Increase liabilities and decrease earned capital

Decrease liabilities and increase earned capital
Decrease expenses and increase liabilities
Decrease assets and decrease liabilities

2. BJ Services, an oil and gas company, reports net income for fiscal 2008 of
$609.4 million, retained earnings at the end of the year of $3,677.3 million,
dividends during the year of $58.7 million and other transactions that
decreased retained earnings by $57.3 million. What was the company’s
retained earnings balance at the start of fiscal 2008?

$3,069.3 million
X $3,183.9 million
$4,170.7 million
There is not enough information to determine the answer

Retained earnings, 2008 = Retained earnings, 2007 + Net Income – Dividends +/-
Other; i.e., 3,677.3 = Retained earnings, 2007 + 609.4 – 58.7 – 57.3.
Therefore, Retained earnings at the start of the year were $3,183.9 million.

3. American Airlines’ 2007 balance sheet reported the following (in millions):

Total Assets $25,385

Total Liabilities 23,941
Contributed Capital $ 4,422

What was the sum of American Airlines’ Total Liabilities and Stockholders’
Equity at December 31, 2007?

X $25,385 million
$23,941 million
$28,363 million
There is not enough information to determine the answer

Assets = Liabilities + Stockholders Equity.

Assets = $25,385 so this is the total of liabilities and equity combined.
 3

4. As inventory and PPE assets on the balance sheet are consumed, they are
reflected:

As a revenue on the income statement

As a cash flow outflow on the Statement of Cash flows
X As an expense on the income statement
Assets are never consumed

5. Nike Inc. has a fiscal year end of May 31. On May 31, 2007, Nike Inc. reported
$10,688.3 million in assets and $7,025.4 million in equity. During fiscal 2008,
Nike’s assets increased by $1,754.4 million while its equity increased by $799.9
million. What were Nike’s total liabilities at May 31, 2007 and May 31, 2008?

May 31, 2007: $3,662.9; May 31, 2008: $4,162.8

X May 31, 2007: $3,662.9; May 31, 2008: $4,617.4
May 31, 2007: $2,863.0; May 31, 2008: $4,617.4
There is not enough information to determine the answer

Assets = Liabilities + Equity

May 31, 2007: $10,688.3 = Liabilities + $7,025.4, Liabilities = $3,662.9
May 31, 2008: $10,688.3 + $1,754.4 = Liabilities + $7,025.4 + $799.9
Therefore, Liabilities = $4,617.4.

Note: Due to a typo, an incorrect amount ($3,362.9) was given as one of the
choices. Students were given the benefit of the doubt if they mentioned the
correct amount and/or showed their work.

6. In its December 31, 2008 financial statements, Harley-Davidson reported the

following (in millions):

Long-term Current Long-term Total Equity

Assets Liabilities Liabilities Liabilities
$2,450.7 $ 2,603.8 $ 3,109.2 $5,713.0 $2,115.6

At December 31, 2008, current assets amount to:

X $5,377.9 million
$7,828.6 million
$153.1 million
There is not enough information to determine the answer
 4

Total assets = Total liabilities + Equity, and Total assets – Long-term assets =
Current assets; i.e., Current assets = $5,713 + $2,115.6 - $2,450.7.
Therefore, Current assets = $5,377.9.

7. The following is NOT an example of accounting adjustments:

Prepaid expenses
X Unforeseen expenses
Accrued expenses
Deferred revenues

8. In its fiscal 2007 Balance Sheet, CarMax reported Cash and cash equivalents at
the start of the year of $19,455 thousand. By the end of the year, the Cash and
cash equivalents had decreased to $12,965 thousand. The company’s Statement
of Cash Flows reported Cash from operating activities of $79,520 thousand,
Cash from financing activities of $171,007 thousand. What amount did the
company report for Cash from investing activities?

$257,017 thousand cash outflow

$257,017 thousand cash inflow
X $257,017 thousand cash outflow
There is not enough information to determine the answer

Cash at end of year = Cash at start of year + Cash from operations + Cash from
investing + Cash from financing
$12,965 = $19,455 + $79,520 + Cash from investing + $171,007
Thus, Cash from investing is an outflow of $257,017.

9. How would a purchase of $100 worth of inventory on credit affect the income
statement?

It would increase liabilities by $100

It would increase expenses by $100
It would increase non-cash assets by $100
X None of the above

There is no income statement effect of an inventory purchase.

 5

10. Intelligentsia Corp. recorded restructuring charges (expenses) of $78,514

thousand during fiscal 2009 related entirely to expected employee separation
payments. Intelligentsia had never before incurred restructuring charges. At the
end of the year, the company’s balance sheet included a restructuring accrual (a
current liability) of $9,881 thousand. How much was the cash flow effect of
Intelligentsia’s restructuring during fiscal 2009 (i.e., how much cash did the
company actually pay out)?

$9,881 thousand
$88,395 thousand
X $68,633 thousand
There is not enough information to determine the answer

The total restructuring charge accrued was $78,514 of which $9,881 was still
unpaid (a liability) at the end of the year. The difference of $68,633 must have
been paid in cash during the year. Therefore, the cash flow effect is $68,633.
 6

Part 2: Oracle Corporation (30 points)

The 2008 annual report of Oracle Corporation includes the following footnote
(excerpted):

Revenue Recognition

We derive revenues from the following sources: (1) software, which includes new
software license and software license updates and product support revenues, and (2)
services, which include consulting, On Demand, and education revenues.

We recognize new software license revenue when: (1) we enter into a legally binding
arrangement with a customer for the license of software; (2) we deliver the products; (3)
customer payment is deemed fixed or determinable and free of contingencies or
significant uncertainties; and (4) collection is probable. Substantially all of our new
software license revenues are recognized in this manner.

The vast majority of our software license arrangements include software license updates
and product support, which are recognized ratably over the term of the arrangement,
typically one year.

Revenues for consulting services are generally recognized as the services are performed.
If there is a significant uncertainty about the project completion or receipt of payment
for the consulting services, revenues are deferred until the uncertainty is sufficiently
resolved. We estimate the proportional performance on contracts with fixed or “not to
exceed” fees on a monthly basis utilizing hours incurred to date as a percentage of total
estimated hours to complete the project. If we do not have a sufficient basis to measure
progress towards completion, revenue is recognized when we receive final acceptance
from the customer.

Oracle On Demand provides multi-featured software and hardware management and

maintenance services delivered either at our data center facilities, at select partner data
centers, or at customer facilities. Revenue from On Demand services is recognized over
the term of the service period, which is generally one year.

Education revenues include instructor-led, media-based and internet-based training in

the use of our products. Education revenues are recognized as the classes or other
education offerings are delivered.

For arrangements with multiple elements, we allocate revenue to each element of a

transaction based upon its fair value as determined by “vendor specific objective
evidence.” Vendor specific objective evidence of fair value for all elements of an
arrangement is based upon the normal pricing and discounting practices for those
products and services when sold separately and for software license updates and
product support services is also measured by the renewal rate offered to the customer.

Answer the following questions based on Oracle’s revenue recognition disclosure.

 7

a. What are the five sources of revenue for Oracle Corporation? (5 points)

Oracle’s five types of revenue are: 1) new software licenses, 2) software

license updates and product support, 3) consulting services, 4) On
Demand, and 5) education revenues.

b. Explain, briefly and in plain English, how Oracle recognizes revenue for
each of the five types of revenue. (10 points)

Revenue on new software licenses is recorded when the customer takes

delivery of the software provided that the sales price is established and
the customer has the ability to pay. Revenue on updates and product
support is prorated over the contractual period that Oracle promises the
updates or support. Consulting revenues are recognized as the services
are performed. On Demand revenues are spread out evenly over a year.
Education revenues are recognized at the end of the training sessions.

c. What are “arrangements with multiple elements”? How does Oracle

account for such arrangements? (5 points)

Arrangements with multiple elements are sales that include two or more
of the five types of Oracle’s revenue items. To account for these, Oracle
first determines the fair value of each element separately and pro rates the
total sales amount to each element. The company then recognizes revenue
as earned on each element according to when it is earned.

d. Assume that Oracle has a sale that involves new software, software license
updates and product support for two years, and an educational package
for the customer’s employees, which will be fulfilled in six months. If sold
separately, Oracle would charge the following for each of these elements:
$1 million, $150,000, and $400,000. Because the customer buys the entire
package, the sales price is $1,317,500. What revenue would Oracle record
for each element? (10 points)

If sold separately, the bill would come to $1,550,000 for this sale
($1,000,000 + $150,000 + $400,000). Oracle allocates the sales price of
$1,317,500 in proportion to the market value of each piece, i.e., new
software: $850,000 recognized when the software is delivered; updates
and support: $127,500 recognized over two years; and educational
package: $340,000 recognized over six months.
 8

Part 3: The Tribune Company (40 points)

The Tribune Company is a large, employee-owned, multimedia corporation

based in Chicago, Illinois. It is the nation's second-largest newspaper publisher,
responsible for the Chicago Tribune, Los Angeles Times, Hartford Courant, Orlando
Sentinel, South Florida Sun-Sentinel, Baltimore Sun and the The Morning Call,
among others. Through other subsidiaries, the Tribune Company also owns
Tribune Broadcasting, Tribune Entertainment, Tribune Media Services, and the
Chicago Cubs baseball team. The company was founded in 1847 and
incorporated in Illinois in 1861.

The Tribune Company filed for Chapter 11 Bankruptcy on December 8, 2008. The
company is struggling under a $13 billion debt load, much of it incurred in
taking the company private in 2007, and from plummeting advertising income at
its newspapers. The following excerpts are taken from the 2007 Annual Report of
The Tribune Company.

Read the financial statement disclosures carefully and answer the questions that
follow the disclosures.

TRIBUNE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies of Tribune Company and subsidiaries (the

“Company”), as summarized below, conform with accounting principles
generally accepted in the United States of America and reflect practices
appropriate to the Company’s businesses.

Accounts Receivable—The Company’s accounts receivable are primarily due

from advertisers. Credit is extended based on an evaluation of each customer’s
financial condition, and generally collateral is not required. The Company
maintains an allowance for uncollectible accounts, rebates and volume discounts.
This allowance is determined based on historical write-off experience and any
known specific collectibility exposures.

Inventories—Inventories are stated at the lower of cost or market. Cost is

determined on the last-in, first-out (“LIFO”) basis for newsprint and on the first-
in, first-out (“FIFO”) basis for all other inventories.
 9

CONSOLIDATED BALANCE SHEETS (EXCEPTED)

(In thousands of dollars)
Dec. 30, 2007 Dec. 31, 2006
Assets
Current Assets
Cash and cash equivalents $ 233,284 $ 174,686
Accounts receivable (net of allowances of $32,230 and $33,771) 732,853 734,871
Inventories 40,675 40,962
Broadcast rights 287,045 271,995
Deferred income taxes — 74,450
Prepaid expenses and other 91,166 49,466
Total current assets 1,385,023 1,346,430

NOTE 6: INVENTORIES

Inventories consisted of the following (in thousands):

Dec. 30, 2007 Dec. 31, 2006

Newsprint $ 28,664 $ 28,629
Supplies and other 12,011 12,333
Total inventories $ 40,675 $ 40,962

Newsprint inventories valued under the LIFO method were less than current
cost by approximately $10 million at Dec. 30, 2007 and $15 million at Dec. 31,
2006.

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS AND

RESERVES
(In thousands of dollars)

Balance at Additions Additions Balance

Recorded Deductions at End
Description Beginning Charged to Upon (1) of Period
Accounts receivable allowances:

Year ended Dec. 30, 2007 $ 33,771 $ ???? $ — $ 71,824 $ ????

Year ended Dec. 31, 2006 $ 42,558 $ 80,553 $ 55 $ 89,395 $ ????

Year ended Dec. 25, 2005 $ 49,507 $ 80,514 $ — $ ???? $ 42,558

Note: I have blanked out some amounts in the above schedule on purpose. You
may need to calculate those amounts in order to answer the following questions.
 10

The following questions relate to fiscal year 2007, unless noted otherwise.
Show your calculations to earn partial credit.

1. What is the total amount owed by Tribune’s customers? (3 points)

Gross A/R, 2007: $732,853 + $32,230 = $765,083

This is the total amount owed by Tribune’s customers in 2007.

2. What percentage of the above amount does Tribune expect to collect? (5

points)

Net A/R, 2007 = $732,853 which is

732,853/765,083 = 95.8% of its gross A/R.

3. What amount of accounts receivable did Tribune write off? (6 points)

Deductions or subtractions from the allowance account represent bad debt

write-offs.

Therefore, from Schedule II, Write-offs in 2007 = $71,824.

4. What amount of bad debt expense did Tribune recognize? (6 points)

Transaction equations for the allowance account:

Beginning balance + Additions (Bad debt expenses) – Subtractions (write-
offs) = Ending balance

From Schedule II and the Balance Sheet:

33,771 + ???? – 71,824 = 32,230

Therefore, bad debt expense in 2007 = $70,283.

 11

5. What would be the value of Tribune’s inventories under the FIFO

method? (6 points)

Newsprint inventories would be higher by $10 million, i.e., $10,000

thousands, in 2007. Therefore, newsprint inventories under FIFO would
be $38,664 (in thousands), and total inventories under FIFO would be
$50,675 thousands.

6. How much is Tribune’s LIFO reserve in 2007? (4 points)

Tribune’s LIFO reserve is the excess of FIFO inventories over LIFO

inventories. As noted above, it is $10,000 thousand ($10 million) in 2007.

7. How much is the change in Tribune’s LIFO reserve from 2006 to 2007? (4
points)

Tribune’s LIFO reserve has decreased from $15,000 thousand in 2006 to

$10,000 thousand in 2007, i.e., a decrease of $5,000 thousand ($5 million).

8. What would be the cost of goods sold under a FIFO approach in 2007? (6
points)

Tribune’s 2007 income statement reported its cost of goods sold (cost of
sales) as $2,545,554 thousand in 2007. This amount is reported under the
company’s policy of reporting its inventories using the LIFO method.

According to the formula for conversion from LIFO to FIFO cost:

COGS FIFO = COGS LIFO + (LIFO Reserve BEG – LIFO Reserve END)

Therefore, COGSFIFO = $2,545,554 + (15,000 – 10,000) = $2,550,554.

In this case, COGSFIFO turns out to be higher than COGSLIFO because the
company has “dipped into its LIFO layers.”