Option #1: Financing Activities Analysis: Hayes, Inc.

Answer the following questions in your submission.

Question #1: Some car companies currently face numerous lawsuits due to reported cases of failed brakes, which could negatively impact image of those companies. Such lawsuits are prime examples of contingent losses because the loss is contingent upon an adverse settlement or verdict in the case. The litigation loss contingency should be accrued if a loss is probable and can be estimated. Probable and estimable are difficult concepts that offer managers a fair degree of discretion.

1. List two reasons why the managers in this case might resist quantification and accrual of a loss liability.
2. In 1-2 paragraphs, describe a circumstance when managers might be willing to accrue a contingent loss that they had earlier resisted accruing.

Question #2: On January 1, 2014, Hayes, Inc. leases equipment from Smithsonian Company for an annual lease rental of $25,000. The lease term is five years, and the lessor’s interest rate implicit in the lease is 8%. The lessee’s incremental borrowing rate is 8.25%. The useful life of the equipment is five years, and its estimated residual value equals its removal cost. Annuity tables indicate that the present value of an annual lease rental of $1 (at 8% rate) is $3.993. The fair value of leased equipment equals the present value of rentals. (Assume the lease is capitalized.)

Required:

1. Prepare accounting entries required by Hayes, Inc. for 2014.
2. Compute and illustrate the effect on the income statement for the year ended December 31, 2014, and for the balance sheet as of December 31, 2014.
3. Construct a table showing payments of interest and principal made every year for the five-year lease term.
4. Construct a table showing expenses charged to the income statement for the five-year lease term if the equipment is purchased. Show a column for (1) amortization, (2) interest, and (3) total expenses.
5. In one paragraph, discuss the income and cash flow implications from this capital lease.

Your submission should:

• Be 1-2 pages for the written portion.
• Include the Excel spreadsheet with computations.
• Clearly separate your responses so your instructor knows the problems you are answering.