TEST BANK for Intermediate Accounting, Volume 2, 5th Edition By Kin Lo; George Fisher by ACADEMIAMILL

TEST BANK

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Appendix A Financial Statement Analysis Learning Objective 1 Describe the purpose of common size financial statements and the information they convey. 1) Which of the following statements is correct regarding "common size financial statements"? A) Common size financial statements are a form of benchmarking. B) Common size financial statements are used to evaluate the liquidity of a company. C) Common size financial statements are a type of vertical analysis. D) Common size financial statements are used primarily for horizontal analysis. Answer: C Diff: 1 Type: MC Skill: Concept Objective: A-1 Describe the purpose of common size financial statements and the information they convey. 2) Which of the following practices presents income statement items as a percentage of sales? A) Benchmarking. B) Horizontal analysis. C) Trend analysis. D) Vertical analysis. Answer: D Explanation: Common-size financial statements, which are a form of vertical analysis, present income statement items as a percentage of sales. Diff: 1 Type: MC Skill: Concept Objective: A-1 Describe the purpose of common size financial statements and the information they convey. 3) Which of the following practices presents balance sheet items as a percentage of total assets? A) Benchmarking. B) Horizontal analysis. C) Trend analysis. D) Vertical analysis. Answer: D Explanation: Common-size financial statements, which are a form of vertical analysis, present balance sheet items as a percentage of total assets. Diff: 1 Type: MC Skill: Concept Objective: A-1 Describe the purpose of common size financial statements and the information they convey.

4) Use the financial statement information that follows to prepare common size financial statements for Example Company Inc. for 2024 and 2025. Round percentages to one decimal place, e.g. 45.2%. Example Company Inc. Income Statement For the years ended December 31 (in millions of dollars) 2025 Revenue $53,400 Cost of goods sold 36,800 Gross profit 16,600 Operating expenses 11,800 Operating profit 4,800 Interest and finance costs 900 Income before taxation 3,900 Income taxes 1,170 Net income $ 2,730 Example Company Inc. Balance Sheet As at December 31 (in millions of dollars) 2025 Assets Current assets Cash and cash equivalents $ 1,250 Accounts receivable 4,900 Inventories 5,100 Prepaid assets 200 Current assets 11,450 Non-current assets 36,300 Total assets $47,750 Liabilities Current liabilities Accounts payable $ 5,350 Other current liabilities 3,800 Current liabilities 9,150 Long-term indebtedness 16,000 Total liabilities 25,150 Equity Common shares 1,000 Retained earnings 21,600 Equity 22,600 Total liabilities and equity $47,750

2024 $50,100 32,700 17,400 13,100 4,300 1,000 3,300 990 $ 2,310

2024

$ 1,200 4,550 4,850 250 10,850 28,650 $39,500

$ 4,900 3,700 8,600 9,400 18,000 1,000 20,500 21,500 $39,500

Answer:

Example Company Inc. Common Size Income Statement For the years ended December 31 (in millions of dollars) 2025 2025 2024 Revenue $53,400 100.0% $50,100 Cost of goods sold 36,800 68.9% 32,700 Gross profit 16,600 31.1% 17,400 Operating expenses 11,800 22.1% 13,100 Operating profit 4,800 9.0% 4,300 Interest and finance costs 900 1.7% 1,000 Income before taxation 3,900 7.3% 3,300 Income taxes 1,170 2.2% 990 $ Net income 2,730 5.1% $ 2,310 Example Company Inc. Common Size Balance Sheet As at December 31 (in millions of dollars) 2025 2025 Assets Current assets Cash and cash equivalents $ 1,250 2.6% Accounts receivable 4,900 10.3% Inventories 5,100 10.7% Prepaid assets 200 0.4% Current assets 11,450 24.0% Non-current assets 36,300 76.0% Total assets $47,750 100.0% Liabilities Current liabilities Accounts payable $ 5,350 11.2% Other current liabilities 3,800 8.0% Current liabilities 9,150 19.2% Long-term indebtedness 16,000 33.5% Total liabilities 25,150 52.7% Equity Common shares 1,000 2.1% Retained earnings 21,600 45.2% Equity 22,600 47.3% Total liabilities and equity $47,750 100.0%

2024 100.0% 65.3% 34.7% 26.1% 8.6% 2.0% 6.6% 2.0% 4.6%

2024

$ 1,200 4,550 4,850 250 10,850 28,650 $39,500

3.0% 11.5% 12.3% 0.6% 27.5% 72.5% 100.0%

$ 4,900 3,700 8,600 9,400 18,000

12.4% 9.4% 21.8% 23.8% 45.6%

1,000 20,500 21,500 $39,500

2.5% 51.9% 54.4% 100.0%

Diff: 2 Type: ES Skill: Concept Objective: A-1 Describe the purpose of common size financial statements and the information they convey.

Learning Objective 2 Describe the purpose of ratio analysis and the information the output conveys. 1) The return on common equity (ROCE) ratio is an example of what type of ratio? A) Liquidity ratio. B) Profitability ratio. C) Solvency ratio. D) Credit risk ratio. Answer: B Diff: 1 Type: MC Skill: Concept Objective: A-2 Describe the purpose of ratio analysis and the information the output conveys.

2) Complete the table below by categorizing each ratio as a liquidity ratio, a profitability ratio, or a solvency ratio. Ratio Category of ratio Accounts payable turnover ratio Accounts receivable turnover ratio Current ratio Earnings per share (EPS) Gross (profit) margin Interest coverage ratio Inventory turnover ratio Long-term debt to equity ratio Profit margin on sales Quick ratio Return on assets Return on equity Answer: Ratio Accounts payable turnover ratio Accounts receivable turnover ratio Current ratio Earnings per share (EPS) Gross (profit) margin Interest coverage ratio Inventory turnover ratio Long-term debt to equity ratio Profit margin on sales Quick ratio Return on assets Return on equity

Category of ratio Liquidity ratio Liquidity ratio Liquidity ratio Profitability ratio Profitability ratio Solvency ratio Liquidity ratio Solvency ratio Profitability ratio Liquidity ratio Profitability ratio Profitability ratio

Diff: 1 Type: SA Skill: Concept Objective: A-2 Describe the purpose of ratio analysis and the information the output conveys.

Exhibit A-1

Example Company Inc. Income Statement For the years ended December 31 (in millions of dollars) 2025 Revenue $53,400 Cost of goods sold 36,800 Gross profit 16,600 Operating expenses 11,800 Operating profit 4,800 Interest and finance costs 900 Income before taxation 3,900 Income taxes 1,170 Net income $ 2,730 Example Company Inc. Balance Sheet As at December 31 (in millions of dollars) 2025 Assets Current assets Cash and cash equivalents $ 1,250 Accounts receivable 4,900 Inventories 5,100 Prepaid assets 200 Current assets 11,450 Non-current assets 36,300 Total assets $47,750 Liabilities Current liabilities Accounts payable $ 5,350 Other current liabilities 3,800 Current liabilities 9,150 Long-term indebtedness 16,000 Total liabilities 25,150 Equity Common shares 1,000 Retained earnings 21,600 Equity 22,600 Total liabilities and equity $47,750

2024 $50,100 32,700 17,400 13,100 4,300 1,000 3,300 990 $ 2,310

2024

$ 1,200 4,550 4,850 250 10,850 28,650 $39,500

$ 4,900 3,700 8,600 9,400 18,000 1,000 20,500 21,500 $39,500

3) Use the information in Exhibit A-1 to calculate the return on assets (ROA) ratio for 2025 using operating profit margin and asset turnover. For interim and final calculations, round dollar-based calculations to the nearest whole dollar, round percentages to four decimal places (e.g. 0.1351, or 13.51%), and round ratios to one decimal place (e.g. 1.6). Answer: Net operating profit after taxes (NOPAT) for the year ended December 31, 2025 = Net income + Interest expense × (1 — Tax rate) = $2,730 + $900 × (1 — $1,170 / $3,900) = $3,360. Operating profit margin for the year ended December 31, 2025= NOPAT / Sales = $3,360 / $53,400 = 6.29%. Asset turnover for the year ended December 31, 2025 = Sales / Average assets = $53,400 / (($47,750 + $39,500) / 2) = 122.41%. Return on assets (ROA) for the year ended December 31, 2025 = Operating profit margin × Asset turnover = 6.29% × 122.41% = 7.70%. Diff: 2 Type: SA Skill: Comp Objective: A-2 Describe the purpose of the ratio analysis and the information conveyed by the output. 4) Use the information in Exhibit A-1 to calculate the return on common equity (ROCE) ratio for 2025 using operating earnings leverage, return on assets (ROA), and financial leverage. Assume ROA for the year was 7.70%. For the interim and final calculations, round dollar-based calculations to the nearest whole dollar, round percentages to four decimal places (e.g. 0.1351, or 13.51%), and round ratios to one decimal place (e.g. 1.6). Answer: Net operating profit after taxes (NOPAT) for the year ended December 31, 2025 = Net income + Interest expense × (1 — Tax rate) = $2,730 + $900 × (1 — $1,170 / $3,900) = $3,360. Earning leverage for the year ended December 31, 2025 = Income available to common shareholders / NOPAT = $2,730 / $3,360 = 81.25%. ROA for the year ended December 31, 2025 = 7.70% from facts in question. Financial leverage for the year ended December 31, 2025 = Average assets / Average common equity = (($47,750 + $39,500) / 2) / (($22,600 + $21,500) / 2) = $43,625 / $22,050 = 197.85%. ROCE for the year ended December 31, 2025 = Earnings leverage × ROA × Financial leverage = 81.25% × 7.70% × 197.85% = 12.38%. Diff: 2 Type: SA Skill: Comp Objective: A-2 Describe the purpose of ratio analysis and the information the output conveys.

5) Use the information in Exhibit A-1 to calculate the ratios listed below for 2025: i) Current ratio ii) Quick ratio iii) Accounts receivable turnover ratio iv) Inventory turnover ratio v) Accounts payable turnover ratio Use sales and cost of goods sold as proxies for credit sales and purchases, respectively. Round ratios to one decimal place (e.g. 1.6). Answer: i) The current ratio as at December 31, 2025 = Current assets / Current liabilities = $11,450 / $9,150 = 1.3:1. ii) The quick ratio as at December 31, 2025 = (Cash + Accounts receivable) / Current liabilities = ($1,250 + $4,900) / $9,150 = 0.7:1. iii) The accounts receivable turnover ratio for the year ended December 31, 2025 = Credit sales / Average accounts receivables = $53,400 / (($4,900 + $4,550) / 2) = 11.3 turns per year. iv) The inventory turnover ratio for the year ended December 31, 2025 = Cost of goods sold / Average inventory = $36,800 / (($5,100 + $4,850) / 2) = 7.4 turns per year. v) The accounts payable turnover ratio for the year ended December 31, 2025 = Purchases / Average accounts payable = $36,800 / (($5,350 + $4,900) / 2) = 7.2 turns per year. Diff: 2 Type: SA Skill: Comp Objective: A-2 Describe the purpose of ratio analysis and the information the output conveys.

6) Use the information in Exhibit A-1 to calculate the ratios listed below for 2025: i) Long-term debt to equity ratio ii) Interest coverage ratio Round ratios to one decimal place (e.g. 1.6). Answer: i) The long-term debt to equity ratio as at December 31, 2025 = Long-term debt / Shareholder's equity = $16,000 / $22,600 = 0.7:1. ii) The interest coverage ratio for the year ended December 31, 2025 = Earnings before interest and taxes (EBIT) / Interest expense = $4,800 / $900 = 5.3:1. Diff: 2 Type: SA Skill: Comp Objective: A-2 Describe the purpose of the ratio analysis and the information conveyed by the output.

Exhibit A-2

Gretta Company Inc. Income Statement For the years ended December 31 (in millions of dollars) 2025 2024 Revenue $53,400 $50,100 Cost of goods sold 36,800 32,700 Gross profit 16,600 17,400 Operating expenses 11,800 13,100 Operating profit 4,800 4,300 Interest and finance costs 900 1,000 Income before taxation 3,900 3,300 Income taxes 1,170 990 Net income $ 2,730 $ 2,310 Gretta Company Inc. Balance Sheet As at December 31 (in millions of dollars) 2025 Assets Current assets Cash and cash equivalents $ 1,250 Accounts receivable 4,900 Inventories 5,100 Prepaid assets 200 Current assets 11,450 Non-current assets 36,300 Total assets $47,750 Liabilities Current liabilities Accounts payable $ 5,350 Other current liabilities 3,800 Current liabilities 9,150 Long-term indebtedness 16,000 Total liabilities 25,150 Equity Preferred shares 100 Common shares 900 Retained earnings 21,600 Equity 22,600 Total liabilities and equity $47,750

2024

$ 1,200 4,550 4,850 250 10,850 28,650 $39,500

$ 4,900 3,700 8,600 9,400 18,000 100 900 20,500 21,500 $39,500

7) Refer to Exhibit A-2. Other information: Dividends of $100 million were declared and paid during the year, with $90 million to the common shareholders and $10 million to the preferred shareholders. For the interim and final calculations, round dollar-based calculations to the nearest whole dollar, round percentages to four decimal places (e.g. 0.1351, or 13.51%), and round ratios to one decimal place (e.g. 1.6). What was Gretta Company Inc.'s return on assets (ROA) ratio for 2025 calculated using operating profit margin and asset turnover? A) 7.03%. B) 7.47%. C) 7.70%. D) 8.32%. Answer: C Explanation: Net operating profit after taxes (NOPAT) for the year ended December 31, 2025 = Net income + Interest expense × (1 — Tax rate) = $2,730 + $900 × (1 — $1,170 / $3,900) = $3,360. Operating profit margin for the year ended December 31, 2025 = NOPAT / Sales = $3,360 / $53,400 = 6.29%. Asset turnover for the year ended December 31, 2025 = Sales / Average assets = $53,400 / (($47,750 + $39,500) / 2) = 122.41%. Return on assets (ROA) for the year ended December 31, 2025 = Operating profit margin × Asset turnover = 6.29% × 122.41% = 7.70%. Diff: 2 Type: MC Skill: Comp Objective: A-2 Describe the purpose of ratio analysis and the information the output conveys.

8) Refer to Exhibit A-2. Other information: Assume that ROA for the year was 7.70%. Dividends of $100 million were declared and paid during the year, with $90 million to the common shareholders and $10 million to the preferred shareholders. For the interim and final calculations, round dollar-based calculations to the nearest whole dollar, round percentages to four decimal places (e.g. 0.1351, or 13.51%), and round ratios to one decimal place (e.g. 1.6). What was Gretta Company Inc.'s return on common equity (ROCE) ratio for 2025 calculated using earnings leverage, ROA, and financial leverage? A) 11.47%. B) 12.33%. C) 12.39%. D) 12.43%. Answer: C Explanation: Net operating profit after taxes (NOPAT) for the year ended December 31, 2025 = Net income + Interest expense × (1 — Tax rate) = $2,730 + $900 × (1 — $1,170 / $3,900) = $3,360. Earning leverage for the year ended December 31, 2025 = Income available to common shareholders / NOPAT = ($2,730 — $10) / $3,360 = 80.95%. ROA for the year ended December 31, 2025 = 7.70% from facts in question. Financial leverage for the year ended December 31, 2025 = Average assets / Average common equity = (($47,750 + $39,500) / 2) / (($22,600 — $100 + $21,500 — $100) / 2) = $43,625 / $21,950 = 198.75%. ROCE for the year ended December 31, 2025 = Earnings leverage × ROA × Financial leverage = 80.95% × 7.70% × 198.75% = 12.39%. Diff: 2 Type: MC Skill: Comp Objective: A-2 Describe the purpose of ratio analysis and the information the output conveys.

Learning Objective 3 Describe some challenges faced by financial statement analysts. 1) List three of the most significant limitations of financial statement analysis. Answer: Three of the most significant limitations of financial statement analysis are: (i) the numbers do not tell the whole story; (ii) the company's choice of accounting policies and estimates matter; and (iii) the scarcity of directly comparable results. Diff: 1 Type: SA Skill: Concept Objective: A-3 Describe some challenges faced by financial statement analysts.

Learning Objective 4 Describe different methods of using accounting information to value a company. 1) Use the financial statement information that follows to calculate the value of a common share of Pippa Company Inc. as at December 31, 2025, using the book value method. There were 1,000 million common shares outstanding at the December 31, 2025, year-end. Pippa Company Inc. Balance Sheet As at December 31 (in millions of dollars) 2025 Assets Current assets Cash and cash equivalents $ 1,250 Accounts receivable 4,900 Inventories 5,100 Prepaid assets 200 Current assets 11,450 Non-current assets 36,300 Total assets $47,750 Liabilities Current liabilities Accounts payable $ 5,350 Other current liabilities 3,800 Current liabilities 9,150 Long-term indebtedness 16,000 Total liabilities 25,150 Equity Preferred shareholders 100 Common shareholders 5,000 Retained earnings 17,500 Equity 22,600 Total liabilities and equity $47,750

2024

$ 1,200 4,550 4,850 250 10,850 28,650 $39,500

$ 4,900 3,700 8,600 9,400 18,000 100 4,500 16,900 21,500 $39,500

Answer: $22,600 million total equity − $100 million preferred equity = $22,500 million common equity; $22,500 million equity / 1,000 million shares outstanding = $22.50 per share Diff: 1 Type: SA Skill: Comp Objective: A-4 Describe different methods of using accounting information to value a company. 2) Calculate the value of a common share of Sample Company Ltd. as at December 31, 2025, using the expected future dividend model if dividends at t = 0 were $0.50 per share, the expected growth rate of dividends was 3% per annum, and the cost of capital was 6%. Answer: ValueDiv =E(DPS1) / (r — g) = (DPS0 × (1 + g)) / (r − g) = ($0.50 × (1 + 0.03)) / (0.06 − 0.03) = $17.17 per share. Diff: 1 Type: SA Skill: Comp Objective: A-4 Describe different methods of using accounting information to value a company. 13 Copyright © 2023 Pearson Canada Inc.

3) Calculate the value of a common share of Libby Company Inc. as at December 31, 2025, by using the earnings multiple model if earnings per share (EPS) at t = 0 were $2.87, the expected growth rate was 4% per annum, and the cost of capital was 6%. Answer: Earnings multiple = (1 + g)) / (r − g) = (1 + 0.04) / (0.06 − 0.04) = 52.0; ValueEarn = (EPS0 × (1 + g)) / (r − g) = EPS0 × Earnings multiple = $2.87 × 52.0 = $149.24 per share. Diff: 2 Type: SA Skill: Comp Objective: A-4 Describe different methods of using accounting information to value a company. 4) What was the value of a common share of Ample Company Inc. as at December 31, 2025, using the free cash flow model? Round present value and future cash flow calculations to the nearest whole dollar (in millions of dollars). Free cash flow (in millions of dollars) 2026 2027 2028

$320 340 380 Increasing at 5% per year from the amount on December 31, 2028

2029 Other information Cash flows Occur at the end of the year Common shares outstanding (in millions) Average in 2025–90; as at December 31, 2025–100 Appropriate discount rate A) $161.26. B) $171.91. C) $180.96. D) $208.56. Answer: B Explanation:

Diff: 3 Type: MC Skill: Comp Objective: A-4 Describe different methods of using accounting information to value a company.

5) What was the value of a common share of Gidget Company Inc. as at December 31, 2025, using the residual income model? Round present value and future cash flow calculations to the nearest whole dollar (in millions of dollars). Residual income (in millions of dollars) 2026 2027 2028

$15 30 25 Increasing at 4% per year from the amount on December 31, 2028

2029 Other information Book value of company (in millions of dollars) Cash flows Occur at the end of the year Common shares outstanding (in millions) Average in 2025–210; as at December 31, 2025–200 Appropriate discount rate A) $5.60. B) $5.69. C) $5.88. D) $6.55. Answer: C Explanation:

Diff: 3 Type: MC Skill: Comp Objective: A-4 Describe different methods of using accounting information to value a company.

$600

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Appendix B Data Analytics Learning Objective 1 Describe the purpose of data analytics. 1) What is the overarching purpose of data analytics? A) Use digital tools to sift through data. B) Detect opportunities to enhance profitability. C) Analyze information to guide business decision-making. D) Transform vast amounts of unstructured data into structured data. Answer: C Diff: 2 Type: MC Skill: Concept Objective: B-1 Describe the purpose of data analytics.

Learning Objective 2 Explain the importance of data analytics to the future of accounting. 1) What is the ability to acquire, transform, visualize, and analyze data? A) The most important ability an accountant can have. B) An integral part of an accountant's skillset. C) An ability that should be performed by data analysis professionals and subsequently interpreted by accountants. D) It is an ability that isunimportant until an accountant becomes a Controller or Chief Financial Officer (CFO). Answer: B Diff: 2 Type: MC Skill: Concept Objective: B-2 Explain the importance of data analytics to the future of accounting.

Learning Objective 3 Define fundamental data concepts. 1) Which of the following is considered "structured" data? A) Email. B) A trial balance. C) Supplier invoices. D) A corporate website. Answer: B Diff: 2 Type: MC Skill: Concept Objective: B-3 Define fundamental data concepts.

2) As corporate Controller, you are reconciling inventory at the end of the quarter. You ask the warehouse manager to provide you with an up-to-date list of inventory. He takes a piece of paper and pencil, quickly writes down a few notes, hands the paper to you, and says "Here's my best guess." Which of the five "Vs" of Big Data is most at risk in this situation? A) Velocity. B) Volume. C) Variety. D) Veracity. Answer: D Diff: 2 Type: MC Skill: Concept Objective: B-3 Define fundamental data concepts. 3) The CFO of your organization has asked you to provide up-to-date weekly profitability updates, but you only receive actual revenue results on a monthly basis. Which of the five "Vs" of Big Data is causing an issue in this situation? A) Velocity. B) Volume. C) Variety. D) Veracity. Answer: A Diff: 2 Type: MC Skill: Concept Objective: B-3 Define fundamental data concepts.

Learning Objective 4 Explain the primary technical steps used in the data analytics process. 1) Your boss says to you, "We've just received a massive amount of unstructured data. I need you to organize these data so they can be of use to us." Which stage of the ETL process is your boss asking you to complete? A) Load. B) Process. C) Extract. D) Transform. Answer: D Diff: 2 Type: MC Skill: Concept Objective: B-4 Explain the primary technical steps used in the data analytics process.

2) When performing data analytics, what is the process of removing unneeded data? A) Data cleansing. B) Data extraction. C) Data removal. D) Data validation. Answer: A Diff: 2 Type: MC Skill: Concept Objective: B-4 Explain the primary technical steps used in the data analytics process.

Learning Objective 5 Tell a story to effectively guide data analysis to address a variety of business issues. 1) Which of the following statements is true? A) The best insights from data analysis are achieved by examination of raw data. B) Data analysts should create a clear objective and subsequently use the objective to measure the success of revised data-driven business strategies. C) The mission statement of a company is irrelevant if decisions are made on a division-level basis rather than a company-wide basis. D) Once a company has implemented a revised strategy based on data-driven results, the data analytics process is complete. Answer: B Diff: 2 Type: MC Skill: Concept Objective: B-5 Tell a story to effectively guide data analysis to address a variety of business issues. 2) The CEO of an airline has asked you to prepare a chart that examines whether there is a relationship between revenues and air miles travelled in a year. Which of the following charts would best visualize this assessment? A) Scatter plot. B) Histogram. C) Stacked bar chart. D) Bubble chart. Answer: A Diff: 2 Type: MC Skill: Concept Objective: B-5 Tell a story to effectively guide data analysis to address a variety of business issues.

Learning Objective 6 Explain why skepticism is important in data analytics. 1) You are considering investing in a company and management presents you with this impressive chart:

Based on this chart, what do you determine? A) This company is experiencing rapid growth since profitability has doubled from 2015 to 2021. B) This company is experiencing significant dependable growth since profitability is steadily increasing in large increments each year. C) The information provided in this chart by the company is misleading since the chart's scale is not defined. D) This company is committing fraud. Answer: C Diff: 2 Type: MC Skill: Concept Objective: B-6 Explain why skepticism is important in data analytics.

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 11 Current Liabilities, Non-Financial Liabilities, and Contingencies Learning Objective 1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 1) Which of the following characteristic is required for a liability under IFRS Framework? A) A past obligation. B) A present obligation. C) An unknown obligation. D) A future obligation. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 2) Which of the following characteristic is required for a liability under IFRS Framework? A) Arises from a past event. B) Arises from a non-financial transaction. C) Arises from a future transaction. D) Arises from a forecasted transaction. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 3) Which of the following characteristic is required for a "liability" under IFRS Framework? A) Expected to result in the inflow of economic benefits. B) Expected to result in the inflow of economic benefits that are measurable. C) Expected to result in the outflow of resources embodying economic benefits. D) Expected to result in the outflow of economic benefits that are virtually certain. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities.

4) Which of the following groups includes only financial liabilities? A) Accounts payable, Notes payable, Warranties payable. B) Bank loan, Bonds payable, Right-of-use obligation. C) Accounts payable, Warranties payable, Bonds payable. D) Bank overdraft, USD bank loan, Obligation under customer loyalty plan. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 5) Which of the following is correct about a "liability" under IFRS Framework? A) A future obligation arising from past events, the settlement of which is expected to result in an inflow of resources. B) A present obligation arising from past events, the settlement of which is expected to result in an inflow of resources. C) A past obligation arising from past events, the settlement of which is expected to result in an outflow of resources. D) A present obligation arising from past events, the settlement of which is expected to result in an outflow of resources. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 6) Which is an example of a liability? A) The decision to borrow $150,000 from the ABC Bank on January 15, 2024. B) Withdrawing $10,000 from the operating line of credit on January 15, 2024. C) Selecting the supplier to provide the raw materials for the manufacturing process. D) Choosing the site for a future plant expansion from a list of several possible choices. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 7) Which of the following is a financial liability? A) A magazine publisher's obligation to provide the magazine monthly for an agreed-upon period. B) Warranties. C) Accounts payable. D) Income taxes payable. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities.

8) Which statement is correct under the IFRS definition for a "liability"? A) The obligating event must be probable before the liability can be recognized. B) The obligating event must be virtually certain before the liability can be recognized. C) A reliable measure of the obligation must exist before the liability can be recognized. D) A precise measure of the obligation must exist before the liability can be recognized. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 9) Which statement regarding liabilities is NOT correct under the IFRS Framework? A) A reliable estimate for an asset is presumed to exist. B) A provision exists if the timing of payment is uncertain. C) A provision exists if the amount of payment is uncertain. D) A reliable estimate for a liability is presumed to exist. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 10) Which statement is correct about financial and non-financial liabilities? A) A non-financial liability is a contractual obligation to deliver cash to another party. B) A non-financial liability does not meet all of the criteria for a "liability." C) The two liabilities may be valued differently for financial reporting purposes. D) A non-financial liability is measured at fair value rather than amortized cost. Answer: C Diff: 3 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 11) Which is NOT an example of a non-financial liability? A) Warranty liability. B) Bank loan. C) Income taxes payable. D) Deferred revenue. Answer: B Diff: 3 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities.

12) Which is NOT an example of a financial liability? A) Payment to supplier for raw material received. B) Obligation to repay a US-dollar bank loan. C) A right-of-use lease obligation. D) Obligation under a customer loyalty program. Answer: D Diff: 3 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 13) Which is NOT a current liability? A) Accounts payable due in 120 days. B) Bank loan due in three years that is in default. C) Bonds payable maturing in five years. D) Certain held for trading liabilities. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 14) Why is it important to distinguish financial from non-financial liabilities? Answer: IFRS requires that some financial liabilities be measured at their fair value rather than at amortized cost. Diff: 1 Type: SA Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 15) Explain some of the challenges that exist in determining the amount of a "liability" by identifying factors that influence the value of the indebtedness. Answer: Factors include whether: • the obligation is a financial liability or a non-financial liability; • the market rate of interest is different from that recorded in the loan documentation; • the market rate of interest has changed since the liability was incurred; • there is uncertainty about the amount owed; • the amount owed depends upon the conclusion of a future event; or • the obligation is payable in a foreign currency. Diff: 2 Type: SA Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities.

16) What are the three broad categories of liabilities? Answer: The three broad categories of liabilities are: 1. Financial liabilities held for trading. 2. Other financial liabilities. 3. Non-financial liabilities. Diff: 1 Type: SA Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 17) Describe what a non-financial liability is, and provide three examples of non-financial liabilities. Answer: A non-financial liability is an obligation that meets the definition of a liability but is not a financial liability. It is settled through the provision of goods or delivery of services-not by settlement in cash or another financial asset. In addition, liabilities established by legislation and are not contractual in nature are also non-financial liabilities. Examples of non-financial liabilities include but are not limited to: unearned revenue, warranties payable, obligation under customer loyalty plan, sales tax payable, and income taxes payable. Diff: 2 Type: SA Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 18) What are "liabilities"? Differentiate between financial liabilities and non-financial liabilities. Answer: • Liabilities are present obligations of the entity arising from past events that are expected to result in an outflow of resources. • Financial liabilities are contractual obligations that will be settled in cash or by transferring another financial asset to the creditor. • A non-financial liability is an obligation that meets the definition of a liability but is not a financial liability. It is settled through the provision of goods or delivery of services—not by settlement in cash or another financial asset. Diff: 1 Type: SA Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities. 19) Explain the meaning of "provision" and give an example. Answer: A provision is a liability for which there is some uncertainty as to the timing or amount of payment. It should be noted, that having uncertainty over the amount or timing of payments does not imply that a liability cannot be reliably measured. For example, payments for warranty costs are uncertain in terms of both amount and timing, yet we would still record a liability for the estimated cost of fulfilling warranties. Diff: 1 Type: SA Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities.

20) Fill in the following chart. Initial measurement of the liability

Subsequent measurement of the liability

Initial measurement of the liability The initial measurement of non-financial liabilities depends on their nature.

Non-financial liability Financial liability held for trading Answer:

Non-financial liability

Financial liability held for trading

Fair value.

Diff: 3 Type: ES Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities.

21) Fill in the following chart: Initial measurement of the liability

Subsequent measurement of the liability

Non-financial liability Financial liability not held for trading Answer:

Non-financial liability

Financial liability not held for trading

Initial measurement of the liability The initial measurement of non-financial liabilities depends on their nature.

Subsequent measurement of the liability Non-financial liabilities are subsequently measured at the initial obligation less the amount earned to date or satisfied to date through performance. Other financial liabilities are Other financial liabilities are initially reported at fair subsequently measured at value minus the transaction amortized cost using the costs directly resulting from effective interest method. incurring the obligation.

Diff: 3 Type: ES Skill: Concept Objective: 11.1 Describe the nature of liabilities and differentiate between financial and non-financial liabilities.

Learning Objective 2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 1) Which statement is correct? A) HST payable is a financial liability. B) Bank overdraft is a non-financial liability. C) Unearned revenue is a non-financial liability. D) Unearned subscriptions are a financial liability. Answer: C Diff: 3 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

2) Which is a non-current liability? A) HST payable. B) 45-day accounts payable. C) Five-year loan that matures four months after the year-end reporting date. D) The creditor has granted a 15-month grace period on a loan in default. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 3) Which statement is correct? A) Contingencies arise from future events. B) The amount to be paid for contingencies is known or reasonably estimable. C) Current liabilities arise from future events. D) The amount to be paid for current liabilities is known or reasonably estimable. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 4) Which of the following liabilities can potentially be reported as either or both a current and a noncurrent liability? A) Bank overdraft. B) Unearned revenue. C) 180-day bank loan. D) Income taxes payable. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 5) Which of the following liabilities will be reported only as a current liability? A) Bank overdraft. B) Unearned revenue. C) Bond payable that matures in two years. D) Obligation under customer loyalty plan. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

6) Which statement is correct? A) Supplier discounts can only be accounted for by using the gross method. B) The amount owing for trade payables is generally not known with a high degree of certainty. C) An accrued liability is needed when a company has received goods, but not the invoice. D) Completeness means that obligations are reported in the proper accounting period. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 7) Which is a reason to use the net method to record purchase discounts? A) Cost-benefit factor is greater for the net method. B) Reporting "purchase discounts lost" signifies inefficient business practices. C) Given the materiality of the amounts involved, the net method is used. D) The net method is technically superior to the gross method. Answer: D Diff: 3 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 8) For a $100,000 trade payable with terms of 2/10, net 45, how much would be reported as "purchase discount lost" under the gross method if a payment was made after 60 days? A) $0 B) $2,000 C) $4,500 D) $10,000 Answer: A Diff: 2 Type: MC Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 9) For a $200,000 trade payable with terms of 2/15, net 50, how much would be reported as "purchase discount lost" under the net method if a payment was made after 60 days? A) $0 B) $4,000 C) $5,000 D) $30,000 Answer: B Explanation: ($200,000 × 2%) Diff: 2 Type: MC Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

10) How are "purchase discounts lost" reported in the financial statements? A) As a reduction of sales. B) As an increase in liability. C) As an increase in inventory. D) As an expense item. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 11) Which statement is correct? A) Trade payables are supported by a written promise to pay. B) Trade payables with no discount terms are expected to be paid in full. C) Notes payable are legally enforceable and can only be interest bearing. D) Notes payables are recognized at the face value or transaction price. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 12) Which of the following is true about non-interest bearing notes? A) The most common method of determining the fair value of non-interest bearing notes is the discounted cash flow analysis. B) Non-interest bearing short-term payables may never be measured at the original invoice amount. C) A rule of thumb is to use the face value for non-interest bearing notes payable with a duration of greater than 90 days. D) A rule of thumb is to use the market value for non-interest bearing notes payable with a duration of 90 days or less. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 13) Which is true about lines of credit? A) The company generally must repay the credit line in full monthly. B) The borrower can borrow up to an agreed-upon limit. C) Interest is charged on the full amount of the agreed-upon limit. D) Lines of credit are particularly useful for steady-income businesses that have very little volatility in revenue. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

14) Which statement about sales taxes is correct? A) The consumer is responsible for remitting the tax to the government. B) Taxes are uniformly applied to all sale transactions. C) Businesses can deduct the GST paid on their purchases from GST collected. D) The same products that are exempt from GST are exempt from PST. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 15) Which statement about sales taxes is correct? A) Businesses can recover the PST paid on all of their purchases. B) Goods purchased for resale are exempt from PST. C) Businesses remit only the GST collected on sales transactions. D) The same products that are exempt from HST are exempt from PST. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 16) Which of the following is true? A) The declaration of a stock dividend gives rise to a liability. B) Stock dividends are revocable by the board of directors at any time before they are issued. C) Undeclared dividends in arrears on cumulative preferred shares are not recorded as a liability. D) No note disclosure is required for the declaration of a stock split. Answer: C Diff: 3 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 17) What is true regarding royalty fees? A) Unpaid royalty fees are recorded as a contra asset. B) Unpaid royalty fees are a debit to royalty fee expense and a credit to unearned revenue. C) Royalty fees are a minor expense for publishing companies. D) A franchise gives the franchisor the right to sell specified goods and/or services within a designated area. Answer: D Diff: 3 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

18) Which statement about warranties is correct? A) Warranties sold separately are accounted for under IFRS7. B) Warranties sold separately are accounted for under IFRS15. C) Warranties are financial liabilities and accounted for at fair value. D) Expected value uses a weighted average of possible outcomes. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 19) Which statement about warranties is correct? A) Warranties are provisions. B) Warranties included with the product sold are accounted for under IFSR15. C) Warranties are financial liabilities. D) Warranties included with the product sold are accounted for under IAS39. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 20) Sales made in fiscal 2025 for $50,000,000 include a 5-year warranty coverage. The estimated cost for warranty is expected to be 2% for each of the first 4 years and 5% for the last year. Determine how much warranty expense will be recorded in fiscal 2025. A) $1,000,000 B) $4,000,000 C) $5,000,000 D) $6,500,000 Answer: D Explanation: ($50,000,000 × [(2% × 4) + 5%]) Diff: 2 Type: MC Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 21) Which statement about deferred revenue is correct? A) Deferred revenue is a financial liability. B) Deferred revenue is a non-financial liability. C) Deferred revenue is a held for trading financial liability. D) Deferred revenue arises when the contract is signed. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

22) Which statement about deferred revenue is correct? A) Deferred revenue is always a non-current liability. B) Deferred revenue could arise from loyalty programs. C) Deferred revenue is measured using expected values. D) Deferred revenue arises when the goods are shipped. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 23) Why is it important to distinguish current liabilities from long-term liabilities? Answer: It is important to distinguish current liabilities from long-term liabilities because financial statement users often need to know the total of current liabilities to assess the liquidity. The current ratio and the working capital ratio are the best indicators of liquidity. These two ratios require total current liabilities. Diff: 1 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

24) Contrast the gross method with the net method of recording purchase discounts by completing the following table: For

Against

Net Method Gross Method

Answer: For Against Net Method The net method is supported by When the net method is IAS 2 Inventories, which employed and discounts are not indicates that the cost of availed of, entities must report a inventory should exclude trade finance expense for "purchase discounts. discounts lost." Managers are loath to do this, as forgoing available discounts is usually considered a poor business practice. Gross Method It is much easier to record The gross method may be invoices at their face value and overstating purchases and it can usually be justified on the payables if the discount is basis of cost-benefit and eventually taken. materiality factors. Diff: 1 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 25) Explain the nature of current liabilities and how these are accounted for in the financial statements. Answer: Current liabilities are obligations that are expected to be settled within one year of the balance sheet date or the business's normal operating cycle, whichever is longer. Current liabilities are reported separately from non-current liabilities in the balance sheet unless they are presented in order of liquidity to provide more reliable and relevant information. Diff: 1 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

26) Explain the meaning of the following terms: current assets, trade payables, expected value, deferred revenue, and warranty. Answer: Current assets: Assets that are expected to be consumed or sold within one year of the balance sheet date or the business's normal operating cycle, whichever is longer. Also includes assets held primarily for trading purposes. Trade payables: Obligations to pay for goods received or services used. Expected value: The value determined by weighting possible outcomes by their associated probabilities. Deferred revenue: A non-financial obligation arising from the collection of revenue that has not yet been earned. Warranty: A guarantee that a product will be free from defects for a specified period. Diff: 1 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 27) Explain what rebates are and how they are accounted for in the financial statements. Answer: A common form of rebate requires buyers to submit evidence of purchase to the manufacturer, who then sends the customer a cheque for the agreed-upon amount. Accounting for rebates is governed by IFRS 15, paragraphs 50–54, "variable consideration." The essence of this guidance is that in accordance with paragraph 48, the transaction price (sales revenue) recognized must be adjusted downward for the envisaged rebate to be disbursed (variable consideration). The entity's obligation for rebates is typically estimated using expected value techniques and a liability established for the amount it expects to refund. The refund liability is subsequently updated in each reporting period based on current facts and circumstances with the resultant adjustment accounted for prospectively as a change in estimate. Diff: 1 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 28) Why are taxes payable not classified as financial liabilities? Answer: The obligations to pay taxes are legislative in nature rather than contractual, hence they do not fit the definition of a financial liability as set out in IAS 32. Diff: 2 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

29) List three reasons why the recording of sales taxes is not straightforward. Answer: 1. Some products are exempt from PST and others are exempt from GST. 2. The regulations and rates in each province differ somewhat, including which products are exempt. 3. Businesses are generally permitted to deduct the GST and HST paid on their purchases from the GST and HST collected and to remit the net amount owing to the federal government. Diff: 3 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 30) List three characteristics of a franchise arrangement. Answer: A franchise arrangement is one in which: 1. the franchisor licenses its trademark or business practices to the franchisee. 2. the franchisee has the right to sell specified goods or services in a designated area. 3. requires the franchisee to pay to the franchisor a royalty fee based on sales or some other metric. Diff: 3 Type: SA Skill: Concept Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 31) For the following transaction, provide all of the required journal entries from inception to liquidation. Assume a December 31 year-end and that the company does not prepare interim statements. Round all amounts to the nearest dollar. Face value of note payable $200,000 Date of issue for note March 1, 2025 Due date for note May 1, 2025 Interest rate in the note 0% Market rate of interest 5% Consideration received Inventory Answer: Issuance Dr. Inventory 200,000 Cr. Note payable 200,000 (record at original invoice amount since it is a short payable with no stated interest rate—a rule of thumb for notes less than 90 days. Additionally, discounting the note to fair value would not be material.) Liquidation/Payment Dr. Note payable 200,000 Cr. Cash 200,000 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

32) For the following transaction, provide all of the required journal entries from inception to liquidation. Assume a December 31 year-end and that the company does not prepare interim statements. Round all amounts to the nearest dollar. Face value of note payable $200,000 Date of issue for note March 1, 2024 Due date for note March 1, 2025 Interest rate in the note 0% Market rate of interest 5% Consideration received Machinery Answer: Issuance Dr. Machinery Cr. Note payable (Discount to fair value: $200,000 / 1.05) At year-end: Dr. Interest expense Cr. Note payable ($190,476 × 5% × 306 days / 365 days)

190,476

7,984

190,476

7,984

Liquidation/Payment Dr. Interest expense 1,540 Cr. Note payable 1,540 ($190,476 × 5% × 59 days / 365 days) - (small difference due to rounding) Dr. Note payable 200,000 Cr. Cash 200,000 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

33) For the following transactions, provide all of the required journal entries from inception to liquidation. Assume a December 31 year-end and that the company does not prepare interim statements. Round all amounts to the nearest dollar. Face value of note payable Date of issue for note Due date for note Interest rate in the note

$200,000 May 1, 2024 May 1, 2025 5% (interest due at maturity) 5% Cash

Market rate of interest Consideration received Answer: Issuance Dr. Cash Cr. Note payable (face amount since note is interest bearing) At year-end: Dr. Interest expense Cr. Accrued interest payable ($200,000 × 5% × 245 days / 365 days) Liquidation/Payment Dr. Interest expense Cr. Accrued interest payable ($200,000 × 5% × 120 days / 365 days)

200,000

6,712

3,288

200,000

6,712

3,288

Dr. Note payable 200,000 Dr. Accrued interest payable 10,000 Cr. Cash 210,000 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

34) A company, using a perpetual inventory system, sells goods on credit for $10,000. The applicable PST rate is 5% and the cost of goods sold was $6,000. Sales taxes are remitted on a monthly basis. Prepare the necessary journal entries for this transaction. Answer: Sale of goods Dr. Accounts receivable 10,500 Cr. Sales 10,000 Cr. PST payable ($10,000 × 5%) 500 Dr. Cost of goods sold Cr. Inventory

6,000

Remit sales tax Dr. PST payable ($10,000 × 5%) 500 Cr. Cash 500 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 35) A company, using a perpetual inventory system, sells goods on credit for $10,000. The applicable PST rate is 5% and the GST rate is 10%. The cost of goods sold was $6,000. Sales taxes are remitted on a monthly basis. Prepare the necessary journal entries for this transaction. Answer: Sale of goods Dr. Accounts receivable 11,500 Cr. Sales 10,000 Cr. PST payable ($10,000 × 5%) 500 Cr. GST payable ($10,000 × 10%) 1,000 Dr. Cost of goods sold Cr. Inventory

6,000 6,000

Remit sales tax Dr. PST payable 500 Dr. GST payable 1,000 Cr. Cash 1,500 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

36) A company, using a perpetual inventory system, sells goods on credit for $10,000. The applicable HST rate is 10%. The cost of goods sold was $6,000. Sales taxes are remitted on a monthly basis. Prepare the necessary journal entries for this transaction. Answer: Sale of goods Dr. Accounts receivable 11,000 Cr. Sales 10,000 Cr. HST payable ($10,000 × 10%) 1,000 Dr. Cost of goods sold Cr. Inventory

6,000

Remit sales tax Dr. HST payable 1,000 Cr. Cash 1,000 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 37) A company purchases inventory on credit for $80,000. Inventory costing $30,000 is sold on credit for $40,000. The applicable HST rate is 10%. Sales taxes are remitted on a monthly basis. Prepare the necessary journal entries for this transaction. Answer: Purchase of inventory Dr. Inventory 80,000 Dr. HST recoverable ($80,000 × 10%) 8,000 Cr. Accounts payable 88,000 Sale of goods Dr. Accounts receivable Cr. Sales Cr. HST payable ($40,000 × 10%) Dr. Cost of goods sold Cr. Inventory

44,000 40,000 4,000 30,000

30,000

Remit sales tax Dr. HST payable 4,000 Dr. HST receivable from government 4,000 Cr. HST recoverable 8,000 Diff: 3 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

38) A company purchases inventory on credit for $40,000. Inventory costing $30,000 is sold on credit for $50,000. The applicable HST rate is 10%. Sales taxes are remitted on a monthly basis. Prepare the necessary journal entries for this transaction. Answer: Purchase of inventory Dr. Inventory 40,000 Dr. HST recoverable ($40,000 × 10%) 4,000 Cr. Accounts payable 44,000 Sale of goods Dr. Accounts receivable Cr. Sales Cr. HST payable ($50,000 × 10%) Dr. Cost of goods sold Cr. Inventory

55,000

30,000

50,000 5,000

30,000

Remit sales tax Dr. HST payable 5,000 Cr. HST recoverable 4,000 Cr. Cash 1,000 Diff: 3 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 39) AV Airlines sold a ticket on May 1, 2024 for travel on Jun 15, 2024 for $1,500. The customer paid at time of booking the flight. Provide the necessary journal entries. Answer: Booking flight Dr. Cash 1,500 Cr. Unearned revenue 1,500 Take flight Dr. Unearned revenue 1,500 Cr. Revenue 1,500 Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

40) A clothing store maintains a loyalty program for its customers. For every purchase, members receive points that do not expire. In fiscal 2024, the store made sales of $1 million and awarded 50,000 points that have a fair value of $50,000. The company estimates that approximately 75% of these points will be redeemed by members. Members redeemed 10,000 points in fiscal 2025. Provide the necessary journal entries for fiscal 2024 and 2025. Answer: 2024 Dr. Cash 1,000,000 Cr. Revenue 950,000 Cr. Unearned revenue 50,000 2025 Dr. Unearned revenue 13,333 Cr. Revenue 13,333 10,000 points × [$50,000 / (50,000 points × 75% redemption)] = 10,000 × $1.3333 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions. 41) In December 2025, a shoe store offered its customers a discount voucher that entitles them to a 30% discount on their purchases the following January. The store's sales for December 2025 were $2 million and 15,000 vouchers were awarded to customers. The store estimates that approximately 20% of the vouchers will be redeemed by customers, and the sale proceeds in January 2026 will be $1.5 million. Provide the necessary journal entries for fiscal 2025 and 2026. Answer: 2025 Dr. Cash 2,000,000 Cr. Revenue 1,910,000 Cr. Unearned revenue 90,000 ($1,500,000 estimated January sales × 30% discount × 20% redemption) = $90,000 2026 Dr. Cash 1,500,000 Dr. Unearned revenue 90,000 Cr. Revenue 1,590,000 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

42) A company purchased inventory from Europe valued at $100,000 Euros (€). The spot rate at the transaction date was C$1.00 = €0.85. The spot rate on the year-end date was C$1.00 = €0.80. When the company paid the supplier 3 months after year-end, the spot rate was C$1.00 = €0.90. Provide all necessary journal entries. Round all amounts to the nearest dollar. Answer: Purchase date Dr. Inventory 117,647 Cr. Accounts payable 117,647 €100,000 × (C$1.00 / €0.85) Year-end Dr. Foreign exchange loss 7,353 Cr. Accounts payable 7,353 €100,000 × (C$1.00 / €0.80) = $125,000; $117,647 - $125,000 = $7,353 loss Pay supplier Dr. Accounts payable 125,000 Cr. Cash 111,111 Cr. Foreign exchange gain 13,889 €100,000 × (C$1.00 / €0.90) = $111,111; $125,000 - $111,111 = $13,889 gain Diff: 3 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

43) Select transactions and other information pertaining to the Best Place in the World Inc. (BPW) are detailed below: Facts: a. BPW is domiciled in Vancouver, British Columbia and all purchases and sales are made in BC. b. The HST rate in British Columbia is 12%. c. The balances in BPWs HST recoverable account and HST payable account as at March 31, 2025, were $7,000 and $18,000, respectively. d. BPW uses a perpetual inventory system. e. Inventory is sold at a 100% mark-up on cost. (Cost of goods sold is 50% of the sales price.) Select transactions in April 2025: 1. BPW purchased inventory on account at a cost of $17,000 plus HST. 2. BPW purchased equipment on account at a cost of $18,000 plus HST. It paid an additional $600 plus HST for shipping. 3. Cash sales-BPW sold inventory for $45,000 plus HST. 4. Sales on account-BPW sold inventory for $35,000 plus HST. 5. BPW paid the supplier in full for the equipment previously purchased on account. 6. At the end of the month, BPW remitted the net amount of HST owing to the Canada Revenue Agency. Required: Prepare summary journal entries to record the transactions detailed above.

Answer: Summary journal entries: 1. Dr. Inventory Dr. HST recoverable ($17,000 × 12%) Cr. Accounts payable

17,000 2,040

2. Dr. Equipment ($18,000 + $600) Dr. HST recoverable ($18,600 × 12%) Cr. Accounts payable

18,600 2,232

3. Dr. Cash [$45,000 × (1 + 12%)] Cr. Sales Cr. HST payable ($45,000 × 12%) Dr. Cost of goods sold ($45,000 × 50%) Cr. Inventory

50,400

4. Dr. Accounts receivable [$35,000 × (1 + 12%)] Cr. Sales Cr. HST payable ($35,000 × 12%) Dr. Cost of goods sold ($35,000 × 50%) Cr. Inventory

39,200

5. Dr. Accounts payable Cr. Cash

20,832

22,500

17,500

19,040

20,832

45,000 5,400 22,500

35,000 4,200 17,500

20,832

6. Dr. HST payable 27,600 Cr. HST recoverable 11,272 Cr. Cash 16,328 Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

44) Simplicity Inc. had the following shareholders' equity account balances on December 31, 2025: Preferred shares A, 500,000 authorized, $1 per share non-cumulative dividend, 50,000 issued and outstanding Common Shares, 1,000,000 authorized, 200,000 issued and outstanding Retained earnings Total shareholders' equity

500,000 2,000,000 8,000,000 $ 10,500,000

On October 31, 2026, Simplicity declared the stipulated dividends on the preferred shares payable on December 1. On November 30, 2026, Simplicity declared cash dividends of $2 per common share payable on January 2, 2027. Required: Prepare the journal entries for 2026 and 2027. Answer: Oct. 31, 2026 Dr. Retained earnings (50,000 sh × $1/sh) Cr. Dividends payable on preferred shares

50,000

Nov. 30, 2026

Dr. Retained earnings (200,000 sh × $2/sh) Cr. Dividends payable on common shares

400,000

Dec. 1, 2026

Dr. Dividends payable on preferred shares Cr. Cash

50,000

Jan. 2, 2027

50,000

400,000

50,000

Dr. Dividends payable on common shares 400,000 Cash 400,000 Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

45) On March 1, 2025, Daisy Miller signed a five-year franchise agreement for the exclusive rights to sell Delightful Shakes products in Montreal, Quebec. The agreement stipulates that Daisy will pay the franchisor $30,000 upon signing the agreement and an ongoing royalty of 6% of monthly sales payable on the 20th of each following month. Daisy started operating the new franchise immediately after signing the agreement. Her sales for the first two months were $20,000, and $30,000. Daisy amortizes the franchise agreement monthly on a straight-line basis. Required: Prepare journal entries related to franchise fees during the first two months of operation. Answer: Mar. 1, 2025 Dr. Franchise agreement fee 30,000 Cr. Cash 30,000 Mar. 31, 2025

Dr. Amortization expense - franchise fee Cr. Franchise agreement ($30,000 /5 years / 12 months)

Mar. 31, 2025

Dr. Royalty fee expense Cr. Royalty fee payable ($20,000 × 6%)

1,200

Apr. 20, 2025

Dr. Royalty fee payable Cr. Cash

1,200

Apr. 30, 2025

Dr. Amortization expense - franchise fee Cr. Franchise agreement ($30,000 / 5 years / 12 months)

Apr. 30, 2025

Dr. Royalty fee expense Cr. Royalty fee payable ($30,000 × 6%)

500

1,200

1,200 500

1,800

May 20, 2025

500

1,800

Dr. Royalty fee payable 1,800 Cr. Cash 1,800 Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

46) Deck Contractors Inc. (DC) enters into a contract to construct six decks adjacent to a commercial building. The purchaser has agreed to pay $8,500 for each deck (total $51,000). The terms of the contract call for a 40% deposit ($3,400 per deck) at time of contract signing and payment of the balance ($5,100 per deck) as each deck is completed. The contract is signed on October 1, 2025. Two decks are completed in 2025 and the balance in 2026. DC has a December 31 year-end. The cost to DC of constructing each deck is $3,400, which it pays in cash. Required: a. Prepare summary journal entries for 2025 and 2026. b. What is the balance in the deferred revenue account as at December 31, 2025? Answer: a. Summary journal entries 2025 Dr. Cash (6 × $3,400) 20,400 Cr. Deferred revenue 20,400 2025

2026

Dr. Cash (2 × $5,100) Dr. Deferred revenue (2 × $3,400) Cr. Revenue (2 × $8,500) Dr. Cost of goods sold (2 × $3,400) Cr. Cash

10,200 6,800

Dr. Cash (4 × $5100) Dr. Deferred revenue (4 × $3,4 00) Cr. Revenue (4 × $8,500) Dr. Cost of goods sold (4 × $3,400) Cr. Cash

20,400 13,600

6,800

13,600

17,000 6,800

34,000 13,600

b. The balance in the deferred revenue account as at December 31, 2025 was $13,600 ($20,400 - $6,800) Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

47) In 2025, Johnson's Cycles Inc. sold 5,000 mountain bikes. For the first time, Johnson offered an instore, no-charge, two-year warranty on each bike sold. Company management estimates that the average cost of providing the warranty is $8 per unit in the first year of coverage and $11 per unit in the second year. Johnson's warranty-related expenditures totaled $36,500 for labor costs during 2025. Required: a. Prepare the summary journal entry to recognize Johnson's warranty expense in 2025. b. Prepare the summary journal entry to recognize the warranty service provided in 2025. c. Determine the total provision for warranty obligations that will be reported on the company's balance sheet at year-end. Assuming that all sales transactions and warranty service took place on the last day of the year, how much of the warranty obligation will be classified as a current liability? As a non-current liability? Answer: a. Dr. Warranty expense 95,000 Cr. Provision for warranty obligations 95,000 5000 × ($8 + $11) b. Dr. Provision for warranty obligations Cr. Wage expense

36,500

c. The total provision for warranty obligations that will be reported at year-end is $58,500 ($95,000 $36,500). Of this amount, $3,500 will be reported as a current obligation [(5,000 × $8) - $36,500 = $3,500] and the $55,000 balance as a non-current liability (5,000 × $11= $55,000) Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

48) On May 1, 2024, British Columbia Brew Supplies Inc. borrowed US$180,000 from its bank. British Columbia's year-end is December 31, 2024. Exchange rates were as follows: May 1, 2024 Dec 31, 2024 Average rate May 1-Dec 31, 2024

US$1.00 = C$1.05 US$1.00 = C$1.07 US$1.00 = C$1.06

Required: Prepare the required journal entries to record receipt of the loan proceeds and for any adjustments required at year-end. Answer: May 1, Dr. Cash (US$180,000 × C$1.05) 189,000 2024 Cr. Bank loan 189,000 Dec. 31, Dr. Foreign exchange loss (US$180,000 × (C$1.07 - C$1.05)) 3,600 2024 Cr. Bank loan 3,600 Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

49) On January 1, 2025, BCL Transmission Services Co. issued a $40,000, non-interest bearing note, due on January 1, 2026, in exchange for a custom-built computer system. The fair value of the computer system is not easily determinable. The market rate of interest for similar transactions is 4%. BCL's year-end is December 31. Required: a. Prepare the journal entry to record the issuance of the note payable. b. Prepare the journal entry to record the accrual of interest at December 31, 2025, assuming that BCL prepares adjusting entries only at year-end. c. Prepare the journal entry to record the retirement of the note payable on January 1, 2026. Answer: a. Dr. Computer system 38,462 Cr. Note payable ($40,000 / 1.04) 38,462 Using a BAII PLUS financial calculator 1N, 4 I/Y, 40000 FV, CPT PV PV b. Dr. Interest expense Cr. Note payable $38,462 × 4%

1,538

40,000

Dr. Note payable Cr. Cash

1,538

40,000

No entry for interest is required as it had been accrued on December 31, 2025. Diff: 1 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

50) St. John Laurulry (SJL) recently hired Huck as its payable clerk, a position that has been vacant for two months. While the other accounting staff have taken care of the "must do's," there are a number of transactions that have not yet been recorded. • Nov. 15, 2025—SJL purchases $8,000 supplies inventory on account. The terms offered are 2/10, net 30. • Nov. 22, 2025—SJL purchases 10 washing machines. SJL issues a $3,000 non-interest bearing note payable due on 01/15/26. • Nov. 28, 2025—SJL borrows $131,400 from the bank. SJL signs a demand note for this amount and authorizes the bank to take the interest payments from its bank account. Interest is payable monthly at 10% per annum. • Dec. 18, 2025—SJL purchases $1,000 supplies inventory on account. The terms offered are 2/10, net 30. • Dec. 21, 2025—SJL purchases 15 dryers. SJL issues a $25,000 non-interest bearing note payable due on Dec. 21, 2026. • Dec. 22, 2025—Huck pays the Nov. 15, 2025 and Dec. 18, 2025 invoices. • Dec. 31, 2025—Huck processes the payroll for the month. The gross payroll is $80,000; $2,700 is withheld for the employees' Canada Pension Plan and Employment Insurance premiums. Other Info • SJL uses the net method to record accounts payable. • SJL's year-end is Dec. 31 and interim statements are normally prepared on a monthly basis. • Due to the vacancy in the accounting department, SJL's latest interim statements are for the period ended Oct. 31, 2025. The necessary accruals were made at that time. • The market rate of interest for SJL's short-term borrowing is 10%. Required: a. Prepare journal entries to record the documented events and the necessary accruals for the months of November and December. Compute interest accruals based on the number of days, rather than months. b. Contrast the gross and net methods of accounting for trade payables.

Answer: a. Nov. 15, 2025

Dr. Supplies inventory Cr. Trade payables [$8,000 × (100% - 2%)]

7,840 7,840

Nov. 22, 2025

Dr. Equipment—washing machines 3,000 Cr. Notes payable 3,000 Recorded at face value as it is a short-term note and the interest component is immaterial

Nov. 28, 2025

Dr. Cash Cr. Notes payable

Nov. 30, 2025

Dr. Interest expense (bank loan) Cr. Cash ($131,400 × 10% × 3 / 365)

108

Dec. 18, 2025

Dr. Supplies inventory Cr. Trade payables ($1,000 × (100% - 2%))

980

Dec. 21, 2025

Dr. Equipment—dryers Cr. Notes payable ($25,000 / 1.10) Using a BAII PLUS financial calculator 1N, 4 I/Y, 2500 FV, CPT PV

131,400

108

980 22,727

22,727

10% is an appropriate discount rate to use as the question identifies this as the market rate of interest for NVL's short-term borrowings Dec. 22, 2025

Dr. Trade payables Dr. Purchase discounts lost Cr. Cash

8820 160

Dec. 31, 2025

Dr. Payroll expense Cr. Cash Cr. Employee remittances payable

Dec. 31, 2025

Dr. Interest expense (note payable) Cr. Note payable [$22,727 × 10% × 11 / 365]

Dec. 31, 2025

Dr. Interest expense (bank loan) Cr. Cash [$131,400 × 10% × 31 / 365 ]

80,000

8,980

77,300 2,700

68 68 1,116

1,116

b. When the gross method is used, the payable is recorded at the invoiced amount, as is the asset acquired. If the discount is taken, the book value of the asset acquired is reduced by an equivalent amount. If the discount is not taken, an adjustment is not required. When the net method is used, the payable is recorded at the invoiced amount less the discount, as is the asset acquired. If the discount is taken, an adjustment is not required. If the discount is not taken, an income statement account "purchase discounts lost" is debited for the amount of the discount forgone. From a theoretical perspective, the net method should be used as forgone discounts are a financing cost. From a practical perspective, the gross method is widely used as it is simpler to use and as the forgone discounts are usually immaterial. Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

51) RJ Magazines sells two-year magazine subscriptions for $108 cash each. The cost of producing and delivering each monthly magazine is $2.75 paid in cash at the time of delivery. RJ's sales activity for the year follows: Sales activity • On January 1, 2025, RJ sells 22,000 subscriptions. • On April 1, 2025, RJ sells 5,000 subscriptions. • On November 1, 2025, RJ sells 12,000 subscriptions RJ delivers the magazines at the end of the month and the year-end is December 31. Required: a. Prepare journal entries to record the subscription sales during the year. b. Prepare summary journal entries to record the revenue earned during the year and the related expense. Answer: a. Jan. 1 Dr. Cash 2,376,000 Cr. Deferred revenue 2,376,000 (22,000 × $108) Apr. 1 Dr. Cash Cr. Deferred revenue (5,000 × $108)

540,000

Nov. 1 Dr. Cash Cr. Deferred revenue (12,000 × $108)

1,296,000

540,000

1,296,000

Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

52) GOT Jetski Corp. has sold motorized watercraft for a number of years. GOT includes a three-year warranty on each watercraft they sell. Management estimates that the cost of providing the warranty coverage is 2% of sales in the first year and 3% of sales in each of years two and three. Other facts follow: • GGT reported a $270,000 provision for warranty payable on its December 31, 2025 balance sheet. • GGT's sales for 2026 totalled $6,000,000 spread evenly through the year. • The cost to GGT of meeting their warranty claims in 2026 was $480,000; $300,000 for parts and $180,000 for labour. • GGT's sales for 2027 totalled $6,200,000 spread evenly through the year. • The cost to GGT of meeting their warranty claims in 2027 was $468,000; $280,800 for parts and $187,200 for labour. Based on recent claims history, GGT revises their 2027 warranty provision to 9% of sales. Required: a. Prepare summary journal entries to record warranty expense and warranty claims in 2026 and 2027. b. Determine the provision for warranty payable that GGT will report as a liability on December 31, 2027.

Answer: To recognize the provision in 2026 a. Dr. Warranty expense Cr. Provision for warranty payable [$6,000,000 × (2% + 3% + 3%)]

480,000 480,000

To recognize partial satisfaction of the warranty obligation in 2026 Dr. Provision for warranty payable 480,000 Cr. Parts inventory Cr. Wage expense To recognize the provision in 2027 Dr. Warranty expense Cr. Provision for warranty payable ($6,200,000 × 9%)

558,000

To recognize partial satisfaction of the warranty obligation in 2027 Dr. Provision for warranty payable 468,000 Cr. Parts inventory Cr. Wage expense

300,000 180,000

558,000

280,800 187,200

b. The balance in the warranty payable account as at December 31, 2027 was $360,000 as set out in the Taccount that follows: Provision for Warranty Payable 270,000 Balance Dec. 31, 2025 480,000 Provision 2026 Claims 2026 480,000 Claims 2027 468,000

558,000 360,000 2027

Provision 2027 Balance Dec. 31,

Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

53) LMZ Computer Systems Inc. maintains office equipment under contract. The contracts are for labour only; customers must reimburse LMZ for parts. LMZ's rate schedule follows:

Photocopies Fax machine

One year $220 175

Two years $400 340

Three years $620 440

LMZ's 2026 sales of maintenance agreements is set out below:

Photocopies Fax machine

One year 20 24

Two years 12 20

Three years 30 30

Required: Assuming that sales occurred evenly through the year: a. What amount of revenue will LMZ recognize for the year ended December 31, 2026? b. What amount of deferred revenue will LMZ report as a current liability on December 31, 2026? c. What amount of deferred revenue will LMZ report as a non-current liability on December 31, 2026? Answer: a. Sales occurred evenly during the year, therefore in 2026 LMZ earned, on average, six months of revenue on the maintenance contracts. As per the chart below, LMZ earned revenues of $12,500. Three Revenue a. One year Two year year earned Photocopiers $220 $400 $620 # of contracts sold 20 12 30 $value of contracts sold $4,400 $4,800 18,600 Revenue earned (%)* 50% 25% 16 2/3% Revenue earned ($) $2,200 $1,200 $3,100 $6,500 Fax machines # of contracts sold $value of contracts sold Revenue earned (%) Revenue earned ($)

$175 24 $4,200 50% $2,100

$340 $440 20 30 $6,800 $13,200 25% 16 2/3% $1,700 $2,200

$6,000 $12,500

* 6 months earned/12 month contract = 50%; 6 month/24 month contract = 25%; 6 month/36 month contract = 16 2/3%

b. and c. Total deferred Photocopiers One year Two year* Three year** Total Fax machines One year Two year*** Three year**** Total Total

Current

Non-current

$2,200 3,600 15,500 $21,300

$2,200 2,400 6,200 $10,800

$0 1,200 9,300 $10,500

$2,100 5,100 11,000 $18,200

$2,100 3,400 4,400 $9,900 $20,700

$0 1,700 6,600 $8,300 $18,800

* The value of the two-year photocopier contracts sold was $4,800. One year of the two year agreement is a current liability: $4,800 / 2 = $2,400 ** The value of the three-year photocopier contracts sold was $18,600. One year of the three year agreement is a current liability: $18,600 / 3 = $6,200 *** The value of the two-year fax machine contracts sold was $6800. One year of the two year agreement is a current liability: $6,800 / 2 = $3,400 **** The value of the three-year fax machine contracts sold was $13,200. One year of the three year agreement is a current liability: $13,200 / 3 = $4,400 Diff: 3 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

54) It is early in February 2025 and you are conducting the audit of Blast Off Airline's 2024 financial statements. Through discussion with Blast Off's Chief Financial Officer you learn of matters that have not yet been incorporated into the 2024 financial statements: During 2024, Blast Off began a customer loyalty program. For each aeronautical mile that a passenger travels on a paid flight, the passenger accrues one flight mile. Passengers can redeem accrued flight miles for free air travel. Earned miles do not expire. Blast Off's analysis of its competitors' programs suggests an average redemption rate of 55%. In 2024, Blast Off awarded 50,000,000 flight miles, 1,375,000 of which were redeemed. Management estimates the fair value of the flight miles is $540,000. Required: Prepare the journal entries to record the required adjustments for the above event. Answer: To allocate a portion of the ticket sales proceeds to the award program Dr. Flight revenue 540,000 Cr. Unearned revenue (award miles) 540,000 As the award portion of the flights has not previously been allowed for, an entry is required to reverse a portion of the ticket sales revenue from flight revenue to award revenue To recognize award point revenue in 2024 Dr. Unearned revenue (award miles) 27,000 Cr. Award revenue 27,000 (50,000,000 × 55% = 27,500,000) miles expected to be redeemed. (1,375,000/27,500,000 × $540,000 = $27,000) Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions.

Learning Objective 3 Describe the nature of contingent assets and liabilities and account for these items. 1) Which statement about contingencies is correct? A) It involves only potential economic outflows of resources. B) It is a possible condition that depends upon the conclusion of a future event. C) It involves uncertainty about either the timing or amount of payment. D) It is an existing condition that depends upon the conclusion of a future event. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items.

2) Which statement about contingent assets is correct? A) It involves only potential economic outflows of resources. B) It is a possible asset that depends upon the conclusion of a future event. C) It involves uncertainty about either the timing or amount of payment. D) It is a condition that depends upon the conclusion of a forecasted event. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 3) Which statement about contingent liabilities is correct? A) It is a possible obligation that arises from past transactions and events. B) It is an obligation that arises from past transactions and events. C) It involves uncertainty about either the timing or amount of payment. D) It is a condition that depends upon the conclusion of an anticipated event. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 4) Which statement about contingent liabilities is correct? A) It is a present obligation that will probably result in the economic outflow of resources. B) It involves uncertainty about either the timing of payment or the amount of payment. C) It is an obligation that arises from past transactions and events and can be reliably measured. D) It is a present obligation that arises from past events but it cannot be reliably measured. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 5) Which statement about contingencies is correct? A) If the future outcome is possible and reliably measurable, a provision is recorded. B) If the future outcome is probable and reliably measurable, a provision is recorded. C) If the future outcome is probable, a provision is recorded even if it is not reliably measurable. D) If the future outcome is possible, a provision is recorded even if it is not reliably measurable. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items.

6) Which statement about contingencies is correct? A) If the future outcome is remote but reliably measurable, a provision is recorded. B) If the future outcome is remote, but not reliably measurable, disclosure is required. C) If the future outcome is remote, but not reliably measurable, no action is required. D) If the future outcome is remote, but reliably measurable, disclosure is required. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 7) Which statement about contingencies is correct? A) If the future outcome is possible and reliably measurable, a provision is recorded. B) If the future outcome is possible, but reliably measurable, no action is required. C) If the future outcome is possible, but not reliably measurable, no action is required. D) If the future outcome is possible, but reliably measurable, disclosure is required. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 8) Which statement about contingencies is correct? A) If the future outcome is probable and reliably measurable, a provision is recorded. B) If the future outcome is probable, disclosure is required if it is reliably measurable. C) If the future outcome is probable, but not reliably measurable, no action is required. D) If the future outcome is probable, a provision is required, even if it is not reliably measurable, Answer: A Diff: 2 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 9) Which statement is correct about provisions, contingent assets and contingent liabilities? A) Provisions are recorded in the financial statements whereas contingent assets are not recorded. B) Provisions are recorded in the financial statements whereas contingent liabilities are not recorded. C) Probable contingent liabilities are recorded at management's best estimates. D) Probable contingent assets are recorded at management's best estimates. Answer: A Diff: 3 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items.

10) Which statement is correct about provisions, contingent assets and contingent liabilities? A) The same probability threshold is used to record contingent liabilities and provisions. B) The same probability threshold is used to record contingent assets and contingent liabilities. C) Possible contingent liabilities are recorded. D) Virtually certain contingent assets are recorded. Answer: D Diff: 3 Type: MC Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 11) A supplier sued Pneumatic Systems Inc. for $200,000 for breach of contract. Pneumatic's legal counsel believes that they will almost certainly be found liable. Based on previous results, the lawyer estimates that there is a 60% probability that the supplier will be awarded the $200,000; a 30% probability that the judgment will be $150,000; and a 10% probability that $100,000 will be conferred. Assuming that Pneumatic reports its financial results in accordance with IFRS, indicate which of the following will be the appropriate accounting treatment: A) Recognize a liability of $175,000. B) Recognize a liability of $200,000. C) Disclose the details of the contingency in the notes to the financial statements. D) Recognize an asset of $175,000. Answer: B Explanation: Liability established for a single event using the most likely outcome approach Diff: 1 Type: MC Skill: Comp Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 12) Explain what contingent assets and liabilities are and how these items are accounted for financial reporting purposes. Answer: A contingent liability is: - a possible obligation whose existence can be confirmed only by future events that are not wholly controlled by the entity; or - it is possible but not probable that the obligation will have to be paid; or - the obligation cannot be measured with sufficient reliability. Contingencies that are probable are reported as provisions. Contingencies that are possible are disclosed in the notes to the financial statements. A contingent asset is a possible asset whose existence can be confirmed only by future events that are not wholly controlled by the entity. Contingent assets are not recognized in the financial statements. Diff: 1 Type: ES Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items.

13) Explain the difference between "probable," "possible," and "remote" under IFRS. Answer: Probable: The probability of occurrence is greater than 50%. Remote: is not numerically defined in IAS 37, but rather uses the common meaning of the word. Possible: A probability of 50% or less., but greater than remote. This is a matter of professional judgment, with each case being decided on its own merits. The upper bound of remote would normally fall between 5% and 10%. Diff: 1 Type: ES Skill: Concept Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items. 14) It is early in February 2025 and you are conducting the audit of Blast Off Airline's 2024 financial statements. Through discussion with Blast Off's Chief Financial Officer you learn of matters that have not yet been incorporated into the 2024 financial statements: In July 2024, 127 passengers on board Blast Off Airlines Flight 007 were seriously injured when the plane missed the runway on final approach. In January 2025, the injured passengers launched a class action lawsuit against Blast Off seeking damages of $15 million. Blast Off's internal investigation of the incident determined that the pilot was intoxicated during the flight. The company's solicitors suggest that if the matter goes to court, Blast Off will be found liable and ordered to pay the $15 million. In an attempt to reduce its loss, Blast Off's solicitors made a settlement offer of $10 million to the plaintiffs. The litigants' attorney has not provided a formal response but has indicated that the offer is being seriously considered. Blast Off's lawyers estimate that there is a 90% probability the plaintiffs will accept the offer. Required: Prepare the journal entries to record the required adjustments for the above event. Answer: To provide for the expected liability settlement Dr. Lawsuit settlement expense* 15,000,000 Cr. Provision for liability settlement costs 15,000,000 *Liability established for a single event using the most likely outcome approach Diff: 2 Type: ES Skill: Comp Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items.

15) Consider the following independent situations. The underlined entity is the reporting entity. 1. The Supreme Court of Canada ordered a supplier to pay Towna Haring Inc. $500,000 for breach of contract. 2. Iwas Pharmaceuticals Inc. sued Game Day Agencies Ltd. for $8 million alleging patent infringement. While there may be some substance to Iwas's assertion, Game Day's legal counsel estimates that Iwas's likelihood of success is about 30%. 3. Environment Canada sued Foil Fan Isotopes Ltd. for $18 million seeking to recover the costs of cleaning up Foil Fan's accidental discharge of radioactive materials. Foil Fan acknowledges liability but is disputing the amount, claiming that the actual costs are in the range of$9 million to $12 million. Foil Fan's $18 million environmental insurance policy includes a $6 million deductible clause. Required: a. For each of the situations, indicate whether the appropriate accounting treatment is to: A. Recognize an asset or liability. B. Disclose the details of the contingency in the notes to the financial statements. C. Neither provides for the item nor discloses the circumstances in the notes to the financial statements. b. For each situation that requires the recognition of an asset or liability, record the journal entry. Answer: 1. (A) Answer = A. Recognize an asset or liability. The asset is provided for as the outcome is virtually certain. Supreme Court decisions cannot be appealed. The supporting journal entry is: Dr. Other receivables (lawsuit) Cr. Lawsuit award

500,000

2. (B) The outcome is possible but not probable, so note disclosure is required. Answer = B. Disclose the details of the contingency in the notes to the financial statements. No Entry 3. (A) Answer = A. Recognize an asset or liability. A $6,000,000 liability is provided for as the loss is probable and can be reliably measured. While the final settlement may be as low as $9 million or as high as $11 million, company is responsible only for the $6,000,000 deductible. Dr. Environmental cleanup expense 6,000,000 Cr. Provision for environmental cleanup costs 6,000,000 Diff: 2 Type: ES Skill: Comp Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items.

16) Consider the following independent situations. The underlined entity is the reporting entity. 1. Call Cattle Inc. sued Nutrient Feed Ltd. for $10 million alleging breach of contract. Nutrient's legal counsel estimates that Call's likelihood of success is about 80%. Based on its experience with cases of this nature, the law firm estimates that, if successful, the litigants will be awarded $8,800,000 to $9,000,000, with all payouts in this range being equally likely. 2. Deana Finnamore broke her leg when she tripped on an uneven floor surface in Groton Co.'s office. On the advice of legal counsel, Groton has offered Finnamore $140,000 to settle her $275,000 lawsuit. It is unknown whether Finnamore will accept the settlement offer. Groton's legal counsel estimates that Finnamore has a 90% probability of success, and that if successful, she will be awarded $230,000. 3. The courts ordered a competitor to pay $1,000,000 to Ferbert and Finn Corp. for patent infringement. The competitor's legal counsel indicated that the company will probably appeal the amount of the award. Required: a. For each of the situations, indicate whether the appropriate accounting treatment is to: A. Recognize an asset or liability. B. Disclose the details of the contingency in the notes to the financial statements. C. Neither provide for the item nor disclose the circumstances in the notes to the financial statements. b. For each situation that requires the recognition of an asset or liability, record the journal entry.

Answer: 1. (A) Answer = A. Recognize an asset or liability. The loss is probable and has to be provided for. A liability is established for a single event using the most likely outcome approach. As all outcomes are equally likely, the midpoint of the range is used. Dr. Contract settlement expense Cr. Provision for contract settlement costs {[($8,800,000 + $9,000,000) / 2]

8,900,000 8,900,000

2. (A) Answer = A. Recognize an asset or liability. The loss is probable and so the company must make a provision. A liability is established for a single event using the most likely outcome approach. If the company subsequently accepts the offer, this is a change in estimate that will be dealt with prospectively. Dr. Lawsuit settlement expense Cr. Provision for liability settlement costs

230,000

3. (C or possibly B) Answer = C. Neither provide for the item nor disclose the circumstances in the notes to the financial statements. OR Possibly B. Disclose the details of the contingency in the notes to the financial statements. The outcome is certainly possible but as the appeal process has not yet been exhausted it is not virtually certain. Whether the outcome is probable (requiring disclosure) or possible (neither provided for nor disclosed) is a matter of professional judgment. Diff: 2 Type: ES Skill: Comp Objective: 11.3 Describe the nature of contingent assets and liabilities and account for these items.

Learning Objective 4 Describe the nature of commitments and guarantees and apply accrual accounting to them. 1) Which statement is correct? A) Contingencies arise from future events. B) Financial guarantees arise from contracts previously entered into. C) Current liabilities arise from future events. D) The amount to be paid for financial guarantees is known or reasonably estimable. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

2) Indemnities and letters of credit are examples of what? A) Commitments. B) Provisions. C) Contingencies. D) Guarantees. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them. 3) Explain how commitments and guarantees are accounted for under accrual accounting. Answer: Contractual commitments pertaining to the acquisition of property, plant, and equipment must be disclosed. Enterprises shall record provisions for onerous contracts. Enterprises shall record provisions for financial guarantee contracts and disclose such guarantees. Diff: 1 Type: SA Skill: Concept Objective: 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them. 4) Explain the meaning of the following terms: "financial guarantee" contract and "onerous" contract. Answer: Financial guarantee contract: A contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due. Onerous contract: A contract in which the unavoidable costs of fulfilling it exceed the benefits expected to be received. Diff: 1 Type: SA Skill: Concept Objective: 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

5) Gladstone Distributors Inc. entered into a non-cancellable contract to buy 40,000 litres of linseed oil for $6 per litre for resale purposes. Gladstone intends to resell the oil to retail paint outlets for $10 per litre. The contract was entered into on October 31, 2024 for delivery on January 15, 2025. Gladstone's year-end is December 31. On December 12, 2024, Gladstone's supplier reduces the price to $5.10 per litre due to adverse market conditions. Required: a. Outline the required accounting treatment assuming that Gladstone expects it can sell the oil for $6.45 per litre. b. Outline the required accounting treatment assuming that Gladstone expects it can sell the oil for $5.55 per litre. Answer: Economic analysis Situation a Situation b Expected economic benefit 40,000 × $6.45 = $258,000 40,000 × $5.55 = $222,000 Unavoidable costs 40,000 × 6.00 = 240,000 40,000 × 6.00 = 240,000 Profit (Loss) $ 18,000 $ (18,000) Result Non-onerous contract Onerous contract for which the expected loss must be provided a. While the company has contracted to pay more for the oil than the current market price, it remains that the expected economic benefit exceeds the unavoidable costs. The contract is thus non-onerous and does not need to be provided for. b. The expected economic benefit is less than the unavoidable costs and must be provided for. Dr. Loss on onerous contract 18,000 Cr. Provision for loss on onerous contract 18,000 Diff: 2 Type: ES Skill: Comp Objective: 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

Comprehensive Questions 1) For each independent situation: 1. A former employee of Melvin Minimarket Inc. sued the company for $900,000, alleging that the company owner sexually harassed her. Melvin's lawyers suggest that the lawsuit has a 30-40% probability of success and that, if successful, the plaintiff will be awarded between $400,000 and $500,000. 2. Leduc Pyrotechnics Ltd. received a $15,000 fee to guarantee the $800,000 bank indebtedness of Kenora Fireworks Inc. The fair value of the guarantee is initially estimated to be $15,000. 3. Montomery Syringes Co. sued a competitor for $800,000, alleging corporate espionage. Montomery's legal counsel believes that the company will be successful and will be awarded somewhere in the range of $650,000 to $800,000. Required: Describe how the event should be dealt with in the financial statements and explain why. Prepare all required journal entries. Answer: 1. This contingent liability does not need to be provided for as it is only possible (20%-30%), not probable (>50%). Note disclosure of the underlying circumstances is required. 2. Company must record the amount received as a liability and also disclose its $800,000 maximum exposure to the underlying credit risk. Dr. Cash Cr. Liability for financial guarantee

15,000

3. This contingent asset cannot be recognized as realization is not virtually certain. As realization is probable, note disclosure of the underlying circumstances is appropriate. Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions; 11.3 Describe the nature of contingent assets and liabilities and account for these items; 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

2) For each independent situation: 1. A customer sued Vernon Tractor Corp. for $300,000 for breach of contract. Vernon's solicitors advise that they will almost certainly be found liable. Based on previous results, counsel estimates that there is a 70% probability that the courts will award the $300,000 being sought; a 20% probability that $230,000 will be conferred; and a 10% probability that the judgment will be $140,000. 2. Pickering Conveyor and Clutch Ltd. are in the midst of preparing their financial statements for the year ended December 31, 2026. Pickering has been in ongoing discussions with its bankers about renewing its $2,500,000 loan maturing on June 30, 2027. While nothing had been finalized by year-end, the bank did agree to extend the maturity by five years on January 15, 2027. Required: Describe how the event should be dealt with in the financial statements and explain why. Prepare all required journal entries. Answer: 1. The loss is probable and has to be provided for. A liability is established for a single event using the most likely outcome approach. Dr. Loss on lawsuit (breach of contract) Cr. Provision for lawsuit settlement costs

300,000

2. A journal entry is not required. Rather, the $2,500,000 must be disclosed as a current liability in the 2026 financial statements as renewal was not effected before year-end. The fact that the bank agreed to renew the loan after year-end, but before the statements were authorized for issue, is disclosed as a nonadjusting event in the notes to the financial statements. Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions; 11.3 Describe the nature of contingent assets and liabilities and account for these items; 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

3) For each independent situation: 1. Moosehead Pool and Skeet Com.'s debt to equity ratio is 1.6: 1 based on its draft financial statements for the year ended December 31, 2025. This leverage ratio exceeds the 1.5:1 maximum stipulated in Moosehead's loan agreement pertaining to a $5,000,000 loan maturing on March 15, 2028. The loan agreement stipulates that the loan becomes payable on demand upon breach of any of the loan covenants. Moosehead's creditors agreed on December 15, 2025 to waive their right to demand payment until December 31, 2026 for reason only that the firm's leverage ratio exceeds the stipulated maximum. 2. Guelph Piano Storage Inc. issued a $30,000, 30-day, non-interest bearing note to Roland's Crating for storage bins. The market rate of interest for similar transactions is 2.5%. 3. On November 30, 2024, Port Meadow Fertilizer Ltd. entered into a non-cancellable agreement to buy 10 tonnes of phosphorus for $1,600 per tonne for delivery on February 28, 2025. Phosphorus is a key component of the custom fertilizer that Port Meadow produces. The market price of phosphorus is extremely volatile, as evident by the $1,175 per tonne that it could be acquired for on December 31, 2024. Notwithstanding the premium price paid for the phosphorus, the company expects that fertilizer sales will remain profitable. Port Meadow's year-end is December 31, 2024. Required: For each of the situations described above, prepare the required journal entry for the underlined entity. If a journal entry is not required, explain why. Answer: 1. A journal entry is not required as the outstanding amount of the liability has not changed. From a reporting perspective, the loan will be reported as a non-current obligation as the lender agreed to a 12month grace period before year-end. 2. IFRS allows for short-term, zero-interest-rate notes to be measured at the original invoice amount if the effect of discounting is immaterial. This is the case here as the note is due in 30 days and the imputed interest amount is immaterial. Dr. Storage bins Cr. Notes payable

30,000 30,000

3. While Port Meadow has contracted to pay more for the phosphorus than the year-end market price, it remains that the expected economic benefit exceeds the unavoidable costs. The contract is thus nononerous and does not need to be provided for. Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions; 11.3 Describe the nature of contingent assets and liabilities and account for these items; 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

4) For each independent situation: 1. Langford Airport Parking Ltd. awards customers 250 reward miles per stay, in a well-known airline mileage program. Langford pays the airline $0.06 for each mile. Langford, which is not an agent for the airline, estimates that the fair value of the miles is the same as the price paid-$0.06. Parking revenues on May 24, 2025 were $52,000. Langford awarded 40,000 airline points to its customers. 2. On October 15, 2025, Hamilton Windows and Sash properly recorded the issue of a $12,000, 7% note due April 15, 2026. Hamilton is preparing its financial statements for the year ended December 31, 2026. Hamilton does not make adjusting entries during the year. Required: For each of the situations described above, prepare the required journal entry for the underlined entity. If a journal entry is not required, explain why. Answer: 1. This is a third-party reward. As the company is not an agent of the airline, revenue and expense pertaining to the award are separately recognized. May 24, 2025

Dr. Cash 52,000 Cr. Parking revenue Cr. Award revenue (40,000 × $0.06)

49,600 2,400

May 24, 2025

Dr. Award expense (40,000 × $0.06) Cr. Cash (40,000 × $0.06)

2,400

2. Dec. 31, 2026

2,400

Dr. Interest expense 180 Cr. Accrued interest payable 180 $12,000 × 7% × 78 / 365 Diff: 2 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions; 11.3 Describe the nature of contingent assets and liabilities and account for these items; 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

5) P. A. Whitehorse owns a successful gardening company called Valley Gardening Ltd. (Valley). The company, which has a year end of December 31, 2024, has asked you, the company accountant, to prepare a report outlining how the following items should be reported in its financial statements. A. On January 1, 2024, Valley took advantage of a vendor-provided financing offer to acquire computer equipment. Valley signed a $30,000 note payable in full on January 1, 2026. Interest is payable annually at a rate of 4% per annum. Valley's bank previously advised that it would charge an interest rate of 8% per annum for a loan on similar terms. B. A client of Valley was injured when she tripped on a piece of Valley's equipment that was in her yard. The injured party is suing Valley for $500,000 for pain and suffering and loss of income. Valley's solicitors advise that the company will almost certainly be found liable. Based on previous verdicts, counsel estimates that there is a 50% probability that the courts will award $400,000, and a 50% probability that the judgment will be $200,000. C. Valley has guaranteed $100,000 of the indebtedness of Healthyway Inc. (HWI), a related corporation. HWI has a long record of profitability and the probability of default is thought to be remote. D. Valley's loan agreement with the bank includes a covenant that Valley will maintain its current ratio of no less than 1.30:1. If Valley fails to meet this or any of the other covenants at year-end, all loan facilities become immediately due and payable. It appears that Valley's current ratio at year-end will be slightly less than this. Required: Prepare the report.

Answer: A. The liability to the vendor will be recorded at $30,087, determined as set out below. The accrued interest of $2,229 will be reported as a current liability, while the principal portion of $27,859 will be reported as long-term debt. Present value of the note at origination: a) Using a BAII PLUS financial calculator: 2 N; 8 I/Y; 30000 FV; 1,200* PMT; CPT PV PV = -27,860 (rounded). *$30,000 × 4% = $1,200 b) Using a PV table a. $30,000 × 0.8573 = $25,719 b. $1,200 × 1.783 = $2,140 $25,719 + $2,140 = $27,859 (small difference due to rounding) The computer asset will be recorded at $27,860. Accrued interest to December 31, 2024 = $27,860 × 8% = $2,229 (rounded) The liability to be recorded = $27,860 + $2,229 = $30,089. B. The loss is probable and has to be provided for. A liability is established for a single event using the most likely outcome approach. Dr. Loss on lawsuit (customer injury) Cr. Provision for lawsuit settlement costs

400,000 400,000

C. IFRS 9 paragraph 5.1.1 requires that the guarantee be initially reported at its fair value. The fair value considers the amount of the guarantee, the prevailing discount (interest) rate, and the probability of default. Subsequently the guarantee is measured at the higher of the best estimate to settle and the remaining provision recorded in the financial statements. IFRS 7 requires that Valley disclose the nature of the guarantee including the maximum risk exposure ($100,000). D. If Valley has not complied with the loan covenant at year-end, the liability must be presented as a current obligation and the loan becomes due on demand. Valley should appeal to the bank for a loan waiver or extension and if accepted before year-end, the loan will continue to appear as a long-term liability. Diff: 3 Type: ES Skill: Comp Objective: 11.2 Describe the nature of current liabilities, and account for common current liabilities including provisions; 11.3 Describe the nature of contingent assets and liabilities and account for these items; 11.4 Describe the nature of commitments and guarantees and apply accrual accounting to them.

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 12 Non-Current Financial Liabilities Learning Objective 1 Describe financial leverage and its impact on profitability. 1) Which statement best explains the concept of "leverage"? A) A measure of the efficiency of the company. B) A measure of solvency of the company. C) A measure of the company's operations. D) A measure of the company's debt paying ability. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability. 2) What are "non-current liabilities"? A) Obligations that are expected to be settled in the next operating cycle of the company. B) Obligations that are expected to be settled within the next 12 months. C) Obligations that are expected to be settled more than 12 months after the company's year-end. D) Obligations that are expected to be settled more than 24 months after the company's year-end. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability. 3) Which of the following would be a "non-current liability"? A) Payment due after 3 years, but the company has violated the debt covenants. B) Payment due to a supplier 45 days after year-end for supplies received before year-end. C) Payment due to a supplier in 18 months for goods to be received 3 months after year-end. D) Payment due after 3 years, on which the debt covenants have been not been violated. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability. 4) Which statement is correct about financial leverage? A) It reduces the risk of bankruptcy to the company. B) It reduces the level of risk exposure of the shareholders. C) It quantifies the relationship between the relative level of a firm's debt and its equity base. D) It has nothing to do with the relationship between the relative level of a firm's debt and its equity base. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability.

5) Which statement best explains a "leveraged buyout"? A) A purchase where a small portion of the purchase price is raised by borrowing against the acquired assets. B) A purchase where a significant portion of the purchase price is raised by borrowing against the acquired assets. C) A purchase that is deemed too risky from a solvency perspective for the shareholders. D) A purchase that is deemed too risky from a solvency perspective for the bondholders. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability. 6) Which statement is correct about financial leverage? A) Leverage can increase an investor's returns but also increases the risk of loss. B) Leverage can decrease an investor's returns and also decrease the risk of loss. C) Leverage decreases the payments that a company makes on an ongoing basis. D) Leverage decreases the debt level relative to a company's equity base. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability. 7) Which statement is correct about the financial leverage of a company with an equity base of $400,000? A) A company that borrows $150,000 is more leveraged than a company that borrows $250,000. B) A company that borrows $250,000 is more leveraged than a company that borrows $150,000. C) The return on equity of the company is unaffected by the financial leverage. D) The return on equity of the company will be higher if it has a lower leverage. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability. 8) Which statement is not correct about financial leverage for a $300,000 investment versus a $100,000 investment? A) The probability of success is the same under both investment options. B) The payout will be 3 times higher or 3 times lower with the larger investment. C) The probability of success is 3 times greater with the larger investment. D) The larger investment increases the return on equity but also faces a greater potential for loss. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability.

9) Explain the meaning of financial leverage and leveraged buyout. Answer: Financial leverage: Quantifies the relationship between the relative level of a firm's debt and its equity base. Leveraged buyout: A purchase where a significant part of the purchase price is raised by borrowing against the acquired assets. Diff: 1 Type: SA Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability. 10) What are some considerations in determining a safe level of debt? Answer: Considerations include: a) the nature of the industry b) degree of operating leverage c) stability of cash flows d) competition e) economic outlook. Diff: 2 Type: SA Skill: Concept Objective: 12.1 Describe financial leverage and its impact on profitability.

11) Complete the following chart to illustrate how leverage can increase investors' returns while concurrently exposing them to large losses. Facts: Calabria Corporation is a new company and has only one asset, its cash of $105,000 from the sale of common shares. In scenario 1, Calabria invests the $105,000 in a venture that will pay out either $85,000 or $135,000 at the end of one year, depending on the success of the venture. In scenario 2, Calabria borrows $210,000 at 7% interest and invests $315,000 in the same project outlined in Scenario 1. The payout will be $255,000 ($85,000 × 3) or $405,000 ($135,000 × 3) because it invests three times as much. Scenario 1 (unlevered) Unsuccessful

Scenario 1 (unlevered) Successful

Scenario 2 (Levered) Unsuccessful

Scenario 2 (Levered) Successful

Answer:

Opening equity Loan proceeds Investment Payout expected Repay loan Pay loan interest Closing equity Opening equity Profit (loss) Return on opening equity (ROE)

Scenario 1 Scenario 2 (unlevered) (Levered) Unsuccessful Successful Unsuccessful Successful $105,000 $105,000 $105,000 $105,000 210,000 210,000 105,000 105,000 315,000 315,000 85,000 135,000 255,000 405,000 (210,000) (210,000) (14,700) (14,700) 85,000 135,000 30,300 180,300 105,000 105,000 105,000 105,000 ($20,000) $30,000 ($74,700) $75,300 -19%

29%

-71%

Diff: 2 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

72%

12) Bank Buy Inc. is in the process of acquiring another business. In light of the acquisition, shareholders are currently re-evaluating the appropriateness of the firm's capital structure (the types of and relative levels of debt and equity). The two proposals being contemplated are detailed below: Proposal 1 Estimated earnings before interest and taxes (EBIT) Long term debt Market value of equity Interest rate on long term debt Tax rate

900,000 4,000,000 4,000,000 14% 25%

Proposal 2 $

900,000 4,500,000 5,500,000 14% 25%

Required: a. Calculate the estimated return on equity (ROE) under the two proposals. (ROE = net income after taxes / market value of equity; net income after taxes = (EBIT - interest on long-term debt) × (1 - tax rate)). b. Which proposal will generate the higher estimated ROE? c. What is the primary benefit of leveraging an investment decision? What are two drawbacks to leveraging an investment decision? Answer: a. Proposal 1 Proposal 2 Estimated EBIT $900,000 $900,000 Less: Interest $4,000,000 × 14% 560,000 $4,500,000 × 14% 630,000 Income before taxes 340,000 270,000 Income taxes $340,000 × 25% 85,000 $270,000 × 25% 67,500 Net income after taxes $255,000 $202,500 ROE (Net income / Market value of equity)

$255,000 / $4,000,000

6.4%

$202,500 / $5,500,000

3.7%

b. Proposal one results in the higher of the two estimated ROEs. c. The primary benefit to the shareholders of leveraging are higher envisaged return. Drawbacks to increased financial leverage include a heightened risk of loss if estimates are not realized and an increased risk of bankruptcy. Diff: 2 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

13) Blue Corp is in the process of acquiring another business. In light of the acquisition, shareholders are currently re-evaluating the appropriateness of the firm's capital structure (the types of and relative levels of debt and equity). The two proposals being contemplated are detailed below: Proposal 1 Estimated earnings before interest and taxes (EBIT) Long term debt Market value of equity Interest rate on long term debt Tax rate

450,000 1,000,000 1,000,000 10% 25%

Proposal 2 $

450,000 2,000,000 500,000 10% 25%

Required: a. Calculate the estimated return on equity (ROE) under the two proposals. (ROE = net income after taxes / market value of equity; net income after taxes = (EBIT - interest on long-term debt) × (1 - tax rate)). b. Which proposal will generate the higher estimated ROE? c. What is the primary benefit of leveraging an investment decision? What are two drawbacks to leveraging an investment decision? Answer: a. Proposal 1 Proposal 2 Estimated EBIT $450,000 $450,000 Less: Interest $1,000,000 × 10% 100,000 $2,000,000 × 10% 200,000 Income before taxes 350,000 250,000 Income taxes $350,000 × 25% 87,500 $250,000 × 25% 62,500 Net income after taxes $262,500 $187,500 ROE (Net income / Market value of equity)

$262,500 / $1,000,000

26%

$187,500 / $500,000

38%

b. Proposal 2 results in the higher of the two estimated ROEs c. The primary benefit to the shareholders of leveraging are higher envisaged return. Drawbacks to increased financial leverage include a heightened risk of loss if estimates are not realized and an increased risk of bankruptcy. Diff: 2 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

14) Universal Inc. is in the process of acquiring another business. In light of the acquisition, shareholders are currently re-evaluating the appropriateness of the firm's capital structure (the types of and relative levels of debt and equity). The two proposals being contemplated are detailed below: Proposal 1 Estimated earnings before interest and taxes (EBIT) Long term debt Market value of equity Interest rate on long term debt Tax rate

750,000 3,000,000 3,000,000 5% 20%

Proposal 2 $

750,000 4,000,000 3,500,000 5% 20%

Required: a. Calculate the estimated return on equity (ROE) under the two proposals. (ROE = net income after taxes / market value of equity; net income after taxes = (EBIT - interest on long-term debt) × (1 - tax rate)). b. Which proposal will generate the higher estimated ROE? Answer: a. Proposal 1 Proposal 2 Estimated EBIT $750,000 $750,000 Less: Interest $3,000,000 × 5% 150,000 $4,000,000 × 5% 200,000 Income before taxes 600,000 550,000 Income taxes $600,000 × 20% 120,000 $550,000 × 20% 110,000 Net income after taxes $480,000 $440,000 ROE (Net income / Market value of equity)

$480,000 / $3,000,000

16%

$440,000 / $3,500,000

b. Proposal 1 results in the higher of the two estimated ROEs Diff: 2 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

13%

15) Fast Track Inc. is in the process of acquiring another business. In light of the acquisition, shareholders are currently re-evaluating the appropriateness of the firm's capital structure (the types of and relative levels of debt and equity). The two proposals being contemplated are detailed below:

Estimated earnings before income tax (EBIT) Long term debt Market value of equity Interest rate on long term debt Tax rate

Proposal 1 $ 600,000 3,000,000 3,000,000 5% 20%

Proposal 2 $ 600,000 4,000,000 3,500,000 5% 20%

Required: a. Calculate the estimated return on equity (ROE) under the two proposals. (ROE = net income after taxes / market value of equity; net income after taxes = (EBIT - interest on long-term debt) × (1 - tax rate)). b. Which proposal will generate the higher estimated ROE? Answer: a. Proposal 1 Proposal 2 Estimated EBIT $600,000 $600,000 Less: Interest $3,000,000 × 5% 150,000 $4,000,000 × 5% 200,000 Income before taxes 450,000 400,000 Income taxes $450,000 × 20% 90,000 $400,000 × 20% 80,000 Net income after taxes $360,000 $320,000 ROE (Net income / Market value of equity)

$360,000 / $3,000,000

12%

$320,000 / $3,500,000

b. Proposal 1 results in the higher of the two estimated ROEs Diff: 2 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

16) Sally has to decide between the following two options: 1) Take out a student loan of $60,000 and study accounting full time for the next three years. The interest on the loan is 5% per year payable annually. The principle is to be paid in full after ten years. 2) Study part-time and work part-time to earn $20,000 per year for the following six years. Once Sally graduates, she estimates that she will earn $35,000 for the first three years and $50,000 for the next four years. Sally's banker says the market interest for a ten-year horizon is 7%. Required: a. Calculate NPV of the ten-year cash flows of the two options. For simplification assume that all cash flows happen at year-end. b. Based on the NPV which of the two options is better for Sally? c. What is the primary benefit of leveraging an investment decision? What are two drawbacks to leveraging an investment decision? Answer: a. Option 1 Option 2

Year Loan Interest Income 0 $60,000 1 ($3,000) 2 (3,000) 3 (3,000) 4 (3,000) $35,000 5 (3,000) 35,000 6 (3,000) 35,000 7 (3,000) 35,000 8 (3,000) 50,000 9 (3,000) 50,000 10 (60,000) (3,000) 50,000 Total

Net Cash flow $60,000 (3,000) (3,000) (3,000) 32,000 32,000 32,000 47,000 47,000 47,000 (13,000)

NPV Income $60,000.00 (2,803.74) $20,000 (2,620.32) 20,000 (2,448.89) 20,000 24,412.65 20,000 22,815.56 20,000 21,322.95 20,000 29,269.24 35,000 27,354.43 35,000 25,564.89 35,000 (6,608.54) 50,000 $196,258.22

NPV $18,691.59 17,468.77 16,325.96 15,257.90 14,259.72 13,326.84 21,796.24 20,370.32 19,037.68 25,417.46 $181,952.50

b. Option 1 results in a higher NPV. Based on this criterion alone, Sally should select this option. c. The primary benefit of leveraging is the higher envisaged return. Drawbacks to increased financial leveraging include a heightened risk of loss if estimates are not realized and an increased risk of bankruptcy. Diff: 3 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

17) Sally has to decide between the following two options: 1) Take out a student loan of $70,000 and study accounting full time for the next three years. The interest on the loan is 4% per year payable annually. The principle is to be paid in full after ten years. 2) Study part time and work part time to earn $15,000 per year for the following six years. Once Sally graduates, she estimates that she will earn $30,000 for the first three years and $40,000 the next four years. Sally's banker says the market interest for a ten-year horizon is 6%. Required: a. Calculate NPV of the ten-year cash flows of the two options. For simplification assume that all cash flows happen at year-end. b. Based on the NPV which of the two options is better for Sally? c. What is the primary benefit of leveraging an investment decision? What are two drawbacks to leveraging an investment decision? Answer: a. Option 1 Option 2 Net Cash Year Loan Interest Income flow NPV Income NPV 0 $70,000 $70,000 $70,000.00 1 ($2,800) (2,800) (2,641.51) $15,000 $ 14,150.94 2 (2,800) (2,800) (2,491.99) 15,000 13,349.95 3 (2,800) (2,800) (2,350.93) 15,000 12,594.29 4 (2,800) 30,000 27,200 21,544.95 15,000 11,881.40 5 (2,800) 30,000 27,200 20,325.42 15,000 11,208.87 6 (2,800) 30,000 27,200 19,174.93 15,000 10,574.41 7 (2,800) 40,000 37,200 24,740.12 30,000 19,951.71 8 (2,800) 40,000 37,200 23,339.74 30,000 18,822.37 9 (2,800) 40,000 37,200 22,018.62 30,000 17,756.95 10 (70,000) (2,800) 40,000 (32,800) (18,315.35) 40,000 22,335.79 Total $175,344.00 $152,626.69 b. Option 1 results in a higher NPV. Based on this criterion alone, Sally should select this option. c. The primary benefit of leveraging is the higher envisaged return. Drawbacks to increased financial leveraging include a heightened risk of loss if estimates are not realized and an increased risk of bankruptcy. Diff: 3 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

18) Sally has to decide between the following two options: 1) take out a student loan of $80,000 and study accounting full time for the next three years. The interest on the loan is 3% per year payable annually. The principle is to be paid in full after ten years. 2) study part time and work part time to earn $20,000 per year for the following six years. Once Sally graduates, she estimates that she will earn $35,000 for the first three years and $45,000 for the next four years. Sally's banker says the market interest for a ten-year horizon is 6%. Required: a. Calculate NPV of the ten-year cash flows of the two options. For simplification assume that all cash flows happen at year-end. b. Based on the NPV which of the two options is better for Sally? c. What is the primary benefit of leveraging an investment decision? What are two drawbacks to leveraging an investment decision? Answer: a. Option 1 Option 2 Net Cash Year Loan Interest Income flow NPV Income NPV 0 $80,000 $80,000 $80,000.00 1 ($2,400) (2,400) ( 2,264.15) $20,000 $ 18,867.92 2 (2,400) (2,400) ( 2,135.99) 20,000 17,799.93 3 (2,400) (2,400) ( 2,015.09) 20,000 16,792.39 4 (2,400) $35,000 32,600 25,822.25 20,000 15,841.87 5 (2,400) 35,000 32,600 24,360.62 20,000 14,945.16 6 (2,400) 35,000 32,600 22,981.71 20,000 14,099.21 7 (2,400) 45,000 42,600 28,331.43 35,000 23,277.00 8 (2,400) 45,000 42,600 26,727.77 35,000 21,959.43 9 (2,400) 45,000 42,600 25,214.87 35,000 20,716.45 10 (80,000) (2,400) 45,000 (37,400) (20,883.96) 45,000 25,127.76 Total $206,139.46 $189,427.13 b. Option 1 results in a higher NPV. Based on this criterion alone, Sally should select this option. c. The primary benefit of leveraging is the higher envisaged return. Drawbacks to increased financial leveraging include a heightened risk of loss if estimates are not realized and an increased risk of bankruptcy. Diff: 3 Type: ES Skill: Comp Objective: 12.1 Describe financial leverage and its impact on profitability.

Learning Objective 2 Describe the categories and types of non-current liabilities. 1) Why do bonds often include covenants? A) To reduce information asymmetry. B) To reduce moral hazard. C) To compensate for value-added services. D) To ensure repayment of the bond. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 2) What is a "covenant"? A) Guarantee of the price to the borrower. B) Contract that outlines the terms of the borrowing agreement. C) Promise from the borrower to restrict certain activities. D) Feature that permits the issuer to redeem before maturity. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 3) What are "secured bonds"? A) Bonds that never mature. B) Bonds that protect investors against inflation. C) Bonds that mature at different dates. D) Bonds backed by specific collateral. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 4) What are "zero-coupon bonds"? A) Bonds that pay the market rate of interest. B) Bonds that are unsecured. C) Bonds that do not pay interest. D) Bonds that are sold at a premium. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities.

5) What is a bond indenture? A) Guarantee of the price to the borrower. B) Contract that outlines the terms of the borrowing agreement. C) Promise from the borrower to restrict certain activities. D) Feature that permits the borrower to redeem before maturity. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 6) What is the "best efforts" approach? A) Broker's guarantee of the price to the borrower. B) Broker sells as much of the debt issue as possible. C) Debt that is backed by specific collateral. D) Feature that permits the issuer to redeem before maturity. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 7) What is "firm commitment" underwriting? A) Broker's guarantee of the price to the borrower. B) Broker sells as much of the debt issue as possible. C) Debt that is backed by specific collateral. D) Feature that permits the borrower to redeem before maturity. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 8) What are "debentures"? A) Bonds that are unsecured. B) Bonds that protect investors against inflation. C) Bonds that mature at different dates. D) Bonds backed by specific collateral. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities.

9) What are "stripped bonds"? A) Bonds that pay the market rate of interest. B) Bonds that are unsecured. C) Bonds that pay no interest and are sold at a discount. D) Bonds that are sold at a premium. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 10) What are "serial bonds"? A) Bonds that are seldom used in Canada. B) Bonds that mature at regular scheduled dates. C) Bonds that are sold at a discount. D) Bonds that are sold at a premium. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 11) What are "callable bonds"? A) Bonds that have cash flows indexed to inflation. B) Bonds that can be redeemed 1 year before maturity. C) Bonds that can be redeemed before maturity. D) Bonds that are sold at a premium. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 12) What is the role of debt rating agencies and what two benefits result from their rating a company? Answer: Their role is to provide an independent and impartial evaluation of the riskiness of debt securities to assist investors in making educated decisions. Similar to an external audit, this evaluation by independent rating agencies (a) helps to reduce information asymmetry between bond issuers and investors which in turn (b) can reduce the cost of financing. Diff: 1 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 13) Why do companies sell notes directly to the investing public? Answer: Companies sell notes directly to the investing public to lower interest costs by reducing or eliminating the spread that banks charge for their value-added services. Explanation: Diff: 1 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities.

14) What is meant by the "spread" charged by banks on loans? Answer: It is the difference between the interest it pays on customer deposits and the interest it earns on loans. Diff: 1 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 15) Why are banks able to pay such low interest rates on customer deposits? Answer: Banks are able to offer a low rate on deposits because they offer a safe place for depositors to put their funds, whereas someone buying a note from a company faces significant information asymmetry about the company. Diff: 1 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 16) What does an "AAA" credit rating mean? Answer: The company's debt is of superior quality with a very low probability of default. Diff: 1 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities.

17) Define the following: a) Financial liabilities b) A mortgage c) A bond indenture d) Secured bonds e) Debentures f) Stripped bonds g) Serial bonds h) Callable bonds i) Convertible bonds j) Inflation-linked or real-return bonds k) Perpetual bonds Answer: a) Financial liabilities are contractual obligations to deliver cash or other financial assets to another party at a future date. b) A mortgage is a special type of note payable specifically secured by a charge over real estate. c) A bond indenture is a contract that outlines the terms of the bond, including the maturity date, rate of interest and interest payment dates, security pledged, and financial covenants. d) Secured bonds are bonds backed by specific collateral such as a mortgage on real estate. e) Debentures are unsecured bonds. f) Stripped (zero-coupon) bonds are bonds that do not pay interest. Stripped bonds are sold at a discount and mature at face value. g) Serial bonds are a set of bonds issued at the same time but that mature at regular scheduled dates rather than all on the same date. h) Callable bonds permit the issuing company to "call" for the bonds to be redeemed before maturity. A call premium is an excess over par value paid to the bondholders when the security is called. i) Convertible bonds allow the holder to exchange or "convert" the bond into other securities in the corporation, usually common shares. j) Inflation-linked or real-return bonds protect investors against inflation. The basic premise is that the cash flows are indexed to inflation. k) Perpetual bonds are bonds that never mature. Diff: 1 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 18) What are the reasons for issuing bonds rather than using a bank loan? Answer: Reasons for issuing bonds include (a) reducing the cost of borrowing and (b) accessing large amounts of capital. Diff: 1 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities.

19) Contrast the two methods used by investment banks when selling bonds on behalf of a company, their client. Answer: The more common method of underwriting is a firm commitment underwriting where the investment bank guarantees the borrower a price for the bonds, expecting to resell them to its investment clients at a profit. A lesser-used arrangement is a best efforts approach, where the broker simply agrees to try to sell as much of the issue as possible to investors. Diff: 2 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 20) Why do lenders avoid lending large amounts of money to one borrower? Answer: Lenders such as banks would rather have diversified holdings of loans such that the default of any single borrower will not entail severe consequences for the lender. Diff: 2 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 21) Explain the difference between real-return bonds, convertible bonds and perpetual bonds. Answer: Inflation-linked (Real-return) bonds — Bonds that provide protection against inflation. Convertible bonds — Bonds that allow the holder to exchange or "convert" the bond into other securities in the corporation, usually common shares. Perpetual bonds — Bonds that never mature. Diff: 2 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 22) Based on the characteristics provided below, what kind of bond is being discussed? 1. ________ are a set of bonds issued at the same time but that mature at regular scheduled dates rather than all on the same date. 2. ________ are bonds that never mature. 3. ________ allow the holder to exchange the bond into other securities in the corporation, usually common shares. 4. ________ protect investors against inflation. Answer: 1. Serial bonds are a set of bonds issued at the same time but that mature at regular scheduled dates rather than all on the same date. 2. Perpetual bonds are bonds that never mature. 3. Convertible bonds allow the holder to exchange or "convert" the bond into other securities in the corporation, usually common shares. 4. Inflation-linked or real-return bonds protect investors against inflation. Diff: 2 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities.

23) Based on the characteristics provided below, what kind of bond is being discussed? 1. ________ permit the issuing company to redeem before maturity. 2. ________ are bonds backed by specific collateral such as a mortgage on real estate. 3. ________ are unsecured bonds. 4. ________ are bonds that do not pay interest and are sold at a discount and mature at face value. Answer: 1. Callable bonds permit the issuing company to "call" for the bonds to be redeemed before maturity. 2. Secured bonds are bonds backed by specific collateral such as a mortgage on real estate. 3. Debentures are unsecured bonds. 4. Stripped (zero-coupon) bonds are bonds that do not pay interest. Stripped bonds are sold at a discount and mature at face value. Diff: 2 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities. 24) What are positive and negative covenants? Give an example of a positive and negative covenant. Answer: Positive covenants require certain actions by the borrower; negative covenants forbid certain actions by the borrower. An example of a positive covenant is the borrower pledging to maintain its current ratio in excess of 1.5:1; a negative covenant is agreeing not to pay dividends in excess of $1,000,000 per year. Diff: 2 Type: SA Skill: Concept Objective: 12.2 Describe the categories and types of non-current liabilities.

Learning Objective 3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 1) How should non-current financial liabilities be recorded initially? A) At face value. B) At fair value. C) At fair value less transaction costs. D) At face value less transaction costs. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 2) Non-current debt instruments exchanged for assets are recognized at: A) book value. B) fair value. C) cash paid. D) cash equivalents paid. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 18 Copyright © 2023 Pearson Canada Inc.

3) What is the coupon rate? A) Yield on the issue date. B) Amount to be repaid at maturity. C) Rate of return earned by the investor. D) Interest rate specified in the bond indenture. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 4) When will bonds sell at a discount? A) When the coupon rate is below the par value. B) When the coupon rate is below the market rate. C) When the coupon rate is above the market rate. D) When the coupon rate is above the par value. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 5) A $100,000 5-year 6% bond is issued on January 1, 2026. The bond pays interest annually. The market rate is 7%. What is the selling price of the bonds, rounded to the nearest dollar? A) $4,100 B) $95,900 C) $100,000 D) $104,213 Answer: B Explanation: PV of coupon payments: $6,000 PVAV(7%,5) = $6,000 × 4.1002 = $24,601 PV of principal repayment: $100,000 PV (7%,5) = $71,299 Total = $24,601 + $71,299 = $95,900 Diff: 1 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 6) What is the market rate? A) Price of bond on issue date. B) Amount to be repaid at maturity. C) Rate of return earned by the investor. D) Interest rate specified in the bond indenture. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 19 Copyright © 2023 Pearson Canada Inc.

7) What is the effective interest rate? A) Yield on the issue date. B) Amount to be repaid at maturity. C) Price of bond on issue date. D) Interest rate specified in the bond indenture. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 8) When will bonds sell at a premium? A) When the coupon rate is equal to the par value. B) When the coupon rate is below the market rate. C) When the coupon rate is above the market rate. D) When the coupon rate is equal to market value. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 9) When will bonds sell without a premium or discount? A) When the coupon rate equals the par value. B) When the coupon rate is below the market rate. C) When the coupon rate is above the market rate. D) When the coupon rate is equal to the market rate. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 10) A $100,000 5-year 6% bond is issued on January 1, 2025. The bond pays interest annually. The market rate is 7%. What is the discount or premium of the sale of the bonds, rounded to the nearest dollar? A) $4,100 discount B) $4,100 premium C) $95,900 discount D) $100,000 premium Answer: A Explanation: PV of coupon payments: $6,000 PVAV(7%,5) = $6,000 × 4.1002 = $24,601 PV of principal repayment: $100,000 PV (7%,5) = $71,299 Total bond price = $24,601 + $71,299 = $95,900; Discount = $100,000 - $95,900 = $4,100 Diff: 1 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 20 Copyright © 2023 Pearson Canada Inc.

11) A $100,000 5-year 6% bond is issued on January 1, 2025. The bond pays interest semi-annually. The market rate is 8%. What is the selling price of the bonds, rounded to the nearest dollar? A) $91,889 B) $92,014 C) $108,425 D) $108,530 Answer: A Explanation: PV of coupon payments: $3,000 PVAV(4%,10) = $3,000 × 8.11090 =$24,333 PV of principal repayment: $100,000 PV (4%,10) = $100,000 × 0.67556 = 67,556 Total $91,889 Diff: 1 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 12) A $100,000 5-year 6% bond is issued on January 1, 2025. The bond pays interest annually. The market rate is 8%. What is the selling price of the bonds, rounded to the nearest dollar? A) $91,575 B) $92,014 C) $107,985 D) $108,425 Answer: B Explanation: PV of coupon payments: $6,000 PVAV(8%,5) = $6,000 × 3.99271 = $23,956 PV of principal repayment: $100,000 PV (8%,5) = $100,000 × 0.68058 = 68,058 Total $92,014 Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 13) A $100,000 5-year 7% bond is issued on January 1, 2025. The bond pays interest annually. The market rate is 6%. What is the selling price of the bonds, rounded to the nearest dollar? A) $4,213 B) $95,500 C) $100,000 D) $104,213 Answer: D Explanation: PV of coupon payments: $7,000 PVAV(6%,5) = $7,000 × 4.21236 = $29,487 PV of principal repayment: $100,000 PV (6%,5) = $100,000 × 0.74726 = 74,726 Total = $104,213 Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

14) A $100,000 5-year 7% bond is issued on January 1, 2025. The bond pays interest semi-annually. The market rate is 6%. What is the selling premium or discount on the bonds, rounded to the nearest dollar? A) $4,213 discount B) $4,213 premium C) $4,265 discount D) $4,265 premium Answer: D Explanation: PV of coupon payments: $3,500 PVAV(3%,10) = $3,500 × 8.5302 = $29,856 PV of principal repayment: $100,000 PV (3%,10) = $100,000 × 0.74409 = 74,409 Total = $104,265 Premium = $100,000 - $104,265 = $4,265 Diff: 1 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 15) A $100,000 5-year 7% bond is issued on January 1, 2025. The bond pays interest annually. The market rate is 6%. What is the selling premium or discount on the bonds, rounded to the nearest dollar? A) $4,213 discount B) $4,213 premium C) $4,265 discount D) $4,265 premium Answer: B Explanation: PV of coupon payments: $7,000 PVAV(6%,5) = $7,000 × 4.21236 = $ 29,487 PV of principal repayment: $100,000 PV (6%,5) = $100,000 × 0.74726 = 74,726 Total = $104,213 Premium = $100,000 - $104,213 = $4,213 Diff: 2 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 16) A $100,000 5-year 7% bond is issued on January 1, 2025. The bond pays interest annually. The market rate is 8%. What is the selling price of the bonds, rounded to the nearest dollar? A) $96,007 B) $103,993 C) $104,100 D) $95,890 Answer: A Explanation: PV of coupon payments: $7,000 PVAV(8%,5) = $7,000 × 3.99271 = $ 27,949 PV of principal repayment: $100,000 PV (8%,5) = $100,000 × 0.68058 = 68,058 Total = $96,007 Diff: 2 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

17) A $100,000 5-year 7% bond is issued on January 1, 2025. The bond pays interest annually. The market rate is 5%. What is the selling premium or discount on the bonds, rounded to the nearest dollar? A) $8,659 premium B) $8,200 premium C) $8,659 discount D) $8,200 discount Answer: A Explanation: PV of coupon payments: $7,000 PVAV(5%,5) = $7,000 × 4.32948 = $ 30,306 PV of principal repayment: $100,000 PV (5%,5) = $100,000 × 0.78353 = 78,453 Total = $108,659 Total Premium : $ 108,659 - $ 100,000 = $ 8,659 Diff: 2 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 18) A $100,000 5-year 5% bond is issued on January 1, 2025. The bond pays interest annually. The market rate is 7%. What is the selling premium or discount on the bonds, rounded to the nearest dollar? A) $8,659 premium B) $8,200 premium C) $8,659 discount D) $8,200 discount Answer: D Explanation: PV of coupon payments: $5,000 PVAV(7%,5) = $5,000 × 4.10020 = $ 20,501 PV of principal repayment: $100,000 PV (7%,5) = $100,000 × 0.71299 = 71,299 Total = $91,800 Total discount : $ 100,000 - $ 91,800 = $ 8,200 Diff: 2 Type: MC Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 19) On April 15, 2025, Cando Inc. sold $10,000,000 of five-year, 3% bonds for $9,972,469. From the proceeds, Cando paid its investment bank a $200,000 sales commission. Interest is payable semi-annually on April 15 and October 15. What is the effective rate of interest (round to 2 decimal places)? A) 1.53% B) 1.75 % C) 3.00% D) 3.50% Answer: B Explanation: The net proceeds (PV) to Cando are $9,772,469 ($9,972,469 - $200,000); N = 10 (5 × 2); PMT = $150,000 ($10,000,000 × 3% × 6/12); 10 N, 9772469 +/- PV, 10000000 FV, 150000 PMT, CPT I/Y I/Y = 1.75% Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

20) On May 5, 2025, Bennix sold $1,000,000 of five-year, 3% bonds for $900,500. From the proceeds, the company paid fees of 100,000. Interest is payable semi-annually on May 5 and November 5. What is the effective rate of interest (round to 2 decimal places)? A) 3.00% B) 3.72 % C) 3.95% D) 6.27% Answer: C Explanation: The net proceeds (PV) to Bennix are $800,500 ($900,500 - $100,000); N = 10 (5 × 2); PMT = $15,000; 10 N, 800,500 +/- PV, 1000000 FV, 15000 PMT, CPT I/Y I/Y = 3.954% = 3.95% Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 21) On November 1, 2025, FastCare sold $5,000,000 of three-year bonds for $4,750,325. From the proceeds, the company paid accounting fees of $50,000. Interest of 5% is payable annually. What is the effective rate of interest (round to 2 decimal places)? A) 7.30% B) 5.00% C) 4.69% D) 3.63% Answer: A Explanation: The net proceeds (PV) are $4,700,325 ($4,750,325 - $50,000); N = 3 (3 × 1); PMT = $250,000; 3 N, 4700325 +/- PV, 5000000 FV, 250000 PMT, CPT I/Y I/Y = 7.296% = 7.30% Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 22) On April 1, 2025, a company sold $3,500,000 of ten year, 6% bonds for $2,222,400. From the proceeds, the company paid $200,000 sales commission. Interest is payable semi-annually on April 1 and October 1. What is the effective rate of interest (round to 2 decimal places)? A) 6.25% B) 6.98% C) 9.81% D) 11.46% Answer: B Explanation: The net proceeds (PV) are $2,022,400 ($2,222,400 - $200,000); N = 20 (10 × 2); PMT = $105,000 ($3,500,000 × 6% × 6/12); 20 N, 2,022,400 +/- PV, 3,500,000 FV, 105,000 PMT, CPT I/Y I/Y = 6.978% = 6.98% Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

23) Canaroo Inc. sold $800,000 of two-year bonds for $701,500 less commissions of $50,500. Interest is of 5.5% is payable annually. What is the effective rate of interest (round to 2 decimal places)? A) 5.50 % B) 8.43% C) 8.65% D) 17.29% Answer: D Explanation: The net proceeds (PV) are $651,000 ($701,500 - $50,500); N = 2 (1 × 2); PMT = $44,000 ($800,000 × 5.5%); 2 N, 651000 +/- PV, 800000 FV, 44000 PMT, CPT I/Y I/Y = 17.292% = 17.29% Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 24) Cindy Corp. sold $400,000 of three-year bonds for $300,500. Interest is of 7.5% is payable annually. What is the effective rate of interest (round to 2 decimal places)? A) 19.15% B) 14.57% C) 13.88% D) 7.50% Answer: A Explanation: The net proceeds (PV) are $300,500; N = 3 ; PMT = $30,000 ($400,000 × 7.5%); 3 N, 300500 +/PV, 400000 FV, 30000 PMT, CPT I/Y I/Y = 19.152% = 19.15% Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 25) Ginny Inc. sold $800,000 of two-year bonds for $701,500 less commissions of $50,500. Interest is of 5.5% is payable semi-annually. What is the effective rate of interest (round to 2 decimal places)? A) 5.50% B) 8.43% C) 8.65% D) 17.29% Answer: B Explanation: The net proceeds (PV) are $651,000 ($701,500 - $50,500); N = 4 (2 × 2); PMT = $22,000 ($800,000 × 5.5% × 6/12); 4 N, 651000 +/- PV, 800000 FV, 22000 PMT, CPT I/Y I/Y = 8.427% = 8.43% Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

26) On June 1, 2025, ABC Ltd. provides a vendor with an $18,500 non-interest-bearing note due on June 1, 2026, in exchange for furniture with a list price of $18,100. At what amount will the property be recorded in the accounting records? The company's banker has suggested that an appropriate market rate is 12% per annum for loans that mature in one year or less and 15% for loans with longer maturities. A) $16,087 B) $16,518 C) $18,100 D) $18,500 Answer: B Explanation: The fair value of the note is determined using discounted cash flow analysis. The market rate suggested by the bank has been used to discount the obligation. List prices are not necessarily a reliable indicator of the asset's fair market value. Using a BAII PLUS financial calculator: 1 N, 12 I/Y, 18500 FV, CPT PV PV = -16,518 (rounded) Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 27) On May 1, 2025, SBC Inc. buys a photocopier listed for $2,900. The office supply store agrees to accept a $800 down payment and a $2,100, three-year note payable at $798 per year. The company's banker has suggested that an appropriate market rate is 11% per annum for loans that mature in one year or less and 14% for loans with longer maturities. At what amount will the note be recorded at in the accounting records? A) $1,853 B) $1,950 C) $2,100 D) $2,900 Answer: A Explanation: The fair value of the note is determined using discounted cash flow analysis as the interest rate in the note is less than the market rate. Using a BAII PLUS financial calculator: 3 N, 14 I/Y, 798 PMT, CPT PV PV = -1,853 (rounded) Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

28) On May 1, 2025, VeryFine Ltd. provides a vendor with a $18,000 non-interest-bearing note due on May 1, 2026 in exchange for furniture with a list price of $17,400. At what amount will the property be recorded in the accounting records? The company's banker has suggested that an appropriate market rate is 6% per annum for loans that mature in one year or less and 8% for loans with longer maturities. A) $16,415 B) $16,667 C) $16,981 D) $18,000 Answer: C Explanation: The fair value of the note is determined using discounted cash flow analysis. The market rate suggested by the bank has been used to discount the obligation. List prices are not necessarily a reliable indicator of the asset's fair market value. Using a BAII PLUS financial calculator: 1 N, 6 I/Y, 18000 FV, CPT PV PV = -16,981 (rounded) Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 29) On May 1, 2025, SBC Inc. buys a photocopier listed for $2,900. The office supply store agrees to accept a $800 down payment and a $2,100, three-year note payable at $798 per year including interest at 7%. The company's banker has suggested that an appropriate market rate is 11% per annum for loans that mature in one year or less and 14% for loans with longer maturities. At what amount will the photocopier be recorded at in the accounting records? A) $1,950 B) $2,100 C) $2,900 D) $2,653 Answer: D Explanation: The fair value of the note is determined using discounted cash flow analysis as the interest rate in the note is less than the market rate. Using a BAII PLUS financial calculator: 3 N, 14 I/Y, 798 PMT, CPT PV PV = -1,853 (rounded); In accounting records: Dr. Office equipment ($1,853 note given + $800 down payment) = $2,653 Diff: 3 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

30) On June 1, 2025, Bean Ltd. provides a vendor with a $125,500 non-interest-bearing note due on June 1, 2028, in exchange for equipment with a list price of $118,100. At what amount will the equipment be recorded in the accounting records? The company's banker has suggested that an appropriate market rate is 6% per annum for loans that mature in one year or less and 9% for loans with longer maturities. A) $118,100 B) $105,372 C) $96,909 D) $91,195 Answer: C Explanation: The fair value of the note is determined using discounted cash flow analysis. The market rate suggested by the bank has been used to discount the obligation. List prices are not necessarily a reliable indicator of the asset's fair market value. Using a BAII PLUS financial calculator: 3 N, 9 I/Y, 125,500 FV, CPT PV PV = - 96,909 (rounded) Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 31) On May 1, 2025, SBC Inc. buys a computer listed for $12,600. The office supply store agrees to accept a $1,600 down payment and a $11,000, three-year note payable at $3,500 per year. The company's banker has suggested that an appropriate market rate is 11% per annum for loans that mature in one year or less and 14% for loans with longer maturities. At what amount will the note be recorded at in the accounting records? A) $1,800 B) $8,126 C) $8,553 D) $11,000 Answer: B Explanation: The fair value of the note is determined using discounted cash flow analysis as the interest rate in the note is less than the market rate. Using a BAII PLUS financial calculator: 3 N, 14 I/Y, 3500 PMT, CPT PV PV = -8,126 (rounded) Diff: 2 Type: MC Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 32) Explain three instances when the fair value of the non-current liability will not equal the cash proceeds. Answer: Some common departures include receiving non-cash assets, bonds issued at premium or discount, issuance of hybrid financial instruments, and debt issuance dates that differ from the interest payment dates. Diff: 2 Type: SA Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

33) Cartwright Corporation had a $1,350,000, 5% bond available for issue on September 1, 2025. Interest is to be paid quarterly beginning November 30. All of the bonds were issued at par on October 1. Prepare the journal entries for October 1 and November 30. Answer: Oct. 1 Cash 1,355,625 Interest payable 5,625 Bonds payable 1,350,000 Issued bonds; $1,350,000 × 5% × 1 / 12 = $5,625. Nov. 30

Interest payable Bond interest expense Cash Paid interest on bonds; $1,350,000 × 5% × 2 / 12 = $11,250.

5,625 11,250 16,875

Diff: 2 Type: SA Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 34) Explain how non-current liabilities are measured after initial recognition. Answer: After initial recognition, all financial liabilities excepting those held for trading are measured and reported at amortized cost, which is the amount initially recognized for the debt adjusted by subsequent amortization of premium or discount. There are two essential steps that must be taken to determine the amortized cost of a financial liability: 1. Establish the effective interest rate; and 2. Amortize the premium or discount using the effective interest method. Diff: 2 Type: ES Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

35) On May 1, 2025, Sea Escape Ltd. purchases a new automobile for $18,000 from the dealer who provides the financing. The three-year, interest-free loan is repayable at $500 per month. The market rate of interest for similar transactions is 0.25% per month. Required: Prepare journal entries to record: a. the purchase of the automobile. b. the accrual of interest and the loan payment at the end of May 2025. Answer: a. The fair value of the note is determined using discounted cash flow analysis. • PVFA(0.25%, 36) = (1/0.0025) × (1-(1/0.0025)36) • PV of the note = $500 × PVFA(0.25%, 36) Dr. Automobile Cr. Notes payable

17,193

b. Dr. Interest expense [$17,193 × 0.250% = (rounded)] 43 Cr. Notes payable* 43 Dr. Notes payable* 500 Cr. Cash 500 *May be combined Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

36) Cynthia Dixie Accounting Inc. takes advantage of a well-known office furnishings store's low-interestrate financing. Cynthia buys furniture on the first day of its fiscal year, signing a $19,000, five-year note. The note is payable in full at maturity. Interest is payable annually at 2%. The market rate of interest for similar transactions is 5%. Required: Prepare journal entries to record: a. The purchase of the office furniture. b. The payment of interest and related amortization of the discount at the end of year 1. Answer: a. The fair value of the note is determined using discounted cash flow analysis. Value of principal = $19,000 / 1.055 = $14,887 Value of coupons Total

= $380 × PVFA(5%,5)

Dr. Office furniture Cr. Notes payable

1,645 $16,532

16,532

b. Dr. Interest expense [$16,532 × 5% = (rounded)] 827 Cr. Cash 380 Cr. Notes payable 447 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

37) Stay Fit for Life Inc. issues three series of $10,000,000 ten-year bonds dated January 1,2025 on the issue date. Interest is payable on June 30 and December 31 each year. Series A has a coupon rate of 7%; series B is 8%; and series C is 11 %. The market rate of interest at time of issue is 8%. Required: a. Prior to making any numerical calculations, comment on whether: i. Series A will sell at a discount, par, or premium and briefly explain why. ii. Series B will sell at a discount, par, or premium and briefly explain why. iii. Series C will sell at a discount, par, or premium and briefly explain why. b. Prepare journal entries to record the issuance of: i. The series A bonds. ii. The series B bonds. iii. The series C bonds. Answer: a(i). Series A will sell at a discount as the coupon rate is less than the market rate of interest a(ii). Series B will sell at par as the coupon rate equals the market rate of interest a(iii). Series C will sell at a premium as the coupon rate exceeds the market rate of interest b. All series: the principal amount = $10,000,000; the number of payments = 10 × 2 = 20; and the market rate of interest = 8% / 2 = 4% b(i). Coupon interest payment = $10,000,000 × (7% / 2) = $350,000; Using a BAII PLUS financial calculator: 20N, 4 I/Y, 350,000 PMT, 10,000,000 FV, CPT PV = -9,320,484 Journal entry on issue date—Series A Dr. Cash 9,320,484 Cr. Bonds payable 9,320,484 b(ii). Using a BAII PLUS financial calculator: • 20N, 4 I/Y, 400,000 PMT; 10,000,000 FV, CPT PV PV = -10,000,000 Journal entry on issue date—Series B Dr. Cash 10,000,000 Cr. Bonds payable

10,000,000

b(iii). Using a BAII PLUS financial calculator:: 20N, 4 I/Y, 550,000 PMT; 10,000,000 FV, CPT PV PV = - 12,038,549 (rounded) Journal entry on issue date—Series C Dr. Cash 12,038,549 Cr. Bonds payable 12,038,549 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations. 32 Copyright © 2023 Pearson Canada Inc.

38) Over the River Co. (OTRC) sells $1,200,000 of 6-year, 10% bonds at par plus accrued interest. The bonds are dated January 1, 2025 but due to market conditions are not issued until May 1, 2025. Interest is payable on June 30 and December 31 each year. The market rate of interest at time of issue is the same as the stated rate. Required: Prepare journal entries to record: a. The issuance of the bonds on May 1, 2025. Assume that OTRC has adopted a policy of crediting accrued interest payable for the accrued interest on the date of sale. b. Payment of interest on June 30, 2025. c. Payment of interest on December 31, 2025. Answer: a. Journal entry on issuance (May 1, 2025) Dr. Cash ($1,200,000 + $40,000) 1,240,000 Cr. Bonds payable 1,200,000 Cr. Accrued interest payable ($1,200,000 × 10% × 4 / 12) 40,000 b. Journal entry on interest payment date (June 30, 2025) Dr. Accrued interest payable Dr. Interest expense ($1,200,000 × 10% × 2 / 12) Cr. Cash

40,000 20,000

60,000

c. Journal entry on interest payment date (Dec. 31, 2025) Dr. Interest expense ($1,200,000 × 10% / 2) 60,000 Cr. Cash 60,000 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

39) Blue Sky Travel Inc. issues $2,000,000 of ten-year, 8% bonds dated January 1, 2025. Interest is payable on January 1 and July 1 each year. The proceeds realized from the issue were the $1,821,367 sales price less the $20,000 fee charged by Blue Sky's investment bank. Blue Sky's year-end is December 31. Required: Prepare journal entries: a. The issuance of the bonds. b. Payment of interest and related amortization on July 1, 2025. c. Accrual of interest and related amortization on December 31, 2025. Answer: Determining the effective interest rate for the period using a BAII PLUS financial calculator: The net proceeds (PV) to Blue Sky are $1,801,367 ($1,821,367 - $20,000); N = 20 (10 × 2); PMT = $80,000 ($2,000,000 × 8% × 6/12); 20 N, 1,801,367 +/- PV, 2000000 FV, 80000 PMT, CPT I/Y I/Y = 4.7823% (rounded) a.

Journal entry on issuance (Jan. 1, 2025) Dr. Cash (Sales proceeds - transaction costs) Cr. Bonds payable

1,801,367

b. Journal entry on interest payment date (July 1, 2025) Dr. Interest expense ($1,801,367 × 4.7823%) 86,147 Cr. Cash Cr. Bonds payable c.

80,000 6,147

Journal entry at year-end (Dec. 31, 2025) Dr. Interest expense ($1,801,367 + $6,147) × 4.7823% 86,441 Cr. Interest payable 80,000 Cr. Bonds payable 6,441 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

40) Canadian Sea Rides Ltd. issues $8,000,000 of four-year, 4% bonds dated January 1, 2025. Interest is payable on January 1 and July 1 each year. The proceeds realized from the issue were the $8,529,082 sales price less the $50,000 fee charged by Sea's lawyers. Sea's year-end is December 31. Required: Prepare entries for a. The issuance of the bonds. b. Payment of interest and related amortization on July 1, 2026. c. Accrual of interest and related amortization on December 31, 2026. Answer: Determining the effective interest rate for the period using a BAII PLUS financial calculator: The net proceeds (PV) to Blue Sky are $8,479,082 ($8,529,082 - $50,000); N = 8 (4 × 2); PMT = $160,000 ($8,000,000 × 8% × 6/12); 8 N, 8,479,082 +/- PV, 8000000 FV, 160000 PMT, CPT I/Y I/Y = 1.2101 % (rounded) a. Journal entry on issuance (Jan. 1, 2025) Dr. Cash (Sales proceeds - transaction costs) Cr. Bonds payable b. Journal entry on interest payment date (July 1, 2025) Dr. Interest expense ($8,479,082 × 1.2101%) Dr. Bonds payable Cr. Cash

8,479,082

102,605 57,395

8,479,082

160,000

c. Journal entry at year-end (Dec. 31, 2025) Dr. Interest expense ($8,479,082 - $57,395) × 1.2101% 101,911 Dr. Bond payable 58,089 Cr. Interest payable 160,000 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

41) Compare and contrast the two methods for amortizing the discount/premium. Interest expense in the first period is higher under which method for bonds sold at a discount? For bonds sold at a premium? Why does IFRS require public companies to use the effective interest method? Why do the Accounting Standards for Private Enterprises allow companies to use the straight-line method? Answer: The straight-line and effective interest methods are different approaches of allocating discounts and premiums to interest expense over the life of the bonds. The choice of methods does not affect a company's cash flow, as the coupon payment (the cash outflow) remains the same. Moreover, total interest expense over the life of the bond is the same. Initial interest expense will be higher under the straight-line method for bonds issued at a discount and lower for bonds issued at a premium. IFRS believes that the effective interest method is conceptually superior as a uniform interest rate is used to calculate interest expense over the life of the bond. It thus provides for better matching of expenses than does the straight-line method. The Accounting Standards for Private Enterprises permits the use of the straight-line method as it is easy to use and period results do not usually differ materially from those obtained under the effective interest method. Diff: 2 Type: ES Skill: Concept Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

42) Really Amazing Vacations Ltd. issues $1,000,000 of ten-year, 10% bonds dated January 1,2025. Interest is payable on January 1 and July 1 each year. The proceeds realized from the issue were the $1,048,801 sales price less the $80,000 fee charged by Really Amazing's investment bank. Really Amazing's year-end is December 31. Required: Prepare journal entries: a. The issuance of the bonds. b. Payment of interest and related amortization on July 1, 2025. c. Accrual of interest and related amortization on December 31, 2025. Answer: Determining the effective interest rate for the period using a BAII PLUS financial calculator:: The net proceeds (PV) to Really Amazing are $968,801 ($1,048,801 - $80,000); N = 20 (10 × 2); PMT = $50,000 ($1,000,000 × 10% × 6/12); 20 N, 968,801 +/- PV, 1000000 FV, 50000 PMT, CPT I/Y I/Y = 5.2558% (rounded) a. Journal entry on issuance (Jan. 1, 2025) Dr. Cash (Sales proceeds - transaction costs) Cr. Bonds payable b. Journal entry on interest payment date (July 1, 2025) Dr. Interest expense ($968,801 × 5.2558%) Cr. Cash Cr. Bonds payable

968,801 968,801

50,918

50,000 918

c. Journal entry at year-end (Dec. 31, 2025) Dr. Interest expense ($968,801+ $918) × 5.2558% 50,966 Cr. Interest payable 50,000 Cr. Bonds payable 966 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

43) Bold Accountants Co. sells $6,000,000 of 10-year, 6% bonds priced to yield 5.5%. The bonds are dated and issued on January 1, 2025. Interest is payable on January 1 and July 1 each year. Bold's year-end is June 30. Required: Prepare entries for a. The issuance of the bonds. b. Accrual of interest and related amortization on June 30, 2025. c. Payment of interest on July 1,2025. d. Payment of interest and related amortization on January 1,2026. Answer: Determining the effective interest rate for the period using a BAII PLUS financial calculator: 5.5%/2 = 2.75%; 20N, 2.75I/Y, 6,000,000 FV, 180000 PMT, CPT PV PV = - 6,228,408 (rounded) a. Journal entry on issuance (Jan. 1, 2025) Dr. Cash (Sales proceeds) Cr. Bonds payable

6,228,408

b. Journal entry at year-end (June 30, 2025) Dr. Interest expense Dr. Bonds payable Cr. Interest payable

171,281 8,719

c. Journal entry on interest payment date (July 1, 2025) Dr. Interest payable Cr. Cash

180,000

6,228,408

180,000

d. Journal entry on interest payment date (Jan. 1, 2026) Dr. Interest expense 171,041 Dr. Bonds payable 8,959 Cr. Cash 180,000 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

44) Flint Corporation issues a $2,000, five-year, 6% bond, dated January 1, 2025, that pays interest on June 30 and December 31 and is sold at par on March 1, 2025. Provide the journal entry on March 1, 2025, and June 30, 2025. Answer: March 1, 2025 Dr. Cash 2,020 Cr. Bonds payable 2,000 Cr. Accrued interest on bond payable 20 On date of first interest payment Dr. Accrued interest on bond payable 20 Dr. Interest expense 40 Cr. Cash 60 Diff: 2 Type: ES Skill: Comp Objective: 12.3 Describe the initial and subsequent measurement of non-current financial liabilities and account for these obligations.

Learning Objective 4 Apply accrual accounting to the derecognition of financial liabilities. 1) Which statement is correct about the derecognition of a matured obligation? A) There will be a gain on retirement. B) There will be a loss on retirement. C) There will be no gain or loss on retirement. D) There could be either a gain or loss on retirement. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities. 2) Which statement is correct about the derecognition of an obligation before maturity? A) There will be a gain on retirement. B) There will be a loss on retirement. C) There will be no gain or loss on retirement. D) There could be either a gain or loss on retirement. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

3) Which statement is correct about offsetting? A) It deteriorates key financial ratios. B) It shows the net amount of related assets and liabilities. C) It shows the related assets and liabilities as contra accounts. D) It makes it easier for borrowers to fulfill covenants. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities. 4) Which statement is correct about offsetting? A) Offsetting generally provides decision-useful information for financial statement users. B) Offsetting aids in financial statement user's ability to correctly interpret financial results. C) Offsetting is generally prohibited under IFRS, unless it is specifically required. D) Offsetting is required under IFRS when there is a legally enforceable right of offset. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities. 5) Which statement is correct about offsetting? A) Offsetting is required under IFRS when the entity is willing and legally able to offset. B) Offsetting is required under IFRS when the company intends to settle on a net basis. C) Offsetting is generally permitted under IFRS, unless it is specifically prohibited. D) Offsetting is required under IFRS when there is a legally enforceable right of offset. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities. 6) Describe the three steps for derecognition of a financial liability prior to maturity. Answer: Derecognition of a financial liability prior to maturity should follow these steps: 1. The company updates its records to account for interim interest expense, including the amortization of discounts or premiums up to the derecognition date. 2. The entity records the outflow of assets expended to extinguish the obligation. 3. The entity records a gain or loss on debt retirement equal to the difference between the amount paid and the book value of the liability derecognized. Diff: 2 Type: SA Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

7) Raysport Inc. sells $1,000,000 of three-year bonds on January 1, 2025, for $980,000. The coupon rate on the bonds is 6% payable on July 1 and January 1. Transaction costs directly attributable to issuing the bonds total $20,000. Raysport Inc's fiscal year-end is December 31. The effective semi-annual rate is 3.6510%. On October 1, 2026, Raysport Inc. repurchases the bonds on the open market for total consideration of $980,000 cash. Raysport uses the effective interest method. Required: Record the journal entries for derecognition at October 1, 2026. Answer: a) Journal entry when bonds are sold on January 1, 2025 Dr. Cash Cr. Cash (transaction costs) Cr Bonds payable

980,000 20,000 960,000

Journal entry to update Raysport's records to October 1, 2026: Dr. Interest expense 17,812 Cr. Interest payable 15,000 Cr. Bonds payable 2,812 Journal entry to record repurchase: Dr. Interest payable Dr. Bonds payable Cr. Cash Cr. Gain on bond redemption Explanation: Notes: Date

15,000 978,521 980,000 13,521

Interest Expense A

Interest Paid B

Interest Amortized C

Amortized Cost D

January 1, 2025 July 1, 2025 January 1, 2026 July 1, 2026 October 1, 2026 TOTAL

(d) $960,000 (a) $35,049 35,235 35,425 17,812 123,521

(b) $30,000 30,000 30,000 15,000 105,000

(e) 965,049 970,284 975,709 978,521

(a) $960,000 × 3.6510% = $35,049 (b) $1,000,000 × 6% × 1 / 2 = $30,000 (c) Column A - Column B = Column C (e) $960,000 (d) + $5,049 (c) = $965,049 (e) Diff: 2 Type: SA Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

8) When should an entity offset a financial asset and a financial liability? Answer: According to IAS 32: A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when, an entity: (a) currently has a legally enforceable right to set off the recognized amounts; and (b) intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously. (Copyright © 2012 IFRS Foundation.) Diff: 2 Type: SA Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities. 9) Offsetting is the practice of showing the net amount of related assets and liabilities on the balance sheet, rather than showing each of the components separately. State and explain the pros and cons of offsetting assets against liabilities. Answer: PROS CONS 1. Offsetting usually improves 1. IFRS asserts that separately key ratios making it easier to reporting assets and liabilities meet lenders' restrictive generally conveys more covenants. information than reporting the net amount, and that offsetting compromises the user's ability to correctly interpret the financial results. 2. Offsetting may free up borrowing capacity as loan agreements typically limit the maximum debt a company can borrow.

2. IAS 1 paragraph 32 prohibits offsetting generally, unless specifically allowed by another standard. One exception is the requirement per IAS 32 paragraph 42.

Diff: 2 Type: SA Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

10) On January 1, 2024, Snuggly Bunny Ltd. issued $3,000,000 of 4%, fifteen-year bonds priced to yield 5%. Interest is payable on June 30 and December 31. Snuggly repurchases the outstanding bonds on July 1, 2026, at which time the market rate of interest is 3.5%. Prepare the journal entries for these transactions. Answer: The fair value of the bond at time of issue is determined using discounted cash flow analysis. The fair market value of the bond at the time of repurchase is determined using discounted cash flow analysis using the current effective rate of interest (5%/2 = 2.5%) to discount the remaining cash flow stream. As at date of redemption, there are 12 1/2 years (25 periods) left to maturity. The book value of the bond at the time of repurchase is determined using discounted cash flow analysis using the original effective rate of interest to discount the remaining cash flow stream. As at date of redemption, there are 12 1/2 years left to maturity. Using a BAII PLUS financial calculator (issue) 30 N (15 × 2),2.5 I/Y , 60,000 PMT, 3,000,000 FV, CPT PVPV = -2,686,046 (rounded) Issue Dr. Cash Cr. Bonds payable

2,686,046 2,686,046

Using a BAII PLUS financial calculator (redemption) market value: 25 N ,1.75 I/Y (3.5/2), 60,000 PMT, 3,000,000 FV, CPT PV PV = 3,150,816 (rounded) book value: 25 N,2.5I/Y , 60,000 PMT, 3,000,000 FV, CPT PVPV = -2,723,635 (rounded) Repurchase Dr. Bonds payable (book value) Dr. Loss on repurchase of bonds Cr. Cash (market value)

2,723,635 427,181 3,150,816

Diff: 2 Type: SA Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities. 11) Explain what an "in-substance defeasance" is and whether this arrangement results in the derecognition of a financial liability. Answer: In-substance defeasance is an arrangement where funds sufficient to satisfy a liability are placed in trust with a third party to pay the creditors directly. The borrower cannot usually derecognize the obligation through in-substance defeasance, which is a unilateral arrangement put in place by the debtor. The defeasance would result in derecognition of the liability only if the creditor also formally confirms that the entity is no longer liable for the indebtedness. Diff: 2 Type: ES Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

12) Missouri Wheels Ltd. (MW) sold $9,000,000 of fourteen-year, 3% bonds at par on January 1, 2025. Interest is payable on June 30 and December 31 each year. The bonds can be called at any time at 103 plus accrued interest. On April 1, 2026, MW bought back $3,500,000 of bonds on the open market for $2,600,000 including accrued interest and retired them. On August 1, 2027, MW called $4,500,000 of bonds and retired them. MW prepares accrual entries only at year-end. Required: Prepare journal entries to record: a. The open market purchase of the bonds on April 1, 2026. b. The calling of the bonds on August 1, 2027. c. Retirement of the remaining bonds on December 31, 2035, assuming that the final interest payment has already been recorded in the company's books. Answer: a. Journal entry for open market purchase and retirement (Apr. 1, 2026) Dr. Bonds payable 3,500,000 Dr. Interest expense ($9,000,000 × 3% × 3 / 12) × $3,500,000 / $9,000,000) 26,250 Cr. Cash 2,600,000 Cr. Gain on bond redemption 926,250 b. Journal entry for calling the bonds (Aug. 1, 2027) Dr. Bonds payable Dr. Interest expense ($4,500,000 × 3% × 1 / 12) Dr. Loss on bond redemption Cr. Cash ($4,500,000 × 103% + $11,250)

4,500,000 11,250 135,000

4,646,250

c. Journal entry on retirement of the bonds (Dec. 31, 2035) Dr. Bonds payable ($9,000,000 - $3,500,000 - $4,500,000) 1,000,000 Cr. Cash 1,000,000 Diff: 1 Type: ES Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

13) Arlington Corp issued $7,000,000, 5% 6-year bonds on January 1, 2024 at par. Interest is due annually on December 31. The market rate of interest has since increased dramatically to 9%. As such, Arlington can repurchase its bonds on the open market for $6,507,449. They decided to take advantage of this situation, and on January 1, 2028 issued a new series of bonds in the amount of $6,507,449 [two-year bonds, 9% interest payable annually]. The bonds were sold at par and the proceeds were used to retire the 5% bonds. Entry for sale of new bonds Dr. Cash Cr. Bonds payable

6,507,449

Arlington has recorded a gain on the retirement which increases its net income for the year. Ignoring transaction costs and taxation effects, is Arlington any better off? Discuss. Answer: There are a number of ways to approach this question, but NPV (net present value) analysis is normally used. The company's cash position has not changed—they raised $6,507,449 using this money to pay out the old bond issue. The present value of the old bond issue is determined by the repurchase price - $6,507,449. This is confirmed by using a BAII PLUS financial calculator. The present value of the new bond issue is determined by the issue price - $6,507,449. This is confirmed by using a BAII PLUS financial calculator. The net cash inflow was $0, as 100% of the sale proceeds of the new issue were used to retire the old issue. This coupled with the fact that the present value of the old and new indebtedness is the same means that the company is not any better off than previously. When taxation and transaction costs are considered, the company will be worse off. Diff: 2 Type: ES Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

14) Legally Yours, a law firm, sells $8,000,000 of four-year, 8% bonds priced to yield 6.6%. The bonds are dated January 1, 2026, but due to some regulatory hurdles are not issued until March 1, 2026. Interest is payable on January 1 and July 1 each year. The bonds sell for $8,388,175 plus accrued interest. In mid-June, Legally Yours earns an unusually large fee of $11,000,000 for one of its cases. They use part of the proceeds to buy back the bonds in the open market on July 1, 2026 after the interest payment has been made. Legally Yours pays a total of $8,456,234 to reacquire the bonds and retires them. Required: Prepare journal entries to record: a. The issuance of the bonds—assume that Legally Yours has adopted a policy of crediting interest expense for the accrued interest on the date of sale. b. Payment of interest and related amortization on July 1, 2026. c. Reacquisition and retirement of the bonds. Answer: a. Journal entry on issuance (March 1, 2026) Dr. Cash 8,494,842 Cr. Bonds payable (given) 8,388,175 Cr. Interest expense ($8,000,000 × 8% × 2 / 12) 106,667 b. Journal entry on interest payment date (July 1, 2026) Dr. Interest expense ($184,540* + $106,667) Dr. Bonds payable Cr. Cash *[$8,388,175 × (6.6% / 2) × (4 / 6) = $184,540 (rounded)]

291,207 28,793

320,000

c. Journal entry on reacquisition of the bonds (July 1, 2026) Dr. Loss on bond redemption ($8,456,234 - ($8,388,175 - $28,793)) 96,852 Dr. Bonds payable 8,359,382 Cr. Cash 8,456,234 Diff: 2 Type: ES Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

15) Fredericton Aerospace Inc. raised $5,369,210 by selling $5,000,000 of six-year, 12% bonds dated January 1, 2024. Fredericton used part of the proceeds to pay its investment bank's fee of $100,000 and related legal and accounting fees of $600,000. Interest is payable on June 30 and December 31 each year. Fredericton can call the bonds on January 1, 2027 at 103. The company exercises this privilege, redeeming 40% of the bonds on the call date and retiring them. The company year ends on December 31. Required: Prepare journal entries to record: a. The issuance of the bonds on January 1, 2024. b. Before completing the entries for parts (b) and (c), prepare the amortization table for the bonds through to December 21, 2026. Prepare entry for the payment of interest and related amortization on December 31, 2026. c. Repurchase of the bonds on January 1, 2027.

Answer: Determining the effective interest rate for the period using a BAII PLUS financial calculator 6.8252% (rounded) Effective period rate 6.8252% Small differences due to rounding

Date Jan. 1, 2024 June 30, 2024 Dec. 31, 2024 June 30, 2025 Dec. 31, 2025 June 30, 2026 Dec. 31, 2026 Jan. 1, 2027 (b)

Interest Expense

Interest Paid

$318,683 319,958 321,320 322,775 324,330 325,990

Discount Amortized

$300,000 300,000 300,000 300,000 300,000 300,000

Amortized Cost (a) $4,669,210 $18,683 4,687,893 19,958 4,707,851 21,320 4,729,171 22,775 4,751,947 24,330 4,776,276 25,990 4,802,267 (1,920,907) $2,881,360

(a) The net sale proceeds of the bonds. (b) Redeem and derecognize 40% of the outstanding bonds. a. Journal entry on issuance (Jan. 1, 2024) Dr. Cash (Sales proceeds - transaction costs) ($5,369,210 - $700,000) Cr. Bonds payable b. Journal entry on interest payment date (Dec. 31, 2026) Dr. Interest expense (from spreadsheet) Cr. Cash Cr. Bonds payable

4,669,210 4,669,210

325,990

300,000 25,990

c. Journal entry on reacquisition of the bonds (Jan. 1, 2027) Dr. Loss on bond redemption 139,093 Dr. Bonds payable (from spreadsheet) 1,920,907 Cr. Cash ($2,000,000 × 103%) 2,060,000 Diff: 3 Type: ES Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

16) Toebee Corporation issued bonds with a part value of $500,000 and a five-year life on May 1, 2024. The contract rate is 7%. The bonds pay interest on October 31 and April 30. They were issued at a price of $489,734 when the market rate was 7.5%. Toebee Corporation's year-end is December 31. Required: 1. Prepare an amortization table using the effective interest method. 2. Prepare an amortization table using the straight-line method. 3. Contrast the two methods, commenting on the following: a. Period interest expense. b. Total interest expense. c. Discount amortized at maturity. d. Amortized cost at maturity. Answer: 1. and 2. Cash interest Period interest Discount Unamortized paid expense amortization Discount Carrying Value May 1/19 $10,266 $489,734 Oct 31/19 $17,500 $ 865 9,401 490,599 $18,3651 Apr 30/20

17,500

Oct 31/20

17,500

Apr 30/21

17,500

Oct 31/21

17,500

Apr 30/22

17,500

Oct 31/22

17,500

Apr 30/23

17,500

Oct 31/23

17,500

18,3972 18,4313

897

8,504

491,496

931

7,573

492,427

18,4664 18,5025

966

6,607

493,393

1,002

5,605

494,395

18,5406 18,5797

1,040

4,565

495,435

1,079

3,486

496,514

18,6198 18,6619

1,119

2,367

497,633

1,161

1,206

498,794

3. a. When using the effective interest method, the period begins smaller and increases in this example with a bond discount. Whereas interest expense remains constant each period when using the straightline method. b. Total interest expense is the same under both methods c. The total amount of the discount amortized over the life of the bond is the same under both methods d. Under both methods, the carrying value at maturity is the face value of the bond. Diff: 3 Type: ES Skill: Concept Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

17) There are three independent situations summarized below. In all three cases the bonds are sold on January 1, 2024 and the issuing company has a December 31 year-end. In situation three, the bonds were all repurchased at par on January 1, 2028.

Face value Coupon rate Coupon dates Market rate Time to maturity

Situation 1 $30,000,000 12% 6/30; 12/31 10% 7 years

Situation 2 $15,000,000 12% 12/31 14% 11 years

Situation 3 $30,000,000 12% 12/31 15% 6 years

Required: Prepare journal entries to record: a. The issuance of the three bonds. b. Payment of interest and related amortization on December 31, 2024. Prepare the amortization table to help you. c. Retirement of the situation 3 bond on January 1, 2028.

Answer: Using a BAII PLUS financial calculator: Situation 1 PV = -32,969,593 (rounded) Situation 2 PV = -13,364,180 (rounded) Situation 3 PV = -26,593,966 (rounded) Amortization tables Situation 1: Small differences due to rounding Date Interest Interest paid Discount Amortized expense amortized cost Jan. 1, 2024 $32,969,593 June 30, 2024 $1,648,480 $1,800,000 $151,520 32,818,073 Dec. 31, 2024 1,640,904 1,800,000 159,096 32,658,977 Situation 2: Small differences due to rounding Date Interest Interest paid Discount Amortized expense amortized cost Jan. 1, 2024 $13,364,180 Dec. 31, 2024 $1,870,985 $1,800,000 $70,985 13,435,165 Situation 3: Small differences due to rounding Date Interest Interest paid Discount Amortized expense amortized cost Jan. 1, 2024 $26,593,966 Dec. 31, 2024 $3,989,095 $3,600,000 $389,095 26,983,061 a. Journal entry on issuance (Jan. 1, 2024) Situation 1 Dr. Cash (Sales proceeds) Cr. Bonds payable

32,969,593

Situation 2

Dr. Cash (Sales proceeds) Cr. Bonds payable

13,364,180

Situation 3

Dr. Cash (Sales proceeds) Cr. Bonds payable

26,593,966

32,969,593

13,364,180

26,593,966

b. Journal entry at year-end (Dec. 31, 2024) Situation 1 Dr. Interest expense Dr. Bonds payable Cr. Cash

1,640,905 159,096

Situation 2

Dr. Interest expense Cr. Bonds payable Cr. Cash

1,870,985

Situation 3

Dr. Interest expense Cr. Bonds payable Cr. Cash

3,989,095

c. Journal entry on retirement (Jan. 1, 2028) Situation 3 Dr. Bonds payable* Dr. Loss on retirement Cr. Cash

1,800,000

28,536,862 1,463,138

70,985 1,800,000

389,095 3,600,000

30,000,000

*Calculate the outstanding balance at the beginning of period 5: 4N, 15I/Y, 30000000 FV, 3600000 PMT, CPT PV PV = -28,536,862 (rounded) Diff: 2 Type: ES Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

18) On July 1, 2024, Club Country Golf Corp. issued $20,000,000 of five-year, 12%, semi-annual bonds for $20,075,000. At time of issue, Club Country paid its investment bank a $75,000 sales commission. On July 31, 2027, Club Country calls $12,000,000 of the bonds, paying 104 plus accrued interest, and retires them. On March 31, 2028, Club Country purchases the remaining bonds on the open market for $8,180,000 including accrued interest and retires them. Club Country's year-end is August 31. The company does not use reversing entries. Required: a. Prepare journal entries to record: i. The issuance of the bonds on July 1, 2024. ii. Repurchase of the bonds on July 31, 2027. iii. Payment of interest on December 31, 2027. iv. Retirement of the remaining bonds on March 31, 2028. b. Provide a brief explanation as to the most likely reasons that Club Country was able to repurchase its bonds at a discount.

Answer: a. (i). Journal entry on issuance (July 1, 2024) Dr. Cash (Sales proceeds) Cr. Bonds payable Cr. Cash (Sales commission)

20,075,000

(ii). Journal entry on reacquisition of the bonds (July 31, 2027) Dr. Interest expense ($12,000,000 × 12% × 1 / 12) 120,000 Dr. Bonds payable 12,000,000 Dr. Loss on redemption of bonds 480,000 ($12,600,000 - $12,000,000 - $120,000) Cr. Cash ($12,000,000 × 104% + $120,000) (iii). Journal entry on interest payment date (Dec. 31, 2027) Dr. Interest expense ($8,000,000 × 12% × 4 / 12) 320,000 Dr. Accrued interest payable ($8,000,000 × 12% × 2 / 12)* 160,000 Cr. Cash ($8,000,000 × 12% × 6 / 12) * does not use reversing entries (iv). Journal entry on retirement of the bonds (March 31, 2026) Dr. Bonds payable 8,000,000 Dr. Interest expense ($8,000,000 × 12% × 3 / 12) 240,000 Cr. Cash Cr. Gain on retirement of bonds

20,000,000 75,000

12,600,000

480,000

8,180,000 60,000

b. The most likely reason why the company was able to repurchase its bonds at a discount on March 31, 2026 is that the market interest rate for similar bonds had increased and was then greater than the coupon rate on the Club Country bonds. The decline in the market price of the company's bonds may have also been attributable to a perceived increase in the probability of default by the market and/or one or more of the debt rating agencies downgrading the rating on the bond. Diff: 2 Type: ES Skill: Comp Objective: 12.4 Apply accrual accounting to the de-recognition of financial liabilities.

Learning Objective 5 Apply accrual accounting to decommissioning and site restoration obligations. 1) Bailey's Gold Mines Inc. (BGMI) purchases a piece of land for the purpose of developing a gold mine. BGMI is legally required to remove all structures and convert the mine site to a wildlife sanctuary at the end of its estimated 10-year useful life. BGMI estimates that it will have to spend $11,000,000 to decommission the site and reclaim the land when operations cease. The present value of this $11,000,000 site restoration cost, assuming a discount rate of 5%, is $6,753,046. BGMI uses straight-line depreciation. Required: Prepare the journal entries to recognize this site restoration cost the company would record upon initial acquisition and subsequently. Answer: Upon Acquisition: Dr. Land $6,753,046 Cr. Obligation for future site restoration cost $6,753,046 (PV of $11,000,000, N=10, 5%) Each year : Dr. Depreciation expense ($6,753,046 / 10 years) 675,304.60 Cr. Accumulated depreciation – land 675,304.60 Year 1: Dr. Interest expense ($6,753,046 × 5%) $337,652 Cr. Obligation for future site restoration cost $337,652 Year 2: Dr. Interest expense (($ 6,753,046 + $337,652) × 5%)) $354,535 Cr. Obligation for future site restoration cost $ 354,535 Diff: 2 Type: SA Skill: Comp Objective: 12.5 Apply accrual accounting to decommissioning and site restoration obligations.

Learning Objective 6 Describe how non-current liabilities are presented and disclosed. 1) Jamieson Inc. issues US$1,000,000 of two-year bonds on January 1, 2025, at par that mature on December 31, 2026. The coupon rate on the bonds is 4% payable annually on December 31. Jameison's year-end is December 31. It does not accrue interest throughout the year. Exchange rates: - January 1, 2025, C$1.00 = US$0.99 - December 31, 2025, C$1.00 = US$0.97 - December 31, 2026, C$1.00 = US$1.01 - Average rate 2026, C$1.00 = US$0.98 - Average rate 2026, C$1.00 = US$0.99 Required: a) Record the journal entry on the date of issuance of the bond. b) Record the journal entry to revalue the obligation at the period end, December 31, 2025. c) Record the journal entry to record the payment of interest, December 31, 2025. Answer: a) Record the journal entry on the date of issuance of the bond Dr. Cash 1,010,101 Cr. Bonds payable 1,010,10 US$ 1,000,000 × C$1.00 / US$0.99 = C$1,010,101 b) Record the journal entry to revalue the obligation at the period end, December 31, 2025. Dr. Foreign exchange loss 20,827 Cr. Bond payable 20,827 US$1,000,000 × C$1.00 / US$0.97 = C$1,030928; $1,030,928 - $1,010,101 = $20,827 c) Record the journal entry to record the payment of interest, December 31, 2025. Dr. Interest expense 40,816 Dr. Foreign exchange loss 421 Cr. Cash 41,237 US$1,000,000 × 4% = US$ 40,000; US$40,000 × C$1/US$0.97 = C$41,237; US$40,000 × C$1.00 / US$0.98 = C$40,816 $41,237 - $40,816 = $421 Diff: 2 Type: SA Skill: Comp Objective: 12.6 Describe how non-current liabilities are presented and disclosed.

2) A company is required to disclose information that enables users to evaluate the significance of financial liabilities on its financial position and performance. Required: List 8 essential aspects that disclosure over financial liabilities should cover: Answer: a) The nature of contingent liabilities. b) A summary of the accounting policies used to determine the measurement basis of valuing liabilities– for example, amortized cost. c) Pertinent details of the indebtedness, including collateral pledged and call or conversion privileges. d) The fair value of each class of financial liability and how this was determined–for example, discounted cash flow analysis. e) Total interest expense on liabilities other than those valued at fair value through profit and loss. f) A schedule that details the contractual maturity dates of financial liabilities. g) The nature and extent of risks arising from financial liabilities, including credit risk, liquidity risk, and market risk. h) Details of any obligations in default, including the carrying amount of loans in default at statement date. Diff: 2 Type: SA Skill: Concept Objective: 12.6 Describe how non-current liabilities are presented and disclosed. 3) Contrast the differences between IFRS and ASPE for financial liabilities using the following table: ISSUE Amortization of premiums and discounts on financial liabilities Increase the provision for site restoration costs due to the passage of time

IFRS

ASPE

Answer: ISSUE IFRS Amortization of premiums and Enterprises must discounts on financial liabilities use the effective interest method.

Increase the provision for site restoration costs due to the passage of time

ASPE Enterprises may use either the effective interest method or the straight-line method because ASPE does not specify a method of amortization. Charged to interest Charged to expense accretion expense

4) Sarah Braun is the owner of Sarah's Shameless Boutique Corp. (SSBC), a newly incorporated company. Sarah believes that she has a great concept but does not have a lot of money to start the business. Sarah is fairly resourceful, though, and has been able to arrange the following: 1. On July 1, 2026, SSBC provides a vendor with a $18,500 non-interest-bearing note due on July 1, 2027, in exchange for furniture with a list price of $18,100. Sarah Braun guarantees the debt. 2. On August 1, 2026, SSBC buys a photocopier listed for $2,900. The office supply store agrees to accept a $800 down payment and a $2,100, three-year note payable at $798 per year including interest at 7% with the first payment due on August 1, 2027. The loan is secured by a lien on the photocopier. 3. On September 1, 2026, SSBC borrows $15,000 from its bank for working capital purposes. The loan, plus interest at 12% per annum, is due on June 30, 2027. SSBC grants the bank a security interest in its accounts receivables and inventory. Unfortunately, SSBC's target audience is a bit more prudish than she anticipated and sales have been slow. While the company was able to retire the bank loan on the due date, it had insufficient cash to pay off the furniture loan. The vendor agrees to accept 2,000 common shares in SSBC in settlement of the obligation. Sarah believed that the shares are worth $20 each, but as this was the first time that SSBC had issued shares to anyone other than Sarah, a fair market price was not yet established. SSBC's year-end is June 30. The company's banker has suggested that an appropriate market rate for SSBC is 12% per annum for loans that mature in one year or less and 14% for loans with longer maturities. Required: a. Prepare journal entries to record: i. The purchase of the office furniture. ii. The acquisition of the photocopier. iii. The receipt of the loan proceeds. iv. Payments and accruals on June 30, 2026. v. The retirement of the office furnishings loan on July 1, 2026. b. Briefly describe the note disclosure that would be required with respect to the foregoing liabilities.

Answer: a(i). The fair value of the note is determined using discounted cash flow analysis. The market rate suggested by the bank has been used to discount the obligation. List prices are not necessarily a reliable indicator of the asset's fair market value. • PV = $18,500 / 1.12 = $16,518 Using a BAII PLUS financial calculator • 1 N, 12 I/Y, 18500 FV, CPT PV PV = -16,518 (rounded) Dr. Office furniture Cr. Notes payable (furniture)

16,518

a(ii). The fair value of the note is determined using discounted cash flow analysis as the interest rate in the note is less than the market rate. Using a BAII PLUS financial calculator • 3 N, 14 I/Y, 798 PMT, CPT PV PV = -1,853 (rounded) Dr. Office equipment ($1853 + $800) Cr. Notes payable (equipment) Cr. Cash

2,653 1,853 800

a(iii). Dr. Cash Cr. Notes payable (bank)

15,000

a(iv). Dr. Interest expense ($16,518 × 12% × 365 / 365) Cr. Notes payable (furniture)

1,982

Dr. Interest expense ($1,853 × 14% × 334 / 365) Cr. Notes payable (equipment)

237

a(v).

15,000

1,982

237

Dr. Notes payable (bank) 15,000 Dr. Interest expense ($15,000 × 12% × 302 / 365) (# days— include the day issued but not the day paid off) 1,489 Cr. Cash ($10,000 + $496)

16,489

Dr. Notes payable (furniture) ($16,518 + $1,982) Cr. Common shares

18,500

b. SSBC disclosure relative to the outstanding liabilities would include: • that the liabilities are carried at amortized cost • details of the indebtedness including the collateral pledged • the fair value of each class of financial liability and how this was determined • total interest expense • a schedule that details the contractual maturity dates of financial liabilities • the nature and extent of risks arising from financial liabilities, including credit, liquidity, and market risk Diff: 2 Type: ES Skill: Comp Objective: 12.6 Describe how non-current liabilities are presented and disclosed. 59 Copyright © 2023 Pearson Canada Inc.

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 13 Equities Learning Objective 1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 1) What does "priority" mean? A) Higher priority confers preferential payout before lower priority claimants. B) Refers to the amount of payment that will be made upon bankruptcy. C) Lower priority confers preferential payout before higher priority claimants. D) Debtors will be paid after the equity holders if there is a bankruptcy. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 2) Which statement is correct? A) Equity holders are concerned more about the debt accounts in the financial statements. B) Equity holders are concerned about the debt and equity accounts in the financial statements. C) Debt holders are concerned about the debt and equity accounts in the financial statements. D) Debt holders are concerned more about the equity accounts in the financial statements. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 3) What is the meaning of "contributed capital"? A) This is the amount received from the debt holders of the company. B) This is the repayment of capital to owners of the company. C) This is the dividends received from the owners of the company. D) This is the amount received from the equity holders of the company. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes.

4) Which statement is correct? A) Dividends are never discretionary payments. B) A corporation need only pay dividends when it declares them to be payable. C) A company can avoid a cumulative dividend on preferred shares if it declares dividends on common shares. D) Companies must pay the shareholders interest to compensate for the time value of money lost on the deferral of dividend payments. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 5) Which of the following statements is correct? A) Common shares have priority over preferred shares. B) All issued shares are eligible to vote for the board of directors. C) The number of shared issued > number outstanding > number authorized. D) A share with cumulative dividends must be a preferred share. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 6) Which of the following statements is correct? A) Investors favor purchasing preferred shares. B) All outstanding shares are eligible to vote for the board of directors. C) The value of preferred shares can be higher or lower than that of common shares. D) Common shares always have voting rights. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 7) If a company issues 2,000 shares for $55 and then repurchases 50 shares at $55, how much is the contributed capital? A) $0 B) $2,750 C) $107,250 D) $110,000 Answer: C Explanation: (2,000 -50) × $55 = $107,250 Diff: 1 Type: MC Skill: Comp Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes.

8) Which statement about "common shares" is correct? A) Common shares have the lowest claim to residual ownership interest of all shares. B) Common shares have the lowest priority of all shares issued by a company. C) Common shares have the highest priority of all shares issued by a company. D) Common shares have no claim to residual ownership interest of all shares. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 9) What is the primary difference between common and preferred shares? Answer: The primary difference between common and preferred shares is that common shares represent the residual interest in the company while preferred shares do not. Diff: 2 Type: SA Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 10) When is a corporation legally obligated (liable) to pay dividends? Answer: A corporation is legally obligated to pay cash dividends when it declares them to be payable. Diff: 1 Type: SA Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 11) Outline the difference between cumulative and non-cumulative dividends. Answer: The difference between cumulative and non-cumulative dividends is that for cumulative dividends, the company must pay any past dividend payments it has missed (i.e., dividends scheduled but not declared) prior to paying any dividends to common shares. This differs from shares with noncumulative dividends, which do not have any rights to missed dividend payments. Diff: 1 Type: SA Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 12) Briefly describe the difference between issued and outstanding shares. Answer: Issued shares are the net number of shares that the corporation has issued; outstanding shares are issued shares that are not held by the company as treasury shares. Diff: 1 Type: SA Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes.

13) Supply Company Ltd. issues a $60 million bond due in 10 years, and the bond indenture specifies that the company must set aside $6 million per year in a sinking fund so that the company will have funds to repay the bondholders at the end of 10 years. Assuming that the company complies with the contractual requirements, what would the journal entry be for each of the next 10 years? Answer: Account Name DR CR Retained earnings Sinking fund reserve Restricted cash Cash

6,000,000 6,000,000 6,000,000 6,000,000

Diff: 1 Type: SA Skill: Comp Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 14) Where is accumulated other comprehensive income reported and what does it represent? Answer: AOCI is reported as a component of equity in the balance sheet. AOCI represents the accumulation of OCI from all prior periods. Diff: 1 Type: SA Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 15) Briefly describe recycling as it pertains to other comprehensive income. Answer: Recycling of OCI refers to the process of recognizing amounts through OCI, accumulating that OCI in reserves, and later recognizing those amounts through net income and retained earnings. Diff: 1 Type: SA Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes.

16) Golf Is for Nerds Inc. sells 20,000 no-par value common shares for $8.00 each on a subscription basis. Terms of the sale require the purchaser to pay $3.00 per share when the contract is signed and the balance in three months' time. Required: Prepare the journal entries at (a) the date of signing the contract; (b) the date that the remaining payment is made; (c) the date the shares are transferred. Answer: DR CR At Date of Contract Cash 60,000 Subscriptions receivable 100,000 Common shares subscribed 160,000 Remaining Payment Cash 100,000 Subscriptions receivable 100,000 To record issuance of shares Common shares subscribed 160,000 Common shares 160,000 Diff: 2 Type: SA Skill: Comp Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes. 17) Who uses information about "equity" and what information about equity is useful to financial statement users? Answer: As equity has legal priority below that of liabilities in general—meaning that available funds go toward paying off liabilities prior to paying equity claims should the enterprise be liquidated—equity holders are more concerned about the equity accounts than creditors. Equity holders who do have residual claims on the enterprise are concerned about the size of their claims, and they need to be aware of changes to their share of profits. Consequently, accounting reports need to provide detailed information about the composition of equity and changes in equity that can result in the dilution of owners' stakes in the business. Equity holders are interested in distinguishing (i) changes in equity due to direct contributions or withdrawals of capital from (ii) changes in equity derived from return on equity capital (i.e., income). This categorization is natural because it separates capital transactions with owners from the entity's income generating transactions with non-owners such as customers, employees, and suppliers. Diff: 2 Type: ES Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes.

18) Explain the meaning of "contributed capital" and "common share." What distinguishes a common share from a preferred share? Answer: common share: An equity interest that has the lowest priority and represents the residual ownership interest in the company. contributed capital: The component of equity that reflects amounts received by the reporting entity from transactions with its owners, net of any repayments from capital. Any share that does not represent the residual interest in the company is a preferred share. Preferred shares have priority over the common shares. Diff: 2 Type: ES Skill: Concept Objective: 13.1 Describe the characteristics of different types of share equity and identify the characteristics that are relevant for accounting purposes.

Learning Objective 2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 1) If 1,000 preferred shares with a benchmark value of $50/share, a dividend rate of 10% and redeemable for $80/share, are sold for $75/share, how much dividend may the preferred equity holders expect to receive? A) $3,000 B) $5,000 C) $7,500 D) $8,000 Answer: B Explanation: $50/share × 10% = $5/share; $5/share × 1,000 shares = $5,000 Diff: 1 Type: MC Skill: Comp Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 2) If 700 preferred shares with a benchmark value of $35/share, a dividend rate of 5% and redeemable for $50/share, are sold for $45/share how much dividend may the preferred equity holders expect to receive? A) $525 B) $1,225 C) $1,575 D) $1,750 Answer: B Explanation: $35/share × 5% × 700 shares = $1,225 Diff: 1 Type: MC Skill: Comp Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

3) Which statement about dividends is correct? A) Dividends on cumulative preferred shares are not discretionary payments. B) Dividends are mandatory payments required for both common and preferred shares. C) Dividends are discretionary payments that can be made for common and preferred shares. D) Dividends must be paid on common shares before dividends can be paid on preferred shares. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 4) Which is an example of "contributed capital"? A) Retained earnings. B) Preferred shares. C) Other comprehensive income. D) Accumulated other comprehensive income. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 5) Which is an example of "contributed capital"? A) Appropriated reserves. B) Unappropriated retained earnings. C) Common shares. D) Accumulated other comprehensive income. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 6) In which account would "transactions with owners" be reported? A) Appropriated reserves. B) Unappropriated retained earnings. C) Contributed surplus. D) Accumulated other comprehensive income. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

7) In which account would "transactions with non-owners" be reported? A) Appropriated reserves. B) Common shares. C) Contributed surplus. D) Preferred shares. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 8) What kind of transaction is "appropriated reserves"? A) An example of "contributed surplus." B) An example of a transaction with owners. C) An example of a "contributed capital." D) An example of a transaction with non-owners. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 9) What kind of transaction is "appropriated reserves"? A) An example of preferred shares. B) An example of a transaction with owners. C) An example of "retained earnings." D) An example of an "other comprehensive income." Answer: C Diff: 2 Type: MC Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 10) What is the meaning of "shares authorized," "shares issued," and "shares outstanding"? Answer: shares authorized: The number of shares that are allowed to be issued by a company's articles of incorporation. shares issued: The number of shares issued by the corporation, whether held by outsiders or by the corporation itself. shares outstanding: Those shares held by outsiders. Diff: 1 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

11) Briefly explain why equity is separated into contributed capital and accumulated income, and the latter is further separated into retained earnings and accumulated other comprehensive income (AOCI). Answer: The separation is necessary to distinguish the results of transactions with owners from those resulting from transactions with non-owners. Transactions with owners include contribution from owners (share issuances), distribution to owners (dividends), and repurchases from owners. Transactions with other parties include all the operating activities (sales, production) as well as investing activities (purchasing equipment) and debt financing. Generally, the distinction helps to separate returns on capital (i.e., profit) from amounts contributed by owners. Diff: 1 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 12) Here is an extract of a trial balance for Soorya Inc. Indicate which accounts would be reported under the "equity" section of the balance sheet of Soorya Inc. Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Bonds payable 101,400 Unappropriated retained earnings 90,000 Provision for doubtful accounts 35,500 Appropriated retained earnings 8,500 Answer: Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 $135,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 67,500 Bonds payable 101,400 Unappropriated retained earnings 90,000 90,000 Provision for doubtful accounts 35,500 Appropriated retained earnings 8,500 8,500 Diff: 2 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

13) Here is an extract of a trial balance for Lipika Inc. Indicate which accounts would be reported under the "retained earnings" section of the balance sheet. Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 Treasury shares 10,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Bonds payable 101,400 Unappropriated retained earnings 90,000 Provision for doubtful accounts 35,500 Appropriated retained earnings 8,500 Answer: Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 Treasury shares 10,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Bonds payable 101,400 Unappropriated retained earnings 90,000 $90,000 Provision for doubtful accounts 35,500 Appropriated retained earnings 8,500 8,500 Diff: 2 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

14) Here is an extract of a trial balance for Zoe and Zia Inc. Indicate which accounts would be under the "contributed capital" section of the balance sheet. Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 Common shares 100,000 Contributed surplus—preferred shares 5,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Bonds payable 101,400 Unappropriated retained earnings 90,000 Provision for doubtful accounts 35,500 Appropriated retained earnings 8,500 Answer: Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 $135,000 Common shares 100,000 100,000 Contributed surplus—preferred shares 5,000 5,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Bonds payable 101,400 Unappropriated retained earnings 90,000 Provision for doubtful accounts 35,500 Appropriated retained earnings 8,500 Diff: 2 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

15) Here is an extract of a trial balance for Masterious Ltd. Indicate which are examples of transactions with non-owners. Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 Common shares 100,000 Treasury shares 10,000 Contributed surplus—preferred shares 5,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Bonds payable 101,400 Unappropriated retained earnings 90,000 Provision for doubtful accounts 35,500 Appropriated retained earnings 8,500 Answer: Investment in common shares of XPedious Corp $104,560 $104,560 Preferred shares 135,000 Common shares 100,000 Treasury shares 10,000 Contributed surplus—preferred shares 5,000 Other comprehensive income 45,000 45,000 Accumulated other comprehensive income 67,500 67,500 Bonds payable 101,400 101,400 Unappropriated retained earnings 90,000 90,000 Provision for doubtful accounts 35,500 35,500 Appropriated retained earnings 8,500 8,500 Diff: 2 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

16) Here is an extract of a trial balance for Masters Ltd. Indicate which item(s) are "assets." Investment in common shares of XPedious Corp $104,560 Preferred shares 135,000 Common shares 100,000 Treasury shares 10,000 Contributed surplus—preferred shares 5,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Unappropriated retained earnings 90,000 Appropriated retained earnings 8,500 Answer: Investment in common shares of XPedious Corp $104,560 $104,560 Preferred shares 135,000 Common shares 100,000 Treasury shares 10,000 Contributed surplus—preferred shares 5,000 Other comprehensive income 45,000 Accumulated other comprehensive income 67,500 Unappropriated retained earnings 90,000 Appropriated retained earnings 8,500 Diff: 2 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components. 17) Which transaction would affect retained earnings? Issue preferred shares $1,500,500 Issue common shares 2,300,000 Declare dividends on common shares 100,500 Stock split 400,000 Skipping dividend payment on preferred shares 200,000 Answer: Declare dividends on common shares $100,500 $100,500 Skipping dividend payment on preferred shares 200,000 200,000 Diff: 2 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

18) Practice Inc. issued a $10 million bond due in five years, and the bond indenture specifies that the company must set aside $2 million per year in a sinking fund so that the company will have funds to repay the bondholders at the end of 5 years. Assuming that the Practice Inc. complies with the contractual requirements, what would be the journal entries for each of the 5 years? Answer: Dr. Retained earnings 2,000,000 Cr. Sinking fund reserve (or appropriated retained earnings) 2,000,000 Dr. Restricted cash 2,000,000 Cr. Cash 2,000,000 Diff: 1 Type: SA Skill: Concept Objective: 13.2 Identify the different components of equity for accounting purposes that apply to a transaction and analyze the effect of the transaction on those equity components.

Learning Objective 3 Apply the accounting standards and procedures for transactions relating to contributed capital. 1) If a company issues 2,000 shares for $55 and then repurchases 50 shares at $50, how much is in the account "contributed surplus on retirement of shares"? A) $250 B) $2,750 C) $107,250 D) $110,000 Answer: A Explanation: (50 shares × $55 each) - (50 shares × $50) = $250 Diff: 1 Type: MC Skill: Comp Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 2) If a company issues 2,000 shares for $55 and then repurchases 50 shares at $50 and subsequently purchases another 50 shares at $60 each, how much is in the account "contributed surplus on retirement of shares"? A) $250 B) $0 C) $107,250 D) $110,000 Answer: B Explanation: "Contributed capital on retirement of shares " has a $250 credit after the first purchase and $250 must be debited from "Contributed capital on retirement of shares " for the second purchase leaving the account balance at NIL or $0. Diff: 2 Type: MC Skill: Comp Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

3) What is a "stock split"? A) It is an increase in the number of shares issued for which book value consideration is received from investors. B) It is an increase in the number of shares issued for which no consideration is received from investors. C) It is an increase in the number of shares issued for which par value consideration is received from investors. D) It is an increase in the number of shares issued for which market value consideration is received from investors. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 4) Which statement about a "stock split" is correct? A) The economic position of the investors is diluted after a stock split. B) The economic position of the investors is increased after a stock split. C) The economic position of the investors is decreased after a stock split. D) The economic position of the investors is unaffected after a stock split. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 5) Which statement is correct respecting a company's repurchase of its own shares? A) It provides a tax disadvantage to the shareholder. B) It enables the company to acquire stock for distribution as compensation to employees. C) It provides a negative signal to the market. D) It causes earnings per share to decrease. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 6) Which statement is correct respecting a company's repurchase of its own shares? A) It can provide a tax advantage to the shareholder. B) It provides a negative signal to the market. C) It causes earnings per share to decrease. D) Infers that corporate executives believe their company's shares to be overvalued. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

7) Which statement about "share buyback" is correct? A) If the repurchase price is below the average issue price, the difference goes to "gain on repurchase of shares," which will increase the net income. B) If the repurchase price is below the average issue price, the difference goes to "common shares." C) If the repurchase price is below the average issue price, the difference goes to "contributed surplus." D) If the repurchase price is below the average issue price, the difference goes to "loss on repurchase of shares," which will decrease the net income. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 8) Assume that a company issued 10,000 shares for $30/share. What entry would be required to record the repurchase and cancellation of 1,000 shares at $28/share? A) Debit to common shares for $28,000. B) Debit to common shares for $30,000. C) Credit to contributed surplus for $29,000. D) Credit to contributed surplus for $1,000. Answer: B Explanation: ($30/share × 1,000 shares) = $30,000 Diff: 2 Type: MC Skill: Comp Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 9) Which statement about contributed surplus is correct? A) Contributed surplus can only arise from the issuance of shares. B) Contributed surplus can arise from the issuance of stock options. C) Contributed surplus arising from share repurchase gives rise to a debit journal entry. D) Contributed surplus arising from share issuance gives rise to a debit journal entry. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 10) Which statement about a "reverse stock split" is correct? A) The economic position of the investors is diluted after a stock split. B) The economic position of the investors is increased after a stock split. C) The economic position of the investors is decreased after a stock split. D) The economic position of the investors is unaffected after a stock split. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

11) Which statement about a "share buyback" is correct? A) The EPS of the company will decrease after a share buyback. B) Share buy-back decreases the information asymmetry for investors. C) It is an administratively cumbersome way to award stock compensation. D) Accounting is the same whether repurchased shares are cancelled or not. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 12) Assume that a company issued 10,000 shares for $30/share. What entry would be required to record the repurchase and cancellation of 1,000 shares at $28/share? A) Credit to common shares for $28,000. B) Credit to common shares for $30,000. C) Credit to contributed surplus for $29,000. D) Credit to contributed surplus for $2,000. Answer: A Explanation: ($30/share - $2/share) × 1,000 shares = $28,000 Diff: 2 Type: MC Skill: Comp Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 13) Which statement best describes the accounting when a company cancels its own shares at an amount lower than the average share value? A) Contributed surplus and retained earnings will be credited. B) Contributed surplus and retained earnings will be debited. C) Contributed surplus will be credited, thereby increasing equity. D) Contributed surplus will be debited, thereby decreasing equity. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 14) Which statement best describes the accounting when a company cancels its own shares at an amount higher than the average share value? A) Contributed surplus and retained earnings will be credited. B) Contributed surplus and retained earnings will be debited. C) Contributed surplus will be credited, thereby increasing equity. D) Contributed surplus will be debited, thereby decreasing equity. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

15) How should subscriptions receivable be reported on the balance sheet and why? Answer: Logically it makes sense to report subscriptions receivable as a contra equity account so as to prevent manipulation of financial statements. The alternative of treating the subscriptions receivable as an asset and the full amount as equity can improve leverage ratios. Diff: 2 Type: SA Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 16) What are three potential outcomes for defaults on share subscriptions? Answer: (i) refund the cash paid and cancel the contract, (ii) issue a lesser number of shares to the subscriber that reflects the amount paid, or (iii) keep the money paid as a penalty for the subscriber defaulting on the contract. Diff: 1 Type: SA Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 17) Briefly describe the primary reason why companies declare a stock split. Answer: Companies engage in stock splits typically to bring their share down to a price where investors can afford to buy several shares. Lowering the price of each share can increase trading volume and improve liquidity in the market for the company's shares. Diff: 2 Type: SA Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital. 18) List and explain four reasons why a company might repurchase its own shares. Answer: Companies repurchasing shares: 1. offer tax advantages to the shareholders because shareholders can choose to sell their shares at a profit when it is most advantageous to their taxes. 2. alleviate information asymmetry by providing a credible positive signal to the market because it is costly for the company to expend cash to buy back its own shares. This infers that corporate executives believe their company's shares to be undervalued. 3. may do so to acquire stock to distribute as compensation to executives and other employees. It is administratively less cumbersome than issuing new shares. 4. decreases the number of shares outstanding which increases reported EPS. Diff: 1 Type: SA Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

19) Explain why accounting does not recognize gains on share repurchase transactions. Answer: A commonly given reason for why accounting does not recognize gains on share repurchase transactions is that it involves a company buying its own shares from its shareholders rather than a transaction with an external party. However, this is not a satisfying explanation because the (former) shareholders who sold the shares on the other side of the transaction would have recorded losses had they purchased at the issue price of $20 a share and sold back to the company at $18 a share. Instead, there are two other explanations that are more compelling. First, a drop in a company's share price is hardly good news for shareholders, so recording a gain in this situation would be inconsistent with the underlying economics. Second, permitting the recognition of gains creates a moral hazard. Since management has superior information relative to shareholders, management could record gains by judiciously timing share issuances and repurchases to the detriment of shareholders if accounting standards permitted the recognition of such gains. Diff: 3 Type: SA Skill: Concept Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

20) Ellwoods Bar and Grill Ltd. sells 1,000 packages of equity security consisting of one common share and one preferred share. Each package was sold for $100; total proceeds were $100,000. At time of sale, the market price of the common shares was $91.00 and the estimated fair value of the preferred shares was $10.00. Contrast the two alternative methods of accounting for this bundled purchase. (a) The company uses the relative fair value method and (b) the company uses the residual value method. Use the following table: a) Relative Fair Value Method

(b) Residual Value Method

Answer:

(a) Relative Fair Value Method

The sum of the fair values is $101 ($91 + $10). Proportional allocation results in 91/101 of the sales price being allocated to the common shares and 10/101 being allocated to the preferred shares. DR

Cash Common shares Preferred shares

b) Residual Value Method Cash Common shares Preferred shares

CR 100,000 90,099 9,901

The common shares can be more reliably measured at their market price of $91, so the common shares pick up the first increment of $91. The preferred shares pick up the residual value of $9 ($100 - $91). 100,000 91,000 9,000

Diff: 1 Type: ES Skill: Comp Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

21) Burlington Corp. has a single class of shares. As its year ended December 31, 2025, the company had 5,000,000 shares issued and outstanding. On the stock exchange, these shares were trading at around $7. In the company's accounts, these shares had a value of $50,000,000. The equity accounts also show $650,000 of contributed surplus from previous repurchases of shares. On January 15, 2026, Burlington repurchased and cancelled 250,000 shares at a cost of $7 per share. Later in the year, on August 20, the company repurchased and cancelled a further 475,000 shares at a cost of $14 per share. Required: Record the journal entries for the two share transactions in 2026. Answer: Note that the common shares have a per share value on the books at $50,000,000 / 5,000,000 sh = $10/sh. Jan. 15

Dr. Common shares (250,000 sh × $10/sh) 2,500,000 Cr. Contributed surplus—from repurchases Cr. Cash (250,000 sh × $7/sh)

750,000 1,750,000

Aug. 20 Dr. Common shares (475,000 sh × $10/sh) 4,750,000 Dr. Contributed surplus ($650,000 + $750,000) 1,400,000 Dr. Retained earnings (remainder) 500,000 Cr. Cash (475,000 sh × $14/sh) 6,650,000 Diff: 2 Type: ES Skill: Comp Objective: 13.3 Apply the accounting standards and procedures for transactions relating to contributed capital.

Learning Objective 4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 1) When does a company record dividends payable? A) On date of record. B) On ex-dividend date. C) On payment date. D) On declaration date. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

2) What is the "ex-dividend" date for the Toronto Stock Exchange? A) 2 business days after the declaration date. B) 2 business days after the date of record. C) 2 business days before the date of record. D) 2 business days before the declaration date. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 3) Which statement about the "ex-dividend date" is correct? A) The ex-dividend date relates only to shares that are publicly traded. B) An investor who buys shares before the ex-dividend date does not have the right to receive a dividend that has been declared. C) The ex-dividend date will occur after the record date. D) An investor who buys shares on or after the ex-dividend date has the right to receive a dividend that has been declared. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 4) Which statement about cash dividends is correct? A) The date of declaration is the date that determines which shareholders will receive the dividends. B) The date of declaration is the date on which the Board of Directors declares a dividend and the company has an obligation to pay the dividend. C) The date of record is the date when the funds for the dividend are transferred to shareholders. D) The company must record a journal entry on the date of declaration, the date of record and the date of payment. Answer: B Explanation: There is no journal entry on the date of record. It is the date that determines who is entitled to the cash dividends. Diff: 2 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

5) Which statement about "stock dividends" is correct? A) Only a memo entry is needed for this transaction. B) No entry is needed in the accounting records. C) A journal entry is needed for this transaction. D) This is the same as a stock split for accounting purposes. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 6) Which of the following statements is correct? A) Only a memo entry is needed for stock dividends transactions. B) The date of record of cash dividends is the date when the funds for the dividend are transferred to shareholders. C) The ex-dividend date relates only to shares that are publicly traded. D) A company will record dividends payable on the ex-dividend date. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 7) Which statement is correct concerning property dividends? A) Issuing property dividends is a common method of distributing value to the shareholders. B) A property dividend could be used to transfer assets from a subsidiary to a parent company. C) Property dividends cannot be used by a parent company to distribute shares of an associate or subsidiary to its shareholders. D) The historical value of the property is used for purposes of recording the value of the dividend. Answer: B Explanation: Issuing property dividends is an uncommon way of distributing value to shareholders because not all shareholders will appreciate the particular type of property being distributed. The fair value of the property is used for the purposes of recording the value of the dividend. Diff: 2 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

8) Which statement is correct regarding dividend entitlement? A) Cumulative preferred shares do not have any rights to missed dividend payments. B) Non-cumulative preferred shares must be paid all missed dividend payments when dividends are declared. C) A corporation need only pay dividends when it declares them to be payable. D) A company can avoid paying dividends in arrears on cumulative preferred shares if it is to pay dividends on common shares. Answer: C Explanation: Companies must pay dividends in arrears on cumulative preferred shares first before paying dividends on common shares. Diff: 2 Type: MC Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 9) Contrast the different treatment between IFRS and ASPE with respect to property dividends when the property dividend consists of the shares of a subsidiary that is being reported in the investor's consolidated financial statements. Answer: IFRIC 17 requires that the property should be transferred at its fair value and the difference between the book value and fair value be recorded in profit and loss. When the property dividend consists of a distribution of shares of a subsidiary or an investee that is being consolidated or accounted for using the equity method, ASPE requires that the book values method be used, and hence no gains or losses are recognized on the distribution. Diff: 2 Type: SA Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

10) Use the following facts to determine how much each of the three classes of shares receives of the $1,000,000 cash dividend. Facts: In 2027 Blueberry Juice Inc. declared $1,000,000 in cash dividends. Its capital structure includes 300,000 common shares; 200,000 cumulative preferred shares "A" each entitled to an annual dividend of $1.00; and 50,000 non-cumulative preferred shares "B" each entitled to an annual dividend of $3.00. The prescribed dividends on both series of preferred shares were last declared and paid in 2026; there are no dividends in arrears. Answer: Class A $200,000 Class B $150,000 Common shares $650,000 Calculations: Cash dividend declared in 2027 $1,000,000 Class A cumulative preferred shares (200,000) Class B non-cumulative preferred shares (150,000) Subtotal 650,000 Common shares $650,000 Diff: 2 Type: SA Skill: Comp Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 11) Use the following facts to determine how much each of the three classes of shares receives of the $1,000,000 cash dividend. Facts: In 2027 Blueberry Juice Inc. declared $1,000,000 in cash dividends. Its capital structure includes 300,000 common shares; 200,000 cumulative preferred shares "A" each entitled to an annual dividend of $1.00; and 50,000 non-cumulative preferred shares "B" each entitled to an annual dividend of $3.00. The prescribed dividends on both series of preferred shares were last declared and paid in 2025. Answer: Class A $400,000 Class B $150,000 Common shares $450,000 Calculations: Cash dividend declared in 2027 $1,000,000 Class A cumulative preferred shares 2026 (200,000) Class A cumulative preferred shares 2027 (200,000) Class B non-cumulative preferred shares 2027 (150,000) Subtotal 450,000 Common shares $450,000 Diff: 2 Type: SA Skill: Comp Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

12) Explain what a "property dividend" is and why it is not common. Under what circumstances would a property dividend be advisable? Answer: A property dividend arises when, instead of cash, companies pay dividends using non-cash assets. This method of distributing value to shareholders is uncommon because different investors will value the distributed property differently, and some may not appreciate it at all. For example, a cookie manufacturer could send its shareholders boxes of cookies, which could be a problem if a shareholder owned many shares. More practically, a property dividend could be used to transfer assets from a subsidiary to a parent company. Diff: 2 Type: SA Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 13) IAS 1, Presentation of Financial Statements, stipulates that a complete set of financial statements includes a statement of changes in equity for the period. The statement of changes in equity provides information about the changes that took place during the period in all equity accounts. List the three equity accounts. Answer: Contributed Capital, Accumulated Other Comprehensive Income, Retained Earnings. Diff: 2 Type: SA Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 14) What needs to be reconciled in each of the components of the statement of changes in equity? Answer: For each component of equity (e.g., contributed capital, unappropriated retained earnings, and AOCI), a reconciliation of the opening and closing balances, separately disclosing changes resulting from profit or loss; other comprehensive income; and capital transactions. Diff: 1 Type: SA Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings. 15) List the five classes of transactions that explain the change in equity on the statement of changes in equity. Answer: 1) Profit or loss–income and expenses as recognized on the statement of comprehensive income, other than (2) below 2) Other comprehensive income (OCI) 3) Dividends 4) Capital transactions–transactions with owners such as share issuances or repurchases 5) Effect of changes in accounting policy and correction of errors Diff: 2 Type: SA Skill: Concept Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

16) Milton Corporation declared and distributed a 8% stock dividend. Milton had 440,000 common shares outstanding and 940,000 common shares authorized before the stock dividend. The board of directors determined the appropriate market value per share as $10. Required: How much should be recorded for the stock dividend? Record the journal entry (if any) for the shares distributed. Answer: # shares outstanding before stock dividend 440,000 shares Dividend rate × 8% Shares issued as a result of the dividend 35,200 shares Market value per share × $10/share Value of stock dividend $352,000 Dr. Retained earnings 352,000 Cr. Common shares 352,000 Diff: 1 Type: ES Skill: Comp Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

17) Nala Company has two classes of shares that were both issued on January 1, 2024: Class A, $10 benchmark value, 8% preferred shares, 2,750,000 shares issued and outstanding; Class B, no par value common shares issued at $30/share, 1,300,000 shares issued and outstanding. Due to challenging start-up problems in 2024 and 2025 there were no dividends declared or paid; in 2026 dividends of $8,000,000 were declared and paid; and, for 2027, dividends declared and paid totaled $16,000,000. Required: How much was the amount of dividends paid to preferred and common shares in 2024 to 2027? First assume that the preferred shares are non-cumulative, then assume that they are cumulative. NC = Non-cumulative C = Cumulative P/S = Preferred shares C/S = Common shares 2024

2025

2026

2027

Answer: Type of Shares NC, P/S C/S Total dividends

2024 $0 0 $0

2025 $0 0 $0

2026 $220,000 7,780,000 $8,000,000

2027 $220,000 15,780,000 $16,000,000

C, P/S C/S Total dividends

$0 0 $0

$660,000 7,340,000 $8,000,000

$220,000 15,780,000 $16,000,000

NC, P/S C/S Total Dividends C, P/S C/S Total Dividends

If preferred shares are non-cumulative, their shareholders get their entitlement for the year only if any dividends are declared. Once paid the balance can go to common shareholders. However, if the preferred shares are cumulative, then all current and arrears dividends must be paid before the common shareholders get any dividends. Diff: 1 Type: ES Skill: Comp Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

18) Cardiff Corporation is a public company traded on a major exchange. Cardiff's common shares are currently trading at $21 per share. The board of directors is debating whether to issue a 200% stock dividend or accomplish a similar result by doing a stock split. The board is wondering how shareholders' equity would be affected, and whether the value of the typical shareholder's investment will change. Details of Cardiff's equity section of the balance sheet are as follows: Common shares, no par, 6,000,000 shares issued and outstanding Retained earnings Total shareholders' equity

$36,000,000 140,000,000 $176,000,000

Required: a. At what price would you expect the shares to trade after either transaction? Explain with calculations. b. Show what the equity section of the balance sheet for Cardiff would look like after the stock dividend or stock split. c. Assume that an investor has 6,000 common shares before the stock dividend or stock split. What would be the value of the investor's holdings before and after the stock dividend or stock split? d. What is your recommendation to the board of directors?

Answer: a. Either the stock dividend or stock split would increase the number of shares by 200%. Consequently, the price per share after the stock split will be: Number of shares before stock dividend or stock split Price per share Market value of equity Number of shares afterward (6,000,000 × $3.00) Price per share

600,000 $21 $126,000,000 ÷ 18,000,000 $7.00

b. Equity section of balance sheet after transactions: Stock dividend Common shares, 18,000,000 shares issued and outstanding $120,000,000 Retained earnings ($140,000,000 - $84,000,000) 56,000,000 Total shareholders' equity $176,500,000 (Stock dividend results in 12,000,000 shares issued at $7.00/sh or $84,000,000. This amount transfers from retained earnings to common shares.) Stock split Common shares, 18,000,000 shares issued and outstanding Retained earnings Total shareholders' equity (no change except for number of shares)

$36,000,000 140,000,000 $176,500,000

c. Value of investment in Cardiff:

Number of shares held Market price per share Total value of investment

Before either transaction 6,000 × $21 $126,000

After either transaction 18,000 × $7 $126,000

d. Recommendation to board of directors: Either a stock dividend or a stock split would result in only cosmetic changes to the balance sheet. In both cases, the number of shares increases by 200%, but total equity in the balance sheet does not change. In the case of a stock dividend, there would be a transfer of $84 million from retained earnings to the common share account, leaving total equity unaffected. However, there are potentially tax consequences for shareholders if the company issues a stock dividend, so a stock split is the preferred option if one or the other option must be chosen. There does not seem to be a compelling reason to increase the number of shares or to decrease the stock price, so I recommend not pursuing either option. Diff: 2 Type: ES Skill: Comp Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

19) Below are details relating to balances for the equity accounts of Cauvet Company, and changes to those balances. Note that AOCI is accumulated other comprehensive income. Balance or changes Common shares, 2024, Jan. 1 Unappropriated R/E, 2024, Jan. 1 Appropriated R/E for sinking fund reserve, 2024, Jan. 1 AOCI from revaluations, 2024, Jan. 1 Net income, 2024 R/E appropriated for sinking fund reserve in 2024 AOCI from revaluations for 2024 Dividends declared in 2024 Net income, 2025 R/E appropriated for sinking fund reserve in 2025 AOCI from revaluations for 2025 Dividends declared in 2025

($000's) $70,000 139,000 3,200 1,900 15,500 1,000 250 900 14,000 800 (250) 2,200

Required: Prepare a statement of changes in equity for the years ended December 31, 2024, and 2025. Answer: Appropriated Common Retained Retained Shares Earnings Earnings AOCI Net income $15,500 OCI on revaluations 0 $250 Total comprehensive income 15,000 250 Dividends declared (900) Appropriation to sinking fund (1,000) $1,000 Net change in equity 13,600 1,000 250 Balance Jan. 1, 2024 $70,000 139,000 3,200 1,900 Balance Dec. 31, 2024 $70,000 $152,600 $4,200 2,150 Net income 2025 OCI on revaluations Total comprehensive income Dividends declared Appropriation to sinking fund Net change in equity Balance at Jan. 1, 2025 Balance Dec. 31, 2025

$70,000 $70,000

$14,000 0 14,000 (2,200) (800) 11,000 152,600 $163,600

$(250) (250) $800 800 4,200 $5,000

(250) 2,150 $1,900

Diff: 2 Type: ES Skill: Comp Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

20) As of January 1, 2026, the equity section of LD Food Co.'s balance sheet contained the following: Common shares, 10 million authorized, 2 million issued and $3,000,000 outstanding Contributed surplus—from repurchase and cancellation of 275,000 common shares Contributed surplus—from expired options on common shares 250,000 Preferred shares, $4.00 cumulative dividend, 7 million authorized, 570,000 30,000 issued and outstanding Retained earnings 2,500,000 Total shareholders' equity $6,595,000 • On May 1, 2026, the company spent $802,500 to repurchase 300,000 common shares. These shares were cancelled immediately. • On July 15, 2026, the company repurchased and cancelled 4,000 preferred shares at $15/sh. • On November 1, 2026, the company declared and paid the annual cash dividends on the preferred shares. On the same day, the company issued a 5% stock dividend on common shares. LD Food's stock traded at $7/share after the dividend. Required: Record the journal entries for the above transactions occurring in 2026. Answer: May 1 Dr. Common shares 450,000 (300,000 sh / 2,000,000 sh × $3, 000,000) Dr. Contributed surplus—from repurchase and cancellation 275,000 of common shares (Type B—use balance available) Dr. Contributed surplus—expired options on common 37,500 shares (Type C—pro rata 300,000 sh / 2,000,000 sh × $250,000) Dr. Retained earnings (remainder) 40,000 Cr. Cash (given) July 15 Dr. Preferred shares (4,000 sh × $19/sh book value) Cr. Contributed surplus—preferred shares, from repurchases and resales Cr. Cash (given)

76,000

Nov. 1 Dr. Retained earnings (26,000 remaining pref shares × $4.00/sh)104,000 Cr. Cash

802,500

16,000 60,000

104,000

Dr. Retained earnings (1,700,000 common shares remaining 595,000 × 5% × $7.00/sh) Cr. Common shares 595,000 Diff: 2 Type: ES Skill: Comp Objective: 13.4 Apply the accounting standards and procedures for transactions relating to the distribution of retained earnings.

Learning Objective 5 Prepare a statement of changes in equity. 1) Below are details relating to balances for the equity accounts of Paras Company, and changes to those balances. Note that AOCI is accumulated other comprehensive income. Balance or changes Common shares, 2024, Jan. 1 Unappropriated retained earnings, 2024, Jan. 1 Appropriated retained earnings for sinking fund reserve, 2024, Jan. 1 AOCI from revaluations, 2024, Jan. 1 Net income, 2024 Retained earnings appropriated for sinking fund reserve in 2024 AOCI from revaluations for 2024 Dividends declared in 2024

Amount ($ 000's) $50,000 48,600 4,200 1,150 14,000 800 (250) 2,200

Required: Prepare a statement of changes in equity for the year ended December 31, 2024. Answer: Paras Company Ltd. Statement of Changes in Equity For the Year Ended 2024 Appropriated C/S R/E AOCI R/E Net income 2024 $14,000 OCI on revaluations 0 ($250) Total comprehensive income 14,000 (250) Dividends declared (2,200) Appropriation to sinking fund (800) $800 0 Net change in equity 11,000 800 (250) Balance at Jan. 1, 2024 $50,000 48,600 4,200 1,150 Balance at Dec. 31, 2024 $50,000 $59,600 $5,000 $900 Diff: 3 Type: SA Skill: Comp Objective: 13.5 Prepare a statement of changes in equity

2) Below are details relating to balances for the equity accounts of Isha Company, and changes to those balances. Note that AOCI is accumulated other comprehensive income. Balance or changes Common shares, 2024, Jan. 1 Unappropriated retained earnings, 2024, Jan. 1 Appropriated retained earnings for sinking fund reserve, 2024, Jan. 1 AOCI from revaluations, 2024, Jan. 1 Net income, 2024 Retained earnings appropriated for sinking fund reserve in 2024 AOCI from revaluations for 2024 Dividends declared in 2024

Amount ($ 000's) $50,000 39,000 3,200 900 11,500 1,000 250 900

Required: Prepare a statement of changes in equity for the year ended December 31, 2024. Answer: Isha Company Ltd. Statement of Changes in Equity For the Year Ended 2024 Appropriated Common Retained Retained AOCI Shares Earnings Earnings Net income $11,500 OCI on revaluations Total comprehensive income Dividends declared Appropriation to sinking fund Net change in equity Balance at Jan. 1, 2024 Balance at Dec. 31, 2024

$50,000 $50,000

Total $11,500

$250

250

11,500 (900)

250

11,750 (900)

0 250 900 $1,150

0 10,850 93,100 $103,950

(1,000) 9,600 39,000 $48,600

1,000 1,000 3,200 $4,200

Diff: 3 Type: SA Skill: Comp Objective: 13.5 Prepare a statement of changes in equity

Appendix Questions 1) Which statement is correct about "par value"? A) Par value refers to the price at which a common share is sold to the equity holders. B) The dividend rate can be specified as a percentage of the par value for common shares. C) The dividend rate can be specified as a percentage of the par value for preferred shares. D) Par value refers to the price at which a preferred share is sold to the equity holders. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 2) Explain the meaning of "par value," "contributed surplus," and "preferred shares." Answer: par value shares: Shares with a dollar value stated in the articles of incorporation; for preferred shares, the dividend rate may be stated as a percentage of the par value. preferred shares: Any shares that are not common shares. contributed surplus: The component of contributed capital other than par value. Diff: 1 Type: SA Skill: Concept Objective: 13.6 Comprehensive Question 3) When shares are repurchased at an amount different from their original issue price, then held in treasury or cancelled, will the journal entry affect the following components? Share capital Contributed surplus Treasury stock Loss/gain on share retirement Accumulated other comprehensive income Appropriated reserves Unappropriated retained earnings Answer: Share capital Contributed surplus Treasury stock Loss/gain on share retirement Accumulated other comprehensive income Appropriated reserves Unappropriated retained earnings Other comprehensive income Diff: 2 Type: ES Skill: Concept Objective: 13.6 Comprehensive Question

Yes Yes Yes No No No Yes No

4) Which statement about a "treasury shares" is correct? A) The company does not pay dividends on these shares. B) These shares must be cancelled upon re-purchase. C) These shares are disclosed as issued and outstanding. D) These shares continue to have voting rights. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 5) Which statement about a "treasury shares" is correct? A) No company is permitted to hold treasury shares. B) Treasury shares have voting rights. C) Treasury shares receive dividends. D) There are two methods that can be used to account for treasury shares: the single-transaction method and the two-transaction method. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 6) Which statement about a "treasury shares" is correct? A) The "single transaction method" treats the reacquisition as the end of the initial share issuance transaction. B) The "two transaction method" decreases the contributed surplus when the repurchased shares are later resold. C) The "two transaction method" treats the reacquisition and subsequent sale as one cycle for accounting. D) The "single transaction method" treats the reacquisition and subsequent sale as two parts of the same transaction. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 7) Which statement best explains the "single transaction method" for treasury shares? A) This method treats the reacquisition as the end of the initial share issuance transaction. B) This method treats the subsequent sale as the start of another transaction. C) This method treats the reacquisition and subsequent sale separately for accounting. D) This method treats the reacquisition and subsequent sale as two parts of the same transaction. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question

8) Which statement is correct about the "two transaction method" for treasury shares resold for greater than their repurchase cost? A) This method decreases the contributed surplus when the repurchased shares are later resold. B) This method has the same effect on contributed surplus to that of the two transaction method. C) This method treats the reacquisition and subsequent sale as one cycle for accounting. D) This method increases contributed surplus at the time of repurchase. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 9) Which statement is correct about the "single transaction method" for treasury shares? A) This method has the same effect on contributed surplus to that of the two transaction method. B) This method uses a separate "treasury shares" account upon repurchase. C) This method treats the reacquisition and subsequent sale separately for accounting. D) This method decreases contributed surplus at the time of repurchase. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 10) Elville Inc. was incorporated under provincial legislation with a December 31 year-end. The company has a single class of shares. As at December 31, 2024, it had 900,000 shares issued and outstanding. These shares had a book value of $18,000,000 on the balance sheet. During 2025, Elville repurchased 10% of the issued shares from one of the minority shareholders at a cost of $25 per share. The company held these in treasury and later found a buyer for half of these shares at $30. The other half were sold at $21 to another investor. Required: Record the share transactions using the single-transaction method for treasury stock, which is the preferred accounting method. Answer: Single transaction method: Repurch. Dr. Treasury shares Cr. Cash (9,000 sh × $25/sh) Resale 1

Resale 2

2,250,000

Dr. Cash (4,500 sh × $30/sh) 1,350,000 Cr. Contributed surplus - from repurchases and resale Cr. Treasury shares (4,500 sh × $25/sh)

Dr. Cash (4,500 sh × $21/sh) Dr. Contributed surplus Cr. Treasury shares (4,500 sh × $25/sh) Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

945,000 180,000

2,250,000

225,000 1,125,000

1,125,000

11) Mountip Inc. was incorporated under provincial legislation with a December 31 year-end. The company has a single class of shares. As at December 31, 2024, it had 150,000 shares issued and outstanding. These shares had a book value of $5,700,000 on the balance sheet. During 2025, Mountip repurchased 5% of the issued shares from one of the minority shareholders at a cost of $48 per share. The company held these in treasury and later found a buyer for half of these shares at $52. The other half were sold at $46 to another investor. Required: Record the share transactions using the alternative two-transaction method for treasury stock. Answer: Two-transaction method: Note that the balance in the common share account of $5,700,000 for 150,000 shares equals $38/sh. In the two-transaction method, the repurchase is the second part of a sell/buy cycle, and the later sales are the beginning of a new sell/buy cycle. Repurch.

Sale 1

Sale 2

Dr. Common shares (7,500 sh × $38/sh) Dr. Retained earnings Cr. Cash (7,500 sh × $48/sh)

285,000 75,000

Dr. Cash (3,750 sh × $52/sh) Cr. Common shares

195,000

Dr. Cash (3,750 sh × $46/sh) Cr. Common shares Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

360,000

172,500

195,000

172,500

12) Dunst Company had the following shareholders' equity account balances on December 31, 2025: Common shares, 150,000 authorized, 40,000 issued Contributed surplus on repurchases and resales Treasury shares, 20,000 shares Retained earnings Total shareholder's equity

$880,000 45,000 (800,000) 500,000 $625,000

During 2026, the following transactions occurred: i. May 1: Dunst resold 1,600 of the treasury shares at $52 per share. ii. Dec. 30: The board of directors declared cash dividends of $2 per share. iii. Dec. 31: Net income for the year ended December 31, 2026, was $150,000. Dunst uses the single transaction method for treasury shares. Required: a. Record the journal entries for the transactions in 2026 and make all the necessary year-end entries relating to shareholders' equity accounts. b. Prepare the presentation of the shareholders' equity section of Dunst's balance sheet as at December 31, 2026. Answer: a. Journal entries: Mar. 15 Dr. Cash (1,600 sh × $52/sh) 83,200 Cr. Treasury shares ($800,000 / 20,000 sh = $40/sh; 64,000 1,600 sh × $40/sh) Cr. Contributed surplus on repurchases and resales 19,200 Dec. 30 Dr. Retained earnings Cr. Dividends payable (21,600 sh × $2/sh) (#shares o/s = 40,000 - 20,000 + 1,600 = 21,600)

43,200

Dec. 31 Dr. Income summary 150,000 Cr. Retained earnings This is the closing entry to close the income statement accounts. b. Common shares, 150,000 authorized, 40,000 issued Contributed surplus on repurchases and resales Treasury shares, 18,400 shares Retained earnings Total shareholder's equity Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

$880,000 64,200 (736,000) 606,800 $815,000

43,200

150,000

13) Pixel Points Inc. has a single class of shares. As at its year ended December 31, 2025, the company had 1,000,000 shares issued and outstanding. These shares have a book value of $5,000,000 on the balance sheet. During 2026, Pixel Points repurchased 5% of the issued shares from one of the minority shareholders at a cost of $7 per share. The company held these shares in treasury and later found a buyer for half of these shares at $8 per share. The other shares were sold at $6 to another investor. Required: Assume the Pixel Points fallows the guidance in ASPE pertaining to accounting for equity transactions. Record the share transactions using the single-transaction method for treasury shares, which is the preferred accounting method. Answer: Repurchase Dr. Treasury shares 350,000 Cr. Cash (50,000 sh × $7/sh) 350,000 Resale 1 Dr. Cash (25,000 sh × $8/sh) Cr. Contributed surplus - from repurchases and resales (Type B) Cr. Treasury shares (25,000 sh × $8/sh) Resale 2

Dr. Cash (25,000 sh × $6/sh) Dr. Contributed surplus - from repurchases and resales (Type B) Cr. Treasury shares (25,000 sh × $8/sh) Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

200,000 25,000 175,000

150,000 25,000

175,000

14) Pixel Points Inc. has a single class of shares. As at its year ended December 31, 2025, the company had 1,000,000 shares issued and outstanding. These shares have a book value of $5,000,000 on the balance sheet. During 2026, Pixel Points repurchased 5% of the issued shares from one of the minority shareholders at a cost of $7 per share. The company held these shares in treasury and later found a buyer for half of these shares at $8 per share. The other shares were sold at $6 to another investor. Required: Assume the Pixel Points fallows the guidance in ASPE pertaining to accounting for equity transactions. Record the share transactions using the two-transaction method for treasury shares. Answer: Repurchase Dr. Common shares (50,000 sh × $5/sh) 250,000 Dr. Retained earnings 100,000 Cr. Cash (50,000 sh × $7/sh) 350,000 Resale 1 Dr. Cash (25,000 sh × $8/sh) Cr. Common Shares Resale 2

Dr. Cash (25,000 sh × $6/sh) Cr. Common Shares Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

200,000

150,000 150,000

15) What is the economic significance of "par value" for accounting purposes? A) The par value determines the amount of contributed surplus. B) Par value has no economic significance for accounting purposes. C) Par values determines the amount of cash received from investors. D) Par value shares are not permitted under IFRS or ASPE. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 16) If 10,000 shares with par value of $15/share are issued for $20/share, how much will be presented as "contributed capital" for financial statement purposes? A) $10,000 B) $50,000 C) $150,000 D) $200,000 Answer: D Explanation: 10,000 shares × $20/share = $200,000 Diff: 2 Type: MC Skill: Comp Objective: 13.6 Comprehensive Question 41 Copyright © 2023 Pearson Canada Inc.

17) If 10,000 shares with par value of $15/share are issued for $20/share, how much will be presented as "contributed surplus" for financial statement purposes? A) $10,000 B) $50,000 C) $150,000 D) $200,000 Answer: B Explanation: 10,000 shares × ($20/share - $15/share) = $50,000 Diff: 2 Type: MC Skill: Comp Objective: 13.6 Comprehensive Question 18) If 10,000 shares with par value of $15/share are issued for $20/share, how much will be presented as "common shares" for financial statement purposes? A) $10,000 B) $50,000 C) $150,000 D) $200,000 Answer: C Explanation: 10,000 shares × $15/share = $150,000 Diff: 2 Type: MC Skill: Comp Objective: 13.6 Comprehensive Question 19) Assume that a company issued 10,000 shares for $30/share and a par value of $5/share. 1,000 shares were repurchased back at $22/share. Which statement about share repurchases and cancellation is correct? A) Contributed surplus from the share repurchase can be netted against the contributed surplus from share issuance. B) Contributed surplus from the share repurchase must be separated from the contributed surplus on share issuance. C) Contributed surplus arising from share repurchase must be debited in this transaction. D) Contributed surplus from the initial share issuance must now be credited in this transaction. Answer: B Diff: 3 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question

20) Which statement best describes the accounting when a company cancels its own shares at an amount greater than their par value? A) Retained earnings will be debited at an amount equal to the par value of the shares. B) Retained earnings will be credited at an amount equal to the par value of the shares. C) Contributed surplus will be debited at an amount equal to the par value of the shares. D) Share capital will be debited at an amount equal to the par value of the shares. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 13.6 Comprehensive Question 21) Assume that a company issued 10,000 shares for $30 and a par value of $1/share. What entry would be required to record the repurchase and cancellation of 1,000 shares at $28/share? A) Debit to common shares for $28,000. B) Debit to common shares for $1,000. C) Credit to contributed surplus for $29,000. D) Credit to contributed surplus for $1,000. Answer: B Explanation: ($1/share × 1,000 shares) = $1,000 Diff: 2 Type: MC Skill: Comp Objective: 13.6 Comprehensive Question 22) Assume that a company issued 10,000 shares for $30 and a par value of $2/share. What entry would be required to record the repurchase and cancellation of 1,000 shares at $28/share? A) Debit to common shares for $2,000. B) Debit to common shares for $28,000. C) Debit to contributed surplus for $1,000. D) Credit to contributed surplus for $1,000. Answer: A Explanation: $2/share × 1,000 shares = $2,000 Diff: 2 Type: MC Skill: Comp Objective: 13.6 Comprehensive Question

23) Long Lifeco Inc. announced the following share issuances: March 1, 2025 10,000,000 2% non-cumulative five-year rate reset first preferred shares (series J) for par value of $12 each. After five years the dividend rate will be reset to the five-year Canada bond rate plus 3.35%. Dividends are payable as declared by the board of directors. April 9, 2025 28,350,000 common shares for $19.25 per share. This represents approximately 4.6% of Lifeco's total outstanding common shares. The CEO of the company stated the following regarding these share issuances: For many years, Long Life and its subsidiaries have pursued a risk-averse strategy with respect to both liabilities and assets. Consequently, today the company's balance sheet is one of the strongest in its industry. With this issue, the company will move forward with an enhanced capability to take advantage of market opportunities. Required: a. Prepare the journal entries to record the share issuances. b. Explain how the share issuances result in a "risk-averse strategy with respect to both liabilities and assets," and how this results in a strong balance sheet that allows the company to take advantage of market opportunities, such as profitable investments. c. Assume the board of directors declares dividends on December 31, 2025, in the amount of $15,000,000. Calculate the amount of dividends to be paid to preferred shareholders and common shareholders (assume the company only has the above stated series of preferred shares outstanding).

Answer: a. Journal entries for share issuances: Mar. 1 Dr. Cash Cr. Preferred shares - par value (10,000,000 sh × $12/sh)

120,000,000

Apr. 9

545,737,500

Dr. Cash Cr. Common shares (28,350,000 sh × $19.25/sh)

120,000,000

545,737,500

b. Equity issuances are viewed as less risky than financing with debt, as a steady stream of cash outflow is required for debt but not equity. Even preferred shares bearing a stated dividend rate do not obligate the company to pay dividends. Less risk in turn is viewed as a stronger financial position (that is, strong balance sheet). Management can use the proceeds from the share issuances to take advantage of market opportunities, as no further obligations are pending, unless management decides to declare dividends. c. Amount of dividends to each class of shareholders: Total dividends declared Dividends declared for preferred shares (120m × 2% × 10 mths/12 mths) Remainder to common shareholders Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

$15,000,000 2,000,000 $13,000,000

24) When a corporation engages in a capital transaction (those relating to its contributed capital), the journal entry may involve either a debit or a credit to contributed surplus. While not permitted by accounting standards, if these debits or credits were to be recognized through income, a debit would be called a "loss" and a credit would be called a "gain." Consider the following sequence of transactions: • Jan. 1, 2024: Company issues 1,500,000 no par common shares at $14 each. • Jan. 1, 2026: Company reacquires 150,000 common shares in the open market at $9 each, and cancels them immediately. There were no other capital transactions and the company had not paid any dividends. Required: a. Prepare the journal entries for the two transactions. b. Review the journal entry for January 1, 2026. How much was credited other than cash? Does this credit reflect good or bad management? As a shareholder, would you be happy or unhappy about this credit entry? c. What would have been the journal entry for January 1, 2026, had the repurchase price been $24? d. In the journal entry for part (c), explain why the debit goes to reduce retained earnings. How would a shareholder interpret the reduction in retained earnings?

Answer: a. Jan. 1, Dr. Cash 2024 Cr. Common shares (1,500,000 sh × $14/sh) Jan. 1, 2026

21,000,000 21,000,000

Dr. Common shares (150,000 sh × $14/sh) Cr. Cash (150,000 sh × $9/sh) Cr. Contributed surplus

2,100,000

1,350,000 750,000

b. The credit (to contributed surplus) reflects poor management. The company issued the shares at $14/share in 2024; two years later, the price has fallen to $9 without any dividends in the intervening period. Shareholders would have been better off to "stuff their money under a mattress" or to put it safely in a bank account. Consequently, shareholders should be unhappy about the credit to contributed surplus. c. Journal entry if repurchase price were to be $24/sh: Jan. 1, 2026

Dr. Common shares (150,000 sh × $14/sh) Dr. Retained earnings Cr. Cash (150,000 sh × $24/sh)

2,100,000 1,500,000

3,600,000

d. The debit is charged against retained earnings because the company has no contributed surplus to use up. Contributed surplus cannot go into a debit balance; if it were to be in a debit position, it would have to be called "contributed deficit," which defies definition because one cannot contribute a negative amount. The debit is not an expense or loss as this is a capital transaction. A shareholder should be happy despite the decline in retained earnings from this repurchase because the share price has increased. Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

25) Summarize the difference between IFRS and ASPE respecting specific recognition and measurement standards for items of equity in the following table: Issue Accounting for repurchase and resale of shares Accounting for treasury shares

IFRS

ASPE

Accumulated other comprehensive income (AOCI) Dividends in kind of a subsidiary reported in the investor's consolidated financial statements. Presentation Answer: Issue IFRS Accounting for repurchase and No specific guidance resale of shares

ASPE ASPE prescribes the allocation of repurchase costs and proceeds from resale of shares. Accounting for treasury shares No specific guidance ASPE permits the use of the single-transaction or the twotransaction method, although the former is preferred. Accumulated other AOCI is a component of There is no concept of "other comprehensive income (AOCI) equity. comprehensive income" in ASPE, and therefore no AOCI. Dividends in kind Distribution to the owners Distribution to the owners of shares of a subsidiary or of shares of a subsidiary investee is normally or investee that is being measured at fair value. consolidated or accounted for by the equity method, is measured at book value unless impaired. Presentation A statement of changes in A statement of retained equity presents balances earnings presents balances and and transactions for all transactions for retained equity components. earnings. Information relating to other equity components should be disclosed.

Diff: 2 Type: SA Skill: Concept Objective: 13.6 Comprehensive Question

26) Key Corp has an October 31 year-end. On October 2, 2025, the board of directors declared a cash dividend of $1.50 per common share, payable on November 24, 2025. The date of record for this dividend is November 17, and the ex-dividend date is November 15, 2025. Additional information relating to the shares follows: Date 2025, Oct. 2 2025, Nov. 14 2025, Nov. 17 2025, Nov. 24

Issued 8,000,000 8,000,000 8,000,000 7,400,000

Outstanding 8,000,000 7,700,000 7,400,000 7,400,000

Required: a. Determine the dollar amount of dividends to be paid as a result of the dividend declaration on October 2, 2025. b. Record all the journal entries related to this dividend in 2025. Answer: a. Dividends are paid only on shares outstanding just prior to the ex-dividend date. Shares issued but not outstanding are held in treasury, and the company does not pay itself. Therefore, the relevant number of shares is 7,700,000, so the amount of dividends equals 7,700,000 sh × $1.50/sh = $11,550,000. b. Journal entries: 2025 Oct 2 Dr. Retained earnings 11,550,000 Cr. Dividends payable 11,550,000 7,700,000 × $1.50 = $11,550,000 2025 Nov 24

Dr. Dividends payable Cr. Cash Diff: 2 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

11,550,000

27) The following is an extract from the balance sheet as at December 31, 2025: Preferred shares, $4 per share non-cumulative dividend, redeemable at $6 per share, 250,000 authorized, 25,000 issued and outstanding Common shares, 60,000,000 authorized, 6,000,000 issued and outstanding Contributed surplus—preferred shares from repurchase and resales Retained earnings Total shareholders' equity

$125,000 6,019,233 50,000 9,281,092 $15,475,325

The company did not declare dividends on preferred shares in 2024. Transactions in 2025 include the following: i. March 15: Hewitt purchased 15,000 preferred shares on the stock exchange for $5.25 per share and held these in treasury. ii. March 28: The company redeemed 5,000 preferred shares directly from shareholders. iii. July 1: The market price of common shares shot up to $5 per share, so Hewitt decided to split the common shares two to one. iv. August 1: Hewitt cancelled 14,000 preferred shares that were held in treasury. v. December 31: The company declared dividends of $0.40 per common share. Required: Prepare the journal entries to record the above transactions. The company uses the single-transaction method to account for treasury shares.

Answer: Mar. 15 Dr. Treasury shares—preferred Cr. Cash (15,000 sh × $5.25/sh) Mar. 28 Dr. Preferred shares (5,000 sh × $5/sh book value) Dr. Contributed surplus—preferred shares, from repurchase and resales (Type B) (amount as needed subject to balance available) Cr. Cash (5,000 sh × $6.00/sh)

78,750

25,000 5,000

30,000

July 1

Memo entry for stock split: Number of common shares outstanding increases to 12 million

Aug. 1

Dr. Preferred shares (14,000 sh × $5/sh) Dr. Contributed surplus—preferred shares, from share repurchases and resales (Type B) Cr. Treasury shares—preferred (14,000 sh × $5.25/sh)

70,000 3,500 73,500

Dec. 31 Dr. Retained earnings Cr. Dividends payable on common shares (12,000,000 sh × $0.40/sh)

4,800,000

Dr. Retained earnings Cr. Dividends payable on preferred shares ((25,000 sh - 15,000 sh - 5,000 sh) × $4.00/sh)

20,000

4,800,000

20,000

Note that it is implied that dividends on preferred shares must have been declared in order for dividends to be declared on common shares. Diff: 3 Type: ES Skill: Comp Objective: 13.6 Comprehensive Question

Comprehensive Questions 1) BA Paint Ltd. was incorporated on January 1, 2024. The incorporation documents authorized an unlimited number of common shares and 200,000 preferred shares. During the following fiscal year, the company engaged in the following transactions relating to its equity: On January 1, the company issued 20,000 no par value common shares at $10 per share. On the same day, it issued 5,000 preferred shares for proceeds of $120 per share. These preferred shares have a par value of $100 per share and cumulative dividends of 6% per year. On March 20, the company issued an additional 20,000 common shares at $20 per share. On April 30, BA Paint Ltd. repurchased and cancelled 2,000 common shares at a cost of $12 per share. On September 1, the company issued stock options to its executives. These stock options entitle the executives to purchase up to 10,000 common shares at a price of $25 per share over the next five years. The board of directors intended the options to compensate for management's services for the eight months from January 1 to August 31, 2024. Compensation consultants have estimated the value of these options to be $20,000. On September 2, the company repurchased and cancelled 2,000 shares at $22 per share. For the fiscal year ended December 31, 2024, the company had net income of $130,000 and zero other comprehensive income. The board of directors declared the 6% dividends payable to preferred shareholders and $20,000 of dividends for the common shareholders. To analyze these transactions, it is often useful to use a spreadsheet. Similar to inventory accounting, it is necessary to keep track of both the dollar amounts and the number of units (shares). In addition, it is necessary to separate the equity components among common and preferred shares, any contributed surplus for each class of shares, as well as retained earnings. Required: 1. Provide the journal entries for each of these transactions. 2. Prepare a statement of changes in equity. Note: AOCI from revaluations during 2024 was $250.

Answer: Part 1: Jan 1 20,000 C/S × $10 = $200,000 Mar 20 20,000 C/S × $20 = 400,000 Average price before repurchase: 600,000 / 40,000 = $15/sh Date Jan 1

Mar 20 Apr 30

Sept 1

Sept 2

Dec 31

Account Cash Common shares (20,000 × $10/sh) Cash (5,000 × $120/sh) Preferred shares, par value Contributed surplus on preferred shares (Type A) Cash Common shares (20,000 × $20/sh) Common shares (2,000 × $15/sh) Cash (2,000 × $12/sh) Contributed surplus on common shares (2,000 × $3/sh) (Type B) Compensation expense Contributed surplus on common shares re stock options (Type C) Common shares (2,000 × $15.sh) Contributed surplus on common shares (Type B) Contributed surplus on common shares ($20,000 × (2,000 sh / 38,000 sh) (Type C) Retained earnings Cash (2,000 × $22/sh) Income summary Retained earnings Retained earnings Preferred dividends payable (P/S 5,000 × $100/sh) × $0.06 Common share dividends payable

Dr 200,000 600,000

400,000 30,000

Cr 200,000 500,000 100,000 400,000 24,000 6,000

20,000 20,000 30,000 6,000 1,053 6,947 44,000 130,000 50,000

130,000 30,000 20,000

Part 2:

C/S

BA Paint Ltd Statement of Changes in Shareholder Equity For the Year Ended December 31, 2024 C.C. C.C. C.C. Retained P/S Type A Type B Type C Earnings AOCI Total $130,000 $250

Net Income OCI Total Comprehensive Income Dividends declared C/S issued during year $600,000 P/S issued $500,000 $100,000 Repurchase C/S (30,000) C/S issued as compensation Repurchase C/S (30,000) December 31, 2024 $540,000 $500,000 $100,000

130,000 (50,000)

250

$130,250 (50,000) 600,000 600,000 (24,000)

$6,000

(6,000)

$20,000 (1,053)

(6,947)

20,000 (44,000)

$18,947

$73,053

$250 $1,232,250

Note: In the above report, the two Repurchase C/S lines were left separate for explanatory reasons; they could be combined as one line for reporting purposes. Diff: 3 Type: ES Skill: Comp Objective: 13.7 Comprehensive Question

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 14 Complex Financial Instruments Learning Objective 1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 1) Which of the following is correct about financial instruments? A) Accounting for financial instruments has been consistent. B) There is no economic substance to financial instruments. C) They may be used in support of innovations designed to circumvent accounting standards. D) All financial instruments are accounted for at fair value. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 2) Which statement is correct about accounting for financial instruments? A) All financial instruments are accounted for at fair value through profit or loss. B) All are accounted for in accordance to their economic substance. C) All financial instruments are accounted for at amortized cost. D) All financial instruments are accounted for at fair value through OCI. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 3) Which of the following statements is correct about accounting for financial liabilities? A) Financial liabilities can only be accounted for using amortized cost. B) Financial liabilities can only be accounted for using fair value though profit and loss. C) Financial liabilities can be accounted for using historical cost. D) Financial liabilities can be accounted for using amortized cost or fair value. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

4) What is an option? A) A contract that gives the holder the right to sell an instrument at a pre-specified price. B) A contract that is derived from some other underlying quantity, index, asset or event. C) A contract that gives the holder the right to acquire an instrument at a pre-specified price. D) A contract that gives the holder the right to buy or sell something at a specified price. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 5) What is a "call" option? A) A contract that gives the holder the right to sell an instrument at a pre-specified price. B) A contract that is derived from some other underlying quantity, index, asset or event. C) A contract that gives the holder the right to acquire an instrument at a pre-specified price. D) A contract that gives the holder the right to buy or sell something at a specified price. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 6) Which of the following is correct regarding a call option? A) The intrinsic value of a call option is the greater of zero and (K- S), the difference between the market price and the strike price. B) The time value of an option reflects the probability that the future market price of the underlying instrument will not exceed the strike price. C) The time value decreases with the length of time to expiration and the volatility of the underlying instrument (such as the share price). D) The time value is always positive until the option expires, so the total value of an unexpired option is always greater than the intrinsic value. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 7) What is a "put" option? A) A contract that gives the holder the right to sell an instrument at a pre-specified price. B) A contract that is derived from some other underlying quantity, index, asset or event. C) A contract that gives the holder the right to acquire an instrument at a pre-specified price. D) A contract that gives the holder the right to buy or sell something at a specified price. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

8) What is a "swap"? A) A contract in which two parties agree to exchange cash flows (e.g. interest cash flows). B) A contract in which one party commits up front to buy or sell commonly traded items at a defined price and maturity date. C) A contract in which one party commits up front to buy or sell something at a defined price at a defined future date. D) A contact that gives the right, but not the obligation, to buy a share at a specified price over a specified period of time. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 9) Which of the following is an example of a "swap"? A) Right to buy 100 shares of CIBC over the next 5 years. B) Commitment to buy 100 barrels of oil next month at $125/barrel. C) Commitment to buy $100,000 US dollars in 4 months at US$ = 1.10. D) Pay interest at prime +3% in exchange for receiving interest at 5%. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 10) What is a "future"? A) A contract in which two parties agree to exchange cash flows (e.g. interest cash flows). B) A contract in which one party commits up front to buy or sell commonly traded items at a defined price and maturity date. C) A contract in which one party commits up front to buy or sell something at a defined price at a defined future date. D) A contact that gives the right, but not the obligation, to buy a share at a specified price over a specified period of time. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

11) Which of the following is an example of a "future"? A) Right to buy 100 shares of CIBC over the next 5 years. B) Commitment to buy 100 barrels of oil next month at $125/barrel on the Chicago Mercantile Exchange. C) Commitment to buy $100,000 U.S. dollars in 120 days at US$ = 1.10 from another company. D) Pay interest at prime +3% in exchange for receiving interest at 5%. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 12) What is a "forward"? A) A contract in which two parties agree to exchange cash flows (e.g. interest cash flows). B) A contract in which one party commits up front to buy or sell commonly traded items at a defined price and maturity date. C) A contract in which one party commits up front to buy or sell something at a defined price at a defined future date. D) A contact that gives the right, but not the obligation, to buy a share at a specified price over a specified period of time. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 13) Which of the following is an example of a "forward"? A) Right to buy 100 shares of CIBC over the next 5 years. B) Commitment to buy 100 barrels of oil next month at $125/barrel on the Chicago Mercantile Exchange. C) Commitment to buy $100,000 US dollars in 120 days at US$ = 1.10 from another company. D) Pay interest at prime +3% in exchange for receiving interest at 5%. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

14) What is a "warrant"? A) A contract in which two parties agree to exchange cash flows (e.g., interest cash flows). B) A contract in which one party commits up front to buy or sell commonly traded items at a defined price and maturity date. C) A contract in which one party commits up front to buy or sell something at a defined price at a defined future date. D) A contract that gives the right, but not the obligation, to buy a share at a specified price over a specified period of time. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 15) Which of the following is an example of a "warrant"? A) Right to buy 100 shares of CIBC at $50.00 per share over the next 5 years. B) Commitment to buy 100 barrels of oil next month at $125/barrel. C) Commitment to buy $100,000 U.S. dollars in 4 months at US$ = 1.10. D) Pay interest at prime +3% in exchange for receiving interest at 5%. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 16) What is a derivative and what are two reasons why parties would enter into a derivative contract? Answer: A derivative is a financial instrument that is derived from some other underlying quantity. Parties enter into derivative contracts for two reasons: to hedge or to speculate. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 17) Describe the underlying quantity that the derivative instrument derives its value from. Answer: That underlying quantity is something implicitly part of the asset that is related to the derivative. The quantity varies. Examples: the price of a share, the value of a stock index, the exchange rate, the temperature. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

18) What is hedging? Answer: Hedging involves identifying a risk and trying to mitigate that risk by entering into derivative contract. For example, a Canadian manufacturer that purchases inventory from a U.S. supplier on credit is subject to the risk that the U.S. dollar may strengthen (appreciate) against the Canadian dollar. The manufacturer can reduce the foreign exchange risk by entering into a forward contract to buy U.S. dollars at a future date at a specified exchange rate, effectively locking in its cost of inventory at the time of purchase. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 19) What is speculation? Answer: Speculation is purposefully taking on an identified risk with a view to making a profit. For instance, one can take a gamble that the exchange rate will move in his/her favour by entering into a forward exchange agreement. For example, a party could bet that the U.S. dollar will weaken against the Canadian dollar. If the US$ weakens during the period, the speculator will make a profit, but if the US$ strengthens in the period, the speculator will lose money. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 20) Briefly explain the difference between a "forward" and a "future." Answer: In a forward contract, one party to the contract commits to buy something at a specified price at a specified future date. A future is similar to a forward but the contract is written in more standardized terms (e.g., prices, maturity dates) and involves commonly traded items (e.g., commodities, currencies). The reason for the standardized terms is that futures are tradable in organized markets, and standardization increases liquidity since more investors are trading the same contracts. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 21) Contrast options with warrants. Answer: The main differences are that warrants are issued only by the company whose shares are the underlying instrument. Compared with options, warrants also tend to have longer times to maturity (typically three to ten years) and they tend to be issued in combination with other financial instruments such as bonds, preferred shares and commons shares. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

22) Indicate whether the following statements are true or false with respect to characteristics of stock options.

a. b. c. d. e. f. g.

Item A stock option provides a right to sell but not a right to buy a share. An option's fair value is at least as high as its exercise price. A stock option's fair value decreases with the volatility of the underlying stock. A stock option's intrinsic value is the price of the share at the time of exercise. An option's intrinsic value cannot be negative. An option's intrinsic value remains the same until the option matures. An out-of-the-money call option is one in which the exercise price is higher than the market price.

True / False

Answer: Item a. b. c. d. e.

f. g.

True / False False A stock option provides a right to sell but not a right to buy a share. (Can be either) An option's fair value is at least as high as its exercise price. False A stock option's fair value decreases with the volatility of the underlying stock. False A stock option's intrinsic value is the price of the share at the time of exercise. False An option's intrinsic value cannot be negative. True False An option's intrinsic value remains the same until the option (Is a function of the matures. market price) An out-of-the-money call option is one in which the exercise price is higher than the market price. True

Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

23) In the table below, choose the financial instrument to list on the left side that best explains the example on the right side. Types of financial instrument to select from: financial asset, financial liability, equity, compound instrument, basic option, swap, forward, future, warrant, put option, or call option. Type of financial instrument

Example A company contracts with an investment bank to pay the bank prime rate + 1% interest on $25 million of debt in exchange for receiving 5% from the bank. Company Abacus issues $10 million debentures with warrants to purchase shares for $10/share within 8 years. A company contracts to sell 100 barrels of oil at $110/barrel in March on the Chicago Mercantile Exchange. Note payable A company purchases the right but not the obligation to purchase 5,000 shares in another company at $15 each over a 12-year period. Company X contracts to buy 1,000 oz of silver at $40/oz on March 15, 2025, from Company Y. Note receivable A company purchases the right but not the obligation to purchase U.S. dollars for CAD$1.08/US$ within a 30-month period.

Answer: Type of financial instrument

Example A company contracts with an investment bank to pay the bank prime rate + 1% interest on $25 million of debt in exchange for Swap receiving 5% from the bank. Company Abacus issues $10 million debentures with warrants to Compound interest purchase shares for $10/share within 8 years. A company contracts to sell 100 barrels of oil at $110/barrel in March Future on the Chicago Mercantile Exchange. Financial liability Note payable A company purchases the right but not the obligation to purchase Warrant 5,000 shares in another company at $15 each over a 12-year period. Company X contracts to buy 1,000 oz of silver at $40/oz on March 15, Forward 2025, from Company Y. Financial asset Note receivable A company purchases the right but not the obligation to purchase Call option U.S. dollars for CAD$1.08/US$ within a 30-month period.

24) Explain how bonds issued with warrants alleviate adverse selection problem. Answer: With such an instrument, the company is initially issuing debt, which does not send the negative signal that share issuances do. Investors who hold these bonds will exercise the warrants only when it is beneficial to them- holders of the warrants would exercise the warrants only if the warrants are in-the-money, which is when the company is doing well. Upon exercise, the warrant holders contribute to the firm an amount of cash equal to the exercise price. The company increases equity not by issuing shares directly, but by issuing shares indirectly via investors exercising their warrants to buy shares. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 25) Explain how convertible bonds alleviate moral hazard. Answer: This instrument provides the company with funds in more than one stage, which is helpful at alleviating moral hazard. Investors do not want to give too much money to management when outcomes are highly uncertain because management may misspend the funds. At the same time, the conversion option is a commitment from investors to provide additional funding—but only if the company performs well. If the company performs poorly, the conversion option will be out-of-the-money, and investors will choose to not exercise these rights. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments. 26) Briefly describe a compound financial instrument and its advantages. Answer: A compound financial instrument is one that has more than one component, for example, debt and equity. A company that issues common shares sends a negative signal to investors, because the share issuance indicates a lack of confidence in the future prospects of the company. Compound financial instruments issue shares indirectly via conversion of bonds, options or warrants into shares. It provides the company with money in stages to prevent management overspending and conversion only occurs if the company is doing well. Diff: 2 Type: SA Skill: Concept Objective: 14.1 Describe the nature of standard financial instruments, derivatives, and compound financial instruments, and identify when transactions involve such instruments.

Learning Objective 2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 1) Which method is used under IFRS to account for compound instruments? A) Fair value method. B) Proportional method. C) Incremental method. D) Zero common equity method. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 2) Which statement best describes the "zero common equity method"? A) Under this method of accounting, for a convertible bond, all of the bond value would be counted as a liability. B) Under this method of accounting, for a convertible bond, the issuing entity would record a liability for the estimated value of the bond without the conversion feature. C) Under this method of accounting, for a convertible bond, an estimate would be made of the fair value of all components and allocated proportionally to all components. D) Under this method of accounting, the common share component is considered the least reliably measured amount. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 3) Which statement best explains the accounting for compound instruments? A) Once separated, each component is accounted for at fair value with changes recorded through income. B) Once separated, each component is accounted for in accordance with its substance. C) Once separated, each component is accounted for at amortized cost. D) Once separated, each component is accounted for at historical cost. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

4) How would the liability portion of the compound instrument be recorded? A) Once separated, this component is accounted for at fair value with changes recorded through income. B) Once separated, this component is accounted for in accordance with its substance. C) Once separated, this component is accounted for at amortized cost. D) Once separated, this component is accounted for at historical cost. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 5) Which method is used under ASPE to account for compound instruments? A) Fair value method. B) Proportional method. C) Book value method. D) Zero common equity method. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 6) Which method is used under ASPE to account for compound instruments? A) Incremental method. B) Fair value method. C) Proportional method. D) Book value method. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 7) Which statement best describes the "incremental method"? A) Under this method of accounting, for a convertible bond, all of the bond value would be counted as a liability. B) Under this method of accounting, for a convertible bond, the issuing entity would record a liability for the estimated value of the bond without the conversion feature. C) Under this method of accounting, for a convertible bond, an estimate would be made of the fair value of all components and allocated proportionally to all components. D) Under this method of accounting, the common share component is considered the most reliably measured amount. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

8) Which statement best describes the "proportional method"? A) Under this method of accounting, for a convertible bond, all of the bond value would be counted as a liability. B) Under this method of accounting, for a convertible bond, the issuing entity would record a liability for the estimated value of the bond without the conversion feature. C) Under this method of accounting, for a convertible bond, estimate the fair value of all components and allocate proportionally to them. D) Under this method of accounting, the common share component is considered the least reliably measured amount. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 9) How would the equity portion of the compound instrument be recorded? A) Once separated, this component is accounted for at fair value through profit or loss. B) Once separated, this component is accounted for in accordance with its substance. C) Once separated, this component is accounted for amortized cost. D) Once separated, this component is accounted for at historical cost. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 10) How would the exercise of an option, that was part of an initial compound instrument, be recorded? A) Common stock is recorded at an amount equal to the fair value of the options at date of conversion. B) Common stock is recorded at an amount equal to the price determined by the Black-Sholes model. C) Common stock is recorded at an amount equal to the market price of the shares on conversion date. D) Common stock is recorded at an amount equal to the cash received plus the contributed surplus initially recorded. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

11) How would exercise of warrants that were part of an original compound instrument be recorded? A) Common stock is recorded at an amount equal to the fair value of the options at date of conversion. B) Common stock is recorded at an amount equal to the cash received plus the contributed surplus initially recorded. C) Common stock is recorded at an amount equal to the market price of the shares on conversion date. D) Common stock is recorded at an amount equal to the price determined by the Black-Sholes model. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 12) How is the subsequent conversion of bonds into common shares recorded under IFRS? A) Book value. B) Market value. C) Fair value. D) Historical value. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 13) Which of the following statements is correct? A) Repayment of a bond on the first day of the fiscal year will have no effect on the shareholders' return on equity. B) Conversion of a 10% bond with no short term maturity, into common shares on the first day of the year will worsen the current ratio. C) The sale of 2,000 common shares for cash will have no effect on the current ratio. D) The sale of $5,000 of inventory on credit for $6,000 will have no effect on the current ratio. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 14) Which of the following statements is correct? A) Repayment of a bond on the first day of the fiscal year will decrease the shareholders' return on equity. B) Conversion of a 10% bond with no short term maturity, into common shares on the first day of the year will have no effect the current ratio. C) The sale of 2,000 common shares for cash will improve the shareholders' return on equity. D) The sale of $5,000 of inventory on credit for $6,000 will have no effect on the operating margin. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 13 Copyright © 2023 Pearson Canada Inc.

15) Which of the following statements is correct? A) Repayment of a bond on the first day of the fiscal year will increase the shareholders' return on equity. B) Conversion of a 10% bond with no short term maturity, into common shares on the first day of the year will improve the current ratio. C) The sale of 2,000 common shares for cash will worsen the shareholders' return on equity. D) The sale of $5,000 of inventory on credit for $6,000 will worsen the shareholders' return on equity. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 16) Enterprises need to separate the components of a compound financial instrument and account for each component separately. (a) What are the three alterative methods of allocating the cost to the components? (b) Contrast the reporting requirements for compound financial instruments under IFRS and ASPE. Answer: (a) The three alternative methods are: i. Proportional method ii. Incremental method iii. Zero common equity method (b) IFRS recommends the incremental method and ASPE recommends either the incremental method or the zero common equity method. Diff: 1 Type: SA Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 17) A company issues convertible bonds with face value of $5,000,000 and receives proceeds of $6,500,000. Each $1,000 bond can be converted, at the option of the holder, into 80 common shares. The underwriter estimated the market value of the bonds alone, excluding the conversion rights, to be approximately $6,300,000. Required: Record the journal entry for the issuance of these bonds based on IFRS. Answer: IFRS requires use of the incremental method. In this case, the conversion right is allocated the residual amount. Dr. Cash (given) 6,500,000 Cr. Bonds payable (stand alone market value) 6,300,000 Cr. Contributed surplus—conversion rights 200,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

18) A company issues convertible bonds with face value of $10,000,000 and receives proceeds of $10,500,000. Each $1,000 bond can be converted, at the option of the holder, into 800 common shares. The underwriter estimated the market value of the bonds alone, excluding the conversion rights, to be approximately $8,300,000. Required: Record the journal entry for the issuance of these bonds based on IFRS. Answer: IFRS requires use of the incremental method. In this case, the conversion right is allocated the residual amount. Dr. Cash (given) 10,500,000 Cr. Bonds payable (stand-alone market value) 8,300,000 Cr. Contributed surplus—conversion rights 2,200,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 19) A company issues convertible bonds with face value of $7,000,000 and receives proceeds of $8,500,000. Each $1,000 bond can be converted, at the option of the holder, into 100 common shares. The underwriter estimated the market value of the bonds alone, excluding the conversion rights, to be approximately $7,300,000. Required: Record the journal entry for the issuance of these bonds based on IFRS. Answer: IFRS requires use of the incremental method. In this case, the conversion right is allocated the residual amount. Dr. Cash (given) 8,500,000 Cr. Bonds payable (stand alone market value) 7,300,000 Cr. Contributed surplus—conversion rights 1,200,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

20) A company issued 95,000 preferred shares and received proceeds of $6,000,000. These shares have a benchmark value of $48 per share and pay cumulative dividends of 6%. Buyers of the preferred shares also received a detachable warrant with each share purchased. Each warrant gives the holder the right to buy one common share at $35 per share within 10 years. The underwriter estimated that the market value of the preferred shares alone, excluding the conversion rights, is approximately $57 per share. Shortly after the issuance of the preferred shares, the detachable warrants traded at $8 each. Required: Record the journal entry for the issuance of these shares and warrants under IFRS. Answer: IFRS requires use of the incremental method. Values for both components are available. However, market prices are more reliable than estimates from the underwriter, so we first assign value to the warrants, and assign the residual to the preferred shares. Dr. Cash (given) 6,000,000 Cr. Contributed surplus—conversion rights 760,000 (95,000 warrants × $8/warrant) Cr. Preferred shares ($6,000,000 - $760,000) 5,240,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 21) A company issued 75,000 preferred shares and received proceeds of $7,000,000. These shares have a benchmark value of $80 per share and pay cumulative dividends of 6%. Buyers of the preferred shares also received a detachable warrant with each share purchased. Each warrant gives the holder the right to buy one common share at $35 per share within 10 years. The underwriter estimated that the market value of the preferred shares alone, excluding the conversion rights, is approximately $90 per share. Shortly after the issuance of the preferred shares, the detachable warrants traded at $5 each. Required: Record the journal entry for the issuance of these shares and warrants under IFRS. Answer: IFRS requires use of the incremental method. Values for both components are available. However, market prices are more reliable than estimates from the underwriter, so we first assign value to the warrants, and assign the residual to the preferred shares. Dr. Cash (given) 7,000,000 Cr. Contributed surplus—conversion rights 375,000 (75,000 warrants × $5/warrant) Cr. Preferred shares ($7,000,000 - $375,000) 6,625,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

22) A company issued 105,000 preferred shares and received proceeds of $7,000,000. These shares have a benchmark value of $50 per share and pay cumulative dividends of 6%. Buyers of the preferred shares also received a detachable warrant with each share purchased. Each warrant gives the holder the right to buy one common share at $35 per share within 10 years. The underwriter estimated that the market value of the preferred shares alone, excluding the conversion rights, is approximately $63 per share. Shortly after the issuance of the preferred shares, the detachable warrants traded at $5 each. Required: Record the journal entry for the issuance of these shares and warrants under IFRS. Answer: IFRS requires use of the incremental method. Values for both components are available. However, market prices are more reliable than estimates from the underwriter, so we first assign value to the warrants, and assign the residual to the preferred shares. Dr. Cash (given) 7,000,000 Cr. Contributed surplus—conversion rights 525,000 (105,000 warrants × $5/warrant) Cr. Preferred shares ($7,000,000 - $525,000) 6,475,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 23) A company issued 105,000 preferred shares and received proceeds of $6,100,000. These shares have a benchmark value of $50 per share and pay cumulative dividends of 6%. Buyers of the preferred shares also received a detachable warrant with each share purchased. Each warrant gives the holder the right to buy one common share at $35 per share within 10 years. The underwriter estimated that the market value of the preferred shares alone, excluding the conversion rights, is approximately $55 per share. Shortly after the issuance of the preferred shares, the detachable warrants traded at $5 each. Required: Record the journal entry for the issuance of these shares and warrants under IFRS. Answer: IFRS requires use of the incremental method. Values for both components are available. However, market prices are more reliable than estimates from the underwriter, so we first assign value to the warrants, and assign the residual to the preferred shares. Dr. Cash (given) 6,100,000 Cr. Contributed surplus—conversion rights 525,000 (105,000 warrants × $5/warrant) Cr. Preferred shares ($6,100,000 - $525,000) 5,575,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

24) A company issued 100,000 preferred shares and received proceeds of $5,750,000. These shares have a benchmark value of $50 per share and pay cumulative dividends of 6%. Buyers of the preferred shares also received a detachable warrant with each share purchased. Each warrant gives the holder the right to buy one common share at $35 per share within 10 years. The underwriter estimated that the market value of the preferred shares alone, excluding the conversion rights, is approximately $55 per share. Shortly after the issuance of the preferred shares, the detachable warrants traded at $5 each. Required: Record the journal entry for the issuance of these shares and warrants under IFRS. Answer: IFRS requires use of the incremental method. Values for both components are available. However, market prices are more reliable than estimates from the underwriter, so we first assign value to the warrants, and assign the residual to the preferred shares. Dr. Cash (given) 5,750,000 Cr. Contributed surplus—conversion rights 500,000 (100,000 warrants × $5/warrant) Cr. Preferred shares ($5,750,000 - $500,000) 5,250,000 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 25) A company had a debt-to-equity ratio of 1.64 before issuing convertible bonds. This ratio included $500,000 in equity. The company issued convertible bonds. The value reported for the bonds on the balance sheet is $180,000 and the conversion rights are valued at $22,000. Required: After the issuance of the convertible bonds, what is the value of the debt-to-equity ratio? Answer: Total liabilities before bond issuance = $500,000 × 1.64 = $820,000. Total liabilities after bond issuance = $820,000 + $180,000 = $1,000,000. Total equity after bond issuance = $500,000 + $22,000 = $522,000. Debt-to-equity after bond issuance = $1,000,000 / $522,000 = 1.916 or 1.92 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

26) A company had a debt-to-equity ratio of 1.65 before issuing convertible bonds. This ratio included $450,000 in equity. The company issued convertible bonds. The value reported for the bonds on the balance sheet is $200,000 and the conversion rights are valued at $25,000. Required: After the issuance of the convertible bonds, what is the value of the debt-to-equity ratio? Answer: Total liabilities before bond issuance = $450,000 × 1.65 = $742,500. Total liabilities after bond issuance = $742,500 + $200,000 = $942,500 Total equity after bond issuance = $450,000 + $25,000 = $475,000. Debt-to-equity after bond issuance = $942,500 / $522,000 = 1.984 or 1.98 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 27) A company had a debt-to-equity ratio of 1.55 before issuing convertible bonds. This ratio included $500,000 in equity. The company issued convertible bonds. The value reported for the bonds on the balance sheet is $180,000 and the conversion rights are valued at $22,000. Required: After the issuance of the convertible bonds, what is the value of the debt-to-equity ratio? Answer: Total liabilities before bond issuance = $500,000 × 1.55 = $775,000. Total liabilities after bond issuance = $775,000 + $180,000 = $955,000. Total equity after bond issuance = $500,000 + $22,000 = $522,000. Debt-to-equity after bond issuance = $955,000 / $522,000 = 1.83 Diff: 1 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

28) LMN Company reported the following amounts on its balance sheet at July 31, 2026. Liabilities Convertible bonds payable, $10,000,000 face value 9%, due July 31, 2027 Equity Contributed surplus—common stock conversion rights Preferred shares, no par, 3,000,000 shares authorized, 10,000 outstanding Common shares, no par, 1,000,000 shares authorized, 180,000 outstanding

$9,909,091

$300,000 1,100,000 4,500,000

Additional information 1. The bonds pay interest each July 31. Each $1,000 bond is convertible into 10 common shares. The bonds were originally issued to yield 10%. On July 31, 2027, all the bonds were converted after the final interest payment was made. LMN uses the book value method to record bond conversions as recommended under IFRS. 2. No other share or bond transactions occurred during the year. Required: a. Prepare the journal entry to record the bond interest payment on July 31, 2027. b. Calculate the total number of common shares outstanding after the bonds' conversion on July 31, 2027. c. Prepare the journal entry to record the bond conversion. Answer: a. Journal entry for interest on July 31, 2027: Dr. Interest expense ($9,909,091 × 10%) 990,909 Cr. Convertible bonds payable 90,909 Cr. Cash ($10,000,000 × 9%) 900,000 b. Number of shares outstanding before conversion Shares issued upon conversion ($10,000,000 × 10 shares / $1,000) Number of shares outstanding after conversion c.

180,000 280,000

Dr. Convertible bonds payable 10,000,000 Dr. Contributed surplus—common stock 300,000 conversion rights Cr. Common shares 10,300,000 Diff: 2 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

100,000

29) LMN Company reported the following amounts on its balance sheet at July 31, 2026: Liabilities Convertible bonds payable, $10,000,000 face value 8%, due July 31, 2027

$9,818,182

Equity Contributed surplus—common stock conversion rights Preferred shares, no par, 3,000,000 shares authorized, 10,000 outstanding Common shares, no par, 1,000,000 shares authorized, 180,000 outstanding

$300,000 1,100,000 4,500,000

Additional information 1. The bonds pay interest each July 31. Each $1,000 bond is convertible into 5 common shares. The bonds were originally issued to yield 10%. On July 31, 2027, all the bonds were converted after the final interest payment was made. LMN uses the book value method to record bond conversions as recommended under IFRS. 2. No other share or bond transactions occurred during the year. Required: a. Prepare the journal entry to record the bond interest payment on July 31, 2027. b. Calculate the total number of common shares outstanding after the bonds' conversion on July 31, 2027. c. Prepare the journal entry to record the bond conversion. Answer: a. Journal entry for interest on July 31, 2027: Dr. Interest expense ($9,818,182 × 10%) 981,818 Cr. Convertible bonds payable 181,818 Cr. Cash ($10,000,000 × 8%) 800,000 b. Number of shares outstanding before conversion Shares issued upon conversion ($10,000,000 × 5 shares / $1,000) Number of shares outstanding after conversion c.

180,000 230,000

50,000

30) On January 1, 2024, Wayward Co. issued a $22 million, 8%, 6-year convertible bond with annual coupon payments. Each $1,000 bond was convertible into 35 shares of Wayward's common shares. Moonbeam Investments purchased the entire bond issue for $22.7 million on January 1, 2024. Moonbeam estimated that without the conversion feature, the bonds would have sold for $21,013,098 (to yield 9%). On January 1, 2025, Moonbeam converted bonds with a par value of $8.8 million. At the time of conversion, the shares were selling at $30 each. Required: a. Prepare the journal entry to record the issuance of convertible bonds. b. Prepare the journal entry to record the conversion according to IFRS (book value method). c. Prepare the journal entry to record the conversion according ASPE (market value method). Answer: a. Journal entry for issuance: Dr. Cash (given) 22,700,000 Cr. Bonds payable (given) 21,013,098 Cr. Contributed surplus—conversion rights 1,686,902 b. Journal entry for conversion under IFRS (book value method): Dr. Bonds payable* Dr. Contributed surplus—conversion rights ($1,686,902 × 40%) Cr. Common stock (100,000 shares)

8,457,711 674,761

*PV of principal ($8,800,000 / 1.095) PV of coupons ($8,800,000 × 8% × PVFA (9%,5)) Carrying value of bond at time of conversion Using BAII Plus financial calculator: 5 N, 9 I/Y, 8800000 FV, 704000 PMT, CPT PV

8,457,711

9,132,472

8,457,711

c. Journal entry for conversion under ASPE (market value method): Dr. Bonds payable 8,457,711 Dr. Contributed surplus - conversion rights ($1,686,902 × 40%) 674,761 Cr. Common stock ($8.8 million/1,000 × 35 sh × $30/sh) 9,240,000 Dr. Loss on conversion 107,528 Diff: 2 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

31) Explain the conceptual meaning of the difference between the book value and market value methods of recording the conversion of bonds into common shares. Answer: Under the "book value" method used under IFRS: On conversion of a convertible instrument at maturity, the entity derecognizes the liability component and recognizes it as equity. The original equity component remains as equity (although it may be transferred from one line item within equity to another). There is no gain or loss on conversion at maturity. Under the "market value" used under ASPE: The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the fair value of the consideration paid, including any non-cash assets transferred, liabilities assumed, or equity instruments issued, shall be recognized in net income for the period. The book value method records the common shares at the current book value of the convertible bond and related contributed surplus; no gain or loss is recorded. In contrast, the market value method records the shares at their fair value at date of conversion, recording a loss for the difference between the market value and the book value as determined above. Diff: 2 Type: ES Skill: Concept Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer. 32) Amel Company issues convertible bonds with face value of $7,000,000 and receives proceeds of $7,500,000. Each $1,000 bond can be converted, at the option of the holder, into 40 common shares. The underwriter estimated the market value of the bonds alone, excluding the conversion rights, to be approximately $7,200,000. Required: Record the journal entry for the issuance of these bonds. Answer: IFRS requires use of the incremental method. In this case, the conversion right is allocated the residual amount. Account Cash Bonds payable (stand alone market value) Contributed surplus

DR 7,500,000

CR 7,200,000 300,000

Diff: 1 Type: SA Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

33) Becamel Company issued 100,000 preferred shares and received proceeds of $6,500,000. These shares have a benchmark price of $60 per share and pay cumulative dividends of 8%. Buyers of the preferred shares also received a detachable warrant with each share purchased. Each warrant gives the holder the right to buy one common share at $30 per share within 10 years. The underwriter estimated that the market value of the preferred shares alone, excluding the conversion rights, is approximately $62 per share. Shortly after the issuance of the preferred shares, the detachable warrants traded at $3 each. Required: Record the journal entry for the issuance of these shares and warrants. Answer: Account DR CR Cash (given) 6,500,000 Preferred shares (100,000 sh x $62/sh) 6,200,000 Contributed surplus-conversion rights (100,000 warrants x $3/warrant) 300,000 Diff: 1 Type: SA Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

34) On September 30, 2026, Pennsylvania Co. issued $3 million of 10%, 10-year convertible bonds maturing on September 30, 2036, with semi-annual coupon payments on March 31 and September 30. Each $1,000 bond can be converted into 80 no par value common shares. In addition, each bond included 20 detachable common stock warrants with an exercise price of $20 each. Immediately after issuance, the warrants traded at $5 each on the open market. Gross proceeds on issuance were $4.6 million (including accrued interest). From these proceeds, the company paid underwriting fees of $55,000. Without the warrants and conversion features the bond would be expected to yield 6% annually. Pennsylvania's yearend is December 31. On February 22, 2029, warrant holders exercised one-half of the warrants. The shares of Pennsylvania traded at $44 each on this day. Required: a) Determine how Niagara should allocate the $4,600,000 proceeds into its components. b) Prepare all the journal entries for fiscal year 2026. c) Record the journal entry for the exercise of stock warrants on February 22, 2029.

Answer: a) Allocation of proceeds: Bond Underwriting fees Warrants ($3,000,000 × 20 warrants / $1,000) × $5 / warrant Conversion rights (remainder) Total proceeds

$3,892,648 55,000

PV of principal ($3,000,000 / 1.0320) PV of coupons ($150,000 × PVFA(3%,20) = $15,000 × 14.87747486) Bond value Using BAII Plus financial calculator: 20 N, 3 I/Y, 3000000 FV, 150,000 PMT, CPT PV

$1,661,027

300,000 352,352 $4,600,000

2,231,621 $3,892,648 3,892,648

b) Journal entries for 2026: 2026 Sep 30

Dr. Cash* 4,545,000 Cr. Bond payable Cr. Contributed surplus—warrants (Type C) Cr. Contributed surplus—conversion rights *Cash = Total proceeds of $4,600,000 — Underwriting Fees of $55,000 2026 Dec 31

Dr. Interest expense ($3,892,648 × 3% × 3 / 6) Dr. Bond payable Cr. Interest payable ($3,000,000 × 5% × 3 / 6)

58,390 16,610

3,892,648 300,000 352,352

75,000

c) Journal entries for exercise of stock warrants: 2029 Feb 22

Dr. Cash (30,000 warrants × $20/warrant) 600,000 Dr. Contributed surplus—warrants ($300,000 × 50%) 150,000 Cr. Common stock 750,000 Diff: 2 Type: ES Skill: Comp Objective: 14.2 Apply the accounting standards for compound financial instruments from the perspective of the issuer.

Learning Objective 3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 1) Which method must be used under IFRS to account for employee stock options? A) Intrinsic value of options. B) Time value of options. C) Market value of the shares. D) Fair value on the grant date of the options. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 2) Which statement is correct about the accounting for employee stock options? A) The expense is recorded over the period of vesting. B) The expense is recorded over the period to expiry. C) The expense is recorded immediately upon grant date. D) No expense is recorded for accounting purposes. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 3) Which method must be used under ASPE to account for employee stock options? A) Intrinsic value of options. B) Time value of options. C) Fair value of the options. D) Market value of the shares. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

4) List three common stock compensation plans and describe them. Answer: a) Employee stock options. An option contract gives the holder the right, but not the obligation, to buy or sell something at a specified price. The most common type of option is a call option, which gives the holder the right to acquire an underlying instrument at a pre-specified price within a defined period of time. b) Stock appreciation rights (SARs). Similar to stock options, employees benefit from SARs when the actual stock price rises above a pre-determined benchmark price. c) Warrants provide the holder with the right, but not the obligation, to buy a company's shares at a specified price over a specified period of time. Thus, warrants are similar to call options. The main differences are that warrants are issued only by the company whose shares are the underlying instrument. Compared with options, warrants also tend to have longer times to maturity (typically three to ten years), and they tend to be issued in combination with other financial instruments such as bonds, preferred shares, and common shares. Diff: 1 Type: SA Skill: Concept Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 5) O'Neil Motor Parts issued 110,000 stock options to its employees. The company granted the stock options at-the-money, when the share price was $40. These options have no vesting conditions. By yearend, the share price had increased to $42. O'Neil's management estimates the value of these options at the grant date to be $1.60 each. Required: Record the issuance of the stock options. Answer: Note that in the absence of other information, the expense is assumed to be incurred in the period that an enterprise grants the options. Dr. Compensation expense or stock option expense 176,000 Cr. Contributed surplus—stock options (110,000 × $1.60) 176,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

6) O'Neil Manufacturing issued 200,000 stock options to its employees. The company granted the stock options at-the-money, when the share price was $40. These options have no vesting conditions. By yearend, the share price had increased to $42. O'Neil's management estimates the value of these options at the grant date to be $1.75 each. Required: Record the issuance of the stock options. Answer: Note that in the absence of other information, the expense is assumed to be incurred in the period that an enterprise grants the options. Dr. Compensation expense or stock option expense 350,000 Cr. Contributed surplus—stock options (200,000 × $1.75) 350,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 7) McMillan Manufacturing issued 60,000 stock options to its employees. The company granted the stock options at-the-money, when the share price was $40. These options have no vesting conditions. By yearend, the share price had increased to $42. McMillan's management estimates the value of these options at the grant date to be $1.10 each. Required: Record the issuance of the stock options. Answer: Note that in the absence of other information, the expense is assumed to be incurred in the period that an enterprise grants the options. Dr. Compensation expense or stock option expense 66,000 Cr. Contributed surplus—stock options (60,000 × $1.10) 66,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

8) Price Farms granted 290,000 stock options to its employees. The options expire 45 years after the grant date of January 1, 2026, when the share price was $23. Employees still employed by Price five years after the grant date may exercise the option to purchase shares at $45 each; that is, the options vest to the employees after five years. A consultant estimated the value of each option at the date of grant to be $1.50 each. Required: Record the journal entries relating to the issuance of stock options. Answer: Since the options vest after five years, the compensation expense should be amortized over this five-year vesting period. Price should record the following entry each year from 2026 to 2030. Dr. Compensation expense (290,000 options × $1.5/option / 5 yr) 87,000 Cr. Contributed surplus—stock options 87,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 9) Princeton Inc. granted 290,000 stock options to its employees. The options expire 45 years after the grant date of January 1, 2026, when the share price was $23. Employees still employed by the company four years after the grant date may exercise the option to purchase shares at $45 each; that is, the options vest to the employees after four years. A consultant estimated the value of each option at the date of grant to be $2.50 each. Required: Record the journal entries relating to the issuance of stock options. Answer: Since the options vest after four years, the compensation expense should be amortized over this four-year vesting period. Princeton should record the following entry each year from 2026 to 2029. Dr. Compensation expense (290,000 options × $2.5/option / 4 yr) 181,250 Cr. Contributed surplus—stock options 181,250 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

10) AnnuG Inc. granted 200,000 stock options to its employees. The options expire 45 years after the grant date of January 1, 2026, when the share price was $23. Employees still employed by the company six years after the grant date may exercise the option to purchase shares at $45 each; that is, the options vest to the employees after six years. A consultant estimated the value of each option at the date of grant to be $2.50 each. Required: Record the journal entries relating to the issuance of stock options. Answer: Since the options vest after six years, the compensation expense should be amortized over this six-year vesting period. AnnuG should record the following entry each year from 2026 to 2031. Dr. Compensation expense (200,000 options × $2.5/option / 6 yr) 83,333 Cr. Contributed surplus—stock options 83,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 11) Windy Lake Lodge issued 24,000 at-the-money stock options to its management on January 1, 2026. These options vest on January 1, 2029. Windy Lake's share price was $19 on the grant date and $22 on the vesting date. Estimates of the fair value of the options showed that they were worth $3 on the grant date and $11 on the vesting date. On the vesting date, management exercised all 24,000 options. Windy Lake has a December 31 year-end. Required: Record all of the journal entries relating to the stock options. Answer: 2026 Dec 31 Dr. Compensation expense 24,000 Cr. Contributed surplus—stock options (24,000 options × $3/option / 3 years) 2027 Dec 31 Same entry as above. 2028 Dec 31 Same entry as above. 2029 Jan 1

24,000

Dr. Cash (24,000 sh × $19/sh) 456,000 Dr. Contributed surplus—stock options 72,000 ($24,000/year × 3 years) Cr. Common stock 528,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

12) Breezy Lodge issued 25,000 at-the-money stock options to its management on January 1, 2026. These options vest on January 1, 2029. Breezy's share price was $18 on the grant date and $25 on the vesting date. Estimates of the fair value of the options showed that they were worth $4 on the grant date and $11 on the vesting date. On the vesting date, management exercised all 25,000 options. Breezy has a December 31 year-end. Required: Record all of the journal entries relating to the stock options. Answer: 2026 Dec 31 Dr. Compensation expense 33,333 Cr. Contributed surplus—stock options (25,000 options × $4/option / 3 years) 2027 Dec 31 Same entry as above. 2028 Dec 31 Same entry as above.

33,333

2029 Jan 1

Dr. Cash (25,000 sh × $18/sh) 450,000 Dr. Contributed surplus—stock options 100,000 ($33,333/year × 3 years) Cr. Common stock 550,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 13) Nippy Lodge issued 15,000 at-the-money stock options to its management on January 1, 2026. These options vest on January 1, 2029. Nippy's share price was $20 on the grant date and $25 on the vesting date. Estimates of the fair value of the options showed that they were worth $3 on the grant date and $11 on the vesting date. On the vesting date, management exercised all 15,000 options. Nippy has a December 31 year-end. Required: Record all of the journal entries relating to the stock options. Answer: 2026 Dec 31 Dr. Compensation expense 15,000 Cr. Contributed surplus—stock options (15,000 options × $3/option/3 years) 2027 Dec 31 Same entry as above. 2028 Dec 31 Same entry as above. 2029 Jan 1

15,000

Dr. Cash (15,000 sh × $20/sh) 300,000 Dr. Contributed surplus—stock options 45,000 ($15,000/year × 3 years) Cr. Common stock 345,000 Diff: 1 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

14) On January 1, 2026, Gilmore Inc. granted stock options to officers and key employees for the purchase of 100,000 of the company's no par value common shares at $28 each. The options were exercisable within a five-year period beginning January 1, 2028 by grantees still in the employ of the company, and they expire December 31, 2032. The market price of Gilmore's common share was $20 per share at the date of grant. Using the Black-Scholes option pricing model, the company estimated the value of each option on January 1, 2026 to be $4.00. On March 31, 2028, 60,000 options were exercised when the market value of common stock was $44 per share. The remainder of the options expired unexercised. The company has a December 31 year-end. Required: Record the journal entries for Gilmore's stock options assuming that the company elects to transfer the balance of contributed surplus pertaining to expired options to a separate contributed surplus account. Answer: 2026 Dec 31 Dr. Compensation expense 200,000 Cr. Contributed surplus—stock options 200,000 The total cost of the options is 100,000 options × $4/option = $400,000. This amount should be amortized over the vesting period (two years), which is presumed to be the period of service expected from the option grant. 2027 Dec 31 Dr. Compensation expense Cr. Contributed surplus—stock options

200,000

2028 Mar 31 Dr. Cash (60,000 shares × $28/share) Dr. Contributed surplus—stock options ($400,000 × 60,000 options / 100,000 options) Cr. Common shares

1,680,000 240,000

200,000

1,920,000

2032 Dec 31 Dr. Contributed surplus—stock options 160,000 ($400,000 - $240,000) Cr. Contributed surplus—expired stock options 160,000 Diff: 2 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

15) On January 1, 2026, Braeben Inc. granted stock options to officers and key employees for the purchase of 180,000 of the company's no par value common shares at $30 each. The options were exercisable within a five-year period beginning January 1, 2028 by grantees still in the employ of the company, and they expire December 31, 2032. The market price of Braeben's common share was $20 per share at the date of grant. Using the Black-Scholes option pricing model, the company estimated the value of each option on January 1, 2026 to be $2.75. On March 31, 2028, 30,000 options were exercised when the market value of common stock was $44 per share. The remainder of the options expired unexercised. The company has a December 31 year-end. Required: Record the journal entries for Braeben's stock options assuming that the company elects to transfer the balance of contributed surplus pertaining to expired options to a separate contributed surplus account. Answer: 2026 Dec 31 Dr. Compensation expense 247,500 Cr. Contributed surplus—stock options 247,500 The total cost of the options is 180,000 options × $2.75/option = $495,000. This amount should be amortized over the vesting period (two years), which is presumed to be the period of service expected from the option grant. 2027 Dec 31

2028 Mar 31

Dr. Compensation expense Cr. Contributed surplus—stock options

247,500

Dr. Cash (30,000 shares × $30/share) 900,000 Dr. Contributed surplus—stock options 82,500 ($495,000 × 30,000 options / 180,000 options) Cr. Common shares

2032 Dec 31

247,500

982,500

Dr. Contributed surplus—stock options 415,500 ($495,000 - $82,500) Cr. Contributed surplus—expired stock options 415,500 Diff: 2 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

16) On January 1, 2026, Taffy Inc. granted 210,000 stock appreciation rights (SARs) to its executives. Each SAR entitled its holder to receive cash equal to the difference between the market price of the common share and the benchmark price of $16. The SARs vested after three years and expired on December 31, 2028. On January 1, 2029, 100,000 SARs are exercised. The market price of the shares remained at $20. On January 1, 2030, 50,000 SARS are exercised. The market price of the shares remained at $22. The remaining SARs expired. Pertinent stock-related data are listed below:

January 1, 2026 December 31, 2026 December 31, 2027 December 31, 2028 December 31, 2029 December 31, 2030 December 31, 2031

Fair value each SAR $10 6 7 8 1 0

Market price of share $16 21 18 20 22 15 14

Required: a. Prepare the journal entry at December 31, 2026, to record compensation expense. b. Prepare the journal entry at December 31, 2027, to record compensation expense. c. Prepare the journal entry at December 31, 2028, to record compensation expense. d. Prepare the journal entry at January 1, 2029, to record the partial exercise of the SARs. e. Prepare the journal entry at December 31, 2029, to record compensation expense. f. Prepare the journal entry at January 1, 2030, to record the partial exercise of the SARs. g. Prepare the journal entry at December 31, 2030, to record compensation expense. h. Prepare the journal entry at December 31, 2031, to record compensation expense.

Answer: a. Dec. 31, 2026 Dr. Compensation expense Cr. Liability for stock appreciation rights ($10 × 210,000 SARs) / 3 = $700,000

700,000

b. Dec. 31, 2027 Dr. Compensation expense 140,000 Cr. Liability for stock appreciation rights ($6 × 210,000 SARs) × 2/3 - $700,000 = $140,000

140,000

c. Dec. 31, 2028 Dr. Compensation expense Cr. Liability for stock appreciation rights ($7 × 210,000 SARs) - $840,000 = $140,000

630,000

d. Jan. 1, 2029

400,000

Dr. Liability for stock appreciation rights Cr. Cash ($20 - $16) × 100,000 SARs = $400,000

e. Dec. 31, 2029 Dr. Liability for stock appreciation rights 190,000 Cr. Compensation expense ($8 × 110,000 SARs) - $1,070,000 = ($190,000) f. Jan. 1, 2030

Dr. Liability for stock appreciation rights Cr. Cash ($22 - $16) × 50,000 SARs = $300,000

g. Dec. 31, 2030 Dr. Liability for stock appreciation rights Cr. Compensation expense ($1 × 60,000 SARs) - $580,000 = ($520,000)

400,000

190,000

300,000 300,000

520,000 520,000

h. Dec. 31, 2031 Dr. Liability for stock appreciation rights 60,000 Cr. Compensation expense 60,000 Diff: 3 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

17) On January 1, 2026, Taffy Inc. granted 210,000 stock appreciation rights (SARs) to its executives. Each SAR entitled its holder to receive cash equal to the difference between the market price of the common share and the benchmark price of $16. The SARs vested after three years and expired on December 31, 2023. On January 1, 2029, 100,000 SARs are exercised. The market price of the shares remained at $20. On January 1, 2030, 50,000 SARS are exercised. The market price of the shares remained at $22. The remaining SARs expired. Pertinent stock-related data are listed below: Fair value each SAR Market price of share January 1, 2026 $16 December 31, 2026 $10 21 December 31, 2027 6 18 December 31, 2028 7 20 December 31, 2029 8 22 December 31, 2030 1 15 December 31, 2031 0 14 Assume that Taffy Inc. reports its financial results in accordance with ASPE. Required: a. b. c. d. e. f. g. h.

Prepare the journal entry at December 31, 2026, to record compensation expense. Prepare the journal entry at December 31, 2027, to record compensation expense. Prepare the journal entry at December 31, 2028, to record compensation expense. Prepare the journal entry at January 1, 2029, to record the partial exercise of the SARs. Prepare the journal entry at December 31, 2029, to record compensation expense. Prepare the journal entry at January 1, 2030, to record the partial exercise of the SARs. Prepare the journal entry at December 31, 2030, to record compensation expense. Prepare the journal entry at December 31, 2031, to record compensation expense.

Answer: a. Dec. 31, 2026 Dr. Compensation expense Cr. Liability for stock appreciation rights (($21 - $16) × 210,000 SARs) / 3 = $350,000

350,000

b. Dec. 31, 2027 Dr. Liability for stock appreciation rights 70,000 Cr. Compensation expense ($18 - $16) × 210,000 SARs × 2/3 - $350,000 = ($70,000)

350,000

70,000

c. Dec. 31, 2028

Dr. Compensation expense 560,000 Cr. Liability for stock appreciation rights ($20 - $16) × 210,000 SARs - $280,000 = $560,000

560,000

d. Jan. 1, 2029

Dr. Liability for stock appreciation rights Cr. Cash ($20 - $16) × 100,000 SARs = $400,000

400,000

e. Dec. 31, 2029

Dr. Compensation expense 220,000 Cr. Liability for stock appreciation rights ($22 - $16) × 110,000 SARs - $440,000 = $440,000

220,000

f. Jan. 1, 2030

Dr. Liability for stock appreciation rights Cr. Cash ($22 - $16) × 50,000 SARs = $300,000

300,000

400,000

300,000

g. Dec. 31, 2030 Dr. Liability for stock appreciation rights 360,000 Cr. Compensation expense 360,000 When market price is lower than benchmark price, the cumulative obligation is reported at $0. h. Dec. 31, 2031 No journal entry is necessary. Diff: 3 Type: ES Skill: Comp Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer. 18) How should employee stock options be accounted for? A) Historical cost. B) Fair value with changes recorded through income. C) Amortized cost. D) Fair value. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 14.3 Apply the accounting standards for employee stock compensation plans from the perspective of the issuer.

Learning Objective 4 Apply the accounting standards for derivatives. 1) How should warrants on the company's own common shares be accounted for? A) Fair value. B) Fair value through profit or loss. C) Amortized cost. D) Historical cost. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 14.4 Apply the accounting standards for derivatives. 2) How are derivative contracts generally accounted for? A) Fair value. B) Fair value with changes recorded through income. C) Amortized cost. D) Historical cost. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.4 Apply the accounting standards for derivatives. 3) Assume that on January 15, 2025, Ariel agrees to purchase US$500,000 for C$550,000 for delivery on January 15, 2026. The exchange rate at its December 31 year-end is US$1 = C$0.95 and on January 15, 2026, the exchange rate is US$1 = C$0.97. What is the foreign exchange gain or loss recognized on January 15, 2025? A) 0 B) $65,000 loss. C) $75,000 gain. D) $75,000 loss. Answer: A Diff: 2 Type: MC Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives. 4) Which is a derivative on the company's own common shares? A) Interest rate swap contract. B) Foreign exchange forward contract. C) Employee stock option. D) Commodity futures contract. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 14.4 Apply the accounting standards for derivatives.

5) Which is a derivative on the company's own common shares? A) Accounts payable. B) Warrants on common shares. C) Commodity futures contract. D) Warranty provision. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 14.4 Apply the accounting standards for derivatives. 6) Assume that on January 15, 2026, MAK agrees to purchase US$500,000 for C$550,000 for delivery on January 15, 2027. The exchange rate at MAK's December 31, 2026, year-end was US$1 = C$0.95 and the January 15, 2027, exchange rate is US$1 = C$0.97. What is the foreign exchange gain or loss recognized at year-end? A) 0 B) $65,000 loss. C) $75,000 gain. D) $75,000 loss. Answer: D Explanation: At purchase: value of C$550,000 At year-end: value of US$500,000 × C$095/US$1.00 = C$475,000 Change is $475,000 - $550,000 = $75,000 loss. Diff: 2 Type: MC Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives. 7) Assume that on January 15, 2026, MAK agrees to purchase US$500,000 for C$550,000 for delivery on January 15, 2027. The exchange rate at MAK's December 31, 2026, year-end was US$1 = C$0.95 and the January 15, 2027, exchange rate is US$1 = C$0.97. What is the foreign exchange gain or loss recognized at January 15, 2027? A) $10,000 gain. B) $10,000 loss. C) $75,000 gain. D) $75,000 loss. Answer: A Explanation: At January 15, 2027: value of US$500,000 × C$0.97/US$1.00 = C$485,000 At year-end: value of US$500,000 × C$0.95/US$1.00 = C$475,000 Change is $485,000 - $475,000 = $10,000 gain Diff: 3 Type: MC Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

8) Assume that on January 15, 2026, Singh agrees to purchase US$100,000 for C$117,000 for delivery on January 15, 2027. The exchange rate at Singh's December 31, 2026, year-end is US$1 = C$1.20 and the January 15, 2027, exchange rate is US$1 = C$1.19. What is the foreign exchange gain or loss recognized at January 15, 2027? A) $1,000 loss. B) $1,000 gain. C) $2,000 loss. D) $2,000 gain. Answer: A Explanation: At January 15, 2027: value of US $100,000 × C$1.19//US$1.00 = C$119,000 At year-end: value of US $100,000 × C$1.20//US$1.00 = C$120,000 $119,000 - $120,000 = $1,000 loss Diff: 3 Type: MC Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives. 9) Assume that on January 15, 2026, Singh agrees to purchase US$100,000 for C$117,000 for delivery on January 15, 2027. The exchange rate at Singh's December 31, 2026, year-end is US$1 = C$1.20 and the January 15, 2027, exchange rate is US$1 = C$1.19. What is the foreign exchange gain or loss recognized at December 31, 2026? A) $2,000 gain. B) $2,000 loss. C) $3,000 gain. D) $3,000 loss. Answer: C Explanation: At purchase: value of C117,000 At year-end: value of US$100,000 × C$1.20/US$1.00 = C$120,000 $120,000 - $117,000 = $3,000 gain. Diff: 2 Type: MC Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives. 10) Assume that on January 15, 2026, Aero's agrees to purchase US$50,000 for C$52,000 for delivery on January 15, 2027. The exchange rate at Aero's December 31, 2026, year-end is US$1 = C$0.98 and the January 15, 2027, exchange rate is US$1 = C$0.97. What is the foreign exchange gain or loss recognized at December 31, 2026? A) $3,000 loss. B) $3,000 gain. C) $3,500 loss. D) $3,500 gain. Answer: A Explanation: At purchase: value of C52,000 At year-end: value of US$50,000 × C$0.98/US$1.00 = C$49,000 $49,000- $52,000 = $3,000 loss Diff: 2 Type: MC Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

11) Assume that on January 15, 2026, Aero's agrees to purchase US$50,000 for C$52,000 for delivery on January 15, 2027. The exchange rate at Aero's December 31 year-end is US$1 = C$0.98 and the January 15, 2027, exchange rate is US$1 = C$0.97. What is the foreign exchange gain or loss recognized at January 15, 2027? A) $500 loss. B) $500 gain. C) $3,500 loss. D) $3,500 gain. Answer: A Explanation: At year-end: $50,000 × C$0.98/US$1.00 = $49,000 At January 15, 2026: $50,000 × C$0.97/US$1.00 = $48,500 $48,500 - $49,000 = $500 loss Diff: 2 Type: MC Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives. 12) What are the two exceptions to the general rule of measuring derivatives at fair value, with changes in fair value recorded through income? Answer: The two exceptions to this general rule are hedging transactions and derivatives related to the reporting entity's own equity (e.g., warrants). Diff: 1 Type: SA Skill: Concept Objective: 14.4 Apply the accounting standards for derivatives. 13) On December 15, 2026, Hammer paid $20,000 to purchase a futures contract that entitles the company to buy US$1 million at a cost of C$1.04 million on March 15, 2027. On December 31, 2026, Hammer's yearend, the exchange rate is US$1:C$1.09. Required: Record the journal entry for (a) the purchase of the futures contract and (b) at year-end. Answer: Date Account DR CR Dec. 15, 2026 Foreign currency derivative (classified as held-for20,000 trading financial asset) Cash 20,000 Year-end Foreign currency derivative (US$1m × 50,000 (Dec. 31, 2026) (C$1.09/US$1.00 - C$1.04/US$1.00)) Gain on currency derivative 50,000 Diff: 1 Type: SA Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

14) On December 15, a company enters into a foreign currency forward to buy €300,000 at C$1.60 per euro in 30 days. The exchange rate on the day of the company's year-end of December 31 was C$1.59: €l. Required: Record the journal entries related to this forward contract. Answer: Dec 15 No entry. A forward contract is executory—nothing has changed hands between the parties to the contract. Dec 31 Dr. Loss on foreign currency forward 3,000 ($0.01/€1 × €300,000) Cr. Foreign currency forward (a liability account) Diff: 1 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

3,000

15) On December 15, a company enters into a foreign currency forward to buy €100,000 at C$1.60 per euro in 30 days. The exchange rate on the day of the company's year-end of December 31 was C$1.55: €l. Required: Record the journal entries related to this forward contract. Answer: Dec 15 No entry. A forward contract is executory—nothing has changed hands between the parties to the contract. Dec 31 Dr. Loss on foreign currency forward 5,000 ($0.05/€1 × €100,000) Cr. Foreign currency forward (a liability account) Diff: 1 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

5,000

16) A company pays $7,000 to purchase futures contracts to buy 200 oz of gold at $1,600/oz. At the company's year-end, the price of gold was $1,625 and the value of the company's futures contracts increased to $10,000. Required: Record the journal entries related to these futures. Answer: Purchase Dr. Gold futures Cr. Cash Year-end

7,000

Dr. Gold futures ($10,000 - $7,000) 3,000 Cr. Gain on gold futures Diff: 1 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

7,000

3,000

17) A company pays $5,000 to purchase futures contracts to buy 50 oz of silver at $40/oz. At the company's year-end, the price of silver rose and the value of the company's futures contracts increased to $6,000. Required: Record the journal entries related to these futures. Answer: Purchase Dr. Silver futures Cr. Cash

5,000

Year-end

Dr. Silver futures ($6,000 - $5,000) 1,000 Cr. Gain on silver futures Diff: 1 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

5,000

1,000

18) On August 15, 2026, Madison Company issued 80,000 options on the shares of MVC (Middefield Valley Corporation). Each option gives the option holder the right to buy one share of MVC at $70 per share until March 16, 2027. Madison received $800,000 for issuing these options. At the company's yearend of December 31, 2026, the options contracts traded on the Montreal Exchange at $9.50 per contract. On March 16, 2027, MVC shares closed at $63 per share, so none of the options was exercised. Required: Record the journal entries related to these call options. Answer: 2026 Aug 15 Dr. Cash Cr. Liability for call options issued (Proceeds equals $10.00/option)

800,000 800,000

2026 Dec 31 Dr. Liability for call options issued 40,000 Cr. Gain on call option issued (80,000 options × ($9.50/option - $10.00/option))

40,000

2027 Mar 16 Dr. Liability for call options issued Cr. Gain on call option issued ($800,000 - $40,000)

760,000

Since the options expire unexercised, liability is extinguished. Diff: 2 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

19) On August 15, 2026, Madison Company issued 10,000 options on the shares of MVC (Middefield Valley Corporation). Each option gives the option holder the right to buy one share of MVC at $70 per share until March 16, 2027. Madison received $100,000 for issuing these options. At the company's yearend of December 31, 2026, the options contracts traded on the Montreal Exchange at $9.50 per contract. On March 16, 2027, MVC shares closed at $63 per share, so none of the options was exercised. Required: Record the journal entries related to these call options. Answer: 2026 Aug 15 Dr. Cash Cr. Liability for call options issued (Proceeds equals $10.00/option) 2026 Dec 31

100,000

Dr. Liability for call options issued 5,000 Cr. Gain on call option issued (10,000 options × ($9.50/option - $10.00/option))

2027 Mar 16 Dr. Liability for call options issued Cr. Gain on call option issued ($100,000 - $10,000)

95,000

Since the options expire unexercised, liability is extinguished. Diff: 2 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

100,000

5,000

95,000

20) Sorrentino Corporation issued call options on 20,000 shares of BWC Inc. on October 21, 2024. These options give the holder the right to buy BWC shares at $35 per share until May 17, 2025. For issuing these options, Sorrentino received $20,000. On December 31, 2024 (Sorrentino's fiscal year-end), the options traded on the Montreal Exchange for $2.00 per option. On May 17, 2025, BWC's share price increased to $38 and the option holders exercised their options. Sorrentino had no holdings of BWC shares. Required: For Sorrentino Corporation, record the journal entries related to these call options. Answer: 2024 Oct 21 Dr. Cash 20,000 Cr. Liability for call options issued 20,000 (Proceeds equals $1.00/option) 2024 Dec 31

Dr. Loss on call options issued 20,000 Cr. Liability for call options issued (20,000 options × ($2/option - $1/option))

2025 May 17 Dr. BWC shares held for trading (20,000 sh × $38/sh) Cr. Cash Dr. Cash (20,000 sh × $35/sh) Dr. Liability for call options issued ($20,000 + $20,000) Dr. Loss on call options exercised Cr. BWC shares held for trading

20,000

760,000 760,000 700,000 40,000 20,000

760,000

When the options are exercised, the company must deliver the shares to the option holders. Therefore, the company must first purchase the shares on the exchange at the prevailing price of $38. Diff: 2 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

21) Naples Corporation issued call options on 20,000 shares of VESPUS Inc. on October 21, 2024. These options give the holder the right to buy VESPUS shares at $35 per share until May 17, 2025. For issuing these options, Naples received $60,000. On December 31, 2025 (Naples's fiscal year-end), the options traded on the Montreal Exchange for $3.50 per option. On May 17, 2025, VESPUS's share price increased to $40 and the option holders exercised their options. Naples had no holdings of VESPUS shares. Required: For Naples Corporation, record the journal entries related to these call options. Answer: 2024 Oct 21 Dr. Cash 60,000 Cr. Liability for call options issued 60,000 (Proceeds equals $3.00/option) 2024 Dec 31 Dr. Loss on call options issued 10,000 Cr. Liability for call options issued (20,000 options × ($3.50/option - $3.00/option)) 2025 May 17 Dr. VESPUS shares held for trading (20,000 sh × $40/sh) Cr. Cash Dr. Cash (20,000 sh × $35/sh) Dr. Liability for call options issued ($60,000 + $10,000) Dr. Loss on call options exercised Cr. VESPUS shares held for trading

10,000

800,000 800,000 700,000 70,000 30,000

800,000

When the options are exercised, the company must deliver the shares to the option holders. Therefore, the company must first purchase the shares on the exchange at the prevailing price of $40. Diff: 2 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

22) Roman Corporation issued call options on 5,000 shares of POMPEI Inc. on October 21, 2024. These options give the holder the right to buy POMPEI shares at $35 per share until May 17, 2025. For issuing these options, Roman received $15,000. On December 31, 2024 (Roman's fiscal year-end), the options traded on the Montreal Exchange for $3.50 per option. On May 17, 2025, POMPEI's share price increased to $40 and the option holders exercised their options. Roman had no holdings of POMPEI shares. Required: For Roman Corporation, record the journal entries related to these call options. Answer: 2024 Oct 21 Dr. Cash 15,000 Cr. Liability for call options issued 15,000 (Proceeds equals $3.00/option) 2024 Dec 31 Dr. Loss on call options issued 2,500 Cr. Liability for call options issued (5,000 options × ($3.50/option - $3.00/option)) 2025 May 17 Dr. POMPEI shares held for trading (5,000 sh × $40/sh) Cr. Cash Dr. Cash (5,000 sh × $35/sh) Dr. Liability for call options issued ($2,500 + $15,000) Dr. Loss on call options exercised Cr. POMPEI shares held for trading

2,500

200,000 200,000 175,000 17,500 7,500

200,000

When the options are exercised, the company must deliver the shares to the option holders. Therefore, the company must first purchase the shares on the exchange at the prevailing price of $40. Diff: 2 Type: ES Skill: Comp Objective: 14.4 Apply the accounting standards for derivatives.

Learning Objective 5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate. 1) What is a "hedge"? A) A financial instrument that is speculative and increases the risk for the company. B) An instrument that moves in the opposite direction to another financial asset or liability. C) An instrument that moves in the same direction as another financial asset or liability. D) A financial instrument that is prohibited by accounting standards under IFRS and ASPE. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate.

2) Which step is not required for hedge accounting under IFRS? A) Demonstration of hedge's effectiveness. B) Identification of the risk exposure. C) Payment of fees to the counterparty. D) Designation of the hedging instrument. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate. 3) Which statement is correct about hedge accounting? A) Hedge accounting must be reported in profit or loss. B) Hedge accounting must be reported in OCI. C) The financial effects of the hedging item and instrument offset 100% in hedge accounting. D) It permits the hedging item and the hedging instrument to be recorded in the same way. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate. 4) What are the similarities and differences between forwards and futures? Answer: A forward is a contract in which one party commits up front to buy or sell something at a defined price at a defined future date. A future is similar to a forward but the contract is written in more standardized terms (e.g., prices, maturity dates) and involves commonly traded items (e.g., commodities, currencies). Diff: 1 Type: SA Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate. 5) Give 4 examples of cash flow hedges. Answer: (1) future interest payments on variable rate debt or (2) interest payments on foreigndenominated debt (3) an expected inventory purchase priced in a foreign currency or (4) the anticipated sale of offshore property. Diff: 2 Type: SA Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate.

6) On December 1, 2026, Mackenzie Mann Ltd. entered into a binding agreement to buy inventory costing US$300,000 for delivery on February 16, 2027. Terms of the sale were COD (cash on delivery). Mackenzie Mann, which has a December 31 year-end, decided to hedge its foreign exchange risk and entered into a forward agreement to receive US$300,000 at that time. Mackenzie Mann designated the forward a fair value hedge. Pertinent exchange rates follow: Date December 1, 2026 December 31, 2026 February 16, 2027

Spot Rate C$ per US$1 $1.010 0.980 0.990

Forward rate for delivery on February 16, 2027 CS$ per US$1 $1.000 0.995 0.990

Required: Record the required journal entries for December 1, December 31, and February 16 using the net method. If no entries are required, state "no entry required" and indicate why. Answer: Date Account DR CR Dec. 1, 2026 No entry required– the contract to purchase the inventory and the forward contract are both mutually unexecuted contracts Dec. 31, 2026 Foreign exchange gains and losses 1,500 Forward contract receivable (US dollars) 1,500 Contract commitment asset 1,500 Foreign exchange gains and losses 1,500 US$300,000 × (C$0.995/US$1.00 - C$1.000/US$1.00) Feb. 16, 2027 Foreign exchange gains and losses 1,500 Forward contract receivable (US dollars) 1,500 Contract commitment asset 1,500 Foreign exchange gains and losses 1,500 US$300,000 × (C$0.990/US$1.00 - C$0.995/US$1.00) Cash (US$) (US$300,000 × C$0.990/US$1.00) 297,000 Forward contract receivable (US dollars) ($1,500 + 3,000 $1,500) Cash (C$) (US$300,000 × C$1.000/US$1.00) 300,000 Inventory (US$) (US$300,000 × C$1.000/US$1.00) 300,000 Cash (C$) (US$300,000 × C$0.990/US$1.00) 297,000 Contract commitment asset 3,000 Diff: 2 Type: SA Skill: Comp Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate.

7) Explain what a "fair value" and "cash flow" hedge is and how each is accounted for under IFRS. Answer: Fair value hedge — Reduces the exposure to changes in fair value. Cash flow hedge — A financial instrument that reduces the exposure to changes in future cash flows. For fair value hedges, the changes in fair value for both the hedged item and the hedging instrument flow through income. For cash flow hedges, the changes in cash flow pass through OCI. Diff: 2 Type: ES Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate. 8) Identify the type of hedge under each of the following transactions:

Item A swap of investment with a fixed interest rate with one providing a variable return. A swap of a Euro-dollar denominated bond payable for one denominated in US dollars. A futures contract to sell 1,000 oz of silver at USD$45/oz. A swap of investment with a variable interest rate with one providing a fixed return.

Fair value hedge or cash flow hedge?

Answer: Item A swap of investment with a fixed interest rate with one providing a variable return. A swap of a Euro-dollar denominated bond payable for one denominated in US dollars. A futures contract to sell 1,000 oz of silver at USD$45/oz. A swap of investment with a variable interest rate with one providing a fixed return.

Fair value hedge or cash flow hedge? Fair value Cash flow Fair value Cash flow

Diff: 2 Type: ES Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate.

9) A company located in Canada spends $2,000 to purchase a foreign currency futures contract to buy US$100,000 at C$1.05:US$1.00. The contract matures 110 days later. Under which of the following circumstances could the company consider this future contract to be a fair value hedge for accounting purposes? Answer: Futures contract to buy USD can be considered as a fair Circumstance value hedge? The company has an account payable of USD$100,000, due in 110 days. Yes The company intends to buy USD$100,000 of inventories for No which it must pay 110 days later. (Cash flow hedge) The company has an investment in shares traded on a U.S. stock exchange and it plans to sell these shares in 110 days. No The company has an account receivable of USD$100,000, due in 110 days. No Diff: 2 Type: ES Skill: Concept Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate.

10) On December 15, 2025, Welders Inc. signed a contract to purchase 200,000 kg of copper pipes to be received on February 15, 2026. Terms of sale were COD (cash on delivery). Welders, which has a December 31 year-end, entered into a two months forward agreement to purchase the copper to mitigate its price change risk. Welders designated the forward as a cash flow hedge. Pertinent commodity prices follow: Date

Spot Price of 1 kg Copper

December 15, 2025 December 31, 2025 February 15, 2026

$4.500 4.510 4.490

Forward price for delivery on February 15, 2026 of 1 kg Copper $4.505 4.520 4.490

Dec. 31, 2025

Feb. 15, 2026

Account No entry required– the contract to purchase the inventory and the forward contract are both mutually unexecuted contracts Forward contract (Copper) Other comprehensive income 200,000 kg × ($4.520/kg - $4.505/kg) Other comprehensive income Forward contract (Copper) 200,000 kg × ($4.490/kg - $4.520/kg) Forward contract (Copper) ($6,000-$3,000) Cash Copper inventory (200,000 kg × $4.490/kg) Cash

3,000 3,000 6,000 6,000 3,000 3,000 898,000 898,000

Diff: 2 Type: ES Skill: Comp Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate.

11) On December 15, 2025, Welders Inc. signed a contract to sell 200,000 kg of copper pipes to be delivered on February 15, 2026. Terms of sale were COD (cash on delivery). Welders, which has a December 31 year-end, entered into a two months forward agreement to sell the copper to mitigate its price change risk. Welders designated the forward as a fair value hedge. Pertinent commodity prices follow: Date

December 15, 2025 December 31, 2025 February 15, 2026

Spot Price of 1 kg Copper

$4.500 4.510 4.490

Forward price for delivery on February 15, 2026 of 1 kg Copper $4.505 4.520 4.490

Required: Record the required journal entries for December 15, December 31, and February 15 using the net method. If no entries are required, state "no entry required" and indicate why. Answer: Date Account DR CR Dec. 15, 2025 No entry required– the contract to purchase the inventory and the forward contract are both mutually unexecuted contracts Dec. 31, 2025 Forward contract (Copper) 3,000 Copper price gains and losses 3,000 Copper price gains and losses 3,000 Contract commitment asset/liability 3,000 200,000 kg × ($4.520/kg - $4.505/kg) Feb. 15, 2026 Copper price gains and losses 6,000 Forward contract (Copper) 6,000 Contract commitment asset/liability 6,000 Copper price gains and losses 6,000 200,000 kg × ($4.490/kg - $4.520/kg) Forward contract (Copper) ($6,000-$3,000) 3,000 Cash 3,000 Copper inventory (200,000 kg × $4.490/kg) 898,000 Cash 898,000 Diff: 2 Type: ES Skill: Comp Objective: 14.5 Apply the accounting standards for hedges and identify situations in which hedge accounting may be appropriate.

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 15 Earnings Per Share Learning Objective 1 Describe the reasons for reporting basic and diluted earnings per share. 1) Which statement is correct about earnings per share (EPS)? A) A company's total earnings is more meaningful than its EPS. B) EPS represents the total amount of earnings of a company. C) EPS measures an ordinary share's interest in a company's earnings. D) The EPS is directly correlated with the company's stock price. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 2) Which statement is correct about earnings per share (EPS)? A) EPS does not provide decision-useful information to investors. B) EPS represents the ordinary share's market value. C) EPS represents the company's market value. D) EPS can be used to predict future earnings by analysts. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 3) Which statement is correct about earnings per share (EPS)? A) EPS does not need to be disclosed under IFRS. B) EPS needs to be disclosed under IFRS. C) EPS is calculated for preferred shares. D) EPS is a ratio used to assess leverage. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 4) Which statement is correct? A) A simple capital structure includes potentially dilutive securities. B) A simple capital structure excludes potentially dilutive securities. C) EPS applies only to a company with a simple capital structure. D) A company with a simple capital structure does not need to calculate EPS. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share.

5) Which statement is correct? A) Basic EPS is based on the dilutive shares outstanding at the end of the year. B) Basic EPS is based on the dilutive shares outstanding during the year. C) Basic EPS is based on the ordinary shares outstanding at during the year. D) Basic EPS is based on the ordinary shares outstanding at the end of the year. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 6) Which statement is correct? A) Companies with a simple capital structure must disclose diluted EPS. B) Companies with a complex capital structure must disclose diluted EPS. C) Companies with a simple capital structure do not need to disclose basic EPS. D) Companies with a complex capital structure do not need to disclose diluted EPS. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 7) Which statement is correct? A) Basic EPS increases the understandability of financial statements. B) Basic EPS decreases the understandability of financial statements. C) Basic EPS addresses the moral hazard information asymmetry. D) Basic EPS can be calculated in different ways by different companies. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 8) Which statement is correct? A) A complex capital structure includes potentially dilutive securities. B) A complex capital structure excludes potentially dilutive securities. C) EPS applies only to a company with a complex capital structure. D) A company with a complex capital structure calculates only basic EPS. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share.

9) Which statement is correct? A) Diluted EPS assumes that all dilutive securities are converted. B) Diluted EPS assumes that all antidilutive and dilutive securities are converted. C) Diluted EPS assumes that all ordinary securities are converted. D) Diluted EPS assumes that all ordinary and dilutive securities are converted. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 10) Which statement is correct? A) Diluted EPS decreases the comparability of financial statements. B) Diluted EPS decreases the understandability of financial statements. C) Diluted EPS addresses the moral hazard information asymmetry. D) Diluted EPS is calculated in the same manner as basic EPS. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 11) Which of the following is correct about the difference between basic earnings per share (EPS) and diluted earnings per share? A) Basic EPS uses total common shares outstanding, whereas diluted EPS uses the weighted-average number of common shares. B) Basic EPS is not a required disclosure, whereas diluted EPS is required disclosure. C) Basic EPS is not adjusted for the potential dilutive effects of complex financial structures, whereas diluted EPS is adjusted. D) Basic EPS uses comprehensive income in its calculation, whereas diluted EPS does not. Answer: C Diff: 3 Type: MC Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 12) Explain why the IASB requires the disclosure of basic and diluted EPS. Answer: The need for basic EPS is simply to increase the understandability and comparability of the earnings number. The need for diluted EPS is to prevent moral hazard, which was discussed in Chapter 1. In the absence of diluted EPS, it would be easier for management to mislead shareholders regarding the profitability of the company by issuing securities such as convertible bonds and stock options that do not entail the issuance of ordinary shares immediately, but which could lead to share issuances in the future. Diff: 2 Type: SA Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share.

13) Explain why private companies are not required to report EPS under according to ASPE. Answer: Accounting Standards for Private Enterprises (ASPE) in Canada do not require companies to report EPS information in their financial statements because the owners of such private enterprises normally have substantial ownerships such that per share amounts are no more informative than the aggregate earnings. Diff: 1 Type: SA Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 14) What EPS information disclosure is required from private companies that choose to apply international standards? Answer: For private companies that choose to apply international standards, IFRS also does not require such companies to disclose EPS information unless they are in the process of going public (IAS 33 paragraph 2). Diff: 2 Type: SA Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 15) Briefly explain the main the difference in the requirements of IFRS and ASPE in regards to EPS information. Answer: IFRS requires publicly accountable enterprises or private entities in the process of going public to present EPS information in accordance with IAS 33. ASPE does not require entities to present EPS information. Diff: 1 Type: SA Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share. 16) Explain the difference between basic and diluted EPS. Answer: Basic EPS communicates "ownership" of earnings based on the average number of ordinary shares actually outstanding during the period. An indicator of profitability that measures how much of the company's earnings are attributable (belong) to each ordinary share. Diluted EPS is more abstract in nature as it conveys the hypothetical worst-case scenario that considers the effect of potentially dilutive securities—securities that could lead to the issuance of additional ordinary shares. Examples of securities that are potentially dilutive include convertible securities and stock options. Measures the amount of the company's earnings attributable to each ordinary shareholder in a hypothetical scenario in which all dilutive securities are converted to ordinary shares. Diff: 2 Type: ES Skill: Concept Objective: 15.1 Describe the reasons for reporting basic and diluted earnings per share.

Learning Objective 2 Calculate basic earnings per share. 1) Which statement is correct about basic EPS? A) It is an indicator of profitability that communicates ownership of earnings attributable to a company's dilutive shares. B) It is an indicator of profitability that communicates ownership of earnings attributable to a company's ordinary shares. C) It indicates the market price attributable to a company's ordinary shares. D) It indicates the market price attributable to a company's dilutive shares. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 2) Which statement is correct about basic EPS? A) It indicates the net income before tax attributable to a company's ordinary shares. B) It indicates the net income before tax attributable to a company's preferred shares. C) It indicates the net income attributable to a company's preferred shares. D) It indicates the net income attributable to a company's ordinary shares. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 3) Which statement is correct about basic EPS? A) It is calculated on the shares outstanding at the beginning of the year. B) It is calculated on the shares outstanding at the end of the year. C) It is calculated on the shares issued during the year. D) It is calculated on the shares outstanding during the year. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 4) What is the meaning of "net income attributable to ordinary shareholders"? A) It means net income plus dividends on common and preferred shares. B) It means net income less dividends on preferred shares. C) It means net income plus dividends on common shares. D) It means net income less dividends on common and preferred shares. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share.

5) What is the meaning of "net income attributable to ordinary shareholders"? A) This is not used in the EPS calculation. B) This refers to the numerator of the EPS calculation. C) This refers to the denominator of the EPS calculation. D) This is the not used in the diluted EPS calculation. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 6) Which statement is correct about the "net income attributable to ordinary shareholders"? A) Other comprehensive income (OCI) is included in this calculation. B) Other comprehensive income (OCI) is excluded from this calculation. C) Dividends to preferred shareholders are added to the net income. D) Dividends to common shareholders are added to the net income. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 7) Use the following information to calculate the "net income available to ordinary shareholders": Net income Dividends on cumulative preferred shares Dividends on non-cumulative preferred shares Dividends declared in 2025: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares Dividends paid in 2025: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares

$1,000,000 40,000 100,000 50,000 80,000 100,000 30,000 50,000 0

A) $820,000 B) $860,000 C) $950,000 D) $960,000 Answer: B Explanation: $1,000,000 - $40,000 - $100,000 = $860,000 Diff: 2 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share.

8) Which statement is correct about the "weighted average number of ordinary shares outstanding" (WASO)? A) It is used only in the numerator of the EPS calculation. B) The weighted average is the number of shares outstanding at the beginning of the year. C) The weighted average accounts for changes in shares issued or cancelled during the year. D) It is used only in the denominator of the diluted EPS calculation. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 9) Use the following information to calculate the "weighted average number of ordinary shares outstanding" (WASO)? Ordinary shares, January 1, 2026 Shares issued, March 1, 2026 Shares repurchased, June 1, 2026 Dividends declared and paid on ordinary shares, November 1, 2026

120,000 60,000 30,000 $90,000

A) 112,500 B) 152,500 C) 157,500 D) 170,000 Answer: B Explanation: 120,000 × (2/12) + 180,000 × (3/12) + 150,000 × (7/12) 152,500 shares Diff: 2 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share. 10) Which statement is correct about "weighted average number of ordinary shares outstanding"? A) Treasury shares that are cancelled are adjusted in this calculation. B) Treasury shares that are not cancelled are adjusted in this calculation. C) Treasury shares that are repurchased are adjusted in this calculation. D) Treasury shares are ignored for purposes of this calculation. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share.

11) What is the meaning of "weighted average number of ordinary shares outstanding"? A) This is not used in the EPS calculation. B) This refers to the numerator of the EPS calculation. C) This refers to the denominator of the basic EPS calculation. D) This is the not used in the diluted EPS calculation. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 12) Ned Company reported the following information for its fiscal year: Net income Preferred dividends Common share dividends Preferred shares are cumulative and carry an annual dividend of

$500,000 30,000 20,000 10,000

The preferred dividends listed above include the current year and prior accumulated dividends. What is the amount of net income available to common shareholders? A) $440,000 B) $450,000 C) $470,000 D) $490,000 Answer: D Explanation: $500,000 - $10,000 = $490,000 Diff: 2 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share.

13) Use the following information to calculate the "net income available to ordinary shareholders": Net income Annual dividends on cumulative preferred shares Annual dividends on non-cumulative preferred shares Dividends declared in 2026: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares Dividends paid in 2026: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares

$1,000,000 40,000 100,000 50,000 80,000 0 30,000 50,000 0

A) $860,000 B) $870,000 C) $950,000 D) $960,000 Answer: D Explanation: $1,000,000 - $40,000 = $960,000 Diff: 3 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share.

14) Use the following information to calculate the "net income available to ordinary shareholders": Net income Annual dividends on cumulative preferred shares Annual dividends on non-cumulative preferred shares Dividends declared in 2026: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares Dividends paid in 2026: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares

$2,000,000 40,000 100,000 50,000 80,000 100,000 30,000 50,000 0

A) $1,820,000 B) $1,860,000 C) $1,950,000 D) $1,960,000 Answer: B Explanation: $2,000,000 - $40,000 - $100,000 = $1,860,000 Diff: 2 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share.

15) Use the following information to calculate the "net income available to ordinary shareholders": Net income Annual dividends on cumulative preferred shares Annual dividends on non-cumulative preferred shares Dividends declared in 2026: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares Dividends paid in 2026: - Common shares - Cumulative preferred shares - Non-cumulative preferred shares

$4,000,000 40,000 100,000 50,000 80,000 0 30,000 50,000 0

A) $3,860,000 B) $3,870,000 C) $3,950,000 D) $3,960,000 Answer: D Explanation: $4,000,000 - $40,000 = $3,960,000 Diff: 3 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share. 16) Use the following information to calculate the "weighted average number of ordinary shares outstanding" (WASO)? Ordinary shares, January 1, 2026 Shares issued, March 1, 2026 Shares repurchased, June 1, 2026 Shares issued, November 1, 2026

100,000 60,000 10,000 90,000

A) 104,170 B) 159,167 C) 164,830 D) 190,000 Answer: B Explanation: 100,000 × (2/12) + 160,000 × (3/12) + 150,000 × (5/12) + 240,000 × (2/12) 159,167 Diff: 3 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share. 11 Copyright © 2023 Pearson Canada Inc.

17) Use the following information to calculate the "weighted average number of ordinary shares outstanding" (WASO)? Ordinary shares, January 1, 2026 Shares issued, March 1, 2026 Shares issued, November 1, 2026

120,000 60,000 90,000

A) 120,000 B) 165,000 C) 185,000 D) 270,000 Answer: C Explanation: 120,000 × (2/12) + 180,000 × (8/12) + 270,000 × (2/12) 185,000 shares Diff: 2 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share. 18) Use the following information to calculate the "weighted average number of ordinary shares outstanding" (WASO)? Ordinary shares, January 1, 2026 Shares issued, March 1, 2026 Shares repurchased, June 1, 2026 and held as treasury shares Shares issued, November 1, 2026

100,000 60,000 10,000 90,000

A) 104,170 B) 159,167 C) 164,830 D) 190,000 Answer: B Explanation: 100,000 × (2/12) + 160,000 × (3/12) + 150,000 × (5/12) + 240,000 × (2/12) 159,167 Diff: 2 Type: MC Skill: Comp Objective: 15.2 Calculate basic earnings per share.

19) Which statement is correct? A) Share issuances increase the EPS denominator. B) Stock splits have the same effect on EPS as share issuances. C) Stock dividends have the same effect on EPS as share issuances. D) Share issuances decrease the EPS denominator. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 20) Which statement is correct? A) Share issuances decrease the EPS numerator. B) Stock splits have the same effect on EPS as share issuances. C) Share issuances increase number of shares. D) Share issuances decrease the EPS denominator. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 21) Which statement is correct about the "weighted average number of ordinary shares outstanding" (WASO)? A) Stock repurchases do not impact the WASO. B) The actual date of share issuances is ignored in the WASO. C) The actual date of stock splits is ignored in the WASO. D) Stock dividends do not impact the WASO. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.2 Calculate basic earnings per share. 22) Explain why other comprehensive income is excluded from the numerator of the EPS calculation. Answer: We exclude other comprehensive income (OCI) from the numerator because EPS is intended to measure performance; items in OCI are deemed not to be a part of current period performance. For example, OCI contains unrealized gains or losses on available-for-sale securities, which are classified as such because management does not intend to actively trade those securities. Diff: 2 Type: SA Skill: Concept Objective: 15.2 Calculate basic earnings per share.

23) Explain why dividends to preferred shareholders are adjusted in the numerator of the EPS calculation. Answer: We need to adjust for dividends on preferred shares. There are two groups that have claims on a company's profit: ordinary shareholders and preferred shareholders. While dividend payments made to the preferred shareholders do not flow through the income statement, these monies are not available to ordinary shareholders and must be deducted for EPS purposes. The amount subtracted reflects either the stated dividend rate or declared dividends, depending on whether the preferred shares are cumulative or non-cumulative. Diff: 2 Type: SA Skill: Concept Objective: 15.2 Calculate basic earnings per share. 24) Explain how the dividends on non-cumulative preferred shares are adjusted in the EPS calculation. What is the underlying logic for this adjustment? Answer: For non-cumulative preferred shares, deduct the dividends declared (whether paid or not) without considering the stated entitlement. The logic underlying these requirements is rooted in the matching concept. The company is not required to pay non-cumulative preferred dividends unless the board of directors declares them. Accordingly, it is proper to deduct dividends from net income only if they have been declared. Also, EPS is based on profit or loss for the period, rather than cash flow; accordingly, we deduct dividends in the period to which they relate rather than when they are paid. Diff: 2 Type: SA Skill: Concept Objective: 15.2 Calculate basic earnings per share. 25) For stock splits and stock dividends, while it is possible to state the number of shares as beginning-ofyear equivalents, it makes more sense to use end-of-year equivalents because financial statement readers are evaluating EPS after the end of the year. Explain why the adjustment for stock splits and stock dividends is standardized. Answer: The reasons for standardizing the adjustment date for splits and dividends are to preclude possible manipulation of EPS through discretionary timing; to ensure that EPS is prepared on a consistent basis by all companies; and to enhance comparability. Diff: 2 Type: SA Skill: Concept Objective: 15.2 Calculate basic earnings per share.

26) Explain how the dividends on cumulative preferred shares are adjusted in the EPS calculation. What is the underlying logic for this adjustment? Answer: For cumulative preferred shares, deduct the preferred shareholders' entitlement to dividends according to the stated dividend rate regardless of whether they were declared or paid. If there are dividends in arrears, only the current period's dividend rate should be considered. The logic underlying these requirements is rooted in the matching concept. The obligation to pay dividends on cumulative preferred shares arises from the passage of time. The responsibility cannot be avoided, as the preferred shareholders must receive all dividends due before any monies are distributed to ordinary shareholders. As such, it is appropriate to deduct the dividend entitlement from net income for the corresponding period even if they have not been declared. Also, EPS is based on profit or loss for the period, rather than cash flow; accordingly, we deduct dividends in the period to which they relate rather than when they are paid. Diff: 2 Type: ES Skill: Concept Objective: 15.2 Calculate basic earnings per share. 27) For the year ended December 31, 2027, Harvest Productions Inc. earned $4,000,000. Outstanding preferred shares included $400,000 in 3% cumulative preferred shares issued on January 1, 2026, and $500,000 in 2% non-cumulative preferred shares issued on January 1, 2027. Dividends on the cumulative preferred shares were not declared in 2026. On December 15, 2027, Harvest declared and paid $24,000 in dividends on the 3% cumulative shares including the arrears. Harvest also declared and paid the $10,000 dividends on the non-cumulative shares. Required: Determine the net income available to ordinary shareholders for the year ended December 31, 2027. Answer: Net income $4,000,000 Less: Cumulative preferred dividends 12,000 Less: Non-cumulative preferred dividends 10,000 Net income available to ordinary shareholders $3,978,000 The yearly dividend entitlement on the cumulative preferred shares is deducted from net income irrespective of whether dividends are declared or how much is paid out during the year. The dividends on the non-cumulative preferred shares are deducted from net income only if they are declared. The declaration date, not the payment date, is the determining factor with respect to the period in which the declared dividends are deducted from net income. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

28) For the year ended December 31, 2026, Harvest Productions Inc. earned $4,000,000. Outstanding preferred shares included $400,000 in 3% cumulative preferred shares issued on January 1, 2025, and $500,000 in 2% non-cumulative preferred shares issued on January 1, 2026. Dividends on the cumulative preferred shares were not declared in 2025. Harvest did not declare any dividends during 2026. Required: Determine the net income available to ordinary shareholders for the year ended December 31, 2026. Answer: Net income $4,000,000 Less: Cumulative preferred dividends 12,000 Less: Non-cumulative preferred dividends 0 Net income available to ordinary shareholders $3,988,000 The yearly dividend entitlement on the cumulative preferred shares is deducted from net income irrespective of whether dividends are declared or how much is paid out during the year. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share. 29) For the year ended December 31, 2026, Harvest Productions Inc. earned $4,000,000. Outstanding preferred shares included $400,000 in 3% cumulative preferred shares issued on January 1, 2025, and $500,000 in 2% non-cumulative preferred shares issued on January 1, 2026. Dividends on the cumulative preferred shares were not declared in 2025. On December 15, 2026, Harvest declared $10,000 in dividends on the non-cumulative preferred shares, payable on January 15, 2027. Dividends on the cumulative preferred shares are neither declared nor paid. Required: Determine the net income available to ordinary shareholders for the year ended December 31, 2026. Answer: Net income $4,000,000 Less: Cumulative preferred dividends 12,000 Less: Non-cumulative preferred dividends 10,000 Net income available to ordinary shareholders $3,978,000 The yearly dividend entitlement on the cumulative preferred shares is deducted from net income irrespective of whether dividends are declared or how much is paid out during the year. The dividends on the non-cumulative preferred shares are deducted from net income only if they are declared. The declaration date, not the payment date, is the determining factor with respect to the period in which the declared dividends are deducted from net income. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

30) For the year ended December 31, 2026, Jovial Productions Inc. earned $13,000,000. Outstanding preferred shares included $1,500,000 in 9% cumulative preferred shares issued on January 1, 2023, and 32,000 $160 non-cumulative preferred shares issued on January 1, 2025, that are each entitled to dividends of $7 per annum. Dividends were neither declared nor paid on either class of the preferred shares in 2024 or 2025. On December 15, 2026, the company declared and paid the $270,000 dividends in arrears on the 9% cumulative preferred shares. The company also declared and paid $224,000 dividends on the noncumulative preferred shares. Required: Determine the net income available to ordinary shareholders for the year ended December 31, 2026. Answer: Net income $13,000,000 Less: Cumulative preferred dividends 135,000 Less: Non-cumulative preferred dividends 224,000 Net income available to ordinary shareholders $12,641,000 The yearly dividend entitlement on the cumulative preferred shares is deducted from net income irrespective of whether dividends are declared or how much is paid out during the year. The dividends on the non-cumulative preferred shares are deducted from net income only if they are declared. The declaration date, not the payment date, is the determining factor with respect to the period in which the declared dividends are deducted from net income. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

31) For the year ended December 31, 2025, Jovial Productions Inc. earned $13,000,000. Outstanding preferred shares included $1,500,000 in 9% cumulative preferred shares issued on January 1, 2022, and 32,000 $160 non-cumulative preferred shares issued on January 1, 2024, that are each entitled to dividends of $7 per annum. Dividends were neither declared nor paid on either class of the preferred shares in 2023 or 2024. On December 15, 2025, the company declared and paid $140,000 of the dividends in arrears on the 9% cumulative preferred shares. Required: Determine the net income available to ordinary shareholders for the year ended December 31, 2025. Answer: Net income $13,000,000 Less: Cumulative preferred dividends 135,000 Less: Non-cumulative preferred dividends 0 Net income available to ordinary shareholders $12,865,000 The yearly dividend entitlement on the cumulative preferred shares is deducted from net income irrespective of whether dividends are declared or how much is paid out during the year. The dividends on the non-cumulative preferred shares are deducted from net income only if they are declared. The declaration date, not the payment date, is the determining factor with respect to the period in which the declared dividends are deducted from net income. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

32) For the year ended December 31, 2025, Jovial Productions Inc. earned $13,000,000. Outstanding preferred shares included $1,500,000 in 9% cumulative preferred shares issued on January 1, 2022, and 32,000 $160 non-cumulative preferred shares issued on January 1, 2024, that are each entitled to dividends of $7 per annum. Dividends were neither declared nor paid on either class of the preferred shares in 2023 or 2024. On December 15, 2025, the company declared $150,000 dividends on the 4% cumulative preferred shares and $150,000 in dividends on the non-cumulative preferred shares, both payable on January 15, 2026. Required: Determine the net income available to ordinary shareholders for the year ended December 31, 2025. Answer: Net income $13,000,000 Less: Cumulative preferred dividends 135,000 Less: Non-cumulative preferred dividends 150,000 Net income available to ordinary shareholders $12,715,000 The yearly dividend entitlement on the cumulative preferred shares is deducted from net income irrespective of whether dividends are declared or how much is paid out during the year. The dividends on the non-cumulative preferred shares are deducted from net income only if they are declared. The declaration date, not the payment date, is the determining factor with respect to the period in which the declared dividends are deducted from net income. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

33) Hamm Corporation had 200,000 ordinary shares outstanding on January 1, 2026. On April 1, 2026, Hamm issued an additional 120,000 shares. On July 1, 2026, Hamm repurchased 20,000 ordinary shares and cancelled them. On October 1, 2026, Hamm issued an additional 50,000 ordinary shares. Required: a. What was the weighted average number of ordinary shares outstanding in 2026? b. Assume that on July 1, 2026, Hamm repurchased the shares and held them as treasury shares. Will the weighted average number of ordinary shares outstanding in 2024 change from the amount in part a? Why or why not? Answer: a. Shares Fraction WASO (OS Date (2026) Activity O/S of year × fraction) Jan. 1-Mar. 31 Opening balance 200,000 3/12 50,000 Apr. 1-June 30 Issued 120,000 shares 320,000 3/12 80,000 July 1-Sept. 30 Repurchased 20,000 shares 300,000 3/12 75,000 Oct. 1-Dec. 31 Issued 50,000 shares 350,000 3/12 87,500 Weighted average number of ordinary shares outstanding 292,500 b. The weighted average number of ordinary shares in 2026 will not change. Treasury shares are issued but not outstanding; we are calculating the weighted average number of ordinary shares outstanding. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

34) Accu Tech Renovations Corp. (ATRC) was incorporated on January 1, 2026. At that time it issued 100,000 ordinary shares; 80,000, $20, 3% preferred shares "A"; and 40,000, $20, 6% preferred shares "B." Net income for the year ended December 31, 2026, was $1,800,000. ATRC declares and pays total of $238,000 in dividends. Both the preferred shares series A and B are cumulative in nature. Series A must be fully paid their current entitlement as well as any arrears before any monies are paid to the series B shareholders. Required: Compute basic EPS. Answer: Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(Both cumulative) 80,000 × $20 × 3% 40,000 × $20 × 6% $1,704,000 / 100,000=

$1,800,000 (48,000) (48,000) $1,704,000 $17.04

Supporting comment—$238,000 in dividends are declared and paid, which is more than sufficient to attend to paying both the preferred series A and B in full. The remaining $142,000 is distributed to the ordinary shareholders; however, this does not affect EPS. Supporting comment—The dividends on both series of preferred shares are cumulative and accordingly are deducted from net income irrespective of whether they have been declared or paid. The dividend entitlement on both series of preferred shares must be paid before monies can be distributed to ordinary shareholders. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

35) Accu Tech Renovations Corp. (ATRC) was incorporated on January 1, 2026. At that time it issued 100,000 ordinary shares; 80,000, $20, 3% preferred shares "A"; and 40,000, $20, 6% preferred shares "B." Net income for the year ended December 31, 2026, was $1,800,000. ATRC declares and pays total of $238,000 in dividends. The series A preferred shares arc cumulative and the series B preferred shares are non-cumulative. Series A must be fully paid their current entitlement before any monies are paid to the series B shareholders. Required: Compute basic EPS. Answer: Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(A cumulative, B non-cumulative) $1,800,000 80,000 × $20 × 3% (48,000) 40,000 × $20 × 6% (48,000) $1,704,000 $1,704,000 / 100,000 $17.04

Supporting comment—$238,000 in dividends are declared and paid, which is more than sufficient to attend to paying both the preferred series A and B in full. The remaining $142,000 is distributed to the ordinary shareholders; however, this does not affect EPS. Supporting comment—The dividends on the series A preferred are cumulative and accordingly are deducted from net income irrespective of whether they have been declared or paid. The dividends on the series B preferred shares are non-cumulative in nature. They have been deducted from net income as they were declared during the year. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

36) Accu Tech Renovations Corp. (ATRC) was incorporated on January 1, 2026. At that time it issued 100,000 ordinary shares; 80,000, $20, 3% preferred shares "A"; and 40,000, $20, 6% preferred shares "B." Net income for the year ended December 31, 2026, was $1,800,000. ATRC declares and pays total of $238,000 in dividends. Both the preferred shares series A and B are non-cumulative in nature. Series A must be fully paid their current entitlement before any monies are paid to the series B shareholders. Required: Compute basic EPS. Answer: Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(Both non-cumulative) $1,800,000 80,000 × $20 × 3% (48,000) 40,000 × $20 × 6% (48,000) $1,704,000 $1,704,000 / 100,000 $17.04

Supporting comment—$238,000 in dividends are declared and paid, which is more than sufficient to attend to paying both the preferred series A and B in full. The remaining $142,000 is distributed to the ordinary shareholders; however, this does not affect EPS. Supporting comment—The dividends on both series of preferred shares are non-cumulative. They have been deducted from net income as they were declared during the year. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

37) Tropical Island Inc. (TIl) was incorporated on January 1, 2026. At that time it issued 300,000 ordinary shares; 10,000, $10, 8% preferred shares "A"; and 100,000, $10, 9% preferred shares "B." Net income for the year ended December 31, 2026, was $1,600,000. TIl declares and pays a total of $68,000 in dividends. Both the preferred shares series A and B are cumulative in nature. Series A must be fully paid their current entitlement as well as any arrears before any monies are paid to the series B shareholders. Required: Compute basic BPS. Answer: Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(Both cumulative) 10,000 × $10 × 8% 10,000 × $10 × 9%

$1,600,000 (8,000) (90,000)

$1,502,000 / 300,000

$1,502,000 $5.01

Supporting comment—$68,000 in dividends are declared and paid, which is insufficient to attend to paying both the preferred series A and B in full. As such, no monies are distributed to the ordinary shareholders. Supporting comment—The dividends on both series of preferred shares are cumulative and accordingly are deducted from net income irrespective of whether they have been declared or paid. The dividend entitlement on both series of preferred shares must be paid before monies can be distributed to ordinary shareholders. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

38) Tropical Island Inc. (TIl) was incorporated on January 1, 2026. At that time it issued 300,000 ordinary shares; 10,000, $10, 8% preferred shares "A"; and 100,000, $10, 9% preferred shares "B." Net income for the year ended December 31, 2026, was $1,600,000. TIl declares and pays a total of $68,000 in dividends. The series A preferred shares are cumulative and the series B preferred shares are non-cumulative. Series A must be fully paid their current entitlement before any monies are paid to the series B shareholders. Required: Compute basic BPS. Answer:

Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(A cumulative, B non-cumulative) 10,000 × $10 × 8% $68,000 - $8,000

$1,600,000 (8,000) (60,000)

$1,532,000 / 300,000

$1,532,000 $5.11

Supporting comment—$68,000 in dividends are declared and paid, which is insufficient to attend to paying both the preferred series A and B in full. As such, no monies are distributed to the ordinary shareholders. Supporting comment—The dividends on the series A preferred are cumulative and accordingly are deducted from net income irrespective of whether they have been declared or paid. The dividends on the series B preferred shares are non-cumulative in nature. Accordingly, only the $60,000 dividend declaration pertaining to the series B preferred shares ($68,000 - $8,000) is deducted from net income available to ordinary shareholders. Diff: 2 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

39) Tropical Island Inc. (TIl) was incorporated on January 1, 2026. At that time it issued 300,000 ordinary shares; 10,000, $10, 8% preferred shares "A"; and 100,000, $10, 9% preferred shares "B." Net income for the year ended December 31, 2026, was $1,600,000. TIl declares and pays a total of $68,000 in dividends. Both the preferred shares series A and B are non-cumulative in nature. Series A must be fully paid their current entitlement before any monies are paid to the series B shareholders. Required: Compute basic BPS. Answer:

Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

Situation iii (Both non-cumulative) 10,000 × $10 × 8% $68,000 - $8,000

$1,600,000 (8,000) (60,000)

$1,532,000 / 300,000

$1,532,000 $5.11

Supporting comment—$68,000 in dividends are declared and paid, which is insufficient to attend to paying both the preferred series A and B in full. As such, no monies are distributed to the ordinary shareholders. Supporting comment—The dividend declaration of $68,000 is insufficient to satisfy both series current entitlement. As dividends on both series of preferred shares are non-cumulative, only the $68,000 declared has been deducted from net income available to ordinary shareholders. Diff: 2 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

40) Summer Surprise Ltd. (SSL) was incorporated on January 1, 2026. At that time, it issued 210,000 ordinary shares; 95,000, $65, 2% preferred shares "A"; and 85,000, $65, 4% preferred shares "B." Net income for the year ended December 31, 2026, was $500,000. SSL neither declares nor pays dividends during the year. Both the preferred shares series A and B are cumulative in nature. Series A must be fully paid their current entitlement as well as any arrears before any monies are paid to the series B shareholders. Required: Compute basic BPS. Answer: Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(Both cumulative) 95,000 × $65 × 2% 85,000 × $65 × 4% $155,500 / 210,000

$500,000 (123,500) (221,000) $155,500 $0.74

Supporting comment—Dividends are neither declared nor paid. Supporting comment—dividends on both series of preferred shares are cumulative and accordingly are deducted from net income irrespective of whether they have been declared or paid. The dividend entitlement on both series of preferred shares must be paid before monies can be distributed to ordinary shareholders. Diff: 2 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

41) Summer Surprise Ltd. (SSL) was incorporated on January 1, 2026. At that time, it issued 210,000 ordinary shares; 95,000, $65, 2% preferred shares "A"; and 85,000, $65, 4% preferred shares "B." Net income for the year ended December 31, 2026, was $500,000. SSL neither declares nor pays dividends during the year. The series A preferred shares are cumulative and the series B preferred shares are noncumulative. Series A must be fully paid their current entitlement before any monies are paid to the series B shareholders. Required: Compute basic BPS. Answer:

Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(A cumulative, B non-cumulative) 95,000 × $65 × 2%

$500,000 (123,500) (0)

$376,500 / 210,000

$376,500 $1.79

Supporting comment—Dividends are neither declared nor paid. Supporting comment—Dividends on the series A preferred are cumulative and accordingly are deducted from net income irrespective of whether they have been declared or paid. The dividends on the series B preferred are non-cumulative in nature and are ignored for EPS purposes as they were not declared. Diff: 1 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

42) Summer Surprise Ltd. (SSL) was incorporated on January 1, 2026. At that time, it issued 210,000 ordinary shares; 95,000, $65, 2% preferred shares "A"; and 85,000, $65, 4% preferred shares "B." Net income for the year ended December 31, 2026, was $500,000. SSL neither declares nor pays dividends during the year. Both the preferred shares series A and B are non-cumulative in nature. Series A must be fully paid their current entitlement before any monies are paid to the series B shareholders. Required: Compute basic BPS. Answer: Net income Less: Preferred dividends "A" Less: Preferred dividends "B" NI available to ordinary shareholders Basic EPS

(Both cumulative) $500,000 (0) (0)

$500,000 / 210,000

$500,000 $2.38

Supporting comment—Dividends are neither declared nor paid. Supporting comment—The dividends on both series of preferred shares are non-cumulative in nature and are ignored for EPS purposes as they were not declared. Diff: 2 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

43) Traditional Bathrooms Inc. (TBI) had 80,000 ordinary shares outstanding on January 1, 2025. Transactions throughout 2025 affecting its shareholdings follow. • February 1: TBI issued 200,000, $10, cumulative 10% preferred shares. • March 1: TBI issued 40,000 ordinary shares. • April l: TBI declared and issued an 8% stock dividend on the ordinary shares. • July 1: TBI repurchased and cancelled 30,000 ordinary shares. • October 1: TBI declared and issued a 3-for-l stock split on the ordinary shares. • December 31: TBI declared $99,600 in dividends on the ordinary shares. • Net income for the year ended December 31, 2025, was $600,000. Its tax rate was 40%. Required: a. What was weighted average number of ordinary shares outstanding in 2025? b. What was basic EPS in 2025? c. If the preferred shares issued on February 1, 2025, were non-cumulative, what would basic EPS for 2025 have been?

Answer:

WASO Adj. Fraction (OS × AF Date (2025) Activity factor of year × fraction) Jan. 1-Feb. 28 Opening balance 3.0 × 1.08 (3) 2/12 43,200 Mar. 1-Mar. 31 Issued shares 120,000 3.0 × 1.08 (3) 1/12 32,400 Apr. 1-June 30 stock dividend 129,600 (1) 3.0 (4) 3/12 97,200 July 1-Sept. 30 Repurchased shares 99,600 3.0 (4) 3/12 74,700 Oct. 1-Dec. 31 3-for-1 stock split 298,800 (2) (5) 3/12 74,700 Weighted average number of ordinary shares outstanding 322,200 Shares O/S 80,000

Supporting comments and computations (1) 120,000 × (1 + 8%) = 129,600 (2) 99,600 × 3 = 298,800 (3) For WASO purposes we assume that the stock split and stock dividend both took place at the beginning of the year. We adjust for this by multiplying the actual number of shares outstanding by 3 (3:1 stock split) and then again by 1.08 (1 + 8% stock dividend). (4) As the outstanding number of shares includes those issued in the stock dividend, we only need to adjust it for the stock split. (5) As the outstanding number of shares includes those issued in the stock split and stock dividend, we need not make any further adjustments. b. Calculation of basic EPS Net income Less: Preferred dividends - cumulative - amount of entitlement Net income available to ordinary shareholders Basic EPS

$600,000 200,000 × $10 × 10% × 11/12*

$416,667 / 322,200

(183,333) $416,667 $1.29

*As the shares were issued during the year we must pro-rate the dividend entitlement c. Basic EPs if preferred shares are non-cumulative Net income Less: Preferred dividends - non-cumulative - amount declared Net income available to ordinary shareholders Basic EPS $500,400 / 322,200 Diff: 3 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

$600,000 (99,600) $500,400 $1.55

44) Micky and Donald Corp. was founded on January 1, 2026. At that time it issued 120,000 ordinary shares and 20,000, $30, cumulative 5% preferred shares. Subsequent transactions affecting its shareholdings follow. 2026 • September 1: Micky issued 300,000, $30, non-cumulative 6% preferred shares. • December 1: Micky issued 80,000 ordinary shares. • Dividends were not declared in 2026. 2027 • February 1: Micky issued 30,000 ordinary shares. • June 1: Micky repurchased 50,000 shares and held them as treasury shares. • July 1: Micky declared and paid $45,000 in dividends on the cumulative preferred shares, $270,000 on the non-cumulative preferred shares, and $180,000 on the ordinary shares. • September 1: Micky reissued (sold) the 50,000 shares held in treasury. • October 1: Micky declared and issued a 3-for-l stock split on the ordinary shares. • December 1: Micky declared and paid $15,000 in dividends on the cumulative preferred shares, $270,000 on the non-cumulative preferred shares, and $180,000 on the ordinary shares. • Micky's net income for the year ended December 31, 2027, was $2,000,000. Its tax rate was 30%. Required: a. What was Micky's weighted average number of ordinary shares outstanding in 2027? b. What was Micky's basic EPS in 2027?

Answer: a. Shares O/S (A) 200,000 230,000 180,000

Date (2027) Jan. 1-Jan. 31 Feb. 1-May 31 June 1-Aug. 31 Sept. 1-Sept. 30

Activity Opening balance (1) Issued shares Repurchased shares (2) Reissued shares held in treasury 230,000 (2) Oct. 1-Dec. 31 Three-for-one stock split 690,000 (3) Weighted average number of ordinary shares outstanding

Adj. Fraction WASO factor of year (A × B (B) (C) × C) 3.0 (4) 1/12 50,000 3.0 (4) 4/12 230,000 3.0 (4) 3/12 135,000 3.0

(4)

1/12

57,500

(5)

3/12

172,500 645,000

Supporting comments and computations (1) From 2026: 120,000 + 80,000 = 200,000 (2) The fact that the repurchased shares are held in treasury is irrelevant as we are interested in outstanding shares, not issued shares (3) 230,000 × 3 = 690,000 (4) For WASO purposes we assume that the stock split took place at the beginning of the year. We adjust for this by multiplying the actual number of shares outstanding by 3 (3:1 stock split) (5) As the outstanding number of shares includes those issued in the stock split, we need not make any further adjustments. b. Calculation of basic EPS Net income Less: Preferred dividends - cumulative - amount of entitlement - non-cumulative - amount declared

$2,000,000 20,000 × $30 × 5% $270,000 + $270,000

(30,000) (540,000) $1,430,000

Basic EPS $1430,000 / 645,000 Diff: 3 Type: ES Skill: Comp Objective: 15.2 Calculate basic earnings per share.

$2.22

Learning Objective 3 Differentiate between dilutive and antidilutive potential ordinary shares. 1) Which statement is correct? A) Diluted EPS will always be less than basic EPS. B) Diluted EPS will always be greater than basic EPS. C) Diluted EPS will always be equal to EPS. D) Diluted EPS will be less than or equal to basic EPS. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

2) Which statement is correct? A) The numerator for diluted EPS is the same as the numerator for basic EPS. B) Potential ordinary shares are derivative instruments that entitle the holder to commodities. C) Potential ordinary shares are financial instruments that entitle the holder to ordinary shares. D) The numerator for diluted EPS is always greater than the numerator for basic EPS. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 3) Which statement is correct about potential ordinary shares (POS)? A) Dilutive POS decrease EPS. B) Dilutive POS increase EPS. C) Anti-dilutive POS decrease EPS. D) Anti-dilutive POS are included in EPS. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 4) Which of the following are financial instruments that give rise to POS? A) Convertible bonds that can be exchanged for cumulative preferred shares. B) Convertible preferred shares that can be exchanged for ordinary shares. C) Land that can be exchanged for preferred shares. D) Stock options and warrants that permit the holder to buy preferred shares from the company at a predetermined price. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 5) Which statement is correct about the "income effect" on EPS? A) This is the incremental before-tax income available to ordinary shareholders. B) This is the incremental after-tax income available to ordinary shareholders. C) This is the incremental number of ordinary shares outstanding before conversion. D) This is the incremental number of ordinary shares outstanding after conversion. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

6) Which statement is correct about the "if-converted" method for EPS? A) This method assumes the convertible security is converted into ordinary shares at the end of the fiscal period. B) This method assumes the convertible security is converted into ordinary shares at the beginning of the fiscal period. C) This method assumes the convertible security is converted into ordinary shares evenly over the fiscal period. D) This method assumes the convertible security is converted into ordinary shares at the mid-point of the fiscal period. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 7) Calculate the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 5% and coupon rate of 5% $2,000,000 Issue date January 1, 2024 Maturity date December 31, 2029 Conversion rate for each $1,000 bond 20 ordinary shares Tax rate 25% A) $0.63 B) $1.88 C) $0,000 D) $75,000 Answer: B Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $2,000,000 × 5% × (1 - 25%) = $75,000 Bonds × conversion rate = $2,000,000 / $1,000 × 20 = 40,000 shares $75,000 / 40,000 shares= $1.88

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

8) Calculate the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 6% and coupon rate of 6% $3,000,000 Issue date January 1, 2024 Maturity date December 31, 2029 Conversion rate for each $1,000 bond 20 ordinary shares Income tax rate 30% A) $0.63 B) $1.88 C) $60,000 D) $2.10 Answer: D Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $3,000,000 × 6% × (1 - 30%) = $126,000 Bonds × conversion rate = ($3,000,000 / $1,000) × 20 = 60,000 shares $126,000 / 60,000 shares = $2.10

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

9) Calculate the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 6% and coupon rate of 6% $3,500,000 Issue date January 1, 2026 Maturity date December 31, 2033 Conversion rate for each $1,000 bond 40 ordinary shares Income tax rate 30% A) $1.05 B) $1.88 C) $140,000 D) $3.15 Answer: A Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $3,500,000 × 6% × (1 - 30%) = $147,000 Bonds × conversion rate = ($3,500,000 / $1,000) × 20 = 140,000 shares $147,000 / 140,000 shares = $1.05

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 10) Which statement is correct about the "share effect" on EPS? A) This is the incremental before-tax income available to ordinary shareholders. B) This is the incremental after-tax income available to ordinary shareholders. C) This is the incremental number of ordinary shares outstanding before conversion. D) This is the incremental number of ordinary shares outstanding after conversion. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 11) What is the meaning of an "in the money call option"? A) A call option is in-the-money when the market price means that it will expire un-exercised. B) A call option is in-the-money if the market price of the share equals the exercise price. C) A call option is in-the-money if the market price of the share is less than the exercise price. D) A call option is in-the-money if the market price of the share exceeds the exercise price. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

12) Which statement is correct about the "if-converted" method for EPS? A) This method assumes the interest is paid on the convertible security until it was converted into ordinary shares. B) This method assumes the interest is paid on the convertible security for one-half of the year. C) This method assumes the interest is paid on the convertible security for the period after its issue date. D) This method assumes the no interest is paid on the convertible security for the entire year. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 13) Calculate the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 3% and coupon rate of 3% $5,000,000 Issue date January 1, 2026 Maturity date December 31, 2033 Conversion rate for each $1,000 bond 25 ordinary shares Income tax rate 30% A) $0.36 B) $0.84 C) $40.00 D) $105,000 Answer: B Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $5,000,000 × 3% × (1 - 30%) = $105,000 Bonds × conversion rate = $5,000,000 / $1,000 × 25 = 125,000 shares $105,000 / 125,000 shares = $0.84

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

14) Calculate the income effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 8% and coupon rate of 8% $5,000,000 Issue date January 1, 2026 Maturity date December 31, 2033 Conversion rate for each $1,000 bond 25 ordinary shares Income tax rate 30% A) $0.96 B) $2.24 C) $120,000 D) $280,000 Answer: D Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $5,000,000 × 8% × (1 - 30%) = $280,000 Bonds × conversion rate = $5,000,000 / $1,000 × 25 = 125,000 shares $280,000 / 125,000 shares = $2.24

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

15) Calculate the income effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 6% and coupon rate of 6% $2,000,000 Issue date January 1, 2026 Maturity date December 31, 2033 Conversion rate for each $1,000 bond 20 ordinary shares Income tax rate 25% A) 0.75 B) 2.25 C) 40,000 D) 90,000 Answer: D Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $2,000,000 × 6% × (1 - 25%) = $90,000 Bonds × conversion rate = $2,000,000 / $1,000 × 20 = 40,000 shares $90,000 / 40,000 shares= $2.25

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

16) Calculate the share effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 5% and coupon rate of 5% $2,000,000 Issue date January 1, 2026 Maturity date December 31, 2033 Conversion rate for each $1,000 bond 40 ordinary shares Income tax rate 25% A) 0.63 B) 0.94 C) 75,000 D) 80,000 Answer: D Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $2,000,000 × 5% × (1 - 25%) = $75,000 Bonds × conversion rate = $2,000,000 / $1,000 × 40 = 80,000 shares $75,000 / 80,000 shares = $0.94

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 17) Calculate the incremental EPS for the following instrument: Face value of 10,000 preferred shares with dividend rate of 5% Conversion rate for each preferred share Income tax rate A) $0.30 B) $0.70 C) $1.00 D) $2.00 Answer: C Explanation: Income effect Share effect Incremental EPS

$5,000,000 25 ordinary shares 30%

Par value × dividend rate = $5,000,000 × 5% = $250,000 PS × conversion rate = 10,000 × 25 = 250,000 shares $250,000 / 250,000 shares = $1.00

18) Calculate the incremental EPS for the following instrument: Face value of 10,000 preferred shares with dividend rate of 5% Conversion rate for each preferred share Income tax rate A) $0.14 B) $0.20 C) $1.40 D) $2.00 Answer: B Explanation: Income effect Share effect Incremental EPS

$1,000,000 25 ordinary shares 30%

Par value × dividend rate = $1,000,000 × 5% = $50,000 PS × conversion rate = 10,000 × 25 = 250,000 shares $50,000 / 250,000 shares = $0.20

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 19) Calculate the income effect on the incremental EPS for the following instrument: Face value of 50,000 preferred shares with dividend rate of 5% Conversion rate for each preferred share Income tax rate A) $1.00 B) $75,000 C) $175,000 D) $250,000 Answer: D Explanation: Income effect Share effect Incremental EPS

$5,000,000 5 ordinary shares 30%

Par value × dividend rate = $5,000,000 × 5% = $250,000 PS × conversion rate = 50,000 × 5 = 250,000 shares $250,000 / 250,000 shares = $1.00

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

20) Calculate the share effect on the incremental EPS for the following instrument: Face value of 50,000 preferred shares with dividend rate of 5% Conversion rate for each preferred share Income tax rate A) 5 B) 25,000 C) 50,000 D) 250,000 Answer: D Explanation: Income effect Share effect Incremental EPS

$5,000,000 5 ordinary shares 30%

Par value × dividend rate = $5,000,000 × 5% = $250,000 PS × conversion rate = 50,000 × 5 = 250,000 shares $250,000 / 250,000 shares = $1.00

Diff: 2 Type: MC Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 21) What is the meaning of "out-of-the-money warrants"? A) Warrants are out-of-the-money if the market price of the share exceeds the exercise price. B) Warrants are out-of-the-money if the market price of the share is less than the exercise price. C) Warrants are out-of-the-money if the market price of the share equals the exercise price. D) Warrants are out-of-the-money when the market price means that it will be exercised. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 22) What is the meaning of "at-the-money options"? A) An option is at-the-money when the market price means that it will be exercised. B) An option is at-the-money if the market price of the share equals the exercise price. C) An option is at-the-money if the market price of the share is less than the exercise price. D) An option is at-the-money if the market price of the share exceeds the exercise price. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

23) What is the formula for diluted EPS? What are dilutive and antidilutive potential ordinary shares and how do they each impact the computation of dilutes EPS? Answer: Diluted EPS = (Net income available to ordinary shareholders + the income effect of dilutive potential ordinary shares) / (Weighted average number of ordinary shares outstanding + the share effect of dilutive potential ordinary shares). Dilutive potential ordinary shares (POS) are financial instruments or agreements that if exercised would result in basic EPS decreasing. Antidilutive POS are financial instruments or agreements that if exercised would result in basic EPS increasing. Dilutive POS are included in the determination of diluted EPS while antidilutive POS are ignored. Diff: 2 Type: SA Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 24) Since, the objective of reporting diluted EPS is to provide the lowest possible EPS figure, we include all dilutive POS but exclude any antidilutive POS. What are the four steps in the process to separate dilutive from antidilutive POS and to calculate diluted EPS? Answer: 1. Identify all potential ordinary shares. 2. Compute "incremental EPS" for each category of potential ordinary shares. 3. Rank order incremental EPS on potential ordinary shares from the lowest (the most dilutive) to the highest (least dilutive). 4. Sequentially compare incremental EPS to "provisional EPS" to determine diluted EPS. Diff: 1 Type: SA Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 25) Explain the purpose of incremental EPS. Answer: Incremental EPS is used to rank the order of the securities in terms of their dilutiveness. This information is needed to identify dilutive and antidilutive POS and ensure that we obtain the lowest (i.e., most dilutive) EPS. Diff: 2 Type: SA Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 26) Explain the "income effect" and "share effect" as they apply to the calculation of incremental EPS. Answer: Income effect: The income effect indicates the incremental after-tax income available to ordinary shareholders if a category of potential ordinary shares had been converted into ordinary shares. There is a different income effect for each class of POS. Share effect: The share effect indicates the incremental number of ordinary shares outstanding if a category of potential ordinary shares had been converted into ordinary shares. There is a different share effect for each class of POS. In addition, it is necessary to treat convertible securities differently from options and warrants because of the different nature of the two types of securities. Diff: 2 Type: SA Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

27) Describe the procedure for identifying dilutive and antidilutive potential ordinary shares and calculating diluted EPS. Answer: The process for identifying dilutive and antidilutive POS and calculating diluted EPS follows: i) Identify all potential ordinary shares ii) Compute incremental EPS for each category of potential ordinary shares a. Calculate incremental EPS on convertible bonds and convertible preferred shares using the ifconverted method b. Determine incremental EPS on warrants and options using the treasury stock method iii) Rank incremental EPS on potential ordinary shares from the lowest (the most dilutive) to the highest (least dilutive) iv) Sequentially compare incremental EPS to provisional EPS. If incremental EPS is lower than provisional EPS, include the POS in the diluted EPS computation and check the next rank-ordered item for dilutiveness. Continue the process until incremental EPS exceeds provisional EPS. At this point, further calculations are not required as the last recorded provisional EPS equals diluted EPS. Diff: 2 Type: ES Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 28) Explain why only in-the-money options need be considered in the diluted EPS calculations. Answer: For purposes of computing diluted EPS, we consider only call options and warrants that are in-the-money, which is when the market price of the underlying security exceeds the exercise price (also called the strike price). They are said to be in-the-money as the holder could pay the agreed-upon exercise price (say $30) and immediately resell the security for the market price (say $32) and earn a profit. Conversely, call options and warrants are out-of-the-money when the market price of the security is less than the exercise price. They are said to be out-of-the-money because the holder would have to pay more for the security (say $34) than he/ she could simultaneously sell it for in the market (say $32), and as such would generate a loss if this sub-optimal strategy were pursued. Diff: 2 Type: ES Skill: Concept Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

29) Two different companies have many similarities, including the following: • They both earned net income of $3,500,000 for the year ended December 31, 2025; • They are both subject to a 35% tax rate; • The average price of the companies' ordinary shares during the year was $26; and • Each company had 1,400,000 ordinary shares outstanding during the year. They do have slightly different complex capital structures, however. Specifically: • Company ACE had stock options outstanding the entire year that allowed employees to buy 50,000 ordinary shares for $20 each until December 31, 2027. • Company DUECE had $600,000 in 5% bonds maturing on December 31, 2027, that were outstanding the entire year. Each $1,000 bond is convertible into 5 ordinary shares any time before expiry. Required: a. Calculate the basic EPS of both companies. b. Prepare a schedule that sets out the income effect, share effect, and incremental EPS for each company's security that is convertible into ordinary shares. c. Consider each company's POS and determine whether it is dilutive or antidilutive. Answer: a. Basic EPS for each company is the same $3,500,000 / 1,400,000* $2.50 b. Incremental EPS c. Dilutive? Potential ordinary Incremental Company shares Income effect Share effect EPS Stock $0 IS = N(1 - K/S) = $0.00 Dilutive option 50,000(1 - $20 / $26) = ACE 11,538 (rounded) Convertible ($600,000 × $600,000 / $1,000 × 5 $79,500 / Antidilutive bond 0.05) × (1 - 35%) = 3,000 3,000 = $6.50 DUECE = $19,500 IS = number of incremental shares to be issued; K = exercise price; N = number of shares that would have been issued for option exercise; S = average market price Diff: 1 Type: ES Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

30) Two different companies have many similarities, including the following: • They both earned net income of $3,500,000 for the year ended December 31, 2025; • They are both subject to a 35% tax rate; • The average price of the companies' ordinary shares during the year was $26; and • Each company had 1,400,000 ordinary shares outstanding during the year. They do have slightly different complex capital structures, however. Specifically: • Company Black had stock options outstanding the entire year that allowed employees to buy 10,000 ordinary shares for $22 each between January 1, 2026, and December 31, 2027. • Company Clark had $4,000,000 in 4% non-cumulative preferred shares outstanding the entire year. Each $100 share is convertible into three ordinary shares. Dividends were not declared in 2025. Required: a. Calculate the basic EPS of both companies. b. Prepare a schedule that sets out the income effect, share effect, and incremental EPS for each company's security that is convertible into ordinary shares. c. Consider each company's POS and determine whether it is dilutive or antidilutive. Answer: a. Basic EPS for each company is the same $3,500,000 / 1,400,000* $2.50 b. Incremental EPS Potential ordinary Company shares

c. Dilutive?

Incremental Share effect EPS IS = N(1 - K/S) = $0.00 Dilutive Stock option $0 10,000(1 - $22 / $26) = Black 1,538 (rounded) Convertible $0** ($4,000,000 / $100) × $0.00 Dilutive Clark preferred 3 = 120,000 **Dividends were not declared on the non-cumulative shares. Income effect

IS = number of incremental shares to be issued; K = exercise price; N = number of shares that would have been issued for option exercise; S = average market price Diff: 1 Type: ES Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

31) The net income for Harley's Equestrian Show Jumping Co. for the year ended December 31, 2025, was $1,400,000. Harley had 30,000 ordinary shares outstanding at the beginning of the year. Harley declared and distributed a 3-for-1 stock split on May 1, 2025, and issued (sold) 40,000 ordinary shares on November 1, 2025. Select details of Harley's liabilities and equities follow: • Bonds A—$1,400,000, 11%, 10-year, semi-annual bonds issued on July 1, 2025. At the option of the holder, each $1,000 bond can be converted into 20 ordinary shares at any time before expiry. • Bonds B—$1,500,000, 9%, semi-annual bonds maturing September 30, 2029. The owners of the bonds elect to convert them into 25,500 ordinary shares on December 1, 2025. • 50,000 cumulative preferred shares that are each entitled to dividends of $20.00 per annum. Dividends are not declared in 2025. • Harley's corporate tax rate was 30%. The recorded conversion factor for the convertible bonds has already been adjusted for the stock split. Required: Assuming that the effective rate of interest on the bonds equals the coupon rate: a. Calculate Harley's basic earnings per share for 2025. b. Prepare a schedule that sets out the income effect, share effect, and incremental EPS for each security that is convertible into ordinary shares. Rank the potential ordinary shares by their dilutiveness. c. Calculate Harley's diluted earnings per share for 2025.

Answer: a. Net income to ordinary shareholders Net income Less: Preferred dividends

$1,400,000 $(1,000,000) $400,000

50,000 × $20.00

Weighted average number of ordinary shares outstanding Shares O/S 30,000 90,000 130,000

Date (2025) Jan. 1-Apr. 31 May 1-Oct. 31 Nov. 1-Nov. 30 Dec. 1-Dec. 31

WASO Adj. Fraction (OS × AF factor of year × fraction) 3.0 4/12 30,000 1 6/12 45,000 1 1/12 10,833

Activity Opening balance 3-for-1 stock split Issued 30,000 shares Bond conversion - 12,000 shares 155,500 1 Weighted average number of ordinary shares outstanding Basic EPS

$400,000 / 98,791

1/12

12,958

98,791

$4.05

b. Incremental EPS / Rank the dilutiveness of POS Potential ordinary shares Income effect Share effect Convertible ($1,400,000 × 0.11) × ($1,400,000 / $1,000) bonds A (1 - 30%) × 6/12* × 20 × 6/12 = $53,900 = 14,000 Convertible ($1,500,000 × 0.09) × 25,500 × 11/12 bonds B (1 - 30%) × 11/12** = 23,375 = $86,625

Incremental EPS $3.85

Rank order 2

$3.71

*As the bonds were issued during the year, the income and share effect both need to be pro-rated. **As the bonds were converted during the year, the income effect is calculated only for the period that the bonds were outstanding. Similarly, the potential ordinary shares are pro-rated for the period the convertible security was outstanding. Factoring in the partial year does not affect incremental EPS because the same adjustment is made to the numerator (income effect) and denominator (share effect). However, the partial year adjustment does affect the calculation of diluted EPS, as determined below. c. Sequentially compare the incremental EPS to the provisional EPS to determine diluted EPS Basic Provisional Diluted Income Shares EPS EPS EPS Basic EPS $400,000 98,791 $4.05 Bond B 86,625 23,375 Provisional EPS 486,625 122,166 $3.98 Bond A 53,900 14,000 Diluted earnings per share $540,525 136,166 $3.97 Diff: 2 Type: ES Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 32) The net income for Cedarsprings Retreat Centre for the year ended December 31, 2025, was $800,000. 49 Copyright © 2023 Pearson Canada Inc.

Cedarsprings had 50,000 ordinary shares outstanding at the beginning of the year. Cedarsprings declared and distributed a three-for-one stock split on May 1, 2025, and issued (sold) 30,000 ordinary shares on November 1, 2025. Select details of Cedarsprings' liabilities and equities follow: Bonds A–$2,000,000, 6%, 10-year, semi-annual bonds issued on July 1, 2025. At the option of the holder, each $1,000 bond can be converted into 14 ordinary shares at any time before expiry. Bonds B–$2,000,000, 5%, semi-annual bonds maturing September 30, 2029. The owners of the bonds elect to convert them into 12,000 ordinary shares on December 1, 2025. 200,000 cumulative preferred shares that are each entitled to dividends of $2.00 per annum. Dividends are not declared in 2025. Cedarsprings' corporate tax rate was 40%. The recorded conversion factor for the convertible bonds has already been adjusted for the stock split. Required: Assuming that the effective rate of interest on the bonds equals the coupon rate: a) Calculate Cedarsprings' basic earnings per share for 2025. b) Prepare a schedule that sets out the income effect, share effect, and incremental EPS for each security that is convertible into ordinary shares. Rank the potential ordinary shares by their dilutiveness. c) Calculate Cedarsprings' diluted earnings per share for 2025.

Answer: Cedarsprings' basic and diluted EPS are $2.56 and $2.56, respectively, determined as follows: Net income to ordinary shareholders Net income Less: Preferred dividends

$800,000 (400,000) $400,000

200,000 × $2.00

Weighted average number of ordinary shares outstanding Shares Adj. Activity O/S factor Opening balance 50,000 3.0 3-for-1 stock split 150,000 1 Issued 30,000 shares 180,000 1 Bond conversion - 12,000 shares 192,000 1 Weighted average number of ordinary shares outstanding Date (2025) Jan. 1-Apr. 31 May 1-Oct. 31 Nov. 1-Nov. 30 Dec. 1-Dec. 31

Basic EPS

WASO Fraction (OS × AF of year × fraction) 4/12 50,000 6/12 75,000 1/12 15,000 1/12

$400,000 / 156,000

16,000 156,000 $2.56

Incremental EPS / Rank the dilutiveness of POS Potential Incremental ordinary shares Income effect Share effect EPS Convertible ($2,000,000 × 0.06) × ($2,000,000 /$1,000) $2.57 bonds A (1 - 40%) × 6/12* = $36,000 × 14 × 6/12 = 14,000 Convertible bonds B

($2,000,000 × 0.05) × (1 - 40%) × 11/12** = $55,000

($2,000,000 /$1,000) × 6 × 11/12 = 11,000

$5.00

Rank order 1

Diff: 2 Type: ES Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares.

33) Know Your Rights Co. has three stock option plans outstanding on December 31, 2025. It provides the holders with the following entitlements: • Stock option A—The holders may purchase 55,000 ordinary shares at any time on or before December 31, 2029, for $41 each. • Stock option B—The holders may purchase 2,000 ordinary shares at any time on or before December 31, 2026 for $47 each. From January 1, 2027, to December 31, 2029, the holders may purchase 7,000 ordinary shares for $52 each. • Stock option C—The holders may purchase 12,000 ordinary shares at any time on or before December 31, 2027 for $51 each. The average price of ordinary shares in 2025 was $50 and its basic EPS from continuing operations for the year was $1.01. Required: a. Which of the stock options are dilutive and which are antidilutive in 2025? What is the rule in this respect? b. Assuming that all three option plans have been in place the entire year, for each plan, determine the incremental number of shares, if any, that need to be considered for diluted EPS purposes. c. Assume that stock option A was issued on April 1, 2025. Does this change your answer to part b? If so, what is the revised number of incremental shares for option A that need to be considered for diluted EPS purposes? Answer: a. Stock options A and B are dilutive, while stock option C is antidilutive. Stock options A and B are in the money: their exercise price is less than the market price of the shares. Stock option C is out of the money: its exercise price is greater than the market price of the shares. The rule in this respect is that if earnings per share from continuing operations is positive, then in-the-money call options are dilutive and out-ofthe-money options are antidilutive. When there are multiple conversion options, as with stock option B, the most dilutive alternative is always considered—which in this case is $47. Hence, stock option B is dilutive. b. The number of incremental shares arising from each of these option plans is as follows: i) Stock option A—9,900 shares [Number of incremental shares to be issued = [[(average market price strike price) / average market price] × number of options = ($50 - $41) / $50] × 55,000] ii) Stock option B—120 shares [Number of incremental shares to be issued = [[(average market price strike price) / average market price] × number of options = ($50 - $47) / $50] × 2,000] iii) Stock option C—0 (the options are antidilutive as they are out of the money) c. Yes, the answer to part b changes, because when options are issued during the year the incremental shares need to be pro-rated: [Number of incremental shares to be issued = [[(average market price - strike price) / average market price] × number of options × fraction of year options outstanding = ($50 - $41) / $50] × 55,000 × 9 / 12 = 7,425] Diff: 2 Type: ES Skill: Comp Objective: 15.3 Differentiate between dilutive and antidilutive potential ordinary shares. 52 Copyright © 2023 Pearson Canada Inc.

Learning Objective 4 Calculate diluted earnings per share. 1) Which statement is correct? A) Out of the money stock options are the most dilutive. B) Convertible bonds are the most dilutive. C) Convertible preferred shares are the most dilutive. D) In the money stock options are the most dilutive. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share. 2) Which statement is correct about diluted EPS? A) The incremental EPS of the least dilutive item is compared to the basic EPS. B) The incremental EPS of the most dilutive item is compared to the basic EPS. C) If the incremental EPS is higher than the basic EPS, the item is dilutive. D) If the incremental EPS is lower than the basic EPS, the item is anti-dilutive. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share. 3) Which statement is correct? A) When convertible securities are redeemed during the year, the income effect and share effect are not pro-rated for the diluted EPS calculation. B) When convertible securities are issued during the year, the income effect and share effect are not prorated for the diluted EPS calculation. C) When the right to convert convertible securities expires during the year, the income effect and share effect are pro-rated for the diluted EPS calculation. D) When convertible securities are issued at the beginning of the year, the income effect and share effect are pro-rated for the diluted EPS calculation. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share.

4) Calculate the income effect on the incremental EPS for the following instrument: Convertible bonds outstanding, effective yield of 7% and coupon rate of 7% Issue date Maturity date Conversion rate for each $1,000 bond Income tax rate A) $30,000 B) $35,000 C) $90,000 D) $105,000 Answer: D Explanation: Income effect Share effect Incremental EPS

$2,000,000 January 1, 2026 December 31, 2029 20 ordinary shares 25%

Carrying amount × yield × (1 - tax rate) = $2,000,000 × 7% × (1 - 25%) = $105,000 Bonds × conversion rate = $2,000,000 / 1,000 × 20 = 40,000 shares $105,000 / 40,000 shares = $2.63

Diff: 2 Type: MC Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

5) Calculate the share effect on the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 5% and coupon rate of 5% $2,000,000 Issue date January 1, 2026 Maturity date December 31, 2033 Conversion rate for each $1,000 bond 40 ordinary shares Income tax rate 25% A) 0.63 B) 0.94 C) 75,000 D) 80,000 Answer: D Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $2,000,000 × 5% × (1 - 25%) = $75,000 Bonds × conversion rate = $2,000,000/ 1,000 × 40 = 80,000 shares $75,000 / 80,000 shares = $0.94

Diff: 2 Type: MC Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

6) Calculate the incremental EPS for the following instrument: Convertible bonds outstanding, effective yield of 7% and coupon rate of 7% Issue date Maturity date Conversion rate for each $1,000 bond Income tax rate A) $0.75 B) $0.88 C) $2.25 D) $2.63 Answer: D Explanation: Income effect Share effect Incremental EPS

$2,000,000 January 1, 2026 December 31, 2029 20 ordinary shares 25%

Carrying amount × yield × (1 - tax rate) = $2,000,000 × 7% × (1 - 25%) = $105,000 Bonds × conversion rate = $2,000,000 / 1,000 × 20 = 40,000 shares $105,000 / 40,000 shares = $2.63

Diff: 2 Type: MC Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

7) Calculate the incremental EPS for the following instrument: Convertible bonds outstanding, yield of 5% and coupon rate of 5% $2,000,000 Issue date January 1, 2026 Maturity date December 31, 2033 Conversion rate for each $1,000 bond 40 ordinary shares Income tax rate 25% A) $0.94 B) $0.75 C) $0.31 D) $0.25 Answer: A Explanation: Income effect Share effect Incremental EPS

Carrying amount × yield × (1 - tax rate) = $2,000,000 × 5% × (1 - 25%) = $75,000 Bonds × conversion rate = $2,000,000 / 1,000 × 40 = 80,000 shares $75,000 / 80,000 shares = $0.94

Diff: 2 Type: MC Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

8) Calculate the diluted EPS given the following information:

Basic EPS Convertible preferred shares A Stock options B Convertible bond

Income effect Shares effect $352,500 300,000 800 0 20,000

1,250 20,000 10,000

A) 1.11 B) 1.06 C) 1.10 D) 1.08 Answer: C Explanation: Income effect Share effect Convertible Preferred Shares A Stock Option B Convertible Bond

Incremental EPS

Rank

$800 0

1,250 20,000

$0.64 0.00

2 1

20,000

10,000

2.00

Provisional Income effect Share effect EPS Diluted EPS Basic EPS $352,500 300,000 $1.18 Stock Option B 0 20,000 352,500 320,000 1.10 Convertible Preferred Shares A 800 1,250 $353,300 321,250 $1.10 $1.10 Convertible Bond is antidilutive and hence ignored as incremental EPS of $2.00 > provisional EPS of $1.10 Diff: 2 Type: MC Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

9) Calculate the diluted EPS given the following information:

Basic EPS Convertible preferred shares A Stock options B Convertible bond

Income effect Shares effect $1,865,000 300,000 110,000 0 200,000

20,000 20,000 100,000

A) 4.94 B) 5.83 C) 4.92 D) 4.90 Answer: C Explanation: Income effect Share effect Convertible Preferred Shares A Stock Option B 0 Convertible Bond

Incremental EPS

Rank

$110,000

20,000 20,000

$5.50 0.00

3 1

200,000

100,000

2.00

Provisional Income effect Share effect EPS Diluted EPS Basic EPS $1,865,000 300,000 $6.22 Stock Option B 0 20,000 1,865,000 320,000 5.83 Convertible bond 200,000 100,000 $2,065,000 420,000 $4.92 $4.92

Convertible Preferred Shares A are antidilutive and hence ignored as incremental EPS of $5.50 > provisional EPS of $4.92 Diff: 2 Type: MC Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

10) Which statement is correct? A) When convertible securities are redeemed during the year, the income effect and share effect are not pro-rated for the diluted EPS calculation. B) When convertible securities are issued during the year, the income effect and share effect are pro-rated for the diluted EPS calculation. C) When convertible securities are issued at the beginning of the year, the income effect and share effect are pro-rated for the diluted EPS calculation. D) When the right to convert convertible securities expires during the year, the income effect and share effect are not pro-rated for the diluted EPS calculation. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share. 11) Which statement is correct? A) When convertible securities are redeemed during the year, the income effect and share effect are prorated for the diluted EPS calculation. B) When convertible securities are issued during the year, the income effect and share effect are not prorated for the diluted EPS calculation. C) When convertible securities are issued at the beginning of the year, the income effect and share effect are pro-rated for the diluted EPS calculation. D) When the right to convert convertible securities expires during the year, the income effect and share effect are not pro-rated for the diluted EPS calculation. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share. 12) Which statement is correct regarding a company which buys call options on its own shares from an outside company? A) Issued options are always antidilutive. B) Issued options are always dilutive. C) Purchased options are always antidilutive. D) Purchased options are always dilutive. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share.

13) Which statement is correct? A) Dilutive potential ordinary shares, if converted, will decrease EPS or decrease the loss per share from continuing operations. B) Dilutive potential ordinary shares, if converted, will increase EPS or increase the loss per share from continuing operations. C) Antidilutive potential ordinary shares, if converted, will increase EPS or decrease the loss per share from continuing operations. D) Antidilutive potential ordinary shares, if converted, will decrease EPS or decrease the loss per share from continuing operations. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share. 14) Which statement is correct? A) Dilutive potential ordinary shares, if converted, will decrease EPS or increase the loss per share from continuing operations. B) Dilutive potential ordinary shares, if converted, will increase EPS or increase the loss per share from continuing operations. C) Anti-dilutive potential ordinary shares, if converted, will increase EPS or increase the loss per share from continuing operations. D) Anti-dilutive potential ordinary shares, if converted, will decrease EPS or decrease the loss per share from continuing operations. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share. 15) Which statement is correct respecting the presentation of discontinued operations on EPS? A) EPS from discontinued operations must be presented on the face of the income statement. B) EPS from discontinued operations may either be presented on the face of the income statement or may be disclosed in the financial statements. C) ASPE requires EPS from discontinued operations to be presented on the face of the income statement. D) IFRS does not require basic EPS to be shown separately for continuing operations and for discontinued operations. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 15.4 Calculate diluted earnings per share.

16) What are the two assumptions of the "if-converted method" used when calculation incremental EPS? Answer: The if-converted method assumes: (i) that the security had been converted into ordinary shares at the beginning of the period. (ii) that the company had not paid interest or preferred dividends on the security during the year because the security had already been converted. Diff: 2 Type: SA Skill: Concept Objective: 15.4 Calculate diluted earnings per share. 17) a. What is the treasury stock method and when is it used? b. Briefly describe the application of the treasury stock method. c. What does the treasury stock method assume about the exercise date? What is the exception to the rule with respect to the assumed exercise date? What alternative procedure is employed in this instance? Answer: a. The treasury stock method is the process used to determine the share effect for call options and warrants when the firm's capital structure includes these financial instruments. b. The treasury stock method is applied as follows: i) For in-the-money options (the average market price > the exercise price) compute the cash to be received upon exercise of the options (cash received = number of shares to be delivered × the strike price per share) ii) Determine the number of shares that the proceeds will buy in the marketplace (number of purchased shares = cash to be received/average market price of shares) iii) Calculate the number of incremental shares that the company will have to issue to meet its obligation (number of incremental shares = number of shares to be delivered - number of purchased shares) c. The procedure assumes that the options were exercised at the beginning of the period. Algebraically, this can be expressed as: IS = [(S – K)/S] × N. Alternatively, this can be expressed as IS = N(1 – K/S), where: IS = number of incremental shares to be issued K = exercise price N = number of shares that would have been issued for option exercise S = average market price The exception to the rule with respect to the assumed exercise date is when the security was issued during the year. If the warrant or option was issued during the year the incremental number of shares to be issued is pro-rated. Diff: 2 Type: ES Skill: Concept Objective: 15.4 Calculate diluted earnings per share.

18) During 2027, Furry Kittens Inc. (FKI) had three series of employee stock options outstanding, details of which follow: • Options A entitle employees to purchase 60,000 ordinary shares for $58.00 each. This series of options was granted on February 1, 2025, and expires on June 30, 2027. • Options B entitle employees to purchase 10,000 ordinary shares for $62.00 each until December 31, 2028 and $59.00 thereafter. This series of options was granted on June 1, 2024, and expires on December 31, 2031. • Options C entitle employees to purchase 45,000 ordinary shares for $57.00 each. This series of options was granted on April 1, 2027, and expires on December 31, 2030. The average market price of FKI's ordinary shares for the year ended December 31, 2027 was $60.00. Required: a. For each of the options series, indicate whether they are dilutive or anti-dilutive in nature in 2027 and provide the reason why. b. For each of the options series that are dilutive, determine the number of incremental shares to be notionally issued. Answer: a. Series Dilutive or antidilutive Reason A Dilutive Exercise price < average market price; in the money Most favourable exercise price < average market price; B Dilutive in the money C Dilutive Exercise price < average market price; in the money b. From part a, series A, B, and C are dilutive in nature. Series A B

Equation Alternative equation IS = [(S - K) / S] × N × 6/12* = [($60 - $58) / $60] × 60,000 × 6/12 IS = N(1 - K/S) × 6/12* IS = [(S - K) / S] × N = [($60 $59**) / $60] × 10,000 IS = N(1 - K/S) IS = [(S - K) / S] × N × 9/12* = [($60 - $57) / $60] × 45,000 × 9/12 IS = N(1 - K/S) × 9/12*

# of incremental shares to be issued 1,000 167

1,688

IS = number of incremental shares to be issued; K = exercise price; N = number of shares that would have been issued for option exercise; S = average market price *The number of incremental shares to be notionally issued must be pro-rated as the options were not outstanding for the entire year. **When more than one conversion option is available, the most dilutive alternative is assumed. Diff: 2 Type: ES Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

19) In 2028, TC Mulch Inc.'s net income was $200,000. Mulch had 220,000 ordinary shares outstanding at year-end. There were two ordinary share transactions during the year: (i) Mulch declared and distributed a 4-for-1 stock split on March 1, 2028; and (ii) Option C was exercised on April 1, 2028. Details of Mulch's stock option plans follow: • Option A entitles employees to purchase 40,000 ordinary shares for $9.00 each. This option was granted during 2027 and expires in 2030. • Option B entitles employees to purchase 40,000 ordinary shares for $21.00 each. This option was granted on July 1, 2028, and expires in 2031. • Option C entitles employees to purchase 40,000 ordinary shares for $13.00 each. This option was granted during 2026 and was exercised on April 1, 2028. • Option D entitles employees to purchase 40,000 ordinary shares for $17.00 each. This option was granted on September 1, 2028, and expires in 2031. The average market price of Mulch's ordinary shares for the year is $18.00. Mulch does not have any preferred shares or convertible bonds outstanding. The recorded exercise prices and number of shares that can be acquired under the stock option plans have already been adjusted for the stock split. Required: a. Calculate Mulch's basic earnings per share for the year ended December 31, 2028. b. Calculate Mulch's diluted earnings per share for the year ended December 31, 2028.

Answer: a. Net income available to ordinary shareholders/ weighted average number of ordinary shares = $200,000 / 210,000* = $0.95 Net income available to ordinary shareholders $ 200,000

/ /

WASO 210,000

= =

Basic EPS $ 0.95

*There were 220,000 ordinary shares outstanding at year-end, 40,000 of which were issued on April 1, 2028 in conjunction with the exercise of option C. 220,000 - 40,000 = 180,000 post-split shares. 180,000 × 3/12 + 220,000 × 9/12 = 210,000 WASO. b. Stock options A, C, and D are dilutive as the exercise price is less than the average market price. Stock option B is anti-dilutive as the exercise price is greater than the average market price, hence it can be ignored. Dilutive stock options do not have an income effect, therefore the incremental EPS of all dilutive options is $0. It does not matter which order they are applied in to determine provisional EPS. Option A [(average market price - strike price) / average market price] × number of options = 20,000 potential ordinary shares. Option C [(average market price - strike price) / average market price] × number of options × period option outstanding = 2,778 potential ordinary shares. Option D [(average market price - strike price) / average market price] × number of options × period option outstanding = 741 potential ordinary shares. Weighted average ordinary shares for diluted EPS purposes = 210,000 + 20,000 + 2,778 + 741 = 233,519. Diluted EPS = $200,000 / 233,519 = $0.86 Diff: 2 Type: ES Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

20) Sad Man Inc. had 220,000 ordinary shares outstanding in all of 2027. On January 1, 2025, Sad issued at par $400,000 in 10% bonds maturing on January 1, 2033. Each $1,000 bond is convertible into 9 ordinary shares. Assume that the effective interest rate is 10%. There are 5,000 outstanding cumulative preferred shares that are each entitled to an annual dividend of $0.20. Dividends were not declared or paid during 2027. Each preferred share is convertible into three ordinary shares. Sad's net income for the year ended December 31, 2027, was $250,000. Its income tax rate was 35%. Required: a. Calculate Sad's basic EPS for 2027. b. Are the convertible bonds dilutive or anti-dilutive in nature? The convertible preferred shares? c. Calculate Sad's diluted EPS for 2027. Net income available to ordinary shareholders $249,000

/ /

WASO 220,000

= =

Basic EPS $ 1.13

Answer: a. Calculation of basic EPS Net income Less: Preferred dividends 5,000 × $0.50 Net income available to ordinary shareholders

$250,000 (1,000) $249,000

Basic EPS $249,000/ 220,000 $1.13 Supporting comment—The dividends are cumulative and accordingly are deducted from net income even though they were not declared. b. Incremental EPS / rank the dilutiveness of POS Potential Incremental ordinary shares Income effect Share effect EPS Convertible ($400,000 × 0.10) × ($400,000 / $1,000) $7.22 bonds (1 - 35%) = $26,000 × 9 = 3,600 Convertible 5,000 × $0.20 5,000 × 3 = 15,000 0.07 preferred shares = $1,000 c.

Basic EPS Preferred shares Provisional EPS Bonds are anti-dilutive and ignored Diluted earnings per share

Basic EPS Rank 1 Provisional EPS Rank 2 Diluted EPS

Income $249,000 1,000 250,000

Shares 220,000 15,000 235,000

0 $250,000

0 235,000

Income $ 249,000 1,000 250,000 0 $ 250,000

Shares 220,000 15,000 235,000 0 235,000

Rank order 2 1

Basic Provisional Diluted EPS EPS EPS $1.13 $1.06

$1.06

EPS $ 1.13 1.06 $ 1.06

Diff: 2 Type: ES Skill: Comp Objective: 15.4 Calculate diluted earnings per share.

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 16 Pensions and Other Employee Future Benefits Learning Objective 1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 1) Which of the following best describes a "defined benefit plan"? A) High returns in the pension plan result in higher benefit payments to the employees in the future. B) A pension plan that specifies how much funds the employee needs to contribute. C) A plan that requires the employer to contribute $10 per hour worked by an employee. D) A plan that specifies how much in pension payments employees will receive in their retirement. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 2) Which of the following best describes a "defined contribution plan"? A) A pension plan where the employer can reduce its contributions if it is overfunded. B) A pension plan that place investment risk on the employees. C) A pension plan that place investment risk on the employers. D) A pension plan where the employee can decrease its contributions if it is overfunded. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 3) Which statement explains the risk involved in "defined contribution plans"? A) Poor returns on the pension investments reduce the benefits for future retirees. B) High returns on the pension investments increase the benefit payments for the employer. C) The plan specifies the fixed benefits that future retirees will receive. D) The plan provides benefits to future retirees depending on their years of service. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

4) Which statement explains the risk involved in "defined benefit plans"? A) The plan places investment risk on employees since the future benefits are pre-specified. B) The plan sponsor never needs to increase its contributions to the pension trust. C) The plan may require the employee to pay $200 per month for each year of service. D) The plan specifies the eventual outflows from the pension trust to future retirees. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 5) Which statement is correct? A) The plan sponsor of a defined benefit plan never needs to increase its contributions to the pension trust. B) A defined contribution plan is a pension plan that places investment risk on the employers. C) Inadequate contributions to a defined benefit plan by the plan sponsor or poor investment returns will result in an underfunded pension. D) A defined contribution plan specifies the fixed benefits that future retirees will receive. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 6) If a company provides a non-contributory pension plan, who makes the contributions? A) Both the employer and employee. B) Only the employee. C) Only the employer. D) No one. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 7) What is true about actuarial gains and losses? A) These gains and losses are caused by actuarial miscalculations. B) IFRS requires actuarial gains and losses to be recorded through the income statement. C) IFRS requires actuarial gains and losses to be recorded through OCI without recycling through the income statement. D) IFRS requires actuarial gains and losses not to be reported as they will reverse themselves over such a long time horizon. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

8) What is the fundamental difference between a defined contribution and a defined benefit pension plan? Answer: The fundamental difference between a defined contribution and defined benefit pension plan is the party who carries the risk related to the pension. A defined contribution plan puts the risk on the beneficiaries (employees) while a defined benefit plan puts the risk on the pension plan sponsor (the employer). Diff: 2 Type: SA Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 9) What is the key objective in the accounting for defined benefit plans that is achieved by estimating and recording current service cost? Answer: Estimating and recording current service cost achieves the key objective of matching the employment expense with the services received from employees in the same period. Not doing so results in expenses being recorded much later than the services received. Diff: 2 Type: SA Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

10) Identify whether each of the following descriptions of pension plans describes defined contribution plans, defined benefit plans, both, or neither. Defined contribution plans

Defined benefit plans

Both

Neither

Places investment risk on employees Uses a pension trust to hold plan's assets Can be underfunded or overfunded Provides guaranteed amount of plan funding Unexpected gains and losses can be capitalized Poor returns on the pension investments reduce the benefits for future retirees Answer:

Defined Defined contribution benefit plans plans X

Both

Neither

X X X X X

Diff: 1 Type: SA Skill: Concept Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

11) Peter is currently 30 years old and he plans to retire early, in 20 years' time. He would like to have an income of $50,000 per year during his retirement, which he anticipates will last for another 40 years. Assume that Peter receives the retirement income at the end of each of the 40 years. Required: Determine the amount of money Peter will need to have accumulated by the time he starts his retirement. Assume a discount rate of 9%. Answer: Expected annual benefits earned per year of service $50,000 PVFA(9%, 40) × 10.75736 Assets required to fund payments during retirement $537,868 Using BAII Plus financial calculator: 40N, 9 I/Y, 50000 PMT, CPT PV → PV = -537,868 Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 12) A pension plan promises to pay $70,000 at the end of each year for 10 years of the retirement period. Required: Compute the funds required to fund this pension plan at the start of the retirement period assuming: a. discount rate of 12%; or b. discount rate of 9%. Answer: a. Expected annual benefits $70,000 PVFA(12%, 10) × 5.65022 Assets required to fund payments during retirement $395,516 b. Expected annual benefits earned per year of service PVFA(9%, 10) Assets required to fund payments during retirement

$70,000 × 6.41766 $449,236

Using BAII Plus financial calculator: a. 10N, 12 I/Y, 70000 PMT, CPT PV b. 10N, 9 I/Y, 70000 PMT, CPT PV Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

13) Orion Steel provides a defined benefit pension plan for its employees. One of its employees, Gail Camden, who just turned 45 years old, expects to retire at age 65. At that time, the pension plan will pay Gail annual pension payments equal to 5% of her final year's salary for each year of services rendered by Gail. The pension payments will continue until Gail's death, which actuaries expect to be when she turns 95 years old. Gail is currently earning $35,000 per year, and this rate is not expected to increase due to the poor state of the steel industry. Orion Steel uses an 8 % interest rate for its pension obligations. Required: Determine the current service cost for Gail Camden's pension for the past year (the year just before she turned 45). Answer: Expected final year's salary at age 64= current annual salary $35,000 Pension payment as % of final year salary × 5% Pension benefits earned per year of service $1,750/yr PVFA(8%, 30) × 11.25778 Assets required at age 65 to fund $19,701 PVF(8%, 20) × 0.21455 Present value of assets required at age 45 = current service cost $4,227 Using BAII Plus financial calculator: 30N, 8 I/Y, 1750 PMT, CPT PV → PV = -19,701 20N, 8 I/Y, 14,979 FV, CPT PV → PV = -4,227 Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

14) Phil works for the Government of Alberta. Phil is covered by a defined benefit pension plan. Phil just turned 45 years old, and expects to retire at age 65. At that time, the pension plan will pay Phil annual pension payments equal to 2% of his final year's salary for each year of services rendered. The pension payments will continue until Phil's death, which actuaries expect to be when he turns 80 years old. For the current year, Phil will earn $55,000, and this rate is expected to increase by 5% per year. Assume that the Alberta Government uses a 10% interest rate for its pension obligations. Required: Determine the current service cost for Phil Jackson's pension for the past year (the year just before he turned 45). Answer: Current annual salary $55,000 × 2.527 Expected increase over next 19 years until age 64 = 1.0519 Expected annual salary in final year of employment at age 64 Pension payment as % of final year salary Expected annual benefits earned per year of service PVFA(10%, 15) Assets required at age 65 to fund payments during retirement PVF(10%, 20) = 1/1.1020

Present value of assets required at age 45 = current service cost

$138,982 × 2% $2,779.64/yr × 7.60608 $21,142 × 0.14864 $3,143

Using BAII Plus financial calculator: 19N, 5 I/Y, -55000 PV, CPT FV → FV = 138,982 15N, 10 I/Y, 2779.64 PMT, CPT PV → PV = -21,142 20N, 10 I/Y, 21,142 FV, CPT PV → PV = -3,143 Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 15) A pension plan promises to pay $75,000 at the end of each year of the retirement period. Required: Compute the funds required to fund this pension plan at the start of the retirement period assuming: a. discount rate of 9% and a retirement period of 30 years; or b. discount rate of 9% and a retirement period of 40 years. Answer: a. Expected annual benefits $75,000 PVFA(9%, 30) × 10.27365 Assets required to fund payments during retirement $770,524 b. Expected annual benefits earned per year of service $75,000 PVFA(9%, 40) × 10.75736 Assets required to fund payments during retirement $806,802 Diff: 2 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 7 Copyright © 2023 Pearson Canada Inc.

16) Kat Singh is currently 30 years old and he plans to retire early, in 25 years' time. He would like to have an income of $50,000 per year during his retirement, which he anticipates will last for another 30 years. Assume that he receives the retirement income at the end of each of the 30 years. Required: Determine the amount of money he will need to have accumulated by the time he starts his retirement. Assume a discount rate of 5%. Answer: Expected annual benefits earned per year of service $50,000 PVFA(5%, 30) × 15.37245 Assets required to fund payments during retirement $768,623 Using BAII Plus financial calculator: 30N, 5 I/Y, 50000 PMT, CPT PV Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 17) Saul is currently 30 years old and he plans to retire early, in 20 years' time. He would like to have an income of $60,000 per year during his retirement, which he anticipates will last for another 40 years. Assume that he receives the retirement income at the end of each of the 40 years. Required: Determine the amount of money he will need to have accumulated by the time he starts his retirement. Assume a discount rate of 5%. Answer: Expected annual benefits earned per year of service $60,000 PVFA(5%, 40) × 17.15909 Assets required to fund payments during retirement $1,029,545 Using BAII Plus financial calculator: 40N, 5 I/Y, 60000 PMT, CPT PV Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

18) Katherina is currently 30 years old and plans to retire later in life. She would like to have an income of $35,000 per year during her retirement, which she anticipates will last for another 25 years. Assume that she receives the retirement income at the end of each of the 25 years. Required: Determine the amount of money Katherina will need to have accumulated by the time she starts her retirement. Assume a discount rate of 5%. Answer: Expected annual benefits earned per year of service $35,000 PVFA(5%, 25) × 14.09394 Assets required to fund payments during retirement $493,288 Using BAII Plus financial calculator: 25N, 5 I/Y, 35000 PMT, CPT PV Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 19) Sally is currently 30 years old and is planning for her retirement. She would like to have an income of $55,000 per year during her retirement, which she anticipates will last for another 25 years. Assume that she receives the retirement income at the end of each of the 25 years. Required: Determine the amount of money Sally will need to have accumulated by the time she starts her retirement. Assume a discount rate of 4%. Answer: Expected annual benefits earned per year of service $55,000 PVFA(4%, 25) × 15.62208 Assets required to fund payments during retirement $859,214 Using BAII Plus financial calculator: 25N, 4 I/Y, 55000 PMT, CPT PV Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

20) A pension plan promises to pay $75,000 at the end of each year for 25 years of the retirement period. Required: Compute the funds required to fund this pension plan at the start of the retirement period assuming: a. discount rate of 5%; or b. discount rate of 4%. Answer: a. Expected annual benefits $75,000 PVFA(5%, 25) × 14.09394 Assets required to fund payments during retirement $1,057,045 b. Expected annual benefits earned per year of service $75,000 PVFA(4%, 25) × 15.62208 Assets required to fund payments during retirement $1,171,656 Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans. 21) Othello Steel provides a defined benefit pension plan for its employees. One of its employees, Ginger Philips, who just turned 45 years old, expects to retire at age 70. At that time, the pension plan will pay Ginger annual pension payments equal to 10% of her final year's salary for each year of services rendered. The pension payments will continue until Ginger's death, which actuaries expect to be when she turns 95 years old. Ginger is currently earning $75,000 per year, and this rate is not expected to increase due to the poor state of the steel industry. Orion Steel uses a 6 % interest rate for its pension obligations. Required: Determine the current service cost for Ginger Philips's pension for the past year (the year just before she turned 45). Answer: Expected final year's salary at age 69 = current annual salary $75,000 Pension payment as % of final year salary × 10% Pension benefits earned per year of service $7,500/yr PVFA(6%, 25) × 12.78336 Assets required at age 70 to fund $95,875 PVF(6%, 25) × 0.23300 Present value of assets required at age 45 = current service cost $22,339 Using BAII Plus financial calculator: 25N, 6 I/Y, 7500 PMT, CPT PV → PV = -95,875 25N, 6 I/Y, 95,875 FV, CPT PV → PV = -22,339 Diff: 1 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

22) In a recent flood some company records have been partially destroyed and it is your job to help reconstruct the missing data. For one of the company employees, Piper Jones, you have managed to gather some information regarding her pension. She currently earns $65,000 per year and expects to be paid through the company's defined benefits pension plan 10% of her final salary for each year of service. Given the state of the company, salaries are not expected to increase. You know that the pension payments should continue until her death, which actuaries expect to be when she turns 85 years old. You also know that the value of the future annuities at date of retirement should be $85,560 to fulfill this commitment. Piper has just turn 45, however, you do not know her planned retirement age. Required: a. Determine Piper Jones planned retirement age assuming the company uses 5% interest rate for its pension plans. b. Determine the current service cost for Piper Jones' pension for the past year (the year just before she turned 45). Answer: a. Pension benefits earned per year of service ($65,000 × 10%) $6,500/yr Assets required at retirement (given) $85,560 at 5% interest rate the number of annuities is 22 Age of retirement (85yr - 22yr) 63 b. Assets required at age 63 to fund $85,560 PVF(5%, 18) × 0.41552 Present value of assets required at age 45 = current service cost $35,552 Diff: 3 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

23) In a recent flood some company records have been partially destroyed and it is your job to help reconstruct the missing data. For one of the company employees, Piper Jones, you have managed to gather some information regarding her pension. She currently earns $78,000 per year and expects to be paid through the company's defined benefits pension plan 7% of her final salary for each year of service. Given the state of the company, salaries are not expected to increase. You know that the pension payments should continue until her death, which actuaries expect to be when she turns 90 years old. You also know that the value of the future annuities at date of retirement should be $71,870 fulfill this commitment. Piper has just turn 55, however, you do not know her planned retirement age. Required: a. Determine Piper Jones planned retirement age assuming the company uses 5% interest rate for its pension plans. b. Determine the current service cost for Piper Jones' pension for the past year (the year just before she turned 45). Answer: a. Pension benefits earned per year of service ($78,000 × 7%) $5,460/yr Assets required at retirement (given) $71,870 at 5% interest rate the number of annuities is 22 Age of retirement (90yr - 22yr) 68 b. Assets required at age 68 to fund $85,560 PVF(5%, 13) × 0.53032 Present value of assets required at age 55 = current service cost $38,114 Diff: 3 Type: ES Skill: Comp Objective: 16.1 Explain the nature of pension plans and distinguish between defined contribution and defined benefit plans.

Learning Objective 2 Apply the accounting standards for defined contribution pension plans. 1) What is the pension expense for the following plan? "The plan requires the company to contribute $500 for each of its 1,000 employees. The plan hopes to accumulate enough funds so that each retiree receives $20,000 in the future; the company has no obligation to guarantee the investment returns." A) $500 B) $20,000 C) $500,000 D) $20,000,000 Answer: C Explanation: 1,000 × $500 = $500,000 Diff: 1 Type: MC Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans.

2) Which statement about "defined contribution plans" is correct? A) Pension expense equals the contributions made based on the plan formula. B) Pension expense equals the present value of the future benefits to be paid to the retiree. C) Pension cost cannot be capitalized to the cost of inventory. D) Pension cost may not be capitalized to the construction cost of property, plant and equipment. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 3) What is the pension expense for the following plan? "The company must contribute $100/year for each of its 500 employees. The plan hopes to accumulate enough funds so that each retiree receives $10,000 in the future; the plan does not guarantee the investment returns to the employees." A) $100 B) $10,000 C) $50,000 D) $5,000,000 Answer: C Explanation: ($100 × 500) = $50,000 Diff: 1 Type: MC Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 4) What is the total pension expense for the following plan after 5 years? "The plan requires the company to contribute $500 for each of its 1,000 employees. The plan hopes to accumulate enough funds so that each retiree receives $20,000 in the future; the company has no obligation to guarantee the investment returns." A) $2,500 B) $100,000 C) $2,500,000 D) $20,000,000 Answer: C Explanation: (1,000 × $500 × 5) = $2,500,000 Diff: 2 Type: MC Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans.

5) What is the total pension expense for the following plan after 10 years? "The company must contribute $100/year for each of its 500 employees. The plan hopes to accumulate enough funds so that each retiree receives $10,000 in the future; the plan does not guarantee the investment returns to the employees." A) $1,000 B) $100,000 C) $500,000 D) $5,000,000 Answer: C Explanation: ($100 × 500 × 10) = $500,000 Diff: 2 Type: MC Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 6) Tener Company sponsors a defined contribution pension plan for its employees. The plan specifies that the company will contribute $2 for every dollar that an employee contributes to the plan. Employees are eligible to contribute up to 7% of their salary to the pension plan. During 2025, employees covered by the pension plan earned salaries totalling $42 million. Employee contributions to the pension totalled $2.1 million. Tener contributed $3 million to the plan during the year. Required: Provide the summary journal entry for Tener's pension plan for 2025. Answer: Dr. Pension expense ($2,100,000 × 2) 4,200,000 Cr. Pension contribution payable 1,200,000 Cr. Cash (given) 3,000,000 Diff: 1 Type: SA Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 7) Wags Inc. sponsors a defined contribution pension plan for its employees. The plan specifies that the company will match the amount each employee contributes to the plan. Employees are eligible to contribute up to 10% of their salary to the pension plan. During 2025, employees covered by the pension plan earned salaries totalling $30 million. Employee contributions to the pension totalled $3 million. Wags Inc. contributed $2 million to the plan during the year. Required: Provide the summary journal entry for Wags Inc.'s pension plan for 2025. Answer: Dr. Pension expense ($3,000,000 × 1) 3,000,000 Cr. Pension contribution payable 1,000,000 Cr. Cash (given) 2,000,000 Diff: 1 Type: SA Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans.

8) Explain the accounting for defined contribution plans and also discuss why it is straightforward. Answer: When a company uses a defined contribution plan, its rights and obligations begin and end with making the specified contribution according to the contribution formula. The company faces neither the risks nor the benefits of low or high investment returns earned by the pension trust. Given the economics of this type of pension plan, the accounting is fairly straightforward: the company records compensation expense for the amount of contribution it owes according to the contribution formula. Diff: 1 Type: SA Skill: Concept Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 9) Dunder Mae Products has a defined contribution pension plan for its employees. The plan requires the company to contribute 8% of these employees' salaries to the pension. In 2024, total salary for employees covered by the pension plan totalled $70 million, of which 85% is attributable to employees involved in manufacturing while the remaining 15% of salaries relate to administrative staff. The company contributed $3 million to the pension during the year. Required: Provide the summary journal entry for Dunder Mae's pension plan for 2024. Answer: Dr. Inventories ($70,000,000 × 8% × 85%) 4,760,000 Dr. Administrative expense ($70,000,000 × 8% × 15%) 840,000 Cr. Pension contribution payable 2,600,000 Cr. Cash (given) 3,000,000 Diff: 1 Type: SA Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 10) What is the key distinction between amounts recorded through income as pension expense versus amounts recorded through OCI? Answer: The key distinction between amounts recorded through income as pension expense versus amounts recorded through OCI is the amount recorded through income reflects the expected outcomes, while the amount recorded through OCI reflects the difference between the actual and expected outcomes. Diff: 1 Type: SA Skill: Concept Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 11) A company reported $430,000 of pension expense in its income statement. The balance sheet showed that the pension liability increased by $29,000 over the year. Required: How much cash was paid to the pension trustee during the period? Answer: Dr. Pension expense (given) 430,000 Cr. Defined benefit pension liability (given) 29,000 Cr. Cash 401,000 Diff: 2 Type: SA Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans. 15 Copyright © 2023 Pearson Canada Inc.

12) Gander Products has a defined contribution pension plan for its employees. The plan requires the company to contribute 6% of these employees' salaries to the pension. In 2024, total salary for employees covered by the pension plan totalled $40 million, of which 75% is attributable to employees involved in manufacturing while the remaining 25% of salaries relate to administrative staff. The company contributed $500,000 to the pension during the year. Required: Provide the summary journal entry for Gander's pension plan for 2024. Answer: Dr. Inventories ($40,000,000 × 6% × 75%) 1,800,000 Dr. Administrative expense ($40,000,000 × 6% × 25%) 600,000 Cr. Pension contribution payable 1,900,000 Cr. Cash (given) 500,000 Diff: 2 Type: SA Skill: Comp Objective: 16.2 Apply the accounting standards for defined contribution pension plans.

Learning Objective 3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 1) Which statement best explains the meaning of "current service cost"? A) The present value of pension benefits that employees have earned. B) The increase in the present value of a defined benefit obligation resulting from employee service in the current period. C) The amount of funds deposited with the pension trust in the year. D) The annual contribution required by the employer as specified in the pension plan agreement. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 2) Which best explains a "curtailment"? A) A reduction in the number of employees covered by the pension plan or the amount of benefits they will receive in the future. B) The employer puts an end to the plan using company lawyers. C) The employer stops contributing to the plan. D) The employees stop contributing to the plan. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

3) What is true of the interest cost component of the pension expense? A) ASPE specifies that enterprises should use a yield that matches the plan's return on pension assets for the period. B) IFRS specifies that enterprises should use the yields on high-quality short-term corporate bonds. C) It represents the increase in the pension obligation due to the passage of time. D) IFRS specifies that enterprises should use the yields on medium-quality corporate bonds. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 4) A company reported $350,000 of pension expense in its income statement. The balance sheet showed that the pension liability increased by $20,000 over the year. How much cash was paid to the pension trustee during the period? A) $320,000 B) $330,000 C) $350,000 D) $370,000 Answer: B Explanation: $350,000 - $20,000. Since the liability increased, in the absence of an actuarial loss, the amount paid out in benefits was less than that expensed. Diff: 2 Type: MC Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 5) What are actuarial losses or gains in a defined benefit plan? A) Difference arising between the actual and the expected value of plan contributions. B) Expected income earned on the pension plan assets. C) Plan amendments that retrospectively improve pension plan benefits. D) Differences arising between the actual and expected values of the obligation. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

6) Which of the following components refers to the services provided by the employees in the current period in a defined benefit plan? A) Current service cost. B) Interest cost on pension obligations. C) Income from plan assets. D) Actuarial gains and losses. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 7) Which of the following components does not relate to the assets/liabilities held in the pension trust for a defined benefit plan? A) Interest cost on pension obligations. B) Actual income from plan assets. C) Actuarial gains and losses. D) Expected income from plan assets. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 8) What are actuarial losses or gains in a defined benefit plan? A) Plan amendments that retrospectively improve pension plan benefits. B) Expected income earned on the pension plan assets. C) Difference arising between the actual and the expected value of plan obligations. D) Differences arising between the actual and expected values of the pension contributions. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 9) What are past service costs in a defined benefit plan? A) Plan amendments that retrospectively improve pension plan benefits. B) Difference arising between the actual and the expected value of plan assets. C) Expected interest, dividend or income earned on the pension plan assets. D) Differences arising between the actual and expected values of the pension obligations. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

10) Current service cost for a defined benefit pension plan amounted to $1,000,000. Expected income on the pension plan's assets amounted to $7,500,000, while actual income was $7,800,000. The interest on the pension obligation was $9,000,000, which matched the actuarial estimates. No past service costs arose during the year. Given this information the pension expense for the year was: A) $500,000 B) $2,200,000 C) $2,500,000 D) $1,000,000 Answer: C Diff: 3 Type: MC Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 11) A company's defined benefit pension plan incurs current service cost of $4,000,000. This pension plan's assets generated $2,500,000 of income, which exceeded expectations by $500,000. Pension obligations incurred interest cost of $1,500,000, which were $700,000 below expectations. During the year, the company increased benefits in the pension plan and incurred $800,000 for past service cost. Given this information, the pension expense for the year was: A) $5,000,000 B) $3,800,000 C) $4,600,000 D) $5,600,000 Answer: A Diff: 3 Type: MC Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 12) A company has a defined benefit pension liability of $4,700,000 at the beginning of the year. The company contributes $7,000,000 to the pension during the year and records a pension expense of $10,200,000. The closing balance of the defined benefit pension plan at year-end is therefore a(n): A) $7,900,000 liability B) $7,900,000 asset C) $11,700,000 liability D) $1,500,000 asset Answer: A Diff: 1 Type: MC Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

13) A company has a defined benefit pension asset of $1,300,000 at the beginning of the year. The company contributes $4,000,000 to the pension during the year and records a pension expense of $6,200,000. The closing balance of the defined benefit pension plan at year-end is therefore a: A) $900,000 asset B) $900,000 liability C) $5,300,000 asset D) $3,500,000 asset Answer: B Diff: 1 Type: MC Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 14) Summarize the three steps in the accounting for defined benefit pension plans. Answer: Step 1: The first establishes the fair value of the net pension asset or liability to be reported on the balance sheet. Step 2: The second step determines the amount of pension expense to record through the income statement. This pension expense goes into the calculation of the expected balance of the net pension asset or liability account. Step 3: The third step resolves the discrepancy between the expected and actual values of the net financial position of the pension plan by recording an adjustment to the net pension asset or liability account and this adjustment flows through OCI. Diff: 2 Type: SA Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 15) A company's defined benefit pension plan incurs current service cost of $2,000,000. Expected income on the pension plan's assets amounted to $8,500,000, while actual income was $8,800,000. The interest on the pension obligation was $10,000,000, which matched the actuarial estimates. No past service costs arose during the year. Required: Compute the amount of pension expense for the year. Answer: Current service cost $2,000,000 Interest on obligation 10,000,000 Expected income on assets (8,500,000) Pension expense $3,500,000 Note that it is the expected income rather than the actual income on the plan assets that factors into the pension expense. Diff: 2 Type: SA Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 20 Copyright © 2023 Pearson Canada Inc.

16) Current service cost for a defined benefit pension plan amounted to $6,000,000. This pension plan's assets generated $5,500,000 of income, which exceeded expectations by $1,000,000. Pension obligations incurred interest cost of $4,500,000, which were above expectations by $200,000. During the year, the company increased benefits in the pension plan and incurred $400,000 for past service cost. Required: Compute the amount of pension expense for the year. Answer: Current service cost +/- Past service cost + Interest on obligation ($4,500,000 - $200,000) - Expected income on assets ($5,500,000 - $1,000,000) Pension expense

$6,000,000 400,000 4,300,000 (4,500,000) $6,200,000

Note that it is the expected income rather than the actual income on the plan assets that factors into the pension expense. Diff: 2 Type: SA Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 17) Prepare the Summarized Pension Trustee's Report on Pension Plan Assets (without numbers) in good form. Answer: Summarized Pension Trustee's Report Pension Plan Assets Beginning balance + Contributions + Expected income on plan assets - Benefit payments = Expected value of assets - Actual value of assets (Ending Balance) = Unexpected (gain) loss pension assets Diff: 2 Type: SA Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

18) Prepare the Summarized Pension Actuary's Report on Pension Plan Obligations (without numbers) in good form. Answer: Summarized Pension Actuary's Report Pension Plan Obligations Beginning balance + Current service cost +/- Past service cost + Interest cost on obligation - Benefit payments = Expected value of obligation - Actual value of obligation (Ending Balance) = Actuarial gain (loss) Diff: 2 Type: SA Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

19) Carmichael Corporation has had a defined benefit pension plan for three decades. Two years ago, the company improved the benefits at a cost of $2,800,000. Pension plan assets were $84,000,000 while pension obligations were $76,000,000 at the beginning of the year. For the current year, Carmichael's pension plan incurred current service cost of $6,400,000 and interest of $8,600,000. The pension's assets earned $9,000,000, which is $400,000 below expectations. There were no actuarial gains or losses for the year. Required: a. Compute the pension expense for the year. b. Record the journal entries for Carmichael's pension plan. Answer: a. Computation of pension expense Current service cost (given) + Interest on obligation (given) -Expected return on assets ($9,000,000 + $400,000) Pension expense

$6,400,000 8,600,000 (9,400,000) $5,600,000

b. Journal entries: Dr. Pension expense - current service cost Dr. Pension expense - interest on obligation Cr. Defined benefit pension asset or liability

6,400,000 8,600,000

Dr. OCI - Unexpected loss on plan assets Cr. Defined benefit pension asset or liability

400,000

5,600,000

400,000

Diff: 1 Type: SA Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

20) Compute the pension expense and the amount of OCI for the two years with the following Pension Trustee Report and Pension Actuary Report: Pension Trustee Report Opening assets, January 1 + Funding - Payments to retirees + Expected return on assets Expected value, December 31 Actual market value, December 31 Unexpected gain (loss) Pension Actuary Report Opening accrued benefit obligation, January 1 + Current service cost (accrued evenly during year) - Payments to retirees (paid evenly through year) + Interest Expected value, December 31 Actual obligation, December 31 Actuarial gain (loss)

2024 $0 550,000 0 44,000 594,000 476,000 $(118,000) 2024 $0 550,000 0 22,000 572,000 540,000 $32,000

2025 $476,000 645,000 (20,000) 88,000 1189,000 1,038,000 $(151,000) 2025 $540,000 580,000 (20,000) 64,000 1,164,000 1,150,000 $ 14,000

Answer: Current service cost (given) + Interest on obligation (given) - Expected return on assets (given) Pension expense OCI - actuarial gains and losses on obligations OCI - unexpected gains and losses on assets Total OCI

2024 $550,000 22,000 (44,000) $528,000 Gain $32,000 Loss 118,000 Loss $86,000

2025 $580,000 64,000 (88,000) $556,000 Gain $14,000 Loss 151,000 Loss $137,000

Diff: 1 Type: SA Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

21) Discuss why accounting for "defined benefit plans" is so complex and the types of estimates required. Answer: In these plans, the employer guarantees to employees a certain amount of benefits in the future. Since the benefit payments could be decades away from the services the company receives now, there is clearly a severe mismatch in the timing of the future cash payments to employees and when they earn those benefits. Thus, cash accounting is obviously inappropriate and accrual accounting is needed. However, the computations of the amounts to be accrued are complex due to the need to forecast decades into the future. In particular, we need to estimate (at least) the following: • When will each employee be entitled to retire and receive pension payments? • For how long will each employee be entitled to pension payments? i.e., how long will employees live (how long is their life expectancy)? • How much will be the periodic pension payments for each employee? • What part of the expected benefit payments relate to services provided in the current year? • What is the value of the pension obligation at retirement? • How much in plan assets are required now in order to satisfy the pension obligation at retirement? Diff: 2 Type: ES Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

22) What are the components of the pension expense in a defined benefit plan? Briefly explain the meaning of each component. Answer: The six components are: A) current service cost B) past service cost C) interest cost on pension obligations D) expected income from plan assets E) actuarial gains and losses on plan obligations F) unexpected gains and losses on plan assets a. Current service cost—this portion of the pension expense is the increase in the present value of the pension obligation that results from the employees' current services. This information is provided by the pension plan's actuary. b. Past service costs arise from plan initiations and amendments offered by the employer. A company could introduce a new pension plan or improve benefits on an existing plan, and give these new/ improved benefits retroactively to cover several years of past service. These costs are normally recoginized when the plan is initiated or amended. c. Interest cost—this component represents the increase in the pension obligation due to the passage of time (i.e., due to the pension payment dates becoming closer). IFRS specifies that enterprises should use the yields on high-quality corporate bonds. The term of the bonds should have a maturity that matches the term of the pension obligations. If pension payments will be 20 years in the future for the average employee, then the yield on 20-year bonds would be most appropriate. d. Expected income from plan assets—Assets in the pension plan earn investment income from interest, dividends, and capital gains. This income increases the value of plan assets. The rate used to estimated expected returns is the same rate used to determine interest costs. Deviations of actual investment results and the expected income accumulate in actuarial gains and losses (see item e). e. These gains and losses come from the difference between the actual and expected values of the obligation. f. These gains and losses come from the difference between the actual and expected values of the plan assets, which reflects an accumulation of differences between actual and expected investment earnings. Diff: 2 Type: ES Skill: Concept Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

23) A company reported $430,000 of pension expense in its income statement. The company fully paid the amount of pension expense owed to the trustee. The balance sheet showed that the pension asset increased by $29,000 over the year. Required: How much cash was paid to the pension trustee during the period? Answer: Dr. Pension expense (given) 430,000 Dr. Defined benefit pension asset (given) 29,000 Cr. Cash 459,000 Diff: 1 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 24) A company has a defined benefit pension liability of $1,050,000 at the beginning of the year. The company contributes $5,500,000 to the pension during the year and records a pension expense of $8,200,000. Required: Determine the value of the defined benefit pension liability at year-end. Answer: The summary journal entry recorded for the pension plan for the year was: Dr. Pension expense (given) 8,200,000 Cr. Defined benefit pension liability 2,700,000 Cr. Cash (given) 5,500,000 Therefore, the defined benefit pension liability account is as follows: Defined benefit pension liability, beginning of year (given) $1,050,000 cr Adjustment to defined benefit pension liability (see journal entry) 2,700,000 cr Defined benefit pension liability, end of year $3,750,000 cr Diff: 1 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

25) A company has a defined benefit pension asset of $750,000 at the beginning of the year. The company contributes $2,500,000 to the pension during the year and records a pension expense of $2,200,000. Required: Determine the value of the defined benefit pension liability at year-end. Answer: The summary journal entry recorded for the pension plan for the year was: Dr. Pension expense (given) 2,200,000 Dr. Defined benefit pension asset 300,000 Cr. Cash (given) 2,500,000 Therefore, the defined benefit pension liability account is as follows: Defined benefit pension asset, beginning of year (given) $750,000 dr Adjustment to defined benefit pension asset (see journal entry) 300,000 dr Defined benefit pension asset, end of year $1,050,000 dr Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 26) A company has a defined benefit pension asset of $1,050,000 at the beginning of the year. The company contributes $5,500,000 to the pension during the year and records a pension expense of $8,200,000. Required: Determine the value of the defined benefit pension liability at year-end. Answer: The summary journal entry recorded for the pension plan for the year was: Dr. Pension expense (given) 8,200,000 Cr. Defined benefit pension liability 2,700,000 Cr. Cash (given) 5,500,000 Therefore, the defined benefit pension liability account is as follows: Defined benefit pension asset, beginning of year (given) $1,050,000 dr Adjustment to defined benefit pension liability (see journal entry) 2,700,000 cr Defined benefit pension liability, end of year $1,650,000 cr Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

27) A company has a defined benefit pension liability of $3,750,000 at the end of the year. The company contributes $5,500,000 to the pension during the year and records a pension expense of $8,200,000. Required: Determine the value of the defined benefit pension liability at the beginning of the year. Answer: The summary journal entry recorded for the pension plan for the year was: Dr. Pension expense (given) 8,200,000 Cr. Defined benefit pension liability 2,700,000 Cr. Cash (given) 5,500,000 Therefore, the defined benefit pension liability account is as follows: Defined benefit pension liability, end of year (given) $3,750,000 cr Subtract adjustment to defined benefit pension liability (see journal entry) 2,700,000 cr Defined benefit pension liability, beginning of year $1,050,000 cr Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 28) A company has a defined benefit pension asset of $1,050,000 at the end of the year. The company contributes $2,500,000 to the pension during the year and records a pension expense of $2,200,000. Required: Determine the value of the defined benefit pension liability at the beginning of the year. Answer: The summary journal entry recorded for the pension plan for the year was: Dr. Pension expense (given) 2,200,000 Dr. Defined benefit pension asset 300,000 Cr. Cash (given) 2,500,000 Therefore, the defined benefit pension liability account is as follows: Defined benefit pension asset, end of year (given) $1,050,000 dr Subtract adjustment to defined benefit pension asset (see journal entry) 300,000 dr Defined benefit pension asset, beginning of year $750,000 dr Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

29) A company has a defined benefit pension asset of $1,650,000 at the end of the year. The company contributes $5,500,000 to the pension during the year and records a pension expense of $8,200,000. Required: Determine the value of the defined benefit pension liability at beginning of the year. Answer: The summary journal entry recorded for the pension plan for the year was: Dr. Pension expense (given) 8,200,000 Cr. Defined benefit pension liability 2,700,000 Cr. Cash (given) 5,500,000 Therefore, the defined benefit pension liability account is as follows: Defined benefit pension asset, end of year (given) $1,650,000 dr Subtract adjustment to defined benefit pension liability (see journal entry) 2,700,000 cr Defined benefit pension liability, beginning of year $1,050,000 cr Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 30) At the beginning of the current year, a pension has assets of $46,600,000 and accrued benefit obligation of $58,500,000. During the year, the sponsor recorded $3,100,000 in pension expense and contributed $5,000,000 to the pension plan. At the end of the year, the plan assets had fair value of $50,400,000 while the plan obligations had a present value of $60,000,000. Required: Compute the amount of other comprehensive income relating to the pension plan for the year. Answer: Plan assets, beginning of year $46,600,000 Plan obligations, beginning of year (58,500,000) Net assets (liabilities), beginning of year (11,900,000) Increase in net assets from cash contribution 5,000,000 Decrease in net assets from pension expenses (3,100,000) Expected value of net assets (liabilities), end of year $(10,000,000) Fair value of plan assets, end of year Present value of plan obligations, end of year Net assets (liabilities) at fair value, end of year

$50,400,000 (60,000,000) $(9,600,000)

Net assets (liabilities) at fair value, end of year Less: Expected value of net assets (liabilities), end of year OCI: gain (loss) on fair value remeasurement

($9,600,000) (10,000,000) $400,000

Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans. 30 Copyright © 2023 Pearson Canada Inc.

31) At the beginning of the current year, a pension has assets of $58,600,000 and accrued benefit obligation of $69,500,000. During the year, the sponsor recorded $3,100,000 in pension expense and contributed $4,000,000 to the pension plan. At the end of the year, the plan assets had fair value of $55,400,000 while the plan obligations had a present value of $64,000,000. Required: Compute the amount of other comprehensive income relating to the pension plan for the year. Answer: Plan assets, beginning of year $58,600,000 Plan obligations, beginning of year (69,500,000) Net assets (liabilities), beginning of year (10,900,000) Increase in net assets from cash contribution 4,000,000 Decrease in net assets from pension expenses (3,100,000) Expected value of net assets (liabilities), end of year $(10,000,000) Fair value of plan assets, end of year Present value of plan obligations, end of year Net assets (liabilities) at fair value, end of year

$55,400,000 (64,000,000) $(8,600,000)

Net assets (liabilities) at fair value, end of year Less: Expected value of net assets (liabilities), end of year OCI: gain (loss) on fair value remeasurement

$(8,600,000) (10,000,000) $1,400,000

Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

32) The following table provides information for a defined benefit pension plan: End-of-year balances, (in $000s) Pension assets at fair value Pension obligations at present value Net pension surplus (deficit) Transactions for the year Employer's contribution to pension Pension expense

2024 $60,000

2025 $67,000

2026 $71,000

2027 $60,000

55,000 $5,000

60,000 $7,000

64,000 $7,000

80,000 $(20,000)

$4,000 2,000

$4,000 5,000

$4,000 4,000

$4,000 5,000

Required: Compute the amount of other comprehensive income for 2025 to 2027. Answer: $000s 2025 2026 Net pension surplus (deficit), beginning of year $5,000 $7,000 Increase in net assets from cash contribution 4,000 4,000 Decrease in net assets from pension expenses (5,000) (4,000) Expected value of net assets (liabilities), end of year $4,000 $7,000 Net pension surplus (deficit), end of year Less: Expected value of net assets (liab), end of year OCI: gain (loss) on fair value remeasurement

2027 $7,000 4,000 (5,000) $6,000

$7,000

$(20,000)

4,000 $3,000

7,000 $0

6,000 $(26,000)

Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

33) Five Star Hotels provides a defined benefit pension for its employees. At the end of fiscal year 2024, which ended on December 31, the pension plan supplied Five Star Hotels with information about the pension, which is summarized in the following table: Opening assets, January 1 + Funding + Expected return on assets - Payments to retirees Expected value, December 31 Actual market value, December 31 Unexpected gain (loss) Opening accrued benefit obligation, January 1 + Current service cost + Interest - Payments to retirees Expected value, December 31 Actual obligation, December 31 Actuarial gain (loss) Required: Provide the journal entries for Five Star's pension plan for 2024. Answer: Dr. Defined benefit pension asset or liability Cr. Cash

$2,100,000 500,000 268,000 (40,000) 2,828,000 2,410,000 $(418,000) $3,000,000 250,000 245,000 (40,000) 3,455,000 2,964,000 $491,000

500,000 500,000

Dr. Pension expense - current service cost Dr. Pension expense - interest on obligation Cr. Pension expense - expected income on assets Cr. Defined benefit pension asset or liability

250,000 245,000

Dr. OCI - Unexpected loss on plan assets Dr. Defined benefit pension asset or liability Cr. OCE - Actuarial gains on the obligations

418,000 73,000

268,000 227,000

491,000

Diff: 2 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

34) A company has a defined benefit pension liability of $750,000 at the beginning of the year. The company contributes $2,500,000 to the pension during the year and records a pension expense of $2,200,000. Required: Determine the value of the defined benefit pension liability at year-end. Answer: The summary journal entry recorded for the pension plan for the year was: Dr. Pension expense (given) 2,200,000 Dr. Defined benefit pension liability 300,000 Cr. Cash (given) 2,500,000 Therefore, the defined benefit pension liability account is as follows: Defined benefit pension liability, beginning of year (given) $750,000 cr Adjustment to defined benefit pension liability (see journal entry) 300,000 dr Defined benefit pension liability, end of year $450,000 cr Diff: 1 Type: ES Skill: Comp Objective: 16.3 Analyze an array of pension plan data to determine the amount of pension expense and other comprehensive income for defined benefit pension plans.

Learning Objective 4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 1) What four accounts are affected by the accounting for a defined benefit pension plan? A) Cash, pension expense, OCI, and the defined benefit asset or liability. B) Expected gains and losses, cash, income, pension expense. C) Pension liability, pension expense, cash, income. D) Pension expense, pension assets, pension liability, cash. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 2) What is an actuarial gain? A) An unfavourable difference between actual and expected amounts for pension obligations. B) A favourable difference between actual and expected amounts for pension plan obligations. C) An unfavourable difference between actual and expected amounts for pension contributions. D) A favourable difference between actual and expected amounts for pension contributions. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions.

3) What is an actuarial loss? A) An unfavourable difference between actual and expected amounts for pension plan obligations. B) A favourable difference between actual and expected amounts for pension assets. C) An unfavourable difference between actual and expected amounts for pension contributions. D) A favourable difference between actual and expected amounts for pension obligations. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 4) Which statement is correct? A) An unexpected gain on plan assets represents an unfavourable difference between actual and expected amounts of income from pension assets. B) Actuarial gains and losses arising from the obligations of a pension plan derive from differences between the actual and expected values of the obligation. C) IFRS requires actuarial gains and losses to be recorded the income statement. D) An unexpected loss on plan assets represents a favourable difference between actual and expected amounts of income from pension assets. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 5) What amount is included in the pension reconciliation for the balance sheet? A) Current service cost. B) Pension plan assets. C) Benefit paid. D) Contributions paid. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions.

6) What amount will be presented on the balance sheet for fiscal 2025?

Fair value of pension plan assets Accrued pension obligation Contributions Benefits

Fiscal 2024 $50,000,000 60,000,000 7,000,000 8,000,000

Fiscal 2025 $45,000,000 42,000,000 10,000,000 8,000,000

Fiscal 2024 $50,000,000 60,000,000 $(5,000,000)

Fiscal 2025 $45,000,000 42,000,000 $3,000,000

A) $3,000,000 surplus B) $3,000,000 deficit C) $5,000,000 D) $8,000,000 Answer: A Explanation: Fair value of pension plan assets Accrued pension obligation Pension surplus (deficit)

Diff: 2 Type: MC Skill: Comp Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 7) What amount is included in the pension reconciliation for the income statement? A) Fair value of plan assets. B) Pension expense. C) Benefit paid. D) Contributions paid. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions.

8) For the following items, indicate if they are components of pension expense or OCI: Pension expense

OCI

Past service cost Actuarial gains and losses on plan obligations Expected income from plan assets Current service costs Unexpected gains and losses on plan assets Interest cost on pension obligations Answer:

Past service cost Actuarial gains and losses on plan obligations Expected income from plan assets Current service costs Unexpected gains and losses on plan assets Interest cost on pension obligations

Pension expense X

OCI X

X X X X

Diff: 1 Type: SA Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 9) Why does IAS 19 require recognizing changes in the fair value of pension assets and liabilities to flow through OCI and not through the income statement? Answer: Allowing pension gains or losses to flow through the income could result in volatility of income which could lead to adverse behavioural consequences. Companies would be less willing to use defined benefit pension plans because management generally dislikes volatility in income. Requiring gains and losses to flow through OCI without recycling through the income statement ensures that the balance sheet reflects the fair value of pension assets and liabilities without increasing the volatility of net income. Diff: 2 Type: SA Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions.

10) What is the key distinction between amounts recorded through income as pension expense versus amounts recorded through OCI? Answer: The key distinction between amounts recorded through income as pension expense versus amounts recorded through OCI is the amount recorded through income reflects the expected outcomes, while the amount recorded through OCI reflects the difference between the actual and expected outcomes. Diff: 2 Type: SA Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 11) What are the two components of OCI related to pensions? What is the conceptual reason for recognizing these two components through OCI rather than net income? Answer: The two components of OCI related to pensions are (i) actuarial gains and losses on pension obligations and (ii) unexpected gains and losses on pension assets. Standards specify that these two amounts should flow through OCI because management generally dislikes volatility in net income; allowing these gains and losses to bypass the income statement avoids unnecessarily deterring the use of defined benefit plans by companies. Diff: 2 Type: SA Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions.

12) Use the following table to explain how a change in each of the following assumptions will impact the pension surplus and the defined benefit pension asset. For each cell, fill in whether there will be an increase, decrease, or no effect.

Change in Assumption Increase rate of wage increase when pension benefits are specified relative to employee wages Increase life expectancy of employees' obligations Increase interest rate on pension obligations Increase age of retirement when employees become eligible for retirement benefits

Pension Surplus

Defined Benefit Pension Asset

Pension Surplus

Defined Benefit Pension Asset

Answer:

Change in Assumption Increase rate of wage increase when pension benefits are specified relative to employee wages Decrease Increase life expectancy of employees' obligations Decrease Increase interest rate on pension obligations No effect Increase age of retirement when employees become eligible for retirement benefit Increase

Decrease Decrease Increase* Increase

*A defined pension asset balance in the general ledger means that plan assets > plan liabilities, e.g. the plan is in a surplus. Given that the expected rate of return on assets must be calculated using the same rate as that used for determining the interest expense on the pension obligation, the increase in the interest rate means that the increase in the expected return on assets will exceed the increased interest expense on plan obligation. In other words, the pension plan asset will grow by more than the plan obligation, thus increasing the defined pension asset reported on the company's financial statements. Diff: 2 Type: SA Skill: Concept Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions.

13) Changing Assumptions Ltd. has the following details related to its defined benefit pension plan as at December 31, 2024: Pension fund assets of $1,900,000 and Actuarial obligation of $1,806,317. The actuarial obligation represents the present value of a single benefit payment of $3,200,000 that is due on December 31, 2030, discounted at an interest rate of 10%; i.e. $3,200,000 / 1.106 = $1,806,317. Funding during 2025 was $55,000. The actual value of pension fund assets at the end of 2025 was $2,171,000. As a result of the current services received from employees, the single payment due on December 31, 2030, had increased from $3,200,000 to $3,380,000. Required: a. Compute the current service cost for 2025 and the amount of the accrued benefit obligation at December 31, 2025. Perform this computation for interest rates of 8%, 10%, and 12%. b. Derive the pension expense for 2025 under various assumptions about the expected return and discount rate. Complete the following table:

Expected return assumption Discount rate assumption Current service cost Interest on obligation Expected return on assets Total pension expense

Case A 10% 10%

Case B 12% 8%

c. Briefly comment on the different amounts of pension expense in relation to the assumptions for expected return and discount rate. How does a change in the discount rate affect the accrued benefit obligation?

Answer: a. Current service cost and actuarial obligations Interest rate

10%

12%

0.68058

0.62092

0.56743

$180,000 0.68058 $ 122,504

$180,000 0.62092 $ 111,766

$180,000 0.56743 $ 102,137

Future value of actuarial obligation, Dec. 31, 2025 $3,380,000 $3,380,000 × PV factor 0.68058 0.62092 = Accrued benefit obligation (ABO), December 31, 2025 $2,300,371 $2,098,714

$3,380,000 0.56743 $1,917,903

Using a BAII Plus financial calculator CSC: 5N, [8 or 10 or 12] I/Y, 180000 FV, CPT PV → PV =

$ 122,504

$ 111,766

$ 102,137

ABO: 5N, [8 or 10 or 12] I/Y, 3,380000 FV, CPT PV → PV =

$2,300,371 $2,098,714

$1,917,903

PV factor for single sum, 5 years = 1/(1 + r)5 Future value of current services (3,380,000 - 3,200,000) × PV factor = Current service cost (CSC)

b. Pension expense

Expected return assumption Discount rate assumption Current service cost (see a) Interest on obligations of $1,806,317 Expected return on assets of $1,900,000 Total pension expense

Case A 10% 10%

Case B 12% 8%

$ 111,766 180,632 (190,000) $102,398

$ 122,504 144,505 (228,000) $39,010

c. The assumptions for the expected return on assets and the discount rate on pension obligations are both important. Increases in the return on assets decrease the pension expense while increases in the discount rate have the opposite effect of increasing the pension expense. When both rates increase by the same amount, the pension expense declines because the current service cost declines; the interest cost and expected return almost offset because plan assets and obligations are at about the same level. When the discount rate increases, the accrued pension obligation decreases. The present value of a payment in the future becomes less when the discount rate is higher. Diff: 2 Type: ES Skill: Comp Objective: 16.4 Analyze the effect of actuarial assumptions on the financial statement assets, liabilities, and income, and evaluate the appropriateness of assumptions used to account for pensions. 41 Copyright © 2023 Pearson Canada Inc.

Learning Objective 5 Integrate pension plan information by preparing the relevant note disclosures. 1) Which statement is correct? A) The defined benefit liability or asset must be separately identified on the income statement. B) The components of pension expense must be disclosed in the notes to the statements. C) The defined benefit liability or asset must be separately identified on the balance sheet. D) Pension asset/liability amounts can be offset if a company has more than one benefit plan. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 16.5 Integrate pension plan information by preparing the relevant note disclosures. 2) Regarding the presentation and disclosure of pension plans, which statement is true? A) Enterprises must disclose the components of pension gains. B) If the pension expense, OCI, and the defined benefit asset or liability are not separately identified on the face of the financial statements, they must be disclosed in the notes. C) When a company has more than one defined benefit plan, IFRS usually permits the company to offset pension asset and pension liability amounts. D) Two plans that both have net liability positions cannot be added together. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 16.5 Integrate pension plan information by preparing the relevant note disclosures. 3) What amount will be presented on the balance sheet for fiscal 2024?

Fair value of pension plan assets Accrued pension obligation Contributions Benefits

Fiscal 2024 $50,000,000 60,000,000 7,000,000 8,000,000

Fiscal 2025 $45,000,000 42,000,000 10,000,000 8,000,000

Fiscal 2024 $50,000,000 60,000,000 $(10,000,000)

Fiscal 2025 $45,000,000 42,000,000 $3,000,000

A) $5,000,000 surplus B) $10,000,000 deficit C) $7,000,000 D) $60,000,000 Answer: B Explanation: Fair value of pension plan assets Accrued pension obligation Pension surplus (deficit)

4) What amount will be presented on the balance sheet for fiscal 2025?

Fair value of pension plan assets Accrued pension obligation Contributions Benefits

Fiscal 2024 $50,000,000 60,000,000 7,000,000 8,000,000

Fiscal 2025 $45,000,000 42,000,000 10,000,000 8,000,00

Fiscal 2024 $50,000,000 60,000,000 $(10,000,000)

Fiscal 2025 $45,000,000 42,000,000 $3,000,000

A) $3,000,000 surplus B) $3,000,000 deficit C) $5,000,000 surplus D) $8,000,000 deficit Answer: A Explanation: Fair value of pension plan assets Accrued pension obligation Pension surplus (deficit)

Diff: 1 Type: MC Skill: Comp Objective: 16.5 Integrate pension plan information by preparing the relevant note disclosures.

Comprehensive Question 1) Capricious Co. Ltd. (Cap) operates a defined benefit pension plan that offers its employees an annual retirement income based on years of service and average of the final five years' earnings prior to retirement. On January 1, 2024, Cap improved the pension benefits by increasing the percentage of the last five years' earnings from 2.1% to 2.2%. This enhancement has been retroactively applied to all actively employed workers on January 1, 2024. The amendment gave rise to an increase in the accrued benefit obligation of $100,000 on January 1, 2024. On January 1, 2025, the balance of the accrued benefit obligation is $600,000 and the pension fund assets total $520,000. The following amounts relate to Cap's pension plan experience as determined by annual valuations in 2025 and 2026:

Plan assets at market value, December 31 Accrued benefit obligation, December 31 Pension benefits earned by employees during year* Payments to retirees* Funding contribution (at end of year) Expected return on assets and interest rate on obligations * The company assumes that pension benefits are paid and earned evenly through the year earned

2025 $591,250 724,500

2026 $ 802,000 865,000

80,000 15,000 100,000

75,000 20,000 115,000

10%

Required: a. Determine the balance of the net defined benefit pension asset or liability as at January 1, 2025. b. Using the above information, prepare the schedules to reconcile the opening and closing balances of pension assets and liabilities for 2025 and 2026. c. For the years 2025 and 2026, complete Cap's pension actuary report and show the individual components which make up the pension expense. d. Record the journal entries for Cap's pension in 2025 and 2026. e. Determine the balance of the net defined benefit pension liability as at December 31, 2025 and 2026.

Answer: a. Balance of net defined pension asset liability equals the pension surplus or deficit. Dr (Cr) $520,000 (600,000) $(80,000)

Pension assets, January 1, 2025 Pension obligations, January 1, 2025 Pension surplus (deficit) = net defined benefit asset (liability) b. Schedules for pension assets and liabilities. Pension trustee report Opening assets, January 1 + Funding (at year-end) - Payments to retirees (paid evenly through year) + Expected return on assets 2024: (10% × $520,000 - 5% × $15,000) 2025: (10% × $591,250 - 5% × $20,000) + Unexpected gain (loss) on plan assets Closing balance

2025 $520,000 100,000 (15,000)

2026 $591,250 115,000 (20,000)

51,250

58,125

(65,000) $591,250

57,625 $802,000

c. Cap's pension actuary report for 2025 and 2026 and the individual components making up the pension expense. Pension actuary report Opening accrued benefit obligation, January 1 + Current service cost (accrued evenly during year) - Payments to retirees (paid evenly through year) + Interest 2025: (10% × $600,000 + 5% × ($80,000 - $15,000)) 2026: (10% × $724,500 + 5% × ($75,000 - $20,000)) Actuarial (gain) loss Closing balance

2025 $600,000 80,000 (15,000)

2026 724,500 75,000 (20,000)

63,250

75,200

(3,750) $724,500

10,300 $865,000

Pension expense Current service cost + Interest on obligation - Expected return on assets Pension expense

2025 $ 80,000 63,250 (51,250) $92,000

2026 75,000 75,200 (58,125) 92,075

d. The journal entries for Cap's pension in 2025 and 2026. 2025

2026

Dr. Defined benefit pension liability Cr. Cash

10,000

Dr. Pension expense - current service cost Dr. Pension expense - interest cost Cr. Pension expense - expected income on assets Cr. Defined benefit pension liability

80,000 63,250

Dr. OCI - unexpected loss on plan assets Cr. OCI - actuarial gain Cr. Defined benefit pension liability

65,000

Dr. Defined benefit pension liability Cr. Cash

115,000

Dr. Pension expense - current service cost Dr. Pension expense - interest cost Cr. Pension expense - expected income on assets Cr. Defined benefit pension liability

75,000 75,200

Dr. OCI - actuarial loss Dr. Defined benefit pension liability Cr. OCI - unexpected gain on plan assets

10,300 47,325

100,000

51,250 92,000

3,750 61,250

115,000

58,128 92,075

57,625

e. Balance of net defined benefit pension liability as of 2025 and 2026. Dr (Cr), at December 31 Pension assets Pension obligations Pension surplus (deficit) = net defined benefit asset (liability)

2025 $591,250 (724,500) $(133,250)

Diff: 3 Type: SA Skill: Comp Objective: 16.6 Comprehensive Question

2026 $802,000 (865,000) $(63,000)

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 17 Accounting for Leases Learning Objective 1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 1) Which statement is correct about "agency cost of leasing"? A) Conditions can be added to the lease agreement to increase agency costs. B) Agency costs are nil if the lease contract covers the entire useful life of the asset. C) Assets that are easy to damage are better candidates for leasing. D) Assets that are difficult to damage have higher agency costs. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 2) Which statement is correct about "agency cost of leasing"? A) The lease payments are lowered to compensate for the agency cost of leasing. B) Shorter lease terms decrease the agency cost of leasing. C) Agency cost of leasing is an illustration of the "moral hazard" problem. D) Agency cost of leasing is an illustration of the "adverse selection" problem. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 3) Which will decrease the "agency cost of leasing"? A) Leased assets that are easy to damage. B) Leased assets that require maintenance and care by the lessee. C) Having lease terms that cover small portions of the asset's useful life. D) Having an unguaranteed residual value by the lessee. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

4) Which will increase the "agency cost of leasing"? A) Having a bargain purchase option in the lease agreement. B) Having maintenance requirements for the leased asset. C) Leasing assets that are easy to damage. D) Having a guaranteed residual value by the lessee. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 5) The following are the characteristics of a lease: Fair value of leased asset Lease payments Lease term (years) Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease

$150,000 25,500 7 Annual End of year None 8%

From the lessor's perspective, which of the following is correct about this lease (assume the company adopts ASPE)? A) The present value of the lease payments is greater than or equal to 90%, so this is a finance (capital) lease. B) The present value of the lease payments is less than 90%, so this is an operating lease. C) The present value of the lease payments is less than 90%, so this is a finance (capital) lease. D) The present value of the lease payments is greater than or equal to 90%, so this is an operating lease. Answer: B Explanation: PVA($ 25,500; N=7; I=8%) = $25,500 x 5.20637 = $132,762 PV vs FV = $132,762/$ 150,000 = 88.5% Diff: 2 Type: MC Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

6) From the perspective of the lessor, which statement is correct respecting the criteria for determining whether a lease is an operating or a finance lease? A) Substantially all of the risks and rewards of ownership have been transferred from the lessee to the lessor. B) There is a transfer of ownership to the lessee or a bargain purchase option (BPO) at the end of the lease. C) The lease term is a minor part of the economic life of the asset. D) The present value of the lease payments is greater than 50% fair value of the leased asset. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 7) For the lessor, which condition would result in an operating lease? A) Risk of breakage is with the lessee. B) Reward of high resale value is with the lessor. C) Risk of change in rental rates is with the lessee. D) Reward of longer than expected useful life for the leased asset is with the lessee. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 8) Which factor would contribute toward the lessor classifying a lease as a finance lease? A) Lessor retains risk of breakage to leased asset. B) Lessor has reward of high resale value. C) Lessor does not have risk of change in demand for the leased asset. D) Lessor does not have guaranteed residual value. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 9) What entry is required for the lessor in a finance lease? A) Net investment in lease. B) Rental income. C) Interest expense. D) Depreciation expense. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

10) What entry is required for the lessor for an operating lease? A) Gain/loss on asset sale. B) Net investment in lease. C) Interest income. D) Depreciation expense. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 11) Which statement is true? A) The guaranteed residual value is provided by the lessor. B) The bargain purchase option is not a part of the lease payment calculation. C) The incremental borrowing rate is the interest rate that the lessor would have to pay on a similar lease or loan. D) One of the risks of ownership is the risk of obsolescence. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 12) What is true respecting the economics behind leasing arrangements? A) By agreeing to provide a guarantee that the leased property will be worth at least a certain amount, the lessor assures the lessee that the property will be treated with due care. B) A guaranteed residual value means that the lessee bears the risk and cost of the property falling below the specified value of the guarantee. C) Since the lessor is assured of receiving the guaranteed amount (or more), the guaranteed residual value does not form part of the lease payment. D) The bargain purchase option (BPO) is not included when calculating the present value of lease payments even though a BPO is almost certain to be exercised. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

13) From the perspective of the lessor, identify whether the following characteristics/facts are relevant to a finance (capital) lease. Yes / No Lease is for land. The lease contains a bargain purchase option after 3 years. The present value of the lease payment comprises 80% of the fair value of the leased asset. Lease is for manufacturing equipment. Lease transfers title to the lessee at the end of the lease. Lease payments exclude the costs of non-lease components. Answer: Lease is for land. The lease contains a bargain purchase option after 3 years. The present value of the lease payment comprises 80% of the fair value of the leased asset. Lease is for manufacturing equipment. Lease transfers title to the lessee at the end of the lease. Lease payments exclude the costs of non-lease components.

Yes / No No Yes No No Yes No

Diff: 3 Type: SA Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 14) List four examples of the risks and four examples of rewards of ownership. Answer: a) the risk of breakage b) the risk of obsolescence c) the risks and rewards of changes in rental prices d) the risks and rewards of changes in demand for the usage of the property e) the reward of a longer-than-expected useful life. f) the reward of high resale value Diff: 3 Type: SA Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

15) The following are characteristics of a lease entered into on January 1, 2025: Price of leased asset from manufacturer Lease payments Lease term Lease frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in the lease agreement

$312,094 100,000 4 years Annual End of year 35,000 15,000 14%

Required: Determine the appropriate classification for this lease for the lessor (who is not the manufacturer) and record the journal entries for the lessor for the first year of the lease. Answer: Using BAII Plus: 4 N,14 I/Y, 100000 PMT, 35000 FV CPT PV → PV = -312,094; $312,094 / $312,094 = 100%. The present value of the lease payments is 100% of the asset's fair value, so the lease transfers substantially all risks and rewards of ownership to the lessee. Thus, this is a finance lease. Jan. 1, 2025

Dec. 31, 2025

Dr. Net investment in lease (lease receivable) Cr. Cash to manufacturer

312,094

Dr. Cash Cr. Finance income ($312,094 × 14%) Cr. Net investment in lease ($100,000 - $43,693)

100,000

312,094

43,693 56,307

Diff: 2 Type: SA Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

16) The following are characteristics of a lease entered into on January 1, 2025: Price of leased asset from manufacturer Lease payments Lease term Lease frequency Payment timing Guaranteed residual value Expected payout under the guaranteed residual Interest rate implicit in the lease agreement

$189,832 50,000 5 years Annual End of year 35,000 20,000 14%

Required: Determine the appropriate classification for this lease for the lessor (who is not the manufacturer) and record the journal entries for the lessor for the first year of the lease. Answer: Using BAII Plus: 5 N,14 I/Y, 50000 PMT, 35000 FV CPT PV→PV = -189,832; $189,832 / $189,832 = 100%. The present value of the lease payments is 100% of the asset's fair value, so the lease transfers substantially all risks and rewards of ownership to the lessee. Thus, this is a finance lease. Jan. 1, 2025

Dec. 31, 2025

Dr. Net investment in lease (lease receivable) Cr. Cash to manufacturer

189,832

Dr. Cash Cr. Finance income ($189,832 × 14%) Cr. Net investment in lease ($50,000 - $26,576)

50,000

189,832

26,576 23,424

Diff: 2 Type: SA Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

17) The following are characteristics of a lease entered into on January 1, 2025: Price of leased asset from manufacturer Lease payments Lease term Lease frequency Payment timing Guaranteed residual value Expected payout under the guaranteed residual Interest rate implicit in the lease agreement

$278,287 75,000 4 years Annual End of year 15,000 15,000 5%

Required: Determine the appropriate classification for this lease for the lessor (who is not the manufacturer) and record the journal entries for the lessor for the first year of the lease. Answer: Using BAII Plus: 4 N,5 I/Y, 75000 PMT, 15000 FV CPT PV→ PV = -278,287; $278,287 / $278,287 = 100%. The present value of the lease payments is 100% of the asset's fair value, so the lease transfers substantially all risks and rewards of ownership to the lessee. Thus, this is a finance lease. Jan. 1, 2025

Dec. 31, 2025

Dr. Net investment in lease (lease receivable) Cr. Cash to manufacturer

278,287

Dr. Cash Cr. Finance income ($278,287 × 5%) Cr. Net investment in lease ($75,000 - $13,914)

75,000

278,287

13,914 61,086

Diff: 2 Type: SA Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 18) List four major risks of ownership. Answer: The risks of ownership include but are not limited to the following: 1. the risk of breakage 2. the risk of obsolescence 3. the risk of changes in rental prices 4. the risk of changes in demand for the usage of the property Diff: 3 Type: SA Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

19) Why do the supporting indicators for lease classification use "major part" and "substantially all" rather than "all" in reference to the amount of time and value contained in the lease? Answer: The supporting indicators use wording that is less than "all" because the standards setters anticipate a certain amount of earnings management in the subjective estimates of useful life and fair value. Lessors prefer finance lease treatment, so they will tend to bias these estimates downward. Diff: 3 Type: SA Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 20) Why do lessors prefer financing lease treatment over operating lease treatment? Answer: A lessor generally prefers the finance lease treatment because on the balance sheet, a nonmonetary item (inventory or capital asset) is converted to a monetary item (loan receivable), which appears more liquid. On the income statement, any profit from the asset sale is recognized immediately. During the life of the lease, interest income is recorded. In the early years of a lease, interest income under finance lease treatment will usually exceed lease revenue net of depreciation under operating lease treatment. Diff: 3 Type: SA Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 21) Salisbury Creamery, leases its ice cream making equipment from Little Rock Finance Company under the following lease terms: • The lease term is five years, non-cancellable, and requires equal rental payments of $56,926 due at the beginning of each year starting January 1, 2024. • Upon inception of the lease on January 1, 2024, Little Rock purchased the equipment at its fair value of $280,000 and immediately transferred it to Salisbury Creamery. The equipment has an estimated economic life of five years, and a $20,000 residual value that is guaranteed by Salisbury Creamery. The expected payout under the residual value guarantee is $15,000. • The lease contains no renewal options, and the equipment reverts to Little Rock Finance Company upon termination of the lease. • Salisbury's incremental borrowing rate is 5%; the rate implicit in the lease is also 4%. The implicit rate in the lease is not readily determinable by Salisbury. • Salisbury depreciates similar equipment that it owns on a straight-line basis. • Both companies have December 31 year-ends. Required: a. Evaluate how the lessor should account for the lease transaction. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. c. Prepare the lessee's amortization schedule for this lease. d. Prepare the journal entries on January 1, 2024, December 31, 2024, and January 1, 2025, for the lessor. e. Prepare the journal entries on January 1, 2024, December 31, 2024, and January 1, 2025, for the lessee.

Answer: a) Using BAII Plus: 2nd BGN, 2nd SET, 5 N, 4 I/Y, 56926 PMT, 20000 FV, CPT PV→ PV = -280,000; $280,000 / $280,000 = 100%; lese term / economic life = 5 years / 5 years = 100%; the lessor should classify this lease as a finance lease as the present value of the lease payments comprises substantially all of the fair value of the lease asset and as the lease term is a major part of the economic life of the leased asset. b) Using BAII Plus: 2nd BGN, 2nd SET, 5 N, 5 I/Y, 56926 PMT, 15000 FV, CPT PV→ PV = -270,536; ROU asset = $270,536; lease liability = $270,536 - $56,926 = $213,610. c) Date 01/01/2024 12/31/2024 01/01/2025 12/31/2025 01/01/2026 12/31/2026 01/01/2027 12/31/2027 01/01/2028 12/31/2028 01/01/2029 d) Jan. 1, 2024

Dec. 31, 2024

Jan. 1, 2024

Payment

$56,926 56,926 56,926 56,926 15,000

Interest expense

Lease Liability $213,610 $10,681 224,291 167,365 8,368 175,733 118,807 5,940 124,747 67,821 3,391 71,212 14,286 714 15,000 0

Dr. Cash Dr. Net investment in lease (lease receivable) Cr. Cash to manufacturer

56,926 223,074

Dr. Net investment in lease (lease receivable) Cr. Finance income ($223,074 × 4%)

8,923

DR Cash Cr. Net investment in lease

56,926

280,000

8,923

56,926

e) Jan. 1, 2024

Dec. 31, 2024

Jan. 1, 2024

Dr. ROU asset Cr. Lease liability Cr. Cash

270,536

Dr. Interest expense1 Cr. Lease liability

10,681

Dr. Depreciation expense2 Cr. Accumulated depreciation — ROU asset

54,107

Dr. Lease liability Cr. Cash

56,926

213,610 56,926

10,681

54,107

56,926

1 $213,610 × 5% = $10,681 2 $270,536 / 5 = $54,107 Diff: 3 Type: SA Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

22) Soaring Pieces Inc. creates aluminum alloy parts for commercial aircraft. In a recent transaction Soaring leased a high precision lathe machine from Rapid Revolving Corp. on January 1, 2024. The following information pertains to the leased asset and the lease agreement: Cost of lathe to lessor Rapid's normal selling price for lathe Useful life Estimated value at end of useful life Lease provisions Lease term Payment frequency Start date of lease Payment timing Estimated residual value at end of lease (unguaranteed) Interest rate implicit in the lease (readily determinable by lessee) Lessee's incremental borrowing rate

$140,000 178,268 7 years 8,000 5 years Annual January 1 December 31 20,000 7% 8%

The lathe machine will revert back to the lessor at end of lease term, title does not transfer to lessee at any time, and there is not a bargain purchase option. Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Classify this lease from the perspective of the lessor, Rapid Revolving Corp. c. Prepare an amortization schedule for the lessor. d. Prepare the journal entries on January 1, 2024, and December 31, 2024, for the lessor.

Answer: a. Using BAII Plus: 5 N, 7 I/Y, +|-178268 PV, 20000 FV, CPT PMT→ PMT = 40,000; 5 N, 7 I/Y, 40000 PMT, 0 FV, CPT PV→ PV = -164,008 b. Rapid Revolving should classify this as a finance lease: Criteria (one of the following) Evaluation Transfer of title or bargain purchase option No 5 years / 7 years = 70% of useful life — Lease covers major part of asset's useful life probably not $164,008 / $178,268 = PV of lease payments is substantially all of fair value 92% — yes c. Using BAII Plus 5 N, 7 I/Y, 40000 PMT, 20000 FV, CPT PV→ PV = -178,268

Year

Interest @ 7%

2024 $12,479 2025 10,552 2026 8,491 2027 6,285 2028 3,925 *Unguaranteed residual value

Payment $40,000 40,000 40,000 40,000 40,000

Principal after interest and payments $178,268 $27,521 150,747 29,448 121,299 31,509 89,790 33,715 56,075 36,075 *20,000

Reduction in principal

d. Using BAII Plus: 5 N, 7 I/Y, 20000 FV, CPT PV→PV = -14,260 Jan. 1, 2024

Dec. 31, 2024

Dr. Net investment in lease (lease receivable) Cr. Sales revenue ($178,268 - $14,260) Dr. Cost of goods sold ($140,000 - $14,260) Cr. Inventory

178,268

Dr. Cash Cr. Finance income ($178,268 × 7%) Cr. Net investment in lease (lease receivable) ($40,000 - $12,479)

40,000

164,008 125,740 140,000

12,479 27,521

Diff: 3 Type: SA Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

23) Soaring Pieces Inc. creates aluminum alloy parts for commercial aircraft. In a recent transaction Soaring leased a high precision lathe machine from Rapid Revolving Corp. on January 1, 2024. The following information pertains to the leased asset and the lease agreement: Cost of lathe to lessor Rapid's normal selling price for lathe Useful life Estimated value at end of useful life Lease provisions Lease term Payment frequency Start date of lease Payment timing Estimated residual value at end of lease (unguaranteed) Interest rate implicit in the lease (readily determinable by lessee) Lessee's incremental borrowing rate

$140,000 178,268 7 years 8,000 5 years Annual January 1 December 31 20,000 7% 8%

The lathe machine will revert back to the lessor at end of lease term, title does not transfer to lessee at any time, and there is not a bargain purchase option. Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Classify this lease from the perspective of the lessor, Rapid Revolving Corp. c. Prepare the journal entries on January 1, 2024, and December 31, 2024, for the lessor. d. Record the lessor's journal entries to reflect the return of the leased asset. e. How would the answer to (c) change if the $20,000 residual value was guaranteed by Soaring Pieces Inc., but when the lease ended the lathe was only worth $15,000?

Answer: a. Using BAII Plus: 5 N, 7 I/Y, +|-178268 PV, 20000 FV, CPT PMT→ PMT = 40,000; 5 N, 7 I/Y, 40000 PMT, 0 FV, CPT PV→ PV = -164,008 b. Rapid Revolving should classify this as a finance lease: Criteria (one of the following) Evaluation Transfer of title or bargain purchase option No 5 years / 7 years = 70% of Lease covers major part of asset's useful life useful life — probably not PV of lease payments is substantially all of fair $164,008 / $178,268 = 92% — value yes c. Using BAII Plus: 5 N, 7 I/Y, 20000 FV, CPT PV→PV = -14,260 Jan. 1, 2024

Dec. 31, 2024

Dr. Net investment in lease (lease receivable) Cr. Sales revenue ($178,268 - $14,260) Dr. Cost of goods sold ($140,000 - $14,260) Cr. Inventory

Dr. Cash Cr. Finance income ($178,268 × 7%) Cr. Net investment in lease (lease receivable) ($40,000 - $12,479)

d. Dec. 31, 2028

e. Dec. 31, 2028

178,268 164,008 125,740 140,000

40,000 12,479 27,521

Dr. Machine lathe Cr. Net investment in lease (lease receivable)

20,000

Dr. Machine lathe Dr. Cash Cr. Net investment in lease (lease receivable)

15,000 5,000

20,000

Diff: 3 Type: SA Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

24) Why do lessors generally prefer finance lease treatment? Explain. Answer: Lessors generally prefer the finance lease treatment because on the balance sheet, a nonmonetary item (inventory or capital asset) is converted to a monetary item (loan receivable), which appears more liquid. On the income statement, any profit from the asset sale is recognized immediately. During the life of the lease, interest income is recorded. Under operating lease treatment, the lessor shows a leased asset and must depreciate the asset. Lease payments are recognized as revenue when earned (which is usually close to its receipt). In the early years of a lease, interest income under finance lease treatment will usually exceed lease revenue net of depreciation under operating lease treatment. Diff: 3 Type: SA Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

25) Complete this table identifying the key differences between IFRS and ASPE standards for leasing. ISSUE IFRS Lessor's lease capitalization criteria Lessor's classification of finance (capital) leases Lessee's lease capitalization criteria Lessee's discount rate for present value calculations Lessee's inclusion of residual value guarantees in the determination of lease payments Lessee's accounting for the lease and non-lease components in a lease contract

ASPE

Answer: ISSUE Lessor's lease capitalization criteria

IFRS ASPE Based on qualitative In addition to the criteria considerations of whether for the lessee, the lessor the lease transfers must also consider the substantially all the risks credit risk of the lessee and and rewards of ownership. whether non-reimbursable costs are reasonably estimable. Lessor's classification of finance No sub-classification of Capital leases are further (capital) leases finance leases. sub-classified into salestype and direct financing leases depending on whether there is a profit margin on the sale. Lessee's lease capitalization The lessee recognizes a Based on both qualitative criteria ROU asset and lease and quantitative liability for virtually all considerations of whether 1 the lease transfers leases. substantially all the risks and rewards of ownership. Lessee's discount rate for Use interest rate implicit in If the interest rate implicit present value calculations the lease if readily in the lease is known to determinable by the lessee. lessee, use the lower of the Otherwise, use the implicit rate and the incremental borrowing rate. incremental borrowing rate. Otherwise, use the incremental borrowing rate. Lessee's inclusion of residual Lessee includes the amount Lessee includes the full value guarantees in the expected to be paid out amount of the residual determination of lease under the guarantee in its value guarantee in its payments determination of lease determination of minimum payments. lease payments. Lessee's accounting for the lease When the lessee adopts the Lease and executory costs and non-lease components in a available practical must be accounted for lease contract expedient, it accounts for separately. the lease and related nonlease components in a lease contract as a single lease component. 1The exceptions are short-term leases and leases of low-value assets for which the lessee has elected to adopt the available practical expedient

26) What are the advantages to the lessee of leasing an asset, rather than purchasing it? Answer: 1. "100%" financing of the asset's purchase price, which is often more than the amount that can be obtained from a loan. 2. Payment schedules that are more flexible in comparison to loans. 3. 100% deductibility of the lease payments from the lessee's taxable income 4. After-tax costs are lower due to differences in tax rates for the lessor and lessee. Diff: 3 Type: ES Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 27) What is meant by the agency cost of leasing? Answer: The user who controls the asset during the lease (the lessee) is not the owner of the asset (because the lessor still owns it). The lessor must bear a risk that the lessee will not take the utmost care of the leased property (or as much care as the lessor would). This reduced level of care due to separation of an asset's ownership and its control is the agency cost of leasing. Diff: 3 Type: ES Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 28) What are four examples of lease conditions that help mitigate agency costs? Answer: a) Damage deposits for apartments deter renters from harming the property. b) Long-term car leases often limit the amount of mileage that can be driven annually. c) A bargain purchase option that allows the lessee to purchase the asset at a price below the market value expected at the end of the lease. d) A guaranteed residual value, whereby the lessee must ensure that the leased asset retains a certain value at the end of the lease. Diff: 3 Type: ES Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

29) List factors that impact the degree to which this agency cost is a factor. Answer: a) The inherent nature of the asset that is leased. Assets that are robust and difficult to damage have lower agency costs and are better candidates for leasing. b) The incentives of the lessee to maintain the condition of the leased asset. Some types of lessees are more motivated to maintain the leased asset than others. For example, airlines are very keen to ensure that their leased aircraft are safe for their customers since the consequences of equipment failure are severe in terms of both the airlines' business and human lives. c) Regulations that require a high degree of care. Airlines again are a good example here. Regulators have stringent requirements for maintaining commercial passenger aircraft. d) Conditions negotiated between the lessor and lessee. Lease agreements often contain conditions that mitigate agency costs. For example, damage deposits for apartments, mileage limits for cars, bargain purchase options and guaranteed residual values. e) The length of the lease contract. If the length of the lease contract covers substantially the entire useful life of the asset then agency costs will be minimal, since the lessee bears the cost of neglecting or abusing the property. Diff: 3 Type: ES Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method. 30) For the lessor, what is the general criterion for deciding whether a lease is an operating or a finance lease? Answer: a) Ownership of the leased asset transfers to the lessee at the end of the lease. b) The lease includes a bargain purchase option (BPO). c) The lease term is a major part of the economic life of the asset. What constitutes a "major part" is a matter of professional judgement, as IFRS does not quantify this term. ASPE, however, establishes that a "major part" is ≥ 75% of the asset's economic life. d) The present value of the lease payments (PVLP) comprises substantially all of the fair value of the leased asset. Again, "substantially all" is a matter of professional judgement, as IFRS does not quantify this term. ASPE, though, establishes that "substantially all" is ≥ 90% of the asset's fair value. e) The leased asset is so specialized that, without major modification, it cannot be used by anyone other than the lessee. The foregoing indicators, individually or together, normally constitute sufficient evidence that substantially all the risks and rewards of ownership have transferred. Thus, if one or more of these factors are present, the lessor will normally classify the lease as a finance lease. Diff: 3 Type: ES Skill: Concept Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

31) Viribana Corporation started operations on March 1, 2025. It needs to acquire a special piece of equipment for its manufacturing operations. It is evaluating two options as follows. Option 1: Lease the equipment for 10 years. Lease payments would be $11,200 per year, due at the beginning of each fiscal year (March 1). Viribana's incremental borrowing rate is 12%. There is not a bargain purchase or renewal option. Viribana is responsible for all non-lease costs of operating the equipment. Option 2: Purchase the equipment for $71,000 by borrowing the full purchase amount at 12% over 10 years. This price is considered the fair value of the equipment. Payments are due at the end of each fiscal year (February 28). The equipment has a useful life of 10 years and would be depreciated on a straight-line basis. No residual value is expected to exist at the end of 10 years. Required: a. Calculate the present value of the lease payments (Option 1). b. Calculate the payment that would be required under the purchase option (Option 2). c. Calculate and briefly discuss the financial impact of each option on the non-current assets, total liabilities, and net income of Viribana for the first year of operations. Assume all payments were made when due. Show your calculations. d. Indicate which option you would recommend for Viribana. Provide an explanation to support your recommendation. Answer: a. Present value of lease payments: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 10 N, 12 I/Y, 11200 PMT, CPT PV → PV = -70,876; ROU asset = $70,876; Lease liability = $70,876 - $11,200 = $59,676 b. Loan payments: Using BAII Plus: 10 N, 12 I/Y, +|- 71000 PV, CPT PMT → PMT = 12,566 c. Impact on financial statement accounts:

Account Non-current assets Liabilities

Option 1 Lease Calculation

Amount

Option 2 Purchase Calculation

Amount

$70,876 × 9 / 10 $59,676 × 1.12

$63,788 66,837

$71,000 × 9 / 10 $71,000 × 1.12 - $12,566

$63,900 66,954

Depreciation $70,876 / 10 Interest expense $59,676 × 12% Effect on income

$7,088 7,161 $14,249

$71,000 / 10 $71,000 × 12%

$7,100 8,520 $15,620

Under both options, non-current assets will increase, as will liabilities. Net income will include expenses for depreciation and interest. The amounts are not materially different between the two options. d. Reasons to lease: asset has no expected value at the end of the lease; leasing is slightly cheaper in terms of present value (but not materially so). Diff: 3 Type: ES Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

32) Curtis Corporation started operations on March 1, 2025. It needs to acquire a special piece of equipment for its manufacturing operations. It is evaluating two options as follows. Option 1: Lease the equipment for 5 years. Lease payments would be $11,000 per year, due at the beginning of each fiscal year (March 1). Curtis's incremental borrowing rate is 5%. There is not a bargain purchase or renewal option. Curtis is responsible for all non-lease costs of operating the equipment. Option 2: Purchase the equipment for $50,000 by borrowing the full purchase amount at 5% over 5 years. This price is considered the fair value of the equipment. Payments are due at the end of each fiscal year (February 28). The equipment has a useful life of 5 years and would be depreciated on a straight-line basis. No residual value is expected to exist at the end of 5 years. Required: a. Calculate the present value of the lease payments (Option 1). b. Calculate the payment that would be required under the purchase option (Option 2). c. Calculate and briefly discuss the financial impact of each option on the non-current assets, total liabilities, and net income of Curtis for the first year of operations. Assume all payments were made when due. Show your calculations. Answer: a. Present value of lease payments: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 5 I/Y, 11000 PMT, CPT PV → PV = -50,005; ROU asset = $50,005; Lease liability = $50,005 - $11,000 = $39,005 b. Loan payments: Using BAII Plus: 5 N, 5 I/Y, +|- 50000 PV, CPT PMT → PMT = 11,549 c. Impact on financial statement accounts:

Account Non-current assets Liabilities Depreciation Interest expense Effect on income

Option 1 Lease Option 2 Purchase Calculation Amount Calculation Amount $50,005 × 4 / 5 $40,004 $50,000 × 4 / 5 $40,000 $39,005 × 1.05 40,955 $50,000 × 1.05 - $11,549 40,951 $50,005 / 5 $39,005 × 5%

$10,001 1,950 $11,951

$50,000 / 5 $50,000 × 5%

$10,000 2,500 $12,500

Under both options, non-current assets will increase, as will liabilities. Net income will include expenses for depreciation and interest. The amounts are not materially different between the two options. Diff: 3 Type: ES Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

33) Cerebral Corporation started operations on March 1, 2025. It needs to acquire a special piece of equipment for its manufacturing operations. It is evaluating two options as follows. Option 1: Lease the equipment for 5 years. Lease payments would be $12,000 per year, due at the beginning of each fiscal year (March 1). Cerebral's incremental borrowing rate is 5%. There is not a bargain purchase or renewal option. Cerebral is responsible for all non-lease costs of operating the equipment. Option 2: Purchase the equipment for $58,000 by borrowing the full purchase amount at 5% over 5 years. This price is considered the fair value of the equipment. Payments are due at the end of each fiscal year (February 28). The equipment has a useful life of 5 years and would be depreciated on a straight-line basis. No residual value is expected to exist at the end of 5 years. Required: a. Calculate the present value of the lease payments (Option 1). b. Calculate the payment that would be required under the purchase option (Option 2). c. Calculate and briefly discuss the financial impact of each option on the non-current assets, total liabilities, and net income of Cerebral for the first year of operations. Assume all payments were made when due. Show your calculations. Answer: a. Present value of lease payments: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 5 I/Y, 12000 PMT, CPT PV → PV = -54,551; ROU asset = $54,551; Lease liability = $54,551 - $12,000 = $42,551 b. Loan payments: Using BAII Plus: 5 N, 5 I/Y, +|- 58000 PV, CPT PMT→ PMT = 13,397 c. Impact on financial statement accounts: Option 1 Lease Option 2 Purchase Account Calculation Amount Calculation Amount Non-current assets $54,551 × 4 / 5 $43,641 $58,000 × 4 / 5 $46,400 Liabilities $42,551 × 1.05 44,679 $58,000 × 1.05 - $13,397 47,503 Depreciation Interest expense Effect on income

$54,551 / 5 $42,551 × 5%

$10,910 2,128 $13,038

$58,000 / 5 $58,000 × 5%

$11,600 2,900 $14,500

Under both options, non-current assets will increase, as will liabilities. Net income will include expenses for depreciation and interest. The amounts are not materially different between the two options. Diff: 3 Type: ES Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

34) Kartik Corporation started operations on March 1, 2025. It needs to acquire a special piece of equipment for its manufacturing operations. It is evaluating two options as follows. Option 1: Lease the equipment for 5 years. Lease payments would be $12,000 per year, due at the beginning of each fiscal year (March 1). Kartik's incremental borrowing rate is 5%. There is not a bargain purchase or renewal option. Kartik is responsible for all non-lease costs of operating the equipment. Option 2: Purchase the equipment for $58,000 by borrowing the full purchase amount at 4% over 5 years. This price is considered the fair value of the equipment. Payments are due at the end of each fiscal year (February 28). The equipment has a useful life of 5 years and would be depreciated on a straight-line basis. No residual value is expected to exist at the end of 5 years. Required: a. Calculate the present value of the lease payments (Option 1). b. Calculate the payment that would be required under the purchase option (Option 2). c. Calculate and briefly discuss the financial impact of each option on the non-current assets, total liabilities, and net income of Kartik for the first year of operations. Assume all payments were made when due. Show your calculations. Answer: a. Present value of lease payments: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 5 I/Y, 12000 PMT, CPT PV → PV = -54,551; ROU asset = $54,551; Lease liability = $54,551 - $12,000 = $42,551 b. Loan payments: Using BAII Plus: 5 N, 4 I/Y, +|- 58000 PV, CPT PMT → PMT = 13,028 c. Impact on financial statement accounts: Option 1 Lease Option 2 Purchase Account Calculation Amount Calculation Amount Non-current assets $54,551 × 4 / 5 $43,641 $58,000 × 4 / 5 $46,400 Liabilities $42,551 × 1.05 44,679 $58,000 × 1.04 - $13,028 47,292 Depreciation Interest expense Effect on income

$54,551 / 5 $42,551 × 5%

$10,910 2,128 $13,038

$58,000 / 5 $58,000 × 4%

$11,600 2,320 $13,920

Under both options, non-current assets will increase, as will liabilities. Net income will include expenses for depreciation and interest. The amounts are not materially different between the two options. Diff: 3 Type: ES Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

35) Boris Corporation started operations on March 1, 2025. It needs to acquire a special piece of equipment for its manufacturing operations. It is evaluating two options as follows. Option 1: Lease the equipment for 5 years. Lease payments would be $12,000 per year, due at the beginning of each fiscal year (March 1). Boris's incremental borrowing rate is 8%. There is not a bargain purchase or renewal option. Boris is responsible for all non-lease costs of operating the equipment. Option 2: Purchase the equipment for $58,000 by borrowing the full purchase amount at 4% over 5 years. This price is considered the fair value of the equipment. Payments are due at the end of each fiscal year (February 28). The equipment has a useful life of 5 years and would be depreciated on a straight-line basis. No residual value is expected to exist at the end of 5 years. Required: a. Calculate the present value of the lease payments (Option 1). b. Calculate the payment that would be required under the purchase option (Option 2). c. Calculate and briefly discuss the financial impact of each option on the non-current assets, total liabilities, and net income of Boris for the first year of operations. Assume all payments were made when due. Show your calculations. Answer: a. Present value of lease payments: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 8 I/Y, 12000 PMT, CPT PV → PV = -51,746; ROU asset = $51,746; Lease liability = $51,746 - $12,000 = $39,746 b. Loan payments: Using BAII Plus: 5 N, 4 I/Y, +|- 58000 PV, CPT PMT → PMT = 13,028 c. Impact on financial statement accounts: Option 1 Lease Option 2 Purchase Account Calculation Amount Calculation Amount Non-current assets $51,746 × 4 / 5 $41,397 $58,000 × 4 / 5 $46,400 Liabilities $39,746 × 1.08 42,926 $58,000 × 1.04 - $13,028 47,292 Depreciation Interest expense Effect on income

$51,746 / 5 $39,746 × 8%

$10,349 3,180 $13,529

$58,000 / 5 $58,000 × 4%

$11,600 2,320 $13,920

Under both options, non-current assets will increase, as will liabilities. Net income will include expenses for depreciation and interest. The amounts are not materially different between the two options. Diff: 3 Type: ES Skill: Comp Objective: 17.1 Apply the criteria for lessors for classifying leases as finance (capital) or operating leases, and apply the appropriate accounting method.

Learning Objective 2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 1) Which statement is correct about the "guaranteed residual value"? A) It is an indicator that the lessee will take care of the property. B) It is provided by the lessor. C) Lessor assumes the risk of the property falling below the guaranteed amount. D) It is not included in the present value of the lease payment calculation. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 2) Which statement is correct about the "guaranteed residual value"? A) It is not included in the present value of the payment calculation. B) Lessee assumes the risk of the property falling below the guaranteed amount. C) Lessor assumes the risk of the property falling below the guaranteed amount. D) It is a non-lease cost in the lease arrangement. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 3) Which statement is correct about the bargain purchase option (BPO)? A) It is cash that the lessee will receive at the end of the lease. B) It cannot be assumed that the BPO will be exercised. C) It is excluded in the present value of the lease payment calculation. D) It means that it is almost certain that ownership will transfer to the lessee. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 4) What is the incremental borrowing rate? A) The interest rate that the lessor would have to pay on a similar lease or loan. B) The interest rate that the lessee would have to pay on a similar lease or loan. C) The risk adjusted interest rate from the cash flow stream expected by the lessor. D) The risk adjusted interest rate from the cash flow stream expected by the lessee. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

5) What is the implicit rate? A) The interest rate that the lessor would have to pay on a similar lease or loan. B) The interest rate that the lessee would have to pay on a similar lease or loan. C) The risk adjusted interest rate from the cash flow stream expected by the lessor. D) The risk adjusted interest rate from the cash flow stream expected by the lessee. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 6) For the following lease, determine the lessor's net investment in lease (lease receivable). Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Unguaranteed residual value

$30,000 5 10% 8% 28,000

A) $113,723 B) $119,781 C) $131,109 D) $138,838 Answer: D Explanation: Using BAII Plus: 5 N, 8 I/Y, 30,000 PMT, 28,000 FV, CPT PV → PV = -138,838 Diff: 2 Type: MC Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

7) For the following lease, determine the lessor's net investment in lease (lease receivable). Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Unguaranteed residual value

$22,000 5 10% 8% 15,000

A) $83,400 B) $92,711 C) $98,048 D) $102,304 Answer: C Explanation: Using BAII Plus: 5 N, 8 I/Y, 22,000 PMT, 15,000 FV, CPT PV → PV = -98,048 Diff: 2 Type: MC Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 8) For the following lease, determine the lessor's net investment in lease (lease receivable). Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Unguaranteed residual value Bargain purchase option

$22,000 5 10% 8% NA 5,000

A) $86,502 B) $91,243 C) $95,816 D) $101,451 Answer: B Explanation: Using BAII Plus: 5 N, 8 I/Y, 22,000 PMT, 5,000 FV, CPT PV → PV = -91,243 Diff: 2 Type: MC Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

9) For the following lease, determine the lessor's net investment in lease (lease receivable). Annual payment (due at the commencement date of the lease Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Non-lease costs included in annual payment

$22,000 5 10% 8% 5,000

A) $67,876 B) $70,888 C) $73,306 D) $94,867 Answer: C Explanation: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 8 I/Y, 17,000 PMT ($22,000 - $5,000), CPT PV → PV = -73,306 Diff: 2 Type: MC Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 10) For the following lease, determine the lessor's net investment in lease (lease receivable). Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (readily determinable by lessee) Non-lease costs included in annual payment

$32,000 5 11% 9% 10,000

A) $81,310 B) $85,572 C) $118,269 D) $124,469 Answer: B Explanation: Using BAII Plus: 5 N, 9 I/Y, 22,000 PMT ($32,000 - $10,000), CPT PV → PV = -85,572 Diff: 2 Type: MC Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

11) The following are characteristics of a lease entered into on January 1, 2025: Fair market value of asset Lease term Lease frequency Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in the lease agreement

$320,000 4 years Annual 35,000 15,000 7%

Required: a. Determine the required lease payment assuming that the first payment is made at the commencement date of the lease. b. Determine the required lease payment assuming that the first payment is made on December 31, 2025. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 4 N, 7 I/Y, +|- 320000 PV, 35000 FV CPT PMT → PMT = 80,925. b. Using BAII Plus: 4 N, 7 I/Y, +|- 320000 PV, 35000 FV CPT PMT → PMT = 86,590. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 12) The following are characteristics of a lease entered into on January 1, 2025: Fair market value of asset Lease term Lease frequency Guaranteed residual value Expected payout under the guaranteed residual Interest rate implicit in the lease agreement

$190,000 5 years Annual 35,000 20,000 8%

Required: a. Determine the required lease payment assuming that the first payment is made at the commencement date of the lease. b. Determine the required lease payment assuming that the first payment is made on December 31, 2025. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 8 I/Y, +|- 190000 PV, 35000 FV CPT PMT → PMT = 38,538. b. Using BAII Plus: 5 N, 8 I/Y, +|- 190000 PV, 35000 FV CPT PMT → PMT = 41,621. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 30 Copyright © 2023 Pearson Canada Inc.

13) The following are characteristics of a lease entered into on January 1, 2025: Fair market value of asset Lease term Lease frequency Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in the lease agreement

$500,000 5 years Monthly 20,000 5,000 6% (0.5% per month)

Required: a. Determine the required lease payment assuming that the first payment is made at the commencement date of the lease. b. Determine the required lease payment assuming that the first payment is made on January 31, 2025. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 60 N (5 × 12), .5 I/Y, +|- 500000 PV, 20000 FV CPT PMT → PMT = 9,333. b. Using BAII Plus: 60 N (5 × 12), .5 I/Y, +|- 500000 PV, 20000 FV CPT PMT → PMT = 9,380. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

14) The following are characteristics of a lease that commenced on January 1, 2025: Fair market value of asset Lease payments Lease term Lease frequency Payment timing Guaranteed residual value Expected payout under the guaranteed residual Interest rate implicit in the lease agreement (not readily determinable by lessee) Lessee's incremental borrowing rate

$352,886 100,000 4 years Annual Beginning of year 35,000 21,000 14%

15%

Required: a. Determine the appropriate classification for this lease for the lessor (who is not the manufacturer). b. Record the journal entries for the lessor for the first year of the lease. c. Prepare the journal entries for the lessee for the first year. Assume the lessee uses straight-line depreciation for its property, plant, and equipment.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 4 N, 14 I/Y, 100000 PMT, 35000 FV, CPT PV → PV = 352,886; the present value of the lease payments is 100% of the asset's fair value ($352,886 / $352,886), so the lease transfers substantially all risks and rewards of ownership to the lessee. Thus, this is a finance lease for the lessor. b. Lessor's journal entries for the first year Jan. 1, 2025

Dec. 31, 2025

Dr. Net investment in lease (lease receivable) Dr. Cash Cr. Cash to manufacturer

252,886

Dr. Net investment in lease (lease receivable) Cr. Finance income ($252,886 × 14%)

35,404

100,000 352,886

35,404

c. Lessee's journal entries for the first year. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 4 N, 15 I/Y, 100000 PMT, 21000 FV, CPT PV→ PV = -340,329; ROU asset $340,329; Lease liability = $340,329 - $100,000 = $240,329 Journal entries: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

340,329

Dr. Interest expense1 Cr. Lease liability

36,049

Dr. Depreciation expense2

85,082

240,329 100,000

36,049

Cr. Accumulated depreciation — ROU asset

85,082

1 $240,329 × 15% = $36,049 2 $340,329 / 4 = $85,082 Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

15) Discuss what is meant by the risk-adjusted rate and which risk adjusted rates the lessee and the lessor should use? Answer: Finance theory suggests that the appropriate discount/interest rate is the risk- adjusted rate. However, there is some uncertainty as to the type of risk that should be factored into this rate: the risk associated with the asset being leased, or the risk of the lessee. First, note that a rational lessor should factor in risks of both the asset and the risk of the lessee in setting the terms of the lease, especially the lease payments. The risk-adjusted interest rate from the cash flow stream expected by the lessor and the fair value of the leased property is called the "implicit rate," The lessee, on the other hand, may not always have sufficient information to calculate the implicit rate. In this case, under IFRS, the lessee uses its incremental borrowing rate, the interest rate that the lessee would have to pay on a similar lease or loan. Thus, under IFRS, the interest rate for the lessee is determined on a hierarchical basis: use the implicit rate if available; otherwise, use the incremental borrowing rate. Diff: 3 Type: SA Skill: Concept Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 16) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (not readily determinable by the lessee) Lessee's incremental borrowing rate

$250,000 10 years Annual Beginning of year 0 9% 10%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 10 N, 9 I/Y, +|-250000 PV, CPT PMT→ PMT = 35,739 b. Using BAII Plus: 2nd BGN, 2nd SET, 10 N, 10 I/Y, 35739 PMT, CPT PV→ PV = -241,561; ROU asset = $241,561; Lease liability = $241,561 - $35,739 = $205,822 Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

17) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$500,000 15 years Annual End of year 0 5% 7%

Required: Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. Answer: Computation of required lease payments Using BAII Plus: 15 N, 5 I/Y, +|-500,000 PV, CPT PMT→ PMT 48,171 Diff: 1 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 18) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$250,000 4 years Annual Beginning of year 25,000 12,000 4% 6%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 4 I/Y, +|-250000 PV, 25000 FV, CPT PMT→ PMT = 60,563 b. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 6 I/Y, 60563 PMT, 12000 FV, CPT PV→ PV = -231,954; ROU asset = $231,954; Lease liability = $231,954 - $60,563 = $171,391 Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

19) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$50,000 8 years Annual Beginning of year 15,000 10,000 9% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 9 I/Y, +|-50000 PV, 15000 FV, CPT PMT→ PMT = 7,040 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 8 I/Y, 7040 PMT, 10000 FV, CPT PV→ PV = -49,096; ROU asset = $49,096; Lease liability = $49,096 - $7,040 = $42,056. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

20) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Useful life Lease term Payment frequency Payment timing Unguaranteed residual value Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$120,000 10 years 7 years Annual Beginning of year 10,000 15% 14%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset. b. Compute the present value of the minimum lease payments for the lessee. d. Evaluate whether the lessee should classify the lease as operating or capital lease using the quantitative guidelines in ASPE. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 15 I/Y, +|-120000 PV, 10000 FV, CPT PMT→ PMT = 24,295 b. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 14 I/Y, 24295 PMT, 0 FV, CPT PV→ PV = -118,770 c. Under ASPE, the lessee should classify this lease as a finance lease because the PV of the minimum lease payments is greater than or equal to 90% of the asset's fair value ($118,770/$120,000 = 99.0%). Diff: 3 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 21) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$65,000 10 years Annual End of year 0 4% 4%

Required: Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. Answer: Using BAII Plus: 10 N, 4 I/Y, +|- 65000 PV, 0 FV, CPT PMT→ PMT = 8,014 Diff: 1 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

22) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$50,000 4 years Annual Beginning of year 25,000 7,000 5% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 5 I/Y, +|- 50000 PV, 25000 FV, CPT PMT→ PMT = 7,905 b. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 8 I/Y, 7905 PMT, 7000 FV, CPT PV→ PV = -33,422; ROU asset = $33,422; Lease liability = $33,422 - $7,905 = $25,517. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

23) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 8 years Annual Beginning of year 5,000 0 6% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 6 I/Y, +|- 150000 PV, 5000 FV, CPT PMT→ PMT = 22,312 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 6 I/Y, 22312 PMT, 0 FV, CPT PV→ PV = -146,866; ROU asset = $146,866; Lease liability = $146,866 - $22,312 = $124,554. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

24) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$175,000 8 years Annual End of year 15,000 0 6% 8%

Required: Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. Answer: Using BAII Plus: 8 N, 6 I/Y, +|- 175000 PV, 15000 FV, CPT PMT→ PMT = 26,666 Diff: 1 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

25) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 8 years Annual Beginning of year 25,000 17,000 9% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 9 I/Y, +|- 150000 PV, 25000 FV, CPT PMT→ PMT = 22,784 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 8 I/Y, 22784 PMT, 17000 FV, CPT PV→ PV = -150,591; ROU asset = $150,591; Lease liability = $150,591 - $22,784 = $127,807. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

26) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 8 years Annual Beginning of year 25,000 14,000 11% 9%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 11 I/Y, +|- 150000 PV, 25000 FV, CPT PMT→ PMT = 24,360 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 9 I/Y, 24360 PMT, 14000 FV, CPT PV→ PV = -153,989; ROU asset = $153,989; Lease liability = $153,989 - $24,360 = $129,629. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

27) The following are some of the characteristics of an asset available for lease: Fair value of leased asset (known to lessee) Useful life Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$80,000 10 years 7 years Annual Beginning of year 10,000 10% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount to be initially recognized as an asset under lease by the lessee under ASPE. c. Evaluate whether the lessee should classify the lease as operating or capital lease using the quantitative guidelines in ASPE. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 10 I/Y, +|- 80000 PV, 10000 FV, CPT PMT→ PMT = 13,980 b. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 8 I/Y, 13980 PMT, 10000 FV, CPT PV→ PV = -84,443. Under ASPE, the amount recognized for assets under capital lease cannot exceed the fair value of the asset ($80,000). Therefore, the asset to be recognized under the lease agreement is to be initially measured at $80,000. c. The lessee should classify this lease as a finance lease because the PV of lease payments is ≥ 90% of the asset's fair value ($84,443 / $80,000 = 106%). Diff: 3 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

28) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Useful life Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$88,000 10 years 7 years Annual Beginning of year 10,000 6,000 10% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 10 I/Y, +|- 88000 PV, 10000 FV, CPT PMT→ PMT = 15,474 b. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 8 I/Y, 15474 PMT, 6000 FV, CPT PV→ PV = -90,509; ROU asset = $90,509; Lease liability = $90,509 - $15,474 = $75,035. Diff: 2 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

29) Soaring Pieces Inc. creates aluminum alloy parts for commercial aircraft. In a recent transaction Soaring leased a high precision lathe machine from Rapid Revolving Corp. on January 1, 2024. The following information pertains to the leased asset and the lease agreement: Cost of lathe to lessor Rapid's normal selling price for lathe Useful life Estimated value at end of useful life Lease provisions Lease term Payment frequency Start date of lease Payment timing Estimated residual value at end of lease (unguaranteed) Interest rate implicit in the lease (readily determinable by lessee) Lessee's incremental borrowing rate

$140,000 178,268 7 years 8,000 5 years Annual January 1 December 31 20,000 7% 8%

The lathe machine will revert back to the lessor at end of lease term, title does not transfer to lessee at any time, and there is not a bargain purchase option. Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Classify this lease from the perspective of the lessor, Rapid Revolving Corp. c. Prepare an amortization schedule for the lessor. d. Prepare the journal entries on January 1, 2024 and December 31, 2024 for the lessor.

Answer: a. Using BAII Plus: 5 N, 7 I/Y, +|-178268 PV, 20000 FV, CPT PMT→ PMT = 40,000; 5 N, 7 I/Y, 40000 PMT, 0 FV, CPT PV→ PV = -164,008 b. Rapid Revolving should classify this as a finance lease: Criteria (one of the following) Evaluation Transfer of title or bargain purchase No option Lease covers major part of asset's useful 5 years / 7 years = 70% of useful life — life probably not PV of lease payments is substantially all $164,008 / $178,268 = 92% — yes of fair value c. Using BAII Plus 5 N, 7 I/Y, 40000 PMT, 20000 FV, CPT PV→ PV = -178,268

Year 2024 2025 2026 2027 2028

Interest @ 7%

Payment

$12,479 10,552 8,491 6,285 3,925

Principal after interest and payments $178,268 $27,521 150,747 29,448 121,299 31,509 89,790 33,715 56,075 36,075 *20,000

Reduction in principal $40,000 40,000 40,000 40,000 40,000

*Unguaranteed residual value

d. Using BAII Plus: 5 N, 7 I/Y, 20000 FV, CPT PV→PV = -14,260

Jan. 1, 2024

Dec. 31, 2024

Dr. Net investment in lease (lease receivable) Cr. Sales revenue ($178,268 - $14,260) Dr. Cost of goods sold ($140,000 - $14,260) Cr. Inventory Dr. Cash Cr. Finance income ($178,268 × 7%) Cr. Net investment in lease (lese receivable) ($40,000 - $12,479)

178,268 164,008 125,740 140,000 40,000 12,479

27,521

Diff: 3 Type: SA Skill: Comp Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee.

30) Soaring Pieces Inc. creates aluminum alloy parts for commercial aircraft. In a recent transaction Soaring leased a high precision lathe machine from Rapid Revolving Corp. on January 1, 2024. The following information pertains to the leased asset and the lease agreement: Cost of lathe to lessor Rapid's normal selling price for lathe Useful life Estimated value at end of useful life Lease provisions Lease term Payment frequency Start date of lease Payment timing Estimated residual value at end of lease (unguaranteed) Interest rate implicit in the lease (readily determinable by lessee) Lessee's incremental borrowing rate

$140,000 178,268 7 years 8,000 5 years Annual January 1 December 31 20,000 7% 8%

The lathe machine will revert back to the lessor at end of lease term, title does not transfer to lessee at any time, and there is not a bargain purchase option. Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Classify this lease from the perspective of the lessor, Rapid Revolving Corp. c. Prepare the journal entries on January 1, 2024, and December 31, 2024, for the lessor. d. Record the lessor's journal entries to reflect the return of the leased asset. e. How would the answer to (c) change if the $20,000 residual value was guaranteed by Soaring Pieces Inc., but when the lease ended the lathe was only worth $15,000?

Answer: a. Using BAII Plus: 5 N, 7 I/Y, +|-178268 PV, 20000 FV, CPT PMT→ PMT = 40,000; 5 N, 7 I/Y, 40000 PMT, 0 FV, CPT PV→ PV = -164,008 b. Rapid Revolving should classify this as a finance lease: Criteria (one of the following) Evaluation Transfer of title or bargain purchase option No Lease covers major part of asset's useful life 5 years / 7 years = 70% of useful life — probably not PV of lease payments is substantially all of $164,008 / $178,268 = 92% — yes fair value c. Using BAII Plus: 5 N, 7 I/Y, 20000 FV, CPT PV→PV = -14,260 Jan. 1, 2024

Dec. 31, 2024

d. Dec. 31, 2028

Dr. Net investment in lease (lease receivable) Cr. Sales revenue ($178,268 - $14,260) Dr. Cost of goods sold ($140,000 - $14,260) Cr. Inventory

178,268

Dr. Cash Cr. Finance income ($178,268 × 7%) Cr. Net investment in lease (lese receivable) ($40,000 $12,479)

40,000

Dr. Machine lathe Cr. Net investment in lease (lese receivable)

20,000

164,008 125,740 140,000

12,479

27,521

20,000

e. Dec. 31, 2028

Dr. Machine lathe Dr. Cash Cr. Net investment in lease (lese receivable)

15,000 5,000 20,000

Learning Objective 3 Apply the appropriate accounting method for lessees' right-of-use assets. 1) Under ASPE, what are executory costs? A) Maintenance costs that are applicable to only operating leases. B) Maintenance costs that are incurred only when the asset is leased. C) Maintenance costs that are incidental costs in a lease that would be incurred by the lessee independent of whether the lessee had purchased or leased the asset. D) Maintenance costs that are applicable to only finance leases. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 2) Under ASPE, what is the meaning of "minimum lease payments"? A) Payments over the lease term including non-lease costs. B) Payments over the lease term excluding non-lease costs. C) Payments over the lease term until the bargain purchase option is exercised. D) Payments over the lease term until guaranteed residual value is received. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.2 Analyze a lease to determine the present value of lease payments, the interest rate implicit in the lease, and the lease payments required from the lessee. 3) Under IFRS, assuming all information is available, which rate is used by the lessee in the minimum lease calculation? A) Implicit borrowing rate. B) Lessee's incremental borrowing rate. C) Lower of the incremental and implicit rate. D) Either the incremental or implicit rate. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

4) Under ASPE, which statement is correct for the lessee? A) Using the higher of the incremental or implicit rate maximizes the present value of the minimum lease payment calculation. B) Using the lower of the incremental or implicit rate maximizes the present value of the minimum lease payment calculation. C) Using the incremental borrowing rate maximizes the minimum lease payment calculation. D) Using the implicit rate maximizes the minimum lease payment calculation. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 5) Under ASPE, which statement is correct for the lessee? A) If the present value of the minimum lease payments exceeds the fair value of the leased asset, the asset will be recorded on the balance sheet at the higher amount. B) If the present value of the minimum lease payments exceeds the fair value of the leased asset, the asset will be recorded on the balance sheet at the fair value amount. C) If the present value of the minimum lease payments is lower that the fair value of the leased asset, the asset will be recorded on the balance sheet at the unguaranteed residual value amount. D) If the present value of the minimum lease payments is lower that the fair value of the leased asset, the implicit rate must be used. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 6) Under ASPE, assuming all information is available, which rate is used by the lessee in the lease present value calculations? A) Implicit borrowing rate. B) Lessee's incremental borrowing rate. C) Lower of the incremental and implicit rate. D) Either the incremental or implicit rate. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

7) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Unguaranteed residual value Guaranteed residual value Expected payout under guarantee

$23,104 5 10% 8% NA 20,000 20,000

A) $75,164 B) $78,636 C) $100,001 D) $105,859 Answer: C Explanation: Using BAII Plus: 5 N, 10 I/Y, 23,104 PMT, 20,000 FV, CPT PV → PV = -100,001 Diff: 2 Type: MC Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 8) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (readily determinable by lessee) Unguaranteed residual value Guaranteed residual value Expected payout under guarantee A) $91,832 B) $102,711 C) $105,444 D) $108,846 Answer: A Explanation: Using BAII Plus: 5 N, 8 I/Y, 23,000 PMT, 0 FV, CPT PV → PV = -91,832 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

$23,000 5 10% 8% NA 25,000 0

9) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due on commencement date of lease) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Guaranteed residual value Expected payout under guarantee

$30,000 5 10% 8% 28,000 15,000

A) $123,037 B) $134,410 C) $139,573 D) $142,482 Answer: B Explanation: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 10 I/Y, 30,000 PMT, 15,000 FV, CPT PV → PV = -134,410 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 10) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due on commencement date of lease) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Unguaranteed residual value Guaranteed residual value Expected payout under guarantee A) $93,792 B) $103,792 C) $107,794 D) $108,759 Answer: B

$23,104 5 10% 8% NA 20,000 12,000

Explanation: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 10 I/Y, 23,104 PMT, 12,000 FV, CPT PV → PV = -103,792 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

11) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (readily determinable by lessee) Guaranteed residual value Expected payout under guarantee

$23,150 5 8% 6% 10,000 10,000

A) $92,431 B) $97,516 C) $99,237 D) $104,989 Answer: D Explanation: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 6 I/Y, 23,150 PMT, 10,000 FV, CPT PV → PV = -104,989 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 12) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due at commencement date of lease) Lease term Incremental borrowing rate Implicit rate (readily determinable by lessee) Unguaranteed residual value Guaranteed residual value Expected payout under guarantee

$23,000 5 10% 8% NA 20,000 14,000

A) $101,360 B) $104,600 C) $108,707 D) $112,791 Answer: C Explanation: Using BAII Plus: 5 N, 8 I/Y, 23,000 PMT, 14,000 FV, CPT PV → PV = -108,707 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

13) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Unguaranteed residual value

$22,000 5 10% 8% 15,000

A) $83,397 B) $92,711 C) $98,048 D) $102,304 Answer: A Explanation: Using BAII Plus: 5 N, 10 I/Y, 22,000 PMT, 0 FV, CPT PV → PV = -83,397 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 14) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Unguaranteed residual value Bargain purchase option

$22,000 5 10% 8% 15,000 5,000

A) $86,502 B) $91,243 C) $95,816 D) $101,451 Answer: A Explanation: Using BAII Plus: 5 N, 10 I/Y, 22,000 PMT, 5,000 FV, CPT PV → PV = -86,502 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

15) For the following lease, determine the amount the ROU asset will be initially measured at assuming that the company does not elect to use the practical expedient available to it. Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Non-lease costs included in annual payment

$22,000 5 10% 8% 5,000

A) $64,443 B) $67,876 C) $83,397 D) $87,840 Answer: A Explanation: Using BAII Plus: 5 N, 10 I/Y, 17,000 PMT, CPT PV → PV = - 64,443 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 16) For the following lease, determine the amount the ROU asset will be initially measured at. Annual payment (due at end of year) Lease term Incremental borrowing rate Implicit rate (readily determinable by lessee) Non-lease costs included in annual payment

$25,000 5 7% 6% 2,000

A) $94,305 B) $96,884 C) $102,505 D) $105,309 Answer: B Explanation: Using BAII Plus: 5 N, 6 I/Y, 23,000 PMT, CPT PV → PV = -96,884 Diff: 2 Type: MC Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

17) The following are the characteristics of a lease: Fair value of leased asset Lease payments Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 25,500 7 Annual Beginning of year None 8% 9%

Required: Determine the amount the right-of-use asset and lease liability are initially measured at from the perspective of the lessee. Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 7 N, 8 I/Y, 25500 PMT, CPT PV → PV = 143,383; ROU asset = $143,383; Lease liability = $143,383 - $25,500 = $117,883 Diff: 2 Type: SA Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 18) The following are the characteristics of a lease: Fair value of leased asset Lease payments Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 30,500 7 Annual Beginning of year None 8% 9%

19) The following are the characteristics of a lease: Fair value of leased asset Lease payments Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$104,000 15,500 10 Annual Beginning of year None 8% 9%

Required: Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 10 N, 8 I/Y, 15500 PMT, CPT PV → PV = 112,327; ROU asset = $112,327; Lease liability = $112,327 - $15,500 = $96,827 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 20) The following are the characteristics of a lease: Fair value of leased asset Lease payments Lease term 6 years Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$180,000 38,540 6 Annual Beginning of year None 8% 9%

21) The terms of a lease are as follows: Lease term Economic life of leased asset Fair value of leased asset Guaranteed residual value Expected payout under residual value guarantee Lease payments, due at the end of the year, starting Nov. 1, 2025 Implicit rate in the lease (not readily determinable by lessee) Lessee's incremental borrowing rate

12 years 13 years $105,000 10,000 5,000 11,000 6% 5%

Required: Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: Using BAII Plus: 12 N, 5 I/Y, 11000 PMT, 5000 FV CPT PV→PV = -100,280; ROU asset and lease liability = $100,280 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

22) On January 1, 2025, Troy Company entered a lease to rent office space. The lease requires Troy to pay $190,000 per year, at the beginning of each year, for 10 years. The lease is non-cancellable and nonrenewable. The building's estimated useful life is 30 years, and its current fair value is estimated to be $6 million. The implicit rate in the lease is not readily determinable. Troy's incremental borrowing rate is 9%. Required: Record the journal entries for the first year of the lease. Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 10 N, 9 I/Y, 190000 PMT, CPT PV → PV = 1,329,097; ROU asset = $1,329,097; Lease liability = $1,329,097 - $190,000 = $1,139,097 Journal entries for first year of lease: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

1,329,097

Dr. Interest expense1 Cr. Lease liability

102,519

Dr. Depreciation expense2

132,910

1,139,097 190,000

102,519

Cr. Accumulated depreciation — ROU asset

132,910

1 $1,139,097 × 9% = $102,519 2 $1,329,097 / 10 = $132,910

Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

23) On January 1, 2025, Rushabh Company entered a lease to rent office space. The lease requires Rushabh to pay $190,000 per year,. at the beginning of each year, for 10 years. The lease is non-cancellable and non-renewable. The building's estimated useful life is 30 years, and its current fair value is estimated to be $6 million. The implicit rate in the lease is 10% and this is readily determinable by the lessee. Rushabh's incremental borrowing rate is 9%. Required: Record the journal entries for the first year of the lease. Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 10 N, 10 I/Y, 190000 PMT, CPT PV → PV = 1,284,215; ROU asset = $1,284,215; Lease liability = $1,284,215 - $190,000 = $1,094,215 Journal entries for first year of lease: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

1,284,215

Dr. Interest expense1 Cr. Lease liability

109,422

Dr. Depreciation expense2

128,422

1,094,215 190,000

109,422

Cr. Accumulated depreciation — ROU asset

128,422

1 $1,094,215 × 10% = $109,422 2 $1,284,215 / 10 = $128,422 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

24) On January 1, 2025, Pelvisee Company entered a lease to rent office space. The lease requires Pelvisee to pay $390,000 per year, at the beginning of each year, for 15 years. The lease is non-cancellable and nonrenewable. The building's estimated useful life is 30 years, and its current fair value is estimated to be $6 million. Pelvisee's incremental borrowing rate is 9%. The implicit rate in the lease is not readily determinable. Required: Record the journal entries for the first year of the lease. Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 15 N, 9 I/Y, 390000 PMT, CPT PV → PV = 3,426,599; ROU asset = $3,426,599; Lease liability = $3,426,599 - $390,000 = $3,036,599 Journal entries for first year of lease: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

3,426,599

Dr. Interest expense1 Cr. Lease liability

273,294

Dr. Depreciation expense2

228,440

3,036,599 390,000

273,294

Cr. Accumulated depreciation — ROU asset

228,440

1 $3,036,599 × 9% = $273,294 2 $3,426,599 / 15 = $228,440 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

25) On January 1, 2025, Travic Company entered a lease to rent office space. The lease requires Travic to pay $390,000 per year, at the end of each year, for 20 years. The lease is non-cancellable and nonrenewable. The building's estimated useful life is 30 years, and its current fair value is estimated to be $6 million. Travic's incremental borrowing rate is 10%. The implicit rate in the lease is 9% and this is readily determinable by the lessee. Required: Record the journal entries for the first year of the lease. Answer: Using BAII Plus: 20 N, 9 I/Y, 390000 PMT, CPT PV → PV = -3,560,133; ROU asset and lease liability = $3,560,133 Journal entries for first year of lease: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability

3,560,133

Dr. Interest expense1 Cr. Lease liability

320,412

Dr. Depreciation expense2

178,007

3,560,133

320,412

Cr. Accumulated depreciation — ROU asset Dr. Lease liability Cr. Cash

178,007

390,000 390,000

1 $3,560,133 × 9% = $320,412 2 $3,560,133 / 20 = $178,007 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

26) On January 1, 2025, Granite Company entered a lease to rent office space. The lease requires $350,000 per year, at the beginning of each year, for 20 years. The lease is non-cancellable and non-renewable. The building's estimated useful life is 30 years, and its current fair value is estimated to be $6 million. The incremental borrowing rate is 5%. The implicit rate in the lease is not readily determinable by the lessee. Required: Record the journal entries for the first year of the lease. Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 20 N, 5 I/Y, 350000 PMT, CPT PV → PV = 4,579,862; ROU asset = $4,579,862; Lease liability = $4,579,862 - $350,000 = $4,229,862 Journal entries for first year of lease: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

4,579,862

Dr. Interest expense1 Cr. Lease liability

211,493

Dr. Depreciation expense2

228,993

4,229,862 350,000

211,493

Cr. Accumulated depreciation — ROU asset

228,993

1 $4,229,862 × 5% = $211,493 2 $4,579,862 / 20 = $228,993 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

27) On January 1, 2025, Brownee Company entered a lease to rent office space. The lease requires $350,000 per year, at the end of each year, for 20 years. The lease is non-cancellable and non-renewable. The building's estimated useful life is 40 years, and its current fair value is estimated to be $6 million. The incremental borrowing rate is 5%. The implicit rate in the lease is 4% and this is readily determinable by the lessee. Required: Record the journal entries for the first year of the lease. Answer: Using BAII Plus: 20 N, 4 I/Y, 350,000 PMT, CPT PV → PV = -4,756,614; ROU asset and lease liability = $4,756,614 Journal entries for first year of lease: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability

4,756,614

Dr. Interest expense1 Cr. Lease liability

190,265

Dr. Depreciation expense2

237,831

4,756,614

190,265

Cr. Accumulated depreciation — ROU asset Dr. Lease liability Cr. Cash

237,831

350,000 350,000

1 $4,756,614 × 4% = $190,265 2 $4,756,614 / 20 = $237,831 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

28) On July 1, 2024, Jupiter Company leased equipment to Planet Company. The terms of the lease are as follows: Fair value of leased asset Lease payments, due each Jul 1 Lease term Economic life of leased asset Guaranteed residual value Expected payout under the guaranteed residual Implicit rate in the lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$70,000 12,000 9 years 10 years 6,000 6,000 13% 15%

Planet uses straight-line depreciation for its property, plant, and equipment, and its year -end is December 31. Required: Prepare the journal entries for the lessee from July 1 through December 31, 2024. Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 9 N, 15 I/Y, 12000 PMT, 6000 FV CPT PV→ PV = -67,553; ROU asset = $67,553; Lease liability = $67,553 - $12,000 = $55,553 Journal entries: July 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

67,553

Dr. Interest expense1 Cr. Lease liability

4,167

Dr. Depreciation expense2

3,753

55,553 12,000

4,167

Cr. Accumulated depreciation — ROU asset

3,753

1 $55,553 × 15% × 6/12 = $4,167 2 $67,553 / 9 × 6/12 = $3,753 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

29) Chambers leased equipment to Montga Company on November 1, 2024. The terms of the lease are as follows: Lease term Economic life of leased asset Fair value of leased asset Guaranteed residual value Expected payout under residual value guarantee Lease payments, due each Nov 1 Implicit rate in the lease (readily determinable by the lessee) Lessee's incremental borrowing rate

10 years 12 year $104,000 10,000 10,000 12,000 6% 5%

Montga uses straight-line depreciation for its property, plant, and equipment. It has a December 31 yearend. Required: a. Prepare the journal entries for the lease from November 1 through December 31, 2024. b. You and the director of finance for Montga Company. You are concerned about the impact the lease will have on your key performance indicator, the total debt to total assets ratio. Discuss the impact the lease will have on this performance indicator.

Answer: Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 10 N, 6 I/Y, 12000 PMT, 10000 FV CPT PV → PV = -99,204; ROU asset = $99,204; Lease liability = $99,204 - $12,000 = $87,204 Journal entries: Nov. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

99,204

Dr. Interest expense1 Cr. Lease liability

872

Dr. Depreciation expense2

87,204 12,000

872 1,653

Cr. Accumulated depreciation — ROU asset

1,653

1 $87,204 × 6% × 2/12 = $872 2 $99,204 / 10 × 2/12 = $1,653 b. Total debt increases, as does total assets. On initial recognition on Nov 1, 2024, both increase by the same amount, so the total debt to total assets ratio increases toward 1.0 from its previous level. Subsequently, the depreciation and interest accrued will further increase the ratio. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

30) On July 1, 2025, Janus Company leased equipment to Pluto Company. The terms of the lease are as follows: Fair value of leased asset Lease payments, due at end of lease term starting June 30, 2026 Lease term Economic life of leased asset Guaranteed residual value Expected payout under the guaranteed residual Implicit rate in the lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$60,000 12,000 9 years 10 years 6,000 4,000 13% 15%

Pluto uses straight-line depreciation for its property, plant, and equipment, and its year-end is December 31. Required: Prepare the journal entries for the lessee from July 1 through December 31, 2025. Answer: Using BAII Plus: 9 N, 15 I/Y, 12000 PMT, 4000 FV CPT PV → PV = -58,396; ROU asset and lease liability = $58,396 Journal entries: July 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability

58,396

Dr. Interest expense1 Cr. Lease liability

4,380

Dr. Depreciation expense2

3,244

58,396

4,380

Cr. Accumulated depreciation — ROU asset

3,244

1 $58,396 × 15% × 6/12 = $4,380 2 $58,396 / 9 × 6/12 = $3,244 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

31) Channel leased equipment to Montage Company on November 1, 2024. The terms of the lease are as follows: Lease term Economic life of leased asset Fair value of leased asset Guaranteed residual value Expected payout under the guaranteed residual Lease payments, due at the end of the year, starting October 31, 2025 Implicit rate in the lease (not readily determinable by lessee) Lessee's incremental borrowing rate

12 years 13 years $105,000 10,000 7,000 11,000 5% 6%

Montage uses straight-line depreciation for its property, plant, and equipment. Its year-end is December 31. Required: Prepare the journal entries for the lessee from November 1, 2024 through October 31, 2025.

Answer: Using BAII Plus: 12 N, 6 I/Y, 11000 PMT, 7000 FV CPT PV → PV = -95,701; ROU asset and lease liability = $95,701 Nov. 1, 2024

Dec. 31, 2024

Dr. ROU asset Cr. Lease liability

95,701

Dr. Interest expense1 Cr. Lease liability

957

Dr. Depreciation expense2

95,701

957 1,329

Cr. Accumulated depreciation — ROU asset Oct. 31, 2025

1,329

Dr. Interest expense3 Cr. Lease liability

4,785

Dr. Lease liability Cr. Cash

11,000

4,785

11,000

1 $95,701 × 6% × 2/12 = $957 2 $95,701 / 12 × 2/12 = $1,329 3 $95,701 × 6% × 10/12 = $4,785 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

32) The following are characteristics of a lease that commenced on January 1, 2025: Fair market value of asset Lease payments Lease term Lease frequency Payment timing Guaranteed residual value Expected payout under the guaranteed residual Interest rate implicit in the lease agreement (not readily determinable by lessee) Lessee's incremental borrowing rate

$352,886 100,000 4 years Annual Beginning of year 35,000 21,000 14% 15%

Dec. 31, 2025

Dr. Net investment in lease (lease receivable) Dr. Cash Cr. Cash to manufacturer

252,886

Dr. Net investment in lease (lease receivable) Cr. Finance income ($252,886 × 14%)

35,404

100,000 352,886

35,404

c. Lessee's journal entries for the first year. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 4 N, 15 I/Y, 100000 PMT, 21000 FV, CPT PV → PV = -340,329; ROU asset $340,329; Lease liability = $340,329 - $100,000 = $240,329 Journal entries: Jan. 1, 2025

Dec. 31, 2025

Dr. ROU asset Cr. Lease liability Cr. Cash

340,329

Dr. Interest expense1 Cr. Lease liability

36,049

Dr. Depreciation expense2

85,082

240,329 100,000

36,049

Cr. Accumulated depreciation — ROU asset

85,082

1 $240,329 × 15% = $36,049 2 $340,329 / 4 = $85,082 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

33) Discuss what is meant by the risk-adjusted rate and which risk adjusted rates the lessee and the lessor should use. Answer: Finance theory suggests that the appropriate discount/interest rate is the risk- adjusted rate. However, there is some uncertainty as to the type of risk that should be factored into this rate: the risk associated with the asset being leased, or the risk of the lessee. First, note that a rational lessor should factor in risks of both the asset and the risk of the lessee in setting the terms of the lease, especially the lease payments. The risk-adjusted interest rate from the cash flow stream expected by the lessor and the fair value of the leased property is called the "implicit rate," The lessee, on the other hand, may not always have sufficient information to calculate the implicit rate. In this case, under IFRS, the lessee uses its incremental borrowing rate, the interest rate that the lessee would have to pay on a similar lease or loan. Thus, under IFRS, the interest rate for the lessee is determined on a hierarchical basis: use the implicit rate if available; otherwise, use the incremental borrowing rate. Diff: 3 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets. 34) Under ASPE, when is it possible for the present value of the minimum lease payments to exceed the fair value of the leased property? What must the lessee do to prevent recording an overvalued asset? Answer: When the lessee does use its incremental borrowing rate, it is possible for the lessee's present value of the lease payments to exceed the fair value of the leased property. However, recording such a finance lease using the present value amount would result in an overvalued asset on the books. In such a circumstance, the lease is recorded at the fair value of the leased property, and the lessee must recompute the interest rate in the lease using the fair value. Diff: 3 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

35) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (not readily determinable by the lessee) Lessee's incremental borrowing rate

$250,000 10 years Annual Beginning of year 0 9% 10%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 10 N, 9 I/Y, +|-250000 PV, CPT PMT→ PMT = 35,739 b. Using BAII Plus: 2nd BGN, 2nd SET, 10 N, 10 I/Y, 35739 PMT, CPT PV→ PV = -241,561; ROU asset = $241,561; Lease liability = $241,561 - $35,739 = $205,822 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

36) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Amount expected to be paid out under the residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$50,000 5 years Annual Beginning of year 10,000 5,000 5% 6%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 5 N, 5 I/Y, +|- 50000 PV, 10000 FV CPT PMT→ PMT = 9,275 b. Using BAII Plus: 2nd BGN, 2nd SET, 5 N, 6 I/Y, 9275 PMT, 5000 FV, CPT PV→ PV = -45,150; ROU asset = $45,150; Lease liability = $45,150 - $9,275 = $35,875 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

37) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$250,000 4 years Annual Beginning of year 25,000 12,000 4% 6%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 4 I/Y, +|-250000 PV, 25000 FV, CPT PMT→ PMT = 60,563 b. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 6 I/Y, 60563 PMT, 12000 FV, CPT PV→PV = -231,954; ROU asset = $231,954; Lease liability = $231,954 - $60,563 = $171,391 Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

38) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$50,000 8 years Annual Beginning of year 15,000 10,000 9% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 9 I/Y, +|-50000 PV, 15000 FV, CPT PMT→ PMT = 7,040 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 8 I/Y, 7040 PMT, 10000 FV, CPT PV→ PV = -49,096; ROU asset = $49,096; Lease liability = $49,096 - $7,040 = $42,056. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

39) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Useful life Lease term Payment frequency Payment timing Unguaranteed residual value Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$120,000 10 years 7 years Annual Beginning of year 10,000 15% 14%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset. b. Compute the present value of the minimum lease payments for the lessee. c. Evaluate whether the lessee should classify the lease as operating or capital lease using the quantitative guidelines in ASPE. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 15 I/Y, +|-120000 PV, 10000 FV, CPT PMT→ PMT = 24,295 b. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 14 I/Y, 24295 PMT, 0 FV, CPT PV→ PV = -118,770 c. Under ASPE, the lessee should classify this lease as a finance lease because the PV of the minimum lease payments is greater than or equal to 90% of the asset's fair value ($118,770/$120,000 = 99.0%). Diff: 3 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

40) Zarlon Leasing Company agrees on January 1, 2025 to rent Killington Winery the equipment that Killington requires to expand its production capacity to meet customers' demands for its products. The lease agreement calls for five annual lease payments of $110,000 at the end of each year. Killington, which reports its financial results in accordance with ASPE has identified this as a finance lease. Furthermore, the company has determined that the present value of the minimum lease payments, discounted at 4%, is $489,700. The leased asset has an estimated useful life of five years and no residual value. Killington uses the straight-line method for depreciating similar equipment that it owns. Required: a. Prepare a lease amortization schedule for this lease for the lessee. b. Prepare the necessary journal entries for the first year of the lease for the lessee. Answer: a. Lease amortization schedule Year

Interest (4%)

Payments

2025 2026 2027

$19,588 15,972 12,210

$110,000 110,000 110,000

2028 2029

8,299 4,231

110,000 110,000

Reduction in Principal

Carrying Value

$90,412 94,028 97,790 101,701 105,769

$489,700 399,288 305,260 207,470 105,769 0

b. Journal entries Jan. 1, 2025

Dec. 31, 2025

Dr. leased asset Cr. Lease liability

489,700

Dr. Interest expense ($489,700 × 4%) Dr. Lease liability ($110,000 - $19,588) Cr. Cash (given)

19,588

Dr. Depreciation expense Cr. Accumulated depreciation — ROU asset (489,700/5 years = $97,940)

97,940

489,700

90,412 110,000

97,940

Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

41) Salisbury Creamery, leases its ice cream making equipment from Little Rock Finance Company under the following lease terms: • The lease term is five years, non-cancellable, and requires equal rental payments of $56,926 due at the beginning of each year starting January 1, 2024. • Upon inception of the lease on January 1, 2024, Little Rock purchased the equipment at its fair value of $280,000 and immediately transferred it to Salisbury Creamery. The equipment has an estimated economic life of five years, and a $20,000 residual value that is guaranteed by Salisbury Creamery. The expected payout under the residual value guarantee is $15,000. • The lease contains no renewal options, and the equipment reverts to Little Rock Finance Company upon termination of the lease. • Salisbury's incremental borrowing rate is 5%; the rate implicit in the lease is also 4%. The implicit rate in the lease is not readily determinable by Salisbury. • Salisbury depreciates similar equipment that it owns on a straight-line basis. • Both companies have December 31 year-ends. Required: a. Evaluate how the lessor should account for the lease transaction. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. c. Prepare the lessee's amortization schedule for this lease. d. Prepare the journal entries on January 1, 2024, December 31, 2024, and January 1, 2025 for the lessor. e. Prepare the journal entries on January 1, 2024, December 31, 2024, and January 1, 2025 for the lessee.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 5 N, 4 I/Y, 56926 PMT, 20000 FV, CPT PV→ PV = -280,000; $280,000 / $280,000 = 100%; lese term / economic life = 5 years / 5 years = 100%; the lessor should classify this lease as a finance lease as the present value of the lease payments comprises substantially all of the fair value of the lease asset and as the lease term is a major part of the economic life of the leased asset. b. Using BAII Plus: 2nd BGN, 2nd SET, 5 N, 5 I/Y, 56926 PMT, 15000 FV, CPT PV→ PV = -270,536; ROU asset = $270,526; lease liability = $270,536 - $56,926 = $213,610. c. Date 01/01/2024 12/31/2024 01/01/2025 12/31/2025 01/01/2026 12/31/2026 01/01/2027 12/31/2027 01/01/2028 12/31/2028 01/01/2029 d. Jan. 1, 2024

Dec. 31, 2024

Jan. 1, 2025

Payment

Interest expense

$56,926 56,926 56,926 56,926 15,000

Lease Liability $213,610 $10,681 224,291 167,365 8,368 175,733 118,807 5,940 124,747 67,821 3,391 71,212 14,286 714 15,000 0

Dr. Cash Dr. Net investment in lease (lease receivable) Cr. Cash to manufacturer

56,926 223,074

Dr. Net investment in lease (lease receivable) Cr. Finance income ($223,074 × 4%)

8,923

DR Cash Cr. Net investment in lease

56,926

280,000

8,923

56,926

e. Jan. 1, 2024

Dec. 31, 2024

Dr. ROU asset Cr. Lease liability Cr. Cash

270,536

Dr. Interest expense1 Cr. Lease liability

10,681

Dr. Depreciation expense2

54,107

213,610 56,926

10,681

Cr. Accumulated depreciation — ROU asset Jan. 1, 2025

Dr. Lease liability Cr. Cash

54,107

56,926 56,926

1 $213,610 × 5% = $10,681 2 $270,536 / 5 = $54,107 Diff: 3 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

42) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$50,000 4 years Annual Beginning of year 25,000 7,000 5% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 5 I/Y, +|- 50000 PV, 25000 FV, CPT PMT→PMT = 7,905 b. Using BAII Plus: 2nd BGN, 2nd SET, 4 N, 8 I/Y, 7905 PMT, 7000 FV, CPT PV→ PV = -33,422; ROU asset = $33,422; Lease liability = $33,422 - $7,905 = $25,517. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

43) Here are the terms of a lease agreement: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 8 years Annual Beginning of year 5,000 0 6% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 6 I/Y, +|- 150000 PV, 5000 FV, CPT PMT→ PMT = 22,312 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 6 I/Y, 22312 PMT, 0 FV, CPT PV→ PV = -146,866; ROU asset = $146,866; Lease liability = $146,866 - $22,312 = $124,554. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

44) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 8 years Annual Beginning of year 25,000 17,000 9% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 9 I/Y, +|- 150000 PV, 25000 FV, CPT PMT→ PMT = 22,784 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 8 I/Y, 22784 PMT, 17000 FV, CPT PV→ PV = -150,591; ROU asset = $150,591; Lease liability = $150,591 - $22,784 = $127,807. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

45) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$150,000 8 years Annual Beginning of year 25,000 14,000 11% 9%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 11 I/Y, +|- 150000 PV, 25000 FV, CPT PMT→ PMT = 24,360 b. Using BAII Plus: 2nd BGN, 2nd SET, 8 N, 9 I/Y, 24360 PMT, 14000 FV, CPT PV→ PV = -153,989; ROU asset = $153,989; Lease liability = $153,989 - $24,360 = $129,629. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

46) The following are some of the characteristics of an asset available for lease: Fair value of leased asset (known to lessee) Useful life Lease term Payment frequency Payment timing Guaranteed residual value Interest rate implicit in lease (not readily determinable by lessee) Lessee's incremental borrowing rate

$80,000 10 years 7 years Annual Beginning of year 10,000 10% 8%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount to be initially recognized as an asset under lease by the lessee under ASPE. c. Evaluate whether the lessee should classify the lease as operating or capital lease using the quantitative guidelines in ASPE. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 10 I/Y, +|- 80000 PV, 10000 FV, CPT PMT→ PMT = 13,980 b. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 8 I/Y, 13980 PMT, 10000 FV, CPT PV→ PV = -84,443. Under ASPE, the amount recognized for assets under capital lease cannot exceed the fair value of the asset ($80,000). Therefore, the asset to be recognized under the lease agreement is to be initially measured at $80,000. c. The lessee should classify this lease as a finance lease because the PV of lease payments is ≥ 90% of the asset's fair value ($84,443 / $80,000 = 106%). Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

47) The following are some of the characteristics of an asset available for lease: Fair value of leased asset Useful life Lease term Payment frequency Payment timing Guaranteed residual value Expected payout under residual value guarantee Interest rate implicit in lease (not readily determinable by lessee)

$88,000 10 years 7 years Annual Beginning of year 10,000 6,000 10%

Required: a. Determine the amount of lease payment that the lessor would require to lease the asset to an outside party. b. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 10 I/Y, +|- 88000 PV, 10000 FV, CPT PMT→ PMT = 15,474 b. Using BAII Plus: 2nd BGN, 2nd SET, 7 N, 8 I/Y, 15474 PMT, 6000 FV, CPT PV→ PV = -90,509; ROU asset = $90,509; Lease liability = $90,509 - $15,474 = $75,035. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

48) Soaring Pieces Inc. creates aluminum alloy parts for commercial aircraft. In a recent transaction Soaring leased a high precision lathe machine from Rapid Revolving Corp. on January 1, 2024. The following information pertains to the leased asset and the lease agreement: Cost of lathe to lessor Rapid's normal selling price for lathe Useful life Estimated value at end of useful life Lease provisions Lease term Payment amount Payment frequency Start date of lease Payment timing Estimated residual value at end of lease (unguaranteed) Interest rate implicit in the lease (readily determinable by lessee) Lessee's incremental borrowing rate

$140,000 178,268 7 years 8,000 5 years 40,000 Annual January 1 December 31 20,000 7% 8%

The lathe machine will revert back to the lessor at end of lease term, title does not transfer to lessee at any time, and there is not a bargain purchase option. Soaring's year-end is December 31. Required: a. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. b. Prepare the lessee's amortization schedule for this lease for the lessee c. Prepare the journal entries on January 1, 2024 and December 31, 2024 for the lessee.

Answer: a. Using BAII Plus: 5 N, 7 I/Y, 40000 PMT, 0 FV, CPT PV→ PV = -164,008; ROU asset and lease liability = $164,008 b. Date 01/01/2024 12/31/2024 12/31/2025 12/31/2026 12/31/2027 12/31/2028 c. January 1

December 31

Payment

Interest expense $40,000 40,000 40,000 40,000 40,000

Lease Liability $164,008 $11,481 135,489 9,484 104,973 7,348 72,321 5,062 37,383 2,617 0

Dr. ROU asset Cr. Lease liability

164,008

Dr. Interest expense ($164,008 × 7%) Dr. Lease liability ($40,000 - $11,481) Cr. Cash

11,481

Dr. Depreciation expense ($164,008 / 5) Cr. Accumulated Depreciation ROU asset

32,802

164,008

28,519 40,000

32,802

Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

49) Gretta Corp. entered into a lease on January 1, 2024, to rent a car for a three-year period. Payments are $700 per month, $600 of which is for the car rental and $100 of which is for a repairs and maintenance service agreement. The first payment is due on the commencement date. The vehicle must be returned to the lessor at the end of the lease agreement. Gretta, which has an incremental borrowing rate of 6% per annum (0.5% per month), is unable to readily identify the interest rate implicit in the lease. Gretta depreciates all assets on a straight-line basis and has a December 31 year end. Required: a. Assume that Gretta Corp. elects to account for the lease and non-lease components of the contract as a single lease component. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Gretta Corp. accounts for the lease and non-lease components of the contract separately. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 36 N, 0.5 I/Y, 700 PMT, 0 FV, CPT PV → PV = -23,125 (rounded). PVLP = $23,125; lease liability = $23,125 - $700 = $22,425; ROU asset = $23,125 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

23,125

Dr. Interest expense ($22,425 × 0.5%) Cr. Lease liability

112

Dr. Depreciation expense ($23,125 / 36)* Cr. Accumulated depreciation — ROU asset

642

Dr. Lease liability Cr. Cash

700

22,425 700

112

642

*Depreciate over lease term as asset returned to lessor at end of lease

700

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 36 N, 0.5 I/Y, 600 PMT, 0 FV, CPT PV → PV = -19,821 (rounded). PVLP = $19,821; lease liability = $19,821 - $600 = $19,221; ROU asset = $19,821. Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Repairs and maintenance expense Cr. Lease liability Cr. Cash

19,821 100 19,221 700

Dr. Interest expense ($19,221 × 0.5%) Cr. Lease liability

Dr. Depreciation expense ($19,821 / 36)* Cr. Accumulated depreciation — ROU asset

551

Dr. Lease liability Dr. Repairs and maintenance expense Cr. Cash

600 100

551

700

*Depreciate over lease term as asset returned to lessor at end of lease. Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

50) Smokey Corp. entered into the lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Estimated useful life Incremental borrowing rate Implicit rate in the lease (not readily determinable by lessee) Repair and maintenance expense included in monthly lease payment Bargain purchase option

$1,000 60 months 108 months 9.0% per annum 7.5% per annum 100 6,000

Required: a. Assume that Smokey Corp. elects to account for the lease and non-lease components of the contract as a single lease component. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Smokey Corp. accounts for the lease and non-lease components of the contract separately. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 60 N, 0.75 I/Y, 1000 PMT, 6000 FV, CPT PV → PV = 52,367 (rounded). PVLP = $52,367; lease liability = $52,367 - $1,000 = $51,367; ROU asset = $52,367 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

52,367

Dr. Interest expense ($51,367 × 0.75%) Cr. Lease liability

385

Dr. Depreciation expense ($52,367 / 108)* Cr. Accumulated depreciation — ROU asset

485

Dr. Lease liability Cr. Cash

51,367 1,000

385

485

1,000

*Depreciate over estimated useful life given bargain purchase option

1,000

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 60 N, 0.75 I/Y, 900 PMT, 6000 FV, CPT PV s PV = 47,513 (rounded). PVLP = $47,513; lease liability = $47,513 - $900 = $46,613; ROU asset = $47,513 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Repairs and maintenance expense Cr. Lease liability Cr. Cash

47,513 100

Dr. Interest expense ($46,613 × 0.75%) Cr. Lease liability

350

Dr. Depreciation expense (($47,513 / 108)* Cr. Accumulated depreciation — ROU asset

440

Dr. Lease liability Dr. Repairs and maintenance expense Cr. Cash

900 100

46,613 1,000

350

440

1,000

*Depreciate over estimated useful life given bargain purchase option Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

51) Sam Inc. entered into the lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Residual value guarantee Expected payout under residual value guarantee Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee) Asset maintenance included in monthly lease payment

$1,500 48 months 5,000 2,000 9.0% per annum 7.5% per annum 100

Required: a. Assume that Sam Inc. elects to account for the lease and non-lease components of the contract as a single lease component. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Sam Inc. accounts for the lease and non-lease components of the contract separately. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 48 N, 0.625 I/Y, 1500 PMT, 2000 FV, CPT PV → PV = 63,908 (rounded). PVLP = $63,908; lease liability = $63,908 - $1,500 = $62,408; ROU asset = $63,908 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

63,908

Dr. Interest expense ($62,408 × 0.625%) Cr. Lease liability

390

Dr. Depreciation expense ($63,908 / 48)* Cr. Accumulated depreciation — ROU asset

1,331

Dr. Lease liability Cr. Cash

1,500

62,408 1,500

390

1,331

*Depreciated over lease term as asset returned to lessor at end of lease

1,500

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 48 N, 0.625 I/Y, 1400 PMT, 2000 FV, CPT PV → PV = 59,747 (rounded). PVLP = $59,747; lease liability = $59,747 - $1,400 = $58,347; ROU asset = $59,747 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Asset maintenance agreement expense Cr. Lease liability Cr. Cash

59,747 100

Dr. Interest expense ($58,347 × 0.625%) Cr. Lease liability

365

Dr. Depreciation expense (($59,747 / 48)* Cr. Accumulated depreciation

1,245

Dr. Lease liability Dr. Asset maintenance agreement expense Cr. Cash

1,400 100

58,347 1,500

365

1,245

1,500

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 3 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

52) Leila Corp. entered into the lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Unguaranteed residual value Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee) Monthly machine maintenance included in monthly lease payment

$1,200 60 months 5,000 7.5% per annum 6.0% per annum 75

Required: a. Assume that Leila Corp. elects to account for the lease and non-lease components of the contract as a single lease component. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Leila Corp. accounts for the lease and non-lease components of the contract separately. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 60 N, 0.5 I/Y (6.0% / 12), 1200 PMT, 0 FV, CPT PV → PV = -62,381 (rounded). PVLP = $62,381; lease liability = $62,381 - $1,200 = $61,181; ROU asset = $62,381 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

62,381

Dr. Interest expense ($61,181 × 0.5%) Cr. Lease liability

306

Dr. Depreciation expense ($62,381 / 60)* Cr. Accumulated depreciation — ROU asset

1,040

Dr. Lease liability Cr. Cash

1,200

61,181 1,200

306

1,040

*Depreciated over lease term as asset returned to lessor at end of lease

1,200

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 60 N, 0.5 I/Y, 1125 PMT, 0 FV, CPT PV → PV = -58,482 (rounded). PVLP = $62,381; lease liability = $58,482 - $1,125 = $57,357; ROU asset = $58,482 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Maintenance expense Cr. Lease liability Cr. Cash

58,482 75

Dr. Interest expense ($57,357 × 0.5%) Cr. Lease liability

287

Dr. Depreciation expense (($58,482 / 60)* Cr. Accumulated depreciation

975

Dr. Lease liability Dr. Maintenance expense Cr. Cash

1,125 75

57,357 1,200

287

975

1,200

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 2 Type: ES Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

53) Rachel Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee)

$1,000 12 months 7.5% per annum 6.0% per annum

Required: a. Assume that Rachel Corp. elects to expense the lease as a practical expedient. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Rachel Corp. does not adopt the practical expedient available to it. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Short-term lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

1,000

Dr. Machine rental expense Cr. Cash

1,000

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 12 N, 0.5 I/Y (6.0% / 12), 1000 PMT, 0 FV, CPT PV → PV = -11,677 (rounded). PVLP = $11,677; lease liability = $11,677 - $1,000 = $10,677; ROU asset = $11,677 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

11,677 10,677 1,000

Dr. Interest expense ($10,677 × 0.5%) Cr. Lease liability

Dr. Depreciation expense (($11,667 / 12)* Cr. Accumulated depreciation

973

Dr. Lease liability Cr. Cash

1,000

973

1,000

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 2 Type: ES Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

54) Daniel Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate Implicit rate in the lease (not readily determinable by lessee)

$1,000 12 months 7.5% per annum 6.0% per annum

Required: a. Assume that Daniel Corp. elects to expense the lease as a practical expedient. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Daniel Corp. does not adopt the practical expedient available to it. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Short-term lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

1,000

Dr. Machine rental expense Cr. Cash

1,000

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 12 N, 0.625 I/Y (7.5% / 12), 1000 PMT, 0 FV, CPT PV → PV = -11,598 (rounded). PVLP = $11,598; lease liability = $11,598 - $1,000 = $10,598; ROU asset = $11,598 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

11,598 10,598 1,000

Dr. Interest expense ($10,598 × 0.625%) Cr. Lease liability

Dr. Depreciation expense (($11,598 / 12)* Cr. Accumulated depreciation

967

Dr. Lease liability Cr. Cash

1,000

967

1,000

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 2 Type: ES Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

55) Complete this table identifying the key differences between IFRS and ASPE standards for leasing. ISSUE IFRS Lessor's lease capitalization criteria Lessor's classification of finance (capital) leases Lessee's lease capitalization criteria Lessee's discount rate for present value calculations Lessee's inclusion of residual value guarantees in the determination of lease payments Lessee's accounting for the lease and non-lease components in a lease contract

ASPE

Answer: ISSUE

IFRS

ASPE In addition to the criteria for the lessee, the lessor Based on qualitative must also consider the considerations of whether credit risk of the lessee and the lease transfers whether non-reimbursable Lessor's lease substantially all the risks costs are reasonably capitalization criteria and rewards of ownership. estimable. Capital leases are further sub-classified into salestype and direct financing leases depending on Lessor's classification of No sub-classification of whether there is a profit finance (capital) leases finance leases. margin on the sale. Based on both qualitative and quantitative The lessee recognizes a considerations of whether ROU asset and lease the lease transfers liability for virtually all Lessee's lease substantially all the risks capitalization criteria leases.1 and rewards of ownership. If the interest rate implicit in the lease is known to Use interest rate implicit in lessee, use the lower of the the lease if readily implicit rate and the Lessee's discount rate determinable by the lessee. incremental borrowing rate. for present value Otherwise, use the Otherwise, use the calculations incremental borrowing rate. incremental borrowing rate. Lessee's inclusion of Lessee includes the amount Lessee includes the full residual value expected to be paid out amount of the residual guarantees in the under the guarantee in its value guarantee in its determination of lease determination of lease determination of minimum payments payments. lease payments. When the lessee adopts the available practical expedient, it accounts for Lessee's accounting for the lease and related nonthe lease and non-lease lease components in a lease Lease and executory costs components in a lease contract as a single lease must be accounted for contract component. separately. 1The exceptions are short-term leases and leases of low-value assets for which the lessee has elected to adopt the available practical expedient.

Diff: 3 Type: SA Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

56) Eli Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee)

$75 36 months 7.5% per annum 6.0% per annum

Required: a. Assume that Eli Corp. elects to expense the lease as a practical expedient. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Eli Corp. does not adopt the practical expedient available to it. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Low value lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 36 N, 0.5 I/Y (6.0% / 12), 75 PMT, 0 FV, CPT PV → PV = -2,478 (rounded). PVLP = $2,478; lease liability = $2,478 - $75 = $2,403; ROU asset = $2,478 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

2,478

Dr. Interest expense ($2,403 × 0.5%) Cr. Lease liability

Dr. Depreciation expense (($2,478 / 36)* Cr. Accumulated depreciation

Dr. Lease liability Cr. Cash

2,403 75

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 2 Type: SA Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

57) Peter Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate and implicit rate in the lease

$90 30 months 7.5% per annum

Required: a. Assume that Peter Corp. elects to expense the lease as a practical expedient. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Peter Corp. does not adopt the practical expedient available to it. Prepare the journal entries for January 2024 and February 1, 2024.

Answer: a. Low value lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 30 N, 0.625 I/Y (7.5% / 12), 90 PMT, 0 FV, CPT PV → PV = -2,470 (rounded). PVLP = $2,470; lease liability = $2,470 - $90 = $2,380; ROU asset = $2,470 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

2,470

Dr. Interest expense ($2,380 × 0.625%) Cr. Lease liability

Dr. Depreciation expense (($2,470 / 30)* Cr. Accumulated depreciation

Dr. Lease liability Cr. Cash

2,380 90

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 2 Type: SA Skill: Concept Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

58) Soaring Pieces Inc. creates aluminum alloy parts for commercial aircraft. In a recent transaction Soaring leased a high precision lathe machine from Rapid Revolving Corp. on January 1, 2024. The following information pertains to the leased asset and the lease agreement: Lease provisions Lease term Annual payment Payment frequency Start date of lease First payment due Guaranteed residual value Expected payout under the residual value guarantee Interest rate implicit in the lease (not readily determinable by lessee) Lessee's incremental borrowing rate

5 years $40,000 Annual January 1 Commencement date of lease 20,000 15,000 7% 8%

The lathe machine will revert back to the lessor at end of lease term, title does not transfer to lessee at any time, and there is not a bargain purchase option. Required: a. Determine the amount the right-of use asset and lease liability are initially measured at from the perspective of the lessee. b. Prepare the journal entries on January 1, 2024, December 31, 2024, and January 1, 2025 for the lessee. c. Record the lessee's journal entries to reflect the return of the leased asset on January 1, 2029, assuming that the fair value of the asset at the end of the lease term is $9,000. d. Record the lessee's journal entries to reflect the return of the leased asset on January 1, 2029 assuming that the fair value of the asset at the end of the lease term is $2,000.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 8 I/Y, 40000 PMT, 15000 FV, CPT PV→ PV = 182,694; ROU asset = $182,694; Lease liability = $182,694 - $40,000 = $142,694 b. Jan. 1, 2024

Dec. 31, 2024

Dr. ROU asset Cr. Lease liability Cr. Cash

182,694

Dr. Interest expense1 Cr. Lease liability

11,416

Dr. Depreciation expense2

36,539

142,694 40,000

11,416

Cr. Accumulated depreciation — ROU asset Jan. 1, 2025

Dr. Lease liability Cr. Cash

36,539

40,000 40,000

1 $142,694 × 8% = $11,416 2 $182,694 / 5 = $36,539 c. Jan. 1, 2029

Dr. Accumulated depreciation — ROU asset Cr. ROU asset

182,694

Dr. Lease liability Cr. Cash ($20,000 guarantee - $9.000 fair value) Cr. Gain on derecognition of lease liability ($15,000 $11,000)

15,000

182,694

11,000

4,000

d. Jan. 1, 2029

Dr. Accumulated depreciation — ROU asset Cr. ROU asset

182,694

Dr. Lease liability Dr. Loss on residual value guarantee ($18,000 - $15,000) Cr. Cash ($20,000 guarantee - $2,000 fair value)

15,000 3,000

182,694

18,000

Diff: 3 Type: ES Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

59) On April 1, 2026, Helo Company entered into a five-year lease for equipment. Annual lease payments are $15,000, payable at the beginning of each lease year (April 1). At the end of the lease, possession of the equipment will revert to the lessor. The equipment has an expected useful life of 5 years. Similar equipment could be purchased for $250,000 cash. Helo's incremental borrowing rate is 12%. Helo cannot readily determine the implicit rate in the lease agreement. Helo has a March 31 year-end, and it uses straight-line depreciation for its property, plant, and equipment. Required: a. Prepare the journal entries relating to the lease and leased asset for Helo's fiscal year ending March 31, 2027. b. Indicate the amounts related to the lease that would be reported on the March 31, 2027 balance sheet, indicating the balance sheet classifications, account names, and amounts.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 12 I/Y, 15000 PMT, CPT PV → PV = -60,560; ROU asset = $60,560; Lease liability = $60,560 - $15,000 = $45,560 Journal entries: Apr. 1, 2026

Mar. 31, 2027

Dr. ROU asset Cr. Lease liability Cr. Cash

60,560

Dr. Interest expense ($45,560 × 12%) Cr. Lease liability

5,467

Dr. Depreciation expense ($60,560 / 5) Cr. Accumulated depreciation — ROU asset

12,112

45,560 15,000

5,467

12,112

b. Balance sheet presentation: Non-current assets ROU asset Less: accumulated depreciation Net

$60,560 (12,112) $48,448

Current liabilities Lease liability - current portion

$15,000

Non-current liabilities Lease liability ($45,560 + $5,467 $15,000)

$36,027

Diff: 3 Type: ES Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

60) On April 1, 2026, Janus Company entered into a five-year lease for equipment. Annual lease payments are $5,000, payable at the beginning of each lease year (April 1). At the end of the lease, possession of the equipment will revert to the lessor. The equipment has an expected useful life of 5 years. Similar equipment could be purchased for $50,000 cash. Janus's incremental borrowing rate is 6%. Janus cannot readily determine the implicit rate in the lease agreement. The company has a March 31 year-end, and it uses straight-line depreciation for its property, plant, and equipment. Required: a. Prepare the journal entries relating to the lease and leased asset for Janus's fiscal year ending March 31, 2027. b. Indicate the amounts related to the lease that would be reported on the March 31, 2027 balance sheet, indicating the balance sheet classifications, account names, and amounts.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 6 I/Y, 5000 PMT, CPT PV → PV = -22,326; ROU asset = $22,326; Lease liability = $22,326 - $5,000 = $17,236 Journal entries: Apr. 1, 2026

Mar. 31, 2027

Dr. ROU asset Cr. Lease liability Cr. Cash

22,326

Dr. Interest expense ($17,326 × 6%) Cr. Lease liability

1,040

Dr. Depreciation expense ($22,326 / 5) Cr. Accumulated depreciation — ROU asset

4,465

17,326 5,000

1,040

4,465

b. Balance sheet presentation: Non-current assets ROU asset Less: accumulated depreciation Net

$22,326 (4,465) $17,861

Current liabilities Lease liability - current portion

$5,000

Non-current liabilities Lease liability ($17,326 + $1,040 - $5,000)

$13,366

Diff: 3 Type: ES Skill: Comp Objective: 17.3 Apply the appropriate accounting method for lessees' right-of-use assets.

61) On April 1, 2026, Luke Company entered into a ten-year lease for equipment. Annual lease payments are $5,000, payable at the beginning of each lease year (April 1). At the end of the lease, possession of the equipment will revert to the lessor. The equipment has an expected useful life of 10 years. Similar equipment could be purchased for $90,000 cash. Luke's incremental borrowing rate is 6%. Luke cannot readily determine the implicit rate in the lease agreement. The company has an March 31 year-end, and it uses straight-line depreciation for its property, plant, and equipment. Required: a. Prepare the journal entries relating to the lease agreement for Luke's fiscal year ending March 31, 2027. b. State the amounts related to the lease that would be reported on the March 31, 2027 balance sheet, indicating the balance sheet classifications, account names, and amounts. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 10 N, 6 I/Y, 5000 PMT, CPT PV → PV = -39,008; ROU asset = $39,008; Lease liability = $39,008 - $5,000 = $34,008 Journal entries: Apr. 1, 2026

Mar. 31, 2027

Dr. ROU asset Cr. Lease liability Cr. Cash

39,008

Dr. Interest expense ($34,008 × 6%) Cr. Lease liability

2,040

Dr. Depreciation expense ($39,008 / 10) Cr. Accumulated depreciation — ROU asset

3,901

34,008 5,000

2,040

3,901

b. Balance sheet presentation: Non-current assets ROU asset Less: accumulated depreciation Net

$39,008 (3,901) $35,107

Current liabilities Lease liability - current portion

$5,000

Non-current liabilities Lease liability ($34,008 + $2,040 - $5,000)

$31,048

Learning Objective 4 Analyze a lease to determine whether practical expedients are available to lessees and, if available, apply the appropriate accounting methods. 1) For the following lease, determine the amount the ROU asset will be initially measured at assuming that the company elects to use the practical expedient available to it. Annual payment (due at commencement date) Lease term Incremental borrowing rate Implicit rate (not readily determinable by lessee) Non-lease costs included in annual payment

$22,000 5 10% 8% 1,000

A) $83,397 B) $87,567 C) $91,737 D) $94,867 Answer: C Explanation: Using BAII Plus: 2nd BGN, 2nd SET, 5 N, 10 I/Y, 22,000 PMT, CPT PV → PV = -91,737 Diff: 2 Type: MC Skill: Comp Objective: 17.4 Analyze a lease to determine whether practical expedients are available to lessees and, if available, apply the appropriate accounting methods.

2) Gretta Corp. entered into a lease on January 1, 2024, to rent a car for a three-year period. Payments are $700 per month, $600 of which is for the car rental and $100 of which is for a repairs and maintenance service agreement. The first payment is due on the commencement date. The vehicle must be returned to the lessor at the end of the lease agreement. Gretta, which has an incremental borrowing rate of 6% per annum (0.5% per month), is unable to readily identify the interest rate implicit in the lease. Gretta depreciates all assets on a straight-line basis and has a December 31 year end. Required: a. Assume that Gretta Corp. elects to account for the lease and non-lease components of the contract as a single lease component. Prepare the journal entries for January 2024 and February 1, 2024. b. Assume that Gretta Corp. accounts for the lease and non-lease components of the contract separately. Prepare the journal entries for January 2024 and February 1, 2024.

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

23,125

Dr. Interest expense ($22,425 × 0.5%) Cr. Lease liability

112

Dr. Depreciation expense ($23,125 / 36)* Cr. Accumulated depreciation — ROU asset

642

Dr. Lease liability Cr. Cash

700

22,425 700

112

642

*Depreciate over lease term as asset returned to lessor at end of lease

700

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Repairs and maintenance expense Cr. Lease liability Cr. Cash

19,821 100 19,221 700

Dr. Interest expense ($19,221 × 0.5%) Cr. Lease liability

Dr. Depreciation expense ($19,821 / 36)* Cr. Accumulated depreciation — ROU asset

551

Dr. Lease liability Dr. Repairs and maintenance expense Cr. Cash

600 100

551

700

*Depreciate over lease term as asset returned to lessor at end of lease. Diff: 3 Type: SA Skill: Comp Objective: 17.4 Analyze a lease to determine whether practical expedients are available to lessees and, if available, apply the appropriate accounting methods.

3) Smokey Corp. entered into the lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Estimated useful life Incremental borrowing rate Implicit rate in the lease (not readily determinable by lessee) Repair and maintenance expense included in monthly lease payment Bargain purchase option

$1,000 60 months 108 months 9.0% per annum 7.5% per annum 100 6,000

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

52,367

Dr. Interest expense ($51,367 × 0.75%) Cr. Lease liability

385

Dr. Depreciation expense ($52,367 / 108)* Cr. Accumulated depreciation — ROU asset

485

Dr. Lease liability Cr. Cash

51,367 1,000

385

485

1,000

*Depreciate over estimated useful life given bargain purchase option

1,000

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Repairs and maintenance expense Cr. Lease liability Cr. Cash

47,513 100

Dr. Interest expense ($46,613 × 0.75%) Cr. Lease liability

350

Dr. Depreciation expense (($47,513 / 108)* Cr. Accumulated depreciation — ROU asset

440

Dr. Lease liability Dr. Repairs and maintenance expense Cr. Cash

900 100

46,613 1,000

350

440

1,000

*Depreciate over estimated useful life given bargain purchase option Diff: 3 Type: SA Skill: Comp Objective: 17.4 Analyze a lease to determine whether practical expedients are available to lessees and, if available, apply the appropriate accounting methods.

4) Sam Inc. entered into the lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Residual value guarantee Expected payout under residual value guarantee Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee) Asset maintenance included in monthly lease payment

$1,500 48 months 5,000 2,000 9.0% per annum 7.5% per annum 100

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

63,908

Dr. Interest expense ($62,408 × 0.625%) Cr. Lease liability

390

Dr. Depreciation expense ($63,908 / 48)* Cr. Accumulated depreciation — ROU asset

1,331

Dr. Lease liability Cr. Cash

1,500

62,408 1,500

390

1,331

*Depreciated over lease term as asset returned to lessor at end of lease

1,500

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Asset maintenance agreement expense Cr. Lease liability Cr. Cash

59,747 100

Dr. Interest expense ($58,347 × 0.625%) Cr. Lease liability

365

Dr. Depreciation expense (($59,747 / 48)* Cr. Accumulated depreciation

1,245

Dr. Lease liability Dr. Asset maintenance agreement expense Cr. Cash

1,400 100

58,347 1,500

365

1,245

1,500

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 3 Type: SA Skill: Comp Objective: 17.4 Analyze a lease to determine whether practical expedients are available to lessees and, if available, apply the appropriate accounting methods.

5) Leila Corp. entered into the lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Unguaranteed residual value Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee) Monthly machine maintenance included in monthly lease payment

$1,200 60 months 5,000 7.5% per annum 6.0% per annum 75

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 60 N, 0.5 I/Y, 1200 PMT, 0 FV, CPT PV → PV = 62,381 (rounded). PVLP = $62,381; lease liability = $62,381 - $1,200 = $61,181; ROU asset = $62,381 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

62,381

Dr. Interest expense ($61,181 × 0.5%) Cr. Lease liability

306

Dr. Depreciation expense ($62,381 / 60)* Cr. Accumulated depreciation — ROU asset

1,040

Dr. Lease liability Cr. Cash

1,200

61,181 1,200

306

1,040

*Depreciated over lease term as asset returned to lessor at end of lease

1,200

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Dr. Maintenance expense Cr. Lease liability Cr. Cash

58,482 75

Dr. Interest expense ($57,357 × 0.5%) Cr. Lease liability

287

Dr. Depreciation expense (($58,482 / 60)* Cr. Accumulated depreciation

975

Dr. Lease liability Dr. Maintenance expense Cr. Cash

1,125 75

57,357 1,200

287

975

1,200

6) Rachel Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee)

$1,000 12 months 7.5% per annum 6.0% per annum

Answer: a. Short-term lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

1,000

Dr. Machine rental expense Cr. Cash

1,000

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 12 N, 0.5 I/Y, 1000 PMT, 0 FV, CPT PV→ PV = -11,677 (rounded). PVLP = $11,677; lease liability = $11,677 - $1,000 = $10,677; ROU asset = $11,677 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

11,677 10,677 1,000

Dr. Interest expense ($10,677 × 0.5%) Cr. Lease liability

Dr. Depreciation expense (($11,667 / 12)* Cr. Accumulated depreciation

973

Dr. Lease liability Cr. Cash

973

1,000 1,000

*Depreciated over lease term as asset returned to lessor at end of lease Diff: 2 Type: SA Skill: Comp Objective: 17.4 Analyze a lease to determine whether practical expedients are available to lessees and, if available, apply the appropriate accounting methods.

7) Daniel Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate Implicit rate in the lease (not readily determinable by lessee)

$1,000 12 months 7.5% per annum 6.0% per annum

Answer: a. Short-term lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

1,000

Dr. Machine rental expense Cr. Cash

1,000

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 12 N, 0.625 I/Y, 1000 PMT, 0 FV, CPT PV → PV = 11,598 (rounded). PVLP = $11,598; lease liability = $11,598 - $1,000 = $10,598; ROU asset = $11,598 Jan. 1, 2024 Dr. Right-of-use asset 11,598 Cr. Lease liability 10,598 Cr. Cash 1,000 Jan. 31, 2024

Feb. 1, 2024

Dr. Interest expense ($10,598 × 0.625%) Cr. Lease liability

Dr. Depreciation expense (($11,598 / 12)* Cr. Accumulated depreciation

967

Dr. Lease liability Cr. Cash

1,000

967

1,000

8) Eli Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate Implicit rate in the lease (readily determinable by lessee)

$75 36 months 7.5% per annum 6.0% per annum

Answer: a. Low value lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 36 N, 0.5 I/Y, 75 PMT, 0 FV, CPT PV→ PV = -2,478 (rounded). PVLP = $2,478; lease liability = $2,478 - $75 = $2,403; ROU asset = $2,478 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

2,478

Dr. Interest expense ($2,403 × 0.5%) Cr. Lease liability

Dr. Depreciation expense (($2,478 / 36)* Cr. Accumulated depreciation

Dr. Lease liability Cr. Cash

2,403 75

9) Peter Corp. entered into an equipment lease that follows on January 1, 2024. Monthly payment (first due at commencement date) Lease term Incremental borrowing rate and implicit rate in the lease

$90 30 months 7.5% per annum

Answer: a. Low value lease practical expedient Jan. 1, 2024

Feb. 1, 2024

Dr. Machine rental expense Cr. Cash

b. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 30 N, 0.625 I/Y, 90 PMT, 0 FV, CPT PV → PV = -2,470 (rounded). PVLP = $2,470; lease liability = $2,470 - $90 = $2,380; ROU asset = $2,470 Jan. 1, 2024

Jan. 31, 2024

Feb. 1, 2024

Dr. Right-of-use asset Cr. Lease liability Cr. Cash

2,470

Dr. Interest expense ($2,380 × 0.625%) Cr. Lease liability

Dr. Depreciation expense (($2,470 / 30)* Cr. Accumulated depreciation

Dr. Lease liability Cr. Cash

2,380 90

Learning Objective 5 Apply the presentation and disclosure requirements applicable to leases. 1) Summarize the main disclosure requirements of lessors, as they pertain to finance leases. Answer: The main disclosure requirements are as followed: - Lease income for the period arising from finance leases segregated into its component parts (e.g., any profit on sale of assets, finance income on the net investment in the lease, and variable lease payments not included in the net investment in the lease). - Lease payments to be received for each of the first five years and the total of the amounts to be received for the remaining years. These amounts are not adjusted for time value of money. - A reconciliation of the net investment in finance leases to the undiscounted lease payments to be received. Unearned finance income and any discounted unguaranteed residual values must be identified. Diff: 1 Type: SA Skill: Concept Objective: 17.5 Apply the presentation and disclosure requirements applicable to leases.

2) On April 1, 2026, Helo Company entered into a five-year lease for equipment. Annual lease payments are $15,000, payable at the beginning of each lease year (April 1). At the end of the lease, possession of the equipment will revert to the lessor. The equipment has an expected useful life of 5 years. Similar equipment could be purchased for $250,000 cash. Helo's incremental borrowing rate is 12%. Helo cannot readily determine the implicit rate in the lease agreement. Helo has a March 31 year-end, and it uses straight-line depreciation for its property, plant, and equipment. Required: a. Prepare the journal entries relating to the lease and leased asset for Helo's fiscal year ending March 31, 2027. b. Indicate the amounts related to the lease that would be reported on the March 31, 2027 balance sheet, indicating the balance sheet classifications, account names, and amounts. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 12 I/Y, 15000 PMT, CPT PV → PV = -60,560; ROU asset = $60,560; Lease liability = $60,560 - $15,000 = $45,560 Apr. 1, 2026

Mar. 31, 2027

Dr. ROU asset Cr. Lease liability Cr. Cash

60,560

Dr. Interest expense ($45,560 × 12%) Cr. Lease liability

5,467

Dr. Depreciation expense ($60,560 / 5) Cr. Accumulated depreciation — ROU asset

12,112

45,560 15,000

5,467

12,112

b. Balance sheet presentation: Non-current assets ROU asset Less: accumulated depreciation Net

$60,560 (12,112) $48,448

Current liabilities Lease liability - current portion

$15,000

Non-current liabilities Lease liability ($45,560 + $5,467 $15,000)

$36,027

3) On April 1, 2026, Janus Company entered into a five-year lease for equipment. Annual lease payments are $5,000, payable at the beginning of each lease year (April 1). At the end of the lease, possession of the equipment will revert to the lessor. The equipment has an expected useful life of 5 years. Similar equipment could be purchased for $50,000 cash. Janus's incremental borrowing rate is 6%. Janus cannot readily determine the implicit rate in the lease agreement. The company has a March 31 year-end, and it uses straight-line depreciation for its property, plant, and equipment. Required: a. Prepare the journal entries relating to the lease and leased asset for Janus's fiscal year ending March 31, 2027. b. Indicate the amounts related to the lease that would be reported on the March 31, 2027 balance sheet, indicating the balance sheet classifications, account names, and amounts.

Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 5 N, 6 I/Y, 5000 PMT, CPT PV → PV = -22,326; ROU asset = $22,326; Lease liability = $22,326 - $5,000 = $17,236 Journal entries: Apr. 1, 2026

Mar. 31, 2027

Dr. ROU asset Cr. Lease liability Cr. Cash

22,326

Dr. Interest expense ($17,326 × 6%) Cr. Lease liability

1,040

Dr. Depreciation expense ($22,326 / 5) Cr. Accumulated depreciation — ROU asset

4,465

17,326 5,000

1,040

4,465

b. Balance sheet presentation: Non-current assets ROU asset Less: accumulated depreciation Net

$22,326 (4,465) $17,861

Current liabilities Lease liability - current portion

$5,000

Non-current liabilities Lease liability ($17,326 + $1,040 - $5,000)

$13,366

Diff: 3 Type: ES Skill: Comp Objective: 17.5 Apply the presentation and disclosure requirements applicable to leases.

4) On April 1, 2026, Luke Company entered into a ten-year lease for equipment. Annual lease payments are $5,000, payable at the beginning of each lease year (April 1). At the end of the lease, possession of the equipment will revert to the lessor. The equipment has an expected useful life of 10 years. Similar equipment could be purchased for $90,000 cash. Luke's incremental borrowing rate is 6%. Luke cannot readily determine the implicit rate in the lease agreement. The company has an March 31 year-end, and it uses straight-line depreciation for its property, plant, and equipment. Required: a. Prepare the journal entries relating to the lease agreement for Luke's fiscal year ending March 31, 2027. b. State the amounts related to the lease that would be reported on the March 31, 2027 balance sheet, indicating the balance sheet classifications, account names, and amounts. Answer: a. Using BAII Plus: 2nd BGN, 2nd SET, 2nd QUIT, 10 N, 6 I/Y, 5000 PMT, CPT PV →PV = -39,008; ROU asset = $39,008; Lease liability = $39,008 - $5,000 = $34,008 Apr. 1, 2026

Mar. 31, 2027

Dr. ROU asset Cr. Lease liability Cr. Cash

39,008

Dr. Interest expense ($34,008 × 6%) Cr. Lease liability

2,040

Dr. Depreciation expense ($39,008 / 10) Cr. Accumulated depreciation — ROU asset

3,901

34,008 5,000

2,040

3,901

b. Balance sheet presentation: Non-current assets ROU asset Less: accumulated depreciation Net

$39,008 (3,901) $35,107

Current liabilities Lease liability - current portion

$5,000

Non-current liabilities Lease liability ($34,008 + $2,040 - $5,000)

$31,048

Diff: 3 Type: ES Skill: Comp Objective: 17.5 Apply the presentation and disclosure requirements applicable to leases.

5) The following amortization schedule is for a five-year lease entered into on January 1, 2024. The company uses straight-line depreciation method. Payments of $56,157 first due on the commencement date of the lease. 4% implicit rate in the lease which is readily determinable by the lessor. The ROU asset was initially measured at $260,000. Date Jan. 1, 2024 Jan. 1, 2024 Dec. 31, 2024 Jan. 1, 2025 Dec. 31, 2025 Jan. 1, 2026 Dec. 31, 2026 Jan. 1, 2027 Dec. 31, 2027 Jan. 1, 2028

Payment

Interest expense

Lease liability $260,000 203,843 211,997 155,840 162,074 105,917 110,154 53,997 56,157 0

$56,157 $8,154 56,157 6,234 56,157 4,237 56,157 2,160 56,157

Required: Provide the appropriate presentation of this lease in the lessee's balance sheet for December 31, 2025, distinguishing amounts that are current from those that are non-current. Answer: Balance sheet presentation for December 31, 2025: Non-current assets ROU asset Less: accumulated depreciation ($260,000 × 2/5) Net

$260,000 (104,000) $156,000

Current liabilities Lease liability — current portion

$56,157

Non-current liabilities Lease liability ($162,074 from schedule - $56,157 current portion)

$105,917

Diff: 3 Type: ES Skill: Comp Objective: 17.5 Apply the presentation and disclosure requirements applicable to leases.

6) The following amortization schedule is for a five-year lease entered into on January 1, 2024. The company uses straight-line depreciation method. Payments of $110,000 first due on the commencement date of the lease. 4% implicit rate in the lease which is readily determinable by the lessor. The ROU asset was initially measured at $509,288. Date Jan. 1, 2024 Jan. 1, 2024 Dec. 31, 2024 Jan. 1, 2025 Dec. 31, 2025 Jan. 1, 2026 Dec. 31, 2026 Jan. 1, 2027 Dec. 31, 2027 Jan. 1, 2028

Payment

Interest expense

Lease liability

$110,000 $15,972 110,000 12,210 110,000 8,299 110,000 4,231 110,000

$509,288 399,288 415,260 305,260 317,470 207,470 215,769 105,769 110,000 0

Required: Provide the appropriate presentation of this lease in the lessee's balance sheet for December 31, 2026, distinguishing amounts that are current from those that are non-current. Answer: Balance sheet presentation for December 31, 2026: Non-current assets ROU asset Less: accumulated depreciation ($509,288 × 3/5) Net

$509,288 (305,573) $203,715

Current liabilities Lease liability — current portion

$110,000

Non-current liabilities Lease liability ($215,769 from schedule - $110,000 current portion)

$105,769

Diff: 2 Type: ES Skill: Comp Objective: 17.5 Apply the presentation and disclosure requirements applicable to leases.

Learning Objective 6 Describe the nature of sale and leaseback transactions and account for these transactions. 1) Why are there special accounting rules for sale-leaseback transactions? Answer: There are special accounting rules for sale-leaseback transactions as the two transactions are bundled, with the same two parties involved in both transactions. As a result, the sales price may not reflect the fair value of the asset, as the buyer-lessor can adjust the future lease payments to compensate for the difference. For example, if the sales price of the asset is $100,000 more than its fair value, then the lease could be structured so that the present value of the lease payments is $100,000 more than the market rent for an equivalent asset. To prevent manipulation of this nature, IFRS 16 and supporting materials clearly prescribe how to treat any gain or loss on sale and leaseback transactions. Diff: 3 Type: SA Skill: Concept Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions. 2) List four factors that preclude the seller-lessee from recognizing a sale on a sale and leaseback transaction. Answer: · The seller-lessee has an option to repurchase the asset at a price stipulated in the sale and leaseback agreement. · The seller-lessee must subsequently repurchase the asset at a price stipulated in the sale and leaseback agreement. · The seller-lessee must repurchase the asset if requested to do so by the buyer-lessor and the stipulated price is lower than the original selling price of the asset. · The seller-lessee must repurchase the asset if requested to do so by the buyer-lessor and the stipulated price is equal to or greater than the original selling price and is more than the expected market value of the asset at the time of repurchase. (Note that when comparing the repurchase price to the selling price, the time value of money must be considered.) Diff: 3 Type: ES Skill: Comp Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions. 3) Describe how the buyer-lessor accounts for a sale and leaseback transaction when the sales criteria are not met. Answer: When the sales criteria are not met, the buyer-lessor does not recognize either a lease receivable or an asset purchase. Rather, it recognizes a financial asset under IFRS 9–Financial Instruments for the consideration paid to the seller-lessee for the sale. Typically, the buyer-lessor will report the financial asset at amortized cost. The lease payments stipulated in the lease agreement are accounted for as payments received on the loan. Diff: 3 Type: ES Skill: Comp Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions.

4) Describe the rationale for the seller-lessee deferring gains or losses on sale-leaseback transactions when the revenue recognition criteria detailed in IFRS 15 have been met. Answer: The rationale for deferring gain or losses on sale-leaseback transactions is that in accordance with IFRS 15, a sale can only be recognized if the transfer meets the requirements of IFRS 15–Revenue from Contracts with Customers. This occurs when the vendor (the seller-lessee) satisfies the performance obligation by transferring the promised good or service (the asset in the sale leaseback agreement) to the customer (the buyer-lessor) and the customer takes control of the asset. The revenue recognition requirement set out above essentially has two parts: (i) the seller-lessee transfers the asset and (ii) the buyer-lessor takes control. Typically, there is no question that the first requirement is met because the seller-lessee and buyer-lessor have entered into an agreement that legally transfers ownership of the asset. The control requirement is not so straightforward, however, as the seller-lessee continues to use the asset. As such, the portion of the gain that relates to the seller-lessee's right-to-use the asset is deferred and recognized over the term of the lease through reporting less depreciation expense than would have been reported had the sale and leaseback transaction not been entered into. Diff: 3 Type: ES Skill: Concept Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions. 5) Describe how the seller-lessee amortizes gains on a sale-leaseback transaction that qualifies as a sale. Answer: When a sale and leaseback transaction qualifies as a sale, the seller-lessee first allocates the gain between the ownership rights that were transferred to the buyer-lessor and the seller-lessee's right to use the asset for the period of the lease. The portion of the gain that relates to the ownership rights transferred to the buyer-lessor is recognized at time of the transaction. The portion of the gain that relates to the seller-lessee's right to use the asset for the lease term is recognized over the lease term. This is facilitated by reporting less depreciation expense than would have been reported had the sale and leaseback transaction not been entered into. Diff: 3 Type: ES Skill: Concept Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions.

6) Gail Equestrian Corp. (GEC), the buyer-lessor, purchased equipment from ILF Inc. (ILF), the sellerlessee, for $1,000,000 cash on January 1, 2024, and entered into an agreement that grants ILF the right to use that equipment for five years. Relevant information includes: · Payments under the lease are $160,000 per year, first payable on December 31, 2024. · The interest rate implicit in the lease is 6%, and ILF is able to readily determine this. · The fair value of the equipment at the time of sale was $1,000,000. · The required lease payments reflect market rates. · The estimated remaining useful life of the equipment at the time of sale was 10 years. The estimated residual value at the end of its useful life is $0. · The book value of the equipment at the time of sale was $1,200,000 cost less $400,000 accumulated depreciation. · Both companies have December 31 year ends. · The residual value of the asset will be $436,291. The expected payout under the guarantee is $0. Required: a. Is this a finance or operating lease from the perspective of GEC, the buyer-lessor? b. Prepare the journal entries for GEC, the buyer-lessor, for 2025.

Answer: a.

Present value test Economic life test Transfer of title Bargain purchase option Significant medication Conclusion b. January 1, 2025 Dr. Equipment Cr. Cash Dr. Net investment in lease (lease receivable) Cr. Equipment December 31, 2025 Dr. Cash Cr. Finance income on lease ($1,000,000 × 6%) Cr. Net investment in lease (lease receivable) ($160,000 $60,000)

Yes→ 5 N, 6 I/Y, 160000 PMT, 436,291 FV, CPT PV = 1,000,000→ $1,000,000 / $1,000,000 = 100.0% No→ 5 years / 10 years = 50% No No No Finance lease

1,000,000 1,000,000 1,000,000 1,000,000

160,000 60,000 100,000

Diff: 3 Type: ES Skill: Comp Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions.

7) Gail Equestrian Corp. (GEC), the buyer-lessor, purchased equipment from ILF Inc. (ILF), the sellerlessee, for $1,000,000 cash on January 1, 2025, and entered into an agreement that grants ILF the right to use that equipment for five years. Relevant information includes: · Payments under the lease are $160,000 per year, first payable on December 31, 2024. · The interest rate implicit in the lease is 6%, and ILF is able to readily determine this. · The fair value of the equipment at the time of sale was $1,000,000. · The required lease payments reflect market rates. · The estimated remaining useful life of the equipment at the time of sale was 10 years. The estimated residual value at the end of its useful life is $0. · The book value of the equipment at the time of sale was $1,200,000 cost less $400,000 accumulated depreciation. · Both companies have December 31 year ends. · ILF must return the leased asset to GEC at the end of the lease term; however, the residual value is not guaranteed. · There are not any lease terms that preclude ILF, the seller-lessee from recognizing a sale of the equipment asset. Required: Prepare the journal entries for ILF, the seller-lessee, for 2025.

Answer: · 5 N, 6 I/Y, 160000 PMT, 0 FV, CPT PV = 673,978 · Lease income for the period arising from finance leases segregated into its component parts (e.g., any profit on sale of assets, finance income on the net investment in the lease, and variable lease payments not included in the net investment in the lease). · Lease payments to be received for each of the first five years and the total of the amounts to be received for the remaining years. These amounts are not adjusted for time value of money. · A reconciliation of the net investment in finance leases to the undiscounted lease payments to be received. Unearned finance income and any discounted unguaranteed residual values must be identified. · Determine the value of the ROU asset: ROU asset = (Present value of lease payments/Fair value of asset given up) × Net book value of asset given up. ROU asset = $673,978 / $1,000,000 × $800,000* = $539,182. (*Net book value = $1,200,000 cost − $400,000 accumulated depreciation = $800,000.) · Calculate the seller-lessee's remaining interest in the equipment: Seller-lessee's remaining interest = Present value of lease payments / Fair value of the asset. Seller-lessee's remaining interest = $673,978 / $1,000,000 = 67.3978%. · Determine the buyer-lessor's interest in the equipment: Buyer-lessor's interest = 100% − Seller-lessee's interest. Buyer-lessor's interest = 100% − 67.3978% = 32.6022%. · Compute the gain on sale relating to the rights transferred to the buyer-lessor to be recognized by the seller-lessee: The buyer-lessor's interest × (Sales price — Net book value of asset). Gain on sale to be recognized upon initial recognition of the sales leaseback = 32.6022% × ($1,000,000 − $800,000*) = $65,204. January 1, 2025 Dr. Cash Dr. Rou asset — equipment (as calculated above) Dr. Accumulated depreciation Cr. Equipment Cr. Lease liability Cr. Gain on sale of equipment December 31, 2025 Dr. Interest expense ($673,978 × 6%) Dr. Lease liability ($160,000 $40,439) Cr. Cash Dr. Depreciation expense — ROU asset ($539,182 / 5) Cr. Accumulated depreciation — ROU asset

1,000,000 539,182 400,000 1,200,000 673,978 65,204

40,439 119,561 160,000 107,836 107,836

Diff: 3 Type: ES Skill: Comp Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions.

8) Gail Equestrian Corp. (GEC), the buyer-lessor, purchased equipment from ILF Inc. (ILF), the sellerlessee, for $1,000,000 cash on January 1, 2025, and entered into an agreement that grants ILF the right to use that equipment for five years. Relevant information includes: · Payments under the lease are $160,000 per year, first payable on December 31, 2024. · The interest rate implicit in the lease is 6%, and ILF is able to readily determine this. · The fair value of the equipment at the time of sale was $1,000,000. · The required lease payments reflect market rates. · The estimated remaining useful life of the equipment at the time of sale was 10 years. The estimated residual value at the end of its useful life is $0. · The book value of the equipment at the time of sale was $1,200,000 cost less $400,000 accumulated depreciation. · Both companies have December 31 year ends. ILF must repurchase the equipment at the end of the lease term for $436,291. Note: this lease term precludes ILF, the seller-lessee from recognizing a sale of the equipment asset. Required: Prepare the journal entries for ILF, the seller-lessee, for 2025. Answer: • 5 N, 160000 PMT, +|- 1000000 PV, 436291 FV, CPT I/Y = 6.0% January 1, 2025 Dr. Cash Cr. Financial liability under sale and leaseback agreement December 31, 2025 Dr. Interest expense ($1,000,000 × 6.0%) Cr. Financial liability under sale and leaseback agreement Dr. Financial liability under sale and leaseback agreement Cr. Cash

1,000,000 1,100,000

60,000 60,000

160,000

Diff: 3 Type: SA Skill: Comp Objective: 17.6 Describe the nature of sale and leaseback transactions and account for these transactions.

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 18 Accounting for Income Taxes Learning Objective 1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 1) Which statement is correct? A) Financial reporting rules are generally consistent with tax reporting rules. B) Tax rules are generally consistent the principles used in accrual accounting. C) Tax rules generally require a higher degree of reliability than financial reporting. D) Accounting income is generally similar to taxable income. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 2) Which statement is correct? A) IFRS allows the taxes payable method because it is consistent with accrual accounting generally and with the IFRS Conceptual Framework. B) The taxes payable method is similar to accrual basis accounting and reflects the effect of transactions when they occur. C) ASPE permits the taxes payable approach because of the different costs and benefits faced by private enterprises. D) ) Recording the effect of deferred taxes is inconsistent with the definition and recognition criteria for assets and liabilities. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 3) Which statement is correct about the "taxes payable method"? A) It is the accounting method used under both ASPE and IFRS. B) It records an amount for income tax equal to the tax payments required. C) It matches income with the associated income tax expense. D) It records an amount for income tax equal to the net income before tax. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

4) Which statement is accurate? A) The taxes payable method is also known as the "deferral method." B) The deferral method and the accrual method are "tax allocation" approaches. C) The income statement approach is also known as the "accrual method." D) The balance sheet approach is also known as the "deferral method." Answer: B Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 5) How much tax would be reported under the taxes payable method for FY2027?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $23,750 B) $25,500 C) $27,500 D) $36,000 Answer: A Explanation: 25% × $95,000 = $23,750 Diff: 1 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 6) Which accurately describes the purpose of the taxes payable method? A) It represents the amount of income recognized for accounting purposes. B) It represents the amount of income recognized for tax purposes. C) It calculates tax expense based on the accounting income before tax. D) It calculates tax expense based on the amount payable to tax authorities. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

7) What is one reason to use the taxes payable method? A) It is a complicated method, but results in the least tax expense. B) A company only pays tax once a year under this method. C) It results in the best matching for the balance sheet. D) It is the least costly method for tax accounting. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 8) How much tax would be reported under the taxes payable method for F2028?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $25,500 B) $31,500 C) $33,750 D) $36,000 Answer: B Explanation: 30% × $105,000 = $31,500 Diff: 1 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 9) Which statement is accurate? A) Accounting income is generally higher than taxable income. B) Accounting income is determined by financial reporting. C) The balance sheet is unaffected by the tax accounting method. D) The taxes payable method is a "tax allocation" approach. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

10) Which statement best describes the "deferral method"? A) This method focuses on the balance sheet. B) This method is an example of a "tax allocation" approach. C) This is the same as the "accrual method" of tax accounting. D) This method is used by companies reporting using IFRS. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 11) Which method does not use "temporary differences" to account for income tax expense? A) The taxes payable method. B) The deferral method. C) The accrual method. D) The tax allocation method. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 12) Which statement is not correct? A) The accrual method focuses on the balance sheet. B) The deferral method focuses on the income statement. C) The deferral method matches tax expense to the balance sheet. D) The accrual and deferral methods are both tax allocation methods. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 13) Which method reflects the tax effect in the period that tax is payable? A) Accrual method. B) Taxes payable method. C) Deferral method. D) Tax allocation method. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

14) What is the tax expense under the deferral method for FY2026?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $25,500 B) $30,000 C) $30,750 D) $36,000 Answer: D Explanation: $120,000 × 30% = $36,000 Diff: 1 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 15) What is the tax expense under the deferral method for FY2027?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $23,750 B) $25,500 C) $27,500 D) $36,000 Answer: C Explanation: $110,000 × 25% = $27,500 Diff: 1 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

16) What is the tax expense under the deferral method for FY2028?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $150,000 105,000 35%

A) $27,500 B) $36,000 C) $36,750 D) $52,500 Answer: D Explanation: $150,000 × 35% = $52,500 Diff: 1 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 17) What is the income tax payable under the deferral method for FY2026?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $25,500 B) $30,000 C) $30,750 D) $36,000 Answer: A Explanation: $85,000 × 30% = $25,500 Diff: 2 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

18) What is the income tax payable under the deferral method for FY2027?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $23,750 B) $25,500 C) $27,500 D) $36,000 Answer: A Explanation: $95,000 × 25% = $23,750 Diff: 2 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 19) What is the income tax payable under the deferral method for FY2028?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $150,000 105,000 35%

A) $27,500 B) $36,000 C) $36,750 D) $52,500 Answer: C Explanation: $105,000 × 35% = $36,750 Diff: 2 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

20) What is the deferred tax liability under the deferral method for FY2026?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $10,500 B) $25,500 C) $30,750 D) $36,000 Answer: A Explanation: Deferred tax liability = ($120,000 × 30% = $36,000) - ($85,000 × 30% = $25,500) = $10,500 Diff: 2 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 21) What is the deferred tax liability under the deferral method for FY2027?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $120,000 105,000 30%

A) $3,750 B) $23,750 C) $27,500 D) $36,000 Answer: A Explanation: Deferred tax liability = ($110,000 × 25% = $27,500) - ($95,000 × 25% = $23,750) = $3,750 Diff: 2 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

22) What is the deferred tax liability under the deferral method for FY2028?

Income before tax Taxable income Tax rate

FY2026 $120,000 85,000 30%

FY2027 $110,000 95,000 25%

FY2028 $150,000 105,000 35%

A) $52,500 B) $36,750 C) $27,500 D) $15,750 Answer: D Explanation: Deferred tax liability = ($150,000 × 35% = $52,500) - ($105,000 × 35% = $36,750) = $15,750 Diff: 2 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 23) Which statement is correct? A) The deferral and accrual methods produce the same tax expense when tax rates are constant. B) The deferral method applies new tax rates to accumulated tax balances. C) The accrual method applies new tax rates to only to current year's income. D) The deferral and accrual methods produce the same tax expense when tax rates are falling. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 24) Under the accrual method, what is the current year temporary difference in FY2027?

Deferred tax liability Income before tax Taxable income Tax rate

FY2026 $30,000

30%

FY2027 $130,000 95,000 35%

A) $30,000 B) $47,250 C) $35,000 D) $12,250 Answer: C Explanation: $130,000 - $95,000 = $35,000 Diff: 3 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 9 Copyright © 2023 Pearson Canada Inc.

25) Under the accrual method, what is the current year temporary difference in FY2026?

Deferred tax liability Income before tax Taxable income Tax rate

FY2025 $27,000

30%

FY2026 $100,000 95,000 35%

FY2027 $150,000 105,000 35%

A) $4,500 B) $30,500 C) $5,000 D) $39,500 Answer: C Explanation: $100,000 - $95,000 = $5,000 Diff: 3 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 26) Under the accrual method, what is the FY2027 tax expense before making any adjustments for deferred tax liabilities?

Deferred tax liability Income before tax Taxable income Tax rate

FY2026 $27,500

25%

FY2027 $150,000 105,000 35%

A) $11,000 B) $42,500 C) $52,500 D) $63,500 Answer: C Explanation: $150,000 × 35% = $52,500 Diff: 3 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

27) A company earned $860,000 in pre-tax income, while its tax return showed taxable income of $560,000. At a tax rate of 40%, how much is the income tax expense under the taxes payable method permitted under ASPE? A) $224,000 B) $344,000 C) $120,000 D) $196,000 Answer: A Explanation: $560,000 × 40% = $224,000 Diff: 1 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 28) GMS Corp. reported $680,000 in income tax expense for the year under the accrual method. Its balance sheet reported an overall increase in deferred income tax liability of $40,000 and a decrease in income tax payable of $50,000. How much would GMS report as income tax expense had it used the taxes payable method? A) $680,000 B) $630,000 C) $720,000 D) $640,000 Answer: D Explanation: $680,000 - $40,000 = $640,000 Diff: 1 Type: MC Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 29) What is the accepted method of accounting for taxes under IFRS and ASPE? Accrual method or taxes payable method? Answer: Currently, the accrual method is the accepted approach in both IFRS and ASPE. The taxes payable method is an accepted alternative to the accrual method under ASPE. Diff: 2 Type: SA Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

30) Why is the taxes payable method not an accepted approach under IFRS? What difference explains why ASPE permits this approach in addition to the accrual approach? Answer: IFRS does not allow the taxes payable method because it is neither consistent with accrual accounting generally nor with the IFRS Conceptual Framework. The taxes payable method is similar to cash basis accounting and does not reflect the effect of transactions when they occur. Not recording the effect of deferred taxes is inconsistent with the definition and recognition criteria for assets and liabilities. ASPE permits the taxes payable approach because of the different costs and benefits faced by private enterprises. This method is less costly, and the limited user base, being primarily owners and lenders, are more concerned about cash flows and can obtain information about deferred taxes should they need it. Diff: 2 Type: SA Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 31) Compare and contrast the two tax allocation methods. Answer: The two tax allocation methods are the deferral method and the accrual method. They are considered tax allocation methods because they allocate the tax effects to periods in which the enterprise recognizes the related financial reporting amounts (in contrast to the taxes payable method, which simply records the tax effect in the period the tax is payable). Both of these methods help account for temporary differences between accounting income and taxable income. The deferral method focuses on obtaining the income statement value for income tax expense that best matches the amount of income recognized for the year. In contrast, the accrual method focuses on obtaining the balance sheet value for the income tax liability (or asset) that best reflects the assets and liabilities recognized on the balance sheet. Diff: 2 Type: SA Skill: Concept Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 32) A company earns $390,000 in pre-tax income, while its tax return shows taxable income of $280,000. At a tax rate of 35%, how much is the income tax expense under the taxes payable method permitted under ASPE? Answer: Taxable income $280,000 Tax rate × 35% Income tax payable; income tax expense $98,000 Diff: 1 Type: ES Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

33) A company earns $490,000 in pre-tax income, while its tax return shows taxable income of $380,000. At a tax rate of 35%, how much is the income tax expense under the taxes payable method permitted under ASPE? Answer: Taxable income $380,000 Tax rate × 35% Income tax payable; income tax expense $133,000 Diff: 1 Type: ES Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE. 34) A company facing a 45% tax rate has calculated its taxable income for the year to be $2,100,000. It made installment payments during the year totalling $955,000; this amount has been recorded in an asset account as "income tax installments" Required: Prepare the journal entry to record the adjusting entry for income taxes at the end of the year under the taxes payable method. Answer: Taxable income $2,100,000 Tax rate × 45% Income tax payable $ 945,000 Installments paid 955,000 Tax due (receivable) $(10,000) Dr. Income tax expense 945,000 Dr. Income tax receivable 10,000 Cr. Income tax installments 955,000 Diff: 1 Type: ES Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

35) SEG Company reported $490,000 in income tax expense for the year under the accrual method. Its balance sheet reported an overall increase in deferred income tax liability of $20,000 and a decrease in income tax payable of $25,000. How much would SEG report as income tax expense had it used the taxes payable method? Answer: Income tax expense under accrual method $490,000 Less: increase in deferred tax liability (20,000) Income taxes paid during year = income tax expense under taxes payable method $470,000 Note that the change in the tax payable account does not factor into the difference in the income tax expense amounts between the two methods. Diff: 1 Type: ES Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

36) Withering Inc. began operations in 2025. Due to the untimely death of its founder, Edwin Delaney, the company was wound up in 2027. The following table provides information on Withering's income over the three years. 2025 Income before tax Taxable income

2026 $95,000 90,000

$5,000 nil

2027 $87,000 97,000

The statutory income tax rate remained at 45% throughout the three years. Required: a. For each year and for the three years combined, compute the following: - income tax expense under the taxes payable method; - the effective tax rate (= tax expense / pre-tax income) under the taxes payable method; - income tax expense under the accrual method; - effective tax rate under the accrual method. b. Briefly comment on any differences between the effective tax rates and the statutory rate of 45%. Answer: a. Computations: Taxes payable method Taxable income (given) (A) Statutory tax rate (given) (B) Income tax expense (C = A × B) Income before tax (given) (D) Effective tax rate (E = C / D) Accrual method Income before tax (given) (F) Statutory tax rate (given) (G) Income tax expense (H) Income before tax (given) (F) Effective tax rate (H / F)

2025 $0 45% $0 $5,000 0%

2026 $90,000 45% $40,500 $95,000 42.6%

2027 $97,000 45% $43,650 $87,000 50.2%

Total $187,000 45% $ 84,150 $187,000 45%

$5,000 45% $2,250 $5,000 45%

$95,000 45% $42,750 $95,000 45%

$87,000 45% $39,150 $87,000 45%

$187,000 45% $ 84,150 $187,000 45%

b. The taxes payable method produces an erratic pattern of effective tax rates that significantly deviate from the statutory tax rate of 45%. However, total tax expense over the three years of $84,150 equals 45% of total taxable income. In contrast, the accrual method produces effective tax rates that are consistently equal to the statutory tax rate of 45%. Diff: 2 Type: ES Skill: Comp Objective: 18.1 Describe the conceptual differences among the three methods of accounting for income taxes, and apply the taxes payable method under ASPE.

Learning Objective 2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 1) Which of the following is an example of a "permanent difference"? A) Warranty provisions. B) Dividends received by corporations. C) Depreciation on capital assets. D) Completed contract method. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 2) Which of the following is true? A) A deductible temporary difference is a temporary difference that results in future taxable income being more than accounting income. B) A Deferred Tax Liability is the amount of income tax payable in future deferred tax liability periods as a result of taxable permanent differences. C) A Taxable Temporary Difference is a temporary difference that results in future taxable income being less than accounting income. D) A deferred tax asset is the amount of income tax recoverable in future periods as a result of deductible temporary differences, losses carried forward, or tax credits carried forward. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 3) What is a "taxable" temporary difference? A) Results in future taxable income being higher than accounting income. B) Results in future taxable income being less than accounting income. C) The amount of income tax payable in the current and future periods. D) Result of an event affecting accounting and taxable income in different periods. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

4) What is a deferred tax asset? A) A deductible temporary difference that results in future taxable income being less than accounting income. B) The amount of income tax recoverable in future periods as a result of deductible temporary differences, losses carried forward, or tax credits carried forward. C) A deductible temporary difference that results in future taxable income being higher than accounting income. D) The amount of income tax payable in future periods as a result of taxable temporary differences. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 5) Which statement is correct? A) A deductible temporary difference results in future taxable income being higher than accounting income. B) A deductible temporary difference results in future taxable income being less than accounting income. C) A deductible temporary difference refers to the amount of income tax payable in the current year. D) A deductible temporary difference results from an event affecting accounting and taxable income in the same periods. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 6) What is an "originating difference"? A) The net carrying amount of a capital asset or capital asset class for tax purposes in Canada. B) A temporary item that narrows that gap between accounting and tax values of an asset or liability. C) A temporary item that widens the gap between accounting and tax values of an asset or liability. D) The terminology used for depreciation of capital assets under for tax purposes in Canada. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 7) When will a terminal loss occur? A) When proceeds of disposal are less than undepreciated capital cost. B) When proceeds of disposal are between undepreciated capital cost and original cost. C) When proceeds of disposal are more than undepreciated capital cost. D) When proceeds of disposal are less than original cost. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 17 Copyright © 2023 Pearson Canada Inc.

8) When will there be a recapture of depreciation? A) When proceeds of disposal are less than undepreciated capital cost. B) When proceeds of disposal are between undepreciated capital cost and original cost. C) When proceeds of disposal are more than undepreciated capital cost. D) When proceeds of disposal are less than original cost. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 9) When will there be recapture and a capital gain? A) When proceeds of disposal are less than undepreciated capital cost. B) When proceeds of disposal are between undepreciated capital cost and original cost. C) When proceeds of disposal are more than undepreciated capital cost. D) When proceeds of disposal are more than original cost. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 10) A company has income before tax of $350,000, which includes a permanent difference of $65,000 relating to non-taxable dividend income. There are no other permanent or temporary differences. The income tax rate is 45%. The taxes payable are: A) $186,750 B) $128,250 C) $157,500 D) $285,000 Answer: B Diff: 1 Type: MC Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

11) A company has income before tax of $200,000. The company also has a temporary difference of $80,000 relating to capital cost allowance (CCA) in excess of depreciation expense recorded for the year. There are no other permanent or temporary differences. The income tax rate is 40%. The taxes payable are: A) $48,000 B) $80,000 C) $112,000 D) $32,000 Answer: A Diff: 1 Type: MC Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 12) Which statement is correct? A) Undepreciated capital cost (UCC) is the net carrying amount of an asset or asset class for tax purposes. B) A deductible temporary difference is a temporary difference that results in future taxable income being more than accounting income. C) A terminal loss is the tax loss arising from the sale of an asset for proceeds above its undepreciated capital cost. D) Recaptured depreciation is the taxable income recorded for the reversal of previous capital cost allowance when the sale proceeds of an asset are less than its undepreciated capital cost. Answer: A Diff: 3 Type: MC Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 13) Describe what is meant by a permanent difference. Answer: A permanent difference arises from a transaction or event that affects accounting income but never taxable income, or vice versa. Diff: 1 Type: SA Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 14) Describe what is meant by a timing difference. Answer: A timing difference arises from a transaction or event that affects both accounting income and taxable income but in different reporting periods. Diff: 1 Type: SA Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

15) Match the following terms with their definitions. Term 1. Permanent Difference

2. Taxable Temporary Difference 3. Deferred Tax Liability 4. Deductible Temporary Difference 5. Deferred Tax Asset

6. Temporary Difference

Definition Arises from a transaction or event that affects both accounting income and taxable income but in different reporting periods. A temporary difference that results in future taxable income being less than accounting income. A temporary difference that results in future taxable income being higher than accounting income. The amount of income tax recoverable in future periods as a result of deductible temporary differences, losses carried forward, or tax credits carried forward. The amount of income tax payable in future deferred tax liability periods as a result of taxable temporary differences. Arises from a transaction or event that affects accounting income but never taxable income, or vice versa.

Answer: #

6 (Temporary Difference)

4 (Deductible Temporary Difference)

2 (Taxable Temporary Difference)

5 (Deferred Tax Asset)

3 (Deferred Tax Liability)

1 (Permanent Difference)

Diff: 2 Type: SA Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 16) Why is it necessary to distinguish permanent differences from temporary differences? Answer: It is necessary to distinguish permanent differences from temporary differences because the latter will reverse while the former will not. Temporary differences reflect differences in timing of recognition in financial reporting standards versus tax laws (when something is taxed). Permanent differences reflect differences in the tax base (i.e., what is and is not taxed). Diff: 2 Type: SA Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

17) Why does the tax system appear to treat profits and losses asymmetrically? Answer: Currently, Canadian tax laws allow corporations to carry an operating loss backward for 3 years and forward for 20 years, and capital losses backward for 3 years and forward indefinitely. Carrying a loss back to offset taxable income in a prior year produces a tax refund. However, carrying a loss forward has no immediate cash flow benefits until the company earns income. When the business is profitable, the government is happy to receive its 30% share. However, the government is reluctant to contribute its 30% share for losses because it may not have reliable information on the source of that loss. Consequently, the government is only willing to provide refunds on taxes previously paid for losses carried back, but it is unwilling to pay for losses in the absence of prior profits. Diff: 2 Type: SA Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 18) Why does Capital Cost Allowance (CCA) usually exceed the amount of depreciation for tax purposes? Answer: Capital cost allowance (CCA) usually exceeds the amount of depreciation for accounting purposes due to governments' desire to encourage investment in capital assets. High capital cost allowance deductions decrease taxes payable in the early years of the asset resulting in a tax deferral. Diff: 2 Type: SA Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 19) Explain the large and growing amount of deferred tax liabilities on corporations' balance sheets mentioned in the opening vignette of this chapter. Answer: Temporary differences due to depreciation tend to build up over time because enterprises continually acquire assets to augment those that are aging and to expand capacity for growth. This accumulation of temporary differences explains the large and growing amount of deferred tax liabilities on corporations' balance sheets mentioned in the opening vignette. Diff: 2 Type: SA Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

20) Indicate whether the item will result in a deductible temporary difference, taxable temporary difference or neither.

Item Rent revenue collected in advance that is taxable in the year received CCA that exceeds depreciation expense for property, plant, and equipment Membership dues that are not deductible Percentage of completion income that is taxable only once the contract is complete Dividends received that are not taxable

Deductible Taxable temporary temporary difference difference

Neither

Answer:

Deductible Taxable temporary temporary difference difference

Neither

✓ ✓ ✓ ✓ ✓

Diff: 2 Type: ES Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

21) Indicate whether the item would result in future income taxes being higher, future income taxes being lower or neither:

Item Warranty expense accrued but not deductible until actual costs incurred CCA that exceeds depreciation expense for property, plant, and equipment Dividends received that are not taxable

Future income taxes will be higher

Future income taxes will be lower

Neither

A deferred tax asset for rent revenue received in advance and taxed upon receipt Equipment that has a carrying value above undepreciated capital cost Answer:

Item Warranty expense accrued but not deductible until actual costs incurred CCA that exceeds depreciation expense for property, plant, and equipment Dividends received that are not taxable

Future income Future income taxes will be taxes will be lower higher

Neither

✓ ✓ ✓

A deferred tax asset for rent revenue received in advance and taxed upon receipt Equipment that has a carrying value above undepreciated capital cost

✓ ✓

Diff: 2 Type: ES Skill: Concept Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

22) A company has income before tax of $350,000, which includes a permanent difference of $65,000 relating to non-taxable dividend income. There are no other permanent or temporary differences. The income tax rate is 45%. Required: Compute the amount of taxes payable and income tax expense. Answer: Income before tax $350,000 Non-taxable dividend income (permanent difference) (65,000) Taxable income and accounting income for computing tax expense $285,000 Tax rate 45% Income tax payable and income tax expense $128,250 Diff: 1 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS. 23) A company has income before tax of $200,000. The company also has a temporary difference of $80,000 relating to capital cost allowance (CCA) in excess of depreciation expense recorded for the year. There are no other permanent or temporary differences. The income tax rate is 40%. Required: Compute the amount of taxes payable and income tax expense. Answer: Income before tax $200,000 CCA in excess of depreciation (80,000) Taxable income $120,000 Tax rate 40% Income tax payable $48,000 Income before tax $200,000 Tax rate 40% Income tax expense $80,000 Diff: 1 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

24) The following summarizes information relating to Gonzalez Corporation's operations for the current year. Sales revenue Dividend revenue (not taxable) Operating expenses other than depreciation Depreciation Income before tax Capital cost allowance claimed Income tax rate

$4,600,000 120,000 (3,220,000) (300,000) $1,200,000 $600,000 35%

Required: Compute the amount of taxes payable and income tax expense for Gonzalez Corporation. Answer: Accounting Income income for statement computing tax amounts Taxable income expense Sales revenue $4,600,000 $4,600,000 $4,600,000 Dividend income (not taxable) 120,000 0 0 Operating expenses other than depreciation (3,220,000) (3,220,000) (3,220,000) Depreciation or CCA (300,000) (600,000) (300,000) Income before tax $1,200,000 $ 780,000 $ 1,080,000 CCA//Tax rate Taxable payable or tax expense

$600,000

35% $ 273,000 Tax payable

35% $ 378,000 Tax expense

Diff: 1 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

25) The following summarizes information relating to Gonzalez Corporation's operations for the current year. Sales revenue Dividend revenue (not taxable) Operating expenses other than depreciation Depreciation Income before tax Capital cost allowance claimed Income tax rate

$5,600,000 180,000 (4,000,000) (500,000) $1,280,000 $800,000 45%

Required: Compute the amount of taxes payable and income tax expense for Gonzalez Corporation. Answer: Accounting Income income for statement computing tax amounts Taxable income expense Sales revenue $5,600,000 $5,600,000 $5,600,000 Dividend income (not taxable) 180,000 0 0 Operating expenses other than depreciation (4,000,000) (4,000,000) (4,000,000) Depreciation or CCA (500,000) (800,000) (500,000) Income before tax $1,280,000 $ 800,000 $ 1,100,000 CCA//Tax rate Taxable payable or tax expense

$800,000

45% $ 360,000 Tax payable

45% $ 495,000 Tax expense

Diff: 1 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

26) For each of the following differences between the amount of taxable income and income recorded for financial reporting purposes, compute the effect of each difference on deferred taxes balances on the balance sheet. Treat each item independently of the others. Assume a tax rate of 25%. Item/transaction Depreciation for accounting CCA Non-taxable dividends Provision for warranty Unearned rent revenue CCA in excess of depreciation Answer:

Item/transaction Depreciation for accounting CCA Non-taxable dividends Provision for warranty Unearned rent revenue CCA in excess of depreciation

Amount $60,000 70,000 20,000 120,000 90,000 10,000

Effect on accounting Temporary Effect on income for difference = taxable computing (tax Amount income tax expense accounting)

Deferred Tax tax debit rate (credit)

$60,000 70,000 20,000 120,000 90,000

$0 (70,000) 0 0 90,000

$(60,000) 0 0 (120,000) 0

$60,000 (70,000) 0 120,000 90,000

25% 25% 25% 25% 25%

$15,000 (17,500) 0 30,000 22,500

10,000

(10,000)

25%

(2,500)

Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

27) For each of the following differences between the amount of taxable income and income recorded for financial reporting purposes, compute the effect of each difference on deferred taxes balances on the balance sheet. Treat each item independently of the others. Assume a tax rate of 30%. Item/transaction Depreciation for accounting CCA Non-taxable dividends Provision for warranty Unearned rent revenue CCA in excess of depreciation Answer:

Item/transaction Depreciation for accounting CCA Non-taxable dividends Provision for warranty Unearned rent revenue CCA in excess of depreciation

Amount $50,000 70,000 80,000 30,000 20,000 20,000

Effect on accounting Temporary Effect on income for difference = taxable computing (tax Amount income tax expense accounting)

Deferred Tax tax debit rate (credit)

$50,000 70,000 80,000 30,000 20,000

$0 (70,000) 0 0 20,000

$(50,000) 0 0 (30,000) 0

$50,000 (70,000) 0 30,000 20,000

30% 30% 30% 30% 30%

$15,000 (21,000) 0 9,000 6,000

20,000

(20,000)

30%

(6,000)

Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

28) At the beginning of the current fiscal year, Withering Corporation had a deferred income tax liability balance of $20,000, which relates to depreciable assets. During the year, Withering reported the following information: • Income before income taxes for the year was $300,000 and the tax rate was 45%. • Depreciation expense was $150,000 and CCA was $130,000. • Unearned rent revenue was reported at $120,000. Rent revenue is taxable when the cash is received. There was no opening balance in the unearned rent revenue account at the beginning of the year. • No other items affected deferred tax amounts other than these transactions. Required: Prepare the journal entry or entries to record income taxes for the year. Answer: Taxable Accounting Temporary income income for difference = and taxes computing tax (tax Item/transaction payable expense accounting) Income before taxes $300,000 $300,000 Add back depreciation 150,000 Deduct CCA (130,000) $20,000 Unearned rent revenue 120,000 120,000 -Subtotal $440,000 $300,000 $140,000 Tax rate 45% Taxes payable or expense $198,000 Journal entries for income taxes: Dr. Income tax expense—current Cr. Income tax payable Dr. Deferred income tax liability * Dr. Deferred income tax asset † Cr. Income tax expense—deferred

45% $135,000

198,000 9,000 54,000

Tax rate

45% 45%

Deferred tax debit (credit)

$9,000 $54,000 $63,000

45% $63,000

198,000

63,000

*This debit is to a liability account (not asset) because it results from a reversing temporary difference. We know this to be the case because the only deferred tax balance at the beginning of the year was a liability of $20,000 and it relates to depreciable assets. This implies that prior years' CCA exceeded depreciation and created a deferred tax liability, which is being drawn down in the current year. †This debit is to an asset account because it results from an originating difference relating to the unearned revenue. Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

29) The following data represent the differences between accounting and tax income for Seafood Imports Inc., whose pre-tax accounting income is $650,000 for the year ended December 31. The company's income tax rate is 45%. Additional information relevant to income taxes includes the following. a. Capital cost allowance of $270,000 exceeded accounting depreciation expense of $160,000 in the current year. b. Rents of $25,000, applicable to next year, had been collected in December and deferred for financial statement purposes but are taxable in the year received. c. In a previous year, the company established a provision for product warranty expense. A summary of the current year's transactions appears below: i. Provision for warranties, January 1 balance ii. Provision for the year iii. Payments made to fulfill product warranties iv. Provision for warranties, December 31 balance

$101,000 42,500 (33,000) $110,500

For tax purposes, only actual amounts paid for warranties are deductible. d. Insurance expense to cover the company's executive officers was $6,800 for the year, and you have determined that this expense is not deductible for tax purposes. Required: Prepare the journal entries to record income taxes for Seafood Imports.

Answer:

Item/transaction Income before taxes Add back depreciation Deduct CCA Unearned rent revenue Add back warranty expense Deduct warranty payments

Taxable Accounting income income for and taxes computing tax payable expense $650,000 $650,000 160,000 0 (270,000) 0 25,000 0

Temporary difference = (tax accounting)

Tax rate

Deferred tax debit (credit)

$(110,000) 25,000

45% 45%

$(49,500) 11,250

42,500

(33,000)

9,500

45%

4,275

Non-ded. life insurance 6,800 Subtotal $581,300 Tax rate 45% Taxes payable or expense $261,585

6,800 $656,800 45% $295,560

0 $(75,500) 45% $(33,975)

45% 45%

0 $(33,975)

Journal entries for income taxes (DIT = deferred income tax): Dr. Income tax expense—current Cr. Income tax payable

261,585

Dr. Income tax expense—deferred Cr. DIT liability (PPE)

49,500

Dr. DIT asset (unearned rent revenue) Cr. Income tax expense—deferred

11,250

261,585

49,500

11,250

Dr. DIT asset (warranties) 4,275 Cr. Income tax expense—deferred 4,275 Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

30) The following information relates to the accounting income for Withering Press Company (WPC) for the current year ended December 31. Income before taxes Dividend income—nontaxable Depreciation CCA Impairment (see additional info below) Tax rate

$300,000 20,000 120,000 100,000 150,000 40%

The company had purchased land some years ago for $600,000. Recently, it was discovered that this land is contaminated by industrial pollution. Because of the soil remediation costs required, the value of the land has decreased. For tax purposes, the impairment loss is not currently deductible. In the future when the land is sold, half of any losses is deductible against taxable capital gains (ie., the other half that is not taxable or deductible is a permanent difference). The deferred income tax liability account on January 1 had a credit balance of $45,000. This balance is entirely related to property, plant, and equipment (PPE). Required: Prepare the journal entries to record income taxes for WPC.

Answer:

Item/transaction Income before taxes Dividend income Add back depreciation Deduct CCA Impairment: - portion deductible in future - portion never deductible

Taxable Accounting income income for and taxes computing tax payable expense $300,000 $300,000 (20,000) (20,000) 120,000 0 (100,000) 0

Temporary difference = (tax accounting) $

Tax rate

Deferred tax debit (credit)

0 20,000

40%

$8,000

40% 40%

30,000 0

75,000 75,000

0 75,000

75,000 0

$450,000

$355,000

$95,000

Tax rate 40% Taxes payable or expense $180,000

40% $142,000

40% $38,000

Subtotal

Journal entries for income taxes (DIT = deferred income tax): Dr. Income tax expense—current 180,000 Cr. Income tax payable

38,000

180,000

Dr. DIT liability (PPE) 8,000 Cr. Income tax expense—deferred 8,000 This entry is a debit to a liability account (rather than an asset) because the opening balance was a credit of $76,000 Dr. DIT asset (land) 30,000 Cr. Income tax expense—deferred 30,000 Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

31) The following information relates to the accounting income for Ontario Uranium Enterprises (OUE) for the current year ended December 31. Income before taxes Membership fees—nondeductible for tax Depreciation and depletion expense CCA Loss on disposal of equipment (see additional info below) Tax rate

$850,000 20,000 380,000 470,000 75,000 30%

During the year, the company sold one of its machines with carrying value of $85,000 for proceeds of $10,000, resulting in an accounting loss of $75,000. This loss has been included in the pre-tax income figure of $850,000 shown above. For tax purposes, the proceeds from the disposal were removed from the undepreciated capital cost (VCC) of Class 8 assets. The deferred income tax liability account on January 1 had a credit balance of $230,000. This balance is entirely related to property, plant, and equipment (PPE). Required: Prepare the journal entries to record income taxes for OUE.

Answer: Taxable Accounting income income for and taxes computing tax Item/transaction payable expense Income before taxes $850,000 $850,000 Add back depr. and depl. 380,000 0 Deduct CCA (470,000) 0 Membership fees 20,000 20,000 Accounting loss on disposal of equipment* 75,000 0 Subtotal

Temporary difference = (tax accounting)

Tax rate

Deferred tax debit (credit)

$(90,000) 0 0

30% 30% 30%

$(27,000) 0 0

75,000

30%

22,500

$855,000

$870,000

$(15,000)

Tax rate 30% Taxes payable or expense $256,500

30% $261,000

30% $(4,500)

$(4,500)

*The accounting loss is not currently deductible. This loss results in a temporary difference because the amount will be claimed through CCA in future years. Journal entries for income taxes (DIT = deferred income tax): Dr. Income tax expense—current 256,500 Cr. Income tax payable 256,500 Dr. Income tax expense—deferred 4,500 Cr. DIT liability (PPE) 4,500 Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

32) The following information relates to the accounting income for Saskatchewan Real Estate Company (SREC) for the current year ended December 31. Income before taxes Depreciation and depletion expense CCA Gain on disposal of equipment (see additional info below) Tax rate

$670,000 420,000 420,000 220,000 25%

During the year, the company sold one of its buildings with carrying value of $780,000 for proceeds of $1,000,000, resulting in an accounting gain of $220,000. This gain has been included in the pre-tax income figure of $670,000 shown above. For tax purposes, the acquisition cost of the building was $870,000. For purposes of CCA, it is a Class 1 Asset, which treats each building as a separate class. The undepreciated capital cost (UCC) on the building at the time of disposal was $660,000. Required: Prepare the journal entries to record income taxes for SREC.

Answer: Taxable Accounting income income for and taxes computing tax Item/transaction payable expense Income before taxes $670,000 $670,000 Add back depr. and depl. 420,000 0 Deduct CCA (420,000) 0 Accounting gain on disposal of equipment* (220,000) 0 Recapture 210,000 0 Capital gain 130,000 0 Non-taxable portion of capital gain (65,000) (65,000) Subtotal

Temporary difference = (tax accounting)

Tax rate

Deferred tax debit (credit)

25%

0 (10,000) 130,000

25% 25% 25%

0 (2,500) 32,500

25%

$725,000

$605,000

$120,000

Tax rate 25% Taxes payable or expense $181,250

25% $151,250

25% 30,000

$30,000

*The accounting gain is not the amount that is taxable. For tax purposes, the proceeds exceed costs, so there is both recapture and capital gain. Only half of capital gains is taxable. Journal entries for income taxes (DIT = deferred income tax): Dr. Income tax expense—current 181,250 Cr. Income tax payable 181,250 Dr. DIT liability (PPE) 30,000 Cr. Income tax expense—deferred 30,000 Diff: 3 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

33) In 2026, Graham Cracker Co. sells a building with a cost of $10 million and undepreciated capital cost (UCC) of $5 million for tax purposes. For financial reporting, the building has carrying amount of $7 million. The sale price of the building is $3 million. Aside from the sale of the building, the company has other income (before taxes) of $5 million. There are no other permanent or temporary differences. The company faces an income tax rate of 30%. Required: Provide the journal entries for the company for 2026. Answer: Computation of Accounting Income Proceeds from sale of building Carrying amount Accounting gain (loss) Other accounting income Accounting income before tax

$3,000 7,000 (4,000) 5,000 $1,000

Computation of taxable income Proceeds from sale UCC Tax basis gain (loss) Portion for recapture (terminal loss) Portion for capital gain Recapture (terminal loss) Capital gain Less non-taxable portion of capital gain Taxable income (loss) due to sale Other taxable income Total Taxable income

$3,000 5,000 (2,000) (2,000) 0 (2,000) 0 0 (2,000) 5,000 $3,000

Permanent difference Temporary difference

$0 2,000

Journal entries Dr. Current income tax expense Cr. Taxes payable Dr. Deferred tax liability Cr. Deferred income tax recovery *Total taxable income × 0.30 = 900 ** Temporary difference × 0.30 = 600

900 * 900 600 600

Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

34) In 2026, Harry, Burly and Toe Co. sells its single machine, which cost $100,000 and has an undepreciated capital cost (UCC) of $25,000 for tax purposes. For financial reporting, the machine has carrying amount of $40,000. The sale price of the machine is $30,000. Aside from the sale of the machine, the company has other income (before taxes) of $600,000, which includes non-taxable dividends of $120,000 dollars received during the year. There are no other permanent or temporary differences. The company faces an income tax rate of 35%. Required: Provide the journal entries for the company for 2026. Answer: Accounting Deferred Taxable income for Temporary tax income and computing tax difference = (tax- Tax debit Item/transaction taxes payable expense accounting) rate (credit) Income before taxes $600,000 $600,000 $0 35% $0 Dividend income (120,000) (120,000) 0 35% 0 Proceeds from sell of machine 30,000 30,000 UCC/Carrying amount 25,000 40,000 Accounting gain (loss) (10,000) 10,000 35% 3,500 Recapture 5,000 5,000 35% 1,750 Subtotal $485,000 $470,000 $15,000 35% $5,250 Tax rate 35% 35% 35% Taxes payable or expense $169,750 $164,500 $5,250

Dr. Income tax expense–current Cr. Income tax payable Dr. DIT liability (PPE) Cr. Income tax expense–deferred

169,750 169,750 5,250 5,250

Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

35) The following summarizes information relating to Crockodile Corporation's operations for the current year. Sales revenue Dividend income (nontaxable) Operating expenses other than depreciation Depreciation Income before tax Capital cost allowance claimed $1,100,000 Income tax rate

$5,000,000 100,000 (3,200,000) 800,000 1,100,000 1,100,000 30%

Required: Compute the amount of taxes payable and income tax expense for Crockodile Corporation. Answer: Sales revenue $5,000,000 $5,000,000 $5,000,000 Dividend income (not taxable) 100,000 0 0 Operating expenses other than depreciation (3,200,000) (3,200,000) (3,200,000) Depreciation or CCA (800,000) (1,100,000) (800,000) Income before tax $1,100,000 $700,000 $1,000,000 Tax rate 30% 30% Tax payable or tax expense $210,000 $300,000 Tax payable Tax expense Diff: 2 Type: ES Skill: Comp Objective: 18.2 Analyze the effect of permanent and temporary differences on income tax expense and income tax liabilities under IFRS.

Learning Objective 3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 1) How much tax expense would be recorded under the accrual method for FY2026?

Deferred tax liability Income before tax Taxable income Tax rate

FY2025 $30,000

30%

FY2026 $130,000 95,000 25%

A) $5,000 B) $27,500 C) $32,500 D) $37,500 Answer: B Explanation: ($130,000 × 25%) + [($30,000 / 30%) × (25% - 30%)] = $32,500 - $5,000 = $27,500 Diff: 3 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 2) How much tax expense would be recorded under the accrual method for FY2026?

Deferred tax liability Income before tax Taxable income Tax rate

FY2025 $30,000

30%

FY2026 $130,000 95,000 35%

A) $5,000 B) $40,500 C) $32,500 D) $50,500 Answer: D Explanation: ($130,000 × 35%) + [($30,000 / 30%) × (35% - 30%)] = $45,500 + $5,000 = $50,500 Diff: 3 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

3) How much tax expense would be recorded under the accrual method for FY2027?

Deferred tax liability Income before tax Taxable income Tax rate

FY2026 $27,500

25%

FY2027 $150,000 105,000 35%

A) $11,000 B) $42,500 C) $52,500 D) $63,500 Answer: D Explanation: ($150,000 × 35%) + [($27,500 / 25%) × (35% - 25%)] = $52,500 + $11,000 = $63,500 Diff: 3 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 4) Under the accrual method, what is the effect of the tax rate change in FY2028?

Deferred tax liability Income before tax Taxable income Tax rate

FY2027 $30,000

30%

FY2028 $130,000 95,000 35%

A) Increase of $5,000. B) Decrease of $5,000. C) Increase of $30,000. D) Decrease of $30,000. Answer: A Explanation: [($30,000 / 30%) × (35% - 30%)] = $5,000 Diff: 3 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

5) Under the accrual method, what is the effect of the tax rate change in FY2028?

Deferred tax liability Income before tax Taxable income Tax rate

FY2027 $30,000

30%

FY2028 $130,000 95,000 40%

A) Increase of $10,000. B) Decrease of $10,000. C) Increase of $30,000. D) Decrease of $30,000. Answer: A Explanation: [($30,000 / 30%) × (40% - 30%)] = $10,000 Diff: 3 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 6) Under the accrual method, what is the effect of the tax rate change in FY2028?

Deferred tax liability Income before tax Taxable income Tax rate

FY2027 $27,500

25%

FY2028 $150,000 105,000 35%

A) Increase of $11,000. B) Decrease of $11,000. C) Decrease of $62,500. D) Increase of $63,500. Answer: A Explanation: [($27,500 / 25%) × (35% - 25%)] = $11,000 Diff: 3 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

7) Under the accrual method, what is the tax expense in FY2026?

Deferred tax liability Income before tax Taxable income Tax rate

FY2025 $27,000

30%

FY2026 $100,000 95,000 35%

FY2027 $150,000 105,000 35%

A) $4,500 B) $30,500 C) $35,000 D) $39,500 Answer: D Explanation: ($100,000 × 35%) + [($27,000 / 30%) × (35% - 30%)] = $35,000 + $4,500 = $39,500 Diff: 3 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 8) What is the opening balance of the deferred tax liability account considering the rate change? Opening taxable temporary differences Tax rate (prior year) Tax rate (current year)

$400,000 25% 30%

A) $100,000 debit B) $100,000 credit C) $120,000 debit D) $120,000 credit Answer: D Explanation: Deferred tax liability = $400,000 × 30% = $120,000 credit Diff: 1 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 9) Which is correct regarding the effect of tax rate changes on income tax expense, assets and liabilities? A) When a company makes no sales and has no expenses such that its pre-tax income is zero, a change in tax rate always results in zero net income. B) Enterprises need to take account of changes in future tax rates legislation only if it has been passed into legislation and not if it is only considered "substantively enacted." C) When the tax rate decreases, the decrease in deferred tax liabilities creates a tax expense. D) When the tax rate increases, the increase in deferred tax liabilities creates tax expense. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 45 Copyright © 2023 Pearson Canada Inc.

10) What is the opening balance of the deferred tax liability account considering the rate change? Opening deductible (taxable) temporary differences Current year deductible (taxable) temporary differences Tax rate (prior year) Tax rate (current year)

($400,000) (100,000) 30% 40%

A) $100,000 credit B) $160,000 credit C) $120,000 credit D) $200,000 credit Answer: B Explanation: Deferred tax liability = $400,000 × 40% = $160,000 credit Diff: 1 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 11) What adjustment is required to the opening deferred taxes as a result of the rate change? Opening deductible (taxable) temporary differences Current year deductible (taxable) temporary differences Tax rate (prior year) Tax rate (current year)

($400,000) (100,000) 30% 40%

A) $40,000 debit B) $40,000 credit C) $130,000 credit D) $190,000 credit Answer: B Explanation: Adjustment to deferred tax liability = $400,000 × (40% - 30%) = $40,000 credit Diff: 2 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

12) What is the ending balance of the current year deferred tax liability? Opening deductible (taxable) temporary differences Current year deductible (taxable) temporary differences Tax rate (prior year) Tax rate (current year)

($400,000) (100,000) 40% 30%

A) $30,000 debit B) $30,000 credit C) $150,000 credit D) $190,000 credit Answer: C Explanation: ($400,000 + $100,000) × 30% = $150,000 credit Diff: 2 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 13) What adjustment is required to the opening deferred taxes as a result of the rate change? Opening deductible (taxable) temporary differences Current year deductible (taxable) temporary differences Tax rate (prior year) Tax rate (current year)

($400,000) (100,000) 40% 30%

A) $30,000 credit B) $90,000 credit C) $40,000 credit D) $40,000 debit Answer: D Explanation: Adjustment to deferred tax liability = $400,000 × (30% - 40%) = $40,000 debit Diff: 2 Type: MC Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

14) A company has a deferred tax liability of $60,000 at the beginning of the fiscal year relating to a taxable temporary difference of $300,000. The tax rate for the year increased from 20% to 25%. Required: Provide the journal entry to reflect the tax rate change. Answer: Dr. Income tax expense-deferred 15,000 Cr. DIT liability ($300,000 × 5%) or ($60,000 cr × (25% / 20% - 1 )) 15,000 Diff: 1 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 15) A company has a deferred tax liability of $112,500 at the beginning of the fiscal year relating to a taxable temporary difference of $450,000. The tax rate for the year increased from 25% to 35%. Required: Provide the journal entry to reflect the tax rate change. Answer: Dr. Income tax expense-deferred 45,000 Cr. DIT liability ($450,000 × 10%) or ($112,500 cr × (35% / 25% - 1 )) 45,000 Diff: 1 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 16) A company has a deferred tax liability of $20,000 at the beginning of the fiscal year relating to a taxable temporary difference of $80,000. The current year tax rate is 20%. Required: Provide the journal entry to reflect the tax rate change. Answer: The tax rate associated with the deferred tax liability was $20,000 / $80,000 = 25%. Thus, the tax rate declined by 5%. Dr. DIT liability ($80,000 × -5%) or ($20,000 cr × (20% / 25% - 1)) 4,000 Cr. Income tax expense—deferred 4,000 Diff: 1 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

17) A company has a deferred tax liability of $120,000 at the beginning of the fiscal year relating to a taxable temporary difference of $300,000. The current year tax rate is 20%. Required: Provide the journal entry to reflect the tax rate change. Answer: The tax rate associated with the deferred tax liability was $120,000 / $300,000 = 40%. Thus, the tax rate declined by 20%. Dr. DIT liability ($300,000 × -20%) or ($120,000 cr × (20% / 40% - 1)) 60,000 Cr. Income tax expense—deferred 60,000 Diff: 1 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 18) A company has a deferred tax liability of $20,000 at the beginning of the fiscal year relating to a taxable temporary difference of $80,000. The current year tax rate is 30%. Required: Provide the journal entry to reflect the tax rate change. Answer: The tax rate associated with the deferred tax liability was $20,000 / $80,000 = 25%. Thus, the tax rate increased by 5%. Dr. Income tax expense-deferred 4,000 Cr. DIT liability ($80,000 × 5%) or ($20,000 cr × (30% / 25% - 1)) 4,000 Diff: 1 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS. 19) A company has a deferred tax liability of $120,000 at the beginning of the fiscal year relating to a taxable temporary difference of $300,000. The current year tax rate is 50%. Required: Provide the journal entry to reflect the tax rate change. Answer: The tax rate associated with the deferred tax liability was $120,000 / $300,000 = 40%. Thus, the tax rate increased by 20%. Dr. Income tax expense—deferred 30,000 Cr. DIT liability ($300,000 × 10%) or ($120,000 cr × (50% / 40% - 1)) 30,000 Diff: 1 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

20) Jay, Kay and Elle Inc. has a deferred tax asset of $50,000 at the beginning and $65,000 at the end of the year. The end-of-the-year balance corresponds to $162,500 of deductible temporary differences. During the year, the company recorded a $15,000 reversal into the deferred tax asset. The tax rate was 5% higher than the rate in the prior year. Required: Determine the following: a. The tax rate in the prior year. b. The amount of change in deductible temporary differences during the year. c. The opening balance of deductible temporary differences for the year. d. The effect of rate change on the deferred tax asset, if any. Answer: a. The current tax rate in effect: $65,000 / $162,500 = 40% Therefore, the prior year tax rate: 40% - 5% = 35% (b) b. The reversal recorded into the deferred tax asset during the year is a result of a temporary difference in the amount of: $15,000 / 40% = $37,500 c. The beginning balance of temporary differences is: $162,500 + $37,500 = $200,000 d. The deferred tax asset opening balance was: $200,000 × 35% = $70,000 The effect of the rate change on the deferred tax opening balance is: $70,000 × (40% / 35% -1) = $10,000 or $65,000 + $15,000 - $70,000 = $10,000

Balance, beginning of the year Effect of tax rate change Taxable temporary difference (reversal) Balance, end of the year

Deductible (taxable) temporary difference $200,000 ($37,500) $162,500

× Tax rate 35% 5% 40% 40%

= Deferred tax asset (liability) $70,000 $10,000 ($15,000) $65,000

Diff: 3 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

21) Elle, Kay and Jay Inc. has a deferred tax liability of $120,000 at the beginning and $105,000 at the end of the year. During the year, the company had a reversed taxable temporary difference of $100,000, and the tax rate was 35%. Required: Determine the balance of temporary differences at the beginning and at the end of the year and the tax rate effective in the previous year. Answer: The reversal of the deferred tax liability due to the temporary difference was: $100,000 × 35% = $35,000 From the other information given it is possible to find the effect of the tax rate change on the deferred tax liability: $120,000 + A - $35,000 = $105,000; A = $20,000 If B is the previous year tax rate then: $120,000 × (35% - B)/35% = $20,000 and B = 30% The beginning balance of the temporary difference is then: $120,000/ 30% = $400,000 and the ending balance is: $400,000 -$100,000 = $300,000

Balance, beginning of the year Effect of tax rate change Taxable temporary difference (reversal) Balance, end of the year

Deductible (taxable) temporary difference $400,000 ($100,000) $300,000

× Tax rate 30% 5% 35% 35%

= Deferred tax asset (liability) $120,000 $20,000 ($15,000) $105,000

Diff: 3 Type: ES Skill: Comp Objective: 18.3 Analyze the effect of changes in tax rates on income tax expenses, assets, and liabilities, and account for these effects under IFRS.

Learning Objective 4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 1) Which statement is correct? A) The income tax system treats income and losses symmetrically. B) The income tax system treats income and losses asymmetrically. C) When a company has a loss, a refund is received equal to the loss multiplied by the tax rate. D) A loss carryforward has immediate cash flow benefits to a company. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

2) Which statement is true? A) A company should carry forward losses when they have had prior years' taxable income. B) A company might carry their tax losses forward if they have exhausted the ability to carry losses backward. C) Carrying forward tax losses results in immediate cash flow to the company. D) Canadian tax laws allow corporations to carry an operating loss backward for 3 years and forward indefinitely, and capital losses backward for 3 years and forward indefinitely. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 3) A company had taxable income of $12 million in fiscal 2025 and paid taxes of 4.8 million; the company incurred a loss of $7 million in fiscal 2026 when the tax rate is 50%. How much refund is the company entitled to? A) Nil B) $2.8 million C) $3.5 million D) $4.8 million Answer: B Explanation: $7 million × 40% (tax rate in effect in fiscal 2025) = $2.8 million Diff: 2 Type: MC Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 4) A company had taxable income of $2 million in fiscal 2025 and paid taxes of 0.4 million; the company incurred a loss of $0.5 million in fiscal 2027 when the tax rate is 30%. How much refund is the company entitled to? A) $0.2 million B) $0.1 million C) $0.4 million D) $0.6 million Answer: B Explanation: $0.5 million × 20% (tax rate in effect in fiscal 2025) = $0.1 million Diff: 2 Type: MC Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

5) A company had taxable income of $2 million in fiscal 2026 and paid taxes of 0.7 million; the company incurred a loss of $8 million in fiscal 2027 when the tax rate is 50%. How much refund is the company entitled to? A) Nil B) $0.7 million C) $3.85 million D) $4 million Answer: B Explanation: $2 million × 35% (tax rate in effect in fiscal 2026) = $0.7 million Diff: 2 Type: MC Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 6) A company had taxable income of $2 million in fiscal 2026 and paid taxes of 0.6 million; the company incurred a loss of $7 million in fiscal 2027 when the tax rate is 50%. How much refund is the company entitled to? A) Nil B) $0.6 million C) $1.0 million D) $3.5 million Answer: B Explanation: $2 million × 30% (tax rate in effect in fiscal 2026) = $0.6 million Diff: 2 Type: MC Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 7) Which statement is true? A) IAS 12 states the following: Deferred tax assets and liabilities shall be discounted. B) Enterprises are expected to keep very detailed scheduling of the timing of the reversal of each temporary difference. C) To permit, but not require discounting would result in deferred tax assets and liabilities which would be comparable between entities. D) The rationale for not discounting is based on considerations of costs and benefits as well as comparability among enterprises. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

8) In the first two years of operations, a company reports taxable income of $200,000 and $250,000, respectively. During these first two years, the tax rates were 30% and 35% respectively. It is now the end of the third year, and the company has a loss of $260,000 for tax purposes. The company carries losses to the earliest year possible. The tax rate is currently 40%. The amount of income tax receivable in the current (third) year is: A) $104,000 B) $81,000 C) $147,500 D) $91,000 Answer: B Explanation: ($200,000 × 30%) + ($60,000 × 35%) = $60,000 + $21,000 = $81,000 Diff: 3 Type: MC Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 9) In its first year of operations, a company reported taxable income of $200,000. In its second year the company incurred a $250,000 loss. During these first two years, the tax rates were 30% and 35% respectively. It is now the end of the third year, and the company has a taxable income of $260,000. The company carries losses to the earliest year possible. The tax rate is currently 40%. The amount of income tax receivable or payable in the current (third) year is: A) $4,000 payable. B) $84,000 receivable. C) $86,500 payable. D) $104,000 payable. Answer: B Explanation: Tax Income Rate Expense LCB LCF Tax Paid Year 1 $200,000 30% $60,000 $60,000 Year 2 ($250,000) 35% *$60,000 **$20,000 ($60,000) Year 3 $260,000 40% $104,000 ***$84,000 *$200,000 × 30%. LCBs and LCFs are refunded at the tax rate paid in the year the loss was carried forward or back to, rather than the tax rate in effect at the time of the loss. **$50,000 × 40%. ***$104,000 − $20,000 LCF; Alternatively, ($260,000 − $50,000) × 40% = $84,000. Diff: 3 Type: MC Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

10) Explain why a company should carry back losses and why a company might choose to carry losses forward instead. Answer: A company should carry back losses when they had prior years' taxable income because it will result in a definite and immediate cash inflow. If a company has taxable income in prior years, it should first carry any losses back until they are used up and then carry any remaining tax losses forward. Diff: 1 Type: SA Skill: Concept Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 11) In the first two years of operations, a company reports taxable income of $200,000 and $250,000, respectively. In these two years, the company paid $45,000 and $56,000, respectively, in income taxes. It is now the end of the third year, and the company has a loss of $420,000 for tax purposes. The company carries losses to the earliest year possible. The tax rate is currently 25%. Required: Compute the amount of income tax payable or receivable in the current (third) year. Answer: The loss of $420,000 can be carried back to the prior two years: $200,000 to the first year and the remainder of $220,000 to the second year. The amount receivable is determined by the rates prevailing in those prior years, not the rate in the year of loss. Year Taxable income Tax paid Tax rate

Loss carried back Amount Tax rate Income tax receivable

Year 1 $200,000 $45,000 22.5%

Year 2 $250,000 $56,000 22.4%

To Year 1 $200,000 22.5% $45,000

To Year 2 $220,000 22.4% $49,280

Total $420,000 – $94,280

Diff: 2 Type: SA Skill: Concept Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

12) State whether or not discounting of deferred assets and liabilities is required or permitted and explain why or why not. Answer: IAS 12 states the following: "Deferred tax assets and liabilities shall not be discounted." Therefore, discounting is neither required nor permitted. The rationale for this requirement is based on considerations of costs and benefits as well as comparability among enterprises. It is surprising that the time value of money is not taken into consideration, given that we are dealing with amounts that can vary in timing for many years, such as temporary differences for depreciable assets and tax losses carried forward. However, detailed scheduling of the timing of the reversal of each temporary difference would be highly complex, time consuming and costly. To permit, but not require discounting would result in deferred tax assets and liabilities which would not be comparable between entities. Diff: 2 Type: SA Skill: Concept Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 13) In the first two years of operations, a company reports taxable income of $125,000 and $65,000, respectively. In the first two years, the company paid $50,000 and $13,000. It is now the end of the third year, and the company has a loss of $160,000 for tax purposes. The company carries losses to the earliest year possible. The tax rate is currently 25%. Required: Compute the amount of income tax payable or receivable in the current (third) year. Answer: The loss of $160,000 can be carried back to the prior two years: $125,000 to the first year and the remainder of $35,000 to the second year. The amount receivable is determined by the rates prevailing in those prior years, not the rate in the year of loss. Year Taxable income Tax paid Tax rate

Year 1 $125,000 $ 50,000 40%

Year 2 $65,000 $13,000 20%

Loss carried back To Year 1 To Year 2 Total Amount $125,000 $35,000 $160,000 Tax rate 40% 20% -Income tax receivable $50,000 $7,000 $57,000 Diff: 2 Type: ES Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

14) In the first two years of operations, a company reports taxable income of $115,000 and $165,000, respectively. In the first two years, the tax rates were 38% and 32% respectively. It is now the end of the third year, and the company has a loss of $160,000 for tax purposes. The company carries losses to the earliest year possible. The tax rate is currently 25%. Required: a. How much tax was paid in year 1 and year 2? b. Compute the amount of income tax payable or receivable in the current (third) year. Answer: Year Year 1 Year 2 Taxable income $115,000 $165,000 Tax paid $ 43,700 $ 52,800 Tax rate 38% 32% Loss carried back Amount Tax rate Income tax receivable

To Year 1 $115,000 38% $ 43,700

To Year 2 $ 45,000 32% $ 14,400

Total $160,000 $ 58,100

Diff: 2 Type: ES Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 15) In the first two years of operations, a company reports taxable income of $125,000 and $165,000, respectively. In the first two years, the tax rates were 44% and 48% respectively. It is now the end of the third year, and the company has a loss of $260,000 for tax purposes. The company carries losses to the earliest year possible. The tax rate is currently 25%. Required: a. How much tax was paid in year 1 and year 2? b. Compute the amount of income tax payable or receivable in the current (third) year. Answer: Year Year 1 Year 2 Taxable income $125,000 $165,000 Tax paid $55,000 $79,200 Tax rate 44% 48% Loss carried back To Year 1 To Year 2 Total Amount $125,000 $135,000 $260,000 Tax rate 44% 48% -Income tax receivable $55,000 $64,800 $ 119,800 Diff: 2 Type: ES Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

16) In the first year of operations, a company reports taxable income of $125,000 and paid $31,250 of income taxes. It is now the end of the second year, and the company has a loss of $175,000 for tax purposes. The company's management believes it is probable the company will be able to use up its tax losses. The tax rate is currently 40%. Required: Compute the amounts of income tax receivable and/ or deferred income tax asset in the current (second) year. Answer: The loss of $175,000 can be partially carried back to completely eliminate the $125,000 of taxable income in Year 1. The remaining $50,000 needs to be carried forward.

Amount Tax rate Income tax receivable Deferred income tax asset

Carry back to Carry forward Year 1 to future years $125,000 $ 50,000 25% 40% $ 31,250 $ 20, 000

Total $175,000

Diff: 1 Type: ES Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS. 17) In the first year of operations, a company reports taxable income of $225,000 and paid a tax rate of 28%. It is now the end of the second year, and the company has a loss of $375,000 for tax purposes. The company's management believes it is probable the company will be able to use up its tax losses. The tax rate is currently 32%. Required: Compute the amounts of income tax receivable and/ or deferred income tax asset in the current (second) year. Answer: The loss of $375,000 can be partially carried back to completely eliminate the $225,000 of taxable income in Year 1. The remaining $150,000 needs to be carried forward.

Amount Tax rate Income tax receivable Deferred income tax asset

Carry back to Carry forward Year 1 to future years $225,000 $150,000 28% 32% $ 63,000 $ 48, 000

Total $375,000

18) During its first year of operations, Keen Corp. reported the following information: • Income before income taxes for the year was $650,000 and the tax rate was 25%. • Depreciation expense was $200,000 and CCA was $100,000. The carrying amount of property, plant, and equipment at the end of the year was $720,000, while UCC was $820,000. • Warranty expense was reported at $110,000, while actual cash paid out was $60,000. • $15,000 of expenses included in income was not deductible for tax purposes. • No other items affected deferred tax amounts besides these transactions. Required: a. Prepare the journal entries to record income tax expense for the year. b. Assume Keen reported a loss instead of income in its first year of operations. Explain what accounting policy choices are available to Keen to record the tax implications of the loss, and provide a recommendation.

Answer: a. To record the journal entry, first prepare a worksheet for permanent and temporary differences: Taxable Accounting income income for and taxes computing tax Item/transaction payable expense Income before taxes $650,000 $650,000 Add back depreciation 200,000 Deduct CCA (100,000) Add back warranty expense 110,000 Deduct warranty payments (60,000)

Temporary difference = (tax accounting)

Tax rate

Deferred tax debit (credit)

$100,000

---

$25,000

50,000

25%

Non-deductible expenses Subtotal

15,000 $815,000

15,000 $665,000

--$150,000

Tax rate Taxes payable or expense

25% $203,750

25% $166,250

25% $37,500

Journal entries for income taxes: Dr. Income tax expense Dr. Deferred income tax liability (PPE) Dr. Deferred income tax asset (warranties) Cr. Income tax payable

166,250 25,000 12,500

Dr. Income tax expense—current Cr. Income tax payable

203,750

Dr. Deferred income tax liability (PPE) Dr. Deferred income tax asset (warranties) Cr. Income tax expense—deferred

25,000 12,500

-$37,500

203,750

37,500

b. Given it is the company's first year of operations, it cannot carry any of the losses back to prior years. The tax savings that would result from applying the losses in future years could be recognized as an asset if it is more likely than not that the amount carried forward will be used within the next 20 years. I recommend that management not claim CCA in a loss year to decrease the chance that those deductions would be wasted if the losses were to expire in future years. Diff: 2 Type: ES Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

19) During its first year of operations, Karol Corp. reported the following information: • Income before income taxes for the year was $550,000 and the tax rate was 35%. • Depreciation expense was $100,000 and CCA was $50,000. • Warranty expense was reported at $20,000, while actual cash paid out was $10,000. • $25,000 of expenses included in income were not deductible for tax purposes. • No other items affected deferred tax amounts besides these transactions. Required: Prepare the journal entries to record income tax expense for the year. Answer: a. To record the journal entry, first prepare a worksheet for permanent and temporary differences: Taxable Accounting income income for and taxes computing tax Item/transaction payable expense Income before taxes $550,000 $550,000 Add back depreciation 100,000 Deduct CCA (50,000) Add back warranty expense 20,000 Deduct warranty payments (10,000)

Temporary difference = (tax accounting) $ 50,000 10,000

Non-deductible expenses Subtotal

25,000 $635,000

25,000 $575,000

--$60,000

Tax rate Taxes payable or expense

35% $222,250

35% $201,250

35% $21,000

Tax rate --35% --35%

Deferred tax debit (credit) $17,500 3,500

-$37,500

Journal entries for income taxes: Dr. Income tax expense Dr. Deferred income tax liability (PPE) Dr. Deferred income tax asset (warranties) Cr. Income tax payable

201,250 17,500 3,500

Dr. Income tax expense—current Cr. Income tax payable

222,250

Dr. Deferred income tax liability (PPE) 17,500 Dr. Deferred income tax asset (warranties) 3,500 Cr. Income tax expense-deferred 21,000 Diff: 2 Type: ES Skill: Comp Objective: 18.4 Analyze the effect of tax losses on past and future income taxes, and evaluate whether and how much of these tax loss benefits can be recognized as assets under IFRS.

Learning Objective 5 Apply the presentation and disclosure standards for income taxes. 1) Using the following table, contrast the substantive differences between IFRS and ASPE for (a) the method of accounting for income taxes and (b) presentation and disclosure. ISSUE Method of accounting for income taxes

IFRS

ASPE

Presentation and disclosures Answer: ISSUE

IFRS ASPE Entities should use the accrual Entities can use either the method of accrual method or the taxes Method of accounting for income taxes accounting. payable method. Deferred tax There is no requirement to assets and identify tax assets and liabilities liabilities need by source. to be identified Entities choosing the taxes by source. payable method need to reconcile their effective tax rate Presentation and disclosures to the statutory tax rate.

Diff: 2 Type: SA Skill: Concept Objective: 18.5 Apply the presentation and disclosure standards for income taxes.

2) A large public company reported that its provision for income taxes was $500 million and that it has a deferred tax liability of 2 billion. A Member of Parliament calls you and says, "I see hundreds of companies who have these huge deferred tax liabilities on their balance sheets. If the government could get even half of what's owed, it could cut the public deficit down to size in a hurry." Required: Write a memo to the Member of Parliament explaining the issues. Answer: To: Member of Parliament From: Re: Provision for Income Taxes vs. Deferred Income Tax Liability The reporting of income taxes in financial reports is complex and can easily mislead those who are not keenly aware of the accounting standards and methods that apply to this area. Income tax expense on the financial statements does not directly correspond to the amount of taxes owing according to the Income Tax Act. Income taxes for financial reporting purposes are computed using the accrual accounting procedure, which tries to record income tax expense in the period in which the taxpayer records the associated revenues. In other words, financial reporting aims to record the tax expense in the period when the economic event occurs, while the amount of actual taxes depends on the tax laws. Differences occur for many reasons. One reason for the difference is the different methods used to depreciate capital assets for accounting purposes versus for tax purposes. The $2 billion does not represent any taxes that are owed and have not been paid. Rather, it is simply an estimated amount to be required to be paid in the future in accordance with tax regulations. Please feel free to provide your comments and questions. Best regards, Diff: 2 Type: SA Skill: Concept Objective: 18.5 Apply the presentation and disclosure standards for income taxes.

3) Under ASPE, Section 3465 indicates less onerous disclosures as private enterprises are permitted to use the tax payable method. Summarize the rules covering presentation and disclosure of the following items according to ASPE using the following template: Item Required separate disclosure for companies using the accrual method No requirement for the following disclosures for companies using the taxes payable method Reconciliation required

Presentation and Disclosure

Answer: Item

Presentation and Disclosure current income tax expense future income tax expense income taxes related to capital transactions unrecognized tax assets arising from unused Required separate disclosure for companies tax losses or deductible temporary using the accrual method differences No requirement for the following future income tax expense disclosures for companies using the taxes deferred tax assets payable method deferred tax liabilities an enterprise using the taxes payable method needs to provide a reconciliation of (i) the effective income tax rate corresponding to the income tax expense to (ii) the statutory tax rate. This disclosure would identify the permanent and temporary differences arising in the year. (This reconciliation under the accrual method would not identify temporary Reconciliation required differences.)

Diff: 2 Type: SA Skill: Concept Objective: 18.5 Apply the presentation and disclosure standards for income taxes. 4) Summarize the IFRS rules for presentation and disclosure of taxes on discontinued operations and comprehensive income. Answer: Taxes on discontinued operations would be presented with those discontinued operations (or netted against those operations with additional note disclosure of the related income tax). Any taxes on items relating to other comprehensive income would be presented in other comprehensive income rather than in profit or loss. Diff: 2 Type: SA Skill: Concept Objective: 18.5 Apply the presentation and disclosure standards for income taxes.

5) For the year ended October 31, 2027, NB Financial Group (National Bank) reported income before tax of $2,160 million and income tax expense of $274 million, for an effective tax rate of 12.7% ($274m / $2,160m). In the notes to the financial statements, NB's disclosures included the following information: Amount Reconciliation of statutory and effective rates ($ millions) Combined Canadian federal and provincial income tax rates at the statutory rate $734 Increase (decrease) resulting from: Tax exempt income (180) Foreign operations subject to different tax rates (210) Change in tax rate for deferred income taxes 14 Intangible assets not deductible for tax purposes 8 Recovery of prior year's income taxes (80) Other (12) Income tax expense and effective tax rate $274 (Dollars amounts in millions) Deferred income tax assets Deferred income tax liabilities

2009 $1,080 750

Rate (%) 34 (8.3) (9.7) 0.6 0.4 (3.7) (0.6) 12.7 2008 $1,205 700

Required: a. From NB's disclosures provided above, identify any permanent differences. b. In which direction did the tax rate change from 2026 to 2027? c. Refer to the line "Recovery of prior years' income taxes" in the above disclosures. What does this information imply about NB's treatment of tax losses in prior years? Answer: a. Permanent differences: Tax-exempt income Intangible assets not deductible for tax purposes b. NB had deferred tax assets that exceeded deferred tax liabilities at the end of 2026. The additional expense for "change in tax rate for deferred income taxes" reflects a decrease in the value of this asset, implying that the tax rate has decreased (modestly) from 2026 to 2027. c. The appearance of "Recovery of prior years' income taxes" in the reconciliation of the statutory and effective tax rates implies that NB had not recognized some deferred tax assets for tax losses in prior years. Had such losses been fully recognized as assets, this line item would not appear. Diff: 2 Type: ES Skill: Comp Objective: 18.5 Apply the presentation and disclosure standards for income taxes.

6) Summarize the rules covering presentation and disclosure of the following items according to IFRS using the following template: Item Income Tax Expense Composition of Income Tax Expense Taxes on discontinued operations Comprehensive income Permanent Differences Offsetting Different jurisdiction and component entities According to source Tax losses carried forward

Presentation and Disclosure

Answer: Item

Presentation and Disclosure The total income tax expense must be shown on the face of the Income Tax Expense income statement An explanation of the composition of tax expense. In particular, the notes should distinguish the amount for current versus deferred tax: • current tax expense; • deferred tax expense due to temporary difference; and • deferred tax expense due to changes in tax rates. • Enterprises need to disclose the impact of a writedown of Composition of Income deferred tax assets or of a previously unrecognized deferred Tax Expense asset on current and deferred tax expense. Taxes on discontinued operations would be presented with those discontinued operations (or netted against those Taxes on discontinued operations with additional note disclosure of the related income operations tax). Any taxes on items relating to other comprehensive income would be presented in other comprehensive income rather than Comprehensive income in profit or loss. the difference between (i) the actual tax expense and (ii) the tax expense expected based on the before-tax income multiplied by the statutory tax rate is disclosed in order to identify the Permanent Differences permanent differences impacting the tax expense for the year. Enterprises must present current tax payables or recoveries, deferred tax assets, and deferred tax liabilities separately (i.e., Offsetting not offset an asset against a liability). Enterprises cannot offset tax assets for one jurisdiction against liabilities relating to another jurisdiction. Likewise, component entities (e.g., corporations) cannot offset the tax liabilities of one Different jurisdiction component entity with tax assets of another. and component entities Enterprises need to identify deferred tax assets or liabilities according to their sources. For example, a deferred tax asset from warranty costs would be disclosed separately from another deferred tax asset from unearned revenue. According to source Enterprises need to disclose the amount of deferred tax assets recognized for tax losses carried forward. Regardless of the source of the deferred tax asset or liability, enterprises must Tax losses carried classify them as noncurrent items when the enterprises use the forward current/noncurrent presentation for the balance sheet.

Diff: 2 Type: ES Skill: Concept Objective: 18.5 Apply the presentation and disclosure standards for income taxes.

Comprehensive Question 1) ZEA Company started operations in 2026. The financial statements of ZEA reflected the following pretax amounts for its December 31 year-end: 2026

2027

Income statement (summarized) Revenues Depreciation expense Other operating expenses Pre-tax accounting income

$4,000,000 500,000 1,100,000 2,400,000

$4,600,000 500,000 1,200,000 2,900,000

Balance Sheet (partial) Property, plant and equipment, cost Accumulated depreciation Net Unearned rent revenue

$3,500,000 (500,000) 3,000,000 ---

$3,500,000 (1,000,000) 2,500,000 140,000

100,000 25,000

125,000

Ordinary shares Outstanding January 1 Issued October 1, 2026 Repurchased March 1, 2027 15% stock dividend August 1, 2027 Outstanding December 31

125,000

(35,000) 13,500 103,500

ZEA has a tax rate of 30% in 2026 and 35% in 2027, enacted in February each year. The unearned rent revenue represents cash received from a tenant that will be moving into the building February 15, 2028. For tax purposes, any cash received for future rent is taxed when the cash is received. On July 1, 2027 the company was fined $20,000 (included in other operating expenses) for violating a building code, this fine is not tax deductible. ZEA claimed CCA for tax purposes of $600,000 in 2026 and $700,000 in 2027. Required: a. Calculate the income tax expense for 2026 and 2027. b. Calculate the weighted average number of ordinary shares outstanding in each of 2026, and 2027. c. Calculate the basic EPS for each of 2026, and 2027.

Answer: a. Calculation of taxes payable: Item/Transaction Income before taxes Add back depreciation Deduct CCA Add unearned revenue Add fine Subtotal Tax rate Taxes payable

2026 $2,400,000 500,000 (600,000) ------$2,300,000 30% $690,000

2027 $2,900,000 500,000 (700,000) 140,000 20,000 $2,860,000 35% $1,001,000

Deferred tax balances: 2026 Deferred tax liability(for property, plant, and equipment) Deferred tax asset (for unearned revenue)

$30,000 0

2027 $105,000 49,000

To calculate these balances, convert the balance of cumulative temporary differences using the tax rate for the appropriate year, as follows: Property, plant, and equipment 2026: ($600,000 - $500,000 ) × 30% = $30,000 2027: ($1,300,000 - $1,000,000 ) × 35% = $105,000 Unearned rent revenue 2027: 140,000 × 35% = $49,000 Calculation of income tax expense: Item/Transaction Income tax payable Increase in deferred tax asset Increase in deferred tax liability Tax expense

2026 $690,000 30,000 $720,000

2027 $1,001,000 (49,000) 75,000 $1,027,000

b. Calculation of weighted average number of ordinary shares outstanding: Adj. Fraction Date Activity Shares O/S factor of year (2026) Jan. 1 - Sept. 31 Opening Balance 100,000 9/12 Oct. 1 - Dec. 31 Issued 25k shares 125,000 3/12 WASO Dec. 31, 2026

75,000 31,250 106,250

(2027) Jan. 1 - Feb. 28 Mar. 1 - July 31 Aug. 1 - Dec. 31 WASO Dec. 31, 2027

Opening Balance Repurchase 35k shares 15% stock dividend

WASO

125,000

1.15

2/12

23,958

90,000 103,500

1.15

5/12 5/12

43,125 43,125 110,208

c. Calculation of basic EPS: 2026 $2,400,000 720,000 $1,680,000 106,250 $15.81

Pre-tax accounting income Income tax expense Net income WASO Dec. 31 Basic EPS Diff: 2 Type: ES Skill: Comp Objective: 18.6 Comprehensive question

2027 $2,900,000 1,027,000 $1,873,000 110,208 $17.00

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 19 Accounting Changes Learning Objective 1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 1) Which of the following is a change in policy? A) Inventory was sold below carrying amount even though the inventory had been previously written down to lower of cost and net realizable value. B) A company changes from the cost model to the revaluation model of measuring the value of land. C) Development costs were capitalized when only five of six criteria for capitalization had been satisfied. D) The company miscalculated the weighted average number of ordinary shares outstanding because it used the wrong date for a share issuance. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 2) Which of the following is a change in an estimate? A) A company changes the presentation of operating expenses from "by function" to "by nature." B) An enterprise switches from the gross method to the net method of presenting government grants. C) A temporary difference was treated as a permanent difference. D) The useful life on a building was originally estimated to be 20 years but the estimated useful life of the building is changed to only 15 years as at the beginning of the year. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 3) Which of the following is a change in policy? A) A company changes from the gross method to the net method of recording cash discounts. B) A change in the terms of a loan from repayment on demand to a fixed repayment date two years after the fiscal year-end. C) A contingency for a lawsuit that was evaluated to be likely to lead to an outflow of resources was ultimately resolved against the reporting entity. D) A temporary tax difference was treated as permanent tax difference. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

4) Which of the following is an accounting error? A) A company changes from the gross method to the net method of recording cash discounts. B) A private corporation previously using ASPE chooses to adopt IFRS. C) Costs not related to the construction of a building were included in the building cost. D) A patent was expected to provide protection of intellectual property for the full legal life of 20 years, but technological advances made the patent obsolete after only 12 years. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 5) Which of the following is an accounting error? A) Inventory was sold below carrying amount even though the inventory had been previously written down to the lower of cost and net realizable value. B) Convertible securities that were identified as dilutive for computing diluted EPS were not converted by the expiration date. C) A change in economic conditions resulted in the fair value of goodwill declining from $15 million to $10 million. D) Development costs of an intangible asset were capitalized when only five of six criteria for capitalization had been satisfied. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 6) Which of the following statements is true? A) The last-in, first-out (LIFO) cost flow assumption is an acceptable method for costing inventories in Canada. B) Over time, the number of areas where management has a free choice over accounting policies has increased. C) A change in accounting policy is an accounting change made at the discretion of management. D) Changes in accounting policy occur more frequently than changes in estimates. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

7) Which statement is correct about a correction of an error from prior periods? A) The correct information was available at the time the error was made. B) The correct information was not available at the time the error was made. C) One should use hindsight to judge whether there is an accounting error that requires correction. D) An example of a correction of an error is the difference between the allowance for doubtful accounts and the actual outcome of bad debts. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 8) Which of the following statements is true? A) A correction of an error is the result of information that was unknown at the time of the error. B) A change is accounting policy is the result of new information. C) A change in estimate is not due to management choice and not due to information known in a prior period. D) A correction of an error is due to management choice. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 9) Over time, has management's free will over accounting changes increased or decreased? Explain why. Answer: The number of areas where management has free choice over a change in accounting policies or estimates has decreased over time to reduce opportunities for management to use accounting changes to manipulate financial statements. Diff: 1 Type: SA Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 10) What is the essential characteristic that distinguishes a change in accounting policy from either an error correction or a change in estimate? Answer: The essential characteristic that distinguishes a change in accounting policy from either an error correction or a change in estimates is that a change in accounting policy involves a management choice among acceptable alternatives. An error is an unintentional misstatement an a change in estimate should reflect new information that has come to light. Diff: 1 Type: SA Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

11) Complete the following table indicating which of the following requires a correction due to an error from a prior period. Financial Statement Item Explanation of Error/Estimate Revenue The cost on a construction contract turned out to be $15,325,000 instead of the $15,000,000 originally estimated. Property, Plant and Equipment Inventory

Revenue

Property, Plant and Equipment Inventory

Intangible assets Deferred income tax

The useful life on a building was originally estimated to be 20 years but the building turned out to be useful for only 15 years. Inventory was sold below carrying amount even though the inventory had been previously written down to lower of cost and net realizable value. All three years of revenue were recognized in year 1 for a construction project which took 3 years to complete. Costs not related to the construction of a building were included in the building cost. Inventory was not written down to lower of cost and net realizable value even though actual sales made in the subsequent events period indicated impairment in inventories. Development costs were capitalized when only five of six criteria for capitalization had been satisfied. A temporary difference was treated as a permanent difference.

Earnings per share (EPS)

The company miscalculated the weighted average number of ordinary shares outstanding because it used the wrong date for a share issuance.

Intangible assets

A patent was expected to provide protection of intellectual property for the full legal life of 20 years, but technological advances made the patent obsolete after only 12 years.

Current Liabilities and long A contingency for a lawsuit that was evaluated to term debt be unlikely to lead to an outflow of resources was ultimately resolved against the reporting entity. Deferred income tax A deferred tax asset for a loss carried forward became worthless when the government reduced the length of the carryforward period. Earnings per share (EPS) Convertible securities that were identified as dilutive for computing diluted EPS were not converted by the expiration date.

YES/NO

Current liabilities and long- The company failed to report as current liabilities term debt the portion of long-term debt that was repayable within 12 months of the fiscal year-end.

Answer: Financial Statement Item Explanation of Error/Estimate Revenue The cost on a construction contract turned out to be $15,325,000 instead of the $15,000,000 originally estimated. Property, Plant and The useful life on a building was originally Equipment estimated to be 20 years but the building turned out to be useful for only 15 years. Inventory Inventory was sold below carrying amount even though the inventory had been previously written down to lower of cost and net realizable value. Revenue All three years of revenue were recognized in year 1 for a construction project which took 3 years to complete. Property, Plant and Costs not related to the construction of a Equipment building were included in the building cost. Inventory Inventory was not written down to lower of cost and net realizable value even though actual sales made in the subsequent events period indicated impairment in inventories. Intangible assets Development costs were capitalized when only five of six criteria for capitalization had been satisfied. Deferred income tax A temporary difference was treated as a permanent difference. Earnings per share (EPS) The company miscalculated the weighted average number of ordinary shares outstanding because it used the wrong date for a share issuance. Intangible assets A patent was expected to provide protection of intellectual property for the full legal life of 20 years, but technological advances made the patent obsolete after only 12 years. Current Liabilities and A contingency for a lawsuit that was evaluated long term debt to be unlikely to lead to an outflow of resources was ultimately resolved against the reporting entity. Deferred income tax A deferred tax asset for a loss carried forward became worthless when the government reduced the length of the carryforward period. Earnings per share (EPS) Convertible securities that were identified as dilutive for computing diluted EPS were not converted by the expiration date.

YES/NO NO

YES

YES YES

YES

YES YES

Current liabilities and long-term debt

The company failed to report as current liabilities the portion of long-term debt that was repayable within 12 months of the fiscal yearend.

YES

Diff: 1 Type: SA Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 12) What is the essential characteristic that distinguishes an error correction from a change in estimate? Answer: We can distinguish an error correction from a change in accounting estimate based on whether the relevant information triggering the change was known or should have been known previously. If so, then there exists an error requiring correction. If not, then the information merely updates the accounting estimates going forward. Diff: 1 Type: SA Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate. 13) The discussion in IAS 16 paragraphs 60-62 indicates that a change in depreciation method is usually a change in accounting estimate. Explain the logic behind why a change in depreciation method is normally considered a change in estimate. Answer: A change in depreciation pattern (e.g., from straight-line to declining-balance) is usually considered a change in estimate because the depreciation pattern is not a free choice among acceptable alternatives. IAS 16 requires enterprises to choose the pattern of depreciation that best reflects the pattern of economic benefits expected from the asset, so a change in depreciation method is presumed to reflect a change in the estimated pattern of benefits. Diff: 1 Type: SA Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

14) Complete the following table by giving one example of a change in accounting policy for each financial statement item. Financial Statement Item

Changes in Accounting Policy

Revenue Operating expenses Receivables Property, plant and equipment (PPE) Government assistance Accounting standards Answer: Financial Statement Item

Revenue

Operating expenses Receivables

Property, plant and equipment (PPE)

Government assistance Accounting standards

Changes in Accounting Policy On construction contracts, a company changes from using the cost ratio to using engineering estimates to determine the percentage completed. A company changes the presentation of operating expenses from "by function" to "by nature. A company changes from the gross method to the net method of recording cash discounts. A company changes from the cost model to the revaluation model of measuring the value of land. An enterprise switches from the gross method to the net method of presenting government grants. A private corporation previously using ASPE chooses to adopt IFRS.

Diff: 1 Type: ES Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

15) A company changes the depreciation for a piece of equipment from 20% declining- balance to unitsof-production. Describe a plausible circumstance that would support this change as one of the following: (i) an error, (ii) a change in estimate, or (iii) a change in accounting policy. Answer: (i) Error: The change in depreciation method could be an error if there existed information that suggested the equipment declines in usefulness in proportion to the number of units produced and that management should have used the information, but did not. (ii) Change in estimate: If there was not error in the past, then a change in depreciation policy should be made when, and only when, changing circumstances suggest that a different depreciation method would be more appropriate. Accounting changes reflecting new circumstances are considered changes in estimate. (iii) Change in accounting policy: If management initially chose the declining balance method because it was simpler to implement. Subsequently, it decided that it would switch to the unit-of-production method without being prompted by any new information regarding the equipment. In other words, this is a choice between equally valid alternatives. Diff: 1 Type: ES Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

16) Complete the table giving an example of a change in estimate from each of the given areas. Financial Statement Items Employee future benefits Deferred income taxes Property, plant and equipment Current liabilities and long-term debt Goodwill Receivables Revenue Answer: Financial Statement Items Employee future benefits Deferred income taxes

Property, plant and equipment

Current liabilities and long-term debt

Goodwill Receivables

Revenue

Changes in Accounting Estimates

Changes in Accounting Estimates Change in life expectancy from 75 to 82 years for beneficiaries of a defined benefit pension plan. A change in income tax rates from 27% to 33%. A company changes the estimated useful life of a building from 10 years to 15 years remaining as at the beginning of the year. A change in the terms of a loan from a fixed repayment date three years from the fiscal yearend to repayment on demand. A change in economic conditions resulted in the fair value of goodwill declining from $20 million to $15 million. A change in the percentage of sales used to estimate bad debts expense from 0.5% to 0.6%. For a construction contract, a change in the estimated total cost of the contract from $12 million to $13 million.

Diff: 2 Type: ES Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

17) For the following financial statement accounts, provide a description of a change in accounting estimates. Financial Statement Items Revenue Receivables Property, Plant and Equipment Goodwill Current liabilities Deferred income taxes Employee future benefits Answer: Financial Statement Items Revenue Receivables Property, Plant and Equipment

Goodwill Current liabilities Deferred income taxes Employee future benefits

Changes in Accounting Estimates

Changes in Accounting Estimates A change in the estimated total cost of the contract A change is the percentage of sales used to estimate bad debts from .4% to .5%. The estimated useful life of the building changes from 20 years to 15 years. Declining economic conditions result in the fair value of goodwill declining from $20 million to $10 million A change in payment terms from a fixed date in the future to repayment on demand. A change in income tax rates. A change in life expectance for beneficiaries of a defined benefit plan.

Diff: 2 Type: ES Skill: Concept Objective: 19.1 Evaluate whether an accounting change is an error correction, a change in accounting policy, or a change in estimate.

Learning Objective 2 Apply the prospective and retrospective treatments for accounting changes. 1) For a company using the straight-line method of depreciation that changes the estimated useful life from 20 years to 15 years remaining as at the beginning of the year, the accountant should do the following: A) Compute current year depreciation as (carrying amount - residual value) divided by 15 years. B) Adjust prior year's depreciation. C) Adjust the amount of accumulated depreciation as at the beginning of the year. D) Compute current year depreciation as (carrying amount) x 15/20. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 2) For a company using the straight-line method of depreciation that changes the estimated useful life from 20 years to 15 years as at the beginning of the year, the accountant should do (or not do) the following: A) Compute current year depreciation as (carrying amount - residual value) divided by 20 years. B) Do not adjust prior year's depreciation. C) Adjust the amount of accumulated depreciation as at the beginning of the year. D) Compute current year depreciation as (carrying amount) × 15/20. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 3) For a company using the straight-line method of depreciation that changes the estimated useful life from 20 years to 15 years as at the beginning of the year, the accountant should do (or not do) the following: A) Compute current year depreciation as (carrying amount - residual value) divided by 20 years. B) Adjust prior year's depreciation. C) Do not adjust the amount of accumulated depreciation as at the beginning of the year. D) Compute current year depreciation as (carrying amount) × 15/20. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

4) For a construction contract where the company uses the percentage of completion method and there is a change in the estimated total cost of the contract from 12 million to 13 million, the accountant should do the following: A) Use the average cost of 12.5 million. B) Compute the percentage completed using the new cost total if the company uses the cost ratio to estimate percentage completed. C) Use estimated costs determined at the beginning of the contract, not actual costs to date. D) Use retrospective treatment. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 5) An analysis of a company's inventory indicates that inventory at the end of 2025 was understated by $30,000 due to an inventory count error. Inventory at the end of 2026 was correctly stated. The company uses the periodic system of inventory and its fiscal year-end is December 31. Given this information, which of the following statements is correct? A) The net income of 2025 is overstated and a retrospective correction should be made. B) The net income of 2026 is overstated and should be corrected. C) The 2026 year-end retained earnings are overstated and a prospective correction should be made. D) The net income of 2026 is understated and should be corrected. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 6) A retailer increases bad debts expense from 2.5% to 3% of credit sales. Given this information, which of the following statements is correct? A) The net income of prior years is overstated and a retrospective correction should be made. B) This is a change in estimate and should be treated prospectively. C) This is a change in accounting policy and treatment is retrospective. D) This is a correction of an error and a retrospective correction should be made. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

7) For the following accounting changes, identify the appropriate treatment under IFRS. Type of Accounting Change Change in estimate Change in accounting policy Correction of an error Answer: Type of Accounting Change Change in estimate Change in accounting policy Correction of an error

Accounting Treatment

Accounting Treatment Prospective Retrospective with restatement Retrospective with restatement

Diff: 1 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 8) Define the term "prospective adjustment." Which type of accounting changes is it applied to? Answer: A prospective adjustment applies an accounting change only to the current and future periods without any changes to past financial statements. This is the appropriate treatment for changes in estimates because this type of change is triggered by new information. Since this information was not previously known, it does not make sense to go backwards in time and amend prior financial statements. Diff: 1 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 9) Why is the prospective treatment conceptually appropriate for changes in estimates? Answer: The prospective approach is conceptually appropriate for changes in estimates because such changes arise from new information that was not previously known. Diff: 1 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

10) For each of the following scenarios, determine the effects (if any) of the accounting change (correction of error, change in accounting policy, or change in estimate) on the relevant asset or liability, equity, and comprehensive income in the year of change and the prior year. Use the following table for your response: Prior Year Current Year Type of accounting Asset or Asset or change Treatment liability Equity Income liability Equity Income a. b. c. a. Company A increases the allowance for doubtful accounts (ADA). Using the old estimate, ADA would have been $45,000. The new estimate is $50,000. b. Company B omitted to record an invoice for a $10,000 sale made on credit at the end of the previous year and incorrectly recorded the sale in the current year. The related inventory sold has been accounted for. c. Company C changes its revenue recognition to a more conservative policy. The result is a decrease in prior-year revenue by $4,000 and a decrease in current-year revenue by $5,000 relative to the amounts under the old policy. Answer: Effects in year Effects in year prior to change of change Type of Treatment Asset or Equity Income Asset or Equity Income accounting liability liability change a. Change in Prospective – – – ↓ $5,000 ↓ $5,000 ↓ $5,000 estimate asset b. Correction Retrospective ↑ $10,000 ↑ $10,000 ↑ $10,000 no effect no effect ↓ $10,000 of error asset c. Change in Retrospective ↓ $4,000 ↓ $4,000 ↓ $4,000 ↓ $9,000 ↓ $9,000 ↓ $5,000 accounting asset asset policy Diff: 2 Type: SA Skill: Comp Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

11) During the audit of Keats Island Brewery for the fiscal year ended June 30, 2027, the auditors identified the following issues: For each of the three issues described below, using the following table, identify both the direction (increase or decrease) and the amount of the effect relative to the amount without the accounting change. a. The company sells beer for $1 each plus $0.10 deposit on each bottle. The deposit collected is payable to the provincial recycling agency. During 2026, the company had recorded $12,000 of deposits as revenue. The auditors believe this amount should have been recorded as a liability. b. The company had been using the first-in, first-out cost flow assumption for its inventories. In fiscal 2027, management decided to switch to the weighted-average method. This change reduced inventory by $25,000 at June 30, 2026, and $40,000 at June 30, 2027. c. The company has equipment costing $6,000,000 that it has been depreciating over 10 years on a straight-line basis. The depreciation for fiscal 2026 was $600,000 and accumulated depreciation on June 30, 2026, was $1,200,000. During 2027, management revises the estimate of useful life to 12 years, reducing the amount of depreciation to $480,000 per year. Type of Accounting Change

Treatment

Assets

Liabilities

Equity

Income

a. b. c. Answer:

Diff: 2 Type: SA Skill: Comp Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 12) Define "a retrospective adjustment." Answer: A retrospective adjustment applies an accounting change to all periods affected in the past, present, and future. Diff: 2 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

13) How many balance sheets are required by IAS 1 when there is a change in accounting policy and why? Answer: When there is a change in accounting policy, IAS 1 requires the presentation of three balance sheets (i.e., for the end of the current fiscal year and the two preceding years) compared with the normal requirement of two balance sheets. The objective of the requirement to present the extra balance sheet is to allow users to follow the articulation of the financial statements for a full two-year cycle. Diff: 2 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 14) Why is the retrospective approach conceptually appropriate for changes in accounting policy? Answer: The retrospective approach is conceptually appropriate for changes in accounting policy because it results in financial statements that are comparable over time. Comparability enhances the usefulness of financial reports. Diff: 2 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 15) How should enterprises reflect changes in accounting standards? Answer: Enterprises should reflect changes in accounting standards according to the transitional provisions of each standard. Where there are no specific transitional provisions, retrospective adjustments should be made to reflect the change in accounting standard. Diff: 2 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 16) What are two reasons why an accounting change may be permitted to give modified retrospective or prospective treatment? Answer: When it is likely that enterprises do not have the necessary information to restate, or that it will be costly to obtain that information, prospective treatment will be the norm. Diff: 2 Type: SA Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

17) Evaluate each of the following independent situations to determine the type of accounting change (correction of error, change in accounting policy, or change in estimate) and the appropriate accounting treatment (retrospective or prospective). Type of Change

Situation

Treat -ment

A A new consumer protection law comes into effect, giving buyers of electronic products a guarantee against defects for 180 days after purchase and the ability to return defective products to the retailer. The retailer has never accrued for product guarantees. B The audit firm recommends that management report inventories at the lower of cost and net realizable value, whereas the company has previously only tracked and reported inventory figures at cost. C A retailer increases bad debts expense from 2.5% to 3% of credit sales. D A fashion designer decides to set up an allowance for doubtful accounts at 3% of amounts over 90 days.

Explana -tion

Answer:

Type of Treat Situation Change -ment A new consumer protection law comes into effect, giving buyers of electronic products a guarantee against defects for 180 days after purchase and the ability to return defective products to the retailer. The retailer has never accrued Change in for product guarantees. estimate Prospective

The audit firm recommends that management report inventories at the lower of cost and net realizable value, whereas the company has previously only tracked and reported inventory figures at cost. A retailer increases bad debts expense from 2.5% to 3% of credit sales.

Change in Retrospective accounting but likely policy or unable to correction restate prior of error periods Change in estimate Prospective

A fashion designer decides to set up an allowance for doubtful accounts at 3% of amounts over 90 days. Change in estimate Prospective

Explana -tion

Due to new information (enactment of new law) Not due to new information. Retrospective treatment would be ideal, but information on net realizable values for prior years is unlikely to be obtainable.

Due to new info Due to new information. Could also be a change in accounting policy and treat retrospectively to maintain comparability from year to year.

Diff: 2 Type: ES Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

18) What types of accounting changes are treated retrospectively and why? Answer: Retrospective adjustment is the appropriate treatment for both corrections of errors and changes in accounting policy. For errors made in previously published financial statements, it is common sense that we should reflect the corrections in the period when those mistakes occurred rather than in the period when the mistakes were discovered. For changes in accounting policy, the benefit of adjusting prior periods using the retrospective approach is the consistency/comparability in the financial reports presented over time. If the retrospective approach were not used, then the financial statements for one year would be presented using one set of accounting policies, while the next year could be presented using quite a different set of policies, making inter-year comparisons difficult and possibly meaningless. Diff: 2 Type: ES Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes. 19) Give an example of a change in accounting policy which does not require retrospective treatment and explain why. Answer: One example of a change in accounting policy that does not require retrospective treatment is a change from the cost model to the revaluation model for PPE and intangible assets. IAS 8 paragraph 17 indicates that such a change in accounting policy should be "dealt with as a revaluation in accordance with IAS 16 or IAS 38," the respective standards for PPE and intangible assets. The effect of this exception is to treat the change in accounting policy as a first revaluation for the asset class (land, buildings, etc.). Presumably, IFRS provides for this exception as a matter of practicality. An enterprise that has been using the cost model for a class of assets is unlikely to have a history of fair values for those assets to be able to retrospectively apply the revaluation model. For PPE and intangible assets, that history could be decades long. Requiring retrospective adjustments in this instance would mean that practically no one would be able to switch from the cost model to the revaluation model. Note that the reverse switch, from the revaluation model to the cost model, does not have the same practical limitations. Enterprises do have the necessary cost information, even when they had been applying the revaluation model. Consequently, switching from the revaluation model to the cost model does need to follow the general requirement of retrospective adjustment. Diff: 2 Type: ES Skill: Concept Objective: 19.2 Apply the prospective and retrospective treatments for accounting changes.

Learning Objective 3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records. 1) Which statement is true regarding accounting accruals? A) The nature of accrual accounting is that accruals will reverse when cash cycles are complete. B) Operating activities generally have relatively long cash cycles. C) Financing and investing activities generally have relatively short cash cycles. D) Errors or changes in accounting policy that affect non-current items like equipment will result in follow-through changes over a relatively short period. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

2) Which statement is true regarding accounting accruals? A) Errors or changes in accounting policy that affect non-current items like equipment will result in follow-through changes over a relatively short period. B) The purchase of equipment involves an initial accrual to record the asset followed by accrual reversals in the form of depreciation expense and derecognition of the asset upon disposal. C) Operating activities generally have relatively long cash cycles. D) Financing and investing activities generally have relatively short cash cycles. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records. 3) Why are retrospective adjustments to past years' income and expenses recorded directly in retained earnings? Answer: We record retrospective adjustments to past years' income and expenses directly in retained earnings because prior years income and expense accounts (i.e., temporary accounts) have been closed to retained earnings, so no entries can be made to those accounts; instead the net effect on income must be reflected directly in retained earnings. Diff: 1 Type: SA Skill: Concept Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

4) Star Company Ltd. is a private company that started on January 1, 2025. During an external audit that was conducted at the end of the second year of the company's operation (2026), the following information was presented:

Long-term contract income Bad debt expense

2026 2025 Preliminary Income Income statement statement $5,000,000 $6,000,000 (200,000) (300,000)

The company used the completed contract method for revenue recognition in 2025. Management now believes that the percentage of completion method would be better. If the percentage of completion method had been used, the incomes for 2025 and 2026 would have been $5,500,000 and $5,700,000 respectively. The accounts receivable on December 31, 2025, included a $50,000 account that was not provided for but subsequently was written off during 2026 as the customer went bankrupt after the issuance of the financial statements. Star Company would like to adjust 2025 for this oversight as it sees this as an error. Required: a. As the auditor on this engagement, what is your recommended treatment for each of these matters in terms of whether they are errors, changes in accounting policy, or changes in estimate? Explain your conclusion. b. Assume that management of Star Company agrees with your recommendations. How would the balances above be presented in the corrected income statements for 2025 and 2026? Answer: a. Long-term contracts: This is a clear change in accounting policy where the new policy is deemed to be more appropriate, so it should be retrospectively applied. Bad debt expense: This is not an error but rather a change in estimate due to new information. As the bankruptcy occurred after the subsequent-events period (i.e. after completion of the audit), no adjustment to the 2025 financial statements is permitted. b.

Long-term contract income Bad debt expense

2025 Income statement Corrected $5,500,00 (200,000)

2026 Income statement Corrected $5,700,000 (300,000)

Diff: 2 Type: SA Skill: Concept Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

5) Star Company Ltd. is a private company that started on January 1, 2025. During an external audit that was conducted at the end of the second year of the company's operation (2026), the following information was presented:

Depreciation expense - machine Depreciation expense - building Warranty expense

2026 2025 Preliminary Income Income statement statement $600,000 $600,000 500,000 450,000 100,000 270,000

Star Company has one huge machine that cost $6,000,000 and was depreciated over an estimated useful life of 10 years. Upon reviewing the manufacturer's reports in 2026, management now firmly believes the machine will last a total of 15 years from date of purchase. They would like to change last year's depreciation charge based on this analysis. The company's building (cost $5,000,000, estimated salvage value $0 useful life 20 years) was depreciated using the 10% declining-balance method. The company and auditor now agree that the straight-line method would be a more appropriate method to use. Star Company does not accrue for warranties; rather, it records the warranty expense when amounts are paid. Star provides a one-year warranty for defective goods. Payments to satisfy warranty claims in 2025 were $100,000 and $270,000 in 2026. Out of the $270,000 paid in 2026, $150,000 related to 2025 sales. A reasonable estimate of warranties payable at the end of 2026 is $275,000. Required: a. As the auditor on this engagement, what is your recommended treatment for each of these matters in terms of whether they are errors, changes in accounting policy, or changes in estimate? Explain your conclusion. b. Assume that management of Star Company agrees with your recommendations. How would the balances above be presented in the corrected income statements for 2025 and 2026?

Answer: a. Machine Depreciation: This is a change in estimate of the useful life of the machine. This new information should be applied prospectively to the 2026 and subsequent depreciation charges. The depreciation expense for 2025 should remain and reduce the carrying value of the machine accordingly for 2026. The remaining useful life of the machine should be changed from 9 to 14 years (15 years total – 1 year elapsed) as at January 1, 2026. Building Depreciation: The new deprecation method should be treated prospectively as the new method is judged to be a more appropriate reflection of the consumption of benefits than the prior method. Warranties: This is an error as warranties should be accrued and matched with the revenue recognized in that period. The 2025 and 2026 income statements should reflect the warranty accrual and related change in expense. b. 2025 Income statement Corrected Depreciation expense - machine

$600,000

Depreciation expense - building

500,000 250,000 3

Warranty expense

2026 Income statement Corrected $385,714 1 236,842 2 395,000 4

1 ($6,000,000 – $600,000) / (15 - 1) = $385,714 2 ($5,000,000 – $500,000) / (20 - 1) = $236,842 3 $100,000 + $150,000 = $250,000

4 $270,000 – $150,000 + $275,000 = $395,000

Diff: 2 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

6) Zyler Company is analyzing its accounts receivable for purposes of preparing its financial report for the year ended December 31, 2025. The company uses the aging method to estimate bad debts. During this analysis, Zyler discovered that staff had written off a $55,000 account in 2025 even though the company had received information about the bankruptcy of the client in late 2024. The company has already recorded bad debts expense for 2025, but the general ledger for the year has not yet been closed. The following table provides information relating to Zyler's accounts receivables just prior to the discovery of the $55,000 error:

Accounts receivable—gross Allowance for doubtful accounts Accounts receivable—net Bad debts expense

2024 $2,240,000 (123,000) $2,117,000 $255,000

2025 $2,460,000 (145,000) $2,315,000 $236,000

Required: Record any adjusting journal entries necessary to correct the error in Zyler's accounts receivable. Answer: To correct for an uncollectible account that should have been written off in DR CR 2025 Dec. 31 2024 but was written off in 2025. Dr. Retained earnings - opening balance 55,000 Cr. Bad debts expense 55,000 The $55,000 account should have been written off in 2024, so accounts receivable (A/R) and the allowance for doubtful accounts (ADA) were overstated by this amount. However, by the year-end of 2024, after the aging analysis, the appropriate balance in ADA would have been established, so the effect of the error is in the understatement of bad debts expense (BDE). Since the uncollectible account had been written off during 2025, the balance in A/R is correct at the end of 2025, so no correction should be made to the A/R account. However, the write-off in 2025 that should have been recorded in 2024 would have reduced ADA such that under the aging method, an additional $55,000 of BDE would have been recorded in 2025. Since BDE is closed to retained earnings, the understatement of BDE has overstated retained earnings at the end of 2024 and beginning of 2025. In summary, this is a timing error: the account should have been written off in 2024 but had been written off during 2025. Therefore, there is only a shift in income/expense between years, but the balance sheet accounts by the end of 2024 remain correct. Diff: 2 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

7) Anfield Corp. is analyzing its accounts receivable for purposes of preparing its second-quarter financial report for June 30, 2025. For interim reporting, the company uses the percentage-of-sales method to estimate bad debts. During this analysis, Anfield identified an account for $42,000 that should have been written off in the first quarter ended March 31, 2025, but was actually written off in May 2025. The following table provides information relating to Anfield accounts receivables after recording the provision for bad debts for the quarter but prior to the discovery of the $42,000 error:

Accounts receivable—gross Allowance for doubtful accounts Accounts receivable—net Bad debts expense

March 31, 2025 June 30, 2025 $2,480,000 $2,560,000 (183,000) (195,000) $2,297,000 $2,365,000 $245,000 $278,000

Required: Record any adjusting journal entries necessary to correct the error in Anfield's accounts receivable. Answer: 2025 Dec. 31 To correct for an uncollectible account that should have been written off in the first quarter but was written off in the second quarter of 2025. No entry required. Explanation: The $42,000 should have been written off in the first quarter (Q1), so accounts receivable (A/R) and allowance for doubtful accounts (ADA) were overstated by this amount. However, since the company estimates bad debts using the percentage-of-sales method, the missing write-off did not have an effect on income. The account was eventually written off in the second quarter (Q2), so the balance sheet is correct by June 30, 2025. In summary, no adjusting entry needs to be made. Diff: 2 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

8) Nadire Company has a December 31 year-end. The company uses the aging method to estimate bad debts at year-end. For interim reporting, the company uses the percentage-of-sales method because it is simpler. In March 2027, the company identified a $109,000 receivable from Woodscreen Inc. as uncollectible. Upon further consideration, staff concluded that the write-off should have occurred in the 2026 fiscal year because the information about the uncollectibility of the account was available at the time. The general ledger accounts for 2026 have already been closed. Required: a. Record the entry to write-off the uncollectible account. b. Record any adjusting journal entries necessary to correct the error in Nadire's accounts receivable. Answer: a. Write-off entry:

2027 Mar. xx

To write off uncollectible account for Woodscreen Inc. Dr. Allowance for doubtful accounts Cr. Accounts receivable - Woodscreen Inc.

109,000 109,000

b. Adjusting entry:

2027 Mar. xx

To correct for an uncollectible account that should have been written off in 2026 but was discovered in the first quarter of 2027. Dr. Retained earnings - opening balance Cr. Allowance for doubtful accounts

109,000 109,000

Diff: 2 Type: SA Skill: Concept Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

9) Victory Welding Company overhauled a printing press for Helman's Printing Ltd. For the services completed on March 31, 2026, Victory received a promissory note for $350,000 due and payable on March 31, 2027. Helman's paid the amount as scheduled. Victory staff recorded the full amount as revenue on March 31, 2026. It is now May 20, 2027. The accounting staff at Victory just realized that the note was improperly recorded, and that no interest income had been recognized. The controller believes that an interest rate of 10% would be appropriate. Required: Record any journal entries necessary to correct Victory's accounts in relation to the note receivable from Helman's. Answer: 2027 To correct error in recording note receivable May 20 from Helman. Dr. Retained earnings–opening balance 7,955 Cr. Interest revenue 7,955 Calculations: 2026 sales revenue 2026 interest revenue Total 2026 revenue (corrected) Revenue recorded in 2026 Difference

= Original PV of note on 2026 Mar. 31 = $350,000 / 1.10 = $185,182 × 10% × 9 / 12 =

$318,182 23,864 $342,049 350,000 $ 7,955

This $7,595 is the amount by which 2026 revenue and retained earnings was overstated, and the amount by which 2027 interest revenue is understated. Note that no adjustment needs to be made to the note receivable account. While the $350,000 value at which it was initially recognized was overstated relative to the correct amount of $318,185, the note has already been collected by March 31, 2027, and has been derecognized from the books. Diff: 3 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

10) For each of the following independent scenarios, indicate the effect of the error (if any) on: - 2024 net income - 2025 net income - 2025 closing retained earnings Additional information: - The company uses the periodic system of inventory and its fiscal year-end is December 31. - Ignore income tax effects. a. Your analysis of inventory indicates that inventory at the end of 2024 was understated by $20,000 due to an inventory count error. Inventory at the end of 2025 was correctly stated. b. Invoices in the amount of $59,000 for inventory received in December 2024 were not entered on the books in 2024. They were recorded as purchases in January 2025 when they were paid. The goods were counted in the 2024 inventory count and included in ending inventory on the 2024 financial statements. c. Goods received on consignment amounting to $99,000 were included in the physical count of goods at the end of 2025 and included in ending inventory on the 2025 financial statements. Answer: 2024 income 2025 income 2025 end R/E Inventory count error understated overstated correct $20,000 $20,000 Invoice recorded too late overstated understated correct $59,000 $59,000 Incorrect inclusion of consignment correct overstated overstated goods in inventory $99,000 $99,000 Diff: 2 Type: SA Skill: Concept Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

11) CBC Biomedical undertook a research and development project in 2024. As of March 1 of that year, management concluded that the project had met the requirements for the capitalization of development costs. For the remainder of 2024 and 2025, the company capitalized $4.3 million of development costs for the project. Capitalizing these costs helped CBC Biomedical to remain profitable; had these costs been expensed, the company would report losses. In 2026, CBC Biomedical began amortizing the development cost over the estimated useful life of 10 years, beginning with a full year of amortization in 2026. In 2029, in preparation for an initial public offering (IPO), the company engaged a public accounting firm to conduct an external audit of its financial statements. The auditors concluded that the development cost did not meet the criteria for capitalization. Specifically, it is their opinion that CBC Biomedical, at the time, did not demonstrate that the company had sufficient financial resources to complete the development project due to the recurring operating losses incurred. After some heated debate, CBC Biomedical management agreed with the auditors' position in order to obtain an unqualified audit opinion. The company had not yet recorded any amortization for 2029 when it agreed to correct the error. The company's tax rate is 30%. Required: Record the journal entries necessary to correct CBC's accounts. Include the effect of income taxes. Answer: Adjusting entries to correct error: To correct error in capitalization of development costs. Dr. Retained earnings - opening balance Dr. Accumulated amortization - development costs Cr. Intangible assets - development cost To record income tax effect of error correction. Dr. Deferred income tax asset or liability Cr. Retained earnings - opening balance

3,010,000 *1,290,000 4,300,000

**903,000 903,000

* $4,300,000 / 10 years × 3 years = $1,290,000. ** $3,010,000 × 30% = $903,000. Diff: 3 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

12) For each of the following independent scenarios, indicate the effect of the error (if any) on: i. 2025 net income ii. 2026 net income iii. 2026 closing retained earnings The company uses the periodic system of inventory and its fiscal year-end is December 31. Ignore income tax effects. a) Invoices in the amount of $42,000 for inventory received in December 2025 were not entered on the books in 2025. They were recorded as purchases in January 2026 when they were paid. The goods were counted in the 2025 inventory count and included in ending inventory on the 2025 financial statements. b) Goods received on consignment amounting to $73,000 were included in the physical count of goods at the end of 2026 and included in ending inventory on the 2026 financial statements. c) Your analysis of inventory indicates that inventory at the end of 2025 was overstated by $152,000 due to an inventory count error. Inventory at the end of 2026 was correctly stated. d) Provide the journal entry in 2026 to correct the error for (a) to (c). Answer: 2025 income 2026 income 2026 end R/E Invoice recorded too late overstated understated correct $42,000 $42,000 Incorrect inclusion of consignment correct overstated overstated goods in inventory $73,000 $72,000 Inventory count error

overstated $152,000

a. Dr. Retained earnings (re: cost of goods sold for 2025) Cr. Cost of goods sold* b. Dr. Cost of goods sold Cr. Inventory c. Dr. Retained earnings (re: cost of goods sold for 2025) Cr. Cost of Goods Sold

understated $152,000

correct

42,000 42,000 73,000 73,000 152,000 152,000

Diff: 3 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

13) Canlan Inc. is a subsidiary of a Canadian publicly traded manufacturer of construction materials. The company uses the first-in, first-out (FIFO) cost flow assumption. a. An invoice for $55,000 of material received and used in production arrived after the year-end. Neither the purchase nor the accounts payable was recorded until year two. However, the amount of raw materials in ending inventory was correct based on the inventory count. b. One of Canlan's products became obsolete and worthless during Year 1, but the inventory write-down did not occur until Year 2. The cost of this inventory was $225,000. c. In the Year 1 closing inventory count, employees improperly included 2,000 units of finished goods that had already been sold to customers. These units had a cost of $20,000 under FIFO. Required: For each of the above independent scenarios (a) through (c), indicate in the following table the effect of the accounting errors on the books of Canlan Inc. Specifically, identify the amount and direction of over- or understatement of inventory and income for Year 1 and Year 2. If an account requires no adjustment, indicate that the account is "correct." Year 1 Income

Year 2 Inventory Income

Income $55,000 overstated $225,000 overstated $20,000 overstated

Year 2 Inventory Income $55,000 correct understated $225,000 correct understated $20,000 correct understated

Inventory a. b. c. Answer: Scenario a. b. c.

Year 1 Inventory correct $225,000 overstated $20,000 overstated

a. Ending inventory is correct according to year-end count. Since purchase was not recorded, COGS = BI + P - EI is understated, so income is overstated in Year 1. Recording the purchase incorrectly in Year 2 overstated COGS and understated income in Year 2. b. Use the cost of goods sold equation: COGS = BI + P - EI. Ending inventory in Year 1 is overstated by $225,000, so COGS is understated and income overstated. Beginning inventory in Year 2 is overstated, so COGS is overstated and income understated in Year 2. The year 2 ending inventory will be correct as the write-down will have occurred by year-end. c. In year 1 the ending inventory is overstated so COGS is understated and income is overstated. In year 2 beginning inventory is overstated so COGS is overstated and income is understated. The year 2 ending inventory will be correct as the improperly counted items will no longer be there, etc. Diff: 3 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

14) Grant Pharmaceuticals Ltd. undertook a research and development project in 2025. As of May 1 of that year, management concluded that the project had met the requirements for the capitalization of development costs. For the remainder of 2025 and 2026, the company capitalized $9.9 million of development costs for the project. Had these costs been expensed, the company would have reported losses. In 2027, Grant began amortizing the development cost over the estimated useful life of 10 years, beginning with a full year of amortization in 2027. In 2030, the auditors concluded that the development cost did not meet the criteria for capitalization. Specifically, Grant did not demonstrate that the company had sufficient financial resources to complete the development project. Grant's management agreed to correct the error in order to obtain a clean audit opinion. The company's tax rate is 30%. Required: Record the journal entries necessary to correct Grant's accounts. Include the effect of income taxes. Answer: Adjusting entries to correct error: To correct error in capitalization of development costs. Dr. Retained earnings - opening balance Dr. Accumulated amortization - development costs Cr. Intangible assets - development cost To record income tax effect of error correction. Dr. Deferred income tax asset or liability Cr. Retained earnings - opening balance

6,930,000 *2,970,000 9,900,000 **2,079,000 2,079,000

* $9,900,000 / 10 years × 3 years = $2,970,000. ** $6,930,000 × 30% = $2,079,000. Diff: 3 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

15) Chisholm Appliances is a relatively new producer of commercial grade appliances. To enhance the competitiveness of its products, on July 1, 2026, the company introduced a warranty against defects for 12 months from the date of installation. No warranty claims were received in 2026. However, in February 2028, when the auditors examined the records for the year ended December 31, 2027, they noted $255,000 of warranty claims relating to 2027 recorded as miscellaneous expense. The auditors requested the company to accrue for the expected warranty costs retrospectively to 2026. The auditors agreed with Chisholm's management that the estimated warranty fulfillment costs should be 0.5% of revenue. The company recorded revenue of $55,598,000 in 2026 and $56,213,000 in 2027. The company's tax rate is 30%. The general ledger for 2027 has not yet been closed. Required: Record any adjusting journal entries required to correct Chisholm's books. Include the effect of income taxes. Answer: To correct error in not accruing for warranty costs in 2026 and 2027. Dr. Retained earnings - opening balance ($55,598,000 × 6 / 12 × 0.5%) 138,995 Dr. Warranty expense ($46,321,000 × 0.5%) 281,065 Cr. Miscellaneous expense (given) 255,000 Cr. Warranty liability 165,060 To adjust income tax expense relating to warranty accrual in 2026 and 2027. Dr. Deferred income tax asset ($165,060 × 30%) 49,518 Cr. Retained earnings - opening balance ($138,995 × 30%) 41,698 Cr. Income tax expense (($281,065 - $255,000) × 30%) 7,820 Diff: 3 Type: SA Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

16) Cantac Construction purchased a piece of equipment for $40 million in early 2025. The company depreciates the equipment using the straight-line method over its useful life of 20 years, when it will have zero residual value. Cantac's income tax rate is 40%. At the end of 2028, after four years of depreciation, the company wrote down the carrying amount of the equipment from $32 million to $24 million after performing an impairment test on the cash generating unit (CGU) to which the equipment belonged. As a result of the impairment, the annual depreciation declined from $2 million to $1.5 million. In 2028, prior to recording depreciation for that year, the company's staff discovered an error in one of the formulas in the spreadsheet used to compute the value in use for the impairment test carried out at the end of 2028. Removing the error in the spreadsheet, the value in use for the CGU exceeded its carrying value. Therefore, the CGU was in fact not impaired, and Cantac should not have recorded an impairment writedown on the demolition equipment at the end of 2028. Required: Prepare the journal entries to correct the error including subsequent years' (2029 and 2030) depreciation and related tax effects. Answer: Dr. Accumulated depreciation 8,000,000 Cr. Retained earnings 8,000,000 Reversal of tax effect on impairment Dr. Retained earnings Cr. Deferred tax liability

3,200,000 3,200,000

Reversal of reduction in depreciation subsequent to recording impairment. Retained earnings - 2029 depreciation expense 500,000 Retained earnings - 2030 depreciation expense 500,000 Accumulated depreciation 1,000,000 Adjust for tax effect of additional depreciation Deferred tax liability 400,000 Retained earnings - 2029 tax related to depreciation expense 200,000 Retained earnings - 2030 tax related to depreciation expense 200,000 Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

17) On December 15, 2025, The Dutton Company factored $1,600,000 of accounts receivable for proceeds of $1,500,000. The company recorded the transaction as being without recourse, with $100,000 recorded to interest expense. During the preparation of the financial statements dated December 31, 2026, staff concluded that the factoring arrangement should have been classified as being with recourse. Additional information about the factoring is as follows: The factor withheld $40,000 for potential uncollectible accounts. Actual uncollectible accounts amounted to $50,000; Dutton paid the additional $10,000 to the factor on August 7, 2026, and recorded this amount as "miscellaneous expense." Required: 1. Reproduce the incorrect journal entry that was recorded on December 15, 2025, and on August 7, 2026. 2. Provide the correct journal entries that should have been recorded on December 15, 2025, and on August 7, 2026. Answer: a. Incorrect entry: 2025 Dec 15

2026 Aug 7

To record receivables factored without recourse. Dr. Cash Dr. Interest expense Cr. Accounts receivable To record settlement of receivables Dr. Miscellaneous expense Cr. Cash

1,500,000 100,000 1,600,000 10,000 10,000

b. Entries that should have been made: 2025 Dec 15

2026 Aug 7

To record receivables factored with recourse. Dr. Cash Dr. Due from factor Cr. Short-term debt–asset-backed financing To record settlement of receivables factored with recourse Dr. Allowance for doubtful accounts Cr. Due from factor Cr. Cash Dr. Short-term debt–asset-backed financing Dr. Interest expense Cr. Accounts receivable

1,500,000 40,000 1,540,000

50,000 40,000 10,000 1,540,000 60,000 1,600,000

Note: the interest expense could be partially accrued at the fiscal year-end of 2025. However, the time to settlement is uncertain, and with only 16 days remaining when the receivables were factored, the amount is immaterial. Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records. 36 Copyright © 2023 Pearson Canada Inc.

18) On June 30, 2025, Whiggins Company received $60,000 from Carrington Finance Inc. in exchange for a promissory note. The terms of the note required Whiggins Company to repay Carrington on June 30, 2027, the principal amount plus interest at 8% compounded semi-annually. Due to financial difficulties, Whiggins could not make the repayment as scheduled. On June 30, 2027, Carrington agreed to extend the terms of repayment by one year, to June 30, 2028. However, accounting staff at Carrington was unaware of the change in repayment terms and did not record the effects of the note restructuring during 2027. The error was discovered on June 30, 2028, when Whiggins paid Carrington $70,192 in fulfillment of the terms of the restructured note. Carrington has a December 31 year-end. No interest had been accrued between the original repayment date and the extended repayment date. Required: Record any adjusting journal entries necessary to correct the error in Carrington's accounting records for the note receivable from Whiggins Company on June 30, 2028. Answer: To correct error in not recording the 2028 restructuring of a note receivable on June 30, Jun 30 2027. Dr. Retained earnings–opening balance 5,296 Cr. Note receivable 5,296 To correct error in not accruing interest from July to December, 2027. Dr. Note receivable 2,596 Cr. Retained earnings–opening balance 2,596 To correct error in not accruing interest from January to June, 2028. Dr. Note receivable 2,700 Cr. Interest income 2,700 Calculations: Original PV of note on 2027 June 30 Revised PV of note on 2027 June 30 Difference = loss on restructuring Interest July to December, 2027 Interest January to June, 2028

$60,000 × 1.044 $70,192 / 1.042 $64,896 × 4% ($64,896 + $2,596) × 4%

$70,192 64,896 $5,296 $2,596 $2,700

Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

19) Albacore Sailboats manufactures small sailing dinghies. In 2027, the company's accountant recorded the following costs into the inventory account: Variable costs (raw materials, labour, variable overhead) Fixed manufacturing overhead Salary of factory manager Shipping to customer Commission on sales Total

$11,098,000 3,000,000 100,000 350,000 550,000 $15,098,000

The company had no work in process at the end of both 2026 and 2027. Finished goods at the end of 2026 amounted to 6,000 sailboats at $300/boat. Production was 50,000 sailboats and 4,000 boats remained in inventory at December 31, 2027. The company uses a periodic inventory system and the FIFO cost flow assumption. Required: a. Of the $15,098,000, how much should have been capitalized into inventories? b. Compute the ending value of inventory and the cost of goods sold for 2027. c. If the error in inventory costing had not been corrected as per part (a), by how much would inventory be overstated at the end of 2027? d. Record the journal entry to correct the error in inventory costing.

Answer: a. The inventory account included $900,000 too much cost. The $350,000 shipping to customer is not a factory cost and the commission on sales of $550,000 is not part of the production process, so they cannot be included in inventories. The corrected amount should be $15,098,000 - $900,000 = $14,198,000. b. To determine the ending value of inventory and cost of goods sold, first determine the per-unit cost of the boats manufactured in the year. Correcting for the error in part (a), total cost is $14,198,000. Production was 50,000 boats, so cost per boat is $14,198,000/50,000 = $283.96. Beginning inventory Cost of goods manufactured Cost of goods available for sale Ending inventory Cost of goods sold

6,000 boats × $300/boat

4,000 boats × $283.96/boat

$1,800,000 14,198,000 $15,998,000 - 1,135,840 $14,862,160

c. If the error in inventory costing has not been corrected as per part (a), the inventory would be overstated by $72,000, computed as follows: Uncorrected cost per unit produced Uncorrected ending inventory Corrected inventory

$13,580,000 / 50,000 boats 4,000 boats × $301.96 From part (b)

$301.96/boat $1,207,840 -1,135,840 $72,000

In this particular scenario, this amount can also be computed more directly using the $900,000 of overstatement: $900,000 / 50,000 units of production = $18.00 /unit $18.00/unit × 4,000 units of ending inventory = $72,000 Note that this computation works in this case because the company used FIFO and the ending inventory costs all derive from production during the year. If the number of units in ending inventory exceeds the number of units in beginning inventory, then this computation would be incorrect. d. The correcting journal entry is as follows. Note that the effect of the error needs to be allocated between the produced units sold and units remaining in inventory. Dr. Freight to customer 350,000 Dr. Commissions on sales 550,000 Cr. Inventory (from part c, $18.00/boat × 4,000 units) 72,000 Cr. Cost of goods sold ($18.00/boat × 46,000 units) 828,000 Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

20) Wasson Company purchased land and a building in 2024 at a cost of $6,000,000. The land was valued at $1,000,000. At the time of purchase, the estimated useful life of the building was 25 years. The company depreciates the building on a straight-line basis and has chosen to record a full year of depreciation in the year of acquisition, and none in the year of disposal. It is now 2034, and Wasson has found it necessary to replace all of the windows in this building at a cost of $1,000,000. Upon further review, management concluded that the windows should have been recorded as a separate component because, as of 2024, their useful lives did not extend for 25 years—the manufacturer's specifications indicate that the windows would be expected to remain in functioning condition until 2034. The estimated value of the windows when the building was purchased was $800,000. Required: a. Record the journal entry to record the replacement of the windows assuming that the windows were recorded as a separate component. b. Assume that LaSalle committed an error in not componentizing the windows separately from the building. Record the adjusting journal entry or entries required to correct this error. Answer: To derecognize windows replaced in the year. Dr. Accumulated depreciation - building *320,000 Dr. Loss on window replacement 480,000 Cr. Building 800,000 To record cost of installing replacement windows. Dr. Building Cr. Cash

1,000,000 1,000.000

* $800,000 × 10 years / 25 years = $320,000 b. Adjusting entries to correct error: To recognize windows as a separate component. Dr. Windows Cr. Building To reduce depreciation recorded on building from 2024 to 2033. Dr. Accumulated depreciation - building Cr. Retained earnings - opening balance To record depreciation on windows from 2024 to 2033. Dr. Retained earnings - opening balance Cr. Accumulated depreciation - windows

800,000 800,000

320,000 320,000

Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

21) Pracene Sports Supply is a relatively new producer of sporting goods. To enhance the competitiveness of its products, on July 1, 2026, the company introduced a warranty against defects for 12 months from the date of sale. The company's products are of a sufficiently high quality such that no warranty claims were received in 2026. However, in February 2028, when the auditors examined the records for the year ended December 31, 2027, they noted a small number of warranty claims in 2027 amounting to $243,000, which was recorded as miscellaneous expense. These claims alerted the auditors to the fact that the company should have but did not accrue for the expected warranty costs starting in 2026. Pracene's management estimates warranty fulfillment costs to be 0.10% of revenue. The company recorded revenue of $51,500,000 in 2026 and $55,300,000 in 2027. There is very little seasonality in the sales pattern through the year. The company's tax rate is 40%. The general ledger for 2027 has not yet been closed. Required: Record any adjusting journal entries required to correct Pracene's books. Include the effect of income taxes. Answer: To correct error in not accruing for warranty costs in 2026 and 2027. Dr. Retained earnings - opening balance ($51,500,000 × 6 / 12 × 1.0%) 257,500 Dr. Warranty expense ($55,300,000 × 1.0%) 553,000 Cr. Miscellaneous expense (given) 243,000 Cr. Warranty liability 567,500 To adjust income tax expense relating to warranty accrual in 2026 and 2027. Dr. Deferred income tax asset ($567,500 × 40%) Cr. Retained earnings - opening balance ($257,500 × 40%) Cr. Income tax expense (($553,000 - $243,000) × 40%)

227,000 103,000 124,000

Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

22) Arbutus Inc. issued a 10-year bond on July 1, 2024. The $30,000,000 par bond pays $900,000 of interest on December 31 and June 30. The company has a calendar year-end. It is now February 2028. During the audit of the 2027 financial statements, it was discovered that the bond indenture allowed holders to convert the bonds to common shares. The terms of the conversion allow each $1,000 bond to be converted into 50 shares. Additional investigation concluded that the bond would have yielded 8%/a, had it not included the conversion option. Required: Record any adjusting journal entries required to correct Arbutus's accounts. The books for 2027 have not yet been closed.

Answer: To answer this question, it is first necessary to compute the value of the liability portion of the convertible debt. Second, a bond amortization schedule will assist the computation of the amounts of adjustment required. PV of principal PV of coupons PV of bond

Period 0 1 2 3 4 5 6 7 8 9

$30,000,000 / 1.0420 = coupons × PVFA(4%, 20) = $900,000 × 13.5903 =

$13,692,000 12,231,270 $25,923,270

Interest Coupon Discount Period ending expense payment Amortized Issuance 2024 Dec. 31 $1,036,931 $900,000 $136,930 2025 June 30 1,031,455 900,000 131,454 2025 Dec. 31 1,026,195 900,000 126,195 2026 June 30 1,021,118 900,000 121,148 2026 Dec. 31 1,016,302 900,000 116,302 2027 June 30 1,011,649 900,000 111,649 2027 Dec. 31 1,007,204 900,000 107,204 2028 June 30 1,002,916 900,000 102,916 2028 Dec. 31 998,799 900,000 98,799

Adjusting entries to correct error: To correct error in initial recognition of convertible bond. Dr. Bonds payable Cr. Contributed surplus –– bond conversion option

NBV $ 25,923,270 25,786,340 25,654,886 25,528,691 25,407,544 25,291,243 25,180,112 25,072,908 24,969,992 24,871,193

4,076,730 4,076,730

To correct interest expense recorded in prior periods (2024 to 2026). Dr. Retained earnings –– opening balance *632,029 Cr. Bonds payable

632,029

To correct interest expense recorded in 2027. Dr. Interest expense Cr. Bonds payable

218,853

*218,853

* Sum of corrected interest expense –– sum of interest expense recorded. See amortization schedule above. Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

23) Sampson Jet Skis manufactures state-of-the-art jet skis. In 2026, the company's accountant recorded the following costs into the inventory account: Variable costs (raw materials, labour, variable overhead) Fixed manufacturing overhead Salary of factory manager Salary of company president Advertising and promotion Total

$10,680,000 2,000,000 100,000 300,000 1,000,000 $14,080,000

The company had no work in process at the end of both 2025 and 2026. Finished goods at the end of 2025 amounted to 8,000 jet skis at $900/jet ski. Production was 13,453 jet skis and 4,000 jet skis remained in inventory at December 31, 2026. The company uses a periodic inventory system and the FIFO cost flow assumption. Required: a. Of the $14,080,000, how much should have been capitalized into inventories? b. Compute the ending value of inventory and the cost of goods sold for 2026. c. If the error in inventory costing had not been corrected as per part (a), by how much would inventory be overstated at the end of 2026? d. Record the journal entry to correct the error in inventory costing. e. If the company uses the weighted-average cost method, how much would be the ending value of inventory and cost of goods sold for 2026?

Answer: a. The inventory account included $1,300,000 too much cost. The $300,000 salary of the company president and the $1,000,000 cost of advertising and promotion are not part of the production process, so they cannot be included in inventories. The corrected amount should be $14,080,000 - $1,300,000 = $12,780,000. b. To determine the ending value of inventory and cost of goods sold, first determine the per-unit cost of the jet skis manufactured in the year. Correcting for the error in part (a), total cost is $12,780,000. Production was 13,453 jet skis, so cost per jet ski is $12,780,000 / 13,453 = $949.97. Beginning inventory 8,000 jet skis × $900/jet ski Cost of goods manufactured Cost of goods available for sale Ending inventory 4,000 jet skis × $949.97/jet ski Cost of goods sold

$7,200,000 12,780,000 $19,980,000 - 3,799,880 $16,180,120

c. If the error in inventory costing has not been corrected as per part (a), the inventory would be overstated by $386,560, computed as follows: Uncorrected cost per unit produced $14,080,000 / 13,453 jet skis Uncorrected ending inventory 4,000 jet skis × $1046.61 Corrected inventory From part (b)

$1046.61/jet ski $4,186,440 - 3,799,880 $386,560

$386,560 / 4,000 = $96.64 d.

The journal entry to correct the error in inventory costing:

Dr. Salary and wages expense Dr. Advertising and promotion expense Cr. Inventory (from part c, $96.64/js × 4,000 units) Cr. Cost of goods sold ($96.64/js × 9,453 units)

300,000 1,000,000 386,560 913,440

e. If the company had used the weighted-average cost method, the ending inventory and COGS would be as follows: Cost of goods available for sale (from part a) $19,980,000 Units available for sale 21,453 jet skis Weighted-average cost per unit 931.34/jet ski Ending inventory 4,000 jet skis × $931.34/jet ski $3,725,360 Cost of goods sold $19,980,000 - $3,725,360 $16,254,640 Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records. 45 Copyright © 2023 Pearson Canada Inc.

24) Catherwood Inc. purchased a piece of real estate in early 2024. The staff accountant allocated the $5,000,000 purchase price as follows: 30% to land, 50% to building, and 20% to fixtures. Catherwood recorded straight-line depreciation based on useful lives of 20 years and 5 years on the building and fixtures, respectively. No residual value was assigned to either depreciable asset. The company has a policy of recording a full year of depreciation in the year of acquisition, and none in the year of disposal. In 2028 a Catherwood staff in the accounting department discovered that the bundled purchase actually cost $6,000,000 and the extra $1,000,000 was debited to land, while the remaining $5,000,000 was allocated 30% to land, 50% to building, and 20% to fixtures. The accounting staff believe that the allocation of 30% to land, 50% to building, and 20% to fixtures still applies. Required: Record any adjusting entries required to correct the accounts in 2028 and provide supporting calculations. Answer: Original entries: Building $5,000,000 50% 2,500,000 20 years 125,000/year 4 years $500,000

Bundle purchase cost × % allocated to item = Allocated purchase cost × Estimated useful life = Annual depreciation × # of years since purchase = Accumulated depreciation

Fixtures $5,000,000 20% 1.000,000 5 years 200,000/year 4 years $800,000

2028 Journal entries to correct error: DR Building Fixtures Land Retained earnings Accumulated depreciation - building Accumulated depreciation - fixtures

500,000 200,000 700,000 260,000 100,000 160,000

Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

25) Nicolla Company recorded the purchase of a building in 2024 at a cost of $7,000,000. At the time of purchase, the estimated useful life of the building was 25 years. The company depreciates the building on a straight-line basis and has chosen to record a full year of depreciation in the year of acquisition, and none in the year of disposal. It is now 2034. Nicolla has found it necessary to replace all of the windows in this building at a cost of $1,000,000. Upon further review, management concluded that the windows should have been recorded as a separate component because the manufacturer's specifications indicated that the windows would have a 10-year life expectancy. The estimated value of the windows when the building was purchased was $600,000. Required: Assume that LaSalle committed an error in not componentizing the windows separately from the building. Record the journal entry to record the windows as a separate component, correct all errors, and record the replacement of the windows. Answer: To recognize windows as a separate component. Dr. Windows 600,000 Cr. Building 600,000 To reduce depreciation recorded on building from 2024 to 2033. Dr. Accumulated depreciation - building 240,000 Cr. Retained earnings - opening balance 240,000 To record depreciation on windows from 2024 to 2033. Dr. Retained earnings - opening balance 600,000 Cr. Accumulated depreciation - windows 600,000 To derecognize windows replaced in the year. Dr. Accumulated depreciation - windows 600,000 Cr. Windows 600,000 To record cost of installing replacement windows. Dr. Windows 1,000,000 Cr. Cash 1,000,000 Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

26) Chesapeake Inc. issued a 7-year bond on October 1, 2026. The $735,000 par bond pays $51,450 of interest on October 1 each year, its year-end. It is now February 2030. During the audit of the 2029 financial statements, it was discovered that the bond indenture allowed holders to convert the bonds to common shares. The terms of the conversion allow each $1,000 bond to be converted into 50 shares. Additional investigation concluded that the bond would have yielded 8%/annum had it not included the conversion option. Required: Record any adjusting journal entries required to correct Chesapeake's accounts. The books for 2029 have not yet been closed.

$735,000 × .5835 = $428,873 $51,450* × 5.2064 = 267,869 $696,742

*$735,000 × 7% = $51,450 Using the table value of $696,742: (a) Cash Interest Paid Period Ending $745,000 × 7% Oct. 1, 2026 Oct. 1, 2027

$51,450

Oct. 1, 2028

51,450

(b) Period Interest Expense (e) × 8%

(c)

(d)

Discount Amort. (a) - (c)

Unamortized Discount $38,258

(e) Carrying Value $735,000 - (d) $696,742

$55,7391 56,0822

$4,289

33,969

701,031

4,632

29,337

705,663

56,4533 56,8534

5,003

24,334

710,666

5,403

18,931

716,069

5,836

13,095

721,905

6,302

6,793

728,207

6,793 38,258

735,000

Oct. 1, 2029

51,450

Oct. 1, 2030

51,450

Oct. 1, 2031

51,450

Oct. 1, 2032

51,450

57,2865 57,7526

Oct. 1, 2033 Totals

51,450 360,150

58,2437 398,408

Adjusting entries to correct error: To correct error in initial recognition of convertible bond. Dr. Bonds payable Cr. Contributed surplus - bond conversion option To correct interest expense recorded in prior periods. (2027 to 2028) Dr. Retained earnings - opening balance Cr. Bonds payable To correct interest expense recorded in 2029. Dr. Interest expense Cr. Bonds payable

38,258

*8,921

*5,003

38,258

8,921

5,003

* Sum of corrected interest expense - sum of interest expense recorded. See amortization schedule above. Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records. 49 Copyright © 2023 Pearson Canada Inc.

27) Allied Fittings reports its financial results in accordance with ASPE. On January 1, 2026, Allied Fittings signed a long-term rental agreement with KM Properties for the exclusive right to use a building for a period of 10 years at a rental rate of $2.5 million per year paid at the beginning of each year. The building has fair market value of $40 million, a 20-year life, and the agreement includes an option for Allied to purchase the property for $20 million at the end of the lease, when the property would be expected to increase in value to $50 million. Allied's accounting staff recorded the lease as an operating lease. In 2028, management realized that the lease should have been recorded as a capital lease due to the bargain purchase option. Allied has a calendar year-end. The books for 2028 have not been closed. The company has an incremental borrowing rate of 6% and depreciates similar property on a straight-line basis with full depreciation taken in the first year. Required: a. Record the adjusting entries necessary to reflect the lease as a finance lease on December 31, 2028.

Answer: Adjusting entries if amendment is considered a correction of an error. To capitalize finance lease as of January 1, 2026. Dr. Leased property ($19,502,000* + $11,168,000**) Cr. Finance lease obligation

30,670,500

To record lease obligation payment on January 1, 2026. Dr. Finance lease obligation Cr. Cash

2,500,000

To record lease entries in prior periods (2026 to 2027). Dr. Retained earnings - opening balance #

Dr. Finance lease obligation ($28,170,500 - $26,502,374) Cr. Accumulated depreciation - leased property

30,670,500

2,500,000

***1,398,924 1,668,126

To record lease entries recorded in 2028 Dr. Interest expense Dr. Finance lease obligation Cr. Operating lease expense Dr. Depreciation expense Cr. Accumulated depreciation

3,067,050

1,590,142 909,858

2,500,000

1,533,525

* PV of $2,500,000 lease payments for next 10 years in advance = $2,500,000 × PVFAD (6%,9) + 1 = ($2,500,000 × 6.801) + $2,500,000 = $19,502,000. ** PV of $20,000,000 purchase option at the end of 10 years = $20,000,000 / 1.0610 = $20,000,000 × 0.5584 = $11,168,000. *** Answers may vary slightly due to rounding of PV calculations Lease amortization schedule:

Year 2026 2026 2027 2028

Instalment Payments

Interest Expense

$2,500,000 2,500,000 2,500,000

$1,690,230 1,641,643 1,590,142

Interest expense not recorded: Depreciation expense not recorded: Reversal of lease expense Net increase in expenses

Principle Reduction $2,500,000 809,770 858,356 909,858

Carrying Value $28,170,500 27,360,730 26,502,374 25,592,516

For 2026 (see amortization schedule) For 2027 (see amortization schedule) $30,670,500 / 20 years × 2 years $2,500,000 × 2 years

$1,690,230 1,641,643 3,067,050 (5,000,000) ***$1,398,923

28) Sawatsky & Company Ltd is involved in the construction of top-class luxury condos in Vancouver, Canada. Until the end of 2027, the company used the cost ratio method to estimate the percentage complete. After that point, the company switched to using estimates from architectural engineers to estimate the degree of completion. To prepare the financial report for the 2028 fiscal year, you have gathered the following data on projects that were in progress at the end of fiscal years 2026, 2027, and 2028:

Project Silver Sea (started 2026) Contract price Estimated total cost % complete at year-end (cost ratio) % complete at year-end (engineering estimate) Project The Callisto (started 2026) Contract price Estimated total cost % complete using cost ratio % complete using engineering estimate Project King's Landing (started 2027) Contract price Estimated total cost % complete using cost ratio % complete using engineering estimate

2026

2027

2028

$20,000,000 $15,000,000

$20,000,000 $15,400,000

– –

42%

100%

–

37%

100%

–

$25,000,000 $20,000,000 16%

$25,000,000 $20,800,000 60%

$25,000,000 $20,600,000 100%

12%

50%

100%

– – –

$12,000,000 $ 8,000,000 22%

$12,000,000 8,100,000 70%

–

25%

75%

Required: a. Compute the amount of revenue and cost of sales that was recognized in 2026 and 2027 using the old accounting policy. b. Compute the amount of revenue and cost of sales that should be recognized in each year using the new accounting policy. c. Record the adjusting journal entries to adjust revenue to reflect the change in accounting policy from using the cost ratio to using engineering estimates. The general ledger accounts for 2028 have not yet been closed. Ignore income tax effects.

Answer: a. Revenue and cost of sales using old accounting policy (cost ratio): 2026

2027

2028

$7,400,000 3,000,000 -$10,400,000

$ 12,600,000$ 9,500,000 3,000,000 $25,100,000

-112,500,000 6,000,000 $ 18,500,000

Cost of sales (same as part (a) for 2023 and 2024; see second table below for 2025) Project Silver Sea $5,550,000 $9,850,000 Project The Callisto 2,400,000 8,000,000 Project King's Landing -2,000,000 Total $7,950,000 $19,850,000

$ -610,200,000 4,075,000 $14,275,000

Revenue (see calculations in table below) Project Silver Sea Project The Callisto Project King's Landing Total

Revenue calculations

Silver Sea

The Callisto

2026

% complete 37% × Contract price $20,000,000 = Cumulative revenue $ 7,400,000 Less: revenue previously recognized 0 Revenue for the year $ 7,400,000

12% $25,000,000 $ 3,000,000 0 $ 3,000,000

2027

% complete × Contract price = Cumulative revenue Less: revenue previously recognized Revenue for the year

50% $25,000,000 $12,500,000 (3,000,000) $ 9,500,000

2028

% complete × Contract price = Cumulative revenue Less: revenue previously recognized Revenue for the year

100% $20,000,000 $20,000,000 (7,400,000) $12,600,000

King's Landing 0%

25% $12,000,000 $ 3,000,000 0 $ 3,000,000

100% 75% $25,000,000 $12,000,000 $25,000,000 $ 9,000,000 (12,500,000) (3,000,000) $12,500,000 $ 6,000,000

Cost calculations

Silver Sea

The Callisto

King's Landing 0%

2026

% complete × Total estimated cost = Cumulative cost-to-date Less: cost of sale prev. recognized Cost of sales for the year

42% $15,000,000 $ 6,300,000 0 $ 6,300,000

16% $20,000,000 $ 3,200,000 0 $ 3,200,000

2027

% complete × Total estimated cost = Cumulative cost-to-date Less: cost of sale prev. recognized Cost of sales for the year

100% $15,400,000 $15,400,000 (6,300,000) $ 9,100,000

60% $20,800,000 $12,480,000 (3,200,000) $9,280,000

22% $8,000,000 $1,760,000 0 $ 1,760,000

2021

2022

2023

$7,400,000 3,000,000 -$10,400,000

$12,600,000$ 9,500,000 3,000,000 $25,100,000

-112,500,000 6,000,000 $ 18,500,000

Cost of sales (same as part (a) for 2018 and 2019; see second table below for 2020) Project Silver Sea $5,550,000 $9,850,000$ Project The Callisto 2,400,000 8,000,000 Project King's Landing -2,000,000 Total $7,950,000 $19,850,000

-610,200,000 4,075,000 $14,275,000

b. Revenue and cost of sales using new accounting policy

Revenue (see calculations in table below) Project Silver Sea Project The Callisto Project King's Landing Total

Revenue calculations

Silver Sea

The Callisto

2021

% complete 37% × Contract price $20,000,000 = Cumulative revenue $ 7,400,000 Less: revenue previously recognized 0 Revenue for the year $ 7,400,000

12% $25,000,000 $ 3,000,000 0 $ 3,000,000

2022

% complete 100% Contract price $20,000,000 = Cumulative revenue $20,000,000 Less: revenue previously recognized (7,400,000) Revenue for the year $ 12,600,000

50% $25,000,000 $12,500,000 (3,000,000) $ 9,500,000

25% $12,000,000 $ 3,000,000 0 $ 3,000,000

2023

% complete × Contract price = Cumulative revenue Less: revenue previously recognized Revenue for the year

100% $25,000,000 $25,000,000 (12,500,000) $12,500,000

75% $ 12,000,000 $ 9,000,000 ( 3,000,000) $ 6,000,000

Silver Sea

The Callisto

% complete × Total estimated cost = Cumulative cost-to-date Less: cost of sale prev. recognized

37% $15,000,000 $ 5,550,000 0

12% $20,000,000 $ 2,400,000 0

King's Landing 0%

Cost of sales for the year

$ 5,550,000

$ 2,400,000

% complete × Total estimated cost = Cumulative cost-to-date Less: cost of sale prev. recognized Cost of sales for the year

100% $15,400,000 $15,400,000 (5,550,000) $ 9,850,000

50% $20,800,000 $10,400,000 (2,400,000) $ 8,000,000

25% $8,000,000 $2,000,000 0 $2,000,000

Silver Sea

The Callisto

King's Landing 775%* $8,100,000 $6,075,000 2,000,000 $4,075,000

Cost calculations 2021

2022

Cost calculations 2023

Cost incurred as % of total est. cost × Total estimated cost = Cumulative cost-to-date Less: cost of sales prev. recognized Cost of sales for the year

100% $20,600,000 $20,600,000 (10,400,000) $10,200,000

King's Landing 0%

* It is important to note that, to derive the total estimated cost, it is necessary to use the engineering estimate of the percentage complete.

Adjusting entries (note: CIP = construction-in-progress)

To adjust for change in 2021 revenue from $12,400,000 to $10,400,000 Dr. Retained earnings Cr. CIP inventory

2,000,000

To adjust for change in 2022 revenue from $25,240,000 to $25,100,000 Dr. Retained earnings Cr. CIP inventory

140,000

2,000,000

140,000

No adjustment required for 2023 revenue, as it would have been recorded correctly under the new policy. Diff: 3 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

29) Stretton Company Limited, a private company, was started on January 1, 2026. For the first year, the chief accountant prepared the financial statements and a local accountant completed the necessary review of these statements. However, for the year ended December 31, 2027, an external auditor was appointed. The income statement for 2026 and the preliminary amounts for 2027 are as follows:

Franchise Revenue

2026 $4,000,000

2027 $4,000,000

Other income (loss)

(800,000)

(900,000)

Bad debt expense

(400,000)

(500,000)

Depreciation expense-machine

(500,000)

Depreciation expense-building

(200,000)

Warranty expense

(400,000)

(420,000)

Income before taxes

1,700,000

1,480,000

Income taxes (at 30%)

(510,000)

(444,000)

Net income

$1,190,000

$1,036,000

In the process of examining the accounting records the auditor noted the following issues: Franchise Revenue: The Stretton Company signed a franchise agreement to allow a franchisee to operate in a specific area for 10 years. The agreement required the franchisee to pay $4,000,000 initially with a royalty of 2% of sales revenue thereafter. In 2026, the 2% of sales revenue was recorded correctly by Stretton Company. However, management recorded the entire $4,000,000 as having been earned in 2026. In 2027, management realized that 40% of the $4,000,000 pertained to ongoing services to be provided over the next 10 years. Accounts receivable: The Stretton Company uses the aging method to estimate bad debts. During 2027, it was discovered that staff had written off a $103,000 account in 2027, even though the company had received information about the bankruptcy of the client in late 2026. Machine impairment: Stretton Company has one machine that cost $5,000,000 with a useful life of 10 years and has been depreciated on a straight-line basis for 4 years, including 2027. Stretton carries this asset under the revaluation model and its auditors find that the machine should have been written down for impairments by $450,000 in 2026. No impairment has been recorded by Stretton in 2026 or 2027. Building depreciation: The company's building (cost $4,000,000, estimated salvage value $0, useful life 20 years) was depreciated last year using the straight line method. The company and the auditor now agree that 10% declining-balance method would be a more appropriate method to use. A depreciation provision of $200,000 has been made for 2026.

Inventories: The accountant failed to apply the lower of cost and net realizable value test to ending inventory in 2026. Upon review, the inventory balance for 2027 should have been reduced by $200,000. The closing inventory allowance balance for 2027 should be $400,000. No entry has been made for this matter. Warranties: Stretton Company does not accrue for warranties; rather, it records the warranty expense when amounts are paid. Stretton provides a one-year warranty for defective goods. Payments to satisfy warranty claims in 2026 were $400,000 and $420,000 in 2027. Out of the $420,000 paid in 2027, $250,000 related to 2026 sales. A reasonable estimate of warranties payable at the end of 2027 is $375,000. There is nothing relating to 2026 warranty claims left owing at the end of 2027. Required: a. As the audit senior on this engagement, what is your recommended treatment for each of these matters in terms of whether they are errors, changes in accounting policy, or changes in estimate? Explain your conclusion. b. Assume that management of Stretton Company agrees with your recommendations. Prepare the corrected statements of comprehensive income for 2026 and 2027.

Answer: a. Each of the six issues should be addressed as follows: i.

Franchise Revenue: This is an error, so it should be retrospectively applied.

ii. Accounts Receivable: This is an error, and a retrospective treatment is required. In 2027, the entry would be 2027 Dec. 31

To correct for an uncollectible account that should have been written off in 2026 but was written off in 2027. Dr. Retained earnings - opening balance 103,000 Cr. Bad debts expense 103,000

iii. Machine Impairment: This is an error, and 2026 needs to be adjusted. The adjustment in the carrying value of the machine lowers the remaining depreciable amount requiring prospective adjustments to future depreciation charges. iv. Building Depreciation: The new depreciation method is a change in estimate and should be treated prospectively. A change in depreciation pattern from declining-balance to straight line is usually considered as a change in estimate because the depreciation pattern is not a free choice among acceptable alternatives. v. Inventories: This is an error correction as lower of cost and net realizable value should have been used in 2026. The 2026 income statement should be adjusted accordingly. The 2027 inventory should be valued using this allowance. vi. Warranties: This is an error, as warranties should be accrued and matched with the revenue recognized in that period. The 2026 and 2027 income statements should reflect the warranty accrual and related change in expense.

Franchise revenue Other income (loss) Bad debt expense Depreciation expense-machine Depreciation expense-building Inventory write-down Warranty expense Income before taxes Income taxes (at 30%) Net income

2026 as originally presented

2026 as amended (answer)

2027 as originally presented

2027 as amended (answer)

$4,000,000 (800,000) (400,000) (500,000) (200,000) 0 (400,000) 1,700,000 (510,000) $1,190,000

$2,560,000(1) (1,250,000) (503,000) (500,000) (200,000) (200,000)(5) (650,000) (743,000) 222,900 ($520,100)

$4,000,000 (900,000) (500,000) (500,000) (200,000) 0 (420,000) 1,480,000 (444,000) $1,036,000

$4,160,000(1) (900,000)(2) (397,000)(3) (435,714)(2) (380,000)(4) (545,000)(6) 1,502,286 (450,686) $1,051,600

(1) Franchise revenue was overstated by $1,600,000 ($4,000,000 × .4) in 2026 since the franchise services are deferred revenue and are to be provided over the next 10 years. The $1,600,000 is being recognized on a straight-line basis over the next 10 years, including 2026. Therefore, revenue for 2026 is ($4,000,000 $1,600,000) + (1,600,000/10) = $2,560,000. In 2027, one-tenth of the service revenue of $160,000 ($1,600,000/10) needs to be recognized. (2) Impairment loss of $450,000 is recorded at the end of 2027 after depreciation has been recorded for 2026. Accumulated depreciation is $1,500,000 ($500,000 × 3) + $450,000 at the end of 2026. The impairment loss increases the accumulated depreciation by $450,000 at the end of 2026. The 2027 depreciation was $500,000. The corrected amount is ($5,000,000 - $1,500,000 - $450,000)/7 years = $435,714. (3) To correct an error by writing off the bad debt in 2026 and reversing the write off incorrectly recorded in 2027. (4) Building depreciation: The company's building (cost $4,000,000, estimated salvage value $0, useful life 20 years) was depreciated last year using the straight-line method. The company and the auditor now agree that declining balance method would be a more appropriate method to use. A depreciation provision of $200,000 has been made for 2026. The remaining balance of $3,800,000 × .10 = $380,000 should be recorded in 2027. (5) To retrospectively adjust write-down inventory in 2026, 2027 needs no adjustment. (6) 2027 warranty expense accrual: $420,000 - $250,000 + $375,000 = $545,000. 2026 warranty expense accrual: $400,000 + $250,000 = $650,000. Diff: 4 Type: ES Skill: Comp Objective: 19.3 Evaluate the effects of retrospective adjustments and record those effects in the accounting records.

Intermediate Accounting, Vol. 2, 5e (Lo/Fisher) Chapter 20 Statement of Cash Flows Learning Objective 1 Describe the purpose of the statement of cash flows and the information it conveys. 1) Which statement is correct? A) Net income equals the cash generated by the company's operations. B) Net income seldom reflects the change in cash during the period. C) Net income is the most important metric to measure the financial performance of a company. D) Cash flow is the most important metric to measure the financial performance of a company. Answer: B Diff: 1 Type: MC Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys. 2) If a company has gaps between the change in cash and the net income for the year: A) the income statement provides sufficient explanation for the sources of these changes. B) the financial statement notes provide explanation for the sources of these changes. C) the statement of cash flow provides explanation of the sources of these changes. D) the statement of cash flow and balance sheet provide explanation for these changes. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys. 3) Which statement is correct? A) Managers are more interested in the net income than the cash generated by the company. B) Under GAAP, only the income statement is required by investors, creditors and managers. C) All companies must have a treasury department to manage their cash resources. D) The cash flow statement shows the capacity of the company to sustain its operations. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys. 4) Which category is used on the cash flow statement? A) Non-current. B) Operating. C) Non-operating. D) Discontinued. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys.

5) To provide information useful to decision makers, IAS 1 requires companies to report cash inflows and outflows using standardized categories. Which one of the following is not one of these standardized categories? A) Operations B) Properties C) Investments D) Financing Answer: B Diff: 1 Type: MC Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys. 6) Which statement is correct? A) If the reported net income is consistently close to or less than cash from operating activities, the company's net income or earnings are said to be of a "low quality." B) If net income is consistently more than cash from operating activities, the company's net income or earnings are said to be of a "high quality." C) One way to evaluate earnings quality is to compare the company's net income with cash from operating activities, because accrual income are less subject to managerial bias compared with cash flows . D) If the reported net income is consistently close to or less than cash from operating activities, the company's net income or earnings are said to be of a "high quality." Answer: D Diff: 1 Type: MC Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys. 7) Discuss how the cash flow statement helps evaluate a company's quality of earnings. Answer: One way to evaluate earnings quality is to compare the company's net income with cash from operating activities, because cash flows are less subject to managerial bias compared with accrual income. If the reported net income is consistently close to or less than cash from operating activities, the company's net income or earnings are said to be of a "high quality." If net income is consistently more than cash from operating activities, further investigation is needed to ascertain why the reported net income is not matched by an increase in cash. Diff: 2 Type: SA Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys. 8) List three reasons why the statement of cash flows is a useful component of an enterprise's financial statements. Answer: Three reasons why the statement of cash flows is a useful component of an enterprise's financial statements include (i) it is useful for evaluating a company's liquidity, (ii) it provides information about the timing and uncertainty of cash flows, and (iii) it can be used to ascertain the firm's quality of earnings. Diff: 2 Type: SA Skill: Concept Objective: 20.1 Describe the purpose of the statement of cash flows and the information it conveys.

Learning Objective 2 Define cash and cash equivalents. 1) Which statement is correct? A) An investment in a security at FVPL must be classified as a cash equivalent. B) An investment in a security at amortized cost must be classified as cash equivalent. C) An investment in a security held to meet short-term cash commitments must be classified as a cash equivalent . D) An investment in a security at FVOCI must be classified as a cash equivalent. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 20.2 Define cash and cash equivalents. 2) What is cash management? A) Cash management includes the investment of excess cash in cash equivalents. B) Cash management excludes the investment of excess cash in cash equivalents. C) Cash management includes the investment of excess cash in equipment. D) Cash management includes the investment of excess cash in joint ventures. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 20.2 Define cash and cash equivalents. 3) Which statement about "cash and cash equivalents" is correct? A) The definition for "cash and cash equivalents" used on the balance sheet differs from the definition for "cash and cash equivalents" used on the cash flow statement. B) Changes in the composition of "cash and cash equivalents" are considered a financing activity on the cash flow statement. C) Changes in the composition of "cash and cash equivalents" are considered a cash flow for purposes of the cash flow statement. D) The definition for "cash and cash equivalents" used on the balance sheet is the same as the definition for "cash and cash equivalents" used on the cash flow statement. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 20.2 Define cash and cash equivalents. 4) What is included in "cash and cash equivalents"? A) Cash on hand. B) Term deposits maturing in 180 days. C) Treasury bills maturing in 120 days. D) Bonds of a publicly traded company that mature in one year. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 20.2 Define cash and cash equivalents.

5) What is included in "cash and cash equivalents"? A) Cash restricted for plant expansion. B) Term deposits maturing in 180 days. C) Treasury bills maturing in 120 days. D) U.S. dollar chequing account. Answer: D Diff: 2 Type: MC Skill: Concept Objective: 20.2 Define cash and cash equivalents. 6) Which statement about "cash and cash equivalents" is correct? A) Exchanges of "cash and cash equivalents" for items that are not "cash and cash equivalents" result in cash flows for the cash flow statement. B) Changes in the composition of "cash and cash equivalents" is considered a cash flow for purposes of the cash flow statement. C) Changes in the composition of "cash and cash equivalents" is considered an operating activity on the cash flow statement. D) Cash equivalents include investment in long-term bonds. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 20.2 Define cash and cash equivalents. 7) The following is an excerpt from a company's financial records at year-end.

US dollars chequing account. Cash in sinking fund account for a future repurchase of common shares. Term deposit maturing 100 days after the year-end. Bank loan Cash restricted for plant expansion. Cash on hand. Bank overdraft - part of cash management system

Balance in CAD $10,000

The "cash and cash equivalents" in the cash flow statement will be: A) ($1,200) B) $8,800 C) ($51,200) D) $17,800 Answer: B Explanation: $10,000 + $7,800 - $9,000 = $8,800 Diff: 1 Type: MC Skill: Comp Objective: 20.2 Define cash and cash equivalents.

50,000 78,000 (60,000) 45,000 7,800 (9,000)

8) Define cash and cash equivalents. Answer: Cash is cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are easily convertible to a known amount of cash and that are subject to an insignificant risk of changes in value. Cash equivalents are held for the purpose of meeting short-term cash commitments, rather than investment or other purposes. Diff: 2 Type: SA Skill: Concept Objective: 20.2 Define cash and cash equivalents. 9) What guidance does IFRS provide with respect to reporting bank overdrafts on the statement of cash flows? Answer: When a bank's overdraft facility is an integral part of an enterprise's cash management system, and if the balance often fluctuates between a positive balance and an overdraft, the overdraft is included in the balance of cash and cash equivalents, the change in which must be explained. Diff: 2 Type: SA Skill: Concept Objective: 20.2 Define cash and cash equivalents. 10) Why are "cash and cash equivalents" treated as a single unit on the cash flow statement? Answer: Cash flows exclude movements between items that constitute cash or cash equivalents because these components are part of the cash management of an entity rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash and cash equivalents. Diff: 2 Type: SA Skill: Concept Objective: 20.2 Define cash and cash equivalents. 11) Describe the options available for reporting investments at FVPL regarding their impact on the statement of cash flows. Answer: Investments at FVPL are classified as a cash equivalent if they are held to meet short-term cash commitments. Changes in the investment holdings form part of the change in the cash and cash equivalents to be reconciled, as they are part of the cash management of an entity rather than part of its operating, investing, and financing activities. The purchase and sale of investments at FVPL held for trading purposes are reported as cash outflows and inflows from operations; investments at FVPL held for other than trading purposes are reported as cash outflows and inflows from investing activities. Diff: 2 Type: ES Skill: Concept Objective: 20.2 Define cash and cash equivalents.

12) Identify if the following investments meet the requirements to be classified as cash and cash equivalents. Readily Cash and cash convertible to Risk of change in equivalents? cash? cash value? (Yes/No) (Yes/No) (High/Med/Low) Chequing account in US dollars. Investment in long-term government bonds. Cash in a sinking fund account for a future repurchase of common shares. Investment in a mutual fund that invests in common shares of public corporations. Term deposit maturing 100 days after the year-end. Answer:

Chequing account in US dollars. Investment in long-term government bonds. Cash in a sinking fund account for a future repurchase of common shares. Investment in a mutual fund that invests in common shares of public corporations. Term deposit maturing 100 days after the year-end.

Cash and Readily cash convertible Risk of change in equivalents? to cash? cash value? (Yes/No) (Yes/No) (High/Med/Low) Yes Yes Low No

Yes

High

None

Yes

Moderate

Low

Diff: 2 Type: ES Skill: Concept Objective: 20.2 Define cash and cash equivalents.

Learning Objective 3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 1) Which of the following is a financing activity? A) Collection of accounts receivable. B) Collection of loans receivable C) Receipt of bank loan. D) Sale of a machine. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 6 Copyright © 2023 Pearson Canada Inc.

2) Which of the following is an operating activity? A) Receipt of customer deposit. B) Proceeds from mortgage issue. C) Purchase of land. D) Redemption of preferred shares. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 3) Which of the following is an investing activity? A) Payment of salaries. B) Purchase of inventory. C) Sale of an investment at FVPL D) Collection of loan receivable. Answer: D Diff: 1 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 4) Which statement is correct according to IAS 7? A) An enterprise must classify the receipt of interest and dividends received as an operating activity. B) An enterprise must classify the receipt of interest and dividends received as an investing activity. C) An enterprise may choose to report the payment of interest and dividends as either an operating or a financing activity. D) An enterprise must choose to report the payment of interest and dividends as an operating activity. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 5) What are investing activities? A) Activities that do not involve cash. B) Activities involving the acquisition and disposal of long-term assets and other investments. C) Activities involving the principal revenue-producing activities of the entity. D) Activities involving changes in the size and composition of the equity's borrowings. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

6) What are financing activities? A) Activities involving the acquisition and disposal of long-term assets. B) Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. C) Activities involving the principal revenue-producing activities of the entity. D) Activities that do not involve cash. Answer: B Diff: 2 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 7) What are operating activities? A) Activities involving the acquisition and disposal of long-term assets. B) Activities involving changes in the size and composition of the contributed equity. C) Activities involving the principal revenue-producing activities of the entity. D) Activities that do not involve cash. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 8) What is not a "non-cash" transaction? A) Exchange of land with another company. B) Conversion of preferred shares. C) Payment of cash dividends. D) Payment of stock dividends. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 9) Which item will be presented on the "investing section" of the cash flow statement? A) Proceeds from sale of sale of inventory. B) Net investment in property, plant and equipment. C) Proceeds from sale of equipment. D) Proceeds from sale of preferred shares. Answer: C Diff: 2 Type: MC Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

10) What are the two distinct components to investing activities? Answer: (a) the acquisition and disposal of fixed assets to establish and maintain the infrastructure necessary to run their businesses, companies purchase and sell assets such as property, plant, and equipment; (b) investing in financial assets other than cash equivalents or those driven primarily by cash management considerations. Diff: 2 Type: SA Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 11) Investing involves buying and selling debt and equity securities. What two categories of investing do not appear in the investing section of the cash flow statement? Answer: (a) buying and selling investments that are classified as cash equivalents are not reported as cash flows because these transactions are primarily driven by cash management considerations.; (b) purchases and sales of investments at FVPL held for trading purposes are reported as operating activities as they are similar to inventory specifically held for resale. Diff: 2 Type: SA Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 12) What are the options for recording interest and dividends received and interest and dividends paid on the cash flow statement according to Accounting Standards for Private Enterprises (ASPE)? Answer: ASPE does not provide options. Rather, the receipt of interest and dividends and the payment of interest are operating activities; the payment of dividends is a financing activity. Diff: 2 Type: SA Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 13) Briefly describe non-cash transactions and how they are reported on the statement of cash flows. Answer: A non-cash transaction is one that does not involve cash. Non-cash financing and investing activities are not reported on the statement of cash flows. If significant, however, they are disclosed in the notes to the financial statements. Diff: 2 Type: SA Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

14) Explain how the following transactions should be reported in the statement of cash flows, assuming the indirect method is used to determine cash flows from operating activities. Identify all available options. If not reported on the statement of cash flows, indicate the disclosure requirements, if any. 1. The purchase of a $100,000, 45-day Treasury bill classified at FVPL. 2. Amortization of the discount on bonds payable in the amount of $20,000. Answer: 1. The $100,000 would be reported as a cash outflow in the operating activities section if the investment were held for trading purposes and as a cash outflow in the investing activities section if the investment were not held for trading purposes. Alternatively, if the Treasury bill was held to meet short-term cash commitments, it would be designated as a cash equivalent, in which case it would form part of the change in cash and cash equivalents to be explained. 2. The $20,000 is a non-cash expense. It is deducted from interest expense to determine interest paid. (Further adjustments may be required for changes in interest payable and the like.) Interest expense can be reported as either a cash outflow from operating activities or a cash outflow from financing. Diff: 2 Type: SA Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities. 15) Explain how the following transactions should be reported in the statement of cash flows, assuming the indirect method is used to determine cash flows from operating activities. Identify all available options. If not reported on the statement of cash flows, indicate the disclosure requirements, if any. 1. Income tax expense of $30,000. The income tax payable account increased $7,000, while the deferred income tax liability account decreased $9,000. 2. Cash dividend of $40,000 declared. The dividends payable account increases $25,000. Answer: 1. The $32,000 net cash paid for taxes is reported as a cash outflow from operating activities ($30,000 income tax expense + $9,000 decrease in deferred income taxes payable account - $7,000 decrease in income taxes payable account = $32,000). 2. The net cash outflow of $15,000 ($40,000 declared - $25,000 increase in the dividends payable account) is reported as either a cash outflow from operating activities or a cash outflow from financing. Diff: 2 Type: SA Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

16) Explain the options for recording interest and dividends received and interest and dividends paid on the cash flow statement according to IAS 7. Answer: An enterprise may classify the receipt of interest and dividends received as either an operating or an investing activity. The ambiguity here arises because it is not clear-cut whether this type of income is part of an enterprise's normal operations or part of its investments. An enterprise may choose to report the payment of interest and dividends as either an operating or a financing activity. The ambiguity occurs because, even though interest and dividend payments both arise from financing activities (issuance of debt and equity), interest is recorded through income, while dividends are not. Regardless of the choice for this accounting policy, the enterprise must apply it consistently to all similar transactions. Diff: 2 Type: ES Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

17) Tub Time Corp.'s policy is to report all cash flows arising from interest and dividends in the operating activities section. Tub Time's activities for the year ended December 31, 2026, included the following: • 2026's net income after taxes totaled $220,000. • Declared and issued a stock dividend valued at $40,000. • Accounts receivable decreased $44,000 in 2026. • Sold an investment at FVPL for $13,000. The book value was $11,000. (Assume this investment at FVPL was held for trading purposes.) • Interest revenue for the period was $6,000. The interest receivable account decreased $4,000. • Declared a $10,000 dividend payable. The dividends payable account decreased $19,000 in 2026. • Sold an investment at FVOCI for $9,000. The original cost of the investment was $14,000. • Tub Time recorded a $15,000 goodwill impairment loss during the year. • Depreciation expense for the year was $14,000. Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the indirect method. b. Identify how the activities listed above that are not operating activities would be required in the statement of cash flows.

Answer: a.

Tub Time Corp. Statement of Cash Flows (partial) Year Ended December 31, 2026

Cash flows from operating activities Net income Adjustments for: Depreciation Gain on sale of investment at FVPL Loss on sale of investment at FVOCI Goodwill impairment loss Decrease in accounts receivable Sale of investment at FVPL Cash generated from operating activities Interest received ($6,000 + $4,000)* Dividends paid (-$10,000 - $19,000)*

$220,0000 14,000 (2,000) 5,000 15,000 44,000 13,000 309,000 10,000 (29,000) $290,000

*Note that while interest received and dividends paid can also be recorded as investing and financing activities, respectively, the company has adopted a policy of reporting these transactions as operating activities. b. • The stock dividend is a non-cash activity and is not reported on the statement of cash flows. Note disclosure is appropriate. • The $9,000 proceeds from the sale of the investment at FVOCI is reported as a cash inflow from investing section. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

18) Mamie K. Ltd.'s policy is to report all cash flows arising from interest and dividends in the operating section. Mamie's activities for the year ended December 31, 2026, included the following: • Income tax expense for the year was $36,000. • Sales for the year were $730,000. • Accounts payable decreased $20,000 in 2026. • Selling and administration expenses for the year totaled $140,000. • Accounts receivable increased $6,000 in 2026. • Mamie's cost of goods sold in 2026 was $315,000. • Mamie's inventory decreased $13,000 during the year. • Interest expense for the period was $17,000. The interest payable account increased $5,000. • Dividends were not declared during the year; however, the dividends payable account decreased $2,000. • Sold an investment at FVOCI for $45,000. The original cost of the investment was $52,000. • Depreciation expense for the year was $19,000. Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the direct method. b. Identify how the activities listed above that are not operating activities would be reported in the statement of cash flows.

Answer: a.

Mamie K. Ltd. Statement of Cash Flows (partial) Year Ended December 31, 2026

Cash flow from operating activities Cash receipts from customers Cash paid to suppliers Selling and administrative expenses paid Cash generated from operating activities Interest paid* Income taxes paid Dividends paid* Net cash from operating activities

$724,000 (322,000)

$730,000 sales - $6,000 increase in AR -$315,000 COGS + $13,000 decrease in inventory - $20,000 decrease in AP

(140,000) 262,000 (12,000)

-$17,000 interest expense + $5,000 increase in interest payable account

(36,000) (2,000) $ 212,000

b. • The sale of the investment at FVOCI will be recorded as a cash inflow from investing. The cumulative loss on sale does not involve cash and is not reported on the statement of cash flows prepared using the direct method. • Depreciation expense does not involve cash and is not reported on the statement of cash flows prepared using the direct method. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

19) Crete Ltd.'s policy is to report all cash flows arising from interest and dividends in the operating section. Crete's activities for the year ended December 31, 2026, included the following: • Income tax expense for the year was $30,000. • Sold an investment at FVOCI for $45,000. The original cost of the investment was $52,000. • Depreciation expense for the year was $19,000. • Sales for the year were $1,030,000. • Selling and administration expenses for the year totaled $240,000. • Mamie's cost of goods sold in 2026 was $315,000. • Interest expense for the period was $12,000. The interest payable account increased $5,000. • Accounts payable increased $20,000 in 2026. • Accounts receivable decreased $36,000 in 2026. • Mamie's inventory increased $13,000 during the year. • Dividends were not declared during the year; however, the dividends payable account decreased $5,000. Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the direct method. b. Identify how the activities listed above that are not operating activities would be reported in the statement of cash flows.

Answer: a.

Crete Ltd. Statement of Cash Flows (partial) Year Ended December 31, 2026

$1,066,000 (308,000)

$1,030,000 sales - (-$36,000 increase in AR) -$315,000 COGS + (-$13,000 increase in inventory) - (-$20,000 increase in AP)

(240,000) 518,000 (7,000) (30,000) (5,000) $ 476,000

-$12,000 interest expense + $50,000 increase in interest payable account

20) Recon Cile Ltd.'s policy is to report all cash flows arising from interest and dividends in the operating section. Recon Cile's activities for the year ended December 31, 2026, included the following: • Sold an investment at FVPL for $16,000. The book value of this investment, which was held for trading purposes, was $13,000. • Purchased an investment at FVOCI for $20,000. • Borrowed $25,000 from the bank for investment purposes. • Sold equipment for $21,000 that originally cost $45,000. The net book value of this item at time of sale was $25,000. • Purchased inventory costing $4,000 for cash. • Received $6,000 in interest and $2,500 in dividends on sundry investments. • Acquired the right to use a forklift costing $22,000 under lease agreement. • Acquired land and buildings valued at $400,000 by issuing ordinary shares. • Bought $300,000 in bonds at a discount, paying $285,000 cash. The investment was classified at amortized cost. Required: a. Prepare the cash flows from investing activities section of the statement of cash flows. b. Identify how the activities listed above that are not investing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method.

Answer: a.

Recon Cile Ltd. Statement of Cash Flows (partial) Year Ended December 31, 2026

Cash flows from investing activities Purchase of investment at FVOCI Sale of equipment Purchase of bonds at amortized cost Net cash from (used in) investing activities

$(20,000) 21,000 (285,000)

$(284,000)

b. • The sale of the investment at FVPL is recorded as a cash inflow in the operating activities section. The gain on sale will be deducted from net income in the operating activities section (indirect method). • The loan is recorded as a cash inflow from financing. • The loss on sale of equipment will be added back to net income in the operating activities section (indirect method). • The inventory purchase will decrease cash from operating activities. • The receipt of interest and dividend income is reported as an increase in cash from operating activities. Note that while the receipt of interest and dividends received can also be classified as an investing activity, Recon Cile has adopted a policy of reporting interest and dividend activities as operating activities. • The acquisition of the forklift by way of a lease agreement is a non-cash activity and is not reported on the statement of cash flows. Material non-cash transactions are reported in the notes to the financial statements. • The acquisition of the land and buildings is a non-cash activity. Material non-cash transactions are reported in the notes to the financial statements. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

21) Jamie Bleay Law Ltd.'s policy is to report all cash inflows from interest and dividends in the investing section and cash outflows arising from interest and dividends in the financing section. Jamie Bleay Law's activities for the year ended December 31, 2024, included the following: • Sold an investment at FVPL for $11,000. The book value of this investment, which was held to meet short-term cash commitments, was $11,000. • Sold an investment at FVOCI for $14,000. The book value and original cost of the investment was $14,000. • Borrowed $120,000 from the bank for investment purposes. • Sold equipment for $26,000 that originally cost $20,000. The net book value of this item at time of sale was $14,000. • Received $9,000 in interest and $7,000 in dividends on sundry investments. • Paid $4,000 interest on the investment loan. • Acquired land and buildings valued at $700,000 by paying $200,000 cash and issuing ordinary shares for the balance. • Bought $550,000 in bonds at a premium, paying $560,000 cash. The investment was classified at amortized cost. Required: a. Prepare the cash flows from investing activities section of the statement of cash flows. b. Identify how the activities listed above that are not investing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method.

Answer: a.

Jamie Bleay Law Ltd. Statement of Cash Flows (partial) Year Ended December 31, 2024

Cash flows from investing activities Sale of investments at FVOCI Sale of equipment Investment income* ($7,000 + $9,000) Purchase of land and buildings Purchase of bonds at amortized cost Net cash from (used in) investing activities

$14,000 26,000 16,000 (200,000) (560,000) $(704,000)

b. • The sale of the investment at FVPL is not reported on the statement of cash flows as it was held to meet short-term cash commitments. It was thus a cash equivalent. • The loan is recorded as a cash inflow from financing. • The gain on sale of equipment will be subtracted from net income in the operating activities section (indirect method). • The payment of interest is recorded as a cash outflow from financing. Note that while interest paid can also be designated as an operating activity, Jamie Bleay Law has adopted a policy of reporting interest paid as a financing activity. • The acquisition of the land and buildings was only partially settled in cash. The remaining amount settled by issuing ordinary shares is a non-cash activity. Material non-cash transactions are reported in the notes to the financial statements. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

22) Sherya Inc.'s policy is to report all cash flows arising from interest and dividends in the operating section. Sherya's activities for the year ended December 31, 2026, included the following: • Interest expense for the period was $10,000. The interest payable account decreased $4,000. • Made a $110,000 principal payment on a bank loan. • Declared a $15,000 cash dividend payable on January 15, 2027. • Declared and issued a stock dividend valued at $50,000. • Paid $55,000 to repurchase ordinary shares and cancelled them. The book value was $40,000. • Accounts payable increased $23,000 during the year. • Issued $1,500,000 in bonds. The cash proceeds were $1,380,000. Required: a. Prepare the cash flows from financing activities section of the statement of cash flows. b. Identify how the activities listed above that are not financing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method. Answer: a. Sherya Inc. Statement of Cash Flows (partial) Year Ended December 31, 2026 Cash flows from financing activities Repurchase ordinary shares Principal reduction of bank loan Sale of bonds Net cash from financing activities

$ (55,000) (110,000) 1,380,000

$1,215,000

b. • The stock dividend is a non-cash activity and is not reported on the statement of cash flows. • Note disclosure is appropriate. • The loss on repurchase of shares is a non-cash item and is not reported on the statement of cash flows. As this is a capital transaction, this amount is deducted directly from equity and does not flow through the income statement. Hence, this amount will be used to explain the change in equity. • The increase in accounts payable is reported as an increase in cash from operating activities. • The interest paid (interest expense + change in interest payable) is reported as a decrease in cash from operating activities. Note that while interest paid can also be classified as a financing activity, Sherya has adopted a policy of reporting interest and dividend activities as operating activities. • The declaration of the dividend is not reported on the statement of cash flows as it was not paid in 2026. Rather, this amount is used to explain the change in retained earnings during the year. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

23) Angela's Angels Corp.'s policy is to report all cash inflows from interest and dividends in the investing section and cash outflows arising from interest and dividends in the financing section. Angela's activities for the year ended December 31, 2024, included the following: • Declared and issued a stock dividend valued at $15,000. • Issued $300,000 in ordinary shares. • Accounts payable decreased $38,000 during the year. • Paid $910,000 to repurchase bonds. The book value of the bonds was $1,000,000. • Made a $25,000 principal payment on a bank loan. • Interest expense for the period was $12,000. The interest payable account increased $2,000. • Declared a $12,000 cash dividend payable on January 15, 2025. • Acquired the right to use an automobile valued at $30,000 under a lease agreement. Required: a. Prepare the cash flows from financing activities section of the statement of cash flows. b. Identify how the activities listed above that are not financing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method. Answer: a. Angela's Angels Corp. Statement of Cash Flows (partial) Year Ended December 31, 2024 Cash flows from financing activities Sale of ordinary shares Repurchase bonds Principal reduction of bank loan Interest expense (-$12,000 + $2,000) Net cash from (used in) financing activities

$ 300,000 (910,000) (25,000) (10,000)

$(645,000)

* Note that while interest paid can also be classified as an operating activity, Angela's has adopted a policy of reporting interest and dividend paid as financing activities. b. • The stock dividend is a non-cash activity and is not reported on the statement of cash flows. Note disclosure is appropriate. • The decrease in accounts payable is reported as a decrease in cash from operating activities. • The gain on repurchase of bonds will be deducted from net income in the operating activities section (indirect method). • The declaration of the dividend is not reported on the statement of cash flows as it was not paid in 2024. Rather, this amount is used to explain the change in retained earnings during the year. • The acquisition of the right to use an automobile under a lease agreement is a non-cash activity and is not reported on the statement of cash flows. Material non-cash transactions are reported in the notes to the financial statements. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

24) Select transactions of SimBis Accounting Inc. (SAI) are listed below. SAI uses the indirect method to determine cash flows from operating activities. 1. SAI purchases a $200,000, 45-day Treasury bill and classified it at FVPL. 2. SAI amortizes $32,000 of the discount on bonds payable. 3. At year-end SAI increases its allowance for bad debts by $10,000. 4. SAI's income tax expense totaled $40,000. Its income tax payable account increased $5,000, while its deferred income tax liability account decreased $8,000. 5. SAI acquires the right to use equipment valued at $80,000 under a lease agreement. 6. SAI declares and distributes a stock dividend valued at $33,000. 7. SAI declares a cash dividend of $30,000. The dividends payable account increases $15,000. 8. SAI's comprehensive income for the year totaled $200,000 consisting of $150,000 net income and $50,000 other comprehensive income. 9. SAI sells an investment at amortized cost for $22,000. The investment's amortized cost is $20,000. Required: Discuss how the activities listed above would be reported in the statement of cash flows. For items with multiple reporting options, identify all available options. For items not reported on the statement of cash flows, indicate the disclosure requirements, if any.

Answer: 1. The $200,000 would be reported as a cash outflow in the operating activities section if the investment is held for trading purposes; as a cash flow from investing activities if held for other than trading purposes. Alternatively, if the Treasury bill is held to meet short-term cash commitments, it is a cash equivalent, in which case it would form part of the change in cash and cash equivalents to be explained. 2. The $32,000 is a non-cash expense. It is deducted from interest expense to determine interest paid. (Further adjustments may be required for changes in interest payable and the like.) Interest expense can be reported as either a cash outflow from operating activities or a cash outflow from financing. 3. The $10,000 is a non-cash expense and will be added back to net income as an adjusting entry in the cash flow from operating activities section. From a practical perspective, this function is accomplished by adjusting net income by the increase or decrease in net accounts receivable. 4. The $43,000 net cash paid for taxes is reported as a cash outflow from operating activities ($40,000 income tax expense + $8,000 decrease in deferred income taxes payable account - $5,000 decrease in income taxes payable account = $43,000). 5. The acquisition of the right to use equipment under a lease agreement is a non-cash expense. If material, the transaction should be disclosed in the notes to the financial statements. 6. The distribution of stock dividends is a non-cash activity and is not reported on the statement of cash flows. The transaction would normally be disclosed in the notes to the financial statements because changes in equity must be explained. 7. The net cash outflow of $15,000 ($30,000 declared - $15,000 increase in the dividends payable account) is reported as either a cash outflow from operating activities or a cash outflow from financing. 8. SAI can either: i) use the $200,000 comprehensive income as the starting point to determine cash flows from operating activities and then deduct the $50,000 other comprehensive income to arrive at $150,000 net income as an interim point; or ii) simply use the $150,000 net income as a starting point. Other comprehensive income does not involve cash flows and companies are not required to report it on the statement of cash flows. 9. The $2,000 gain on sale ($22,000 - $20,000 = $2,000) is deducted as an adjustment from net income in the cash flows from operating activities section. The $22,000 cash received is reported as a cash inflow from investments at amortized cost and is reported in the investing activities section of the cash flow statement. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

25) Select transactions of June Bowen Inc. (JBI) are listed below. JBI uses the indirect method to determine cash flows from operating activities. 1. JBI amortizes $12,000 of the discount on bonds payable. 2. At year-end JBI increases its allowance for bad debts by $18,000. 3. JBI's income tax expense totaled $50,000. Its income tax payable account increased $5,000, while its deferred income tax liability account decreased $8,000. 4. JBI makes a principal payment of $25,000 on a lease liability subsequent to the commencement date. 5. JBI declares and distributes a stock dividend valued at $33,000. 6. JBI declares a cash dividend of $30,000. The dividends payable account increases $10,000. 7. JBI sells an investment at amortized cost for $28,000. The investment's book value is $20,000. Required: Discuss how the activities listed above would be reported in the statement of cash flows. For items with multiple reporting options, identify all available options. For items not reported on the statement of cash flows, indicate the disclosure requirements, if any. Answer: 1. The $12,000 is a non-cash expense. It is deducted from interest expense to determine interest paid. (Further adjustments may be required for changes in interest payable and the like.) Interest expense can be reported as either a cash outflow from operating activities or a cash outflow from financing. 2. The $18,000 is a non-cash expense and will be added back to net income as an adjusting entry in the cash flow from operating activities section. From a practical perspective, this function is accomplished by adjusting net income by the increase or decrease in net accounts receivable. 3. The $53,000 net cash paid for taxes is reported as a cash outflow from operating activities ($50,000 income tax expense + $8,000 decrease in deferred income taxes payable account - $5,000 decrease in income taxes payable account = $53,000). 4. Principal payment on a lease made subsequent to the commencement date are reported on the statement of cash flows as a cash outflow from financing activities. 5. The distribution of stock dividends is a non-cash activity and is not reported on the statement of cash flows. The transaction would normally be disclosed in the notes to the financial statements because changes in equity must be explained. 6. The net cash outflow of $20,000 ($30,000 declared - $10,000 increase in the dividends payable account) is reported as either a cash outflow from operating activities or a cash outflow from financing. 7. The $8,000 gain on sale ($28,000 - $20,000 = $8,000) is deducted as an adjustment from net income in the cash flows from operating activities section. The $28,000 cash received is reported as a cash inflow from investments at amortized cost and is included in the investing activities section of the cash flow statement. Diff: 2 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

26) Select transactions of Irene Accounting Inc. (IAI) are listed below. IAI uses the indirect method to determine cash flows from operating activities. 1. IAI sells an investment at amortized cost for $28,000. The investment's book value is $20,000. 2. IAI's income tax expense totaled $30,000. Its income tax payable account increased $5,000, while its deferred income tax liability account decreased $18,000. 3. IAI declares a cash dividend of $3,000. The dividends payable account increases $1,000. 4. At year-end IAI increases its allowance for bad debts by $15,000. Required: Discuss how the activities listed above would be reported in the statement of cash flows. For items with multiple reporting options, identify all available options. For items not reported on the statement of cash flows, indicate the disclosure requirements, if any. Answer: 1. The $8,000 gain on sale ($28,000 - $20,000 = $8,000) is deducted as an adjustment from net income in the cash flows from operating activities section. The $28,000 cash received is reported as a cash inflow from investments at amortized cost and is included in the investing activities section of the cash flow statement. 2. The $43,000 net cash paid for taxes is reported as a cash outflow from operating activities ($30,000 income tax expense + $18,000 decrease in deferred income taxes payable account - $5,000 decrease in income taxes payable account = $43,000). 3. The net cash outflow of $2,000 ($3000 declared - $1,000 increase in the dividends payable account) is reported as either a cash outflow from operating activities or a cash outflow from financing. 4. The $15,000 is a non-cash expense and will be added back to net income as an adjusting entry in the cash flow from operating activities section. From a practical perspective, this function is accomplished by adjusting net income by the increase or decrease in net accounts receivable. Diff: 1 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

27) The opening balance in the land account for Adara Corp for fiscal 2025 was $500,000; the closing balance was $610,000. During the year land costing $130,000 was given to a creditor in full settlement of a $152,000 loan. The fair value of the land at the time of the exchange was $152,000. The company also purchased a separate parcel of land for cash during the year. Required: a. Prepare the underlying journal entries to record the foregoing transactions and record events stemming from the transactions (e.g. the gain or loss on exchange of land for loan, etc.). b. For each entry identify the cash flow effects, if any, under both the direct and indirect methods of presentation and classify the cash flow according to its nature. c. Why does the IASB require that companies classify cash flows as arising from operations, investing, or financing activities? Answer: Parts a and b Loan repayment using land Loan payable 152,000 Land (old) 130,000 Gain on exchange of land 22,000 SCF: Non-cash gain. Not reported on the SCF (direct). Subtract $22,000 from net income in the cash flow from operating activities on the SCF (indirect). Land (new) 240,000 Cash 240,000 SCF: Cash outflow of $240,000 from investing activities for both the direct and indirect methods of presentation. c. The IASB requires that companies categorize the sources and uses of cash so as to assist investors, creditors, and other interested parties in assessing the company's ability to make payments when due and pay dividends. Diff: 3 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

28) The opening balance in the computer account for Adara Corp for fiscal 2025 was $100,000; the closing balance was $107,000. The corresponding balances in the accumulated depreciation accounts were $63,000 and $67,500. During the year Adara scrapped a computer originally costing $13,000 having a remaining net book value of $3,500 and purchased a replacement machine for cash. Required: a. Prepare the underlying journal entries to record the foregoing transactions and record events stemming from the transactions. b. For each entry identify the cash flow effects, if any, under both the direct and indirect methods of presentation and classify the cash flow according to its nature. Answer: Replacement of computer equipment Accumulated depreciation—computers 9,500 Loss on disposal 3,500 Computers 13,000 SCF: Non-cash loss. Not reported on the SCF (direct). Add back $3,500 to net income in the cash flow from operating activities on the SCF (indirect). Computers 20,000 Cash 20,000 SCF: Cash outflow from investing activities for both the direct and indirect methods of presentation. Depreciation expense—computers 14,000 Accumulated depreciation—computers 14,000 SCF: Non-cash expense. Not reported on the SCF (direct). Add back $14,000 to net income in the cash flow from operating activities on the SCF (indirect). Diff: 3 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

29) On January 1, 2025, Adara acquired the right to use equipment under a lease agreement. The lease calls for 15 annual payments of $10,000 due at the beginning of the year. Adara must return the equipment to the lessor at the end of the lease. The January 1, 2025, payment was made as agreed. The implicit rate in the lease is 7%; the present value of the lease payments is $97,455. Required: a. Prepare the underlying journal entries to record the foregoing transactions and record events stemming from the transactions (e.g. depreciation and the accrual of interest at year-end). b. For each entry identify the cash flow effects, if any, under both the direct and indirect methods of presentation and classify the cash flow according to its nature. Answer: Purchase of equipment by way of a lease agreement ROU asset - machinery 97,455 Lease liability 87,455 Cash 10,000 The cash payment is reported as a cash outflow from investing activities for both the direct and indirect methods as it was made on or before the commencement date of the lease. The balance of the transaction is not reported on the SCF but is disclosed if material. Interest expense 6,122 Lease liability 6,122 SCF: Non-cash expense. Not reported on the SCF (direct). Add back to net income in the cash flow from operating activities on the SCF (indirect). Depreciation expense—ROU asset- machinery 6,497 Accumulated depreciation—ROU asset -machinery 6,497 SCF: Non-cash expense. Not reported on the SCF (direct). Add back to net income in the cash flow from operating activities on the SCF (indirect). Diff: 3 Type: ES Skill: Comp Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

30) Explain how the following transactions should be reported in the statement of cash flows, assuming the indirect method is used to determine cash flows from operating activities. Identify all available options. If not reported on the statement of cash flows, indicate the disclosure requirements, if any. 1. An increase in allowance for bad debts by $18,000. 2. A principal payment of $35,000 on a lease liability subsequent to the commencement date of the lease. Answer: 1. The $18,000 is a non-cash expense and will be added back to net income as an adjusting entry in the cash flow from operating activities section. From a practical perspective, this function is accomplished by adjusting net income by the increase or decrease in net accounts receivable. 2. Principal payments on a lease liability subsequent to the commencement date are reported as a cash outflow in the financing activities section in the SCF. Diff: 2 Type: ES Skill: Concept Objective: 20.3 Differentiate among cash flows from operating activities, investing activities, and financing activities.

Learning Objective 4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities. 1) Which is a correct statement? A) The direct method of presentation for the cash flow statement must be used under ASPE. B) The direct method of presentation for the cash flow statement must be used under IFRS. C) The statement of cash flows explains the change between opening and closing cash. D) The "cash" balance on the cash flow statement does not have to be equal to the "cash" balance amount on the balance sheet. Answer: C Diff: 1 Type: MC Skill: Concept Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities. 2) Hoboken's activities for the year ended December 31, 2026, included the following: • Sold an investment at FVPL for $12,000. The investment was held for trading purposes. The book value was $10,000. • Sold an investment at FVOCI for $8,000. The original cost of the investment was $9,000. Using the direct method, which of the following would be presented as cash flow from operations for the investment at FVPL investment? A) Proceeds from sale of an investment at FVPL in the amount of $12,000. B) Disposal of an investment at FVPL investment in the amount of $10,000. C) Gain on sale of an investment at FVPL investment in the amount of $2,000. D) Loss on sale of an investment at FVPL investment in the amount of $2,000. Answer: A Diff: 2 Type: MC Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities. 31 Copyright © 2023 Pearson Canada Inc.

3) A company's activities for the year ended December 31, 2026 included the following: • Sold an investment at FVPL for $10,000. The investment was held for trading purposes. The book value was $15,000. • Sold an Investment at FVOCI for $10,000. The original cost was $5,000. Using the indirect method, how much would be presented as cash flow from operating activities? A) Proceeds from disposal in the amount of $10,000. B) Proceeds from disposal in the amount of $20,000. C) Loss on sale in the amount $5,000. D) Adjustment of $5,000 on loss on sale of the investment at FVPL, an adjustment of ($5,000) on the recycled gain on sale on the investment at FVOCI, and + $10,000 inflow from the sales proceeds of the investment at FVPL. Answer: D Diff: 2 Type: MC Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities. 4) Suzanne Inc.'s policy is to report all cash flows arising from interest and dividends in the operating activities section. The activities for the year ended December 31, 2026, included the following: • Interest revenue for the period was $12,000. The interest receivable account decreased $3,000. • Sold an investment at FVOCI for $10,000. The original cost was $5,000. Using the indirect method, which of the following would be presented as cash flow from operating activities? A) Proceeds from disposal in the amount of $10,000 + Interest received in the amount of $12,000. B) Proceeds from disposal in the amount of $10,000 + Interest received in the amount of $15,000. C) Gain on sale in the amount $5,000 + Interest received in the amount of $12,000. D) Adjustment to Net Income of - $5,000 for the recycled gain on sale of the investment at FVOCI + Interest cash flow of +$15,000. Answer: D Diff: 2 Type: MC Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

5) The activities for the year ended December 31, 2026, included the following: • 2026's net income after taxes totaled $125,000. • Accounts receivable increased $32,000. • Recorded a $10,000 goodwill impairment loss during the year. • Inventory decreased $8,000. How much would be presented as cash flow from operations? A) $85,000 B) $111,000 C) $127,000 D) $135,000 Answer: B Explanation: $125,000 - $32,000 + $10,000 + $8,000 = $111,000 Diff: 2 Type: MC Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities. 6) The Company's activities for the year ended December 31, 2026, included the following: • Income tax expense for the year was $30,000. • Sales for the year were $650,000. • Accounts payable decreased $10,000 in 2026. • Selling and administration expenses for the year totaled $200,000. • Accounts receivable increased $20,000 in 2026. • The Company's cost of goods sold in 2026 was $325,000. • The Company's inventory decreased $15,000 during the year. What are the cash receipts from customers under the direct method? A) $110,000 B) $320,000 C) $670,000 D) $630,000 Answer: D Explanation: $650,000 - $20,000 = $630,000 Diff: 2 Type: MC Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

7) The Company's activities for the year ended December 31, 2026, included the following: • Income tax expense for the year was $30,000. • Sales for the year were $650,000. • Accounts payable decreased $10,000 in 2026. • Selling and administration expenses for the year totaled $200,000. • Accounts receivable increased $20,000 in 2026. • The Company's cost of goods sold in 2026 was $325,000. • The Company's inventory increased $15,000 during the year. • Depreciation expense for the year was $13,000. What are the net cash payments to suppliers under the direct method? A) $307,000 B) -$315,000 C) $320,000 D) -$350,000 Answer: D Explanation: -$325,000 - $15,000 - $10,000 = -$350,000 Diff: 2 Type: MC Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities. 8) A company's activities for the year ended December 31, 2026, included the following: • Declared and issued a stock dividend valued at $50,000. • Paid $975,000 to repurchase bonds at amortized cost. The book value of the bonds was $1,000,000. • Made a $20,000 principal payment on a bank loan. How much will be presented as cash flow from financing activities? A) $955,000 B) -$975,000 C) $980,000 D) -$995,000 Answer: D Explanation: $975,000 + $20,000 = $995,000 outflow Diff: 2 Type: MC Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

9) Contrast the primary differences between IFRS and ASPE with respect to the presentation of the statement of cash flows using the following table:

ISSUE

IFRS Statement of Cash Flows

ASPE Cash Flow Statement

Interest and dividends received Interest paid Dividends paid Interest and dividends received and paid Income taxes paid

Answer: IFRS ASPE ISSUE Statement of Cash Flows Cash Flow Statement Enterprises may classify cash Cash inflows arising from the inflows arising from the receipt receipt of interest and of interest and dividends as dividends must be classified as Interest and dividends either an operating or an an operating activity. received investing activity. Enterprises may classify cash outflows arising from the Cash outflows arising from the payment of interest as either an payment of interest is normally operating or a financing classified as an operating Interest paid activity. activity. Enterprises may classify cash outflows arising from the payment of dividends as either Cash outflows arising from the an operating or a financing payment of dividends must be Dividends paid activity. classified as a financing activity. ASPE requires that interest and IFRS requires separate dividends paid and charged Interest and dividends disclosure of the amount of directly to retained earnings be received and paid interest and dividends both separately presented as cash received and paid. outflows from financing. ASPE does not require IFRS requires disclosure of the disclosure of the amount of Income taxes paid amount of income taxes paid. income taxes paid. Diff: 2 Type: SA Skill: Concept Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

10) Answer the following: a. What are the similarities and differences between the direct and indirect methods of preparing the statement of cash flows? b. In practice, which method of preparation is used for the statement of cash flows and why? c. Is the indirect method of presenting the statement of cash flows required by the IASB? d. Briefly discuss how unrealized gains and losses arising from an investments at FVPL that are held for trading purposes are reported on the statement of cash flows. Answer: a. The difference between the direct and indirect methods relates to the composition of the information explaining "Net cash from (used in) operating activities." The total cash reported will be the same under the two formats. Moreover, "Net cash from (used in) investing activities" and "Net cash from (used in) financing activities" is identical under both approaches. b. The vast majority of companies use the indirect method to present the statement of cash flows. Probable motives include those of comparability and ease of preparation. c. The IASB does not prescribe the use of the direct or indirect method; it encourages the use of the direct method of presenting the statement of cash flows with the governing standards, reading in part "Entities are encouraged to report cash flows from operating activities using the direct method." The IASB is currently considering requiring all entities to report cash flows from operating activities using the direct method. d. Unrealized gains and losses on investments at FVPL that are held for trading purposes are recorded in the income statement. When the indirect method of presentation is used, the unrealized profit or loss must be reversed in the cash flow from operating activities section of the statement of cash flows. Gains and losses are not reported on the statement of cash flows prepared using the direct method as gains and losses do not give rise to cash flows. Diff: 2 Type: ES Skill: Concept Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

11) Complete the following: a. List the three primary sources of information required to prepare a statement of cash flows. b. A company may report its accounts receivable at the gross amount less an allowance for bad debts. Contrast the direct and indirect methods of adjusting for accounts receivable reported at the gross amount. c. Briefly discuss how cash flows arising from the purchase and sale of treasury shares are reported on the statement of cash flows. d. Briefly discuss how other comprehensive income is reported on the statement of cash flows. e. Briefly discuss how cash flows arising from investments in associates are reported on the statement of cash flows. f. Briefly discuss the alternatives for reporting discontinued operations in the statement of cash flows. Answer: a. The three primary sources of information required to prepare a statement of cash flows are the company's comparative balance sheet, its income statement for the period, and select transaction data. b. The indirect method ignores the component parts and reports the change in the net receivables as an adjustment to net income in the cash flow from operating activities section. The direct method of presentation deals with the two elements separately. Cash from sales is adjusted for the change in the gross amount of the receivables and the operating component of the cash paid to suppliers and employees is adjusted for the change in the allowance account. c. Cash flows from the purchase and sale of treasury shares are reported as a financing activity. d. Other comprehensive income (OCI) is not normally reported on the statement of cash flows as OCI does not affect cash since it records only unrealized gains and losses on select items. The exception to this is that under the indirect method companies can use comprehensive income as a starting point, with the components of other comprehensive income being recorded as reversing items in the cash flows arising from operating activities section. e. Investments in associates are typically accounted for using the equity method. The statement of cash flows is concerned only with the cash received or advanced, rather than investment income. The required adjustment for the indirect method of presentation entails deducting income from investments in the operating section and recording dividends received in either the operating or investing section. f. Cash flows from discontinued operating activities are shown separately in the operating, investing, and financing activities of the statement of cash flows according to their nature. Alternatively, this information may be disclosed in the notes to the financial statements. Diff: 2 Type: ES Skill: Concept Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

12) Provide a summary of presentation and disclosure requirements relating to the statement of cash flows. Summary of presentation and disclosure requirements relating to the statement of cash flows. Presentation:

Disclosure:

Answer: Summary of presentation and disclosure requirements relating to the statement of cash flows. Presentation: The change in cash and cash equivalents must be explained. Cash flows must be classified as arising from operating, investing, or financing activities. Cash flows from operating activities may be reported using either the direct or indirect method. Major classes of cash inflows and outflows for both investing and financing activities must be separately reported. Cash flows from interest paid and received, dividends paid and received, and income taxes paid must be individually disclosed. This information may be included directly on the statement of cash flows or discussed in the supporting notes to the financial statements. Disclosure: The components of cash and cash equivalents must be disclosed. The policy adopted to determine the composition of cash and cash equivalents must be disclosed. Non-cash transactions are not reported on the statement of cash flows, but must be disclosed elsewhere in the financial statements. Diff: 2 Type: ES Skill: Concept Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

13) Financial information for Fesone Inc.'s balance sheet for fiscal 2025 and 2026 follows:

Cash Accounts receivable Inventory Investments at FVPL Investments at amortized cost Property, plant, and equipment Accumulated depreciation Total

2026 $204,800 1,150,000 410,000 400,000 150,000 3,400,000 (1,860,000) $3,854,800

2025 $550,000 1,300,000 250,000

3,400,000 (1,570,000) $3,930,000

Accounts payable Bank loan Bonds payable Preferred shares Common shares Retained earnings Total

$260,000 2,226,000 187,800 0 597,000 584,000 $3,854,800

$80,000 2,850,000 185,000 15,000 450,000 350,000 $3,930,000

Additional information: 1. Preferred shares were converted to common shares during the year at their book value. 2. The face value of the bonds is $200,000; they pay a coupon rate of 6% per annum. The effective interest rate of interest is 8% per annum. 3. Net income was $290,000. 4. There was an ordinary stock dividend valued at $12,000 and cash dividends were also paid. 5. Interest expense for the year was $130,000. Income tax expense was $116,000. 6. Fesone arranged for a $200,000 bank loan to finance the purchase of the investment at amortized cost. 7. Fesone has adopted a policy of reporting cash flows arising from the payment of interest and dividends as operating and financing activities, respectively. 8. The investment at FVPL is held for trading purposes. Required: a. Prepare a statement of cash flows for the year ended December 31, 2026, using the indirect method. b. Discuss how the transaction(s) above that are not reported on the statement of cash flows are reported in the financial statements.

Answer: a. (Investment at FVPL is held for trading purposes.) Fesone Inc. Statement of Cash Flows Year Ended December 31, 2026 Cash flow from operating activities Explanation Net income $290,000 Adjustments for: Depreciation 1 290,000 Interest expense 130,000 Income tax expense 116,000 Decrease in accounts receivable 150,000 Increase in accounts payable 180,000 Increase in inventory (160,000) Purchase of investment at FVPL held-for-trading (400,000) Cash generated from operating activities 596,000 Interest paid 2 (127,200) Incomes taxes paid (116,000) Net cash from operating activities

$352,800

Cash flow from investing activities Purchase of investment at amortized cost Cash used in investing activities

(150,000)

Cash flow from financing activities Bank loan Bank loan repayment Issuance of ordinary shares Cash dividends Cash used in financing activities Net decrease in cash Cash, January 1, 2023 Cash, December 31, 2023

(150,000)

3 4 5

200,000 (824,000) 120,000 (44,000)

(548,000) (354,200) 550,000 $204,800

Explanations 1. $1,860,000 closing accumulated depreciation – $1,570,000 opening accumulated depreciation = $290,000 depreciation for the year. 2. $130,000 interest expense – $2,800 decrease in the discount on bonds payable ($187,800 – $185,000) = $127,200 interest paid. 3. It is instructive to use a T-account to help determine the bank loans repaid during the year: Bank loans Opening Balance New borrowing Solve for repayment Closing balance 4. Using a T-account Opening Balance Conversion of preferred shares Stock dividend Solve for new issue Closing balance

2,850,000 200,000 824,000 2,226,000

Ordinary shares 450,000 15,000 12,000 120,000 597,000

5. Using a T-account Opening Balance Net income Stock dividend Solve for cash dividend Closing balance

Retained earnings 350,000 290,000 12,000 44,000 584,000

b. The following transactions are non-cash transactions and would not appear on the cash flow statement, but would appear in a note to the financial statements: • Preferred shares were converted to common shares. • There was an ordinary stock dividend valued at $12,000. • Fesone arranged for a $200,000 bank loan to finance the purchase of the investment at amortized cost. Diff: 3 Type: ES Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

14) Financial information for Fesone Inc.'s balance sheet for fiscal 2026 and 2025 follows:

Cash Accounts receivable Inventory Investments at FVPL Investments at amortized cost Property, plant, and equipment Accumulated depreciation Total

2026 $32,300 1,670,000 710,000 350,000 150,000 4,000,000 (1,935,000) $4,977,300

2025 $350,000 1,800,000 450,000 0 0 4,000,000 (1,660,000) $4,940,000

Accounts payable Bank loan Bonds payable Preferred shares Common shares Retained earnings Total

$220,000 2,601,000 595,300 0 473,000 1,088,000 $4,977,300

$40,000 3,000,000 590,000 20,000 350,000 940,000 $4,940,000

Additional information: 1. Preferred shares were converted to common shares during the year at their book value. 2. The face value of the bonds is $600,000; they pay a coupon rate of 6% per annum. The effective interest rate of interest is 7% per annum. 3. Net income was $205,000. 4. There was an ordinary stock dividend valued at $13,000 and cash dividends were also paid. 5. Interest expense for the year was $115,000. Income tax expense was $61,500. 6. Fesone arranged for a $425,000 bank loan to finance the purchase of the investment at amortized cost. 7. Fesone has adopted a policy of reporting cash flows arising from the payment of interest and dividends as operating and financing activities, respectively. 8. The investment at FVPL is held for trading purposes. 9. Sales = $2,000,000; cost of goods sold = $300,000; sales and administration expenses = $1,043,500 Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the direct method. b. Explain the difference between the direct method and the indirect method.

Answer: a.

Fesone Inc. Statement of Cash Flows (Partial) Year Ended December 31, 2026

Cash flow from operating activities Cash receipts from customers ($2,000,000 sales + $130,000 decrease in AR) Cash paid to suppliers ($300,000 COGS $180,000 increase in AP + $260,000 increase in inventory) Sales and administration expenses Cash generated from operating activities Purchase of investment at FVPL Interest paid (see below) Income taxes paid Net cash from operating activities

$2,130,000

(380,000) (1,043,500) 706,500 (350,000) (109,700) (61,500) $185,300

$115,000 interest expense - $5,300 decrease in the discount on bonds payable ($595,300 - $590,000) = $109,700 interest paid. b. The difference between the direct and indirect methods relates to the composition of the information explaining "Net cash from (used in) operating activities." The total cash reported will be the same under the two formats. Moreover, "Net cash from (used in) investing activities" and "Net cash from (used in) financing activities" is identical under both approaches. Diff: 3 Type: ES Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

15) Financial information for Flagstone Inc.'s balance sheet for fiscal 2026 and 2025 follows:

Cash Accounts receivable Inventory Investments at FVPL Investments at amortized cost Property, plant, and equipment Accumulated depreciation Total

2026 $35,000 1,700,000 800,000 400,000 200,000 5,500,000 (1,800,000) $6,835,000

2025 $400,000 1,900,000 500,000 0 0 5,000,000 (1,550,000) $6,250,000

Accounts payable Bank loan Bonds payable Preferred shares Common shares Retained earnings Total

$200,000 3,400,000 595,000 10,000 800,000 1,830,000 $6,835,000

$60,000 3,200,000 590,000 50,000 750,000 1,600,000 $6,250,000

Additional information: 1. Preferred shares were converted to common shares during the year at their book value. 2. The recorded increase in the bonds payable account was due to the amortization of the discount. 3. Net income was $318,000. 4. There was a common stock dividend valued at $20,000 and cash dividends were also paid. 5. Interest expense for the year was $95,000. Income tax expense was $57,000. 6. Flagstone arranged for a $500,000 bank loan to finance the purchase of the equipment. 7. Flagstone has adopted a policy of reporting cash flows arising from the payment of interest and dividends as operating and financing activities, respectively. 8. The investment at FVPL is held for trading purposes. 9. Sales = $1,900,000; cost of goods sold = $450,000; sales and administration expenses = $980,000 (includes depreciation expense) Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the direct method. b. Prepare the cash flows from operating activities section of the statement of cash flows using the indirect method. c. Compare and contrast the cash flows from operating activities using the direct method (a) and the indirect method (b). Which statement provides investors and other users of the financial statements with more useful information? Why?

Answer: a. Direct method:

Flagstone Inc. Statement of Cash Flows Year Ended December 31, 2026

Cash flow from operating activities Cash receipts from customers (1) Cash paid to suppliers (2) Sales and admin expenses (3) Cash generated from operating activities Purchase of investment at FVPL Interest paid (4) Income taxes paid Net cash used in operating activities

$2,100,000 (610,000) (730,000) 760,000 (400,000) (90,000) (57,000) $213,000

(1) $1,900,000 (sales) + $200,000 (decrease in AR) (2) $450,000 (COGS) - $140,000 (increase in AP) + $300,000 (increase in inventory) (3) $980,000 (S&A) - $250,000 (dep. expense) (4) $95,000 (interest expense) - $5,000 (decrease in the discount on bonds payable) b. Indirect method: Flagstone Inc. Statement of Cash Flows Year Ended December 31, 2026 Cash flow from operating activities Net income Adjustments for: Depreciation expense Interest expense Income tax expense Decrease in accounts receivable Increase in accounts payable Increase in inventory Purchase of investment at FVPL Cash generated from operating activities Interest paid (1) Income taxes paid Net cash used in operating activities

$318,000 250,000 95,000 57,000 200,000 140,000 (300,000) (400,000) 360,000 (90,000) (57,000) $213,000

(1) $95,000 (interest expense) - $5,000 (decrease in the discount on bonds payable)

c. The net cash from operating activities is the same under both methods. The indirect method starts with net income and then systematically adjusts the company's accrual-based financial statements to cashbased statements. For example, depreciation expense is added back to net income as it is a non-cash expense. In contrast, the direct method specifically identifies cash inflows and outflows from identified activities, for example sales. Statements prepared using the direct method provide more useful information as the reader can clearly see how much cash was generated from sales; how much cash was paid to suppliers; how much cash was paid to meet operating expenses; and so on. Diff: 3 Type: ES Skill: Comp Objective: 20.4 Describe the difference between the direct and indirect methods of calculating cash flows from operating activities.

Learning Objective 5 Prepare a statement of cash flows using both the direct and indirect methods. 1) Which statement is true? A) Stock splits and dividends are non-cash transactions. They are not recorded on the SCF. B) Cash flows from the purchase and sale of treasury shares are reported as an investing activity. C) OCI is normally reported in the financing section of the SCF. D) Cash flows from discontinued operations would never be reported in the investing section of the SCF regardless of their nature. Answer: A Diff: 2 Type: MC Skill: Concept Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods. 2) Which statement is correct? A) Cash flows are grouped by operating, investing and financing activities. B) Cash inflows and outflows are netted against each other. C) Net interest received or paid can be offset in the cash flow statement. D) Income tax paid does not need to be disclosed. Answer: A Diff: 1 Type: MC Skill: Concept Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods. 3) How do companies account for allowance for doubtful accounts on the cash flow statement? Answer: Companies often report receivables at the gross amount less an allowance. To obtain the amount of operating cash flow, the indirect method simply adjusts for the change in the net receivables. For the direct method of presentation, the two elements are dealt with separately. Cash receipts from customers = sales - increase in gross accounts receivables - write offs, or alternatively, cash receipts from customers = sales -change in net receivables - bad debt expense. Diff: 2 Type: SA Skill: Concept Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

4) How are cash flows from discontinued operations shown in the statement of cash flows? Answer: Cash flows from discontinued operations are shown separately in the operating, investing, and financing sections of the Statement of Cash Flows according to their nature. Alternatively, as per paragraph 33(c) of IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, this information may be disclosed in the notes to the financial statements. Diff: 2 Type: SA Skill: Concept Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods. 5) How is other comprehensive income (OCI) shown on the statement of cash flows (SCF)? Answer: OCI is not normally reported on the SCF. OCI does not affect cash since it records only unrealized gains and losses on select items. If companies use comprehensive income as a starting point in the indirect method, the components of other comprehensive income are shown as reversing items in the cash flows arising from operating activities. Diff: 2 Type: SA Skill: Concept Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

6) Green Leaf's activities for the year ended December 31, 2026, included the following: • Comprehensive income totaled $538,000 including $88,000 in other comprehensive income. • Paid a cash dividend of $80,000 that was declared in 2025. • Interest expense for the year was $29,000; the opening and closing balances in the interest payable account were $26,000 and $17,000, respectively. • Accounts receivable increased $33,000 and accounts payable decreased $24,000 during the year. • The company paid $56,000 cash for equipment. • The company sold an investment at amortized cost for $26,000. The book value of the investment was $27,000. • Depreciation expense for the year totaled $19,000. • Suffered an impairment loss on patents of $10,000. • Declared and issued a 2-for-l stock split. There were 400,000 ordinary shares outstanding before the split with a collective market value of $100,000,000. Required: Prepare the cash flows from operating activities section of the statement of cash flows using the indirect method assuming that the company's policy is to report interest and dividends received as an investing activity and interest and dividends paid as a financing activity. Answer: Green Leaf Statement of Cash Flows (Partial) Year Ended December 31, 2026 Cash flows from operating activities Comprehensive income Less: Other comprehensive income Net income Adjustments for: Depreciation Loss on sale of an investment at amortized cost Impairment loss–patent Increase in accounts receivable Decrease in accounts payable Cash generated from operating activities

$538,000 (88,000) 450,000 19,000 1,000 10,000 (33,000) (24,000) $423,000

Note that while interest paid can also be classified as an operating activity, the company has adopted a policy of reporting interest and dividend payments as financing activities. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

7) Green Leaf's activities for the year ended December 31, 2026 included the following: • Comprehensive income totaled $538,000 including $88,000 in other comprehensive income. • Paid a cash dividend of $80,000 that was declared in 2025. • Interest expense for the year was $29,000; the opening and closing balances in the interest payable account were $26,000 and $17,000, respectively. • Accounts receivable increased $33,000 and accounts payable decreased $24,000 during the year. • The company paid $56,000 cash for equipment. • The company sold an investment at amortized cost for $26,000. The book value of the investment was $27,000. • Depreciation expense for the year totaled $19,000. • Suffered an impairment loss on patents of $10,000. • Declared and issued a 2-for-l stock split. There were 400,000 ordinary shares outstanding before the split with a collective market value of $100,000,000. Required: Prepare the cash flows from operating activities section of the statement of cash flows using the indirect method assuming that the company's policy is to report interest received and paid and dividends paid as an operations activity. Answer: Green Leaf Statement of Cash Flows (Partial) Year Ended December 31, 2026 Cash flows from operating activities Comprehensive income Less: Other comprehensive income Net income Adjustments for: Depreciation Loss on sale of an investment at amortized cost Impairment loss–patent Increase in accounts receivable Decrease in accounts payable Cash generated from operating activities Interest paid* [-$29,000 - ($26,000 - $17,000)] Dividends paid* Net cash from operating activities *Note that while interest received and dividends paid can also be recorded as investing and financing activities, respectively, the company has adopted a policy of reporting these transactions as operating activities.

$538,000 (88,000) 450,000 19,000 1,000 10,000 (33,000) (24,000) 423,000 (38000) (80,000) $305,000

8) Reuse It Inc.'s (RII) policy is to report all cash flows arising from interest and dividends in the operating section. The company's activities for the year ended December 31, 2026 included the following: • Comprehensive income totaled $468,000 including $88,000 in other comprehensive income. • Paid a cash dividend of $30,000 that was declared in 2025. • Interest expense for the year was $14,000; the opening and closing balances in the interest payable account were $28,000 and $19,000, respectively. • Accounts receivable increased $63,000 and accounts payable decreased $19,000 during the year. • RII paid $51,000 cash for equipment. • RII sold an investment at amortized cost for $36,000. The book value of the investment was $39,000. • Depreciation expense for the year totaled $9,000. • Suffered an impairment loss on patents of $1 0,000. • Declared and issued a 2-for-l stock split. There were 20,000 ordinary shares outstanding before the split with a collective market value of $3,000,000. Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the indirect method. b. Identify how the activities detailed above that are not operating activities would be reported in the statement of cash flows.

Answer: a.

Reuse It Inc. Statement of Cash Flows (Partial) Year Ended December 31, 2026

Cash flows from operating activities Comprehensive income Less: Other comprehensive income Net income Adjustments for: Depreciation Loss on sale of an investment at amortized cost Impairment loss–patent Increase in accounts receivable Decrease in accounts payable Cash generated from operating activities Interest paid* [-$14,000 - ($28,000 - 19,000)] Dividends paid* Net cash from operating activities *Note that while interest received and dividends paid can also be recorded as investing and financing activities, respectively, the company has adopted a policy of reporting these transactions as operating activities.

$468,000 (88,000) 380,000 9,000 3,000 10,000 (63,000) (19,000) 320,000 (23,000) (30,000) $267,000

b. • The cash paid for equipment is reported as a cash outflow in the investing section. • The cash proceeds from the sale of the investment at amortized cost securities is reported as an increase in cash flows from investing section. • The stock split is a non-cash activity and is not reported on the statement of cash flows. Note disclosure is appropriate. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

9) Financial information for Fesone Inc.'s balance sheet for fiscal 2025 and 2026 follows:

Cash Accounts receivable Inventory Investments at FVPL Investments at amortized cost Property, plant, and equipment Accumulated depreciation Total

2026 $204,800 1,150,000 410,000 400,000 150,000 3,400,000 (1,860,000) $3,854,800

2025 $550,000 1,300,000 250,000

3,400,000 (1,570,000) $3,930,000

Accounts payable Bank loan Bonds payable Preferred shares Common shares Retained earnings Total

$260,000 2,226,000 187,800 0 597,000 584,000 $3,854,800

$80,000 2,850,000 185,000 15,000 450,000 350,000 $3,930,000

Additional information: 1. Preferred shares were converted to common shares during the year at their book value. 2. The face value of the bonds is $200,000; they pay a coupon rate of 6% per annum. The effective interest rate of interest is 8% per annum. They are reported at amortized cost. 3. Net income was $290,000. 4. There was an ordinary stock dividend valued at $12,000 and cash dividends were also paid. 5. Interest expense for the year was $130,000. Income tax expense was $116,000. 6. Fesone arranged for a $200,000 bank loan to finance the purchase of the investments at amortized cost. 7. Fesone has adopted a policy of reporting cash flows arising from the payment of interest and dividends as operating and financing activities, respectively. 8. The investment at FVPL is held to meet short-term cash commitments. Required: a. Prepare a statement of cash flows for the year ended December 31, 2026, using the indirect method. b. Discuss how the transaction(s) above that are not reported on the statement of cash flows are reported in the financial statements.

Answer: a.

Fesone Inc. Statement of Cash Flows Year Ended December 31, 2026 (Investment at FVPL held to meet short-term cash commitments)

Cash flow from operating activities Net income Adjustments for: Depreciation Interest expense Income tax expense Decrease in accounts receivable Increase in accounts payable Increase in inventory Cash generated from operating activities Interest paid Incomes taxes paid Net cash from operating activities

Explanation $290,000 1

Cash flow from investing activities Purchase of investments at amortized cost Cash used in investing activities Cash flow from financing activities Bank loan Bank loan repayment Issuance of ordinary shares Cash dividends Cash used in financing activities Net increase in cash Cash, January 1, 2026 Cash, December 31, 2026

290,000 130,000 116,000 150,000 180,000 (160,000) 996,000 (127,200) (116,000)

(150,000)

3 4 5

200,000 (824,000) 120,000 (44,000)

$752,800

(150,000)

(548,000) 54,800 550,000 $604,800

Explanations 1. $1,860,000 closing accumulated depreciation - $1,570,000 opening accumulated depreciation = $290,000 depreciation for the year. 2. $130,000 interest expense -$2,800 decrease in the discount on bonds payable ($187,800 - $185,000) = $127,200 interest paid. 3. It is instructive to use a T-account to help determine the bank loans repaid during the year: Bank loans Opening Balance New borrowing Solve for repayment Closing balance 4. Using a T-account Opening Balance Conversion of preferred shares Stock dividend Solve for new issue Closing balance

2,850,000 200,000 824,000 2,226,000

Ordinary shares 450,000 15,000 12,000 120,000 597,000

5. Using a T-account Opening Balance Net income Stock dividend Solve for cash dividend Closing balance

Retained earnings 350,000 290,000 12,000 44,000 584,000

6. Total cash for 2026 includes the cash balance of $200,000 and FVPL investment of $400,000. b. All non-cash transactions do not appear on the cash flow statement, but in a note to the financial statements. Diff: 3 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

10) ABC Inc.'s policy is to report all cash flows arising from interest and dividends in the operating activities section. The company's activities for the year ended December 31, 2025, included the following: • Net income after taxes totaled $400,000. • The company recorded a $4000 goodwill impairment loss during the year. • Depreciation expense for the year was $24,000. • Declared and issued a stock dividend valued at $10,000. • Accounts receivable increased $33,000 in the year. • Sold an investment at FVPL for $23,000. The book value was $18,000. The investment was held for trading purposes. • Interest revenue for the period was $6,000. The interest receivable account decreased $4,000. • Declared a $10,000 dividend payable. The dividends payable account decreased $19,000 in the year. • Sold an investment at FVOCI for $19,000. The original cost was $14,000. Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the indirect method. b. Identify how the activities listed above that are not operating activities would be required in the statement of cash flows.

Answer: a.

ABC Inc. Statement of Cash Flows (partial) Year Ended December 31, 2025

Cash flows from operating activities Net income Adjustments for: Depreciation Gain on sale of investments at FVPL Gain on sale of investments at FVOCI Goodwill impairment loss Decrease in account receivable Sales of investment at FVPL held-for-trading Cash generated from operating activities Interest received ($6,000 + $4,000)* Dividends paid (-$10,000 - $19,000)*

$400,000 24,000 (5,000) (5,000) 4,000 (33,000) 23,000 408,000 10,000 (29,000) $389,000

* Note that while interest received and dividends paid can also be recorded as investing and financing activities, respectively, the company has adopted a policy of reporting these transactions as operating activities. b. • The stock dividend is a non-cash activity and is not reported on the statement of cash flows. Note disclosure is appropriate. • The sale of the investment at FVOCI is reported as an increase in the cash flows from investing section. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

11) Katie Ltd.'s policy is to report all cash flows arising from interest and dividends in the operating section. Katie's activities for the year ended December 31, 2026, included the following: • Income tax expense for the year was $30,000. • Sales for the year were $1,030,000. • Accounts payable decreased $20,000 in 2026. • Selling and administration expenses for the year totaled $240,000. • Accounts receivable decreased $36,000 in 2026. • Mamie's cost of goods sold in 2026 was $315,000. • Mamie's inventory increased $13,000 during the year. • Interest expense for the period was $12,000. The interest payable account increased $5,000. • Dividends were not declared during the year; however, the dividends payable account increased $5,000. • Sold an investment at FVOCI for $45,000. The original cost was $52,000. • Depreciation expense for the year was $19,000. Required: a. Prepare the cash flows from operating activities section of the statement of cash flows using the direct method. b. Identify how the activities listed above that are not operating activities would be reported in the statement of cash flows.

Answer: a. Katie Ltd. Statement of Cash Flows (partial) Year Ended December 31, 2026 Cash flow from operating activities Cash receipts from customers (1) Cash paid to suppliers (2) Selling and administrative expenses paid Cash generated from operating activities Interest paid* (3) Income taxes paid Dividends paid* Net cash from operating activities

$ 1,066,000 (348,000) (240,000) 478,000 (7,000) (30,000) 5,000 $ 446,000

* Note that while interest paid and dividends paid can also be recorded as a financing activity, the company has adopted a policy of reporting this type of transaction as an operating activity. (1) $1,030,000 sales - (-$36,000 increase in AR) (2) -$315,000 COGS + (-$13,000 increase in inventory) - $20,000 decrease in AP (3) -$12,000 interest expense + $5,000 increase in interest payable account b. • The sale of the investment at FVOCI will be reported as a cash inflow from investing. The loss on sale does not involve cash and is not reported on the statement of cash flows prepared using the direct method. • Depreciation expense does not involve cash and is not reported on the statement of cash flows prepared using the direct method. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

12) Rusabh Ltd.'s policy is to report all cash flows arising from interest and dividends in the operating section. Rusabh's activities for the year ended December 31, 2026, included the following: • Sold an investment at FVPL for $16,000. The book value of this investment, which was held for trading purposes, was $13,000. • Purchased an investment at FVOCI for $51,000. • Borrowed $100,000 from the bank for investment purposes. • Sold equipment for $23,000 that originally cost $55,000. The net book value of this item at time of sale was $35,000. • Purchased inventory costing $84,000 for cash. • Received $8,000 in interest and $5,500 in dividends on sundry investments. • Acquired the right to use forklift costing $32,000 under a lease agreement. • Acquired land and buildings valued at $100,000 by issuing ordinary shares. • Bought $400,000 in bonds at a discount, paying $375,000 cash. The bonds were reported at amortized cost. Required: a. Prepare the cash flows from investing activities section of the statement of cash flows. b. Identify how the activities listed above that are not investing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method.

Answer: a.

Rusabh Ltd. Statement of Cash Flows (partial) Year Ended December 31, 2026

Cash flows from investing activities Purchase of investment at FVOCI Sales of equipment Purchase of bonds at amortized cost Net cash from (used in) investing activities

$(51,000) 23,000 (375,000)

$(403,000)

b. • The sale of the investment at FVPL is reported as a cash inflow in the operating activities section. The gain on sale will be deducted from net income in the operating activities section (indirect method). • The loan is recorded as a cash inflow from financing. • The loss on sale of equipment will be added back to net income in the operating activities section (indirect method). • The inventory purchase will decrease cash from operating activities. • The receipt of interest and dividend income is reported as an increase in cash from operating activities. Note that while the receipt of interest and dividends received can also be classified as an investing activity, Rusabh has adopted a policy of reporting interest and dividend activities as operating activities. • The acquisition of the right to use the forklift is a non-cash activity and is not reported on the statement of cash flows. Material non-cash transactions are reported in the notes to the financial statements. • The acquisition of the land and buildings is a non-cash activity. Material non-cash transactions are reported in the notes to the financial statements. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

13) Soorya Law Ltd.'s policy is to report all cash inflows from interest and dividends in the investing section and cash outflows arising from interest and dividends in the financing section. Soorya Law's activities for the year ended December 31, 2024, included the following: • Sold an investment at FVPL for $11,000. The book value of this investment, which was held to meet short-term cash commitments, was $11,000. • Sold an investment at FVOCI for $27,000. The cost of the investment was $27,000. • Borrowed $120,000 from the bank for investment purposes. • Sold equipment for $63,000 that originally cost $80,000. The net book value of this item at time of sale was $54,000. • Received $5,000 in interest and $5,000 in dividends on sundry investments. • Paid $4,000 interest on the investment loan. • Acquired land and buildings valued at $450,000 by paying $150,000 cash and issuing ordinary shares for the balance. • Bought $350,000 in bonds at a premium, paying $305,000 cash. Required: a. Prepare the cash flows from investing activities section of the statement of cash flows. b. Identify how the activities listed above that are not investing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method.

Answer: a.

Soorya Law Ltd. Statement of Cash Flows (partial) Year Ended December 31, 2024

Cash flows from investing activities Sales of investment at FVOCI Sales of equipment Investment income * ($5,000 + $5,000) Purchase of land and buildings Purchase of bonds Net cash from (used in) investing activities

$ 27,000 63,000 10,000 (150,000) (305,000) $(355,000)

*Note that while interest and dividends received can also be classified as an operating activity, Soorya Law has adopted a policy of reporting interest and dividend income as investment activities. b. • The sale of the investment at FVPL is not reported on the statement of cash flows as it is a cash equivalent. • The loan is recorded as a cash inflow from financing. • The gain on sale of equipment will be subtracted from net income in the operating activities section (indirect method). • The payment of interest is recorded as a cash outflow from financing. Note that while interest paid can also be designated as an operating activity, Soorya Law has adopted a policy of reporting interest paid as a financing activity. • The acquisition of the land and buildings was only partially settled in cash. The remaining amount settled by issuing ordinary shares is a non-cash activity. Material non-cash transactions are reported in the notes to the financial statements. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

14) Boboto Inc.'s policy is to report all cash flows arising from interest and dividends in the operating section. Boboto's activities for the year ended December 31, 2026, included the following: • Declared and issued a stock dividend valued at $50,000. • Paid $46,000 to repurchase ordinary shares and cancelled them. The book value was $33,000. • Accounts payable decreased $23,000 during the year. • Issued $1,500,000 in bonds. The cash proceeds were $1,410,000. • Interest expense for the period was $10,000. The interest payable account decreased $4,000. • Made a $75,000 principal payment on a bank loan. • Declared a $15,000 cash dividend payable on January 15, 2027. Required: a. Prepare the cash flows from financing activities section of the statement of cash flows. b. Identify how the activities listed above that are not financing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method. Answer: a. Boboto Inc. Statement of Cash Flows (partial) Year Ended December 31, 2026 Cash flows from financing activities Repurchase of ordinary shares Principal reduction of bank loan Sale of bonds Net cash from financing activities

$(46,000) (75,000) 1,410,000

$1,289,000

b. • The stock dividend is a non-cash activity and is not reported on the statement of cash flows. Note disclosure is appropriate. • The loss on repurchase of shares is a non-cash item and is not reported on the statement of cash flows. As this is a capital transaction, this amount is deducted directly from equity and does not flow through the income statement. Hence, this amount will be used to explain the change in equity. • The decrease in accounts payable is reported as a decrease in cash from operating activities. • The interest paid (interest expense + change in interest payable) is reported as a decrease in cash from operating activities. Note that while interest paid can also be classified as a financing activity, Boboto has adopted a policy of reporting interest and dividend activities as operating activities. • The declaration of the dividend is not reported on the statement of cash flows as it was not paid in 2026. Rather, this amount is used to explain the change in retained earnings during the year. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

15) George Corp.'s policy is to report all cash inflows from interest and dividends in the investing section and cash outflows arising from interest and dividends in the financing section. Angela's activities for the year ended December 31, 2024, included the following: • Declared a $12,000 cash dividend payable on January 15, 2025. • Acquired the right to use an automobile costing $30,000 under a lease agreement. • Declared and issued a stock dividend valued at $15,000. • Issued $330,000 in ordinary shares. • Accounts payable increased $18,000 during the year. • Paid $980,000 to repurchase bonds. The book value of the bonds was $1,010,000. • Made a $15,000 principal payment on a bank loan. • Interest expense for the period was $8,000. The interest payable account increased $2,000. Required: a. Prepare the cash flows from financing activities section of the statement of cash flows. b. Identify how the activities listed above that are not financing activities would be reported in the statement of cash flows assuming that the statement is prepared using the indirect method. Answer: a. George Corp. Statement of Cash Flows (partial) Year Ended December 31, 2024 Cash flows from financing activities Sale of ordinary shares Repurchase of bonds Principal reduction of bank loan Interest expense (-$8,000 + $2,000)* Net cash from (used in) financing activities

$330,000 (980,000) (15,000) (6,000)

$671,000

* Note that while interest paid can also be classified as an operating activity, George's has adopted a policy of reporting interest and dividend paid as financing activities. b. • The stock dividend is a non-cash activity and is not reported on the statement of cash flows. Note disclosure is appropriate. • The increase in accounts payable is reported as an increase in cash from operating activities. • The loss on repurchase of bonds will be added back to net income in the operating activities section (indirect method). • The declaration of the dividend is not reported on the statement of cash flows as it was not paid in 2024. Rather, this amount is used to explain the change in retained earnings during the year. • The acquisition of the automobile is a non-cash activity and is not reported on the statement of cash flows. Material non-cash transactions are reported in the notes to the financial statements. Diff: 2 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

16) Reuse It Inc.'s activities for the year ended December 31, 2027, included the following: • Comprehensive income totaled $468,000 including $88,000 in other comprehensive income. • Paid a cash dividend of $30,000 that was declared in 2026. • Interest expense for the year was $14,000; the opening and closing balances in the interest payable account were $28,000 and $19,000, respectively. • Accounts receivable increased $63,000 and accounts payable decreased $19,000 during the year. • RII paid $51,000 cash for equipment. • RII sold an investment at amortized cost for $36,000. The book value of the investment was $39,000. • Depreciation expense for the year totaled $9,000. • Suffered an impairment loss on patents of $10,000. • Declared and issued a 2-for-l stock split. There were 20,000 ordinary shares outstanding before the split with a collective market value of $3,000,000. Required: Prepare the cash flows from operating activities section of the statement of cash flows using the indirect method, assuming that the company's policy is to report interest and dividends received as an investing activity, and interest and dividends paid as a financing activity. Answer: Reuse It Inc. Statement of Cash Flows (partial) Year Ended December 31, 2027 Cash flows from operating activities Comprehensive income Less: Other comprehensive income Net income Adjustments for: Depreciation Loss on sales of investment at amortized cost Impairment loss - patent Increase in accounts receivable Decrease in accounts payable Cash generated from operating activities

$468,000 (88,000) 380,000 9,000 3,000 10,000 (63,000) (19,000) $320,000

17) Financial information for Flagstone Inc.'s balance sheet for fiscal 2026 and 2025 follows:

Cash Accounts receivable Inventory Investments at FVPL Investments at amortized cost Property, plant, and equipment Accumulated depreciation Total

2026 $35,000 1,700,000 800,000 400,000 200,000 5,500,000 (1,800,000) $6,835,000

2025 $400,000 1,900,000 500,000 0 0 5,000,000 (1,550,000) $6,250,000

Accounts payable Bank loan Bonds payable Preferred shares Common shares Retained earnings Total

$200,000 3,400,000 595,000 10,000 800,000 1,830,000 $6,835,000

$60,000 3,200,000 590,000 50,000 750,000 1,600,000 $6,250,000

Additional information: 1. Preferred shares were converted to common shares during the year at their book value. 2. The recorded increase in the bonds payable account was due to the amortization of the discount. 3. Net income was $318,000. 4. There was a common stock dividend valued at $20,000 and cash dividends were also paid. 5. Interest expense for the year was $95,000. Income tax expense was $57,000. 6. Flagstone arranged for a $500,000 bank loan to finance the purchase of the equipment. 7. Flagstone has adopted a policy of reporting cash flows arising from the payment of interest and dividends as operating and financing activities, respectively. 8. The investment at FVPL is held for trading purposes. 9. Sales = $1,900,000; cost of goods sold = $450,000; sales and administration expenses = $980,000 (includes depreciation expense). Required: Prepare a statement of cash flows for the year ended December 31, 2026, using the direct method.

Answer: Flagstone Inc. Statement of Cash Flows Year Ended December 31, 2026 Cash flow from operating activities Cash receipts from customers (1) Cash paid to suppliers (2) Sales and admin expenses (3) Cash generated from operating activities Purchase of an investment at FVPL Interest paid (4) Income taxes paid Net cash used in operating activities Cash flow from investing activities Purchase of an investment at amortized cost Purchase of property, plant, and equipment Net cash used in investing activities Cash flow from financing activities Bank loan Bank loan repayment (5) Purchase of common shares (6) Cash dividends (7) Net cash from financing activities Net increase (decrease) in cash Cash, January 1, 2026 Cash, December 31, 2026

$ 2,100,000 (610,000) (730,000) 760,000 (400,000) (90,000) (57,000) $ 213,000 (200,000) (500,000) (700,000) 500,000 (300,000) (10,000) (68,000) 122,000 (365,000) 400,000 $ 35,000

(1) $1,900,000 (sales) + $200,000 (decrease in AR) (2) $450,000 (COGS) - $140,000 (increase in AP) + $300,000 (increase in inventory) (3) $980,000 (S&A) - $250,000 (dep. expense) (4) $95,000 (interest expense) - $5,000 (decrease in the discount on bonds payable) (5) Using a T-account Bank loans Opening Balance 3,200,000 New borrowing 500,000 Solve for repayment 300,000 Closing balance 3,400,000 (6) Using a T-account Common shares Opening Balance Conversion of preferred shares Stock dividend Solve for purchase Closing balance

(7) Using a T-account Opening Balance Net income Stock dividend Solve for cash dividend Closing balance

Retained earnings 1,600,000 318,000 20,000 68,000 1,830,000

Diff: 3 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

18) Financial information for Flagstone Inc.'s balance sheet for fiscal 2026 and 2025 follows:

Cash Accounts receivable Inventory Investments at FVPL Investments at amortized cost Property, plant, and equipment Accumulated depreciation Total

2026 $35,000 1,700,000 800,000 400,000 200,000 5,500,000 (1,800,000) $6,835,000

2025 $400,000 1,900,000 500,000 0 0 5,000,000 (1,550,000) $6,250,000

Accounts payable Bank loan Bonds payable Preferred shares Common shares Retained earnings Total

$200,000 3,400,000 595,000 10,000 800,000 1,830,000 $6,835,000

$60,000 3,200,000 590,000 50,000 750,000 1,600,000 $6,250,000

Additional information: 1. Preferred shares were converted to common shares during the year at their book value. 2. The recorded increase in the bonds payable account was due to the amortization of the discount. 3. Net income was $318,000. 4. There was a common stock dividend valued at $20,000 and cash dividends were also paid. 5. Interest expense for the year was $95,000. Income tax expense was $57,000. 6. Flagstone arranged for a $500,000 bank loan to finance the purchase of the equipment. 7. Flagstone has adopted a policy of reporting cash flows arising from the payment of interest and dividends as operating and financing activities, respectively. 8. The investment at amortized cost is held for trading purposes. 9. Sales = $1,900,000; cost of goods sold = $450,000; sales and administration expenses = $980,000 (includes depreciation expense) Required: Prepare a statement of cash flows for the year ended December 31, 2026, using the indirect method.

Answer: Flagstone Inc. Statement of Cash Flows Year Ended December 31, 2026 Cash flow from operating activities Net income Adjustments for: Depreciation expense Interest expense Income tax expense Decrease in accounts receivable Increase in accounts payable Increase in inventory Purchase of an investment at FVPL Cash generated from operating activities Interest paid (1) Income taxes paid Net cash used in operating activities Cash flow from investing activities Purchase of an investment at amortized cost Purchase of property, plant, and equipment Net cash used in investing activities Cash flow from financing activities Bank loan Bank loan repayment (2) Purchase of common shares (3) Cash dividends (4) Net cash from financing activities Net increase (decrease) in cash Cash, January 1, 2026 Cash, December 31, 2026

$ 318,000 250,000 95,000 57,000 200,000 140,000 (300,000) (400,000) 360,000 (90,000) (57,000) $ 213,000 (200,000) (500,000) (700,000) 500,000 (300,000) (10,000) (68,000) 122,000 (365,000) 400,000 $ 35,000

(1) $95,000 (interest expense) - $5,000 (decrease in the discount on bonds payable) (2) Using a T-account Bank loans Opening Balance 3,200,000 New borrowing 500,000 Solve for repayment 300,000 Closing balance 3,400,000

(3) Using a T-account Opening Balance Conversion of preferred shares Stock dividend Solve for purchase Closing balance (4) Using a T-account Opening Balance Net income Stock dividend Solve for cash dividend Closing balance

Common shares 750,000 40,000 20,000 10,000 800,000

Retained earnings 1,600,000 318,000 20,000 68,000 1,830,000

Diff: 3 Type: ES Skill: Comp Objective: 20.5 Prepare a statement of cash flows using both the direct and indirect methods.

Comprehensive Question 1) Prepare the Statement of Cash Flows for Renoir Art Gallery Ltd for the year ended December 31, 2026, using the indirect method from the following income statement, comparative balance sheets, and supplemental information: Renoir Art Gallery Ltd. Income Statement For the Year Ended December 31, 2026 Sales Cost of sales Gross profit Other expenses Interest expense Depreciation expense Income before income taxes Income tax expense Net income before discontinued operations Discontinued operations, net of taxes ($100,000) Net income

$2,432,000 -1,756,000 676,000 -356,600 -80,000 -234,400 5,000 -2,000 3,000 283,100 $286,100

Renoir Art Gallery Ltd. Comparative Balance Sheet As at December 31, 2026 2026 Cash and cash equivalents $166,000 Accounts receivable 150,000 Inventory 580,000 Investments at FVPL 140,000 Current assets 1,036,000 Property, plant, and equipment at cost 1,984,000 Accumulated depreciation -650,400 Patents 690,000 Total assets $3,059,600 Liabilities Trade payables $93,000 Current liabilities 93,000 Bank loan 0 Bonds payable 670,500 Total liabilities 763,500 Shareholders' equity Ordinary shares 1,041,000 Retained earnings 1,255,100 Total shareholders' equity 2,296,100 Total liabilities and shareholders' equity $3,059,600

2025 $200,000 170,000 500,000 190,000 1,060,000 1,296,000 -587,000 552,000 $2,321,000

Change -$34,000 -20,000 80,000 -50,000 -24,000 688,000 -63,400 138,000 $738,600

$86,000 86,000 100,000 675,000 861,000

$7,000 7,000 -100,000 -4,500 -97,500

491,000 969,000 1,460,000 $2,321,000

550,000 286,100 836,100 $738,600

Supplemental information: • The decrease in bonds payable is due entirely to the amortization of the related premium. • Renoir's policy is to report interest and dividends paid as a cash outflow from operating activities. • The investments at FVPL are held for trading purposes. • $10,000 of held-for-trading investments were purchased during the year; none were sold. • Property, plant, and equipment costing $670,000 was sold for $422,000. • 100,000 ordinary shares (valued at $550,000) were exchanged as part of the acquisition cost of new property, plant, and equipment. The balance was paid in cash. • The $212,000 cost of successfully suing a competitor for patent infringement was capitalized during the year. • "Other Expenses" includes gains and losses on asset sales, holding losses, and patent amortization. • Cash was received or paid for all revenues and expenses other than those relating to inventories, sales, depreciation, and amortization. • Income from discontinued operations represents the operating profits of a plant that is in the process of being decommissioned. The recorded profit was received in cash. Required: 1. Prepare Renoir's statement of cash flows for the year ended December 31, 2026, using the indirect method, including disclosure of non-cash activities.

Answer:

Renoir Art Gallery Ltd. Statement of Cash Flow As at December 31, 2026 Cash Flows from operating activities References Net income from continuing operations Net income from discontinued operations 1 Adjustments for: Holding loss on investments at FVPL 6 Loss on sale of property, plant, and equipment 4, 9 Depreciation and amortization expense Interest expense Income tax expense—continuing operations Income tax expense—discontinued operations Subtotal Purchase of investment at FVPL held-fortrading Decrease in accounts receivable Increase in inventory Increase in trade payables Dividends paid Interest paid Income taxes paid—continuing operations Income taxes paid—discontinued operations Net cash from operating activities Cash flows from investing activities Purchase of property, plant, and equipment Sale of property, plant, and equipment Patent Net cash used in investing activities Cash flows from financing activities Retire bank loan Net cash from financing Net increase (decrease) in cash Cash, January 1, 2026 Cash, December 31, 2026

3, 8

7 5

$3,000 283,100 60,000 77,000 308,400 80,000 2,000 100,000 913,500 -10,000 20,000 -80,000 7,000 0 -84,500 -2,000 -100,000 $664,000 -808,000 422,000 -212,000 -598,000 -100,000 -100,000 -34,000 200,000 $166,000

1. Income and income taxes pertaining to discontinued operations must be separately disclosed. 2. Non-cash transactions relating to financing and investing activities must be disclosed. 3. $234,400 depreciation (PPE) + $74,000 amortization (patent) = $308,400. Depreciation is reported on the income statement, while amortization is determined using a T-account (see #8 below). 74 Copyright © 2023 Pearson Canada Inc.

4. Loss on sale = Sales proceeds − Net book value = $422,000 − ($670,000 − $171,000) = $77,000. The accumulated depreciation on the PPE sold is determined using a T-account (see #9 below). 5. Interest paid = Interest expense + Amortization of the bond premium = $80,000 + $4,500 = $84,500. Amortization of the bond premium is the change in the bonds payable balance from the comparative balance sheet. 6.

• Non-cash transactions are not reported on the statement of cash flows, but must be disclosed elsewhere in the financial statements Diff: 4 Type: ES Skill: Comp Objective: 20.6 Comprehensive Question

2) Financial information for Flagstone Inc.'s balance sheet for fiscal 2026 and 2025 follows:

Cash Accounts receivable Inventory Investments at FVPL Investments at amortized cost Property, plant, and equipment Accumulated depreciation Total

2026 $35,252 1,600,000 800,000 400,000 200,000 3,500,000 (1,800,000) $4,735,252

2025 $300,818 1,900,000 500,000 0 0 3,000,000 (1,550,000) $4,150,818

Accounts payable Bank loan Bonds payable Preferred shares Common shares Retained earnings Total

$200,000 1,400,000 ? 10,000 800,000 ? $4,735,252

$60,000 1,200,000 490,818 50,000 750,000 1,600,000 $4,150,818

Additional information: 1. Preferred shares were converted to common shares during the year at their book value. 2. Bonds payable - the coupon rate on the bonds is 6% per year, payable on June 30 and December 31. Flagstone sold the $500,000 three year bonds on January 1, 2025, for $486,679. 3. There was a common stock dividend valued at $20,000 and cash dividends were also paid. 4. Income tax expense was $57,000. 5. Flagstone arranged for a $500,000 bank loan to finance the purchase of the equipment in 2026. Interest paid and interest expense due to the bank loan were $60,566 in 2026. 6. Flagstone has adopted a policy of reporting cash flows arising from the payment of interest and dividends as operating and financing activities, respectively. 7. Investments - both investments were purchased on the last day of the year. The investment at FVPL is held for trading purposes. 8. Sales = $1,900,000; cost of goods sold = $450,000; and, sales and administration expenses = $980,000 (includes depreciation expense). Required: a. Determine the 2026 year-end balance of the bonds payable, interest expense, and interest paid. b. Prepare Flagstone's income statement for 2026. c. Prepare a statement of cash flows for the year ended December 31, 2026, using the indirect method.

Answer: a. Determining the effective interest rate for the period using a BAII PLUS financial calculator: 6N, 500,000 FV, 30000 PMT, 486,679 PV CPT I/Y I/Y = 3.5% (rounded) Amortization table for the bonds payable in 2026:

Date January 1, 2026 June 30, 2026 December 31, 2026 Totals

Interest expense

Discount amortization Amortized cost $490,818 $ 15,000 $2,179 492,997 15,000 2,255 495,252 30,000 4,434

Interest paid

$17,179 17,255 34,434

The bonds payable balance as of December 31, 2026: $495,252; Interest expense due to the bond during 2026: $34,434; Interest paid in 2026 due to the bond: $30,000 b. Flagstone Inc. Income Statement Year Ended December 31, 2026 Sales Cost of goods sold Gross profit Operating expenses Interest expense Income before income taxes Income tax expense Net income

$1,900,000 450,000 1,450,000 980,000 95,000 375,000 57,000 $318,000

Flagstone Inc. Statement of Cash Flows Year Ended December 31, 2026 Cash flow from operating activities Net income $318,000 Adjustments for: Depreciation expense 250,000 Interest expense 95,000 Income tax expense 57,000 Decrease in accounts receivable 300,000 Increase in accounts payable 140,000 Increase in inventory (300,000) Purchase of an investment at FVPL (400,000) Cash generated from operating activities 360,000 Interest paid (1) (90,566) Income taxes paid (57,000) Net cash used in operating activities Cash flow from investing activities Purchase of an investment at amortized cost (200,000) Purchase of property, plant, and equipment (500,000) Net cash used in investing activities Cash flow from financing activities Bank loan 500,000 Bank loan repayment (2) (300,000) Repurchase of common shares (3) (10,000) Cash dividends (4) (68,000) Net cash from financing activities Net increase (decrease) in cash Cash, January 1, 2026 Cash, December 31, 2026

$312,434

(700,000)

122,000 (265,566) 300,818 $35,252

(1) $95,000 (interest expense) - $4,434 (decrease in the discount on bonds payable) (2) Using a T-account Bank loans Opening Balance 3,200,000 New borrowing 500,000 Solve for repayment 300,000 Closing balance 3,400,000 (3) Using a T-account Opening Balance Conversion of preferred shares Stock dividend Solve for purchase Closing balance

(4) Using a T-account Opening Balance Net income Stock dividend Solve for cash dividend Closing balance

Retained earnings 1,600,000 318,000 20,000 68,000 1,830,000

Diff: 5 Type: ES Skill: Comp Objective: 20.6 Comprehensive Question