Understanding Financial Accounting, 3rd Canadian Edition, by Christopher D. Burnley TEST BANK by ACADEMIAMILL

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

corporations, whereas they are at risk in the case of proprietorships and partnerships. It also means corporations file separate tax returns, whereas the income from proprietorships and partnerships is reported on the personal tax returns of their owners.

4. Explain the three categories of business activities and identify examples of transactions related to each category. • The three categories of business activities are: (1) operating, (2) investing, and (3) financing activities. • Operating activities are related to the company’s revenues and expenses, such as sales to customers, collections from customers, purchases of inventory, and payments of wages and other expenses. • Investing activities include buying and selling property, plant, and equipment and buying and selling the shares of other companies. • Financing activities include borrowing money, issuing shares, repaying loan principal, and paying dividends.

5. Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. • There are four basic financial statements: (1) the statement of income, (2) the statement of changes in equity, (3) the statement of financial position, and (4) the statement of cash flows. • The objective of the statement of income is to measure the company’s operating performance (its profit) for a period of time. This is measured by subtracting the expenses incurred during the period from the income earned (revenues) in the same period. • The objective of the statement of changes in equity is to provide details on how each component of shareholders’ equity changed during the period. The components of shareholders’ equity include share capital (the shares issued by the company) and retained earnings (the company’s earnings that have been kept and not distributed as dividends). • The objective of the statement of financial position is to present information on a company’s assets, liabilities, and shareholders’ equity at a specific date. Assets must be controlled by the company and embody a future benefit. Examples include cash; accounts receivable; inventory; property, plant, and equipment; land; and so on. Liabilities are obligations of a company that will result in an outflow of resources. Examples include accounts payable, deferred revenue, long-term debt, and so on. Shareholders’ equity represents the shareholders’ interest in the assets of the company and is referred to as net assets. Examples include common shares and retained earnings. • The objective of the statement of cash flows is to enable financial statement users to assess the company’s inflows and outflows of cash related to its operating, investing, and financial activities for a period of time. • The notes to a company’s financial statements are used to provide additional detail and context for items in the financial statements. They enable the financial statements themselves to remain uncluttered, while increasing their usefulness.

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TRUE-FALSE STATEMENTS 1. Decision makers are often referred to as users of the financial statements and include investors and creditors. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Define financial accounting and understand its relationship to economic decisionmaking. CPA: Financial Reporting AACSB: Analytic

2. The primary purpose of financial accounting information is to aid users in their economic decisionmaking relative to the organization. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define financial accounting and understand its relationship to economic decisionmaking. CPA: Financial Reporting AACSB: Analytic

3. The section of an annual report that contains management’s discussion of the company’s operating results is referred to as the Statement of Management’s Responsibility. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Define financial accounting and understand its relationship to economic decisionmaking. Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

4. The shareholders are an example of an internal user of annual report information.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

5. Information contained in the financial statements of a company is of use to both internal and external users. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

6. There may be a single shareholder in the case of a public company or many shareholders in the case of a private company. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

7. A firm's activities can be divided into borrowing, investing, and operating. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

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8. If an investor owns 10% of the shares of a company, they normally own 10 shares of the company. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

9. Dividends are payments made by the company to distribute future profits. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

10. A gain or increase in the value of shares is known as capital appreciation. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

11. Creditors are entities that lend money to a company rather than buying shares of a company. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category.

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CPA: Financial Reporting AACSB: Analytic

12. The financial statements of a company are prepared by the shareholders. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

13. Assets are listed in the order of their liquidity on the classified Statement of Financial Position. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

14. Prepaid expenses can be found on the Statement of Income. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

15. The Statement of Financial Position measures cash inflows and outflows of a company over a period of time. Answer: False Bloomcode: Knowledge

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Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

16. Profit is determined by subtracting the income earned during the period from the expenses incurred during the same period. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

17. Income can also include gains that a company generates from sales that are outside their normal course of operations. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

18. Expenses are defined as increases in economic benefits. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

19. Gross profit is equal to the sales received from goods and the operating expenses incurred during

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the period. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

20. Net earnings is the amount of the company’s revenue that remains after all its expenses are accounted for. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

21. Retained earnings are the earnings that have been kept and NOT paid out as dividends. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

22. Liquidity refers to how long something will be received, realized, or consumed. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting

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AACSB: Analytic

23. Canadian companies use a 12-month period to distinguish between items that are current from those that are non-current. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

24. Working capital measures the company’s ability to meet its short-term obligations using its noncurrent assets. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

25. Deferred revenue represents customer deposits. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

26. Shareholders’ equity is often referred to as the net assets of the company. Answer: True Bloomcode: Knowledge

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

27. Share capital records the amount that investors have received in the form of dividends. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

28. Companies that are growing normally have negative cash flows from investing activities. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

29. IFRS is the financial reporting standard that must be followed by Canadian public companies. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

30. The MD&A section of the annual report provides a discussion of the risks facing the company and information about future plans.

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Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS 31. The annual report includes everything, EXCEPT for a) managerial statements. b) management discussion and analysis. c) financial statements. d) notes to the financial statements. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define financial accounting and understand its relationship to economic decisionmaking. CPA: Financial Reporting AACSB: Analytic

32. Financial accounting is also referred to as a) internal reporting. b) management reporting. c) external financial reporting. d) stakeholder reporting. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Define financial accounting and understand its relationship to economic decisionmaking. CPA: Financial Reporting AACSB: Analytic

33. In which section of the annual report does management comment on the company and its operating results? a) report to the shareholders b) management's discussion and analysis c) corporate profile d) selected financial data Answer: b Bloomcode: Knowledge Difficulty: Medium

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Learning Objective: Define financial accounting and understand its relationship to economic decisionmaking. CPA: Financial Reporting AACSB: Analytic

34. Which of the following is an internal user of the annual report information? a) creditors b) management c) regulators d) shareholders Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

35. The shareholders typically elect which of the following to represent their interests? a) senior management b) independent auditors c) board of directors d) chief operating officer Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

36. All of the following are external users EXCEPT a) labour unions. b) management. c) regulators. d) journalists. Answer: b

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Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

37. Those who lend money or otherwise extend credit rather than invest it directly in the company are known as a) investors. b) regulators. c) creditors. d) unions. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

38. Publicly traded corporations that fail to comply with securities regulations related to statement presentation and timing, may a) be fraudulent. b) be delisted. c) face criminal charges. d) have a questionable management team. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

39. Creditors include which of the following? a) suppliers b) financial institutions c) employees

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d) All of the choices are correct. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

40. Privately held corporations a) always have multiple shareholders. b) always require a board of directors to represents its interests. c) raise capital through the sale of shares. d) are not traded on the stock market. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the main users of financial accounting information and explain how they use this information. Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

41. The form of business ownership that most effectively limits the risk of ownership is a) sole proprietorship. b) general partnership. c) corporation. d) all forms of business ownership, since they are equally risky. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

42. Jennifer is a university student looking to earn some cash for tuition over the summer months (April–August). She has decided to start a lawn care business, what business structure would best suit her needs? a) private corporation b) public corporation c) general partnership d) sole proprietorship Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

43. A corporation whose shares are held by a small number of individuals is referred to as a a) proprietorship. b) publicly traded corporation. c) small business corporation. d) privately held corporation. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

44. Businesses can be operated in a number of different forms, such as a a) corporation. b) partnership. c) proprietorship. d) All of the choices are correct. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form.

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CPA: Financial Reporting AACSB: Analytic

45. Which statement is INCORRECT with regard to the characteristics of a corporation? a) It is a separate legal entity. b) It can be sued. c) Shareholders liability is limited to their investment. d) It cannot be publicly accountable. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

46. Which of the following statements best describes a proprietorship? a) A proprietorship can be comprised of single or multiple owners. b) The owners are taxed separately from the business. c) It is the most expensive business structure to establish. d) The owner is responsible for the debt of the company. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

47. Which of the following statements best describes a partnership? a) A partnership is a separate legal entity from its owners. b) There is only a single owner. c) It is the most expensive business structure to establish. d) The owners are responsible for the debt of the company. Answer: d Bloomcode: Knowledge Difficulty: Medium

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

48. Which of the following statements best describes a corporation? a) The business can be comprised of single or multiple owners. b) The owners are taxed separately from the business. c) It is the most expensive structure to establish. d) All of the choices are correct. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

49. What is the initial investment by the shareholders in a company called? a) owners’ capital b) shareholders’ capital c) retained earnings d) shareholders’ equity Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

50. The fundamental types of business activities that a firm typically engages in include all of the following EXCEPT for a) operating activities. b) borrowing activities. c) investing activities. d) financing activities. Answer: b

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Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

51. Which of the following is an example of an operating activity? a) paying dividends b) sale of investment in other companies' shares c) purchase of property, plant, and equipment d) payment of interest expense Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

52. Which of the following is a typical financing activity? a) purchasing property, plant or equipment b) purchasing another company’s shares c) paying interest expense d) paying dividends Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

53. All of the following are investing activities EXCEPT for a) earning interest income. b) purchasing property, plant, and equipment. c) purchasing other companies' shares. d) selling property, plant, and equipment.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

54. Which of the following is a typical financing activity? a) payment of dividends b) payment of interest expense c) payment of wages d) purchases of inventory Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

55. Operating activities include all of the following EXCEPT for a) collections of accounts receivable. b) payment of tax expense. c) payment of dividends. d) payment of interest expense. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

56. Which of the following is NOT a typical operating activity? a) payment of accounts payable b) payment of long-term notes payable

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c) payment of wages d) collection of accounts receivable Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

57. An example of a financing activity is a) purchase of property. b) issuing shares. c) sales to customers. d) payment of taxes. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

58. An example of an investing activity is a) purchase of inventory. b) collections of amounts owed by customers. c) purchase of shares of other companies. d) payment of taxes. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

59. An example of an operating activity is

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a) repaying loan principal. b) paying dividends. c) purchase of shares of other companies. d) payments of taxes owed to the government. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

60. A friend is looking to purchase shares as an investment, but would like information about whether the company has paid dividends in the last year. Where would your friend find this information in the financial statements? a) Income Statement b) Operating Activities on the Cash Flow Statement c) Investing Activities on the Cash Flow Statement d) Financing Activities on the Cash Flow Statement Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

61. A positive ___ represents an internal source of funding. a) cash flow b) revenue account c) dividends account d) share capital account Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting

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AACSB: Analytic

62. Capital Appreciation refers to a) the sale of shares at a price higher than the purchase price. b) the gain on the sale of an asset. c) the allocation of the value of an asset over its useful life. d) the sale of shares at cost. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

63. Which of the following statements best describes financial accounting? a) an information system in which the underlying transactions of an organization are captured, analyzed, and reported b) the reports that management prepares for the owners of the company summarizing how the company performed during the period c) an information system in which all transactions with the company are accurately reported d) the reports that management prepares for use in making decisions related to the financing, investing, and operating activities of a company Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

64. Where would the information about company operations be found? a) on the Statement of Income b) on the Statement of Financial Position c) in the notes of the financial statements d) in the statement of management responsibility Answer: a

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

65. Muller Ltd. earned gross revenues of $2,500,000 and had net income of $480,000 in the current year. During the year, the company had 200,000 common shares outstanding and its average shareholders’ equity was $1,000,000. Muller’s basic earnings per share for the year is a) $2.50. b) $2.40. c) $12.50. d) $0.48. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

66. All of the following can be found on the Statement of Income EXCEPT for a) interest expense. b) depreciation expense. c) prepaid rent expense. d) other income. Answer: c Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

67. Which of the financial statements provides information about the company’s financial position? a) Statement of Income b) Statement of Financial Position c) Statement of Cash Flows

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d) Statement of Changes in Equity Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

68. Which of the following is the proper order to list current assets on the Statement of Financial Position? a) Cash, Short-Term Investments, Inventory, Prepaid Expenses b) Cash, Short-Term Investments, Prepaid Expenses, Accounts Receivable c) Cash, Inventory, Accounts Receivable, Short-Term Investments d) Cash, Accounts Receivable, Short-Term Investments, Inventory Answer: a Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

69. Which of the following is the basic accounting equation? a) Assets = liabilities – shareholders' equity b) Assets = liabilities × shareholders' equity c) Assets = liabilities ÷ shareholders' equity d) Assets = liabilities + shareholders' equity Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

70. Which of the following are the two components of Shareholders’ equity?

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a) Dividends and Retained Earnings b) Share Capital and Retained Earnings c) Share Capital and Net Income d) Net Income and Dividends Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

71. The change in retained earnings can be calculated as follows a) Net Income – Dividends b) Net Income + Dividends c) Net Income – Interest d) Net Income + Interest Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

72. Dividends are paid when approved by the a) board of directors. b) management. c) shareholders. d) creditors. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

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73. The following information is NOT found on the Statement of Income: a) EPS. b) Depreciation Expense. c) Goodwill. d) Cost of Goods Sold. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

74. Which of the following statements is correct? a) The market value and the book value of a company’s shareholders’ equity are usually the same. b) The market value is usually less than the book value of a company’s shareholders’ equity. c) The market value is usually more than the book value of a company’s shareholders’ equity. d) The value of the shareholders’ equity on the Statement of Financial Position is based on the value of the company’s shares in the market. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

75. Which of the following is a section found in the Statement of Cash Flows? a) cash from lending activities b) cash from shareholder activities c) cash from financing activities d) cash from borrowing activities Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

76. On the Statement of Cash Flows, the repayment of long-term obligations would be considered a) a financing activity. b) an investing activity. c) an operating activity. d) a reduction in a liability. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

77. The starting point in the operating activities section of the cash flow statement is a) Sales Revenue. b) Retained Earnings. c) Beginning Cash Balance. d) Net Income. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

78. Where in the financial statements would a user find out which accounting policies management has selected to use? a) Statement of Management Responsibility b) Notes to the Financial Statements c) Auditors’ Report d) Management Discussion and Analysis Answer: b Bloomcode: Knowledge

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79. The Statement of Income is also known as a) Statement of Operations. b) Statement of Earnings. c) Statement of Profit or Loss. d) All of the choices are correct. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

80. Who determines the amount of earnings to be paid as dividends? a) management b) board of directors c) shareholders d) regulators Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

81. The working capital equation is a) Working Capital = Current Assets – Current Liabilities. b) Working Capital = Current Assets + Current Liabilities. c) Working Capital = Current Assets – Non-Current Liabilities. d) Working Capital = Non-current Assets + Current Liabilities. Answer: a

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Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

82. The accounting equation is a) Assets = Liabilities – Shareholders’ Equity. b) Assets + Liabilities = Shareholders’ Equity. c) Assets = Liabilities + Shareholders’ Equity. d) Shareholders’ Equity – Liabilities = Assets. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

83. A characteristic of an asset is a) a resource controlled by an entity. b) a future economic outflow. c) an event that will happen in the future. d) that it results in an outflow of resources. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

84. Licences, patents, trademarks, and copyrights are all examples of a) current assets. b) goodwill. c) intangible assets. d) short-term investments.

Overview of Corporate Financial Reporting 1 - 31

Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

85. Goods held for resale to customers are called a) Inventory. b) Prepaid Deposits. c) Property, Plant, and Equipment. d) Intangible Assets. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

86. Amounts owed to customers for advance payments until the related goods or services have been provided are called a) Accounts Payable. b) Deferred Revenue. c) Accrued Liabilities. d) Deferred Income Taxes. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

87. Measures the resources controlled by a company and the claims on resources at a given point in time.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

a) Statement of Financial Position b) Statement of Income c) Statement of Cash Flows d) Statement of Changes in Equity Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

Overview of Corporate Financial Reporting 1 - 33

EXERCISES 88. Algoma District Hospital (ADH) has over 100 employees and has the capacity to service up to 220 patients at any given time. ADH is a non-profit organization that receives most of its funding from the provincial government and various donations made by individuals and companies. Although there are no shareholders, ADH does have outstanding loans from its local bank. ADH has an active board of directors that assists with governance activities. Instructions Describe the various users of Algoma District Hospital financial information, including what information they would find useful. Also, indicate which of these users are considered internal or external. Solution (15 min.) The key users of ADH can be summarized as follows. Note: additional users beyond this list may be relevant. User Staff/Workers

Internal/External Internal

Local bank

External

Provincial government

External

ADH management

Internal

Board of directors

Internal

Useful Information Staff/workers would care about how well their organization is operating. The statement of operations/income statement would be of most interest to this group of users. The bank would care about certain key ratios such as interest coverage ratio and debt ratio, and whether it will recover its investment. Operating income and cash flow management would be of interest to the bank. The provincial government would be interested in how its funding was spent and how ADH is managing its operations and cash flows. The statement of operations/income statement would identify the revenues and expenses, and the statement of cash flows would assist this group of users in assessing cash management. Management is concerned managing its financial assets and liabilities, in addition to keeping the organization out of a deficit position. The board of directors would be interested in assessing the performance of management by examining key liquidity ratios such as current ratio and debt ratio. This group of users would also be interested in the statement of operations/income statement to assess the performance of the organization's various programs and overall performance.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Suppliers

External

Suppliers would be interested in the amount of ADH’s accounts payable and liquidity ratios such as current ratio and debt ratio to assess its ability to pay supplier invoices.

Note: As a non-profit organization, ADH would not be subject to income taxes. Therefore, stating the taxing authority as a key user may not be accurate. The organization may still have to comply with sales tax regulations, making the taxing authority a relevant user. Bloomcode: Analysis Difficulty: Hard Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

89. The following data was taken from the books of Jeepers Creepers Inc. as of December 31: Cost of goods sold $ 15,300 Selling & administrative expense $3,500 Income tax expense 6,120 Accounts payable 12,000 Cash 3,500 Common shares, (3,250 shares) 20,000 Retained earnings (Jan 1) 8,000 Dividends 6,000 Other income 1,500 Interest expense 900 Sales revenue 35,000 Depreciation expense 1,500 Equipment 39,680 Instructions a) Calculate total assets. b) Calculate total revenue and expenses. c) Calculate total liabilities. Solution (10 min.) a) Total Assets Cash Equipment Total b)

Total revenue Sales Other income Total Revenue Total expenses Cost of goods sold Selling & administrative expense Interest expense

$3,500 39,680 43,180

$35,000 1,500 $36,500 $15,300 3,500 900

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Depreciation expense Income tax expense Total expenses c)

Total Liabilities Accounts payable

1,500 6,120 $27,320

$12,000

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

90. The following data was taken from the books of Scodnick Supplies Ltd. as of December 31: Accounts payable $ 9,000 Income tax payable $ 36,800 Cost of goods sold 214,000 Selling expense 80,000 Cash 12,000 General expense 50,000 Long-term notes payable 19,000 Accounts receivable 10,000 Sales revenue 480,000 Prepaid rent 2,000 Short-term investment 5,000 Dividends payable 5,000 Inventory 66,000 Income tax expense 40,800 Common shares 60,000 Equipment 100,000 Retained earnings 65,200 Number of common shares 20,000 Instructions From the list above, determine which items should NOT be reported on the Statement of Financial Position. Solution (10 min.) Cost of goods sold Selling expense General expense Sales revenue Income tax expense Number of common shares

214,000 80,000 50,000 480,000 40,800 20,000

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91 The following data was taken from the books as at December 31 of Harman Inc.: Cash $15,000 Common shares Income tax expense 2,300 Cost of goods sold Sales revenue 85,000 Retained earnings (as of January 1) Inventory 21,500 Notes payable Accounts payable 32,000 Equipment Operating expenses 28,900 Dividends paid Interest expense 5,600 Accounts Receivable Prepaid expenses 750

$15,000 39,000 8,500 50,750 125,000 4,000 10,000

Instructions a) Determine the gross profit. b) List the current assets in order of liquidity. Solution (10 min.) a) Gross profit = $85,000 – 39,000 = $46,000 b)

Cash Accounts receivable Inventory Prepaid expenses

15,000 10,000 21,500 750

92. The following data was taken from the books of Xiao Inc. as of December 31: Cost of goods sold $ 35,300 Selling & administrative expense Income tax expense 6,120 Accounts payable Cash 4,755 Common shares, (3,250 shares) Retained earnings (Jan 1) 8,000 Dividends Other income 2,225 Interest expense Sales revenue 57,250 Depreciation expense PPE (net) 34,425 Accounts Receivable Instructions a) Calculate total assets. b) Calculate total revenue, expenses and net income.

$9,500 14,225 20,000 3,250 250 2,850 5,250

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c) d)

Calculate total liabilities. Calculate earnings per share.

Solution (15 min.) a) Total Assets Cash A/R PPE TOTAL Total revenue Sales Other income Total Revenue Total expenses Cost of goods sold Selling & administrative expense Interest expense Depreciation expense Income Tax Expense Total expenses Net Income $59,475 – $54,020 = $5,455

$ 4,755 $ 5,250 $34,425 $44,430

Total Liabilities Accounts payable

$57,250 2,225 $59,475 $35,300 9,500 250 2,850 6,120 $54,020

$14,225

d) EPS = $5,455 / 3,250 = $1.68 Bloomcode: Analysis Difficulty: Hard Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

93. The following data was taken from the books as at December 31 of Malibu Inc.: Cash $13,500 Common shares Income tax expense 5,250 Cost of goods sold Sales revenue 105,550 Retained earnings (as of January 1) Inventory 31,500 Bank Loan payable Accounts payable 32,750 Equipment Operating expenses 28,900 Dividends paid Interest expense 3,600 Accounts Receivable Prepaid expenses 1,250

$15,000 59,000 80,450 50,750 125,000 5,250 11,250

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Instructions a) Determine the gross profit and net income. b) Calculate the balance in the retained earnings account as of December 31. c) Calculate the working capital. Solution (18 min.) a) Gross profit = $105,550 – 59,000 = $46,550 Net Income = $46,550 – 28,900 – 3,600 – 5,250 = $8,800 b)

Balance in R/E account: $80,450 + $8,800 – $5,250 = $84,000

Current Assets = $13,500 + 11,250 + 31,500 + 1,250 = $57,500 Current Liabilities = $32,750 Working Capital: $57,500 – $32,750 = $24,750

Bloomcode: Analysis Difficulty: Hard Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

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MATCHING 94. Match each of the following activities to the transactions listed below by placing the appropriate letter in the space provided. ACTIVITIES a) b) c)

Operating Investing Financing

___

Borrowing money

___

Payment of salaries and wages

___

Payment of dividends

___

Sale of long-term assets

___

Purchase of another company's shares

___

Receipt of dividends

___

Collections of amounts owed by customers

___

Issuing shares

___

Purchase of another company’s bonds

___

10.

Purchase of inventory

___

11.

Sales to customers

___

12.

Share repurchase

Solution (5 min.) 1. c 2.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

10. a 11. a 12. c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

95. Match each of the following financial statement lines to the correct financial statement by placing the appropriate letter in the space provided. Financial Statement a) Statement of Financial Position b) Statement of Income c) Statement of changes in equity d) Statement of Cash Flows ___

Income Taxes Payable

___

Cost of Goods Sold

___

Property, plant and equipment

___

Cash from Operating activities

___

Dividends Declared

___

Inventory

___

Operating expenses

___

Gain on machinery

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___

Prepaid Expenses

___

10.

Accounts Receivable

___

11.

Net Income

___

12.

Goodwill

Solution (5 min.) 1. a 2.

10. a 11. b 12. a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS 96. How do internal users differ from external users of financial statements? Identify one internal and two external users of annual reports. Solution (5 min.) Internal users are using the information to make decisions regarding product/service pricing, operational expenses, buy versus lease decisions, and cost control measures. External users use the information in a variety of ways • • • • •

Shareholders – to make buy/sell decisions Board of Directors – to assess how well management is running the business Creditors – to see if the company can fulfill its debt obligations in both the short- and long-term Regulators – are looking for corporate compliance Tax authorities – tax assessment and compliance

Internal—management External—board of directors, shareholders, creditors, regulators, taxing authorities, other corporations, security analysts, credit-rating agencies, unions Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the main users of financial accounting information and explain how they use this information. CPA: Financial Reporting AACSB: Analytic

97. Briefly explain the relationship between the management, the board of directors, and the shareholders in a public company. Solution (5 min.) The shareholders are the owners of the company. In a large public company, they are generally not involved in the day-to-day operations of the company. The shareholders elect the members of the board of directors to represent them. The board then hires (and fires) senior management to manage the operations of the company. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

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98. Identify and describe the two main types of corporate structure. What impact, if any, does the structure have on management and financial reporting requirements? Solution (8 min.) Publicly traded companies trade on public stock exchanges such as the TSX. Shares are widely held and owned by a large number of individuals and / or entities. Some portion of the ownership will usually change hands every day. Typically a board of directors is elected to represent the interest of the shareholders. The board of directors has the authority to hire a management team who will manage day-to-day operations. The management team periodically reports to the shareholders. Financial statements are typically prepared quarterly. Annual financial statements are prepared and included in the company’s annual report. Privately held corporations shares are not available through public exchanges. The shares are narrowly held and owned by a small number of shareholders. It is not as easy to transfer ownership and shareholders are often involved in the day-to-day operations of the business. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the major forms of business organization and explain the key distinctions between each form. CPA: Financial Reporting AACSB: Analytic

99. Identify the three types of business activities a firm engages in. Provide an example of an inflow and outflow for each type of activity. Which type of activity is most critical to the company’s success and why? Solution (10 min) The three types of activities include: Operating activities – example of an inflow: collection of A/R, example of an outflow: purchase of inventory Investing activities – example of an inflow: sale of PPE, example of an outflow: purchase of PPE Financing activities – example of an inflow: share issue or borrowing, example of an outflow: payment of dividends, loan repayment Operating activates is considered the most critical to the company’s long run success or failure. If the company is not successful at generating cash flows from its operations it will ultimately run out of cash as financing sources dry up because it will not be able to attract new lenders or investors. It would begin selling PPE that is uses, further compromising operations. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the three categories of business activities and identify examples of

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

transactions related to each category. CPA: Financial Reporting AACSB: Analytic

100. Identify and describe the three primary financial statements prepared by accountants. How do these statements differ? Solution (10 min.) Statement of Income • Measures the operating activities and performance of a company over a period of time, normally a year. Calculates the net income for a period of time by deducting expenses from sales revenues. Revenues – Expenses = Net Income Statement of Financial Position • Can be represented by the equation: Assets = Liabilities + Shareholders’ equity. • Measures the resources controlled by a company (assets) and the claims on those resources (liability and equity holders) at a given point in time. Statement of Cash Flow • Measures the cash inflows and outflows or change in cash flow over a period of time, normally a year, and groups the cash flows into operating, investing, and financing activities. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

101. List the three types of business activities that are measured and reflected on the cash flow statement and provide three examples of transactions found within each activity. Solution (5 min.) Financing These activities involve raising long-term capital to finance the purchase of long-term assets. Typically, this includes borrowing money, repaying loans, issuing shares, repurchasing shares, and paying dividends. Investing These activities involve the sale or purchase of long-term assets. This includes purchasing property, plant, and equipment; selling property, plant, and equipment; investing in other companies' shares; selling the investment in other companies' shares. Operating

Overview of Corporate Financial Reporting 1 - 45

These are day-to-day activities the firm engages in, including sales to customers, collections on accounts receivable, purchase of inventory, payments on accounts payable, operating expenses, and taxes. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

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ESSAY QUESTIONS 102. What are consolidated statements? Do these statements provide useful information to users? Solution (12 min.) Consolidated statements are the combination of all the elements of the subsidiary’s financial statements with that of the parent company. When businesses expand, they will often establish other companies or buy shares in other companies. This enables them to expand operations and diversify their risk. When subsidiary companies are similar to the parent company’s business, the consolidated financial statements provide much more useful information because they cover the entire group of companies that are under common ownership. When the business subsidiary is very different from the parent company, it may be difficult to interpret the financial statements due to the complexity. Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain the three categories of business activities and identify examples of transactions related to each category. CPA: Financial Reporting AACSB: Analytic

103. What are the “notes to the financial statements”? Why are they used? Solution (15 min). The notes to the financial statements are a critical part of the financial statements. In them, management gives more detail about specific items such as the various types of inventory held by the company and details on their long-term assets. By including additional explanations in notes rather than in the financial statements, management keeps the company’s statements simple and uncluttered. Note disclosures help to increase the usefulness of the financial statements and enhance the user’s understanding of the various components of the statements. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements. CPA: Financial Reporting AACSB: Analytic

CHAPTER 2 ANALYZING TRANSACTIONS AND THEIR EFFECTS ON FINANCIAL STATEMENTS CHAPTER LEARNING OBJECTIVES 1. Identify the accounting standards used by Canadian companies. Canadian public companies (those whose shares trade on a public stock exchange) are required to prepare their financial statements using International Financial Reporting Standards (IFRS). Private companies in Canada generally follow Accounting Standards for Private Enterprises (ASPE), but have the option of following IFRS.

2. Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. Standards setters have developed conceptual frameworks (one for IFRS and another for ASPE) to assist them in determining what “useful information” is. Useful information has two fundamental qualitative characteristics. It must be relevant (it must matter to users’ decision-making) and it must be representationally faithful (it must represent transactions and balances as they took place or are at present). To be relevant, the information must be material and have a predictive value or a confirmatory value. To be representationally faithful, the information must be complete, neutral, and free from error. Four other enhancing qualitative characteristics have been identified that can increase the usefulness of financial information. These are comparability, verifiability, timeliness, and understandability. These characteristics increase usefulness, but they cannot make useless information useful. Financial statements are prepared using the going concern assumption. This assumes that the company will continue to operate for at least the next 12 months, and if it is a public company that its shares will continue to trade on an exchange during that period.

3. Explain the difference between the cash basis of accounting and the accrual basis of accounting. Under the cash basis of accounting, revenues are only recorded when cash is received and expenses are recorded when cash is paid out. Under the accrual basis of accounting, revenues are recorded when they are earned and expenses are recorded when they are incurred. Revenues are earned when the company has satisfied its performance obligations in the contract by providing the goods or services to its customers.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Accounting standard setters have determined that financial information prepared using the accrual basis of accounting is more useful than that resulting from the use of the cash basis.

4. Explain the accounting equation template approach to recording transactions. Every transaction must affect at least two accounts when it is recorded. The accounting equation must remain in balance as transactions are recorded; total assets must equal the sum of total liabilities plus shareholders’ equity. One of the main limitations of the accounting equation template method is that the number of columns that can be used is limited, which means that the number of accounts is also limited. The information resulting from this system may lack the level of detail required by management and other users. The other main limitation of the accounting equation template method is the lack of specific accounts for recording revenues, expenses, and dividends declared. Instead, these are recorded in the Retained Earnings account. This makes it difficult and time-consuming for management to quantify revenue and expense information, which is critical for managing any business.

5. Analyze basic transactions and record their effects on the accounting equation. Transactions affecting the Retained Earnings account (revenues, expenses, and the declaration of dividends) should be referenced to indicate the nature of the transaction. Revenues increase Retained Earnings, while expenses and the declaration of dividends decrease Retained Earnings.

6. Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. The statement of income is normally the first financial statement prepared. This statement, which includes all revenues and expenses, provides the net income figure that is required for all of the other financial statements. The statement of changes in equity is the next financial statement prepared. It illustrates any changes in the number of shares, changes in the dollar value of share capital, and changes to the Retained Earnings account (due to net income or loss or the declaration of dividends). The statement of financial position is a vertical presentation of the accounting equation. It includes all assets, liabilities, and shareholders’ equity accounts. It is often prepared on a classified basis, meaning that asset and liability accounts are presented in order of liquidity. Current assets are presented separately from non-current assets, while current liabilities are presented separately from non-current liabilities. All assets expected to be received, realized, or consumed within the next 12 months are considered to be current assets. All liabilities expected to be settled or paid within the next 12 months are considered to be current liabilities. The final financial statement to be prepared is the statement of cash flows. This statement categorizes all transactions of a business that affect cash into three categories: operating activities, investing activities, and financing activities.

Analyzing Transactions and Their Effects on Financial Statements 2 - 3

7. Calculate and interpret three ratios used to assess the profitability of a company. The profit margin ratio is calculated by dividing net income by sales revenue. It indicates the percentage of sales revenue that remains after all expenses, including income taxes, have been recorded. The return on equity ratio is calculated by dividing net income by average shareholders’ equity. It compares profit relative to the amount invested by shareholders. It provides shareholders with a sense of the returns being generated on their equity in the company. The return on assets ratio is calculated by dividing net income by average total assets. It provides an indication of how effective management has been at generating a return given the assets at their disposal.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

TRUE-FALSE STATEMENTS 1. All public companies must follow IFRS. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the accounting standards used by Canadian companies. CPA: Financial Reporting AACSB: Analytic

2. The objective of both IFRS and ASPE is to allow financial reporting that is useful to the financial statement users. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the accounting standards used by Canadian companies. CPA: Financial Reporting AACSB: Analytic

3. Public companies are prohibited from being cross listed. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the accounting standards used by Canadian companies. CPA: Financial Reporting AACSB: Analytic

4. Relevance, faithful representation and the cost constraint are examples of the fundamental qualitative characteristics. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these.

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CPA: Financial Reporting AACSB: Analytic

5. Information is considered to be material if it impacts the decisions of a financial statement user. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

6. Information has predictive value if it provides feedback to users on their previous assessments of the company. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

7. Revenue recognition criteria are necessary to determine when to recognize revenue when using both accrual and cash accounting methods. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the difference between the cash basis of accounting and the accrual basis of accounting. CPA: Financial Reporting AACSB: Analytic

8. The sales of merchandise on credit will cause the retained earnings and long-term liabilities

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

accounts to increase. Answer: False Bloomcode: Application Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

9. The purchase of equipment costing $19,500 with a $1,500 down payment and the balance owing on account will increase both sides of the Statement of Financial Position by $18,000. Answer: True Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

10. The issuance of common shares with a value of $9,000 to purchase land will increase the common share account. Answer: True Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

11. Dividends are an expense of doing business. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions.

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CPA: Financial Reporting AACSB: Analytic

12. Carrying Value of an asset is the cost of the asset that has already been expensed. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

13. Straight-line depreciation = (cost + residual value) ÷ estimated useful life. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

14. A significant limitation of the template method is the lack of specific retained earnings and dividends declared accounts. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Analyze basic transactions and record their effects on the accounting equation. CPA: Financial Reporting AACSB: Analytic

15. The template method can only be used by large companies. Answer: False Bloomcode: Knowledge

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Easy Learning Objective: Analyze basic transactions and record their effects on the accounting equation. CPA: Financial Reporting AACSB: Analytic

16. The Classified Statement of Financial Position distinguishes between current and noncurrent assets and liabilities. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

17. Accumulated depreciation is deducted when calculating net income. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

18. The purchase of a three-year insurance policy should be reflected on the Statement of Financial Position under current assets. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

19. A declaration of dividends results in an increase in liabilities and a decrease in

Analyzing Transactions and Their Effects on Financial Statements 2 - 9

shareholders’ equity. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

20. The return on assets = net income ÷ average total assets. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

21. The profit margin ratio = sales ÷ net income. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS 22. The accounting standards that publicly traded companies in Canada must adhere to are a) International Financial Reporting Standards. b) Accounting Standards for Private Enterprise. c) Canada Revenue Agency Standards. d) All of the choices are correct. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the accounting standards used by Canadian companies. CPA: Financial Reporting AACSB: Analytic

23. The main objective of IFRS and ASPE is a) to ensure compliance with the income tax act. b) to protect shareholder investment. c) to produce financial reporting that is useful for financial statement users. d) to provide specific guidelines for publicly traded companies. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the accounting standards used by Canadian companies. CPA: Financial Reporting AACSB: Analytic

24. The enhancing qualitative characteristics that increase the usefulness of financial information includes all of the following, EXCEPT for a) verifiability. b) materiality. c) understandability. d) comparability. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the qualitative characteristics of useful financial

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information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

25. The benefits of reporting financial information must exceed the costs of doing so, according to which characteristic of financial information? a) the concept of materiality b) faithful representation c) cost constraint d) verifiability Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

26. All of the following are examples of enhancing qualitative characteristics EXCEPT a) verifiability. b) understandability. c) neutrality. d) timeliness. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

27. Information that has been determined based on the best information available using the correct process, which also provides an adequate explanation is an example of which fundamental characteristic? a) neutral b) faithful representation c) timeliness d) verifiability

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Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

28. Which of the following enhancing characteristics is achieved if a third party, with sufficient understanding, can arrive at a result that is similar to that of the company? a) comparability b) understandability c) timeliness d) verifiability Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

29. The receipt of cash is a revenue recognition criterion for a) IFRS. b) ASPE. c) cash basis of accounting. d) accrual basis of accounting. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the difference between the cash basis of accounting and the accrual basis of accounting. CPA: Financial Reporting AACSB: Analytic

30. Under the accrual basis of accounting, expenses are a) always paid in cash. b) recorded only when paid.

Analyzing Transactions and Their Effects on Financial Statements 2 - 13

c) recorded when incurred. d) only relevant for the determination of net income. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the difference between the cash basis of accounting and the accrual basis of accounting. CPA: Financial Reporting AACSB: Analytic

31. Cost of goods sold should be matched up with the revenue generated on each year's Statement of Income because of the a) revenue recognition criteria. b) cash basis of accounting. c) actual basis of accounting. d) accrual basis of accounting. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the difference between the cash basis of accounting and the accrual basis of accounting. CPA: Financial Reporting AACSB: Analytic

32. A company received a $6,500 deposit from a customer for goods to be delivered in the following month. Under the accrual and cash basis of accounting respectively, the account credited is a Accrual basis Cash basis a) liability liability b) liability revenue c) revenue liability d) revenue revenue Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Explain the difference between the cash basis of accounting and the accrual basis of accounting. Learning Objective: Explain the accounting equation template approach to recording transactions.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

33. During a recent week, McMunn Legal Services received $25,000 cash from clients for services performed with a total value of $75,000. The balance is to be received within 30 days. The effect of this transaction in the accounting records would be a) + $75,000 revenue = + $25,000 cash + $50,000 accounts receivable. b) + $50,000 net income = + $50,000 assets. c) + $25,000 revenue = + $25,000 cash. d) + $75,000 revenue = + $75,000 accounts receivable. Answer: a Bloomcode: Application Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

34. During a recent week, McMunn Legal Services received $25,000 cash from clients for services performed with a total value of $75,000. The balance is to be received within 30 days. The effect on the Statement of Financial Position equation for this transaction would be a) + $25,000 cash = – $50,000 accounts payable + $75,000 retained earnings. b) + $25,000 cash – $50,000 accounts receivable = $75,000 retained earnings. c) + $25,000 cash + $50,000 accounts receivable = + $75,000 retained earnings. d) + $25,000 cash = + $25,000 retained earnings. Answer: c Bloomcode: Application Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

35. On March 31, Exacto Company paid $5,200 for a 1-year insurance policy. To record this transaction Exacto Company should a) decrease Cash and increase Insurance Expense. b) decrease Cash and increase Prepaid Insurance. c) increase Accounts Payable and increase Insurance Expense. d) increase Cash and increase Prepaid Insurance.

Analyzing Transactions and Their Effects on Financial Statements 2 - 15

Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

36. How is cash invested by shareholders in exchange for shares recorded in a company’s accounting records? a) as an increase in Retained Earnings, and an increase in Cash b) as an increase in Long-Term Investments, and a decrease in Cash c) as an increase in Common Shares, and a decrease in Cash d) as an increase in Common Shares, and an increase in Cash Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

37. All the following costs are initially expressed as assets but are then reclassified as expenses when they are consumed, EXCEPT for a) inventory. b) prepaid insurance. c) prepaid rent. d) short-term investments. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

38. Chamber Enterprises signed a lease for office space during its first month of business. At

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

that time it paid a total of $12,000 for first and last months’ rent. At the end of the first month, the effect on the financial statements would be a) $12,000 rent expense. b) $6,000 rent expense and $6,000 prepaid rent on the Statement of Financial Position. c) $12,000 prepaid rent on the Statement of Financial Position. d) Nothing recorded because the company has not made any sales yet. Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

39. Oxford Company paid $22,000 for goods it had purchased last month on account. What is the effect of the payment? a) a decrease in inventory b) a decrease in accounts payable c) an increase in cost of goods sold d) an increase in inventory Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

40. A company sold merchandise for cash. What is the effect of this sale? a) increase in revenue, increase in COGS, decrease in inventory b) increase in revenue, decrease in COGS, increase in inventory c) increase in revenue, increase in COGS, increase in inventory d) increase in revenue, decrease in COGS, decrease in inventory Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions.

Analyzing Transactions and Their Effects on Financial Statements 2 - 17

CPA: Financial Reporting AACSB: Analytic

41. A piece of equipment was recently purchased for $10,600 on April 1. It is estimated that it will last for 10 years and have a residual value of $600. The depreciation expense to be recognized in the year of acquisition, assuming a December year end, would be a) $1,000.00. b) $750.00. c) $662.50. d) $833.33. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

42. If a vehicle was purchased for $6,500 and has a residual value of $500, the annual depreciation expense will be $1,000 if the estimated useful life is a) 6 years. b) 6.5 years. c) 7 years. d) 13 years. Answer: a Bloomcode: Application Difficulty: Hard Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

43. When $10,000 of inventory is purchased with a three-month note payable bearing 2% interest, the inventory has a total cost of a) $10,200. b) $10,000. c) $10,100. d) $10,050.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

44. The asset that results when a customer buys goods or services on credit is a) an accounts receivable. b) an accounts payable. c) a notes receivable. d) cash. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

45. The asset that results from the payment of expenses in advance is a) an accounts receivable. b) a short-term investments. c) inventory. d) a prepaid expense. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

46. On Oct. 1, 2024, Howey Inc. signed a 1-year $75,000 note payable from First National Bank. The loan plus 6% interest is to be paid on Sept. 30, 2025. Howey’s year-end is December 31. In its 2024 financial statements, Howey will record interest expense of a) $375.

Analyzing Transactions and Their Effects on Financial Statements 2 - 19

b) $1,125. c) $4,500. d) $75,000. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

47. If dividends are declared and paid in the same accounting period, what is the net effect on the accounting equation? a) a decrease in Retained Earnings and an increase in Expenses b) a decrease in Cash and an increase Expenses c) a decrease in Cash and an increase in Retained Earnings d) a decrease in Cash and a decrease in Retained Earnings Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

48. The purchase of land for a combination of cash and the issuance of shares would result in which of the following? a) increase in Land, increase in Common shares, increase in Cash b) increase in Cash, decrease in Common shares, decrease in Land c) increase in Land, increase in Common shares d) increase in Land, increase in Common shares, decrease in Cash Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

49. The sale of merchandise to a customer partly for cash and partly on account would require which of the following? a) increase in Accounts Receivable, increase in Cash, increase in Sales Revenue b) increase in Cash, decrease in Accounts Payable, increase in Sales Revenue c) increase in Cash, increase in Sales Revenue d) decrease in Accounts Payable, increase in Accounts Receivable, increase in Sales Revenue Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

50. When the board of directors declares a $500 dividend, which of the following would be included in recording the transaction? a) increase in Retained Earnings, increase in Dividends Declared b) decrease in Cash, decrease in Dividends Payable c) increase in Dividends Declared, increase in Dividends Payable d) decrease in Dividends Payable, increase in Cash Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

51. If the company had a loan outstanding, which of the following would be included in recording the accrued interest at the end of the accounting period? a) increase Interest Expense, decrease Cash b) increase Interest Expense, increase Interest Payable c) decrease Interest Payable, increase Interest Income d) decrease Interest Payable, decrease Cash Answer: b Bloomcode: Comprehension

Analyzing Transactions and Their Effects on Financial Statements 2 - 21

Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

52. Which of the following reflects the effect of a transaction that records the portion of prepaid rent that has expired within a period? a) increase Prepaid Rent, decrease Rent Expense b) increase Rent Expense, decrease Cash c) increase Prepaid Rent, decrease Cash d) increase Rent Expense, decrease Prepaid Rent Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

53. Which of the follow statements regarding the limitations of the accounting template approach is INCORRECT? a) It creates challenges in Printing out reports. b) This approach is only suitable for very small businesses. c) This approach does not allow users to properly quantify revenues and expenses. d) This is theoretically an incorrect treatment of accounting information. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Analyze basic transactions and record their effects on the accounting equation. CPA: Financial Reporting AACSB: Analytic

54. Which of the following is NOT an example of a financing activity? a) accepting cash deposits b) debt repayment c) share issues d) borrowing money to buy a building

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

55. How are goods that are purchased for resale at a later date recorded in the financial statements? a) as inventory b) as prepaid expenses c) as cost of goods sold d) as operating expenses Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

56. Which of the following expenses has NO effect on the cash flow of a firm? a) salaries expense b) interest expense c) depreciation expense d) cost of goods sold Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

57. Which of the following assets is NEVER expensed on the Statement of Income? a) land

Analyzing Transactions and Their Effects on Financial Statements 2 - 23

b) building c) inventory d) equipment Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

58. Which of the following will NOT appear on the Statement of Income? a) depreciation b) interest c) cost of goods sold d) dividends declared Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

59. Which of the following would be the most useful in determining if a company has sufficient resources to continue operations in the short-term? a) the profit margin ratio b) the return on assets ratio c) the cash from operating activities d) the cash from financing activities Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

60. Which of the following transactions would decrease the cash from operating activities? a) the payment of dividends b) the sale of goods on account c) the purchase of goods on account d) the payment of wages Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

61. The accounting basis that attempts to measure performance in the period in which it occurred is the a) approval basis. b) cash basis. c) matching basis. d) accrual basis. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

62. Shareholders of a publicly traded company want to assess the return on their investment. Which ratio should shareholders use to specifically help assess this? a) Gross profit margin b) ROE c) ROA d) Profit margin Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a

Analyzing Transactions and Their Effects on Financial Statements 2 - 25

company. CPA: Financial Reporting AACSB: Analytic

63. Boro Enterprises ROA has increased year over year. Factors contributing to this increase may include a) an increase in the average cost of total assets. b) an increase in revenues. c) an increase in expenses. d) an increase in dividend payments. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

64. Use the following information to answer the question. Revenues .......................... Cost of goods sold ............ Operating expenses ......... Beginning assets .............. Beginning liabilities ......... Ending assets ................... Ending liabilities...............

$ 50,000 35,000 5,500 350,000 245,000 450,000 255,000

The profit margin is closest to a) 2%. b) 19%. c) 30%. d) 89%. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

65. Use the following information to answer the question. Revenues .......................... Cost of goods sold ............ Operating expenses ......... Beginning assets .............. Beginning liabilities ......... Ending assets ................... Ending liabilities...............

$ 50,000 35,000 5,500 350,000 245,000 450,000 255,000

The return on assets is closest to a) 2.1%. b) 2.4%. c) 3.75%. d) 11.13%. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

66. Use the following information to answer the question. Revenues .......................... Cost of goods sold ............ Operating expenses ......... Beginning assets .............. Beginning liabilities ......... Ending assets ................... Ending liabilities............... The return on equity is a) 1.0%. b) 6.3%. c) 7.6%. d) 9.0%. Answer: b

$ 50,000 35,000 5,500 350,000 245,000 450,000 255,000

Analyzing Transactions and Their Effects on Financial Statements 2 - 27

Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

EXERCISES 67. The following transactions have occurred for Madagascar Co. during the month of April: April 1: April 4: April 10: April 16: April 19: April 23: April 28: days. April 30:

Purchased a one-year insurance policy for cash of $5,500. Paid utilities bill received last month for $645. Performed a service on account of $3,100. Paid $9,250 for bi-weekly salaries to employees. Received $1,700 from a customer on account. Received the amount owing from the April 10 transaction. Received a bill for online advertising used in the month of April, $1,310, due in 30 Received $4,000 cash in advance for a job to be completed in the month of May.

Instructions Using the template provided below, indicate the amount of revenue and / or expense that should be recognized for each transaction under both the accrual basis and the cash basis of accounting.

Date

ACCRUAL BASIS Revenue Expense

CASH BASIS Revenue Expense

ACCRUAL BASIS Revenue Expense

CASH BASIS Revenue Expense $5,500 $645

Solution (15 min.)

Date April 1 April 4 April 10 April 16 April 19 April 23 April 28 April 30

$3,100 $9,250

$9,250 $1,700 $3,100

$1,310 $4,000

Analyzing Transactions and Their Effects on Financial Statements 2 - 29

Bloomcode: Application Learning Objective: Explain the difference between the cash basis of accounting and the accrual basis of accounting. Bloom’s: Application Difficulty: Medium CPA: Financial Reporting AACSB: Analytic

68. Analyze the effect of the following transactions using the basic accounting equation: a) Bought land with an estimated fair value of $250,000 by issuing 100,000 shares. b) Issued 10,000 common shares for $25,000 cash. c) Purchased a 2-year insurance policy for $4,800. d) Bought a building for $100,000. Paid one-fourth in cash and the balance on a 10-year, 10% interest note payable. e) Purchased $9,000 of merchandise inventory on credit. f) Paid utilities bill for $750. g) Sold $8,000 of merchandise inventory for $16,000 cash. h) Paid $2,500 on merchandise inventory previously purchased. i) Declared a $1,000 dividend. j) Recognized that 1 month of the insurance coverage had expired. Solution (12 min.) ASSETS Trans. a) b) c) d) e) f) g) g) h) i) j)

= Cash

A/R

Inv.

+25,000 –4,800 –25,000

Prepaid expense

Land +250,000

Building

LIABILITIES + Dividend A/P Payable

SHAREHOLDERS’ EQUITY Long-term debt

CS +250,000 +25,000

+4,800 +100,000 +9,000

+75,000 +9,000

–750 +16,000

–750 +16,000 –8,000

–8,000 –2,500

–2,500 +1,000

+7,950 =363,550

R/E

+1,000

–200 +4,600

+250,000

+100,000

+6,500 = 363,550

+1,000

+75,000

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

+275,000

–1,000 –200 +6,050

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

69. Consider the following independent transactions: 1. On January 1, paid, in advance, $6,000 for first and last month’s rent. 2. On January 1, paid, in advance, $3,000 for 12 months insurance. 3. Bought a truck to use for delivery purposes for $45,000 and paid for it with $10,000 cash and with a loan from the bank of $35,000 at 8%. The company expects to use the truck for 7 years after which they estimate the residual value will be $3,000. 4. Sold goods worth $25,000 on credit, that had an inventory cost $15,000. 5. Bought $5,000 of inventory on account. Instructions For each transaction indicate: a) which accounts are immediately affected and how they are affected, b) which accounts will be affected in the future as a result of the transaction. Solution (15 min.) 1. a) Immediate: Increase in Prepaid Rent of $6,000 and decrease in Cash of $6,000. b) Future effect: At the end of the month $3,000 in Rent Expense will be recognized; Prepaid Rent Expense will decrease and Rent Expense will increase which decreases Retained Earnings. 2.

a) b)

Immediate: Increase in Prepaid Insurance of $3,000 and decrease in Cash of $3,000. Future effect: Every month a portion of the Prepaid Expense will need to be recognized as Insurance Expense. Prepaid Insurance will decrease $250/month and Insurance Expense will increase, which decreases Retained Earnings.

Immediate: Increase in capital assets: truck for $45,000 and decrease in cash of $10,000 and increase in loan payable by $35,000. Future: The truck will need to be depreciated at a rate of ($45,000 – $3,000)/7 = $6,000 per year. The truck account will decrease (or Accumulated Depreciation will increase) and Depreciation Expense will increase which decreases Retained Earnings. Also, the loan interest will become payable which will be recorded as an increase in Interest Expense and decrease in Cash. Interest Expense is ($35,000 *.08) = $2,800 annually. (Answers may vary if students make assumptions about when the interest is paid). The increase in Interest Expense will decrease Retained Earnings.

Immediate: Accounts Receivable increases $25,000 and Sales Revenue increases $25,000 which increases retained earnings. Increase in Cost of Goods Sold expense of $15,000 and decrease in Inventory of $15,000. The increase in Cost of Goods Sold decreases Retained Earnings $15,000. Future: When the payments are received on account, the Accounts Receivable will decrease and Cash will increase. Immediate: Inventory increases by $5,000 and Accounts Payable increases by $5,000.

Analyzing Transactions and Their Effects on Financial Statements 2 - 31

Future: When the inventory is sold the Inventory account will decrease and the Cost of Goods Sold account will increase which will decrease retained earnings, all by $5,000. When payments are made on account, Accounts Payable will decrease and Cash will decrease.

Bloomcode: Analysis Difficulty: Hard Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

70. Consider the following independent transactions: 1. On June 30, paid in advance, $8,500 for first and last month’s rent. 2. On July 1, paid in advance, $3,000 for 6 months insurance. 3. Issued $5,000 in common shares for legal services. 4. Bought a used delivery van for $25,000 and paid for it with $10,000 cash and with a $15,000 loan from the bank at 5%. The company expects to use the truck for 5 years. At the end of 5 years the company expects that the vehicle will be worthless. 5. Sold goods worth $32,000, 80% of the sales were on credit and the remainder was in cash. The goods had an inventory cost $15,000. 6. Bought $7,500 of inventory on account. Instructions For each transaction indicate: a) which accounts are immediately affected and how they are affected, b) which accounts, if any, will be affected in the future as a result of the transaction. Solution (20 min.) 1. a) Immediate: Increase in Prepaid Rent of $8,500 and decrease in Cash of $8,500. b) Future effect: At the end of July, $4,250 in Rent Expense will be recognized; Prepaid Rent Expense will decrease and Rent Expense will increase which decreases Retained Earnings. 2.

a) b)

Immediate: Increase in Prepaid Insurance of $3,000 and decrease in Cash of $3,000. Future effect: Every month a portion of the Prepaid Expense will need to be recognized as Insurance Expense. Prepaid Insurance will decrease $500/month and Insurance Expense will increase, which decreases Retained Earnings.

a) Immediate: Increase in Common Shares of $5,000 and an increase in expenses, which decreases retained earnings b) No additional future effect.

Immediate: Increase in capital assets: van for $25,000 and decrease in cash of

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a) b)

Test Bank for Understanding Financial Accounting, Third Canadian Edition

$10,000 and increase in loan payable by $15,000. Future: The truck will need to be depreciated at a rate of ($25,000 – $0)/5 = $5,000 per year. The truck account will decrease (or Accumulated Depreciation will increase) and Depreciation Expense will increase which decreases Retained Earnings. Also, the loan interest will become payable which will be recorded as an increase in Interest Expense and decrease in Cash. Interest Expense is ($15,000 *.05) = $750 annually. (Answers may vary if students make assumptions about when the interest is paid). The increase in Interest Expense will decrease Retained Earnings. Immediate: Accounts Receivable increases $25,600, cash increases by $6,400 and Sales Revenue increases $32,000 which increases retained earnings. Increase in Cost of Goods Sold expense of $15,000 and decrease in Inventory of $15,000. The increase in Cost of Goods Sold decreases Retained Earnings $15,000. Future: When the payments are received on account, the Accounts Receivable will decrease and Cash will increase. Immediate: Inventory increases by $7,500 and Accounts Payable increases by $7,500. Future: When the inventory is sold the Inventory account will decrease and the Cost of Goods Sold account will increase which will decrease retained earnings, all by $7,500. When payments are made on account, Accounts Payable will decrease and Cash will decrease.

Bloomcode: Analysis Difficulty: Hard Learning Objective: Explain the accounting equation template approach to recording transaction. CPA: Financial Reporting AACSB: Analytic

71. Golladay Inc. began operations in April of the current year with the following transactions occurring during the month: Apr 1 Sold 15,000 common shares for $13 per share. 2 Paid $6,300 for three months' rent in advance. 5 Purchased $25,000 of equipment paying 25% down and agreeing to pay the balance in two years. 6 Purchased inventory for $19,000 on credit. 10 Sold on account $16,000 of inventory for $23,000. 15 Paid wages of $1,200. 20 Collected $8,000 from customers on account. 25 Paid suppliers $3,000 on account. 31 Paid wages of $1,100. 31 Recognized one month's rent expense. 31 Recognized one month's equipment depreciation expense. The estimated salvage value is $4,000 and the estimated useful life is 5 years.

Analyzing Transactions and Their Effects on Financial Statements 2 - 33

Instructions Indicate the effects of these transactions on the balance sheet equation. Solution (20 min.) Assets =

Liabilities +

Date

Cash

1 2 5 6 10 10 15 20 25 31 31 31 Total

+195,000 –6,300 –6,250

+A/R

+Inv

+Prepaid Rent

+Equipment

A/P

Shareholders’ Equity +N/P

+CS +195,000

+6,300 +25,000

+18,750

+19,000

+23,000

+23,000 –16,000 –1,200

–16,000 –1,200 +8,000 –3,000 –1,100

–8,000 –3,000 –2,100

+185,150 = 232,000

+R/E

+15,000

+3,000

+4,200

–350 +24,650

+16,000 = 232,000

+18,750

+195,000

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transaction. CPA: Financial Reporting AACSB: Analytic

72. Apply the template approach by using the template provided. Identify the accounts affected in the following transactions and the impact on each account by indicating an “increase” or “decrease”. Assess the impact on any revenue, expense or dividend transactions based on the impact on retained earnings. The first transaction has been provided as an example. Transactions: 1. The company borrowed $200,000 by taking out a bank loan. 2. Purchased equipment for $100,000, paying half with cash and issuing a note payable for the remainder. 3. Purchase $46,000 of inventory on account. 4. Sale of merchandise for cash of $5,600. The cost of the goods sold amount to $1,450. 5. Paid a supplier $46,000 in settlement of its accounts payable.

–1,100 –2,100 –350 +2,250

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

6. Declared and paid cash dividends totalling $50,000. Response template: Transaction Accounts 1. Cash Bank Loan

Increase X X

Decrease

Increase X X

Decrease

Solution (15 min.) Transaction Accounts 1. Cash Bank Loan 2.

Cash Equipment Note Payable

X X X

Inventory Accounts Payable

X X

Cash Inventory Retained Earnings (net)

X X X

Cash Accounts Payable

X X

Cash Retained Earnings

X X

Bloomcode: Application Difficulty: Medium Learning Objective: Analyze basic transactions and record their effects on the accounting equation. CPA: Financial Reporting

AACSB: Analytic 73. Shown below are the account balances for Daisy Corporation for their year-end September 30: Cash ....................................................... $ 10,475 Accounts receivable .............................. 16,640

Analyzing Transactions and Their Effects on Financial Statements 2 - 35

Inventory ............................................... Building ................................................. Accumulated depreciation—building .. Accounts payable ..................................

98,220 188,600 72,600 14,850

Common shares .................................... Retained earnings, beginning............... Dividends declared ............................... Sales revenue ........................................ Cost of goods sold ................................. Salaries and wages expense ................. Depreciation expense ........................... Utilities expense .................................... Supplies expense ..................................

$154,525 40,720 7,500 265,000 143,600 64,540 12,850 3,300 1,970

Instructions Given the above information, prepare the a) Statement of Income, b) Statement of Changes in Equity, and c) Classified Statement of Financial Position. Solution (20 min.) a) DAISY CORPORATION Statement of Income For the Year Ended September 30 Sales revenue ............................................................................... Cost of goods sold ....................................................................... Gross Profit .................................................................................. Expenses Salaries and wage expense.................................................. Depreciation expense .......................................................... Utilities expense ................................................................... Supplies expense ................................................................. Total operating expense.............................................................. Net income ...................................................................................

$265,000 143,600 121,400 $64,540 12,850 3,300 1,970 82,660 $ 38,740

b) DAISY CORPORATION Statement of Changes in Equity Year Ended September 30 Retained earnings, October 1 ......................................................

$ 40,720

Add: Net income ..........................................................................

38,740

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Deduct: Dividends declared ........................................................ Retained earnings, September 30 ...............................................

(7,500) $71,960

c) DAISY CORPORATION Statement of Financial Position As at September 30 Assets Current Assets Cash ..................................................... Accounts receivable............................ Inventory ............................................. Non-current Assets Building ............................................... Accumulated depreciation .................

Total Assets .........................................

$ 10,475 16,640 98,220 $125,335

Liabilities Current Liabilities Accounts payable ...........

$ 14,850

188,600 (72,600) 116,000

Shareholders' Equity Common shares ............. 154,525 Retained earnings .......... 71,960 Total shareholders' equity $226,485

$241,335

Total Liabilities and Shareholders' Equity ......

$241,335

Bloomcode: Application Difficulty: Medium Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

74. Maple Grove Hardware Ltd. has the following balances in the company ledgers for the year ending December 31: Mortgage Payable ............................... Prepaid Insurance............................... Short-term investments. .................... Common Shares ................................. Cash ..................................................... Advertising .......................................... Accounts Receivable ........................... Sales revenue ...................................... Accounts Payable ............................... Buildings (Net) .................................... Cost of Goods Sold..............................

$80,000 $ 2,000 $ 5,000 $15,000 $ 5,000 $50,000 $15,000 $600,000 $12,000 $100,000 $300,000

Interest Expense ............. Land ................................ Office salaries ................. Sales Salaries .................. Supplies expense............ Insurance expense ......... Depreciation expense .... Income tax expense ....... Dividend Payments ........ Interest Income .............. Inventory ........................

$10,000 $25,000 $70,000 $100,000 $20,000 $10,000 $20,000 $10,000 $10,000 $15,000 $20,000

Analyzing Transactions and Their Effects on Financial Statements 2 - 37

Note Payable (due in 9 months) ......... Retained Earnings (Beg Bal-Jan 1) .....

$10,000 $40,000

Instructions Using the above information prepare the following: a) Statement of Income b) Statement of Changes in Equity c) Classified Statement of Financial Position Solution (20 min.) a) MAPLE GROVE HARDWARE LTD. Statement of Income For the Year Ended December 31 Sales revenue ............................................................................... Cost of goods sold ....................................................................... Gross Profit .................................................................................. Expenses Advertising ........................................................................... Office salaries ....................................................................... Sales salaries ........................................................................ Insurance expense ............................................................... Depreciation expense .......................................................... Supplies expense ................................................................. Interest expense ................................................................... Total operating expense.............................................................. Net operating income .................................................................. Other Income—Interest ............................................................... Earnings before taxes .................................................................. Income tax expense ............................................................. Net income ...................................................................................

$600,000 300,000 300,000 50,000 70,000 100,000 10,000 20,000 20,000 10,000 280,000 20,000 15,000 35,000 10,000 $ 25,000

b) MAPLE GROVE HARDWARE LTD. Statement of Changes in Equity Year Ended December 31 Retained earnings, January 1 ...................................................... Add: Net income .......................................................................... Deduct: Dividends declared ........................................................ Retained earnings, December 31 ................................................ c) MAPLE GROVE HARDWARE LTD. Statement of Financial Position

$ 40,000 25,000 (10,000) $ 55,000

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December 31 Assets Current Assets Cash ..................................................... Short-term investments ..................... Accounts receivable............................ Prepaid insurance ............................... Inventory ............................................. Total Current Assets ........................... Non-current Assets Land..................................................... Buildings (net)..................................... Total Long-term Assets.......................

Total Assets .........................................

$ 5,000 5,000 15,000 2,000 20,000 $47,000 25,000 100,000 $125,000

$172,000

Liabilities Current Liabilities Accounts payable ........... Note payable ..................

$ 12,000 10,000

Total Current Liabilities . Non-current Liabilities Mortgage Payable...........

22,000

Total Liabilities ...............

$102,000

Shareholders' Equity Common shares ............. Retained earnings .......... Total shareholders' equity

15,000 55,000 $70,000

Total Liabilities and Shareholders' Equity ......

$172,000

80,000

75. Cormorant Corporation had the following transactions during the fiscal year ended August 31: a) Purchased inventory costing $325,000 on account. b) Sold inventory to customers for $725,000; of these sales, $125,000 were cash sales. c) Borrowed $90,000 from the bank on March 1 at 6% interest payable annually at year-end. d) Paid employees $110,000 in cash. e) Purchased equipment costing $225,000 in cash. f) Collected $520,000 from customers on account. g) Purchased $55,000 of another company's shares as a long-term investment. h) Issued 50,000 common shares for $3.75 per share. i) Paid suppliers $340,000. j) Collected a $7,500 cash dividend on the share investment. k) Declared and paid a $13,500 dividend during the year. l) Sold a piece of land for proceeds of $150,000.

Analyzing Transactions and Their Effects on Financial Statements 2 - 39

m) Paid the interest due on the loan from the bank in part c. Instructions Prepare a statement of cash flow for the August 31 year end. Solution (20 min.) CORMORANT CORPORATION Statement of Cash Flow For the Year Ended August 31 Cash flows from operating activities: Receipts from customers ($125,000 + $520,000) ................ Dividend from investment ................................................... Payments to suppliers ......................................................... Payments to employees ...................................................... Payments for interest (.06 x $90,000 x 6/12) ....................... Total cash flows from operating activities ..................

$645,000 7,500 (340,000) (110,000) ( 2,700)

Cash flows from investing activities: Purchase of equipment ....................................................... Proceeds on sale of land ...................................................... Purchase of long-term investment...................................... Total cash flows from investing activities ...................

(225,000) 150,000 ( 55,000)

Cash flows from financing activities: .......................................... Borrowed from bank ............................................................ Issued common shares ........................................................ Dividends paid ..................................................................... Total cash flows from financing activities ...................

90,000 187,500 (13,500)

Net change in cash during the period .........................................

$199,800

(130,000)

264,000 $333,800

76. Due to the sudden resignation of the accountant at Floyd Flower Shop, the sales manager has prepared the annual financial statements, shown below: FLOYD FLOWER SHOP Statement of Income December 31

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Sales Revenue .............................................................................. Cost of goods sold ....................................................................... Gross Profit .................................................................................. Operating expenses: Salaries & Wages expense.................................................... Rent expense Prepaid rent ......................................................................... Dividends . Accumulated Depreciation .................................................. Supplies expense ................................................................. Earnings before taxes .................................................................. Income tax expense ..................................................................... Net income ...................................................................................

$326,000 182,000 $144,000 $24,600 24,000 3,600 5,000 28,400 2,100

87,700 $56,300 26,000 $30,300

FLOYD FLOWER SHOP Statement of Changes in Equity For the Year Ended December 31 Retained earnings, January 1 ...................................................... Add: Net income .......................................................................... Retained earnings, December 31 ................................................

$138,200 30,300 $168,500

FLOYD FLOWER SHOP Statement of Financial Position For Year Ended December 31 Assets Cash ..................................................... Accounts receivable............................

Liabilities $ 22,450 11,250

Inventory ............................................. .....................................................

92,000

Building ...............................................

172,000

Less depreciation expense ......... .....................................................

(14,200) $157,800

Total assets .................................

$283,500

Instructions a) Identify the errors in the financial statements.

Accounts payable ...........

$ 9,600

Long-term debt .............. Total Liabilities ............... Shareholders' Equity

32,000 41,600

Common shares ............. Retained earnings ..........

$45,000 168,500

Total shareholders' equity 213,500 Total liabilities and Shareholders' Equity ...... $255,100

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Prepare corrected financial statements for Floyd Flower Shop.

Solution (25 min.) a) The errors are: • The Statement of Financial Position is not classified and the title is incorrect. This statement measures a point in time, not a year ended. • The Statement of Financial Position is not balanced (Total Assets do not equal Liabilities + Shareholders’ Equity). • Prepaid rent is recorded on the Statement of Income; it should be a current asset. • Dividends are recorded on the Statement of Income; they should be deducted and shown in the Statement of Changes in Equity. (This is just a presentation error and would not affect the Statement of Financial Position from balancing). • Depreciation expense should be recorded on the Statement of Income and not deducted from the asset. The accumulated depreciation should be reflected on the Statement of Financial Position and deducted from the related asset. • The income statement measures a period ending not a snapshot in time, the statement title is incorrect.

b) FLOYD FLOWER SHOP Statement of Income For the Year Ended December 31 Sales Revenue .............................................................................. Cost of goods sold ....................................................................... Gross Profit .................................................................................. Operating expenses: Salaries & Wages expense.................................................... Depreciation expense .......................................................... Rent expense ........................................................................ Supplies expense ................................................................. Earnings before taxes .................................................................. Income tax expense ............................................................. Net income ..................................................................................

$326,000 182,000 $144,000 $24,600 14,200 24,000 2,100

64,900 $79,100 26,000

$53,100

FLOYD FLOWER SHOP Statement of Changes in Equity For the Year Ended December 31 Retained earnings, January 1 ...................................................... Add: Net income .......................................................................... Deduct: Dividends declared ........................................................

$138,200 53,100 191,300 ( 5,000)

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Retained earnings, December 31 ................................................

$186,300

FLOYD FLOWER SHOP Statement of Financial Position December 31 Assets Current Assets Cash ..................................................... Accounts receivable............................ Inventory ............................................. Prepaid rent ........................................ Total Current Assets ........................... Non-current Assets Building ............................................... Less: Accumulated depreciation ........ .............................................................

Total assets .........................................

$ 22,450 11,250 92,000 3,600 129,300

Liabilities Current Liabilities Accounts payable ........... Non-current Liabilities Long-term debt .............. Total Liabilities ...............

$ 9,600 32,000 41,600

Shareholders' Equity

172,000 (28,400) 143,600

Common shares ............. Retained earnings .......... Total shareholders' equity

$45,000 186,300 231,300

$272,900

Total liabilities and shareholders' equity ......

$272,900

Bloomcode: Analysis Difficulty: Hard Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

77. Jones Pharmaceuticals accounting system provided the following data for the last two years: 2024 2023 Revenues ............................. $ 40,000 $ 25,000 Cost of goods sold .............. 22,500 6,000 Operating expenses ............ 10,000 5,000 Interest expense ................. 1,500 750 Income tax .......................... 2,500 1,500 Total assets ......................... 150,000 120,000 Total liabilities .................... 80,000 60,000 Total equity ......................... 70,000 60,000 Instructions Calculate the profit margin, return on assets, and return on equity for 2024. Explain what each ratio measures in general, and what each specifically indicates for Jones Pharmaceuticals.

Analyzing Transactions and Their Effects on Financial Statements 2 - 43

Solution (15 min.) a) Profit margin = Net income ÷ Sales Revenue = $3,500 ÷ $40,000 = 8.75% Net income = $40,000 – $22,500 – $10,000 – $1,500 – $2,500 = $3,500 This ratio measures how much profit is made on each sales dollar. For Jones Pharmaceuticals, this means 8.75 cents of every sales dollar is profit. b)

Return on assets = Net income ÷ Average total assets = $3,500 ÷ [($120,000 + $150,000)/2] = 2.6%

This ratio measures the profit earned on the average amount invested in the company's assets. For Jones Pharmaceuticals, each dollar invested in assets earns 2.6 cents. c)

Return on equity = Net income ÷ Average total shareholders’ equity = $3,500 ÷ [($60,000 + $70,000) ÷ 2] = 5.4%

This ratio measures the profit earned on the average shareholders' investment. For Jones Pharmaceuticals each dollar invested by the shareholders earns 5.4 cents. Bloomcode: Analysis Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

78. Jetty’s Landscaping accounting system provided the following data for the last two years: 2024 2023 Revenues ............................. $ 42,250 $ 31,500 Gross Profit ......................... 21,000 17,000 Operating expenses ............ 11,500 7,750 Interest expense ................. 3,500 3,000 Income tax .......................... 1,500 950 Total assets ......................... 175,000 160,000 Total liabilities .................... 80,000 75,000 Total equity ......................... 95,000 85,000 Instructions Calculate the profit margin, return on assets, and return on equity for 2024. Explain what each ratio measures in general, and what each specifically indicates for Jetty’s Landscaping. Solution (15 min.)

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Profit margin = Net income ÷ Sales Revenue = $4,750 ÷ $42,250 = 11.2% Net income = $21,000 – $11,500 – $3,500 – $1,250 = $4,750

This ratio measures how much profit is made on each sales dollar. For Jetty’s, this means 11.2 cents of every sales dollar is profit. b)

Return on assets = Net income ÷ Average total assets = $4,750 ÷ [($175,000 + $160,000)/2] = 2.8%

This ratio measures the profit earned on the average amount invested in the company's assets. For Jetty’s, each dollar invested in assets earns 2.8 cents. c)

Return on equity = Net income ÷ Average total shareholders’ equity = $4,750 ÷ [($95,000 + $85,000) ÷ 2] = 5.3%

This ratio measures the profit earned on the average shareholders' investment. For Jetty’s each dollar invested by the shareholders earns 5.3 cents. Bloomcode: Analysis Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

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MATCHING 79. For each of the following transactions, indicate if total assets would I increase, D decrease, or NE for no effect. ____

a) Sale of common shares for cash

____

b) Purchase of inventory for cash

____

c) Collection of accounts receivable

____

d) Payment of dividends

____

e) Sale of merchandise to customers on account

____

f) Recording of depreciation expense

____

g) Payment of accounts payable

____

h) Recording the cost of goods sold

____

i) Receipt of cash and signed long-term note payable

____

j) Purchase of machinery for cash

Solution (7 min.) a) I b)

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Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

80. For each of the following transactions, indicate the effect on shareholders' equity. Use I to indicate an increase, D to indicate a decrease, or NE for no effect. ____

a) Sale of goods for cash

____

b) Payment of operating expenses

____

c) Sale of goods on credit

____

d) Payment of dividends previously declared

____

e) Payment of accounts payable

____

f) Payment of income taxes.

____

g) Prepayment of expenses.

____

h) Recognizing depreciation expense.

____

i) Exchange of Common Shares for Land

____

j) Dividend declaration

Solution (5 min.) a) I b)

Analyzing Transactions and Their Effects on Financial Statements 2 - 47

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the accounting equation template approach to recording transactions. CPA: Financial Reporting AACSB: Analytic

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SHORT-ANSWER ESSAY QUESTIONS 81. Identify and describe the accounting standards used in Canada. What is the general objective of these standards? Solution (7 min.) The two accounting standards used in Canada are IFRS and ASPE. All publicly traded corporation must use IFRS, while privately held corporation may choose to use IFRS, but generally follow ASPE. The general objective of both sets of standards is to produce financial reporting that is useful to the financial statement users. Both IFRS and ASPE focus on the needs of the shareholders (current and potential) and creditors in determining what financial information that would be useful. Specifically the aim of the standards is to provide financial information that assists these two user groups in making decisions about providing resources to the reporting company, such as whether they should buy or sell the reporting company’s shares and whether or not they should extend credit to the reporting company. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the accounting standards used by Canadian companies. CPA: Financial Reporting AACSB: Analytic

82. Identify and briefly describe all of the characteristics and constraints of accounting information according to the IFRS conceptual framework. Solution (12 min.) Fundamental Qualitative Characteristics: • Relevance – matters to the decision makers • Predictive Value – can be used to predict future performance • Confirmatory Value – provides feedback on previous assessments • Materiality – consider material if in the absence of this information a different decision might be made • Faithful Representation – represents what actually took place • Completeness – provides all the information users need to understand the financial information • Neutrality – information is unbiased and exhibits prudence • Freedom from Error – if information is determined based on the best information available Enhancing qualitative characteristics – on their own cannot make useless information useful • Comparability • Verifiability

Analyzing Transactions and Their Effects on Financial Statements 2 - 49

• •

Timeliness Understandability

Constraints • Cost – if the cost of obtaining the information is outweighed by the benefit, then this information should not be captured Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. CPA: Financial Reporting AACSB: Analytic

83. What are the limitations of the template method for recording financial information? Provide examples of these limitations. When might it be appropriate for a company to use this method? Solution (8 min) The limitations of the template method include: 1. Number of columns used in the template. This can be unlimited in an excel spreadsheet; however, this makes it very difficult to print out reports. For example, a company may have different types of assets or inventory that it would like to account for separately, but would not be able to do this under this method. 2. Lack of specific revenue, expense and dividend accounts. These transactions would be recorded directly to R/E. This makes it very difficult for business owners to quantify revenue and expense information. For example, if management was wondering about sale for a given period, they would need to go through the R/E account and pull out all revenue transactions. This method would normally only be used by very small companies. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Analyze basic transactions and record their effects on the accounting equation. CPA: Financial Reporting AACSB: Analytic

84. Identify which statement(s) dividends declared and paid affects and explain why. Solution (5 min.) Dividends paid are a distribution of a portion of the company’s earnings to the shareholders of the company. As a result this is not an expense and is deducted from Retained Earnings when

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declared. When declared, a liability for Dividends Payable (on the Statement of Financial Position) is created and it is reduced when the dividends are paid, a short time later. The payment of the dividends reduces Cash on the Statement of Financial Position. Dividends Paid appear in the financing activities section of the statement of cash flow as a cash outflow representing a return on the amount invested by shareholders. Bloomcode: Comprehension Difficulty: Hard Learning Objective: Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. CPA: Financial Reporting AACSB: Analytic

85. What are three profitability ratios? How are these ratios calculated and interpreted and when would be these ratios be used? Solution (12 min.) 1. Profit Margin Ratio = Net Income / Revenues, expressed as a percentage and measures the amount of net income after all expenses / dollar of sales. For example, a profit margin of 8.5% indicates 8.5 cents of profit after all expenses for each dollar in revenues. The higher the profit margin the better. Theses profits can be retained in the company or distributed to shareholders as dividends. 2. Return on Equity = Net Income / Average Total SHE, expressed as a percentage and measures the net income / dollar of shareholder investment. For example, a ROE of 3.8% indicates that the company earned a net income of 3.8 cents for each dollar invested by owners. The higher the ROE the better, shareholders can compare this return with other investment alternatives. 3. Return of Assets= Net Income / average total assets, expressed as a percentage and measures the net income / dollar invested in company assets. For example, a ROA of 2.1% indicates that the company earned 2.1 cents in net income for every dollar that was invested in company assets. The higher the ROA the better, it indicates that the company is using its assets effectively. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret three ratios used to assess the profitability of a company. CPA: Financial Reporting AACSB: Analytic

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ESSAY QUESTIONS 86. Explain both the accrual basis and the cash basis of accounting and indicate why most companies use the accrual basis. Solution (8–10 min.) The accrual basis of accounting recognizes revenues in the period in which the revenues are earned and expenses in the period in which the expenses are incurred. Under this basis, the financial statements would be much more reflective of actual events because the revenues and related expenses would be shown in periods in which they were earned or incurred. It is meaningful because all of the profit generating activity incurred during a period is captured on the Statement of Income. The cash basis of accounting only recognizes revenues when the related cash is received. Expenses are only recognized when the related cash is paid out. With this basis, if a revenue or expense transaction is incurred in one period, but the relating revenue or expense transaction is not recognized until a later period, then each period's performance is distorted. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the difference between the cash basis of accounting and the accrual basis of accounting. CPA: Financial Reporting AACSB: Analytic

CHAPTER 3 DOUBLE-ENTRY ACCOUNTING AND THE ACCOUNTING CYCLE CHAPTER LEARNING OBJECTIVES 1. Explain how the double-entry accounting system works, including how it overcomes the limitations of the template approach. • Every transaction must be recorded in a way that affects at least two accounts, with the effects of these entries being equal and offsetting. • The double-entry accounting system enables the use of a huge number of accounts and is not limited to a fixed number of columns as is the case with the template approach. This allows the company to capture information at the level of detail required to manage the business, yet make it easy to summarize the information for reporting purposes.

2. Explain the normal balance concept and how it is used within the double-entry accounting system. • The normal balance concept is used to determine whether an account normally has a debit or credit balance. • To determine an account’s normal balance, a “T” is drawn through the middle of the accounting equation. Accounts on the left side of the “T” (assets) normally have a debit (DR) balance, while accounts on the right side of the “T” (liabilities and shareholders’ equity) normally have a credit (CR) balance. • An account’s normal balance illustrates what needs to be done to increase that account. The opposite is done to decrease it. • Because Retained Earnings is a shareholders’ equity account, it normally has a credit balance. Therefore, to increase it, we would credit it, and to decrease it, we would debit it. • Following this, revenue accounts, which ultimately increase retained earnings, normally have a credit balance. Expense and dividends declared accounts, which ultimately decrease retained earnings, normally have a debit balance.

3. Identify and explain the steps in the accounting cycle. • The steps in the accounting cycle are: (1) start with opening balances, (2) complete transaction analysis, (3) record transactions in the general journal, (4) post transactions to the general ledger, (5) prepare a trial balance, (6) record and post adjusting entries, (7) prepare an adjusted trial balance, (8) prepare financial statements, and (9) prepare closing entries. • At a minimum, this cycle is repeated annually, but parts of it repeat much more frequently (quarterly, monthly, weekly, or even daily).

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4. Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. • The chart of accounts outlines the type of information management wishes to capture to assist them in managing the business. • The chart of accounts is dynamic and can be changed when the company enters into new types of operations, opens new locations, requires more detailed information, or requires less detailed information. • Changes to the chart of accounts are most often introduced at the beginning of a fiscal year.

5. Explain the difference between permanent and temporary accounts. • Permanent accounts have balances that are carried over from one accounting period to the next. • Temporary accounts have balances that are closed to retained earnings at the end of each accounting period. That is, they are reset to zero. • All of the accounts on the statement of financial position (assets, liabilities, and shareholders’ equity accounts) are permanent accounts. • All of the accounts on the statement of income (revenues and expenses) and Dividends Declared are temporary accounts.

6. Identify and record transactions in the general journal and general ledger. • The general journal is a chronological listing of all transactions. It contains detailed information on each transaction. • Each journal entry must affect two or more accounts and the total dollar amount of debits in the entry must be equal to the total dollar amount of credits. In other words, total DR = total CR. • On a periodic basis (such as daily, weekly, or monthly), the information recorded in the general journal is posted to the general ledger. • The general ledger is used to prepare summary information for each account. The detail from each journal entry affecting a specific account is recorded in the general ledger account for that specific account. • A trial balance is prepared to ensure that the total of all debits posted to the general ledger is equal to the total credits posted.

7. Explain why adjusting entries are necessary and prepare them. • Adjusting entries are required at the end of each accounting period to record transactions that may have been missed. • There are two types of adjusting entries: accruals and deferrals. • Accrual entries are used to record revenues or expenses before cash is received or paid. • Deferral entries are used to record revenues or expenses after cash has been received or paid. • Depreciation is a type of deferral entry. Adjusting entries never involve cash.

Double-Entry Accounting and the Accounting Cycle

8. Explain why closing entries are necessary and prepare them. • Closing entries are used to close temporary accounts and transfer the balances in these accounts to Retained Earnings. • There are four closing entries: (1) close all revenue accounts to the Income Summary account, (2) close all expense accounts to the Income Summary account, (3) close the Income Summary account to Retained Earnings, and (4) close Dividends Declared to Retained Earnings.

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TRUE-FALSE STATEMENTS 1. All accounts are increased by credits and decreased by debits. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

2. All Statement of Financial Position accounts increase with debits, while all Statement of Income accounts increase with credits. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

3. Cash is normally a credit balance. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

4. Increases to assets are recorded on the credit side of a T account. Answer: False Bloomcode: Knowledge Difficulty: Easy

Double-Entry Accounting and the Accounting Cycle

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Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

5. A Chart of Accounts lists the accounts and balances at a specific time. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. CPA: Financial Reporting AACSB: Analytic

6. Prepaid expenses, inventory and accounts payable are examples of permanent accounts. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting AACSB: Analytic

7. Salary expense, sales revenue, and depreciation expense are examples of permanent accounts. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting AACSB: Analytic

8. At the beginning of the fiscal year an entity’s permanent and temporary accounts should all have a zero balance. Answer: False Bloomcode: Knowledge

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Difficulty: Medium Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting AACSB: Analytic

9. An adjusting entry can be used to record transactions that have been missed. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

10. Net income is calculated as sales revenues minus the cost of goods sold. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

11. Closing entries are done monthly for all companies. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

12. All Statement of Financial Position items are temporary and must be closed out annually. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them.

Double-Entry Accounting and the Accounting Cycle

CPA: Financial Reporting AACSB: Analytic

13. Balances in the revenue and expense accounts will affect retained earnings at the end of the period. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

14. An income summary account can be used when closing the books. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 15. When transactions are recorded in at least two separate accounts that are equal and offsetting, this is referred to as a) double-entry accounting. b) posting to the general ledger. c) date entry. d) transaction analysis. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the double-entry accounting system works, including how it overcomes the limitations of the template approach. CPA: Financial Reporting AACSB: Analytic

16. A major disadvantage of the accounting equation template approach is the number of columns that can be manageably used. This disadvantage can be eliminated through a) general ledger accounts. b) transaction analysis. c) double-entry accounting system. d) chart of accounts. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the double-entry accounting system works, including how it overcomes the limitations of the template approach. CPA: Financial Reporting AACSB: Analytic

17. The right side of a T account is also known as the a) debit side. b) credit side. c) asset side. d) liability side. Answer: b Bloomcode: Knowledge

Double-Entry Accounting and the Accounting Cycle

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Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

18. Which of the following relationships best expresses the double-entry nature of an accounting system? a) assets = liabilities b) assets = debits c) liabilities = credits d) debits = credits Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

19. Which of the following statements is correct? a) The normal balance is always on the side of the T account that is increasing. b) The normal balance is always on the side of the T account that is decreasing. c) The normal balance is always on the debit side of the T account. d) The normal balance is always on the credit side of the T account. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

20. Which of the following statements regarding the retained earnings account is NOT correct? a) It normally has a credit balance. b) Its balance is increased by revenues. c) Its balance is decreased by expenses. d) Its balance is increased by the declaration of dividends.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

21. Which of the following transactions would involve a debit to an asset account? a) recording depreciation expense on capital assets b) payment of an accounts payable c) payment of a dividend d) collection of an accounts receivable Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

22. Which of the following results in a debit entry to the account identified? a) increase in shareholders' equity b) recording interest income c) payment on accounts receivable d) decrease in shareholders' equity Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

23. Which of the following statements about accumulated depreciation is NOT correct? a) It is a contra asset account. b) It records the portion or how much of the asset has been used up. c) It is reflected on the Statement of Financial Position.

Double-Entry Accounting and the Accounting Cycle

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d) It helps determine how much an asset can be sold for. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

24. Which of the following accounts normally has a debit balance? a) Accumulated depreciation b) Prepaid insurance c) Accounts payable d) Common shares Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

25. Which of the following accounts normally has a credit balance? a) Accumulated depreciation b) Accounts receivable c) Dividends declared d) Rent expense Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

26. Which of the following accounts normally has a credit balance? a) Cash

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

b) Dividends declared c) Insurance expense d) Retained earnings Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

27. Which of the following accounts normally has a debit balance? a) Accounts payable b) Retained earnings c) Land d) Sales revenue Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

28. Which of the following is the first step in the accounting cycle? a) Recognize that a transaction has occurred. b) Prepare a source document. c) Prepare a chart of accounts. d) Journalize a transaction. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the steps in the accounting cycle. CPA: Financial Reporting AACSB: Analytic

29. Which one of the following sequences concerning the accounting cycle is correct?

Double-Entry Accounting and the Accounting Cycle

a) journalize, post, adjusting entries, financial statements b) transaction analysis, trial balance, post, adjusted trial balance c) post, adjusting entries, closing entries, financial statements d) adjusting entries, closing entries, adjusted trial balance, financial statements Answer: a Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify and explain the steps in the accounting cycle. CPA: Financial Reporting AACSB: Analytic

30. Which of the following is NOT part of the accounting cycle? a) posting b) financial statement analysis c) adjusted trial balance d) transaction analysis Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the steps in the accounting cycle. CPA: Financial Reporting AACSB: Analytic

31. In practice, an accounting system’s chart of accounts includes a) a numerical identifier. b) the use of account titles only. c) statement of financial position accounts only. d) a restriction on the number of accounts that can be used. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. CPA: Financial Reporting AACSB: Analytic

32. The following accounts are closed directly into retained earnings; therefore, this (these)

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

account(s) are NOT accounted for separately in the company’s chart of accounts a) Revenues. b) Expenses. c) Dividends. d) None of the choices are correct. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. CPA: Financial Reporting AACSB: Analytic

33. The chart of accounts is ___ a) static. b) dynamic. c) not generally useful. d) contains only permanent accounts. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. CPA: Financial Reporting AACSB: Analytic

34. A list of all the accounts used by the company in its accounting records is referred to as a a) chart of accounts. b) adjusted trial balance. c) general journal. d) general ledger. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. CPA: Financial Reporting AACSB: Analytic

Double-Entry Accounting and the Accounting Cycle

35. Which of the following is an example of a temporary account? a) Accumulated depreciation b) Retained earnings c) Deferred revenues d) Dividends declared Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting AACSB: Analytic

36. The use of temporary accounts helps managers, at least in part, to assess a) liquidity. b) stability. c) profitability. d) efficiency. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting AACSB: Analytic

37. Which of the following types of accounts appear on the Statement of Financial Position and Statement of Income respectively? Statement of Financial Position Statement of Income a) Permanent accounts Permanent accounts b) Permanent accounts Temporary accounts c) Temporary accounts Permanent accounts d) Temporary accounts Temporary accounts Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

38. Which of the following accounts would have a balance that carries over from one period to the next? a) Revenue b) Insurance expense c) Prepaid insurance d) Dividends declared Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting AACSB: Analytic

39. Which of the following accounting records is in chronological order? a) the chart of accounts b) the general journal c) the general ledger d) the statement of income Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

40. The process of transferring data from the general journal to the general ledger is called a) journalizing. b) ledgerizing. c) posting. d) balancing. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting

Double-Entry Accounting and the Accounting Cycle

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AACSB: Analytic

41. Which of the following is a listing of all the account balances at a specific point in time? a) the statement of financial position b) the chart of accounts c) the general journal d) the trial balance Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

42. The process of recording transactions is called a) transaction analysis. b) posting. c) recognizing. d) journalizing. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

43. The purchase of land for a combination of cash and issuance of shares would require which of the following entries? a) Dr. Land, Cr. Common shares, Cr. Cash b) Dr. Cash, Dr. Common shares, Cr. Land c) Dr. Land, Cr. Cash, Dr. Common Shares d) Dr. Cash, Cr. Land, Cr. Common shares Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

44. The sale of merchandise to a customer partly for cash and partly on account would require which of the following entries? a) Dr. Accounts receivable, Dr. Cash, Cr. Sales revenue b) Dr. Cash, Dr. Accounts payable, Cr. Sales revenue c) Dr. Cash, Cr. Sales revenue d) Dr. Accounts payable, Dr. Accounts receivable, Cr. Sales revenue Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

45. The purchase of land for a combination of cash and a 15-year note would require which of the following entries? a) Dr. Land, Dr. Cash, Cr. Long-term note payable b) Dr. Land, Cr. Cash, Cr. Long-term note payable c) Dr. Cash, Cr. Long-term note payable, Cr. Land d) Dr. Land, Dr. Long-term note payable, Cr. Cash Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

46. When the board of directors declares and pays a $500 dividend, which of the following would be included in the resulting journal entry? a) Dr. Dividends Declared, Cr. Cash b) Dr. Cash, Cr. Retained Earnings c) Dr. Retained Earnings, Cr. Dividends declared d) Dr. Cash, Cr. Dividends payable Answer: a Bloomcode: Comprehension Difficulty: Medium

Double-Entry Accounting and the Accounting Cycle

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Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

47. When an inventory item that cost $75 is sold on account for $100, which of the following would be included in the journal entry recording the cost of goods sold? a) Dr. Cash $100 b) Cr. Cost of goods sold $75 c) Cr. Accounts Receivable $100 d) Cr. Inventory $75 Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

48. Which of the following statements about the trial balance is NOT correct? a) Debit balances must equal credit balances. b) It includes only assets, liability and equity accounts. c) It is useful for detecting errors. d) It is an important step in the accounting cycle. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

49. An example of a contra asset account is a) accumulated depreciation. b) depreciation expense. c) gain on sale of land. d) prepaid expenses. Answer: a Bloomcode: Knowledge Difficulty: Easy

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

50. Which of the following could cause the trial balance to be out of balance? a) an entry recorded with only debits b) an unrecorded entry c) an entry recorded twice d) an entry recorded to the wrong accounts Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

51. Which statement regarding adjusting entries is NOT correct? a) Adjusting entries are made at the end of the accounting period. b) Adjusting entries can include cash transactions. c) Adjusting entries are required for accrual accounting. d) The recognition of depreciation expense is a deferral. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

52. A debit entry made to the deferred revenue account and credit entry made to the revenue account at the end of the period is referred to as a(n) a) accrual. b) deferral. c) correcting entry. d) closing entry. Answer: b Bloomcode: Comprehension Difficulty: Medium

Double-Entry Accounting and the Accounting Cycle

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Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

53. Which of the following would normally be recorded with an adjusting entry? a) sales on account b) payment for supplies bought on account c) utilities expense d) depreciation expense Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

54. Which of the following would be the adjusting entry to record accrued interest on a loan made to the business at the end of an accounting period? a) Dr. Interest expense, Cr. Cash b) Dr. Interest expense, Cr. Interest payable c) Dr. Interest payable, Cr. Interest income d) Dr. Interest payable, Cr. Cash Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

55. Which of the following would be the adjusting journal entry to expense prepaid rent for the period? a) Dr. Prepaid rent, Cr. Rent expense b) Dr. Rent expense, Cr. Cash c) Dr. Prepaid rent, Cr. Cash d) Dr. Rent expense, Cr. Prepaid rent Answer: d Bloomcode: Comprehension

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

56. Which of the following would be the adjusting journal entry to recognize earned but unpaid wages for the period? a) Dr. Wages Expense, Cr. Cash b) Dr. Wages Payable, Cr. Cash c) Dr. Wages Payable, Cr. Wages Expense d) Dr. Wages Expense, Cr. Wages Payable Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

57. Which of the following is NOT an example of an adjusting entry? a) recording unpaid interest at year end relating to an outstanding loan balance at year end b) recording depreciation on office equipment purchased during the year c) recording the gain on the sale of equipment made during the year d) reducing the prepaid rent account for the portion of rent actually used Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

58. The closing process includes the following journal entries: a) Dr. Revenues, Cr. R/E. b) Dr. R/E, Cr. Expenses. c) Dr. R/E, Cr. Dividends Declared. d) All of the choices are correct. Answer: c Bloomcode: Comprehension

Double-Entry Accounting and the Accounting Cycle

Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

59. The temporary account used in the closing process is called a) Income Summary. b) Revenues. c) Expenses. d) Dividends. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

60. A net loss occurs when a) assets exceed liabilities. b) expenses exceed revenues for the year. c) dividends exceed income for the year. d) cumulative expenses and dividends have exceeded income. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

61. Which of the following types of entries are used to reset the temporary accounts to zero and update the balance in the retained earnings? a) journal entries b) adjusting entries c) closing entries d) balancing entries Answer: c Bloomcode: Knowledge

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

62. Which of the following would be the closing entry for dividends declared? a) Dr. Expense summary, Cr. Dividends declared b) Dr. Retained earnings, Cr. Dividends declared c) Dr. Dividends declared, Cr. Income summary d) Dr. Dividends declared, Cr. Retained earnings Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

63. Which of the following is a current asset item on the Statement of Financial Position? a) Equipment b) Prepaid expenses c) Accounts payable d) Accrued wages payable Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

64. Consider the following data: Cash ............................................................... Accounts receivable...................................... Accounts payable ......................................... Note payable ................................................. Inventory ....................................................... Dividends payable ........................................ Equipment .................................................... Supplies......................................................... Net Income ....................................................

$ 15,200 29,500 34,500 50,000 17,000 5,200 220,000 6,400 35,000

Double-Entry Accounting and the Accounting Cycle

Accumulated Depreciation........................... Common shares ............................................ Beginning Retained earnings ....................... Prepaid rent .................................................. Salaries payable............................................

100,000 40,000 23,400 1,600 12,000

Total assets amounts to a) $189,700. b) $288,100. c) $289,700. d) $389,700. Answer: a Bloomcode: Application Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

65. Consider the following data: Cash ............................................................... Accounts receivable...................................... Accounts payable ......................................... Note payable ................................................. Inventory ....................................................... Dividends payable ........................................ Equipment .................................................... Supplies......................................................... Net Income .................................................... Accumulated Depreciation........................... Common shares ............................................ Beginning Retained earnings ....................... Prepaid rent .................................................. Salaries payable............................................ Total liabilities amounts to a) $101,700. b) $98,100. c) $196,500. d) $198,100. Answer: a Bloomcode: Application

$ 15,200 29,500 34,500 50,000 17,000 5,200 220,000 6,400 35,000 100,000 40,000 23,400 1,600 12,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Easy Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

66. Consider the following data: Cash ............................................................... Accounts receivable...................................... Accounts payable ......................................... Note payable ................................................. Inventory ....................................................... Dividends declared ....................................... Equipment .................................................... Supplies......................................................... Net Income .................................................... Accumulated Depreciation........................... Common shares ............................................ Beginning Retained earnings ....................... Prepaid rent .................................................. Salaries payable............................................

$ 15,200 29,500 34,500 50,000 17,000 5,200 220,000 6,400 35,000 100,000 40,000 23,400 1,600 12,000

Total Shareholder’s Equity amounts to a) $53,200. b) $58,400. c) $93,200. d) $98,400. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

Double-Entry Accounting and the Accounting Cycle

EXERCISES 67. Prepare the journal entries for the following transactions: a) Bought land for 15,000 shares with a $35 per share market value. b) Paid six months rent in advance for a total of $6,000. c) Paid insurance premiums for the year in the amount of $8,000. d) Bought a building for $250,000. Paid one-fifth in cash and the balance with a 10-year, 6% interest note payable. e) Purchased $20,000 of merchandise inventory on credit. f) Paid utilities bill for $450. g) Sold $8,000 of merchandise inventory for $12,000 on credit. h) Collected a $10,000 cash deposit from customers for custom orders. i) Paid salaries and wages of $8,500. j) Paid $8,000 on merchandise inventory previously purchased in part e). k) Received $7,000 from customers on account. l) Declared and paid a $5,000 dividend. Solution (12 min.) a) Land (A) ...................................................... Common shares (SE) ....................... (15,000 shares x $35 / share) b)

525,000 525,000

Prepaid rent (A) .......................................... Cash (A) ............................................

6,000

Prepaid insurance (A)................................. Cash (A) ............................................

8,000

Building (A) ................................................. Cash (A) ............................................ Long-term note payable (L).............

250,000

Merchandise inventory (A) ......................... Accounts payable (L) .......................

20,000

Utilities expense (SE) ................................. Cash (A) ............................................

450

Accounts receivable (A) ............................. Cost of goods sold (SE) .............................. Sales revenue (SE) ........................... Merchandise inventory (A) ..............

12,000 8,000

6,000

8,000

50,000 200,000

20,000

450

12,000 8,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Cash (A)....................................................... Deferred Revenues (L) .....................

10,000

Salaries and wages expense (SE) .............. Cash (A) ............................................

8,500

Accounts payable (L).................................. Cash (A) ............................................

8,000

Cash (A)....................................................... Accounts receivable (A) ...................

7,000

Dividends declared (SE) ............................. Cash (A) ............................................

5,000

10,000

8,500

8,000

7,000

5,000

Bloomcode: Application Difficulty: Easy Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

68. Fire and Safety Inc. is a new start-up, selling fire safety services and products to its customers. The following activities occurred in month 1. Prepare the journal entries for the following transactions: a) Issued 25,000 shares with a $17.50 per share market value. b) Bought a building for $250,000 and Land for $100,000. Paid 25% in cash and the balance with a 10-year, 4% interest note payable. c) Paid insurance premiums, quarterly in advance, in the amount of $5,925. d) Purchased $32,500 of inventory, 30% cash and the balance on credit. e) Paid utilities bill for $350. f) Negotiated an annual contract to provide safety services to the university for $125,000 / year. g) Sold $22,750 of services on account, no parts were required. h) Collected a $5,500 cash deposit from customers for custom orders. i) Paid salaries and wages of $8,500. j) Paid the balance owing on inventory previously purchased in part d). k) Received $7,700 from customers on account. l) Declared and paid a $2,500 dividend. Solution (12 min.) a) Cash (A)....................................................... Common shares (SE) ....................... (25,000 shares x $17.50) b)

Building (A) .................................................

437,500 437,500

250,000

Double-Entry Accounting and the Accounting Cycle

Land (A)…………………………………. .... Cash (A) ............................................ Long-term note payable (L).............

100,000

Prepaid insurance (A)................................. Cash (A) ............................................

5,925

Inventory (A) ............................................... Cash (A) ............................................ Accounts payable (L) .......................

32,500

Utilities expense (SE) ................................. Cash (A) ............................................

350

87,500 262,500

5,925

9,750 22,750

350

No Entry

Accounts receivable (A) ............................. Service revenue (SE) ........................

22,750

Cash (A)....................................................... Deferred Revenues (L) .....................

5,500

Salaries and wages expense (SE) .............. Cash (A) ............................................

8,500

Accounts payable (L).................................. Cash (A) ............................................

22,750

Cash (A)....................................................... Accounts receivable (A) ...................

7,700

Dividends declared (SE) ............................. Cash (A) ............................................

2,500

22,750

5,500

8,500

22,750

7,700

2,500

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

69. The ledger accounts of Brick House Gym Inc. at July 31, 2024 are shown below: Accounts Payable ......................................... $ 5,100 Accounts Receivable .................................... 1,050 Building ......................................................... 50,400

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Common Shares ........................................... Cash............................................................... Exercise Equipment ...................................... Weight Equipment ........................................ Notes Payable ............................................... Office Supplies .............................................. Office Equipment.......................................... Dividends ...................................................... Retained Earnings ........................................

53,100 12,000 18,900 22,000 49,000 350 2,000 10,500 10,000

Instructions Prepare a trial balance with the ledger accounts arranged in the proper financial statement order. Include the appropriate heading. Assume all accounts have a normal balance. Solution (10 min.) BRICK HOUSE GYM INC. Trial Balance July 31, 2024 Debit Cash ......................................................................... $ 12,000 Accounts Receivable ............................................... 1,050 Office Supplies ........................................................ 350 Office Equipment .................................................... 2,000 Exercise Equipment ................................................ 18,900 Weight Equipment .................................................. 22,000 Building ................................................................... 50,400 Accounts Payable ................................................... Notes Payable ......................................................... Common Shares ..................................................... Dividends ................................................................ 10,500 Retained Earnings ................................................... ______ Totals....................................................................... $117,200

Credit

$ 5,100 49,000 53,100 10,000 $117,200

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

70. Shown below is the trial balance for Whole Home Co. as at December 31, 2024, the company’s year end. The company owner provides you with the following additional information: a) No interest has been paid yet on the note payable. The note has been outstanding since April 1 and the interest rate is 6%. b) The equipment originally cost $200,000 and has an estimated residual value of $20,000 and a

Double-Entry Accounting and the Accounting Cycle

c) d)

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useful life of 6 years. On June 1 the company renewed its insurance policy and paid a $1,200 premium for the year. It was correctly recorded at that time as prepaid insurance. On October 1 the company sold a 12-month service contract to a client for $18,000 and recorded it as Deferred Revenue because at that point they had not yet provided any service to the client. They have been providing the service since the contract was sold.

WHOLE HOME CO. Trial Balance as at December 31, 2024 Debit Cash ......................................................................... $ 8,900 Accounts Receivable ............................................... 28,000 Prepaid insurance ................................................... 1,200 Equipment .............................................................. 200,000 Accumulated depreciation ..................................... Accounts Payable ................................................... Notes Payable ......................................................... Deferred revenue .................................................... Common Shares ..................................................... Retained Earnings ................................................... Sales & service revenue .......................................... Salaries .................................................................... 120,000 Rent ......................................................................... 24,000 Supplies expense .................................................... 29,500 Depreciation expense ............................................. 0 Insurance expense .................................................. 1,100 Interest expense ..................................................... 0 Totals....................................................................... $412,700

Credit

$6,000 12,000 20,000 18,000 60,000 56,700 240,000

_______ $412,700

Instructions Prepare any adjusting entries required. Solution (12 min.) a) Dr. Interest expense (SE)...................................................... Cr. Interest payable (L) ................................................. To record interest owing on note payable: (.06 × 20,000 × 9 months/12) b)

900 900

Dr. Depreciation expense- Equipment (SE)......................... Cr. Accumulated depreciation—Equipment (XA) ........ To record annual depreciation expense: (200,000 – 20,000)/ 6 years

30,000

Dr. Insurance expense (SE) .................................................. Cr. Prepaid insurance (A) .............................................

700

30,000

700

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

To recognize 7/12ths of the insurance premium as expired. d)

Dr. Deferred revenue (L)....................................................... Cr. Sales and service revenue (SE) .............................. To recognize 3/12 of the service contract revenue as earned.

4,500 4,500

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

71. Prepare year-end adjustments for the following transactions: a) Accrued interest on notes receivable is $85. b) Deferred revenues earned totals $1,000. c) Three years' rent, totalling $36,000, was paid in advance at the beginning of the year. d) Services totalling $2,100 had been performed but not yet billed at the end of the year. e) Depreciation on equipment totalled $4,500 for the year. f) Supplies for use totalled $690. By year end, only $100 in supplies remained. g) Salaries owed to employees at the end of the year total $1,000. Solution (10 min.) a)

Interest Receivable.................... .......................................... Interest Income................... .........................................

Deferred Revenues....................... ........................................ Service Revenue ...........................................................

1,000

Rent Expense ........................................................................ Prepaid Rent ................................................................. ($36,000 ÷ 3 = $12,000)

12,000

Accounts Receivable.................... ........................................ Service Revenue ...........................................................

2,100

Depreciation Expense .......................................................... Accumulated Depreciation—Equipment.....................

4,500

Supplies Expense ................................................................. Supplies............................. ...........................................

590

1,000

12,000

2,100

4,500

590

Double-Entry Accounting and the Accounting Cycle

Salaries Expense....................... ........................................... Salaries Payable ...........................................................

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1,000 1,000

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

72. The Play House Theatre offers 8 shows per year from September until April. The company has one show each month over the 8-month season. September is always very busy as the company gears up for the new season. The following activities occurred at the Play House during the month of September: a) b) c)

On September 1, the company sold season tickets for admission to the season’s shows. Ticket sales totalled $1,800,000. On September 1, the theatre issued a casting call and hired the actors for the first show beginning in mid-September. Actor wages for September were $22,750 and paid October 15. On September 1, the Theatre Company also prepaid the stage rental for the entire season. The cost was $500,000.

The company has an outstanding short term $150,000 loan with First National bank that was negotiated in August and must be repaid in full by December 15. The interest rate on the loan is 5% and the interest must be paid monthly on the 1st.

On September 10, theatre playbills were printed for the first half of the entire season. The printing cost was $10,500.

Instructions For each of the transactions above, prepare the journal entry to record the INITIAL transaction if one is required and then prepare any required ADJUSTING ENTRIES on September 30, the end of the fiscal year. Solution (10 min.) a) Journal Entry Cash ............................................................................. Deferred Admissions Revenue .......................... Adjusting Entry Deferred Admissions Revenue .................................... Admissions Revenue.......................................... ($1,800,000  8 = $225,000) b)

1,800,000 1,800,000

225,000 225,000

No Initial Entry Adjusting Entry Wages ...........................................................................

22,750

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Wages Payable ................................................... c)

Journal Entry Prepaid Rent ................................................................ Cash .................................................................... Adjusting Entry Rent Expense ............................................................... Prepaid Rent ...................................................... ($500,000 / 8 = $62,500)

500,000 500,000

62,500 62,500

No initial entry Adjusting Entry Interest Expense .......................................................... Interest Payable ................................................. ($150,000 x 5% x 1 / 12 = $625)

22,750

Journal Entry Prepaid Printing .......................................................... Cash .................................................................... Adjusting Entry Printing Expense.......................................................... Prepaid Printing ................................................. ($10,500 / 4 = $2,625)

625 625

10,500 10,500 2,625 2,625

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

73. Compliant Computer Inc. prepares annual financial statements. Below are some selected accounts and their balances on the June 30 trial balance before any adjustments have been made. COMPLIANT COMPUTER INC. Trial Balance June 30, 2024 Cash .............................................................................................. Office supplies ............................................................................. Prepaid insurance ........................................................................ Equipment ................................................................................... Accumulated depreciation—equipment .................................... Accounts payable ........................................................................

Debit 9,935 2,700 6,600 16,200

Credit

$ 0 1,100

Double-Entry Accounting and the Accounting Cycle

Deferred revenue ......................................................................... Common shares ........................................................................... Retained earnings ........................................................................ Rent revenue ................................................................................ Salaries expense .......................................................................... Total .............................................................................................

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1,200 10,000 18,925 6,360 2,150 $37,585

$37,585

An analysis of the account balances provided the following additional information: 1. A physical count of office supplies revealed $1,200 on hand on June 30. 2. An annual insurance policy was purchased on June 1 for $6,600. 3. The office equipment was purchased on December 1 for $16,200 and has an estimated useful life of five years and no residual value. 4. Rent received in advance that remains deferred at June 30 is $500. 5. An additional $500 of wages has been earned but not yet paid. Instructions Using the above additional information, prepare the adjusting entries that should be made on June 30 (adjusting entries are made annually). Solution (10 min.) 1. Office Supplies Expense ($2,700 – $1,200) .................................... Office Supplies........................................................................ (To record the amount of office supplies used) 2.

1,500 1,500

Insurance Expense ......................................................................... Prepaid Insurance .................................................................. (To record insurance expired; $6,600  12)

550

Depreciation Expense .................................................................... Accumulated Depreciation—Equipment............................... (To record depreciation; $16,200  5 x 7 / 12)

1,890

Deferred Revenue ($1,200 – $500) ................................................. Rent Revenue.......................................................................... (To record rent revenue earned)

700

Wages Expense ............................................................................... Wages Payable........................................................................

500

550

1,890

700

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

500

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

74. Prepare year-end adjustments for the following transactions: 1. The company has a $21,000 note receivable with an interest rate of 7%, interest is due on 1st of the month. Interest expense is recorded monthly. 2. Customer deposits of $7,500 have been received and not yet earned. 3. Annual rent, totalling $12,000, was paid in advance at the beginning of the year. 4. Services totalling $22,100 had been performed but not yet billed by the end of the year. 5. The company owns equipment worth $105,000. It has a 10 year estimated useful life and no residual value. 6. Supplies on hand at the beginning of the year totalled $880, during the year an additional $350 worth of supplies was purchased. By year end, only $100 in supplies remained. 7. Salaries owed to employees at the end of the year total $1,550. Solution (10 min.) 1. Interest Receivable .............................................................. Interest Income ............................................................ ($21,000 x 7% x 1/12) 2.

122.50 122.50

Deferred Revenues ............................................................... Revenues ......................................................................

7,500

Rent Expense ........................................................................ Prepaid Rent .................................................................

12,000

Accounts Receivable ............................................................ Services Revenue .........................................................

22,100

Depreciation Expense—Equipment .................................... Accumulated Depreciation—Equipment..................... ($105,000 / 10 years = $10,500)

10,500

Supplies Expense ................................................................. Supplies ........................................................................ ($880 + $350 – $100 = $1,130)

1,130

Salaries Expense .................................................................. Salaries Payable ...........................................................

1,550

7,500

12,000

22,100

10,500

1,130

1,550

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

Double-Entry Accounting and the Accounting Cycle

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75. Presented below are the unadjusted trial balance and adjusted trial balance for Dewalt Engineering Co. on December 31: DEWALT ENGINEERING CO. Trial Balance December 31

Cash Accounts Receivable Prepaid Insurance Supplies Equipment Accumulated Depreciation— Equipment Accounts Payable Salaries Payable Deferred Revenue Retained Earnings Dividends Declared Service Revenue Salaries Expense Utilities Expense Insurance Expense Supplies Expense Depreciation Expense Interest Expense Totals

Unadjusted Trial Balance Adjusted Trial Balance Dr. Cr. Dr. Cr. $ 42,000 $ 42,000 16,000 16,000 7,000 3,400 14,500 6,900 99,000 99,000 $ 20,000 12,100 0 13,700 90,700

$ 30,000 12,100 5,900 4,500 90,700

40,000

40,000 170,000

69,500 15,800 0 0 0 __2,700 $306,500

179,200 75,400 15,800 3,600 7,600 10,000 __2,700 $322,400

_______ $306,500

_______ $322,400

Instructions a) Prepare in journal form the adjusting entries that explain the changes in the balances from the unadjusted trial balance to the adjusted trial balance. b) Prepare the necessary closing entries for Dewalt Engineering Co. at December 31. Solution (20 min.) a) Supplies Expense .............................................................................. Supplies ..................................................................................... To record supplies used during the period

7,600 7,600

Insurance Expense ............................................................................ Prepaid Insurance ..................................................................... To record expired prepaid insurance

3,600

Depreciation Expense .......................................................................

10,000

3,600

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Accumulated Depreciation—Equipment ................................. To record depreciation expense on equipment for the period

10,000

Salaries Expense ............................................................................... Salaries Payable ........................................................................ To record salaries owed but not yet paid

5,900

Deferred Revenue ............................................................................. Service Revenue ........................................................................ To record revenue earned

9,200

5,900

9,200

b) Service Revenue................................................................................ 179,200 Income Summary ...................................................................... To close revenues to income summary.

179,200

Income Summary ............................................................................. 115,100 Salaries Expense ....................................................................... Utilities Expense........................................................................ Insurance Expense .................................................................... Supplies Expense ...................................................................... Depreciation Expense ............................................................... Interest Expense........................................................................ To close expenses to income summary.

75,400 15,800 3,600 7,600 10,000 2,700

Income Summary ............................................................................. Retained earnings ..................................................................... To close income summary to retained earnings.

64,100 64,100

Retained earnings ............................................................................. Dividends Declared ................................................................... To close dividends declared to retained earnings.

40,000 40,000

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

76. Sara Lee owns and operates Coffee and Just Desserts Inc., a small bakery and café. COFFEE AND JUST DESSERTS, INC. Statement of Income Month Ending April 30 Revenues .................................................................

$12,850

Double-Entry Accounting and the Accounting Cycle

Cost of Goods Sold.................................................. Gross Profit ............................................................. Operating expenses Wages ............................................................ Utilities .......................................................... Depreciation ................................................. Total operating expenses ....................................... Net income before interest and income taxes ...... Interest expense ..................................................... Net income before income taxes ........................... Income tax expense ................................................ Net income ..............................................................

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4,600 $8,250 $795 360 145 1,300 $6,950 25 $6,925 1,731 $5,194

Instructions Prepared any closing entries required. Solution (10 min.) DR Revenue ........................................................................ CR Income Summary .................................................

$12,850 $12,850

DR Income Summary ......................................................... CR Cost of Goods Sold ............................................... CR Wages .................................................................... CR Utilities .................................................................. CR Depreciation ......................................................... CR Interest expense ................................................... CR Income tax expense ..............................................

$7,656

DR Income Summary ......................................................... CR Retained Earnings.................................................

$5,194

$4,600 795 360 145 25 1731

$5,194

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

77. Shown below is an adjusted trial balance for Togo Enterprises Ltd. at the end of its fiscal year end, October 31, 2024. TOGO ENTERPRISES LTD. Adjusted Trial Balance October 31, 2024 Debit Cash ......................................................................... $4,600

Credit

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Accounts receivable................................................ Inventory ................................................................. Prepaid expenses .................................................... Building ................................................................... Accumulated depreciation-building ...................... Accounts payable ................................................... Common shares ...................................................... Retained earnings, Nov 1, 2023 .............................. Dividends declared ................................................. Sales revenue .......................................................... Cost of goods sold .................................................. Wages expense........................................................ Supplies expense .................................................... Depreciation expense ............................................. Insurance expense .................................................. Totals.......................................................................

6,200 12,500 5,000 140,000 $20,000 20,500 5,000 78,000 5,000 280,000 168,000 53,000 2,000 6,200 1,000 $403,500

_______ $403,500

Instructions a) Prepare a Statement of Income. b) Prepare a Statement of Changes in Equity. c) Prepare a classified Statement of Financial Position. Solution (12 min.) TOGO ENTERPRISES LTD. Statement of Income For the Year Ended October 31, 2024 Sales ........................................................................ Cost and expenses Cost of goods sold .................................................. Gross Profit ............................................................. Wages expense........................................................ Supplies expense .................................................... Depreciation expense ............................................. Insurance expense ..................................................

$280,000 $168,000 $112,000 53,000 2,000 6,200 1,000

Net income ..............................................................

$49,800

TOGO ENTERPRISES LTD Statement of Changes in Equity For the Year Ended October 31, 2024 Retained earnings, November 1, 2023 ...................

$ 78,000

Double-Entry Accounting and the Accounting Cycle

Add: net income ...................................................... Deduct: Dividends declared ................................... Retained earnings, October 31, 2024 .....................

49,800 127,800 5,000 $122,800

TOGO ENTERPRISES LTD. Statement of Financial Position As at October 31, 2024 ASSETS Current Assets Cash ......................................................................... Accounts receivable................................................ Inventory ................................................................. Prepaid expenses .................................................... Total current assets ...................................... Non-current assets Building ................................................................... Accumulated depreciation- Building ..................... Total non-current assets .............................. TOTAL ASSETS ........................................................

140,000 (20,000) 120,000 $148,300

LIABILITIES Current Liabilities Accounts payable ................................................... Total current liabilities .................................

$ 20,500 20,500

SHAREHOLDERS’ EQUITY Common shares ...................................................... Retained earnings ................................................... TOTAL SHAREHOLDERS’ EQUITY ................. TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $148,300

$ 4,600 6,200 12,500 5,000 28,300

5,000 122,800 127,800

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

78. Given the following adjusted trial balance: JIMBO CORPORATION Adjusted Trial Balance November 30, 2024 Debit

Credit

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Cash ......................................................................... Temporary investments ......................................... Accounts receivable................................................ Inventory ................................................................. Prepaid expenses .................................................... Land......................................................................... Buildings ................................................................. Equipment .............................................................. Patents .................................................................... Accumulated depreciation—buildings .................. Accumulated depreciation—equipment ............... Accounts payable ................................................... Accrued expenses ................................................... Deferred revenue .................................................... Note payable—due in 4 years ................................. Preferred shares...................................................... Common shares ...................................................... Retained earnings ................................................... Sales Revenue ......................................................... Interest income ....................................................... Cost of goods sold .................................................. Operating expenses ................................................ Interest expense ..................................................... Income tax expense ................................................

$25,000 40,000 58,000 79,000 7,000 125,000 352,000 117,000 21,000 88,000 29,250 60,000 12,000 18,000 125,000 100,000 250,000 130,250 420,000 19,750 285,600 137,000 3,400 2,250 $1,252,250

_________ $1,252,250

Instructions a) Determine the 1. net income (loss). 2. current assets. 3. total assets. 4. shareholders’ equity. 5. gross profit. 6.current liabilities. b) Prepare any closing entries required. Assume dividends declared and paid in 2024 are $19,000. Solution (25 min.) a) 1. $11,500 = $420,000 – 285,600 – 137,000 – 3,400 + 19,750 – 2,250 2.

$209,000 = $25,000 + 40,000 + 58,000 + 79,000 + 7,000

$706,750 = $209,000 + 125,000 + 352,000 + 117,000 + 21,000 – 88,000 – 29,250

$491,750 = $100,000 + 250,000 + (130,250 + 11,500)

Double-Entry Accounting and the Accounting Cycle

$134,400 = $420,000 – 285,600

$90,000 = $60,000 + 12,000 + 18,000

b) DR Sales Revenue ................................................... DR Interest Income ................................................. CR Income Summary ......................................

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$420,000 19,750 $439,750

DR. Income Summary ............................................. CR Cost of goods sold ..................................... CR Operating expenses ................................... CR Interest expense ........................................ CR Income tax expense ...................................

$428,250

DR Income Summary .............................................. CR Retained Earnings......................................

$11,500

DR Retained Earnings ............................................. CR Dividends Declared ....................................

$19,000

$285,600 137,000 3,400 2,250

$11,500

$19,000

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

79. The following is a summary of ledger balances at the end of the 2023 and 2024 for Miller’s Meat Store: Dec 31, 2023

Dec 31, 2024

Dec 31, 2023

Dec 31,2024

Accounts Payable

$30,000

$20,000

Temporary Investment

$5,000

Accounts Receivable

$2,000

$2,500 Interest expense

$8,000

$9,000

Accumulated depreciation on Fixed Assets

($20,000)

($22,500) Inventory

$90,000

$120,000

$13,000 Line of Credit

$5,000

$1,200

Depreciation expense

$2,500

$3,500 Mortgage on

$90,000

$85,000

Advertising Buildings (at cost) Cash

$7,500 $150,000 $2,500

$150,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Building Common Shares

$50,000

$50,000 Purchases

$600,000

$750,000

Cost of Goods Sold

$611,500

??????? Rent Expense

$12,000

Equipment (at cost)

$45,000

Retained Earnings

$100,000

????

Revenue

$800,000

$950,000

Income Tax Expense

$20,000

$25,000 Salaries expense

$75,000

$85,000

Insurance for coming year

$2,000

$2,200 Salaries Payable

$1,500

$2,000

Insurance for past year

$8,500

$10,000 Utilities expense

$5,000

$6,000

Instructions Prepare a Statement of Financial Position for 2024 based on the above information, assuming the company declared and paid a dividend of $20,000 in 2024. Solution (25 min.) MILLER’S MEAT STORE Statement of Financial Position As at December 31, 2024 ASSETS Current Assets Cash ......................................................................... Accounts Receivable ............................................... Inventory ................................................................. Temporary Investment ........................................... Prepaid Insurance................................................... Total Current Assets ...............................................

$ 3,500 2,500 120,000 5,000 2,200 $133,200

Non- current assets Property, Plant, and Equipment Building ................................................................... Equipment .............................................................. Less: Accumulated Depreciation............................ Property, Plant, and Equipment ............................ Total Assets .............................................................

$150,000 45,000 (22,500) 172,500 $305,700

LIABILITIES Current Liabilities Line of Credit ........................................................... Accounts Payable ................................................... Salaries Payable......................................................

$1,200 20,000 2,000

Double-Entry Accounting and the Accounting Cycle

Total Current Liabilities .........................................

$ 23,200

Non-Current Liabilities Mortgage Payable ................................................... Total Liabilities .......................................................

$85,000 $108,200

SHAREHOLDERS’ EQUITY Common Shares ..................................................... Retained Earnings ................................................... Total Shareholders’ Equity .....................................

$50,000 147,500 $197,500

Total Liabilities & Shareholders’ Equity.................

$305,700

Retained earnings is calculated as: RE = Total assets – total liabilities – common shares RE = $305,700 – $108,200 – $50,000 = $147,500 Bloomcode: Application Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

MATCHING 80. Indicate with a Dr. or a Cr. whether each of the following accounts normally has a debit or a credit balance. ___ a) Shareholder’s Equity ___ b) Accumulated depreciation ___ c) Investments ___ d) Dividends declared ___ e) Accounts payable ___ f) Inventory ___ g) Sales revenues ___ h) Bonds payable ___ i) Prepaid rent expense ___ j) Deposits from customers Solution (5 min.) a) Cr. b) Cr. c) Dr. d) Dr. e) Cr. f) Dr. g) Cr. h) Cr. i) Dr. j) Cr. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

Double-Entry Accounting and the Accounting Cycle

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81. Fill in the blanks using the words provided below: analyzing, Statement of Financial Position, crediting, debiting, journal, ledger, prepaid expenses, posting, deferred revenue. a) The act of entering an amount on the left side of an account is called ___ the account, and making an entry on the right side is called ___ the account. b) The basic steps in the recording process are ___ each transaction, entering the transaction in a ___, and ___ the information to appropriate accounts in the ___. c) Expenses paid and recorded in an asset account before they are used or consumed are called ___. Revenue received and recorded as a liability before it is earned is referred to as ___. d) The ___ reports the assets, liabilities, and shareholders' equity of a business on a specific date. Solution (5 min.) a) debiting, crediting

analyzing, journal, posting, ledger

prepaid expenses, deferred revenue

Statement of Financial Position

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. Learning Objective: Identify and explain the steps in the accounting cycle. Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

82. Arrange the following accounting cycle steps in the proper order by placing numbers 1 through 9 in the blanks provided: ___ a) Journalize an entry ___ b) Prepare financial statements ___ c) Prepare trial balance ___ d) Journalize adjusting entries ___ e) Analyze a transaction ___ f) Post to the general ledger ___ g) Journalize closing entries ___ h) Prepare adjusted trial balance

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

___ i) Recognize an event or a transaction that has occurred Solution (5 min.) a) 3 b) 8 c) 5 d) 6 e) 2 f) 4 g) 9 h) 7 i) 1 Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the steps in the accounting cycle. CPA: Financial Reporting AACSB: Analytic

Double-Entry Accounting and the Accounting Cycle

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SHORT-ANSWER ESSAY QUESTIONS 83. Describe the double-entry accounting system? Explain when, why and how it is used? Solution (7 min.) The double-entry accounting system alleviates and mitigates the cumbersome process of accounting using the template method, particularly when a company uses a large number of accounts. The double-entry accounting system requires that each transaction be recorded in a way that affects at least two accounts and has the transaction amount recorded in each account. The total effects of the entries will be equal and offsetting. The double-entry accounting system overcomes the limitations of using spreadsheets by enabling companies to use hundreds, even thousands of accounts to capture information at the level of detail required to manage the business effectively. It enables businesses to capture transaction details while making it easy to summarize information by account. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how the double-entry accounting system works, including how it overcomes the limitations of the template approach. CPA: Financial Reporting AACSB: Analytic

84. What are T accounts and how does this relate to the concept of a normal balance? What is the normal balance for each of the financial statement elements? Solution (5 min.) T accounts are a convention used to illustrate the accounting process. The left side of the T account is known as the debit side, while the right side is referred to as the credit side. The side of the T account that increases the account balance is referred to as the normal balance. Assets, expenses and dividends have a normal balance on the debit side, while liabilities, shareholder equity and revenues have a normal balance on the credit side. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the normal balance concept and how it is used within the double-entry accounting system. CPA: Financial Reporting AACSB: Analytic

85. What is a chart of accounts? Identify and describe what is contained in a chart of accounts and what management would take into consideration when developing the chart of accounts? Solution (8–10 min.)

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

A list of a company’s accounts is known as its chart of accounts. When a company is formed one of the most critical initial decisions management makes as the accounting system as set up is to determine what information is required to manage the business. Questions that should be asked during the development process include: • What information is needed to make well informed decisions? • What information is needed by outside users? • What information is needed to comply with the appropriate financial reporting standards? The information needs of managers differ, so companies will develop their own unique information systems and capture different information or summarize information in different ways. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. CPA: Financial Reporting AACSB: Analytic

86. What are temporary accounts and why are they used? Solution (5 min.) Temporary accounts measure and track the activity that is occurring over a period of time. These accounts include revenues, expenses, and dividends and are closed out to retained earnings at the end of the period. Temporary accounts are only measuring activity for a particular period of time and must be zeroed out prior to the next period in order to allow accurate tracking of activities for comparison purposes. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the difference between permanent and temporary accounts. CPA: Financial Reporting AACSB: Analytic

87. Why is a trial balance prepared and what is its function? Solution (8 min.) The trial balance is prepared to ensure that the equation debits = credits has not been violated and that no errors were made in the recording process. If it does not balance, the accountant must determine what error(s) occurred and correct it (them). Potential errors could include: (1) not recording an entry, (2) recording an entry twice, (3) recording the correct amount to the wrong accounts, and (4) recording the wrong amount to the correct accounts. Bloomcode: Knowledge

Double-Entry Accounting and the Accounting Cycle

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Difficulty: Medium Learning Objective: Identify and record transactions in the general journal and general ledger. CPA: Financial Reporting AACSB: Analytic

88. What are adjusting entries and in what two types of situations are they necessary? Provide an example. Solution (5 min.) Adjusting entries are entries at the end of the accounting period before the financial statements are prepared. Adjusting entries are used to: correct any errors discovered from the entries posted during the year and for transactions or events that were not recognized or recorded during the period. There are two broad categories of entries: Accrual and Deferrals. Accruals are required when a company needs to recognize a revenue or expense before the receipt or payment of cash. Deferrals are required when a company needs to recognize a revenue or expense in an accounting period after the cash has been received or paid. Adjusting entries never involve cash. The types of items that need to be adjusted are generally time related such as the expiration of prepaid expenses, the depreciation of capital assets, or the accruing of interest payable or receivable. Additional examples are possible – deferred revenue, warranty expenses, etc. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

89. At the end of December 2024 when preparing the financial statements, the accountant forgot to make the adjusting entry related to the depreciation of the capital assets. Instructions Explain the effect of the error on the Statement of Income and Statement of Financial Position for 2024 and 2025. Assume the error was not discovered and was not corrected in 2025. Solution (8 min.) The depreciation expense on the 2024 Statement of Income will be understated which would overstate the net income and all measures of profit. The Statement of Financial Position will be overstated in 2024 because the accumulated depreciation will be understated and retained earnings overstated due to the overstated net income. In 2025, if the error is not corrected but the 2025 depreciation expense is correctly calculated, then the Statement of Income will be correct. The Statement of Financial Position will continue to be overstated by the missing accumulated depreciation from 2024 and the overstated balance in retained earnings.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain why adjusting entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

90. What are closing entries and why are they necessary? Identify and describe the 4 steps in the closing process. Make sure to list the steps in the correct order. Solution (10 min.) Closing entries are required to transfer the balances in the temporary accounts (revenues, expenses and dividends declared) to retained earnings. The temporary accounts begin the new period with a nil balance. Companies can then measure their revenues, expenses and dividends declared for each year rather than having cumulative balances for multiple years. The four steps for closing entries are as follows: 1. Close all revenue accounts to Income summary. 2. Close all expense accounts to Income Summary. 3. Close Income Summary to Retained Earnings. 4. Close Dividends Declared to Retained Earnings. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

Double-Entry Accounting and the Accounting Cycle

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ESSAY QUESTIONS 91. List and provide a brief explanation of each step in the accounting cycle. Solution (10 min.) 1) Start with the opening balances. 2) Complete transaction analysis: Determine which accounts are affected and by how much. 3) Journalize entry: Enter in the general journal. 4) Posting: Transfer data to the general ledger. 5) Prepare trial balance: List all account balances and ensure that total debits = total credits. 6) Prepare adjusting entries: Enter adjustments and corrections in the journal and ledger. 7) Prepare adjusted trial balance: List all account balances and ensure that total debits = total credits. 8) Prepare financial statements: Prepare the Statement of Income, Statement of Changes in Equity, Statement of Financial Position, and Cash Flow Statement. 9) Prepare closing entries: Close all temporary accounts. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. Learning Objective: Explain the difference between permanent and temporary accounts. Learning Objective: Identify and record transactions in the general journal and general ledger. Learning Objective: Explain why adjusting entries are necessary and prepare them. Learning Objective: Explain why closing entries are necessary and prepare them. CPA: Financial Reporting AACSB: Analytic

CHAPTER 4 REVENUE RECOGNITION AND THE STATEMENT OF INCOME CHAPTER LEARNING OBJECTIVES 1. Explain the nature of revenue and why revenue is of significance to users. • Revenues are inflows of economic benefits from a company’s ordinary operating activities (the transactions a company normally has with its customers in relation to the sale of goods or services). • Revenues are not tied to the receipt of cash because other economic benefits such as accounts receivable can result. • For a company to be successful, it must generate revenues in excess of the expenses it incurs doing so. • Users assess the quantity of revenues (changes in the amount of revenues) and the quality of revenues (the source of any growth and how closely any change in revenues corresponds with changes in cash flows from operating activities).

2. Identify and explain the contract-based approach to revenue recognition. • There are two approaches to revenue recognition used in accounting standards: a contracts-based approach, which is required under IFRS, and an earnings-based approach, which is required under ASPE. This course focuses on the contract-based approach. • Under the contract-based approach a company recognizes revenue whenever its net position in a contract increases. This occurs when the company’s rights under a contract increase or its obligations under the contract decrease. • A five-step model is used to determine when revenue should be recognized and what amount that should be. The steps are: (1) Identify the contract; (2) identify the performance obligation; (3) determine the transaction price; (3) allocate the transaction price to the performance obligations; and (5) recognize revenue when each performance obligation is satisfied. • A contract is a legally enforceable agreement that has been approved by the parties and to which they are committed. It specifies the rights and obligations of each party, it has commercial substance and collection of payment is considered probable. • Performance obligations relate to distinct goods or services. Goods or services are considered to be distinct if the customer can benefit from them through use, consumption, or by selling the goods or services on their own or with other resources the customer has or can access. • The transaction price is the amount of consideration the seller expects to receive in exchange for providing the goods or services. If the amount is variable, as a result of the discounts, refunds, rebates, incentives, and so on, then the transaction price should

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reflect this, so that it reflects the amount that the seller expects to receive after these amounts have been factored in. If there are multiple performance obligations, then the transaction prices must be allocated to each obligation. This is done using the stand-alone selling price for each obligation and determining the percentage of each relative to the combined total. Revenue is recognized when each performance obligation is satisfied through the transfer of goods or the provision of services. A performance obligation is deemed to have been satisfied when the control of the goods and services has been transferred to the customer.

3. Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. • If goods are sold with a right of return, management must estimate the extent of expected refunds and reduce the estimated transaction price by this amount. A refund liability is established for the expected refund amount. • There are two types of warranties: Assurance warranties and service warranties. Service warranties are sold separate from the warrantied goods and typically have a longer warranty coverage period. Service warranties are considered to be a separate performance obligation, so a portion of the transaction must be allocated to it. Assurance warranties are not considered to be a separate performance obligation. • Consignment arrangements involve the consignor transferring their goods to a consignee who, in turn, sells them to a customer. The goods remain in the control of the consignor and the consignee is only entitled to a commission upon the sale of the goods. The consignee only recognizes the amount of the commission, rather than the total selling price of the goods, as revenue. • Third-party sales involve an agent arranging sales on behalf of a principal. The principal is responsible for providing goods or services to customers and the agent receives a commission or fee for arranging the sale. The agent only recognizes as revenue the commission or fee, rather than the gross amount of the sale.

4. Understand the difference between a single-step statement of income and a multi-step statement of income. • A single-step statement of income has two parts. All revenues are reported together in one section and all expenses are reported together in another section. The source of the revenues and the nature of the expenses are not considered. • On a multi-step statement of income, the revenues earned from operations are presented separately from incidental revenues such as interest or dividends. Some expenses, such as cost of goods sold, are presented separately from other expenses. Multi-step statements of income also provide users with key measures such as gross profit and income from operations. • Users of a single-step statement of income can determine measures such as gross margin and income from operations, but they are not presented on the statement itself.

5. Understand the difference between comprehensive income and net income.

Revenue Recognition and the Statement of Income

• • •

Companies are required to report net income and comprehensive income. Comprehensive income is equal to net income plus other comprehensive income. Other comprehensive income includes gains and losses resulting from the revaluation of certain financial statement items to fair value or as a result of changes in foreign currency exchange rates. Because these revaluation transactions are not transactions with third parties, they are not included in net income but are included in other comprehensive income.

6. Understand the difference between presenting expenses by function or by nature of the item on the statement of income. • Companies can present their expenses by function or by nature on the statement of income. Function refers to the functional area of the business (such as sales, distribution, and administration), while nature refers to the type of expense (such as wages, rent, and insurance). • Management can choose which method to use. If they choose to present expenses by function, then they must disclose information on the nature of the expenses in the notes to the company’s financial statements.

7. Calculate and interpret a company’s basic earnings per share. • The earnings-per-share ratio can be determined by dividing net income less preferred dividends by the weighted average number of common shares outstanding. • EPS expresses net income, after preferred dividends, on a per-share basis. • EPS is one of the most commonly cited financial measures and companies are required to report their EPS on the statement of income or disclose it in the notes to their financial statements.

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TRUE-FALSE STATEMENTS 1. There must be a receipt of cash in order for a company to recognize revenue. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting AACSB: Analytic

2. The amount of revenue is one of the most significant amounts reported in the financial statements. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting AACSB: Analytic

3. Under the accrual basis, accounting revenues are recognized when they are earned regardless of whether the related cash was received by the company. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting AACSB: Analytic

4.Revenue and gains arise from a company’s ordinary activities. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting

Revenue Recognition and the Statement of Income

AACSB: Analytic

5. Revenue recognition approaches differ between IFRS and ASPE. Answer: True Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

6. Under the contract-based approach, revenue is recognized whenever a company’s net position in a contract decreases. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

7. In retail stores, revenue is normally recognized at the time of sale. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

8. When following ASPE, part of the revenue recognition criteria includes reasonable assurance of collectability of at least some portion of the amount earned. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting

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AACSB: Analytic

9. A contract has commercial substance when the risk, timing, or amount of the company’s future cash flows is expected to change as a result of the contract. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

10. At the time of sale, the selling price does NOT have to be determined in order for the selling company to quantify the economic benefits of the transactions. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

11. When making sales on account, there are costs that may be incurred in the future; an example of a cost is bad debts. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

12. Under IFRS, companies offering sales discounts must adjust the original amount of the sales revenue by the expected sales discount. Answer: True Bloomcode: Comprehension Difficulty: Easy

Revenue Recognition and the Statement of Income

Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

13. When customers are granted a right to return goods purchased, management must estimate the extent of expected returns. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

14. A service warranty is considered to be a separate performance obligation under the contract-based approach for revenue recognition. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

15. When a company uses a multi-step income statement, all revenues are presented first regardless of the source. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

16. A single-step income statement requires several steps to reach a company’s net profit or loss.

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Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

17. The multi-step income statement allows readers to easily identify gross profit and profits earned from operating activities. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

18. Private companies must report comprehensive income in their financial statements. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand the difference between comprehensive income and net income. CPA: Financial Reporting AACSB: Analytic

19. Comprehensive income must be reported on a separate statement called the Statement of Comprehensive Income or on the statement of income, immediately below net income. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand the difference between comprehensive income and net income. CPA: Financial Reporting

Revenue Recognition and the Statement of Income

AACSB: Analytic

20. The choice of presenting expenses based on their nature or function rests with management. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between presenting expenses by function or by nature of the item on the statement of income. CPA: Financial Reporting AACSB: Analytic

21. The earnings per share figure expresses net income, after deducting common dividends, on a per-share basis. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Calculate and interpret a company’s basic earnings per share. CPA: Financial Reporting AACSB: Analytic

22. EPS may be reported either on the statement of financial position or the statement of income. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Calculate and interpret a company’s basic earnings per share. CPA: Financial Reporting AACSB: Analytic

23. When there has been a change in the number of preferred shares during the period, a weighted average number of shares must be determined for the EPS calculation. Answer: False Bloomcode: Knowledge

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Difficulty: Medium Learning Objective: Calculate and interpret a company’s basic earnings per share. CPA: Financial Reporting AACSB: Analytic

Revenue Recognition and the Statement of Income

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MULTIPLE CHOICE QUESTIONS 24. If a company generates gains a) this represents income from ordinary activities. b) this is not considered income. c) this is separate and distinct from sales revenue. d) this is considered a financing activity. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting AACSB: Analytic

25. Which of the following would indicate high-quality earnings for a company? a) increasing revenue while cash from operations is stable b) increasing net income while cash from operations decreases c) revenue and net income that move together d) net income and cash flow from operations that move in the same direction Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting AACSB: Analytic

26. In which of the following businesses would the delivery of the product and the collection of cash occur at the same time? a) a clothing retail store b) a consulting firm c) a home builder d) an advertising firm Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the nature of revenue and why revenue is of significance to users.

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CPA: Financial Reporting AACSB: Analytic

27. When a company reports net income, financial statement users see this as a sign that a) the company is viable. b) the company has the ability to sustain itself. c) the company has the ability to declare dividends. d) All options are correct. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting AACSB: Analytic

28. Earnings are considered to be of higher quality if a) cash flow from operating activities is greater than net earnings. b) cash flow from operating activities is less than net earnings. c) cash flow from investing activities is greater than net earnings. d) cash flow from investing activities is less than net earnings. Answer: a Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting AACSB: Analytic

29. Earnings are considered to be of lower quality if a) cash flow from operating activities is greater than net earnings. b) cash flow from financing activities is less than net earnings. c) cash flow from operating activities is less than net earnings. d) cash flow from investing activities is less than net earnings. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain the nature of revenue and why revenue is of significance to users. CPA: Financial Reporting

Revenue Recognition and the Statement of Income

AACSB: Analytic

30. In the retail industry, when customers pay cash at the time of sale, revenue is recognized a) when the inventory is purchased. b) when the cash is received. c) when the time frame for returns has passed. d) when the cash is deposited in the bank. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

31. Which of the following is NOT required for revenue recognition under ASPE, for the sale of goods using the earnings-based approach? a) The amount of consideration received can be measured with reasonable assurance. b) Collection is reasonably assured. c) All estimated sales returns and allowances have been recorded. d) The risks and rewards of ownership have been transferred to the customer. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

32. When goods and services are bundled in a sales transaction a) the service must be performed before any revenue is recognized. b) collection must occur before any revenue is recognized c) the amount of consideration received for the service must be recognized first. d) each performance obligation under the contract must be measured separately. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting

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AACSB: Analytic

33. Under the contract-based approach, revenue is recognized when a) a company’s net position is increased. b) when the transaction price is determined. c) when the performance obligation has been defined. d) the contract has commercial substance. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

34. Which of the following criteria is NOT required for a contract to exist? a) The contract has been approved and the parties are committed to their obligations. b) The contract includes a contractual commitment in the form of a deposit. c) The contract must have commercial substance. d) The contract is legally enforceable. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

35. Performance obligations relate to a) distinct goods or services. b) input costs of products or services. c) customer payment terms. d) the transaction price. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

Revenue Recognition and the Statement of Income

36. Variable consideration in the transaction price refers to, at least in part: a) variations in the number of items ordered and delivered. b) the impact of price related to discounts or refunds. c) the selling company’s return policies. d) the purchaser’s payment terms. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

37. Which of the following is NOT an indicator that control has been transferred to a customer under the contract-based approach? a) payment has been received b) transfer of risks and rewards of ownership c) physical possession d) legal title Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

38. Frenzo Furniture Co. is a manufacturer of specialty furniture, and uses the contract-based approach for revenue recognition. Since each piece of furniture is customized, the company requires a contract prior to beginning the production process. Contract terms include a payment of 40% of the estimated cost of the finished piece before production begins. Frenzo Furniture Co. should record the collection as a a) credit to sales revenue. b) credit to deferred revenue. c) credit to inventory. d) credit to cost of goods sold. Answer: b Bloomcode: Application

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Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

39. Rainbow Designers took a $1,500 deposit from a customer when it signed the contract to paint the customer’s residence. It took three weeks to complete the job. On completion, the customer paid the $3,500 balance. How should Rainbow Designers recognize revenue for this job assuming the job is performed in one accounting period? a) The $1,500 as revenue when it is received, and the $3,500 as revenue when it is received. b) The $1,500 as deferred revenue and the $3,500 as revenue when it is received. c) $5,000 as revenue at the completion of the project. d) The $1,500 as deferred revenue and $5,000 as revenue when the project is completed. Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

40. Bailey Consulting, is a Winnipeg-based company that uses the contract-based approach to revenue recognition. The company has just signed a contract to complete a strategic plan for a local business. In using the five-step model, which of the following items would NOT be included as part of the revenue recognition process? a) allocate the transaction price to performance obligations b) sign the contract c) identify the performance obligations d) determine the transaction price Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

41. The Carluccis decided to open a resort. In the first month of operation they collected cash and credit card receipts of $1,612.50. All rooms rent out at $75 a night and during the month they had 19 room rentals. In addition to the 19 rentals, they received non-refundable deposits of $37.50 each on another five nights of rentals. Two of those deposits related to the current

Revenue Recognition and the Statement of Income

month and the people failed to show up. The Carluccis did NOT refund the deposits for these two customers. The remaining three deposits are for future stays. The appropriate amount for them to recognize as revenue for their first month is a) $1,425. b) $1,500. c) $1,800. d) $1,575. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

42. Magic Mountain accounts for revenues using the contract-based approach. It operates a ski resort in the Rocky Mountains of Alberta. It sells three types of ski tickets. Season tickets are sold throughout the year, and entitle the holder to ski any day all season long. They are non-refundable. Daily tickets are sold at the mountain and are only valid for the day they are sold. Corporate group tickets are sold throughout the year. The buyer receives a package of 20 daily ticket coupons at a discounted price and the coupons can be redeemed for a day of skiing any time during the season. The skier needs to present the coupon for a ticket on the desired ski day. Unused tickets (coupons) expire at the end of the season and are nonrefundable. When should Magic Mountain recognize revenue for the season tickets? a) at the time of sale b) on the day the mountain first opens for skiing c) throughout the ski season d) at the end of the ski season Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

43. Magic Mountain accounts for revenues using the contract-based approach. It operates a ski resort in the Rocky Mountains of Alberta. It sells three types of ski tickets. Season tickets are sold throughout the year, and entitle the holder to ski any day all season long. They are non-refundable. Daily tickets are sold at the mountain and are only valid for the day they are

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sold. Corporate group tickets are sold throughout the year. The buyer receives a package of 20 daily ticket coupons at a discounted price and the coupons can be redeemed for a day of skiing any time during the season. The skier needs to present the coupon for a ticket on the desired ski day. Unused tickets (coupons) expire at the end of the season and are nonrefundable. When should Magic Mountain recognize revenue for the corporate tickets redeemed? a) at the time of sale b) on the day they are redeemed for a ticket c) throughout the ski season d) at the end of the ski season Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

44. Magic Mountain accounts for revenues using the contract-based approach. It operates a ski resort in the Rocky Mountains of Alberta. IT sells three types of ski tickets. Season tickets are sold throughout the year, and entitle the holder to ski any day all season long. They are non-refundable. Daily tickets are sold at the mountain and are only valid for the day they are sold. Corporate group tickets are sold throughout the year. The buyer receives a package of 20 daily ticket coupons at a discounted price and the coupons can be redeemed for a day of skiing any time during the season. The skier needs to present the coupon for a ticket on the desired ski day. Unused tickets (coupons) expire at the end of the season and are nonrefundable. How should Magic Mountain account for the corporate tickets NOT redeemed? a) It should estimate an amount at the time of sale and recognize it as revenue then. b) It should estimate an amount at the time of sale and recognize it as revenue evenly throughout the ski season. c) It should estimate an amount at the time of sale and recognize it as revenue proportionally every time a coupon is redeemed. d) It should recognize it as revenue at the end of the ski season. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

Revenue Recognition and the Statement of Income

45. During the current year, BMI Corporation sold $1,250,000 in goods that cost $750,000. Cash sales were $500,000 and credit sales $750,000. BMI collected $500,000 of the credit sales during the year. What amount of revenue should BMI recognize for the year under the revenue recognition criteria of the contract-based approach? a) $1,250,000 b) $500,000 c) $750,000 d) $1,000,000 Answer: a Bloomcode: Application Difficulty: Easy Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

46. On September 1, Duval Enterprises collected rent for three months in advance. The total collected was $1,200. How much rent revenue should Duval recognize for the month of September? a) $1,200 b) $300 c) $600 d) $400 Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

47. Oceans Limited sold $1,750,000 worth of goods during the current year. The cost of goods sold is $1,050,000. Credit sales were $1,575,000, of which 40% were still outstanding. How much cash was collected by Oceans Ltd.? a) $1,575,000 b) $1,120,000 c) $805,000 d) $175,000 Answer: b

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Bloomcode: Application Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

48. The contract-based approach to revenue recognition is used under a) ASPE. b) IFRS. c) both IFRS and ASPE. d) either IFRS and ASPE, companies may choose the method that best reflect the firm’s economic position. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

49. All of the following categories include established revenue recognition criteria EXCEPT for a) the sale of goods. b) the collection of accounts receivable. c) the provision of services. d) contracts. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

50. Which of the following is NOT a criteria that must be satisfied in order to recognize revenue for the sales of goods under the earnings-based approach when using ASPE? a) The service has been performed. b) The risks and rewards have been transferred to the customer. c) The seller has no continuing involvement. d) Collection is reasonably assured.

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Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

51. Which of the following is NOT a criteria that must be satisfied in order to recognize revenue for the provision of services under the earnings-based approach when using ASPE? a) The service has been performed. b) The amount of consideration to be received can be measured with reasonable assurance. c) the seller has no continuing involvement. d) Collection is reasonably assured. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

52. All of the following are examples of service revenues EXCEPT for a) cell phone, internet, or television services. b) cargo revenues when airlines provide flight services to its customers. c) textbook sales by universities and colleges. d) service and maintenance revenue by vehicle manufacturers. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

53. Tuition collected by universities and colleges for the provision of educational activities is considered revenue from a) sale of goods. b) provision of services. c) receipt of interest. d) none of these.

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Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

54. Under the contract-based approach, when management estimates the extent of expected returns as a form of variable consideration, the company must establish a(n) a) warranty expense account. b) returns and allowances account. c) refund liability account. d) warranty liability account. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

55. Melanie purchases a new Honda Civic. During the negotiations, the sales representative gives her the opportunity to purchase a 10-year bumper-to-bumper warranty. This is referred to as a(n) a) assurance warranty. b) purchase warranty. c) money-back guarantee. d) service warranty. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

56. Which of the following statements regarding service warranties is NOT correct?

Revenue Recognition and the Statement of Income

a) The warranty is legally required. b) The warranty’s price is negotiated separately. c) The warranty is considered to be a separate performance obligation. d) Warranty coverage period is longer. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

57. With consignment sales, at the time of the sale to a third party a) the consignee only records revenue. b) the consignor only records revenue. c) the customer records the sale. d) the consignee and the consignor record revenue. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

58. With consignment arrangements a) the consignee owns the goods. b) the consignor has physical possession of the goods. c) the consignor recognizes revenue when it transfers the goods to the consignee. d) the consignor owns the goods until they are sold. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

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59. The difference between sales revenue and cost of goods sold is a) sales revenue. b) gross profit. c) operating income. d) net income. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

60. The difference between gross profit and the company’s operating expenses is a) sales revenue. b) gross profit. c) operating income. d) net income. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

61. The final step in preparing the multi-step income statement is a) sales revenue. b) gross profit. c) operating income. d) net income. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting

Revenue Recognition and the Statement of Income

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AACSB: Analytic

62. Operating expenses included all of the following EXCEPT for a) advertising. b) depreciation. c) rent. d) loss on sale of equipment. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

63. Comprehensive income includes a) gains or losses from the sale of property, plant and equipment. b) gains or losses from the sale of intangible assets. c) gains or losses from revaluing certain financial statement items to fair value. d) gains or losses from the retirement of bonds payable. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand the difference between comprehensive income and net income. CPA: Financial Reporting AACSB: Analytic

64. Comprehensive income is equal to a) net income minus other comprehensive income. b) net income plus other comprehensive income. c) gross profit plus other comprehensive income. d) gross profit minus other comprehensive income. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand the difference between comprehensive income and net

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

income. CPA: Financial Reporting AACSB: Analytic

65. If your university or college presents its expenses using the terms academic, administration, and student services, the university is presenting its expenses a) by nature. b) by function. c) alphabetically. d) arbitrarily. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between presenting expenses by function or by nature of the item on the statement of income. CPA: Financial Reporting AACSB: Analytic

66. Examples of functional areas of the income statement are a) sales, gross profit, and net income. b) cost of sales, administrative activities, and selling activities. c) wages expenses, depreciation, and rent expense. d) gross profit, operating income, and net income. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand the difference between presenting expenses by function or by nature of the item on the statement of income. CPA: Financial Reporting AACSB: Analytic

67. Basic EPS is a) a measurement of company growth. b) required on the financial statements under IFRS. c) used by creditors to make lending decisions. d) used to determine share price, the lower the EPS the higher the share price. Answer: b

Revenue Recognition and the Statement of Income

Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret a company’s basic earnings per share. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

EXERCISES 68. On September 25, Olive Oil Distributors receives an order from Davinci Italian Supermarkets for 125 cases of extra virgin olive oil. Olive Oil accepts the order, which needs to be delivered to Davinci’s warehouse, and Davinci agrees to pay within 30 days of the receipt of the product. Each case of extra virgin olive oil contains 12 bottles at a selling price of $7.50 each. Olive Oil’s cost is $3 / bottle. The shipment is received at Davinci’s warehouse on October 2, and Davinci mails a cheque to Olive Oil at the end of the agreed upon payment terms. Olive Oil Distributors used a contact-based approach to revenue recognition. Instructions a) Determine if there is a contract between Olive Oil Distributors and Davinci Italian Supermarkets. b) If there is a contract, record Olive Oil’s entries related to these transactions. Solution (10 min.) a) Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to, and each party’s rights under the contract are clear. The contract has commercial substance. There does not appear to be any concerns regarding collectability. b) Sep 25 No Entry Oct 2

Oct 31

DR. Accounts Receivable ($7.50 * 12 *125) ........ CR. Sales Revenues ..................................

$11,250

DR. COGS ($3 *12 *125) ...................................... CR. Inventory ............................................

$4,500

DR. Cash .............................................................. CR. Accounts Receivable..........................

$11,250

$4,500

$11,250

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

69. On March 15, Luxurious Landscapers enters into a contract with Direct Insurance Brokers to provide landscaping services for the spring and summer season. The contract is to begin on May 1 and terminate on October 31. Luxurious will provide weekly landscaping services during this period. The entire value of the contract is $7,200 for six months, to be paid monthly on the first day of each month. Luxurious Landscapers uses the contract-based approach for revenue recognition.

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Instructions a) Determine if there is a contract between Luxurious Landscapers and Direct Insurance Brokers. b) If there is a contract, record Luxurious’ entries related to these transactions for the month of May. Solution (5 min.) a) Yes, both parties have agreed to enter into a contract. The service to be provided, price and payment terms have been agreed to and each party’s rights under the contract are clear. The contract has commercial substance. There does not appear to be any concerns regarding collectability. b) March 15 No Entry May 1

DR. Accounts Receivable($7,200 / 6) ................. CR. Deferred Revenue ..............................

$1,200

May 30 DR. Deferred Revenue ........................................$1,200 CR. Service Revenue.................................

$1,200

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

70. On January 2, 2024 Cool Computers enters into a contract with Buffalo Protection, a wellestablished fire protection company, to upgrade and install new computers at 65 work stations. As part of the contract Cool computers also agrees to connect and network all of the computers. Contract details include the following: • The total contract price is $67,500. • The normal retail price of the computers is $48,750. Cool Computers would normally charge $12,500 for an installation of this size and $10,750 for networking services. • The computers cost Cool Computers $500 each. • The contract requires Cool Computers to deliver the computers by January 25, 2024 and have the installation and networking completed by February 15, 2024. • Buffalo agrees to pay $45,000 upon the delivery of the computers and the balance once the installation is complete, the final payment was made February 28. • Cool Computers uses the contact-based approach for revenue recognition. Instructions a) Determine if there is a contract between Cool Computers and Buffalo Protection. b) If there is a contract, record Cool Computer’s entries related to these transactions.

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Solution (15 min.) a) Yes, both parties have agreed to enter into a contract. The goods and services to be provided, price and payment terms have been agreed to and each party’s rights under the contract are clear. The contract has commercial substance. There does not appear to be any concerns regarding collectability. b) January 2 No Entry Jan 25

Feb 15

Feb 28

DR. Cash .............................................................. DR. Accounts Receivable .................................... CR. Sales Revenue ....................................

$45,000 $698

DR. COGS ($500 * 65) .......................................... CR. Inventory ............................................

$32,500

Performance Obligation

Stand-Alone Price

Contract Price

Allocation of Contract Price

Supply of Computers Installation Computer Networking

$48,750

% of Total Stand-Alone Price 67.7%

X $67,500

$45,698

$12,500 $10,750

17.4% 14.9%

X $67,500 X $67,500

$11,745 $10,057

$72,000

100%

$45,698

$32,500

$67,500

DR. Accounts Receivable .................................... CR. Service Revenue.................................

$21,802

DR. Cash .............................................................. CR. Accounts Receivable ..........................

$22,500

$21,802

$22,500

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

71. Gossip Girl publishes and sells magazines catering to teenage girls. Subscriptions are sold for $36 for twelve monthly issues. The following chart indicates how many magazines were sold during 2024 and what payment they had received from subscribers by year-end. The first magazine is delivered the same month the subscription is sold. Gossip Girl uses the earning approach for revenue recognition. Date January 1

# subscriptions sold 200

Cash Received $ 7,200

Revenue Recognition and the Statement of Income

May 1 September 1 December 1

350 800 650

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12,600 28,800 23,400

Instructions a) How much cash did Gossip Girl collect in 2024? b) What amount of revenue should Gossip Girl report for the year ended December 31, 2024? c) Are there differences between the amount of cash collected and the revenues recognized? If so, explain why. Solution (8 min.) Date # subscriptions January 1 200 May 1 350 September 1 800 December 1 650 TOTAL

# of issues delivered 12 of 12 8 of 12 4 of 12 1 of 12

Revenue $ 7,200 8,400 9,600 1,950 $27,150

Cash Collected $ 7,200 12,600 28,800 23,400 $72,000

Gossip Girl should recognize revenue based on the number of issues published and delivered during the period, not the total number of subscriptions sold. At the time the subscription is sold the earning process is not complete even though it can be measured and collection is reasonably assured. Bloomcode: Application Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

72. Place an X for each criterion that must be met in order to recognize revenue in each category. Criteria

Risks and rewards of ownership are transferred Seller has no continuing involvement Amount of consideration to be received can be measured with

Sale of Goods, under earningsbased approach

Provision of Services, under earnings-based approach

Satisfaction of Performance obligation under contract-based approach

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

reasonable assurance Collection is reasonably assured The goods or services have been accepted Obligation to pay The service has been performed Physical possession and legal title have transferred Solution (7 min.) Criteria

Risks and rewards of ownership are transferred Seller has no continuing involvement Amount of consideration to be received can be measured with reasonable assurance Collection is reasonably assured The goods or services have been accepted Obligation to pay The service has been performed Physical possession and legal title have transferred

Sale of Goods, under earningsbased approach

Provision of Services, under earnings-based approach

Satisfaction of Performance obligation under contract-based approach X

X X

X X X X X

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

73. Basically Beautiful Wholesalers sells beauty products to salons and spas. The company’s sales for the period ended December 31, 2024 were $1,175,000. The cost of sales are estimated at 60% of revenues, with an estimated return rate of 5%. Returned product is expected to be scrapped. All sales are made on account. Instructions a) Prepare Basically Beautiful’s partial Statement of Income.

Revenue Recognition and the Statement of Income

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Record Basically Beautiful’s sales for the period.

Solution (10 min.) a) BASICALLY BEAUTIFUL WHOLESALERS Partial Statement of Income Period Ended December 31, 2024 Revenues ...................................................................................... $1,116,250 Cost of Goods Sold ($1,175,000 x 60%) ....................................... 705,000 Gross Profit .................................................................................. $ 411,250 b)

DR. Accounts Receivable ...........................................$1,175,000 CR. Sales Revenue ($1,175,000 – $58,750) ...... CR. Refund Liability ($1,175,000 * 5%) ............

$1,116,250 $58,750

Dr. COGS .......................................................................... $705,000 Cr. Inventory ....................................................

$705,000

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

74. HARTLEY’S HARLEY BIKES INC. Trial Balance April 30, 2024 Cash Accounts Receivable Inventory Office Supplies Store Supplies Prepaid Rent Office Equipment Accumulated Depreciation—Office Equipment Store Equipment Accumulated Depreciation—Store Equipment Accounts Payable Notes Payable Common Shares

$14,245 5,280 9,780 100 200 600 3,000 $600 5,800 580 1,390 5,000 3,023

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Dividends Sales Revenue Cost of goods sold Office Salaries Expense Rent Expense Office Supplies Expense Advertising Expense Income tax expense Depreciation Expense Totals

18,000 86,400 18,200 6,825 1,200 300 1,800 1,263 400 $91,993

$91,993

Instructions Prepare a multi-step Income Statement for the year ended April 30, 2024. Solution (10 min.) HARTLEY’S HARLEY BIKES INC. Income Statement For the year ended April 30, 2024 Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses: Office Salaries Expense Rent Expense Advertising Expense Depreciation Expense Office Supplies Expense Total operating expenses Income before income tax Income tax Expense Net Income

$86,400 18,200 $68,200 $6,825 1,200 1,800 400 300 10,525 $57,675 1,263 $56,412

Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

75. Conquistitor Ltd. reported net income of $750,000 for the year ended July 31, 2024. During the year, the company also declared and paid dividends of $45,000 on the company’s preferred shares. At the beginning of the year, Conquistitor had 350,000 common shares outstanding. No shares were issued or repurchased during the year.

Revenue Recognition and the Statement of Income

Instructions a) Calculate the basic earnings-per-share ratio. b) Assume 200,000 common shares were issued on August 1, 2023, and an additional 150,000 common shares issued on April 1, 2024. Calculate the basic earnings-per-share ratio. Solution (10 min.) Basic earnings per share =

Net income – preferred dividends Weighted average number of common shares outstanding

EPS = 750,000 – 45,000 350,000 EPS = $2.01

200,000 x 8 / 12 = 350,000 x 4 / 12 =

133,333 116,667 250,000

EPS = 750,000 – 45,000 250,000 EPS = $2.82 Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret a company’s basic earnings per share. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

MATCHING 76. Match the following terms to the descriptions. TERMS a) Contract-Based approach b) Earnings per share c) Revenue recognition d) Multi-Step Income Statement e) Earnings-Based approach f) Refund Liability DESCRIPTIONS 1.

Performance obligations are satisfied; control of goods and services are transferred to the customer.

A negotiated or posted reduction to the selling price.

Presents total earnings on a per-share basis.

Generally used by private companies reporting under ASPE.

An agreement between two parties that creates a combination of rights and performance obligations.

Requires several steps to reach a company’s net profit or loss.

Solution (5 min.) 1. c 2.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition.

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Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. Learning Objective: Understand the difference between a single-step statement of income and a multi-step statement of income. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS 77. Under IFRS the contract-based approach must be used for revenue recognition. Identify and describe the five-step model of revenue recognition that must be used. Solution (10 min.) The five steps include: 1. Identify the contract, a contract exists only when the following criteria are met: a) There is a legally enforceable agreement between two or more parties b) It has been approved, and the parties are committed to their obligations c) Each party’s rights to receive goods or services or payments has been identified d) The contract has commercial substance e) Collection is considered probable 2. Identify the performance obligation, the performance obligation must relate to distinct goods or services, and both of the following criteria must be met: a) The customer can benefit from the good or service on its own or with resources that it possesses or can be obtained from a third party b) The promise to transfer the goods or services is separate from other promised goods or services in the contract. 3. Determine the transaction price. The transaction price must reflect any variable consideration i.e., discounts, refunds, rebates, price concessions, performance bonuses, penalties, etc. 4. Allocate the transaction price to the performance obligation 𝑖f there are multiple performance obligations, then a portion of the transaction price is determined in step three and allocated accordingly 5. Recognize revenue when each performance obligation is satisfied. Indicators that the performance obligation is satisfied include: a) Physical possession b) Legal title c) Risks and rewards of ownership are transferred d) Accepted the goods or received the services e) An obligation to pay Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

78. Identify and describe the differences between an assurance warranty and a service warranty. What are the characteristics of a service warranty? Solution (7 min.) Warranty coverage that is included in the price of a product is known as an assurance

Revenue Recognition and the Statement of Income

warranty. When customers are given the option to purchase separate warranty coverage, this is called a service warranty. Characteristics of a service warranty include: the warranty is priced separately, the warranty coverage period is longer, the warranty period is not legally required, and the warranty period is considered a separate performance obligation. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how revenues recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. CPA: Financial Reporting AACSB: Analytic

79. What is comprehensive income? How is it reflected in the financial statements? How does it differ from operating income? Provide examples. Solution (10 min.) Comprehensive income is defined as the total change in the shareholder’s equity (or net assets) of the enterprise from non-owner sources. It is equal to net income plus other comprehensive income. Standards require that certain gains / losses be reported as other comprehensive income rather than being included in net income. These gains and losses normally arise when certain financial statement items are revalued, either to fair value as the result of changes in foreign currency exchange rates. As these revaluation transactions are not considered to be third party they are considered unrealized. They are excluded from net income but are included in other comprehensive income. These items can be presented on the statement of income immediately below net income or in a separate statement of comprehensive income. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand the difference between comprehensive income and net income. CPA: Financial Reporting AACSB: Communication

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

ESSAY QUESTIONS 80. Standard setters provide guidelines for recognizing revenue. There are separate standards for IFRS versus ASPE regarding how and when revenue can be recognized. Instructions a) Identify and explain the method used to recognize revenue under IFRS. b) How does the method allowed for IFRS differ from what is allowed under ASPE? Solution (15 min.) a) Under IFRS, the contract-based approach must be used. A contract is an agreement between two or more parties that creates a combination of rights and performance obligations. The contract can represent an asset (when rights exceed obligations) or a liability (when obligations exceed rights). Under the contract-based approach, an important factor in determining when to recognize revenue is when there is a change in the company’s net position. The key revenue recognition principle under the contractbased approach is that revenues are recognized when a company’s net position in the contract increases; that is, when a company’s rights under the contract increase or when its obligations under the contract decrease. b)

Under ASPE, privately held companies use an earnings-based approach to determine when earnings should be recognized. Under this approach, earnings are recognized when the earnings process is substantially complete.

Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

81. Pump it Up, a privately held corporation using ASPE, successfully operates two high-end fitness centres in the same town. Members pay a $150 non-refundable initiation fee, and then a one-year membership for unlimited access to the facilities costs an additional $900. They have 3,200 active members. Memberships are required to be paid in full, in three equal monthly instalments over the first three months of a membership year. Partial refunds of the annual fees are only given if a member moves more than 50 kilometres away. In addition to the facilities, there is a juice bar that sells fruit smoothies and healthy snacks. Members can sign for their purchases at the juice bar, and then they are billed at the end of the month. Instructions Discuss when all revenues should be recognized at Pump it Up. Support your discussion with reference to the specific revenue recognition criteria. Solution (20 min.)

Revenue Recognition and the Statement of Income

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In order for revenue to be recognized, the general revenue recognition criteria under the earnings-based approach must be satisfied. Revenue for the sale of goods can be recognized when the following criteria are met: 1. The risks and rewards of ownership are transferred to the customer. 2. Seller has no continuing involvement or control over the goods. 3. Amount of consideration to be received can be measured with reasonable assurance. 4. Collection is reasonably assured. Whereas, revenue for the sale of services can be recognized when the following criteria are met: 1. The service has been performed. 2. The amount of consideration to be received can be measured with reasonable assurance. 3. Collection is reasonably assured. For the initiation fee, all general revenue recognition criteria are met at the time of signing the contract and paying the fee, so revenue can be recognized at that time. For the membership fee, although they are measurable when the contract is signed, and collection is estimable at that time, (and with certainty when it is fully paid at the end of three months), the services have not been provided at that time (significant risk and rewards have not been transferred). The service is provided over the year, and therefore revenue should be recognized evenly over the year. The amounts received will initially be recorded as deferred revenue, and then every month, $75 would be recorded as revenue. A small allowance should be set-up for expected refunds that might be claimed. The amount could be based on previous years’ experience. The revenues from the juice bar (sale of goods) should be recognized at the time of sale as they are measurable and earned. Although, collection will not take place until the end of the month, collection appears to be reasonably assured and would not prevent the revenue from being recognized at the time of sale. A small allowance for uncollectible amounts, if any, should be accrued. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the contract-based approach to revenue recognition. CPA: Financial Reporting AACSB: Analytic

CHAPTER 5 THE STATEMENT OF CASH FLOWS CHAPTER LEARNING OBJECTIVES 1. Understand and explain why the statement of cash flows is of significance to users. • Cash includes cash on hand, bank deposits, and cash equivalents (which are short-term, highly liquid investments with little risk of a change in their value). • The statement of cash flows enables users to assess the cash generated from core operations, the cash that has been obtained from investors and creditors, the extent of new investment in capital assets, the cash available to repay debt, and the amount of cash distributed to shareholders as dividends. • The statement of cash flows also provides a basis for estimating the value of a company and predicting its ability to service its debt and pay dividends. 2. Explain how the statement of cash flows and the statement of income differ. • The statement of cash flows uses the cash basis of accounting, whereas the statement of income is prepared using the accrual basis. • The statement of income focuses only on a company’s operating activities (its revenues and expenses). The statement of cash flows includes cash flows from operating activities, but it also includes cash flows related to investing and financing activities. • There are two methods of preparing the statement of cash flows: the direct method and the indirect method. The only difference between the two methods is how cash flows from operating activities is determined. Total operating cash flows are the same under both methods, and the choice of method has no effect on cash flows from investing or financing activities. 3. Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. • The statement of cash flows categorizes a company’s cash-related transactions into three categories: operating activities, investing activities, and financing activities. • Typical operating activities include cash sales to customers, collections of customer receivables, purchases of inventory, payments to suppliers, payments of wages, and payments of taxes. • Typical investing activities include cash purchases of property, plant, and equipment; purchases of shares of other companies; sales of property, plant, and equipment; and sales of shares in other companies. • Typical financing activities include the proceeds from issuing shares, the proceeds received from new loans, repayments of loan principal, and payments of cash dividends. • Cash flows from operating activities normally receive the greatest scrutiny as these are the cash flows that result from what the company is in the business of doing and are a key source for financing future growth. They are also the source for future debt repayments and/or

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

• •

dividend payments. Companies using IFRS have options in terms of how receipts and payments of interest and dividends are classified. Any non-cash investing and financing activities should also be disclosed.

4. Prepare a statement of cash flows using the indirect method for operating activities. • The indirect method is simpler to prepare, uses information available in most accounting systems, and provides a linkage between net income and cash flows from operating activities. • To determine cash flows from operating activities under the indirect method, net income is adjusted for any non-cash expenses (depreciation and amortization), any gains or losses from investing activities, and changes in current asset and liability accounts (except for the Cash and the Dividends Payable accounts). • Cash flows from investing activities are equal to the cash payments to purchase property, plant, and equipment, less any cash receipts of property, plant, and equipment. The amount of cash payments to purchase the shares of other companies and any proceeds from the sale of such shares are also included. • Cash flows from financing activities are equal to the cash received from issuing shares or the proceeds from any new loans, less any principal repayments or dividends paid during the period. • The sum of the three cash flows should be equal to the net change in cash and cash equivalents for the period. • Companies are also required to disclose the amount of interest paid and received, the amount of dividends paid and received, and the amount of income taxes paid. 5. Prepare a statement of cash flows using the direct method for operating activities. • To determine cash flows from operating activities under the direct method, cash flows are aggregated into categories that commonly include receipts from customers, payments to suppliers, payments to employees, payments of interest, and payments of income taxes. Each category is calculated using the relevant revenue or expense account(s) and adjusted for changes in the related current asset or current liability account. • The investing and financing activities sections are completed exactly the same as is done under the indirect method. 6. Interpret a statement of cash flows and develop potential solutions to any cash flow challenges identified. • Information from the statement of cash flows can help to identify challenges related to significant increases in sales volumes, lengthy cash-to-cash cycles, and undercapitalization. • The cash-to-cash cycle is the time between a company paying out cash to purchase goods and when those goods are ultimately paid for by customers. The longer the cycle, the more pressure is placed on cash flow. • When assessing a company’s cash flows, users will consider whether the cash flows from operating activities are sufficient to sustain the company over time. They will also look for indications of concern related to the collection of receivables; excess inventories; an inability to settle payables; or significant sales of property, plant, and equipment. • A company’s cash flow pattern is the direction (positive or negative) of its cash flows from operating, investing, and financing activities. Reviewing a company’s cash flow pattern can

The Statement of Cash Flows

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provide users with a quick means of initially assessing its financial condition. The most common cash flow patterns are positive operating cash flows, negative investing cash flows, and either positive or negative financing cash flows. 7. Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. • The operating cash flow ratio can be determined by dividing cash flows from operating activities by current liabilities. • It measures the percentage of a company’s current liabilities that could be met with one year’s operating cash flows. When interpreting this ratio, it is important to remember that not all of a company’s current liabilities may be settled with cash. • Net free cash flow is equal to cash flows from operating activities, less net capital expenditures and any dividends on preferred shares. Net capital expenditures equal the total purchases of property, plant, and equipment less the proceeds from the sale of property, plant, and equipment. • It is considered to be the cash flow generated from operations that would be available to the company’s common shareholders. It would be reinvested in the company to grow the business, while a portion may be distributed to shareholders as dividends.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

TRUE-FALSE STATEMENTS 1. The Statement of Cash Flows and the Statement of Income both measure a company's performance. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

2. The components of a Statement of Cash Flows are investing, financing, and operating activities. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

3. A company can only analyze its operations properly provided it has all the detailed financial statements. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

4. The Statement of Cash Flows and Statement of Income are both important measurements of longterm profitability. Answer: False

The Statement of Cash Flows

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

5. The Statement of Cash Flows provides a perspective of an organization’s performance by highlighting the results in the net change in its cash position during the year. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

6. A positive cash flow from operating activities indicates that a company’s financing activities are generating more cash than required for operations. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

7. The Statement of Income reflects the overall change in cash flows for an accounting period. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Financial Reporting AACSB: Analytic

8. Non-cash expenses will reduce the amount of cash a company is able to generate from its

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

operations. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Financial Reporting AACSB: Analytic

9. Cash paid for dividends to shareholders is classified as an investing activity. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

10. All companies must present operating activities first on the statement of cash flows. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

11. Cash equivalents include investments that can be readily converted into cash; investment maturity dates are irrelevant. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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12. If prepaid expenses are shown as having a positive effect on cash flow, it is because prepaid expenses increased during the year. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

13. Cash from operating activities will be the same using either the direct or indirect method to prepare the Statement of Cash Flows. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

14. The cash position of a company takes into consideration cash and cash equivalents. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

15. If a company has used a line of credit, then the amount borrowed can be considered “positive cash”. Answer: False Bloomcode: Comprehension

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

16. Accounting standard setters have established three acceptable methods for preparing a Statement of Cash Flows. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

17. The most common type of non-cash item is depreciation expense. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

18. The direct method is also known as the reconciliation method. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

19. In the early part of the cash-to-cash cycle, net cash flows are normally inflows. Answer: False

The Statement of Cash Flows

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

20. Companies can raise an unlimited amount of cash from financing activities as long as they are willing to pay higher interest rates. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

21. When a company is said to be undercapitalized, this if referring to its long-term assets on the Statement of Financial Position. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

22. Inadequate financing is the most common reason new business start-ups experience cash shortages. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

23. The cash-to-cash cycle is the time between when a company pays out cash to purchase goods until when those goods are ultimately sold on credit to the end-user. Answer: False Bloomcode: Comprehension Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

24. One way to solve cash flow challenges is to slow down the sales growth rate. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

25. A large increase in accounts receivable may indicate that a company is having difficulties collecting its receivables. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

26. A large increase in accounts payable indicates that a company is paying its suppliers on time. Answer: False Bloomcode: Comprehension Difficulty: Easy

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Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

27. The operating cash flows ratio is used to assess a company’s ability to meet its current liabilities through its operating cash flows. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

28. Free cash flow is a commonly used measure in the management discussion and analysis section of annual reports. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

29. A negative net free cash flow is considered to be a good thing. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS 30. “Cash” includes everything EXCEPT for a) demand deposits. b) money market funds. c) treasury bills. d) bank overdrafts. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

31. When may the cash account have a credit balance? a) This is not possible; the normal balance for the cash account is a debit. b) If the company only has cash equivalents and no demand deposits. c) When the company has used its bank overdraft facility. d) When all of the company’s cash is tied up in Accounts Receivable and Inventory. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

32. A banker contemplating a loan to a company should focus on which section(s) of the Statement of Cash Flows in order to determine the company’s ability to repay the loan? a) Operating activities b) Operating and financing activities c) Investing activities d) Operating and investing activities Answer: a Bloomcode: Comprehension Difficulty: Medium

The Statement of Cash Flows

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Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

33. The information presented on the Statement of Cash Flows enables users to a) assess the company’s ability to generate cash flows from its core operations. b) evaluate the cash flows the company has been able to obtain from investors and creditors. c) assess the extent to which the company has invested cash to replace or add revenue-generating capital assets. d) all are correct Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

34. Information on a company’s cash flows is used for all of the following, EXCEPT to a) assess the company’s ability to repay debt in the future. b) evaluate the potential for the company to be able to pay dividends in the future. c) evaluate a company’s liquidity (i.e., the value of a company’s liquid assets in comparison to its short-term debt obligations). d) estimate the company’s future cash requirements. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

35. Which of the following is NOT a major difference between the income statement and the cash flow statement? a) The income statement is a measurement of cash position. b) The income statement does not capture many creditor transactions. c) The income statement is prepared on an accrual basis. d) The income statement captures mainly operating activities.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Financial Reporting AACSB: Analytic

36. Which of the following statements is NOT correct? a) To analyze operations properly you need both the Statement of Income and the Statement of Cash Flows. b) In the long run, total profits and net cash flows will be very similar. c) The Statement of Cash Flows considers events that the Statement of Income does not. d) The Statement of Cash Flows and the Statement of Income both cover only a one-year period of time since profits and cash flows are very similar over the period of a year. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Financial Reporting AACSB: Analytic

37. The following items are reported on a company’s Statement of Income. Which of them is most likely equal to its cash flow impact? a) Depreciation expense b) Gain on sale of capital assets c) Loss on sale of investment d) Interest expense Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Financial Reporting AACSB: Analytic

38. The Statement of ___ is used by shareholders to assess company profitability. a) Cash Flows b) Shareholders’ Equity

The Statement of Cash Flows

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c) Financial Position d) Income Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Financial Reporting AACSB: Analytic

39. Which of the following activities would cause an inflow of cash? a) issuing common shares to retire long-term debt b) payment of a dividend to the shareholders c) incurring a loss on the sale of a capital asset d) recognizing depreciation expense Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

40. Which of the following activities would cause an outflow of cash? a) sale of inventory for cash b) the sale of an investment for a loss c) issuing common shares to acquire capital assets d) purchase of a temporary investment Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

41. Investing activities typically involve accounts classified as a) long-term assets.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

b) long-term liabilities. c) shareholders' equity. d) short-term assets. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

42. Financing activities typically involve accounts classified as a) current assets and current liabilities. b) current liabilities and shareholders' equity. c) long-term liabilities and shareholders' equity. d) current liabilities and long-term liabilities. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

43. Operating activities typically involve accounts classified as a) current assets and current liabilities. b) current assets and long-term liabilities. c) long-term assets and current liabilities. d) long-term assets and long-term liabilities. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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44. Cash flows from financing activities include a) proceeds received from sale of equipment. b) proceeds received from sale of the company’s shares. c) purchase of land. d) proceeds from the sale of shares of another company. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

45. Which of the following would be an example of an investing activity on the Statement of Cash Flows? a) issuance of bonds payable b) purchase of bonds as an investment c) issuance of common shares d) collection of rent from tenants Answer: b Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

46. Which of the following would be an example of a financing activity on the Statement of Cash Flows? a) payment of rent to landlord b) repayment of a loan from another company c) receipt of interest on investments d) sale of equipment Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

47. Which of the following would be an example of an investing activity on the Statement of Cash Flows? a) purchase of capital assets b) issuance of preferred shares c) repurchase of shares issued d) dividends paid to shareholders Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

48. Obtaining resources for the corporation from investors or debt-holders and the return of resources to shareholders and debt-holders are considered part of which of these activities on the Statement of Cash Flows? a) Operating activities b) Investing activities c) Financing activities d) none of these Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

49. The activities of a corporation that are directed to investing the resources of the corporation over extended periods of time in long-term assets is considered part of which of these activities on the Statement of Cash Flows? a) Operating activities b) Financing activities c) Investing activities d) none of these

The Statement of Cash Flows

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Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

50. Which of the following transactions or activities would NOT be reflected on the cash flow statement? a) The company declared and paid shareholders a dividend. b) The company paid interest on a loan. c) The company repurchases its own shares. d) The company purchased land with shares. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

51. If a company has made arrangements with a bank to borrow money in the months when it has a negative cash balance, this arrangement is a a) bank overdraft. b) demand loan. c) long-term loan. d) line of credit. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

52. How should a gain on the sale of equipment be reflected in the operating section of the Statement

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

of Cash Flows when using the indirect method? a) as a deduction from net income b) as a cash inflow c) as an addition to net income d) It is not reflected in the operating section. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

53. Cash equivalents includes everything, EXCEPT for a) demand deposits. b) money market funds. c) short-term bank loans. d) lines of credit. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

54. Under the indirect approach, in preparing the cash from operations section of the Statement of Cash Flows, depreciation is added to net income because a) it is not a cash expense. b) it is a cash outflow. c) it is a source of cash. d) it is not an allowable expense in determining net income. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting

The Statement of Cash Flows

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AACSB: Analytic

55. Under the indirect approach, adjustments must be made to net income in the operations section for all of the following items, EXCEPT for a) depreciation. b) gain on the sale of equipment. c) loss on the sale of land. d) proceeds for the issuance of preferred shares. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

56. Which of the following is normally disclosed as supplementary information on the Statement of Cash Flows? a) cash paid for dividends during the year b) depreciation expense for the year c) property taxes paid during the year d) cash paid for interest during the year Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

57. Which of the following is a deduction from net income when using the indirect approach to prepare the cash from operating activities of the Statement of Cash Flows? a) increase in accounts payable b) increase in prepaid expenses c) loss on sale of investments d) depreciation expense Answer: b

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

58. Which of the following would be added to net income when using the indirect approach to prepare the cash from operating activities on the Statement of Cash Flows? a) increase in inventory b) gain on sale of investments c) decrease in wages payable d) decrease in accounts receivable Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

59. A company has surplus cash available and decides to purchase a 120-day treasury bill. The correct classification of the treasury bill purchase on the Statement of Cash Flows would be a) as a net change in cash equivalents. b) as a cash outflow in operating activities. c) as a cash outflow in investing activities. d) as a cash outflow in financing activities. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

60. Kategat Co. reported the following for current year: Statement of Income Additional Data Sales $800,000 Cost of sales 400,000 Decrease in accounts payable

$30,000

The Statement of Cash Flows

Gross profit 400,000 Proceeds from sale of land Cash operating expenses 100,000 Increase in inventory Depreciation 40,000 Decrease in accounts receivable Loss on sale of land 20,000 Net income $240,000 Using the indirect method, the net cash flow from operating activities is a) $365,000. b) $300,000. c) $235,000. d) $240,000.

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40,000 40,000 5,000

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

61. Tobias Ltd. reported the following for the current year: Statement of Income Additional Data Sales $750,000 Dividends declared and paid Cost of sales 300,000 Increase in accounts payable Gross profit 450,000 Purchase of land Cash operating expenses 75,000 Decrease in inventory Depreciation 25,000 Decrease in accounts receivable Gain on sale of land 15,000 Net income $365,000 Using the indirect method, the net cash flow from all activities is a) $380,000. b) $375,000. c) $350,000. d) $345,000.

$5,000 25,000 100,000 40,000 15,000

Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

62. Assume a company reported net income of $53,000, loss on the sale of equipment of $10,000, and gain on sale of investments of $21,000. If there were no other adjustments to reconcile net income to cash from operating activities, the cash inflow from operating activities must be a) $42,000. b) $63,000. c) $84,000. d) $32,000. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

63. Momentum Consulting Corp. company records revealed the following for the current year: Increase in inventory $ 7,000 Depreciation expense 24,000 Decrease in accounts payable 3,000 Decrease in accounts receivable 9,000 Net loss 25,000 What was the net cash flow from operating activities for the year? a) $8,000 cash inflow b) $0 c) $2,000 cash outflow d) $4,000 cash outflow Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

64. If a company reported net income for the year of $160,000, cash from operating activities of $105,000, cash flows from financing activities of $225,000, and cash used in investing activities of $450,000, what was the company’s change in cash for the year? a) $120,000 decrease b) $170,000 decrease

The Statement of Cash Flows

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c) $40,000 increase d) $65,000 decrease Answer: a Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

65. Soria Co. reported sales of $350,000 and total expenses of $280,000; wages payable increased by $12,000; inventory decreased by $25,000; accounts payable decreased by $50,000; and depreciation was $30,000. What was the net cash flow from operating activities? a) $87,000 b) $40,000 c) $15,000 d) $63,000 Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

66. Caterpillar Industrial reported $10,000 cash used in the operating activities section of the Statement of Cash Flows and the following data: depreciation expense $10,000; an accounts payable increase of $12,000; a $3,000 decrease in accounts receivable; an increase in wages payable of $8,000; and a $15,000 gain on the sale of long-term investments. Caterpillar’s net income/loss for the period was a) $8,000 income. b) $28,000 loss. c) $38,000 loss. d) $2,000 income. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

activities. CPA: Financial Reporting AACSB: Analytic

67. Cobra Enterprises reported $26,000 of cash from operating activities and has the following data: Depreciation $45,000 Increase in accounts payable 12,000 Increase in wages payable 8,000 Increase in inventory 9,000 Decrease in taxes payable 2,000 Cobra’s net income/loss for the period was a) $10,000 income. b) $54,000 loss. c) $28,000 loss. d) $8,000 loss. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

68. GS Transport reported a cash position of $35,000 and as of December 31, after its first year of operations. GS also reported the following: Net Income $23,000 Depreciation Expense $17,000 Gain on the sale of equipment $5,000 Cash from operating activities $42,000 Cash used in investing activities $100,000 How much cash was provided through GS’s financing activities? a) $100,000 b) $ 93,000 c) $ 90,000 d) $ 0 Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities.

The Statement of Cash Flows

CPA: Financial Reporting AACSB: Analytic

69. AFM Co. had the following activity during the current year: Proceeds from sale of equipment $193,000 Dividends paid on common shares 7,000 Purchase of long-term investments 29,000 Repurchase of shares issued 17,000 What was the cash flow from investing activities? a) $157,000 b) $140,000 c) $164,000 d) $147,000 Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

70. QUE Ltd had the following activity during the current year: Proceeds from the sale of long-term investments $ 156,000 Gain on the sale of long-term investments 16,000 Loss on the disposal of equipment ($0 proceeds from disposal) 17,000 Proceeds from issuance of preferred shares 182,000 Repayment of long-term debt 30,000 What was the cash flow from investing activities? a) $16,000 b) $156,000 c) $173,000 d) $189,000 Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

71. QUE Ltd had the following activity during the current year: Proceeds from the sale of long-term investments $ 156,000 Gain on the sale of long-term investments 16,000 Loss on the disposal of equipment ($0 proceeds from disposal) 17,000 Proceeds from issuance of preferred shares 182,000 Repayment of long-term debt 30,000

What was the cash flow from financing activities? a) $135,000 b) $168,000 c) $169,000 d) $152,000 Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

72. Craft Co. had the following activity during the current year: Net Income $50,000 Cash Receipts from customers $1,750,000 Cash Payments to suppliers $1,050,000 Depreciation Expense $35,000 Cash Payments for operations $640,000 What was the cash flow from operating activities? a) $ 25,000 b) $ 50,000 c) $ 60,000 d) $ 95,000 Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting

The Statement of Cash Flows

AACSB: Analytic

73. Muzeen Ltd. had the following activity during the current year: Proceeds from issuance of bonds payable $200,000 Loss of disposal of equipment ($0 proceeds from disposal) 18,000 Repayment of long-term debt 25,000 Issuance of shares 125,000 Gain on the sale of short-term investments 75,000 What was the cash flow from investing activities? a) $ 57,000 b) $ 75,000 c) $ 93,000 d) $ - 0 Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

74. Muzeen Ltd. had the following activity during the current year: Proceeds from issuance of bonds payable $200,000 Loss of disposal of equipment ($0 proceeds from disposal) 18,000 Repayment of long-term debt 25,000 Issuance of shares 125,000 Gain on the sale of short-term investments 75,000 What was the cash flow from financing activities? a) $300,000 b) $292,000 c) $325,000 d) $275,000 Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

75. HammerTech Co. had the following activity for the current year: Payment of long-term note payable $375,000 Interest paid on debt 67,200 Proceeds from sale of common shares 500,000 Dividends received on investments 15,000 What was the cash flow from financing activities? a) $57,800 b) $72,800 c) $125,000 d) $140,000 Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

76. Determine the cash inflows from investing and financing activities given the following data: Proceeds from issuance of preferred shares $80,000 Proceeds from sale of equipment Proceeds from issuance of bonds payable

89,000 300,000

Proceeds from sale of investments Gain on the sale of a temporary investment a) investing $132,000; financing $380,000 b) investing $135,000; financing $391,000 c) investing $143,000; financing $380,000 d) investing $148,000; financing $391,000

43,000 4,000

Answer: a Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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77. Given the following activities:

Purchase of machinery $175,000 Repayment of bank loans 75,000 Sale to customer or account 60,000 Payment on mortgage payable 200,000 Payment to suppliers 65,000 Purchase of 30 day treasury bill 15,000 The cash outflows for investing and financing activities were a) investing $175,000; financing $310,000. b) investing $190,000; financing $275,000. c) investing $190,000; financing $310,000. d) investing $175,000; financing $275,000. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

78. Fellow Agriculture Company had reported the following items: Cash provided by operations $60,000 Cash used in investing activities 250,000 Cash provided by financing activities 175,000 If cash and cash equivalents at the beginning of the year were $18,500, the ending cash and cash equivalents are a) ($15,000). b) $ 3,500. c) $153,500. d) $360,000. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

79. On the Statement of Cash Flows, which of the following would equal cash paid for income taxes? a) income taxes payable plus change in cash b) income taxes expense plus ending balance in income taxes payable c) income taxes expense plus beginning balance in income taxes payable d) income taxes expense plus change in income taxes payable Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

80. The direct method of Statement of Cash Flows preparation is a) widely used in practice. b) preferred by standard setters. c) misunderstood by investors. d) inconsistent and provided different operating results. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

81. The direct approach differs from the indirect approach with regard to preparing which section of the Statement of Cash Flows? a) Operating activities b) Investing activities c) Financing activities d) There is no difference between the two approaches. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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82. Which of the following items related to the cash-to-cash cycle should be investigated when reviewing the Statement of Cash Flows? a) increase in both accounts receivable and accounts payable b) decrease in both accounts receivable and accounts payable c) increase in accounts receivable and decrease in accounts payable d) stable levels of accounts receivable and accounts payable. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

83. Which of the following would be considered a continuing source of cash? a) cash from issuing common shares b) cash from refinancing debt c) cash from reducing cash and cash equivalents d) cash from operations Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

84. Which of the following is NOT an example of a common cash flow challenge? a) a significant decrease in sales volumes b) lengthy cash-to-cash sales cycle c) inadequate capitalization d) a significant increase in sales volumes Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

85. When analyzing a company’s cash flow situation, the term “capitalization” refers to a) how much cash the company has to start with. b) how many capital assets the company has purchased during the period. c) the amount of common shares sold during the period. d) the length of time in the lead/lag relationship. Answer: a Bloomcode: Comprehension Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

86. If a company is experiencing cash flow problems, it can alleviate the problem by a) increasing sales. b) increasing the amount of capitalization. c) increasing the amount of goods sold on credit. d) extending customer payment terms. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

87. Cash from operations is negatively impacted by all of the following, EXCEPT for a) increasing inventory. b) increasing accounts receivable. c) decreasing accounts payable. d) increasing accounts payable. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash

The Statement of Cash Flows

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flow. CPA: Financial Reporting AACSB: Analytic

88. If a company’s sales are increasing, which of the following would normally be expected on the Statement of Cash Flows? a) an increase in both accounts receivable and accounts payable b) a decrease in both accounts receivable and accounts payable c) a decrease in accounts receivable and an increase in accounts payable d) an increase in accounts receivable and a decrease in accounts payable Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

89. Scenario 1. 2. 3. 4. 5. 6. 7. 8.

Cash flows from operating activities + + + + -

Cash flows from investing activities + + + + -

Cash flows from financing activities + + + + -

Based on the chart above, which company profile will fit the cash flow pattern for scenario 1? a) Successful, but actively relocating using financing from operations with cash from creditors and shareholders. b) Struggling, but using cash inflows from the sale of capital assets and new borrowings to remain in operation. c) A start-up or struggling company that is able to attract new financing for growth or reorganization. d) Struggling, but using existing cash balances to cover losses, purchase capital assets and repay creditors. Answer: a

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Comprehension Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

90. Scenario 1. 2. 3. 4. 5. 6. 7. 8.

Cash flows from operating activities + + + + -

Cash flows from investing activities + + + + -

Cash flows from financing activities + + + + -

Based on the chart above, which company profile will fit the cash flow pattern for scenario 3? a) Successful and growing, with growth partially financed by creditors and shareholders. b) Struggling, but using cash inflows from the sale of capital assets and new borrowings to remain in operation. c) Successful, with operating activities providing sufficient cash to finance growth and repay debt or pay dividends. d) Struggling, but using existing cash balances to cover losses, purchase capital assets and repay creditors. Answer: a Bloomcode: Comprehension Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

91. Scenario 1. 2. 3. 4.

Cash flows from operating activities + + + +

Cash flows from investing activities + + -

Cash flows from financing activities + + -

The Statement of Cash Flows

5. 6. 7. 8.

+ + -

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+ + -

Based on the chart above, which company profile will fit the cash flow pattern for scenario 5? a) Successful, but actively relocating using financing from operations with cash from creditors and shareholders. b) Struggling, but using cash inflows from the sale of capital assets and new borrowings to remain in operation. c) A start-up or struggling company that is able to attract new financing for growth or reorganization. d) Struggling, but using existing cash balances to cover losses, purchase capital assets and repay creditors. Answer: b Bloomcode: Comprehension Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

92. Scenario 1. 2. 3. 4. 5. 6. 7. 8.

Cash flows from operating activities + + + + -

Cash flows from investing activities + + + + -

Cash flows from financing activities + + + + -

Based on the chart above, which company profile will fit the cash flow pattern for scenario 8? a) Struggling and using cash from the sales of capital assets to repay creditors. b) Struggling, but using cash inflows from the sale of capital assets and new borrowings to remain in operation. c) Successful, with operating activities providing sufficient cash to finance growth and repay debt or pay dividends. d) Struggling, but using existing cash balances to cover losses, purchase capital assets and repay creditors. Answer: d

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Comprehension Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

93. Scenario 1. 2. 3. 4. 5. 6. 7. 8.

Cash flows from operating activities + + + + -

Cash flows from investing activities + + + + -

Cash flows from financing activities + + + + -

Based on the chart above, which company profile will fit the cash flow pattern for scenario 2? a) Successful, but actively relocating using financing from operations with cash from creditors and shareholders. b) Struggling, but using cash inflows from the sale of capital assets and new borrowings to remain in operation. c) Successful, mature company that is downsizing and returning capital to shareholders and repaying debt. d) Struggling, but using existing cash balances to cover losses, purchase capital assets and repay creditors. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

94. Which of the following measures would NOT resolve common cash flow challenges experienced by a company? a) increasing the amount of capitalization b) shortening the cash-to-cash cycle c) reducing the rate of growth

The Statement of Cash Flows

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d) decreasing the amount of capitalization Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

95. Companies can improve their cash flow by a) increasing sales. b) purchasing inventory on credit. c) selling inventory on credit. d) reducing credit losses. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

96. The term free cash flow is often referred to as a) IFRS non-financial measure. b) IFRS financial measure. c) IFRS performance measure. d) non-IFRS financial measure. Answer: d Bloomcode: Comprehension Difficulty: Hard Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

97. Free cash flow measures the amount of cash that a company generates a) from its operations that is in excess of cash required to maintain its productive capacity.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

b) from its investing activities that is in excess of cash required to maintain its productive capacity. c) from its financing activities that is in excess of cash required to maintain its productive capacity. d) from its operations that is below the cash required to maintain its productive capacity. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

98. The operating cash flows ratio measures a) the percentage of a company’s current liabilities that could be met with one year’s investing cash flows. b) the percentage of a company’s long-term liabilities that could be met with one year’s operating cash flows. c) the percentage of a company’s total liabilities that could be met with one year’s operating cash flows. d) the percentage of a company’s current liabilities that could be met with one year’s operating cash flows. Answer: d Bloomcode: Comprehension Difficulty: Hard Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

99. One way that a company can assess whether it can meet its obligations through its operating cash flow is by measuring its a) net free cash flow. b) operating activities section of the cash flow statement. c) the liabilities section of the Statement of Financial Position. d) operating cash flow ratio. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the

The Statement of Cash Flows

amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

EXERCISES 100. Maylee Inc. had the following activity during a recent period: Decrease in inventory $ 15,000 Decrease in accounts receivable 235,000 Decrease in accounts payable 150,000 Net loss (35,000) Proceeds on sale of capital assets 450,000 Loss on sale of capital assets 50,000 Purchase of patent 125,000 Issued common shares for land 210,000 Depreciation expense 45,000 Instructions a) Determine the net cash flow from operating activities. b) Determine the net cash flow from investing activities. c) Determine the net cash flow from financing activities. Solution (8 min.) a) Cash flows from operating activities: Net loss Add: Depreciation expense Decrease in accounts receivable Loss on sale of capital assets Decrease in inventory Less: Decrease in accounts payable Net cash from operating activities b)

$(35,000) 45,000 235,000 50,000 15,000 (150,000) $160,000

Cash flows from investing activities: Proceeds on sale of capital assets Purchase of patent Net cash from investing activities

$450,000 (125,000) $325,000

Cash flows from financing activities:

$-0-

Bloomcode: Application Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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101. The Katagate Industries prepared the following Statement of Income and comparative Statement of Financial Positions for 2024: KATAGATE INDUSTRIES Statement of Income For the Year Ended December 31, 2024 Sales Less: Cost of goods sold Gross Profit Less: Depreciation expense—capital assets Amortization expense—patents Other operating expenses Interest expense Loss on sale of land Income before taxes Income taxes Net Income

$1,900,000 980,000 920,000 200,000 27,000 197,000 160,000 100,000 236,000 70,800 $ 165,200

KATAGATE INDUSTRIES Statement of Financial Position December 31, 2024 Assets Cash Accounts Receivable Trading Investments Inventory Property, Plant, and Equipment Less: Accumulated Depreciation Patents, net Total Assets

2024 $ 405,200 180,000 460,000 2,336,000 880,000 (760,000) a 192,000 $3,693,200

2023 $ 200,000 350,000 320,000 2,090,000 800,000 (560,000) a 219,000 $3,419,000

Liabilities and Shareholders' Equity Accounts Payable Other Accrued Payables Dividends Payable Income Taxes Payable Note Payable (Long-Term) Bonds Payable Common Shares Retained Earnings Total Liabilities & Shareholders' Equity

$ 389,000 160,000 80,000 27,000 180,000 900,000 1,600,000 a 357,200 $3,693,200

$ 265,000 240,000 80,000 42,000 560,000 400,000 1,600,000 a 232,000 $3,419,000

Additional data

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1. 2. 3. 4. 5.

Test Bank for Understanding Financial Accounting, Third Canadian Edition

Equipment was purchased for $400,000. Cash dividends of $40,000 were paid in 2024. Land was sold for cash proceeds of $220,000. The company sold bonds of $500,000 and made $380,000 of principal payments on notes payable. Any additional transactions were non-cash transactions and can be ignored for these exercises.

Instructions Prepare a Statement of Cash Flows for 2024 using the indirect approach. Assume that Katagate follows the policy of classifying dividends paid as financing activities and interest paid as operating activities. Solution (25 min.) KATAGATE INDUSTRIES Statement of Cash Flows—Indirect Approach For the Year Ended December 31, 2024 Cash flows from operating activities Net Income Add: Depreciation—capital assets Amortization—patents Loss on sale of land Decrease in accounts receivable Increase in accounts payable Less: Increase in inventory Decrease in income taxes payable Decrease in other accrued payables Cash from operating activities

$165,200 200,000 27,000 100,000 170,000 124,000 (246,000) (15,000) (80,000)

Cash flows from investing activities Proceeds from sale of land Purchase of trading investments Purchase of equipment Cash for investing activities

220,000 (140,000) (400,000)

Cash flows from financing activities Proceeds from issuance of bonds payable Payment on notes payable Payment of cash dividends Cash from financing activities

500,000 (380,000) (40,000)

Net change in cash Cash balance, January 1, 2024 Cash balance, December 31, 2024 Bloomcode: Application

$445,200

(320,000)

80,000 205,200 200,000 $405,200

The Statement of Cash Flows

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Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

102. The financial statements of Mulan Advertising Inc. appear below: MULAN ADVERTISING INC. Comparative Statement of Financial Position December 31 2024 Assets Cash $ 59,000 Accounts receivable 31,000 Inventory 20,000 Property, plant, and equipment 50,000 Accumulated depreciation (20,000) Total $140,000

2023 $ 23,000 34,000 15,000 78,000 (24,000) $126,000

Liabilities and Shareholders' Equity Accounts payable Income taxes payable Mortgage payable Common shares Retained earnings Total

$ 15,000 13,000 9,000 39,000 64,000 $140,000

$ 23,000 8,000 33,000 24,000 38,000 $126,000

MULAN ADVERTISING INC. Statement of Income Year Ended December 31, 2024 Sales Cost of goods sold Gross profit Operating expenses Income from operations Interest expense Income before income taxes Income tax expense Net Income

$380,000 290,000 90,000 36,000 54,000 4,000 50,000 10,000 $ 40,000

The following additional data were provided: 1. Dividends declared and paid were $14,000. 2. During the year, equipment was sold for $12,000 cash. This equipment cost $28,000 originally and

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

had a carrying amount of $12,000 at the time of sale. Depreciation expense is included in operating expenses.

Instructions Prepare a Statement of Cash Flows using the indirect approach. Assume that Mulan follows the policy of classifying dividends paid as financing activities and interest paid as operating activities.

Solution (22 min.) MULAN ADVERTISING INC. Statement of Cash Flows – Direct Method Year Ended December 31, 2024 Operating activities: Net Income Add: Depreciation expense (1) Add: decrease in accounts receivable Add: decrease in income taxes payable Less: increase in inventory Less: decrease in accounts payable Net cash from operating activities

$40,000 12,000 3,000 5,000 (5,000) (8,000)

Investing activities: Sale of equipment Net cash from investing activities

$12,000

Financing activities: Payment of mortgage payable Issue of common shares Payment of cash dividend Net cash for financing activities Net change in cash Cash, January 1, 2024 Cash, December 31, 2024 1.

47,000

12,000

$(24,000) 15,000 (14,000) (23,000) 36,000 23,000 $ 59,000

*$24,000 – $16,000 = $8,000 balance in accumulated depreciation after sale. Ending balance, $20,000 – $8,000 = $12,000 depreciation expense.

Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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103. The condensed financial data of Expedial Corporation appears below: EXPEDIAL CORPORATION Comparative Statement of Financial Position July 31 Assets: 2024 2023 Cash $ 72,000 $ 35,000 Accounts receivable 85,000 53,000 Inventory 120,000 132,000 Prepaid expenses 19,000 25,000 Long-Term Investments 90,000 75,000 Property, plant and equipment 310,000 250,000 Accum. depreciation (65,000) (60,000) Total assets $631,000 $510,000 Liabilities & Shareholders’ Equity: Accounts payable Accrued expenses payable Bonds payable Common shares Retained earnings Total liabilities & owners’ equity

93,000 29,000 130,000 245,000 134,000 $631,000

75,000 24,000 160,000 170,000 81,000 $510,000

EXPEDIAL CORPORATION Income Statement For the Year Ended July 31, 2024 Sales Expenses: Cost of goods sold Operating expenses (excluding depreciation) Depreciation expense Income tax expense Interest expense Loss on equipment sale Net income

$480,000 290,000 60,000 17,000 15,000 18,000 3,000 $ 77,000

Additional information: (a) New equipment costing $85,000 was purchased for cash in 2024. (b) Old equipment costing $25,000 was sold for $10,000 cash when its book value was $12,000. (c) Bonds with a face value of $30,000 were converted into $30,000 of common shares. (d) A cash dividend of $24,000 was declared and paid during the year. (e) Prepaid expenses pertain to operating expenses; accounts payable pertains to merchandise purchases. Instructions

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Prepare the Statement of Cash Flows using the indirect method. Assume that Expedial follows the policy of classifying dividends paid as financing activities and interest paid as operating activities. Solution (25 min.) EXPEDIAL CORPORATION Statement of Cash Flows – Indirect Method Year Ended July 31, 2024 Operating Activities: Net Income Add: Depreciation Loss on Equipment Sale Less: Increase in Accounts Receivable Add: Decrease in Inventory Decrease in Prepaid Expenses Increase in Accounts Payable Increase in Accrued Expenses

$77,000 17,000 3,000 (32,000) 12,000 6,000 18,000 5,000

Net cash provided by operating activities

$106,000

Investing Activities: Long-term Investment Purchase Equipment Purchase Proceeds from Equipment Sale

($15,000) ( 85,000) 10,000

Net cash used from investing activities

($90,000)

Financing Activities: Sale of Common Shares (Note X) Dividend Payment

$45,000 (24,000)

Net cash provided by financing activities

$21,000

Net change in Cash Cash, August 1, 2023 Cash, July 31, 2024

$37,000 $35,000 $72,000

Note X: Bonds payable with a face value of $30,000 were converted into $30,000 in Common shares. Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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104. Ricoh Co. had the following activity during a recent period: Net income $ 175,000 Depreciation 27,500 Issuance of bonds payable 1,000,000 Decrease in accounts payable 28,000 Decrease in inventory 75,000 Proceeds on sale of capital assets 575,000 Gain on sale of capital assets 37,500 Increase in long-term notes payable 55,000 Decrease in wages payable 71,000 Increase in accounts receivable 22,500 Instructions a) Prepare the cash flows from operating activities section of the Statement of Cash Flows. b) Comment on the changes in accounts receivable, accounts payable and inventory for Ricoh. Would you normally expect the changes in these three accounts to be related? Solution (10 min.) a) Cash flows from operating activities: Net income Add: Depreciation Decrease in inventory Less: Decrease in accounts payable Gain on sale of capital assets Decrease in wages payable Increase in accounts receivable Net cash from operating activities b)

$175,000 27,500 75,000 (28,000) (37,500) (71,000) (22,500) $118,500

Accounts receivables increased while inventory and accounts payable decreased. All three of these accounts are related to sales, and you would normally expect these accounts to move in the same direction unless there has been a change in policies related to one of them, such as more lenient credit terms (accounting for the increase in accounts receivable). In most cases, the increase in accounts receivable would normally be associated with an increase in sales, but the decrease in inventory and accounts payable would normally indicate a decrease in sales. Thus for Ricoh Co., it is difficult to interpret the conflicting signals in these three accounts.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

105. The Olympic Industries prepared the following Statement of Income and comparative Statement of Financial Positions for 2024: OLYMPIC INDUSTRIES Statement of Income For the Year Ended December 31, 2024 Sales Less: Cost of goods sold Gross Profit Less: Depreciation expense—capital assets Amortization expense—patents Other operating expenses Interest expense Loss on sale of land Income before taxes Income taxes Net Income

$1,900,000 980,000 920,000 200,000 27,000 197,000 160,000 100,000 236,000 70,800 $ 165,200

OLYMPIC INDUSTRIES Statement of Financial Position December 31, 2024 Assets Cash Accounts Receivable Trading Investments Inventory Property, Plant, and Equipment Less: Accumulated Depreciation Patents, net Total Assets

2024 $ 405,200 180,000 460,000 2,336,000 880,000 (760,000) a 192,000 $3,693,200

2023 $ 200,000 350,000 320,000 2,090,000 800,000 (560,000) a 219,000 $3,419,000

$ 389,000 160,000 80,000 27,000 180,000 900,000 1,600,000 a 357,200 $3,693,200

$ 265,000 240,000 80,000 42,000 560,000 400,000 1,600,000 a 232,000 $3,419,000

Additional data

The Statement of Cash Flows

1. 2. 3. 4. 5.

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Instructions Prepare a Statement of Cash Flows for 2024 using the direct approach. Do not include the reconciliation of net income to cash flows from the operating activities schedule. Assume that Olympic follows the policy of classifying dividends paid as financing activities and interest paid as operating activities.

Solution (25 min.) OLYMPIC INDUSTRIES Statement of Cash Flows—Direct Approach For the Year Ended December 31, 2024 Cash flows from operating activities: Receipts from customers Payments to suppliers Payments for interest Payments for other operating expenses Payments for income taxes Cash from operating activities

$2,070,000 (1,102,000) (160,000) (277,000) ( 85,800) $445,200

Cash flows from investing activities: Proceeds from sale of land Purchase of trading investments Purchase of equipment Cash for investing activities

220,000 (140,000) (400,000)

Cash flows from financing activities: Proceeds from sale of bonds Payment on notes payable Payment of cash dividends Cash from financing activities

500,000 (380,000) (40,000)

Net change in cash Cash balance, January 1, 2024 Cash balance, December 31, 2024

(320,000)

80,000 205,200 200,000 $405,200

Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the direct method for operating activities.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

106. The financial statements of Galaxy Paints Inc. appear below: GALAXY PAINTS INC. Comparative Statement of Financial Position December 31 2024 Assets Cash $ 59,000 Accounts receivable 31,000 Inventory 20,000 Property, plant, and equipment 50,000 Accumulated depreciation (20,000) Total $140,000

2023 $ 23,000 34,000 15,000 78,000 (24,000) $126,000

Liabilities and Shareholders' Equity Accounts payable Income taxes payable Mortgage payable Common shares Retained earnings Total

$ 15,000 13,000 9,000 39,000 64,000 $140,000

$ 23,000 8,000 33,000 24,000 38,000 $126,000

GALAXY PAINTS INC. Statement of Income Year Ended December 31, 2024 Sales Cost of goods sold Gross profit Operating expenses Income from operations Interest expense Income before income taxes Income tax expense Net Income

$380,000 290,000 90,000 36,000 54,000 4,000 50,000 10,000 $ 40,000

The following additional data were provided: 1. Dividends declared and paid were $14,000. 2. During the year, equipment was sold for $12,000 cash. This equipment cost $28,000 originally and had a carrying amount of $12,000 at the time of sale. 3. Depreciation expense is included in operating expenses.

The Statement of Cash Flows

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Instructions Prepare the Statement of Cash Flows using the direct approach. Assume that Galaxy follows the policy of classifying dividends paid as financing activities and interest paid as operating activities.

Solution (22 min.) GALAXY PAINTS INC. Statement of Cash Flows – Direct Method Year Ended December 31, 2024 Operating activities: Cash receipts from customers ($380,000 + $3,000) Cash payments: To suppliers For operating expenses For interest expense For income taxes ($10,000 - $5,000) Net cash from operating activities Investing activities: Sale of equipment Net cash from investing activities Financing activities: Payment of mortgage payable Issue of common shares Payment of cash dividends Net cash for financing activities Net change in cash Cash, January 1 Cash, December 31 (1) Cost of goods sold Add: Increase in inventory Purchases Add: Decrease in accounts payable Cash payments to suppliers

$383,000 $303,000 (1) 24,000 (2) 4,000 5,000

$12,000 12,000

$(24,000) 15,000 (14,000) (23,000) 36,000 23,000 $ 59,000 $290,000 5,000 295,000 8,000 $303,000

(2) Operating expenses $36,000 Less: Depreciation expense *(12,000) Cash payments for operating expenses $24,000 *$24,000 – $16,000 = $8,000 balance in accumulated depreciation after sale. Ending balance, $20,000 – $8,000 = $12,000 depreciation expense. Bloomcode: Application Difficulty: Hard

336,000 47,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

107. The condensed financial data of Jamalia Corporation appears below: JAMALIA CORPORATION Comparative Statement of Financial Position July 31 Assets: 2024 2023 Cash $ 72,000 $ 35,000 Accounts receivable 85,000 53,000 Inventory 120,000 132,000 Prepaid expenses 19,000 25,000 Long-Term Investments 90,000 75,000 Property, plant and equipment 310,000 250,000 Accum. depreciation (65,000) (60,000) Total assets $631,000 $510,000 Liabilities & Shareholders’ Equity: Accounts payable Accrued expenses payable Bonds payable Common shares Retained earnings Total liabilities & owners’ equity

93,000 29,000 130,000 245,000 134,000 $631,000

75,000 24,000 160,000 170,000 81,000 $510,000

JAMALIA CORPORATION Income Statement For the Year Ended July 31, 2024 Sales Expenses: Cost of goods sold Operating expenses (excluding depreciation Depreciation expense Income tax expense Interest expense Loss on equipment sale Net income

$480,000 290,000 )

60,000 17,000 15,000 18,000 3,000 $ 77,000

The Statement of Cash Flows

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(d) A cash dividend of $24,000 was declared and paid during the year. (e) Prepaid expenses pertain to operating expenses; accounts payable pertains to merchandise purchases. Instructions Prepare the Statement of Cash Flows using the direct method. Assume that Jamalia follows the policy of classifying dividends paid as financing activities and interest paid as operating activities.

Solution (25 min.) JAMALIA CORPORATION Statement of Cash Flows – Direct Method Year Ended July 31, 2024 Operating Activities: Cash Receipts from Customers: ($480,000-$32,000) Cash Payments: To Suppliers For Operating Expenses For Interest Expense For Income Tax Expense

$260,000 (1) 49,000 (2) 18,000 15,000

Net cash provided by operating activities

$448,000

$342,000 $106,000

Investing Activities: Long-term Investment Purchase Equipment Purchase Proceeds from Equipment Sale

($15,000) (85,000) 10,000

Net cash used from investing activities

($90,000)

Financing Activities: Sale of Common Shares (Note X) Dividend Payment

$45,000 (24,000)

Net cash provided by financing activities

$21,000

Net change in Cash Cash, August 1, 2023 Cash, July 31, 2024

$37,000 $35,000 $72,000

Note X: Bonds payable with a face value of $30,000 were converted into $30,000 in Common shares. (1) Cost of Goods sold Less: increase in inventory

$290,000 (12,000)

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Purchases Less: increase in A/P Cash Payments to Suppliers

$278,000 (18,000) $260,000

(2) Operating Expenses $60,000 Less: Decrease in prepaid expenses (6,000) Increase in accrued expenses (5,000) Cash Payments for Operating Expenses $49,000 Bloomcode: Application Difficulty: Hard Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

108. Below is the Statement of Cash Flows for Carlyle Products Inc. It has just finished its second year of operations and has approached you, the manager of the local branch of The Canadian Bank, to ask for a loan. CARLYLE PRODUCTS INC. Statement of Cash Flows—Indirect Approach For the Year Ended October 31, 2024 Cash flows from operating activities: Net income Add: Depreciation Less: Increase in accounts receivable Increase in inventory Increase in prepaid expenses Decrease in accounts payable Cash from operating activities

$ 45,000 24,500 (18,000) (71,000) (5,500) (4,600)

Cash flows from investing activities: Proceeds from sale of temporary investments Purchase of equipment Cash for investing activities

12,000 (95,000)

Cash flows from financing activities: Proceeds from issue of common shares Payment of cash dividends Cash from financing activities Decrease in cash Cash balance, November 1, 2023 Cash balance, October 31, 2024

$(29,600)

(83,000)

75,000 (25,500) 49,500 (63,100) 58,000 $ (5,100)

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Instructions a) Do you think Carlyle Products Inc. has had a successful year? Support your answer. b) What areas are of concern to you when reviewing its Statement of Cash Flows? c) What other information would you like? Are there any conditions you would require before you granted them a loan? Solution (20 min.) a) The company has a positive net income in its second year, which is very good. (Start-up companies might not show a profit for several years.) However, the cash flow from operations and overall change in cash for the year are both negative. The company appears to be growing since it invested in equipment and has increased the amount of inventory on hand, but perhaps the company is growing too fast or it is undercapitalized (although it sold more shares this year). Both of those issues can lead to cash flow problems. It is difficult to completely evaluate its performance without the Statement of Income. b)

The increase in inventory, accounts receivable, and prepaids are all consistent with a growing company; however, the increase in inventory is much larger than the increase in accounts receivable, and there may be a concern with its inventory management. Does the company have too much inventory on hand? Are there any obsolete items? The decrease in accounts payable is also a concern given the increase in inventory. Is the company paying its accounts more (or too) quickly? Perhaps it would not be in such a tight situation for cash if the company could stretch the payable out more or if the payables had grown on a basis consistent with the inventory or accounts receivable. Another concern is the high level of dividends paid in a relatively new company. The company paid out a significant portion of net income as dividends. Are the owners taking out too much money from the company, and could they leave more of it invested in the company to help finance the growth?

The other information I would like to see is the comparative Statement of Income, comparative Statement of Financial Position and more information about the level of inventory. I would also want to confirm its credit policies and accounts payable terms to see if the company is making the best use of the cash available from those sources. I would also like to know what assets are available for collateral for the loan. I would want restrictions on future dividend payments before I granted them a loan and some form of collateral.

Bloomcode: Analysis Difficulty: Hard Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow. CPA: Financial Reporting AACSB: Analytic

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109. AZALIA CORP. Comparative Statement of Financial Position December 31 2024 Assets Cash $ 59,000 Accounts receivable 31,000 Inventory 20,000 Property, plant, and equipment 50,000 Accumulated depreciation (20,000) Total $140,000

$ 23,000 34,000 15,000 78,000 (24,000) $126,000

Liabilities and Shareholders' Equity $ 15,000 13,000 9,000 39,000 64,000 $140,000

$ 23,000 8,000 33,000 24,000 38,000 $126,000

Accounts payable Income taxes payable Mortgage payable Common shares Retained earnings Total

2023

AZALIA CORP. Statement of Cash Flows Year Ended December 31, 2024 Operating activities Net Income Add: Depreciation expense (1) Add: Decrease in accounts receivable Add: Increase in income taxes payable Less: Increase in inventory Less: Decrease in accounts payable Net cash from operating activities

$40,000 12,000 3,000 5,000 (5,000) (8,000)

Investing activities Sale of equipment Net cash from investing activities

$12,000

Financing activities Payment of mortgage payable Issue of common shares Payment of cash dividend Net cash for financing activities Net change in cash Cash, January 1, 2024 Cash, December 31, 2024

47,000

12,000

$(24,000) 15,000 (14,000) (23,000) 36,000 23,000 $ 59,000

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Instructions Calculate the operating cash flows ratio. Solution Operating cash flows ratio

= cash flows from operating activities current liabilities = 47,000 / 28,000 = 1.68 or 168%

Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

110. SANDSTONE CORP Statement of Financial Position March 31, 2024 Assets Cash Accounts Receivable Short-Term Investments Inventory Property, Plant, and Equipment Less: Accumulated Depreciation Patents, net Total Assets

2024 $ 405,200 180,000 460,000 2,336,000 880,000 (760,000) a 192,000 $3,693,200

2023 $ 200,000 350,000 320,000 2,090,000 800,000 (560,000) a 219,000 $3,419,000

$ 389,000 160,000 80,000 27,000 180,000 900,000 1,600,000 357,200 $3,693,200

$ 265,000 240,000 80,000 42,000 560,000 400,000 1,600,000 232,000 $3,419,000

Sandstone Corporation Statement of Cash Flows

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For the Year Ended March 31, 2024 Cash flows from operating activities Net Income Add: Depreciation—capital assets Amortization—patents Loss on sale of land Decrease in accounts receivable Increase in accounts payable Less: Increase in inventory Decrease in income taxes payable Decrease in other accrued payables Cash from operating activities

$165,200 200,000 27,000 100,000 170,000 124,000 (246,000) (15,000) (80,000)

Cash flows from investing activities Proceeds from sale of land Purchase of short-term investments Purchase of equipment Cash for investing activities

220,000 (140,000) (400,000)

Cash flows from financing activities Proceeds from sale of bonds Payment on notes payable Payment of cash dividends (common shares) Cash from financing activities

500,000 (380,000) (40,000)

$445,200

(320,000)

Net change in cash Cash balance, April 1, 2023 Cash balance, March 31, 2024

80,000 205,200 200,000 $405,200

Instructions Calculate the operating cash flow ratio and net free cash flow. Comment on Sandstone’s performance. Which financial statement users would be interested in this information and why? Solution (15 min.) Operating cash flow ratio = Cash Flow from Operating Activities / Current Liabilities = $445,200 / $656,000 =.68 or 68% This may be cause for concern, given that the cash flow from operating activities only provides $.68 for every $1.00 in current liabilities. Lenders and creditors would be interested in the company’s ability to meet its obligations. Free Cash Flow = Cash Flow from operating activities – net capital expenditures – dividends on preferred shares

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Free Cash Flow: $445,200 – $320,000 – $0 = $125,200 A positive free cash flow is generally considered good. It is considered to be the cash available to the company’s common shareholders, although it is unlikely that management would distribute all of it to shareholders. It is more likely to be used to repay debt, finance expansion plans, and repurchase shares or make investments in other companies. Bloomcode: Analysis Difficulty: Medium Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

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MATCHING 111. Listed below is a series of terms and descriptions concerning the Statement of Cash Flows (SCF). Match each description to the appropriate term by placing its letter in the space provided. TERMS A. Non-cash transaction B. Direct approach C. Components of the SCF D. Cash equivalent E. Financing activity

F. G. H. I. J.

Reconciliation approach Purpose of the SCF Investing activity Indirect approach Operating activity

DESCRIPTIONS ___ 1. Operating, investing and financing activities ___

Highly liquid, risk-free, short-term investments

___

Payment of dividends

___

Another name for the indirect approach

___

Payments to suppliers

___

Exchange long-term debt for common shares

___

Sale of plant assets

___

Assist users in assessing the company's ability to generate cash flows

___

Presents a company’s cash flows by cash receipts and cash payments

___

10.

Adjust net income for non-cash expenses

Solution (5 min.) 1. C 2.

The Statement of Cash Flows

10.

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Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand and explain why the statement of cash flows is of significance to users. Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

112. Listed below are the various types of activities or transactions reported on the Statement of Cash Flows, followed by a series of transactions. Match each transaction to its related activity by placing the appropriate letter in the space provided. Assume the indirect method is used. The company has a policy of classifying dividends paid as financing activities and interest paid as operating activities, O = Operating activity I = Investing activity

F = Financing activity N = Non-cash transaction

___

Payment of cash dividends

___

Collection from customers

___

Proceeds from sale of patent

___

Payment of interest

___

Purchase of land with common shares

___

Proceeds from the sale of long-term investments

___

Depreciation expense

___

Prepayment of insurance policy

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___

10.

Purchase of equipment

___

11.

Gain / loss of the disposal of a non-current asset

___

12.

Proceeds on the sale of equipment

___

13.

Declaration of a dividend payment

Solution (5 min.) 1. F 2.

10.

11.

12.

13.

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

The Statement of Cash Flows

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SHORT-ANSWER ESSAY QUESTIONS 113. A friend of yours is taking a financial accounting course. Your friend asks you to explain the purpose of the Statement of Cash Flows and how it assists internal and external users. Instructions Write an explanation to your friend. Solution (8 min.) The primary purpose of a Statement of Cash Flows is to provide information about a company's cash receipts and cash payments during an accounting period. Together with the other statements, it can be used to assess (a) a company's ability to generate positive future net cash flows, (b) a company's ability to meet its obligations and pay dividends, (c) a company's need for external financing, (d) the reasons for differences between a company's net income and its cash receipts and payments, and (e) both the cash and non-cash aspects of a company's financing and investing transactions during an accounting period. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

114. Explain the relationship between the Statement of Cash Flows and the Statement of Income, and the Statement of Financial Position. Solution (10 min.) The Statement of Cash Flows uses information from all the other financial statements to explain the change in cash for the year. The Statement of Income measures performance for a period on the accrual basis. It is a good predictor of the long-run performance of a company, but in the short run, companies must have enough cash flows coming in to meet the cash outflows they have. Cash inflows and outflows are a result of more than just the operating activities of the company. A company also spends cash on capital assets, other investments, and repaying liabilities while it receives cash from loans, sale of assets, and selling shares. Comparative Statement of Financial Positions explains what assets and liabilities the company has at the beginning and end of a period but does not fully explain the changes that occurred in between. The Statement of Cash Flows summarizes all of the cash flows for the year and groups them into three activities — operating, investing, and financing. The financing activities section includes any dividends

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the company has paid, based on the amounts reported on the Statement of Shareholders’ Equity. Therefore, the Statement of Cash Flows uses information from all the other financial statements to explain the change in cash for the year. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand and explain why the statement of cash flows is of significance to users. CPA: Financial Reporting AACSB: Analytic

115. Explain the differences between the Statement of Cash Flows and the Statement of Income. Solution (7 min.) The Cash Flow Statement reflects the cash position, while the Statement of Income is prepared on an accrual basis and reflects the profitability of a company. The Cash Flow Statement also includes information on investing and financing activities as opposed to mainly operating activities as found in the Statement of Income. The Statement of Income does not reflect many of the transactions a firm has with its creditors, nor does it capture many of the cash payments or receipts for PP and E. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Communication AACSB: Communication

116. Identify and describe the options available under IFRS for classifying interest and dividends paid and received on the Statement Cash Flows. Solution (5 min.) Under IFRS, a company may classify interest paid, and interest and dividends received as either operating activities since these items flow through net income as expenses and revenues or it may classify interest and dividends paid as financing activities, while interest and dividends received can be classified as investing activities. Whatever classifications are selected, they must be applied consistently from period to period. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

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117. Identify the three major types of activities that are presented in a Statement of Cash Flows and describe some of the typical transactions included in each category. Solution (5 min.) The Statement of Cash Flows categorizes a company’s cash-related transactions into three categories: operating activities, investing activities, and financing activities. Typical operating activities include cash sales to customers, collections of customer receivables, purchases of inventory, payments to suppliers, payments of wages, and payments of taxes. Typical investing activities include cash purchases of property, plant, and equipment; purchases of shares of other companies; sales of property, plant, and equipment; and sales of shares in other companies. Typical financing activities include the proceeds from issuing shares, the proceeds received from new loans, repayments of loan principal, and payments of cash dividends. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category. CPA: Financial Reporting AACSB: Analytic

118. The Statement of Cash Flows must be prepared on a cash and cash equivalents basis. Instructions a) Define a cash equivalent for purposes of the Statement of Cash Flows and provide two examples. b) Explain why cash and cash equivalents are combined for purposes of preparing the Statement of Cash Flows even though cash equivalents are not really cash. Solution (8 min.) a) Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash. Examples include: treasury bills, short-term deposits, and money market funds. b)

Since cash equivalents are so near maturity (three months or less), there is little risk of price fluctuations due to interest rate changes. Also, these items are convertible into known amounts of cash and, as a result, are considered equivalent to cash.

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

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119. Are there investing and financing activities that do NOT appear on the Statement of Cash Flows? If so, please provide some examples. Solution (5 min.) Yes, it is possible for a company to have investing and financing activities that do not appear on the Statement of Cash Flows. This would be the case if any of the following occurred: • The company purchased capital assets, by assuming debt or issuing shares rather than paying cash. • The company acquired the shares of another company by assuming debt or issuing shares rather than paying cash. • The company repaid debt by issuing shares rather than paying cash. As these transactions did not involve the inflow or outflow of cash, they would not be presented on the Statement of Cash Flows. Instead, they would be disclosed in the notes to the company’s financial statements so that financial statement users are made aware of them. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. CPA: Financial Reporting AACSB: Analytic

120. The operating activities section of the Statement of Cash Flows can be prepared using either the direct approach or the indirect approach. Instructions a) List three cash inflows reported under the direct approach. b) List three cash outflows reported under the direct approach. c) List three additions reported under the indirect approach. d) List three deductions reported under the indirect approach. Solution (5 min.) Note: There could be a variety of answers to these questions. a)

collections from customers collections of interest and/or dividend income (assuming the company has selected the policy to show interest and dividends received as operating activities) collections of other operating revenues b)

payments to suppliers payments to employees payments of interest or taxes

depreciation

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loss on sale of operational assets decrease in current assets increase in current liabilities d)

gain on sale of operational assets increase in current assets decrease in current liabilities

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the indirect method for operating activities. Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

121. What is the preferred method of Statement of Cash Flows preparation by standard setters? Why is this the preferred method? Solution (5 min.) The direct method is the preferred method of Statement of Cash Flows preparation. Theoretically, it provides more informative and useful information; however, the indirect approach is used more often in practice. The direct method shows total cash received from customers and collections, along with total cash used for expenditures and payments to suppliers. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

122. What is the cash-to-cash cycle? Explain the impact on a company’s cash flow. Solution (5 min.) This cycle is the time between when the company pays out cash to purchase goods or raw materials for manufacturing products until those goods are paid for by the customer. Items that impact this cycle include collection of A/R, purchase and sale of inventory and the payment of A/P. The longer the cycle, the greater the company’s cash requirements. In periods of high growth, this problem is magnified. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Interpret a statement of cash flows and develop potential solutions to any cash flow.

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CPA: Financial Reporting AACSB: Analytic

123. How is the operating cash flow ratio calculated? What does it measure, and why is it important? Solution (5 min.) Operating cash flow ratio = cash flows from operating activities / current liabilities This ratio measures the percentage of a company’s current liabilities that could be met with one year’s operating cash flows. Some current liabilities may not be paid in cash either, i.e., deferred revenues. The company may also have additional assets available to settle debt, such as investments. Given this, the ratio could safely be below one—however, the higher above 1, the better. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated. CPA: Financial Reporting AACSB: Analytic

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ESSAY QUESTIONS 124. When assessing the performance of a company, users of financial statements often look at the relationship between net income and cash from operations. Instructions a) Explain how it would be possible for a company to report a positive net income on the Statement of Income but a net cash outflow in cash from operations on the Statement of Cash Flows. Does the cash outflow in operations indicate that the company is in trouble? b) Would the opposite situation be possible? Could a company that reported a loss on the Statement of Income report a positive cash flow from operations on the Statement of Cash Flows? Explain. Solution (15 min.) a) The Statement of Income is prepared on the accrual basis, and it may be possible for a company to report a net income but have a negative cash flow from operations. This would arise if a company incurred costs and paid for them, but had not yet expensed them. For example, prepaid insurance or inventory items. Alternatively, the company could be reporting sales but not have collected all of the cash yet. This would result in an increase in revenues (and hence income)but not a corresponding increase in the cash from operations. Similarly, paying off current liabilities would also reduce the cash from operations but may not be reflected on the Statement of Income. The cash outflows in operations does not necessarily mean the company is in trouble. It is not uncommon for companies to have a negative cash flow from operations while they are getting established or growing. In a more mature company it might be a sign of trouble because in the long run, cash from operations should be positive to support the financing and investing activities of the company. b)

The opposite situation is also possible. A company could have a net loss on its Statement of Income and still have positive cash flow from operations if it has large non-cash expenses on its Statement of Income, like depreciation or the loss from the sale of investments or assets. These items would decrease net income but not the cash from operations. This may also occur if the company were incurring expenses but not paying for them. For example, buying inventory that it has sold (and hence expensed) before it is paid for the items. The inventory cost would be reflected in accounts payable on the Statement of Financial Position.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how the statement of cash flows and the statement of income differ. CPA: Financial Reporting AACSB: Analytic

125. A friend who started a business during the last year has asked you for some help. The accountant has prepared the financial statements for the company at year-end and has indicated that your

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friend’s company is facing a cash flow problem. Your friend is confused and does not know what this means. Instructions Prepare a reply to your friend. Include three causes of cash flow problems and solutions to solve the cash flow problems. Explain how the Statement of Cash Flows will assist in managing the business. Solution (10 min.) Cash flow difficulties are typical of many new businesses. Three fundamental causes of cash flow problems are: high growth rates in sales, significant lead or lag times between cash inflows and outflows (this includes timing differences related to making a sale versus collecting cash and the purchase versus the sale of inventory items), and undercapitalization. One way to solve the cash flow problem is to slow down the rate of growth of sales. The second way to solve the cash flow problem is to shorten the cash-to-cash cycle. This can be done by changing the lead/lag times between the inflows and outflows, that is, change the accounts receivable, accounts payable, or inventory policies. Specifically reducing the number of days accounts receivable are outstanding and the number of days items are in inventory and negotiating longer payment terms for outstanding payables. A third way to solve the cash flow problem is to address the undercapitalization problem, that is, to start with a larger amount of cash on hand or ensure access to a line of credit. The Statement of Cash Flows provides additional information that is not captured by the Statement of Income and Statement of Financial Position. The Statement of Cash Flows can be used to assess the financial health of the corporation. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Prepare a statement of cash flows using the direct method for operating activities. CPA: Financial Reporting AACSB: Analytic

CHAPTER 6 CASH AND ACCOUNTS RECEIVABLE

CHAPTER LEARNING OBJECTIVES 1. Explain why cash and accounts receivable are of significance to users. • As a company’s most liquid assets, cash and accounts receivable provide the resources necessary to meet immediate, short-term financial obligations. • Knowing a company’s cash and receivables balances enables users to assess a company’s liquidity (its ability to meet its obligations in the short term).

2. Describe the valuation methods for cash. • Cash includes the cash physically on hand, on deposit at financial institutions, and any cash equivalents. • Cash equivalents are amounts that can be converted into known amounts of cash and must be maturing within three months of the acquisition date. • Cash is measured at its face value at the reporting date, with any foreign currency translated into Canadian dollars using the rate of exchange at the statement of financial position date.

3. Explain the main principles of internal control and their limitations. • The board of directors are ultimately responsible for an organization’s internal controls. The board establishes the “tone at the top” regarding the importance of internal controls. Management are delegated the responsibility for establishing and operating the internal control system and their performance is monitored by the board. • An internal control system includes (1) physical controls (locks, alarms, cash registers); (2) assignment of responsibilities (making one person responsible for each task); (3) separation of duties (separation of transaction authorization, recording, and asset custody); (4) independent verification (either internal or external); and (5) documentation (receipts, invoices, and so on). • The effectiveness of internal controls is limited by factors including: (1) cost/benefit considerations; (2) human error; (3) collusion; (4) management override; and (5) changing circumstances.

4. Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. • A bank reconciliation ensures that any differences between the accounting records for cash and the bank statement are identified and explained. • The reconciliation adjusts the bank balance for items that the company is aware of but the

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•

bank is not (outstanding cheques and outstanding deposits). It also adjusts the company’s cash balance for items that appear on the bank statement that have not yet been reflected in the company’s records (such as bank charges, interest, and cheque returns due to nonsufficient funds). Journal entries must be made for each adjustment required to the company’s cash balance in order to adjust the cash balance in the general ledger.

5. Explain why companies sell on account and identify the additional costs that result from this decision. • Companies sell on account to increase total sales, remain competitive, and generate additional revenue (interest). • When selling on account, companies incur additional costs, including wages for the creditgranting function, wages for the collections function, and credit losses.

6. Explain how the carrying amount of accounts receivable is determined. • Accounts receivable are reflected on the statement of financial position at their carrying amount, which is equal to the full amount of all receivables less the allowance for expected credit losses. • The allowance for expected credit losses represents management’s best estimate of the total accounts receivable that it expects it will be unable to collect.

7. Explain the allowance method of accounting for expected credit losses. • The allowance method involves management estimating the amount of receivables that it expects it will be unable to collect. The estimated credit losses are recorded in the same period in which the credit sales were reported rather than waiting to record the credit loss until the customers fail to pay. • Since the specific customers who will not pay are unknown at the time the credit losses are estimated, no adjustment can be made to the Accounts Receivable account. Instead, the amount is recorded in Allowance for Expected Credit Losses, a contra-asset account. • Under the allowance method, journal entries are required to initially record the credit losses, to record the writeoff of specific receivables once they are known, and to record the recovery of any receivables that have previously been written off.

8. Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. • The risk characteristics that are used to group receivables can include the length of time the receivable is outstanding, geographic region, type of customer, and size of customer. Other factors can also be used if they represent a credit risk characteristic shared by a group of receivables. • The expected rates of credit losses are determined by adjusting a company’s historic credit loss rates to reflect both current and future economic conditions expected in the period in which the receivables will remain outstanding.

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•

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The allowance for expected credit losses is quantified by multiplying the adjusted rates of expected credit losses by the receivables balance for each of the related groupings. The total expected credit losses determined in this process represents the balance that should be reflected in the company’s Allowance for Expected Credit Losses account at the end of the reporting period. The amount that needs to be recorded to adjust the allowance account from its current balance to the required ending balance represents the company’s credit losses for the period.

9. Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. • Under the direct writeoff method, there is no accounting for credit losses until a specific customer’s account is written off. As such, allowance for expected credit losses is not needed. • This method is not acceptable under accounting standards in Canada, but it is sometimes used by companies with an insignificant amount of credit losses because the difference between it and the allowance method would not result in material differences.

10. Explain alternative ways in which companies shorten their cash-to-cash cycle. • One way that companies shorten their cash-to-cash cycle is to accept credit cards rather than offering their customers credit directly. The company is able to collect much more quickly from the credit card companies than it would from customers. • Another way that companies shorten the cash-to-cash cycle is to offer sales discounts to encourage customers who have purchased on account to pay their accounts early. A common sales discount is “2/10; n/30,” which entitles the customer to a 2% discount if they pay they account within 10 days; otherwise, the net amount is due within 30 days. • Some companies also factor (sell) their accounts receivables to a financial institution (known as a factor) in order to shorten their cash-to-cash cycle. The receivables may be sold with recourse (the company remains responsible for their ultimate collection) or without recourse (the factor assumes collection responsibility).

11. Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. • Liquidity is a company’s ability to convert assets into cash so that liabilities can be paid. • The current ratio is equal to current assets divided by current liabilities and is a measure of the amount of current assets the company has relative to each dollar of current liabilities. • The quick ratio is a stricter measure of liquidity than the current ratio. This is because it is determined without including inventory and prepaid expenses. Specifically, the ratio is equal to current assets less inventory and prepaids divided by current liabilities. • The accounts receivable turnover ratio is equal to credit sales divided by average accounts receivable. It measures how often accounts receivable are collected in full during the period. • The average collection period is the average length of time, in days, that it takes a company to collect its receivables. It is calculated by dividing 365 by the accounts receivable turnover ratio.

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TRUE-FALSE STATEMENTS 1. The definition of cash only includes currency and bank accounts. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why cash and accounts receivable are of significance to users. CPA: Financial Reporting AACSB: Analytic

2. Cash and accounts receivable are a company’s least liquid assets. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why cash and accounts receivable are of significance to users. CPA: Financial Reporting AACSB: Analytic

3. Foreign currency is valued and reported on the statement of financial position using the exchange rate that existed on the transaction date. Answer: False Bloomcode: Knowledge Difficulty: Hard Learning Objective: Describe the valuation methods for cash. CPA: Financial Reporting AACSB: Analytic

4. Cash equivalents have a maturity date within three months of the date of acquisition. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for cash. CPA: Financial Reporting AACSB: Analytic

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5. A treasury bill is an example of a long-term investment. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the valuation methods for cash. CPA: Financial Reporting AACSB: Analytic

6. Companies NEVER have a negative cash balance since cash is an asset and must always be in a debit position. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for cash. CPA: Financial Reporting AACSB: Analytic

7. Cash held in foreign currencies must be translated into Canadian dollars using the rate of exchange at the statement of financial position date. Answer: True Bloomcode: Knowledge Difficulty: Hard Learning Objective: Describe the valuation methods for cash. CPA: Financial Reporting AACSB: Analytic

8. Writing cheques instead of using cash would be a proper internal control procedure. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

9. For internal control purposes, if duties are effectively separated, there is no way fraud can occur. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting AACSB: Analytic

10. Collusion is where two or more employees work together to commit the theft and conceal it. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting AACSB: Analytic

11. Independent verification can be done internally or externally. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting AACSB: Analytic

12. When preparing a bank reconciliation, the balance as reported by the bank is adjusted until it agrees with the balance reported in the company’s books. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

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13. Bank reconciliations should only be prepared for a company’s main operating account. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

14. A bank reconciliation has two sides, one is the” bank side” and the other is the “balancing side”. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

15. The reconciling items on the bank side of a bank reconciliation will be items the company knows about but the bank does NOT. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

16. To adjust the cash account to the correct amount, the accountant needs to make journal entries for all the adjustments on the G/L side of the bank reconciliation. Answer: True Bloomcode: Knowledge Difficulty: Medium

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

17. All adjustments that are additions to the G/L side of a bank reconciliation are credits to cash. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

18. An accounts receivable is usually evidenced by a formal promissory note. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

19. Selling on account reduces overall sales. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

20. The likelihood that a customer will default on payments depends on the customer’s creditworthiness. Answer: True

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

21. A company with strict credit policies may lose potential sales. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

22. A company with loose credit policies will benefit from a substantial increase in sales with no impact to expenses. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

23. The gross amount of accounts receivable should be reflected on the statement of financial position; this is what the company expects to collect in cash. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

24. Accounts receivable are reflected on the statement of financial position at their gross amounts. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

25. Allowance for expected credit losses is a contra-liability account. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

26. When companies are using the allowance for expected credit losses, they are using the allowance method. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

27. The A/R subledger is used to manage the individual account details of each of the company’s suppliers. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

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28. The total of all the A/R subledgers must equal the total of the Accounts Receivable account. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

29. Companies following IFRS must disclose changes in the allowance for expected credit losses balance in the notes to the financial statements. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

30. The allowance method of recognizing credit losses does NOT properly match revenues and expenses. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

31. Under the allowance method, a company must record the credit losses in the same period in which the credit sales were recorded. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

32. A writeoff is the process of reinstating a customer’s account when it is deemed collectible. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

33. When a customer makes full or partial payment of an account that has previously been written off, this is considered a recovery. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

34. A recovery of an account will decrease the Cash account and increase the Accounts Receivable account. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

35. Credit losses is a permanent account. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

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36. If credit losses is over or underestimated in a prior period, an adjustment will be made to the allowance for expected credit losses this period. Answer: True Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

37. Under the allowance method, the credit loss for the period is equal to the total expected credit losses. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

38. In determining credit losses, the expected rate of credit losses are multiplied by the total credit sales for the period. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

39. When estimating credit losses under the allowance method, companies must estimate credit losses based on historical and future forecasted loss rates.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

40. New businesses CANNOT account for credit losses because they do NOT have any historical data in relation to collectible accounts. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

41. The longer a receivable goes without being collected, the less likely it will become uncollectible. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

42. As a contra-asset account, allowance for expected credit losses will always have a credit balance. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected

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credit losses. CPA: Financial Reporting AACSB: Analytic

43. The analysis of aged accounts receivable will always result in an accurate calculation of credit losses. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

44. The direct writeoff method recognizes credit losses only when they know the customer is NOT going to pay. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic

45. The direct writeoff method requires two journal entries when an account is written off. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic

46. The appropriate method to use when credit losses are significant is the allowance method.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic

47. Selling to customers on account reduces the cash-to-cash cycle. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Financial Reporting AACSB: Analytic

48. To shorten the cash-to-cash cycle companies offer a sales discount for early payment. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Financial Reporting AACSB: Analytic

49. The current ratio is most commonly used to measure the stability of an entity. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

50. Analyzing the accounts receivable turnover is important in assessing the short-term liquidity of an organization.

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Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

51. The quick ratio is a less stringent measure of liquidity than the current ratio. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

52. Two common ratios for long-term liquidity are the current ratio and the quick ratio. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

53. One problem with the current ratio is that some assets may be less liquid than others. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

54. A higher accounts receivable turnover ratio number is better than a lower accounts receivable turnover number. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 55. All of the following are normally considered liquid assets of a company EXCEPT a) accounts receivable. b) inventory. c) notes receivable. d) short-term investments. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why cash and accounts receivable are of significance to users. CPA: Financial Reporting AACSB: Analytic

56. Which of the following would be classified as part of the cash account on the statement of financial position? a) short-term investments b) prepaid expenses c) currency d) restricted cash Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why cash and accounts receivable are of significance to users. CPA: Financial Reporting AACSB: Analytic

57. Foreign currency held by a Canadian corporation is disclosed on the financial statements using the exchange rate that existed on the date of the a) financial statements. b) purchase of the currency. c) change in the exchange rate. d) intended use of the currency. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for cash.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

58. All of the following are examples of internal controls over cash EXCEPT a) depositing cash in the bank regularly. b) ensuring different people are responsible for receiving and depositing cash. c) ensuring that all cash transactions are recorded on a regular basis. d) maintaining a separate facility for the storage of perishable inventory. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting AACSB: Analytic 59. The effectiveness of internal control is limited by a) fraud. b) cash on hand. c) collusion. d) auditors. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. CPA: Communication AACSB: Analytic

60. Opportunities for employee fraud arise when a) an employee is in charge of purchasing, inspecting, and recording assets. b) employees verify each other’s work. c) an employee has clear documentation procedures. d) an employee is responsible for making the daily cash bank deposit. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting

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AACSB: Analytic

61. Policies and procedures that are established to protect and manage a company’s assets are known as a) a record-keeping system. b) an accounting system. c) internal controls. d) management controls. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting AACSB: Analytic

62. All of the following are examples of physical controls EXCEPT a) locks. b) fences. c) bank reconciliations. d) alarms. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting AACSB: Analytic

63. Separation of duties means a) one person receives cash and one person signs cheques. b) one person signs cheques and orders goods. c) one person enters transactions and signs cheques. d) one person receives cash and reconciles the bank. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

64. Which of the following is NOT a reconciling item when preparing a bank reconciliation? a) bank service charges not recorded by the corporation b) outstanding cheques c) interest collected on a note receivable by the bank and recorded by the corporation d) outstanding deposits Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

65. The ending balance on the bank statement for June is $1,425.33. The company has outstanding cheques of $263.35, outstanding deposits of $729.61, and incurred bank service fees of $12.00 during the month. The adjusted cash balance for the company as at June 30 is a) $947.07. b) $1,891.59. c) $1,879.59. d) $1,903.59. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

66. Who should be responsible for preparing the bank reconciliation? a) the person who makes the deposits b) the person who writes the cheques c) the person who maintains the accounting records d) a person not involved in the day-to-day banking activities Answer: d Bloomcode: Application

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Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

67. As part of the bank reconciliation process, the following must occur: a) bank adjusting entries. b) company adjusting entries. c) verification of bank charges. d) inventory of company cheques. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

68. A key control used to mitigate the unethical manipulation of accounting records and fraudulent cash transactions is a) bank reconciliation. b) separation of duties. c) physical controls. d) documentation. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Communication, Financial Reporting AACSB: Analytic, Ethics

69. Bank reconciliations are NOT a) an important cash control. b) to be completed by all companies. c) sufficient to determine fraud. d) useful.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: c Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

70. All the following are reasons why a transaction may have been reflected in the company’s accounting records but NOT by the bank, EXCEPT when a) a cheque has been written but the receiving company did not deposit it yet. b) the bank has charged service fees. c) the company made a deposit on the last day of the month. d) the company recorded a payment received however forgot to deposit the cheque. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

71. The starting point for the bank portion of the bank reconciliation is labelled a) Account Balance. b) Bank Balance. c) Transaction Balance. d) Cash Balance. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

72. Which of the following statements is INCORRECT? a) Companies sell on account to increase total sales. b) Companies sell on account to remain competitive.

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c) Companies sell on account to generate additional forms of revenue. d) Companies sell on account to increase credit losses. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

73. When selling on account, companies incur costs such as a) wages for credit-granting function. b) rent expense. c) credit losses revenue. d) sales discounts. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

74. A company can mitigate credit losses by a) extending payments terms. b) not charging interest on late payments. c) performing credit checks. d) writing off more accounts. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Communication, Financial Reporting AACSB: Analytic, Communication

75. Which of the following does NOT affect the amounts collected on accounts receivables?

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

a) credit policy b) returns policy c) discounts policy d) the allowance for expected credit losses Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

76. The individual account details for each of a company’s customers is managed in the a) control account. b) allowance for expected credit losses. c) credit losses. d) subledger. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic, Communication

77. Accounts Receivable are reflected on the statement of financial position at the carrying amount which is a) accounts receivable plus allowance for expected credit losses. b) accounts receivable less allowance for expected credit losses. c) accounts receivable plus credit losses. d) accounts receivable less credit losses. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Financial Reporting AACSB: Analytic

78. Which of the following entries would be the appropriate entry for writing off an uncollectible

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account receivable under the allowance method? a) Dr. Credit Losses Cr. Accounts Receivable b) Dr. Sales Cr. Accounts Receivable c) Dr. Accounts Receivable Cr. Credit losses d) Dr. Allowance for Expected Credit Losses Cr. Accounts Receivable Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

79. Which of the following is a contra account? a) Credit Losses b) Accounts Receivable Recoveries c) Allowance for Expected Credit Losses d) Credit Sales Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

80. When an account receivable that has previously been written off is later paid, under the allowance method the correct accounting is to a) Dr. A/R Cr. Allowance for Expected Credit Losses Dr. Cash Cr. A/R b) Dr. A/R Cr. Cash Dr. A/R Cr. Allowance for Expected Credit Losses c) Dr. Cash Cr. A/R

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Dr. A/R Cr. Allowance for Expected Credit Losses

Answer: a Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

81. Aurora Co. had Accounts Receivable totalling $450,000 and an Allowance for Expected Credit Losses with a balance of $5,000 on December 1. On December 2 Aurora wrote off $7,500 of uncollectible accounts. The net carrying value of Accounts Receivable before and after the writeoff was Before After a) $450,000 $442,500. b) $445,000 $445,000. c) $445,000 $452,500. d) $445,000 $457,500. Answer: b Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

82. The process of removing a specific customer’s account receivable from a company’s books when the account is deemed uncollectible is a) an allowance. b) a writeoff. c) a recovery. d) estimated credit losses. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

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83. The contra-asset account used to provide for an estimate of uncollectible accounts is a) credit losses. b) allowable accounts receivable. c) allowance for expected credit losses. d) A/R subledger. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

84. The entry to provide for uncollectible accounts under the allowance method affects both the statement of income and the statement of financial position by a) increasing expenses and increasing the carrying amount of the accounts receivable. b) decreasing expenses and increasing the carrying amount of the accounts receivable. c) increasing expenses and decreasing the carrying amount of the accounts receivable. d) decreasing expenses and decreasing the carrying amount of the accounts receivable. Answer: c Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

85. Which of the following statements is correct in regards to the recovery entry of a specific accounts receivable? a) It does not affect the statement of financial position. b) It affects both the statement of income and the statement of financial position. c) It only affects the statement of income. d) It only affects the statement of financial position. Answer: d Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

86. The allowance for expected credit losses a) is easier to use than the direct writeoff method. b) is a control account. c) is part of ensuring faithful representation. d) captures all the A/R that will never be collected. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic, Communication

87. Use the following information to answer the question. Bailey Inc.'s books revealed the following data at year end after all adjustments were made: Cash sales $825,000 Sales returns (on credit sales) 35,000 Allowance for expected credit losses (credit balance) 3,800 Credit sales 575,000 Accounts receivable 168,000 Bailey estimates the expected rate of credit losses to be 5%. The credit losses for the year were a) $28,750. b) $4,600. c) $8,400. d) $24,950. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

88. Use the following information to answer the question.

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Bailey Inc.'s books revealed the following data at year end after all adjustments were made: Cash sales $825,000 Sales returns (on credit sales) 35,000 Allowance for expected credit losses (credit balance) 3,800 Credit sales 575,000 Accounts receivable 168,000 Bailey estimates the expected rate of credit losses to be 5%. The net realizable value or carrying value of accounts receivable after the credit losses is recognized is a) $159,600. b) $163,400. c) $168,000. d) $171,800. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

Use the following information to answer the question. Melrose Company recorded $3,500,000 in credit sales and prepared the following aging schedule for its $730,000 in Accounts Receivable: Days outstanding Balance Estimated percentage uncollectible 0–30 days $350,000 1% 31–60 days 275,000 2% 61–90 days 67,500 5% 0ver 90 days 37,500 25% The balance in its allowance for expected credit losses before year-end adjustments is a $2,000 credit.

89. Use the following information to answer the question. Melrose Company recorded $3,500,000 in credit sales and prepared the following aging schedule for its $730,000 in Accounts Receivable: Days outstanding Balance Estimated percentage uncollectible 0–30 days $350,000 1% 31–60 days 275,000 2% 61–90 days 67,500 5% 0ver 90 days 37,500 25%

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

The balance in its allowance for expected credit losses before year-end adjustments is a $2,000 credit. The credit losses for the year were a) $21,750. b) $23,750. c) $19,750. d) $35,000. Answer: c Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

90. Use the following information to answer the question. Melrose Company recorded $3,500,000 in credit sales and prepared the following aging schedule for its $730,000 in Accounts Receivable: Days outstanding Balance Estimated percentage uncollectible 0–30 days $350,000 1% 31–60 days 275,000 2% 61–90 days 67,500 5% 0ver 90 days 37,500 25% The balance in its allowance for expected credit losses before year-end adjustments is a $2,000 credit. The balance in the Allowance for expected credit losses after year-end adjustments will be a) $2,000. b) $23,750. c) $21,750. d) $19,750. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

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91. Which of the following would allow a company to estimate credit losses by analyzing the statement of financial position? a) analysis of credit sales b) random assignment of credit losses c) analysis of aging of accounts receivable d) analysis of sales trends Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

92. Which one of the following calculations is correct for determining the total expected credit losses? a) Credit losses = Accounts receivable x Expected rate of credit losses b) Credit losses = Credit Sales x Expected rate of credit losses c) Credit losses = Allowance for expected credit losses x Expected rate of credit losses d) Credit losses = Accounts Receivable x Prior period’s rate of credit losses Answer: a Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

93. If a company is experiencing more writeoffs than were estimated, a) the credit losses should be reduced next period. b) the direct method should be implemented. c) the percentage of credit losses should be increased next accounting period. d) an adjustment should be made retrospectively. Answer: c Bloomcode: Knowledge Difficulty: Hard

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

94. The most common threshold for account receivable groupings is a) 0–5 days. b) n/120 days. c) 30–60 days. d) 160–180 days. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

95. All the following are steps in the process of determining the allowance for expected credit losses EXCEPT a) updating historical loss rates to reflect future forecasts. b) determining an appropriate percentage of credit sales to quantify expected credit losses. c) determining the historic loss rates for each group. d) grouping the receivables by credit risk. Answer: b Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

96. All the following are considered when analyzing the aging of accounts receivable EXCEPT for a) accounts receivables that are grouped based on specific age ranges. b) an analysis of the age grouping will assist in establishing a allowance for expected credit losses. c) different aging groups that involve different risk.

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d) applying a set loss rate to the aging of accounts receivable will always results in an accurate assessment of credit losses. Answer: d Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic, Communication

97. All of the following are credit risk characteristics used for grouping receivables, EXCEPT a) geographical region where the customer is located. b) the size of the customer. c) the company’s ability to absorb credit losses. d) the type of customer. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic, Communication

98. When a company has an immaterial amount of credit losses, it may choose to account for credit losses using a) the direct writeoff method. b) the percentage receivables method. c) the percentage of credit sales method. d) aging of accounts receivable method. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

99. Which of the following methods does NOT accurately match revenues to expenses in the same period? a) direct writeoff method b) allowance method c) percentage of credit sales method d) aging of accounts receivable method Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic

100. When is it acceptable to use the direct writeoff method to account for uncollectible accounts? a) when the expected credit losses are significant b) when the company has historical data in regard to uncollectible accounts c) when the company uses the percentage of sales method d) when the expected credit losses are not significant Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic

101. No allowance for expected credit losses is used for the a) direct writeoff method. b) percentage of credit sales method. c) allowance method. d) aging of accounts receivable method. Answer: a Bloomcode: Knowledge Difficulty: Medium

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Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic

102. If credit losses are NOT significant, which method is best to use? a) direct writeoff method b) percentage of credit sales method c) allowance method d) aging of accounts receivable method Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic

103. If a company is experiencing cash flow difficulties, it may opt to sell its receivables to a third party to generate cash. This is known as a) internal cash controls. b) pledging. c) factoring. d) cash management. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Financial Reporting AACSB: Analytic

104. Many companies have to pay a fee for credit card transactions; this fee is normally a) 0–1%. b) 5–10%. c 10–30%. d) 1–4%. Answer: d

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Financial Reporting AACSB: Analytic

105. If a company recorded a $5,500 credit card transaction and the credit card discount was 4%, what is the correct entry to accounts receivable? a) Dr. Accounts Receivable $5,720 b) Dr. Accounts Receivable $5,280 c) Cr. Accounts Receivable $5,720 d) Cr. Accounts Receivable $5,280 Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Financial Reporting AACSB: Analytic

106. If a company is looking to shorten its cash-to-cash cycle, it can sell its accounts receivable and this is called a) recourse. b) factoring. c) writeoff. d recovery. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Financial Reporting AACSB: Analytic

107. Strategies a company may engage in to improve its cash-to-cash cycle include a) reducing the days accounts payable. b) reducing the accounts receivable turnover. c) offering early payment discounts. d) reducing its days inventory.. Answer: c

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Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Financial Reporting AACSB: Analytic, Communication

108. Use the following information to answer the question. Fabulous Enterprise Ltd. revealed the following information for the years ended December 31, 2023 and 2024: 2024 2023 Current Assets Cash $ 25,000 $ 26,250 Accounts Receivable 247,500 299,000 Inventory 1,950,000 1,725,000 Prepaid expenses 4,000 4,000 Total Current Assets $2,226,500 $2,054,250 Current Liabilities

$1,400,000

$1,225,000

Net Credit Sales

$2,400,000

$2,255,000

Fabulous Enterprise’s credit terms are net 30 days. Fabulous Enterprise’s 2024 current ratio is a) 1.59:1. b) 1.39:1. c) 1.00:1. d) 0.19:1. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

109. Use the following information to answer the question. Fabulous Enterprise Ltd. revealed the following information for the years ended December 31, 2023 and 2024:

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

2024

2023

Current Assets Cash Accounts Receivable Inventory Prepaid expenses Total Current Assets

$ 25,000 247,500 1,950,000 4,000 $2,226,500

$ 26,250 299,000 1,725,000 4,000 $2,054,250

Current Liabilities

$1,400,000

$1,225,000

Net Credit Sales

$2,400,000

$2,255,000

Fabulous Enterprise’s credit terms are net 30 days. Fabulous Enterprise’s quick ratio for Year 2024 is a) 1.59:1. b) 1.39:1. c) 0.88:1. d) 0.19:1. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

110. Use the following information to answer the question. Fabulous Enterprise Ltd. revealed the following information for the years ended December 31, 2023 and 2024: 2024 2023 Current Assets Cash $ 25,000 $ 26,250 Accounts Receivable 247,500 299,000 Inventory 1,950,000 1,725,000 Prepaid expenses 4,000 4,000 Total Current Assets $2,226,500 $2,054,250 Current Liabilities

$1,400,000

$1,225,000

Net Credit Sales

$2,400,000

$2,255,000

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Fabulous Enterprise’s credit terms are net 30 days. Fabulous Enterprise’s A/R turnover ratio is a) 9.70. b) 8.78. c) 8.03. d) 8.52. Answer: b Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

111. Use the following information to answer the question. Fabulous Enterprise Ltd. revealed the following information for the years ended December 31, 2023 and 2024: 2024 2023 Current Assets Cash $ 25,000 $ 26,250 Accounts Receivable 247,500 299,000 Inventory 1,950,000 1,725,000 Prepaid expenses 4,000 4,000 Total Current Assets $2,226,500 $2,054,250 Current Liabilities

$1,400,000

$1,225,000

Net Credit Sales

$2,400,000

$2,255,000

Fabulous Enterprise’s credit terms are net 30 days. On average Fabulous Enterprise has been collecting its accounts receivable a) within the 30 days required by its credit terms. b) after the 30 days has passed. c) within the discount period of 10 days. d) More information is needed to answer this question. Answer: b Bloomcode: Knowledge Difficulty: Medium

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Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

112. The current ratio is also known as a) working capital ratio. b) debt to equity ratio. c) current turnover. d) quick ratio. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

113. A current ratio of 3:1 means a) the company has 3 dollars of current debt to every dollar of current assets. b) the company has 3 dollars of current assets to every 1 dollar of current debt. c) the company has 3 dollars of current assets for every 3 dollars of current debt. d) the company has 3 dollars of current debt to every 3 dollars of current assets. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

114. The quick ratio is also known as a) working capital ratio. b) debt to equity ratio. c) current turnover. d) acid test ratio. Answer: d

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

115. Which of the following statements is INCORRECT? a) If the current ratio is too high the company may not be managing its assets effectively. b) If the current ratio is too high the company may have overly high levels of inventory. c) If the current ratio is too high the company may have too much cash on hand. d) If the current ratio is too high the company may have an insignificant amount of receivables. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

116. Quick assets are a) inventory plus cash and prepaid expenses. b) current assets plus current liabilities. c) current assets less prepaid expenses. d) current assets less inventory and prepaid expenses. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

117. A company’s effectiveness regarding its collection efforts can be measured by using the a) working capital ratio. b) acid test ratio. c) accounts payable turnover. d) accounts receivable turnover.

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Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic, Communication

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EXERCISES 118. The October 31 bank statement for Juggernaut Ltd had an ending balance of $4,250.12. The cash account according to the company’s records was $3,433.52 as at the same date. The following additional data was available 1. The company had made a deposit in the night box of $1,200.00 on October 31 after the branch was closed. 2. There were outstanding cheques totalling $2,718.60 as at October 31. 3. The bank service fee was $40.00 for the month. 4. A cheque in the amount of $650.00 deposited by Juggernaut on October 21 had been returned NSF and the bank charged a $12.00 fee on the item. Juggernaut had NOT known about the returned item until it received the bank statement. Instructions Prepare the bank reconciliation for Juggernaut Ltd. for the month of October. Solution (10 min.) Juggernaut Ltd. Bank Reconciliation as at October 31 Bank Balance Add: Outstanding deposit Deduct: Outstanding cheques

$4,250.12

(2,718.60)

Reconciled Balance

$2,731.52

G/L Balance

$3,433.52

Deduct: Bank service fees ($40 + $12) Returned cheque Reconciled Balance

(52.00) (650.00) $2,731.52

1,200.00

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

119. The cash records of Montrose Corporation show the following: 1. The March 31 bank reconciliation indicated that deposits in transit totalled $400. During April, the general ledger account, Cash, shows deposits of $10,700, but the bank statement indicates that only $8,540 in deposits were received during the month. 2. The March 31 bank reconciliation also reported outstanding cheques of $2,100. During the month of April, Montrose Corporation’s books show that $11,170 of cheques were issued, yet the bank statement showed that $11,500 of cheques cleared the bank in April.

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There were no bank debit or credit memoranda and no errors were made by either the bank or Montrose Co. Instructions a) What were the deposits in transit at April 30? b) What were the outstanding cheques at April 30? Solution (10 min.) a) Deposits in transit: Deposits per books in April ....................................... Deposits per the bank in April ................................... Less: March 31 deposits in transit ............................. March receipts deposited in April ............................. Deposits in transit, April 30 ....................................... b)

Outstanding cheques: Cheques per books in April ....................................... Cheques clearing the bank in April ........................... Less: Outstanding cheques, March 31 ...................... March cheques clearing in April ................................ Outstanding cheques, April 30 ..................................

$10,700 $8,540 400 8,140 $ 2,560

$11,170 $11,500 2,100 9,400 $ 1,770

Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

120. TurnLeaf Corporation is a newly created company and noted the following cash related transactions for the first month of the current year ended April 30: 1. According to the bank statement received for the month of April, the balance in TurnLeaf’s bank account on April 30 was $11,356.69. 2. The balance in the company’s Cash account in the general ledger on April 30 was $13,211.76. 3. The last deposit of the month, for $867.91, was made as a night deposit on April 30. 4. One of TurnLeaf’s customers paid its account by making an EFT payment from its bank into TurnLeaf’s bank account in the amount of $616.09. 5. The bank subtracted a service charge of $42.00 from the company’s bank account for April. 6. Cheque number 001 for $603.44, cheque number 009 for $531.00, and cheque number 010 for $78.49 were still outstanding at the end of April. 7. The bank statement showed that $750.00 was deducted from TurnLeaf’s account by the bank as payment of loan principal. 8. The bank returned a cheque from one of TurnLeaf’s customers marked NSF for $206.80 that a

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customer used to pay off their account. 9. The bank statement showed that cheque number 004 (which TurnLeaf had issued to pay for utilities expense) was recorded by the bank as $784.65, while the company incorrectly recorded this cheque as $874.65. 10. The bank deducted a cheque written by OakLeaf Company (a different company) from TurnLeaf Company’s account. The amount of the cheque was $1,907.38. Instructions a) Prepare the bank reconciliation for April 30. b) Prepare all necessary journal entries to balance the cash ledger. Solution (15 min.) a) TurnLeaf Corporation Bank Reconciliation as at April 30 Bank Balance Add: Outstanding deposit Correction of error made by bank Deduct: Outstanding cheques: #001 #009 #010 Reconciled Balance b)

$11,356.69 867.91 $1,907.38

($603.44) ($531.00) ($78.49) $12,919.05

G/L Balance Add: EFT receipts Correction of error made by company Deduct: Bank charges Automatic deduction for loan payment NSF cheque Reconciled Balance

Cash............................................................................ Accounts Receivable ..........................................

$616.09

Cash............................................................................ Utilities Expense ................................................

$90.00

Bank charges expense ............................................... Cash ....................................................................

$42.00

Bank loan payable ..................................................... Cash ....................................................................

$750.00

Accounts Receivable ................................................. Cash ....................................................................

$206.80

Bloomcode: Knowledge Difficulty: Hard

$616.09

$90.00

$42.00

$750.00

$206.80

$13,211.76 $616.09 $90.00 (42.00) ($750.00) (206.80) $12,919.05

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Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

121. Bering Computers has credit sales of $600,000 and a debit balance of $1,600 in the allowance for expected credit losses at year end. As of December 31, $105,000 of accounts receivable remain uncollected. The credit manager of Bering prepared an aging schedule of accounts receivable and estimates that $5,600 will result in credit losses. On April 15 of the following year, Bering Computers writes off the $1,500 balance owed by A. Justice. Instructions a) Prepare the adjusting entry to record the estimated credit losses at December 31. b) Show the statement of financial position presentation of accounts receivable on December 31. c) On April 15, before the writeoff, assume the balance of Accounts Receivable account is $123,000 and the balance of Allowance for Expected Credit Losses is a credit of $3,000. Make the appropriate entry to record the writeoff of the Justice account receivable. What it is the net realizable value of the accounts receivable before and after the writeoff? Solution (15 min.) a) Credit Losses ($5,600 + $1,600) ................................. Allowance for Expected Credit Losses .............. b)

7,200 7,200

Accounts Receivable ................................................. Less: Allowance for Expected Credit Losses .............

$105,000 5,600

Allowance for Expected Credit Losses ...................... Accounts Receivable—A. Justice .......................

1,500

Accounts Receivable ......................................................... Less: Allowance for Expected Credit Losses..................... Net Realizable Value..........................................................

$99,400

1,500 Before Writeoff $123,000 3,000 $120,000

After Writeoff $121,500 1,500 $120,000

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. CPA: Financial Reporting AACSB: Analytic

122. The December 31, 2023 statement of financial position for Ambrosia Limited had accounts receivable of $450,000 and a credit balance in allowance for expected credit losses of $45,000. During 2024 the following transactions occurred: service revenue billed on account, $1,500,000; collections from customers, $1,300,000; accounts written off $37,000; previously written off accounts of $4,000

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were collected. Instructions a) Record the 2024 transactions. b) If the company determines that the expected rate of credit losses is 5% of accounts receivable, what is the adjusting entry at December 31, 2024? HINT: Use a T account to track account balances for Accounts Receivable and Allowance for Expected Credit Losses. c) What is the net realizable value of the accounts receivable on December 31, 2024? Solution (15 min.) a) Accounts Receivable ................................................................................ Service Revenue ................................................................................ (To record credit service revenue)

1,500,000 1,500,000

Cash .......................................................................................................... Accounts Receivable ......................................................................... (To record collection of receivables)

1,300,000

Allowance for expected credit losses ...................................................... Accounts Receivable ......................................................................... (To writeoff specific accounts)

37,000

Accounts Receivable ................................................................................ Allowance for expected credit losses ............................................... (To reverse writeoff of account)

4,000

b) ACCOUNTS RECEIVABLE 450,000 1,500,000 4,000 Bal.

1,300,000

37,000

4,000

ALLOWANCE FOR EXPECTED CREDIT LOSSES 37,000

1,300,000 37,000 4,000

Bal.

613,000

Required balance ($613,000 .05) ............................................................................... Balance before adjustment ......................................................................................... Adjustment required .................................................................................................... Dec. 31

45,000 4,000 12,000

Credit losses ...................................... Allowance for expected credit losses .............................

$30,650 12,000 $18,650

18,650 18,650

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

c) Accounts Receivable (net realizable value)

$582,350 ($613,000 – $30,650)

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

123. Vatera Co Inc. generated $5.5 million in credit sales during the current year. Based on a thorough analysis of its accounts receivable, Vatera has estimated credit losses to be 1.5% of credit sales for the year. The balance of the allowance for expected credit losses at December 31 is $8,900 credit. Accounts receivable at December 31 consists of the following: Account Classification Amount 1–30 days $850,000 31–60 days 175,000 61–90 days 120,000 91–120 days 50,000 Over 120 days 20,000 Instructions a) Calculate and record the journal entry for credit losses for the current year using the percentage of credit sales method. b) Vatera Co. has decided to writeoff all the accounts that were over 120 days old. Record the journal entry. c) What is the balance for Accounts Receivable as shown on the December 31 statement of financial position? d) One of the customers whose $5,000 account was written off, paid Vatera Co. in full. Record the journal entry. Solution (10 min.) a) Credit Losses ($5,500,000 ×.015) ............................... Allowance for Expected Credit Losses .............

$82,500

20,000

Allowance for Expected Credit Losses ...................... Accounts Receivable .......................................... Accounts Receivable ($1,215,000 – $20,000) ............ Less Allowance for Expected Credit Losses .............. ($8,900 + $82,500 – $20,000) Net A/R .......................................................................

82,500

20,000 1,195,000 71,400 1,123,600

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Accounts Receivable ................................................. 5,000 Allowance for Expected Credit Losses .............. Cash .................................................................... 5,000 Accounts Receivable ..........................................

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5,000 5,000

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

124. Imaginary Inc. generated $2.75 million in credit sales during the current year. The balance of the allowance for expected credit losses at December 31 is $2,500 debit. Accounts receivable at December 31 consists of the following:

Account Classification 1–30 days 31–60 days 61–90 days Over 90 days

Amount $350,000 180,000 55,000 21,000

Expected Rate of Credit Losses 1.5% 3% 5% 25%

Instructions a) Calculate and record the journal entry for credit losses for the current year using the credit loss estimates provided. b) Imaginary Inc. has decided to write off $15,000 of the accounts that were over 90 days old. Record the journal entry. c) What is the balance for Accounts Receivable as shown on the December 31 statement of financial position? d) One of the customers whose $2,200 account was written off paid in full. Record the journal entry. e) Is the balance in the allowance for expected credit losses affected by the transaction in part d)? If so, by how much? What is the new balance? Solution (12 min.) a) Required balance for allowance for expected credit losses: 1–30 days $350,000 1.5% $ 5,250 31–60 days 180,000 3% 5,400 61–90 days 55,000 5% 2,750 Over 90 days 21,000 25% 5,250 $18,650 Existing balance in the account (debit) 2,500

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Entry required (credit losses)

$21,150

Credit Losses .............................................................. Allowance for Expected Credit Losses ..............

21,150

Allowance for Expected Credit Losses ...................... Accounts Receivable ..........................................

15,000

21,150

15,000

Accounts Receivable ($606,000 – $15,000) ............... Less Allowance for Expected Credit Losses ($18,650 – $15,000) Net Accounts Receivable ...........................................

Accounts Receivable ................................................. Allowance for Expected Credit Losses .............. Cash............................................................................ Accounts Receivable ..........................................

591,000 3,650 587,350

2,200 2,200 2,200 2,200

e) The allowance for expected credit losses balance would increase by $2,200; the new credit balance would be $5,850. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

125. Matt’s Magic Store has credit sales of $500,000 and a debit balance of $800 in the Allowance for expected credit losses at year end. As of December 31, $120,000 of accounts receivable remain uncollected. Matt’s Magic estimates the rate of credit losses based on an analysis of accounts receivable to be 2.5%. Instructions a) Prepare the adjusting entry to record the estimated credit losses on December 31 year end. b) Show the Statement of Financial Position presentation of accounts receivable on December 31. Solution (8 min.) a) Credit Losses ............................................................................................. Allowance for Expected Credit Losses .............................................. (120,0000 x 2.5% = $3,000 + 800 = 3,800) b)

Accounts Receivable Less: Allowance for Expected Credit Losses

$120,000 3,000

3,800 3,800

$117,000

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Bloomcode: Application Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

126. Triple H Enterprises Ltd. revealed the following information for the years ended December 31, 2024 and 2023: 2024 2023 Current Assets Cash.................................................................. $ 25,000 $ 24,500 Accounts Receivable ....................................... 435,000 550,000 Inventory .......................................................... 675,000 630,000 Total Current Assets ........................................ $1,135,000 $1,204,500 Current Liabilities ............................................ $1,040,000

$1,091,000

Net Credit Sales ............................................... $4,054,000

$4,169,000

Triple H Enterprise’s credit terms are net 30 days. Instructions a) Calculate Triple H’s 2024 and 2023 current ratio. b) Calculate Triple H’s quick ratio for 2024 and 2023. c) Comment on Triple H’s year over year liquidity position. d) Calculate Triple H’s accounts receivable turnover ratio for 2024. e) On the average how long does it take Triple H to collect its accounts receivable? Is this good? If not, what types of things might Triple H consider in order to improve its collections? Solution (15 min.) a) Current Ratio = Current Assets / Current Liabilities 2024: 2023: b)

Quick Ratio = Current Assets – Inventory – Prepaid expenses \ Current Liabilities

2024: 2023: c)

1,135,000 / 1,040,000 = 1.09 1,204,500/ 1,091,000 =1.10

(1,135,000 – 675,000 – 0) / 1,040,000 = 0.44 (1,204,500 –630,000 – 0) / 1,091,000 = 0.53

The current ratio is stable year over year and indicates that on average Triple H has $1.09 in

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current assets for every dollar in current liabilities. When inventory is subtracted from current assets the company only has $0.44 in current assets for every dollar in current debt in 2024 as measured by the quick ratio. The quick ratio in 2024 has also further eroded when compared to the quick ratio of .53 in 2023. The quick ratio for both 2024 and 2023 is concerning, particularly if inventory is not easily liquidated. This could compromise the company’s ability to meet current obligations. d)

Accounts Receivable turnover ratio= Credit sales / Average Accounts Receivable

2024:

4,054,000 / (435,000 + 550,000) / 2 = 4,054,000 / 492,500 = 8.23

Average collection period = 365 days / A/R Turnover = 365 / 8.23 = 44.35 days Therefore: on average it takes Triple H 44 days to collect its receivables. Given that Tripe H’s credit terms are net 30 this is not very good. Triple H can improve collections by accepting credit cards or offering early payment discounts.

Bloomcode: Analysis Difficulty: Hard Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

127. OMG Enterprise Ltd. revealed the following information for the years ended December 31, 2023 and 2024: 2024 2023 Current Assets Cash.................................................................. $ 45,000 $ 46,250 Accounts Receivable ....................................... 547,500 699,000 Inventory .......................................................... 1,065,000 1,089,000 Prepaid expenses ............................................ 4,000 4,000 Total Current Assets ........................................ $1,661,500 $1,838,250 Current Liabilities ............................................ $1,040,000

$1,091,000

Net Credit Sales ............................................... $4,054,000

$4,169,000

OMG Enterprise’s credit terms are net 30 days. Instructions a) Calculate OMG Enterprise’s 2024 and 2024 current ratio.

Cash and Accounts Receivable

b) c) d)

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Calculate OMG Enterprise’s quick ratio for 2024 and 2023. Calculate OMG Enterprise’s Accounts Receivable turnover ratio for 2024. On the average how long does it take OMG Enterprise to collect its accounts receivable?

Solution (15 min.) a) Current Ratio = Current Assets / Current Liabilities 2024: 2023: b)

Quick Ratio = Current Assets – Inventory – Prepaid expenses \ Current Liabilities 2024: 2023:

1,661,500 – 1,065,000 – 4,000 / 1,040,000 = 0.57 1,838,250 –1,089,000 – 4,000 / 1,091,000 = 0.68

Accounts Receivable turnover ratio= Credit sales / Average Accounts Receivable 2024:

1,661,500 / 1,040,000 = 1.60 1,838,250/ 1,091,000 =1.68

4,054,000 / (547,500 + 699,000) / 2 = 4,054,000 / 623,250 = 6.50

Average collection period = 365 days / A/R Turnover = 365 / 6.50 = 56.15 days Therefore on average it takes OMG Enterprise 56 days to collect their receivables.

Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

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MATCHING 128. Listed below are a set of terms and a set of definitions. Match each term to the appropriate definition by placing its letter in the space provided.

A. B. C. D. E. F.

TERMS Current ratio Internal control Factoring Allowance method Writeoff Carrying amount

G. H. I. J.

Recovery Physical controls Quick Ratio Direct writeoff method

DEFINITIONS ____

Collection of a specific accounts receivable that has been previously written off

Answer: G Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

____

Designed to protect assets from theft, diversion, damage or destruction

Answer: H Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses.

Cash and Accounts Receivable

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Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

____

Full value of accounts receivable less the allowance for expected credit losses

Answer: F Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

____

Estimates are made in regards to the uncollectible amount and a credit losses is recorded in the same period as the credit sales

Answer: D Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses.

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Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

____

The process of removing a customer’s account receivable from the books when the account is deemed uncollectible

Answer: E Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

____

Ratio that measures the entity’s short-term liquidity

Answer: A Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results.

Cash and Accounts Receivable

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CPA: Financial Reporting AACSB: Analytic

____

Selling of accounts receivable

Answer: C Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

____ ____

Recognize credit losses only when the company knows the customer will NOT pay

Answer: J Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

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____

System established to promote safeguarding of assets

Answer: B Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

____

10.

Used to assess short-term liquidity but only includes quick assets

Answer: I Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. Learning Objective: Explain how the carrying amount of accounts receivable is determined. Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

Cash and Accounts Receivable

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SHORT-ANSWER ESSAY QUESTIONS 129. Identify and describe the five limitations of internal control. Solution (10 min.) 1. Cost / Benefit – Management will only establish controls where the benefits that result exceed the costs of implementing. 2.

Human Error – errors in design may limit effectiveness. Also controls that rely on judgement of individual employees are only as effective as their decision making.

Collusion – when two or more individuals work together to circumvent the existing internal controls.

Management Override – even if an internal control is well designed a manager may be able to override it by virtue of their position.

Changing Circumstance – internal controls that were well designed may become ineffective as a result of changing circumstances such as new technology.

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the main principles of internal control and their limitations. CPA: Communication, Financial Reporting AACSB: Analytic, Communication

130. Explain the main principles of internal control. Solution (10 min.) Internal control consists of the systems within a company that help it achieve reliable financial reporting, operate effectively and efficiently, and comply with relevant laws and regulations. Internal controls can be preventive (which stop something management does not want to happen from occurring) or detective (which indicate when something that management did not want to happen has occurred). An internal control system includes (1) physical controls (locks, alarms, cash registers); (2) assignment of responsibilities (making one person responsible for each task); (3) separation of duties (separation of transaction authorization, recording, and asset custody); (4) independent verification (either internal or external); and (5) documentation (receipts, invoices, and so on). Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the main principles of internal control and their limitations.

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CPA: Financial Reporting AACSB: Analytic

131. The following five items are usually considered to be part of the bank reconciliation process: 1. Outstanding cheques 2. Deposits in transit 3. NSF Cheques 4. Bank collection of notes receivable on company’s behalf 5. Service charge Instructions Classify each item as (1) an addition to the book balance; (2) an addition to the bank balance; (3) a subtraction from the book balance; or (4) a subtraction from the bank balance. Solution (5 min.) 1. (4) a subtraction from the bank balance 2.

(2) an addition to the bank balance

(3) a subtraction from the book balance

(1) an addition to the book balance

(3) a subtraction from the book balance

132. Explain why companies sell on account and identify the additional costs that result from this decision. Solution (5 min.) Companies sell on account to increase total sales, remain competitive, and generate additional revenue (interest). When selling on account, companies incur additional costs, including wages for the credit-granting function, wages for the collections function, and credit losses. Bloomcode: Knowledge Difficulty: Medium

Cash and Accounts Receivable

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Learning Objective: Explain why companies sell on account and identify the additional costs that result from this decision. CPA: Financial Reporting AACSB: Analytic

133. Describe the how accounts receivable is valued. Solution (5 min.) Accounts receivable are reflected on the statement of financial position at their carrying amount, which is equal to the full amount of all receivables less the allowance for expected credit losses. The allowance for expected credit losses represents management’s best estimate of the total accounts receivable that it expects it will be unable to collect. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how the carrying amount of accounts receivable is determined. CPA: Communication, Financial Reporting AACSB: Analytic, Communication

134. Which of the two methods of accounting for uncollectible accounts, the allowance method or the direct writeoff method, is most acceptable? Why? Solution (8 min.) The allowance method requires that an estimate of credit losses be made and matched to the revenue earned in the related period. This leads to more accurate financial reporting and is therefore the method that is most acceptable. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the allowance method of accounting for expected credit losses. Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic, Communication

135. Briefly explain the steps involved in determining the Allowance for Expected Credit Losses. Solution (8 min.) Steps in the process 1. Group the receivables by credit risk

Explanation Groups should share similar credit risk characteristics. These could include the length of time they are past due, geographic

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2. Determine the historic loss rates for each group 3. Update historic loss rates to reflect future forecasts 4. Determine the total expected credit losses 5. Determine the amount of the adjustment required to the Allowance for Expected Credit Losses account

region, customer type (such as wholesale or retail), and so on. This is based on the company’s collection data from the past two to five years or, if the company is new, on industry averages. This is based on forecasted future economic conditions that management expects will affect the historic loss rates. This is done by multiplying the updated loss rates by the total amount of receivables in each related grouping. This is the difference between the account’s balance at the end of the current period and the amount of the expected credit losses determined in step 4.

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for these groupings, and quantify the total expected credit losses. CPA: Financial Reporting AACSB: Analytic

136. Describe the direct writeoff method when accounting for credit losses and explain when it is appropriate to use this method and demonstrate how credit losses would be accounted for? Solution (10 min.) The direct writeoff method has companies recognizing credit losses only when they can directly writeoff a specific customer’s account, so when the customer is not going to pay. Company’s should wait until the account has reached an age where by the company’s policy states that it should be written off, (i.e., 180 day overdue) or when there is specific indication (i.e., bankruptcy notification). The direct method is often used by companies with an immaterial amount of credit losses. The entry would appear as follows: Dr. Credit losses Cr. A/R Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. CPA: Financial Reporting AACSB: Analytic, Communication

Cash and Accounts Receivable

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137. Identify and describe the three methods a company can use to shorten its cash-to-cash cycle, and explain why this is important. Solution (10–12 min.) Companies may engage in the following strategies to shorten the cash-to-cash cycle: 1. Accept credit cards as a form of payment – payment is received within a day or two; however it does come at a cost. Merchant fees may vary from 1.5% - 4% This is known as a credit card discount. 2.

Offering early payment discounts known as sales discounts, this motivates customers to pay “early” or prior to the 30 day credit period. Maybe expressed as 2/10 n 30.

Companies may sell their accounts receivable to a financial institution at a discount. This is called factoring.

A company wants to increase its cash collections to make more cash available for day-to-day operating transactions and decrease a company’s reliance on an operating line of credit and the incurrence of costs associated with such a debt instrument. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain alternative ways in which companies shorten their cash-to-cash cycle. CPA: Communication, Financial Reporting AACSB: Analytic, Communication

138. Explain the concept of liquidity and how it is measured. Solution (5 min.) Liquidity refers to a company’s ability to convert assets into cash so that liabilities can be paid. The current ratio is equal to current assets divided by current liabilities and is a measure of the amount of current assets the company has relative to each dollar of current liabilities. The quick ratio is a stricter measure of liquidity than the current ratio. This is because it is determined without including inventory and prepaid expenses. Specifically, the ratio is equal to current assets less inventory and prepaids, divided by current liabilities. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results. CPA: Financial Reporting AACSB: Analytic

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ESSAY QUESTIONS 139. A client who is an owner/operator of a small convenience store has come to you for advice on how to prepare a bank reconciliation. She has read somewhere that there are definite benefits to preparing a bank reconciliation every month, but she is NOT sure how doing so will help her. Instructions Provide your client with a summary of how to prepare a bank reconciliation. Explain how preparing monthly bank reconciliations can provide important control procedures for her business. Solution (10 min.) A bank reconciliation is the procedure used to ensure that the accounting records agree with the bank records. The bank reconciliation procedure consists of reconciling the balance recorded in the general ledger account by the corporation to the bank statement received from the bank. The main reconciling items are outstanding cheques, outstanding deposits (deposits recorded by the corporation on one day but not received or recorded by the bank until the next business day), bank service charges that have been deducted from the bank statement but not recorded in the general ledger, errors in recording items by the business or the bank, and other items which cause differences between the business and the bank. A convenience store has cash sales on a daily basis. The main concern is control of cash to ensure it is not lost or stolen. Proper control of cash includes policies to ensure that all cash is deposited into the bank account on a daily basis and use of safes and cash registers. A bank reconciliation also provides control over cash and helps to manage cash most effectively. The reconciliation provides assurance that all transactions affecting the bank account have been properly recorded and no transactions have been missed. The person who prepares the bank reconciliation should not have access to the bank account or the accounting records. However, in this case, the small business is managed by the owner. Bloomcode: Knowledge Difficulty: Hard Learning Objective: Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. CPA: Financial Reporting AACSB: Analytic

CHAPTER 7 INVENTORY CHAPTER LEARNING OBJECTIVES 1. Discuss the importance of inventory to a company’s overall success. • Inventory includes any item purchased by a company for resale to customers or to be used in the manufacture of a product that is sold to customers. • Inventory is often a company’s most significant current asset. • Management must source suppliers, determine order quantities (ensuring that the risks of obsolescence and stockouts are considered), establish selling prices, and implement safeguards to prevent damage and losses due to theft.

2. Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. • Manufacturers have three classes of inventory: (1) raw materials, (2) work-in-process, and (3) finished goods. • All of the goods that retailers and merchandisers have available for sale are included in a single classification of inventory. • Goods that are purchased with shipping terms FOB shipping point become part of buyer’s inventory when they leave the seller’s premises. Goods purchased with shipping terms FOB destination become part of the buyer’s inventory when they are received at the buyer’s premises. • Goods on consignment remain as part of the inventory of their owner (the consignor) and are not part of the inventory of the consignee (the business where the goods are being held for sale).

3. Explain the differences between perpetual inventory systems and periodic inventory systems. • Cost of goods available for sale (COGAS) is equal to opening inventory plus purchases. It is allocated between cost of goods sold and ending inventory. This allocation is affected by the type of inventory system in use. • Periodic inventory systems update a company’s inventory information periodically (at the end of each month, quarter, or year) when inventory is physically counted. Until inventory is physically counted, a company using a periodic inventory system is unable to assign costs to cost of goods sold or ending inventory. It is also unaware of the number of units sold or that remain on hand. • Perpetual inventory systems constantly update a company’s inventory information; it is updated with every purchase or sale of inventory. Companies always know their cost of goods sold and ending inventory amounts. Perpetual inventory systems often

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

also track the physical flow of goods, enabling automatic reordering to occur. Perpetual inventory systems also enable companies to quantify shrinkage (theft) and eliminate the need for frequent inventory counts. An inventory count is still required at least annually in order to quantify shrinkage.

4. Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. • The cost of inventory includes purchase price, non-refundable taxes, shipping or transportation costs, and import duties. • Cost formulas are necessary because inventory purchase costs change (that is, different units of inventory will have different costs), and companies need to determine which unit costs will be allocated to cost of goods sold and which will be allocated to ending inventory. • There are three cost formulas: (1) specific identification, (2) weighted-average, and (3) first-in, first-out. • If a company’s goods are not interchangeable (in other words, the goods are unique and each item can be identified), then the specific identification cost formula must be used. If the goods are interchangeable, then the company can use either weightedaverage or first-in, first-out. • The same cost formula must be used for all inventories of a similar nature or use, but different cost formulas can be selected for inventories with a different nature or use. • Specific identification assigns the specific costs of each item to either cost of goods sold or ending inventory depending upon whether it has been sold or remains on hand. • Under the weighted-average cost formula, a weighted-average cost per unit is determined each time additional goods are purchased. This is used to assign costs when goods are sold or when the value of ending inventory is determined. • When the first-in, first-out formula is used, the costs of the first units purchased are assigned to the first units sold. Ending inventory is valued using the costs of the most recent purchases.

5. Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. • Inventory is carried on the statement of financial position at the lower of cost and net realizable value. Net realizable value is equal to the expected selling price less the estimated costs to make the sale. • This ensures that inventory is being carried at a value that reflects the economic benefits expected to flow from it. • When the carrying amount of inventory is reduced to net realizable value, it is referred to as an inventory writedown. • Inventory errors can result from errors during the inventory count, including items that should be excluded (i.e. goods on consignment if consignee or goods in transit if terms are FOB destination), excluding items that should have been included (i. e.

Inventory

•

consigned goods if consignor or goods in transit if terms are FOB shipping point), data entry errors (such as incorrect number of units or costs), or not accounting for required inventory writedowns. Inventory errors will offset over a two-year period.

6. Explain how a company’s gross margin is determined and why it is an important measure. • Gross margin is equal to sales revenue less cost of goods sold. It is often expressed as a percentage of sales revenue. • It represents the portion of sales revenue, after product costs, available to meet operating expenses and income taxes. • Gross margin is commonly used to assess a company’s performance in terms of its pricing strategies and controlling its product costs either period-to-period or relative to its competitors.

7. Describe management’s responsibility for internal control measures related to inventory. • The five key elements of internal control are applied to inventory. These are: 1. Physical controls—use of locks, inventory behind counters, use of electronic alarm tags. 2. Assignment of responsibility—specific employees are responsible for different types of inventory. 3. Separation of duties—ordering and receiving is done by different employees. 4. Independent verification—use of independent count teams or external auditors. 5. Documentation—use of purchase orders, receiving reports, and so on.

8. Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. • The inventory turnover ratio is determined by dividing cost of goods sold by average inventory. It is a measure of how fast inventory is sold or how long it is held before being sold. • The days to sell inventory ratio is calculated by dividing 365 days by the inventory turnover ratio. It measures the number of days, on average, that it took a company to sell through its inventory.

9. Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. • The allocation of COGAS to COGS and EI is the same under either the specific identification or first-in, first-out cost formulas regardless of which type of inventory system (periodic or perpetual) is used. • With periodic inventory systems, only one weighted-average cost per unit amount is calculated for the accounting period regardless of the number of purchases during the period.

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TRUE-FALSE STATEMENTS 1. Companies that make products are known as retailers. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Discuss the importance of inventory to a company’s overall success. CPA: Financial Reporting AACSB: Analytic

2. The Finished Goods account collects all the costs incurred as a product is being made. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

3. Raw materials are the components or ingredients required to make a product. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

4. Once the manufacturing process is complete, the product is transferred from the Work-inProcess account to Raw Materials account. Answer: False Bloomcode: Knowledge Difficulty: Easy

Inventory

Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

5. FOB means “For only Buyers”. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

6. FOB shipping means the seller owns the inventory until it reaches the buyers premise. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

7. Periodic inventory systems provide more relevant and timely information to managers for decision-making purposes than perpetual inventory systems do. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

8. Perpetual inventory systems are incapable of identifying inventory shrinkage. Answer: False

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

9. Perpetual inventory systems provide more timely information than periodic systems. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

10. COGS is equal to the inventory purchased for a given time period. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

11. The cost formula used by a firm to value inventory must match the physical flow of units through the firm. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

Inventory

12. Under the FIFO inventory formula, the cost of ending inventory and cost of goods sold will be the same under both the perpetual and periodic inventory systems. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

13. If prices were rising and a Canadian company wanted to report a smaller amount of profit for tax purposes, it should use the weighted-average cost formula. Answer: True Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

14. The lower of cost and net realizable value rule is usually applied to groups of similar items. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

15. Gross margin is the difference between sales revenue and costs of goods available for sale. Answer: False Bloomcode: Knowledge

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Difficulty: Easy Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. CPA: Financial Reporting AACSB: Analytic

16. The gross margin ratio is equal to gross margin divided by sales revenue. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. CPA: Financial Reporting AACSB: Analytic

17. Just-in-time inventory systems are designed to reduce the cost of inventory storage and increase the amount of cash on hand. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe management’s responsibility for internal control measures related to inventory. CPA: Financial Reporting AACSB: Analytic

18. The inventory turnover ratio is calculated as cost of goods sold divided by total inventory. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

19. One way to estimate the cost of goods sold is to multiply the sales revenue for the period by the inventory turnover ratio.

Inventory

Answer: False Bloomcode: Comprehension Difficulty: Hard Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

20. If a company’s inventory turnover ratio is 6.6, it takes 55 days on average for the company to sell its inventory. Answer: True Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

21. The cost-to-sales ratio is a method used to estimate inventory instead of performing a physical count. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

22. When calculating the weighted-average using the periodic system, a new weightedaverage cost per unit is calculated after every sale. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic

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inventory system. CPA: Financial Reporting AACSB: Analytic

23. The major difference between the periodic and perpetual inventory systems is that inventory must be physically counted in the periodic system to determine ending inventory. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. CPA: Financial Reporting AACSB: Analytic

Inventory

MULTIPLE CHOICE QUESTIONS 24. A major consideration for a company when selecting a supplier is a) supplier location. b) online presence. c) company profitability. d) inventory valuation. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Discuss the importance of inventory to a company’s overall success. CPA: Financial Reporting AACSB: Analytic

25. Customers become frustrated if a company does NOT have a product available when they order it. This is called a) a sell out. b) spoilage. c) obsolescence. d) a stockout. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Discuss the importance of inventory to a company’s overall success. CPA: Financial Reporting AACSB: Analytic

26. The longer the inventory remains unsold, the higher the risk of a) spoilage. b) damage. c) obsolescence. d) all of these are correct Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Discuss the importance of inventory to a company’s overall success. CPA: Financial Reporting

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AACSB: Analytic

27. Goods available for sale are found in a) work-in-process inventory. b) raw materials inventory. c) finished goods inventory. d) cost of goods sold. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

28. Wowsers Inc. purchases goods from a supplier FOB destination. This means that a) while the goods are in transit Wowsers owns the items. b) the supplier has paid for the shipping. c) Wowsers has paid for the shipping. d) Wowser’s should treat this as an operating expense. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

29. All of the following are manufacturing accounts EXCEPT for a) Cost of Goods Available for Sale. b) Raw Materials. c) Finished Goods. d) Work-in-Process. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Distinguish between the different inventory classifications and determine

Inventory

which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

30. Which of the following is the correct flow of costs in a manufacturing operation? a) Raw materials to finished goods to COGS b) Raw materials to COGS to finished goods to work-in-process c) Raw materials to work-in-process to finished goods to COGS d) Direct materials to work-in-process to finished goods to COGS Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

31. Which of the following is NOT an inventory account in a manufacturing company? a) Raw Material b) Work-in-Process c) Goods Available For Sale d) Finished Goods Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

32. In a manufacturing process, overhead costs are added to which inventory account? a) Raw Materials b) Finished Goods c) Work-in-Process d) Cost of Goods Sold Answer: c Bloomcode: Comprehension

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Difficulty: Medium Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

33. Which term describes a situation where the buyer is responsible for paying shipping and other costs incurred while goods are in transit from the seller’s premise to the buyer’s premises. a) FOB shipping point b) FOB destination c) FOB purchasing d) FOB receiving Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

34. The cost of goods available for sale includes a) just beginning inventory. b) beginning inventory less ending inventory. c) beginning inventory plus purchases less ending inventory. d) beginning inventory plus purchases. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

35. Physical inventory counts are a) only necessary for periodic systems. b) only necessary for perpetual systems. c) necessary for periodic and perpetual systems as part of internal control. d) not necessary at all if a company has an appropriate accounting system.

Inventory

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Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

36. When a perpetual inventory system is used, a) a physical inventory count must be taken to determine cost of goods sold. b) inventory shrinkage is difficult to determine. c) it eliminates the need for frequent inventory counts. d) the timeliness of data is sacrificed for lower costs of operation. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

37. When a periodic inventory system is used a) inventory shrinkage is impossible to calculate. b) timely data is of utmost importance. c) cost of goods sold is always known. d) every inventory transaction is reflected in the inventory account. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

38. Which of the following would most likely use a perpetual inventory system? a) hardware store b) shoe store

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

c) car dealership d) bookstore Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

39. Which of the following would most likely use a periodic inventory system? a) car dealership b) heavy metal distributor c) computer dealership d) local handcrafted furniture store Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

40. The following amounts are always known under which inventory costing system? Current inventory Cost of goods sold Inventory shrinkage a) Periodic Periodic Perpetual b) Perpetual Perpetual Periodic c) Perpetual Perpetual Perpetual d) Periodic Periodic Periodic Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

Inventory

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41. Which of the following is true under a periodic system? a) A COGS expense is recognized each time a sale is made. b) The inventory account is not updated with each purchase. c) Inventory shrinkage is easily identified. d) This system can be costly to implement. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

42. When a company is evaluating whether or not to use a perpetual vs. a periodic inventory system, which of the following statements is most accurate? a) A perpetual inventory system provides far superior information and should be used at any cost. b) A periodic system is inferior and should never be used if possible. c) The cost of the system used should be measured against the benefits provided. d) Both systems are equally good. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

43. A small local convenience store is opening in your neighbourhood. Inventory is limited, and keeping initial start-up costs low is a priority. What type of inventory system would you recommend? a) perpetual b) periodic c) specific identification d) Company is so small one is not needed. Answer: b Bloomcode: Comprehension Difficulty: Medium

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

44. Management may use the cost formula decision tree when determining which cost formula to use. If goods are not interchangeable, management’s options are a) weighted-average. b) FIFO. c) Just-in-time. d) specific identification. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

45. Which of the following should be included in the cost of inventory? a) the cost of keeping the inventory records b) depreciation on the inventory warehouse c) the salesperson’s commission d) shipping costs to purchase the inventory Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

46. Which of the following cost formulas would be most appropriate when the inventory units are unique or costly?

Inventory

a) FIFO b) specific identification c) just-in-time d) weighted-average Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

47. Which of the following would be most likely to use the specific identification method? a) shoe store b) car dealership c) grocery store d) bookstore Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

48. Which cost formula will produce the same results under both the periodic and perpetual inventory systems? a) FIFO b) weighted-average c) They both produce the same results. d) They both produce different results. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in,

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first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

49. Which of the following cost formulas would be most appropriate for costing an inventory of liquids stored in tanks? a) weighted-average b) FIFO c) periodic d) perpetual Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

50. An inventory of grocery items where the shelves are stocked from the back would be similar to which cost formula? a) FIFO b) specific identification c) weighted-average d) LIFO Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

51. Which of the following statements about the FIFO cost formula is correct? a) The same costs per unit are assigned to the ending inventory and the cost of goods sold. b) Companies prefer to use FIFO because it lowers their tax liability. c) In times of rising prices, FIFO will produce a higher net income than weighted-average. d) In times of rising prices, FIFO produces an inventory cost per unit that is lower than the cost

Inventory

per unit of cost of goods sold. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

52. Use of the FIFO cost formula means that a) the perpetual costing system is used. b) the ending inventory contains the oldest costs. c) the periodic costing system is used. d) the ending inventory contains the most recent costs. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

53. Which of the following statements about the weighted-average cost formula is true? a) If prices are rising, companies prefer it because it lowers their tax liability. b) It is the most popular method in Canada. c) In times of rising prices, weighted-average will produce a higher net income than FIFO. d) In times of rising prices, weighted-average produces an inventory cost per unit that is higher than the cost per unit of cost of goods sold. Answer: a Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

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54. K-tel Industries has the following activity with one of its inventory items during the current period: Units Unit Cost Beginning inventory 30 $8.00 Purchase December 5 80 10.50 Sale December 11 (40) Purchase December 17 60 12.00 Sale December 26 (70) Using a perpetual inventory system and the FIFO cost formula, the ending inventory was valued at a) $500. b) $625. c) $720. d) $825. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

55. K-tel Industries has the following activity with one of its inventory items during the current period: Units Unit Cost Beginning inventory 30 $8.00 Purchase December 5 80 10.50 Sale December 11 (40) Purchase December 17 60 12.00 Sale December 26 (70) Using a perpetual inventory system and the FIFO cost formula, the cost of goods sold was a) $975. b) $1,080. c) $1,175. d) $1,300. Answer: b

Inventory

Bloomcode: Application Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

56. K-tel Industries has the following activity with one of its inventory items during the current period: Units Unit Cost Beginning inventory 30 $8.00 Purchase December 5 80 10.50 Sale December 11 (40) Purchase December 17 60 12.00 Sale December 26 (70) Using a perpetual inventory system and the weighted-average cost formula, the cost of goods sold for the December 11 sale was closest to a) $540. b) $420. c) $393. d) $370. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

57. A company has the following inventory activity during April:

Beginning inventory Purchase: April 6 Sale: April 11 Purchase: April 17 Sales: April 24

Units 800 1,400 (1,500) 900 (900)

Unit Cost $10.00 11.00

Total Cost $ 8,000 15,400

10.50

9,450

If the company is using a perpetual system and the FIFO cost formula, what is the ending

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inventory closest to? a) $7,100 b) $7,350 c) $7,650 d) $7,920 Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

58. A company has the following inventory activity during April:

Beginning inventory Purchase: April 6 Sale: April 11 Purchase: April 17 Sales: April 24

Units 800 1,400 (1,500) 900 (900)

Unit Cost $10.00 11.00

Total Cost $ 8,000 15,400

10.50

9,450

If the company is using a perpetual system and the FIFO cost formula, what is the cost of goods sold closest to? a) $25,700 b) $25,500 c) $25,200 d) $25,930 Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

59. A company has the following inventory activity during April:

Inventory

Beginning inventory Purchase: April 6 Sale: April 11 Purchase: April 17 Sales: April 24

Units 800 1,400 (1,500) 900 (900)

Unit Cost $10.00 11.00

Total Cost $ 8,000 15,400

10.50

9,450

If the company is using a perpetual system and the weighted-average cost formula, what is the ending inventory closest to? a) $8,470 b) $7,777 c) $7,560 d) $7,391 Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

60. A company has the following inventory activity during April:

Beginning inventory Purchase: April 6 Sale: April 11 Purchase: April 17 Sales: April 24

Units 800 1,400 (1,500) 900 (900)

Unit Cost $10.00 11.00

Total Cost $ 8,000 15,400

10.50

9,450

If the company is using a perpetual system and the weighted-average cost formula, what is the cost of goods sold closest to? a) $24,380 b) $24,840 c) $25,459 d) $25,631 Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods

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sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

61. Net realizable value is also known as the a) replacement cost. b) wholesale price. c) estimated selling price. d) liquidated price. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

62. Which of the following statements best describes net realizable value when applying the lower of cost and net realizable value rule? a) Net realizable value is the selling price less the costs necessary to sell the item. b) Net realizable value is the selling price plus the costs necessary to sell the item. c) Net realizable value is the selling price plus the normal profit margin. d) Net realizable value is the selling price less the normal profit margin. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

63. In order to ensure that the inventory values presented on the statement of financial position at year end reflect the true economic benefits of the inventory, the company may need to a) have an inventory fire sale. b) use a perpetual inventory system. c) use a JIT system. d) prepare an inventory writedown.

Inventory

Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

64. Yodle Company failed to include a number of inventory items in the inventory count at the end of the last period. Assuming no other inventory errors, the effect on the current period is a) an overstatement of gross profit. b) an understatement of COGS. c) an overstatement of ending inventory. d) an understatement of net income. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

65. Hanuv Corporation counts its ending inventory incorrectly in year 1, assuming no other inventory errors in future period, a) the impact of the error affects the inventory account only. b) the error affects profitability, net income and retained earnings for year 1 only. c) the error extends into future years indefinitely. d) the error will self-correct by the end of year 2. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

66. Ruppert Co. prepares its estimate of the lower of cost and net realizable value of its

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inventory. Inventory item 101 cost $45, and its current replacement cost is $50. The item is currently selling in the market for $55, and selling costs are estimated to be $6. Ruppert expects to earn a profit of $4 on the sale of this item. In its year-end financial statements, Ruppert Co. should value this item at a) $50. b) $45. c) $49. d) $55. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

67. When using the lower of cost and market rule in Canada, the market value is most commonly a) net present value. b) selling price less profit margin. c) replacement cost. d) net realizable value. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

68. The inventory writedown that results from the application of the lower of cost and net realizable value rule is often hidden in the a) selling expense. b) inventory account. c) cost of goods sold. d) loss due to market decline of inventory. Answer: c Bloomcode: Comprehension

Inventory

Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

69. The inventory writedown incurred from applying the lower of cost and net realizable value rule to inventory is a) not reflected on the Statement of Financial Position. b) an adjustment to cost of goods sold. c) not reflected on the Statement of Income. d) not considered a permanent loss. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

70. JibJab Supplies Inc. values its inventory at the lower of cost and net realizable value. The following data was provided for the company’s current year inventory, which consisted of two items:

Original cost Selling price Estimated selling costs Replacement cost Normal profit margin

Item # 2530 $12,000 15,000 5,000 13,000 1,500

Item # 2533 $15,000 26,000 10,000 15,000 1,000

The appropriate carrying value for the entire inventory when applying the lower of cost and net realizable value rule using net realizable value on an item-by-item basis would be a) $15,000. b) $12,500. c) $27,000. d) $28,000. Answer: a Bloomcode: Application Difficulty: Hard

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Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

71. JibJab Supplies Inc. values its inventory at the lower of cost and net realizable value. The following data was provided for the company’s current year inventory, which consisted of two items:

Original cost Selling price Estimated selling costs Replacement cost Normal profit margin

Item # 2530 $12,000 15,000 5,000 13,000 1,500

Item # 2533 $15,000 26,000 10,000 15,000 1,000

The appropriate carrying value for the entire inventory when applying the lower of cost and net realizable value rule using net realizable value to the inventory as a whole would be a) $15,000. b) $12,500. c) $27,000. d) $28,000. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

72. When applying the lower of cost and net realizable value, the following is true: a) the inventory account remains at its original value. b) a contra account to inventory is used. c) COGS rises when ending inventory is reduced to net realizable value. d) lower of cost and net realizable value can only be applied to individual items. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors.

Inventory

CPA: Financial Reporting AACSB: Analytic

73. A company had the following inventory activity during November:

Beginning inventory Purchase: November 3 Sale: November 5 Purchase: November 15 Sale: November 28

Units 100 900 (900) 1,000 (900)

Unit Cost $20.00 $21.00

Total Cost $ 2,000 18,900

Unit Price

$30.00 $21.00

21,000 $30.00

If the company uses a perpetual system and the FIFO cost formula, what is the gross margin on the November 5 sale? a) $6,100 b) $8,100 c) $8,200 d) $8,550 Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. CPA: Financial Reporting AACSB: Analytic

74. A company had the following inventory activity during November:

Beginning inventory Purchase: November 3 Sale: November 5 Purchase: November 15 Sale: November 28

Units 100 900 (900) 1,000 (900)

Unit Cost $20.00 $21.00

Total Cost $ 2,000 18,900

Unit Price

$30.00 $21.00

21,000 $30.00

If the company uses a perpetual system and the weighted-average cost formula, what is the gross margin on the November 5 sale? a) $6,100 b) $8,100 c) $8,190 d) $8,550

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Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. CPA: Financial Reporting AACSB: Analytic

75. A company had the following inventory activity during November:

Beginning inventory Purchase: November 3 Sale: November 5 Purchase: November 15 Sale: November 28

Units 100 900 (900) 1,000 (900)

Unit Cost $20.00 $21.00

Total Cost $ 2,000 18,900

Unit Price

$30.00 $21.00

21,000 $30.00

If the company uses a perpetual system and the FIFO cost formula, what is the gross margin for the month? a) $12,100 b) $16,200 c) $16,300 d) $17.100 Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. CPA: Financial Reporting AACSB: Analytic

76. Umbrella Co.’s gross profit margin increased from 41.5% in year 1 to 44.3% in year 2. Possible reasons may include: a) increased shipping costs. b) use of early payment discounts for merchandise purchases. c) cost of obsolete product passed on to the customer. d) reduced selling prices. Answer: b Bloomcode: Analysis

Inventory

Difficulty: Medium Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. CPA: Financial Reporting AACSB: Analytic

77. One strategy managers use to reduce the holding costs of inventory is a) separation of duties. b) regular inventory counts. c) electronic tags. d) JIT delivery. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe management’s responsibility for internal control measures related to inventory. CPA: Financial Reporting AACSB: Analytic

78. Effective inventory management would have one person place the order for new inventory, a second person check it against the purchase order when it arrives, and a third person record the receipt of inventory in the accounting records. The purpose of this system is a) to reduce spoilage. b) to reduce storage costs. c)to guard against stockouts. d) to guard against internal theft and collusion. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe management’s responsibility for internal control measures related to inventory. CPA: Financial Reporting AACSB: Analytic

79. Carolina Company has a normal markup of 40%. Its cost-to-sales ratio is a) 71.4%. b) 67.5%. c) 60%. d) Cannot be calculated.

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Answer: a Bloomcode: Application Difficulty: Hard Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

80. Ghimmy Industries had beginning inventory of $10,000 and purchased $75,000 of merchandise during the current period. The company sales are$90,000 for the period and has traditionally had a cost-to-sales ratio of 75%. Using the gross margin estimation method, the company estimates its ending inventory to be a) $67,500. b) $65,000. c) $17,500. d) $22,500. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

81. Foamy Suds Ltd. had a fire at its warehouse and was trying to determine the cost of the inventory lost. The year-to-date sales are $525,000, opening inventory is $125,000, purchases to date are $318,000, and the cost-to-sales ratio is normally 60%. Inventory not damaged in the fire was valued at $18,000. What is the cost of the inventory damaged in the fire? a) $110,000 b) $124,000 c) $160,000 d) $74,000 Answer: a Bloomcode: Application Difficulty: Hard Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting

Inventory

AACSB: Analytic

82. Saladi Company has the following information for the current period: Beginning inventory - $106,000 Purchases -$1,126,500 Ending Inventory - $116,000 Accounts Payable - $49,605 Sales - $2,147,250. What is the inventory turnover? a) 9.625 b) 10.06 c) 10.15 d) 10.53 Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

83. Very high inventory turnovers a) are always the goal of management. b) may create stockouts. c) are a measurement of profitability. d) are unaffected by inventory writedowns. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

84. Inventory turnover and days to sell inventory a) are different names for the same metric. b) are inversely related. c) are interpreted to be as the higher the better.

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d) are rarely used by management. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

85. The gross margin estimation method estimates the cost of goods sold by a) multiplying the sales revenue by cost-to-sales ratio. b) multiplying the cost of goods available by the gross margin percentage. c) multiplying the costs to sales ratio by purchases. d) multiplying the sales revenue by the inventory turnover ratio. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

86. A company has the following inventory activity during June:

Beginning inventory Purchases: June 5 June 13 Sales: June 8 June 24

Units 450

Unit Cost $9.50

Total Cost $ 4,275

1,500 900

10.00 10.25

15,000 9,225

1,100 600

If the company is using a FIFO cost formula and a periodic system, what is the cost of goods sold? a) $17,225 b) $17,000 c) $16,775 d) $16,500

Inventory

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. CPA: Financial Reporting AACSB: Analytic

87. A company has the following inventory activity during June:

Beginning inventory Purchases: June 5 June 13 Sales: June 8 June 24

Units 450

Unit Cost $9.50

Total Cost $ 4,275

1,500 900

10.00 10.25

15,000 9,225

1,100 600

If the company is using a FIFO cost formula and a periodic system, what is the ending inventory? a) $11,275 b) $11,500 c) $11,725 d) $12,000 Answer: c Bloomcode: Application Difficulty: Easy Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. CPA: Financial Reporting AACSB: Analytic

88. A company has the following inventory activity during June:

Beginning inventory Purchases: June 5

Units 450

Unit Cost $9.50

Total Cost $ 4,275

1,500

10.00

15,000

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June 13

900

June 8 June 24

1,100 600

10.25

9,225

Sales:

If the company is using a weighted-average cost formula and a periodic system, what is the cost of goods sold closest to? a) $17,085 b) $17,000 c) $16,915 d) $16,575 Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. CPA: Financial Reporting AACSB: Analytic

89. A company has the following inventory activity during June:

Beginning inventory Purchases: June 5 June 13 Sales: June 8 June 24

Units 450

Unit Cost $9.50

Total Cost $ 4,275

1,500 900

10.00 10.25

15,000 9,225

1,100 600

If the company is using a weighted-average cost formula and a periodic system, what is the ending inventory closest to? a) $11,925 b) $11,415 c) $11,500 d) $11,585 Answer: c Bloomcode: Application Difficulty: Easy Learning Objective: Calculate the cost of goods sold and ending inventory under the specific

Inventory

identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. CPA: Financial Reporting AACSB: Analytic

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EXERCISES 90. Gemini Ltd. has just completed a physical inventory count at year end, July 31, 2024. Only the items on the shelves, in storage, and in the receiving area were counted. The inventory amounted to $77,000. Gemini uses a perpetual inventory system. During the year-end audit, the independent CPA discovered the following additional information: 1. There were goods in transit on July 31, 2024, from a supplier with terms FOB destination, costing $8,500. These items were excluded from the physical inventory count. 2. On July 27, 2024, a regular customer purchased goods for cash amounting to $1,000 and left them for pickup on August 4, 2024. Gemini paid $1,200 for the goods and included them in the physical inventory count. 3. Gemini Ltd., on the date of the inventory count, received notice from a supplier that goods ordered earlier at a cost of $10,000, were shipped on July 28, 2024; the terms were FOB shipping point. The goods had not yet been received. These items were excluded from the physical inventory. 4. On July 31, 2024, there were goods in transit to customers, with terms FOB shipping point, amounting to $800 (expected delivery on August 8, 2024). The items were excluded from the physical inventory count. 5. On July 31, 2024, Gemini shipped $2,500 worth of goods to a customer, FOB destination. This shipment arrived on August 5, 2024. These items were not included in the physical inventory count. 6. Gemini, as the consignee, had goods on consignment that cost $5,000. These items were included in the physical inventory count. Instructions Analyze the above information and calculate a corrected amount for the ending inventory. Explain the rationale for your treatment of each item. Solution (20 min.) Start with

$77,000

Item 1.

—

(Since the goods were shipped FOB destination, the title will pass to Gemini upon arrival. Correctly excluded.)

Item 2.

– 1,200

(Goods should be excluded. The customer owns them.)

Item 3.

+ 10,000

(Goods belong to Gemini. Title passed when supplier shipped the goods.)

Item 4.

—

(Since the goods were shipped FOB shipping point, Gemini no longer has title to these goods. Correctly excluded.)

Item 5.

+ 2,500

(Goods were shipped FOB destination. Gemini retains title

Inventory

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until the customer receives them.) Item 6.

Corrected inventory

– 5,000

(These goods are owned by the consignor, not the consignee, and should not be included in Gemini's inventory.)

$83,300

Bloomcode: Analysis Difficulty: Medium Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

91. Villany Company. uses a perpetual inventory system and had the following activity for a single inventory item: Units Unit Cost Total Cost July 1, inventory 140 $2.50 $350 Purchases: July 5 200 3.50 700 July 10 140 4.50 630 July 15 160 5.50 880 Sales: July 11 250 July 19 150 Instructions Using the perpetual system, determine the ending inventory and cost of goods sold under: a) FIFO b) Weighted-average (round unit cost to nearest cent) Show your work. Solution (10 min.) a) FIFO: July 11 sale

= (140 × $2.50 + 110 × $3.50) = 350 + 385 = $735 July 19 sale = (90 × $3.50 + 60 × $4.50) = (315 + 270) = $585 Total cost of sales = $735 + $585 = $1,320

Ending inventory

= 160 × $5.50 + 80 × $4.50 = $1,240

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or $2,560 – $1,320 = $1,240 b) Weighted-average: July 11 sale average cost Cost of sale July 15 sale average cost Cost of sale = 150 × $4.32 Total cost of goods sold Ending Inventory:

= (140 × $2.50 + 200 × $3.50 + 140 × $4.50) ÷ 480 = $3.50 per unit = 250 × $3.50 = $875 = (230 × $3.50 + 160 × $5.50) ÷ 390 = $4.32 per unit = $648 = $875 + $648 = $1,523 = 240 × $4.32 = $1,037 or $2,560 – $1,523 = $1,037

Bloomcode: Application Difficulty: Medium Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

92. Omer Anchors Inc. uses a perpetual inventory system and had the following activity for a single inventory item: Units Unit Cost Total Cost March 1, inventory 500 $2.50 $1,250 Purchases: March 5 250 3.50 875 March 10 175 4.50 787.50 March 15 100 5.50 550 Sales: March 11 550 March 19 375 Instructions Using the perpetual system, determine the ending inventory and cost of goods sold under: a) FIFO b) Weighted-average (round unit cost to nearest cent) Solution (10 min.) a) FIFO: March 11 sale March 19 sale

= (500 × $2.50 + 50 × $3.50) = $1,425 = (200 × $3.50 + 175 × $4.50) = $1,487.50

Inventory

Total cost of sales

= 2,912.50

Ending inventory: 100 × $5.50 or $3,462.5 – 2,912.50 b) Weighted-average: March 11 sale average cost Cost of sale March 19 sale average cost

= $550 = $550

= (500 × $2.50 + 250 × $3.50 + 175 × $4.50) / 925 = $3.15 per unit = 550 × $3.15 = $1,732.50

Cost of sale = 375 × $3.64 Total cost of goods sold

= (375 × $3.15 + 100 × $5.50) / 475 = $3.64 per unit = $1,366 = $1,732.50 + $1,366 = $3,098.50

Ending Inventory: 100 × $3.64

= $364

93. The following information is available for Acme Inc.: Sales ............................................................................................. Purchases ..................................................................................... Operating expenses ..................................................................... Interest expense .......................................................................... Income tax expense ..................................................................... Inventory, August 1, 2024 ............................................................ Inventory, July 31, 2025 ...............................................................

$575,000 467,000 82,000 20,000 25,000 40,000 65,000

Instructions Use the above information to calculate the cost of goods available for sale and cost of goods sold for Acme Inc. for the year ended July 31, 2025. Solution (5 min.) Beginning Inventory .................................................................... + purchases .................................................................................. = Cost of Goods Available for Sale ............................................... – Ending Inventory .......................................................................

$ 40,000 467,000 507,000 (65,000)

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COGS ............................................................................................

$442,000

Bloomcode: Application Difficulty: Easy Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

94. Benji Electric Ltd. distributes electronic components and has just completed its first year of operation. Management is looking forward to finding out what the profit for the year was because they get paid a bonus based on net income. The accountant has provided the company with the following information concerning its inventory for the year: Sales: 8,000 units Total revenue: ..................... $172,000 Purchases: 10,000 units Total cost: ............................ $190,000 Ending inventory under weighted- average: ...................... $ 36,667 Ending inventory under FIFO: ...................................... $ 36,000 Due to over-supply in the industry at year end, the price for the product has fallen to $20 and the company estimates that the costs to ship and sell the product are $2.50 per unit. Instructions a) Calculate the gross margin if Benji decides to use the weighted-average cost formula. b) Calculate the gross margin if Benji decides to use the FIFO cost formula. c) Based on your answers to a) and b) which cost formula would management prefer? Why? d) Have prices for the inventory been rising or falling during the year? e) What is the net realizable value of the inventory? f) What value should Benji report on its financial statements for cost of goods sold and ending inventory? Support your answer. Solution (25 min.) Cost of goods sold = Purchases – ending inventory (there is no opening inventory in the first year of operation) a)

Sales ..................................................................................... Cost of goods sold (190,000 – 36,667) ................................. Gross margin ........................................................................

$172,000 153,333 $ 18,667

Sales ..................................................................................... Cost of goods sold (190,000 – 36,000) ................................. Gross margin ........................................................................

$172,000 154,000 $ 18,000

Management would prefer weighted-average in order to maximize the net income and

Inventory

hence their bonuses. d)

Prices have been falling. If prices were rising the ending inventory for FIFO would be the larger than for weighted-average and the gross margin would be smaller for weightedaverage.

Net realizable value = $20.00 – $2.50 = $17.50

Average unit cost; weighted-average ending inventory: $36,667 / 2,000 = $18.33 Average unit cost; FIFO ending inventory: $36,000 / 2,000 = $18.00 Since the NRV is lower than the average costs for either FIFO or weighted-average the ending inventory should be valued at NRV: $17.50 x 2,000 = $35,000 Costs of goods sold would be: purchases – ending inventory: $190,000 – $35,000 = $155,000.

Note: it does not matter which cost formula is selected. Some students may use the cost of goods sold they calculated in part (a) or (b) and then add the loss on the decline in value of inventory to that. Cost of goods sold (weighted-average)............................... $153,333 Loss on inventory 2,000 x (18.33 – 17.50) ............................ 1,660 Total cost of goods sold: ...................................................... $154,993 (the $7 difference is due to rounding) Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. CPA: Financial Reporting AACSB: Analytic

95. Naismith Co. uses a perpetual inventory system and has provided you with the following information on the company’s inventory valuation:

Product A-Type Anchors B-Type Anchors

Cost per Unit $4.50 $7.00

Number of Units 2,220 1,105

Total Net Realizable Value $18,500 $4,000

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Instructions Provide the journal entry to record the inventory writedown (if any) for Naismith Co.? Solution (10 min.)

Product A-Type Anchors B-Type Anchors Totals

Cost per Unit

Number of Units

(A) Total Cost

Total Net Realizable Value

(B) LCNRV

$4.50

2,220

$9,990

$18,500

$9,990

$7.00

1,105

$7,735 $17,725

$4,000

$4,000 $13,990

Journal entry: Dr. Cost of goods sold Cr. Inventory

(A-B) Writedown Required

$3,735

3,735 3,735

Bloomcode: Application Difficulty: Medium CPA: Financial Reporting AACSB: Analytic Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of the valuation errors.

96. For each of the independent events listed below, analyze the impact on the indicated items at the end of the current calendar year by placing the appropriate code under the correct heading. Code: O = item is overstated U = item is understated NA = item is not affected Items Shareholders’ Cost of Events Assets Equity Goods Sold Profit 1.

The ending inventory in the previous period was overstated.

During the current period, items were counted twice as part of the physical year-end count

Inventory

of goods on hand. 3.

Goods in transit purchased in December of the current year and shipped FOB shipping point were not included in the count of goods on hand on December 31.

4. Goods in transit sold in December of the current year and shipped FOB destination were not included in the count of goods on hand on December 31. 5.

The internal auditors discovered that the ending inventory in the previous period was understated $15,000 and that the ending inventory in the current period was overstated $25,000.

Solution (20 min.) Items Shareholders’ Cost of Equity Goods Sold NA O

Events 1.

Assets NA

Profit U

Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

97. SleepTown Ltd. uses the gross margin method to calculate the cost of its ending inventory.

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In the current year, the company had beginning inventory of $475,000, purchases of $3,750,000 and sales of $5,250,000. The company has traditionally marked up its inventory 45%. Instructions Calculate SleepTown Ltd.’s ending inventory. Solution (5 min.) Cost-to-sales ratio for 45% markup is 69%, i.e., an item that costs $60 will sell for $87 (60 ÷ 87 = 69%) Sales × cost-to-sales ratio = cost of goods sold $5,250,000 × 69% = $3,622,500 Ending inventory = = =

Beginning inventory + Purchases – Cost of Goods Sold $475,000 + $3,750,000 – $3,622,500 $602,500

Bloomcode: Analysis Difficulty: Hard Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

98. The following information is available from recent financial statements of Laurel Incorporated and Hardy Enterprises: (Amounts in millions) Laurel Hardy Ending inventory ........................................................ $ 7,500 $ 5,210 Beginning inventory................................................... 8,100 6,059 Cost of goods sold ...................................................... 23,760 33,616 Sales ........................................................................... 30,251 39,950 Instructions a) Calculate the inventory turnover and days in inventory for both companies. b) What conclusions concerning the management of inventory can be drawn from these data? Solution (20 min.) a) Inventory turnover

Laurel $23,760 (7,500 + $8,100) ÷ 2

Hardy $33,616 ($5,210 + $6,059) ÷ 2

Inventory

$23,760 / $7,800 = 3.0 times Days in inventory

365 ÷ 3.0 = 122 days

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$33,616 / $5,634.50 = 6.0 times 365 ÷ 6.0 = 61 days

(b) Hardy’s inventory turnover is approximately 100% [(6.0 – 3.0) ÷ 3.0)] higher than Laurel’s. In addition, Hardy’s days in inventory is 50% [(122– 61) ÷ 122] lower than Laurel’s. Generally, a company prefers to maintain as high an inventory turnover as possible. We can conclude that Hardy manages inventory more effectively than Laurel. Bloomcode: Analysis Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

99. Solve for the missing amounts: Sales ......................................................... Cost of goods sold ................................... Inventory, beginning of year ................... Inventory, end of year.............................. Average inventory .................................... Gross profit............................................... Inventory turnover................................... Days in inventory .....................................

Huey $100,000 (a) 23,000 17,000 (b) 46% (c) (d)

Dewy Louey $239,000 122,000 45,000 39,000 (e) (f) (g) 126

$438,000 345,000 (h) 105,000 101,500 (i) (j) (k)

Huey $100,000 54,000 23,000 17,000 20,000 46% 2.7 135

Dewy Louey $239,000 122,000 45,000 39,000 42,000 49% 2.9 126

$438,000 345,000 98,000 105,000 101,500 21% 3.4 107

Solution (20 min.) Sales ......................................................... Cost of goods sold ................................... Inventory, beginning of year ................... Inventory, end of year.............................. Average inventory .................................... Gross profit .............................................. Inventory turnover................................... Days in inventory .....................................

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AACSB: Analytic

100. Aladina Co. uses a periodic inventory system and had the following activity for a single inventory item: Units Unit Cost Total Cost September 1, inventory 140 $2.50 $ 350 Purchases: Sept 5 200 3.50 700 Sept 10 140 4.50 630 Sept 15 160 5.50 880 Sales: Sept 11 250 Sept 19 150 Instructions Determine the ending inventory and cost of goods sold using: a) FIFO b) Weighted-average (round unit cost to nearest cent) Solution (8 min.) a) Units in ending inventory

= Goods available – sales = 640 – 400 = 240 units

Ending inventory

= (160 × $5.50) + (80 × $4.50) = $1,240

COGS

= Cost of goods available – ending inventory = $2,560 – $1,240 = $1,320

b) Beginning inventory Purchases: Sept 5 Sept 10 Sept 15 Total Cost per unit Ending inventory COGS

Units 140

Unit Cost $2.50

Total Cost $ 350

200 140 160 640

3.50 4.50 5.50

700 630 880 $2,560

= $2,560 ÷ 640 units = $4.00 = 240 units × $4.00 = $960 = $2,560 – $960 = $1,600

Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic

Inventory

inventory system. CPA: Financial Reporting AACSB: Analytic

101. Jolly Gyms Inc. uses a periodic inventory system and had the following activity for a single inventory item: Units Unit Cost Total Cost April 1, inventory 500 $2.50 $1,250 Purchases: April 5 250 3.50 875 April 10 175 4.50 787.50 April 15 100 5.50 550 Sales: April 11 550 April 19 375 Instructions Determine the ending inventory and cost of goods sold using: a) FIFO b) Weighted-average (round unit cost to nearest cent) Solution (8 min.) a) Units in ending inventory

Ending inventory

= Goods available – sales = 1,025 – 925 = 100 units = (100 × $5.50) = $550

C.G.S. = Cost of goods available – ending inventory = $3,462.5 – $550 = $2,912.50 b)

Cost per unit = $3,462.50 / 1025 units Ending inventory = 100 units × $3.38

= $3.38 = $338

C.G.S. = $3,462.5 – $338

= $3,124.50

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102. Wabatech Ltd. uses the periodic inventory system, and has the following information about purchases and sales during the year: April 1, 2024 Beginning inventory 150 items @ $3 = $ 450 Purchases 450 items @ $5 = 2,250 Total 600 items $2,700 Total sales 300 items March 31, 2025Ending inventory 300 Instructions Calculate the cost to be assigned to ending inventory for each of the cost methods below: (a) Average $____________ (b) FIFO $____________ Solution (10 min.) (a) $1,350 ($2,700  600 = $4.50  300) (b) $1,500

(300  $5)

Bloomcode: Application Difficulty: Easy Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. CPA: Financial Reporting AACSB: Analytic

Inventory

MATCHING 103. Listed below are characteristics relating to inventory costing systems. Place a check mark under the appropriate column that matches the characteristic to the inventory system. Periodic Perpetual Systems Systems a) Cost of goods sold is calculated at the end of each accounting period. ______ ______ b)

Inventory shrinkage can be determined.

______

A physical inventory count must be taken to determine ending inventory.

______

Provides more timely data.

______

Involves a more costly bookkeeping system.

______

The merchandise inventory account only reflects the beginning inventory balance during the accounting period.

______

The cost of an item sold may not be known at the time of sale.

______

Uses the physical inventory count at year end to verify the balance of the inventory account.

______

Every transaction involving inventory results in an entry to the inventory account.

______

Does not record a reduction in inventory every time a sale is made

______

Can be very expensive to maintain.

______

Continuously updated inventory units.

______

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Solution (5 min.) Periodic Perpetual Systems Systems a) X b) c)

X X

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

104. Listed below are the various inventory cost formulas, followed by a series of descriptive statements. Match the inventory cost formulas to the descriptive statements by placing the appropriate letter in the space provided. INVENTORY COST FORMULAS A. Specific identification B. Weighted-average C. FIFO D. None of these STATEMENTS

Inventory

___

Includes the oldest costs in cost of goods sold.

___

Cost of goods sold and ending inventory are based on the same unit cost.

___

Cost of goods sold and ending inventory are based on the most recent costs.

___

Physical units are unique and the accounting records identify each unit and its cost.

___

Results in the highest net income in a period of rising costs.

___

Unit cost is recalculated after each purchase.

___

Ending inventory consists of the most recent costs.

___

Calculates a new unit cost after each sale.

___

Can be used to manipulate income by the choice of units sold.

Solution (5 min.) 1. C 2.

Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. CPA: Financial Reporting AACSB: Analytic

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SHORT-ANSWER ESSAY QUESTIONS 105. Explain why inventory is important for retailers and manufacturers? What is management’s objective in managing inventory? Explain how this objective is achieved. Solution (10 min) Inventory is often the most significant current asset and an asset that requires conversion into cash over the next year. Management’s objective for inventory is to sell it to customers at a higher price than is was purchased for. In order to achieve this objective a company must consider where the inventory will be sourced, the mix and quantity of inventory to be ordered, pricing strategies and how to safeguard inventory. More specifically: 1. A company needs to select suppliers – considerations include location, ability to deliver goods in a timely fashion and shipping costs. 2. Management needs to determine the amount of goods it should purchase – considerations include estimates of what the company can sell and at what price, and cost of purchasing the inventory. 3. Goods need to be protected from theft – considerations include keeping goods under lock and key, determining the process for how goods can be removed from inventory and how this will be tracked Bloomcode: Comprehension Difficulty: Hard Learning Objective: Discuss the importance of inventory to a company’s overall success. CPA: Financial Reporting AACSB: Analytic

106. A friend of your works for a local electric products distributor and has been put in charge of the inventory count at year end. He has been told that he needs to make sure that he includes all the inventory the company owns in his count, even those items that are not physically on the premises. He is confused by this. He knows that you are studying accounting and business and asks for your help. What explanation do you provide? Solution (8 min) There are items that must be included in the inventory count even though these items may not physically be on the premises. These items include: • Items that have been purchased and shipped FOB shipping point. The company has paid for the shipping; therefore the company owns these goods while in transit. •

Items that have been sold and shipped FOB destination. The company has paid for the shipping; therefore, the company owns these goods while in transit.

•

Consignment items. If the company (consignor) has asked another company (consignee)

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to sell its goods on its behalf, those goods are part of the inventory count of the consignor even if physically housed with the consignee. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. CPA: Financial Reporting AACSB: Analytic

107. Compare and contrast a perpetual and a periodic inventory system. What factors should a company take into consideration when deciding which system to use? Solution (10 min.) Perpetual Systems: • can be either a physical or cost inventory system • inventory units and costs are updated on a continuous basis • information is up to date, timely and can provide a trigger for ordering • helps to identify inventory shrinkage • helps managers make better decisions Periodic Systems: • no adjustments are made to inventory when a sale is recorded, COGS are calculated at the end of the period when inventory is counted • it is impossible to identify shrinkage or theft – the COGS calculation assumes that all items have been sold • inventory counts can be very expensive, particularly when inventory levels are very high When choosing an inventory system, a company should take into account the cost of maintaining a system versus the benefits received from it. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

108. Explain how the periodic inventory system differs from a perpetual system. Use the cost of goods sold model or calculation in your explanation. Solution (10 min.) Unlike the perpetual inventory system, where the inventory ledger is continuously updated for

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inventory purchases and sales, the periodic system does not track the inventory ledger. The inventory balance is determined on a periodic basis (once in a while) by performing a physical inventory count and computing cost of goods sold using the following calculation: Opening Inventory

⟶ (Last period’s ending inventory)

+ Purchases

⟶ (Based on invoices during the period)

Cost of Goods Available for Sale − Ending Inventory (EI) Cost of Goods Sold (COGS)

⟶ (Based on a physical inventory count) (Whatever goods are not on hand are assumed to have been sold)

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems.

109. Explain how the choice of inventory cost formula, FIFO or weighted-average, would affect the analysis of a company’s financial statements by a potential user. Identify what ratios are affected and how they are affected. Solution (12 min.) The choice of cost formula affects both the Statement of Financial Position and the Statement of Income. The effect depends on if prices are rising or falling. In periods of rising prices, weighted-average will have a lower net income and a lower ending inventory figure then FIFO. • Current ratio would be lower; company appears less liquid. • Gross margin and profit margin are lower; company appears less profitable. • Inventory turnover would be higher (COGS higher, inventory lower). In periods of falling prices, the opposite is true.

Inventory

Note: Depending on the coverage by the instructor, other ratios, such as ROA may be discussed and the fact that there is no effect on cash flow. Bloomcode: Analysis Difficulty: Hard Learning Objective: Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. Learning Objective: Explain how a company’s gross margin is determined and why it is an important measure. Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

110. Explain what happens if management realizes the economic benefit of the inventory on hand is less than its original cost? What must management do? Solution: (5 min) Companies are required to carry inventory at the lower of cost or net realizable value. Net realizable value is equal to the expected selling price of the goods less the estimated costs to make the sale. This requires management to estimate the expected selling price of the inventory item and the costs associated with selling the product. If the amount management estimates is lower than the inventory’s cost, the inventory must be reduced. This is known as an inventory write down, which is treated as an expense (COGS) for the period. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. CPA: Financial Reporting AACSB: Analytic

111. Inventory is a major asset for retailers. Identify and explain what types of internal control procedures can be used to effectively manage inventory? Solution: (5 min.) Some common control procedures for managing inventory include: • The use of electronic tags on items that sound alarms when the item leaves the premises without being purchased •

Having different employees responsible for ordering the inventory, checking the inventory when it is received, and entering inventory info into the accounting system

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•

Storing goods in locked storage units

•

Regular inventory counts

•

JIT purchasing

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe management’s responsibility for internal control measures related to inventory. CPA: Financial Reporting AACSB: Analytic

112. Prairie Fruit is a fruit distributor located in Sudbury, Ontario. The company has been losing significant business over the past year, and the manager has asked you to use the following information to calculate the company’s inventory ratios to help identify any areas of concern: Year Cost of goods sold Average inventory Year 1 $6,200,000 $875,000 Year 2 $5,750,000 $520,000 Solution (5 min.) The company’s inventory turnover has been falling: Year 2: $6,200,000 ÷ $875,000 = 7.1 times or 51 days (365 days ÷ 7.1). Year 1: $5,750,000 ÷ $520,000 = 11.1 times or 33 days (365 days ÷ 11.1) Since Prairie Fruit is a fruit distributor, it would seem that the company is selling its inventory much too slowly, and it may be selling spoiled fruit to its customers (51 days is a long time to stock fresh fruit). This may explain why the company is losing customers. One suggestion is that the company should decrease the amount of inventory it is carrying, thereby speeding up its turnover and ensuring a fresher product for its customers. Bloomcode: Analysis Difficulty: Medium Learning Objective: Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. CPA: Financial Reporting AACSB: Analytic

113. Drewlyn Dawg Inc. began business in the current month. The bookkeeper received a report from an outside firm specializing in physical inventory counts that the ending inventory was $1,426.60. However, according to the bookkeeper's records, the inventory at month end was $1,517.50. The bookkeeper has rechecked his records several times and still comes up

Inventory

with the same amount. He believes that the difference between the two amounts must be due to inventory shrinkage. The company had no inventory at the beginning of the month and 70 units on hand per a physical inventory count at the end of the month. The company uses the periodic method. Listed below are the company's purchases for the month: Purchase Units Unit Cost 1 40 $20.00 2 50 21.00 3 60 20.50 4 75 20.00 5 90 19.00 6 50 22.00 7 45 21.50 Instructions Write an explanation for the bookkeeper on how the difference in amounts could occur. (Hint: use different cost formulas to calculate the ending inventory). Provide numerical support. Solution (10 min.) The difference is due to applying different inventory cost formulas to the 70 units in ending inventory. The outside company used the weighted-average method, and the bookkeeper used the FIFO method. Numerical support: Weighted-average: Cost per unit Ending inventory FIFO: Ending inventory

= $8,357.50 ÷ 410 units = $20.38/unit = 70 units × $20.38 = $1,426.60

= (45 × $21.50) + (25 × $22.00) = $967.50 + $550.00 = $1,517.50

Bloomcode: Analysis Difficulty: Medium Learning Objective: Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system. CPA: Financial Reporting AACSB: Analytic

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ESSAY QUESTIONS 114. A car dealership specializing in luxury vehicles most likely uses a perpetual inventory system for inventory management. Instructions Why would the perpetual system be important for the manager of the car dealership? Solution (10 min.) A perpetual system provides more up-to-date information, which would be useful to the manager. In a car dealership often final prices are negotiated at the time of sale. The manager must have accurate information in order to ensure he does not sell the car below its cost to the dealership. They must also have an up-to-date listing of what is in inventory, so they do not sell the same car twice. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

115. Purdy Furniture uses a periodic inventory system. The company president has heard that a perpetual inventory system would help him make better decisions in the day-to-day management of his business. He has come to you, the company accountant, for more information. Instructions Prepare a reply to the president that includes a brief description of the perpetual inventory system. Identify three disadvantages and three advantages associated with implementing such a system. Solution (10 min.) Perpetual inventory systems keep track of units or their associated costs, or both, on a continual basis. This means that as soon as a unit is sold, it (or its cost) is immediately removed from the inventory account. In this type of system, the ending inventory balance and the cost of goods sold account are always up to date in terms of units or costs. The information provided by this system is very useful in making day-to-day decisions because the information is received on a timely basis. Advantages: a) Computer technology has come down in price, making the implementation of a perpetual system a real possibility for most businesses. b) May be able to implement an EDI system (electronic data interchange) where the

Inventory

c) d)

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information concerning the level of inventory could be linked to suppliers such that the system automatically reorders items when the level of inventory reaches a predetermined level. Can identify shrinkage due to theft or spoilage. Main benefit is that it provides timely information. Management knows which items are selling and how many they still have on hand. They can make informed decisions about reordering, pricing, and other issues.

Disadvantages: a) Costly to maintain b) May only be useful to track units (not costs), especially if there are several identical items in inventory, which were purchased at different times and costs c) Must still conduct inventory counts to provide assurance that the system works Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the differences between perpetual inventory systems and periodic inventory systems. CPA: Financial Reporting AACSB: Analytic

CHAPTER 8 LONG-TERM ASSETS CHAPTER LEARNING OBJECTIVES 1. Identify and distinguish between the various types of long-term assets. • Property, plant, and equipment (PP&E) items: have physical substance and provide economic benefits to a company because they are used to generate revenues, usually in combination with other assets. • Intangible assets: have no physical substance, but provide economic benefits as a result of the rights they bestow on the company that owns them. • Goodwill: results from a business combination, has no physical substance, and cannot be separated from the business it is a part of. Provides economic benefits through the average earnings that are expected as a result of the acquisition.

2. Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. • PP&E items are reported on the statement of financial position at their carrying amount; that is, cost less accumulated depreciation and accumulated impairment losses. • An asset’s carrying amount is the portion of its cost that has yet to be expensed. It is not what the asset could be sold for. • Cost includes purchase price, non-refundable taxes, legal costs, shipping costs, site preparation, and installation costs. • When multiple PP&E assets are purchased for a single price (a basket purchase), the cost of each is determined using the assets’ relative fair values. • Costs incurred after the purchase of a PP&E asset are capitalized (added to the cost of the asset) if they will extend the useful life of the asset, reduce its operating costs, or improve its output in terms of quantity or quality. Otherwise, these costs are expensed as period costs (for example, repairs and maintenance expense).

3. Explain why property, plant, and equipment assets are depreciated. • Depreciating PP&E allocates a portion of the cost of each asset to each period in which the asset’s economic benefits are being used up or consumed. • Only the depreciable amount (cost less estimated residual value) is expensed. • The depreciable amount is allocated or expensed over the asset’s estimated useful life.

4. Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation.

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• •

• • • • • •

The choice of depreciation method depends upon the pattern in which the PP&E asset’s economic benefits are expected to be used up or consumed by the company. Common methods of depreciation: o straight-line: allocates the depreciable amount evenly over time (in equal amounts each period) o diminishing balance: allocates a greater portion of the depreciable amount early in the asset’s life and less as time goes by (that is, there is a larger depreciation expense early in the asset’s life, reducing over time) o units-of-production: allocates the depreciable amount on a per-unit basis (that is, depreciation expense varies with the asset’s use). Companies are expected to select the method that is most consistent with the way in which they expect the asset’s economic benefits will be used up or consumed. A contra-asset account, accumulated depreciation, is used to capture the portion of a PP&E asset’s cost that has been depreciated. Depreciation should cease when the depreciable amount has been expensed; that is, when the asset’s carrying amount is equal to the estimated residual value. Companies often use the “15-day rule” to determine depreciation for a partial period. The Income Tax Act does not allow depreciation expense as a deductible expense in calculating taxable income. Instead, the Income Tax Act allows capital cost allowance (CCA), with specific rules about how the maximum amount of annual CCA is calculated.

5. Describe and implement changes in depreciation estimates and methods. • Depreciation expense is an estimate because the variables that go into its calculation are almost all estimates. Over time, if the estimates change materially, the periodic expense must also change. This is a change in accounting estimate, and is accounted for prospectively; in other words, in future periods, rather than going back and changing prior periods. • Depreciation expense for future periods is based on the asset’s carrying amount at the time of change, the revised estimate of residual value, the remaining estimated useful life, and the pattern in which the asset’s remaining economic benefits are expected to be used.

6. Explain what it means if property, plant, and equipment assets are impaired. • With PP&E, management expects future economic benefits to flow from the use of the PP&E asset. These benefits should be at least equal to the asset’s carrying amount. • At year end, management must determine whether there are any internal or external factors that might indicate that their PP&E assets are impaired. That is, the expected future economic benefits are less than the asset’s carrying amount. • If such factors are present, the company will determine the amount of the asset’s impairment loss, which is equal to the asset’s carrying amount less the greater of the expected future cash flows and the asset’s fair value less selling costs.

Long-Term Assets

•

Any impairment loss is recorded in the period in which it occurs. The asset’s carrying amount is reduced through using accumulated impairment losses, a contra-asset account.

7. Account for the disposal of property, plant, and equipment. • Accounted for using a two-step approach: o Step one: The asset is depreciated to the disposal date so the correct expense from using it in the period is recognized and the relevant accumulated depreciation account is updated. o Step two: the carrying amount (balances in the asset and accumulated depreciation and impairment accounts) is removed from the records and the proceeds of sale (cash or other assets) are recognized. If the proceeds of sale exceed the carrying amount, a gain is recognized. If the proceeds of sale are less than the carrying amount, a loss is reported.

8. Explain the accounting treatment for intangible assets, including amortization. • Intangible assets are recorded only when purchased from a third party. • Determining cost follows the same principles as used for PP&E. • Intangible assets with a finite (limited) useful life are amortized (expensed) over this period, usually by the straight-line method. Amortization is similar to depreciation. • The useful life of an intangible asset is often shorter than its legal life. • Intangible assets with an indefinite useful life are not amortized, but are tested annually for impairment.

9. Explain the accounting treatment for goodwill, including impairment. • Recognition of goodwill: o happens only as a result of the acquisition of a business o is equal to the excess of the purchase cost over the fair values of the identifiable assets net of liabilities acquired, because of the potential for above-average earnings that are expected to result from the acquisition. • Internally generated goodwill cannot be recognized. • After acquisition, goodwill is carried at cost and is not amortized. It is reviewed annually for evidence of impairment. If impaired, it is reported at cost less accumulated impairment losses.

10. Explain the accounting treatment for right-of-use and biological assets. • Recognition of goodwill: o Right-of-use assets are assets that are leased or rented by a company. o They are accounted for in the same way as property, plant, and equipment. o Biological assets are living plants and animals whose biological transformation or growth is being managed. Examples include cannabis plants, trees, grape vines, cows, and fish.

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o o

Biological assets become agricultural produce when they are harvested and then inventory when they have been processed and are available for sale. Biological assets are reported at their fair value less estimated selling costs.

11. Assess the average age of property, plant, and equipment; calculate the fixed assets turnover ratio; and assess the results. • The average age of PP&E can be determined by dividing the company’s accumulated depreciation by the annual depreciation expense. • The average age percentage can be determined by dividing accumulated depreciation by total PP&E assets (excluding land). • The older a company’s PP&E assets, the more likely it will need cash for investing purposes in the near future. • The fixed asset turnover ratio is equal to sales revenue divided by average net PP&E. • Assessing results of fixed asset turnover ratio indicates how effective an entity has been in managing its investment in PP&E.

Long-Term Assets

TRUE-FALSE STATEMENTS 1. The cash inflows generated from a long-term asset will be received over several future periods. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify and distinguish between the various types of long-term assets. CPA: Financial Reporting AACSB: Analytic

2. Under ASPE, property, plant, and equipment must be recognized using the revaluation model. Answer: False Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

3. The total accumulated depreciation on a long-term asset is also known as the asset's amortized cost. Answer: False Bloomcode: Knowledge Difficulty: Hard Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

4. In a basket purchase, the total purchase price is divided equally among the assets acquired. Answer: False Bloomcode: Knowledge

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Difficulty: Easy Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

5. Depreciation expense is a measure of an asset's increase in value due to wear and tear. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why property, plant, and equipment assets are depreciated. CPA: Financial Reporting AACSB: Analytic

6. Depreciation is a cost allocation method and has nothing to do with determining an asset’s market value. Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why property, plant, and equipment assets are depreciated. CPA: Financial Reporting AACSB: Analytic

7. Residual value directly enters into the calculation of depreciation expense under all depreciation methods. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

8. If a company determines that due to damage, the recoverable cost of its asset is reduced, it increases accumulated depreciation.

Long-Term Assets

Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain what it means if property, plant, and equipment assets are impaired. CPA: Financial Reporting AACSB: Analytic

9. An impairment loss should be recognized if the net recoverable amount of the asset exceeds the carrying value. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what it means if property, plant, and equipment assets are impaired. CPA: Financial Reporting AACSB: Analytic

10. Upon the disposal of an asset, if the carrying value is NOT equal to the proceeds, a gain or loss must be recognized. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Account for the disposal of property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

11. Basic research costs that occur prior to any decision to develop a product or process are usually capitalized. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

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12. All patents have useful and economic lives of 20 years. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

13. Internally generated goodwill may be capitalized annually. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting AACSB: Analytic

Long-Term Assets

MULTIPLE CHOICE QUESTIONS 14. Which of the following is NOT a tangible capital asset? a) buildings b) land c) copyrights d) equipment Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and distinguish between the various types of long-term assets. CPA: Financial Reporting AACSB: Analytic

15. Which of the following would NOT be classified as property, plant, and equipment? a) buildings in current use b) land purchased for resale c) machinery d) tools used in production Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and distinguish between the various types of long-term assets. CPA: Financial Reporting AACSB: Analytic

16. Capital assets include all of the following EXCEPT for a) goodwill. b) franchise rights. c) buildings. d) inventory. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and distinguish between the various types of long-term assets. CPA: Financial Reporting, Communication AACSB: Analytic, Communication

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17. Which of the following would NOT be capitalized as part of a purchased asset's cost? a) non-refundable taxes b) installation cost c) shipping costs d) insurance costs Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

18. In 2024, as part of a property purchase, Melrose Ltd. incurred and paid the 2023 property taxes. These costs should be a) recognized as an impairment loss. b) recognized on the Statement of Income as an expense. c) recognized as a capital cost. d) not be taken into consideration, these costs are irrelevant. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

19. Barium Corp. purchased a piece of equipment on September 30 for $27,000. It cost $400 to ship the equipment to the company’s facilities and another $1,000 to install the equipment. After the equipment was installed, the company had to pay an additional $1,500 for increased insurance. The capitalized cost of the equipment was a) $29,900. b) $29,500. c) $28,400. d) $27,400. Answer: c

Long-Term Assets

Bloomcode: Application Difficulty: Easy Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

20. A plot of land was purchased for $120,000 and had $10,000 of past-due property taxes on it. Non-refundable taxes on the purchase were $1,400, and the title search cost $500. The capitalized cost of the land was a) $120,000. b) $121,900. c) $130,000. d) $131,900. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

21. A machine was purchased for $125,500 during August; the cost included $750 in supplies that would be used with the new machine. The company had to pay $6,000 to have the machine shipped. The capitalized cost of the equipment is a) $125,500. b) $126,250. c) $131,500. d) $132,250. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

22. Assets acquired in a basket purchase are to be allocated a portion of the total price based on their respective

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a) fair market values. b) book values. c) present values. d) assessed values. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

23. AFM Holdings Co. purchased 15 acres of land with an office building and warehouse on it for $2,000,000. The assets were appraised at: land $1,000,000, building $600,000, and warehouse $900,000. The assets were carried on the seller's books at: land $800,000, building $500,000, and warehouse $700,000. At what cost should the purchasing company record each of the assets? Land Building Warehouse a) $1,000,000 $600,000 $900,000 b) $800,000 $480,000 $720,000 c) $800,000 $500,000 $700,000 d) $1,000,000 $500,000 $500,000 Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

24. Which of the following statements is correct with respect to capitalizing asset costs? a) All additional costs related to acquiring an asset should be expensed. b) Land cannot be depreciated so it should just be expensed when acquired. c) When costs are capitalized, the company gets the tax deduction immediately. d) Some small expenses related to the purchase of an asset can be expensed for simplicity. Answer: d Bloomcode: Comprehension Difficulty: Medium

Long-Term Assets

Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

25. When capitalizing the cost of a purchased asset, all of the following costs should be included in capitalization EXCEPT for a) the full purchase price including any discounts. b) set up costs. c) legal costs. d) shipping costs. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

26. When deciding whether to expense or capitalize the costs incurred after acquiring a capital asset, which one of the following questions is NOT relevant to the decision? a) Will these costs extend useful life? b) Will these costs reduce asset operating costs? c) Will these costs improve output? d) Will these costs be incurred for more than one year? Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

27. The portion of a depreciable asset that will not be expensed is called a) accumulated depreciation. b) net realizable value. c) estimated residual value. d) net present value.

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Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why property, plant, and equipment assets are depreciated. CPA: Financial Reporting AACSB: Analytic

28. The ultimate sales value of a long-term asset is referred to as its a) residual value. b) value in use. c) net book value. d) historical value. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why property, plant, and equipment assets are depreciated. CPA: Financial Reporting AACSB: Analytic

29. The depreciable amount of an asset is defined as the a) original cost less residual value. b) original cost less depreciation. c) original cost less accumulated depreciation. d) original cost. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why property, plant, and equipment assets are depreciated. CPA: Financial Reporting AACSB: Analytic

30. A key reason that there are various acceptable depreciation methods is a) different assets have different expected usage patterns. b) some methods are too complicated to calculate. c) to make it easier to calculate corporate income taxes. d) to account for assets with indefinite lives. Answer: a

Long-Term Assets

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why property, plant, and equipment assets are depreciated. CPA: Financial Reporting AACSB: Analytic, Communication

31. Depreciation Expense a) applies to all non-current assets. b) cannot be used for calculating income taxes. c) is acceptable for use under GAAP and the Income Tax Act. d) is very similar to CCA. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic, Communication

32. The Capital Cost Allowance (CCA) a) ignores residual value. b) has prescribed depreciation rates. c) is very similar to accelerated depreciation rates. d) all of these are correct. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic, Communication

33. According to accounting standards, the method of depreciation chosen should a) measure the change in an asset's value. b) be systematic and rational. c) allocate the most of the asset's cost to the early periods benefiting from its use. d) recognize the reduced usefulness of an asset.

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Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

34. The depreciation method that most closely resembles what is allowable for tax purposes under CRA is a) the straight-line method. b) units-of-activity method. c) the declining-balance method. d) depletion method. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

35. An asset that produces its greatest benefits to a firm early in its useful life should be depreciated using the a) straight-line method. b) declining-balance method. c) compound interest method. d) units-of-activity method. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

36. The most commonly used method of depreciation is a) straight-line.

Long-Term Assets

b) capital cost allowance. c) declining-balance. d) units-of-activity. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

37. The residual value is NOT directly used for the calculation of depreciation expense under which method? a) units-of-activity method b) straight-line method c) interest capitalization method d) declining-balance method Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

38. To apply the units-of-activity method, all of the following information is needed EXCEPT for the a) original cost. b) estimated residual value. c) estimated useful life. d) estimated usage. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

39. A company is depreciating a $1,000,000 building using a straight-line rate of 5%. The building has an estimated residual value of $200,000. What would the amount of depreciation be in the first year using the straight-line method and the double-declining-balance method? Straight-line Double-declining-balance a) $40,000 $80,000 b) $40,000 $100,000 c) $50,000 $80,000 d) $50,000 $100,000 Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

40. Which of the following depreciation methods calculates annual depreciation expense based on an asset's cost minus its residual value? a) deferred depreciation b) straight-line c) capital cost allowance d) declining-balance Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

41. If an asset generates revenues evenly over its useful life, which depreciation method should be used? a) capital cost allowance b) declining-balance c) units-of-activity d) straight-line Answer: d

Long-Term Assets

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

42. If management wanted to show an increase in income over the life of an asset which method of depreciation should they choose? a) capital cost allowance b) declining-balance c) units-of-activity d) straight-line Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

43. Which of the following amortization methods ignore residual value in the calculation of the annual depreciation expense? a) double-declining-balance and capital cost allowance b) straight-line and double-declining-balance c) straight-line and capital cost allowance d) present value and straight-line Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

44. The correct entry to record the annual depreciation expense for a long-term asset is a) Dr. Accumulated depreciation, Cr. Depreciation Expense. b) Dr. Depreciation expense, Cr. Accumulated depreciation.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

c) Dr. Accumulated depreciation, Cr. Long-Term asset. d) Dr. Depreciation expense, Cr. Long-Term asset. Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

45. Maryam Co. purchased a machine on January 1, 2024, for $22,500. The machine had an estimated useful life of 10 years and an estimated residual value of $2,500. The company uses double-declining-balance depreciation. What will be the depreciation expense for 2024? a) $4,500 b) $3,500 c) $2,250 d) $2,000 Answer: ac Bloomcode: Application Difficulty: Hard Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

46. Maryam Co. purchased a machine on January 1, 2024, for $22,500. The machine had an estimated useful life of 10 years and an estimated residual value of $2,500. If Maryam Co. used the straight-line method of depreciation, what would the carrying value of the machine be at the end of 2024? a) $20,500 b) $20,250 c) $18,250 d) $18,000 Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation.

Long-Term Assets

CPA: Financial Reporting AACSB: Analytic

47.Ponderosa Farms purchased some equipment on January 1, 2024, for $12,600. The equipment has an estimated useful life of 10 years and an estimated residual value of $1,200. The company uses double-declining-balance depreciation. Depreciation expense for 2020 would be a) $1,140. b) $1,260. c) $2,280. d) $2,520. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

48. Ponderosa Farms purchased some equipment on January 1, 2024, for $12,600. The equipment has an estimated useful life of 10 years and an estimated residual value of $1,200. The company uses double-declining-balance depreciation. The net book value on January 1, 2021, would be a) $10,080. b) $10,320. c) $11,340. d) $11,460. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

49. On July 1, 2023, Tanguay Co. purchased some equipment that initially cost $52,800. Additional costs included freight costs $300, non-refundable taxes $6,400, and installation $500. Estimated residual value is $2,000. The company uses a straight-line rate of 10%. Tanguay’s fiscal year end is June 30. Depreciation expense for the 2024 fiscal year end is

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a) $6,130. b) $5,900. c) $5,800. d) $5,930. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

50. On July 1, 2023, Tanguay Co. purchased some equipment that initially cost $52,800. Additional costs included freight costs $300, non-refundable taxes $6,400, and installation $500. Estimated residual value is $2,000. The company uses a straight-line rate of 10%. Tanguay’s fiscal year end is June 30. Accumulated depreciation at the fiscal year end of 2026 is a) $17,400. b) $17,700. c) $17,790. d) $18,390. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

51. On July 1, 2023, Tanguay Co. purchased some equipment that initially cost $52,800. Additional costs included freight costs $300, non-refundable taxes $6,400, and installation $500. Estimated residual value is $2,000. The company uses a straight-line rate of 10%. Tanguay’s fiscal year end is June 30. What would the depreciation expense be for 2020 if Tanguay Co. used the double-declining-balance method? a) $12,200 b) $12,000 c) $11,600 d) $ 6,000 Answer: b

Long-Term Assets

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

52. A building currently has a net book value of $650,000 after three years of straight-line depreciation totalling $150,000. The estimated residual value is $50,000. What was the building's original cost? a) $900,000 b) $850,000 c) $800,000 d) $750,000 Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

53. A depreciable asset with a cost of $42,500 has a residual value of $2,500 and a useful life of 8 years. Total estimated units of output are 80,000 and in year 1 a total of 5,200 units were produced. Under the straight-line method and the units-of-activity method the depreciation expense for the first year would be Straight-line Units-of-activity a) $5,000.00 $2,600.00 b) $5,000.00 $2,762.50 c) $5,312.50 $2,600.00 d) $5,312.50 $2,762.50 Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

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54. An asset being depreciated with the straight-line method has a residual value of $10,000 and accumulated depreciation of $30,000 in its second year. What was the original cost of the asset if its useful life was 5 years? a) $160,000 b) $140,000 c) $ 85,000 d) $75,000 Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

55. Bombay Inc. bought new computers on January 1 for $18,000 to improve the quality of its animation products. The computers have a useful life of 8 years but Bombay Inc. thinks that continuing technological developments will likely mean it will replace the computers after 4 years, at which time the computers will be worth $2,000. If Bombay uses straight-line depreciation, the depreciation expense for the first year will be a) $2,000. b) $2,250. c) $4,000. d) $4,500. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

56. Changes in the estimates for residual value or useful life result in changes in the depreciation expense calculation. These changes are handled a) retroactively. b) as cumulative changes. c) prospectively. d) as prior period adjustments. Answer: c

Long-Term Assets

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe and implement changes in depreciation estimates and methods. CPA: Financial Reporting AACSB: Analytic

57. The depreciation expense of an asset can change for all of the following reasons EXCEPT a) change in the estimated useful life. b) change in the asset’s expected residual value. c) increases due to additions to the asset for major repairs and improvements. d) increase in the asset due to regular repairs and maintenance. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe and implement changes in depreciation estimates and methods. CPA: Financial Reporting AACSB: Analytic

58. An asset that cost $16,200 with a residual value of $1,200 and a useful life of 5 years was depreciated for two years using the straight-line method. In the third year, the useful life was determined to be 2 years longer than initially expected. Depreciation in the third year would be a) $3,000. b) $2,143. c) $2,040. d) $1,800. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Describe and implement changes in depreciation estimates and methods. CPA: Financial Reporting AACSB: Analytic

59. Proctor Papers purchased a machine on January 1, 2022, at a cost of $380,000 with an estimated residual value of $30,000 at the end of its estimated useful life of 8 years. On January 1, 2024, Proctor Paper estimates that the machine only has a remaining life of 5 years and a residual value of $20,000. Proctor Paper uses straight-line depreciation. Depreciation expense for 2024 would be

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

a) $48,500. b) $54,500. c) $57,000. d) $72,000. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Describe and implement changes in depreciation estimates and methods. CPA: Financial Reporting AACSB: Analytic

60. Cola Company purchased a bottling machine on October 1, 2022, for $250,000. The estimated useful life is 25 years, and they are using straight-line depreciation. On October 1, 2023, it spent $46,000 on the machine to double its capacity and $5,000 on routine cleaning. The company’s year end is September 30. What should the depreciation expense be at September 30, 2024? a) $10,000 b) $30,000 c) $12,200 d) $11,9170 Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Describe and implement changes in depreciation estimates and methods. CPA: Financial Reporting AACSB: Analytic

61. Oceanside Developments owns a piece of land it had purchased in 2023 for $400,000. When it started to develop the land in 2024, it discovered that there were environmental problems with the land. It is now estimated to be worth only $150,000. Which of the following is the correct way to account for this? a) No accounting is necessary because the land is recorded at its historical cost, not its market value. b) The land account should be written down to $150,000 and a loss recognized. c) The land should be written off completely because now the company cannot use it for the purpose they intended to. d) The land should be depreciated at a new rate to reflect the decline in its value. Answer: b

Long-Term Assets

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what it means if property, plant, and equipment assets are impaired. CPA: Financial Reporting AACSB: Analytic

62. Factors that may contribute to, or may be assessed in relation to, the impairment of PPE include a) environmental spills or damage. b) elimination of a business unit due to corporate restructuring. c) the changing economic benefits of an asset. d) all of these are correct. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain what it means if property, plant, and equipment assets are impaired. CPA: Financial Reporting AACSB: Analytic, Communication

63. Farrah Corporation has a calendar year end and owns equipment that was purchased for $225,000 on March 1, 2024. On December 31, 2025, after the year-end adjusting entries, the carrying amount of the asset is $155,000. Due to damage, management determines the recoverable value to be $125,000. Farrah would make the following entry related to this asset: a) Dr. Depreciation Expense $30,000 Cr. Accumulated Depreciation $30,000 b) Dr. Loss on Impairment $30,000 Cr. Accumulated Impairment Losses—Equipment $30,000 c) Dr. Depreciation Expense $100,000 Cr. Equipment $30,000 d) Dr. Loss on Impairment $100,000 Cr. Accumulated Impairment Losses—Equipment $30,000 Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain what it means if property, plant, and equipment assets are impaired. CPA: Financial Reporting AACSB: Analytic, Communication

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64. An asset with an original cost of $75,000, a residual value of $7,500, and a useful life of 5 years is given away without any consideration at the end of year five. The entry to record this is a) Dr. Accumulated depreciation, Dr. Loss on disposal, Cr. Long-Term asset. b) Dr. Accumulated depreciation, Cr. Gain on disposal, Cr. Long-Term asset. c) Dr. Long-Term asset, Cr. Accumulated depreciation. d) Dr. Accumulated depreciation, Cr. Long-Term Asset. Answer: ac Bloomcode: Application Difficulty: Medium Learning Objective: Account for the disposal of property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

65. Global Enterprises purchased a machine on January 1, 2024, for $22,500. The machine had an estimated useful life of 10 years and an estimated residual value of $2,500. Assuming Global uses straight-line depreciation, what would be the book value of the machine on December 31, 2025? a) $ 0 b) $10,000 c) $11,250 d) $12,500 Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Account for the disposal of property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

66. On July 1, 2024, a truck was sold for $10,000. The company originally paid $28,000 on June 30, 2017, and has recorded accumulated depreciation on it to date of $15,000. The entry to record the sale would include a a) credit to accumulated depreciation for $15,000. b) debit to trucks for $28,000. c) credit to gain on sale of truck for $3,000. d) debit to loss on sale of truck for $3,000. Answer: d

Long-Term Assets

Bloomcode: Application Difficulty: Easy Learning Objective: Account for the disposal of property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

67. Upon the disposal of an asset, if the proceeds are greater than the carrying value of the asset, the company must a) recognize a loss. b) recognize a gain. c) adjust the accumulated depreciation account so the carrying value equals the proceeds. d) adjust the carrying value to market value. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Account for the disposal of property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

68. Losses on the cash sale of capital assets a) are the excess of the cash proceeds over the carrying value of the asset. b) are the excess of the cash proceeds over the market value of the asset. c) are the excess of the carrying value of the asset over the cash proceeds. d) are the excess of the carrying value of the asset over the market value. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Account for the disposal of property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

69. Long-term capital assets with a(n) ___ may NOT be depreciable. a) finite life b) indefinite life c) residual value d) undefined value Answer: b

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

70. Which of the following methods of amortization is a company most likely to use for financial statement purposes if it purchases a patent? a) capital cost allowance b) double-declining-balance c) units-of-activity d) straight-line Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

71. Which of the following statements is correct with respect to intangible assets with indefinite lives? a) The assets should be amortized over a period of 40 years. b) The assets should be expensed to income in the year acquired. c) The assets should be evaluated each year to determine if there has been any impairment in their value. d) The assets are never amortized or written down but remain on the company’s balance sheet at the original cost forever. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

72. Drugs R Us spent $25,000 on research and development to create a new product. The

Long-Term Assets

product was successfully developed and launched into the market. How should the research and development costs be treated? a) The full $25,000 should be capitalized. b) The research portion of the $25,000 should be capitalized. c) The research portion of the $25,000 should be expensed. d) The full $25,000 should be expensed. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

73. Harmax Limited spent $5,000 registering an internally developed patent and then another $20,000 defending and enforcing the patent in its first year. How should the patent be reflected in the financial statements? a) the full $25,000 expensed in the year b) $5,000 capitalized as Patent asset and the $20,000 expensed c) $20,000 capitalized as Patent asset and the $5,000 expensed d) the full $25,000 capitalized in the year Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

74. Which of the following is an example of an intangible with an indefinite life? a) a copyright on a song b) a patent on a new technology c) the development costs of a new drug d) the cost of a trademark Answer: d Bloomcode: Comprehension Difficulty: Hard Learning Objective: Explain the accounting treatment for intangible assets, including

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amortization. CPA: Financial Reporting AACSB: Analytic

75. The only long-term asset that cannot be separated from the business and sold is a) land. b) buildings. c) goodwill. d) trademarks. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting, Communication AACSB: Analytic, Communication

76. Which of the following intangibles would be capitalized? a) research b) advertising c) the cost of successfully defending a patent d) internally developed patent Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting AACSB: Analytic

77. Goodwill a) is the net value of the purchase price less the book value of the asset. b) has economic value and can be sold to generate revenues. c) can be generated internally. d) only arises when businesses are combined. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting treatment for goodwill, including impairment.

Long-Term Assets

CPA: Financial Reporting AACSB: Analytic, Communication

78. The carrying amount of goodwill a) is not relevant, because goodwill is not amortized. b) captures impairment losses. c) is calculated using CCA. d) all of these are correct. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting AACSB: Analytic, Communication

79. Right-to-use assets are typically depreciated over which of the following basis? a) carrying value. b) term of the lease. c) economic life. d) useful life. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for right-of-use and biological assets. CPA: Financial Reporting AACSB: Analytic

80. Which of the following industries would be least expected to account for biological assets? a) diary production. b) wine production. c) media production. d) cannabis production. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for right-of-use and biological assets. CPA: Financial Reporting

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AACSB: Analytic

81. Companies can estimate when capital assets may need to be replaced in order to maintain operating capacity by using the following ratio(s): a) fixed asset turnover. b) average age %. c) current. d) inventory turnover. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Assess the average age of property, plant, and equipment; calculate the fixed assets turnover ratio; and assess the results. CPA: Financial Reporting AACSB: Analytic, Communication

Long-Term Assets

EXERCISES 82. Sandex Architecture made the following cash expenditures during its first year in operations: 1. Cost of real estate purchased as a plant site (land and building) $ 130,000 2. Accrued property taxes paid at the time of the purchase of the real estate 3,000 3. Cost of demolishing building to make land suitable for construction of a new building 9,000 4. Architect's fees on building plans 12,000 5. Excavation costs for new building 27,000 6. Cost of filling and grading the land 2,500 7. Full payment to building contractor 750,000 8. Cost of parking lots and driveways 32,000 9. Property taxes paid for the current year on the land 5,000 Instructions Record the above transactions and determine the cost of the land, land improvements, and building that will appear on Sandex’s year-end statement of financial position. Solution (15 min.) 1. Dr. Land ......................................................... Cr. Cash ............................................... 2.

$130,000 $130,000

Dr. Land ......................................................... Cr. Cash ...............................................

$3,000

Dr. Land ......................................................... Cr. Cash ...............................................

$9,000

Dr. Building ................................................... Cr. Cash ...............................................

$ 12,000

Dr. Building ................................................... Cr. Cash ...............................................

$27,000

Dr. Land ......................................................... Cr. Cash ...............................................

$ 2,500

Dr. Building ................................................... Cr. Cash ...............................................

$750,000

$3,000

$9,000

$12,000

$2,500

$750,000

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Dr. Land Improvements ............................... Cr. Cash ...............................................

$32,000

Dr. Property Tax Expense ............................. Cr. Cash ...............................................

$5,000

$32,000

$5,000

The account balances on the statement of financial position at the end of the period are as follows: Land $144,500 Land Improvement $32,000 Building $789,000 Bloomcode: Application Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized . CPA: Financial Reporting AACSB: Analytic

83. Poltergeist Surplus purchased specialized equipment. The following expenditures were

incurred relating to the specialized equipment: - Purchase price of $360,000 less $40,000 rebate. - Paid shipping fees of $20,500. - Paid customs/duty fees of $82,000. - Paid $8,400 for the installation of the equipment. - Paid to train employees and supervisors to use the equipment. Instructions What amount would Poltergeist record for the specialized equipment? Solution (5 min.) Specialized equipment = $360,000 - $40,000 + $20,500 + $82,000 + $8,400 = $430,900 Costs to train employees/supervisors are not a cost to be capitalized. Bloomcode: Application Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

84. Beach Front Foods Inc. has decided to add a delivery service to its business. In 2024 the

Long-Term Assets

company purchased a car to use to deliver customer orders. The purchase price of the car was $42,000, which includes non-refundable taxes of $5,800. The car was painted with the store logo for $1,000 and an additional $750 was spent on the annual license fee. During the year they spent $3,000 on gas and $1,000 on maintenance costs. They expect to drive the car 200,000 kilometres and have a residual value of $5,000. In 2024, they drove 27,500 km. Instructions a) Calculate the cost of the asset to Beach Front. Provide brief support for all items included in the cost and the reason any costs are not included. b) Record the depreciation expense for 2024 using the units-of-activity method. Solution (10 min.) a) Purchase cost non-refundable taxes (included in purchase price) paint Total capital cost Costs not included: License Gas Maintenance

$42,000

original cost has future benefit

1,000 $43,000

necessary to get asset ready to use

$750 3,000 1,000

Depreciable cost estimated kilometres rate per km # km driven Depreciation expense

an annual cost, expense each year an annual operating cost, expense did not increase the future benefits therefore expensed $43,000 – $5,000 = $38,000 200,000 $0.19

27,500 $5,225

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

85. On September 1, 2024, Augusta Aerodynamics purchased a piece of equipment which cost $68,900, has a $4,900 residual value, and an 8-year useful life. The company has a fiscal year end of August 31. Instructions

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Calculate the depreciation expense for the year ended August 31, 2025 under a) Straight-line, b) Double-declining-balance. Solution (5 min.) a) ($68,900 – $4,900) ÷ 8 years = $8,000 b)

$68,900 × 25% = $17,225

86. Josi Industries purchases $110,000 of machinery on January 1, 2021. The machinery is expected to have a 5-year useful life and a residual value of $10,000. On January 1, 2024, management determines that the equipment will last for an additional 2 years and the new residual value is $6,000. Josi uses straight-line depreciation and has a calendar year end. Instructions Calculate the depreciation expense related to this piece of machinery and determine the carrying value of the machinery on December 31, 2024. Solution (10 min.) Initial Depreciation Expense: ($110,000-$10,000) / 5 years = $20,000 Carrying amount of the machinery @ December 31, 2023 (($110,000 – (3 x $20,000)) = $50,000 Changes in Estimates: Remaining Useful Life: 4 years Estimated Residual Value: $6,000 2024 Depreciation Expense: ($50,000 – $6,000) / 4 years = $11,000 2024 Carrying Value: $110,000 – $71,000 = $39,000 Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. Learning Objective : Describe and implement changes in depreciation estimates and methods. CPA: Financial Reporting AACSB: Analytic

Long-Term Assets

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87. Wilma’s Wicker Furniture purchased a laser-guided mitre saw on September 1, 2022 at a cost of $20,000. Depreciation for 2022 and 2023 was based on an estimated 8-year useful life and $4,000 estimated residual value. In 2024, Wilma’s revised its estimates and now believes the laser mitre saw will have a total service life of an additional three years but the residual value will be only $2,000. Wilma’s uses the straight-line method to depreciate all assets. Wilma’s Wicker Furniture has a December 31 year end. Instructions Calculate depreciation expense for 2022, 2023, and 2024. Solution (10 min.) 2022 and 2023 Cost Residual value Depreciable cost Estimated life (years) Annual depreciation (for 2023) Depreciation expense for 2022 ($2,000 x 4/12)

$20,000 4,000 16,000 ÷8 $2,000 $ 677

2024 Cost Less: depreciation 2022 and 2023 Book value at December 31, 2023 Less: revised residual value Depreciable cost Remaining life (years) (6 years 4 months + 3 years) Annual depreciation

$20,000 2,667 17,333 2,000 15,333 ÷ 9.67 $ 1,586 (rounded to the nearest $).

88. Lucky Lure Co. purchased a machine on October 1, 2022 for $125,000. It has a $15,000 residual value and a 10-year useful life. On July 1, 2024 the machine sold for $79,500. The company uses the double-declining-balance method of depreciation. The company fiscal year end is December 31. Instructions Prepare the journal entries for 2022 through 2024.

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Solution (12 min.) 2022 Oct 1 Machinery ..................................................................... Cash....................................................................... Dec 31

2023 Dec 31

2024 Jul 1

125,000 125,000

Depreciation expense—machinery.............................. Accumulated depreciation—machinery .............. (125,000 x .2) x 3/12

6,250

Depreciation expense—machinery.............................. Accumulated depreciation—machinery .............. ([$125,000 – $6,250] x .2)

23,750

Depreciation expense—machinery.............................. Accumulated depreciation—machinery .............. ([$125,000 – $6,250 – $23,750] x.2 x 6/12) Cash .............................................................................. Accumulated depreciation—machinery...................... Loss on sale of machinery ............................................ Machinery..............................................................

9,500

6,250

23,750

9,500 79,500 39,500 6,000 125,000

89. Numar Limited sold a piece of equipment August 1, 2024 for proceeds of $22,000. The equipment had an original value of $60,000 and was purchased on January 1, 2021. It was estimated to have a residual value of $3,000 and 5-year useful life. Numar uses the straightline method. Numar has a December 31 year end. Instructions Journalize all entries required to update depreciation and record the sale of the asset in 2024. Solution (10 min.) Aug. 1 Depreciation Expense...... ....................... Accumulated depreciation ($60,000 – $3,000) ÷ 5 years x 7/12 = $6,650 Cash...................................... .................... Accumulated depreciation** ..................

6,650 6,650

22,000 40,850

Long-Term Assets

Equipment ....................................... Gain on Disposal ($22,000 – $19,150)

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60,000 2,850

**2021, 2022 and 2023: ($60,000 – $3,000) ÷ 5 years = $11,400 x 3 = $34,200 + $11,400 x 7/12 = $6,650 Total accumulated depreciation at date of disposal = $40,850 Bloomcode: Application Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. Learning Objective : Account for the disposal of property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

90. Othello Corporation purchases Shakespeare Inc. for $3.5 M. Shakespeare has the following assets all recorded at cost: Accounts Receivable $ 125,000 Inventory $ 350,000 Land $ 500,000 Building (net) $ 350,000 Equipment (net) $ 50,000 Total Assets $1,375,000 The fair value of the assets is $2,350,000 and Othello also assumes $600,000 of debt from Shakespeare. Instructions Determine if there is any goodwill related to Othello’s purchase of Shakespeare and if so, what is the value of the goodwill. Show your work. Where is goodwill captured on the financial statements? Solution (7 min.) Purchase Price Less: Fair value of the assets: Add: Assumed Debt Goodwill

$3,500,000 $2,350,000 $ 600,000 $1,750,000

Goodwill is captured on the Statement of Financial Position under Long-Term Assets. Bloomcode: Application Difficulty: Hard Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting AACSB: Analytic

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91. Wazam Technologies is in the process of assessing some of its equipment for possible

impairment as a result of some significant technological advancements within the industry the company operates. After some investigation Wazam determines that the equipment is indeed impaired and the company has recorded an impairment loss of $120,000. The equipment’s carrying value prior to the impairment loss was $750,000. Instructions a) What was the equipment’s recoverable amount as determined by Wazam? b) What is the equipment’s carrying value immediately after the impairment loss? Solution (5 min.) Carrying value prior to impairment = $750,000 Less: Impairment loss = $(120,000) a) Recoverable amount = $630,000 b) Carrying value after impairment = $630,000 Bloomcode: Application Difficulty: Medium Learning Objective: Explain what it means if property, plant, and equipment assets are impaired. CPA: Financial Reporting AACSB: Analytic

92. The following Comparative Information has been provided by Amigo Corporation and Peru Enterprises: in '000's $ Sales Cash Inventory Land Building (net) Machinery (net)

Amigo 2024 11,535 450 625 1,050 750 825

2023 10,432 110 575 1,050 825

Peru 2024 21,375 175 872 3,533 2,520

2023 20,439 159 903 2,990 2,100

905

1,250

1,010

Instructions Calculate the fixed asset turnover in 2024 for both companies. Which company is using its assets more effectively? Solution (15 min.)

Long-Term Assets

Average Net PPE Land Building (net) Machinery (net)

2024 1,050 750 825

Amigo 2023 1,050 825 905

2024 3,533 2,520 1,250

Peru 2023 2,990 2,100 1,010

2,625

2,780

7,303

6,100

Amigo: (2,625 + 2,780)/2 = Peru:(7,303 + 6,100)/ 2 =

2,703 6,702

Fixed Asset Turnover: Amigo: 11,535 / 2703 = Peru: 21,375/6702 =

4.3 3.2

times times

Amigo is using its assets more effectively. It is generating $4.30 in sales for every $1 in longterm assets versus Peru, where it is generating $3.20 in sales for every $1 in long-term assets. Bloomcode: Analysis Difficulty: Medium Learning Objective: Assess the average age of property, plant, and equipment; calculate the fixed assets turnover ratio; and assess the results. CPA: Financial Reporting AACSB: Analytic

93. The following information has been provided by Amigo Corporation and Peru Enterprises: in '000's $ Cash Inventory Land Building Accum Depreciation Machinery Accum Depreciation

Amigo

Peru

450 625 1,050 1,000

175 872 3,533 3,100

250 1,225

580 2,550

400

1,250

Additional Information: Both Companies use straight-line depreciation; buildings are estimated to have no residual value and a 40-year useful life, while machinery is estimated to have no residual value and a 10-year useful life.

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Instructions Calculate the average age of PPE using both the average age % and average age ratios. Assess the age of Amigo and Peru’s assets. Which company is likely to begin to replace its assets first? Solution (10 min.) Average Age % Amigo: (250 + 400) / (1,000 + 1,225) = Peru: (580 + 1,250) / (3,100 + 2,550) =

29.21% 32.39%

Average Age Amigo: (250 + 400) / 147.5 = Peru: (580 + 1,250) / 332.5 =

4.41 years 5.50 years

Depreciation Expense Amigo: (1,000/40) + (1,225/10) = Peru: (3,100/40) + (2,550 / 10) =

147.5 332.5

Based on the above analysis, Peru is likely to need to start replacing its assets first. The % usage of its assets is 32.39% of the useful life versus 29.21% of Amigo’s assets. The average age of Peru’s assets is 5.5 years versus 4.41 years for Amigo’s. Peru’s assets are obviously older. Bloomcode: Analysis Difficulty: Medium Learning Objective: Assess the average age of property, plant, and equipment; calculate the fixed assets turnover ratio; and assess the results. CPA: Financial Reporting AACSB: Analytic

Long-Term Assets

MATCHING 94. Listed below are various methods of allocating the cost of certain long-term assets over their useful lives, followed by a series of descriptive statements. Match the methods to the statements by placing the appropriate letter in the space provided. METHODS A. Capitalized and depreciated/amortized B. Capitalized and depleted C. Evaluated for impairment D. Expensed E. None of these STATEMENTS ____ 1. research costs incurred internally ____

cost of timber

____

five-acre parcel of land where a firm's headquarters is located

____

purchased tools

____

goodwill

____

non-refundable taxes included in purchase price of land

____

development costs for a new product

____

purchased patent

____

basket purchase of vehicles and equipment

____

10. advertising costs

____

11. intangible assets with indefinite live

____

13. development costs that do not assist in creating a new product

Solution (3 min.) 1.

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10. D 11. C 13. D Bloomcode: Comprehension Difficulty: Hard Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. Learning Objective: Explain the accounting treatment for intangible assets, including amortization. Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting AACSB: Analytic

95. Listed below are various depreciation methods followed by a series of descriptive statements. Match the depreciation method to the statements by placing the appropriate letter in the space provided. In some cases, more than one method is appropriate. DEPRECIATION METHODS A. Straight-line B. Units-of-activity C. Double-declining-balance D. Capital cost allowance E. None of these STATEMENTS ____ 1. results in the measurement of the asset at its fair market value ____

sometimes used for financial reporting by small businesses

Long-Term Assets

____

the simplest method to apply

____

produces decreasing amounts of depreciation each year

____

appropriate when related assets generate revenue evenly over their useful lives

____

required for Canadian tax purposes

____

provides the largest annual depreciation expense for financial reporting in the related asset's first year

____

residual value is not used in annual depreciation expense calculation

____

annual depreciation is calculated using a per-unit cost

Solution (4 min.) 1. E 2.

C and D

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

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SHORT-ANSWER ESSAY QUESTIONS 96. Explain the significance and importance of long-term assets to its users. Solution (5 min.) Companies invest in long-term assets to contribute to the generation of future revenues. These assets generally have significant costs and impact company operations for many years to come. These assets are often critical to future success of the company. Users will want to monitor the age of the company’s long-term assets. Users will want to understand the average age of these assets and anticipate when future cash flows will be required to replace them. They will also want to understand the company’s depreciation and amortization polices related to these assets. Users will also want to know if a long-term asset’s expected use has been negatively affected or if these assets have been pledged to creditors for security. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and distinguish between the various types of long-term assets. CPA: Financial Reporting, Communication AACSB: Analytic, Communication

97. Langford Company bought a piece of land with a building on it for a total of $4,400,000. They hired two companies to estimate the fair values of the land and building. The first estimate was: Land $1,200,000, Building $3,600,000. The second appraisal was: Land $1,000,000 and Building $4,000,000. Instructions a) If management’s objectives are to minimize the amount of income tax the company pays, which of the two appraisals should be used to allocate the purchase price? Support your answer. b) Based on your answer in part a, calculate the amount to be allocated to the Land and the Building account. c) Under what circumstances might management use the other appraisal value? Solution (10 min.) a) If management wants to minimize taxable income and hence taxes payable, they want the maximum amount allocated to the building, which is deductible (over time through capital cost allowance) for tax purposes. Therefore, they would select the second appraisal: Land $1,000,000 and Building $4,000,000. b)

Total appraised value = $5,000,000 Allocated to Land: 1,000,000/5,000,000 = 20% x 4,400,000 = $880,000 Allocated to Building: 4,000,000/5,000,000 = 80% x 4,400,000 = $3,520,000

c) If management’s objectives were to maximize income in order to increase bonuses or share

Long-Term Assets

price, they would want the maximum amount allocated to Land, because that amount would never be expensed as land is not amortized. So, they would select the first appraisal that allocates 25% of the purchase price to Land. Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting, Communication AACSB: Analytic, Communication

98. What is depreciation? Explain how and why it is used in relation to PP&E. Solution (5 min.) PP&E is depreciated in order to allocate a portion of the asset’s cost to each of the periods that the future economic benefits are being captured as the asset is being used up or consumed. Depreciation expense on an asset is captured in the same time period as the revenues that the asset has helped generate. PP&E assets other than land have a finite life. In order to depreciate an asset, we must know the cost of the asset, its estimated residual value and estimated life. The depreciable amount of the asset = Cost – Estimated Residual Value. If costs are capitalized, those costs are expenses in future years through the depreciation process. Bloomcode: Comprehension, Knowledge Difficulty: Medium Learning Objective: Explain why property, plant, and equipment assets are depreciated. CPA: Financial Reporting AACSB: Analytic, Communication

99. You are advising a client who has just started a business, on how to select accounting policies. The client wants to use capital cost allowance (CCA) for her financial statements. Discuss the pros and cons of her choice. Solution (8 min.) Pros: • simplifies record keeping • only have to maintain one set of books (not one set for taxes and another set using a different method of amortization for financial statement purposes) • tax return preparation will be easier Cons: • CCA is based on government objectives and may not result in a useful measure of net income for financial statement purposes • in general, CCA rates are initially higher than depreciation rates, so net income will be

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understated. May affect ability to attract more investment, pay dividends, etc. Bloomcode: Analysis Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting, Communication AACSB: Analytic, Communication

100. Explain the four differences between depreciation and CCA (capital cost allowance) that have been highlighted in your text. What is CRA’s motivation behind the CCA system? Solution (12 min.) The four differences are as follows: 1. Under GAAP, a company may choose the deprecation method most suitable for the deprecation of long-term assets, whereas the Income Tax Act specifies the use of CCA. 2.

Company management is able to estimate the asset’s useful life which is then used to determine the depreciation rate; whereas, the Income Tax Act specifies the CCA rate that must be used.

Company management is able to estimate the asset’s residual value which has an impact on the annual depreciation expense. Under the Income Tax Act residual values are ignored.

Depreciation expense must be recorded annually on the Income Statement, while the amount of CCA determined under the income tax only represents the MAXIMUM that can be claimed on the income tax return.

CRA rules remove all management judgement from the CCA system, limiting bias. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting, Communication AACSB: Analytic, Communication

101. Explain what goodwill is and when / how it can be recognized and reflected on the financial statements. Solution (10 min.) Goodwill is a long-term asset that arises when two businesses are combined. It represents the expected future economic benefits that will arise from the combination that cannot be

Long-Term Assets

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separately identified as either PP&E or an intangible asset. It is the purchase price less the fair value of the PP&E and identifiable tangible assets being acquired plus the fair value of any liabilities being assumed as part of the purchase. Goodwill is only recorded when a business combination has taken place, it cannot be internally generated. Goodwill is captured on the Statement of Financial Position under long-term or non-current assets. It is considered to have an indefinite useful life and is not amortized, but it is tested for impairment annually. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting AACSB: Analytic

102. A friend has come to you with the following question, "What is this goodwill account that I see on the statement of financial position of a company that I own stock in?" Instructions Write a reply to your friend. Include in your explanation three factors that contribute to goodwill, under what circumstances goodwill is recorded, and how it is accounted for. Solution (8 min.) Goodwill stems from a number of factors, including: above-average management skills, excellent location, excellent customer relations, and above-average earnings. Goodwill is recorded as an asset only when it is acquired in the purchase of another company. When the purchasing company pays more than the fair market value of the selling company's net assets, goodwill is acquired and is represented by the difference. Goodwill is reported as an intangible asset on the balance sheet and is not amortized. Management is required to periodically review the carrying value of the goodwill to determine if any impairment in value has occurred. If impairment has occurred the goodwill should be written down and an impairment loss recognized. Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for goodwill, including impairment. CPA: Financial Reporting, Communication AACSB: Analytic

103. Explain what a biological asset is and how such assets are reported on the statement of financial position. Use examples to support your answer. Solution (8 mins.) Biological assets are living plants and animals whose biological transformation or growth is being managed. Cannabis plants, trees, fish, cows, hogs, poultry, etc. are all examples of biological assets. Biological assets are reported at fair value less any estimated selling costs.

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the accounting treatment for right-of-use and biological assets. CPA: Financial Reporting AACSB: Analytic

104. Explain why it is important for a company to be able to assess the average age of capital assets. What metrics are available to assist in this analysis, and what do they measure? Solution (12 min.) Understanding the age of the long-term assets is useful to financial statement users. The newer the long-term asset base, the longer the company will be able to go without replacing these assets. Companies with older asset bases will need to reinvest in order to replace these assets and maintain their operating capacity. The basic measures that can be used to assess the relative age of a company’s long-term assets include: Average Age % = Total Accumulated Depreciation / (Total PP&E – Land) This measures the extent to which the company’s assets have been depreciated. Average Age = Total Accumulated Depreciation / Depreciation Expense This provides information on how long a company has been using its PP&E. Measured in years. Bloomcode: Analysis Difficulty: Medium Learning Objective: Assess the average age of property, plant, and equipment; calculate the fixed assets turnover ratio; and assess the results. CPA: Financial Reporting AACSB: Analytic

Long-Term Assets

ESSAY QUESTIONS 105. Cringan George Advertising is relocating its operations. In doing so it purchases a new plant, land, and printing equipment for $1,500,000. The fair value of these assets had they been purchased separately is as follows: Equipment $800,000, Plant $500,000, and Land $750,000. Explain how these assets should be reflected on the books and why? What values should be assigned to these assets? Solution (10 min.) The price paid for the assets must be divided over the land, building, and equipment based on the relative fair values at the time of acquisition. This must be done for three reasons: full disclosure requires that each asset must be reflected separately on the statement of financial position, assets have different depreciation rates that must be recorded separately, and some assets are not depreciable at all. The value these assets should be reflected at are as follows: Equipment: $1,500,000 x 39% = $585,000 Plant: $1,500,000 x 24% = $360,000 Land: $1,500,000 x 37% = $555,000 Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. CPA: Financial Reporting AACSB: Analytic

106. Depreciation is the allocation of an asset's cost over its useful life. As a result, depreciation affects each of the financial statements. Explain how depreciation affects the statement of income, statement of financial position, and cash flow statement. Solution (8 min.) Statement of Income Depreciation expense is reported on the Statement of Income as selling and/or administrative expense (for retail companies) and a part of the cost of goods sold (for manufacturing companies). As an expense, it reduces net income. Statement of Financial Position Depreciation is accumulated in a contra-asset account, Accumulated Depreciation. This account is deducted from the cost of the related asset to reflect the asset's net book value. It reflects the portion of the asset’s original cost that has been allocated to net income to date. Cash Flow Statement Depreciation is not a cash expense. However, it does impact the cash flow statement in two ways: (1) if the indirect method is used, depreciation is added back to net income to

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determine cash flows from operating activities; (2) under the direct method, depreciation (as a proxy for Capital Cost Allowance) affects the cash outflow for income taxes because depreciation expense reduces a firm's tax liability. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. CPA: Financial Reporting AACSB: Analytic

107. Capital assets can be classified as tangible or intangible assets and generally benefit a number of accounting periods. Identify the different processes used to allocate the cost of each of those types of long-term assets over the periods that they benefit. Match each process with the type of asset it relates to and explain how the process is implemented. Solution (10 min.) Depreciation is the process of allocating the cost of plant and equipment. It involves allocating the depreciable cost (cost minus residual value) over the asset's useful life using one of the generally accepted depreciation methods—straight-line, units-of-production or doubledeclining-balance. Amortization is the process of allocating the cost of an intangible asset over its economic life. It involves allocating the capitalized cost to each year based on the asset's economic life. The most commonly used method is straight-line. Some intangible assets have an unlimited economic life and hence are not amortized, but must be tested annually for impairment. If the value of the asset has decreased, it needs to be written down to that new value and a loss recognized. Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. Learning Objective: Explain the accounting treatment for intangible assets, including amortization. CPA: Financial Reporting AACSB: Analytic

CHAPTER 9 CURRENT LIABILITIES CHAPTER LEARNING OBJECTIVES 1. Explain why current liabilities are of significance to users. • Working capital is an important liquidity measure in assessing a company’s ability to meet its short-term obligations and whether any additional financing is required. A company’s current liabilities must be identified and measured in order to correctly determine working capital.

2. Describe the valuation methods for current liabilities. • Current liabilities are carried at their fair value (or face value). • They are not discounted to take into account the time value of money because the time period in which they will be settled is short (less than one year).

3. Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. • Common current liabilities that arise from transactions with lenders include bank indebtedness, short-term loans, and the current portion of long-term debt. • Bank indebtedness represents a company’s use of a line of credit or revolving credit facility. It will normally be repaid with the company’s subsequent cash deposits. • Short-term loans (also known as working capital loans) are often secured by the company’s accounts receivable and/or inventory, with the maximum amount of the loan changing as the level of the related security change. • The current portion of long-term debt represents the principal portion of long-term loans that is due within the next year.

4. Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. • Accounts payable (or trade payables) are common current liabilities for all companies. • They are sometimes considered “free debt” because payment to suppliers is not required for 30 or more days depending on the terms agreed to with the supplier.

5. Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. • Common current liabilities that arise from transactions between a company and its customers include deferred revenue, gift card liability, customer loyalty provision, and warranty provision.

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•

Deferred revenues (or unearned revenues) represent payments received from customers in advance of them receiving the goods or services being purchased. Until this is done, the company has not satisfied its performance obligation under the contract. Gift card liabilities arise when customers purchase gift cards (or gift certificates) from a company. Until such time as the gift card is used, the company has a liability. Some gift cards will never be used or never fully used by their owners. This is known as breakage, and companies record the estimated amount of breakage as revenue, reducing their gift card liability. Customer loyalty provisions are related to programs that enable customers to accumulate points or other credits when making purchases. These points can be subsequently redeemed for free goods or services. The points are considered to be a separate performance obligation, and the revenue related to them must be deferred, which is often reported as a customer loyalty provision. This performance obligation is satisfied when the customer redeems the points to purchase goods or services. There are two types of warranties: assurance-type and service-type warranties. The primary distinction between the two is that service-type warranties are available for purchase and provide customers with some assurance beyond the product performing as expected and being free from defects. Service-type warranties are considered to be a separate service obligation. A liability, deferred warranty revenue, is recorded and recognized over the period of the warranty. Any warranty expenses are recorded as incurred. Assurance-type warranties are not considered to be separate performance obligations. Instead, the estimated warranty expenses are recorded in the period in which the related product was sold, and a corresponding liability, warranty provision, is recorded. Any warranty claims are charged against this provision (because the warranty expense was recorded when it was established).

6. Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. • Common employee-related current liabilities include wages payable, CPP payable, EI payable, and employee income taxes payable. • Because employees normally work prior to being paid, a liability (wages payable) arises as employees work. • Employers are responsible for withholding source deductions from the wages of their employees. These include CPP, EI, and income taxes. Employers are also required to pay CPP and EI based on the wages earned by their employees. These source deductions and employer portions result in current liabilities until they are remitted (sent in) to the government.

7. Identify the current liabilities that arise from transactions with government and explain how they are accounted for. • Companies are required to file corporate tax returns (a T2). They must also make monthly income tax instalment payments, which are usually based on the taxes paid in the previous year, with any outstanding taxes due within two months of year end.

Current Liabilities

Until it is paid, any outstanding income tax balance would be a current liability (income taxes payable).

8. Identify the current liabilities that arise from transactions with shareholders and explain how they are accounted for. • The most common liability that companies have to their shareholders is in relation to dividends that have been declared but not yet paid. When dividends are declared, a company establishes a liability (dividends payable) that is extinguished when they are paid, which generally occurs within four to six weeks.

9. Calculate the accounts payable turnover ratio and average payment period and assess the results. • The accounts payable turnover ratio can be determined by dividing a company’s credit purchases by its average accounts payable. It measures the number of times per year that a company settles (or pays) its trade payables. • The average payment period is equal to 365 days divided by the accounts payable turnover ratio. It measures the number of days on average a company took to pay its accounts payable. • The results of the accounts payable turnover ratio and average payment period help users assess the extent of any change in the supplier payment portion of the cash-tocash cycle from one period to another. It is ideally assessed in relation to the credit terms normally available in the industry in which the company operates.

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TRUE-FALSE STATEMENTS 1. All current liabilities are settled with cash. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why current liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

2. Liabilities are the result of events or transactions that have already occurred. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why current liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

3. Accounting standards require that liabilities be recorded at their present value. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for current liabilities. CPA: Financial Reporting AACSB: Analytic

4. The difference between the face value of a liability and its present value is due to the time value of money. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for current liabilities. CPA: Financial Reporting AACSB: Analytic

Current Liabilities

5. All current liabilities have fixed due dates and fixed payment amounts. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

6. A line of credit helps a company deal with temporary cash shortages. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

7. Bankers will often compare current assets to current liabilities to assess liquidity. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

8. Long-term debt that is due within one year is classified with other long-term debt. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting

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AACSB: Analytic

9. A line of credit is always reflected under the current liabilities regardless of the size of the debt. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

10. Accounts receivable occur when a company buys goods or services on credit. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

11. Gift cards are an example of a contingent liability. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

12. Deferred revenue is an example of a liability that is settled by the provision of goods or services. Answer: True Bloomcode: Knowledge

Current Liabilities

Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

13. The balance for outstanding income taxes are reported as a current liability. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with government and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

14. The amount owing on income taxes is recorded as deferred income taxes. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with government and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

15. The accounts payable turnover ratio measures the number of times per year that a company settles its trades payable. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate the accounts payable turnover ratio and average payment period and assess the results. CPA: Financial Reporting AACSB: Analytic

16. The accounts payable turnover ratio can be converted to days by using the accounts payable payment period formula.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate the accounts payable turnover ratio and average payment period and assess the results. CPA: Financial Reporting AACSB: Analytic

Current Liabilities

MULTIPLE CHOICE QUESTIONS 17. Which of the following is NOT a characteristic of a liability? a) There is a probable future sacrifice of resources. b) There is a fixed payment amount and payment date. c) There is little discretion to avoid the obligation. d) The event giving rise to the liability has already occurred. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why current liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

18. All of the following are examples of current liabilities, EXCEPT for a) accrued expenses. b) deferred revenues. c) interest payable. d) prepaid expenses. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why current liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

19. Given that most current liabilities will be settled with cash, it is important to identify and record these liabilities separately because it helps users to assess a) solvency. b) cash position. c) net income. d) liquidity. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why current liabilities are of significance to users.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

20. Accounts payable are recorded on the books at the a) net present value. b) net amount. c) net realizable value. d) face value. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for current liabilities. CPA: Financial Reporting AACSB: Analytic

21. Non-current liabilities are recorded in the books at the a) present value. b) net amount. c) net realizable value. d) gross amount. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for current liabilities. CPA: Financial Reporting AACSB: Analytic

22. Time value of money a) is generally used for valuing all liabilities. b) reflects the difference between the value of a dollar today versus a dollar paid in the future. c) is not used for financial reporting purposes. d) is immaterial. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the valuation methods for current liabilities. CPA: Financial Reporting

Current Liabilities

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AACSB: Analytic

23. On July 31, 2024, Able Co. has a $500,000 15-year mortgage outstanding. Over the next year, the company will make 12 monthly payments of $5,000, representing $33,500 of interest and $26,500 of principal repayment. Which of the following best represents how the mortgage will be reported on the July 31, 2024, statement of financial position? Current Liabilities Non-Current Liabilities a) $26,500 $473,500 b) $26,500 $440,000 c) $60,000 $440,000 d) $60,000 $473,500 Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe the valuation methods for current liabilities. CPA: Financial Reporting AACSB: Analytic

24. For which of the following reasons would a user examine the current liabilities? a) to determine how quickly accounts receivable are collected b) to determine how much cash will be required to meet obligations in the short term c) to determine how much cash will be required to meet obligations in the long-term d) to evaluate company performance Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

25. A short-term liability used by a company to finance the purchase of current assets and that is often secured by accounts receivable, or inventory is referred to as a(n) a) accounts payable. b) current liability. c) line of credit. d) overdraft protection. Answer: c

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

26. Corporations can finance current cash shortages using all of the following, EXCEPT for a) a line of credit. b) the current portion of long-term debt. c) a short-term loan. d) a working capital loan. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

27. Bank indebtedness includes all of the following, EXCEPT for a) a bank overdraft. b) a line of credit. c) revolving credit facilities. d) the current portion of long-term debt. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

28. A company has $5,000,000 in long-term debt outstanding. It expects to repay the loan evenly over the next four years. Which of the following represents how the debt will be presented on the year-end statement of financial position? a) Accounts Payable: $1,250,000, Long-Term Debt: $3,750,000 b) Current Portion of Long-Term Debt: $1,250,000, Long-Term Debt: $3,750,000

Current Liabilities

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c) Current Portion of Long-Term Debt: $2,500,000, Long-Term Debt: $2,500,000 d) Long-Term Debt: $5,000,000 Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

29. Which of the following liabilities is often referred to as “free debt” because it rarely carries any interest if paid within a specified period of time? a) line of credit b) working capital loan c) accounts payable d) all current liabilities carry an interest rate Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

30. Typically, acquisition costs for inventory can be financed through the use of a) overdraft protection. b) accounts payable. c) working capital. d) notes payable. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

31. Which of the following statements about accounts payable is NOT true? a) They are usually due within 30 to 60 days. b) They normally carry implicit interest charges. c) There may be a penalty for late payment. d) They are typically used to finance inventory purchases. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

32. During 2024, Lockport Appliances sold 400 appliances worth $2,000,000. Each appliance comes with a one-year assurance-type warranty, which Lockport estimates will cost $75 each. During the year, Lockport spent $12,500 on warranty costs for the appliances sold in 2024. At the end of 2024, the warranty provision and the warranty expense related to these sales would be closest to Warranty Provision Warranty Expense a) $17,500 $12,500 b) $17,500 $30,000 c) $12,500 $12,500 d) $30,000 $30,000 Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

33. Which of the following liabilities requires the use of an estimate when it is initially recorded? a) Wages Payable b) Deferred Revenue c) Warranty Provision d) Accounts Payable Answer: c

Current Liabilities

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

34. Which of the following companies would be most likely to have a deferred revenue account? a) grocery store b) department store c) hotel chain d) car dealership Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

35. Which of the following companies would usually NOT have a deferred revenue account? a) magazine publishing company b) property management company c) airline d) hardware store Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

36. All of the following situations contribute to the need for a company to recognize deferred revenues, EXCEPT for a) partially executed contracts between buyers and sellers. b) the requirement by sellers for the prepayment of goods and services. c) mutually unexecuted contracts between buyers and sellers.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

d) the seller has collected a deposit but has an outstanding performance obligation under the contract. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

37. Botanical Spas sells $2,500 worth of gift certificates in November and December. 25% of the gift certificates are redeemed in December prior to the December 31 year end. The entry to record the sale of the gift certificates is a) Dr. Cash, Cr. Gift Card Revenue b) Dr. Gift Card Revenue, Cr. Gift Card Liability c) Dr. Prepaid Gift Cards, Cr. Gift Card Revenue d) Dr. Cash, Cr. Gift Card Liability Botanical Spas sells $2,500 worth of gift certificates in November and December. 25% of the gift certificates are redeemed in December prior to the December 31 year end. Answer: d Bloomcode: Application Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

38. Botanical Spas sells $2,500 worth of gift certificates in November and December. 25% of the gift certificates are redeemed in December prior to the December 31 year end. The required year-end adjusting entry is a) Dr. Revenues $625, Cr. Gift Card Liability $625 b) Dr. Revenues $1,875, Cr. Gift Card Liability $1,875 c) Dr. Gift Card Liability $625, Cr. Revenues $625 d) Dr. Gift Card Revenues $1,875, Cr. Revenues $1,875 Answer: c Bloomcode: Application

Current Liabilities

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Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

39. The term breakage refers to a) deferred gift card revenues. b) the portion of a gift card that will never be redeemed. c) the amount of gift card revenue that cannot be recognized. d) expenses related to damaged credit cards. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

40. Lokus Lofts is a rental company that requires its tenants to pay rent one month in advance. Lokus should record the cash received as a) Prepaid Rent. b) Rent Revenue. c) Deferred Revenue. d) Accounts Payable. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

41. When business owners offer programs that enable customers to accumulate points or other credit when making purchases, this results in a) customer loyalty revenues. b) performance obligations. c) prepaid services. d) an assurance warranty.

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Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

42. A customer loyalty provision specifically refers to a) points that a customer has redeemed in the past. b) the liability related to the unused loyalty points or credits. c) the revenues earned from the use of points. d) the cash received from the use of points. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

43. Outstanding balances for service-type warranties are a) expensed against revenues in the current period. b) not considered separate performance obligations. c) reported the same way as deferred revenues. d) reduce the selling price of a company’s services. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

44. Ruby’s & Rings Inc. offers a two-year assurance warranty against failure of its products. The estimated liability is 4% of sales in the year of sale and 6% in the second year. Sales for 2024 and 2025 were: $2,500,000 and $2,800,000, respectively. The company incurred no warranty

Current Liabilities

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costs in 2024, but in 2025 they spent $175,000 on repairs related to the warranties issued in 2024 and 2025. The warranty provision at the 2024 year end was a) $0. b) $100,000. c) $150,000. d) $250,000. Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

45. Ruby’s & Rings Inc. offers a two-year assurance warranty against failure of its products. The estimated liability is 4% of sales in the year of sale and 6% in the second year. Sales for 2024 and 2025 were: $2,500,000 and $2,800,000, respectively. The company incurred no warranty costs in 2024, but in 2025 they spent $175,000 on repairs related to the warranties issued in 2024 and 2025. The warranty expense for 2024 was a) $80,000. b) $100,000. c) $150,000. d) $250,000. Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

46. Ruby’s & Rings Inc. offers a two-year assurance warranty against failure of its products. The estimated liability is 4% of sales in the year of sale and 6% in the second year. Sales for 2024 and 2025 were: $2,500,000 and $2,800,000, respectively. The company incurred no warranty costs in 2024, but in 2025 they spent $175,000 on repairs related to the warranties issued in 2024 and 2025.

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The balance in the warranty provision account at the end of the 2025 year was a) $75,000. b) $280,000. c) $355,000. d) $530,000. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

47. Radio Hut Inc. offers a two-year assurance warranty against failure of its products. The estimated liability is 1.5% in the year of sale and 3% in the second year. Sales and actual warranty expense for 2024 and 2025 were:

2024 2025

Sales $3,500,000 $3,900,000

Actual Warranty Costs Incurred During Year $110,000 $195,000

The warranty provision on the December 31, 2024 statement of financial position was a) $47,500. b) $105,000. c) $110,000. d) $157,500. Answer: a Bloomcode: Application Difficulty: Hard Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

48. Radio Hut Inc. offers a two-year assurance warranty against failure of its products. The estimated liability is 1.5% in the year of sale and 3% in the second year. Sales and actual warranty expense for 2024 and 2025 were:

Current Liabilities

2024 2025

Sales $3,500,000 $3,900,000

Actual Warranty Costs Incurred During Year $110,000 $195,000

The warranty provision on the December 31, 2025 statement of financial position was a) $0. b) $28,000. c) $138,000. d) $175,500. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

49. Radio Hut Inc. offers a two-year assurance warranty against failure of its products. The estimated liability is 1.5% in the year of sale and 3% in the second year. Sales and actual warranty expense for 2024 and 2025 were:

2024 2025

Sales $3,500,000 $3,900,000

Actual Warranty Costs Incurred During Year $110,000 $195,000

The warranty expense for 2025 was a) $157,500. b) $175,500. c) $195,000. d) $305,000. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

50. The following information relates to KC Enterprises payroll for the month of July: Total wages ............................................................ $15,000

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Income tax withheld ............................. 3,000 Employees’ CPP contributions ............. 742.50 Employees’ EI contributions................. 240 Company contributions for CPP ........... 742.50 Company contributions for EI .............. 336 The total wage expense for KC Enterprises for the month of July is a) $14,107.50. b) $16,078.50. c) $9,285. d) $16,024.50. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

51. Which of the following liabilities results from amounts owed by both the employee and the employer? a) employee income tax payable b) wages payable c) employment insurance payable d) vacation pay payable Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

52. An employee earns $1,500 a week, the deductions from the employee’s paycheque for EI, CPP, and income taxes are equal to $185. The company must contribute an additional $105 for EI and CPP. How much would the company record as total salary expense for the employee in this week? a) $1,420 b) $1,500 c) $1,605 d) $1,790

Current Liabilities

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

53. Miller Manufacturing has a two-week payroll of $8,200 for its eight employees. Income tax of $1,080 is deducted from the employees' pay cheques, as well as 5.45% for CPP and 1.58% for EI. Wages deposited in employees' bank accounts, rounded to the nearest dollar, would be a) $6,544. b) $7,120. c) $7,663. d) $8,200. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

54. Which of the following statements concerning income taxes in Canada is NOT true? a) Income taxes must often be estimated based on prior years’ tax returns. b) Income taxes are usually paid through instalment payments throughout the year. c) The deadline for filing a corporate tax return and payment of any outstanding taxes is six months after the company's year end. d) Income taxes payable is reported as a current liability. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with government and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

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55. When the board declares dividends, the correct journal will be a) Dividends Expense Dividends Payable b) Dividend Declared Cash c) Dividends Declared Dividends Payable d) Dividends Receivable Dividends Revenue Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with shareholders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

56. Dividends Payable is the most common type of liability the corporation has to a) the government. b) the employees. c) the shareholders. d) the board of directors. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with shareholders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

57. An increase in A/P turnover year over year a) is due to increased payments to suppliers. b) increases the number of days accounts payable are outstanding. c) increases expenses. d) is meaningless without comparative data. Answer: a Bloomcode: Comprehension Difficulty: Medium

Current Liabilities

Learning Objective: Identify the current liabilities that arise from transactions with shareholders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

58. The accounts payable turnover ratio measures a) number of times the company settles its trade payable. b) average accounts payable balance. c) the average number of times the industry settles their trade payable. d) the average balance of accounts payable to current assets. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Calculate the accounts payable turnover ratio and average payment period and assess the results. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

EXERCISES 59. The following instalment payment schedule is for a long-term mortgage payable for Melrose Enterprises: Interest Period Cash Payment Interest Expense Reduction of Principal Principal Balance Jan 1, 2024 $120,000.00 Dec 31, 2024 $28,487.57 $7,200.00 $21,287.57 98,712.43 Dec 31, 2025 28,487.57 $5,922.75 22,564.82 76,147.61 Dec 31, 2026 28,487.57 $4,568.86 23,918.71 52,228.89 Dec 31, 2027 28,487.57 $3,133.73 25,353.84 26,875.06 Dec 31, 2028 28,487.57 $1,612.50 26,875.06 0.00 In addition to the mortgage payable, Melrose also has balances in the following select accounts on December 31, 2026: Accounts Payable $25,000 Bank overdraft $12,500 Income Tax Payable $11,500 Interest Expense $2,750 Deferred Revenues $1,250 Instructions a) Prepare the necessary entry to update the current portion of long-term debt account for December 31, 2026. b) Prepare the liabilities section of the statement of financial position for December 31, 2026, for Melrose Enterprises. Solution (10 min.) a) Dr. Long-term debt ....................................................$ 25,353.84 Cr. Current Portion of LTD.................................. $ 25,353.84 b) MELROSE ENTERPRISES Statement of Financial Position December 31, 2026 Current Liabilities Bank Indebtedness Accounts Payable Income Tax Payable Deferred Revenues Current Portion of LTD Total Current Liabilities

$ 12,500 $ 25,000 $ 11,500 $ 1,250 $ 25,353.84 $ 75,603.84

Non-Current Liabilities Mortgage Payable

$ 26,875.06

Current Liabilities

Total Liabilities

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$102,478.90

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

60. Spring Water Corporation has the following selected accounts at March 31, 2024, after posting adjusting entries: Accounts Payable, March 31, 2024 ...................................... $ 67,500 Accounts Payable, March 31, 2023……………………. ....... 61,500 Credit Purchases………………………………………. ........ 625,750 Bank Loan Payable, 3-month .............................................. 135,000 Employee Benefits Expense ................................................ 6,000 Interest Payable ................................................................... 7,550 Mortgage Payable ................................................................ 135,000 Income Tax Payable ............................................................. 14,000 Instructions a) Prepare the current liability section of Spring Water Corporation's statement of financial position, assuming $19,500 of the mortgage is payable next year. b) Calculate the A/P turnover, day’s turnover and working capital. Comment on Spring Water’s liquidity, assuming total current assets are $575,000 and supplier terms are net 30. Solution (12 min.) a)

SPRING WATER CORPORATION Statement of Financial Position (partial) March 31, 2024

Current Liabilities Accounts payable ..................................................................................... Interest payable ....................................................................................... Income tax payable .................................................................................. Bank loan payable, 3-month ................................................................... Current portion of long-term debt ..........................................................

67,500 7,550 14,000 135,000 $ 19,500

Total current liabilities .....................................................................

$243,550

A/P turnover: $625,750 / ((67,500 + 61,500) / 2) = 9.7 X or 37.6 days. The liquidity position looks favourable. If all current liabilities are paid out of current assets, there would still be $331,450 of current assets (working capital). The current ratio is 2.4:1, and it appears as

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

though Spring Water Corporation has sufficient current resources to meet current obligations when due. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with government and explain how they are accounted for. Learning Objective: Calculate the accounts payable turnover ratio and average payment period and assess the results. CPA: Financial Reporting AACSB: Analytic

61. Juliana Limited has an October 31 year end. On October 1, 2024, Juliana had the following current liabilities listed on its books: Bank overdraft ................................................ $23,250 Accounts payable ............................................ 112,500 CPP, EI and income tax payable ..................... 8,620 Deferred revenues ........................................... 12,000 During October 2024, Juliana engaged in the following transactions: Oct 1 Negotiated a $50,000 line of credit with their bank to replace the bank overdraft. Oct 5 Sold goods worth $30,000 on which they had previously received a $12,000 deposit. The balance is due in 30 days. Oct 12 Bought $20,000 of inventory on credit, terms of 30 days. Oct 15 Paid amounts due the Government of Canada for the payroll amounts outstanding from September 30. Oct 20 Paid $87,000 owing to a supplier. Oct 21 Received $5,000 from a client for work that will be performed in January 2018. Oct 21 Sold $56,000 of goods, half for cash, half on credit. Oct 22 Made a $10,000 payment on the line of credit. Oct 30 Paid the monthly payroll amounts to employees. The gross payroll was $16,200. Amounts withheld from the employees' cheques were as follows: • Canada pension plan premiums (CPP) $802 • Employment insurance premiums (EI) $259 • Income tax $2,800 At this time, the company also recorded their liability for amounts due to the government for CPP and EI.

Current Liabilities

Oct 31

Declared $5,000 of dividends payable next year.

Instructions a) Prepare all of the journal entries required as a result of the above transactions. b) Prepare the current liabilities section of the statement of financial position at October 31, 2024. Solution (25 min.) a) Oct 1 Dr. Bank overdraft ................................... Cr. Bank loan—current.................. Oct 5

Oct 12

Oct 15

Oct 20

Oct 21

Oct 22

Oct 30

Oct 31

23,250 23,250

Dr. Accounts receivable........................... Dr. Deferred revenue ............................... Cr. Sales .........................................

18,000 12,000

Dr. Inventory ............................................ Cr. Accounts payable ....................

20,000

Dr. CPP, EI and income tax payable ........ Cr. Cash..........................................

8,620

Dr. Accounts payable .............................. Cr. Cash..........................................

87,000

Dr. Cash .................................................... Cr. Deferred revenue .....................

5,000

Dr. Cash .................................................... Dr. Accounts receivable........................... Cr. Sales .........................................

28,000 28,000

Dr. Bank loan, current ............................. Cr. Cash..........................................

10,000

Dr. Wage expense .................................... Cr. CPP payable ............................. Cr. EI payable................................. Cr. Income tax payable ................. Cr. Cash..........................................

16,200

Dr. Wage expense .................................... Cr. CPP payable ............................. Cr. EI payable ................................

1,165

Dr. Dividends declared ............................

5,000

30,000

20,000

8,620

87,000

5,000

56,000

10,000

802 259 2,800 12,339

802 363

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Cr. Dividends Payable ...................

5,000

b) JULIANA LIMITED Partial Statement of Financial Position October 31, 2024 Current Liabilities Bank loan ($23,250 – 10,000) ............................................... Accounts payable ($112,500 + 20,000 – 87,000) .................. CPP and EI payable ($8,620 – 8,620 + 1,061+ 1,165) ........... Income taxes payable .......................................................... Dividends payable................................................................ Deferred revenue ($12,000 – 12,000 + 5,000) ...................... Total......................................................................................

$13,250 45,500 2,226 2,800 5,000 5,000 $73,776

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with government and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with shareholders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

62. In September 2024, EastWest Airlines sells all of its available seats for travel from Calgary to Ixtapa, Mexico, during the months of December 2024 and January and February 2025. Total airfare collected by EastWest for the sale of these airline tickets is $2,400,000. There are an equal number of flights to Ixtapa each month. EastWest’s estimated Cost of Sales (fuel, salaries, etc.) is 60%. Instructions a) Prepare all of the necessary journal entries for 2024. b) What liabilities, if any, will need to be reflected on the December 2024 statement of financial position? Solution (8 min.) a) Sep 2024

Current Liabilities

Dr. Cash ........................................................... Cr. Deferred Revenues............................. Dec 2024 Dr. Deferred/Deferred Revenues .................... Cr. Revenues ............................................ Dr. Cost of Sales .............................................. Cr. Cash ....................................................

2,400,000 2,400,000

800,000 800,000 480,000 480,000

b) Current liabilities – Deferred Revenues .............

1,600,000

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

63. Canadian Health Care Inc. provides a two-year assurance warranty on its products. Estimates are that warranty costs will be 3% of sales in the year of sale and 5% the following year. Sales and actual warranty costs for Canadian Health Care’s first two years of operations were Sales Actual Warranty Costs Incurred During the Year 2024 $2,000,000 $ 65,000 2025 $2,500,000 $273,000 Instructions a) Determine the warranty expense and warranty provision as at year end for 2024. b) Determine the warranty expense and warranty provision liability as at year end for 2025. c) Prepare all relevant journal entries assuming that all actual warranty claims are settled at year end. Solution (12 min.) a) Warranty expense = $2,000,000 ×.08 = $160,000 Warranty provision as at year end = $160,000 – $65,000 = $95,000 b)

Warranty expense = $2,500,000 ×.08 = $200,000 Warranty provision as at year end = $95,000 + 200,000 – 273,000 = $22,000

c) 2024 Dr. Warranty Expense...................................... Cr. Warranty provision ............................ Dr. Warranty provision .................................... Cr. Cash ....................................................

$160,000 $160,000 $65,000 $65,000

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2025 Dr. Warranty Expense...................................... Cr. Warranty provision ............................ Dr. Warranty provision .................................... Cr. Cash ....................................................

$200,000 $200,000 $273,000 $273,000

64. During the current month, the employees of a company have earned wages of $120,000, and the following source deductions were withheld: • Income tax $30,000 • CPP premiums $5,940 • EI Premiums $1,920 On the 15th of the following month the employer paid all required remittances. Instructions Prepare all the necessary payroll journal entries, including the necessary remittance. Solution (10 min.) Dr. Wage Expense ............................................ Cr. Employee income taxes payable....... Cr. CPP payable ....................................... Cr. EI payable ........................................... Cr. Cash ....................................................

$120,000 $30,000 $5,940 $1,920 $82,140

Dr. Wage Expense ............................................ Cr. CPP payable ....................................... Cr. EI payable ...........................................

$8,628

Dr. Employee income taxes payable .............. Dr. CPP payable ............................................... Dr. EI payable .................................................. Cr. Cash ....................................................

$30,000 $11,880 $4,608

$5,940 $2,688

$46,488

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting

Current Liabilities

AACSB: Analytic

65. Forever House Company’s (FHC) payroll for the semi-monthly pay period ending August 31 amounted to $324,000. The following deductions were withheld from the employees’ wages for this period: Federal and Provincial Income Taxes .................... $58,600 CPP ................................................................. 10,050 EI 4,010 Union Dues .............................................................. 2,000 Charitable Donations.............................................. 1,500 Instructions Prepare the journal entry to record FHC’s semi-monthly payroll ending August 31 and any necessary entries to record FHC’s share of source deductions. Solution (10 min.) Aug 31 Wage Expense ......................................................... 324,000 Employee Income Taxes Payable ................. CPP Payable .................................................. EI Payable ...................................................... Union Dues Payable ...................................... Charitable Donations Payable ...................... Cash ............................................................... To record payroll for the month ending August 31.

58,600 10,050 4,010 2,000 1,500 247,840

Aug 31 Wage Expense ......................................................... 15,664 CPP Payable .................................................. 10,050 EI Payable ($4,010 × 1.4) ............................... 5,614 To record the employer's share of CPP and EI premiums on the August 31 payroll. Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

66. Below is the financial data pertaining to Printcraft Inc.:

Accounts Payable COGS

2024 22,500 102,750

2025 17,500 98,000

2026 15,450 96,450

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Beg. Inv End. Inv

130,000 121,750

121,750 101,500

101,500 112,500

Instructions Compute the accounts payable turnover ratio and the accounts payable payment period for 2025 and 2026. Solution

COGS Beg. Inv End. Inv Purchases

2024 102,750 (130,000) 121,750 94,500

2025 98,000 (121,750) 101,500 77,750

2026 96,450 (101,500) 112,500 107,450

Accounts Payable Turnover Ratio: 2025 = 77,750 / ((22,500 + 17,500 )/ 2) = 3.89 2026= 107,450 / ((17,500 + 15,450) / 2) = 6.52

Accounts payable payment period: 2025 = 365 / 3.89= 93.83 days 2026 = 365 / 6.52 = 55.98 days Bloomcode: Application Difficulty: Medium Learning Objective: Calculate the accounts payable turnover ratio and average payment period and assess the results. CPA: Financial Reporting AACSB: Analytic

Current Liabilities

MATCHING 67. Listed below are several ways to classify liabilities followed by a series of situations. Match the classifications to the situations by placing the appropriate letter in the space provided. CLASSIFICATIONS A) Current liabilities that arise from transactions with employees B) Current liabilities that arise from transactions with customers C) Current liabilities that arise from transactions with lenders D) Current liabilities that arise from transactions with shareholders E) Current liabilities that arise from transactions with government F) Not a current liability SITUATIONS ____ 1. Gift cards sold ____

2. Wages payable

____

3. Wages Expense

___

4. Estimates of future costs associated with assurance-type warranties

___

5. EI and CPP payable

___

6. Annual corporate income tax payable

___

7. Current portion of long-term debt

___

8. Bank overdraft

___

9. Dividend payable

___

10. Warranty expense

___

11. Customer Loyalty Provision

___

12. Sale of service-type warranties

Solution (3 min.) 1. B

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10. F 11. B 12. B Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why current liabilities are of significance to users. Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with government and explain how they are accounted for. Learning Objective: Identify the current liabilities that arise from transactions with shareholders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

Current Liabilities

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SHORT-ANSWER ESSAY QUESTIONS 68. In order for an item to be classified as a liability, what three characteristics must it have? Solution (3 min.) 1. It is a present obligation of the entity. 2.

The company expects to settle it through an outflow of resources that represent future economic benefits.

The obligation results from an event that has already happened.

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why current liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

69. You have just started your new position at Entity Investments as the financial statement analyst. Your boss is concerned about the value of liabilities reported on the financial statements. The non-current liabilities are recorded using the discounted present values, and the current liabilities are recorded using the face value. Instructions Explain to your boss why current liabilities and non-current liabilities are valued differently. Solution (5 min.) Liabilities should be recorded at their fair value and in subsequent periods recorded at their present value of the payments required. This represents the time value of money, a dollar paid in the future is worth less than a dollar paid today. Therefore, non-current liabilities must be recorded as the present value of payment required. Present value calculations are not necessary for current liabilities since the time period in which they must be settled is short (less than one year). Therefore, the difference in the present value and face value would not be material. Given this, current liabilities can remain to be recorded at face value. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the valuation methods for current liabilities. CPA: Financial Reporting AACSB: Analytic

70. Explain what a line of credit is and why a company might need one, and how a company

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would use it. Provide examples. How does this differ from a working capital loan? Solution (10 min.) A line of credit is a revolving credit facility provided by the bank to deal with short-term or temporary cash fluctuations. The bank assesses the company’s ability to repay short-term debt and establishes a short-term loan limit that it believes is reasonable. If the company writes cheques that exceed the company’s cash balance in the bank, the bank covers the shortfall. The bank uses subsequent cash deposits by the company to repay the loan. The company might use this facility during seasonal fluctuations in the business, to bridge timing differences between the collection of A/R and purchases of inventory. This differs slightly from a working capital loan that is based on the value of, and secured by, outstanding A/R and inventory. The bank may authorize a loan based on 60% of the outstanding A/R or 40% of the inventory for example. As the A/R and inventory balances fluctuate, so too does the maximum amount of the working capital loan. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

71. You have just recently been hired to oversee Kid’s R Us’ accounts payable department. You have been asked to review the department’s “free debt” policy. Currently payables are never paid early even though there are significant early payment discounts available. What is “free debt”? Provide a rationale both for and against such a policy. Solution (5 min.) Free debt is considered to be the normal A/P period; whereby, the A/P generally do not carry implicit interest charges and are thought of as “free debt”. However, there is sometimes a provision for either a discount for early payment or a penalty for late payment. In such cases, not taking advantage of the discount, or paying a penalty for being late, can be viewed as equivalent to paying interest. Students arguments for and against will vary. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

Current Liabilities

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72. Easy Electronics Inc. is a store specializing in electronic products. For the first time this year, it offered a one-year warranty on all products sold in the store and sold on gift cards. The company estimates that the warranty costs should average 2% of sales (total sales of $8,000,000 in this past year), and by year end it had spent $40,000 on the program. Easy Electronics t sold $25,000 worth of gift cards during the year, but only $5,000 had been redeemed. Instructions The accountant has asked you to explain how these two new types of services should be recorded. Solution (10 min.) The warranty expense should be accrued for the full estimated amount, $160,000. The full expense is recorded in the same period as the revenue is recognized. A liability would be established for the same amount, and then as costs are incurred, in this case the $40,000, the liability is reduced. In the next year, when more costs are incurred, they will be recorded as a further reduction in the liability and not as an expense of that period. Gift cards sold are not recorded as a sale, but as a liability. Although the cash has been received the amount has not been earned, in that Easy Electronics has not performed a service or provided a product yet. Since it is not known what product will be purchased with the gift card, the cost of the products cannot be recorded, so the income cannot be measured. The $5,000 of cards redeemed during the year would be recorded as a sale and a reduction in the gift card liability. Bloomcode: Application Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

ESSAY QUESTIONS 73. You are the controller of a large Auto dealership that offers customers a three year, 60,000 km, bumper to bumper warranty at no extra cost, or customers may purchase an extended warranty that provided bumper to bumper coverage for five years or 100,000 km. In reviewing the year-end financial statements the General Manager notices that you have accounted for these two warranties differently. Provide the GM with an explanation of these two types of warranties and how the warranties are accounted for. Solution (10 min.) There are two types of warranties: an assurance-type warranty and a service-type warranty. The primary distinction between the two is that service-type warranties are available for purchase and provide customers with some additional assurance beyond the product performing as expected and being free from defects. Service-type warranties are considered to be a separate service obligation. A liability, deferred warranty revenue, is recorded and recognized over the warranty period. Any warranty expenses are recorded as incurred. Assurance type warranties are not considered to be separate performance obligations. Instead the estimated warranty expenses are recorded in the period in which the related product was sold and a corresponding liability, warranty provision is recorded. Any warranty claims are charged against this provision (as warranty expense was recorded when the provision was established). Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

74. Several provinces have eliminated the expiry dates for gift cards with a dollar value. What challenges does this create for businesses issuing gift cards? Solution (5 min.) Gift card sales are generally recorded as deferred revenue under current liabilities. If gift cards no longer have an expiry date, there is no guarantee as to when those gift cards will be redeemed. As a result, the deferred revenue liability may not be a current liability but rather a non-current liability creating accounting difficulties for firms. Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

CHAPTER 10 LONG-TERM LIABILITIES CHAPTER LEARNING OBJECTIVES 1. Explain why long-term liabilities are of significance to users. • Long-term liabilities will affect a company for many years. Some long-term liabilities, such as bonds or employee pensions, may not be settled for 30 or 40 years. • It is also important to be aware of the potential for unrecorded liabilities, such as contractual commitments or litigation involving the company.

2. Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. • Long-term liabilities involving lenders include loans payable, mortgages payable, notes payable, and bonds payable. • Mortgages are long-term debt for which a capital asset has been pledged as collateral. • Most loans and mortgages are instalment loans that require periodic loan payments. These are usually blended, meaning that they include both principal and interest components. • It is common for loan financing agreements to specify certain covenants, which are conditions or restrictions on the borrower. • The terms and conditions related to bonds (or notes) are specified in indenture agreements. • The bond rate (or contract rate) is used to determine the amount of the interest payment that will be made to the bondholders. • The yield (or effective rate) is used to determine the amount of the interest expense that will be recorded by the issuer. • Bonds may be issued at par (bond rate equals yield), at a premium (bond rate is greater than yield), or at a discount (bond rate is less than yield). • Bond premiums and discounts are amortized over the life of the bond, with the amortization amount for each period equal to the difference between the interest payment and the interest expense. • Debentures are bonds that are not backed by specific collateral.

3. Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. • Companies lease assets for a variety of reasons, including not having the cash to purchase them, wanting to preserve their cash, having only a short-term need for the asset, and expecting the asset to become obsolete quickly. • Virtually all leases result in the leased asset being recorded as a right-of-use asset and a corresponding lease liability. The right-of-use asset is depreciated like other

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property, plant, and equipment. The lease payments are allocated between a repayment of the lease liability and interest expense.

4. Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. • The most common type of long-term liability arising from transactions with employees is a pension plan. There are three types of pension plans: (1) defined contribution, (2) defined benefit, and (3) hybrid plans. • With defined contribution plans, the employer is responsible for funding only its contribution and has no ongoing responsibility. The employee’s pension will depend upon the investment returns realized on the funds in the plan. • With defined benefit plans, the employer is responsible for providing employees with the agreed-upon benefit upon retirement. The employer bears the risk related to poor investment returns on the funds in the plan. If a defined benefit plan is fully funded, it means that the present value of the estimated future pension benefits is equal to the assets of the pension plan. Many defined benefit plans are underfunded, meaning that the present value of the estimated future pension benefits exceeds the plan’s assets. • Hybrid pension plans combine features of both defined contribution and defined benefit plans. Target benefit levels are established and funded through fixed contributions. If these are insufficient, then benefit levels can be reduced or contributions increased.

5. Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. • Deferred income taxes result from differences between the accounting treatment a company follows and the treatment specified by the Income Tax Act. A common difference is in how to depreciate capital assets, whereby a company would use accounting depreciation but the Income Tax Act requires using capital cost allowance for tax purposes • Deferred taxes are taxes that are expected to come due at some point in the future but are not payable to the government at present.

6. Explain what commitments and guarantees are and how they are treated. • Mutually unexecuted contracts are contracts in which neither party to the contract has done anything other than entering into the contract. As neither party has done anything, no liability is recorded in relation to the contracts, but they are disclosed when they may have a material impact in future years.

7. Explain contingencies and how they are accounted for. Contingencies are potential liabilities for which there is uncertainty with respect to timing or amount. Their outcome depends upon some future event occurring.

Long-Term Liabilities

• •

The most common type of contingency involves litigation against a company. The outcome of the litigation will depend upon a court decision or future settlement. Provisions are not established if there is uncertainty with respect to whether or not the company will have a liability, it is considered unlikely that the company will have a liability, or the amount of any obligation cannot be reliably measured.

8. Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. • The debt to equity ratio can be determined by dividing net debt by shareholders’ equity. Net debt is equal to a company’s interest-bearing debt less its cash balance. The debt to equity ratio measures the amount of debt relative to shareholders’ equity (that is, the amount of long-term debt a company has for each dollar of shareholders’ equity). The higher a company’s level of debt, the higher this ratio will be. Companies with a high debt to equity ratio are considered to be highly leveraged. • The net debt as a percentage of total capitalization ratio can be determined by dividing net debt by total capitalization. Total capitalization is equal to a company’s shareholders’ equity plus its interest-bearing debt less its cash balance. The net debt as a percentage of total capitalization ratio measures the proportion that debt makes up of a company’s total capitalization (that is, what percentage debt represents of the company’s total financing). The higher a company’s long-term debt, the higher this ratio will be. The higher the ratio, the more highly leveraged a company is considered to be. • The interest coverage ratio can be determined by dividing earnings before interest, taxes, depreciation, and amortization (EBITDA) by interest expense. The interest coverage ratio measures the number of times a company’s earnings could pay its interest expense. The higher the ratio, the less risk there is that the company will be unable to meet its interest obligations.

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TRUE-FALSE STATEMENTS 1. There is an inverse relationship between the discount rate and the selling price of a bond. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

2. The carrying value of a bond issued at a discount decreases over time. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

3. Restrictions placed on a company by the lender are also known as covenants. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

4. An investment banker is usually hired to assist a company in issuing debt securities. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders

Long-Term Liabilities

and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

5. A company is NOT required to disclose the details of its long-term loans in the notes to the financial statements. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

6. Companies must always accrue interest between the last loan payment date and the company’s reporting date. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

7. Bank loan covenants only pertain to financial data such as ratios. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

8. Non-financial covenants may include a requirement to have an annual audit. Answer: True

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

9. All bond covenants are recorded in an agreement called a debenture agreement. Answer: False Bloomcode: Knowledge Difficulty: hard Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

10. A public offering is open to all investors including institutions. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

11. Debentures can be either senior or subordinated. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

12. The interest rate paid on the bond is known as the effective rate.

Long-Term Liabilities

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

13. Under all leases the liability is recorded as “lease liability.” Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

14. Off-balance sheet financing occurs for all leases. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

15. Post-employment benefits other than pensions are expensed on an accrual basis. Answer: True Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

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16. Benefits that are NOT contingent upon an employee's continued employment are called vested benefits. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

17. The two kinds of pension plans that are commonly used by employers are: defined obligation plans and defined contribution plans. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

18. A defined benefit plan is similar to a defined contribution plan in that only employers contribute to the plan. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

19. An actuary is only necessary when there is a dispute between contributions made and benefits expected to be received for a defined benefit plan. Answer: False Bloomcode: Comprehension

Long-Term Liabilities

Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

20. Pension funds are described as underfunded if the value of the pensions fund assets is less than the present value of the future pension obligations. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

21. Hybrid pension plans are also known as target benefit plans. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

22. Temporary differences between accounting and taxable income will eventually offset. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

23. A deferred tax asset can be recognized when a lower income tax payable will occur in the future.

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Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

24. Deferred income taxes represent amounts due to Canada Revenue Agency in the current year. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

25. A temporary difference is a difference between tax and accounting income that will NOT reverse in a future period. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

26. The calculation of future taxes is based on the temporary differences between accounting income and taxable income. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law.

Long-Term Liabilities

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27. Depreciation expense and Capital Cost Allowance create temporary differences for the purpose of calculating future taxes. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

28. A purchase commitment is an example of a mutually unexecuted contract. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what commitments and guarantees are and how they are treated. CPA: Financial Reporting AACSB: Analytic

29. Liabilities are the result of events or transactions that have already occurred. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

30. The debt/equity ratio is most commonly used by a lender in order to evaluate an entity’s profitability. Answer: False Bloomcode: Comprehension Difficulty: Medium

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Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

31. The interest-coverage ratio uses interest expense as its numerator. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

32. Leverage is the extent to which a company is using the funds provided by its shareholders to generate returns for creditors. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

33. The debt to equity ratio measures the extent of debt relative to each dollar in equity. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

34. Net debt is the name given to the amount of interest-bearing debt less all current assets. Answer: False

Long-Term Liabilities

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 35. Which of the following statements regarding long-term liabilities is NOT correct? a) Long term liabilities has an affect on the company for many years into the future. b) Long term liabilities have an impact on the firm’s liquidity. c) Long term liabilities can provide information on potential litigation and contractual obligations. d) Long term liabilities provide information about the health of employee pension plans. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why long-term liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

36. Long-term liabilities include all of the following, EXCEPT for a) deferred income taxes. b) lease liabilities. c) wage obligations. d) pension liabilities. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why long-term liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

37. A long-term loan against which collateral has been pledged is known as a) bank indebtedness. b) Line of Credit. c) Mortgage Payable. d) Lease Liability. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for.

Long-Term Liabilities

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CPA: Financial Reporting AACSB: Analytic

38. Loans that require payments of principal plus interest are referred to as a) Lines of Credit. b) instalment loans. c) bank overdraft. d) Bonds Payable. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

39. Blended payment loans require a loan amortization schedule separating principal and interest. This is required, in part, because a) interest only is reflected on the cash flow statement. b) interest and principal needs to be reflected under current and not current liabilities section of the statement of financial position. c) the interest expense is recorded separately from the reduction of the loan payable. d) interest will also be reflected as a principal reduction in the loan amortization schedule. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

40. The distinction between senior and subordinated debt is associated with a) general debenture bonds. b) mortgage bonds. c) collateral trust bonds. d) commercial bonds. Answer: a

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

41. All of the following are used to determine the bond premium or the bond discount EXCEPT for a) market rate. b) yield rate. c) coupon rate. d) capital rate. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

42. The proceeds from the sale of a bond are equal to a) the face value of the bond. b) the face value of the bond plus the present value of the interest to be paid. c) the maturity value of the bond plus the interest to be paid. d) the present value of the principal and interest to be paid. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

43. A bond issue is a form of a) equity financing. b) debt financing. c) collateral financing. d) financing similar to an instalment loan.

Long-Term Liabilities

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

44. If a bond is issued at a premium, the coupon rate is a) equal to the effective rate. b) less than the effective rate. c) greater than the effective rate. d) not needed to determine the bond's sale price. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

45. If a bond is issued at a discount, the coupon rate is a) equal to the effective rate. b) less than the effective rate. c) greater than the effective rate. d) not needed to determine the bond's sale price. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

46. If a bond is trading at 103 the a) the interest expense is greater than the interest payment. b) the interest expense is less than the interest payment.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

c) the interest expense is equal to the interest payment. d) the interest expense cannot be determined. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

47. If a bond is trading at 98 the a) the interest expense is greater than the interest payment. b) the interest expense is less than the interest payment. c) the interest expense is equal to the interest payment. d) the interest expense cannot be determined. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

48. Restrictions placed on a company in their bond indenture agreement are known as a) collateral. b) bond indenture. c) bond covenants. d) agreements. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

49. How would the Amortization of a bond discount affect each of the following?

Long-Term Liabilities

Bond's Net Carrying Value a) increase b) increase c) decrease d) decrease

Bond’s Interest Expense decrease increase increase decrease

Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

50. If a bond sells at a premium, the amortization of the premium will a) have no effect on periodic expense. b) decrease periodic expense. c) increase periodic interest expense. d) make periodic interest expense equal to the periodic interest payment. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

51. Reasons a company may choose to lease an asset include all of the following, EXCEPT for a) short-term need for the asset. b) high risk of obsolescence. c) lack of cash. d) preferential tax treatment of leased assets. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

52. From the lessee’s perspective, a lease results in all of the following EXCEPT a) recognition of an asset on the Statement of Financial Position. b) recognition of a liability on the Statement of Financial Position. c) recognition of interest expense on the Statement of Income. d) recognition of rent expense on the Statement of Income. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

53. A lease will be reflected on the Statement of Financial Position of the lessee as a) a current liability. b) a non-current liability. c) a non-current liability and a fixed asset. d) nothing; it is not reflected on the Statement of Financial Position. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

54. Canin Cranes Co. leased an asset under the following terms: Annual lease payments ................................... $7,500 Asset's estimated useful life ........................... 8 years Asset’s fair market value ................................. $65,000 Lease term ....................................................... 4 years Present value of lease payments.................... $35,500 The lessee’s entry to record the leased asset and lease acquired would include a a) debit to right-of-use for $35,500. b) debit to right-of-use for $40,000. c) credit to lease liability for $7,500. d) credit to lease payable for $7,500.

Long-Term Liabilities

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Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

55. DRM Corporation leased a piece of machinery on January 1, 2024. At the date of signing the asset and lease obligation were recorded for $42,000. The first lease payment of $6,000 was due December 31, 2024, and the interest rate they used in their calculations was 7%. The lease term was 10 years. Which of the following best describes what would be reported on DRM’s Statement of Income for the year ending December 31, 2024? a) $6,000 Lease Expense b) $6,000 Lease Expense, $4,200 Depreciation Expense c) $2,940 Interest Expense, $1,260 Depreciation Expense d) $2,940 Interest Expense, $4,200 Depreciation Expense Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

56. An employee has been working for a university with a defined benefit pension plan for 34 years. The employee’s highest five-year average earnings is $95,000. If the employee expects to receive 2% of these earnings based on years of service, what is the employee’s expected pension benefit if he or she retires in six years? a) $64,600 b) $95,000 c) $47,500 d) $76,000 Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

57. Which of the following statements about defined benefit pension plans is correct? a) The expense is equal to the contribution amounts in a period. b) The contributions to the fund are equal to the benefits paid in a period. c) The expense is equal to the present value of the future benefit obligations incurred that period. d) The amount of benefits the employee will receive depends on the performance of the pension plan. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

58. The entry made when cash is set aside to pay for future pension benefits is called a(n) a) funding entry. b) adjusting entry. c) accrual entry. d) reclassification entry. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

59. Which of the following statements concerning pensions is correct? a) Defined benefit plans offer a retiree more security than defined contribution plans. b) The accounting for a defined contribution plan is more complex than for a defined benefit plan. c) Pension funding must always equal the pension expense. d) The employee will forfeit vested pension contributions if he or she is terminated. Answer: a

Long-Term Liabilities

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

60. Vested benefits in a pension plan a) belong to an employee even if they leave the firm. b) are paid to an employee if they leave the firm. c) revert to the company if an employee leaves the firm. d) are paid to an employee in the year of vesting. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

61. If the assets in the pension fund exceed the present value of future pension obligations, the pension fund is described as a) fully funded. b) underfunded. c) partially funded. d) overfunded. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

62. A pension plan that pays employees benefits upon retirement based on how well the investments in the pension plan perform is called a a) defined contribution plan. b) defined performance plan.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

c) defined benefit plan. d) defined investment plan. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

63. A pension plan that pays employees benefits upon retirement based on their length of service and salary is called a a) defined contribution plan. b) defined service plan. c) defined benefit plan. d) defined performance plan. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

64. A pension plan that shares the risk for an underfunded plan between the employees and employer is known as a ___ plan. a) target benefit b) defined benefit c) defined contribution d) Canada pension plan Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

Long-Term Liabilities

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65. A deferred income tax asset is created when the difference will result in a) higher income tax payable in the future. b) no income tax payable in the future. c) lower income tax payable in the future. d) an immediate refund in income taxes. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

66. The depreciation method that is allowable under the Income Tax Act is referred to as a) Straight-line. b) Diminishing balance. c) Capital cost allowance. d) Units of depletion. e) All methods are allowed. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

67. Mutually unexecuted contracts refers to a) contracts that have been cancelled by either party. b) contracts that have not been fully negotiated; the parties cannot agree on the terms. c) contracts related to future transactions. d) contracts that have no commitments. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what commitments and guarantees are and how they are treated. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

68. Which of the following would best describe a contingent liability? a) an obligation to transfer services instead of cash to settle a liability b) an obligation where the costs will be covered by insurance c) an obligation with a high degree of uncertainty about the amount or timing of the payment d) an obligation with a low degree of uncertainty about the amount or timing of the payment Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

69. When the occurrence of a liability is dependent on the outcome of some future event, the liability is referred to as a(n) a) contingent liability. b) commitment. c) accrued liability. d) accounts payable. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

70. How should a liability that has a probable chance of occurring and can be reasonably estimated be disclosed? Accrual Footnote a) No No b) Yes No c) No Yes d) Yes Yes Answer: b Bloomcode: Comprehension Difficulty: Easy

Long-Term Liabilities

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Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

71. How should a liability that has an unlikely chance of occurring and is insignificant in size be disclosed? Accrual Footnote a) No Yes b) No No c) Yes No d) Yes Yes Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

72. How should a liability that has a probable chance of occurring but the amount of the loss cannot be reasonably estimated be disclosed? Accrual Footnote a) No No b) Yes Yes c) Yes No d) No Yes Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

73. Which of the following losses would require a footnote disclosure only? a) a probable loss with an amount that can be reasonably estimated b) a probable loss of a known amount c) a gain considered not probable d) a probable loss with an amount that cannot be reasonably estimated Answer: d

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

74. Resolute Limited reported the following items on their Statement of Financial Position: Prepaid Expenses ............................................ $ 85,000 Current liabilities (interest bearing) ............... 135,000 Long-term note payable ................................. 250,000 Bonds payable................................................. 95,000 Share capital ................................................... 125,000 Retained earnings ........................................... 157,500 The debt to equity ratio for Resolute is closest to a) 2.0. b) 1.7. c) 1.22. d) 0.88. Answer: b Bloomcode: Application Difficulty: Hard Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

75. The interest-coverage ratio is calculated as a) (net income – taxes – interest – depreciation) ÷ interest. b) (net income + taxes – interest - depreciation) ÷ interest. c) (net income + interest + depreciation) ÷ interest. d) (net income + taxes + interest + depreciation) ÷ interest. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

Long-Term Liabilities

76. The debt to equity ratio and interest-coverage ratio for Vega Corporation for the last two years are as follows: 2024 2023 Debt to equity .34 .35 Interest-coverage ratio 4.2x 5.5x Which of the following conclusions could be made about Vega Corporation? a) The company is less able to pay its interest costs in 2024. b) The company is better able to pay its interest costs in 2024. c) The company has more debt outstanding in 2024. d) The company is less risky in 2024. Answer: a Bloomcode: Analysis Difficulty: Hard Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

77. A debt to equity ratio of 100% indicates that a) half of the company’s assets are financed through equity. b) 50% of the company’s interest expense comes from long-term debt financing. c) the company is close to bankruptcy. d) the company spends 50% of its operating earnings on interest. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

78. The following information is from the financial statements of Shakespeare Inc.: Net income ...................................................... $450,000 Income tax expense ........................................ 250,000 Interest expense .............................................. 150,000 Long-term debt ............................................... 1,875,000 The interest-coverage ratio for Shakespeare would be closest to a) 3 times. b) 4.7 times.

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c) 5.7 times. d) 8 times. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

Long-Term Liabilities

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EXERCISES 79. On August 31, 2024, Montrose Mortgage enters into a 10-year, 6%, $200,000 mortgage to finance the construction of a condo complex. The terms provide for monthly instalment payments at the end of each month, commencing September 30, 2024. Instructions a) Record the issue of the mortgage payable on August 31, 2024. b) Record the first two instalment payments on September 30, 2024, and October 30, 2024, assuming the payment is (1) a fixed principal payment of $1,667, and (2) a blended principal and interest payment of $2,220. Round your answers to the nearest dollar. Solution (15 min.) a) Aug 31, 2024 Cash...................................................................................... Mortgage Payable ........................................................ (b) Payment 1: Sep 30, 2024

Oct 31, 2024

Payment 2: Sep 30, 2024

Oct 31, 2024

200,000 200,000

Mortgage Payable ................................................................ Interest Expense ($200,000 x 6% x 1/12)............................. Cash ($1,667 + $1,000) .................................................

1,667 1,000

Mortgage Payable ................................................................ Interest Expense [($200,000 – $1,667) x 6% x 1 / 12] .......... Cash ($1,667 + $992) ....................................................

1,667 992

Mortgage Payable ($2,220 – $1,000) ................................... Interest Expense ($200,000 x 6% x 1 / 12) ........................... Cash ..............................................................................

1,220 1,000

Mortgage Payable ($2,220 – $994) ...................................... Interest Expense [($200,000 – $1,220) x 6% x 1 / 12] .......... Cash ..............................................................................

1,226 994

2,667

2,659

2,220

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

2,220

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

80. On January 1, 2024, Barrymore Ltd. issued $200,000, 8%, 10-year bonds, when the market interest rate was 10%. Therefore, the bonds were trading at $175,076, Interest is payable semiannually on July 1 and January 1. The company has a calendar year end. Instructions a) Record the issue of the bonds. b) Record the first interest payment on July 1, 2024. Round to nearest dollar. Solution (10 min.) a) Jan 1 Cash ............................................................................................. Note Payable ....................................................................... b)

Jul 1

175,076

Interest Expense ($175,076 x 5%) ............................................... Note Payable ....................................................................... Cash ($200,000 x 8% x ½) ....................................................

175,076 8,754 754 8,000

81. On January 1, 2024, Liberty Bank issues $500,000, 6%, five-year bonds, with interest payable on July 1 and January 1. Since the market interest rate is 5%, the bonds sell for $521,880. Instructions For the issue date and first semi-annual period, complete a) through e) in the table below and show your calculations. a) Interest to be Paid

b) Interest Expense to be Recorded

c) Premium Amortization

d) Unamortized Premium

e) Bond Carrying amount

Solution (15 min.) a) Interest Period to be Paid

b) Interest Expense to be Recorded

c) Premium Amortization

d) Unamortized Premium

$1,953

$21,880 19,927

e) Bond Carrying amount $521,880 519,927

Period

$15,000

$13,047

Long-Term Liabilities

$500,000 × 6% x 6 / 12 = $15,000

Market interest rate 5% x 6 / 12 = 2.5% semi-annual 2.5% × $521,880 (bond carrying amount) = $13,047

Premium amortization = $15,000 – $13,047 = $1,953

Unamortized premium = $21,880 – $1,953 = $19,927

Bond carrying amount = $500,000 + $19,927 = $519,927

82. A company issued a $500,000 Bond. Instructions a) Prepare the journal entry to record the issuance if i) the bond sells for 103. ii) the bond sells at par. iii) the bond sells for 97. b) Prepare the journal entry to record the first interest payment of $10,000 if the interest expense is i) $12,768. ii) $9,170. iii) $10,000. Solution (15 min.) a) i) Cash (A)............................................................ Note Payable (L) ...................................... ii)

515,000 515,000

Cash (A)............................................................ Note Payable (L) ......................................

500,000

iii) Cash (A)............................................................ Note Payable (L) ......................................

485,000

500,000

485,000

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b) i)

Test Bank for Understanding Financial Accounting, Third Canadian Edition

Interest expense (SE) ...................................... Cash (A) .................................................... Note Payable (L) ......................................

12,768

Interest expense (SE) ...................................... Note Payable (L) .............................................. Cash (A) ....................................................

9,170 830

iii) Interest expense (SE) ...................................... Cash (A) ....................................................

10,000

ii)

10,000 2,768

10,000

83. Deborah Limited has entered into an agreement to lease manufacturing equipment. The following terms are included in the lease: Lease terms ..................................................... 5 years Payments required monthly on the last day of the month $2,376 Leasing interest rate …………………………. 7% / annum Estimated useful life of equipment ................ 5 years PV of lease payments. ..................................... $120,000 The lease is entered into on January 1, 2024. The equipment can be purchased for $125,000. The company uses straight-line depreciation. Instructions a) Prepare the journal entry for 2024 to recognize the lease. b) Record the entry for the first lease payment on January 31, 2024. What is the value of the outstanding lease liability on January 31, 2024? c) What is the carrying value of the equipment on January 31, 2024? Solution (20 min.) a) January 1, 2024 Dr. Right-of-use asset (A) ................................ Cr. Lease Liability (L) ............................... b) January 31,2024 Dr. Interest Expense ........................................ ($120,000*.07* 1/12)

120,000 120,000

$700

Long-Term Liabilities

Dr. Lease Liability ............................................ Cr. Lease Payment ...................................

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$1,676 $2,376

The lease liability on January 31, 2024, is $118,324. c) Carrying Value: $120,000 – $2,000 = $118,000 $120,000 / 5 years *1 / 12 = $2,000 in depreciation expense

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

84. Pendulum Enterprises has a defined benefit plan. Employees receive a pension equal to 2% of the average of the highest five years of salary and based on years of service. On December 31, 2024, the fair value of the pension assets in the plan is $10.7 M, although pension contributions were in excess of $12.5 M, and the estimated pension obligation is $12.3M. Instructions a) Mary-Lou is considering retirement but wants to know how much she is entitled to receive under this defined benefit plan. Her 5 years highest average earnings are $67,500, and she has 30 years of service. What is her annual pension benefit? b) Is the plan over or underfunded? By how much? Does this get reflected in the financial statements? If so, where and by how much? c) In determining the pension obligation, what factors should management take into consideration? Solution (10 min.) a) Mary-Lou’s pension benefit is $67,500 *.02 * 30 years = $40,500 b)

The plan is underfunded by $1.6 M ($12.3 – $10.7). This should be reflected as a long-term liability on the Statement of Financial Position.

Management should consider: • Expected return on plan assets • Expected increases in employee wages • Expected retirement age of employees

Bloomcode: Application Difficulty: Medium

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

85. Mergeron Industries purchases a new delivery van. The van costs $32,000 and is expected to last five years. The company uses straight-line depreciation for accounting purposes. The residual value is expected to be $2,000. The summary rate is 30%. Calculate the increase in deferred tax liability for year one and year two of owning this van. Ignore the half-year rule. Solution (15 min.) Yearly depreciation expense= ($32,000 – $2,000) / 5 years = $6,000 Year one CCA = $32,000 *.30 = $9,600 Year two CCA = ($32,000 – $9,600) *.3 = $6,720 Year 1: Increase in Deferred Tax Liability = $9,600 – $6,000 = $3,600 Year 2: Increase in Deferred Tax Liability = $6,720 – $6,000 = $ 720

Bloomcode: Application Difficulty: Hard Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

86. Nora Corp reports pre-tax accounting income of $250,000, but due to a difference between its actual warranty costs and those estimated for accounting purposes, taxable income is $280,000. At the beginning of the year, no temporary differences existed. The temporary difference is expected to reverse in the next year as actual warranty expenses incurred are expected to reach the warranty provision. Nora is subject to a corporate tax rate of 30%. Instructions Prepare the journal entry to record Nora’s income taxes. Solution (5 min.) Dr. Income tax expense................................... ($250,000 × 30%) Dr. Deferred Tax Asset (current) ..................... Cr. Income taxes payable ........................ ($280,000 × 30%)

75,000 9,000 84,000

Long-Term Liabilities

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. CPA: Financial Reporting AACSB: Analytic

87. Rousseau Corporation has the following Statement of Income for the year ended May 31, 2024: Sales ................................................................ $1,675,200 Cost of goods sold ........................................... 887,600 Gross margin ................................................... 787,600 Selling & administrative expense ................... 241,200 Interest expense .............................................. 65,000 Income before income taxes .......................... 481,400 Income taxes ................................................... 192,500 Net income ...................................................... $ 288,900 Instructions Calculate the interest-coverage ratio for Rousseau Corporation for May 31, 2024. What does this mean? Solution (5 min.) The interest-coverage ratio is calculated by the following formula: Income before interest and taxes ——————————————— Interest

Net income + taxes + interest = ————————————— Interest 288,900 + 192,500 + 65,000 = ———————————––– = 8.4 65,000

This indicates that there are sufficient earnings available to cover interest expense by more than eight times.

Bloomcode: Application Difficulty: Medium Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

88. Dynamic Manufacturers Inc. reported the following information in its financial statements: DYNAMIC MANUFACTURERS INC. Statement of Financial Position June 30 Assets ..................................................................................................... Cash ................................................................................................ Accounts receivable ....................................................................... Prepaid Insurance .......................................................................... Inventory ........................................................................................ Building .......................................................................................... Equipment ...................................................................................... Total Assets ............................................................................................

2025 $ 32,000 7,500 1,100 220,000 145,000 36,000 $441,600

2024 $ 29,000 5,500 1,450 175,000 155,000 40,000 $405,950

Liabilities and shareholders’ equity Accounts Payable ........................................................................... Notes Payable ................................................................................ Bonds Payable ............................................................................... Long-Term Debt ............................................................................. Common shares ............................................................................. Retained earnings .......................................................................... Total liabilities and shareholders’ equity .............................................

$ 12,500 10,000 145,000 116,000 25,000 133,100 $441,600

$ 14,500 0 95,000 175,000 25,000 96,450 $405,950

Revenue.................................................................................................. Operating expenses ............................................................................... Profit from operations ........................................................................... Interest expense .................................................................................... Income tax expense ............................................................................... Profit.......................................................................................................

$450,000 300,000 150,000 6,000 36,000 $108,000

$300,000 210,000 90,000 9,000 20,250 $60,750

Instructions a) Calculate the company’s debt to equity and times interest earned ratios for each year. b) From the perspective of the company, determine if the change from 2024- 2025 is an improvement or deterioration. c) If industry averages for debt to equity is 1.5:1 and times interest earned is six times, are Dynamic ratios comparable? Solution (20 min.) a) 2025 Debt to equity = ((10,000 + 145,000 + 116,000) – 32,000) 158,100 = 1.51: 1 TIE

=108,000 + 6,000 + 36,000 6,000

2024 = ((95,000 + 175,000) – 29,000) 121,450 = 1.98:1 =60,750 + 9,000 + 20,250 9,000

Long-Term Liabilities

= 25 times

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= 10 times

b) Debt to equity ratio is improving. Times interest earned ratio is improving. b) Dynamic’s debt to equity ratio is higher than the industry in 2024, which means they may have more debt or less equity than the industry averages. However, this has eroded in 2025 but is still in line with industry averages. Overall debt to equity varies across industries because different financing options are appropriate for different industries. The company’s time interest earned is significantly better than the industry.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

MATCHING 89. Listed below are various bond terms followed by a series of descriptions of bond characteristics. Match the terms to the descriptions by placing the appropriate letter in the space provided. TERMS A. Bond B. Bond covenants C. Coupon rate D. Convertible bond E. Debenture F. Blended payments

G. H. I. J.

Mortgage Yield Public Offering Face value

DESCRIPTIONS ___ 1. A bond issue with no specific collateral ___

Restrictions placed on a firm that issues bonds

___

Real property as collateral

___

A bond that can be exchanged for common shares

___

Periodic payments of both interest and principal

___

Open to all investors, both individuals and institutions.

___

Generally $1,000 per bond

___

Interest rate used to calculate the interest expense

___

A long-term borrowing with periodic coupon payments for interest and the principal repaid at maturity

___

10.

Interest rate used to calculate the semi-annual interest payments

Solution (3 min.) 1. E 2.

Long-Term Liabilities

10. C

90. Listed below are various leasing terms followed by a series of descriptive statements. Match the terms to the most accurate descriptions by placing the appropriate letter in the space provided. TERMS A. Lease obligation B. Depreciation C. Residual value D. Lease agreement E. Lease term F. Lessee G. Lessor STATEMENTS ___

The renter in a lease agreement

___

The contract between the lessee and the lessor

___

The asset's value at the end of a lease.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

___

The length of a lease agreement

___

Present value of the lease payments

___

The recipient of the lease payment

___

Expense taken over the useful life of a leased asset

Solution (3 min.) 1. F 2.

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

91. Listed below are various disclosure options followed by a series of situations. Match the disclosure options to the situations by placing the appropriate letter in the space provided. DISCLOSURE OPTIONS A. Footnote disclosure required B. Accrual required

C. D.

Footnote disclosure permitted Footnote disclosure not recommended

SITUATIONS ___ 1. It is probable that the company will have to pay on a note that it is the guarantor on and the amount can be estimated reliably. ___

The company is a defendant in a lawsuit where the loss is unlikely, but the amount can be reliably estimated.

Long-Term Liabilities

___

The firm is a plaintiff in a liability lawsuit in which a gain is reasonably possible, and the amount can be reliably estimated.

___

It is unlikely that the company will have to pay another company's note that it guaranteed. The amount cannot be reliably estimated.

___

It is probable that the firm may lose a lawsuit. The amount cannot be reliably estimated.

___

It is unlikely that the firm may realize a gain on a pending insurance claim. The amount cannot be reliably estimated.

___

The company offers a warranty on its products, and it is probable that claims will be filed. The amounts can be reliably estimated.

___

The company signed a purchase commitment. The chance that it will be honoured is probable, and the cost is known with certainty.

Solution (3 min.) NOTE: Assignment of this question should be determined by the instructor based on the extent of coverage of this material in class. 1.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

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Long-Term Liabilities

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SHORT-ANSWER ESSAY QUESTIONS 92. Your parents know that you are currently taking a financial accounting course. Their financial advisor has told them that it is important for them to review the financial statements of their previous employers, particularly the liabilities section, because they are receiving pension income from a defined benefit plan. They are uncertain about their financial advisor’s advice. Is your parents’ financial advisor correct? Explain why or why not. Solution (5 min.) The advisor is correct. The long-term liabilities section of the statement of financial position reflects liabilities that will affect the company for many years to come. Bonds can have a life of 20, 30 or even 40 years and retired employees draw down on their pensions over a similar number of years. It is important for users to have an awareness and understanding of the potential liabilities such as contractual commitments or the possible outcomes of litigation against the company. As a pensioner with a defined benefit plan, you would have a particular interest in knowing whether or not the pension fund is appropriately funded and whether the fund is under or over funded.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why long-term liabilities are of significance to users. CPA: Financial Reporting AACSB: Analytic

93. A first-year accounting student comes to you and wants to know why it is possible to buy a bond in the market for less than its $1,000 face value. Instructions Answer the student’s question. Solution (7 min.) The price of a bond is the sum of the present value of the principal based on the discount rate chosen by the investment banker, and the present value of the semi-annual interest payments based on the rate chosen by the investment banker. PV of principal + PV of semi-annual interest payments = Bond price The discount rate used to calculate the present value is based on effective rates that reflect the risk of the bond and the desired rate of return of the investors. That rate may or may not be the same as the coupon rate. The bond interest rate is the rate quoted on the bond and is used to determine the semi-annual cash payment that the investor will receive. When the effective rate and the bond interest rate are the same, the bond will sell for its face value. When the effective rate is higher than the bond interest rate the bond will sell for a discount, for less than its face value and that must be the case for this student. In effect the coupon

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

alone is not providing an adequate rate of return so the investor is not willing to pay the full amount and wants to earn a portion of their return from the capital gain that will accrue to them.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

94. You are considering investing in one of two companies in the same industry; Hanzel Inc. and Gretel Inc. You have calculated the debt/equity ratios and profitability ratios for each company and notice that the results between the two are very similar. You did notice that Hanzel Inc. has a defined contribution pension plan for its employees while Gretel Inc. has a defined benefit plan. Your friend suggests that you look in the notes before making your investment decision. Instructions What information should you be looking for in the notes related to the assets and pension plans, and how will it influence your decision? Solution (12 min.) I should look in the notes for undisclosed liabilities that mean the company is riskier than the ratios calculated imply. For the pension plans, the defined benefit pension plan of Gretel is riskier from the company’s point of view than the defined contribution plan of Hanzel. In a defined benefit plan the company is liable to provide a determined level of benefits to employees when they retire. If the pension plan assets (with the plan trustee) are not adequate to meet the payments, the company must make-up the shortfall. Depending on the amount of contributions they have been making, the estimates of the future obligations, and the return earned on the plan assets, they might have an unfunded obligation in the plan. Whether the full amount of that obligation is shown on the Statement of Financial Position depends on a variety of accounting factors. The note on pension plans will show me if the plan is over- or underfunded and what obligation is recognized on the Statement of Financial Position. In a defined contribution plan the company is only responsible for making a defined amount of contributions when the employees are working for the company. There is no uncertainty about any future obligation for the company. So the company with the defined contribution plan would be less risky than the company with the defined benefit plan.

Bloomcode: Comprehension Difficulty: Medium

Long-Term Liabilities

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Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. Learning Objective: Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health. CPA: Financial Reporting AACSB: Analytic

95. A purchasing agent has just signed a two-year purchase commitment with a major supplier. The agent brought the contract to the bookkeeper and requested that a liability be recorded for the obligation the firm has committed to over the next two years. The bookkeeper is uncertain about this treatment of the item and comes to you, the chief accountant, for advice on how to record this item. Instructions Explain to the bookkeeper why no entry is necessary and under what circumstances a commitment would be recognized. Solution (5 min.) Commitments are generally not recognized under Canadian accounting guidelines because they are mutually unexecuted contracts, that is, neither party to the contract has performed any part of the contract. When one party has performed a part of the contract, such as making a deposit, then that action would have to be accounted for. The commitment would be disclosed in a note to the financial statements if it were felt that the commitment would have a material effect on future operations.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain what commitments and guarantees are and how they are treated. CPA: Financial Reporting AACSB: Analytic

96. After reading about contingencies in a financial accounting textbook, an introductory accounting student believes that such items should never be recorded. Instructions Explain what criteria must be met before a contingent liability is recorded on the financial statements.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Solution (5 min.) Obligations may not meet the definition of liability because of one of the following reasons: 1. There is uncertainty about whether or not the obligation is in fact an obligation of the firm. This uncertainty will only be resolved when one or more future events occur and the event is outside the control of the company. 2. It is not considered probable that an outflow of resources representing economic benefits will be required to settle the obligation. 3. The amount of the obligation cannot be reliably measured. If any of these circumstances is present then no liability can be recorded related to the obligation. These are then considered to be contingent liabilities and should be disclosed in the notes to the financial statements.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

Long-Term Liabilities

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ESSAY QUESTIONS 97. Your grandparents have some of their money invested in corporate bonds. They have just returned from a meeting with their investment advisor and have asked you the following: "What is all this confusion about interest rates? There is a coupon rate, a market rate, and the current yield. And, as we understand it, some of the rates change during the life of a bond and some don't. Why is it so confusing?" Instructions Explain what is meant by the coupon rate and the market rate. Also, indicate which rates change and which remain constant during a bond's life and why. Solution (5 min.) The coupon rate is the rate stated in the bond indenture. It is used to calculate the semiannual interest payments. This rate remains constant during the bond's life. The market rate is the rate the marketplace demands on its investments. It is the rate used to determine the market value of a bond (i.e., the sales price of the bond). As the rate increases, the price of the bond will decrease. When the price increases, this rate will change as the marketplace changes its perception of a particular bond.

Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

98. The CFO wants to know whether it is better to purchase or lease a new warehouse. Instructions Prepare a response discussing the pros and cons for each alternative. Solution (6 min.) There are a number of reasons why a company may choose to lease an asset rather than purchase it. These include: ● The company lacks the cash to be able to purchase it or it wants to use its cash for other purposes. ● The company lacks the cash to be able to purchase it and is unwilling or unable to obtain a loan to finance the purchase of the asset. ● The company only has a short-term need for the asset; that is, it will not need the asset for most of its useful life. ● The asset is expected to quickly become obsolete and the company wants to be able to have

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

the newest model without having to sell the old asset and purchase the latest one. For example, some technology assets are quickly replaced with newer technology. If a company has short-term leases in place, then it can return the old equipment and lease the latest technology at the end of each lease term.

Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

99. A personnel officer has come to you for information concerning the difference between pension plans. He has heard that an emerging plan is gaining popularity. The company is planning on offering a pension plan to its employees and needs to decide which type would best meet their needs. Instructions Define the three types of pension plans. Solution (8 min.) A defined contribution plan requires the employer to make a set contribution to a retirement fund for the employee. The ultimate payment the employee will receive upon retirement will depend on the contributions made and the rate of return earned by the plan; there is no guaranteed payment amount. A defined benefit plan guarantees to pay an employee a certain amount of money during each year of retirement based on a formula related to employee service and salary. Hybrid pension plans have emerged in recent years as an alternative to the traditional defined contribution and defined benefit plans. As the name suggests, hybrid plans combine features of both the traditional plans. Hybrid plans establish targeted benefit levels that are funded through fixed contributions of both the employer and employee.

Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. CPA: Financial Reporting AACSB: Analytic

100. What factors are important in determining whether a pending lawsuit should be accrued

Long-Term Liabilities

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in the financial statements? What type of evidence would be necessary to support the accrual? Solution (5 min.) In order for a contingency to be accrued in the financial statements it must be probable that the future event will occur, there is a probable outflow of economic benefits and the amount must be able to be reliably measured. Evidence of this can be gathered by: 1. discussing the outcome with the entity’s attorneys, 2. determining when the action occurred, since a contingency is based on actions that have already occurred, 3. reviewing recent court rulings in similar actions. If it is probable that the loss will occur and the amount cannot be reasonably estimated, the contingency cannot be accrued in the financial statements, but note disclosure is required.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain contingencies and how they are accounted for. CPA: Financial Reporting AACSB: Analytic

CHAPTER 11 SHAREHOLDERS’ EQUITY CHAPTER LEARNING OBJECTIVES 1. Explain why the shareholders’ equity section is significant to users. • Share ownership is common in a wide variety of circumstances, such as among individuals, companies, and pension funds. • It is important for shareholders to understand how shareholders’ equity is measured and disclosed in the financial statements, so they can assess their return on investment, have an awareness of the various types and classes of shares a company can issue, and understand the reasons for changes in a company’s equity. 2. Explain the components of the shareholders’ equity section of the statement of financial position. • The components of shareholders’ equity are (1) share capital, (2) retained earnings, (3) accumulated other comprehensive income, and (4) contributed surplus. • Share capital is the amount received from investors on the initial issuance of a company’s shares. • Retained earnings represents the company’s accumulated earnings that have not been distributed as dividends. • Accumulated other comprehensive income includes unrealized gains and losses resulting from revaluations rather than from transactions with third parties. • Contributed surplus results from the sale or repurchase of a company’s shares or from the issuance of stock options. 3. Describe the different types of shares and explain why corporations choose to issue a variety of share types. • A company’s articles of incorporation outline the various types and classes of shares that it can issue, which are referred to as the authorized shares. • Shares that have been issued (sold) to shareholders are referred to as issued and outstanding. • If a company repurchases shares from shareholders and does not cancel them, then they are considered to be issued but not outstanding and are referred to as treasury shares. These shares are not entitled to any dividends. • There are two types of shares: (1) common and (2) preferred. • Being able to issue different types of shares (that is, common versus preferred shares), with multiple classes providing differing levels of risk and return, enables companies to appeal to a wider group of investors, making it easier to raise capital. • Every company must have at least one class of common shares, but can have multiple classes (such as Class A, Class B). Common shares come with the right to vote at shareholder meetings, the right to receive dividends (if declared), and the right to a share of the company’s net assets upon liquidation of the company. ▪ Common shares can also include an anti-dilution provision, which enables shareholders to maintain their proportionate ownership in future share issuances.

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There can also be multiple voting common shares, which enable their owner to more than one vote for each share owned. Preferred shares are typically issued at $25 per share. They are typically non-voting, but are normally entitled to receive dividends (the amount of which is normally fixed) ahead of common shareholders in the event that dividends are declared. They are also entitled to receive a return of their capital upon liquidation of the company before common shareholders. Preferred shares are known as hybrid securities as they have some features that are similar to debt (non-voting, fixed dividend, and may have a maturity date [redemption provision]) and some features similar to equity (represent an ownership interest, pay dividends [rather than interest], and they are reported as part of shareholders’ equity). Preferred shares may be: ▪ perpetuals—which pay a fixed dividend for as long as the shares are outstanding ▪ floating rate—which pay a dividend linked to a measure such as the prime rate ▪ rate reset—which pay a fixed dividend until an established rate reset date ▪ redeemable—the issuing company can repurchase them ▪ retractable—the shareholder can require the company to repurchase them ▪ convertible—they may be converted into common shares ▪ cumulative—if dividends are not declared in one year, the right to receive them accumulates until dividends are eventually declared ▪ participating—preferred shareholders share with common shareholders in any dividends declared that are in excess of the fixed rate on the preferred shares Companies issue preferred shares as: ▪ Dividends can be postponed in periods of financial difficulty (which is not an option with interest on bonds or other forms of debt). ▪ They provide new capital while improving the debt to equity ratio. ▪ They do not dilute future earnings (as preferred shareholders would only be entitled to their fixed or stated dividend amount regardless of any increase in earnings). ▪

•

4. Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. • Companies are not required to declare dividends. In order to declare dividends, a company must have retained earnings and sufficient cash. • There are different types of dividends. The two most common forms of dividends are (1) cash dividends and (2) stock dividends. ▪ Cash dividends entitle shareholders to cash payments and are the most common type of dividend. ▪ Stock dividends entitle shareholders to receive additional shares rather than cash. A company can declare stock dividends when it wants to declare dividends, but also wants to preserve its cash. • Both cash and stock dividends reduce retained earnings. • The recording of the declaration and payment of dividends is affected by the four key dates in the dividend declaration process: ▪ the date of declaration—creates a liability ▪ the ex-dividend date—used in the marketplace to determine who will receive the dividend ▪ the date of record—used by the company to determine who the dividend payments will be made to

Shareholders’ Equity

▪

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the date of payment—the date the company pays the dividends

5. Describe what a stock split is and explain how it is accounted for. • A stock split occurs when the company issues additional shares to existing shareholders at a specified ratio (such as two-for-one) without any effect on retained earnings. Stock splits lower the share price in the market. • Companies may also have reverse stock splits (known as consolidations), which decrease the number of outstanding shares at a specified ratio (such as one-for-two). This increases the share’s market price. • There is no accounting entry necessary to record a stock split because there is no change in either share capital or retained earnings. 6. Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. • The price/earnings ratio is determined by dividing the market price per share by earnings per share. It is used by investors to assess a company’s share price relative to earnings and relative to the share prices of other companies. • The dividend payout ratio is calculated by dividing dividends per share by earnings per share. It measures the portion of a company’s earnings that are distributed as dividends. • The dividend yield is determined by dividing dividends per share by price per share. It measures the return provided to investors from dividends. • The return on shareholders’ equity ratio is calculated by dividing net income (after deducting preferred dividends) by average common shareholders’ equity. It measures the rate of return that common shareholders are earning on the equity they have invested in the company. 7. Identify the advantages and disadvantages of using equity financing. • The advantages of using equity financing are that it does not have to be repaid (whereas loan principal must be repaid) and dividends are at the option of the company’s board (whereas interest must be paid). • The disadvantages of using equity financing are that it can result in a dilution of ownership and dividends are not tax deductible (whereas interest is).

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TRUE-FALSE STATEMENTS 1. Employees are NOT eligible to purchase their employer’s shares. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why the shareholders’ equity section is significant to users. CPA: Financial Reporting AACSB: Analytic

2. Share capital represents the amount that investors paid for the shares when they were initially issued by the company. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

3. Accumulated other comprehensive income is a revenue account reported on the statement of income. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

4. Convertible preferred shares are convertible to common shares at the option of the shareholder. Answer: True Bloomcode: Knowledge Difficulty: Easy

Shareholders’ Equity

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Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

5. The repurchase of shares may result in a recognizable gain or loss. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

6. Contributed surplus is reported on the statement of income because it is a recognized gain. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

7. If a company would like to issue additional shares, it does NOT need to amend its Articles of Incorporation. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

8. Repurchasing shares increases the number of shares outstanding. Answer: False

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

9. Shares that have been sold by the company are known as issued shares. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

10. Corporations generally issue shares through investment bankers known as “tellers”. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

11. Every corporation must have one class of shares that represents the company’s basic voting ownership rights. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

Shareholders’ Equity

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12. Common shareholders have the right to vote at shareholder meetings. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

13. All companies are obligated to declare dividends. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

14. Pre-emptive rights prevent ownership interests from being diluted. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

15. Preferred shares are normally non-voting. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

16. Non-cumulative means that common shareholders must be paid for dividends in arrears before preferred shareholders are paid. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

17. Retractable shares can be sold back to the company at the option of the shareholder. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

18. Convertible preferred shares can be converted, at the option of the company, into other types of preferred shares. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

19. Stock dividends are accounted for using the fair market value of the shares on the date of declaration. Answer: True Bloomcode: Knowledge

Shareholders’ Equity

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Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

20. Dividends are only paid in cash. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

21. The Statement of Financial Position shows all the dividends declared during the year. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

22. Cash dividends are paid on the date of record. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

23. The date of record results in a legal obligation to pay the cash dividends. Answer: False

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

24. Early-stage or growing companies do NOT normally pay dividends. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

25. A company may pay a one-time dividend if it has benefitted from an unusual gain. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

26. Public companies CANNOT pay a dividend on the date of declaration. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

27. Stock splits only apply to common shareholders.

Shareholders’ Equity

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

28. Stock splits do NOT impact the value of the share capital or retained earnings accounts. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

29. A 2-for-1 stock split should have the effect of cutting the market price per share in half. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

30. Stock splits are normally associated with profitable, growing companies. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

31. Reverse stock splits are also known as consolidations. Answer: True

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

32. The denominator in the return on equity calculation is the average number of common shares outstanding. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

33. The price/earnings ratio provides a measure of the return to common shareholders. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

34. Stable companies usually pay out a lower portion of their earnings in dividends. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

35. Dividend yield measures the dividends an investor will receive relative to the share price.

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Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

36. Earnings per share provides a measure of the earnings relative to the number of common shares outstanding. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS 37. The shareholders’ equity section of the statement of financial position, includes all of the following accounts EXCEPT for a) contributed surplus. b) accumulated OCI. c) dividends. d) share capital. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

38. Unrealized gains and losses from the revaluation of certain types of investments to fair value is reported on a) the statement of retained earnings. b) the statement of financial position. c) the statement of changes in shareholders’ equity. d) the comprehensive income statement. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

39. Bailey Inc. issues 100,000 shares at $11 / share in January. Later that year the company repurchases 9,000 of these shares at $10 per share. The effect of this is a) a decrease to the share capital account of $90,000. b) an increase to the contributed surplus account of $9,000. c) a decrease to total shareholders’ equity of $99,000. d) an increase in retained earnings by $9,000. Answer: b

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Bloomcode: Application Difficulty: Medium Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

40. The repurchase of shares at a price lower than what the shares were initially issued will result in a) share capital. b) retained earnings. c) other comprehensive income. d) contributed surplus. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

41. When the value of a company is determined by the trading price of its shares multiplied by the number of shares outstanding, this is referred to as a) other comprehensive income. b) share capital. c) market capitalization. d) contributed surplus. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

42. Which of the following accounts is NOT reported on the Statement of Changes in Shareholders’ Equity? a) Accumulated Other Comprehensive Income b) Retained Earnings c) Goodwill

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

d) Share Capital Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

43. The articles of incorporation include all of the following EXCEPT for a) what kinds of shares are to be issued. b) the costs of issuing the shares. c) the type of business to be conducted. d) how the board of directors is organized. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

44. For accounting purposes, the most important section of the articles of incorporation is the description of a) the shares to be issued. b) the type of business to be conducted. c) how the board of directors will be organized. d) who will make up the management team. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

45. The maximum number of shares that a firm can issue is the number of

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a) issued shares. b) authorized shares. c) outstanding shares. d) permissible shares. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

46. When a company decides to repurchase shares it’s previously sold, this is referred to as a) retired share capital. b) treasury shares. c) a buyback. d) contributed surplus. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

47. Calypso Inc. issues 100,000 shares at $10 / share in January. Later that year the company repurchases 9,000 of these shares at $11 per share. The balance in the contributed surplus account is $0 prior to the share repurchase. The effect of this is a) a decrease to the share capital account of $99,000. b) an increase to the contributed surplus account of $9,000. c) an increase to total shareholders’ equity of $99,000. d) a decrease in retained earnings by $9,000. Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

48. In the case of liquidation, where do preferred shareholders rank? a) before creditors and common shareholders b) after creditors and common shareholders c) after creditors and equally with common shareholders d) before common shareholders and after creditors Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

49. Which of the following is NOT a basic right of common shares? a) right to share in profits and losses b) right to participate in the management of the company c) right to vote in the selection of the board of directors for the corporation d) right to share in the assets upon liquidation Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

50. The one class of shares that represent a company’s basic voting rights are a) preferred shares. b) capital shares. c) cumulative shares. d) common shares. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to

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issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

51. Generally, the major difference between preferred shares and common shares is a) preferred shares are restricted by the amount the dividends that can be paid out. b) common shares have a priority claim over corporate assets. c) preferred shares have voting rights. d) there are no significant differences between preferred and common shares. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

52. The pre-emptive right is the right to a) share in the management of the company. b) share proportionately in any new sale of shares. c) share in the profits and losses of the company. d) share in any dividends paid by the company. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

53. Which of the following statements is correct? a) Dividends are guaranteed to preferred shareholders. b) Dividends accumulate on common shares. c) Dividends are only issued if the board of directors declares them. d) Dividends are paid to all classes of shares on the same basis. Answer: c Bloomcode: Comprehension

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

54. Which of the basic rights of shareholders does the preferred shareholder usually give up in order to acquire preferences over the common shareholder? a) right to share in profits and losses b) right to share in subsequent issues of shares c) right to share in assets upon liquidation d) right to vote Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

55. In a situation where a CDN company has a dual-class share structure and common shareholders have more than one vote, this is referred to as a a) pre-emptive right. b) participating common share. c) super voting share. d) hybrid share. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

56. The type of preferred share that can be bought back by the company at a specified time and price is a a) cumulative preferred share. b) convertible preferred share. c) redeemable preferred share.

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d) non-participating preferred share. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

57. What type of preferred share is entitled to dividends above its specified dividend if the common shares receive excess dividends and must receive dividends in arrears before the common dividends can be declared? a) cumulative and participating b) cumulative and non-participating c) redeemable and participating d) redeemable and cumulative Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

58. Preferred shares that pay a fixed dividend for as long as the shares remain outstanding are called a) floating rate shares. b) rate reset shares. c) fixed dividend rate shares. d) perpetual shares. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

59. Which of the following represents the largest number of shares? a) outstanding shares b) authorized shares c) issued shares d) approved shares Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

60. Dividends in arrears relate to which of the following? a) cumulative preferred shares b) participating preferred shares c) cumulative common shares d) participating common shares Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

61. Shares that have been issued and subsequently repurchased but NOT cancelled are called a) issued shares. b) re-issued shares. c) treasury shares. d) outstanding shares. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

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62. When shares are repurchased for less than cost, the difference is recognized as a) contributed surplus. b) ordinary gains. c) extraordinary gains. d) an increase to retained earnings. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

63. Dividends are NOT paid on a) common shares. b) preferred shares. c) treasury shares. d) outstanding shares. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

64. All of the following are terms used to refer to the number of company shares EXCEPT for a) authorized. b) available. c) issued. d) outstanding. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

65. Repurchasing shares a) increases the number of shares outstanding. b) decreases the number of shares outstanding. c) has no effect on the number of shares outstanding. d) splits shares in half. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

66. When common or preferred shares are made available for sale to the public, the details of the shares are discussed in a legal document called a) articles of incorporation. b) share repurchase agreement. c) shareholder composition. d) prospectus. Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

67. Which of the following is NOT a right of a company’s common shares? a) The right to vote at meetings of the company’s shareholders. b) The right to receive dividends, if declared. c) The right to a share of the company’s net assets upon liquidation of the company. d) The right to convert shares to cumulative participating preferred shares. Answer: d Bloomcode: Knowledge

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Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

68. Dividends NOT declared in one year carry over to the next year for a) cumulative preferred shares. b) cumulative common shares. c) arrears shares. d) pre-emptive shares. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

69. Which of the following dates occurs first when dividends are paid? a) payment date b) announcement date c) date of record d) declaration date Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

70. A new company just starting to pay dividends may choose to make a one-time dividend payment known as a(n) a) unexpected dividend. b) special dividend. c) ex-dividend. d) stock dividend.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

71. Which of the following entries occur at the date of declaration of a cash dividend? a) Dr. Dividends Expense, Cr. Dividends Declared b) Dr. Dividends Declared, Cr. Cash c) Dr. Dividends Declared, Cr. Dividends Payable d) No entry Answer: c Bloomcode: Application Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

72. Which of the following occurs at the date of record of a cash dividend? a) Dr. Dividends Declared, Cr. Dividends Payable b) Dr. Dividends Declared, Cr. Cash c) No entry is made in the accounts, but a list of shareholders entitled to receive the dividend is prepared. d) The board of directors approves the dividend but no entry is made in the accounts. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

73. A legal liability for cash dividends occurs on which of the following dates? a) date of record b) ex-dividend date

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c) date of payment d) date of declaration Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

74. Which date is used to determine which shareholders will receive the declared dividend? a) date of record b) date of declaration c) ex-dividend date d) date of payment Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

75. Seaside Developments Inc. has $200,000 of no-par value 4% cumulative preferred shares, and 12,000 shares of no-par value common shares outstanding. In its first three years of operation, the company paid cash dividends as follows: Year 1: $8,000; Year 2: $18,000; and Year 3: $24,000. The amount of dividends received by the common shareholders in year 1 was a) $4,000. b) $ 0. c) $8,000. d) $12,000. Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

76. Seaside Developments Inc. has $200,000 of no-par value 4% cumulative preferred shares, and 12,000 shares of no-par value common shares outstanding. In its first three years of operation, the company paid cash dividends as follows: Year 1: $8,000; Year 2: $18,000; and Year 3: $24,000. The amount of dividends received by the preferred shareholders in year 2 was a) $8,000. b) $9,000. c) $12,000. d) $18,000. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

77. Seaside Developments Inc. has $200,000 of no-par value 4% cumulative preferred shares, and 12,000 shares of no-par value common shares outstanding. In its first three years of operation, the company paid cash dividends as follows: Year 1: $8,000; Year 2: $18,000; and Year 3: $24,000. The amount of dividends received by the common shareholders in year 3 was a) $8,000. b) $12,000. c) $16,000. d) $20,000. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

78. The declaration and issuance of a stock dividend a) increases total shareholders' equity. b) does not change total shareholders' equity.

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c) increases current liabilities. d) does not change total retained earnings. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

79. On January 1, The Blue Azul Diving Co. had total shareholders' equity as shown below when their shares were selling at $25 per share: Common shares (125,000 shares) ................... $2,500,000 Retained earnings............................................ 4,000,000 Total shareholders' equity ...................... $6,500,000 Assume the company declared and issued a 50% stock dividend. The effect of this dividend would a) increase common shares by $1,250,000 and shares issued and outstanding by 62,500. b) increase common shares by $1,250,000 with no change in the number of issued and outstanding shares. c) leave total shareholders' equity unchanged but increase the number of shares issued and outstanding to 187,500. d) reduce retained earnings by $2,000,000 and double the number of shares issued and outstanding. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

80. On January 1, The Blue Azul Diving Co. had total shareholders' equity as shown below when their shares were selling at $25 per share: Common shares (125,000 shares) ................... $2,500,000 Retained earnings............................................ 4,000,000 Total shareholders' equity ...................... $6,500,000 Assume the company declared and issued a 10% stock dividend and that the market price remained constant. The effect of this dividend would a) increase common shares by $312,500.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

b) increase common shares by $250,000. c) decrease retained earnings by $250,000. d) increase common shares by $400,000. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

81. On January 1, The Blue Azul Diving Co. had total shareholders' equity as shown below when their shares were selling at $25 per share: Common shares (125,000 shares) ................... $2,500,000 Retained earnings............................................ 4,000,000 Total shareholders' equity ...................... $6,500,000 If the company declared a 15% stock dividend, the number of issued and outstanding shares would a) remain unchanged. b) increase by 18,750 shares. c) decrease by 18,750 shares. d) total 143,700 shares. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

82. Which of the following is NOT a reason to issue small stock dividends? a) The stock dividend does not reduce the assets of the company. b)The stock dividend provides an opportunity for the company to capitalize its retained earnings. c) The stock dividend allows the company to issue a dividend without recording it in their records. d) The stock dividend allows the shareholders the option of keeping the shares or selling them for cash. Answer: c Bloomcode: Comprehension

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Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

83. Information to determine the amount of dividends declared and the amount of dividends paid during the year is found on which financial statement? Dividends declared Dividends paid a) Statement of Changes in Shareholders’ Equity Income Statement b) Statement of Changes in Shareholders’ Equity Cash Flow Statement c) Cash Flow Statement Income Statement d) Cash Flow Statement Cash Flow Statement Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

84. In 2024, Bouchard Enterprises reported net income of $75,000 and declared a dividend of $40,000. The dividend is to be paid on February 1, 2025, to shareholders of record on January 15, 2025. The balance in the retained earnings account on January 1, 2024, was $140,000. At Bouchard’s year end on December 31, 2024, the company reported the following ending balance for retained earnings on the statement of changes in shareholders’ equity: a) $35,000. b) $115,000. c) $175,000. d) $215,000. Answer: c Bloomcode: Application Difficulty: Hard Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

85. Stock splits

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

a) decrease the Retained Earnings account. b) increase the number of outstanding shares. c) increase the Share Capital account. d) increase market value of shares. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

86. Which of the following is a reason a company would declare a stock split? a) to increase the marketability of its shares b) to increase the share price in the market c) to increase the value of the company d) to increase the share capital of the company Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

87. On December 1, Murial Ltd. declared a 2 for 1 stock split when the market value was $40 per share. Prior to the split, there were 200,000 shares issued at $40 and outstanding. After the stock split, the number of shares outstanding and the share capital balance were Shares Capital a) 200,000 $8,000,000. b) 200,000 $4,000,000. c) 400,000 $8,000,000. d) 400,000 $4,000,000. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

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88. Stock splits are usually declared in order to a) increase the number of shares outstanding. b) improve the earnings per share. c) reduce the shareholders' equity. d) reduce the shares' market price. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

89. Reverse stock splits are used by companies whose low share price a) puts the company at risk of being listed on a stock exchange as a result of its share price being barely above the minimum threshold for listing on the exchange. b) makes a company an eligible investment for certain institutional investors. c) allows a company to list on a public exchange. d) prevents a company from listing on a public exchange. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

90. Which of the following statements is correct in regard to the effect on share capital? a) Cash dividends increase share capital. b) Stock dividends increase share capital. c) Stock splits increase share capital. d) Cash dividends, stock dividends and stock splits have no effect on share capital. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

91. Missing Pieces Ltd. is a public company trading on the Toronto Stock Exchange. The company's shares are currently trading for $16 per share. Missing Pieces just released the following information related to its 2024 year end: 2024 2023 Total assets ................................................................ $14,500,000 13,250,000 Total liabilities ........................................................... 7,500,000 6,750,000 Net income ................................................................ 762,500 555,000 Preferred share dividends ......................................... 65,000 65,000 Average number of common shares outstanding .... 100,000 For 2024, the company’s earnings per share were closest to a) $7.63. b) $6.98. c) $6.50. d) cannot be calculated with the information provided. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

92. Partridge Ltd.’s shares were issued for $21 per share but now have a market value of $35 per share. The most recent EPS for the company was $3. The P/E ratio for Partridge Ltd. is a) 4.67. b) 7.0. c) 11.67. d) 18.67. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

93. The first step in calculating the price/earnings ratio is to a) calculate number of preferred shares.

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b) calculate number of common shares. c) calculate balance in the retained earnings account. d) calculate earnings per share. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

94. What measures the dividends an investor will receive relative to the share price? a) dividend payout ratio b) EPS c) dividend yield d) price/earnings ratio Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

95. The dividend payout ratio measures a) the portion of a company’s earnings that are distributed as dividends. b) the dividends an investor will receive relative to the share price. c) accounting earnings to market price. d) the earnings attributed to each shareholder. Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

96. A major advantage of using equity financing is a) dividends are not optional. b) ownership interests are not diluted. c) dividends are deductible for tax purposes. d) there is no requirement for repayment. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the advantages and disadvantages of using equity financing. CPA: Financial Reporting AACSB: Analytic

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EXERCISES 97. Grizzly Corporation has the following shareholders’ equity balances at January 1, 2024: Common shares, unlimited authorized, 200,000 issued ........................................ $800,000 Retained earnings.................................................................................................... 120,000 Accumulated other comprehensive income .......................................................... 30,000 The following events occurred in 2024: 1. Issued 50,000 common shares for $150,000 cash. 2. Declared and paid dividends of $25,000. 3. Reported profit of $40,000. 4. Reported other comprehensive income of $10,000. Instructions Prepare a statement of changes in equity using the following tabular format:

Common Shares

Retained Earnings

Accumulated Other Comprehensive Income

Common Shares

Retained Earnings

Accumulated Other Comprehensive Income

Total

Jan 1, 2024

Dec 31, 2024 Solution (10 min.)

Jan 1, 2024

$800,000

Issued common shares

150,000

$120,000

$30,000

$950,000 150,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Declared Dividends

(25,000)

Profit

40,000

Other comprehensive income Dec 31, 2024

$950,000

$135,000

10,000

$40,000

$1,125,000

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

98. Snowflake Corporation's shareholders' equity section at December 31, 2023, appears below: Shareholders' equity Share capital Common shares, 82,000 issued ............................................................... $ 820,000 Retained earnings ............................................................................................ 350,000 Total shareholders' equity ...................................................................................... $1,170,000 Instructions In 2024 Snowflake repurchases 2,000 shares. Please treat the following two situations independently. a) If the shares are repurchased at $9 / share, record this transaction. What is the impact of this repurchase on the shareholders’ equity accounts? b) If the shares are repurchased at $11 / share, record this transaction. What is the impact of this repurchase on the shareholders’ equity accounts? Solution (10 min.) a) Dr. Common Shares (2000 x ($820,000 / 82,000) ..................................... $20,000 Cr. Cash ............................................................................................. $18,000 Cr. Contributed Surplus .................................................................... $ 2,000 After the share repurchase, the balance in the Common Share account is $800,000, Retained Earnings account is $350,000, and the Contributed Surplus account is $2,000. b)

Dr. Common shares (2000 x ($820,000 / 82,000)...................................... $20,000 Dr. Retained Earnings ............................................................................... $ 2,000 Cr. Cash ............................................................................................. $22,000 After the share repurchase, the balance in the Common Shares account is $800,000, and the Retained Earnings account is $348,000, there is no balance in the Contributed Surplus account.

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Bloomcode: Application Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

99. Peppermint Inc. has the following shares outstanding at December 31, 2024: Common shares, $1,500,000 no-par value, 10,000 shares issued and outstanding, unlimited number authorized. Preferred shares, $200,000, $5.00, no-par value, non-voting shares, and 2,000 shares issued and outstanding. Assume the following situations are independent: a) The preferred shares are non-cumulative and non-participating. Dividends declared are $47,500. b) The preferred shares are cumulative and non-participating. Dividends have not been declared for the past two years. Dividends declared are $30,000. Instructions Determine the amount of the dividend that would be paid to each class of shares under each situation. Solution (5 min.) a) Preferred $10,000* *(2,000 × $5)

Common $37,500

b) In arrears Current Totals *(2,000 × $5 × 2)

Preferred $20,000* 10,000 $30,000

Total $47,500

Common $ -0-0$ -0-

Total $20,000 10,000 $30,000

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

100. The shareholders' equity section of Polar Industries Ltd. at December 31, 2023, included the following: $3 preferred shares, cumulative, 10,000 shares authorized, 9,000 shares issued Common shares, 500,000 shares authorized, 400,000 shares issued

$900,000 2,000,000

Dividends were not declared on the preferred shares in 2023 and are in arrears. On September 15, 2024, the board of directors declared dividends on the preferred shares for 2023 and 2024, to shareholders of record on October 1, 2024, payable on October 15, 2024. On November 1, 2024, the board of directors declared a $0.50 per share dividend on the common shares, payable November 30, 2024, to shareholders of record on November 15, 2024. Instructions Prepare the journal entries that should be made by Polar Industries for 2024. If no entry is needed write “No entry required.” Solution (10 min.) Sep 15 Cash Dividends ............................................................................ 54,000 Dividends Payable................................................................ 54,000 To record declaration of dividends in arrears and the current year's preferred dividend (9,000 shares × $3 × 2) Oct

Oct 15

Nov

No entry required. Dividends Payable ....................................................................... Cash ...................................................................................... To record payment of cash preferred dividend

54,000 54,000

Cash Dividends ............................................................................ 200,000 Dividends Payable................................................................ To record declaration of a cash dividend on common shares (400,000 shares × $0.50)

Nov 15

No entry required.

Nov 30

Dividends Payable ....................................................................... Cash ...................................................................................... To record payment of common share cash dividends

200,000

200,000 200,000

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rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

101. Bambino Baby Store has provided the shareholders’ equity section of the company’s Statement of Financial Position at January 1, 2024: Share capital $2 Preferred shares, cumulative, 100,000 shares authorized, 14,000 shares issued Common shares, 500,000 shares authorized, 140,000 shares issued Retained Earnings Total Shareholders’ Equity

$ 147,000 1,000,000 1,147,000 2,425,000 $3,572,000

On December 31, 2024, Bambino declared cash dividends of $90,000, which will be paid on January 10, 2025. Bambino did not declare any dividends in 2023. Instructions a) b)

How much of the dividends declared by Bambino would each class of shares receive? Prepare the journal entry to record the dividends declared on December 31, 2024.

Solution (15 min.) a)

Total dividends declared = $90,000 Preferred shares would receive: $56,000 (2023 dividend in arrears = $2 x 14,000 = $28,000 + 2024 dividend = $28,000) Common shares would receive excess dividends remaining = $90,000 - $56,000 = $34,000

Dr. Dividends Declared – Preferred Shares.............................................. Dr. Dividends Declared – Common Shares .............................................. Cr. Dividends Payable .......................................................................

$56,000 $34,000 $90,000

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

102. Charlie Inc. had the following balances in its shareholders' equity at the beginning of the current

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year: Common shares (no par value, 9,000 shares) .................... Retained earnings................................................................ Total shareholders' equity ..........................................

$ 180,000 92,000 $272,000

During the year, the following transactions took place: 1. Issued 7,000 shares at $20 per share. 2. Declared a 10% stock dividend, market price $21 per share. 3. Paid the stock dividend. 4. Declared a 4 to 1 stock split. Instructions a) Prepare the journal entries to record the transactions. b) Determine the number of shares outstanding. Solution (5 min.) a) 1. Cash (A) ............................................................................ Common Shares (SE) ...................................................

140,000 140,000

2. Stock Dividend declared* (SE) ........................................ Stock dividend issuable (SE) ....................................... *10% × (9,000 + 7,000) × 21 1,600 new shares issued

33,600

3. Stock dividend issuable (SE) ........................................... Common shares (SE) ...................................................

33,600

4. Memo entry increasing number of shares issued and outstanding and reducing the book value per share. b)

(9,000 +7,000 +((9,000+7,000) x10%))) × 4 = 70,400

Bloomcode: Application Difficulty: Easy Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

103. On December 31, 2023, Pekoe Corporation reported $3,000,000 in its Common Shares account (200,000 issued) and retained earnings of $1,000,000. During 2024, the following events occurred: 1. On July 1, the company issued 100,000 common shares at $17 per share. 2. On December 15, the board of directors declared a 15% stock dividend to common shareholders

Shareholders’ Equity

3. 4.

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of record on December 31, payable on January 15, 2025. The market value of Pekoe Corporation common shares was $16 per share on December 15 and $14 per share on December 31. Profit for 2024 was $625,000.

Instructions a) Record the issue of shares on July 1 and the declaration of the stock dividend on December 15. b) Prepare the shareholders' equity section of the statement of financial position at December 31, 2024. Solution (15 min.) a) Jul 1 Cash ...................................................................................... Common Shares ........................................................... Issued 100,000 shares at $17/share Dec 15

Stock Dividends Declared (45,000 × $16) ............................ Stock Dividends Issuable ............................................. (200,000 + 100,000) × 15% = 45,000 shares)

1,700,000 1,700,000

720,000 720,000

b) PEKOE CORPORATION Statement of Financial Position (partial) December 31, 2024 Shareholders' equity Share capital Common shares, 300,000 shares issued ......................................................... Stock dividend issuable ................................................................................... Total share capital ................................................................................... Retained earnings* .................................................................................................. Total shareholders' equity .......................................................................

$4,700,000 720,000 5,420,000 905,000 $6,325,000

* Retained earnings = $1,000,000 – $720,000 + $625,000 = $905,000 Bloomcode: Application Difficulty: Hard Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

104. Sunset Corporation has the following account balances on January 1, 2024: Preferred Shares, $5, non-cumulative, non-voting, 10,000 issued ......... $ 250,000 Common shares, unlimited number authorized, no par value, voting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

shares, 150,000 issued .............................................................................. $1,500,000 Retained Earnings .................................................................................... $ 375,000 The following transactions took place during 2024: Mar 1 – a $0.50 / share cash dividend is declared on common shares Mar 15 – date of record Mar 31 – date of payment Jul 1 – 2-for-1 stock split Aug 15 – 10% stock dividend declared on common shares, share price is $11 Sep 15 – date of issuance of stock dividend Dec 15 – preferred shares dividend is paid Dec 31 – Net income of $275,000 Instructions a) Make all of the necessary journal entries, Including closing entries. b) Determine the 2024 year-end balance in the preferred shares, common shares and retained earnings accounts. c) Prepare the shareholders equity section of the Statement of Financial Position. Solution (20 min.) a) Mar 1 Dr. Dividends Declared – Common Shares ................................. Cr. Dividends payable .......................................................... Mar 15 no entry required Mar 31 Dr. Dividends Payable.................................................................. Cr. Cash ................................................................................ Jul

Aug 15

Sep 15

Dec 15

Dec 31

$75,000 $75,000 $75,000 $75,000

memo note only, (outstanding common shares have now doubled to 300,000) Dr. Stock Dividends Declared ...................................................... (10% * 300,000 shares * $11 / share) Cr. Stock Dividend Issuable .................................................

$330,000

Dr. Stock Dividend Issuable......................................................... Cr. Common Shares .............................................................

$330,000

Dr. Dividends Declared —Preferred Shares ................................ Cr. Cash.................................................................................

$50,000

Dr. Income Summary ................................................................... Cr. Retained Earnings .......................................................... Dr. Retained Earnings .................................................................. Cr. Dividends Declared – Common Shares.......................... Dr. Retained Earnings .................................................................. Cr. Dividends Declared Preferred Shares. ...........................

$275,000

$330,000

$50,000

$275,000 $ 75,000 $75,000 $ 50,000 $50,000

Shareholders’ Equity

Dr. Retained Earnings .................................................................. Cr. Stock Dividends Declared . ............................................

Account balances at December 31, 2024: Preferred Shares ........................................................ Common Shares ........................................................ Retained Earnings .....................................................

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$330,000 $330,000

$ 250,000 $1,830,000 $ 195,000

c) SUNSET CORPORATION Statement of Financial Position– partial December 31, 2024 Shareholders’ Equity Share Capital Preferred Shares, $5, non-cumulative, non-voting, 10,000 issued ...............................

$ 250,000

Common shares, unlimited number authorized, no par value, voting shares, 330,000 issued .................................................................................................... Total Share Capital ........................................................................................................

$1,830,000 $2,080,000

Retained Earnings ...........................................................................................................

$ 195,000

Total Shareholders’ equity...........................................................................................

$2,275,000

Bloomcode: Application Difficulty: Hard Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

105. Determine whether a cash dividend, stock dividend, or stock split will result in the effect listed in the first column. For example, for the first item, indicate by inserting a yes or no in the space provided whether a cash dividend will result in a decrease in total assets; whether a stock dividend will result in a decrease in total assets; and whether a stock split will result in a decrease in total assets.

Effect Decrease in total assets Decrease in total shareholders' equity Increase in share capital Decrease in retained earnings

Possible Transaction Cash Dividend Stock Dividend

Stock Split

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Increase in the number of shares Solution (5 min.)

Effect Decrease in total assets Decrease in total shareholders' equity Increase in share capital Decrease in retained earnings Increase in the number of shares

Possible Transaction Cash Dividend Stock Dividend Yes No Yes No No Yes Yes Yes No Yes

Stock Split No No No No Yes

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

106. Hartly Inc. is a manufacturer of custom motorcycle and automotive parts. The company is publicly traded with its common shares trading at $8.75/share. In 2024, the company earned a net income of $975,250 and had an average shareholders’ equity of $3,457,000. During 2024, the company had shareholders’ equity consisting of 575,000 common shares and 125,000, $1 non-voting, cumulative preferred shares. There were no common shares sold or repurchased in 2024, and preferred shareholders received a dividend payment. Instructions Calculate and comment on the following ratios for Hartly for 2024: a) Earnings per share b) Price/earnings ratio c) Return on shareholders’ equity Solution (10 min.) a) Earnings per share

= = =

b) Price/earnings ratio = =

Net Income – Preferred Dividends Average Number of Common Shares Outstanding $975,250 – 125,000 575,000 shares $1.48 return on each share based on the current number of outstanding shares. Market price per share EPS $8.75 $1.48

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5.91 (This relates the share’s current market price to its earnings.) It is used to compare companies within similar industries. A higher number indicates that the market places a higher value on the company, relatively speaking.

c) Return on shareholders’ equity

Net Income – Preferred Dividends Average Common Shareholders’ Equity = $975,250 – 125,000 $3,457,000 = 24.6%. This indicates that shareholders enjoyed a return of 24.6% on their investment.

Bloomcode: Analysis Difficulty: Hard Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

107. Below is the financial data for Eric’s Electric Energy Inc. for the year ended December 31, 2024: Market price per share......................................................................... $150.00 Net Income........................................................................................... $1,750,000 Preferred Dividends declared ............................................................. $75,000 Average # of common shares .............................................................. 100,000 Dividends per share ............................................................................. $2.50 Average common shareholders’ equity.............................................. 10,000,000 Total assets .......................................................................................... $22,500,000 Total Liabilities .................................................................................... $11,675,000 Accumulated Other Comprehensive Income ..................................... $185,000 Instructions Calculate the following amounts: a) Price/earnings ratio b) Dividend payout ratio c) Dividend yield d) Return on shareholders’ equity Solution (10 min.) In order to calculate P/E ratio we must first compute EPS. a) EPS

= Net income – Preferred dividends / average common shares = ($1,750,000 – $75,000) / 100,000 = $16.75

Price/ Earnings ratio

= market price per share/earnings per share

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

= $150 / $16.75 = 8.96 times b) Dividend payout ratio = Dividends per share/Earnings per share = $2.50 / $16.75 = 14.9% c) Dividend yield

= dividends per share/price per share = $2.50 / $150.00 = 1.67%

d) Return on equity ratio equity

= (net income – preferred dividends)/average common shareholders’ = ($1,750,000 – $75,000) / $10,000,000 = 16.75%

Bloomcode: Application Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

Shareholders’ Equity

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MATCHING 108. Listed below are several types of dividends followed by a series of descriptive characteristics. Match the types of dividends to the characteristics by placing the appropriate letter(s) in the space provided. Some characteristics may pertain to more than one type of dividend. TYPES OF DIVIDENDS A. Cash C. Stock Split B. Stock D. In arrears CHARACTERISTICS ___ 1. Does not change assets, liabilities, or total shareholders' equity ___

Results in the value per share being changed

___

Pertains to preferred shares only

___

Results in a liability on the date of declaration based on fair market value

___

An entry may not be made on the date of declaration

___

May be reflected with a memorandum entry

___

Reduces total assets and shareholders' equity

___

Increases the number of shares outstanding

___

Results in a change to the number of authorized shares

Solution (3 min.) 1. B and C 2.

B and C

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

none

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

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SHORT-ANSWER ESSAY QUESTIONS 109. What is OCI? What types of items would be included in OCI? Where in the financial statements would this be reflected? What is the rationale for this? Solution (5 min.) OCI is the unrealized gains and losses that result from revaluations of certain types of investments and the revaluation of items denominated in foreign currencies into the reporting currency for example. These gains and losses that result from these transactions are considered unrealized because they did not result from transactions with third parties; therefore, they are excluded from net income and retained earnings. These gains and losses are reflected on the Other Comprehensive statement. OCI is then aggregated in an account known as Accumulated OCI under SHE on the statement of financial position. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the components of the shareholders’ equity section of the statement of financial position. CPA: Financial Reporting AACSB: Analytic

110. Preferred shares are often referred to as hybrid securities—a hybrid between debt and common shares. Instructions Discuss the features of a preferred share that make it resemble debt and explain why it is normally recorded in the equity section of the Statement of Financial Position. Why would a company choose to issue preferred shares? Solution (5 min.) The features of a preferred share that make it resemble debt are that it normally has a fixed payment dividend associated with it that is similar to interest on debt. Also, like debt, preferred shares do not have a voting right, and the shares have priority in the event of liquidation ahead of common shareholders but behind debt. Reasons for issuing preferred shares include: • Enable a company to raise capital without having to dilute ownership interests of common shareholders • Dividends can be postponed in periods of financial difficulty • Provides new capital to a company while improving the debt to equity ratio • Does not result in the dilution of future earnings as preferred shareholders would only be entitled to the fixed or stated dividend amount regardless of any increase in earnings. Bloomcode: Comprehension Difficulty: Medium

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Describe the different types of shares and explain why corporations choose to issue a variety of share types. CPA: Financial Reporting AACSB: Analytic

111. Accounting for cash dividends involves four important dates. Some of these dates have accounting significance, and some do not. Instructions Identify and briefly discuss each of the four dates connected with accounting for dividends and indicate which dates require a journal entry. Solution (5 min.) The date of declaration is the date the board of directors formally announces a dividend. On this date, the dividend becomes a legal liability and an accounting entry must be made. The date of record is the date on which the list of shareholders who will receive the dividend is prepared. No journal entry is required. The ex-dividend date is the day on which the shares are sold without the right to receive the dividend. It is typically a few days before the record date. On this date, share prices will fall by the amount of the dividend. No journal entry is required. The date of payment is the date on which the dividend is paid. A journal entry is made to remove the liability and reduce the asset paid out. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. CPA: Financial Reporting AACSB: Analytic

112. Corporations have several dividend options when it comes to compensating shareholders. These options include cash dividends, stock dividends, and stock splits. Instructions Compare and contrast these dividend options and discuss why a corporation may choose one option over the other. Solution (8 min.) Cash dividends are a payment to shareholders in return for the use of their money. Many shareholders invest with the expectation of such a return and may become dissatisfied in the absence of such a return. Cash dividends are only paid to shareholders once the board of directors has voted and

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declared a dividend payment. Once the dividend has been declared, it is a legally binding obligation and becomes a liability to the corporation. Cash dividends reduce overall shareholders’ equity by directly reducing the Retained Earnings account and reducing the company’s assets (specifically the Cash account) by the amount of the dividend payment. Stock dividends result from the issue of additional company shares to shareholders. Stock dividends may be used when the company is not in a position to or does not want to use any of its cash for cash dividends. A stock dividend does not erode shareholders’ equity or the overall value of the corporation. The net effect of the stock dividend is to increase the capital account and decrease the Retained Earnings account by the value of the stock dividend. Stock Splits are generally done to improve the marketability of the company’s shares. It also provides shareholders with the ability to increase future dividend payments and gains as a result of the increased number of shares they now own. Stock splits have no effect on total assets, share capital or retained earnings. All that changes is the number of shares outstanding. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. Learning Objective: Describe what a stock split is and explain how it is accounted for. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

ESSAY QUESTIONS 113. Shareholders have certain rights as owners of a corporation. These rights may differ depending on the type of shares purchased. Instructions a) List and briefly discuss the general rights of a common shareholder. b) List and briefly discuss the rights and preferences attached to preferred shares that differ from those of common shares. Solution (7 min.) a) Common shareholders have the right to share proportionately in the following: (1) Profits and losses of a corporation: This is accomplished through the distribution and receipt of dividends. (2) Management of a corporation: This is accomplished by voting for members of the board of directors. Each common shareholder gets one vote per share. So, the shareholders elect the board that, in turn, hires and fires management. (3) Assets upon liquidation: This is accomplished by establishing an order in which creditors and owners are paid upon liquidation. Common shareholders come last and split any assets remaining in proportion to their relative number of shares. (4) Subsequent issues of shares: This is accomplished by guaranteeing the common shareholder the right to a proportionate share of any new shares (the pre-emptive right). This allows shareholders to maintain their ownership interest. b)

Preferred shareholder rights are modified slightly and may include the following: (1) Preference as to dividends: The right to a predetermined amount of dividends before the common shareholders receive theirs. (2) Preference as to liquidation: The right to receive a share of the assets left after paying off the creditors in liquidation, before the common shareholders receive anything. (3) Loss of the voting right: The voting right is often given up in order to receive the preferences over common shares.

114. You have just started a new job as a financial analyst assessing investment performance for publicly traded companies. What metrics would you use to do this and why? Solution (10 min.) Metrics that would be used include:

Shareholders’ Equity

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Price / earnings ratio. Measured as P/E ratio = market price / EPS. Higher is better. It relates the accounting earnings back to the market price of the shares. This ratio should be used to compare performance between companies in the same industry. This comparison gives the user information about how the market is valuing the company in relation to others. Dividend payout ratio. Measured as dividend payout ratio = dividends per share / EPS. This ratio measures the portion of a company’s earnings that is distributed as dividends. More mature or stable companies generally pay a higher portion of their earnings as dividends. Dividend yield. Measured as dividend yield = dividends per share / price per share. Measures the dividends an investor will receive relative to the share price. More mature companies tend to be low growth stocks and pay out a larger portion of earnings as dividends. Return on shareholders’ equity. Measured as return on equity ratio = (NI – preferred dividends) / average common shareholders’ equity. Provides information on the rate of return common shareholders are earning on the amount they invested in the company, which includes assets represented by undistributed retained earnings.

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. CPA: Financial Reporting AACSB: Analytic

115. Why would a company prefer to issue shares? Instructions List the advantages and disadvantages to issuing additional shares. Solution (10 min.) The advantages of financing with equity instead of debt are: 1. Equity financing does not have to be repaid. Equity financing is considered to be permanent capital: it does not have to be returned to shareholders unless the company is being liquidated. This is a significant difference from debt financing, which requires that the principal borrowed be repaid by a specific date. 2. Dividends are optional. Unlike interest, which must be paid on borrowed money, dividends are at the discretion of the board. This ensures that, if needed, the company can reinvest all of its profits to grow and support the business, instead of using a portion of profits to pay interest to creditors. The disadvantages of using equity financing instead of debt are: 1. Ownership interests may be diluted. Issuing additional common shares may dilute the ownership interest of existing shareholders because existing shareholders will own a lower percentage of the company’s voting shares. Of course, this would not be the case if the existing shareholders purchased all of the new shares, but that is very unlikely for a public company. 2.

Dividends are not deductible for tax purposes. Interest paid on borrowed funds is an expense to the borrower and is deductible for tax purposes. This is not the case with dividends paid because

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

these are not expenses, but a distribution of profits. As such, dividends do not reduce a company’s income for tax purposes. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the advantages and disadvantages of using equity financing. CPA: Financial Reporting AACSB: Analytic

CHAPTER 12 FINANCIAL STATEMENT ANALYSIS CHAPTER LEARNING OBJECTIVES 1. Understand and explain the process of financial analysis. • Financial analysis involves evaluating a company’s performance based on the information in its financial statements, MD&A, and so on. • A basic five-step analysis process includes: (1) determining the purpose or context for the analysis, (2) collecting the required information, (3) preparing common-size analysis and calculating ratios, (4) analyzing and interpreting the common-size analysis and ratios, and (5) developing conclusions and recommendations.

2. Identify the common contexts for financial statement analysis and explain why an awareness of context is essential to the analysis. • Financial statement analysis is conducted in a variety of contexts, including share purchase/hold/sale decisions, lending decisions, credit application decisions, and corporate acquisitions analysis. • The context for the analysis is important in determining the most appropriate tools for the analysis, such as trend analysis (the same company’s results over time) or cross-sectional analysis (one company’s results relative to another’s).

3. Explain why knowledge of the business is important when analyzing a company’s financial statements. • Interpreting the results of ratios and other analysis requires the analyst to have an understanding of the business, including the various activities the company is engaged in and any significant changes to the company’s operations during the period being analyzed. • Companies present information on any distinct operating segments that meet certain thresholds. These segments can be based on different types of businesses the company is involved in or by the different geographic regions it operates in, if applicable. • Understanding a company’s strategies is also essential to being able to interpret financial statement analysis correctly.

4. Identify the types of information used when analyzing financial statements and where it is found. • The primary source of the information used in the analysis is a company’s annual report. It includes the company’s comparative financial statements, management’s discussion and analysis of the most recent results, and the auditors’ report.

5. Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Retrospective analysis is historical analysis (assessing past results), while prospective analysis is forward-looking analysis (trying to determine what the future results may be). There are two major types of retrospective analysis: trend analysis and cross-sectional analysis. Trend analysis involves assessing results over a period of time, such as 3 to 10 years, and looking for patterns or changes over time. Cross-sectional analysis normally involves comparing the results of one company with other companies in the same industry, including competitors. In certain contexts, cross-sectional analysis can also involve comparisons with companies in other industries.

6. Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. • Common-size analysis involves restating the various amounts in the financial statements into percentages of a specific base amount. For example, statements of income can be restated so that each amount is a percentage of total revenues or statements of financial position can be restated so that each amount is a percentage of total assets. Common-size statements make it easy to identify the degree of changes from period to period. • Ratio analysis is also commonly used to assess a company’s results from one period to the next or to compare one company with others. • Ratios are useful for identifying issues that require further investigation, but do not provide the reason for the changes. • There are five common categories of ratios: liquidity, activity, solvency, profitability, and equity analysis ratios. • The formulas for the various ratios in each category are presented in Exhibit 12.5.

7. Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. • The current and quick ratios are used to analyze liquidity. • The ratios commonly used to assess activity include accounts receivable turnover, average collection period, inventory turnover, days to sell inventory, accounts payable turnover, and accounts payable payment period ratio. • The debt to equity, net debt as a percentage of total capitalization, and interest coverage ratios are used to analyze solvency. • Profitability is assessed using the gross profit margin, net profit margin, return on equity, and return on assets ratios. • Equity analysis uses the basic earnings per share, price/earnings, dividend payout, dividend yield, and net free cash flow ratios.

8. Identify and explain the limitations of ratio analysis. • The limitations of ratio analysis include companies using different accounting policies or estimates, the existence of different ratio definitions, the challenge of comparing diverse operations, the impacts of seasonality in terms of when ratio analysis is conducted, and the potential for manipulation by management.

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9. Identify and explain commonly used non-IFRS financial measures and performance measures. • Performance measures include IFRS measures (or GAAP measures), non-IFRS measures (or non-GAAP measures), other financial measures (or financial metrics), and operational measures (or non-financial measures). • Non-IFRS measures are based on information that is not taken directly from IFRS financial statements. • Free cash flow, EBITDA and net debt are commonly used non-IFRS financial measures. • Other financial measures are not drawn from IFRS-based financial information and include measures such as same-store sales, comparable sales growth, and sales per square foot. As the information these measures are based on is unaudited, caution must be exercised when using them. • Operational measures report physical or non-financial data such as customer retention rates, churn rate, subscriber counts, number of units delivered, number of units ordered, and so on.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

TRUE-FALSE STATEMENTS 1. Financial statement analysis is the process of evaluating a company’s performance based on an analysis of its financial statements. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

2. It is important that the conclusion of an analysis differentiates between factual results and the analysts’ opinion. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

3. A banker assessing a loan application and an equity analyst making an investment decision would perform the same type of analysis of a company. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the common contexts for financial statement analysis and explain why an awareness of context is essential to the analysis. CPA: Financial Reporting AACSB: Analytic

4. An investment analyst will analyze the company’s results relative to other companies. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the common contexts for financial statement analysis and explain why an

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awareness of context is essential to the analysis. CPA: Financial Reporting AACSB: Analytic

5. An investment analyst will only focus on historical results as future growth will NOT impact shareholder decisions. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the common contexts for financial statement analysis and explain why an awareness of context is essential to the analysis. CPA: Financial Reporting AACSB: Analytic

6. When analyzing companies that have diverse business activities, analysts should NOT rely on segmented information. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

7. When a company operates in different geographic locations, it is considered to have different operating segments. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

8. A company is required to disclose information related to the segment(s) in a note to the financial statements if it has only one distinctive operating segment.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

9. The auditor’s report guarantees the accuracy of the information presented in the financial statements. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

10. The objective of MD&A is to allow the user to see the company through the eyes of management. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

11. Financial statement users value the auditors’ opinion as the auditor is an independent third party. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

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12. The audit report guarantees the accuracy of financial information contained in the financial statements. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

13. Analyzing financial data on the same company over time is called cross-sectional analysis. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

14. Retrospective analysis reviews past trends in order to help predict the future. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

15. Time series analysis compares the data from one company with the data from another company. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

16. Prospective analysis is known as a forward-looking analysis. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

17. Retrospective analysis is using the past to predict future trends. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

18. Historical results CANNOT be used as a foundation for predicting future outcomes. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

19. Trend analysis is used to examine one period of a company’s information. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting

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AACSB: Analytic

20. Cross-sectional analysis compares data from one company with those of another company over many periods. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

21. Common-size analysis is useful for making comparisons across the various financial statements. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

22. Common-size income statement analysis uses net revenues as a base for all percentages. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

23. Ratio analysis provides a complete picture of the general financial health and wellbeing of a company. Answer: False Bloomcode: Comprehension Difficulty: Easy

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

24. Common-size analysis involves converting the percentage values in the financial statements to dollar values. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

25. Ratios exhibit the relationship between figures from year to year and the reason for the changes year to year. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

26. Ratios are more conclusive than attention directing. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

27. Return on equity is a measure of performance from management's perspective. Answer: False

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Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

28. Fully diluted earnings per share is a worst-case scenario. Answer: True Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

29. When calculating the EPS, the cumulative preferred dividends must be removed even if the dividends have NOT been declared and paid. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

30. The current ratio is an activity ratio. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

31. Activity ratios measure how efficiently or effectively a company is managing its short-term assets

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

and short-term obligations. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

32. The current ratio should normally be 1.0 or less. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

33. Activity ratios help an analyst assess the company’s management of its working capital. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

34. Accounting policy choices will affect the financial statements but do NOT impact the calculation of the ratios. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the limitations of ratio analysis. CPA: Financial Reporting AACSB: Analytic

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35. The diversity of operations can make it difficult to compare companies and also affects the trend analysis for the same company.

Answer: False Bloomcode: Comprehension Difficulty: Hard Learning Objective: Identify and explain the limitations of ratio analysis. CPA: Financial Reporting AACSB: Analytic 36. “Window dressing” is a term used when a company postpones transactions to produce a more desirable number to be used in ratio calculations. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the limitations of ratio analysis. CPA: Financial Reporting AACSB: Analytic

37. Financial measures or ratios that are not prepared using information taken directly from these financial statements are referred to as IFRS financial measures or GAAP financial measures. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain commonly used non-IFRS financial measures and performance measures. CPA: Financial Reporting AACSB: Analytic

38. Free cash flow is a commonly used non-IFRS financial measure. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain commonly used non-IFRS financial measures and performance measures. CPA: Financial Reporting

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

AACSB: Analytic

39. Non-IFRS financial measures can only be taken from unaudited financial information. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain commonly used non-IFRS financial measures and performance measures. CPA: Financial Reporting AACSB: Analytic

40. Investors should be cautious when using non-IFRS financial measures and industry metrics because there are no standard definitions for these measures. Answer: False Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain commonly used non-IFRS financial measures and performance measures. CPA: Financial Reporting AACSB: Analytic

Financial Statement Analysis

MULTIPLE CHOICE QUESTIONS 41. Place the following steps involved in financial statement analysis in the proper order: I. Determine the purpose and context of the analysis. II. Develop conclusions and recommendations. III. Collect information needed for the analysis. IV. Analyze and interpret the metrics. V. Prepare common-size analysis and calculate ratios. a) I, III, V, IV, II b) I, II, III, IV, V c) V, I, III, IV, II d) IV, III, V, I, II Answer: a Bloomcode: Knowledge Difficulty: Medium Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

42. Financial statement analysis can be performed by a(n) a) credit rating agency. b) potential investors. c) creditors. d) all are correct. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

43. Financial statement analysis would include a) calculating ratios. b) looking at relationships with the financial statements. c) comparing results with industry benchmarks. d) all are correct. Answer: d Bloomcode: Comprehension

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Easy Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

44. Analysts use financial statements to conduct an analysis for all of the following reasons EXCEPT a) to assess corporate performance. b) for employee satisfaction. c) for lending decisions. d) to assess risks related to the investment. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

45. Which one of the following steps adds the most value to a financial statement analysis? a) Determine the purpose of the analysis. b) Develop conclusions. c) Analyze and interpret the ratios. d) Prepare common-size analysis. Answer: c Bloomcode: Comprehension Difficulty: Hard Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

46. Historical financial results a) help a lender determine the company’s ability to service debt. b) predict future cash flows with accuracy. c) are not really needed for a financial analysis. d) replace the need for financial projections. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the common contexts for financial statement analysis and explain why an

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awareness of context is essential to the analysis. CPA: Financial Reporting AACSB: Analytic

47. In accounting terms, the different business activities that the firm engages in or the different geographic regions it does business in are referred to as a) operating activities. b) business segments. c) operating segments. d) operating divisions. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

48. In order to understand a company’s business, an analyst must understand the corporation’s strategy. Which of the following is an example of a corporate strategy? a) being a high-cost producer b) following product simplification c) being a low-cost producer d) being a low-volume producer Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

49. A low-cost producer focuses on a) providing goods and services at the highest possible costs and selling at high prices. b) providing goods and services at the lowest possible costs and selling at high prices. c) providing goods and services at the highest possible costs and selling at low prices. d) providing goods and services at the lowest possible costs and selling at low prices. Answer: d

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

50. A product differentiation strategy includes a) providing superior service at a premium price. b) providing superior service at a low price. c) providing regular service at a low price. d) providing regular service at a high price. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

51. Which of the following best represents a low-cost producer? a) gourmet grocery store b) discount grocery store c) high-end retailer d) specialty store Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

52. Which of the following best represents a company following the product differentiation strategy? a) gourmet grocery store b) discount grocery store c) discount retailer d) dollar store Answer: a

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

53. Why is the audit report important in the analysis of a company? a) It guarantees the accuracy of the information in the financial statements. b) It guarantees the accuracy of the internal controls of the company. c) The auditors are hired by management to assess the appropriateness of the accounting policies chosen. d) The auditors are an independent third party expressing an opinion on the fairness of the financial statements. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

54. The auditor's report confirms that a) the financial statements are error free. b) the information contained in the auditor’s report is negative information. c) the statements present fairly the financial condition of a company. d) the auditor has qualifications to make on the information. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

55. The descriptive section of the annual report that provides insight into what the company does and the types of risks it faces is referred to as a) the audit opinion. b) the industry overview. c) notes to the financial statements.

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d) management discussion and analysis. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

56. Cross-sectional analysis involves examining a company’s financial data a) across account classifications. b) as percentages of net sales or total assets. c) and comparing it with other companies. d) across time periods. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

57. The analysis of financial statements to assist in predicting future results is an example of a) historical analysis. b) retrospective analysis. c) retroactive analysis. d) prospective analysis. Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

58. Which of the following is NOT an example of cross-sectional analysis? a) Determining how the growth in sales from one company differed from that of another company. b) Comparing growth in sales across different industries.

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c) Determining the growth in sales for a company over a five-year period. d) Comparing total sales across companies in the same industry for the past three years. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

59. Which of the following depicts earnings per share? a) Net income ÷ number of common shares b) Net income ÷ weighted average number of common shares c) (Net income – preferred dividend) ÷ weighted average number of common shares d) (Net income – preferred dividend) ÷ number of common shares Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

60. EBITDAR is best described as a) earnings before income, taxes, depreciation, acquisition, and restructuring. b) earnings before interest, taxes, depreciation, amortization, acquisition, and restructuring. c) earnings before income, taxes, discounts, acquisition, and restructuring. d) equity before interest, taxes, depreciation, amortization, acquisition, and restructuring. Answer: b Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

61. Which of the following descriptions best describes trend analysis? a) Converting dollar values on the financial statements to percentages of a specific base amount.

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b) Comparing data from one company with those of another company over the same period. c) Examining company information from multiple periods. d) Using historical information as a basis for predicting future outcomes. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

62. Which of the following descriptions best describes cross-sectional analysis? a) Converting dollar values on the financial statements to percentages of a specific base amount. b) Comparing data from one company with those of another company over the same period. c) Examining company information from multiple periods. d) Using historical information as a basis for predicting future outcomes. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

63. On a common-size income statement, all items are shown as a) percentages of net income. b) percentages of total assets. c) percentages of gross revenue. d) percentages of gross profit. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

64. Which of the following is NOT a general category of ratios?

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a) liquidity b) activity c) solvency d) leverage Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

65. An analytical tool for comparing two companies of different sizes is a) common-size statements. b) short-term liquidity. c) financial leverage. d) performance. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

66. Review of the financial statements revealed the following for Jekyll Inc.: sales $1,250,000, net income $37,500, total assets $650,000, long-term debt $750,000, interest expense $65,000 and cost of goods sold $775,000. When preparing common-size financial statements, interest expense would be shown as a) 10.0%. b) 9.3%. c) 8.4%. d) 5.2%. Answer: d Bloomcode: Application Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

67. To see if a company’s cost of sales is increasing proportionately with sales, an analyst would use a) raw financial data. b) common-size analysis. c) trend analysis. d) prospective analysis. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

68. Ratios are useful in explaining the a) relationships between financial data. b) differences between companies. c) trends within industries. d) reasons for financial performance. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

69. Consider the following income statement data for Barolo Inc.: 2024 Sales revenue $97,300 Less: Cost of goods sold 45,600 Gross profit 51,700 Less: Selling and administration costs 22,500 Net Income $29,200

2023 $86,200 53,400 32,800 18,300 $14,500

The common-size percentage for selling and administration costs in 2024 was a) 21.2%. b) 23.1%. c) 43.5%. d) 77.0%.

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Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

70. Consider the following income statement data for Barolo Inc.: 2024 Sales revenue $97,300 Less: Cost of goods sold 45,600 Gross profit 51,700 Less: Selling and administration costs 22,500 Net Income $29,200

2023 $86,200 53,400 32,800 18,300 $14,500

Based on common-size analysis, which of the following statements is correct? a) The increase in sales revenue in 2024 was caused by higher selling and administrative expenses. b) The company's cost to sales ratio improved in 2024. c) The increase in gross profit in 2024 was due to increased sales. d) Net income as a percent of sales declined in 2024. Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

71. Given the following data: sales $1,500,000; gross profit $640,000; net income after tax $40,000 and income tax expense $35,000. What is the common-size percentage for operating expenses? a) 37.7% b) 42.7% c) 95.0% d) 97.3% Answer: a Bloomcode: Application Difficulty: Hard Learning Objective: Identify the different metrics used in financial analysis, including common-size

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analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

72. Given the following data: sales $1,500,000; gross profit $640,000; net income $40,000 and income tax expense $35,000. What is the common-size percentage for the cost of sales? a) 3.0% b) 37.7% c) 42.7% d) 57.3% Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

73. Which of the following is a short-term liquidity ratio? a) debt/equity ratio b) profit margin ratio c) quick ratio d) return on assets ratio Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

74. How are prepaid expenses used in each of the following ratios? Current ratio Quick ratio a) Numerator Denominator b) Numerator Numerator c) Numerator Not used d) Not used Numerator Answer: c

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

75. Purchase of inventory for cash will a) increase the current ratio. b) decrease the current ratio. c) increase the quick ratio. d) decrease the quick ratio. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

76. Which of the following represents the debt/equity ratio? a) total liabilities ÷ total shareholders' equity b) total liabilities ÷ (total liabilities + shareholders' equity) c) total liabilities ÷ (total assets – shareholders' equity) d) total long-term liabilities ÷ (total long-term liabilities + shareholders' equity) Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

77. Which of the following descriptions best describes common-size analysis? a) Converting dollar values on the financial statements to percentages of a specific base amount. b) Comparing data from one company to with those of another company over the same period. c) Examining company information from multiple periods. d) Using historical information as a basis for predicting future outcomes. Answer: a

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

78. When preparing common-size analysis of a statement of income, the base is normally a) Net income. b) Operating expenses. c) Revenues. d) Cost of goods sold. Answer: c Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

79. All of the following measure activity EXCEPT for a) accounts receivable turnover. b) inventory turnover. c) equity turnover. d) accounts payable turnover. Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

80. Review of the financial statements revealed the following for Hyde Inc.: sales $1,250,000, net income $37,500, total assets $650,000, long-term debt $750,000, interest expense $65,000, and cost of goods sold $775,000. What is Hyde’s gross profit margin closest to? a) 3%

Financial Statement Analysis

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b) 38% c) 52% d) 62% Answer: b Bloomcode: Application Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

81. Which of the following companies would be least likely to calculate accounts receivable turnover ratios? a) a restaurant b) a construction company c) a consulting firm d) an insurance office Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

82. Which of the return on investment ratios would be of most interest to the owners of a company? a) return on assets b) return on interest c) return on debt d) return on equity Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

83. Lenders would be most concerned with a) debt to equity ratio. b) EPS. c) inventory turnover. d) price/earnings ratio. Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

84. Which of the return on investment ratios would be of most interest to the management of a firm? a) return on assets b) return on debt c) return on equity d) return on profits Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

85. The return on assets ratio could be used for a(n) a) financing decision. b) liquidity decision. c) investment decision. d) debt to equity decision.

Financial Statement Analysis

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Answer: c Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

86. Changes in the profit margin ratio could indicate changes in any of the following EXCEPT changes in a) sales volume. b) product profitability. c) the cost structure. d) the pricing policy. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

87. The following data was taken from the accounting records of White Oleander Corporation: 2024 2023 Total assets $950,000 $850,000 Total liabilities 250,000 240,000 Preferred shares 75,000 75,000 Common shares 300,000 300,000 Retained earnings 325,000 235,000 Additional data: Net income Interest expense Sales revenue The return on assets for 2024 is a) 15.6%. b) 16.5%.

140,000 25,000 980,000

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c) 17.4%. d) 18.5%. Answer: a Bloomcode: Application Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

88. The following data was taken from the accounting records of White Oleander Corporation: 2024 2023 Total assets $950,000 $850,000 Total liabilities 250,000 240,000 Preferred shares 75,000 75,000 Common shares 300,000 300,000 Retained earnings 325,000 235,000 Additional data: Net income Interest expense Sales revenue

140,000 25,000 980,000

The return on equity for 2024 is a) 20.0%. b) 21.4%. c) 26.7%. d) 46.7%. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

89. Consider the following income statement data for Boris Inc.:

Financial Statement Analysis

Sales revenue Less: Cost of goods sold Gross profit Less: Selling and administration costs Net Income

2024 $97,300 45,600 51,700 22,500 $29,200

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2023 $86,200 53,400 32,800 18,300 $14,500

What was the 2024 profit margin closest to? a) 16.8% b) 23.1% c) 30.0% d) 53.1% Answer: c Bloomcode: Application Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

90. Hogwart Corporation's books revealed the following for 2024 and 2023: 2024 2023 Cash $ 27,750 $ 21,250 Accounts receivable 42,000 37,500 Inventory 72,250 61,600 Other prepaid expenses 12,500 12,500 Accounts payable 41,250 38,000 Other current payables 13,000 15,000 Shareholders' equity 100,250 79,850 Sales 525,000 450,750 Cost of goods sold 300,000 240,750 Operating expenses 70,000 65,000 Net income $155,000 $145,000 The number of days to collect the average receivable in 2024 was a) 28 days. b) 29 days. c) 30 days. d) 31 days. Answer: a

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

91. Hogwart Corporation's books revealed the following for 2024 and 2023: 2024 2023 Cash $ 27,750 $ 21,250 Accounts receivable 42,000 37,500 Inventory 72,250 61,600 Other prepaid expenses 12,500 12,500 Accounts payable 41,250 38,000 Other current payables 13,000 15,000 Shareholders' equity 100,250 79,850 Sales 525,000 450,750 Cost of goods sold 300,000 240,750 Operating expenses 70,000 65,000 Net income $155,000 $145,000 The current ratio for the 2024 year end is a) 2.85. b) 2.62. c) 1.29. d) 1.02. Answer: a Bloomcode: Application Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

92. Hogwart Corporation's books revealed the following for 2024 and 2023: 2024 2023 Cash $ 27,750 $ 21,250 Accounts receivable 42,000 37,500 Inventory 72,250 61,600

Financial Statement Analysis

Other prepaid expenses Accounts payable Other current payables Shareholders' equity Sales Cost of goods sold Operating expenses Net income

12,500 41,250 13,000 100,250 525,000 300,000 70,000 $155,000

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12,500 38,000 15,000 79,850 450,750 240,750 65,000 $145,000

The quick ratio for the 2024 year end is a) 1.99. b) 1.69. c) 1.52. d) 1.29. Answer: d Bloomcode: Application Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

93. Which of the following depicts the current ratio? a) (current assets – inventory) ÷ current liabilities b) currents assets ÷ total assets c) (current assets – inventory) ÷ total assets d) current assets ÷ current liabilities Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

94. Which of the following depicts the quick ratio? a) (cash + accounts receivable + short-term investments) ÷ current liabilities

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b) (cash + accounts receivable) ÷ total assets c) (current assets – current liabilities) ÷ total assets d) (cash + inventory) ÷ current liabilities Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

95. Two companies have an identical amount of current assets and current liabilities. Donald Inc. has 40% of its current assets invested in inventory, whereas Mickey Corp. has 30% of its current assets invested in inventory. Which of the following statements is true? a) Donald will have the higher quick ratio. b) Donald will have the higher current ratio. c) The companies are equally liquid because their current ratios are the same. d) Donald is less liquid than Mickey. Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

96. Which of the following transactions will increase the current ratio (assuming the ratio is initially greater than 1)? a) purchasing inventory on credit b) selling inventory for more than cost c) buying office supplies d) collecting accounts receivable Answer: b Bloomcode: Comprehension Difficulty: Medium

Financial Statement Analysis

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Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

97. The quick ratio will be negatively impacted by a) tying up cash in inventory. b) increasing accounts receivable. c) decreasing the level of prepaid accounts. d) increasing levels of long-term debt. Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

98. An analyst is comparing two companies, a retail bookstore chain and an on-line bookstore. Which of the following activity ratios is most likely significantly higher for the on-line bookstore? a) accounts receivable turnover b) inventory turnover c) accounts payable turnover d) gross margin Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

99. An analyst is comparing two companies, a retail bookstore chain and an online bookstore. Which of the following liquidity ratios is most likely significantly lower for the retail bookstore?

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

a) quick ratio b) current ratio c) working capital d) operating cash flow to short-term debt Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

100. To best interpret the accounts receivable turnover ratio, the days in accounts receivable should be compared to the company's a) inventory turnover. b) sales revenue. c) credit terms. d) accounts receivable balance. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

101. Irksome Industries' books revealed the following data for 2024: Total assets $575,000 Shareholders' equity Current liabilities 52,100 Long-term liabilities Operating Cash flow 125,500 The debt/equity ratio for 2024 is a) 1.25. b) 1.34. c) 1.58. d) 2.33.

$222,900 300,000

Financial Statement Analysis

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Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

102. Irksome Industries' books revealed the following data for 2024: Total assets $575,000 Shareholders' equity Current liabilities 52,100 Long-term liabilities Operating Cash flow 125,500

$222,900 300,000

The operating cash flow ratio for 2024 is a) 2.41. b) 1.97. c) 0.42. d) 0.36. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

103. Which of the following represents the interest coverage ratio? a) Net income ÷ interest b) [Net income + (interest × (1 – tax rate))] ÷ interest c) Income before interest but after taxes ÷ interest d) Income before interest, taxes and depreciation ÷ interest Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used.

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

104. Lonesome Inc. had the following activity during 2024: Sales $1,250,000 Interest expense Cost of sales 787,500 Income tax expense Selling & Admin. expenses 252,300

$41,000 27,400

The interest coverage ratio during 2024 is a) 5.13. b) 5.80. c) 7.69. d) 11.28. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

105. Which ratio can help estimate the number of years required to pay off a company’s total debt? a) total debt ÷ net income b) net income ÷ operating cash flow c) total debt ÷ current assets d) cash flows for operations ÷ total liabilities Answer: d Bloomcode: Knowledge Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

Financial Statement Analysis

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106. The price investors are willing to pay for a dollar’s worth of earnings is the a) ROE. b) EPS. c) price/earnings ratio. d) stock market price. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

107. The following information is from the year-end financial statements of LuLu Limes (LLL) Ltd.: Common Preferred Average shareholders’ equity $1,500,000 $ 120,000 Average number of shares outstanding 100,000 30,000 Dividends paid 50,000 90,000 Additional Data: Net Income Interest expense Average Total assets

$340,000 $22,000 $2,535,000

The EPS for LLL Ltd. is a) $1.92. b) $2.00. c) $2.50. d) $3.40. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

108. Which of the following ratios would be considerably higher for a financial services company as opposed to a manufacturer? a) EPS b) debt to equity c) net profit margin d) price/earnings Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

109. Limitations in ratio analysis include all of the following EXCEPT for a) seasonality. b) diversity of operations. c) potential manipulation. d) cross-sectional analysis. Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and explain the limitations of ratio analysis. CPA: Financial Reporting AACSB: Analytic

Financial Statement Analysis

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EXERCISES 110. The current year income statement and comparative figures have been provided for Thames Bay Company: THAMES BAY COMPANY Income Statement For the Year Ended May 31 2024 Sales Revenue ................................................................... 10,410,000 Cost of Goods Sold ............................................................ 3,950,500 Gross Profit ........................................................................ 6,459,500

2023 12,175,000 4,480,000 7,695,000

Operating Expenses Selling Expenses ........................................................ Administrative Expenses ........................................... Depreciation Expense................................................ Interest Expense ........................................................ Total Operating Expenses .................................................

1,015,000 839,000 420,500 185,000 2,459,500

1,375,000 1,090,500 580,000 199,500 3,245,000

Income before Income Taxes............................................ Income Taxes..................................................................... Net Income ........................................................................

4,000,000 1,560,000 2,440,000

4,450,000 1,780,000 2,670,000

Instructions Using the comparative income statement provided as a template, perform a common-size analysis for Thames Bay, expressing each line item as a percentage of total sales revenue. Round all percentages to the nearest whole percent. Solution (15 min.) Sales Revenue ................................................................... Cost of Goods Sold ............................................................ Gross Profit ........................................................................

2024 100% 38% 62%

2023 100% 37% 63%

10% 8% 4% 2% 24%

11% 9% 5% 2% 27%

38% 15% 24%

37% 15% 22%

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Application Difficulty: Medium Learning Objective 1: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

111. Maylee Corporation's financial statements for 2024 follow: MAYLEE CORPORATION Statement of Income For the Year Ended July 31, 2024 Sales.................................................................................................................. $1,575,000 Cost of goods sold ............................................................................................ (976,500) Gross profit ....................................................................................................... 598,500 Operating expenses ......................................................................................... (236,250) Income before taxes ......................................................................................... 362,250 Income taxes .................................................................................................... (144,900) Net income ....................................................................................................... $ 217,350 MAYLEE CORPORATION Statement of Financial Position July 31, 2024 Cash .................................................................................................................. $ 49,000 Receivables ....................................................................................................... 143,900 Inventory .......................................................................................................... 167,800 Property, plant and equipment (net) .............................................................. 682,800 Total assets ............................................................................................... $1,043,500 Current liabilities .............................................................................................. $ 131,000 Non-current liabilities ...................................................................................... 450,000 Common shares ............................................................................................... 250,000 Retained earnings ............................................................................................ 212,500 Total liabilities and shareholders' equity ................................................ $1,043,500 Instructions a) If Maylee were preparing common-size financial statements, calculate the following: i. Cost of goods sold ii. Operating expenses iii. Net Income b) Calculate the following liquidity ratios for Maylee: i. Current ratio

Financial Statement Analysis

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ii. Quick ratio iii. Days Accounts receivable (assume average assets are the same as year-end assets) iv. Days Inventory (assume average assets are the same as year-end assets) c) Comment on Maylee’s performance. Solution (15 min.) a) i. Cost of goods sold (976,500 / 1,575,000) = 62.0% ii.

Operating expenses (236,250 / 1,575,000) = 15.0%

iii

Net Income (217,350 / 1,575,000) = 13.8%

b) i.

Current ratio [(49,000 + 143,900 + 167,800) / 131,000] = 2.75

ii.

Quick ratio [(49,000 + 143,900) / 131,000] = 1.47

iii. Days A/R [1,575,000 / 143,900] = 10.9 times, 365 / 10.9 = 33.5 days iv.

Days Inventory [976,500 / 167,800] = 5.8 times, 365 / 5.8 = 62.9 days

Maylee appears to have good short-term liquidity. Its current ratio is 2.75, above the rule of thumb of 2, and its quick ratio is also very strong at 1.47. This is even more impressive given the fast A/R turnover. The company is collecting its A/R on average in (365/10.9) = 33 days. Prompt collection of accounts receivable is an important source of cash and reduces the cash cycle of a company. The inventory turnover is slower at 5.8 time (365/5.8) or 63 days, but whether that is slow enough to worry about would depend on the type of inventory.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

112. Abbreviated versions of the financial statements for Snapps Industries are presented below: SNAPPS INDUSTRIES Statement of Income For the Year Ended December 31, 2024 Sales................................................................................... Costs and expenses

$1,700,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Cost of goods sold ..................................................... $1,140,000 Operating expenses ................................................... 364,800 Interest expense ........................................................ 37,800 Income before income taxes ............................................ Income tax expense ................................................... Net income ........................................................................

1,542,600 157,400 55,090 $ 102,310

SNAPPS INDUSTRIES Statement of Financial Position December 31, 2024

Total assets........................................................................ Total liabilities ................................................................... Total shareholders' equity ................................................

2024 $842,110 329,600 512,510

2023 $717,800 279,600 438,200

Instructions Calculate the following: a) Net profit margin ratio b) Return on assets c) Return on equity Solution (15 min.) a)

$102,310 Net profit margin ratio = ————–— = 6.02% 1,700,000

ROA =

c) ROE =

102,310 ––––––––––––––––––––– = 13.12% (842,110 + 717,800) ÷2

$102,310 ——————————–— = 21.5% (512,510 + 438,200) ÷ 2

Financial Statement Analysis

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113. The following are the comparative financial statements for Cactus Corporation for 2024 and 2023: CACTUS CORPORATION Comparative Statement of Incomes For Periods Ending October 31

Sales Revenue ................................................................... Cost of Goods Sold ............................................................ Gross Profit ........................................................................

2024 167,500 100,000 67,500

2023 140,000 85,000 55,000

Expenses Depreciation .............................................................. Selling and Administrative ........................................ Interest Expense ........................................................ Total Expenses ..................................................................

15,000 22,500 5,000 42,500

15,000 15,000 2,500 32,500

Net Income (before taxes)................................................. Income Taxes..................................................................... Net Income ........................................................................

25,000 10,000 15,000

22,500 7,500 15,000

CACTUS CORPORATION Comparative Statement of Financial Positions As at October 31 2024

2023

Assets Current Assets: Cash............................................................................ Marketable Securities ................................................ Accounts Receivable ................................................. Inventory .................................................................... Total Current Assets ..........................................................

4,000 10,000 35,000 31,000 80,000

2,500 7,500 30,000 25,000 65,000

Investments (at cost).........................................................

30,000

32,500

Property, plant and equipment Property, Plant and Equipment ................................ Less: Accumulated Depreciation .............................. .................................................................................... Goodwill............................................................................. Total Assets .......................................................................

200,000 87,500 112,500 2,500 225,000

190,000 80,000 110,000 2,500 210,000

Liabilities and Shareholders’ Equity Current Liabilities: Accounts Payable ......................................................

12,500

10,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Notes Payable ............................................................ Accrued and Other Liabilities .................................... Total Current Liabilities ....................................................

25,000 20,000 57,500

20,000 15,000 45,000

Non-current Liabilities: Bonds and Notes Payable ......................................... Total Liabilities ..................................................................

72,500 130,000

78,250 123,250

Shareholders’ Equity Common shares......................................................... Contributed Surplus .................................................. Retained Earnings ..................................................... Total Shareholders’ Equity ...............................................

15,000 55,000 25,000 95,000

15,000 61,750 10,000 86,750

Total Liabilities and Shareholders’ Equity .......................

225,000

210,000

Instructions Comment on the financial performance of Cactus Corporation in terms of a) Liquidity b) Activity c) Profitability d) Solvency Solution (25 min.) a) Liquidity Current Ratio = 80,000 / 57,500 = 1.39 in 2024, 65,000 / 45,000 = 1.44 in 2023. Quick Ratio = (80,000 – 31,000) / 57,500 = 0.85 in 2024, (65,000 – 25,000) / 5,000 =.89 in 2023. Both the current and quick ratios are fairly stable from year to year but slightly below the ideal of a 2:1 current ratio and 1:1 quick ratio. Further analysis should be done comparing these ratios to industry averages. b)

Activity Ratios Ratio Inventory Turnover

Formula COGS Average Inventory

2024 100,000 = 3.57 times (25,000 + 31,000) / 2

Days to sell Inventory

365 days Inventory Turnover

365 days / 3.57 = 102 days

Account Receivables Turnover

Credit Sales Average Account Receivables

167,500*_______ = 5.15 times (30,000 + 35,000) / 2

Financial Statement Analysis

Average Collection period Accounts Payable Turnover Accounts Payable Payment period

365 days Account Receivables turnover Credit Purchases Average Accounts Payable

365 / Accounts Payable Turnover

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365 days / 5.15 = 71 days 100,000**_____ = 8.9 times (12,500+10,000) / 2

365 days / 8.9 = 41 days

* this assumes that all sales were made on credit. **assumes all COGS relates to credit purchases Inventory is turning over less than 4 times per year. This may be an indicator of a problem depending on what type of industry Cactus is in. Accounts receivable are only being collected every 71 days. This is far too long. Cactus’s receivable policies and procedures should be reviewed. Both inventory and receivables are tying up the company’s cash and could contribute to future cash shortfalls. Suppliers are being paid every 41 days; this is not too bad depending on the company credit terms with suppliers. Again more questions need to be asked, and further analysis should be undertaken. c) Profitability Ratios Gross Profit Margin = 67,500 / 167,500 x 100 = 40% in 2024, 55,000 / 140,000 x 100 = 39.3% in 2023. Net Profit Margin = 15,000 / 167,500 x 100 = 9.0% in 2024, 15,000 / 140,000 x 100 = 10.7% in 2023. Return on Assets =

15,000________ x 100 = 6.90%. (225,000 + 210,000) / 2

Return on Equity =

15,000________ x 100 = 16.5% (95,000 + 86,750) / 2

The gross profit margin has gone up slightly from 2023 to 2024, and net income has declined by nearly 2%. While variable costs have gone down slightly, there has been an increase in operating expenses in 2024. Both the ROE and ROA are strong and provide a strong return for shareholders on their investment and for the company in terms of the use of its assets. d)

Solvency Ratios

Debt to Equity: (72,500 – 4,000) = .72 95,000 The company has $.72 in debt for every $1 in shareholders’ equity. This ratio measures how much a

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

company is borrowing in relation to the amount of equity invested in it. Again lenders will want to see lower ratios. Interest Coverage: (15,000 + 10,000 + 5,000 + 15,000) / 5,000 = 9, or in other words the company generates sufficient net income to cover the interest payments 9 times. This would provide a lender with a reasonable margin of safety. Bloomcode: Analysis Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

114. Selected data for Ocean Fish Sales appear below: Sales................................................................................... Cost of goods sold ............................................................. Inventory at end of year .................................................... Accounts receivable at end of year...................................

2024 $745,000 375,000 50,000 35,000

2023 $660,000 250,000 40,000 25,000

All sales are made on credit. Instructions Calculate the following ratios for 2024: (a) Inventory turnover (b) Days in inventory (c) Receivables turnover (d) Average collection period Solution (8 min.) (a) Inventory turnover

= Cost of goods sold ÷ Average inventory = $375,000 ÷ [($50,000 + $40,000) ÷ 2] = 8.3 times = $375,000 ÷ $45,000 = 8.3 times

(b) Days in inventory

= 365 days ÷ inventory turnover = 365 ÷ 8.3 = 44 days

= Credit sales ÷ Average accounts receivable = $745,000 ÷ [($35,000 + $25,000) ÷ 2] = $745,000 ÷ $30,000 = 24.8 times

(d) Average collection period

= 365 days ÷ receivables turnover

Financial Statement Analysis

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= 365 ÷ 24.8 = 15 days Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

115. Hibiscus Corporation reported the following comparative current assets and current liabilities: Dec. 31, 2024 Current assets Cash............................................................................ Trading investments ................................................. Accounts receivable .................................................. Inventory .................................................................... Prepaid expenses ...................................................... Total current assets ........................................... Current liabilities Accounts payable ...................................................... Salaries payable ........................................................ Income tax payable ................................................... Total current liabilities ......................................

Dec. 31, 2023

$ 30,000 40,000 65,000 120,000 35,000 $290,000

$ 25,000 15,000 95,000 90,000 20,000 $245,000

$125,000 35,000 25,000 $185,000

$115,000 30,000 10,000 $155,000

During 2024, credit sales and cost of goods sold were $480,000 and $288,000, respectively. Instructions Calculate the following ratios for 2024: (a) Current ratio (b) Receivables turnover (c) Inventory turnover Solution (8 min.) (a) Current ratio

= Current Assets ÷ Current Liabilities = $290,000 ÷ $185,000 = 1.6:1

(b) Receivables turnover = Credit sales ÷ Average gross accounts receivable = $480,000 ÷ $80,000 = 6.0 times (c) Inventory turnover

= =

Cost of goods sold ÷ Average inventory $288,000 ÷ $105,000 = 2.7 times

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

116. The financial statements of GFPI Distributors Inc. appear below: GFPI DISTRIBUTORS INC. Comparative Statements of Financial Position December 31 Assets Cash .......................................................................................................... Trading investments ................................................................................ Accounts receivable ................................................................................. Inventory .................................................................................................. Property, plant, and equipment (net) ..................................................... Total assets .......................................................................................

2024 $ 35,250 15,000 50,000 60,000 260,000 $420,250

2023 $ 40,000 60,000 30,000 70,000 300,000 $500,000

Liabilities and Shareholders' Equity Accounts payable ..................................................................................... Short-term bank loan payable................................................................. Mortgage payable..................................................................................... Common shares ....................................................................................... Retained earnings .................................................................................... Total liabilities and shareholders' equity ........................................

$ 20,000 40,000 80,000 170,000 110,250 $420,250

$ 30,000 90,000 160,000 145,000 75,000 $500,000

GFPI DISTRIBUTORS INC. Income Statement Year Ended December 31, 2024 Sales.................................................................................................................. Cost of goods sold ............................................................................................ Gross profit ....................................................................................................... Expenses Operating expenses .................................................................................. Interest expense ....................................................................................... Total expenses .................................................................................... Profit before income tax .................................................................................. Income tax expense ......................................................................................... Profit .................................................................................................................

$400,000 190,000 210,000 $85,000 18,000 103,000 107,000 26,750 $ 80,250

Financial Statement Analysis

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Additional information for 2024: 1. Cash dividends of $45,000 were declared and paid. 2. Average number of common shares was 60,000 shares. 3. Market value of common shares on December 31 was $20 per share. Instructions Using the financial statements and the additional information, calculate the following ratios for 2024: a) Current ratio b) Return on equity c) Price/earnings ratio d) Accounts Receivables turnover e) Profit margin f) Days to sell inventory g) Return on assets h) Dividend yield Solution (20 min.) a) Current ratio: $160,250 / $60,000 = 2.7 b)

Return on equity: $80,250 / (($280,250 + $220,000) / 2) = 32.1%

Price/earnings ratio: $20 / $1.34 = 14.9 times, where is EPS: $80,250 / 60,000 = $1.34

Accounts Receivables turnover: $400,000 / (($50,000 + $30,000) ÷ 2) = 10 times

Net Profit margin: $80,250 / $400,000 = 20.1%

Days to sell inventory: 365 / 2.9 = 126 days Inventory turnover: $190,000 / (($60,000 + $70,000) ÷ 2) = 2.9

Return on assets: $80,250 / (($420,250 + $500,000) ÷ 2) = 17.4%

Dividend yield: ($45,000 ÷ 60,000) / $20 = 3.8%

117. Ishan Corporation has only common shares issued. The company’s average gross profit margin is

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

40%. The information shown below was taken from Ishan’s latest financial statements: Average common shareholders' equity ..................................... $4,000,000 Average accounts receivable ...................................................... 625,000 Beginning inventory .................................................................... 300,000 Ending inventory ......................................................................... ? Inventory purchased ................................................................... 3,050,000 Net Income .................................................................................. 280,000 Sales (all on credit) ...................................................................... 5,000,000 Instructions Calculate the following ratios: a) Accounts Receivables turnover and average collection period b) Inventory turnover and days to sell inventory c) Return on equity Solution (20 min.) a) Receivables turnover: $5,000,000 ÷ $625,000 = 8.0 times Average collection period: 365 ÷ 8.0 times = 46 days b)

Inventory turnover = Cost of goods sold ÷ Average inventory Calculate ending inventory: Beginning Inventory ............................ $ 300,000 + Inventory purchased ......................... 3,050,000 – Cost of Goods Sold ............................ *(3,000,000) Ending Inventory .................................. $ 350,000 *Since the gross profit margin is 40%, the cost of goods sold ratio is 60%. 60% × $5,000,000 (net sales) = $3,000,000 Ending Inventory = $350,000 (per above) Average Inventory = ($300,000 + $350,000) ÷ 2 = $325,000 Inventory Turnover = $3,000,000 ÷ $325,000 = 9.2 times Days to sell Inventory = 365 days ÷ 9.2 times = 40 days

c) Return on equity: $280,000 ÷ $4,000,000 = 7.0% Bloomcode: Analysis Difficulty: Hard Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

Financial Statement Analysis

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118. The statement of financial position for Hyde Corporation at the end of the current year includes the following: Mortgage payable, 8%............................................................ $2,250,000 $5 noncumulative preferred shares ...................................... 1,050,000 Common shares (400,000 shares issued) .............................. 4,000,000 Income before income tax was $1,850,000, and income tax expense for the current year was $550,000. Cash dividends paid on common shares was $200,000, and cash dividends paid on preferred shares was $100,000. The common shares were selling for $85 per share at year end. Instructions Calculate the following ratios: a) Earnings per share b) Price/earnings c) Dividend yield Solution (7 min.) a) Earnings per share: ($1,300,000 – $100,000) / 400,000 shares = $3.00 b) Price/earnings ratio: $85 / $3 / share = 28.3 times c) Dividend per share: $200,000 ÷ 400,000 = $0.50 Dividend yield: $0.50 / $85 = 0.6% Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

119. Bonjour Inc. has approached the bank that you work for looking for a $250,000 long-term loan. The loan committee has asked you to review the following data submitted with Bonjour's loan application: 2022 2023 2024 Current assets ................................ $316,500 $475,200 $820,800 Current liabilities ........................... 120,000 155,400 414,600 Non-current liabilities ................... 60,800 175,200 300,000 Shareholders' equity ..................... 303,700 408,600 490,200 Operating income .......................... 168,900 103,500 208,500 Interest expense ............................ 7,200 13,200 28,500 Income tax expense ....................... 65,400 34,200 72,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Net income.....................................

96,300

56,100

108,000

Instructions a) Calculate the solvency ratios: debt/equity, and interest coverage for all three years. b) Write a brief report giving your recommendation on granting the loan. Provide support for your position. Solution (15 min.) a) Debt/Equity Interest coverage

2022 59.5% 23.46

2023 80.9% 7.84

2024 145.8% 7.32

The debt/equity ratio has increased significantly over the three-year period. Both long-term and short-term debt have experienced substantial growth. Specifically, the debt/equity shows that creditors have lent $1.46 for every $1.00 of shareholders' equity. The higher this ratio, the greater the risk to the lender since the shareholders' equity acts as a cushion when operating losses occur. In addition, the interest coverage ratio has dropped dramatically, indicating the decreasing likelihood that long-term lenders will receive their interest payments when due.

The bank should not advance any monies at this time due to the substantial risks involved. Bloomcode: Analysis Difficulty: Medium Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

Financial Statement Analysis

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MATCHING 120. Listed below are the names and definitions of various measures used in financial analysis. Match the names to the definitions by placing the appropriate letter in the space provided. NAMES A. Prospective analysis F. Operating segment B. Return on equity C. Price/earnings ratio D. Debt/equity ratio

E. G. H. I. J.

Cross-sectional analysis Common-size statements Retrospective analysis Current ratio Diluted EPS

DEFINITIONS ___ 1. Statements in which each element is expressed as a percentage of some denominator value ___

Measures what EPS would have been if all securities are converted into common shares

___

Measures the return on shareholders' investment

___

Based on historical data only

___

Compares share price with the earnings per share

___

Different business activities with a company

___

A short-term liquidity measure

___

Comparing one company's performance to another

___

Measures of a firm's financial leverage

___

10.

Determining the future results of a company

Solution (5 min.) 1. G 2.

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10.

Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

121. Listed below are the names and formulas for various financial ratios. Match the formulas to the ratio names by placing the appropriate letter in the space provided. NAMES A. Return on Equity B. Debt Equity C. Quick ratio D. Inventory turnover E. Return on Assets

F. G. H. I.

Interest coverage Accounts Receivable turnover Current Ratio Accounts Payable Turnover

FORMULAS ___ 1.

Net income ÷ Average total assets

___

(Net income – preferred dividends) ÷ average shareholders' equity

___

Cost of goods sold ÷ average inventory

___

Credit sales ÷ average accounts receivable

___

Credit purchases ÷ average accounts payable

___

Current assets ÷ current liabilities

Financial Statement Analysis

___

(Current assets – inventory – prepaid expenses) ÷ current liabilities

___

Total liabilities ÷ shareholders' equity

___

(Net income + taxes + interest + depreciation) ÷ interest expense

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Solution (5 min.) 1. E 2.

Bloomcode: Knowledge Difficulty: Hard Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS 122. Identify the different users of the financial statements and how they use the statements for financial analysis purposes. Solution (7 min.) Statements users include: • Investment analysts or stockbrokers use financial analysis to make recommendations to clients to buy, sell or hold shares of a company • Commercial lenders use financial analysis to assess credit worthiness of companies for loan applications and to ensure existing borrowers are in compliance with loan covenants • Credit departments assess credit worthiness of new customers • Companies seeking to acquire other company’s shares • Pension funds considering potential or existing investment Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the common contexts for financial statement analysis and explain why an awareness of context is essential to the analysis. CPA: Financial Reporting AACSB: Analytic

123. Why is it important for an analyst to understand a company’s corporate strategy? Define and describe two common strategies. Provide an example of each. Solution (5 min.) An analyst must understand the corporate strategy because different companies follow different strategies to gain success. Understanding the strategy will help the analyst interpret the financial results and explain differences. There are two common strategies, they are: • Being a low-cost producer, focusing on providing and selling goods or services at the lowest possible price. This requires high volume sales, and the selling price needs to be the major decision factor. Ex. Discount retailers • Product differentiation, selling products that are specialized or provide superior service that customers are willing to pay a premium for. This way companies can make a higher margin and sell fewer goods. Ex. Speciality gourmet grocery stores Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why knowledge of the business is important when analyzing a company’s financial statements. CPA: Financial Reporting AACSB: Analytic

124. BNI Corporation has just received an unmodified audit opinion from the company’s external auditor.

Financial Statement Analysis

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As the internal CPA, you have been asked by your management team what this means and what the implications of opinion are? Solution (5 min.) This is good news for BNI. An unmodified audit opinion means that the external auditors are of the opinion that the company’s financial statements are fairly presented and that the auditor has no qualifications to make on the information that has been presented. This is a “clean” audit opinion where the auditors do not have any concerns, reservations or qualifications. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the types of information used when analyzing financial statements and where it is found. CPA: Financial Reporting AACSB: Analytic

125. What is the difference between trend analysis and cross-sectional analysis? What drawbacks are there with cross-sectional analysis? Solution (7 min.) • Trend analysis examines the company information from multiple periods to look for patterns or changes in the data over time. For example sales growth and profitability. • Cross-sectional analysis compares the data from one company with those of another company over the same time period. Companies would normally operate in the same industry, perhaps as competitors. A draw back with cross-sectional analysis is that companies may be using different accounting methods. For example different deprecation methods or different cost formulas. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. CPA: Financial Reporting AACSB: Analytic

126. The textbook identifies five common categories of ratios. What are these categories and what do they measure? Provide an example for each category. Solution (10 min.) 1. Liquidity ratios – used to assess a company’s ability to meet its obligations in the near future. Examples – current ratio, quick ratio 2. Activity ratios – used to assess how efficiently a company manages it operations. Examples – A/R turnover, average collection period, inventory turnover, days to sell inventory, accounts payable turnover, days collection 3. Solvency ratios – used to assess a company’s ability to meet its long-term obligations. Examples – debt to equity, net debt as a % of total capitalization, interest coverage

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4. 5.

Test Bank for Understanding Financial Accounting, Third Canadian Edition

Profitability ratios – used to assess a company’s ability to generate profits. Examples – gross profit margin, net profit margin, return on equity, return on assets Equity Analysis ratios – used to assess shareholder returns. Examples – Basic EPS, P/E ratio, dividend payout, dividend yield, net free cash flow

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. CPA: Financial Reporting AACSB: Analytic

127. Below are data taken from the financial statements of two companies in the same industry: Viola Inc. Tuba Co. Total assets ...................................................... $600,000 $600,000 Total liabilities ................................................. 0 200,000 Total common equity ...................................... 600,000 400,000 Income before interest & taxes ....................... 100,000 100,000 Taxes ................................................................ 25,000 20,000 Interest rate on liabilities ................................ 10% 10% Instructions Calculate the ROA and ROE for both companies. Assume total assets and equity have not changed from the previous year. Solution (8 min.) EBIT .................................................................. Interest ............................................................. EBT ................................................................... Taxes ................................................................ Net Income.......................................................

Viola $100,000 _______ $100,000 25,000 $ 75,000

ROA:

Viola 75,000 ÷ 600,000 = 12.5%

Tuba 60,000 ÷ 600,000 =10.0%

ROE:

75,000 ÷ 600,000 = 12.5%

60,000 ÷ 400,000 = 15%

Tuba $100,000 20,000 $ 80,000 20,000 $ 60,000

Bloomcode: Analysis Difficulty: Medium Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

Financial Statement Analysis

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128. In 2024, Bazz Company had total sales of $3,547,500, it is estimated that 80% of company sales are made on credit and the average balance in the accounts receivable for the same period was $345,000. The company’s credit terms require that all receivables be paid within 30 days. Instructions Calculate Bazz ’s average days to collect accounts receivable. Solution (7 min.) Accounts receivable Turnover

Net Credit Sales_______ Average Accounts Receivable

= $2,838,000 (3,547,500*80%) $345,000 = 8.23 Average Days to Collect

= 365 days 8.23 = 44.3 days

Bloomcode: Analysis Difficulty: Easy Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic

129. Sunco Credit Union is considering granting a loan to Michalski Printing. Michalski Printing is a commercial printer and, in anticipation of a major sales increase expected in the coming year, has applied for a one-year loan of $100,000 to finance an expansion of its inventory. The following excerpts are from Michalski’s 2024 Statement of Financial Position: Current Assets Cash ......................................................................... Accounts receivable ................................................ Inventory ................................................................. Prepaid expenses ....................................................

2024 $ 45,000 350,000 424,000 12,000

2023 $ 24,000 250,000 368,000 12,000

Current Liabilities ....................................................

375,000

290,000

Instructions Calculate the following ratios for Michalski for the years ended December 31, 2023, and 2024: i. Current ratio

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ii.

Test Bank for Understanding Financial Accounting, Third Canadian Edition

Quick ratio

Solution (5 min.) i.

Current Ratio = Current Assets/Current Liabilities 2024: $831,000/ $375,000 = 2.2 times 2023: $654,000/$290,000 = 2.26 times

ii.

Quick Ratio = (Cash + Accounts receivable)/Current Liabilities 2024: $395,000/$375,000 = 1.05 times 2023: $274,000/$290,000 =.95 times

130. Identify and describe the five limitations of ratio analysis. Solution (10 min.) The following are limitations to ratio analysis: 1. Accounting policies – need to be aware of different accounting treatments when analyzing the results of various companies. Ex. Some companies may carry assets at historical cost versus market value. 2. Definitions of ratios – how the ratio was calculated needs to be defined prior to analysis. 3. Diversity of operations – more difficult to calculate ratios for firms that are operating in more than one industry. 4. Seasonality – companies generally choose a year end that is at the end of its business cycle. Therefore, the statement of financial position balances may be lower than the average balances for the year. 5. Potential for manipulation – certain ratios are based on figures at one point in time. This makes it possible for companies to manipulate these figures. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify and explain the limitations of ratio analysis. CPA: Financial Reporting AACSB: Analytic

Financial Statement Analysis

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ESSAY QUESTIONS 131. Many people think that financial statements analysis is the process of calculating ratios for a company. Outline the steps necessary for an analyst to undertake before calculating the ratios. Explain how the type of analysis might differ for a bank’s commercial loans officer and an investment analyst. Solution (10 min.) Before the ratios are calculated the analyst should undertake the following three steps: 1. Determine the purpose and context of the analysis. One way of doing this is to determine the questions that the analysis will assist in answering. For example, should we extend credit to this company? Should we invest in this company? Knowing the context for the analysis or the type of questions you are trying to answer will help you make decisions regarding the type(s) of information that you will need to gather and determine the tools or techniques that would best support this analysis. 2. Collect the information needed for the analysis. Having completed Step 1, the analyst can then focus on obtaining the necessary data such as the company’s annual report, industry data (including industry ratios and trends), and other economic data (such as inflation rates and exchange rates) may also be gathered. It is important to understand that the analyst must move beyond the four financial statements and use information from the notes to the financial statements. 3. Now the analyst can prepare common-size analysis and calculate ratios or other metrics. The challenge is to ensure the right data are being used and the metrics being calculated make sense given the purpose of the analysis. The type of analysis undertaken will differ depending on the purpose of the analysis. A bank’s commercial loans officer is normally focused on the short-term needs of the company and its ability to pay back those funds. They would focus their analysis on short-term liquidity ratios and available collateral for the loan. An investment analyst may be looking at investing in the shares of the company for a longer-term. They would be interested in the company’s performance, particularly ROE, and the overall risk of the company as reflected in long-term liquidity ratios such as D/E and Interest coverage. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Understand and explain the process of financial analysis. CPA: Financial Reporting AACSB: Analytic

132. Presented below are a series of financial ratios for two companies in the same industry: Business Furnishings Inc. Office Space Co.__ 2022 2023 2024 2022 2023 2024 Inventory turnover 11.8 13.6 15.5 8.4 8.5 8.0 Accts. receivable turnover 15.1 14.5 16.0 10.5 10.2 10.6 Current ratio 2.2 2.0 2.1 2.2 2.9 3.6

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Quick ratio

1.3

1.2

1.1

1.7

2.3

2.8

Instructions Write an analysis of the two companies. Include any comments you might have about each company’s relative ability to manage its current assets and to meet its current obligations. Solution (10 min.) It appears that Business Furnishings has been more successful in collecting its receivables and selling its inventory than Office Space, based on the inventory and receivable turnovers. This may, in fact, indicate that Business Furnishings is the more efficient firm; however, it may also indicate that Business Furnishings' credit policy is too strict and that it has a conservative inventory policy. Such policies would restrict sales and have a negative effect on profits. It is impossible to know if either set of ratios for the companies is acceptable or not, without industry comparisons. Office Space’s current and quick ratios are significantly better than Business Furnishings'; however, this may indicate that Office Space has excessive funds tied up in low-yielding current assets. Additionally, Business Furnishings' numbers are within the traditional rule of thumb amounts: 2.0 for the current ratio and 1.0 for the quick ratio. Again, without industry statistics it is impossible to tell if these numbers are acceptable. At present, it appears that both companies do have sufficient current assets to meet their currently maturing liabilities. However, if the trend in inventory and receivable turnovers continues for Business Furnishings Inc., it will have difficulty meeting its current obligations. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic 133. Below are data taken from the financial statements of two companies in the same industry and some ratios: Viola Inc. Tuba Co. Total assets ...................................................... $600,000 $600,000 Total liabilities ................................................. 0 200,000 Total common equity ...................................... 600,000 400,000 Income before interest & taxes ....................... 100,000 100,000 Taxes ................................................................ 25,000 20,000 Interest rate on liabilities ................................ 10% 10%

ROA: ROE:

Instructions

Viola 12.5% 12.5%

Tuba 10.0% 15.0%

Financial Statement Analysis

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As an equity investor, which company would you prefer to invest in? Solution (3 min.) As an equity investor I would prefer to invest in Tuba; it has higher returns but it also has higher risks due to the use of debt to partially finance the assets. Bloomcode: Analysis Difficulty: Medium Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic 134. In 2024, Bazz Company had total sales of $3,547,500, it is estimated that 80% of company sales are made on credit and the average balance in the accounts receivable for the same period was $345,000. The company’s credit terms require that all receivables be paid within 30 days. Its accounts receivable turnover ratio is 8.23 times and the average days to collect is 44.3 days. Instructions Comment on Bazz’s credit policies. Solution (5 min.) Bazz is taking much longer to collect its accounts receivables than is required per its credit policies (44 days versus 30 days). The company needs to revisit the credit policies and take steps to ensure faster collection. The company may also need to review the criteria for granting credit to try and prevent granting credit to customers who do not pay within the required 30 days. Bloomcode: Analysis Difficulty: Easy Learning Objective: Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. CPA: Financial Reporting AACSB: Analytic 135. Sunco Credit Union is considering granting a loan to Michalski Printing. Michalski Printing is a commercial printer and, in anticipation of a major sales increase expected in the coming year, has applied for a one-year loan of $100,000 to finance an expansion of its inventory. The following excerpts are from Michalski’s 2024 Statement of Financial Position: Current Assets Cash ......................................................................... Accounts receivable ................................................ Inventory ................................................................. Prepaid expenses ....................................................

2024 $ 45,000 350,000 424,000 12,000

2023 $ 24,000 250,000 368,000 12,000

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Test Bank for Understanding Financial Accounting, Third Canadian Edition

Current Liabilities .................................................... 2024 2.2 times 1.05 times

375,000

290,000

2023 2.26 times .95 times

Current ratio Quick Ratio Instructions a) Based on the above information, comment on whether you would recommend granting the loan. b) What steps should you undertake before making your decision and is there other information you would like to have? Solution (5 min.) a)

Both the current ratio and the quick ratio are within accepted norms and the ratios have remained fairly constant over the past two years. This indicates that the company is not a high credit risk. These ratios also fall within the acceptable limits of 2:1 for the current ratio and 1:1 for the quick ratio (with the 2023 quick ratio falling slightly below this limit).

Before making a decision, knowledge of the business is necessary including a review of the financial statements including the auditor’s report and notes. Other information, such as the industry norms and earnings projections, should be obtained as well. An analysis of long-term liquidity looking at both coverage and leverage ratios should also be done.

APPENDIX B REVENUE RECOGNITION AND LONG-TERM CONTRACTS APPENDIX LEARNING OBJECTIVE 1. Determine the appropriate method for recognizing revenue from long-term contracts. • Revenues from long-term contracts are normally recognized over time, if one of the following criteria are met: (1) the customer simultaneously receives and consumes the benefits as they are performed by the seller, (2) the seller’s performance creates or enhances an asset that the customer controls, or (3) the seller’s performance creates an asset for which the seller has no alternative use and the seller has an enforceable right to payment for its performance to date. • The percentage-of-completion method is used to measure progress under a contract if possible. The percentage can be measured using either an input method or an output method. • If the percentage-of-completion method is used, the company will recognize revenue, expenses, and gross profit in each year of the contract. • If measurement is not possible, then the zero-profit method is used, which results in revenues being recognized only to the extent of the construction expenses incurred, except for the year in which the contract is completed. In the year of completion, any gross profit earned on the contract is recognized.

Appendix B - 2 Test Bank for Understanding Financial Accounting, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS 1. Mark Construction Ltd. uses the percentage-of-completion method to account for long-term contracts. During 2024, Mark entered into a fixed-price contract to construct a shopping complex for $6,000,000. Information relating to the contract is as follows: At December 31 2024 2025 Total estimated cost of project $4,500,000 $4,500,000 Costs incurred in year $ 675,000 $2,025,000 What is the percentage of completion for this project at the end of 2025? a) 0% b) 45% c) 60% d) 65% Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Determine the appropriate method for recognizing revenue from long-term contracts. CPA: Financial Reporting AACSB: Analytic Feedback: ($675,000+$2,025,00) / $4,500,000 x 100 = 60%

2. Mark Construction Ltd. is unable to accurately measure its progress towards completion for longterm contracts, and therefore must use the zero-profit method. During 2024, Mark entered into a fixed-price contract to construct a shopping complex for $6,000,000. Information relating to the contract is as follows: At December 31 2024 2025 Total estimated cost of project $4,500,000 $4,500,000 Costs incurred in year $ 675,000 $2,025,000 Using the zero-profit method to account for this contract, how much revenue would be recognized in 2025? a) $0 b) $1,800,000 c) $2,025,000 d) $6,000,000

Appendix B - 3 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Determine the appropriate method for recognizing revenue from long-term contracts. CPA: Financial Reporting AACSB: Analytic Feedback: Under the zero-profit method for accounting for long-term contracts, revenue will equal costs for a contract in a period, resulting in zero profit. Construction costs in 2025 are $2,025,000; therefore, revenue will be the same.

3) The following accounts and balances were provided for Tanis Excavation Company’s long term contract to construct the foundation for the local community college: Construction revenue $4,400,000 Construction expenses $4,400,000 Excluding all other factors, this long-term contract appears to be accounted for using which method? a) Completed contract method b) Percentage-of-completion method c) Construction in-progress method d) Zero-profit method Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Determine the appropriate method for recognizing revenue from long-term contracts. CPA: Financial Reporting AACSB: Analytic Feedback: Under the zero-profit method for accounting for long-term contracts, revenue will equal costs for a contract in a period, resulting in zero profit.

Appendix B - 4 Test Bank for Understanding Financial Accounting, Third Canadian Edition

EXERCISE 4. Mark Construction Ltd. uses the percentage-of-completion method to account for long-term contracts. During 2024, Mark entered into a fixed-price contract to construct a shopping complex for $6,000,000. Information relating to the contract is as follows: At December 31 2024 2025 Total estimated cost of project $4,500,000 $4,500,000 Costs incurred in year $ 675,000 $2,025,000 Instructions Using the percentage-of-completion method to account for this contract, how much revenue would be recognized in 2025? Solution (8 min.) The answer is $2,700,000. Please see below: At December 31 Costs incurred in year Costs incurred to date (A) Total estimated cost of project (B) Percentage of completion (A)/(B) Contract price Total revenue recognized to-date Less: prior year revenue Current year revenue

2024 $675,000 $675,000 $4,500,000 15% $6,000,000 $900,000 $0 $900,000

2025 $2,025,000 $2,700,000 $4,500,000 60% $6,000,000 $3,600,000 $900,000 $2,700,000

Bloomcode: Application Difficulty: Medium Learning Objective: Determine the appropriate method for recognizing revenue from long-term contracts. CPA: Financial Reporting AACSB: Analytic

APPENDIX C LONG-TERM ASSETS APPENDIX LEARNING OBJECTIVE 1. Explain the asset revaluation model for property, plant, and equipment. • Companies using IFRS can choose to use the cost model or the revaluation model for determining the carrying amount of their PP&E. • The revaluation model results in PP&E being carried at its fair value, which must be reassessed with sufficient frequency to ensure that the carrying value of these assets does not differ materially from their fair values. • When the revaluation model is used, it must be used for all of the assets in a given class of assets. • Companies can use either the asset adjustment (or elimination) method or the proportionate method when accounting for the revaluation. • The revaluation method increases the carrying amount of a company’s PP&E and its shareholders’ equity (as the revaluation surplus increases other comprehensive income). Revaluations have no effect on net income.

Appendix C - 2

Test Bank for Understanding Financial Accounting, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS 1. Which of the following is not an acceptable asset revaluation method for property, plant, and equipment? a) proportionate method b) elimination method c) asset adjustment method d) relative fair value method Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the asset revaluation model for property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

2. Where is revaluation surplus reported on the statement of comprehensive income? a) other income/revenue b) revenue c) other comprehensive income d) discontinued operations Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the asset revaluation model for property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

3. Morris Lake Company uses the proportionate method for revaluing its equipment every three years. At the end of a revaluation year (after depreciation has been recorded), Morris has a cost of $1,650,000 and accumulated depreciation of $800,000 on the equipment. Fair value at this date has been appropriately determined to be $1,100,000. How much would be recorded to revaluation surplus? a) $0 b) $250,000 c) $850,000 d) $1,100,000 Answer: b Bloomcode: Application

Appendix C - 3

Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Medium Learning Objective: Explain the asset revaluation model for property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic Feedback: Fair value less carrying value at the date of revaluation = revaluation surplus. $1,100,000 – ($1,650,000 - $800,000) = $250,000.

4. Bain Bath Products Inc. uses the asset adjustment method for revaluing its building every three years. At the end of a revaluation year (after depreciation has been recorded), Bain has a cost of $2,500,000 and accumulated depreciation of $600,000 on the building. Fair value at this date has been appropriately determined to be $2,900,000. What balance would be reported in the accumulated depreciation – building account immediately after the revaluation? a) $0 b) $600,000 c) $1,900,000 d) $2,300,000 Answer: a Bloomcode: Application Difficulty: Medium Learning Objective 1: Explain the asset revaluation model for property, plant, and equipment. CPA: Financial Reporting AACSB: Analytic

APPENDIX D INVESTMENTS APPENDIX LEARNING OBJECTIVES

1. Explain why companies make investments and distinguish between the different types of investments. • Companies make investments for either strategic or non-strategic reasons. Strategic investments are made to influence or control another company, and are made by purchasing 20% or more of the voting shares of the other company. Non-strategic investments are made to generate short-term returns in the form of interest, dividends, or capital appreciation. • Strategic investments are normally classified as an investment in an associate if between 20% and 50% of the voting shares of the investee are acquired. The investor is deemed to be able to exercise significant influence over the investee’s decision-making. The investee is referred to as an associate and the equity method must be used to account for the investment. If more than 50% of the voting shares are acquired, then the investor controls the investee. The investor is referred to as the parent and the investee is referred to as the subsidiary. The consolidation method must be used to account for the investment. • There are three classifications for non-strategic investments. Investments in debt instruments that management intends to hold to maturity are classified as measured at amortized cost. Investments in debt or equity instruments that management intends to sell in the near term are considered to be held for trading and are classified as measured at fair value through profit or loss. Non-strategic investments that are purchased with the intent to collect interest or dividends and also to sell, if required, are classified as measured at fair value through other comprehensive income. 2. Explain how non-strategic investments are accounted for. • Held to maturity investments are measured at amortized cost. These investments are recorded at cost and any difference between the investment’s cost and its face value is amortized over the time period between its acquisition and maturity using the effective interest method. The effective interest method results in the investor recognizing interest income at a constant yield rate in relation to the investment’s carrying amount. • Investments that are held for trading are measured at fair value at each financial statement reporting date. Any unrealized gains or losses between the fair value and the carrying amount of the investment are included in net income for the period. • Investments that are classified as measured at fair value through other comprehensive income are also measured at fair value at each financial statement reporting date. Any unrealized gains or losses between the fair value and the carrying amount of the investment are included in other comprehensive income (rather than net income) for the period. When these investments are sold, any unrealized gains or losses that have been recorded in other comprehensive income must be reclassified to retained earnings.

Appendix D - 2 Test Bank for Understanding Financial Accounting, Third Canadian Edition

3. Explain how non-strategic investments are accounted for. • Strategic investments involving the acquisition of between 20% and 50% of the voting shares of a company are normally considered to enable the investor to exercise significant influence over the investee (known as the associate). These investments are accounted for using the equity method. Under the equity method, the investor reports investment income and increases the carrying amount of the investment whenever the associate reports income. Any dividends declared by the associate reduce the carrying amount of the investment. • If more than 50% of the voting shares of the investee are acquired, the strategic investment results in the investor (known as the parent) having control over the investee (known as the subsidiary). When this is the case, the parent and the subsidiary are considered to be a single economic entity and consolidation is required. This involves a set of consolidated financial statements being prepared that reflect the combined financial information of the parent and subsidiary. A consolidation work sheet is used to prepare the consolidated statements. At the date of acquisition, the consolidated statement of financial position reflects the combination of the two companies, with the Investment in Subsidiary account eliminated, together with the equity accounts of the subsidiary. Any differences between the fair values and carrying values of the subsidiary’s assets and liabilities are recorded, together with any goodwill.

Appendix D - 3 Test Bank for Understanding Financial Accounting, Third Canadian Edition

TRUE-FALSE STATEMENTS 1. The intentions of acquiring a strategic investment are to generate short-term returns of interest, dividends, or changes in value. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

2. Strategic investments are always considered long-term in duration. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

3. All investments in debt instruments are accounted for under the amortized cost method. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

4. An investment in a debt instrument with the intention of selling before maturity is accounted for at amortized cost. Answer: False Bloomcode: Knowledge

Appendix D - 4 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

5. The fair value of debt investments accounted for at amortized cost at each financial statement reporting date is not relevant to financial statement users because the company intends to hold the investments to maturity. Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

6. A bond with a maturity value of $100,000 purchased for $106,500 was purchased at a discount. Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

7. Bond discounts/premiums are amortized over bond term using the effective interest method. Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

8. Gains and losses on fair value through profit or loss investments are considered unrealized because they have been realized through the sale to a third party.

Appendix D - 5 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic 9. The equity method of accounting does not take into account the change in fair value of an investment.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

10. Significant influence exists in an equity investment with over 50% of the voting shares outstanding. Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

11. Under the equity method of accounting, dividends are recorded as a reduction to the investment account.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 6 Test Bank for Understanding Financial Accounting, Third Canadian Edition

12. Goodwill recorded in a business acquisition is calculated as the excess of the amount paid for the investment over and above the carrying value of the acquired company.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

MULTIPLE CHOICE QUESTIONS 13. Which of the following could be considered a strategic investment? a) Investment in common shares. b) Investment in preferred shares. c) Investment in bonds. d) Investment in money market fund. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

14. ABC Company acquired a 40% ownership interest in the voting shares of XYZ Company. The remaining 60% of the voting shares are widely held by many investors. How would the investment in XYZ be categorized? a) Debt investment. b) Strategic investment. c) Non-strategic investment. d) Bond investment. Answer: b Bloomcode: Application Difficulty: Medium

Appendix D - 7 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

15. Dominion Company acquired a controlling interest in the common voting shares of Victoria Company. How would this investment be accounted for by Dominion? a) Amortized cost. b) Fair value through other comprehensive income. c) Fair value through profit or loss. d) Consolidation method. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

16. Which of the following is NOT an acceptable method to account for non-strategic investments? a) Amortized cost. b) Fair value through other comprehensive income. c) Equity method. d) Fair value through profit or loss. Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

17. Which of the following is NOT a requirement for a debt instrument to be accounted for at amortized cost? a) Intention to collect interest. b) Intention to hold for trading.

Appendix D - 8 Test Bank for Understanding Financial Accounting, Third Canadian Edition

c) Intention to hold instrument to maturity. d) Intention to collect principal. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

18. An investment in a debt instrument with the intention of collecting interest and principal as well as selling the instrument before maturity should be accounted for at: a) amortized cost. b) fair value through profit or loss. c) equity method. d) fair value through other comprehensive income. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

19. Fargo Co. has purchased 600 common shares of Margo Co., which represents a negligible portion of Margo’s outstanding common shares. Fargo’s intention in acquiring this investment is for shortterm trading profits. How would Fargo Co. classify and account for its investment in Margo Co.? a) Amortized cost. b) Fair value through other comprehensive income. c) Equity method. d) Fair value through profit or loss. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments.

Appendix D - 9 Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

20. A non-strategic investment in either a debt or an equity instrument with the intent to collect interest or dividends, and to sell the instrument should be accounted for at a) amortized cost. b) fair value through other comprehensive income. c) equity method. d) fair value through profit or loss. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

21. Giorgio Co. has purchased an investment in bonds from Valencia Co. Giorgio’s intention is to hold this bond until it matures, collecting the contractual payments over the term of the bond, including the principal value at maturity. How would Giorgio Co. classify and account for its investment? a) amortized cost. b) fair value through other comprehensive income. c) equity method. d) fair value through profit or loss. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

22. Transvision Inc. has invested in $100,000 of five-year bonds. The bonds pay interest semi-annually at 6%, while the market rate for similar bonds is 5%. Assuming the bond is issued and purchased on January 1, 2024 for $104,376, what is the carrying value of the bond investment after the first payment on July 1, 2024? (Round to the nearest whole number)

Appendix D - 10 Test Bank for Understanding Financial Accounting, Third Canadian Edition

a) $100,000. b) $103,985. c) $104,376. d) $104,767. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

23. Lady Bee Company provided the following partial amortization schedule for its $100,000, five-year bond investment. The bond pays interest semi-annually at 7%, and the market rate (yield) is 6%.

Date Jan. 1, 2024 Jul. 1, 2024

Cash received

Interest income

Bond discount/premium amortization

Carrying value of bonds $104,265

How much would Lady Bee Company report as the cash received on this bond at July 1, 2024? (Round to the nearest whole number) a) $3,128. b) $3,500. c) $6,256. d) $7,000. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

24. Lady Bee Company provided the following partial amortization schedule for its $100,000, five-year bond investment. The bond pays interest semi-annually at 7%, and the market rate (yield) is 6%. (Round to the nearest whole number)

Date

Cash received

Interest income

Bond discount/premium

Carrying value of bonds

Appendix D - 11 Test Bank for Understanding Financial Accounting, Third Canadian Edition

amortization Jan. 1, 2024 Jul. 1, 2024

$104,265

How much would Lady Bee Company report as the interest income on this bond at July 1, 2024? a) $3,129. b) $3,500. c) $6,256. d) $7,000. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

25. Lady Bee Company provided the following partial amortization schedule for its $100,000, five-year bond investment. The bond pays interest semi-annually at 7%, and the market rate (yield) is 6%.

Date Jan. 1, 2024 Jul. 1, 2024

Cash received

Interest income

Bond discount/premium amortization

Carrying value of bonds $104,265

How much would Lady Bee Company report as the bond premium amortization at July 1, 2024? (Round to the nearest whole number) a) $4,265. b) $3,893. c) $372. d) $0. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 12 Test Bank for Understanding Financial Accounting, Third Canadian Edition

26. Lady Bee Company provided the following partial amortization schedule for its $100,000, five-year bond investment. The bond pays interest semi-annually at 7%, and the market rate (yield) is 6%.

Date Jan. 1, 2024 Jul. 1, 2024

Cash received

Interest income

Bond discount/premium amortization

Carrying value of bonds $104,265

How much would Lady Bee Company report as the unamortized bond premium after the first bond payment on July 1, 2024? (Round to the nearest whole number) a) $4,265. b) $3,893. c) $372. d) $0. Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

27. Lady Bee Company provided the following partial amortization schedule for its $100,000, five-year bond investment. The bond pays interest semi-annually at 7%, and the market rate (yield) is 6%.

Date Jan. 1, 2024 Jul. 1, 2024

Cash received

Interest income

Bond discount/premium amortization

Carrying value of bonds $104,265

How much would Lady Bee Company report as the carrying amount of the bond investment at July 1, 2024? (Round to the nearest whole number) a) $100,000. b) $101,425. c) $103,893. d) $104,265. Answer: c Bloomcode: Application

Appendix D - 13 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

28. Monterrey Music Company has the following short-term trading investment information: Investment Moxam Ltd Shares Dallas Dumpling Co.

# shares

Fair value / share Dec 31 2024

Fair value / share Dec 31 2025

500 260

$11.00 $ 6.00

$17.00 $ 4.50

Assuming no investments were purchased or sold during the year, what would be the impact on the fair value through profit or loss investment account at December 31, 2025? a) An increase in the investment account of $3,000. b) A decrease in the investment account of $2,610. c) A decrease in the investment account of $3,000. d) An increase in the investment account of $2,610. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

29. Jasper Automation Co. purchased 200 shares of Tiger Traxx Inc. for $29,000 on November 29, 2024. Assuming Jasper Automation accounts for this investment using fair value through profit or loss and the fair value for Tiger Traxx is $140 per share on December 31, 2024. The adjustment required for this investment would include a a) credit to investment income/loss of $1,000. b) credit to fair value through other comprehensive income investment of $1,000. c) debit to investment income/loss of $1,000. d) debit to fair value through profit or loss investment of $1,000. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for.

Appendix D - 14 Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

30. Lazlo Ltd. purchased 1,000 shares in Cosmo Co. for $3.50 per share on July 10, 2024. Lazlo acquired these shares with the intention of holding them for trading purposes and accounts for the shares as fair value through profit or loss (FVPL). On December 31, 2024, Lazlo’s year end, Cosmo’s shares are trading at $3.77 per share. Lazlo sold the shares in Cosmo on February 19, 2025 for $3.60 per share. Which of the following would most accurately reflect the journal entry by Lazlo on July 10, 2024? a) Credit to Investment Income or Loss for $220. b) Credit to FVPL Investments for $3,770. c) Debit to Investment Income or Loss for $220. d) Debit to FVPL Investments for $3,500. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

31. Lazlo Ltd. purchased 1,000 shares in Cosmo Co. for $3.50 per share on July 10, 2024. Lazlo acquired these shares with the intention of holding them for trading purposes and accounts for the shares as fair value through profit or loss (FVPL). On December 31, 2024, Lazlo’s year end, Cosmo’s shares are trading at $3.77 per share. Lazlo sold the shares in Cosmo on February 19, 2025 for $3.60 per share. Which of the following would most accurately reflect the journal entry by Lazlo on December 31, 2024? a) Credit to Investment Income or Loss for $270. b) Credit to FVPL Investments for $3,770. c) Debit to Investment Income or Loss for $270. d) Debit to FVPL Investments for $3,550. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

32. Lazlo Ltd. purchased 1,000 shares in Cosmo Co. for $3.50 per share on July 10, 2024. Lazlo acquired these shares with the intention of holding them for trading purposes and accounts for the shares as

Appendix D - 15 Test Bank for Understanding Financial Accounting, Third Canadian Edition

fair value through profit or loss (FVPL). On December 31, 2024, Lazlo’s year end, Cosmo’s shares are trading at $3.77 per share. Lazlo sold the shares in Cosmo on February 19, 2025 for $3.60 per share. Which of the following would most accurately reflect the journal entry by Lazlo on February 19, 2025? a) Credit to Investment Income or Loss for $270. b) Credit to FVPL Investments for $3,500. c) Debit to Investment Income or Loss for $170. d) Debit to FVPL Investments for $3,600. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

33. Lars Fromagio Ltd. owns 6,000 shares in Oga Cheese Co. During the current period, Lars received dividends of $1,700 from Oga. Assuming Lars accounts for its investment in Oga as FVPL, which of the following would be appropriate to record the receipt of dividends from Oga? a) Debit to Investment Income or Loss for $1,700. b) Credit to Dividend Revenue for $1,700. c) Debit to Dividends Declared for $1,700. d) Debit to FVPL Investments for $1,700. Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

34. Fitzgerald Acoustics Co. has provided the following information pertaining to the company’s portfolio of equity investments at December 31, Fitzgerald’s year end: Investment Duncan Co. Gemini Co. Malia Co.

# Shares 5,000 2,000 1,100

Carrying value $22,800 $45,500 $5,600

Fair value $19,900 $56,700 $5,700

Which of the following would represent the unrealized holding gain or loss on Fitzgerald’s portfolio at December 31?

Appendix D - 16 Test Bank for Understanding Financial Accounting, Third Canadian Edition

a) Unrealized loss of $8,400. b) Unrealized loss of $11,200 c) Unrealized gain of $8,400. d) Unrealized gain of $100. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

35. Fitzgerald Acoustics Co. has provided the following information pertaining to the company’s portfolio of equity investments at December 31, Fitzgerald’s year end: Investment Duncan Co. Gemini Co. Malia Co.

# Shares 5,000 2,000 1,100

Carrying value $22,800 $45,500 $5,600

Fair value $19,900 $56,700 $5,700

Assuming Fitzgerald accounts for this portfolio using fair value through profit or loss (FVPL), which of the following entries would be most appropriate at December 31? a) Investment Income or Loss FVPL Investments b) FVPL Investments Investment Income or Loss c) Dividend Income FVPL Investments b) Cash $8,400 Investment Income or Loss

$8,400 $8,400 $8,400 $8,400 $8,400 $8,400 $8,400

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

36. Fitzgerald Acoustics Co. has provided the following information pertaining to the company’s portfolio of equity investments at December 31, Fitzgerald’s year end:

Appendix D - 17 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Investment Duncan Co. Gemini Co. Malia Co.

# Shares 5,000 2,000 1,100

Carrying value $22,800 $45,500 $5,600

Fair value $19,900 $56,700 $5,700

Assuming Fitzgerald accounts for this portfolio using fair value through other comprehensive income (FVOCI), which of the following entries would be most appropriate at December 31? a) Unrealized gain or Loss - OCI FVOCI Investments b) FVOCI Investments Investment Income or Loss c) Dividend Income FVOCI Investments b) FVOCI Investments Unrealized gain or Loss - OCI

$8,400 $8,400 $8,400 $8,400 $8,400 $8,400 $8,400 $8,400

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

37. Magna Ltd. sold 1,000 shares of Molten Ltd. for $10.50 per share on May 20. Magna originally purchased these shares a year ago at $14.00 per share and classified the investment as fair value through other comprehensive income (FVOCI). The appropriate entry made by Magna to reclassify the realized gains/losses on the Molten shares at May 20 would include a: a) Credit to FVOCI Investments for $10,500. b) Credit to Investment Income or Loss for $3,500. c) Debit to Retained Earnings for $3,500. d) Debit to Unrealized Gain or Loss (OCI) for $14,000. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 18 Test Bank for Understanding Financial Accounting, Third Canadian Edition

38. Howler Co. has acquired following investment portfolio of equity securities during the year. The following information relating to the portfolio at December 31 has been provided: Investment Sabola Co. Swiss Co. Chard Co.

# Shares 5,000 2,000 1,100

Fair value $4.70 $2.10 $9.20

Cost $5.00 $2.00 $10.00

Which of the following would represent the unrealized holding gain or loss on Howler’s portfolio at December 31? a) Unrealized loss of $2,180. b) Unrealized loss of $880. c) Unrealized gain of $880. d) Unrealized gain of $2,180. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

39. Lars Fromagio Ltd. owns 6,000 shares in Oga Cheese Co. During the current period, Lars received dividends of $1,700 from Oga. Assuming Lars is able to exercise significant influence over Oga, and therefore uses the equity method to account for this investment, which of the following would be appropriate to record the receipt of dividends from Oga? a) Debit to Investment Income or Loss for $1,700. b) Credit to Dividend Revenue for $1,700. c) Debit to Dividends Declared for $1,700. d) Credit to Investment in Associate for $1,700. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

40. Cruela Inc. has acquired a significant influence investment in Dalmation Ltd. for $75,000 cash on January 1, 2024, which represents 30% of the outstanding shares in Dalmation. Dalmation has

Appendix D - 19 Test Bank for Understanding Financial Accounting, Third Canadian Edition

declared and paid dividends totalling $40,000 and reported net income of $440,000 during 2024. What amount would be reported on Cruela’s Statement of Financial Position at December 31, 2024 for this investment? a) $63,000. b) $75,000. c) $132,000. d) $195,000. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

41. Cruela Inc. has acquired a significant influence investment in Dalmation Ltd. for $75,000 cash on January 1, 2024, which represents 30% of the outstanding shares in Dalmation. Dalmation has declared and paid dividends totalling $40,000 and reported net income of $440,000 during 2024. What amount would be reported on Cruela’s Income Statement for the year ended December 31, 2024 relating to this investment? a) $12,000. b) $75,000. c) $132,000. d) $195,000. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

42. Border Ltd. as a 40% significant influence investment in Jasma Inc. The Investment in Associate account at January 1 has a balance of $125,000. During the year, Jasma reported a net loss of $50,000. No dividends were paid during the year. What balance would be reported for the investment account at the end of the year? a) $105,000. b) $101,000. c) $125,000.

Appendix D - 20 Test Bank for Understanding Financial Accounting, Third Canadian Edition

d) $141,000. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

43. Macay Ltd. has a 20% significant influence investment in Ignition Inc. The Investment in Associate account at January 1 has a balance of $210,000. During the year, Ignition paid total dividends of $100,000 and reported net income of $350,000. What balance would be reported for the investment account at the end of the year? a) $190,000. b) $210,000. c) $225,000. d) $260,000. Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

44. Lola Ltd. has a 30% significant influence investment in Padma Inc. The Investment in Associate account at January 1 has a balance of $1,050,000. Padma reported net income of $970,000 for the year. Assuming the ending balance in the Investment in Associate account is $1,210,000, how much dividends did Lola receive from Padma during the year? a) $131,000. b) $120,000. c) $160,000. d) $0. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 21 Test Bank for Understanding Financial Accounting, Third Canadian Edition

45. Jack Snack Inc. has acquired a 30% investment in the voting common shares of Bean Barn Ltd. for $100,000. How should Jack account for this investment in Bean? a) FVPL. b) FVOCI. c) Equity Method. d) Consolidation. Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how strategic investments are accounted for CPA: Financial Reporting AACSB: Analytic

46. Eli Monk Company has acquired a 70% investment in the voting common shares of Space Craft Inc. for $100,000,000. How should Eli account for this investment in Space? a) FVPL. b) FVOCI. c) Equity Method. d) Consolidation. Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how strategic investments are accounted for CPA: Financial Reporting AACSB: Analytic

47. Equity Long Ltd. acquired 100% of the voting shares of Big Equity Inc. for $700,000. On the date of the acquisition, the carrying amount of Big Equity’s net assets is $590,000. The carrying value of all net assets approximated the fair value, except for land, which has a fair value in excess of the carrying amount of $40,000. What amount would be the acquisition differential on this transaction? a) $700,000. b) $110,000. c) $70,000. d) $40,000.

Appendix D - 22 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for CPA: Financial Reporting AACSB: Analytic

48. Gallo Ltd. has a 25% significant influence investment in Joy Inc. The Investment in Associate account at January 1 has a balance of $290,000. Joy paid dividends of $40,000 to Gallo during the year. Assuming the ending balance in the Investment in Associate account is $280,000, what was Joy’s net income for the year? a) $30,000. b) $50,000. c) $100,000. d) $120,000. Answer: d Bloomcode: Application Difficulty: Hard Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

49. Equity Long Ltd. acquired 100% of the voting shares of Big Equity Inc. for $700,000. On the date of the acquisition, the carrying amount of Big Equity’s net assets is $590,000. The carrying value of all net assets approximated the fair value, except for land, which has a fair value in excess of the carrying amount of $40,000. What amount would be reported as Goodwill at the date of acquisition? a) $700,000. b) $110,000. c) $70,000. d) $40,000. Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 23 Test Bank for Understanding Financial Accounting, Third Canadian Edition

50. Olay Olay Ltd. acquired 100% of the voting shares of Wavy Inc. for $1,500,000. On the date of the acquisition, the carrying amount of Wavy’s net assets is $1,000,000. The carrying value of all net assets approximated the fair value, except for land and building, which have fair values in excess of the carrying amounts totalling $100,000. What amount would be reported as Goodwill at the date of acquisition? a) $400,000. b) $500,000. c) $100,000. d) $200,000. Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

51. Agusta International Inc. purchased a 25% interest in Montebello Corporation for $110,000 on March 1. Montebello declared and paid dividends totalling $90,000 in the year. Which entry would be made by Agusta assuming the equity method of accounting is used for the investment in Montebello? a) Cash

$22,500 Dividend Income b) Cash $90,000 Investment Income or Loss c) Cash $22,500 Investment in Associate b) Cash $90,000 Unrealized gain or Loss - OCI

$22,500 $90,000 $22,500 $90,000

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 24 Test Bank for Understanding Financial Accounting, Third Canadian Edition

EXERCISES 52. Moffat Inc. purchased a $500,000, 6% bond investment that matures in 5-years for $521,880 on January 1, 2024. The bond pays interest semi-annually on July 1 and January 1, and the yield on similar bonds is 5%. Moffat has a December 31 year-end. Round all calculations to the nearest dollar. Instructions a) Prepare a bond amortization schedule using the following form:

DATE Jan 1, 2024 Jul 1, 2024 Jan 1, 2025

INTEREST PAYMENT

INTEREST INCOME

PREMIUM AMORTIZATION

CARRYING AMOUNT $521,880

b) Prepare the journal entries for the issuance of the bond on January 1, 2024, the first interest payment on July 1, 2024, and the accrual of interest on December 31, 2024. Solution (15 min.) a)

Bond amortization schedule:

DATE Jan 1, 2024 Jul 1, 2024 Jan 1, 2025

INTEREST PAYMENT $15,000 $15,000

INTEREST INCOME $13,047 $12,998

PREMIUM AMORTIZATION $1,953 $2,002

b) Jan 1, 2024

Bond investment .................................................. Cash ..............................................................

521,880

Cash ...................................................................... Interest income ............................................ Bond investment ..........................................

15,000

Dec 31, 2024 Interest receivable ................................................. Interest income ............................................ Bond investment ..........................................

15,000

Jan 1, 2025

15,000

Jul 1, 2024

Cash ...................................................................... Interest receivable ........................................

521,880

13,047 1,953

12,998 2,002

15,000

CARRYING AMOUNT $521,880 $519,927 $517,925

Appendix D - 25 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Application Difficulty: Hard Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

53. Fancy Pants Inc. purchased a $100,000, 4% bond investment that matures in 10-years for $92,278 on January 1, 2024. The bond pays interest annually on December 31, and the yield on similar bonds is 5%. Fancy has a December 31 year-end. Round all calculations to the nearest dollar. Instructions a) Prepare a bond amortization schedule using the following form: INTEREST PAYMENT

INTEREST INCOME

DISCOUNT AMORTIZATION

CARRYING AMOUNT $92,278

DISCOUNT AMORTIZATION $614 $645

CARRYING AMOUNT $92,278 $92,892 $93,537

DATE Jan 1, 2024 Dec 31, 2024 Dec 31, 2025 b) Prepare the journal entries for the issuance of the bond on January 1, 2024, and the first interest payment on December 31, 2024. c) Prepare the journal entry to record the maturity of the bond on January 1, 2034. Solution (15 min.) a)

Bond amortization schedule:

DATE Jan 1, 2024 Dec 31, 2024 Dec 31, 2025

INTEREST PAYMENT $4,000 $4,000

INTEREST INCOME $4,614 $4,645

b) Jan 1, 2024

Bond investment .................................................. Cash ..............................................................

92,278

Dec 31, 2024 Cash ........................................................................ Bond investment ................................................. Interest income ............................................ c) Jan 1, 2034 Cash ...................................................................... Bond investment ..........................................

4,000 614

92,278

4,614 100,000 100,000

Appendix D - 26 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

54. Ghanu Co. purchased 100 shares in Bhatia Ltd. on October 1, 2024, for $24 per share. Ghanu received a $5 dividend per share from Bhatia on November 5, 2024. Bhatia’s fair value at December 31, 2024, is $20 per share. Ghanu sold the investment in Bhatia on January 14, 2025, for $25 per share. Ghanu has a December 31 year end and accounts for the investment as fair value through profit or loss (FVPL). Instructions a) Prepare all necessary journal entries relating to the investment in Bhatia during 2024. b) Record the sale of the Bhatia shares on January 14, 2025. Solution (15 min.) a) 2024 Oct 1

Nov 5

Dec 31

FVPL investment (100 x $24) ........................................ Cash ..............................................................

2,400

Cash (100 x $5) ............................................................. Dividend income...........................................

500

Investment income or loss ......................................... FVPL investments ......................................... (100 x ($20-$24))

400

FVPL investments ........................................................ Investment income or loss ........................... (100 x ($25-$20))

500

Cash (100 x $25)........................................................... FVPL investments .........................................

2,500

2,400

500

400

b) 2024 Jan 14

Jan 14

500

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for.

2,500

Appendix D - 27 Test Bank for Understanding Financial Accounting, Third Canadian Edition

CPA: Financial Reporting AACSB: Analytic

55. Pond Hollow Ltd. has the following investment portfolio at January 1, 2024, accounted for as at fair value through profit or loss (FVNI): Investment Morrow Co. Elsa Co. Joro Co.

# Shares 300 500 100

Carrying value $17,200 $15,500 $1,600

The following events took place during 2024 relating to the portfolio: -

Pond Hollow received a dividend from Elsa Co. on June 12 for $2.50 per share.

Pond Hollow sold all 300 of the Morrow shares on August 5 for $60 per share.

The fair value per share of the Elsa and Joro shares at December 31 are $30 and $22 respectively.

Instructions a) Prepare all necessary journal entries relating to the portfolio during 2024. b) What amount would be presented in the Statement of Financial Position at December 31, 2024 relating to these investments? Where in the statement would they be reported? Solution (20 min.) a) 2024 Jun 12

Aug 5

Dec 31

Cash (500 x $2.50) ........................................................ Dividend income...........................................

1,250

FVPL investments ........................................................ Investment income or loss ........................... (300 x $60) – $17,200

800

Cash (300 x $60) ........................................................... FVPL investments .........................................

18,000

FVPL investments ........................................................ Investment income or loss ...........................

100

Investment Elsa Co.

# Shares 500

Carrying value $15,500

1,250

800

18,000

100 Fair value $15,000

Appendix D - 28 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Joro Co. Total FV increase (decrease)

100

$1,600 $17,100

$2,200 $17,200 $100

b) The FVPL Investments would be presented in the current asset section of the Statement of Financial Position at December 31, 2024, at the fair value of $17,200. Bloomcode: Application Difficulty: Medium Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

56. Hardy Inc. has the following equity investments at January 1, 2024, accounted for as at fair value through other comprehensive income (FVOCI): Investment Laslow Co. McEwan Co. Elwood Co.

# Shares 220 500 1,100

Carrying value $2,000 $9,500 $17,200

The following events took place during 2024 relating to the investments: -

Hardy received a dividend from Elwood Co. on May 13 for $1.70 per share.

Hardy sold all 500 of the McEwan shares on June 29 for $11 per share. The original cost of the McEwan shares were $8 per share.

The fair value per share of the Laslow and Elwood shares at December 31 are $12 and $13, respectively.

Instructions a) Prepare all necessary journal entries relating to the FVOCI investments during 2024. b) Explain where and what amount would be presented in the Statement of Comprehensive Income relating to these investments? Solution (20 min.) a) 2024 May 13 Cash (1,100 x $1.70) .....................................................

1,870

Appendix D - 29 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Dividend income........................................... Jun 29

Jun 29

Dec 31

1,870

Unrealized holding gain or loss - OCI .......................... FVOCI investments ....................................... (500 x $11) – $9,500

4,000

Cash (500 x $11) ........................................................... FVOCI investments .......................................

5,500

Unrealized holding gain or loss - OCI .......................... Retained Earnings ........................................ (500 x ($11-$8))

1,500

Unrealized holding gain or loss - OCI .......................... FVOCI investments .......................................

2,260

Investment Laslow Co. Elwood Co. Total FV increase (decrease)

# Shares 220 1,100

Carrying value $2,000 $17,200 $19,200

4,000

5,500

1,500

2,260 Fair value $2,640 $14,300 $16,940 $(2,260)

b) The impact of these investments on the Statement of Comprehensive Income for the year ended December 31, 2024, is as follows: Other income: Dividend income ..................................................................... Net income

$1,870

..............................................................................

1,870

Other Comprehensive Income: Unrealized holding gain (loss) ...............................................

(7,760)

Comprehensive income ..............................................................

$(5,890)

Bloomcode: Application Difficulty: Hard Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 30 Test Bank for Understanding Financial Accounting, Third Canadian Edition

57. Thames Co. purchased 11,400 shares, representing 30% of the outstanding voting shares of Kamal Co. on January 1, 2024, for $125,000. Thames uses the equity method to account for its investment in Kamal. During the year, Kamal paid dividends totalling $15,000 on October 1 and reported net income of $160,000 on December 31. Kamal’s shares are trading at $10 per share on December 31, 2024. Instructions Prepare all necessary journal entries for the investment in Kamal during 2024. Solution (10 min.) 2024 Jan 1

Oct 1

Dec 31

Investment in associate ............................................... Cash ..............................................................

125,000

Cash .............................................................................. Investment in associate ............................... $15,000 x 30%

4,500

Investment in associate ............................................... Investment income or loss ........................... $160,000 x 30%

48,000

125,000

4,500

48,000

*There is no fair value adjustment under the equity method Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

58. Oak Ridge Co. purchased 11,500 of the outstanding voting shares of Maple Coast Co. on January 1, 2024, for $500,000. Maple has 50,000 voting shares outstanding after the transaction took place. Oak Ridge can exercise significant influence over Maple. The following events took place during 2024 relating to the investments: -

Maple paid total dividend of $45,000 on May 1 and $45,000 on September 1.

Maple reported net income for the year of $210,000.

Maple shares are trading at $50 per shares on December 31.

Instructions a) Prepare all journal entries during 2024.

Appendix D - 31 Test Bank for Understanding Financial Accounting, Third Canadian Edition

b) What amount would be presented in the Statement of Financial Position relating to the investment in Maple? Where in the statement would the investment be reported? Solution (15 min.) a) 2024 Jan 1

May 1

Sep 1

Dec 31

Investment in associate ............................................... Cash ..............................................................

500,000

Cash .............................................................................. Investment in associate ............................... (11,500 / 50,000) x $45,000

10,350

Cash .............................................................................. Investment in associate ............................... (11,500 / 50,000) x $45,000

10,350

Investment in associate ............................................... Investment income or loss ........................... (11,500 / 50,000) x $210,000

48,300

500,000

10,350

48,300

*There is no fair value adjustment under the equity method b) Statement of Financial Position: Long-Term Investments: Investment in Associate ..........................................................

$527,600

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

59. Dante Dance Co. acquired a controlling interest in Shay Entertainment Co. for $1,000,000 on May 1, 2024, acquiring 100% of the outstanding voting shares of Shay. Shay had total assets and liabilities of $6,200,000 and 5,500,000, respectively, on the date of acquisition. The carrying value of Shay’s assets and liabilities approximates fair values except for the land and building, which has a fair value excess of $120,000 over carrying value. Instructions

Appendix D - 32 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Calculate the acquisition differential and goodwill, if any, from the acquisition of Shay. Solution (15 min.) Purchase price Less: Carrying value of Shay’s net assets: Assets Liabilities Acquisition differential Less: Fair value excess Goodwill

$1,000,000 $6,200,000 5,500,000

700,000 300,000 120,000 $180,000

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 33 Test Bank for Understanding Financial Accounting, Third Canadian Edition

MATCHING 60. Listed below are various methods of accounting for investments. Match the scenarios described below to the method of accounting that best meets the scenario’s reporting requirements. METHODS OF ACCOUNTING A. Fair value through profit or loss (FVPL) B. Fair value through other comprehensive income (FVOCI) C. Amortized cost D. Equity method E. Consolidation SCENARIO ____

Investment in publicly traded shares with the intentions of short-term trading

____

Investment in a large number of voting shares, sufficient to exercise significant influence.

____

Investment in equity instrument representing 100% of the outstanding voting shares.

____

Investment in bonds traded in an active market with the intentions of short-term trading.

____

Investment in a large number of voting shares, sufficient to exercise control.

____

Investment in bonds traded in an active market with the intention of collecting interest payments and selling the bonds before maturity.

____

Investment in bonds with the intention of holding to maturity and collecting all contractual payments.

____

Investment in equity instrument representing 40% of the outstanding voting shares.

Solution (5 min.) 1.

Appendix D - 34 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

Appendix D - 35 Test Bank for Understanding Financial Accounting, Third Canadian Edition

SHORT-ANSWER 61. Explain the difference between a strategic and non-strategic investment. Solution (10 min.) An investment can be either a non-strategic or a strategic investment. Although non-strategic investments can be current or long-term, these investments are passive in nature and not intended to have any influence or control over the investee. Strategic investments would have a long-term outlook and intended for investments exercising control or influence over investing, financing and operating decision-making of the investee. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments. CPA: Financial Reporting AACSB: Analytic

62. Explain what goodwill is and how it can be recognized and classified on the statement of financial position. Solution (10 min.) Goodwill is a long-term asset that arises when two businesses are combined. It represents the expected future economic benefits that will arise from the combination that cannot be separately identified as either PP&E or an intangible asset. It is the purchase price less the fair value of the identifiable assets being acquired, plus the fair value of any liabilities being assumed as part of the purchase. Goodwill is only recorded when a business combination has taken place, it cannot be internally generated. Goodwill is captured on the Statement of Financial Position under long-term or non-current assets. It is considered to have an indefinite useful life and is not amortized, but it is tested for impairment annually. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

63. Explain what reporting options are available for investments in debt instruments. Consider what differences exist in the accounting treatment, including the effect on the financial statements. Solution (10 min.)

Appendix D - 36 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Investments in debt instruments are classified based on the intentions of the investment. The following classifications exist for accounting for debt instruments: Amortized cost: Debt investments that are intended to be held to maturity while collecting contractual cash flows are accounted for at amortized cost. The investment account would remain at cost until disposal (ignoring potential impairments), and interest income would be reported in net income. Fair value through other comprehensive income: Debt instruments that are intended to be sold before maturity and collect contractual cash flows are accounted for at fair value through other comprehensive income. The investment account would be adjusted to reflect fair value at each reporting period, with these changes reported to other comprehensive income, and interest income would be reported in net income. Fair value through profit and loss: Debt instruments that are intended to be traded before maturity and not to collect contractual cash flows would be accounted for at fair value through profit or loss. The investment account would be adjusted to reflect fair value at each reporting period, with these changes reported to net income, and interest income would be reported in net income. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments. Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

64. Explain what reporting options are available for non-strategic investments in equity instruments. Consider what differences exist in the accounting treatment, including the effect on the financial statements. Solution (10 min.) Non-strategic equity investments are classified based on the intention of management related to the investment. The following classifications exist for accounting for these equity instruments: Fair value through profit and loss: Equity instruments that are purchased with the intention of trading for short-term profit-taking are accounted for at fair value through profit or loss. The investment is remeasured to fair value at each reporting period with unrealized gains and losses reported in net income. Any dividend received would be reported in net income. Fair value through other comprehensive income: Equity instruments that are purchased without the intention of active trading, and that are not managed on a fair value basis are accounted for at fair value through other comprehensive income. The investment is re-measured to fair value at each reporting period with unrealized gains and losses reported in other comprehensive income. Any dividend received would be reported in net income. Bloomcode: Comprehension

Appendix D - 37 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments. Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

65. Describe the accounting treatment required for strategic investments in equity instruments. Solution (10 min.) The two possible methods of accounting for strategic equity investments are the equity method and consolidation. The following provides an overview of both methods of accounting. Equity method: An equity investment capable of exercising significant influence over the investee, typically represented by acquiring between 20-50% of the outstanding voting shares of the investee, would be accounted for under the equity method. Under the equity method, the investment account will increase (decrease) with changes in the investor’s share of the investee’s net income (loss), and will decrease by any dividends received from the investee. Fair value is not a factor that affects the accounting under the equity method and net income will increase (decrease) based on the investor’s share of the investee’s net income (loss). Consolidation: An equity investment that enables control over the investee, typically represented by acquiring over 50% of the outstanding voting shares of the investee, would require full consolidation as the method of accounting. The investee would be referred to as a subsidiary, and their financial statements would be combined with the financial statements of the investor, known as the parent, during consolidation at each reporting period. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments. Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

Appendix D - 38 Test Bank for Understanding Financial Accounting, Third Canadian Edition

ESSAY QUESTIONS 66. Laura Simon is the controlling shareholder of Awkward Aroma Inc. Awkward has a significant cash balance that seems to be climbing since the company recently experienced significant growth. Laura would like to put this cash to good use and invest an amount of approximately $2 million. Although Laura is open to both, debt or equity investments, she also does not have a particular intention established for these investments. The company will not be relying on the income generated from the cash investment; however, it may be open to reinvesting into opportunities that are more lucrative in the future. With limited accounting knowledge, Laura would like a comprehensive breakdown of the different accounting treatments available for investments. Be sure to specify any requirements in the application of the accounting treatments. Solution (20 min.) The accounting for investments can be initially separated between non-strategic and strategic investments. Although non-strategic investments can be current or long-term, these investments are passive in nature and not intended to have any influence or control over an organization. Strategic investments would have a long-term outlook and intended for investments exercising control or influence over investing, financing and operating decision-making. The following accounting treatments are available to non-strategic and strategic investments. Non-Strategic (debt and equity instruments) Debt instruments: Amortized cost: Debt investments that are intended to be held to maturity while collecting contractual cash flows are accounted for at amortized cost. The investment account would remain at cost until disposal (ignoring potential impairments), and interest income would be reported in net income. Fair value through other comprehensive income: Debt instruments that are intended to be sold before maturity and collect contractual cash flows are accounted for at fair value through other comprehensive income. The investment account would be adjusted to reflect fair value at each reporting period, with these changes reported to other comprehensive income, and interest income would be reported in net income. Fair value through profit and loss: Debt instruments that are intended to be traded before maturity and not to collect contractual cash flows would be accounted for at fair value through profit or loss. The investment account would be adjusted to reflect fair value at each reporting period, with these changes reported to net income, and interest income would be reported in net income. Equity instruments: Fair value through profit and loss: Equity instruments that are purchased with the intention of trading for short-term profit-taking are accounted for at fair value through profit or loss. The investment is remeasured to fair value at each reporting period with unrealized gains and losses reported in net income. Any dividend received would be reported in net income. Fair value through other comprehensive income: Equity instruments that are purchased without the

Appendix D - 39 Test Bank for Understanding Financial Accounting, Third Canadian Edition

intention of active trading, and that are not managed on a fair value basis, are accounted for at fair value through other comprehensive income. The investment is re-measured to fair value at each reporting period with unrealized gains and losses reported in other comprehensive income. Any dividend received would be reported in net income. Strategic investments (only equity instruments) Equity method: An equity investment capable of exercising significant influence over the investee, typically represented by acquiring between 20-50% of the outstanding voting shares of the investee, would be accounted for under the equity method. Under the equity method, the investment account will increase (decrease) with changes in the investor’s share of the investee’s net income (loss), and will decrease by any dividends received from the investee. Fair value is not a factor that affects the accounting under the equity method, and net income will increase (decrease) based on the investor’s share of the investee’s net income (loss). Consolidation: An equity investment that enables control over the investee, typically represented by acquiring over 50% of the outstanding voting shares of the investee, would require full consolidation as the method of accounting. The investee would be referred to as a subsidiary, and their financial statements would be combined with the financial statements of the investor, known as the parent, during consolidation at each reporting period. Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain why companies make investments and distinguish between the different types of investments. Learning Objective: Explain how non-strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic

67. A friend has come to you with the following question, "What is this goodwill account that I see on the statement of financial position of a company that I own stock in?" Instructions Write a reply to your friend. Include in your explanation three factors that contribute to goodwill, under what circumstances goodwill is recorded, and how it is accounted for. Solution (10 min.) Goodwill is the result of a number of factors, including: above-average management skills, excellent location, excellent customer relations, and above-average earnings. Goodwill is recorded as an asset only when it is acquired in the purchase of another company. When the purchasing company pays more than the fair market value of the selling company's net assets, the difference is captured as goodwill. Goodwill is reported as an intangible asset on the balance sheet and is not amortized. Management is required to periodically review the carrying value of the goodwill to determine if any impairment in value has occurred. If impairment has occurred the goodwill should be written down and an impairment loss recognized.

Appendix D - 40 Test Bank for Understanding Financial Accounting, Third Canadian Edition

Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain how strategic investments are accounted for. CPA: Financial Reporting AACSB: Analytic