Part 1 CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS LEARNING OBJECTIVES 1. 2. 3. 4.
Identify the uses and users of accounting information. Describe the primary forms of business organization. Explain the three main types of business activity. Describe the purpose and content of each of the financial statements.
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Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file.
LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
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ANSWERS TO QUESTIONS 1.
Accounting is the information system that identifies and records the economic events of an organization, and then communicates them to a wide variety of interested users.
LO 1 BT: K Difficulty: S TIME: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
(a)
Internal users of accounting information work for the company and include finance directors, marketing managers, human resource personnel, production supervisors, and company officers.
(b)
Some external users may be individuals who are employees of the company but are not directly involved in managing the company. External users of accounting information generally do not work for the company. The primary external users are investors, lenders, and other creditors. Other external users include labour unions, customers, the Canada Revenue Agency (CRA), and securities commissions.
LO 1 BT: C Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
Internal users may want the following questions answered: Is there enough cash to purchase a new piece of equipment? What price should we sell our product for to cover costs and to maximize net income? How many employees can we afford to hire this year? Which product line is the most profitable? How much of a pay raise can the company afford to give me? External users may want the following questions answered: Is the company earning enough to give me my required return on investment? Will the company be able to repay its debts as the debts come due? Will the company stay in business long enough to service the products I buy from it?
LO 1 BT: K Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
Primary users of accounting information include investors, lenders, and creditors. These external users need to make decisions concerning their ongoing business relationship with the company. They need to be able to assess the company’s performance and financial health because they intend to start, continue, or discontinue having transactions with the company. Other decision makers who have specific needs for certain financial information, such as the amount of taxes paid by the company, are not considered primary users.
LO 1 BT: C Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
Decision makers rely on financial statement information and expect the accounting information to have been prepared ethically. Without the expectation of ethical behaviour, the information presented in the financial statements would have no credibility for the users of the accounting information. Without credibility, financial statement information would be useless to financial statement users.
LO 1 BT: C Difficulty: M TIME: 5 min. AACSB: None Ethics CPA: cpa-t001 CM: Reporting and Ethics
6.
(a) Proprietorship: Proprietorships are easier to form (and dissolve) than other types of business organizations. They are not taxed as separate entities; rather, the proprietor pays personal income tax on the company’s net income. Depending on the circumstances, this may be an advantage or disadvantage. Disadvantages of a proprietorship include unlimited liability (proprietors are personally liable for all debts of the business) and difficulty in obtaining financing compared to other forms of organization. In addition, the life of the proprietorship is limited as it is dependent on the willingness and capability of the proprietor to continue operations. (b) Partnership: Partnerships are easier to form (and dissolve) than a corporation, although not as easy as a proprietorship. Similar to a proprietorship, partnerships are not taxed as separate entities. Instead, the partners pay personal income tax on their share of income. Depending on the circumstances this may be an advantage or disadvantage. Disadvantages of partnerships include unlimited liability (partners are jointly and severally liable for all debts of the business) and difficulty in obtaining financing compared to corporations. In addition, the life of a partnership can be limited depending on the terms of the partnership agreement and actions of the other partners.
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Financial Accounting, Seventh Canadian Edition
6. (continued) (c) Private corporation: Advantages of a private corporation include limited liability (shareholders not being personally liable for corporate debts), indefinite life, and transferability of ownership. In many cases, depending on the size of the corporation, a creditor such as a bank will ask for a personal guarantee which will void the limited liability advantage. In addition, transferability of ownership may be limited since shares are not publicly traded. Disadvantages of a private corporation include increased government regulations and paperwork. The fact that corporations are taxed as a separate legal entity may be an advantage or a disadvantage. Corporations often receive more favourable income tax treatment than other forms of business organizations. As mentioned above, depending on the size of the corporation, many of the advantages of the corporate form are not available to a small private corporation. (d) Public corporation: The advantages of a public corporation include limited liability, indefinite life, and transferability of ownership. These features make it easier for publicly traded corporations to raise financing compared to other forms of business organizations. Corporations often receive more favourable income tax treatment than other forms of business organizations. Disadvantages include increased government regulations and paperwork. In addition, because the shares of public companies are listed and traded on Canadian or other exchanges such as the Toronto Stock Exchange (TSX), these corporations are required to distribute their financial statements to investors, lenders, creditors and other interested parties, and the general public. This requirement involves greater costs to the corporation. LO 2 BT: C Difficulty: M TIME: 20 min. AACSB: None CPA: cpa-t001, cpa-t006 CM: Reporting and Tax
7.
While both public and private corporations enjoy many of the same advantages and disadvantages, one key difference is that public corporations list their shares for sale to the public on Canadian or other stock exchanges. In contrast, while private corporations issue shares, they do not make them available to the general public or trade them on public stock exchanges. Private corporations may also not enjoy the advantages of limited liability and ease of transfer of ownership that public corporations generally experience because of their size and distribution of shares.
LO 2 BT: C Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
(a)
Public corporations must apply International Financial Reporting Standards (IFRS). Private corporations can apply either IFRS or Accounting Standards for Private Enterprises (ASPE).
(b)
The information needs of users of public corporations and private corporations are different. Users of financial information of public corporations require more extensive disclosure. They may also be benefit from the enhanced comparability to global companies provided by international standards. Since private corporations tend to be smaller with easier access to company information, their users do not require as extensive reporting.
LO 2 BT: C Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
A private company that has plans to grow significantly in the near future, and that wishes to have access to large amounts of capital obtained from external investors will want to go public. In order to go public, the company would be required to have several years of past financial statements prepared using IFRS. In addition, some businesses choose to follow IFRS in order to be able to compare their performance with businesses in the same industry that are public and whose financial information is readily available.
LO 2 BT: C Difficulty: C TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
The reporting entity concept means that economic activity of any business organization or economic entity is kept separate and distinct from the activities of the owner and all other economic entities. In the case of corporations such as The North West Company Inc., it also means that economic activities of related corporations that are owned or controlled by one corporation are consolidated. The results of these individual companies are also reported separately as separate economic entities.
LO 2 BT: K Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
11.
(a) (b) (c)
(d) (e)
Solutions Manual .
Assets are what the company owns such as cash and equipment. A liability is an amount the company owes such as accounts payable and income tax payable. Shareholders’ equity represents the residual interest (assets less liabilities) of a company at a point in time and includes share capital and retained earnings, in addition to other possible components. Revenues are an increase in a company’s economic resources from operating activities such as the sale of a product. Expenses are the cost of assets that are consumed or services that are used in the process of generating revenues. Examples include cost of goods sold, rent expense, and salaries expense. 1-6
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12.
Operating activities are the activities that the organization undertakes to earn net income. They include the day-to-day activities that generate revenues and cause expenses to be incurred. In order to earn net income, a company must first purchase resources they need to operate. The purchase of these resources (assets) is considered to be an investing activity. Finally, the company must have sufficient funds to purchase assets and to operate. While some of the necessary cash will be generated from operations, often the company has to raise external funds by either issuing shares or borrowing money. Financing activities involve the activities undertaken by the company to raise cash externally.
LO 3 BT: C Difficulty: M TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
(a)
Two examples of operating activities are revenue generated from providing auto repair services (an inflow of cash) and the expenses related to paying employee salaries (an outflow of cash).
(b)
Two examples of investing activities are the purchase of property, plant, and equipment, such as a building (an outflow of cash), and the sale of a long-term investment (an inflow of cash).
(c)
Two examples of financing activities for a corporation are borrowing money (debt), which is an inflow of cash, and declaring and paying dividends (equity), an outflow of cash
LO 3 BT: C Difficulty: M TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
Local companies providing services and therefore generating service revenue would include doctors, dentists, architects, engineers, law practices, and accountants. The names of these businesses would likely include the name of the practitioners or groups providing these services. Local companies providing sales revenue would include farms that provide produce or milk products and the retail stores selling the local produce to customers.
LO 3 BT: C Difficulty: M TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
A fiscal year is an accounting time period that is one year in length, but does not have to end on December 31. Corporations can select their fiscal year end based on when their operations are low or when inventory is low. Selecting a fiscal year end when operations are low provides more time for accounting staff to complete the year-end reporting requirements. If inventories are low, this simplifies the inventory count and minimizes the business disruption caused by counting the inventory.
LO 4 BT: K Difficulty: S TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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16.
Financial Accounting, Seventh Canadian Edition
The internal accounting records do use exact figures. However, for presentation purposes, it is unlikely that the use of rounded figures would change a decision made by the users of the financial statements. As well, presenting the information in this manner makes the statements easier to read and analyze thereby increasing their utility to the users. Rounding the numbers to the nearest million does not have a material impact on decision-making using the financial statements.
LO 4 BT: K Difficulty: S TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
17.
Assets = Liabilities + Shareholders’ Equity $793,795 = $436,183 + $357,612 (amounts are in thousands of dollars)
LO 4 BT: AP Difficulty: M TIME: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
18.
A statement of changes in equity explains the changes in the components of shareholders’ equity, such as share capital and retained earnings. Examples of items that increase the components are issue of shares (increases share capital) and net income (increases retained earnings). Examples of items that decrease the components are repurchases of shares (decreases share capital) and payment of dividends (decrease retained earnings).
LO 4 BT: C Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
19.
(a)
The primary purpose of the statement of cash flows is to provide financial information about the cash receipts (inflows) and cash payments (outflows) of a company for a specific period of time.
(b)
The three categories of the statement of cash flows are operating activities, investing activities, and financing activities. These categories represent the three principal types of business activities.
LO 4 BT: K Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
20.
The cash obtained from operating activities is not necessarily expected to be positive in the early years of a company’s life. If a business offers credit to its customers and needs to hold a significant amount of inventory to satisfy customer demands, a large amount of any cash obtained from selling goods will be tied up in accounts receivable and inventory. Creditors on the other hand will have little leniency on a new business when expecting to be paid. Consequently, the amount of cash from operating activities could very likely be negative. For investing activities, a negative cash outflow would also be expected as the business must invest in long-lived assets needed for operations.
LO 4 BT: C Difficulty: C TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
The statement of financial position is prepared as at a specific point in time because it shows what the business owns (its assets) and what it owes (its liabilities). These items are constantly changing. It is necessary to select one point in time at which to present them. The other statements (income statement, statement of changes in equity, and statement of cash flows) cover a period of time as they report activities and measure performance that takes place over time.
LO 4 BT: C Difficulty: M TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
22.
(a)
The income statement reports net income for the period. The net income figure from the income statement is shown on the statement of changes in equity as an addition to beginning retained earnings. If there is a loss it is deducted from beginning retained earnings.
(b)
The statement of changes in equity explains the change in the balances of the components of shareholders’ equity (for example, common shares and retained earnings) from one period to the next. The ending balances are reported in the shareholders’ equity section of the statement of financial position.
(c)
The statement of cash flows explains the change in the cash balance from one period to the next. The ending balance of cash reported in the statement of cash flows agrees with the ending cash balance reported in the current assets section on the statement of financial position.
LO 4 BT: C Difficulty: M TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
23.
(a)
Companies using IFRS must report an income statement, statement of changes in equity, statement of financial position, and statement of cash flows. In addition, companies using IFRS may also need to prepare a statement of comprehensive income.
(b)
Companies using ASPE must report an income statement, statement of retained earnings, balance sheet, and a statement of cash flows.
LO 4 BT: K Difficulty: S TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1 (a) Type of Evaluation
(b) Type of User
5 4 1 6 2 3
External Internal External Internal External External
Investor Marketing manager Creditor Chief financial officer Canada Revenue Agency Labour union
LO 1 BT: C Difficulty: S TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 1-2 (a) (b) (c) (d) (e)
1 4 3 2 4
Proprietorship Private corporation Public corporation Partnership Private corporation
LO 2 BT: K Difficulty: S TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 1-3 (a) (b) (c) (d) (e) (f) (g) (h) (i)
F O I F F F O I O
Inflow Inflow Inflow Outflow Inflow Outflow Outflow Outflow Outflow
Note to instructors: As we will learn later in Chapter 13, companies reporting under IFRS have a choice in classifying dividends paid as an operating or financing activity. We have chosen to classify dividends paid as financing activities in this textbook. LO 3 BT: C Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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BRIEF EXERCISE 1-4
1. 2. 3. 4. 5. 6.
(a)
(b)
O F O O O I
NE + + -
LO 3 BT: C Difficulty: M TIME: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 1-5 (a)
Total assets
= = =
Total liabilities + Shareholders’ equity $55,000 + $120,000 $175,000
(Liabilities + Shareholders’ equity = Assets)
(b)
Total assets
= = =
Total liabilities + Shareholders’ equity (share capital + retained earnings) $170,000 + ($100,000 + $90,000) $360,000
(Liabilities + Shareholders’ equity = Assets)
(c)
Total liabilities
= = =
Total assets – Shareholders’ equity (share capital + retained earnings) $150,000 – ($50,000 + $25,000) $75,000
(Assets – Shareholders’ equity = Liabilities)
(d)
Shareholders’ equity
= = =
Total assets – Total liabilities $500,000 – ($500,000 ÷ 2) $250,000
(Assets – Liabilities = Shareholders’ equity) LO 4 BT: AP Difficulty: M TIME: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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BRIEF EXERCISE 1-6 Beginning of Year: Assets = Liabilities + Shareholders’ equity Beginning of Year: $720,000 = $420,000 + Shareholders’ equity Beginning of Year: Shareholders’ equity = $300,000 (a)
($720,000 + $250,000) = ($420,000 – $80,000) + Shareholders’ equity Shareholders’ equity = $630,000
[(Assets ± Change in assets) – (Liabilities ± Change in liabilities) = Shareholders’ equity]
(b)
Assets = ($420,000 – $100,000) + ($300,000 + $90,000 + $125,000) Assets = $835,000
[(Liabilities ± Change in liabilities) + (Shareholders’ equity ± Change in shareholders’ equity) = Assets]
(c)
($720,000 – $90,000) = Liabilities + ($300,000 + $120,000) Liabilities = $210,000
[(Assets ± Change in assets) – (Shareholders’ equity ± Change in shareholders’ equity) = Liabilities] LO 4 BT: AP Difficulty: C TIME: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 1-7 (a) (b) (c) (d) (e) (f) (g) (h)
IS SFP SCE SCF SFP SCF IS SCE
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BRIEF EXERCISE 1-8 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)
L A L L A A A SE L SE A
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BRIEF EXERCISE 1-9
(a) (b) (c) (d) (e) (f) (g) (h)
Share Capital
Retained Earnings
Total Shareholders' Equity
NE NE NE + NE NE NE
+ NE NE NE NE NE
+ NE + NE NE
Net income Repayment of bank loan Declared dividends Issue of common shares Cash Repurchase of common shares Net loss Issue of long-term debt
LO 4 BT: C Difficulty: C TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 1-10 (a)
Beginning balance Issue additional shares Net income Dividends declared Ending balance (b)
Beginning balance Issue additional shares Net loss Ending balance
(1)
(2)
Common Shares $100,000 50,000
Retained Earnings $475,000
$150,000
75,000 (15,000) $535,000
(1)
(2)
Common Shares $100,000 50,000
Retained Earnings $475,000 (75,000) $400,000
$150,000
(3) Total Shareholders' Equity $575,000 50,000 75,000 (15,000) $685,000 (3) Total Shareholders' Equity $575,000 50,000 (75,000) $550,000
(Beginning equity ± Changes to equity = Ending equity) LO 4 BT: AN Difficulty: M TIME: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 1-1 (a)
Chief Financial Officer – Does Facebook generate enough cash to expand its operations and purchase other businesses? Human Resource Manager – What is Facebook’s annual salary expense?
(b)
Creditor – Does Facebook have enough cash available to make its monthly debt payments? Investor – How much did Facebook pay in dividends last year?
Other examples are also possible. LO 1 BT: C Difficulty: M TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 1-2 Proprietorship Partnership 1. 2. 3. 4. 5.
No personal liability Owner(s) pay(s) personal income tax on company income Generally easiest form of organization to raise capital Ownership indicated by shares Required to issue quarterly financial statements
Public Corporation
Private Corporation
F
F
T
T
T
T
F
F
F
F
T
F
F
F
T
T
F
F
T
F
6.
Owned by one person
T
F
F
F
7.
Limited life
T
T
F
F
T
F
F
F
F
F
T
F
F
F
F
T
8. 9.
Usually easiest form of organization to set up Required to use IFRS as its accounting standards
10. Shares are closely held
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Financial Accounting, Seventh Canadian Edition
EXERCISE 1-3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
O I O F F F O O O F
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EXERCISE 1-4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.
(a) O F I F I I O O I F F O
(b) + + + + + -
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Financial Accounting, Seventh Canadian Edition
EXERCISE 1-5 1. 2. 3. 4. 5. 6. 7. 8.
IS SFP, SCF SCF IS SCE, SFP SCE IS, SCE SFP
9. 10. 11. 12. 13. 14. 15.
SFP IS IS SCF SFP SCE, SFP SFP
LO 4 BT: K Difficulty: S TIME: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 1-6 ; (a)
Assets – Liabilities = Shareholders’ equity 2017: $550,000 – $400,000 = $150,000 2018: $630,000 – $420,000 = $210,000
(Assets – Liabilities = Shareholders’ equity)
(b)
Change in shareholders’ equity $210,000 – $150,000 = $60,000 increase
(c)
1. Net income is $60,000 = the increase in shareholders’ equity 2. Net income is $70,000 = the increase in shareholders’ equity + dividends declared of $10,000 3. Net income is $30,000 = the increase in shareholders’ equity – common shares issued of $30,000 4. Net income is $50,000 = the increase in shareholders’ equity + dividends declared of $10,000 – common shares issued of $20,000
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EXERCISE 1-7 [1]
Total revenues – Net income = Total expenses $1,000,000 – $150,000 = $850,000
[2]
Common shares, end of year $100,000 = Beginning balance of common shares + Issue of shares of $100,000
[3]
$150,000 equal to Net income given above
[4]
Beginning balance of retained earnings plus net income less dividends declared = Ending balance of retained earnings. $0 + $150,000 – Dividends declared = $100,000 Dividends declared = $50,000
[5]
Beginning balance in shareholders' equity + Issue of shares + Net income – Dividends declared = Ending balance in shareholders’ equity $0 + $100,000 + $150,000 – $50,000 = $200,000
[6]
Total assets – Total liabilities = total Shareholders’ equity $1,050,000 – $850,000 = $200,000 or [5] above
[7]
Total revenues – Total expenses = Net income Total revenues – $250,000 = $50,000 Total revenues = $300,000
[8]
Beginning balance of common shares + Issue of shares = Common shares, end of year $0 + Issue of shares = $20,000 Issue of shares = $20,000
[9]
$50,000 equal to Net income given above
[10]
Common shares, end of year + Retained Earnings, end of year $20,000 + $40,000 = $60,000 Total shareholders’ equity, end of year
[11]
Total liabilities + Total shareholders’ equity = Total assets $150,000 + $60,000 (from [10]) = $210,000
[12]
$60,000 (from [10]) or $210,000 (from [11]) − $150,000 total liabilities = $60,000 total shareholders’ equity
LO 4 BT: AN Difficulty: C TIME: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-8 [1]
Total expenses + Net income = Total revenues $1,700,000 + $1,100,000 = $2,800,000
[2]
Common shares, end of year $200,000 = Beginning balance of common shares (nil) + Issue of shares of $200,000
[3]
$1,100,000 equal to Net income given above
[4]
Beginning balance of retained earnings plus net income less dividends declared + Beginning balance of common shares + Issue of shares = Ending balance in shareholders’ equity. $0 + $1,100,000 – $300,000 + $0 + $200,000 = $1,000,000 Ending balance in total shareholders’ equity = $1,000,000
[5]
Total liabilities + Total Shareholders’ equity = Total assets $1,600,000 + $1,000,000 or [4] above = $2,600,000
[6]
[4] above $1,000,000
[7]
Total revenues – Net income = Total expenses $3,200,000 – $1,500,000 = $1,700,000
[8]
Beginning balance of common shares + Issue of shares = Common shares, end of year $0 + Issue of shares = $500,000 Common shares, end of year $500,000
[9]
$1,500,000 equal to Net income given above
[10]
Beginning balance of retained earnings plus net income less dividends declared = Ending balance of retained earnings. $0 + $1,500,000 – Dividends declared = $1,200,000 Dividends declared = $300,000
[11]
Common shares, end of year + Retained Earnings, end of year $500,000 (from [8]) + $1,200,000 = $1,700,000 Total shareholders’ equity, end of year
[12]
Total assets – Total Shareholders’ equity = Total liabilities $3,100,000 – $1,700,000 = $1,400,000
LO 4 BT: AN Difficulty: C TIME: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
1-19
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-9 ($ in thousands) (a) Assets – Liabilities = Shareholders’ equity 2015: $2,630,865 – $577,731 = $2,053,134 2014: $2,876,490 – $631,994 = $2,244,496 (b)
Assets = Liabilities + Shareholders’ equity 2015: $2,630,865 = $577,731 + $2,053,134 Assets = Liabilities + Shareholders’ equity 2014: $2,876,490 = $631,994 + $2,244,496
(c)
Change in shareholders’ equity $2,053,134 – $2,244,496= $191,362 decrease
(d)
Shareholders’ equity, Dec. 31, 2014 Add: Net income Deduct: Dividends declared Other shareholders’ equity items Shareholders’ equity, Dec. 31, 2015
$2,244,496 ? 44,668 188,274 $2,053,134
Solving for Net income: $2,053,134 + $188,274 + $44,668 − $2,244,496 = $41,580. (Beginning equity ± Changes to equity = Ending equity) LO 4 BT: AP Difficulty: M TIME: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
1-20
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-10 (a) L A L A A SE A (b)
Accounts payable Accounts receivable Bank loan payable Buildings Cash Common shares Equipment
L A A L SE A
Income tax payable Land Merchandise inventory Mortgage payable Retained earnings Supplies
Note to instructors: Students may list the accounts in the following statement in any order within the assets, liabilities, and shareholders’ equity classifications as they have not yet learned how to classify/order accounts.
AVENTURA INC. Statement of Financial Position November 30, 2018 Assets Cash Accounts receivable Merchandise inventory Supplies Land Buildings Equipment Total assets
$ 20,000 19,500 18,000 700 44,000 100,000 30,000 $232,200
Liabilities and Shareholders’ Equity Liabilities Accounts payable Income tax payable Bank loan payable Mortgage payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$ 26,200 6,000 34,000 97,500 163,700 20,000 48,500 68,500 $232,200
(Assets = Liabilities + Shareholders’ equity) LO 4 BT: AP Difficulty: M TIME: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-11 (a) E E NR E R E E R (b)
Administrative expenses Cost of goods sold Dividends declared Finance expenses Finance income Income tax expense (recovery) Selling and distribution expenses Sales REITMANS (Canada) Limited Income Statement Year Ended January 30, 2016 (in thousands)
Revenues Sales Finance income Total revenues Expenses Selling and distribution expenses Cost of goods sold Administrative expenses Finance expenses Total expenses Loss before income tax Income tax recovery Net loss
$937,155 7,998 945,153 $497,854 410,035 46,950 16,443 971,282 (26,129) 1,426 $ (24,703)
[Revenues – Expenses = Net income or (loss)] LO 4 BT: AP Difficulty: M TIME20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-12 KON INC. Income Statement Year Ended December 31, 2018 Revenues Service revenue Expenses Salaries expense Rent expense Utilities expense Office expense Total expenses Income before income tax Income tax expense Net income
$61,000 $30,000 12,400 2,400 1,600 46,400 14,600 3,000 $11,600
[Revenues – Expenses = Net income or (loss)]
KON INC. Statement of Changes in Equity Year Ended December 31, 2018
Balance, January 1 Issued common shares Net income Dividends declared Balance, December 31
Common Shares $20,000 10,000
$30,000
Retained Earnings $58,000 11,600 (5,000) $64,600
Total Equity $78,000 10,000 11,600 (5,000) $94,600
(Beginning equity ± Changes to equity = Ending equity) LO 4 BT: AP Difficulty: M TIME: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
1-23
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-13 (a)
Camping revenue Expenses Operating expenses Income tax expense Net income
$283,000 $245,000 10,000
255,000 $ 28,000
[Revenues – Expenses = Net income or (loss)]
(b)
Balance, January 1 Issued common shares Net Income Dividends declared Balance, December 31
SEA SURF CAMPGROUND INC. Statement of Changes in Equity Year Ended December 31, 2018 Common Shares $30,000 15,000
$45,000
Retained Earnings $18,000 28,000 (12,000) $34,000
Total Equity $48,000 15,000 28,000 (12,000) $79,000
(Beginning equity ± Changes to equity = Ending equity) Note to instructors: Students may list the accounts in the following statement in any order within the assets, liabilities, and shareholders’ equity classifications as they have not yet learned how to classify/order accounts.
Solutions Manual .
1-24
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-13 (CONTINUED) (b) (continued) SEA SURF CAMPGROUND INC. Statement of Financial Position December 31, 2018 Assets Cash Supplies Equipment Total assets
$
19,000 2,500 124,000 $145,500
Liabilities and Shareholders’ Equity Liabilities Accounts payable Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$ 16,500 50,000 66,500 45,000 34,000 79,000 $145,500
(Assets = Liabilities + Shareholders’ equity) LO 4 BT: AP Difficulty: M TIME: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
1-25
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 1-14 1.
Yu Corporation is distributing nearly all of this year's net income as dividends. This suggests that Yu is not pursuing rapid growth. Companies that are pursuing opportunities for growth normally retain their net income and pay low, or no dividends.
2.
Surya Corporation is not generating sufficient cash from operating activities to fund its investing activities. The company is borrowing to finance its investing activities. This is common for companies in their early years of existence. It could also be in an expansion stage.
3.
Naguib Ltd. is financing its assets in a slightly higher proportion through equity than through debt. The company has $450,000 ($200,000 + $250,000) of total assets, which are funded 44.4% ($200,000 ÷ $450,000) by liabilities and 55.6% ($250,000 ÷ $450,000) by equity. Since equity does not have to be repaid and does not require interest payments, the company appears to be in a healthy financial position.
4.
Rijo Inc. does not have any liabilities and its assets are completely financed by equity. This places it in a very strong financial position since there are no outside claims on the company’s assets. This also means that the company is using its own funds to finance assets. While this reduces risk, it may also reduce return if borrowed funds can be employed to generate an internal return higher than the cost of borrowing.
LO 4 BT: AN Difficulty: C TIME: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
1-26
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 1-1A (a)
1. The South Face Inc. is an external user of accounting information in assessing the creditworthiness of their customer. 2. An investor purchasing common shares of Orbite Online Inc. is an external user. 3. In deciding whether to extend a loan, Caisse d’Économie Base Montréal is an external user. 4. As an employee of Tech Toy Limited, the CFO is an internal user.
(b)
1. In deciding to extend credit, South Face would focus its attention on the statement of financial position of the new customer. The terms of credit they are extending require repayment in a short period of time. Funds to repay the credit would come from cash on hand and other current assets. The statement of financial position of the new customer will show if the company has enough current assets to meet its current obligations. 2. Since the investor intends to hold the shares for a long period of time (at least five years), s(he) should focus on the company’s income statement. The income statement reports the company’s past performance in terms of revenues, expenses, and net income. This is generally regarded as a good indicator of the company’s future performance. 3. The Caisse is interested in two things—the ability of the company to make interest payments on a monthly basis for the next three years and the ability to repay the principal amount at the end of the three years. In order to evaluate both of these factors, the focus should be on the statement of cash flows. This statement provides information on the cash the company generates from its operations on an ongoing basis. It also tells whether the company is currently borrowing or repaying debt. 4. The CFO should focus on the statement of cash flows as this statement clearly sets out the cash generated from operating activities and the amount the company has spent in the past on purchasing equipment and paying dividends.
Note to instructors: Other answers may be valid provided they are properly supported. LO 1 BT: C Difficulty: M TIME: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-2A (a)
(b)
1.
The professors should incorporate their business as a private corporation because of their concerns about legal liabilities. A corporation is the only form of business that provides limited liability. Since the professors do not need access to large amounts of investment capital, a private corporation provides the limited liability advantage the professors need.
2.
Joseph should run his bicycle rental shop as a proprietorship because this is the simplest and least costly form of business organization to establish and eventually dissolve. He is the only person involved in the business and is planning to operate for a limited time.
3.
The size of the businesses is not given, but Robert and Tom should likely form a public corporation, if possible, when they combine their operations. This is the best form of business for them to choose because they expect to raise funds in the coming year. A public corporation will enable them to raise significant amounts of funds for their manufacturing company. A corporation may also receive more favourable income tax treatment. If they are not large businesses, then Robert and Tom may choose to form a private corporation.
4.
A partnership would be the most likely form of business for Darcy, Ellen, and Meg to choose. It is simpler to form than a corporation and less costly.
5.
Hervé is most likely to select to operate his business as a private corporation. This will assist him with the liability of storing goods for others. He will also be able to raise funds to purchase equipment, rent space in airports, and hire employees. It is easier to raise funds through a private corporation rather than a proprietorship or partnership.
1. 2. 3. 4. 5.
ASPE ASPE IFRS ASPE ASPE
LO 2 BT: C Difficulty: M TIME: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-3A (a) Operating
(b)
Investing
Financing
Indigo Books & Music
Sale of books
Purchase of store equipment
Issue of shares
High Liner Foods
Payment for fish
Purchase of production equipment
Borrowing money from a bank
Mountain Equipment Co-op
Payment for inventory
Purchase of store fixtures
Borrowing money from a bank
Ganong Bros.
Payment of salaries and benefits
Purchase of production equipment
Payment of dividends to shareholders
Royal Bank
Payment of interest on savings accounts
Purchase of office Issue of bonds equipment
Financing Issuing shares is common to all corporations. Issuing debt is common to most corporations. Borrowing from a bank is common to most companies. Payment of dividends is common to many, but not all, corporations. Issuing bonds is common to large public corporations. Investing Purchasing property, plant, and equipment is common to most companies—the types of assets would vary according to the nature of the business. Some types of companies require a larger investment in longlived assets. A new business or expanding business would be more apt to be acquiring assets. Operating The general activities identified above would be common to most corporations with the exception of the payment of interest on savings accounts. The source of the cash receipt (for example, from the sale of books) and cash payment (for example, for the payment for fish) would vary by the nature of the business.
LO 3 BT: C Difficulty: C TIME: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-4A
Accounts payable Accounts receivable Bank indebtedness Bank loan payable Cash Common shares Equipment Goodwill Income tax expense Income tax payable Interest expense Office expense Prepaid insurance Rent expense Repair and maintenance expense Salaries payable Service revenue Supplies Vehicles
(a)
(b)
L A L L A SC A A E L E E A E E L R A A
SFP SFP SFP SFP SFP SFP, SCE SFP SFP IS SFP IS IS SFP IS IS SFP IS SFP SFP
LO 4 BT: K Difficulty: S TIME: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
1-30
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-5A (a) and (b) (b)
Accounts payable Accounts receivable Bank loan payable Cash Common shares Equipment Income tax payable Intangible assets Interest payable Inventory Prepaid insurance Retained earnings Salaries payable Supplies Unearned revenue Vehicles Totals
$15,600 13,100 32,000 9,350 20,000 30,500 1,800 5,000 300 9,200 1,000 21,250 700 2,800 1,800 22,500
(a) L A L A SE A L A L A A SE L A L A
Assets
Liabilities $ 15,600
Shareholders’ Equity
$13,100 32,000 9,350 $ 20,000 30,500 1,800 5,000 300 9,200 1,000 21,250 700 2,800 22,500 $93,450
1,800 ______ $52,200
______ $41,250
Assets = Liabilities + SE $93,450 = $52,200 + $41,250 (c)
Beginning balance in Retained Earnings + Revenues – Expenses – Dividends declared = Ending balance in Retained Earnings $18,000 + $296,750 – $278,500 – $15,000 = $21,250
LO 4 BT: AP Difficulty: M TIME 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
1-31
Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-6A (a)
(All amounts are in millions of dollars)
Sears [1]
Total assets = Total liabilities + Total shareholders’ equity Total assets = $1,203.3 + $570.8 Total assets = $1,774.1
[2]
Total liabilities = Total assets – Total shareholders’ equity Total liabilities = $1,633.2 – $554.2 Total liabilities = $1,079.0
[3]
Shareholders’ equity, beginning of year + Total revenues – Total expenses – Other increases in shareholders’ equity = Shareholders’ equity, end of year $570.8 + $3,145.7 – [3] + $51.3 = $554.2 [3] Total expenses = $3,213.6
Canadian Tire [4]
Total liabilities = Total assets – Total shareholders’ equity Total liabilities = $14,553.2 – $5,630.8 Total liabilities = $8,922.4
[5]
Total assets = Total liabilities + Total shareholders’ equity Total assets = $9,198.1 + $5,789.7 [6] Total assets = $14,987.8
[6]
Shareholders’ equity, beginning of year – Repurchase of shares – Dividends declared + Total revenues – Total expenses + Other increases in shareholders’ equity = Shareholders’ equity, end of year $5,630.8 − $434.6 – $162.4 + $12,279.6 – $11,543.7 + $20.0 = $5,789.7
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-6A (CONTINUED) (b)
At the end of the most recent fiscal year, Sears has a higher proportion of debt financing and Canadian Tire has a higher proportion of equity financing. Canadian Tire financed 38.6% ($5,789.7 million ÷ $14,987.8 million) of its assets with equity and 61.4% of its assets with debt ($9,198.1 million ÷ $14,987.8 million). For the equivalent fiscal year end, 33.9% ($554.2 million ÷ $1,633.2 million) of Sears’s assets were financed by equity and 66.1% ($1,079.0 million ÷ $1,633.2 million) by debt. Sears is riskier because more of its assets are financed by debt.
(c)
Both retailers typically have low inventories at the end of December and at the end of January as a result of the Christmas sales, with little or no new inventory purchased during the month of January so no major differences in financial position at the end of December compared to January would be anticipated. As long as there were no significant economic events that affected one company more than the other in the intervening period (January), it is unlikely that the different year-end dates would affect the comparison in (b).
LO 4 BT: AN Difficulty: C TIME: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-7A (a) ONE PLANET COSMETICS CORP. Income Statement Month Ended June 30, 2018 Revenues Service revenue Expenses Salaries expense Office expense Utilities expense Supplies expense Interest expense Total expenses Income before income tax Income tax expense Net income
$24,200 $5,700 1,500 1,500 2,100 800 11,600 12,600 700 $11,900
[Revenues – Expenses = Net income or (loss)]
ONE PLANET COSMETICS CORP. Statement of Changes in Equity Month Ended June 30, 2018
Balance, June 1 Issued common shares Net income Dividends declared Balance, June 30
Common Shares $ 0 36,000
$36,000
Retained Earnings $ 0 11,900 (1,000) $10,900
Total Equity $ 0 36,000 11,900 (1,000) $46,900
(Beginning equity ± Changes to equity = Ending equity)
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-7A (CONTINUED) (a) (continued) Note to instructors: Students may list the accounts in the following statement in any order within the assets, liabilities, and shareholders’ equity classifications as they have not yet learned how to classify/order accounts. ONE PLANET COSMETICS CORP. Statement of Financial Position June 30, 2018 Assets Cash Accounts receivable Supplies Equipment Total assets
$ 15,000 9,000 1,200 52,000 $77,200 Liabilities and Shareholders’ Equity
Liabilities Accounts payable Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$ 7,300 23,000 30,300
0
36,000 10,900 46,900 $77,200
(Assets – Liabilities = Shareholders’ equity)
(b)
The financial statements must be prepared in the order of (1) income statement, (2) statement of changes in equity, and (3) statement of financial position. This is because each subsequent financial statement depends on information contained in the previous statement. The net income from the income statement flows to the retained earnings account on the statement of changes in equity. The shareholders’ equity totals in the statement of changes in equity (for example, for common shares and retained earnings) then flow to the shareholders’ equity section of the statement of financial position.
LO 4 BT: AP Difficulty: M TIME: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-8A (a) Cash dividends paid Cash paid to purchase equipment Cash payments for operating activities Cash receipts from operating activities Cash received from issue of long-term debt Cash received from issue of shares
$ 10,000 35,000 120,000 140,000 20,000 20,000
Activity financing investing operating operating financing financing
(b) MAISON CORPORATION Statement of Cash Flows Year Ended December 31, 2018 Operating activities Cash receipts from operating activities Cash payments for operating activities Net cash provided by operating activities
$140,000 (120,000)
Investing activities Purchase of equipment Net cash used by investing activities
$(35,000)
Financing activities Issue of long-term debt Issue of shares Payment of dividends Net cash provided by financing activities
$ 20,000 20,000 (10,000)
$20,000
(35,000)
Net increase in cash Cash, January 1 Cash, December 31
30,000 15,000 12,000 $27,000
(Cash flows from operating, investing, and financing activities = Net change in cash)
(c)
The company is generating less cash from operating activities (+$20,000) than it is using for its investing activities (–$35,000) and the payment of dividends (–$10,000). The company, however, is making up for the deficiency by generating cash from financing activities. Cash from financing activities is not a renewable source of cash and usually entails future cash payments in the form of interest on debt, principal repayment, and dividend payments for shares.
LO 4 BT: AN Difficulty: M TIME: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-9A (a) [1]
Operating expenses = Service revenue – Income before income tax Operating expenses = $225,000 – $45,000 Operating expenses = $180,000
[2]
Net income = Income before income tax – Income tax expense Net income = $45,000 – $9,000 Net income = $36,000
[3]
Net income (from [2]) = $36,000
[4]
Ending retained earnings = Beginning retained earnings + Net income – Dividends declared Ending retained earnings = $0 + $36,000 (from [2]) – $15,000 Ending retained earnings = $21,000
[5]
Total issued common shares = $250,000
[6]
Net income = $36,000 (from [3])
[7]
Total equity = Beginning balance + Issued common shares + Net income – Dividends declared Total equity = $0 + $250,000 (from [5]) + $36,000 (from [6]) – $15,000 Total equity = $271,000
[8]
Land = Total assets (from [9]) – Cash – Accounts receivable – Building – Equipment Land = $964,000 – $22,000 – $34,000 – $390,000 – $218,000 Land = $300,000
[9]
Total assets = Total liabilities + Shareholders' equity Total Assets = $964,000
[10]
Accounts payable = Total liabilities – Bank loan payable Accounts payable = $693,000 – $600,000 Accounts payable = $93,000
[11]
Common shares = $250,000 (from the Statement of Changes in Equity)
[12]
Retained earnings = $21,000 (from [4])
[13]
Total shareholders' equity = Common shares + Retained earnings Total shareholders' equity = $250,000 (from [11]) + $21,000 (from [12]) = $271,000 or (from [7])
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-9A (CONTINUED) (b)
(1)
In preparing the financial statements, the first statement to be prepared is the income statement, followed by the statement of changes in equity, and then the statement of financial position. Note to instructors: While the statements must be prepared in this sequence, these statements can be presented in a variety of orders. Often the statement of financial position is presented first, as the most “permanent” statement.
(2)
The reason the statements must be prepared in the order indicated above is that each statement depends on information in the previously prepared statement. For example, the net income figure from the income statement is used in the statement of changes in equity to calculate the ending balance of retained earnings. The shareholders’ equity section of the statement of financial position is then completed using the ending balances of common shares and retained earnings as calculated in the statement of changes in equity.
LO 4 BT: AN Difficulty: C TIME: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-10A (a)
1. Remove the boat from the listing of assets since it does not belong to the corporation. Remove the boat loan payable from the listing of liabilities since this is a personal loan of Guy Gélinas. 2. Remove the $10,000 outstanding receivable from Guy’s brother. This is not a company receivable and should not be listed on the company’s statement of financial position. 3. Correct the Common Shares account to remove the extra amount that had been added to “balance”: Remove accounts receivable $10,000 Remove boat asset 24,000 Remove bank loan (40,000) Net adjustment to common shares $ 6,000 Provide separate totals for liabilities and shareholders’ equity as the two components that are financing the assets of the company.
(b)
GG CORPORATION Statement of Financial Position July 31, 2018 Assets
Cash Accounts receivable ($50,000 − $10,000) Inventory Total assets Liabilities and Shareholders’ Equity Liabilities Accounts payable Total liabilities Shareholders’ equity Common shares [$50,000 + $6,000 (from (3) above)] Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$20,000 40,000 36,000 $96,000
$34,000 34,000
0
56,000 6,000 62,000 $96,000
(Assets – Liabilities = Shareholders’ equity)
(c)
As a private company, GG Corporation should also prepare an income statement, a statement of retained earnings, and a statement of cash flows.
LO 4 BT: AN Difficulty: C TIME: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 1
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 1-1B (a)
1. An investor purchasing common shares of Fight Fat Ltd. is an external user. 2. As a potential creditor, Comeau Ltée is an external user. 3. The chief financial officer is an internal user. 4. As a potential creditor, Drummond Bank is an external user.
(b)
1. In making an investment in common shares, the Ontario investor is becoming a partial owner (shareholder) of the company. In this case, the investment will be held for at least three years. The information that will be most relevant to him/her will be on the income statement. The income statement reports the past performance of the company in terms of its revenue, expenses, and net income. This is the best indicator of the company’s future potential. 2. In deciding to extend credit to a new customer, Comeau would focus its attention on the new customer's statement of financial position. The terms of credit they are extending require repayment in a short period of time. Funds to repay the credit would come from current assets. The statement of financial position of the new customer will show whether the company has enough current assets to meet its current obligations. 3. In order to determine whether the company is generating enough cash to increase the amount of dividends paid to investors, the CFO of Private Label needs information on the amount of cash generated and used in various activities of the business. The statement of cash flows is the most useful statement for this purpose. This statement presents the amount of cash at the beginning and end of the period as well as the details of the amount of cash generated by operating activities and the amount spent on expanding operations (investing activities).
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-1B (CONTINUED) 4. In deciding whether to extend a loan, Drummond Bank is interested in two things: the ability of the company to make its monthly interest payments for the next five years and the ability to repay the principal amount at the end of five years. In order to evaluate both of these factors the focus should be on the statement of cash flows. This statement provides information on the cash the company generates from its operating activities on an ongoing basis. This will be the most important factor in determining if the company will survive and be able to repay the principal and interest on the loan. Note to instructors: Other answers may be valid provided they are properly supported. LO 1 BT: C Difficulty: M TIME: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-2B (a)
1. Dawn will likely operate her vegetable stand as a proprietorship because she is planning on operating it for a short time period. A proprietorship is the simplest and least costly business organization to form and dissolve. 2. Joseph and Sabra should form a private corporation when they combine their operations. A private corporation will be easier and less expensive to form than a public corporation. It will also be an easier type of organization in which to raise funds than a proprietorship or partnership. A corporation may also receive more favourable income tax treatment. 3. The professors should incorporate their business as a private corporation because of their concerns about the legal liabilities. A corporation is the only form of business that provides limited liability to its owners. 4. Abdul would likely form a public corporation because he needs to raise funds to invest in inventories and property, plant, and equipment. He has no savings or personal assets and it is normally easier to raise funds through a corporation than through a proprietorship or partnership. A public corporation will allow Abdul to raise larger amounts of funds by selling shares to the public. 5. A partnership would be the most likely form of business for Mary, Richard, and Jigme to choose. It is simpler to form than a corporation and less costly.
(b)
1. ASPE 2. ASPE 3. ASPE 4. IFRS 5. ASPE
LO 2 BT: C Difficulty: M TIME: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-3B (a) Operating
Investing
Financing
WestJet Airlines
Payment for jet fuel
Purchase of airplanes
Issue of shares
University of Calgary Students’ Union
Payment of salaries and benefits Payment of research expenses Payment for facilities rentals
Purchase of office equipment Purchase of other companies Purchase of equipment
Borrowing money from a bank Issue of bonds
Receipt of revenue from sales of food from Sobeys
Purchase of real estate to build Sobeys’ stores
Repaying money to a bank
GlaxoSmithKline
Maple Leaf Sports & Entertainment
Empire Company
(b)
Payment of dividends to shareholders
Financing Issuing shares is common to all corporations. Borrowing from and repaying money to a bank is common to most companies. Payment of dividends is common to many, but not all, corporations. Issuing bonds is common to large corporations. Investing Purchasing property, plant, and equipment would be common to most companies—the types of assets would vary according to the type of business. Some types of businesses require a larger investment in longlived assets. A new business or expanding business would be more likely to engage in investing activities (for example, acquiring assets). The purchase of other companies would not be common to all companies. Operating The general activities identified above (sales and expenditures) would be common to most businesses, although the service or product might change.
LO 3 BT: C Difficulty: C TIME: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-4B
Accounts payable Accounts receivable Bank loan payable Buildings Cash Common shares Cost of goods sold Equipment Income tax expense Income tax payable Intangible assets Interest expense Land Merchandise inventory Mortgage payable Office expense Prepaid insurance Retained earnings Salaries payable Sales Unearned revenue
(a)
(b)
L A L A A SE E A E L A E A A L E A SE L R L
SFP SFP SFP SFP SFP SFP, SCE IS SFP IS SFP SFP IS SFP SFP SFP IS SFP SFP, SCE SFP IS SFP
LO 4 BT: K Difficulty: S TIME: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-5B (a) and (b) (b)
Accounts payable Accounts receivable Bank loan payable Cash Common shares Equipment Income tax payable Interest payable Inventory Prepaid insurance Retained earnings Salaries payable Supplies Unearned revenue Totals
(a) L A L A SE A L L A A SE L A L
$23,100 6,950 25,000 17,750 20,000 66,200 1,900 500 21,300 950 39,850 3,050 3,750 3,500
Assets
Liabilities $23,100
Shareholders’ Equity
$ 6,950 25,000 17,750 $ 20,000 66,200 1,900 500 21,300 950 39,850 3,050 3,750 _______ $116,900
3,500 $57,050
_______ $59,850
Assets = Liabilities + Shareholders’ equity $116,900 = $57,050 + $59,850 (c)
Beginning balance in Retained Earnings + Revenues – Expenses – Dividends Declared = Ending balance in Retained Earnings $8,850 + $365,000 – $333,000 – $1,000 = $39,850
LO 4 BT: AP Difficulty: M TIME: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-6B (a)
(All amounts are in U.S. millions of dollars) Restaurant Brands [1]
Total liabilities = Total assets – Total shareholders’ equity Total liabilities = $21,343.0 – $7,636.8 Total liabilities = $13,706.2
[2]
Total shareholders' equity = Total assets – Total liabilities Total shareholders' equity = $18,408.5 – $12,198.4 Total shareholders' equity = $6,210.1
[3]
Shareholders’ equity, beginning of year – Repurchase of shares – Dividends declared + Total revenues – Total expenses – Other decreases in shareholders’ equity = Shareholders’ equity, end of year $7,636.8 − $293.7 − $[3] + $4,052.2 – $3,540.5 − $1,167.8 = $6,210.1 [3] Dividends declared = $476.9
Starbucks [4]
Total assets = Total liabilities + Total shareholders’ equity Total assets = $5,479.2 + $5,273.7 Total assets = $10,752.9
[5]
Total assets = Total liabilities + Total shareholders’ equity Total assets = $6,626.3 + $5,038.4 (from [6]) Total assets = $11,664.7
[6]
Shareholders’ equity, beginning of year + Issuance of shares – Dividends declared + Total revenues – Total expenses – Other increases in shareholders’ equity = Shareholders’ equity, end of year $5,273.7 + $23.5 − $1,016.2 + $19,162.7 – $18,616.6 + $211.3 = $5,038.4
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-6B (CONTINUED) (b)
At the end of the most recent fiscal year, Restaurant Brands has a higher proportion of debt financing and Starbucks has a higher proportion of equity financing. Starbucks financed 43.2% (U.S. $5,038.4 million ÷ U.S. $11,664.7 million) of its assets with equity and 56.8% of its assets with debt (U.S. $6,626.3 million ÷ U.S. $11,664.7 million). For the same period, 33.7% ($6,210.1 million ÷ $18,408.5 million) of Restaurant Brands’ assets were financed by equity and 66.3% ($12,198.4 million ÷ $18,408.5 million) by debt. Restaurant Brands is riskier because more of its assets are financed by debt.
(c)
As long as there are no unusual transactions or economic events that affect one company differently than another during the intervening period of time (October through December), or at each company’s year-end date, the differing year ends should not have a significant impact on the assessment of the financial position and performance for the two companies.
LO 4 BT: AN Difficulty: C TIME: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-7B (a)
AERO FLYING SCHOOL LTD. Income Statement Month Ended May 31, 2018
Revenues Service revenue Expenses Fuel expense Rent expense Office expense Salaries expense Repair and maintenance expense Interest expense Income before income tax Income tax expense Net income
$215,300 $85,400 12,100 12,700 36,600 40,900 12,500
200,200 15,100 2,800 $ 12,300
[Revenues – Expenses = Net income or (loss)]
AERO FLYING SCHOOL LTD. Statement of Changes in Equity Month Ended May 31, 2018
Balance, May 1 Issued common shares Net income Dividends declared Balance, May 31
Common Shares $ 0 180,000
$180,000
Retained Earnings $ 0 12,300 (2,700) $9,600
Total Equity $ 0 180,000 12,300 (2,700) $189,600
(Beginning equity ± Changes to equity = Ending equity)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-7B (CONTINUED) (a) (continued) Note to instructors: Students may list the accounts in the following statement in any order within the assets, liabilities, and shareholders’ equity classifications as they have not yet learned how to classify/order accounts. AERO FLYING SCHOOL LTD. Statement of Financial Position May 31, 2018 Assets Cash Accounts receivable Supplies Equipment Total assets
$ 26,900 22,600 15,000 372,500 $ 437,000 Liabilities and Shareholders’ Equity
Liabilities Accounts payable Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$
6,400 241,000 247,400
180,000 9,600 189,600 $437,000
(Assets – Liabilities = Shareholders’ equity)
(b)
The financial statements must be prepared in the order of (1) income statement, (2) statement of changes in equity, and (3) statement of financial position. This is because each subsequent financial statement depends on information contained in the previous statement. The net income from the income statement flows to the retained earnings in the statement of changes in equity. The shareholders’ equity totals (for example, for common shares and retained earnings) in the statement of changes in equity then flow to the shareholders’ equity section of the statement of financial position.
LO 4 BT: AP Difficulty: M TIME: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-8B (a) Cash payments for operating activities Cash paid for equipment Repayment of long-term debt Cash dividends paid Cash receipts from operating activities
$109,000 40,000 15,000 13,000 158,000
Activity operating investing financing financing operating
(b) FURLOTTE CORPORATION Statement of Cash Flows Year Ended June 30, 2018 Operating activities Cash receipts from operating activities Cash payments for operating activities Net cash provided by operating activities
$158,000 (109,000)
Investing activities Cash paid to purchase equipment Net cash used by investing activities
$(40,000)
Financing activities Repayment of long-term debt Cash dividends paid Net cash used by financing activities
$(15,000) (13,000)
$49,000
(40,000)
Decrease in cash Cash, July 1, 2017 Cash, June 30, 2018
(28,000) (19,000) 40,000 $21,000
(Cash flows from operating, investing, and financing activities = Net change in cash)
(c)
The company is not generating sufficient cash from its operating activities ($49,000) to pay for the total of its investing activities ($40,000) and dividend payments ($13,000). If the company expects to continue to use cash for investing activities and dividend payments in future years, it will either have to generate more cash from its operating activities or from its financing activities (for example, borrow money) as its ending cash balance will not sustain this cash outflow on its own.
LO 4 BT: AN Difficulty: M TIME: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-9B (a)
[1]
Operating expenses = Service revenue – Income before income tax Operating expenses = $325,000 – $116,000 Operating expenses = $209,000
[2]
Net income = Income before income tax – Income tax expense Net income = $116,000 – $23,000 Net income = $93,000
[3]
Net income = $93,000 (same as [2])
[4]
Dividends declared = Beginning retained earnings + Net income – Ending retained earnings Dividends declared = $440,000 + $93,000 – $521,000 Dividends declared = $12,000
[5]
Beginning total equity = Beginning common shares + Beginning retained earnings Beginning total equity = $250,000 + $440,000 Beginning total equity = $690,000
[6]
Total common shares issued = $60,000
[7]
Net income = $93,000 (same as [3])
[8]
Dividends declared = $12,000 (same as [4])
[9]
Ending total equity = Ending common shares + Ending retained earnings Ending total equity = $310,000 + $521,000 Ending total equity = $831,000
[10]
Cash = Total assets – (Accounts receivable + Land + Buildings + Equipment) Cash = $1,351,000 (from [11]) – ($34,000 + $310,000 + $616,000 + $364,000) Cash = $27,000
[11]
Total assets = Total liabilities and shareholders’ equity Total assets = $1,351,000
[12]
Common shares = $310,000 (as per statement of changes in equity)
[13]
Retained earnings = $521,000 (as per statement of changes in equity)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 1-9B (CONTINUED) (b)
(1)
In preparing the financial statements, the first statement to be prepared is the income statement, followed by the statement of changes in equity, and then the statement of financial position. While the statements must be prepared in this sequence, these statements can be presented in a variety of orders. Often the statement of financial position is presented first, as the most “permanent” statement.
(2)
The reason the statements must be prepared in the order indicated above is that each statement depends on information in the previously prepared statement. For example, the net income figure in the income statement is used in the statement of changes in equity to calculate the ending balance of retained earnings. The shareholders’ equity section of the statement of financial position is then completed using the ending balances of the shareholders’ equity components (such as common shares and retained earnings) as calculated in the statement of changes in equity.
LO 4 BT: AN Difficulty: C TIME: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 1-10B (a) 1.
Remove accounts receivable from the revenue section of the income statement since it is a current asset and does not belong on the income statement.
2.
Remove the $3,000 of service revenue that has not yet occurred.
3.
Remove the $12,000 rent expense. This is not an actual transaction and cannot be listed on the company’s income statement.
4.
Remove the $4,000 vacation expense. This is not a business expense but rather a personal expense of the business owner.
5.
Deduct expenses from revenues rather than adding them.
(b)
INDEPENDENT BOOK SHOP LTD. Income Statement Year Ended March 31, 2018
Revenues Service revenue ($41,000 – $3,000) Expenses Office expense Income before income tax Income tax expense Net income
$38,000 5,000 33,000 5,000 $28,000
[Revenues – Expenses = Net income or (loss)]
(c)
As a private company, Independent Book Shop should also prepare a statement of financial position, a statement of retained earnings, and a statement of cash flows.
LO 4 BT: AN Difficulty: C TIME: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT1-1 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
North West presents the following five financial statements: Statement of Earnings (which we call income statement in the chapter), Statement of Comprehensive Income, Balance Sheet (which we call statement of financial position), Statement of Changes in Shareholders’ Equity (which we call statement of changes in equity), and Statement of Cash Flows. All of the above financial statements, except the Statement of Comprehensive Income, were discussed in this chapter.
(b)
As demonstrated in the table below, North West’ sales and net income increased in fiscal 2016. ($ in thousands) Sales Net income (net earnings)
2016 $1,796,035 69,779
2015
Change
$1,624,400 62,883
$171,635 6,896
Net income is affected by revenue and expenses incurred by a company during the year. An increase in sales does not always translate into an increase in net income. For North West, both revenue and net income increased.
(c) ($ in thousands)
(1) January 31, 2016
Total assets Total liabilities Total shareholders’ equity
$793,795 436,183 357,612
(2) January 31, 2015 $724,299 395,016 329,283
(Assets = Liabilities + Shareholders’ equity)
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CT1-1 (CONTINUED) (d)
($ in thousands)
January 31, 2016
Share capital Retained earnings
$167,910 156,664
January 31, 2015
$167,460 140,527
Yes, the above balances taken from the statement of changes in equity agree to the same amounts reported in the shareholders’ equity section of the balance sheet. Note that these do not comprise all of North West’s’ shareholders’ equity. Other shareholders’ equity items make up the remainder of the total shareholders’ equity balances reported on both statements as shown below. ($ in thousands) Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Total shareholders’ equity
(e)
($ in thousands) Cash
January 31, 2016
January 31, 2015
$167,910 2,620 156,664
$167,460 2,831 140,527
30,418 $357,612
18,465 $329,283
January 31, 2016 $37,243
January 31, 2015 $29,129
This information can be obtained on the balance sheet (statement of financial position) or on the statement of cash flows. LO 4 BT: AN Difficulty: M TIME: 40 min. AACSB: Communication and Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT1-2 (a) and (b)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
[North West ($ in thousands)]
1. Assets Liabilities Shareholders’ equity
2016 $793,795 436,183 357,612
2015 $724,299 395,016 329,283
% change 9.6% 10.4% 8.6%
2016 $1,796,035 69,779
2015 $1,624,400 62,883
% change 10.6% 11.0%
1. Assets Liabilities Shareholders’ equity
2016 $7,960.6 5,230.9 2,729.7
2015 $10,261.0 5,282.6 4,978.4
% change (22.4)% (1.0)% (45.2)%
2. Sales Net income (loss)
2016 $24,618.8 (2,119.2)
2015 $23,928.8 366.7
% change 2.9% *
2. Sales Net income Sobeys ($ in millions)
*not meaningful (c)
North West experienced growth in assets, liabilities, and shareholders’ equity. However, its liabilities grew at a faster pace than its assets which is not always a positive sign. From a profitability standpoint, the 10.6% increase in sales caused an increase in net income of 11% which demonstrates a strong management of expenses. Due to the nature of the goodwill impairment loss of just under $3 billion in 2016, both assets and equity decreased substantially for Sobeys. In addition, the impairment did not affect increases in sales. The size of the impairment loss removes the opportunity to assess profitability.
(d)
In 2016, Sobey’s fiscal year (May 3, 2015 through May 7, 2016) covers the majority of the same period as North West’s fiscal year (Feb. 1, 2015 through January 31, 2016). The same is true for their previous fiscal years. Consequently, unless there was a significant economic impact that affected the stores in the non-overlapping period of four months (February through May), I would have no concerns about the comparisons made in (c) as they both cover a single fiscal year.
LO 4 BT: AN Difficulty: M TIME: 40 min. AACSB: Communication and Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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CT1-3 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Both North West and Sobeys declared and paid dividends in fiscal year 2016 as revealed in their respective statement of changes in equity, as follows: North West Sobeys (in thousands) (in millions) Dividends
(b)
$58,210
$130.3
Both North West and Sobeys generated positive cash flows from their operations as revealed in their respective statement of cash flows, as follows: North West Sobeys (in thousands) (in millions) Cash from operating activities
(A)
$132,987
$837.7
Cash used in investing activities
(B)
75,813
631.4
175%
133%
A divided by B
Both companies are reinvesting cash from operations back into the business. (c)
Only Sobeys repaid long-term debt during the 2016 fiscal year as revealed in their respective statement of cash flows, as follows: North West Sobeys (in thousands) (in millions) Repayment of long-term debt
nil
$594.4
Although it appears as if Sobeys paid off debt, this is really not the case since new debt of $582.7 was obtained. Consequently, the two companies have similar changes to long-term debt. (d)
Only North West issued common shares during the 2016 fiscal year as revealed in their respective statement of cash flows, as follows: North West Sobeys (in thousands) (in millions) Issuance of common shares
$115
nil
LO 4 BT: AN Difficulty: M TIME: 30 min. AACSB: Communication and Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT1-4 (a)
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
Both public and private companies are separate legal entities owned by shareholders. One of the key differences between the two types of companies is the availability of the shares. Shares of public companies are traded on organized stock exchanges and are available to the general public. In contrast, shares of a private company are not made available to the general public nor are they traded on a public stock exchange. Another difference is access to capital. Since public companies are traded on organized stock exchanges, they generally have more access to capital than private companies. Private companies tend to rely upon bank financing for capital. Public and private companies also differ in terms of the amount of information they disclose publicly. Public companies are required to file financial statements with the regulators of the stock exchange. This makes their statements widely available. In contrast, private companies do not have any requirement to make their financial statements publicly available.
(b)
The key users of public company financial statements are shareholders, lenders and other creditors, regulators, analysts, and the general public. In contrast, the key users of private company financial statements are generally lenders and other creditors as well as private shareholders.
(c)
The key difference between the users of public and private financial statements is the different areas of emphasis of the users’ objectives and needs when reviewing the financial statements. Users of public company financial statements can represent a wide range with varying levels of understanding about the company and its operations. They tend to be a broad group of users who benefit from detailed disclosure that will help them make the appropriate financial decision to invest or to lend, etc. On the other hand, users of private company financial statements tend to be a small group, who usually have a high degree of understanding of the company and its operations. They consist mostly of lenders and other creditors and a small group of shareholders. These users tend to place a greater emphasis on liquidity, solvency, and short-term cash flow planning.
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Financial Accounting, Seventh Canadian Edition
CT1-4 (CONTINUED) (d)
One of the main reasons that Canada adopted IFRS is that these global set of standards will be beneficial to investors, lenders, other creditors, and other financial statement users by increasing the comparability and quality of financial statements. In other words, users will be able to make an “apples to apples” comparison. If Canadian public companies had a choice of which GAAP to use, then it would entirely defeat the purpose of increasing comparability among public companies.
(e)
Since most private companies in Canada are small to medium-sized businesses, the Canadian Accounting Standards Board (AcSB) decided that IFRS, with its extensive disclosure reporting requirements and sophisticated reporting, was not appropriate for most of these companies. However, since private companies can represent a wide range of companies – from large multinationals to small local restaurants, the AcSB decided it was best if private companies have a choice of which standard to adopt. A company’s choice of which GAAP to adopt is generally driven by users’ objectives and needs.
LO 1, 2 BT: C Difficulty: M TIME: 30 min. AACSB: Communication CPA: cpa-t001, cpa-e003 CM: Reporting and Comm.
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CT1-5
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a) Divide revenue by the hourly rate charged to clients: IMS: $1,020,000 ÷ $17 per hour = 60,000 hours PCS: $900,000 ÷ $30 per hour = 30,000 hours (b) Knowing the hours worked from the above, we can derive the hourly salary by dividing total salary expense for each company by the hours worked as follows: IMS: $600,000 ÷ 60,000 hours = $10 per hour PCS: $450,000 ÷ 30,000 hours = $15 per hour (c) IMS uses larger facilities because its rent expense is higher. This makes sense because they have larger types of cleaning equipment that will need to be stored. Furthermore, the company has a larger staff given the size of its operations and may need more office space. (d) PCS has higher other operating expenses because that company owns and operates vehicles. (e) Given that both companies pay interest at the same rate, IMS has the larger bank loan because its interest expense higher. (f) The most significant factor that makes PCS more profitable is the fact that this company charges its clients an hourly rate that is double the hourly wage rate paid to its employees. IMS is not able to charge its clients at double the wage rate. LO 4 BT: AN Difficulty: M TIME20 min. AACSB: Communication and Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT1-6
ETHICS CASE
(a)
The stakeholders in this situation are the new CEO and CFO, and the creditors and investors who rely on the financial statements to make business decisions.
(b)
The CEO and CFO should not sign the certification until they have taken steps to assure themselves that the most recent reports accurately and completely reflect the activities of the business. However, as the current management of the company, they cannot refuse to sign the certification just because they are new. They are the management team now and must assume the responsibilities that go with these positions.
(c)
The CEO and CFO have no alternative other than to take the steps necessary to assure themselves of the accuracy and completeness of the financial information, and, if accurate, sign the certification. If the information is not accurate or complete, they need to make the required corrections to the financial information. The company may need to delay issuing its financial statements.
LO 1 BT: E Difficulty: M TIME15 min. AACSB: Communication and Ethics CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT1-7 (a)
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
Compu-Tech Consulting is a proprietorship. A proprietorship has the advantage of lower administrative costs than a corporation—fewer regulations and procedures to adhere to. Emily may also have more flexibility in working for herself (or less depending on the demands of the business). In addition, as a separate proprietorship, all of the income of the business belongs to Emily. However, the disadvantage of a proprietorship is that Emily has personal and unlimited liability for the debts of the business. She may also have difficulty in raising capital to grow the business. Anthony Business Company Ltd. (ABC) is a private corporation. It has the advantage of limited liability for the shareholders’ investments in the business compared to a proprietorship. However, this advantage may be negated by a demand from creditors (such as the bank) for a personal guarantee by the shareholders. Another disadvantage is that if net income is distributed by declaring dividends, it must be shared with all shareholders in proportion to their shareholdings. More regulations and paperwork are required for a corporation compared to that of a proprietorship; however, more opportunities exist to share the administrative burdens and to grow the business.
(b)
Given its current size, Compu-Tech Consulting likely has no requirements to produce financial statements used by external creditors. It could choose to follow Accounting Standards for Private Enterprises (ASPE) if it was required to produce financial statements. Anthony Business Company Ltd. would most likely use Accounting Standards for Private Enterprises (ASPE) ) but could also, if it wished, choose to use International Financial Reporting Standards (IFRS). We will assume the former for the purpose of this case.
. (c)
Emily will need information on the revenues and cost of the services performed and the cost of products and accessories sold so she can determine if new contracts are profitable. She will need this information more often initially (for example, on a weekly basis) so she can monitor the results of the contracts and their impact on the operations of the company. She will also need forecasts of future services and product and accessory sales to plan the work, estimate staffing and other costs, and determine delivery schedules. Emily would also find financial statements useful to better understand ABC’s business and identify financial issues as early as possible. Monthly financial statements would be best as the more timely the information is, the more useful it is for managing the business.
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CT1-7 (CONTINUED) (d)
The users of ABC’s accounting information include the existing shareholders (Emily’s parents), potential shareholders such as Emily, creditors such as the bank, and taxing authorities such as the CRA. Emily’s parents are internal users and they need accounting information to plan, organize, and run the company and determine if they can obtain the financing to meet the increased demand. Emily needs accounting information to determine if her parents’ business is a sound investment for her and what her responsibilities as administrator would be. Creditors and taxing authorities would be considered external users. The bank and the CRA require financial statements—income statement, statement of retained earnings (since it is assumed that ABC follows ASPE; however, if it follows IFRS then it would be required to prepare a statement of changes in equity), statement of financial position, statement of cash flows, in addition to accompanying notes to the financial statements—to assess the financial health of the company.
(e)
The following are examples of activities that ABC is likely to be engaged in: Operating activities include cash collection from revenue generated from the sale of products and accessories and from providing business services. Cash payments would be made for products, accessories,supplies, salaries, utilities, and interest on bank loans. Investing activities include the purchase of equipment or the sale of used equipment no longer in use. Financing activities include borrowing money from the bank (debt) and paying dividends to shareholders (equity).
LO 1,2,3,4 BT: C Difficulty: M TIME: 50 min. AACSB: Comm. CPA: cpa-t001 CM: Reporting
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CHAPTER 2 A FURTHER LOOK AT FINANCIAL STATEMENTS LEARNING OBJECTIVES 1. Identify the sections of a classified statement of financial position. 2. Identify and calculate ratios for analyzing a company’s liquidity, solvency, and profitability. 3. Describe the framework for the preparation and presentation of financial statements.
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT Item LO
BT Item LO BT Item LO Questions
BT Item LO
BT
1.
1
K
7.
1
C
13.
2
C
19.
3
C
25.
3
C
2.
1
C
8.
1
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14.
2
K
20.
3
C
26.
3
C
3.
1
C
9.
2
C
15.
2
C
21.
3
C
27.
3
K
4.
1
K
10.
2
C
16.
2
C
22.
3
C
28.
3
C
5.
1
C
11.
2
C
17.
2
K
23.
3
C
29.
3
C
6.
1
C
12.
2
C
18.
2
C
24.
3
C
Brief Exercises 1.
1
K
3.
1
AP
5.
2
AP
7.
2
AN
9.
3
C
2.
1
K
4.
1
AP
6.
2
AN
8.
3
K
10.
3
C
Exercises 1.
1
K
3.
1
AP
5.
1
AP
7.
2
AN
9.
3
K
2.
1
AP
4.
1
AP
6.
2
E
8.
2
AN
10.
3
C
Problems: Set A and B 1.
1
K
3.
1
AP
5.
2
AN
7.
2
AN
9.
3
E
2.
1
AP
4.
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AP
6.
2
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8.
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10.
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Cases 1.
1
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3.
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Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to complete in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM
CPA Canada Competency Map Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
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ANSWERS TO QUESTIONS 1.
(a)
Current assets are assets that are expected to be converted into cash, sold, or used up within one year of the company’s financial statement date or its operating cycle, whichever is longer.
(b)
Examples of current assets include cash, accounts receivable, inventory, and supplies. Current assets are listed in order of liquidity in the current asset section of the statement of financial position.
LO 1 BT: K Difficulty: S Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
The term operating cycle stands for the average time it takes to go from cash to cash in producing revenue. In a merchandising business, this means the time it takes to purchase inventory on account, pay cash to suppliers, sell the inventory on account, and then collect cash from customers. In a service business, it stands for the time it takes to pay employees, provide services on account, and then collect the cash from customers.
LO 1 BT: C Difficulty: M Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
(a)
Current assets are assets that are expected to be converted into cash, sold, or used up within one year of the company’s financial statement date or its operating cycle, whichever is longer. Noncurrent assets are assets that are not expected to be converted into cash, sold, or used up by the business within one year of the financial statement date or its operating cycle. In other words, noncurrent assets are all assets that are not classified as current assets.
(b)
Current assets are assets that are expected to be converted into cash, sold, or used up within one year of the company’s financial statement date or its operating cycle, whichever is longer. Current liabilities are obligations that are to be paid or settled within one year of the company’s financial statement date or its operating cycle, whichever is longer. Ideally, current assets will exceed current liabilities for a company. Showing items as current in nature matters because doing so assists the user of the financial statements to assess the business’s liquidity.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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4.
Financial Accounting, Seventh Canadian Edition
(a)
Current liabilities are obligations that are to be paid or settled within one year of the company’s financial statement date or its operating cycle, whichever is longer.
(b)
Examples of current liabilities include bank indebtedness, accounts payable, accrued liabilities, and current maturities of long-term debt. Current liabilities are listed in the order in which they are expected to be paid in the current liability section of the statement of financial position.
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
(a)
The major differences between current liabilities and non-current liabilities are:
Difference Source of payment
Current Liabilities Existing current assets or other current liabilities
Non-Current Liabilities Other than existing current assets or other current liabilities
Time of expected payment
Within one year
Beyond one year
Nature of items
Debts pertaining to the operating cycle and other short-term debts
Mortgages, notes, loans, bonds, and other noncurrent liabilities
(b)
Some liabilities, such as bank loans, appear on the statement of financial position with a current and non-current portion. Included in the balance of the bank loan payable are principal payments that will be due in the next year. That amount must be shown as a current liability as at the company’s financial statement date. The remaining principal balance is classified as a non-current liability.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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6.
Financial Accounting, Seventh Canadian Edition
(a)
Contra accounts are accounts that offset the account to which they relate. Contra accounts serve to keep track of and disclose the amount of the reduction to the balance of the related account and arrive at its carrying amount. An example is accumulated depreciation, which is offset against the related asset account to arrive at the asset’s carrying amount.
(b)
In the case of property, plant, and equipment, users find it useful to know the historical cost of assets as well as the cumulative amount of depreciation (contra account called accumulated depreciation) that has been recorded to date on them. The difference between cost and accumulated depreciation is referred to as the carrying amount, also commonly known as net book value or just simply book value.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
Current assets and liabilities are listed in the statement of financial position in the order in which they are expected to be converted into cash, sold or used up in the case of assets and paid or settled, in the case of liabilities; that is, in their order of liquidity. Liquidity is enhanced when an asset can be converted to cash more quickly than another asset. In the case of liabilities, some liabilities will be paid more quickly than others and so they would be deemed to be more liquid. Other assets are listed in the order of permanency. Long-term assets, such as property, plant, and equipment, are usually presented in order of permanence, with the most permanent (land) being presented first.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
8.
(a)
The two components of shareholders' equity and the purpose of each are: (1) Share capital is used to record investments of assets, i.e. cash, in the business by the owners (shareholders). If there is only one class of shares, it is known as common shares. (2) Retained earnings is used to record accumulated profit, net of any losses and dividends declared, retained in the company.
(b)
Under ASPE, the ending balances of share capital and retained earnings would appear on the statement of financial position and the ending balance of retained earnings would also appear on the statement of retained earnings. Under IFRS, the presentation on the statement of financial position would be the same, and both share capital and retained earnings would appear on the statement of changes in shareholders’ equity.
LO 1 BT: K Difficulty: S M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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9.
Financial Accounting, Seventh Canadian Edition
Intracompany ratio comparisons compare elements and ratios within the same financial statements (example, current assets and current liabilities) or between the income statement and the statement of financial position (example, basic earnings per share) from the same company. Intracompany ratio comparisons can also involve comparing elements or ratios in two or more accounting periods for the same company. Intercompany ratio comparisons compare elements or ratio results between different companies.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
(a)
Liquidity ratios measure a company’s short-term ability to pay its current liabilities and meet its unexpected needs for cash. Examples of liquidity ratios include working capital and current ratios.
(b)
Solvency ratios measure a company’s ability to survive over a long period of time. An example of a solvency ratio is the debt to total assets ratio.
(c)
Profitability ratios measure a company’s operating success for a given period of time. Examples of profitability ratios include basic earnings per share and the price-earnings ratio.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
11.
(a)
Working capital is arrived at by deducting current liabilities from current assets.
(b)
Positive working capital means that there are more current assets than current liabilities. Whenever there is positive working capital, the current ratio is greater than 1:1.
(c)
Having positive working capital does not mean that a company has lots of cash. It could mean the company has significant accounts receivable or inventory. The working capital may be a very large amount and yet the company may have no cash as it is instead borrowing all of the necessary cash from the bank to make day-today payments to suppliers and employees.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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12.
Financial Accounting, Seventh Canadian Edition
The current ratio is a better measure of liquidity than working capital when making comparisons between different businesses. The amount of working capital is an absolute amount. It could vary tremendously depending on the size of the operations of the business. The current ratio on the other hand presents a relationship of current assets to current liabilities and is therefore appropriate as a tool to compare the liquidity of different size businesses.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
Current assets include accounts receivable and inventory. These may have increasing balances because of uncollectible receivables or slowmoving inventory. This would cause the current ratio to increase. Even though the current ratio may seem high, it is an artificial measure of liquidity if receivables and inventory cannot be easily or quickly converted into cash. Consequently, the current ratio alone does not provide a complete assessment of liquidity.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
Dong Corporation is more solvent as only 45% of its assets are financed by debt whereas 55% of Du's assets are financed by debt. A company carrying a higher proportion of debt has an increased likelihood of encountering financial difficulties and is therefore considered less solvent.
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
15.
Raising money using debt adds more risk to a company than raising money through equity because the terms of repayment of debt require cash outflows for the payment of interest and repayment of principal. These payments tap into cash balances that could hurt the company’s liquidity. In contrast to debt, equity does not have to be repaid.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
Basic earnings per share comparisons among different companies are difficult due to variations in the financing structure of the companies and in the number of shares issued. Hence, there is no industry average for basic earnings per share. On the other hand, since the price-earnings ratio uses basic earnings per share relative to the market price of the common shares, the ratio can be compared among companies.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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17.
Financial Accounting, Seventh Canadian Edition
Investors appear to favour TD Bank. Its higher price-earnings ratio indicates that investors are willing to pay proportionately more for TD's shares and have more favourable expectations of future growth.
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
18.
Increases in the basic earnings per share, price-earnings ratio, and the current ratio are considered to be signs of improvement because:
An increase in the basic earnings per share means that the amount of net income per share is greater than in the previous period.
An increase in the price-earnings ratio means that the share price has increased at a greater rate than the company’s basic earnings per share, which implies the market believes future net income will continue to increase.
An increase in the current ratio indicates that the company has more current assets available to settle its current liabilities and is more liquid (assuming the components of current assets (e.g., receivables and inventory) are also liquid.
On the other hand, the debt to total assets ratio measures how much of the company is financed by debt. The more debt a company has, the higher the debt to total assets ratio. A company with a higher debt level has increased financial risk due to higher fixed interest and principal repayments, and is less solvent than a company with a lower level of debt. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
19.
(a)
The conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards. The framework prescribes the nature, function, and limits of financial accounting statements. It guides choices about what to present in financial statements, decisions about alternative ways of reporting economic events, and the selection of appropriate ways of communicating such information.
(b)
Internationally, the conceptual framework may vary from country to country. Canadian companies use the same framework, whether they are reporting under IFRS or under ASPE.
LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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20.
Financial Accounting, Seventh Canadian Edition
(a)
The primary objective of financial reporting is to provide information useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company.
(b)
The main users of financial reporting are investors, lenders, and other creditors.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
21.
The going concern assumption states that the business will remain in operation for the foreseeable future. The timing of when the asset will be converted to cash or used in operations and when liabilities are to be paid determines their classification on the statement of financial position. Since the business is expected to remain in operation for the foreseeable future, these elements can continue to be reported in accordance with their respective current or non-current classifications. If the company were about to be shut down, all of its assets and liabilities would be classified as current.
LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
22.
The fundamental qualitative characteristics are (1) relevance and (2) faithful representation. Relevant information will impact a user’s decision by having predictive value, confirmatory value, or both. Faithful representation means that the financial statements should reflect the economic reality of what really exists or has happened. The information must be complete, neutral, and free from material error.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
23.
Enhancing qualitative characteristics make useful financial information more useful (i.e. they enhance its usefulness). To be useful, financial information must reflect the two fundamental qualitative characteristics of relevance and faithful representation. Enhancing characteristics bring more specific support to the objectives achieved by using the fundamental qualitative characteristics. Enhancing qualitative characteristics cannot enhance the usefulness of financial information that is not useful (i.e. information which does not reflect the fundamental qualitative characteristics).
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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24.
Financial Accounting, Seventh Canadian Edition
Materiality is related to relevance in that they are both defined in terms of what influences or makes a difference to the decision-maker. In order to be relevant to a financial statement user, a transaction, a narrative explanation in the notes to the financial statements, or an amount reported for an element must make a difference to the user in the making of a decision. An item is considered to be material if its omission or misstatement could influence the decision.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
25.
The four enhancing qualitative characteristics are (1) comparability, (2) verifiability, (3) timeliness, and (4) understandability. There is no prescribed order in applying these characteristics.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
26.
The cost constraint means that information will be presented only when the benefit associated with it exceeds the cost of obtaining and providing it. In attempting to fulfill a completeness objective when obtaining financial information, one could expend considerable resources. The cost of this search may greatly outweigh any benefit in achieving the completeness objective. Consequently, the search for completeness will be restricted by this constraint.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
27.
The elements of financial statements are broad categories or classes of financial statement effects of transactions and other events. They include assets, liabilities, equity, income, and expenses (which include losses). The grouping is selected in accordance with the economic characteristics of the transactions.
LO 3 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
28.
The two bases are historical cost and current value. The current value basis of accounting is applied to those assets that are intended to be sold and whose current value is readily available. Securities traded on the stock exchanges would be a good example of assets reported at their current value. The historical cost basis of accounting is used for most of the remaining assets used by the business. Since in most cases the intention is to use the assets to earn revenue, the current value of the asset is not as relevant as its historical cost.
LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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29.
Financial Accounting, Seventh Canadian Edition
In order to be relevant for decision making, the measurement of elements of financial statements need to reflect amounts that are reliable. For assets that are intended to be sold, the current value of the assets becomes the most relevant measurement as it approximates the current amount of cash that could be obtained on the sale of the asset. On the other hand, for assets held for use by the corporation, the value at resale is not as relevant to the financial statement user. In that case, the historical cost of the assets is the better measurement for reporting the financial statement element. An example of a revenue generating asset is land used for a parking lot. It is relevant to compare the actual cost of the land to the amount of the revenue generated from its use. Using the historical cost basis of accounting gives a faithful representation to the financial statement users.
LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2-1 (a) (b) (c) (d) (e) (f) (g)
5 1 3 3 1 7 5
(h)
4
Accounts payable Accounts receivable Accumulated depreciation Buildings Cash Common shares Current portion of mortgage Payable Patents (q)
(i) (j) (k) (l) (m) (n) (o) (p) 5
8 5 2 3 1 1 6
Dividends declared Income tax payable Long-term Investments Land Inventory Supplies Mortgage payable, due in 20 years 1 Prepaid insurance Unearned revenue
LO 1 BT: K Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 2-2 (a) (b)
1 2
Accounts receivable Accumulated depreciation
(i) (j)
(c) (d)
4 5
(k)
(e) (f) (g) (h)
1 6 2 3
Bank indebtedness Bank loan payable, due in three years Cash Common shares Equipment Goodwill (q)
1 Inventory 1 Notes receivable, due in six months 1 Prepaid rent
(l) (m) (n) (o) (p) 4
6 Retained earnings 4 Salaries payable 1 Supplies 4 Unearned revenue 1 Prepaid insurance Accounts payable
LO 1 BT: K Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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BRIEF EXERCISE 2-3 SHUM CORPORATION Statement of Financial Position (Partial) Assets Current assets Cash Accounts receivable Inventory Supplies Prepaid insurance Total current assets Property, plant, and equipment Land Buildings Less: Accumulated depreciation—buildings Equipment Less: Accumulated depreciation—equipment Total property, plant, and equipment Total assets
$16,400 14,500 9,000 4,200 3,900 48,000 65,000 $110,000 33,000 $70,000 25,000
77,000 45,000 187,000 $235,000
(Assets = Liabilities + Shareholders’ equity) LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 2-4 HIRJIKAKA INC. Statement of Financial Position (Partial) Current liabilities Accounts payable Salaries payable Interest payable Income tax payable Unearned revenue Current portion of mortgage payable Total current liabilities
$22,500 3,900 5,200 6,400 900 5,000 $43,900
LO 1 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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BRIEF EXERCISE 2-5 (a)
($ in thousands) 2016 Working capital:
2015 Working capital:
$453,254 – $235,400 = $217,854 $421,955 – $223,239 = $198,716 Current Assets – Current Liabilities
Current ratio: $453,254 $235,400
Current ratio:
= 1.9:1
$421,955 $223,239
= 1.9:1
Current Assets Current Liabilities
(b)
The working capital increased slightly in 2016 and the current ratio remained the same. Indigo's liquidity is slightly stronger in 2016 compared with 2015.
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 2-6 (a)
(in US$ millions) 2016
2015
Debt to total assets ratio:
Debt to total assets ratio:
($2,705.5 + $4,554.8) = 59.0% ($2,934.8 + $9,369.1)
($2,470.3 + $4,655.1) = 64.6% ($2,742.3 + $8,286.1)
Total Liabilities Total Assets
(b)
The company’s solvency was stronger in 2016 compared with 2015 because total debt has decreased as a proportion of total assets.
LO 2 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 2-7 (a)
($ in thousands) 2015
2014
Basic earnings per share:
Basic earnings per share:
$76,629 = $1.08 per share 71,218
$75,524 = $1.07 per share 70,899
Income available to common shareholders Weighted average number of common shares
Price-earnings ratio:
Price-earnings ratio:
$13.99 = 13.0 times $ 1.08
$17.31 = 16.2 times $ 1.07
Market price per share Basic earnings per share
(b)
The increase in net income and in the basic earnings per share during the year would indicate that profitability has improved in 2015. In spite of the increase in net income, investors appear to have less confidence in Leon’s future income as indicated by the decrease in the price-earnings ratio in 2015.
LO 2 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 2-8 (a) (b) (c) (d) (e) (f)
Faithful representation Verifiability Understandability Cost Going concern Current value
LO 3 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 2-9 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m)
10 5 13 8 12 9 1 2 4 3 11 6 7
LO 3 BT: C Difficulty: C Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 2-10 (a)
Sosa Ltd. has purchased the land for sale and not for use. The current value of the land becomes the most relevant measurement as it approximates the current amount of cash that could be obtained on the sale of the asset.
(b)
Mohawk has purchased land for use and not for sale. The current value is not as relevant to the financial statement user in this case. The historical cost of the land is the better measurement for reporting the land on the statement of financial position.
LO 3 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 2-1 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n)
5 1 3 3 7 5 5 4 5 1 1 3 6 1
Accounts payable and accrued liabilities Accounts receivable Accumulated depreciation Buildings and leasehold improvements Common shares Current maturities of long-term debt Dividends payable Patents Income and other taxes payable Income and other taxes receivable Inventories Land Long-term debt Prepaid expenses
LO 1 BT: K Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
EXERCISE 2-2 BIG ROCK BREWERY INC. Statement of Financial Position (partial) December 31, 2015 (in thousands) Assets Current assets Cash Accounts receivable Inventories Prepaid expenses and other Total current assets Property, plant, and equipment Land Buildings Less: Accumulated depreciation Machinery and equipment Less: Accumulated depreciation Mobile equipment Less: Accumulated depreciation Office furniture and equipment Less: Accumulated depreciation Total property, plant, and equipment Intangible assets Total assets
$ 540 2,221 4,935 1,573 $ 9,269 $ 8,377 $17,692 1,817 $24,860 10,122 $ 1,054 434 $ 1,286 516
15,875 14,738 620 770 40,380 456 $50,105
LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
EXERCISE 2-3 SAPUTO INC. Statement of Financial Position (partial) March 31, 2016 (in millions) Liabilities and Shareholders' Equity Current liabilities Accounts payable and accrued liabilities Income taxes payable Bank loans payable Total current liabilities Non-current liabilities Long-term debt Deferred income taxes payable Other long-term liabilities Total non-current liabilities Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity
$ 896.6 37.1 423.1 $ 1,356.8 $1,208.3 475.6 61.8 1,745.7 3,102.5 $ 821.0 3,180.8 4,001.8 $7,104.3
LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 2-4 (a)
Net income
= Revenues – Expenses = $183,040 – $158,680– $4,550 – $5,200 = $14,610
Retained earnings = Beginning retained earnings + Net income – Dividends declared = $116,520 + $14,610 – $0 = $131,130 (b)
SUMMIT LTD. Statement of Financial Position December 31, 2018 Assets
Current assets Cash Accounts receivable Supplies Prepaid insurance Total current assets Long-term investments Property, plant, and equipment Land Buildings $133,800 Less: Accumulated depreciation 50,600 Equipment $66,100 Less: Accumulated depreciation 21,470 Total property, plant, and equipment Total assets
$ 24,040 20,780 1,240 1,420 $47,480 28,970 $194,000 83,200 44,630 321,830 $398,280
Liabilities and Shareholders' Equity Current liabilities Accounts payable Interest payable Current portion of mortgage payable Total current liabilities Mortgage payable ($104,000 – $30,500) Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity
$21,050 2,100 30,500 $ 53,650 73,500 127,150 $140,000 131,130 271,130 $398,280
LO 1 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 2-5 BATRA CORPORATION Income Statement Year Ended July 31, 2018 Revenues Service revenue Rent revenue Total revenues Expenses Salaries expense Operating expenses Rent expense Depreciation expense Utilities expense Interest expense Supplies expense Total expenses Income before income tax Income tax expense Net Income
$113,600 18,500 132,100 $44,700 32,500 10,800 3,000 2,600 2,000 900 96,500 35,600 5,000 $30,600
[Revenues – Expenses = Net income or (loss)]
BATRA CORPORATION Statement of Changes in Equity Year Ended July 31, 2018
Balance, August 1, 2017 Issued common shares Net income Dividends declared Balance, July 31, 2018
Common Shares
Retained Earnings
$ 15,000 10,000
$17,940
000 000 $25,000
30,600 (12,000) $36,540
Total Equity $32,940 10,000 30,600 (12,000) $61,540
[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared]
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Financial Accounting, Seventh Canadian Edition
EXERCISE 2-5 (CONTINUED) BATRA CORPORATION Statement of Financial Position July 31, 2018 Assets Current assets Cash Held for trading investments Accounts receivable Supplies Total current assets Property, plant, and equipment Equipment Less: Accumulated depreciation Total property, plant, and equipment Total assets
$ 5,060 20,000 17,100 1,500 $ 43,660 $62,900 6,000 56,900 $100,560
Liabilities and Shareholders' Equity Current liabilities Accounts payable Interest payable Unearned revenue Bank loan payable Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity
$ 4,220 1,000 12,000 21,800 $ 39,020 $25,000 36,540 61,540 $100,560
(Assets = Liabilities + Shareholders’ equity) LO 1 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 2-6 (a)
Current ratio: $60,000 $40,000
= 1.5:1
Current Assets Current Liabilities
(b)
Current ratio: ($60,000 – $20,000) = 2:1 ($40,000 – $20,000)
(c)
The request of the CFO to pay off an accounts payable ahead of the due date is clearly done to manipulate the current ratio. His instructions to make the payment came after he was presented with the calculation of the current ratio. In this case the current ratio that is meant to show Padilla’s liquidity position has been artificially altered by a simple payment on account. That said, it is not unethical to pay an account payable in advance of its due date. Rather, it is the motivation for the transaction that would lead one to conclude that the CFO is acting unethically.
LO 2 BT: E Difficulty: M Time: 15 min. AACSB: Analytic and Ethics CPA: cpa-e001, cpa-t001 and cpat005 CM: Reporting
Solutions Manual .
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Chapter 2
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Financial Accounting, Seventh Canadian Edition
EXERCISE 2-7 (a)
(in thousands) 2015
2014
Working capital: $167,816 – $158,120 = $9,696
Working capital: $63,150 – $193,384 = $(130,234)
Current Assets – Current Liabilities
Current ratio: $167,816 = 1.1:1 $158,120
$63,150 = 0.3:1 $193,384
Current Assets Current Liabilities
Debt to total assets ratio: ($158,120 + $2,166,843) = 67.0% ($167,816 + 3,304,377)
($193,384 + $2,036,716) = 65.3% ($63,150 + $3,350,264)
Total Liabilities Total Assets
(b)
Crombie REIT’s liquidity improved dramatically in 2015 when compared to 2014, while at the same its solvency deteriorated slightly.
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Chapter 2
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Financial Accounting, Seventh Canadian Edition
EXERCISE 2-7 (CONTINUED) (c) Crombie Working capital (in thousands) Current ratio Debt to total assets ratio
$9,696 1.1:1 67.0%
Crombie Working capital (thousands) Current ratio Debt to total assets ratio
$(130,234) 0.3:1 65.3%
2015 CT $(215,889) 0.1:1 49.1% 2014 CT $(295,123) 0.0:1 50.2%
Choice
Industry
$(416,879) 0.4:1 90.5%
n/a 0.3 :1 43.8%
Choice
Industry
$(142,356) 0.6:1 87.3%
n/a 0.4:1 45.9%
Based on working capital and the current ratio, Crombie’s liquidity is the best (highest) of the three companies, as the current ratio far exceeds the ratios for CT and Choice as well as the industry average. Compared to 2014, Crombie and CT improved working capital and the current ratio, while both deteriorated for Choice. The industry average current ratio also declined. Based on the debt to total assets ratio, CT’s solvency is the best of the three companies, but it is not as good as the industry average. Crombie’s solvency deteriorated slightly. Choice’s solvency is the worst of the three companies. LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 2-8 (a)
(in thousands) 2015
2014
Basic earnings per share:
Basic earnings per share:
$65,286 = $0.16 per share 395,793
$185,234 395,740
= $0.47 per share
Income available to common shareholders Weighted average number of common shares
Price-earnings ratio: $17.07 $0.16
Price-earnings ratio:
= 106.7 times
$18.62 $0.47
= 39.6 times
Market price per share Basic earnings per share
(b)
The decrease in the basic earnings per share during the year would indicate that profitability has deteriorated dramatically in 2015. However, investors appear to have some confidence in Cameco's future profitability as its share price has declined by only 8%.
LO 2 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting
EXERCISE 2-9 (a) (b) (c) (d) (e) (f)
7 10 11 3 2 8
(g) (h) (i) (j) (k) (l)
1 6 4 5 9 12
LO 3 BT: K Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
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Financial Accounting, Seventh Canadian Edition
EXERCISE 2-10 1.
(a) (b)
The historical cost basis of accounting is involved in this situation. The historical cost basis of accounting has been violated. The land was reported at its current value when it should have remained at its historical cost.
2.
(a) (b)
The current value basis of accounting is involved in this situation. The principle has not been violated since the parcel of land is being held for resale and not for use.
3.
(a)
The assumption involved in this situation is the going concern assumption. The going concern assumption has been violated. The elements on the statement of financial position should have been classified between current and non-current.
(b)
LO 3 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 2-1A Statement of Financial Position Category
Item Accounts payable Accounts receivable Accumulated depreciation
Current liabilities Current assets Contra asset to property, plant, and equipment Current assets Share capital Property, plant, and equipment Current liabilities Property, plant, and equipment Goodwill Property, plant, and equipment Non-current liabilities Current assets Current liabilities
Cash Common shares Computer equipment Current portion of long-term debt Furniture and equipment Goodwill Land, buildings and improvements Long-term debt Prepaid expenses Unearned revenue
LO 1 BT: K Difficulty: S Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-2A (a) Statement of Financial Position Category
Item Accounts receivable Accumulated depreciation—aircraft Accumulated depreciation—buildings Accumulated depreciation—ground, property and equipment Aircraft
Current assets Property, plant, and equipment (contra account) Property, plant, and equipment (contra account) Property, plant, and equipment (contra account)
Buildings Cash Ground and other property and equipment Intangible assets Inventory Other assets Prepaid expenses, deposits, and other
Property, plant, and equipment Current assets Property, plant, and equipment
Solutions Manual .
Property, plant, and equipment
Intangible assets Current assets Other assets Current assets
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-2A (CONTINUED) (b) WESTJET AIRLINES LTD. Statement of Financial Position (partial) December 31, 2015 (in thousands)
Assets Current assets Cash Accounts receivable Inventory Prepaid expenses, deposits, and other Total current assets Property, plant, and equipment Aircraft Less: Accumulated depreciation Ground and other property and equipment Less: Accumulated depreciation Buildings Less: Accumulated depreciation Total property, plant, and equipment Intangible assets Other assets Total assets
$1,252,370 82,136 36,018 131,747 $1,502,271 $3,912,617 1,170,643 $ 821,753 196,829 $ 136,783 30,419
$2,741,974 624,924 106,364 3,473,262 63,549 89,942 $5,129,024
LO 1 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-3A (a) Item Accounts payable and accrued liabilities Advance ticket sales Current portion of long-term debt Deferred income tax (long-term) Long-term debt Other current liabilities Other long-term liabilities Other shareholders’ equity items Retained earnings Share capital
(b)
Statement of Financial Position Category Current liabilities Current liabilities Current liabilities Non-current liabilities Non-current liabilities Current liabilities Non-current liabilities Shareholders’ equity Shareholders’ equity Shareholders’ equity
WESTJET AIRLINES LTD. Statement of Financial Position (partial) Liabilities and Shareholders' Equity December 31, 2015 (in thousands)
Current liabilities Accounts payable and accrued liabilities Advanced ticket sales Other current liabilities Current portion of long-term debt Total current liabilities Non-current liabilities Long-term debt Other long-term liabilities Deferred income tax Total non-current liabilities Total liabilities Shareholders' equity Share capital Retained earnings Other shareholders’ equity items Total shareholders’ equity Total liabilities and shareholders' equity
$545,438 620,216 158,880 227,391 $1,551,925 $1,276,475 13,603 327,028 1,617,106 3,169,031 $ 582,796 1,292,581 84,616 1.959.993 $5,129,024
(c) Yes, these two amounts agree. Assets of $5,129,024 thousand equal total liabilities plus shareholders’ equity of the same amount. LO 1 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-4A (a) MBONG CORPORATION Income Statement Year Ended December 31, 2018 Revenues Service revenue Interest revenue Total revenues Expenses Salaries expense Operating expense Depreciation expense Repair and maintenance expense Insurance expense Utilities expense Interest expense Supplies expense Total expenses Income before income tax Income tax expense Net income
$213,900 500 $214,400 $129,800 39,400 6,200 2,800 2,200 2,000 1,500 1,000 184,900 29,500 6,000 $23,500
[Revenues – Expenses = Net income or (loss)]
MBONG CORPORATION Statement of Changes in Equity Year Ended December 31, 2018
Balance, January 1 Issued common shares Net income Dividends declared Balance, December 31
Common Shares
Retained Earnings
$30,000 4,200
$221,000
_ _____ $34,200
23,500 (5,000) $239,500
Total Equity $251,000 4,200 23,500 (5,000) $273,700
(Beginning equity ± Changes to equity = Ending equity) [Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared]
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-4A (CONTINUED) (a) (continued) MBONG CORPORATION Statement of Financial Position December 31, 2018 Assets Current assets Cash $ 11,900 Held for trading investments 20,000 Accounts receivable 14,200 Supplies 200 Prepaid insurance 2,000 Total current assets Property, plant, and equipment Land $156,000 Buildings $72,000 Less: Accumulated depreciation—buildings 18,000 54,000 Equipment $66,000 Less: Accumulated depreciation—equipment 17,600 48,400 Total property, plant, and equipment Total assets Liabilities and Shareholders' Equity Current liabilities Accounts payable $15,000 Salaries payable 3,000 Current portion of bank loan payable 1,500 Total current liabilities Non-current liabilities Bank loan payable ($15,000 - $1,500) Total liabilities Shareholders' equity Common shares $ 34,200 Retained earnings 239,500 Total shareholders’ equity Total liabilities and shareholders' equity
$ 48,300
258,400 $306,700
$ 19,500 13,500 33,000
273,700 $306,700
(Assets = Liabilities + Shareholders’ equity)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-4A (CONTINUED) (b)
The income statement reports the net income or loss for the period. This figure is then used in the statement of changes in equity, along with dividends declared and any issues (or repurchases) of shares, to calculate the balances in common shares and retained earnings at the end of the period. These ending balances are then used in the statement of financial position to determine shareholders’ equity and complete the accounting equation.
LO 1 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-5A (a) 1.
Working capital
Current assets – Current liabilities $ 446,900 – $142,500 = $304,400
2.
Current ratio
Current assets Current liabilities $446,900
=
3.1 :1
$142,500 3.
Debt to total assets
Total liabilities Total assets $452,500
= 42.2%
$1,072,200
4.
5.
(b)
Basic earnings per share
Price-earnings ratio
Income available to common shareholders Weighted average number of common shares $160,000 = $4.00 40,000 Market price per share Basic earnings per share $35.00 = 8.8 times $4.00
Johanssen’s liquidity has improved dramatically as the working capital is greater in 2018 and the current ratio is almost double that of 2017. On the other hand, the solvency has deteriorated as the debt to total assets ratio is higher in 2018. Johanssen’s profitability has improved as the basic earnings per share ratio has increased in 2018, as has investors’ expectations for future profitability as indicated by the increasing priceearnings ratio.
LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance.
Solutions Manual .
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Chapter 2
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-6A (a) Working capital Chen Caissie
= = =
Current ratio
Current assets – Current liabilities $407,200 – $166,325 = $190,400 – $133,700 = Current assets Current liabilities
=
Chen $407,200
$240,875 $56,700
Caissie =
$190,400
2.4 :1
$166,325
=
1.4 :1
$133,700
Chen is significantly more liquid than Caissie. It has a higher current ratio and more current assets available to pay current liabilities as they come due. (b) Debt to total assets
=
Total liabilities Total assets
Chen ($166,325 + $108,500)
Caissie = 29.3%
($407,200 + $532,000)
($133,700 + $40,700)
=
52.8%
($190,400 + $139,700)
Caissie is considerably less solvent than Chen. Caissie's debt to total assets ratio of 52.8% is almost double that of Chen’s ratio of 29.3%. The lower the percentage of debt to total assets, the lower the risk that a company may be unable to pay its debts as they come due.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-6A (CONTINUED) (c) Service revenue Operating expenses Interest expense Income tax expense Total expenses
Chen $1,800,000 1,458,000 10,000 85,000 1,553,000
Caissie $620,000 438,000 4,000 35,400 477,400
Net income
$ 247,000
$142,600
Basic earnings per share =
Income available to common shareholders Weighted average number of common shares
Chen
Caissie
$247,000 = $3.25 76,000 Price-earnings ratio
$142,600 62,000 =
Market price per share Basic earnings per share
Chen $25.00 $3.25
= 7.7 times
= $2.30
Caissie $15.00 $2.30
= 6.5 times
Based on the price-earnings ratio, investors believe that Chen will be more profitable than Caissie in the future. It is not meaningful to compare basic earnings per share between companies. LO 2 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-7A (a)
(in thousands) Le Château
Reitmans
$116,724 – $36,038 = $80,686
$319,362 – $121,172 = $198,190
1.
Working capital
2.
Current ratio
$116,724 $36,038
= 3.2:1
$319,362 $121,172
= 2.6:1
3.
Debt to total assets
$108,136 $168,490
= 64.2%
$160,915 $542,083
= 29.7%
4.
Basic earnings per share
$(35,745) 29,964
= $(1.19)
$(24,703) 64,079
= $(0.39)
5.
Price-earnings ratio
(b)
= N/A
= N/A
Liquidity With a current ratio of 3.2:1, Le Château is more liquid than Reitmans and both companies have stronger ratios than the industry average of 1.8:1. Solvency Reitmans is more solvent than Le Château as evidenced by its lower debt to total assets ratio, which is better than the industry average of 57%. Profitability Although the basic earnings per share ratio does not provide a basis for comparison by investors, both companies have net losses for the year and therefore negative earnings per share. Consequently, no priceearnings ratio can be calculated to compare to each other or to the industry average.
LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-8A (a)
The higher the amount of working capital, the better a company’ liquidity. From 2016 to 2018 Pitka Corporation’s working capital deteriorated and showed a constant downward trend over the three-year period. A higher current ratio is evidence of better liquidity for a company (assuming the components of the current assets are also liquid). Although the current ratio stayed the same from 2016 to 2017, it deteriorated 2017 to 2018 and is low. A smaller (lower) debt to total assets ratio shows evidence of better solvency. The percentage of total liabilities to total assets increased from 2016 to 2017, showing deterioration in the solvency for Pitka. On the other hand, the ratio improved substantially from 2017 to 2018. The higher the basic earnings per share, the better the profitability. Profitability decreased from 2016 to 2017, but improved from 2017 to 2018. The investors appeared to have less confidence in the future net income of Pitka as evidenced by Pitka's price-earnings ratio, which declined from 2016 to 2017. This view changed as demonstrated by the climb in the price-earnings ratio from 2017 to 2018.
(b)
Liquidity Pitka’s current ratio, although steady in 2016 and 2017, declined slightly in 2018. This trend is of concern given the low level of liquidity the company has with a current ratio of 1.1:1.
Solvency Pitka’s debt to total assets ratio improved in the last year. It appears to be reasonable in size, as does the solvency of the company in 2016.
Profitability Pitka’s profitability declined and then recovered as is demonstrated by the basic earnings per share ratio. The price-earnings ratio in 2018 indicates expectations of improving profitability. LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-9A (a)
The objective of financial reporting is to provide information that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company. In this case, the information will be used by the team’s bank. Bucky’s suggestions concerning how elements should be reported on the financial statements do not meet the objective of financial reporting. His suggestions would lead to a violation of the fundamental basis on which financial statements are prepared: accrual accounting. The suggested changes to the financial statements would not portray economic reality and would not faithfully represent the performance of the business and its financial position at December 31, 2018. Bucky’s suggestions show bias and an attempt to portray a financial picture that would be perceived as more favourable than it is in reality.
(b)
1. Failing to include the estimated expenses for utilities and the corresponding liability for the utilities already consumed by December 31, 2018 violates accrual accounting. The expense was incurred and a liability exists, and although the exact amount is not known, a reasonable estimate can be made as this type of expense occurs often. The definitions of the elements have been met. Failing to include the expense would represent an error of omission done on purpose to increase the profitability and reduce the liabilities of the company at December 31, 2018. 2. Unless the company uses the revaluation model for all of its longlived assets, increasing the value of the building to its current value would violate the historical cost basis of accounting. It is likely far more relevant to the financial statement user of this company to see the original purchase price of the building rather than its current value as it is unlikely to be resold soon. Assets and revenue (from the recording of an unrealized gain from the increase in the value of the asset) would be overstated if Bucky’s instructions were followed. 3. The signing bonus paid to Wayne Crosby does not represent an asset at December 31, 2018. No future benefit can be derived from this payment as it was not conditional upon the occurrence of a future event. Consequently, the expenditure does not fit the definition of an asset.
LO 3 BT: E Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-10A (a)
The advantage of the current value basis of accounting is that it represents a more up-to-date measurement of the value of the asset reported. Consequently, the amounts reported are more relevant to the financial statement users. The disadvantage of the current value basis of accounting and corresponding advantage of historical cost is that historical cost is more reliable and shows the amount paid for the asset. The historical cost might provide a more faithful representation because it can be easily verified and is neutral.
(b)
The reason a company might choose to adopt the current value basis of accounting for real estate is that assets reported on the statement of financial position will have higher values than they would using the historical cost basis. It is inherent in the nature of real estate that the land will increase in value over time. Creditors will find the current value a more relevant basis for making lending decisions. The increase in the assets will have a corresponding increase in equity.
(c)
The reason a company might choose to adopt the historical cost basis of accounting for real estate is that assets reported on the statement of financial position will have more faithful representation because it reports the actual cost of the asset when it was acquired and this measurement can be easily verified and it is neutral. There is also a significant cost to obtaining reliable current value information on a regular basis to be reported in the financial statements.
(d)
When comparing real estate companies, the reader is well advised to read the accounting policy note to the financial statements disclosing the measurement policy used for the real estate property. One would need to determine the corresponding current value for real estate for the company using the historical cost basis of accounting. In fact, this information is required to be disclosed for real estate companies even if they adopted the historical cost basis of accounting to improve comparability and disclosure. Otherwise, trying to compare businesses that use different bases of accounting would be very difficult.
LO 3 BT: E Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
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PROBLEM 2-1B Statement of Financial Position Category
Item Accumulated amortization—patents and trademarks Accumulated depreciation—industrial machinery and equipment Bank overdraft Cash Common (ordinary) shares Current borrowings and debts Income tax payable (current) Industrial machinery and equipment Inventories Land Long-term investments Non-current borrowings and debts Patents and trademarks Prepaid expenses Trade accounts payable Trade accounts receivable
Intangible assets (contra account) Property, plant, and equipment (contra account) Current liabilities Current assets Share capital Current liabilities Current liabilities Property, plant, and equipment Current assets Property, plant, and equipment Non-current assets Non-current liabilities Intangible assets Current assets Current liabilities Current assets
LO 1 BT: K Difficulty: S Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 2-2B (a) Statement of Financial Position Category
Item Accounts receivable Accumulated depreciation— buildings Accumulated depreciation— equipment Buildings Cash Equipment Goodwill Held for trading investments Inventory Land Patent Prepaid expenses
Current assets Property, plant, and equipment (contra account) Property, plant, and equipment (contra account) Property, plant, and equipment Current assets Property, plant, and equipment Goodwill (after intangibles) Current assets Current assets Property, plant, and equipment Intangible assets Current assets
(b) DEVON LIMITED Statement of Financial Position (partial) December 31, 2018 Assets Current assets Cash $100,460 Held for trading investments 52,520 Accounts receivable 13,345 Inventory 105,320 Prepaid expenses 13,950 Total current assets Property, plant, and equipment Land $207,290 Buildings $ 58,275 Less: Accumulated depreciation 27,595 30,680 Equipment $287,400 Less: Accumulated depreciation 146,550 140,850 Total property, plant, and equipment Intangible assets Patent Goodwill Total assets
$285,595
378,820 20,225 39,590 $724,230
LO 1 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-3B (a) Item
Category
Accounts payable Common shares Current portion of mortgage payable Mortgage payable Retained earnings Unearned revenue
Current liabilities Shareholders’ equity Current liabilities Non-current liabilities Shareholders’ equity Current liabilities
(b) DEVON LIMITED Statement of Financial Position (partial) December 31, 2018 Liabilities and Shareholders' Equity Current liabilities Accounts payable Unearned revenue Current portion of mortgage payable Total current liabilities Non-current liabilities Mortgage payable Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity
(c)
$ 13,100 14,180 29,000 $ 56,280 231,255 287,535 $115,400 321,295 436,695 $724,230
Yes, the total assets of $724,230 matches the total liabilities and shareholders’ equity.
LO 1 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 2-4B (a) BEAULIEU LIMITED Income Statement Year Ended December 31, 2018 Revenues Service revenue Interest revenue Total revenues Expenses Salaries expense Interest expense Depreciation expense Utilities expense Insurance expense Total expenses Income before income tax Income tax expense Net Income
$193,100 500 $193,600 $145,600 8,000 5,400 3,700 2,400 165,100 28,500 5,000 $23,500
[Revenues – Expenses = Net income or (loss)]
BEAULIEU LIMITED Statement of Changes in Equity Year Ended December 31, 2018
Balance, January 1 Issued common shares Net income Dividends declared Balance, December 31
Common Shares
Retained Earnings
$25,000 20,000
$34,000
_ _____ $45,000
23,500 (3,500) $54,000
Total Equity $59,000 20,000 23,500 (3,500) $99,000
(Beginning retained earnings ± Changes in retained earnings = Ending retained earnings) [Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared]
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PROBLEM 2-4B (CONTINUED) (a) (continued) BEAULIEU LIMITED Statement of Financial Position December 31, 2018 Assets Current assets Cash Accounts receivable Prepaid insurance Total current assets Long-term investments Property, plant, and equipment Land Buildings $105,000 Less: Accumulated depreciation—buildings 12,000 Equipment $ 32,000 Less: Accumulated depreciation—equipment 19,200 Total property, plant, and equipment Total assets
$11,170 7,500 250 $ 18,920 20,000 $145,800 93,000 12,800 251,600 $290,520
Liabilities and Shareholders' Equity Current liabilities Accounts payable Salaries payable Current portion of mortgage payable Total current liabilities Non-current liabilities Mortgage payable ($175,800 - $35,100) Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity
(b)
$ 9,550 6,170 35,100 $ 50,820 140,700 191,520 $45,000 54,000 99,000 $290,520
The income statement reports the net income or loss for the period. This figure is then used in the statement of changes in equity, along with dividends declared and issues (or repurchases) of shares to calculate the balances in common shares and retained earnings at the end of the period. These ending balances are then used in the statement of financial position to determine shareholders’ equity and complete the accounting equation.
LO 1 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 2-5B (a) 1.
2.
Working capital
Current ratio
Current assets – Current liabilities $253,850 – $156,550 =
$97,300
Current assets Current liabilities $253,850
=
1.6 :1
=
40.1%
$156,550
3.
Debt to total assets
Total liabilities Total assets $288,550 $719,150 Income available to common shareholders
4.
Basic earnings per share
5.
Price-earnings ratio
Weighted average number of common shares $96,600 = $2.42 40,000 Market price per share Basic earnings per share $30.00 = 12.4 $2.42
(b)
times
Fast’s liquidity has improved as the working capital is larger in 2018 and the current ratio is greater than that of 2017. The solvency has improved as the debt to total assets ratio is a smaller percentage in 2018 than in 2017. Fast’s profitability has improved dramatically as the basic earnings per share ratio has increased by a large amount in 2018, as has the priceearnings ratio, suggesting that investors are excited about the company’s future prospects. LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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PROBLEM 2-6B (a) Working capital Belliveau
= = =
Shields Current ratio
Current assets – Current liabilities $180,000 – $75,000 = $700,000 – $300,000 = Current assets Current liabilities
=
Belliveau $180,000
$105,000 $400,000
Shields =
$700,000
2.4 :1
$75,000
=
2.3 :1
$300,000
Belliveau is slightly more liquid than Shields as it has a higher current ratio, even though its absolute working capital amount is lower. (b) Debt to total assets
=
Total liabilities Total assets
Belliveau ($75,000 + $190,000) ($180,000 + $600,000)
Shields = 34.0%
($300,000 + $200,000) ($700,000 + $800,000)
= 33.3%
The debt to asset ratios are similar and both companies are solvent. The lower the percentage of debt to total assets, the lower the risk that a company may be unable to pay its debts as they come due.
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PROBLEM 2-6B (CONTINUED) (c) Service revenue Operating expenses Interest expense Income tax expense Total expenses
Belliveau $450,000 390,000 6,000 10,000 406,000
Shields $890,000 679,000 10,000 65,000 754,000
Net income
$ 44,000
$136,000
Basic earnings per share =
Income available to common shareholders Weighted average number of common shares
Belliveau $44,000 200,000
Shields
= $0.22
Price-earnings ratio
$136,000 200,000 =
Market price per share Basic earnings per share
Belliveau $2.50 $0.22
= 11.4 times
= $0.68
Shields $6.00 $0.68
= 8.8 times
Investors have higher expectations for Belliveau’s future profitability, as evidenced by the price-earnings ratio. It is impractical to compare basic earnings per share between companies. LO 2 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-7B (a)
(in US$ millions) Walmart
Costco
1.
Working capital
$60,239 – $64,619 = $(4,380)
$17 ,299 – $16,540 = $759
2.
Current ratio
$60,239 $64,619
= 0.9:1
$17,299 $16,540
= 1.0:1
3.
Debt to total assets
$115,970 $199,581
= 58.1%
$22,597 $33,440
= 67.6%
4.
Basic earnings per share
$14,694 3,207
= $4.58
$2,377 439
= $5.41
5.
Price-earnings ratio
$65.39 $4.58
= 14.3 times
$133.58 $5.41
= 24.7 times
(b)
Liquidity Both companies are not very liquid, with Walmart having a working capital deficiency. Both Walmart and Costco have current ratios that are lower (worse) than the industry average. Solvency Walmart is more solvent than Costco as evidenced by its lower debt to total assets ratio. However, since both companies have a debt to total assets ratio that is lower than the industry average, they are more solvent than the average company in the industry. Profitability Although the basic earnings per share ratio does not provide a basis for comparison, investors appear to have more confidence in the future net income of Costco as evidenced by Costco’s price-earnings ratio. Both Costco and Walmart have lower price-earnings ratios than the industry. LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-8B (a)
The higher the amount of working capital, the better a business’ liquidity. From 2016 to 2017, Giasson Corporation’s working capital improved. It then deteriorated from 2017 to 2018, decreasing by $17,000. A higher current ratio is evidence of better liquidity for a business, assuming all components of current assets are also liquid. The current ratio for Giasson has been deteriorating steadily from 2016 to 2018. The corporation remains liquid, as its current ratio was 1.5:1 in 2018. A smaller debt to total assets ratio shows evidence of better solvency. The percentage of total liabilities to total assets increased from 2016 to 2017, showing deterioration in the solvency for Giasson. On the other hand, this ratio improved from 2017 to 2018. Less than half of the company’s assets have been financed using debt. The higher the basic earnings per share, the better evidence of improved profitability. Profitability increased from 2016 to 2017 but declined significantly from 2017 to 2018 indicating poorer profitability. The investors appear to have less confidence in the future profitability of Giasson as evidenced by Giasson's price-earnings ratio which declined from 2016 to 2018.
(b)
Liquidity Giasson’s current ratio, although declining over the past two years, demonstrates adequate liquidity. There is $1.50 of current assets available to cover each $1 of current liabilities. Solvency Giasson’s debt to total assets ratio, although deteriorating from 2016 to 2018, remains modest in size and so the solvency of the company continues to be good. Profitability Giasson’s profitability is declining steadily as is demonstrated by the basic earnings per share ratio and the price-earnings ratio. LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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PROBLEM 2-9B (a)
The objective of financial reporting is to provide information that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company. Virginia’s suggestions concerning how elements should be reported on the financial statements do not meet the objective of financial reporting. Two of her suggestions would lead to a violation of the fundamental basis on which financial statements are prepared: accrual accounting. The suggested changes to the financial statements would not portray the economic reality and would not faithfully represent the performance of the construction company and the financial position at its year end. Virginia’s suggestions show bias and an attempt to portray a financial picture that would be perceived as more favourable than it is in reality.
(b)
1. Failing to include the estimated expense and the related liability for the damages that have already occurred by the end of the year violates accrual accounting. The expense was incurred and a liability exists that can be estimated. The definitions of the elements have been met. Failing to include the expense would represent an error of omission done on purpose to increase the profitability and reduce the liabilities of the construction company at its year end. 2. The suggestion of increasing the revenues from construction would result not only in the recording of revenue but the recording of an accounts receivable. The revenue from construction has not been earned as no work has been performed. Furthermore, no account receivable should be recorded because no asset exists yet. Because revenue would be overstated if recorded, equity would also be overstated if Virginia’s instructions were followed. Virginia’s suggestions would not faithfully represent the reality of the performance of Ace Construction Limited for the current fiscal year. 3. Although there are no fixed repayment terms for the bank overdraft, the bank can require repayment on demand since no contract or agreement has been entered into to delay the repayment of the overdraft. For this reason, the classification of the bank overdraft as a non-current liability would falsely portray the financial position of Ace Construction Limited at the year end. When assessing the construction company’s liquidity, the users of the financial statements would be misinterpreting the financial position because of this misclassification. Classifying the debt as non-current would not faithfully represent the economic reality of the construction company’s liquidity position.
LO 3 BT: E Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 2-10B (a)
The advantage of the current value basis of accounting is that it represents a more up-to-date measurement of the value of the asset reported. Consequently, the amounts reported are more relevant to the financial statement users. The disadvantage of the current value basis of accounting and corresponding advantage of historical cost is that historical cost is more reliable and shows the amount paid for the asset. The historical cost might provide a more faithful representation because it can be easily verified and is neutral.
(b)
The following is the recommended basis of measurement that should be used for the following purchases: 1. Due the nature of the asset, a textbook purchase should be recorded at the historical cost basis of accounting because of its intended use. The objective of owning the asset is to use it and not to immediately resell it at a profit. 2. In the case of an iPad, the use of the asset will be limited due to technological obsolescence. Because of this obsolescence, the iPad purchase should be recorded and reported using the historical cost basis of accounting. 3. Software is very similar to the iPad of item 2 above in that it becomes technologically obsolete very quickly. On the other hand, the manufacturer has recognized this problem and has included in the sale of the software, automatic upgrades to attempt to deal with the future needs and demands of the purchaser. This asset is purchased for use and not for resale at a gain and consequently the historical cost basis of accounting should be used for its recording and reporting. 4. If the purchase of the used car is for use in the business, the historical cost basis of accounting should be used. On the other hand, if the purchase is for resale, the current value basis of accounting should be used. 5. Since the intention of the buyer of land is to eventually build a home on the land, the purchase of the land should be recorded using the historical cost basis of accounting. If the intention changes over the years and the buyer decides to resell the property and intends to hold the land for resale at a gain, the reporting of the asset should change to the current value basis of accounting used for investments, assuming the current value is readily available.
LO 3 BT: E Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
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CT2-1 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
Total current assets were $335,581,000 at January 31, 2016, and $315,840,000 at January 31, 2015. Total assets were $793,795,000 at January 31, 2016, and $724,299,000 at January 31, 2015.
(b)
Current assets are listed in the order of liquidity from most to least liquid. Cash is the most liquid asset and is reported first. Non-current assets are listed in order of permanency, with property, plant, and equipment listed first.
(c)
The current liabilities total $155,501,000 at January 31, 2016, and $146,275,000 at January 31, 2015. The total liabilities at January 31, 2016 and January 31, 2015 were $436,183,000 and $395,016,000, respectively.
(d)
The current liabilities are listed in order of due date from those due first to those due last, with accounts payable and accrued liabilities listed first. It is not clear what order was chosen for non-current liabilities. Accounting standards do not suggest any particular order for the presentation of noncurrent liabilities.
LO 1 BT: K Difficulty: S Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT2-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
(a) North West (in thousands) 1. Working capital
Sobeys (in millions)
$335,581 – $155,501 = $180,080 $2,581.4 – $2,707.4 = $(126.0)
2. Current ratio
$335,581 $155,501
= 2.2:1
$2,581.4 $2,707.4
= 1.0:1
3. Debt to total assets
$436,183 $793,795
= 54.9%
$5,230.9 $7,960.6
= 65.7%
(b)
Liquidity: Working capital is not comparable, because of the differing sizes of the two companies involved. However, using the current ratio to assess liquidity, we can determine that North West is significantly more liquid than Sobeys and well ahead of the industry average. Sobeys is in a difficult position of having a working capital deficiency. Solvency: The higher a company’s percentage of debt to total assets is, the greater the risk that this company may be unable to meet its maturing obligations. North West has a better ratio than the industry while Sobeys has a worse ratio.
LO 2 BT: C Difficulty: S Time: 25 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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CT2-3 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
McCain’s multinational structure means that accounting personnel from various countries are involved with preparing financial statements. Since IFRS is a global standard, most of the accounting personnel would be familiar with IFRS. Also, by using one standard across all subsidiaries, there is no need to make adjustments for various GAAP differences (this was often the case for Canadian multinationals prior to the adoption of IFRS). For McCain, it means that the company will reduce cost as well as the chance for errors. In addition, the users of McCain’s financial statements are located throughout the world. Those located in countries using IFRS, or wishing to compare McCain’s financial statements to other global public companies, would better understand financial statements prepared using this standard.
(b)
Relevance – Researchers have found that companies who voluntarily adopt IFRS find that IFRS’ accounting measures are better tools for evaluating performance. Therefore, IFRS statements are more relevant to McCain’s management. Also, when global lenders are looking at financial statements prepared according to IFRS, they are no longer concerned about differences in GAAP. This increases the relevance to lenders. Faithful Representation – In comparison to ASPE, IFRS requires more detailed information to be disclosed in the notes to the financial statements. From a user’s perspective, more information and explanation is provided to help understand the economic event being depicted. Comparability - McCain Foods is a global company that competes against various other global companies (most of whom follow IFRS). By adopting IFRS, it is easier for McCain to compare its results to other similar companies. This information would be useful to both internal users (management and shareholders) as well as external (lenders). Understandability – When different accounting standards are used by various companies within a corporate group they are less understandable. Furthermore, when users are not resident in the country where the head office of the company is located, they often have a difficult time understanding financial statements that are presented using standards that they are not familiar with. For instance, a McCain manager in a United States subsidiary that follows U.S. GAAP may have difficulty understanding the statements of a McCain subsidiary located in the U.K. (that follows IFRS).
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CT2-3 (CONTINUED) (c)
The assumption that small companies would avoid IFRS can relate to many things like: i. Not planning to take their company public in the future; ii. They like the simplicity and familiarity of ASPE; iii. They have many competitors, customers, and suppliers that use ASPE which makes their financial statements comparable and understandable. Examples of why private companies may adopt IFRS: i. Private companies that plan to be public sometime in the near future or who have foreign private investors, may choose to adopt IFRS. ii. Private companies that have global shareholders or lenders (who are more familiar with IFRS). They may also want to provide financial statements to customers.
LO 3 BT: S Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting
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CT2-4
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a)
Sheila paid $25,000 for 10,000 common shares of Kenmare Architects Ltd. (or $2.50 per share) when the company was formed. This amount is reported as the balance in the Common Shares account on the statement of financial position of December 31, 2017. Sheila’s mother paid $10,000 for 1,000 common shares (or $10.00 per share) in early 2018. This amount paid can be determined by calculating the increase of $10,000 ($35,000 less $25,000) in the Common Shares account on the statement of financial position of December 31, 2018.
(b)
By December 31, 2017, Uncle Harry wanted $8,000 of the loan paid off in 2018. This amount is classified as the current portion of the loan due at December 31, 2017. The actual amount of principal paid in 2018 was $30,000. This amount paid can be determined by calculating the total decrease in the loan payable from December 31, 2017 to December 31, 2018: [($52,000 + $8,000) less ($26,000 + $4,000)]. During 2017 Uncle Harry received interest only in the amount of $3,600 as indicated in the statement of income for interest expense. In 2018, Uncle Harry received $32,700. This amount is equal to the principal repayment of $30,000 and the interest of $2,700.
(c) Current ratio
2018 $46,000 $33,580
= 1.4:1
2017 $31,000 $22,490
= 1.4:1
Although the current ratio is unchanged, we need to further examine the account balances that make up the ratio. There has been deterioration in liquidity due to the declining cash balance and a significant rise in accounts receivable which may indicate difficulty in collecting amounts owed from customers. This decreased cash flow from customers has probably caused the increase in accounts payable as the company seems to have delayed payment to suppliers.
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CT2-4 (CONTINUED) (d) Debt to total assets
2018 $59,580 $106,000
= 56.2%
2017 $74,490 $103,000
= 72.3%
Kenmare’s solvency improved significantly. The decrease in the ratio occurred mainly because of changes in the numerator rather than in the denominator. Total liabilities fell because of the large pay down of the loan from the uncle even though accounts payable rose. This had an impact on the income statement by lowering interest expense because of the lower loan balance. Because Kenmare’s debt level is lower, the amount of interest expense is also lower, making the business more profitable. (e) Basic earnings per share
2018 $7,910 11,000
= $0.72
2017 $3,510 10,000
= $0.35
The basic earnings per share more than doubled because net income more than doubled while there was only a 10% increase in the number of shares. (f)
Sheila paid $2.50 per share for her shares ($25,000 ÷ 10,000). The amount Sheila’s mother paid for her shares was $10.00 per share ($10,000 refer to part (a) above ÷ 1,000). 2018 2017 Price-earnings $10.00 = 13.9 times $2.50 = 7.1 times ratio $0.72 $0.35 The service revenue increased 20% from 2017 to 2018 [($120,000 – $100,000) ÷ $100,000]. The net income increased by 125% from 2017 to 2018 [($7,910 – $3,510) ÷ $3,510]. Sheila’s salary increased by 25% from 2017 to 2018 [($74,000 – $59,000) ÷ $59,000]. The price-earnings ratio changed mostly because of the price difference paid by the two shareholders. Sheila’s mother paid four times the price Sheila paid for her shares. This increase is very dramatic taking into account other ratios for measurement of performance. The fourfold increase in the share price is not justified by the financial performance of the business. The future profitability of the business is based on the amount of service revenue that can be generated by the single employee, Sheila, and is therefore limited.
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Financial Accounting, Seventh Canadian Edition
CT2-4 (CONTINUED) (g)
The likely reason for the sale in shares in 2018 was to obtain $10,000, which was used to repay the debt to Uncle Harry earlier than originally scheduled.
LO 1,2 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT2-5 (a)
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
The stakeholders in this case are: Kathy Onishi, controller Redondo’s vice-president of finance Users of the company's financial statements, including shareholders and creditors
(b)
The ethical consideration in this situation is whether or not switching from ASPE to IFRS would affect the decisions of the users of the financial statements. Because Redondo Corporation is a private corporation, the use of IFRS is not required. It is ethically preferable to disclose the most financially relevant information to the users of the financial statements so that they can make informed decisions. One should question the reasoning of Redondo’s vice-president of finance who is focusing on the effect of the implementation on the net income for the year.
(c)
As the controller, by supporting the conversion from ASPE to IFRS, Kathy could gain the trust and respect of the board of directors and the shareholders in general. The users of the company’s financial statements will find the information provided under IFRS to be more useful in making comparisons with Redondo’s competitors. This in turn will lead to better decisions being made by users of the financial statements.
LO 3 BT: E Difficulty: M Time: 15 min. AACSB: Ethics CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT2-6 (a)
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
Software Solutions’ financial statements will include the statement of financial position, income statement, statement of changes in equity, and statement of cash flows. It may also include a statement of comprehensive income. It will also include the notes to the financial statements. The statement of financial position reports the assets, liabilities, and shareholders’ equity at a specific date. The income statement presents the revenues and expenses and resulting net income or loss for a specific period of time. The statement of changes in equity summarizes the changes in equity accounts, including common shares and retained earnings, for a specific period of time. Finally, the statement of cash flows provides information about the cash inflows and cash outflows provided or used for operating, investing, and financing activities for a specific period of time.
(b)
Because Software Solutions is public company, it is required to have its financial statements audited. The auditor’s report provides users with assurance that the financial statements are fairly presented. As a public company, Software Solutions is also required to file financial statements on a timely basis with the regulator of the stock exchange on which its share trade.
(c)
By looking at the statement of financial position and determining the composition of Software Solutions’ current assets and current liabilities, we can assess its ability to pay its short-term obligations. We can also calculate liquidity ratios, such as working capital and the current ratio, for the current and prior periods to help determine its ability to meet its current obligations. This will not guarantee that Software Solutions is able to pay ABC’s invoices in the future, but it will provide some assurance with respect to how it has performed in the past. The statement of cash flows also provides information to determine if Software Solutions generates positive cash flows from its operating activities.
(d)
By looking at the types of revenues and expenses reported in the income statement, we can determine if Software Solutions is profitable. If revenues earned by Software Solutions exceed expenses incurred, then Software Solutions is profitable. As well, profitability ratios that measure a company’s ability to generate net income over a period of time can be determined. These profitability ratios include basic earnings per share and the price-earnings ratio. The latter measures investors’ expectations about Software Solutions’ future profitability.
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT2-6 (CONTINUED) (e)
By looking at the statement of financial position, we can determine Software Solutions’ total liabilities, and the mix of current and non-current debt. We can also calculate solvency ratios, such as the debt to total assets ratio, to determine whether Software Solutions has the ability to repay its total debt. Solvency ratios help measure a company’s ability to survive over a long period of time. Reviewing the company’s income statement and statement of cash flows helps in determining whether Software Solutions is able to pay its interest expense. The more profitable the company, the better able it is to make the interest payments on its debt and generate sufficient cash to repay its obligations.
(f)
Be aware that the financial statements of Software Solutions provide a historical perspective of what has already taken place. The financial statements may not prove to be the best indicator of what will happen in the future. Consumer tastes change and as a result the demand for Software Solutions’ products may also change. As well, consider this business opportunity from your perspective. Ask yourself if the price obtained for the hours worked is reasonable considering some of the risks involved. There is a risk that, by taking on this obligation, additional opportunities cannot be pursued. Does Anthony Business Company have the ability to meet the demands of Software Solutions? Is it able to commit to providing 500 hours of service per month? Does it have enough staff to enable the company to do so? Does it have enough cash to pay for the staff that will be required, along with other operating expenses, and wait 30 days from the date of the invoice to collect from Software Solutions?
LO 2,3 BT: E Difficulty: M ime: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 2
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM LEARNING OBJECTIVES 1. 2. 3. 4. 5.
Analyze the effect of transactions on the accounting equation. Explain how accounts, debits, and credits are used to record transactions. Journalize transactions in the general journal. Post transactions to the general ledger. Prepare a trial balance.
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO 1. 2. 3. 4.
1 1 1 2
BT Item LO
BT Item LO BT Item LO Questions
BT Item LO
BT
C C C C
C C C C
5. 6. 7. 8.
2 2 3 3
9. 10. 11. 12.
3,4 3,4 4 4
C C K K
13. 14. 15. 16.
4 5 5 5
K C C C
17. 1,3,4,5
C
AP
10.
4
AP
13.
5
AN
AP
Brief Exercises 1.
1
C
4.
2
AP
7.
3
2.
1
AN
5.
1,2
AN
8.
3
AP
11.
4
AP
3.
2
AP
6.
3
AP
9.
4
AN
12.
5
AP
10.
4,5
AP
13.
5
Exercises 1.
1
AN
4.
1,2
AN
7.
1,2,3,4 AN
2.
1
AN
5.
3
AP
8.
4
AP
11.
5
AP
14.
5
AP
3.
2
K
6.
3
AP
9.
4
AN
12.
5
AP
15.
5
AN
Problems: Set A and B 1.
1
AN
4.
2
K
7.
3,4
AP
10.
5
AP
2.
1
AN
5.
1,2,3
AN
8.
3,4,5
AP
11.
5
AP
3.
2
AP
6.
3
AP
9.
3,4,5
AP
12.
5
AN
Accounting Cycle Review 1.
3,4,5
AP
2.
3,4,5
AP
Cases 1.
1
AP
3.
3,4,5
E
5.
5
S
2.
1
AN
4.
5
AN
6.
3,4,5
AN
Solutions Manual .
3-1
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file.
LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
Solutions Manual .
3-2
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
(a)
(b)
Only events that cause a change in an asset, liability, or shareholders’ equity account are recorded as accounting transactions. Other events, such as the agreement to provide a service, do not immediately impact an asset, liability, or shareholder’s equity account and, therefore, are not considered an accounting transaction. Examples of events that would not be recorded include hiring employees, signing a lease, and placing an order to purchase services.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
Accounting transactions that affect the accounting equation (assets = liabilities + shareholders’ equity) should be recorded. (a)
(b)
(c) (d)
(e)
Winning an award is not an accounting transaction, as it does not affect the accounting equation. The award did not involve the receipt of an asset, such as cash. Supplies purchased on account is an accounting transaction because it affects the accounting equation (assets are increased because supplies were received and liabilities are increased because accounts payable were incurred). A shareholder dying is not an accounting transaction, as it does not affect the accounting equation. Declaring and paying a cash dividend to shareholders is an accounting transaction as it does affect the accounting equation (shareholders’ equity is decreased and assets (cash) are decreased). The agreement to provide legal services to the company is not an accounting transaction as it does not affect the accounting equation. No expense has been incurred yet and no liabilities have been affected as yet. Once the lawyer begins providing services and an amount is paid or owed, then a transaction would be recorded.
LO 1 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
Yes, a company can enter into a transaction in which only the left (assets) side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset. A decrease in the Accounts Receivable account which is offset by an increase in the Cash account is a specific example (that is, a customer paying for goods previously purchased on account).
LO 1 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
4.
Financial Accounting, Seventh Canadian Edition
The structure of the accounting equation matches the debit-credit rules in accounting. Assets are shown on the left-hand side of the accounting equation and debits are shown on the left-hand side of the accounting equation and T accounts. Because of this, asset accounts have normal debit balances. Liabilities and shareholders’ equity are shown on the right-hand side of the accounting equation and credits are shown on the right-hand side of the accounting equation and T accounts. Liabilities and shareholders’ equity accounts (such as share capital and retained earnings) have normal credit balances. Following the debit-credit rules will ensure that the accounting equation will be consistently applied.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
Shareholders' equity consists of different components, and they do not all move in the same direction. Shareholders’ equity is usually comprised of share capital (which is increased by credits) and retained earnings. Retained earnings can be further subdivided into revenues and expenses and dividends declared which are then added to opening retained earnings in the case of revenues, and deducted from opening retained earnings in the case of expenses and dividends. Revenues are increased by credits while expenses and dividends declared are increased by debits.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
Emily is likely relating the term debit and credit to the normal balances of accounts. Since assets have normal debit balances and, from a personal standpoint, acquiring and possessing assets is viewed in a positive light, it might follow in Emily’s mind that debits are favourable. On the other hand, liabilities have a normal credit balance and might be viewed by Emily in a negative light because debt is unfavourable from a personal standpoint. However, Emily is incorrect. Debits mean nothing more than the left side of accounts and credits the right side of the accounts. Neither is favourable or unfavourable.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
(a) (b)
Solutions Manual .
A general journal is a book of original entry, in which transactions are recorded in chronological order. The general journal facilitates the recording process by documenting the debit and credit effects on specific accounts. The general journal discloses the complete effect of a transaction in one place, including an explanation and, where applicable, identification of the source document. The general journal provides a chronological record of transactions and it helps to prevent and locate errors, because the debit and credit amounts for each entry can be quickly compared. 3-4
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
8.
While the account title choices suggested by Meghan provide details of the type of truck the company purchased, the title of the account used to record the purchase should be more generic to include all types of trucks and other vehicles that can be owned and used by the business. Ambiguous or multiple account titles with similar names can lead to incorrect financial reporting. The name of the account often used by companies for purchases of this nature is Vehicles.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
This would not be efficient because the journal provides a record that shows both “sides” of the transaction along with a description of the transaction. This information is vital to the understanding of the event. A general ledger is not intended to be used to capture the recording of transactions, but to tabulate the effects of transactions in separate accounts. The balances arrived at in the ledger are then used to communicate information to the users of the financial statements. If one attempted to omit the use of journal entries, one could not retrace the transactions as they originated in the journal. One would only see one side of a transaction at a time by looking at an account in the ledger. It would become very confusing and unruly to try to keep track of transactions.
LO 3,4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
Posting should be done on a timely basis, at least monthly, so that account balances can be monitored and reconciled. This ensures that any errors are identified as soon as possible.
LO 3,4 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
11.
(a)
(b)
The general ledger is the entire group of accounts maintained by a company, including all the asset, liability, and shareholders' equity accounts, including the share capital, retained earnings, dividends declared, revenue, and expense accounts. The general ledger is often arranged in the order in which accounts are presented in the financial statements, beginning with the statement of financial position accounts. The asset accounts come first, followed by liability accounts, and then shareholders’ equity accounts, including the share capital, retained earnings, dividends declared, revenue, and expense accounts.
LO 4 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-5
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
12.
(a)
(b)
Financial Accounting, Seventh Canadian Edition
The chart of accounts is a list of a company’s accounts. The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and identify their location in the general ledger. Numbering the accounts helps identify and sort the accounts.
LO 4 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
Cash, Accounts Receivable, Supplies, Prepaid Insurance, Accounts Payable, Unearned Revenue, Common Shares, Dividends Declared, Service Revenue, Salaries Expense, and Income Tax Expense.
LO 4 BT: K Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
14.
(a)
(b)
A trial balance is a list of accounts and their balances at a point in time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits after all journalized transactions have been posted. A trial balance also facilitates the discovery of errors in journalizing and posting. In addition, it is useful in preparing financial statements. While it does not matter in what order the accounts are listed in the trial balance, it is usual for the accounts in the trial balance to be listed in the same order as they are listed in the general ledger (asset accounts, liability accounts, and shareholders’ equity accounts, including the share capital, retained earnings, dividends declared, revenue, and expense accounts). This makes it easier to compare the trial balance accounts to the general ledger accounts, as well as to prepare the financial statements from the trial balance.
LO 5 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
The retained earnings account in the unadjusted trial balance shows the beginning balance of the period (which is the same as the ending balance of the prior period) as it has not yet been updated for the effect that the revenues, expenses, and dividends declared have on retained earnings for the current accounting period. (Note to instructors: This chapter only includes references to an unadjusted and pre-closing trial balance; the post-closing trial balance is not introduced until Chapter 4.)
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-6
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
16.
Financial Accounting, Seventh Canadian Edition
Claire, here are some tips to help you find the $100 difference in the trial balance columns assuming it is a single error: 1.
2.
3.
4.
If the difference between the debit and credit totals is an amount such as $1, $100, or $1,000, re-add the trial balance columns and recalculate the account balances. If the amount of the difference can be evenly divided by two, (which it is in this case) scan the trial balance to see if a balance equal to half the error has been entered in the wrong column. If the amount of the difference can be evenly divided by nine, (which it is not in this case) retrace the account balances on the trial balance to see whether they have been incorrectly copied from the ledger. For example, if a balance was $12 but was listed as $21, a $9 error has been made. Reversing the order of numbers is called a transposition error. A slide, which is adding or deducting one or several zeros in a figure, has the same effect. If the amount of the difference cannot be evenly divided by two or nine, scan the ledger to see whether an account balance in the amount of the error has been omitted from the trial balance. Scan the journal to see whether a posting in the amount of the error has been omitted.
When all else fails, all of the transactions should be carefully traced through the process again. LO 5 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
17.
The first four steps in the accounting cycle are: (a) (1) Analyze the business transactions and determine their effects on the accounting equation and also determine when and how to record the transactions. (2) Journalize the transactions in the general journal to record the effects of the transactions on the accounts involved in the transactions. (3) Post to the general ledger accounts to provide an accumulation of the effect of several journalized transactions in the individual accounts. (4) Prepare a trial balance to prove that the sum of the debit account balances equals the sum of the credit account balances after posting. (b) It does matter in which order the steps of the accounting cycle are completed. Each step performed has been designed in the sequence with the understanding that the previous step has been performed. Failing to do so would result in incomplete and inaccurate financial information.
LO 1,3,4,5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
3-7
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3-1 (a) Assets 1. 2. 3. 4. 5. (b)
= (+) (-) NE NE (+) NE
Liabilities
+ NE NE NE NE NE
Shareholders’ Equity NE NE NE (+) NE
Items 1 and 4 are accounting transactions that should be recorded in the accounting records. Each of these transactions have an impact on the accounting equation as shown in part (a). Items 2, 3, and 5 should not be recorded in the accounting equation. They do not yet impact the accounting equation.
LO 1 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-8
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-2 Assets
=
Liabilities
Shareholders’ Equity Retained Earnings
+
= Transaction 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Total
Cash
Accounts Receivable
Supplies +$250
Prepaid Insurance
Accounts Payable +$250
Unearned Revenue
Common + Shares
+$500 –$300 +5,000 –100 +500 −250 –100 +300
−500
$5,050
+ $0
– Expenses
– Dividends Declared
+$500 −$300 +$5,000 −$100 −250 +$100
+$250
+ $100 =
$0
+$300 −300 + $0
+ $5,000
+300 + $800
– $300
TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $5,400
TOTAL ASSETS = $5,400
LO 1 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
+ Revenues
3-9
Chapter 3
– $100
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-3
1. Accounts Payable
(a) Basic Type Liability
(b) Normal Balance Credit
(c) Debit Effect decrease
(d) Credit Effect increase
2. Accounts Receivable
Asset
Debit
increase
decrease
3. Cash
Asset
Debit
increase
decrease
4. Common Shares
Shareholder's equity
Credit
decrease
increase
5. Dividends Declared
Shareholder's equity
Debit
increase
decrease
Debit
increase
decrease
Debit
increase
decrease
Credit
decrease
increase
Credit
decrease
increase
Credit
decrease
increase
6. Equipment 7. Income Tax Expense 8. Retained Earnings 9. Service Revenue 10. Unearned Revenue
Asset Shareholder's equity Shareholder's equity Shareholder's equity Liability
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-10
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-4 (a) Transaction
Basic Type
Account Debited (b) Specific Account
(c) Effect
Account Credited (a) (b) Specific Basic Type Account
Effect
1.
Asset
Cash
Increase
Shareholders’ equity
Common Shares
Increase
2.
Asset
Prepaid Rent
Increase
Asset
Cash
Decrease
3.
Shareholders’ equity
Salaries Expense
Increase
Asset
Cash
Decrease
4.
Asset
Accounts Receivable
Increase
Shareholders’ equity
Service Revenue
Increase
5.
Asset
Cash
Increase
Asset
Accounts Receivable
Decrease
6.
Asset
Supplies
Increase
Liability
Accounts Payable
Increase
7.
Liability
Accounts Payable
Decrease
Asset
Cash
Decrease
8.
Asset
Cash
Increase
Liability
Bank Loan Payable
Increase
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
(c)
3-11
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-5 Transaction 1
June 1: Issued common shares to shareholders in exchange for $2,500 cash.
(a) Basic Analysis
The asset account Cash is increased by $2,500; the shareholders’ equity account Common Shares is increased by $2,500.
(b) Equation Analysis
Assets
=
Liabilities
+
Cash +$2,500
Shareholders’ Equity Common Shares +$2,500
(c) Debit−Credit Analysis
Debits increase assets: debit Cash $2,500. Credits increase share capital (shareholders’ equity): credit Common Shares $2,500.
Transaction 2
June 4: Purchased supplies on account for $250.
(a) Basic Analysis
The asset account Supplies is increased by $250; the liability account Accounts Payable is increased by $250.
(b) Equation Analysis
Assets
=
Liabilities
Solutions Manual .
Shareholders’ Equity
Accounts Payable +$250
Supplies +$250
(c) Debit−Credit Analysis
+
Debits increase assets: debit Supplies $250. Credits increase liabilities: credit Accounts Payable $250.
3-12
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-5 (CONTINUED) (a), (b), and (c) (continued) Transaction 3
June 7: Billed J. Kronsnoble $300 for welding work done.
(a) Basic Analysis
The asset account Accounts Receivable is increased by $300; the revenue account Service Revenue is increased by $300.
(b) Equation Analysis
Assets
=
Liabilities
+
Accounts Receivable +$300
Shareholders’ Equity Service Revenue +$300
(c) Debit−Credit Analysis
Debits increase assets; debit Accounts Receivable $300. Credits increase revenues; credit Service Revenue $300.
Transaction 4
June 18: Received partial payment from J. Kronsnoble for work billed on June 7.
(a) Basic Analysis
The asset account Cash is increased by $200; the asset account Accounts Receivable is decreased by $200.
(b) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Cash +$200 Accounts Receivable -$200 (c) Debit−Credit Analysis
Solutions Manual .
Debits increase assets: debit Cash $200. Credits decrease assets: credit Accounts Receivable $200.
3-13
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-5 (CONTINUED) (a), (b), and (c) (continued) Transaction 5
June 25: Hired new employee to start work on July 3.
(a) Basic Analysis
An accounting transaction has not occurred. There is only an agreement of employment to start on July 3.
Transaction 6
June 27: Received cash of $200 from Liu Controls Ltd. as a deposit for welding work to be done in July.
(a) Basic Analysis
The asset account Cash is increased by $200; the liability account Unearned Revenue is increased by $200.
(b) Equation Analysis
Assets
=
Liabilities
Solutions Manual .
Shareholders’ Equity
Unearned Revenue +$200
Cash +$200
(c) Debit−Credit Analysis
+
Debits increase assets: debit Cash $200. Credits increase liabilities: credit Unearned Revenue $200.
3-14
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-5 (CONTINUED) (a), (b), and (c) (continued) Transaction 7
June 28: Paid for supplies purchased on June 4.
(a) Basic Analysis
The asset account Cash is decreased by $250; the liability account Accounts Payable is decreased by $250.
(b) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Accounts Payable -$250
Cash -$250
(c) Debit−Credit Analysis
Debits decrease liabilities: debit Accounts Payable $250. Credits decrease assets: credit Cash $250.
Transaction 8
June 29: Paid $100 for monthly income tax instalment.
(a) Basic Analysis
The expense account Income Tax Expense is increased by $100; the asset account Cash is decreased by $100.
(b) Equation Analysis
Assets
=
Liabilities
Cash -$100
(c) Debit−Credit Analysis
+
Shareholders’ Equity Income Tax Expense -$100
Debits increase expenses: debit Income Tax Expense $100. Credits decrease assets: credit Cash $100.
LO 1,2 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-15
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-6 1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Supplies ....................................................... Accounts Payable .................................
250
Accounts Receivable ................................... Service Revenue ...................................
500
Salaries Expense ......................................... Cash ......................................................
300
Cash ............................................................ Common Shares ...................................
5,000
Dividends Declared ...................................... Cash ......................................................
100
Cash ............................................................ Accounts Receivable .............................
500
Accounts Payable ..................................... Cash ...................................................
250
Prepaid Insurance ........................................ Cash ...................................................
100
Cash .......................................................... Unearned Revenue ............................
300
Unearned Revenue .................................... Service Revenue ................................
300
250
500
300
5,000
100
500
250
100
300
300
LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-16
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-7 1.
2.
3.
4.
5.
6.
7.
8.
Cash ............................................................ Common Shares ...................................
5,000
Prepaid Rent ................................................ Cash ......................................................
2,100
Salaries Expense ......................................... Cash ......................................................
500
Accounts Receivable ................................... Service Revenue ...................................
1,200
Cash ............................................................ Accounts Receivable .............................
900
Supplies ....................................................... Accounts Payable..................................
500
Accounts Payable ........................................ Cash ......................................................
500
Cash ............................................................ Bank Loan Payable ...............................
1,000
5,000
2,100
500
1,200
900
500
500
1,000
LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-17
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-8 June
1
4
7
18
Cash ....................................................... Common Shares..........................
2,500
Supplies ................................................. Accounts Payable ........................
250
Accounts Receivable .............................. Service Revenue .........................
300
Cash ....................................................... Accounts Receivable ...................
200
2,500
250
300
200
25
No transaction – no asset, liability, or equity account affected
27
Cash ..................................................... Unearned Revenue ......................
200
Accounts Payable .................................. Cash ............................................
250
Income Tax Expense ............................. Cash ............................................
100
28
29
200
250
100
LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-18
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-9 Accounts Receivable Aug. 10 17,500 15 6,500 Aug. 23 (a) 15,000 Bal. 9,000 Sept. 5 (b) 4,000 Sept. 15 8,000 Bal. 5,000
Accounts Payable Aug. 5 (c) 6,000 18 3,400 Aug. 29 5,800 Bal. 3,600 Sept. 12 7,700 Sept. 23 5,900 Bal. (d) 5,400
(a)
$17,500 + $6,500 – $9,000 = $15,000
(b)
$5,000 – $9,000 + $8,000 = $4,000
(c)
$3,600 + $5,800 – $3,400 = $6,000
(d)
$3,600 + $7,700 – $5,900 = $5,400
(e)
$50,000 – $500 + $45,000 = $94,500
(f)
$99,000 + $450 – $94,500 = $4,950
Service Revenue Aug. 10 50,000 Aug. 12 500 15 45,000 Bal. (e) 94,500 Sept. 5 (f) 4,950 Sept. 25 450 Bal. 99,000
LO 4 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-19
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-10 June 1 June 18 June 27 Bal.
Cash 2,500 June 28 200 June 29 200 2,550
June 7 Bal.
Accounts Receivable 300 June 18 100
June 4
June 28
June 29
250 100
200
Supplies 250 Accounts Payable 250 June 4 Bal.
250 0
Unearned Revenue June 27
200
Common Shares June 1
2,500
Service Revenue June 7
300
Income Tax Expense 100
LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-20
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-11 (a) May 4 May 7 May 11 May 21 May 25 May 28 May 31
Billed clients $3,200 for services provided on account Declared and paid dividends of $500 Collected $1,900 from a customer on account Received $2,000 from client for services provided Paid salaries of $2,500 Paid supplier $200 on account Paid income tax of $750
(b) Apr. 30 May 11 May 21 Bal.
Apr. 30 May 4 Bal.
May 28
May 7
Cash 1,500 May 7 1,900 May 25 2,000 May 28 May 31 1,450 Accounts Receivable 1,800 May 11 3,200 3,100 Accounts Payable 200 Apr. 30 Bal.
500 2,500 200 750
1,900
900 700
Dividends Declared 500 Service Revenue May 4 May 21 Bal.
May 30
Income Tax Expense 750
May 25
Salaries Expense 2,500
3,200 2,000 5,200
LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-21
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-12 (a)
Account Normal Balance Accounts payable ............................................................ Credit Accounts receivable ........................................................ Debit Accumulated depreciation—equipment ........................... Credit Cash ................................................................................ Debit Common shares .............................................................. Credit Dividends declared .......................................................... Debit Equipment ....................................................................... Debit Held for trading investments............................................ Debit Income tax expense ........................................................ Debit Rent expense .................................................................. Debit Retained earnings ........................................................... Credit Salaries expense ............................................................. Debit Service revenue .............................................................. Credit Unearned revenue .......................................................... Credit
(b) CARLAND INC. Trial Balance June 30, 2018 Debit Cash Accounts receivable Held for trading investments Equipment Accumulated depreciation—equipment Accounts payable Unearned revenue Common shares Retained earnings Dividends declared Service revenue Salaries expense Rent expense Income tax expense Totals
Credit
$ 4,400 4,000 6,000 17,000 $ 3,600 3,000 150 10,000 12,650 200 7,600 4,000 1,000 400 $37,000
_ $37,000
(Total of debit account balances = Total of credit account balances) LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-22
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 3-13 Error 1. 2. 3. 4. 5. 6.
(a) In Balance No No Yes Yes Yes No
(b) Difference $ 900 1,000 N/A N/A N/A 1,000
(c) Larger Column Debit Credit N/A N/A N/A Debit
LO 5 BT: AN Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-23
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 3-1 (a) 1.
Received cash of $1,000 from a customer as a deposit for work to be done in the future. 2. Purchased equipment for $5,000 paying cash $1,000 with the remaining balance of $4,000 on account. 3. Paid $750 for supplies. 4. Performed services for $9,500 collecting cash of $4,100 and the remaining balance on account of $5,400. 5. Paid $2,000 to suppliers on account. 6. Declared and paid dividends of $1,000. 7. Paid for operating expenses of $4,800 8. Collected $5,000 on account from customers. 9. Paid interest expense of $300 10. Paid income tax expense of $880.
(b) Service revenue Less: Expenses Operating expenses Interest expense Income tax expense Total expenses Net income
$9,500 $4,800 300 880 5,980 $3,520
Retained earnings: Beginning balance Add: Net income Less: Dividends declared Ending balance
$4,500 3,520 (1,000) $7,020
[Revenues – Expenses = Net income or (loss)]
Solutions Manual .
3-24
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-1 (CONTINUED) (c) =
Assets
Liabilities
Shareholders’ Equity
+
Retained Earnings
Cash
Accounts Receivable Supplies Equipment =
Accounts Payable
Unearned Common Revenue + Shares
$2,000
$5,000
Bal.
+ – Revenues Expenses
July 31 Bal. (1)
$6,500 1,000
(2)
−1,000
(3)
−750
(4)
+4,100
(5)
-2,000
(6)
-1,000
(7)
-4,800
(8)
+5,000
(9)
-300
-300
(10)
-880
-880
Aug. 31 Bal.
$5,870
$5,000
$4,500
+$1,000 +$5,000
+4,000
+750 +5,400
+$9,500 -2,000 -$1,000 -$4,800
-5,000
+ $5,400
+ $750
+ $5,000 =
$4,000
+ $1,000
+ $5,000
+$4,500
+ $9,500
- $5,980
TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $17,020
TOTAL ASSETS = $17,020
LO 1 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
– Dividends Declared
3-25
Chapter 3
- $1,000
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-2 Assets
Trans. Apr. 30 Bal. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. May 31 Bal.
Cash $5,000
=
Liabilities
Accounts Prepaid Accounts Receivable Insurance Equipment = Payable $6,000 $2,000
+$8,000
Bank Loan Payable
Shareholders’ Equity Retained Earnings
+
+
Common + Shares Balance Revenues $5,000 $4,000
-$1,600 +$3,800
+$3,800 −300 +$20,000 −8,000 +$500
−3,000 −$500 + $6,800
+ $500
+ $8,000 =
$2,000
+ $20,000
+$5,000 +$4,000
+ $3,800
−250 – $2,150
TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $32,150
TOTAL ASSETS = $32,150
LO 1 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
– Dividends Declared
+$8,000
−1,600 −300 +20,000 −8,000 −500 +3,000 −500 −250 $16,850
– Expenses
3-26
Chapter 3
– $500
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-3 (a) Type of Account
(b) Normal Balance
Bank loans payable
Liabilities
Credit
Buildings
Assets
Debit
Cash
Assets
Debit
Depreciation expense
Expenses
Debit
Income Statement
Dividends declared
Dividends
Debit
Statement of Changes in Equity
Finance income
Revenues
Credit
Income Statement
Furniture, machinery, and equipment
Assets
Debit
Statement of Financial Position
Income tax expense
Expenses
Debit
Income Statement
Income taxes payable
Liabilities
Credit
Statement of Financial Position
Interest expense
Expenses
Debit
Income Statement
Inventories
Assets
Debit
Prepaid expenses
Assets
Debit
Receivables
Assets
Debit
Revenues
Revenues
Credit
Account
(c) Financial Statement Statement of Financial Position Statement of Financial Position Statement of Financial Position
Statement of Financial Position Statement of Financial Position Statement of Financial Position Income Statement
LO 2 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-27
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-4 Transaction 1
March 2: Issued common shares for $11,000 cash.
(a) Basic Analysis
The asset account Cash is increased by $11,000; the shareholders’ equity account Common Shares is increased by $11,000.
(b) Equation Analysis
Assets
=
Liabilities
+
Cash +$11,000
Shareholders’ Equity Common Shares +$11,000
(c) Debit−Credit Analysis
Debits increase assets: debit Cash $11,000. Credits increase share capital (shareholders’ equity): credit Common Shares $11,000.
Transaction 2
March 4: Purchased used car for $1,000 cash and $9,000 on account, for use in the business.
(a) Basic Analysis
The asset account Vehicles is increased by $10,000; the liability account Accounts Payable is increased by $9,000; the asset account Cash is decreased by $1,000.
(b) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Account Payable +$9,000
Cash -$1,000 Vehicles +$10,000 (c) Debit−Credit Analysis
Solutions Manual .
Debits increase assets: debit Vehicles $10,000. Credits increase liabilities: credit Accounts Payable $9,000. Credit decrease assets: credit Cash $1,000.
3-28
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-4 (CONTINUED) (a), (b), and (c) (continued) Transaction 3
March 10: Billed customers $2,300 for services performed.
(a) Basic Analysis
The asset account Accounts Receivable is increased by $2,300; the revenue account Service Revenue is increased by $2,300.
(b) Equation Analysis
Assets
=
Liabilities
+
Accounts Receivable +$2,300
Shareholders’ Equity Service Revenue +$2,300
(c) Debit−Credit Analysis
Debits increase assets: debit Accounts Receivable $2,300. Credits increase revenues: credit Service Revenue $2,300.
Transaction 4
March 13: Paid $225 cash to advertise business opening.
(a) Basic Analysis
The expense account Advertising Expense is increased by $225; the asset account Cash is decreased by $225.
(b) Equation Analysis
Assets
=
Liabilities
Cash -$225
(c) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Advertising Expense -$225
Debits increase expenses: debit Advertising Expense $225. Credits decrease assets: credit Cash $225.
3-29
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-4 (CONTINUED) (a), (b), and (c) (continued) Transaction 5
March 25: Received $1,000 cash from customers billed on March 10.
(a) Basic Analysis
The asset account Cash is increased by $1,000; the asset account Accounts Receivable is decreased by $1,000.
(b) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Cash +$1,000 Accounts Receivable -$1,000
(c) Debit−Credit Analysis
Debits increase assets: debit Cash $1,000. Credits decrease assets: credit Accounts Receivable $1,000.
Transaction 6
March 27: Paid amount owing for used car purchased on March 4.
(a) Basic Analysis
The liability account Accounts Payable is decreased by $9,000; the asset account Cash is decreased by $9,000.
(b) Equation Analysis
Assets
Cash -$9,000 (c) Debit−Credit Analysis
Solutions Manual .
=
Liabilities
+
Shareholders’ Equity
Accounts Payable -$9,000
Debits decrease liabilities: debit Accounts Payable $9,000. Credits decrease assets: credit Cash $9,000.
3-30
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-4 (CONTINUED) (a), (b), and (c) (continued) Transaction 7
March 30: Received $700 cash from a customer for services to be performed in April.
(a) Basic Analysis
The asset account Cash is increased by $700; the liability account Unearned Revenue is increased by $700.
(b) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Unearned Revenue +$700
Cash +$700 (c) Debit−Credit Analysis
Debits increase assets: debit Cash $700. Credits increase liabilities: credit Unearned Revenue $700.
Transaction 8
March 31: Declared and paid $300 of dividends to shareholders.
(a) Basic Analysis
The asset account Cash is decreased by $300; the Dividends Declared account is increased by $300.
(b) Equation Analysis
Assets
=
Liabilities
Cash -$300 (c) Debit−Credit Analysis
+
Shareholders’ Equity Dividends Declared -$300
Debits increase dividends: debit Dividends Declared $300. Credits decrease assets: credit Cash $300.
LO 1,2 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-31
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-5 1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Equipment ............................... Accounts Payable...............
8,000
Rent Expense .......................... Cash .................................
1,600
Accounts Receivable ............... Service Revenue ..............
3,800
Utilities Expense ...................... Cash .................................
300
Cash ........................................ Bank Loan Payable ..........
20,000
Accounts Payable.................... Cash .................................
8,000
Prepaid Insurance ................... Cash .................................
500
Cash ........................................ Accounts Receivable........
3,000
Dividends Declared ................. Cash .................................
500
Income Tax Expense............... Cash .................................
250
8,000
1,600
3,800
300
20,000
8,000
500
3,000
500
250
LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-32
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-6 Mar. 2
4
10
13
25
27
30
31
Cash ........................................ Common Shares.................
11,000
Vehicles ................................... Cash .................................. Accounts Payable .............
10,000
Accounts Receivable ............... Service Revenue ..............
2,300
Advertising Expense ................ Cash .................................
225
Cash ........................................ Accounts Receivable ........
1,000
Accounts Payable .................... Cash .................................
9,000
Cash ........................................ Unearned Revenue ..........
700
Dividends Declared ................. Cash .................................
300
11,000
1,000 9,000
2,300
225
1,000
9,000
700
300
LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
3-33
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-7 Transaction 1
Sept. 1: Issued common shares for $20,000 cash.
(a) Basic Analysis
The asset account Cash is increased by $20,000; the shareholders’ equity account Common Shares is increased by $20,000.
(b) Equation Analysis
Assets
=
Liabilities
+
Cash +$20,000
Shareholders’ Equity Common Shares +$20,000
(c) Debit−Credit Analysis
Debits increase assets: debit Cash $20,000. Credits increase share capital (shareholders’ equity): credit Common Shares $20,000.
Transaction 2
Sept. 2: Performed $9,000 of services on account for a customer.
(a) Basic Analysis
The asset account Accounts Receivable is increased by $9,000; the revenue account Service Revenue is increased by $9,000.
(b) Equation Analysis
Assets
=
Liabilities
Accounts Receivable +$9,000 (c) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Service Revenue +$9,000
Debits increase assets; debit Accounts Receivable $9,000. Credits increase revenues; credit Service Revenue $9,000.
3-34
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-7 (CONTINUED) (a), (b), and (c) (continued) Transaction 3
Sept. 4: Purchased equipment for $12,000 paying $5,000 in cash and borrowing the balance from the bank.
(a) Basic Analysis
The asset account Equipment is increased by $12,000; the asset account Cash is decreased by $5,000 and the liability account Bank Loan Payable increased by $7,000.
(b) Equation Analysis
Assets
=
Liabilities
Shareholders’ Equity
+
Bank Loan Payable +$7,000
Cash -$5,000 Equipment +$12,000
(c) Debit−Credit Analysis
Debits increase assets: debit Equipment $12,000. Credits decrease assets: credit Cash $5,000 Credits increase liabilities: credit Bank Loan Payable $7,000.
Transaction 4
Sept. 10: Purchased $500 of supplies on account.
(a) Basic Analysis
The asset account Supplies is increased by $500; the liability account Accounts Payable is increased by $500.
(b) Equation Analysis
Assets
Supplies +$500
(c) Debit−Credit Analysis
Solutions Manual .
=
Liabilities
+
Shareholders’ Equity
Accounts Payable +$500
Debits increase assets: debit Supplies $500. Credits increase liabilities: credit Accounts Payable $500.
3-35
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-7 (CONTINUED) (a), (b), and (c) (continued) Transaction 5
Sept. 25: Received $4,500 cash in advance for architectural services to be provided next month.
(a) Basic Analysis
The asset account Cash is increased by $4,500; the liability account Unearned Revenue is increased by $4,500.
(b) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Unearned Revenue +$4,500
Cash +$4,500
(c) Debit−Credit Analysis
Debits increase assets: debit Cash $4,500. Credits increase liabilities: credit Unearned Revenue $4,500.
Transaction 6
Sept. 30: Paid $300 on account in partial payment of amount owing for supplies purchased Sept. 10.
(a) Basic Analysis
The liability account Accounts Payable is decreased by $300; the asset account Cash is decreased by $300.
(b) Equation Analysis
Assets
Cash -$300 (c) Debit−Credit Analysis
Solutions Manual .
=
Liabilities
+
Shareholders’ Equity
Accounts Payable -$300
Debits decrease liabilities: debit Accounts Payable $300. Credits decrease assets: credit Cash $300.
3-36
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-7 (CONTINUED) (a), (b), and (c) (continued) Transaction 7
Sept. 30: Collected $5,000 on account owing from customer from Sept. 2.
(a) Basic Analysis
The asset account Cash is increased by $5,000; the asset account Accounts Receivable is decreased by $5,000.
(b) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Cash +$5,000 Accounts Receivable -$5,000
(c) Debit−Credit Analysis
Debits increase assets: debit Cash $5,000. Credits decrease assets: credit Accounts Receivable $5,000.
(d)
Cash................................................... Common Shares .........................
20,000
Accounts Receivable.......................... Service Revenue.........................
9,000
Equipment .......................................... Cash ........................................... Bank Loan Payable .....................
12,000
Supplies ............................................. Accounts Payable .......................
500
Cash................................................... Unearned Revenue .....................
4,500
Accounts Payable .............................. Cash ...........................................
300
Cash................................................... Accounts Receivable ..................
5,000
Sept. 1
2
4
10
25
30
30
Solutions Manual .
3-37
20,000
9,000
5,000 7,000
500
4,500
300
5,000 Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-7 (CONTINUED) (e) Sept. 1 Sept. 25 Sept. 30 Bal.
Cash 20,000 Sept. 4 4,500 Sept. 30 5,000 24,200
Sept. 2 Bal.
Accounts Receivable 9,000 Sept. 30 4,000
Sept. 10
Supplies 500
Sept. 4
Equipment 12,000
Sept. 30
5,000 300
5,000
Accounts Payable 300 Sept. 10 Bal.
500 200
Unearned Revenue Sept. 25
4,500
Bank Loan Payable Sept. 4
7,000
Common Shares Sept. 1
20,000
Service Revenue Sept. 2
9,000
LO 1,2,3,4 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
EXERCISE 3-8 Cash Mar.
Mar.
2
11,000 Mar.
4
1,000
25
1,000
13
225
30
700
27
9,000
31
300
25
1,000
31 Bal.
2,175 Accounts Receivable
Mar.
10
2,300 Mar.
Mar.
31 Bal.
1,300 Vehicles
Mar.
4
10,000 Accounts Payable
Mar.
27
9,000 Mar.
4
Mar. 31 Bal.
9,000 0
Unearned Revenue Mar. 30
700
Common Shares Mar. 2
11,000
Dividends Declared Mar. 31
300 Service Revenue Mar. 10
2,300
Advertising Expense Mar. 13
225
LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-9 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Operating activity Investing activity Operating activity Operating activity Operating activity Financing activity Operating activity Operating activity Operating activity Operating activity
LO 4 BT: AN Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-10 (a) Aug. 7 Aug. 10 Aug. 14 Aug. 16 Aug. 28 Aug. 30 Aug. 31
Provided services and was paid cash Purchased equipment with a down payment of $1,500 and the balance from a bank loan payable Performed services on account Collected cash in advance of providing services Received a collection from a customer on account Paid salaries Declared and paid dividends
(b) Cash July 31 bal. 4,000 Aug. 7 1,800 Aug. 10 16 900 30 28 700 31 Bal. 3,400 Accounts Receivable July 31 bal. 2,000 Aug. 14 1,450 Aug. 28 Bal. 2,750
Bank Loan Payable Aug. 10 1,500 2,000 500
Unearned Revenue Aug. 16
Solutions Manual .
Common Shares July 31 bal. 2,000 Retained Earnings July 31 bal. 5,000
700
Equipment July 31 bal. 2,500 Aug. 10 4,000 Bal. 6,500 Accounts Payable July 31 bal.
2,500
Aug. 31
Dividends Declared 500
1,500
Service Revenue Aug. 7 14 Bal.
900
Salaries Expense 2,000
Aug. 30
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1,800 1,450 3,250
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-10 (CONTINUED) (c) KANG LTD. Trial Balance August 31 Debit Cash Accounts receivable Equipment Accounts payable Unearned revenue Bank loan payable Common shares Retained earnings Dividends declared Service revenue Salaries expense Totals
Credit
$ 3,400 2,750 6,500 $ 1,500 900 2,500 2,000 5,000 500 2,000 $15,150
3,250 _ $15,150
(Assets, dividends, and expense accounts have debit balances) LO 4,5 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-11 (a) Oct. 1 Oct. 2 Oct. 3 Oct. 4 Oct. 5 Oct. 9 Oct. 12 Oct. 16 Oct. 17 Oct. 22 Oct. 30 Oct. 31 Oct. 31 (b)
Issued common shares in exchange for cash Purchased equipment using a bank loan payable Performed services on account Purchased advertising on account Purchased supplies for cash Received cash for services to be performed in the future Made a partial payment on account Declared and paid dividends Received a collection on account Performed services on account Paid rent for the month of October Paid salaries Recorded income taxes owing
After summing the debit and credits in each account, the following net balances would result. Note that because the Supplies, Equipment, Income Tax Payable, Bank Loan Payable, Unearned Revenue, Common Shares, Dividends Declared, Salaries Expense, Advertising Expense, Rent Expense, and Income Tax Expense accounts have only one entry, there is no need to sum these accounts. Balance 550 2,240 400 3,500 100 180 650 3,500 2,000 300 2,740 500 250 1,250 180
Cash Accounts receivable Supplies Equipment Accounts payable Income tax payable Unearned revenue Bank loan payable Common shares Dividends declared Service revenue Salaries expense Advertising expense Rent expense Income tax expense
Solutions Manual .
3-43
Debit or Credit Debit Debit Debit Debit Credit Credit Credit Credit Credit Debit Credit Debit Debit Debit Debit
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-11 (CONTINUED) (c) HOLLY CORP. Trial Balance October 31 Debit Cash Accounts receivable Supplies Equipment Accounts payable Income tax payable Unearned revenue Bank loan payable Common shares Dividends declared Service revenue Salaries expense Advertising expense Rent expense Income tax expense Totals
Credit
$ 550 2,240 400 3,500 $
100 180 650 3,500 2,000
300 2,740 500 250 1,250 180 $9,170
0 $9,170
(Total of debit account balances = Total of credit account balances) LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-12 BOURQUE LTD. Trial Balance December 31, 2018 Debit Cash Accounts receivable Supplies Equipment Accumulated depreciation—equipment Accounts payable Salaries payable Unearned revenue Common shares Retained earnings Dividends declared Service revenue Salaries expense Office expense Depreciation expense Rent expense Supplies expense Income tax expense
Credit
$10,000 6,500 3,500 10,000 $ 4,000 1,500 3,000 2,200 5,000 16,000 4,500 22,000 9,100 4,400 2,000 2,000 1,200 500 $53,700
$53,700
(Liabilities, common shares, retained earnings, and revenue accounts have credit balances) LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-13 BOURQUE LTD. Income Statement Year Ended December 31, 2018 Revenues Service revenue Expenses Salaries expense Office expense Depreciation expense Rent expense Supplies expense Total expenses Income before income tax Income tax expense Net income
$22,000 $9,100 4,400 2,000 2,000 1,200 18,700 3,300 500 $ 2,800
BOURQUE LTD. Statement of Changes in Equity Year Ended December 31, 2018 Common Shares
Retained Earnings
Total Equity
$5,000
$16,000 2,800 (4,500) $14,300
$21,000 2,800 (4,500) $19,300
Balance, January 1, 2018 Net income Dividends declared Balance, December 31, 2018
Solutions Manual .
$5,000
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Financial Accounting, Seventh Canadian Edition
EXERCISE 3-13 (CONTINUED) BOURQUE LTD. Statement of Financial Position December 31, 2018 Assets Current assets Cash Accounts receivable Supplies Total current assets Property, plant, and equipment Equipment Less: Accumulated depreciation Total property, plant, and equipment Total assets
$10,000 6,500 3,500 $20,000 $10,000 4,000 6,000 $26,000
Liabilities and Shareholders' Equity Current liabilities Accounts payable Salaries payable Unearned revenue Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$ 1,500 3,000 2,200 6,700 $ 5,000 14,300 19,300 $26,000
[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared] LO 5 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
EXERCISE 3-14 (a) SPEEDY SERVICE INC. Trial Balance July 31, 2018 Debit Cash Held for trading investments Accounts receivable Prepaid insurance Equipment Accumulated depreciation—equipment Accounts payable Salaries payable Bank loan payable, due 2020 Common shares Retained earnings Dividends declared Service revenue Salaries expense Depreciation expense Rent expense Repairs and maintenance expense Interest expense Insurance expense Income tax expense Totals
Credit
$ 8,000 20,000 14,000 200 99,000 $ 21,400 9,500 800 39,000 38,000 20,850 800 75,000 25,000 9,700 9,000 10,450 3,600 1,800 3,000 $204,550
0 $204,550
(Asset, dividends, and expense accounts have debit balances)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
EXERCISE 3-14 (CONTINUED) (b) SPEEDY SERVICE INC. Income Statement Year Ended July 31, 2018 Revenues Service revenue Expenses Salaries expense Repairs and maintenance expense Depreciation expense Rent expense Interest expense Insurance expense Total expenses Income before income tax Income tax expense Net income
$75,000 $25,000 10,450 9,700 9,000 3,600 1,800 59,550 15,450 3,000 $12,450
SPEEDY SERVICE INC. Statement of Changes in Equity Year Ended July 31, 2018
Balance, August 1, 2017 Issued common shares Net income Dividends declared Balance, July 31, 2018
Solutions Manual .
Common Shares
Retained Earnings
Total Equity
$27,000 11,000
$20,850
$47,850 11,000 12,450 (800) $70,500
$38,000
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12,450 (800) $32,500
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 3-14 (CONTINUED) (b) (continued) SPEEDY SERVICE INC. Statement of Financial Position July 31, 2018 Assets Current assets Cash Held for trading investments Accounts receivable Prepaid insurance Total current assets Property, plant, and equipment Equipment Less: Accumulated depreciation Total property, plant, and equipment Total assets
$ 8,000 20,000 14,000 200 $ 42,200 $99,000 21,400 77,600 $119,800
Liabilities and Shareholders' Equity Current liabilities Accounts payable Salaries payable Total current liabilities Non-current liabilities Bank loan payable, due 2020 Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$9,500 800 $ 10,300 39,000 49,300 $38,000 32,500 70,500 $119,800
[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared]
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Financial Accounting, Seventh Canadian Edition
EXERCISE 3-14 (CONTINUED) (c)
If the amount of the retained earnings was not known, it would be more difficult to prepare the three financial statements in part (b) above. However, the beginning balance of retained earnings could either be derived from the trial balance or worked backwards by determining the ending retained earnings amount from a complete (except for retained earnings) statement of financial position and adjusting the ending amount by calculating and deducting net income and adding dividends declared. Remember that ending retained earnings = beginning retained earnings + net income – dividends declared; so it follows mathematically that beginning retained earnings = ending retained earnings – net income + dividends declared
LO 5 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 3-15 Error
(a) In Balance
(b) Difference
(c) Larger Column
1. 2. 3. 4. 5. 6.
No Yes Yes No No No
$400 0 0 500 225 9
Debit n/a n/a Credit Debit Credit
LO 5 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 3-1A (a) Assets
Transaction 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Apr. 30 Bal.
Cash +$5,000 +20,000 –11,000 –1,200 –1,450
Accounts Receivable
Supplies
=
Equipment
Liabilities
Accounts = Payable
Bank Loan Payable
Shareholders’ Equity Retained Earnings
+
Common + Shares +$5,000
+ Revenues
(b)
+$20,000 –$1,200 +$1,450 –600
+$16,000
+$18,000 –$400 –2,000 –600 –100 –6,400
–12,000 + $4,000
+$1,450
+ $11,000 =
$0
+ $20,000
+ $5,000
+ $18,000
–1,500 –$11,800
–$400
TOTAL ASSETS = $30,800 TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $20,000 + ($5,000 + $18,000 – $11,800 – $400) = $30,800 NET INCOME = $18,000 – $11,800 = $6,200
LO 1 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
– Dividends Declared
+$11,000
+$600 +2,000 –400 –2,000 –600 –100 –6,400 +12,000 –1,500 $14,350
– Expenses
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-2A (a) Assets
Shareholders’ Equity Retained Earnings
Liabilities
Bank Accounts Loan Accounts Common Cash + Receivable +Supplies+Equipment= Payable + Payable + Shares + Jul 31 Bal.. Aug. 2 3 6 7 13 17
$4,000 +1,200 +1,300 −2,700 +3,000 –400 –4,675
17 20 22 24 28 31 Aug. 31 Bal.
+3,500 –500
$1,500 –1,200
$500
$5,000
$4,100
$3,500
Balance
Dividends +Revenues – Expenses– Declared
$3,400
+1,300 −2,700 +3,500
+$6,500 +1,200
+800 –$3,500 –900 –275
–3,500 –$500 +1,000
+1,000
+2,000
+$2,000
–500
$1,300
0 0
00 00
700 000
+275 00 000
00 000
00 000
$6,225+
$1,300+
$500+
$6,200=
$2,000+
$2,475+
$4,800 +
$3,400
+
00 000
–275 −500
00 0
$7,500 –
$5,450 –
$500
TOTAL ASSETS $14,225 = TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY $14,225 Note: The August 27th transaction does not affect the accounting equation and is therefore not recorded in the accounting records.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-2A (CONTINUED) (b) HILLS LEGAL SERVICES INC. Income Statement Month Ended August 31, 2018 Revenues Service revenue Expenses Salaries expense Rent expense Advertising expense Utilities expense Total expenses Income before income tax Income tax expense Net income
$7,500 $3,500 900 275 275 4,950 2,550 500 $2,050
[Revenues – Expenses = Net income or (loss)]
HILLS LEGAL SERVICES INC. Statement of Changes in Equity Month Ended August 31, 2018
Balance, August 1 Issued common shares Net income Dividends declared Balance, August 31
Solutions Manual .
Common Shares
Retained Earnings
$3,500 1,300
$3,400
00 $4,800
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2,050 (500) $4,950
Total Equity $6,900 1,300 2,050 (500) $9,750
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-2A (CONTINUED) (b) (continued) HILLS LEGAL SERVICES INC. Statement of Financial Position August 31, 2018 Assets Current assets Cash Accounts receivable Supplies Total current assets Property, plant, and equipment Equipment Total assets
$6,225 1,300 500 $ 8,025 6,200 $14,225
Liabilities and Shareholders' Equity Current liabilities Accounts payable Bank loan payable Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity
$2,475 2,000 $ 4,475 $4,800 4,950 9,750 $14,225
(Assets = Liabilities + Shareholders’ equity) LO 1 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-3A (a) Account Debited (2) Specific Basic Type Account (1)
Transaction
(3)
(1)
Effect
Basic Type
Account Credited (2) Specific Account
(3) Effect
Apr. 2
Shareholders’ equity
Rent Expense
Increase
Assets
Cash
Decrease
Apr. 3
Assets
Accounts Receivable
Increase
Shareholders’ equity
Sales
Increase
Apr. 5
Assets
Cash
Increase
Shareholders’ equity
Sales
Increase
Apr. 6
Assets
Equipment
Increase
Liabilities
Accounts Payable Cash
Increase
Assets
Decrease
Apr. 12
Assets
Cash
Increase
Assets
Accounts Receivable
Decrease
Apr. 15
Shareholders’ equity
Dividends Declared
Increase
Assets
Cash
Decrease
Apr. 16
Assets
Inventory
Increase
Liabilities
Accounts Payable
Increase
Repairs and Maintenance Expense
Increase
Assets
Cash
Decrease
Apr. 19
Shareholders’ equity
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-3A (CONTINUED) (a) (continued)
Transaction
Apr. 20
Apr. 25
Apr. 27 Apr. 30
Solutions Manual .
Account Debited (1) (2) Specific Basic Type Account
(3) Effect
Account Credited (1) (2) Specific Basic Type Account
(3) Effect
Assets
Accounts Receivable
Increase
Shareholders’ equity
Sales
Increase
Liabilities
Accounts Payable
Decrease
Assets
Cash
Decrease
Assets
Cash
Increase
Liabilities
Unearned Revenue
Increase
Shareholders’ equity
Salaries Expense
Increase
Assets
Cash
Decrease
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-3A (CONTINUED) (b) Normal Balance debit
Date Apr. 2
Account Rent Expense
Apr. 3, 12, 20
Accounts Receivable
debit
Apr. 3, 5, 20
Sales
credit
Apr. 2, 5, 6, 12, 15, 19, 25, 27, 30
Cash
debit
Apr. 6
Equipment
debit
Apr. 6, 16, 25
Accounts Payable
credit
Apr. 15
Dividends Declared
debit
Apr. 16
Inventory
debit
Apr. 19
Repairs and Maintenance Expense
debit
Apr. 27
Unearned Revenue
credit
Apr. 30
Salaries Expense
debit
LO 2 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-4A (a) Account Accumulated depreciation Administrative expenses Buildings Common shares, beginning of year Cost of goods sold Dividends declared Finance income Goodwill Income tax expense Income taxes recoverable Inventories Prepaid expenses Retained earnings, beginning of year Sales Trade and other payables Trade and other receivables
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(1) Increases By Credit Debit Debit Credit Debit Debit Credit Debit Debit Debit Debit Debit Credit Credit Credit Debit
(2) Normal Balance Credit Debit Debit Credit Debit Debit Credit Debit Debit Debit Debit Debit Credit Credit Credit Debit
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-4A (CONTINUED) (b) Account Accumulated depreciation Administrative expenses Buildings Common shares, beginning of year Cost of goods sold Dividends declared Finance income Goodwill Income tax expense Income taxes recoverable Inventories Prepaid expenses Retained earnings, beginning of year Sales Trade and other payables Trade and other receivables
Financial Statement Statement of Financial Position Income Statement Statement of Financial Position Statement of Changes in Equity Income Statement Statement of Changes in Equity Income Statement Statement of Financial Position Income Statement Statement of Financial Position Statement of Financial Position Statement of Financial Position Statement of Changes in Equity Income Statement Statement of Financial Position Statement of Financial Position
Note: Beginning-of-the-year equity amounts such as opening common shares or opening retained earnings balances are shown on the statement of changes in equity and do not appear on the statement of financial position. Only end-of-year amounts for equity accounts would appear on the statement of financial position. (c) Account Accumulated depreciation Buildings Goodwill Income taxes recoverable Inventories Prepaid expenses Trade and other payables Trade and other receivables
Classification Non-current assets Non-current assets Non-current assets Current assets Current assets Current assets Current liabilities Current assets
LO 2 BT: K Difficulty: S Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5A (a) Transaction 1
Feb.2: Purchased supplies on account for $600.
(1) Basic Analysis
The asset account Supplies is increased by $600; the liability account Accounts Payable is increased by $600.
(2) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Accounts Payable +$600
Supplies +$600
(3) Debit−Credit Analysis
Debits increase assets: debit Supplies $600. Credits increase liabilities: credit Accounts Payable $600.
Transaction 2
Feb.3: Purchased equipment for $10,000 by signing a bank loan due in three months.
(1) Basic Analysis
The asset account Equipment is increased by $10,000; the liability account Bank Loan Payable is increased by $10,000.
(2) Equation Analysis
Assets
=
Liabilities
Solutions Manual .
Shareholders’ Equity
Bank Loan Payable +$10,000
Equipment +$10,000 (3) Debit−Credit Analysis
+
Debits increase assets: debit Equipment $10,000. Credits increase liabilities: credit Bank Loan Payable $10,000.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5A (CONTINUED) (a) (continued) Transaction 3
Feb.6: Earned service revenue of $50,000. Of this amount, $30,000 was received in cash. The balance was on account.
(1) Basic Analysis
The asset account Cash is increased by $30,000; the asset account Accounts Receivable is increased by $20,000; the shareholders’ equity account Service Revenue is increased by $50,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Cash +$30,000
Shareholders’ Equity Service Revenue +$50,000
Accounts Receivable +$20,000
(3) Debit−Credit Analysis
Debits increase assets: debit Cash $30,000. Debits increase assets: debit Accounts Receivable $20,000. Credits increase revenues: credit Service Revenue $50,000.
Transaction 4
Feb.13: Declared and paid dividends of $500 to shareholders.
(1) Basic Analysis
The asset account Cash is decreased by $500; the Dividends Declared account is increased by $500.
(2) Equation Analysis
Assets
=
Liabilities
Cash -$500 (3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Dividends Declared -$500
Debits increase dividends: debit Dividends Declared $500. Credits decrease assets: credit Cash $500.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5A (CONTINUED) (a) (continued) Transaction 5
Feb. 18: Received cash of $2,000 from a customer as a deposit for services to be provided next month.
(1) Basic Analysis
The asset account Cash is increased by $2,000; the liability account Unearned Revenue is increased by $2,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Unearned Revenue +$2,000
Cash +$2,000
(3) Debit−Credit Analysis
Debits increase assets: debit Cash $2,000. Credits increase liabilities: credit Unearned Revenue $2,000.
Transaction 6
Feb. 20: Paid amount owing from the supplies purchased on Feb. 2.
(1) Basic Analysis
The asset account Cash is decreased by $600; the liability account Accounts Payable is decreased by $600.
(2) Equation Analysis
Assets
Cash -$600 (3) Debit−Credit Analysis
Solutions Manual .
=
Liabilities
+
Shareholders’ Equity
Accounts Payable -$600
Debits decrease liabilities: debit Accounts Payable $600. Credits decrease assets: credit Cash $600.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5A (CONTINUED) (a) (continued) Transaction 7
Feb. 23: Collected $20,000 of the amount owing from the Feb. 6 transaction.
(1) Basic Analysis
The asset account Cash is increased by $20,000; the asset account Accounts Receivable is decreased by $20,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Cash +$20,000 Accounts Receivable -$20,000
(3) Debit−Credit Analysis
Debits increase assets: debit Cash $20,000. Credits decrease assets: credit Accounts Receivable $20,000.
Transaction 8
Feb. 24: Paid office expenses for the month, $22,000.
(1) Basic Analysis
The expense account Office Expense is increased by $22,000; the asset account Cash is decreased by $22,000.
(2) Equation Analysis
Assets
=
Liabilities
Cash -$22,000
(3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Office Expense -$22,000
Debits increase expenses: debit Office Expense $22,000. Credits decrease assets: credit Cash $22,000.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5A (CONTINUED) (a) (continued) Transaction 9
Feb.27: Recorded salaries due to employees for work performed during the month, $14,000.
(1) Basic Analysis
The expense account Salaries Expense is increased by $14,000; the liability account Salaries Payable is increased by $14,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Salaries Payable +$14,000
Shareholders’ Equity Salaries Expense -$14,000
(3) Debit−Credit Analysis
Debits increase expenses: debit Salaries Expense $14,000. Credits increase liabilities: credit Salaries Payable $14,000.
Transaction 10
Feb. 28: Paid interest of $50 on the bank loan signed on Feb. 3.
(1) Basic Analysis
The expense account Interest Expense is increased by $50; the asset account Cash is decreased by $50.
(2) Equation Analysis
Assets
=
Liabilities
Cash -$50 (3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Interest Expense -$50
Debits increase expenses: debit Interest Expense $50. Credits decrease assets: credit Cash $50.
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PROBLEM 3-5A (CONTINUED) (b) Feb. 2 Supplies........................................................... Accounts Payable.....................................
600 600
3 Equipment ....................................................... Bank Loan Payable .................................
10,000
6 Cash ................................................................ Accounts Receivable ...................................... Service Revenue ......................................
30,000 20,000
13 Dividends Declared ......................................... Cash .........................................................
500
18 Cash ................................................................ Unearned Revenue ..................................
2,000
20 Accounts Payable ............................................ Cash .........................................................
600
23 Cash ................................................................ Accounts Receivable ................................
20,000
24 Office Expense ................................................ Cash .........................................................
22,000
27 Salaries Expense............................................. Salaries Payable ......................................
14,000
28 Interest Expense.............................................. Cash .........................................................
50
10,000
0 50,000
500
2,000
600
20,000
22,000
14,000
50
LO 1,2,3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-6A May 1 Cash ................................................................ Common Shares ......................................
120,000
4 Land ................................................................ Buildings .......................................................... Equipment ....................................................... Cash ......................................................... Mortgage Payable ....................................
125,000 100,000 45,000
4 Prepaid Insurance ........................................... Cash .........................................................
1,500
5 Advertising Expense ........................................ Cash .........................................................
800
6 Equipment ....................................................... Accounts Payable ....................................
9,000
18 Cash ................................................................ Fees Earned.............................................
8,800
20 Dividends Declared ......................................... Cash .........................................................
500
22 Cash ................................................................ Unearned Revenue ..................................
1,200
29 Accounts Payable............................................ Cash .........................................................
9,000
30 Interest Expense ............................................. Cash .........................................................
800
30 Salaries Expense ............................................ Cash .........................................................
3,400
120,000
70,000 200,000
1,500
800
9,000
8,800
500
1,200
9,000
800
3,400
(Each journal entry must balance and reflect the actual amount of the transaction) LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-7A (a) Apr. 1
Cash ................................................................ Equipment ....................................................... Common Shares.......................................
10,000 6,000 16,000
1 No entry. Not a transaction 2
3
10
13
20
21
23
25
27
30
30
Solutions Manual .
Rent Expense .................................................. Cash .........................................................
950
Supplies ........................................................... Accounts Payable .....................................
1,900
Accounts Receivable ....................................... Service Revenue ......................................
1,200
Cash ................................................................ Unearned Revenue ..................................
800
Cash ................................................................ Service Revenue ......................................
2,500
Cash ................................................................ Accounts Receivable ................................
600
Utilities Expense .............................................. Accounts Payable .....................................
135
Dividends Declared ......................................... Cash .........................................................
160
Accounts Payable ............................................ Cash .........................................................
950
Salaries Expense ............................................. Cash .........................................................
1,900
Income Tax Expense ....................................... Cash .........................................................
100
3-68
950
1,900
1,200
800
2,500
600
135
160
950
1,900
100
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-7A (CONTINUED) (b) Cash 10,000 Apr. 2 800 Apr. 25 2,500 Apr. 27 600 Apr. 30 Apr. 30 9,840
Apr. 1 Apr. 13 Apr. 20 Apr. 21 Bal.
Accounts Receivable 1,200 Apr. 21 600
Apr. 10 Bal.
950 160 950 1,900 100 Apr. 25
Apr. 13
800
Common Shares Apr. 1
16,000
Dividends Declared 160 Service Revenue Apr. 10 Apr. 20 Bal.
600
Apr. 3
Supplies 1,900
Apr. 30
Salaries Expense 1,900
Apr. 1
Equipment 6,000
Apr. 2
Rent Expense 950
Apr. 23
Utilities Expense 135
Apr. 30
Income Tax Expense 100
Accounts Payable 950 Apr. 3 Apr. 23 Bal.
Apr. 27
1,900 135 1,085
1,200 2,500 3,700
Unearned Revenue (c)
This suggestion is not a good idea. Journals are used to record transactions. A general ledger is not intended to be used to capture the recording of transactions, but to tabulate the effects of transactions in separate accounts. The balances arrived at in the ledger are then used to communicate information to the users of the financial statements. If one attempted to omit the use of journal entries, one could not retrace the transactions as they originated in the journal. One would only see one side of a transaction at a time by looking at an account in the ledger. It would become very confusing and unruly to try to keep track of transactions.
LO 3,4 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-8A (a) Mar. 1
Rent Expense .................................................. Accounts Payable ..................................... Cash .........................................................
27,000 17,000 10,000
2
No entry.
5
No entry.
12
Accounts Payable ........................................... Cash .........................................................
17,000
Accounts Payable ........................................... Cash .........................................................
12,000
Cash ................................................................ Fees Earned .............................................
25,500
Advertising Expense ........................................ Cash .........................................................
950
20
Rent Expense .................................................. Cash .........................................................
3,000
23
Salaries Expense ............................................. Cash .........................................................
4,200
Mortgage Payable ............................................ Interest Expense .............................................. Cash .........................................................
1,250 750
Income Tax Expense ....................................... Cash .........................................................
3,000
Cash ................................................................ Accounts Receivable ($2,490 × ½) .................. Concession Revenue ................................
1,245 1,245
Cash ................................................................ Fees Earned .............................................
25,800
13
15
19
26
28
30
31
Solutions Manual .
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17,000
12,000
25,500
950 0 3,000
4,200
2,000
3,000
2,490 0 25,800
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-8A (CONTINUED) (b) Cash Feb. 28 Bal. 15,000 Mar. 1 Mar. 15 25,500 Mar. 12 Mar. 30 1,245 Mar. 13 Mar. 31 25,800 Mar. 19 Mar. 20 Mar. 23 Mar. 26 Mar. 28 Bal. 15,395
10,000 17,000 12,000 950 3,000 4,200 2,000 3,000
Accounts Receivable 1,245
Retained Earnings Feb. 28 Bal.
27,000
Fees Earned Mar. 15 Mar. 31 Bal.
25,500 25,800 51,300
Concession Revenue Mar. 30
2,490
Mar. 1 Mar. 20 Bal.
Rent Expense 27,000 3,000 30,000
Buildings Feb. 28 Bal. 77,000
Mar. 23
Salaries Expense 4,200
Equipment Feb. 28 Bal. 20,000
Mar. 19
Advertising Expense 950
Mar. 26
Interest Expense 750
Mar. 28
Income Tax Expense 3,000
Mar. 30
Land Feb. 28 Bal. 85,000
Mar. 12 Mar. 13
Accounts Payable 17,000 Feb. 28 Bal. 12,000 Mar. 2 Bal.
Mar. 26
Mortgage Payable 1,250 Feb. 28 Bal. 118,000 Bal. 116,750 Common Shares Feb. 28 Bal.
Solutions Manual .
12,000 17,000 0
40,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-8A (CONTINUED) (c) STAR THEATRE INC. Trial Balance March 31, 2018 Debit Cash Accounts receivable Land Buildings Equipment Mortgage payable Common shares Retained earnings Fees earned Concession revenue Rent expense Salaries expense Advertising expense Interest expense Income tax expense Totals
Credit
$ 15,395 1,245 85,000 77,000 20,000 $116,750 40,000 27,000 51,300 2,490 30,000 4,200 950 750 3,000 $237,540
00 $237,540
[Liabilities (mortgage payable) and shareholders’ equity items such as common shares, retained earnings, and revenue accounts (fees earned and concession revenue) have credit balances] LO 3,4,5 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-9A (a) May 1
Rent Expense ................................................. Cash ........................................................
1,000
Accounts Payable ........................................... Cash ........................................................
1,100
Cash................................................................ Unearned Revenue ..................................
1,500
Cash................................................................ Service Revenue......................................
2,000
Salaries Expense ............................................ Cash ........................................................
1,200
Unearned Revenue ........................................ Service Revenue......................................
700
18
Accounts Payable ........................................... Cash ........................................................
1,000
22
Supplies .......................................................... Accounts Payable ....................................
700
Advertising Expense ....................................... Accounts Payable ....................................
500
Utilities Expense ............................................. Cash ........................................................
400
Cash................................................................ Service Revenue......................................
2,100
Unearned Revenue ......................................... Service Revenue......................................
600
Interest Expense ............................................. Cash ........................................................
50
Salaries Expense ............................................ Cash ........................................................
1,200
4
7
15
15
17
24
25
28
29
30
31
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1,000
1,100
1,500
2,000
1,200
700 0 1,000
700
500
400
2,100
600
50
1,200
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-9A (CONTINUED) (a) (continued) May 31
Income Tax Expense ...................................... Cash ........................................................
150 150
(b)
Bal.
Cash 5,000May 1 1,500 4 2,000 15 2,100 18 25 30 31 31 4,500
Apr. 30 May 22 Bal.
Supplies 500 700 1,200
Apr. 30
Equipment 24,000
Apr. 30 May 7 15 28
May 4 18
May 17 29
Accounts Payable Apr. 30 1,100May 22 1,000 24 Bal. Unearned Revenue 700 Apr. 30 600 May 7 Bal. Bank Loan Payable Apr 30
1,000 1,100 1,200 1,000 400 50 1,200 150
Common Shares Apr. 30
5,000
Retained Earnings Apr. 30
11,400
Service Revenue May 15 17 28 29
2,000 700 2,100 600
Bal. Salaries Expense May 15 1,200 31 1,200 Bal. 2,400
May 1
Rent Expense 1,000
May 24
Advertising Expense 500
May 25
Utilities Expense 400
1,000 1,500 1,200
May 30
Interest Expense 50
10,000
May 31
Income Tax Expense 150
2,100 700 500 1,200
5,400
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-9A (CONTINUED) (c) PAMPER ME SALON INC. Trial Balance May 31, 2018 Debit Cash Supplies Equipment Accounts payable Unearned revenue Bank loan payable Common shares Retained earnings Service revenue Salaries expense Rent expense Advertising expense Utilities expense Interest expense Income tax expense Totals
Credit
$ 4,500 1,200 24,000 $ 1,200 1,200 10,000 5,000 11,400 5,400 2,400 1,000 500 400 50 150 $34,200
$34,200
(Asset and expense accounts have debit balances) LO 3,4,5 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-10A (a) TAGGAR ENTERPRISES INC. Trial Balance June 30, 2018 Debit $ 1,800 3,000 5,100 900 7,400 15,000
Cash Accounts receivable Inventory Prepaid insurance Land Buildings Accumulated depreciation—buildings Equipment Accumulated depreciation—equipment Long-term investments Accounts payable Income tax payable Mortgage payable, due 2025 Common shares Retained earnings Dividends declared Sales Cost of goods sold Office expense Interest expense Income tax expense Totals
Credit
$ 4,000 3,000 1,000 3,550 3,500 100 15,000 5,000 6,250 2,000 25,000 13,700 3,300 100 1,000 $59,850
$59,850
(Asset, dividends declared, and expense accounts have debit balances. Liability, common shares, retained earnings, and revenue (sales) accounts have credit balances)
(b)
When debits equal credits in a trial balance, there is some assurance that certain types of errors were not made. However, there is no guarantee that other types of errors do not exist because entries may have been omitted completely, duplicated, or recorded to incorrect accounts.
LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-11A TAGGAR ENTERPRISES INC. Income Statement Year Ended June 30, 2018 Sales Expenses Cost of goods sold Office expense Interest expense Total expenses Income before income tax Income tax expense Net income
$25,000 $13,700 3,300 100 17,100 7,900 1,000 $ 6,900
TAGGAR ENTERPRISES INC. Statement of Changes in Equity Year Ended June 30, 2018
Balance, July 1, 2017 Issued common shares Net income Dividends declared Balance, June 30, 2018
Solutions Manual .
Common Shares
Retained Earnings
$3,000 2,000
$ 6,250
__ ___ $5,000
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6,900 (2,000) $11,150
Total Equity $ 9,250 2,000 6,900 (2,000) $16,150
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-11A (CONTINUED) TAGGAR ENTERPRISES INC. Statement of Financial Position June 30, 2018 Assets Current assets Cash Accounts receivable Inventory Prepaid insurance Total current assets Long-term investments Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Total property, plant, and equipment Total assets
$1,800 3,000 5,100 900 $10,800 3,550 $ 7,400 $15,000 4,000 $3,000 1,000
11,000 2,000 20,400 $34,750
Liabilities and Shareholders’ Equity Current liabilities Accounts payable Income tax payable Current portion of mortgage payable Total current liabilities Non-current liabilities Mortgage payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders' equity Total liabilities and shareholders' equity
$3,500 100 1,250 $ 4,850 13,750 18,600 $ 5,000 11,150 16,150 $34,750
[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared] LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-12A (a) (1) General: Three accounts are listed in the wrong columns: Cash (debit), Accumulated Depreciation (credit), and Unearned Revenue (credit). (2) 1. The trial balance totals are not affected, only the amounts appearing on the trial balance are affected. Cash would be understated by $180 ($750 – $570) and Accounts Receivable overstated by the same amount. Note that Cash was one of the accounts listed in the wrong column (credit instead of debit). If Cash had not been corrected and was still in the credit column, then the trial balance would still balance but the total credits would be understated by $180 (since Cash is in the credit column) and total debits would be understated by $180 (because of Accounts Receivable in the debit column). 2. The trial balance totals are not affected, only the accounts and amounts appearing on the trial balance are affected. Equipment would be understated by $360 and Supplies overstated by the same amount. 3. Trial balance is out of balance because of the slide error (wrong number of zeros/position of decimal spot). Service Revenue would be understated by $801 ($890 – $89) and the total for the credit column is lower by the same amount. 4. Trial balance is out of balance because of transposition error. Salaries Expense is understated by $900 ($4,300 – $3,400) and the total for the debit column is lower by the same amount. 5. The trial balance totals are not affected by this omission; only the accounts and amounts appearing on the trial balance are affected. Rent Expense would be understated by $1,000 (should be shown on the trial balance) and Cash overstated by the same amount. Note that Cash is one of the accounts listed in the wrong column (credit instead of debit).
Solutions Manual .
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PROBLEM 3-12A (CONTINUED) (b) CANTPOST LTD. Trial Balance June 30, 2018 Debit Cash ($1,241 + $750 – $570 − $1,000) Accounts receivable ($2,630 – $750 + $570) Supplies ($860 – $360) Equipment ($3,000 + $360) Accumulated depreciation—equipment Accounts payable Unearned revenue Common shares Dividends declared Service revenue ($8,440 – $89 + $890) Salaries expense (given) Rent expense Office expense Depreciation expense Income tax expense Totals
$
Credit
421 2,450 500 3,360 $
600 2,665 1,200 1,000
800 9,241 4,300 1,000 910 600 365 $14,706
0 $14,706
Note that the opening retained earnings balance is zero, as this is the company’s first year of operations. (Asset, dividends declared, and expense accounts have debit balances) LO 5 BT: AN Difficulty: C Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-1B (a) Assets
Trans. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. May 31 Bal.
Cash +$8,000 –1,280 –4,000
A/R
Supplies
Equipment
=
Liabilities
=
Bank Loan Payable
A/P
Shareholders’ Equity Retained Earnings
+
Unearned Revenue
+
Common Shares +$8,000
– Expenses
– Dividends Declared
–$1,280 +$16,000
+$12,000
+$700
+$700
+4,200 –700 –200
+$4,200 –700 –200 +$3,600
–2,000 +700 +1,600 –500 –80 –600 $5,140
(b)
+ Revenues
+3,600 –2,000 +$700
–1,600 –$500
+ $2,000
+ $700
+ $16,000
=
$0
+ $12,000
+ $700
+
$8,000
+ $7,800
–80 –600 –$4,160
–$500
TOTAL ASSETS = $23,840 TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY = ($12,000 + $700) + ($8,000 + $7,800 – $4,160 – $500) = $23,840 NET INCOME = $7,800 – $4,160 = $3,640
LO 1 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-2B (a) Assets
Cash Aug. 31 Bal. Sept. 4 4 5 7 10 12 14 17 20 21 26 27 28 Sep. 30 Bal.
+
$4,500 –3,200 –1,200 +1,450 +2,300 –700
A/R
Shareholders’ Equity Retained Earnings
Liabilities
+
$1,800
Supplies
+ Equip. =
$350
$6,500
A/P
Bank Loan Common + Payable + Shares +
$3,200 –3,200
$2,500
+
Rev. –
Div.
–$1,200 +2,300 +2,050
+1,350 +$500 –300 +2,500
+1,500
+4,500
0 $2,350 +
0 $350 +
0 $8,550 =
–750 –175
0 $1,525+
0 $2,500 +
0 $4,800 +
0 0 $7,450 + $5,000 –
–350 $2,775 –
TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY = $18,000
TOTAL ASSETS = $18,000
Note: The transactions on September 6 (hired a part-time office assistant) and 18 (sent a statement) do not affect the accounting equation and are therefore not recorded in the accounting records.
Solutions Manual .
–
$7,450
+175 –500 –350 $6,750+
Exp.
–1,450
+500 –300 +2,500 +3,000 –750
Bal.
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Chapter 3
–$500 0 $500
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-2B (CONTINUED) (b) CORSO CARE CORP. Income Statement Month Ended September 30, 2018 Revenues Service revenue Expenses Rent expense Salaries expense Advertising expense Utilities expense Total expenses Income before income tax Income tax expense Net income
$5,000 $1,200 750 300 175 0
2,425 2,575 350 $2,225
[Revenues – Expenses = Net income or (loss)]
CORSO CARE CORP. Statement of Changes in Equity Month Ended September 30, 2018
Balance, September 1 Issued common shares Net income Dividends declared Balance, September 30
Solutions Manual .
Common Shares
Retained Earnings
$2,500 2,300
$7,450
0 $4,800
3-83
2,225 (500) $9,175
Total Equity $ 9,950 2,300 2,225 (500) $13,975
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-2B (CONTINUED) (b) (continued) CORSO CARE CORP. Statement of Financial Position September 30, 2018 Assets Current assets Cash Accounts receivable Supplies Total current assets Property, plant, and equipment Equipment Total assets
$6,750 2,350 350 $ 9,450 8,550 $18,000
Liabilities and Shareholders' Equity Current liabilities Accounts payable Bank loan payable Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity
$1,525 2,500 $ 4,025 $4,800 9,175 13,975 $18,000
(Assets = Liabilities + Shareholders’ equity) LO 1 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-3B (a) Account Debited (2) Specific Basic Type Account (1)
Transaction
(3)
(1)
Effect
Basic Type
Account Credited (2) Specific Account
(3) Effect
Mar. 1
Shareholders’ equity
Rent Expense
Increase
Assets
Cash
Decrease
Mar. 3
Assets
Accounts Receivable
Increase
Shareholders’ equity
Service Revenue
Increase
Mar. 5
Assets
Cash
Increase
Shareholders’ equity
Sales
Increase
Mar. 8
Assets
Equipment
Increase
Liabilities
Bank Loan Payable Cash
Increase
Assets
Decrease
Mar. 12
Assets
Cash
Increase
Assets
Accounts Receivable
Decrease
Mar. 15
Shareholders’ equity
Salaries Expense
Increase
Assets
Cash
Decrease
Mar. 16
Assets
Supplies
Increase
Liabilities
Accounts Payable
Increase
Mar. 20
Shareholders’ equity
Repairs and Maintenance Expense
Increase
Assets
Cash
Decrease
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-3B (CONTINUED) (a) (continued) Account Debited (2) Specific Basic Type Account (1)
Transaction
(3) Effect
Account Credited (2) Specific Basic Type Account (1)
(3) Effect
Mar. 22
Assets
Accounts Receivable
Increase
Shareholders’ equity
Sales
Increase
Mar. 26
Liabilities
Bank Loan Payable
Decrease
Assets
Cash
Decrease
Mar. 28
Assets
Cash
Increase
Liabilities
Unearned Revenue
Increase
Mar. 31
Shareholders’ equity
Dividends Declared
Increase
Assets
Cash
Decrease
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-3B (CONTINUED) (b) Normal Balance debit
Date Mar. 1
Account Rent Expense
Mar. 3, 12, 22
Accounts Receivable
debit
Mar. 3
Service Revenue
credit
Mar. 1, 5, 8, 12, 15, 20, 26, 28, 31
Cash
debit
Mar. 5, 22
Sales
credit
Mar. 8
Equipment
debit
Mar. 8, 26
Bank Loan Payable
credit
Mar. 15
Salaries Expense
debit
Mar. 16
Accounts Payable
credit
Mar. 16
Supplies
debit
Mar. 20
Repairs and Maintenance Expense
debit
Mar. 28
Unearned Revenue
credit
Mar. 31
Dividends Declared
debit
LO 2 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-4B (a)
Account Accounts payable Accounts receivable Bank loans payable (short-term) Cash Common shares, beginning of year Dividends declared Furniture, fixtures, and production equipment Income taxes expense Income taxes receivable Interest expense Inventories Prepaid expenses Retained earnings, beginning of year Sales Selling, general, and administrative expenses
Solutions Manual .
3-88
(1) Increases with Credit Debit Credit Debit Credit Debit Debit Debit Debit Debit Debit Debit Credit Credit Debit
(2) Normal Balance Credit Debit Credit Debit Credit Debit Debit Debit Debit Debit Debit Debit Credit Credit Debit
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-4B (CONTINUED) (b) Account Accounts payable Accounts receivable Bank loans payable (short-term) Cash Common shares, beginning of year Dividends declared Furniture, fixtures, and production equipment Income taxes expense Income taxes receivable Interest expense Inventories Prepaid expenses Retained earnings, beginning of year Sales Selling, general, and administrative expenses
Financial Statement Statement of Financial Position Statement of Financial Position Statement of Financial Position Statement of Financial Position Statement of Changes in Equity Statement of Changes in Equity Statement of Financial Position Income Statement Statement of Financial Position Income Statement Statement of Financial Position Statement of Financial Position Statement of Changes in Equity Income Statement Income Statement
Note: Beginning-of-the-year equity amounts such as opening common shares or opening retained earnings balances are shown on the statement of changes in equity and do not appear on the statement of financial position as only end-of-year amounts for equity accounts would appear on that statement. (c) Account Accounts payable Accounts receivable Bank loans payable (short-term) Cash Furniture, fixtures, and production equipment Income taxes receivable Inventories Prepaid expenses
Classification Current liabilities Current assets Current liabilities Current assets Non-current assets Current assets Current assets Current assets
LO 2 BT: K Difficulty: S Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 3-5B (a) Transaction 1
Jan. 2: Issued $5,000 of common shares for cash.
(1) Basic Analysis
The asset account Cash is increased by $5,000; the shareholders’ equity account Common Shares account is increased by $5,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Cash +$5,000
Shareholders’ Equity Common Shares +$5,000
(3) Debit−Credit Analysis
Debits increase assets: debit Cash $5,000. Credits increase share capital: credit Common Shares $5,000.
Transaction 2
Jan. 5: Provided services on account $2,500.
(1) Basic Analysis
The asset account Accounts Receivable is increased by $2,500; the revenue account Service Revenue is increased by $2,500.
(2) Equation Analysis
Assets
=
Liabilities
Accounts Receivable +$2,500
(3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Service Revenue +$2,500
Debits increase assets: debit Accounts Receivable $2,500. Credits increase revenues: credit Service Revenue $2,500.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5B (CONTINUED) (a) (continued) Transaction 3
Jan. 6: Obtained a bank loan for $30,000.
(1) Basic Analysis
The asset account Cash is increased by $30,000; the liability account Bank Loan Payable is increased by $30,000.
(2) Equation Analysis
Assets
=
Liabilities
Shareholders’ Equity
+
Bank Loan Payable +$30,000
Cash +$30,000
(3) Debit−Credit Analysis
Debits increase assets: debit Cash $30,000. Credits increase liabilities: credit Bank Loan Payable $30,000.
Transaction 4
Jan. 7: Paid $40,000 to purchase a hybrid car.
(1) Basic Analysis
The asset account Vehicles is increased by $40,000; the asset account Cash is decreased by $40,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Cash -$40,000 Vehicles +$40,000
(3) Debit−Credit Analysis
Solutions Manual .
Debits increase assets: debit Vehicles $40,000. Credits decrease assets: credit Cash $40,000.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5B (CONTINUED) (a) (continued) Transaction 5
Jan. 9: Received a $5,000 deposit from a customer for services to be performed in the future.
(1) Basic Analysis
The asset account Cash is increased by $5,000; the liability account Unearned Revenue is increased by $5,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Unearned Revenue +$5,000
Cash +$5,000
(3) Debit−Credit Analysis
Debits increase assets: debit Cash $5,000. Credits increase liabilities: credit Unearned Revenue $5,000.
Transaction 6
Jan. 12: Billed customers $20,000 for services performed during the month.
(1) Basic Analysis
The asset account Accounts Receivable is increased by $20,000; the revenue account Service Revenue is increased by $20,000.
(2) Equation Analysis
Assets
=
Liabilities
Accounts Receivable +$20,000
(3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Service Revenue +$20,000
Debits increase assets: debit Accounts Receivable $20,000. Credits increase revenues: credit Service Revenue $20,000.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5B (CONTINUED) (a) (continued) Transaction 7
Jan. 19: Paid $500 to purchase supplies.
(1) Basic Analysis
The asset account Supplies is increased by $500; the asset account Cash is decreased by $500.
(2) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Cash -$500 Supplies +$500 (3) Debit−Credit Analysis
Debits increase assets: debit Supplies $500. Credits decrease assets: credit Cash $500.
Transaction 8
Jan 20: Provided $1,500 of services for the customer who paid in advance on January 9.
(1) Basic Analysis
The liability account Unearned Revenue decreased by $1,500; the revenue account Service Revenue is increased by $1,500.
(2) Equation Analysis
Assets
=
Liabilities Unearned Revenue -$1,500
(3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Service Revenue +$1,500
Debits decrease liabilities: debit Unearned Revenue $1,500. Credits increase revenues: credit Service Revenue $1,500.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5B (CONTINUED) (a) (continued) Transaction 9
Jan. 23: Collected $5,000 owing from customers from the January 12 transaction.
(1) Basic Analysis
The asset account Cash is increased by $5,000; the asset account Accounts Receivable is decreased by $5,000.
(2) Equation Analysis
Assets
=
Liabilities
+
Shareholders’ Equity
Cash +$5,000 Accounts Receivable -$5,000
(3) Debit−Credit Analysis
Debits increase assets: debit Cash $5,000. Credits decrease assets: credit Accounts Receivable $5,000.
Transaction 10
Jan 26: Received a bill for utilities of $125, due February 26.
(1) Basic Analysis
The expense account Utilities Expense is increased by $125; the liability account Accounts Payable is increased by $125.
(2) Equation Analysis
Assets
=
Liabilities Accounts Payable +$125
(3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Utilities Expense -$125
Debits increase expenses: debit Utilities Expense $125. Credits increase liabilities: credit Accounts Payable $125.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5B (CONTINUED) (a) (continued) Transaction 11
Jan. 29: Paid rent for the month, $1,500.
(1) Basic Analysis
The expense account Rent Expense is increased by $1,500; the asset account Cash is decreased by $1,500.
(2) Equation Analysis
Assets
=
Liabilities
+
Cash -$1,500
Shareholders’ Equity Rent Expense -$1,500
(3) Debit−Credit Analysis
Debits increase expenses: debit Rent Expense $1,500. Credits decrease assets: credit Cash $1,500.
Transaction 12
Jan. 31: Paid $4,000 of salaries to employees.
(1) Basic Analysis
The expense account Salaries Expense is increased by $4,000; the asset account Cash is decreased by $4,000.
(2) Equation Analysis
Assets
=
Liabilities
Cash -$4,000
(3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Salaries Expense -$4,000
Debits increase expenses: debit Salaries Expense $4,000. Credits decrease assets: credit Cash $4,000.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-5B (CONTINUED) (a) (continued) Transaction 13
Jan 31: Paid interest of $300 on the bank loan from the January 6 transaction.
(1) Basic Analysis
The expense account Interest Expense is increased by $300; the asset account Cash is decreased by $300.
(2) Equation Analysis
Assets
=
Liabilities
+
Cash -$300
Shareholders’ Equity Interest Expense -$300
(3) Debit−Credit Analysis
Debits increase expenses: debit Interest Expense $300. Credits decrease assets: credit Cash $300.
Transaction14
Jan. 31: Paid income tax for the month, $3,600.
(1) Basic Analysis
The expense account Income Tax Expense is increased by $3,600; the asset account Cash is decreased by $3,600.
(2) Equation Analysis
Assets
=
Liabilities
Cash -$3,600
(3) Debit−Credit Analysis
Solutions Manual .
+
Shareholders’ Equity Income Tax Expense -$3,600
Debits increase expenses: debit Income Tax Expense $3,600. Credits decrease assets: credit Cash $3,600.
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PROBLEM 3-5B (CONTINUED) (b) Jan. 2 Cash ................................................................ Common Shares ......................................
5,000 5,000
5 Accounts Receivable ....................................... Service Revenue ......................................
2,500
6 Cash ................................................................ Bank Loan Payable ..................................
30,000
7 Vehicles ........................................................... Cash .........................................................
40,000
9 Cash ................................................................ Unearned Revenue ..................................
5,000
12 Accounts Receivable ....................................... Service Revenue ......................................
20,000
19 Supplies .......................................................... Cash .........................................................
500
20 Unearned Revenue ......................................... Service Revenue ......................................
1,500
23 Cash ................................................................ Accounts Receivable ................................
5,000
26 Utilities Expense .............................................. Accounts Payable ....................................
125
29 Rent Expense .................................................. Cash .........................................................
1,500
31 Salaries Expense ............................................ Cash .........................................................
4,000
31 Interest Expense ............................................. Cash .........................................................
300
31 Income Tax Expense ....................................... Cash .........................................................
03,600
2,500
30,000
40,000
5,000
20,000
500
1,500
5,000
125
1,500
4,000
300
3,600
LO 1,2,3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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PROBLEM 3-6B Apr. 1 Cash ...................................................................... Common Shares ............................................
100,000
3 Land ...................................................................... Buildings ................................................................ Equipment ............................................................. Cash ............................................................... Bank Loan Payable ........................................
204,000 121,000 45,000
8 Advertising Expense .............................................. Accounts Payable ..........................................
1,800
10 Salaries Expense .................................................. Cash ...............................................................
2,800
100,000
60,000 310,000
1,800
2,800
13 No entry as the accounting equation is not affected. 14 Prepaid Insurance ................................................ Cash ..............................................................
5,500
17 Dividends Declared .............................................. Cash ..............................................................
600
20 Cash ..................................................................... Fees Earned..................................................
10,600
30 Accounts Payable................................................. Cash ..............................................................
1,800
30 Interest Expense .................................................. Cash ..............................................................
2,000
30 Income Tax Expense ............................................ Cash ..............................................................
800
5,500
600
10,600
1,800
2,000
800
(Each journal entry must balance and reflect the actual amount of the transaction) LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-7B (a)
May 1 Cash ........................................................................... 20,000 Common Shares ..................................................
20,000
1 Rent Expense ............................................................. Cash ....................................................................
950
950
4 No entry. Not an accounting transaction.
Solutions Manual .
4 Supplies .............................................................. Accounts Payable ........................................
750
11 Accounts Receivable .......................................... Service Revenue .........................................
2,725
12 Cash ................................................................... Unearned Revenue......................................
3,500
15 Cash ................................................................... Service Revenue .........................................
2,350
20 Cash ................................................................... Accounts Receivable ...................................
1,725
22 Accounts Payable ($750 × 1/3) ........................... Cash ............................................................
250
25 Utilities Expense ................................................. Accounts Payable ........................................
275
29 Salaries Expense ................................................ Cash ............................................................
2,000
29 Income Tax Expense .......................................... Cash ............................................................
300
29 Dividends Declared ............................................. Cash ............................................................
250
3-99
750
2,725
3,500
2,350
1,725 , 250
275
2,000
300
250
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-7B (CONTINUED) Common Shares May 1
(b) May 1 12 15 20 Bal.
Cash 20,000May 1 3,500 22 2,350 29 1,725 29 29 23,825
Accounts Receivable May 11 2,725May 20 Bal. 1,000
May 4
May 22
May 29
Accounts Payable 250May 4 25 Bal.
Dividends Declared 250 Service Revenue May 11 15 Bal.
2,725 2,350 5,075
1,725 May 29
Salaries Expense 2,000
May 1
Rent Expense 950
May 25
Utilities Expense 275
May 29
Income Tax Expense 300
Supplies 750
Unearned Revenue May 12
(c)
950 250 2,000 300 250
20,000
750 275 775
3,500
This suggestion is a good idea. Most companies use computerized accounting systems, which speed up the process of recording in the journals and subsequently use summarized transactions that are posted to the general ledger. Systems such as these can reduce errors (from posting or calculations) and provide timely information for decision-making. However, computerized accounting systems cannot eliminate human errors nor can they perform the analysis of transactions needed as a first step before entries can be recorded in the accounting system. This aspect of the cycle needs to be performed by a person who can interpret the information and decide which accounts are affected.
LO 3,4 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 3-8B (a) Apr. 2 Rent Expense ............................................................. Cash ....................................................................
800
3 Advertising Expense ................................................... Cash ....................................................................
620
800
620
5 No entry, not a transaction. 6 No entry, not a transaction. 15 Cash ........................................................................... Fees Earned ........................................................
1,950
16 Mortgage Payable....................................................... Interest Expense ......................................................... Cash ....................................................................
2,000 850
17 Accounts Payable ....................................................... Cash ....................................................................
2,800
19 Rent Expense ............................................................. Accounts Payable ................................................
750
20 Prepaid Rent ............................................................... Cash ....................................................................
700
26 Salaries Expense ........................................................ Cash ....................................................................
2,900
27 Income Tax Expense .................................................. Cash ....................................................................
1,000
30 Cash ........................................................................... Accounts Receivable .................................................. Concession Revenue (20% × $5,600) .................
560 560
30 Cash ........................................................................... Fees Earned ........................................................
7,300
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1,950
2,850
2,800
750
700
2,900
1,000
1,120
7,300
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-8B (CONTINUED) (b) Cash Mar. 31 Bal. 6,000 Apr. 2 Apr. 15 1,950 Apr. 3 Apr. 30 560 Apr. 16 Apr. 30 7,300 Apr. 17 Apr. 20 Apr. 26 Apr. 27 Bal. 4,140
800 620 2,850 2,800 700 2,900 1,000
Fees Earned Apr. 15 Apr. 30 Bal.
1,950 7,300 9,250
Concession Revenue Apr. 30
1,120
Apr. 26
Salaries Expense 2,900
Apr. 2 Apr. 19 Bal.
Rent Expense 800 750 1,550
Land Mar. 31 Bal. 100,000
Apr. 3
Advertising Expense 620
Buildings Mar. 31 Bal. 80,000
Apr. 16
Interest Expense 850
Apr. 27
Income Tax Expense 1,000
Apr. 30
Accounts Receivable 560
Apr. 20
Prepaid Rent 700
Equipment Mar. 31 Bal. 25,000
Apr. 17
Apr. 16
Accounts Payable Mar. 31 Bal. 2,800 Apr. 19 Bal.
5,000 750 2,950
Mortgage Payable 2,000 Mar. 31 Bal. 125,000 Bal. 123,000 Common Shares Mar. 31 Bal.
50,000
Retained Earnings Mar. 31 Bal. 31,000
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PROBLEM 3-8B (CONTINUED) (c)
LAKE THEATRE INC. Trial Balance April 30, 2018 Debit Cash Accounts receivable Prepaid rent Land Buildings Equipment Accounts payable Mortgage payable Common shares Retained earnings Fees earned Concession revenue Salaries expense Rent expense Advertising expense Interest expense Income tax expense Totals
Credit
$
4,140 560 700 100,000 80,000 25,000 $ 2,950 123,000 50,000 31,000 9,250 1,120
2,900 1,550 620 850 1,000 $217,320
0000 000 $217,320
(Liability, common shares, retained earnings, and revenue (fees earned and concession revenue) accounts have credit balances) LO 3,4,5 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-9B (a) Apr.
2 Rent Expense .............................................................. 5,000 Cash .....................................................................
5,000
4 No entry. Not a transaction. 6 Advertising Expense .................................................... Cash .....................................................................
500
9 Accounts Payable ........................................................ Cash .....................................................................
300
500
300
13 Salaries Expense ........................................................ 1,000 Cash .....................................................................
1,000
16 Rent Expense .............................................................. 5,000 Cash .....................................................................
5,000
18 Utilities Expense .......................................................... Accounts Payable.................................................
100
19 Supplies Expense ........................................................ Cash .....................................................................
200
100
200
24 Cash ............................................................................ 2,200 Unearned Revenue .............................................. 25 Income Tax Expense ................................................... Cash .....................................................................
880
27 Advertising Expense .................................................... Cash .....................................................................
300
2,200
880
300
30 Salaries Expense ........................................................ 1,000 Cash .....................................................................
1,000
30 Unearned Revenue ..................................................... 17,500 Fees Earned .........................................................
17,500
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PROBLEM 3-9B (CONTINUED) (b) Cash Mar. 31 Bal. 23,000 Apr. 2 Apr. 24 2,200 Apr. 6 Apr. 9 Apr. 13 Apr. 16 Apr. 19 Apr. 25 Apr. 27 Apr. 30 Bal. 11,020 Equipment Mar. 31 Bal. 2,000
Apr. 9
Apr. 30
Accounts Payable Mar. 31 Bal. 300 Apr. 18 Bal.
5,000 500 300 1,000 Apr. 2 5,000 Apr. 16 200 Bal. 880 300 1,000 Apr. 13 Apr. 30 Bal.
500 100 300
Unearned Revenue Mar. 31 Bal. 17,500 17,500 Apr. 24 2,200 Bal. 2,200 Common Shares Mar. 31 Bal. 1,000
Salaries Expense 1,000 1,000 2,000
Apr. 6 27 Bal.
Apr. 19
Supplies Expense 200
Apr. 18
Utilities Expense 100
Apr. 25
Income Tax Expense 880
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17,500
Rent Expense 5,000 5,000 10,000
Advertising Expense 500 300 800
Retained Earnings Mar. 31 Bal. 6,000
Solutions Manual .
Fees Earned Apr. 30
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-9B (CONTINUED) (c)
KG SKATING SCHOOL INC. Trial Balance April 30, 2018 Debit Cash Equipment Accounts payable Unearned revenue Common shares Retained earnings Fees earned Rent expense Salaries expense Advertising expense Supplies expense Utilities expense Income tax expense Totals
Credit
$11,020 2,000 $
300 2,200 1,000 6,000 17,500
10,000 2,000 800 200 100 880 $27,000
_ $27,000
(Asset and expenses accounts have debit balances) LO 3,4,5 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 3-10B (a) ASIAN IMPORTERS LIMITED Trial Balance January 31, 2018 (thousands) Debit Cash Accounts receivable Inventory Prepaid insurance Land Buildings Accumulated depreciation—buildings Equipment Accumulated depreciation—equipment Goodwill Accounts payable Other current liabilities Bank loan payable (due 2021) Mortgage payable Common shares Retained earnings Dividends declared Sales Cost of goods sold Office expense Interest expense Income tax expense Totals
Credit
$ 10,000 30,200 74,250 3,950 42,500 39,500 $ 13,000 10,900 3,600 7,600 46,300 12,200 10,050 19,750 32,900 37,050 1,850 370,000 244,200 67,750 2,150 10,000 $544,850
00000 0 $544,850
(Asset, dividends declared, and expense accounts have debit balances. Liability, common shares, retained earnings, and revenue (sales) accounts have credit balances)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 3-10B (CONTINUED) (b)
The following are some steps to help find the error(s) in a trial balance: 1.
2.
3.
4.
If the error (difference between the debit and credit totals) is an amount such as $1, $100, or $1,000, re-add the trial balance columns and recalculate the account balances. If the error can be evenly divided by two, scan the trial balance to see if a balance equal to half the error has been entered in the wrong column. If the error can be evenly divided by nine, retrace the account balances on the trial balance to see whether they have been incorrectly copied from the ledger. For example, if a balance was $12 but was listed as $21, a $9 error has been made. Reversing the order of numbers is called a transposition error. A slide, which is adding or deducting one or several zeros in a figure, has the same effect. If the error cannot be evenly divided by two or nine, scan the ledger to see whether an account balance in the amount of the error has been omitted from the trial balance. Scan the journal to see whether a posting in the amount of the error has been omitted.
When all else fails, all of the transactions should be carefully traced through the process again. LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 3-11B ASIAN IMPORTERS LIMITED Income Statement Year Ended January 31, 2018 (thousands) Revenues Sales Expenses Cost of goods sold Office expense Interest expense Total expenses Income before income tax Income tax expense Net income
$370,000 $244,200 67,750 2,150 314,100 55,900 10,000 $ 45,900
ASIAN IMPORTERS LIMITED Statement of Changes in Equity Year Ended January 31, 2018
Balance, February 1, 2017 Issued common shares Net income Dividends declared Balance, January 31, 2018
Solutions Manual .
Common Shares
Retained Earnings
$20,000 12,900
$37,050
000 000 $32,900
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45,900 (1,850) $81,100
Total Equity $ 57,050 12,900 45,900 (1,850) $114,000
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PROBLEM 3-11B (CONTINUED) ASIAN IMPORTERS LIMITED Statement of Financial Position January 31, 2018 (thousands) Assets Current assets Cash Accounts receivable Inventory Prepaid expenses Total current assets Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Goodwill Total assets
$10,000 30,200 74,250 3,950 $118,400 $42,500 $39,500 13,000 $10,900 3,600
26,500 7,300
76,300 7,600 $202,300
Liabilities and Shareholders' Equity Liabilities Current liabilities Accounts payable Current portion of mortgage payable Other current liabilities Total current liabilities Non-current liabilities Mortgage payable ($19,750 − $6,300) Bank loan payable Total non-current liabilities Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$ 46,300 6,300 12,200 64,800 $13,450 10,050 23,500 88,300 $32,900 81,100 114,000 $202,300
[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared] LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 3-12B (a)
(1)
General: Eight accounts are listed in the wrong columns: Accumulated depreciation (credit), Accounts payable (credit), Common Shares (credit), and all five expense accounts (debit).
(2) 1.
Each of the Prepaid Insurance, Accounts Payable, and Income Tax Expense accounts are understated by $100. Note also that the last two accounts—Accounts Payable and Income Tax Expense—are also listed in the wrong debit/credit column as described above in (1). Before these errors were identified, the Prepaid Insurance account was missing and each of the Accounts Payable and Income Tax Expense accounts were in debit and credit columns, respectively, and each understated $100 so one of the reasons the trial balance did not balance was because the Prepaid Insurance account had been omitted.
2.
The trial balance is out of balance by $270 ($14,529 – $14,259) because of the transposition error. Service Revenue is overstated by $270, as is the total for the credit column.
3.
The trial balance is not out of balance because of this recording error. The Salaries Expense account is overstated by $750 and the Dividends Declared account understated by the same amount. The Dividends Declared account is not included in the incorrect trial balance, so it needs to be included.
4.
The trial balance is out of balance because of this recording error. The total for the debit column is lower by $120 (because the Cash account is understated) and the credit column is lower by $120 (because the Accounts Payable account is understated). Recall that the Accounts Payable account is one of the accounts listed in the wrong column (debit instead of credit).
5.
The trial balance is not out of balance because of this omission; only the accounts and amounts appearing on the trial balance are affected. The Equipment and Bank Loan Payable accounts are each understated by $2,000.
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 3-12B (CONTINUED) (b) MESSED UP LTD. Trial Balance May 31, 2018 Debit Cash ($2,997 + $120) Accounts receivable Prepaid insurance (+$100) Equipment ($9,200 + $2,000) Accumulated depreciation—equipment Accounts payable ($4,600 + $100 + $120) Bank loan payable (+$2,000) Common shares Dividends declared (+$750) Service revenue ($14,529 –$14,529 + $14,259) Salaries expense ($8,150 – $750) Advertising expense Depreciation expense Insurance expense Income tax expense ($400 + $100) Totals
Credit
$ 3,117 2,630 100 11,200 $ 4,200 4,820 2,000 4,250 750 14,259 7,400 1,132 2,100 600 500 $29,529
0 $29,529
(Asset, dividends declared, and expense accounts have debit balances) LO 5 BT: AN Difficulty: C Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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ACR3-1 ACCOUNTING CYCLE REVIEW (a) Date
Account Titles
Ref.
Debit
Credit
Jan. 2 Cash ....................................................................................................................... 100 65,000 Common Shares (1,000 × $65) ...................................................................... 400 65,000 4 Rent Expense ......................................................................................................... 740 3,000 Cash............................................................................................................... 100 3,000 5 Equipment .............................................................................................................. 200 40,000 Cash............................................................................................................... 100 10,000 Bank Loan Payable ........................................................................................ 310 30,000 8 Advertising Expense ............................................................................................... 700 500 Cash............................................................................................................... 100 500 10 Supplies .................................................................................................................. 120 1,000 Accounts Payable .......................................................................................... 300 1,000 11 Advertising Expense ............................................................................................... 700 3,000 Cash............................................................................................................... 100 3,000 12 Salaries Expense .................................................................................................... 710 7,500 Cash............................................................................................................... 100 7,500 15 Accounts Receivable ............................................................................................. 110 15,000 Service Revenue ............................................................................................ 500 15,000 17 Office Expense ...................................................................................................... 730 1,000 Cash ............................................................................................................... 100 1,000 19 Prepaid Insurance .................................................................................................. 130 6,000 Cash ............................................................................................................... 100 6,000 24 Cash ...................................................................................................................... 100 10,000 Accounts Receivable ...................................................................................... 110 10,000 25 Dividends Declared ................................................................................................ 490 500 Cash ............................................................................................................... 100 500
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Financial Accounting, Seventh Canadian Edition
ACR3-1 (CONTINUED) (a) (continued) Date
Account Titles
Ref.
Debit
Credit
Jan. 26 Salaries Expense .................................................................................................... 710 7,500 Cash ............................................................................................................... 100 7,500 29 Accounts Receivable .............................................................................................. 110 18,000 Service Revenue ............................................................................................ 500 18,000 30 Interest Expense ..................................................................................................... 720 200 Bank Loan Payable ................................................................................................. 310 700 Cash ............................................................................................................... 100 900 31 Income Tax Expense .............................................................................................. 900 1,500 Cash ............................................................................................................... 100 1,500 (b)
Jan.
Cash 65,000 Jan. 10,000
2 24
Jan. 31 Bal.
4 5 8 11 12 17 19 25 26 30 31
Equipment 40,000
#200
Accounts Payable Jan. 10
$300 1,000
Bank Loan Payable Jan. 30 700 Jan. 5 31
#310 30,000 Bal. 29,300
Common Shares Jan. 2
#400 65,000
Jan. 5
33,600
Accounts Receivable Jan. 15 15,000 Jan. 24 29 18,000 Jan. 31 Bal. 23,000 Supplies 1,000
Jan. 10
Jan. 19
#100 3,000 10,000 500 3,000 7,500 1,000 6,000 500 7,500 900 1,500
Prepaid Insurance 6,000
Solutions Manual .
Dividends Declared Jan. 25 500
#490
10,000 Service Revenue #500 Jan. 15 15,000 29 18,000 Jan. 31 Bal. 33,000
#120
Advertising Exepense Jan. 8 500 11 3,500 Jan. 31 Bal. 3,500
#130
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Financial Accounting, Seventh Canadian Edition
ACR3-1 (CONTINUED) (b) (continued) Salaries Expense Jan. 12 7,500 26 7,500 Jan. 31 Bal. 15,000 Interest Expense Jan. 30 200
(c)
100 110 120 130 200 300 310 400 490 500 700 710 720 730 740 900
#710 Office Expense Jan. 17 1,000
#730
Rent Expense Jan. 4 3,000 #720 Income Tax Expense Jan. 31 1,500
#740
#900
SOFTWARE ADVISORS LIMITED Trial Balance January 31, 2018 Debit $ 33,600 23,000 1,000 6,000 40,000
Cash Accounts receivable Supplies Prepaid insurance Equipment Accounts payable Bank loan payable Common shares Dividends declared Service revenue Advertising expense Salaries expense Interest expense Office expense Rent expense Income tax expense
Credit
$ 1,000 29,300 65,000 500 33,000 3,500 15,000 200 1,000 3,000 1,500 $128,300
0 $128,300
(Asset, dividends declared, and expense accounts have debit balances)
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ACR3-1 (CONTINUED) (d) (1) SOFTWARE ADVISORS LIMITED Income Statement Month Ended January 31, 2018 Revenues Service revenue Expenses Salaries expense Advertising expense Rent expense Office expense Interest expense Total expenses Income before income tax Income tax expense Net income
$33,000 $15,000 3,500 3,000 1,000 200 22,700 10,300 1,500 $ 8,800
(d) (2) SOFTWARE ADVISORS LIMITED Statement of Changes in Equity Month Ended January 31, 2018
Balance, January 1 Issued common shares Net Income Dividends declared Balance, January 31
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Common Shares $ 0 65,000 0 $65,000
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Retained Earnings $ 0 8,800 (500) $8,300
Total Equity $ 0 65,000 8,800 (500) $73,300
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Financial Accounting, Seventh Canadian Edition
ACR3-1 (CONTINUED) (d) (3) SOFTWARE ADVISORS LIMITED Statement of Financial Position January 31, 2018 Assets Current assets Cash Accounts receivable Supplies Prepaid insurance Property, plant, and equipment Equipment Total assets
$33,600 23,000 1,000 6,000
$63,600 40,000 $103,600
Liabilities and Shareholders’ Equity Current liabilities Accounts payable Non-current liabilities Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total liabilities and shareholders’ equity
$ 1,000 29,300 30,300 $65,000 8,300
73,300 $103,600
[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared] LO 3,4,5 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
ACR3-2 ACCOUNTING CYCLE REVIEW (a) Aug. 1 Advertising Expense ........................................ Cash .........................................................
250 250
2 Unearned Revenue ......................................... Service Revenue ......................................
1,260
3 Rent Expense .................................................. Cash .........................................................
980
6 Cash ................................................................ Accounts Receivable ................................
1,200
1,260
980
1,200
7 No entry, not a transaction 10 Salaries Payable ............................................. Salaries Expense ............................................ Cash .........................................................
1,420 1,700
13 Cash ................................................................ Service Revenue ......................................
2,800
15 Equipment ....................................................... Bank Loan Payable ..................................
2,000
20 Accounts Payable ............................................ Cash .........................................................
2,000
22 Supplies .......................................................... Accounts Payable ....................................
800
24 Salaries Expense ............................................ Cash .........................................................
2,900
27 Accounts Receivable ....................................... Service Revenue .....................................
3,760
29 Cash ................................................................ Unearned Revenue..................................
780
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3,120
2,800
2,000
2,000
800
2,900
3,760
780
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Financial Accounting, Seventh Canadian Edition
ACR3-2 (CONTINUED) (a) (continued) Aug. 30 Bank Loan Payable ......................................... Interest Expense ............................................. Cash .........................................................
500 50
31 Income Tax Expense ....................................... Cash .........................................................
380
31 Dividends Declared ......................................... Cash .........................................................
0400
550
380
400
(b) Cash 8,040 Aug. 1 1,200 3 2,800 10 780 24 30 31 31 2,240
July 31 Aug. 6 13 29
Aug. 31
250 980 3,120 2,900 550 380 400
Accumulated Depreciation—Vehicles July 31 5,000
Aug. 20
Aug. 10 July 31 27 Aug. 31
Accounts Receivable 3,200 Aug. 6 3,960 Bal. 5,760
July 31 Aug. 22 Aug. 31
Supplies 1,030 800 Bal. 1,830
Aug. 2
Equipment 10,000 2,000 Bal. 12,000
Accumulated Depreciation—Equipment July 31 1,000
July 31 Solutions Manual .
Vehicles 25,000
Salaries Payable 1,420 July 31 Aug. 31
1,420 Bal. 0
Unearned Revenue July 31 Aug. 29 1,260 Aug. 29
1,260 780 Bal. 780
Bank Loan Payable July 31 500 Aug. 15 Aug. 31
4,000 2,000 Bal. 5,500
Common Shares July 31
14,000
1,200
Aug. 30 July 31 Aug. 15 Aug. 31
Accounts Payable July 31 2,300 2,000 Aug. 22 800 Aug. 31 Bal. 1,100
Retained Earnings June 30 Bal. 17,290
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ACR3-2 (CONTINUED) (b) (continued) Service Revenue Aug. 2 1,260 Aug. 13 2,800 Aug. 27 3,760 Aug. 31 Bal. 7,820
Aug. 1
Advertising Expense 250
Aug. 3
Rent Expense 980
Aug. 10 24 Aug. 31
Salaries Expense 1,700 2,9000 4,600
Aug. 30
Interest Expense 50
Aug. 31
Income Tax Expense 380
(c) B&B REPAIR SERVICES LTD. Trial Balance August 31, 2018
Cash Accounts receivable Supplies Equipment Accumulated depreciation—equipment Vehicles Accumulated depreciation—vehicles Accounts payable Unearned revenue Bank loan payable Common shares Retained earnings Dividends declared Service revenue Advertising expense Rent expense Salaries expense Interest expense Income tax expense
Debit $ 2,240 5,760 1,830 12,000
Credit
$ 2,000 25,000 5,000 1,100 780 5,500 14,000 17,290 400 7,820 250 980 4,600 50 380 $53,490
$53,490
(Asset, dividends declared, and expense accounts have debit balances) Solutions Manual .
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ACR3-2 (CONTINUED) (d) B&B REPAIR SERVICES LTD. Income Statement Month Ended August 31, 2018 Revenues Service revenue Expenses Salaries expense Rent expense Advertising expense Interest expense Total expenses Income before income tax Income tax expense Net income
$7,820 $4,600 980 250 50 5,880 1,940 380 $1,560
B&B REPAIR SERVICES LTD. Statement of Changes in Equity Month Ended August 31, 2018 Common Shares Balance, July 31 Net income Dividends declared Balance, August 31
Solutions Manual .
$14,000 0 $14,000
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Retained Earnings $17,290 1,560 (400) $18,450
Total Equity $31,290 1,560 (400) $32,450
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Financial Accounting, Seventh Canadian Edition
ACR3-2 (CONTINUED) (d) (continued) B&B REPAIR SERVICES LTD. Statement of Financial Position August 31, 2018 Assets Current assets Cash Accounts receivable Supplies Property, plant, and equipment Equipment Accumulated depreciation—equipment Vehicles Accumulated depreciation—vehicles Total assets
$2,240 5,760 1,830 $12,000 2,000 $25,000 5,000
$ 9,830
$10,000 20,000
30,000 $39,830
Liabilities and Shareholders’ Equity Current liabilities Accounts payable Unearned revenue Non-current liabilities Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total liabilities and shareholders’ equity
$1,100 780
$ 1,880 5,500 7,380
$14,000 18,450
32,450 $39,830
[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends declared]
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Financial Accounting, Seventh Canadian Edition
ACR3-2 (CONTINUED) (e) Payments: Cash flow Aug.
1 3
980 Rent
Operating Operating
10
3,120 Salaries
Operating
20
2,000 On account to suppliers
Operating
24
2,900 Salaries
Operating
30
$ 250 Advertising
550 Loan principal $500
Financing
Loan interest $50
Operating
31
380 Income tax
Operating
31
400 Dividends declared and paid
Financing
6
1,200 On account from customers
Operating
13
2,800 Revenue
Operating
Receipts: Aug.
29
780 Unearned revenue
Operating
LO 3,4,5 BT: AP Difficulty: M Time: 70 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT3-1 (a)
FINANCIAL REPORTING CASE
North West ($ in thousands)
Total Assets =
Total Liabilities +
$793,795 =
$436,183 +
(b)
Shareholder's Equity $167,910 Share capital 156,664 Retained earnings Other equity items (contributed surplus $2,620 and accumulated other 33,038 comprehensive income $30,418) $357,612
Sobeys ($ in millions)
Total Assets =
Total Liabilities +
$7,960.6 =
$5,230.9 +
(c)
Financial Accounting, Seventh Canadian Edition
Shareholder's Equity $ 2,752.9 Capital stock (172.1) Retained earnings (Deficit) Other equity items (contributed surplus $93, accumulated other comprehensive loss $3.2, and non-controlling interest 148.9 $59.1) $2,729.7
Sobeys has about 10 times the assets compared to North West ($7,960.6 million compared to $793.795 million). However, it also has 12 times the liabilities ($5,230.9 million compared to $436.183 million) which is why its shareholders’ equity is proportionately lower. Sobeys’s shareholders’ equity is less than 8 times the equity reported by North West ($2,729.7 million compared to $357.612 million). North West’s share capital comprises about 47% of its total shareholders’ equity whereas Sobeys’s is more than 100% of its total equity. Of course, this comparison is skewed because Sobeys reported a deficit (negative retained earnings) rather than a positive retained earnings for its latest fiscal year.
LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT3-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
Uber’s network of riders and drivers are resources available to the business but are not assets owned or controlled by the business. Nor can the company predict the future economic benefits to be contributed by a person or measure the “value” of a person. Consequently, people are not recorded in the accounting records.
(b)
Uber would likely report current assets such as cash, accounts receivable, and supplies. Its non-current assets likely consist of property, plant, and equipment such as office furniture and equipment and computer systems including hardware and software. It also would report intangible assets such as the software developed to run its ride-sharing app. In addition, this category would include technology the company purchased from Microsoft related to street imaging and 3-D views.
(c)
The valuation given by the market to Uber Technologies Inc. is not based on the assets on its statement of financial position but on investors’ perception of its ability to produce growth and income in the future.
LO 1 BT: AN Difficulty: C Time: 15 min. AACSB: Analytic and Tech. CPA: cpa-t001 CM: Reporting
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CT3-3
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
(a) Assets
Cash 1. 2. 3. 4. 5. 6. 7. 8. 9. Aug. 31 Bal.
+
A/R
+
Prepaid Rent
=
Liabilities
=
Income Tax Payable
A/P
+
+
Shareholders' Equity Retained Earnings
+
Unearned Rev.
+$10,000
+
Common Shares
+
Revenue
-
Expenses
-
Div.
+$10,000 +$229,400 -190,000
+190,000 -45,500 -120,000 -32,400 +2,000
+$229,400 +$3,500
-$42,000 -120,000 -36,400
+$4,000 +$2,000
-1,000
00 0 000
00 000
0 00 00
+$6,200 0 00000
0 0 0 00
0 0 0000
0 0 0000
00
-6,200 0000
-$1,000
+$3,100
+$39,400
+$3,500
+$4,000
+$6,200
+$2,000
+$10,000
+$229,400
-$204,600
-$1,000
Total liabilities ($12,200) + shareholders’ equity ($33,800) = $46,000
Total assets = $46,000
(b)
A spreadsheet can help, in a small business like Bob’s Repairs, to organize information. However, it lacks the date, specific account title for multiple expenses, and explanation for each entry that one would find in a traditional general journal. It could assist in posting, although again it lacks any cross-referencing to allow transactions to be traced back to the source, if required. Finally, use of a spreadsheet, while convenient for very small businesses, would limit growth in the number of accounts and transactions.
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CT3-3 (CONTINUED) (c) BOB'S REPAIRS LTD. Income Statement Year Ended August 31, 2018 Service revenue Expenses Salaries expense Rent expense Office expense Income before income tax Income tax expense Net income
$229,400 $120,000 42,000 36,400
198,400 31,000 6,200 $ 24,800
[Revenues – Expenses = Net income or (loss)]
BOB'S REPAIRS LTD. Statement of Changes in Equity Year Ended August 31, 2018
Balance, September 1 Issued common shares Net income Dividends declared Balance, August 31
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Common Shares $ 0 10,000 00 0000 $10,000
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Retained Earnings $ 0 24,800 (1,000) $23,800
Total Equity $ 0 10,000 24,800 (1,000) $33,800
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Financial Accounting, Seventh Canadian Edition
CT3-3 (CONTINUED) (c) (continued) BOB'S REPAIRS LTD. Statement of Financial Position August 31, 2018 Current assets Cash Accounts receivable Prepaid rent Total assets
$ 3,100 39,400 3,500 $46,000
Current liabilities Accounts payable Income tax payable Unearned revenue Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
(d)
$4,000 6,200 2,000 $12,200 $10,000 23,800 33,800 $46,000
Five of the cash transactions relate to operating activities: Cash collected from customers Payments to the landlord Salaries paid Payments for office expenses Customer advances Total effect on cash flow
$190,000 (45,500) (120,000) (32,400) 2,000 $ (5,900)
Uncle Bob would not be pleased to find out that operating cash flows were not positive. This can often happen during the first year that a company operates. The other two cash transactions not shown above are financing activities: the issue of common shares for $10,000 and the declaration and payment of dividends for $1,000. The net increase to cash of $9,000 allowed the company to have a positive cash balance $3,100 (−$5,900 + $9,000) at the end of the year. Solutions Manual .
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CT3-3 (CONTINUED) (e)
The bank would want collateral for any loan given to the company. Usually such collateral consists of property, plant, or equipment and this company has none of these. It may be possible to secure a loan with accounts receivable but the company did not have this type of asset when it was first formed.
(f)
No, the company does not have enough cash to pay the income tax. The company would have to collect some accounts receivable if it hoped to pay the income tax.
(g)
The government levies income tax on corporations, which are considered legal entities, separate from their shareholders. Uncle Bob would pay income tax only on the dividends he received from the company.
LO 3,4,5 BT: E Difficulty: M Time: 55 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT3-4 (a)
Financial Accounting, Seventh Canadian Edition
STUDENT VIEW CASE
On September 1, 2018, my personal equity would be as follows: Cash ................................................ Cell phone ....................................... Total assets ..................................... Less: student loan ........................... Personal equity, Sept. 1, 2018 ........
(c)
$21,000 200 21,200 (9,000) $12,200
Errors in the trial balance: The cash amount should be the amount in the bank account at December 15. The computer was recorded at $100 rather than the actual cost of $1,000. The damage deposit of $400 for the residence has been omitted. The travel costs are $450, not $540.
Personal Trial Balance December 15, 2018 Debit Cash ....................................................................... $ 7,400 Clothes ................................................................... 1,500 Cell phone .............................................................. 200 Computer ............................................................... 1,000 Damage deposit on residence ................................ 400 Student loan ........................................................... Personal equity ...................................................... Residence and meal plan fees ($1,100 per month) 4,400 Tuition for September to December ....................... 3,500 Textbooks .............................................................. 600 Personal costs (personal items, entertainment, eating out) 1,500 Cellphone costs ...................................................... 250 Travel to go home at Christmas ............................. 450 $21,200
Credit
$ 9,000 12,200
____ __ $21,200
(Total of debit account balances = Total of credit account balances)
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CT3-4 (CONTINUED) (c)
Expenses Clothes..................................................................... Residence and meal plan fees ($1,100 per month) . Tuition for September to December ......................... Textbooks ............................................................... Personal costs (personal items, entertainment, eating out) Cellphone costs ....................................................... Travel to go home at Christmas ............................... Total expenses September to December .................
$ 1,500 4,400 3,500 600 1,500 250 450 $12,200
Personal equity, September 1 .................................. Total expenses......................................................... Personal equity, December 15 ................................. By December 31, 2018, the personal equity is nil.
$12,200 (12,200) $ 0
(d)
Balance of cash December 15, 2018 ....................... Assumed expenses for second term same as first... Shortfall in cash .......................................................
$ 7,400 (12,200) $ 4,800
(e)
Personal expenses in the first term are far too high. Some expenses that can be reduced in the second term include personal costs for entertainment and eating out. If half as much is spent in the second term, $750 can be saved. In addition, clothes expenses could be reduced to $300, saving another $1,200. Travel to go home can be eliminated. Finally, if the residence room is kept in good condition and with no damages, $400 for the damage deposit will be returned in cash.
(f)
Personal expenses savings ..................................... Reduced clothing costs ............................................ Travel costs ............................................................. Return of residence damage deposit ....................... Additional cash made available ...............................
$ 750 1,200 450 400 $2,800
Cash shortfall ........................................................... Additional cash from spending changes .................. Ask parents for extra cash .......................................
$4,800 2,800 $2,000
LO 5 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT3-5
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a)
Ron, here are some tips to help you find the $810 error in the trial balance assuming it is a single error: 1.
2.
3.
4.
If the error is an amount such as $1, $100, or $1,000, re-add the trial balance columns and recalculate the account balances. This tip does not apply in this case because the difference between the debit and credit columns is $810. If the error can be evenly divided by two (which it can be in this case $810 ÷ 2 = $405), scan the trial balance to see if a balance equal to half the error has been entered in the wrong column. If the error can be evenly divided by nine (which it can be in this case $810 ÷ 9 = $90), retrace the account balances on the trial balance to see whether they have been incorrectly copied from the ledger. For example, if a balance was $12 but was listed as $21, a $9 error has been made. Reversing the order of numbers is called a transposition error. A slide, which is adding or deducting one or several zeros in a figure, has the same effect. If the error cannot be evenly divided by two or nine, scan the ledger to see whether an account balance in the amount of the error has been omitted from the trial balance. Scan the journal to see whether a posting in the amount of the error has been omitted.
Note that these suggestions will not always work, especially if there is more than one error and sometimes, the only way to find an error is to retrace all of the work carefully. (b)
The stakeholders in this situation are: Ron Hollister The other students in the group who will be graded for Ron’s work The other students in the class The professor The College or University attended by Ron Future employers of the graduates of the school
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CT3-5 (CONTINUED) (c)
By adding $810 to the Salaries Expense account, the account total has been deliberately misstated. By not locating the error causing the imbalance, some other account or accounts may also be misstated by a net amount of $810. Ron did not advise his fellow team members of the action he has taken to avoid detection. While his motivation was most likely to meet the deadline for handing in the assignment, he also “hoped no one would notice the difference” so he made this change with deliberate intent. It was inappropriate not to offer the other group members an opportunity to find the error in one or more of their parts of the assignment, or to take action without advising them. The entire group will be affected by Ron’s actions and had no means of agreeing to the strategy taken to address the problem. As an aside, it is important for students to agree as a group on “behavioural norms” ahead of time to help reduce the likelihood of unintended consequences affecting one or more of the group. The adding of the $810 to the Salaries Expense account is not by itself unethical in a classroom situation but it does not adhere to the qualitative characteristic of faithful representation of the numbers. The professor would obviously catch this error and grade the assignment accordingly. However, Ron’s failure to inform other group members that he was changing amounts that they had prepared would be considered by many to be both inappropriate and unethical. Although the assignment will not affect external users of a real financial report, it is important to understand that if this had been a real life situation, Ron’s actions—both the changing of an account balance and the failure to inform—would be considered to be unethical because financial information was intentionally altered and done deliberately to mislead users. [See also the answer to part (e).] While Ron is not likely in breach of any rule or directive issued by the school concerning academic integrity, the professor and the other group members will not agree with the strategy used by Ron. They will wonder if this is the type of action Ron would take while at a future job. Such actions would then affect others who are not part of the school community and the reputation of the school would be diminished. This in turn could affect society’s opinion of the past and future graduates of the school.
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Financial Accounting, Seventh Canadian Edition
CT3-5 (CONTINUED) (d)
Ron's alternatives are: 1. Discuss the situation with the teammates and reach a consensus that it is better to miss the deadline but find the error causing the imbalance and suffer the corresponding penalty for submitting the assignment late. 2. Discuss the situation with teammates and reach a consensus to tell the professor of the imbalance and ask for an extension of time or suffer the consequences. 3. Discuss the situation with teammates and potentially get their assistance to locate the error causing the imbalance as a team effort so that the assignment can still submitted by the deadline.
(e)
External users of the financial information prepared by Ron could potentially be affected by the errors that remain undetected. It is highly likely that another account may also be wrong on the financial statements. The consequences are more far reaching and so the behaviour is more serious. Deliberate deception for this purpose would be viewed as unethical.
LO 5 BT: S Difficulty: M Time: 20 min. AACSB: Analytic and Ethics CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT3-6
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
(a) June 5 Supplies ........................................................................ Accounts Payable ....................................................
2,500
14 Equipment .................................................................... Cash ........................................................................
2,520
16 Cash ............................................................................. Unearned Revenue..................................................
1,000
19 Cash ............................................................................. Unearned Revenue ...................................................... Sales........................................................................
300 100
21 Accounts Receivable .................................................... Sales........................................................................
2,040
27 Utilities Expense ........................................................... Accounts Payable ....................................................
200
2,500
2,520
1,000
400
2,040
200
29 No entry, not a transaction 30 Salaries Expense .......................................................... Cash ........................................................................
3,250
30 Accounts Receivable .................................................... Sales........................................................................
2,550
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3,250
2,550
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Financial Accounting, Seventh Canadian Edition
CT3-6 (CONTINUED) (b) Accounts Payable June Bal. 5 27 Bal.
3,540 2,500 200 6,240
Unearned Revenue 100 June Bal. 16 Bal.
100 1,000 1,000
June Bal.
Inventory 16,250
Bank Loan Payable June Bal.
22,500
June Bal. 5 Bal.
Supplies 1,875 2,500 4,375
Mortgage Payable June Bal.
53,200
June Bal.
Prepaid Insurance 12,000
Common Shares June Bal.
300
June Bal. 16 19 Bal.
Cash 39,004 June 1 1,000 30 300 34,534
June Bal. 21 30 Bal.
Accounts Receivable 5,900 2,040 2,550 10,490
42,520 3,250
June 19
Land June Bal. 100,000 Buildings June Bal. 165,000
Retained Earnings June Bal. 146,788
June Bal.
Accumulated Depreciation—Buildings June Bal. 137,500
June Bal. 14 Bal.
Equipment 42,000 2,520 44,520
Accumulated Depreciation—Equipment June Bal. 14,000
June Bal.
Solutions Manual .
Vehicles 52,500
June Bal.
3-136
Dividends Declared 30,000 Rent Revenue June Bal.
6,000
Sales June Bal. 19 21 30 Bal.
633,768 400 2,040 2,550 638,758
Cost of Goods Sold 102,386
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT3-6 (CONTINUED) (b) (continued)
June Bal. 30 Bal.
Salaries Expense 387,532 3,250 390,782
June Bal.
Office Expense 18,000
June Bal. 27 Bal.
Utilities Expense 12,000 200 12,200
June Bal.
Property Tax Expense June Bal. 5,950
June Bal.
Solutions Manual .
Advertising Expense 9,000
Interest Expense 5,299
Income Tax Expense June Bal. 13,000
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CT3-6 (CONTINUED) (c) ANTHONY BUSINESS COMPANY LTD. Trial Balance June 30, 2017 Debit Cash ................................................................. Accounts receivable ......................................... Inventory........................................................... Supplies ........................................................... Prepaid insurance ............................................ Land ................................................................. Buildings ........................................................... Accumulated depreciation—buildings .............. Equipment ........................................................ Accumulated depreciation—equipment ............ Vehicles ............................................................ Accounts payable ............................................. Unearned revenue ............................................ Bank loan payable ............................................ Mortgage payable ............................................. Common shares ............................................... Retained earnings ............................................ Dividends declared ........................................... Rent revenue .................................................... Sales ................................................................ Cost of goods sold............................................ Salaries expense .............................................. Office expense ................................................. Utilities expense ............................................... Advertising expense ......................................... Property tax expense ....................................... Interest expense ............................................... Income tax expense ......................................... Totals ...............................................................
Credit
$ 34,534 10,490 16,250 4,375 12,000 100,000 165,000 $ 137,500 44,520 14,000 52,500 6,240 1,000 22,500 53,200 300 146,788 30,000 6,000 638,758 102,386 390,782 18,000 12,200 9,000 5,950 5,299 _ 13,000 $1,026,286
_ _ 00 $1,026,286
(Liabilities, common shares, retained earnings, and revenue (sales) accounts have credit balances) LO 3,4,5 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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CHAPTER 4 Accrual Accounting Concepts LEARNING OBJECTIVES 1. 2. 3. 4. 5.
Explain the accrual basis of accounting and the reasons for adjusting entries. Prepare adjusting entries for prepayments. Prepare adjusting entries for accruals. Prepare an adjusted trial balance and financial statements. Prepare closing entries and a post-closing trial balance.
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT
Item LO
BT
Item LO
BT
Item LO
BT
Item LO
BT
Questions 1.
1
C
6.
2
C
11.
2,3
C
16.
4,5
C
21.
5
K
2.
1
AP
7.
2
C
12.
2,3
C
17.
4,5
C
22.
5
K
3.
1
C
8.
2
C
13.
3
AN
18.
5
K
4.
1
C
9.
2
C
14.
4
C
19.
5
C
5.
2
C
10.
2,3
C
15.
2,3,4
C
20.
5
C
1.
1
K
4.
2
AP
7.
3
AN
10.
3
AP
13.
5
AP
2.
1
AP
5.
2,3
AP
8.
3
AP
11.
4
AP
14.
5
AP
3.
2
AP
6.
3
AP
9.
3
AN
12.
4
AP
15.
5
K
Brief Exercises
Exercises 1.
1
AP
4.
2
AP
7.
2,3
AP
10.
2,3,4
AP
13.
5
AP
2.
1
AP
5.
2
AP
8.
2,3
AP
11.
4
AP
14.
5
AP
3.
1
C
6.
3
AP
9.
2,3
AP
12.
4
AP
5
AP
13.
5
AP
Problems: Set A and B 1.
2
AP
4.
2,3
AP
7.
1
AN
10.
2.
3
AP
5.
2,3
AP
8.
2,3,4
AP
11.
4,5
AP
3.
2,3
AP
6. 1,2,3,4 AP
9.
2,3,4
AP
12.
2,3,4
AN
Accounting Cycle Review 1. 2,3,4,5 AP
2. 2,3,4,5 AP
Cases 1.
1,2
C
3.
2,3
AN
5.
2
C
2.
1
AP
4.
1,2,3
E
6.
2,3,4
AP
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Chapter 4
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Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
Adjusting entries are made to adjust the accounts at the end of the period to ensure revenues and expenses are recorded when they are earned or incurred. When revenues and expenses should be recognized in the accounting records is dictated by recognition criteria. Revenue is recognized or recorded when an increase in future economic benefits arising from an increase in an asset or a decrease in a liability has occurred in the course of ordinary activities. In general, revenue recognition occurs when or as the performance obligation has been satisfied. In a service company, revenue is considered to be earned when the service is provided. In a merchandising company, revenue is considered to be earned when the merchandise is sold (normally at the point of sale). Expenses are recognized in the accounting records when there is a decrease in future economic benefits related to a decrease in an asset or an increase in a liability in the course of ordinary activities. Expense recognition is linked to revenue recognition in that expenses are recognized, wherever possible, in the period in which a company makes efforts to generate revenues. This gives rise to adjusting entries so that revenues and expenses can be recorded in the proper period.
LO 1 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
(a)
The five-step process to use to measure and report revenue is: 1. 2. 3. 4.
(b)
Identify the contract with the client or customer. Identify the performance obligations in the contract. Determine the transaction price. Allocate the transaction price to the performance obligations in the contract. 5. Recognize revenue when (or as) the company satisfies the performance obligations. For the law firm: 1. The contract was created in March between the law firm and the client when the engagement was accepted by the law firm. 2. The performance obligation in the contract is to provide legal services. 3. The transaction price is $8,000. 4. There is a single task and so there are no other obligations in the contract that need to be allocated. 5. The revenue is recognized by the law firm once it satisfies the obligation under the engagement and performs the work for the client in April.
LO 1 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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3.
Financial Accounting, Seventh Canadian Edition
Expenses of $4,500 should be deducted from the revenues in April because that is when the expenses were incurred and the revenues earned.
LO 1 BT: C Difficulty: S Time: 2 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
4.
(a)
(b) (c)
The accrual-basis financial statements provide reporting of assets, liabilities, and shareholders’ equity as well as revenues and expenses. They include receivables and payables to ensure that revenues are recorded when earned and expenses recorded when incurred in the period revenue is generated. Receivables and payables do not exist under the cash basis of accounting. The cash-basis financial statements provide reliable reporting of cash receipts and cash disbursements. No estimates are required, as is the case with accrual-basis financial statements. Companies using IFRS or ASPE cannot choose between the cash and accrual basis of accounting for financial reporting purposes because generally accepted accounting principles require the accrual basis. In addition, the cash basis could allow for the manipulation of income by delaying or speeding up the timing of cash flow.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
(a) (b)
Prepaid expenses are assets because they have a future benefit since they were paid for before they are used or consumed. As the benefit of the prepayment expires, (often with the passage of time) the asset must be reduced and an expense recognized. This requires an adjustment at the end of each accounting period, to expense the portion of the prepaid that has expired (been used up) during the period.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
(a)
(b)
Unearned revenue arises when cash is received for goods or services to be provided in the future. It represents a liability because the cash has not yet been earned—the company has a future obligation to provide the goods or services. Unearned revenues must be adjusted at the end of an accounting period to reflect any revenues that have been earned.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
No. Depreciation is the process of allocating the cost of a long-lived asset to expense over its useful life. Depreciation results in the presentation of the carrying amount (cost less accumulated depreciation) of the asset, not its current value.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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8.
(a)
Financial Accounting, Seventh Canadian Edition
Depreciation expense is an expense account with a normal debit balance and is reported on the income statement as part of the operating expenses. This account shows the portion of the cost of a long-lived asset that has expired during the current accounting period. Accumulated depreciation is a contra asset account with a normal credit balance that is reported on the statement of financial position as a reduction of a depreciable asset (such as building and equipment). The balance in the accumulated depreciation account is the total depreciation that has been recognized from the date of acquisition of the depreciable asset to the statement of financial position date.
(b)
Cost is the original cost of the asset when purchased. The carrying amount is the original cost of the asset less its related accumulated depreciation, and represents the portion of the asset that has not yet been depreciated.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
A contra asset account is an account with a credit balance that is deducted from the related asset account on the statement of financial position. Using a contra asset account, such as Accumulated Depreciation, enables disclosure of both the original cost of the asset and the total estimated cost that has expired or been used up to date. This information is useful to the financial statement user who can determine how long until the asset is fully depreciated.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
Yes, I agree. A “simple” adjusting entry affects one statement of financial position account and one income statement account. An adjusting entry reallocates amounts between a statement of financial position account and an income statement account. For example: to record the expiration of insurance the following entry would be recorded; a debit to Insurance Expense (an income statement account) and a credit to Prepaid Insurance (a statement of financial position account). Compound adjusting journal entries are also possible which would affect more accounts, but at least one statement of financial position account and one income statement account are always affected whether a simple adjusting entry or a compound adjusting entry is made.
LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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11.
Financial Accounting, Seventh Canadian Edition
Disagree. Adjusting entries never involve the Cash account. In making adjusting entries for prepayments, the cash has already been paid or received and recorded. The adjusting journal entry is prepared to reflect the fact that a portion of the unearned revenue or prepaid expense arising in the past when the cash flow occurred is now earned or incurred. In making adjusting entries for accruals, we record the fact that, although the cash has not been paid or received, revenue has been earned or an expense has been incurred. Again, there is no impact on the Cash account because cash has not yet been received or paid but is expected to be subsequently.
LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
To ensure that the adjusting entry is properly calculated and prepared, the preparer of the adjusting entry must first properly understand the original cash payment transaction that lead to the recording of the prepayment. For example, if you are preparing an adjusting entry to record the supplies on hand, you must know first how much is already recorded. On the other hand, in the case of an accrual, there is no cash payment to look up in the accounts. Consequently, there is no original entry to examine in the process of preparing an adjusting entry related to an accrual.
LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
(a)
Yes, it does matter whether the adjusting entry is made on December 31. If the interest is not accrued on December 31, then expenses (interest expense) and liabilities (interest payable) will both be understated in that year’s financial statements. In addition, expenses (interest expense) will be overstated in the subsequent year, when the expense is recorded (incorrectly) when paid on January 1. By not making this journal entry, expenses will not be matched with the period in which the loan was available for use.
(b)
The correct journal entries are as follows: Dec. 31 Interest Expense .............................. Interest Payable.........................
100
Jan. 1
100
Interest Payable .............................. Cash ..........................................
100
100
If no entry is made on Dec. 31, and interest expense is recorded on January 1 when paid, interest expense will be understated by $100 and interest payable will be understated by the same amount for the year ended December 31, 2018. LO 3 BT: AN Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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14.
Financial Accounting, Seventh Canadian Edition
Financial statements can be prepared from an adjusted trial balance because the balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period. An unadjusted trial balance is not up to date for prepayments and accruals.
LO 4 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
(a)
Original transaction entries are made throughout the accounting period when transactions arise. Adjusting entries are only recorded at the end of the accounting period, prior to the preparation of the financial statements. As well, adjusting entries never affect the Cash account and always result in an adjustment to a statement of financial position account and an income statement account. Transaction entries often result in a debit or credit to Cash and can affect any account on the statement of financial position or the income statement (or both).
(b)
Closing entries are required to reset the revenue and expense (income statement) and dividend declared accounts to zero and to update the balance in Retained Earnings to the ending balance as shown in the statement of changes in equity. Unlike adjusting entries, which are prepared before the financial statements are prepared and could be prepared more than once per year (for example, monthly, quarterly), closing entries are only prepared and posted after the year-end financial statements have been completed.
LO 2,3,4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
The unadjusted, adjusted, and post-closing trial balances are similar in that they prove the equality of the total debit and total credit balances. Another similarity between the unadjusted and adjusted trial balances is that they are prepared at the end of an accounting period. Where trial balances differ is that the unadjusted trial balance is prepared before any adjusting entries have been recorded or posted. An adjusted trial balance is prepared after the adjusting entries have been posted to the accounts. The financial statements are prepared from the adjusted trial balance. After the financial statements have been prepared, closing entries are prepared and posted. The post-closing trial balance is then prepared and used to form the basis of the opening balances for the next accounting period. Unlike the adjusted trial balance which will list temporary (revenue, expense, dividend declared) account balances prior to recording the closing entries, a post-closing trial balance will not list temporary account balances as these have now been closed out to the Retained Earnings account. Unadjusted and adjusted trial balances are prepared whenever financial statements are prepared but a postclosing trial balance is prepared only at the end of the year.
LO 4,5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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17.
Financial Accounting, Seventh Canadian Edition
The retained earnings balance on the unadjusted and adjusted trial balances are the same since the account does not yet reflect the changes that arise from the recording of closing entries. After the adjusted trial balance and financial statements are prepared, closing entries are recorded. These will change the retained earnings balance by updating it for the effect of any net income or loss and dividends declared. Consequently, the retained earnings balance on the post-closing trial balance will be different from the balance shown on the adjusted trial balance.
LO 4,5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
18.
Closing entries are prepared to transfer temporary account balances to retained earnings, a permanent account, so retained earnings will show an up-to-date amount that includes the effect of revenues, expenses, and dividends declared for the year. Secondly, closing entries produce a zero balance in each temporary account so that the temporary accounts are ready for the next accounting period, where only transactions relating to that period are recorded in them.
LO 5 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
19.
The Dividends Declared account is not closed into the Income Summary account along with the expense accounts because it is not an expense; it was not incurred for the purpose of generating revenue and does not appear on the income statement. Dividends Declared represent a distribution of retained earnings and is reported on the statement of changes in equity. The Dividends Declared account is also a temporary account and therefore requires a closing entry.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
20.
The Income Summary account is used in the closing process to avoid having too much detail in the Retained Earnings account. Only the net result of the revenues less expenses will be recorded as a closing entry from the Income Summary account to the Retained Earnings account. Before closing the Income Summary account, the net balance is compared to the income statement to ensure that the amounts used in closing the revenue and expense temporary accounts are complete and accurate.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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21.
Financial Accounting, Seventh Canadian Edition
(a) (1) (2) (3) (4)
Net income: (Dr) Individual revenue accounts and (Cr) Income Summary (Dr) Income Summary and (Cr) Individual expense accounts (Dr) Income Summary and (Cr) Retained Earnings (Dr) Retained Earnings and (Cr) Dividends Declared
(b) (1) (2) (3) (4)
Net loss: (Dr) Individual revenue accounts and (Cr) Income Summary (Dr) Income Summary and (Cr) Individual expense accounts (Dr) Retained Earnings and (Cr) Income Summary (Dr) Retained Earnings and (Cr) Dividends Declared
Note that it is only step 3 that differs between the two situations shown in (a) and (b) and the Income Summary is not involved in the fourth closing entry. LO 5 BT: K Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
22.
Steps in the accounting cycle that may be done on a daily basis include: 1. Analyzing business transactions 2. Journalizing the transactions Steps in the accounting cycle that are done on a periodic basis include: 3. Posting to the general ledger accounts 4. Preparing a trial balance 5. Journalizing and posting adjusting entries (prepayments and accruals) 6. Preparing an adjusted trial balance 7. Preparing the financial statements: income statement, statement of changes in equity, statement of financial position, and statement of cash flows Steps in the accounting cycle that are usually only done at the end of the company’s accounting period include: 8. Journalizing and posting closing entries 9. Preparing a post-closing trial balance
LO 5 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)
Cash –$ 100 0 0 +800 –5,000 0 +1,000 0 +500 0 0
Net Income $ 0 –75 +1,000 0 0 –1,000 0 –50 0 +200 –250
LO 1 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 4-2 (a) Accrual Basis
(b) Cash Basis
$
0
$200
2. Collected $500 cash from customers for services provided in September.
500
500
3. Billed customers $600 for services provided in September.
600
0
4. Provided $100 of services to customers who paid in advance in August.
100
0
0
100
$1,200
$800
1. Collected $200 cash from customers for services provided in August.
5. Received $100 from customers in advance for services to be provided in October. Total revenue
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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BRIEF EXERCISE 4-3 (a)
Jan. 11
Supplies ............................................. Accounts Payable........................
(b)
Supplies Used = $1,500 + $1,800 – $1,100 = $2,200
(c)
Jan. 31
1,800 1,800
Supplies Expense .............................. Supplies ......................................
2,200 2,200
(d)
Open. Bal. Jan. 11 Jan. 31 Bal.
Supplies 1,500 1,800 Jan. 31 Adj. 1,100
Jan. 31 Adj.
Supplies Expense 2,200
2,200
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 4-4 (a) (b)
Jan. 2
Vehicles............................................. Cash ............................................
50,000 50,000
The journal entry for the years 2018 and 2019 will be the same: Dec. 31
Depreciation Expense ........................ 10,000 Accumulated Depreciation—Vehicles ($50,000 ÷ 5 = $10,000 per year)
10,000
(c) CLAYMORE CORPORATION Statement of Financial Position (partial) December 31
Property, plant, and equipment Vehicles Less: Accumulated depreciation Carrying amount
2019
2018
$50,000 20,000 $30,000
$50,000 10,000 $40,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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BRIEF EXERCISE 4-5 (a) (1) Bere Ltd. June
1
Prepaid Insurance ....................................... Cash...................................................
6,000 6,000
(2) Safety Insurance Corp. June
(b)
1
Cash............................................................ Unearned Revenue ............................
6,000 6,000
Expired in 2018 = $6,000 × 7/12 = $3,500 Unexpired at December 31, 2018 = $6,000 × 5/12 = $2,500
(c) (1) Bere Ltd. Dec. 31
Insurance Expense ....................................... Prepaid Insurance ................................
3,500 3,500
(2) Safety Insurance Corp. Dec. 31
Unearned Revenue ..................................... Insurance Revenue ............................
3,500 3,500
(d) Bere Ltd. Prepaid Insurance 6,000 Dec. 31 Adj. 3,500 Dec. 31 Bal. 2,500
Insurance Expense Dec. 31 Adj. 3,500
June 1
Safety Insurance Corp. Unearned Revenue June 1 Dec. 31 Adj. 3,500 Dec. 31 Bal.
Insurance Revenue Dec. 31 Adj.
6,000
3,500
2,500
LO 2,3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-6 (a)
(b)
(c)
Oct. 27
Oct. 31
Nov. 3
Salaries Expense .............................................. Cash .........................................................
5,000
Salaries Expense (Oct. 29-31: $1,000 × 3 days) Salaries Payable ......................................
3,000
Salaries Expense (Nov. 1-2: $1,000 × 2 days) .. Salaries Payable ............................................... Cash .........................................................
2,000 3,000
5,000
3,000
5,000
LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 4-7 (a)
Nov. 30
Accounts Receivable......................................... Service Revenue ......................................
375 375
(b)
No, Zieborg will not have to make a journal entry on December 1 when it prepares the invoice because the November 30 adjusting entry already recorded the amount.
(c)
Jan. 10
Cash ................................................................. Accounts Receivable ................................
375 375
LO 3 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 4-8 (a)
(b)
2018 July
1
2018 Dec. 31 2019 Dec. 31
(c)
2020 Jan.
1
Vehicles ................................................... Bank Loan Payable ......................... Cash ...............................................
50,000
Interest Expense ($40,000 × 6% × 6/12) Interest Payable ..............................
1,200
Interest Expense ($40,000 × 6%) ............. Interest Payable ..............................
2,400
Bank Loan Payable .................................. Interest Payable ($1,200 + $2,400) .......... Cash ................................................
40,000 3,600
40,000 10,000
1,200
2,400
43,600
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-9 (a)
(b)
2018 July
1
2018 Dec. 31
2019 Dec. 31 (c)
(d)
2020 Jan.
1
Bank Loan Receivable ................................. Cash ...................................................
40,000
Interest Receivable ($40,000 × 6% × 6/12) Interest Revenue .................................
1,200
Interest Receivable ($40,000 × 6%) ............. Interest Revenue .................................
2,400
Cash ............................................................ Interest Receivable ($1,200 + $2,400) Bank Loan Receivable ........................
43,600
40,000
1,200
2,400
3,600 40,000
The total amount collected by the Canada Bank corresponds to the total paid by Nahkooda. The total amount of interest revenue earned by the Canada Bank is the same as the total interest expense incurred by Nahkooda. The primary differences are that the Canada Bank records an asset (bank loan receivable and interest receivable) and revenue (interest revenue) while Nahkooda records a liability (bank loan payable and interest payable) and expense (interest expense).
LO 3 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 4-10 (a)
$400 = $2,600 – $2,200
(b)
$3,500 = $400 (2016 payable balance) + $3,600 – $500. Notice how the change in the payable each year indicates the difference between the expense and the cash paid. In other words, in this year, the company had to pay off last year’s tax of $400 but did not pay off $500 of this year’s tax. Since this year’s tax was $3,600, only $3,100 of this was paid off. This $3,100 along with the $400 relating to last year totals $3,500.
(c)
$4,400 = $4,200 – $500 (2017 payable balance) + $700 (2018 payable balance). The $4,200 that was paid would have included $500 relating to the prior year so the remainder of $3,700 would have related to the current year. Since $700 of the current year’s tax is unpaid, the total tax expense for this year must have been $3,700 + $700.
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-11 OROMOCTO CORPORATION Adjusted Trial Balance February 28, 2018
Cash .................................................................................. Accounts receivable ........................................................... Supplies ............................................................................. Prepaid insurance .............................................................. Equipment .......................................................................... Accumulated depreciation—equipment .............................. Accounts payable ............................................................... Salaries payable................................................................. Income tax payable ............................................................ Common shares ................................................................. Retained earnings .............................................................. Dividends declared............................................................. Fees earned ....................................................................... Salaries expense ................................................................ Rent expense ..................................................................... Depreciation expense ........................................................ Supplies expense ............................................................... Insurance expense ............................................................. Utilities expense ................................................................. Income tax expense........................................................... Totals ............................................................................
Debit $ 18,000 28,000 1,000 2,500 23,450
Credit
$ 5,400 13,000 3,000 4,550 10,000 21,000 2,000 89,500 46,400 6,000 4,400 4,000 3,500 2,400 4,800 $146,450
0000 000 $146,450
(Total debits = Total credits) LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-12 (a) OROMOCTO CORPORATION Income Statement Year Ended February 28, 2018 Revenues Fees earned ......................................................................... Expenses Salaries expense .................................................................. Rent expense ....................................................................... Depreciation expense .......................................................... Supplies expense ................................................................. Insurance expense ............................................................... Utilities expense ................................................................... Total expenses Income before income tax ............................................................. Income tax expense ...................................................................... Net income ....................................................................................
$89,500 $46,400 6,000 4,400 4,000 3,500 2,400 66,700 22,800 4,800 $18,000
[Revenues – Expenses = Net income or (Loss)]
(b) OROMOCTO CORPORATION Statement of Changes in Equity Year Ended February 28, 2018
Common Shares
Retained Earnings
Total Equity
Balance, March 1, 2017 ................................................................. $ 5,000 $21,000 Issued common shares .................................................................. 5,000 Net income ..................................................................................... 18,000 Dividends declared......................................................................... 000 000 (2,000) Balance, February 28, 2018 ........................................................... $10,000 $37,000
$26,000 5,000 18,000 (2,000) $47,000
(Beginning equity ± Changes to equity = Ending equity)
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-12 (CONTINUED) (c) OROMOCTO CORPORATION Statement of Financial Position February 28, 2018
Assets Current Assets Cash ....................................................................... Accounts receivable ............................................... Supplies .................................................................. Prepaid insurance .................................................. Total current assets ....................................... Property, plant, and equipment Equipment .............................................................. Less: Accumulated depreciation—equipment........ Total assets ....................................................................
$ 18,000 28,000 1,000 2,500 49,500 $23,450 5,400
18,050 $67,550
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ................................................... Salaries payable ..................................................... Income tax payable ................................................ Total current liabilities .................................... Shareholders’ equity Common shares ..................................................... Retained earnings .................................................. Total shareholders’ equity .............................. Total liabilities and shareholders’ equity .........................
$13,000 3,000 4,550 20,550 $10,000 37,000 47,000 $67,550
(Assets = Liabilities + Shareholders’ equity) LO 4 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-13 2018 Feb. 28 Fees Earned ................................................. Income Summary ...................................
89,500
28 Income Summary .......................................... Salaries Expense ................................... Rent Expense......................................... Depreciation Expense ............................ Supplies Expense .................................. Insurance Expense ................................ Utilities Expense..................................... Income Tax Expense .............................
71,500
28 Income Summary .......................................... Retained Earnings..................................
18,000
28 Retained Earnings ........................................ Dividends Declared ................................
2,000
89,500
46,400 6,000 4,400 4,000 3,500 2,400 4,800
18,000
2,000
(Income statement accounts are closed to the Income Summary account) LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-14 (a)
Service revenue ............................................ Expenses Salaries expense.................................... Repairs and maintenance expense ........ Supplies expense ................................... Utilities expense ..................................... Income tax expense ............................... Net income....................................................
$126,000 $65,000 15,000 6,000 2,000 5,700
93,700 $ 32,300
(Revenues increase net income and expenses decrease net income)
(b)
Nov. 30 Service Revenue .................................... Income Summary ...................................
126,000
30 Income Summary .......................................... Salaries Expense ................................... Repairs and Maintenance Expense ....... Supplies Expense .................................. Utilities Expense..................................... Income Tax Expense .............................
93,700
30 Income Summary .......................................... Retained Earnings..................................
32,300
30 Retained Earnings ........................................ Dividends Declared ................................
5,000
126,000
65,000 15,000 6,000 2,000 5,700
32,300
5,000
(Income statement accounts are closed to the Income Summary account)
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 4-14 (CONTINUED) (c) Service Revenue Income Tax Expense Nov 30 Bal. 126,000 Nov 30 Bal 5,700 Nov 30 CE1 126,000 Nov 30 CE2 Nov 30 Bal. 0 Nov 30 Bal.
5,700 0
Salaries Expense Dividends Declared Nov 30 Bal. 65,000 Nov 30 Bal 5,000 Nov 30 CE2 65,000 Nov 30 CE4 Nov 30 Bal. 0 Nov 30 Bal.
5,000 0
Supplies Expense Nov 30 Bal. 6,000 Nov 30 CE2 Nov 30 Bal. 0 Utilities Expense Nov 30 Bal. 2,000 Nov 30 CE2 Nov 30 Bal. 0
Income Summary Nov 30 CE2 93,700 Nov 30 CE1 126,000 6,000 Bal. 32,300 Nov 30 CE3 32,300 Nov 30 Bal. 0 2,000
Retained Earnings Nov 1 50,000 Nov 30 CE4 5,000 Nov 30 CE3 32,300 Nov 30 Bal. 77,300
Repairs and Maintenance Expense Nov 30 Bal. 15,000 Nov 30 CE2 15,000 Nov 30 Bal. 0 LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 4-15 (a) (c) (e) (g) (i) (k) (m)
Yes Yes Yes Yes No Yes No
(b) (d) (f) (h) (j) (l)
Yes Yes No No Yes No
LO 5 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 4-1 1.
Since the performance by WestJet is not complete until the flight actually occurs, revenue should not be recognized until December. WestJet should recognize the revenue in December when the customer has been provided with the flight.
2.
Revenue should be recognized as each magazine is delivered (on a monthly basis).
3.
Revenue should be recognized on a per game basis over the season from April to October, since that is when the games are provided to the fans.
4.
Interest revenue should be accrued and recognized by RBC Financial Group evenly over the term of the loan.
5.
Revenue should be recognized when the sweater is shipped to the customer in September.
(Revenues are recognized when they are earned and expenses are recognized when they are incurred.) LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 4-2 Service revenue Expenses Operating expenses Insurance expense
(a) Accrual Basis $52,000
Income before income tax Income tax expense Net income (c)
(b) Cash Basis $44,000
31,000 1,000 32,000
27,500 2,000 29,500
20,000 3,000 $17,000
14,500 $14,500
The accrual basis of accounting provides more useful information for decision makers because it recognizes revenue when earned and expenses when incurred. This provides a better measurement of performance because it records what has happened regardless of the movement of cash. This also enhances the predictive ability of the income statement.
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-3 (a) Transaction
Cash Basis
Accrual Basis
1 Revenue from services
Revenues are recorded when they are collected
Revenues are recorded when they are earned
2 Purchase equipment
Equipment is expensed when the cash is paid out
Equipment is an asset that is depreciated over its useful life
3 Pay insurance
Full amount expensed when cash is paid
Insurance is a prepayment until consumed and expensed
Expensed when paid
Accrued when owed to employees
4 Employee salaries
The proper accrual accounting would include: 1. 2. 3.
4.
(b)
The recognition of revenue from providing consulting services when earned. The recognition of equipment in the accounts when purchased, followed by recording depreciation expense over the years of use of the equipment. The recognition of the payment for insurance as Prepaid Insurance which will then be allocated to Insurance Expense during the periods of benefit, over the next two years. Any unpaid salaries at the end of the accounting period are recognized as expenses and as salaries payable. Due to the terms of payment offered to customers (90 days) and the timing of payments for operating expenses, it is not surprising that the business has experienced delays in cash inflows compared to cash outflows. In addition, when prepayments are involved, large sums of cash are paid out for things like equipment or for prepaid insurance, which require immediate payment but will become expenses over several years. Consequently, it is highly probable, particularly at the start of a new business, that net income is realized, while at same time, cash resources are scarce. Quite often, new businesses require financing to cover cash shortfalls until they have been able to accumulate sufficient cash to cover their business activities.
LO 1 BT: C Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-4 (a)
2018 June Aug. Sept. Nov. Dec.
(b)
2018 Dec.
1 31 4 30 5
31
31
31
.
31
31
Solutions Manual .
Prepaid Insurance ................................. Cash ............................................
1,800
Prepaid Rent ......................................... Cash ............................................
6,500
Cash ..................................................... Unearned Revenue .....................
3,600
Prepaid Services ................................... Cash ............................................
2,000
Cash ...................................................... Unearned Revenue .....................
1,500
Insurance Expense ............................... Prepaid Insurance........................ ($1,800 × 7/12 months = $1,050)
1,050
Rent Expense........................................ Prepaid Rent ................................ ($6,500 × 4/5 months = $5,200)
5,200
Unearned Revenue ............................... Sponsorship Revenue ................. ($3,600 × 4/9 games = $1,600)
1,600
Repairs and Maintenance Expense ...... Prepaid Services..........................
1,000
1,800 6,500 3,600 2,000 1,500
1,050
5,200
1,600
Unearned Revenue ............................... 1,025 Sponsorship Revenue ................. ($1,500 – $475 not played = $1,025 played)
4-23
1,000
1,025
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-4 (CONTINUED) (c) Prepaid Insurance June 1 1,800 Dec. 31 Adj. Dec. 31 Bal. 750
Aug. 31 Dec. 31 Bal.
Prepaid Rent 6,500 Dec. 31 Adj. 1,300
Unearned Revenue Sept. 4 Dec. 5 Dec. 31 Adj. 1,600 Dec. 31 Adj. 1,025 Dec. 31 Bal. Prepaid Services 2,000 Dec. 31 Adj. Dec. 31 Bal. 1,000
Insurance Expense Dec. 31 Adj. 1,050 1,050
Dec. 31 Adj.
Rent Expense 5,200
5,200
3,600 1,500
Sponsorship Revenue Dec. 31 Adj. Dec. 31 Adj.
1,600 1,025
2,475
Dec. 31 Bal.
2,625
Repairs and Maintenance Expense Dec. 31 Adj. 1,000
Nov . 30
1,000
Note: The Cash account has not been included in this solution, as per the instructions. LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-5 (a)
2018 Dec. 31
31
Depreciation Expense .......................................... Accumulated Depreciation—Vehicles ............ ($33,000 ÷ 3 = $11,000 per year)
11,000
Depreciation Expense .......................................... Accumulated Depreciation—Equipment ........ ($15,000 ÷ 5 × 6/12 = $1,500)
1,500
11,000
1,500
(b)
Cost Accumulated depreciation $33,000 ÷ 3 × 2 $15,000 ÷ 5 × 6/12 Carrying amount
Vehicles $33,000
Equipment $15,000
22,000 000 000 $11,000
1,500 $13,500
LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-6 (a)
2018 Dec.
31
31
31
31 31
(b)
2019 Jan.
21 7
1
4 2
Utilities Expense................................................... Accounts Payable .......................................
425
Salaries Expense ................................................. Salaries Payable ......................................... ($3,500 × 1/7 days = $500)
500
Interest Expense .................................................. Interest Payable .......................................... ($45,000 × 5% × 1/12 months = $188 (rounded))
188
Accounts Receivable............................................ Fees Earned ...............................................
300
Accounts Receivable............................................ Rent Revenue ............................................
6,000
Accounts Payable ................................................ Cash ...........................................................
425
Salaries Payable .................................................. Salaries Expense ................................................. Cash ...........................................................
500 3,000
Interest Payable ................................................... Cash ...........................................................
188
Cash. .................................................................... Accounts Receivable ..................................
300
Cash. .................................................................... Accounts Receivable ..................................
6,000
425
500
188
300 6,000
425
3,500
188
300 6,000
LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-7 (a)
July
2 7 14
15 21 28 (b)
July
31
31
31
31
31
31
31
Prepaid Rent ........................................................ Cash ...........................................................
1,500
Supplies ............................................................... Accounts Payable .......................................
200
Cash .................................................................... Accounts Receivable .................................. ($6,550 2)
3,275
Cash .................................................................... Bank Loan Payable .....................................
1,000
Cash .................................................................... Unearned Revenue .....................................
1,000
Accounts Receivable............................................ Service Revenue ........................................
1,500
Accounts Receivable............................................ Service Revenue ........................................
800
Rent Expense....................................................... Prepaid Rent ............................................... ($1,500 ÷ 2 = $750)
750
Supplies Expense ................................................ Supplies ...................................................... ($1,200 + $200 − $500 = $900)
900
Depreciation Expense .......................................... Accumulated Depreciation—Equipment ..... ($15,000 ÷ 5 x 1/12)
250
Interest Expense .................................................. Interest Payable........................................... ($1,000 × 5% × 1/12 months)
4
Salaries Expense ................................................. Salaries Payable..........................................
2,500
Unearned Revenue ............................................. Service Revenue .........................................
2,000
1,500 200 3,275
1,000 1,000 1,500 800
750
900
250
4
2,500
2,000
LO 2,3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-8 1.
Mar. 031
2.
3.
4.
5.
6.
31
31
31
31
31
Depreciation Expense .......................................... Accumulated Depreciation—Equipment ...... ($21,600 ÷ 4 × 3/12 months)
1,350
Unearned Revenue .............................................. Rent Revenue ($9,600 × 2/3) ......................
6,400
Interest Expense .................................................. Interest Payable........................................... ($20,000 × 6% × 1/12 months)
100
Supplies Expense ................................................. Supplies ($2,800 – $850) ............................
1,950
Insurance Expense .............................................. Prepaid Insurance ....................................... ($14,400 × 3/12)
3,600
Income Tax Expense ............................................ Income Tax Payable ....................................
3,200
1,350
6,400
100
1,950
3,600
3,200
LO 2,3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 4-9
Net Income
Total Assets
Total Liabilities
Total Shareholders’ Equity
Incorrect balances
$90,000
$170,000
$70,000
$100,000
Adjustments: 1. Salaries 2. Rent 3. Depreciation
(10,000) 4,000 (9,000)
(9,000)
10,000 (4,000) 00000 0
(10,000) 4,000 (9,000)
Correct balances
$75,000
$161,000
$76,000
$ 85,000
LO 2,3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-10 (a)
December entry: Cash ..................................................... Unearned Revenue ......................
1,600
January entry:
1,600
Unearned Revenue .............................. Service Revenue ..........................
Adj.
Unearned Revenue Jan. 1 Bal. 1,600 Jan. 31 Bal.
1,600
1,600
2,350 750
The balance in Unearned Revenue on January 1, 2018 was $2,350 ($750 + $1,600). (b)
Journal entry to record depreciation: Depreciation Expense........................... Accumulated Depreciation ...........
120 120
1 month = $120; Annual depreciation = $1,440 ($120 × 12) Number of months depreciated = accumulated depreciation ($3,000) monthly depreciation ($120) = 25 months or 2 years, 1 month Therefore, the equipment is 2 years, 1 month old. purchased on January 1, 2016. (c)
Journal entry to adjust insurance: Insurance Expense..... Prepaid Insurance .
It would have been
400 400
Since the prepaid insurance is $1,200, we can assume that 3 months ($1,200 ÷ $400 = 4) of the policy remain. Consequently, if it expires at $400 per month, then the policy is $3,600 ÷ $400 = 9 months old and it was purchased on May 1, 2017. Prepaid Insurance May 1, 2017 4,800 May 1 to Dec. 31 Adj. 3,200 Dec. 31, 2017 Bal. 1,600 Jan. 31 Adj. 400 Jan. 31, 2018 Bal. 1,200 The original insurance policy premium was $4,800 ($400 × 12). The monthly adjustments made May 1 through December 31 totalled $3,200 ($400 × 8). Solutions Manual .
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Chapter 4
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Financial Accounting, Seventh Canadian Edition
EXERCISE 4-10 (CONTINUED) (d)
Journal entry to adjust supplies: Supplies Expense ...................... Supplies .............................. Supplies Expense
Adj. Jan. 31 Bal.
Jan. 1 Bal. Purchase Jan. 31 Bal.
950 950
950 950
Supplies 900 750 Adj. 700
950
Derive the balance by working backward up through the T account. Therefore, the balance in Supplies on January 1 was $900 ($700 + $950 – $750).
(e)
Journal entry to record income tax payable: Income Tax Expense ................ Income Tax Payable...........
Income Tax Expense Adj. Jan. 31 Bal.
150
Income Tax Payable Jan. 1 Bal. Payment 100 Adj. Jan. 31 Bal.
100 100
150
150 100 150
Derive the balance by working backward up through the T account. The balance in Income Tax Payable on January 1 was $150 ($150 − $100 + $100). It is assumed that income tax instalments are paid monthly and that the balance owing at December 31 (January 1) was the adjustment required at year-end after the income tax return was prepared. This balance owing must be paid within three months of the company’s year-end. LO 2,3,4 BT: AP Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-11 FRASER VALLEY SERVICES LTD. Adjusted Trial Balance August 31, 2018 Debit Cash ........................................................................................................ $ 11,430 Accounts receivable.................................................................................. 18,225 Supplies .................................................................................................... 3,400 Prepaid insurance ..................................................................................... 3,450 Equipment ................................................................................................ 25,600 Accumulated depreciation—equipment .................................................... Accounts payable ..................................................................................... Salaries payable ....................................................................................... Interest payable ........................................................................................ Rent payable ............................................................................................ Income tax payable................................................................................... Unearned revenue .................................................................................... Bank loan payable, due 2021 ................................................................... Common shares ....................................................................................... Retained earnings .................................................................................... Dividends declared ...................................................................................600 Service revenue ........................................................................................ Salaries expense ...................................................................................... 19,200 Rent expense ........................................................................................... 15,000 Depreciation expense ............................................................................... 2,275 Supplies expense ..................................................................................... 1,750 Interest expense ....................................................................................... 1,500 Insurance expense ................................................................................... 1,100 Income tax expense.................................................................................. 2,000 Totals ............................................................................ $105,530
Credit
$ 5,905 2,800 2,200 1,500 1,250 1,500 700 25,000 5,000 5,400 54,275
000 0000 $105,530
(Total debits = Total credits) LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-12 (a) FRASER VALLEY SERVICES LTD Income Statement Year Ended August 31, 2018
Revenues Service revenue .................................................................... Expenses Salaries expense .................................................................. Rent expense ....................................................................... Depreciation expense ........................................................... Supplies expense ................................................................. Interest expense ................................................................... Insurance expense ............................................................... Total expenses ............................................................ Income before income tax ............................................................. Income tax expense ...................................................................... Net income ....................................................................................
$54,275
$19,200 15,000 2,275 1,750 1,500 1,100 40,825 13,450 2,000 $11,450
[Revenues – Expenses = Net income or (Loss)]
(b) FRASER VALLEY SERVICES LTD. Statement of Changes in Equity Year Ended August 31, 2018
Balance, September 1, 2017......................... Issued common shares ................................. Net income .................................................... Dividends declared ....................................... Balance, August 31, 2018 .............................
Common Shares $4,000 1,000 00 000 $5,000
Retained Earnings $ 5,400 11,450 (600) $16,250
Total Equity $ 9,400 1,000 11,450 (600) $21,250
(Beginning equity ± Changes to equity = Ending equity)
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Financial Accounting, Seventh Canadian Edition
EXERCISE 4-12 (CONTINUED) (c) FRASER VALLEY SERVICES LTD. Statement of Financial Position August 31, 2018 Assets Current assets Cash .............................................................................................. Accounts receivable....................................................................... Supplies ......................................................................................... Prepaid insurance .......................................................................... Total current assets .............................................................. Property, plant, and equipment Equipment .................................................................. $25,600 Less: Accumulated depreciation—equipment............ 5,905 Total assets ............................................................................................
$11,430 18,225 3,400 3,450 36,505
19,695 $56,200
Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................................... Salaries payable ............................................................................ Interest payable ............................................................................. Rent payable ................................................................................. Income tax payable........................................................................ Unearned revenue ......................................................................... Total current liabilities ........................................................... Non-current liabilities Bank loan payable ......................................................................... Total liabilities ....................................................................... Shareholders’ equity Common shares ......................................................... $ 5,000 Retained earnings....................................................... 16,250 Total shareholders’ equity ..................................................... Total liabilities and shareholders’ equity .................................................
$ 2,800 2,200 1,500 1,250 1,500 700 9,950 25,000 34,950
21,250 $56,200
(Assets = Liabilities + Shareholders’ equity) LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
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Financial Accounting, Seventh Canadian Edition
EXERCISE 4-13 (a) Dec.
31
31
31
31
Service Revenue .............................................. Interest Revenue .............................................. Income Summary ....................................
396,000 9,000
Income Summary .............................................. Salaries Expense ..................................... Office Expense ........................................ Depreciation Expense .............................. Utilities Expense ...................................... Interest Expense ...................................... Income Tax Expense ...............................
330,400
Income Summary .............................................. Retained Earnings ...................................
74,600
Retained Earnings ............................................ Dividends Declared ..................................
10,500
405,000
240,000 21,500 20,000 19,000 11,250 18,650 74,600
10,500
(Income statement accounts are closed to the Income Summary account) (b) Income Summary Dec. 31 CE2 330,400 Dec. 31 CE1 Bal. Dec. 31 CE3 74,600 Dec. 31 Bal. Retained Earnings Jan. 1 Bal. Dec. 31 CE4 10,500 Dec. 31 CE3 Dec. 31 Bal. Dividends Declared Dec. 31 Bal. 10,500 Dec. 31 CE4 Dec. 31 Bal. 0 Solutions Manual .
405,000 74,600 0
185,000 74,600 249,100
10,500
Service Revenue Dec. 31 Bal. Dec. 31 CE1 396,000 Dec. 31 Bal. Interest Revenue Dec. 31 Bal. Dec 31 CE1 9,000 Dec. 31 Bal.
396,000 0
9,000 0
Salaries Expense Dec. 31 Bal. 240,000 Dec. 31 CE2 240,000 Dec. 31 Bal. 0
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Financial Accounting, Seventh Canadian Edition
EXERCISE 4-13 (CONTINUED) (b) (continued) Utilities Expense Dec. 31 Bal. Dec. 31 Bal.
Office Expense 21,500 Dec. 31 CE2 0
Dec. 31 Bal. 19,000 Dec. 31 CE2 21,500
Dec. 31 Bal.
19,000
0 Interest Expense
Depreciation Expense Dec. 31 Bal. 20,000 Dec. 31 CE2 Dec. 31 Bal. 0
Dec. 31 Bal. 11,250 Dec. 31 CE2 20,000
Dec. 31 Bal.
11,250
0 Income Tax Expense
Dec. 31 Bal. 18,650 Dec. 31 CE2 Dec. 31 Bal.
18,650
0
LO 5 BT: AP Difficulty: S Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 4-14 (a) 2018 Aug. 31 31
031 31
Service Revenue ...................................... Income Summary ............................
54,275
Income Summary ...................................... Salaries Expense ............................. Rent Expense .................................. Depreciation Expense ...................... Interest Expense .............................. Insurance Expense .......................... Income Tax Expense .......................
42,825
Income Summary ...................................... Retained Earnings ...........................
11,450
Retained Earnings .................................... Dividends Declared ..........................
600
54,275 19,200 15,000 2,275 1,500 1,100 2,000 11,450 600
(Income statement accounts are closed to the Income Summary account) (b)
FRASER VALLEY SERVICES LTD. Post-Closing Trial Balance August 31, 2018
Cash .................................................................................. Accounts receivable .......................................................... Supplies ............................................................................ Prepaid insurance ............................................................. Equipment ......................................................................... Accumulated depreciation—equipment ............................. Accounts payable .............................................................. Salaries payable ................................................................ Interest payable ................................................................. Rent payable ..................................................................... Income tax payable ............................................................ Unearned revenue ............................................................. Bank loan payable ............................................................. Common shares ................................................................ Retained earnings ............................................................. Totals ............................................................................
Debit $11,430 18,225 3,400 3,450 25,600
00000 0 $62,105
Credit
$ 5,905 2,800 2,200 1,500 1,250 1,500 700 25,000 5,000 16,250 $62,105
(Total debits = Total credits) LO 5 BT: AP Difficulty: S Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 4-1A 1. (a)
(b)
2. (a)
(b)
3. (a)
(b)
4. (a) (b)
5. (a) (b)
Jan.
2 Supplies.................................................. Cash .................................................
4,100
Dec. 31 Supplies Expense ($4,100 – $700) ........ Supplies ............................................
3,400
Apr.
1 Vehicles .................................................. Cash ................................................. Bank Loan Payable ...........................
45,000
Dec. 31 Depreciation Expense ............................ Accumulated Depreciation—Vehicles ($45,000 ÷ 5 years × 9/12 months)
6,750
Aug.
3,600
1 Prepaid Insurance .................................. Cash .................................................
4,100
3,400
5,000 40,000
6,750
3,600
Dec. 31 Insurance Expense ($3,600 × 5/12 months) Prepaid Insurance.............................
1,500
Nov.
9 Cash ....................................................... Unearned Revenue ...........................
1,600
Dec. 31 Unearned Revenue ($1,600 × ½) ........... Service Revenue ..............................
800
Dec.
1 Prepaid Rent .......................................... Cash .................................................
Dec. 31 Rent Expense ......................................... Prepaid Rent .....................................
1,500
1,600 800 2,400 2,400 1,200 1,200
LO 2 BT: AP Difficulty: S Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-2A 1. (a)
(b)
2. (a)
(b)
3. (a)
(b)
4. (a)
(b)
5. (a) (b)
Mar. 31 Interest Expense .................................... Interest Payable ................................ ($12,000 × 6% × 1/12 months)
60
Apr. 1 Interest Payable ..................................... Cash...................................................
60
Mar. 31 Interest Receivable ................................ Interest Revenue ..............................
250
Apr. 1 Cash ...................................................... Interest Receivable ...........................
250
Mar. 31 Salaries Expense .................................. Salaries Payable (5 × $200 × 5 days)
5,000
Apr. 2 Salaries Payable ................................... Cash..................................................
5,000
Mar. 31 Utilities Expense .................................... Accounts Payable ............................
750
Apr. 10 Accounts Payable .................................. Cash..................................................
750
Mar. 31 Accounts Receivable ............................. Service Revenue ...............................
3,000
60
60
250
250
5,000
5,000
750
750
3,000
Apr. 4 No entry required Apr. 30 Cash ...................................................... Accounts Receivable.........................
2,000 2,000
LO 3 BT: AP Difficulty: S Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-3A 1. (a) June 1, 2017
(b) Nov. 30, 2018
2. (a) Oct. 1, 2018
(b) Nov. 30, 2018
3. (a) Feb. 16, 2018
(b) Nov. 30, 2018
4. (a) June 1, 2018
(b) Nov. 30, 2018
(c) Dec. 1, 2018
5. (a) Nov. 2, 2018
(b) Nov. 30, 2018
(c) Dec. 4, 2018
Solutions Manual .
Vehicles ..................................................... Cash ..................................................
80,000
Depreciation Expense................................ Accumulated Depreciation—Vehicles . ($80,000 ÷ 5 years × 6/12)
8,000
Cash (400 × $320) ..................................... Unearned Revenue ...........................
128,000
Unearned Revenue.................................... Ticket Revenue ($128,000 × 2/8 plays)
32,000
Supplies ..................................................... Cash ..................................................
2,100
Supplies Expense ($1,000 + $2,100 – $500) Supplies ............................................
2,600
Cash .......................................................... Bank Loan Payable ...........................
100,000
Interest Expense ........................................ Interest Payable ................................ ($100,000 × 6% × 1/12 months)
500
Interest Payable ........................................ Cash ..................................................
500
Cash .......................................................... Unearned Revenue ...........................
40
80,000
8,000
128,000
32,000
2,100
2,600
100,000
500
500
40
Unearned Revenue.................................... Accounts Receivable ................................. Rent Revenue ...................................
40 360
Cash .......................................................... Accounts Receivable .........................
360
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400
360
Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-3A (CONTINUED) 6. (b) Nov. 30, 2018
(c) Dec. 3, 2018
7. (b) Nov. 30, 2018
(c) Dec. 14, 2018
Salaries Expense ....................................... Salaries Payable [$7,000 × 6/7 days (Sunday through Friday)]................
6,000
Salaries Payable (Sunday through Friday) Salaries Expense (Saturday) ..................... Cash ..................................................
6,000 1,000
Income Tax Expense ................................. Income Tax Payable .........................
1,250
Income Tax Payable .................................. Cash ..................................................
1,250
6,000
7,000
1,250
1,250
LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-4A (a) 1. June 30
2.
3.
4.
5.
6.
7.
Solutions Manual .
30
30
30
30
30
30
Rent Revenue.......................................................... Unearned Rent Revenue .................................
57,000
Supplies Expense ($8,200 - $800) ......................... Supplies..........................................................
7,400
Insurance Expense ($14,400 x 3/12) ...................... Prepaid Insurance ..........................................
3,600
Advertising Expense ............................................... Repairs and Maintenance Expense ........................ Utilities Expense ..................................................... Accounts Payable ...........................................
110 4,450 215
Salaries Expense ($300 x 4) .................................. Salaries Payable.............................................
1,200
Interest Expense..................................................... Interest Payable .............................................
1,875
Income Tax Expense .............................................. Income Tax Payable .......................................
8,000
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57,000
7,400
3,600
4,775
1,200
1,875
8,000
Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-4A (CONTINUED) (b) ROADSIDE TRAVEL COURT LTD. Income Statement Quarter Ended June 30, 2018
Revenues Rent revenue ($212,000 – $57,000) ..................................... Expenses Salaries expense ($80,500 + $1,200) ................................... Repair and maintenance expense ($4,300 + $4,450) ........... Supplies expense ................................................................. Advertising expense ($3,800 + $110) ................................... Insurance expense ............................................................... Depreciation expense ........................................................... Interest expense ................................................................... Utilities expense ($900 + $215) ............................................ Total expenses ............................................................ Income before income tax ............................................................. Income tax expense ...................................................................... Net income ....................................................................................
$155,000
$81,700 8,750 7,400 3,910 3,600 2,700 1,875 1,115 111,050 43,950 8,000 $ 35,950
[Revenues – Expenses = Net Income or (Loss)] LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-5A (a)
Prepaid Insurance
1.
After 8 months of insurance coverage the balance in the Prepaid Insurance account is $9,600. The remaining balance is for 16 months of coverage (24 months less 8 used in the previous fiscal year). $9,600 divided by 16 months equals $600 per month.
2.
The policy was taken out on December 1, 2016. When the company made adjusting entries at the end of the prior fiscal year, on July 31, 2017, insurance expense for the period December 1, 2016 to July 31, 2017, which covers 8 months, would have been recorded. The entry would have been in the amount of $600 × 8 = $4,800. This would have reduced the Prepaid Insurance account to $9,600 ($14,400 – $4,800). During this past fiscal year ended July 31, 2018, this balance would have remained unchanged as no adjusting entries would have been prepared and recorded.
3.
The insurance policy cost $14,400 and covers a 24-month period. The original purchase price of the policy was $14,400 ($600 per month part 1. above X 24 months).
4.
By July 31, 2018, the adjusted balance in the Prepaid Insurance account will be $2,400 representing 4 months of insurance coverage from August 1 to November 30, 2018, the end of the term of the insurance policy.
Original Cost (1)
Period of Coverage (2)
(3) Monthly Cost (1) ÷ (2)
Remaining Months of Policy at July 31, 2018 (4)
$14,400
24 months (Dec. 1, 2016 to Nov. 30, 2018)
$600
4 months
Solutions Manual .
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Prepaid Insurance (3) × (4) $2,400
Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-5A (CONTINUED) (b)
Depreciation Expense
1.
The annual depreciation expense on the building is calculated as follows: ($252,000 ÷ 30 years) = $ 8,400
2.
The purchase date of the building was September 1, 2014. From September 1, 2014 to July 31, 2015, the depreciation expense recorded would have been $8,400 x 11/12 or $7,700. For the fiscal years 2016 and 2017, the depreciation expense recorded would have been $16,800 ($8,400 x 2). Consequently, the balance of the Accumulated Depreciation – Buildings account (unadjusted) at July 31, 2018 would be $24,500 ($7,700 + $16,800).
3.
After an additional year’s depreciation expense ($8,400) is recorded, the adjusted balance of the Accumulated Depreciation–Buildings account (unadjusted) at July 31, 2018 would be $32,900 ($24,500 + $8,400).
(c)
Unearned Revenue
1.
The amount of monthly revenue earned on digital magazine subscriptions is calculated as follows: 1,000 subscriptions x $60 divided by 24 months = $2,500
2.
By July 31, 2017, the company has earned 7 of the 24 months of subscription revenue. This covers the period from January 1, 2017 to July 31, 2017. Initially the Unearned Revenue account received $60,000 from the sale of subscriptions. Of this amount 7/24 had been earned and an adjustment was made to reduce the balance by $17,500 ($2,500 x 7) and so the adjusted balance of Unearned Revenue at July 31, 2017 was $42,500, ($60,000 - $17,500). This balance represents 17 months at $2,500 per month of subscription service remaining. During this past fiscal year ended July 31, 2018, this balance would have remained unchanged since adjusting entries are only made annually.
3.
By July 31, 2018, the company has earned a further 12 of the 24 months of subscription revenue or $30,000. Consequently, the adjusted balance in the Unearned Revenue account is $12,500 ($42,500 - $30,000). This balance represents 5 months of subscription service remaining at $2,500 per month for the period August 1 December 31.
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-5A (CONTINUED) (d)
Salaries Payable
1.
The total salary paid on the last payday, Monday July 30 was in the amount of: 6 × $625 = $3,750 3 × $750 = 2,250 $6,000
2.
The amount of salaries expense to be accrued at July 31, 2018 for two days (Monday and Tuesday) is: 6 × $625 × 2/5 = $1,500 [3 × $750 × 2/5 = 900 $2,400
3.
The total salary that will be paid on Monday, August 6 will be the same as that of Monday July 30, $6,000.
(e) 1.
2018 July 31
2.
3.
4.
31
31
31
Insurance Expense ($600 x 12)......................... Prepaid Insurance ....................................
7,200
Depreciation Expense ....................................... Accumulated Depreciation—Buildings......
8,400
Unearned Revenue ........................................... Subscription Revenue ..............................
30,000
Salaries Expense .............................................. Salaries Payable.......................................
2,400
7,200
8,400
30,000
2,400
LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-6A Cash Balance, December 31, 2018 = $177,600 cash receipts – $150,440 cash payments = $27,160.
(a)
(b) (1) CREATIVE DESIGNS LTD. Income Statement Year Ended December 31, 2018
Revenues Fees earned ($157,600 + $2,400) ................................. Expenses Salaries expense ($59,800 + $3,050) ............................ Rent expense ($20,000 – $2,000) ................................. Supplies expense ($8,600 – $1,260) ............................. Advertising expense ...................................................... Depreciation expense ($35,400 ÷ 6) .............................. Insurance expense ($3,840 × 11/12) ............................ Total expenses ..................................................... Income before income tax ...................................................... Income tax expense ($6,000 + $7,000) .................................. Net income .............................................................................
$160,000 $62,850 18,000 7,340 6,800 5,900 3,520 104,410 55,590 13,000 $ 42,590
[Revenues – Expenses = Net income or (Loss)]
(b) (2) CREATIVE DESIGNS LTD. Statement of Changes in Equity Year Ended December 31, 2018 Common Shares Balance, January 1 ........................................................................ $ 0 Issued common shares.................................................................. 20,000 Net income ......................................................... Dividends declared ........................................................................ 000 000 Balance, December 31 .................................................................. $20,000
Retained Earnings $
0
42,590 (10,000) $32,590
Total Equity $ 0 20,000 42,590 (10,000) $52,590
(Beginning equity ± Changes to equity = Ending equity)
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Chapter
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-6A (CONTINUED) (b) (3) CREATIVE DESIGNS LTD. Statement of Financial Position December 31, 2018
Assets Current assets Cash .................................................................. Accounts receivable ......................................... Supplies ............................................................ Prepaid rent....................................................... Prepaid insurance ($3,840 – $3,520) ................ Total current assets ................................... Property, plant, and equipment Equipment .......................................................... Less: Accumulated depreciation—equipment .... Total assets .................................................................
$27,160 2,400 1,260 2,000 320 33,140 $35,400 5,900
Liabilities and Shareholders’ Equity Current liabilities Salaries payable ................................................. Income tax payable ............................................ Total current liabilities ................................ Shareholders’ equity Common shares ................................................. $20,000 Retained earnings .............................................. 32,590 Total shareholders’ equity .......................... Total liabilities and shareholders’ equity ......................
29,500 $62,640
$ 3,050 7,000 10,050
52,590 $62,640
(Assets = Liabilities + Shareholders’ equity) LO 1,2,3,4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-7A (a)
Revenue (total fees collected) ............................................. Expenses Salaries expense .......................................................... Equipment...................................................................... Rent expense ................................................................ Supplies expense ......................................................... Advertising expense ...................................................... Insurance expense ........................................................ Income tax expense ....................................................... Cash-based net income ........................................................
$157,600 $59,800 35,400 20,000 8,600 6,800 3,840 6,000
(b)
Cash-based net income ........................................................ $ 17,160 Accrual-based net income (from P4-6A) ............................... 42,590 Difference ............................................................................. $(25,430)
(c)
I recommend the accrual basis of reporting because the accrual-based income statement fairly portrays the performance of the business, with revenues and expenses measured in the financial period they were earned and incurred.
140,440 $ 17,160
LO 1 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-8A (a) 2018 Nov. 30
1.
2.
30
3.
30
4.
30
5.
30
6.
30
7.
30
8.
30
9.
30
10.
30
Solutions Manual .
Insurance Expense .................................................. Prepaid Insurance ($7,320 ÷ 12 × 8) ..............................................
4,880
Depreciation Expense.............................................. Accumulated Depreciation—Equipment ($13,440 ÷ 8 yrs). .......................................... Accumulated Depreciation—Vehicles ($140,400 ÷ 6 yrs).........................................
25,080
Supplies Expense ($965 – $300). ............................ Supplies. .........................................................
665
Interest Expense ($54,000 × 7% × 1/12 months) .... Interest Payable ..............................................
315
Unearned Revenue.................................................. Fees Earned ($1,400 × 10 tours) ....................
14,000
Salaries Expense ..................................................... Salaries Payable .............................................
500
Accounts Receivable ............................................... Fees Earned ...................................................
1,250
Advertising Expense ................................................ Accounts Payable ...........................................
260
Rent Expense .......................................................... Prepaid Rent ($2,400 ÷ 2) .............................
1,200
Income Tax Expense ............................................... Income Tax Payable .......................................
300
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4,880
1,680 23,400
665
315
14,000
500
1,250
260
1,200
300
Chapter
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-8A (CONTINUED) (b)
Vehicles Nov. 30 Bal. 140,400
Cash Nov. 30 Bal. 15,800
Accumulated Depreciation—Vehicles Nov. 30 Bal. 46,800 Nov. 30 Adj. 23,400 Nov. 30 Bal. 70,200
Accounts Receivable Nov. 30 Bal. 7,640 Nov. 30 Adj. 1,250 Nov. 30 Bal. 8,890
Nov. 30 Bal. Nov. 30 Bal.
Nov. 30 Bal. Nov. 30 Bal.
Supplies 965 Nov. 30 Adj. 300
Prepaid Rent 2,400 Nov. 30 Adj. 1,200
Prepaid Insurance Nov. 30 Bal. 7,320 Nov. 30 Adj. Nov. 30 Bal. 2,440
Accounts Payable Nov. 30 Bal. Nov. 30 Adj. Nov. 30 Bal.
665
1,925 260 2,185
Bank Loan Payable Nov. 30 Bal. 54,000 1,200
4,880
Interest Payable Nov. 30 Adj.
315
Salaries Payable Nov. 30 Adj.
500
Equipment Nov. 30 Bal. 13,440 Accumulated Depreciation – Equipment Nov. 30 Bal. 3,360 Nov. 30 Adj. 1,680 Nov. 30 Bal. 5,040
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-8A (CONTINUED) (b) (continued) Income Tax Payable Nov. 30 Adj.
Rent Expense Nov. 30 Bal 13,200 Nov. 30 Adj. 1,200 Nov. 30 Bal 14,400
300
Unearned Revenue Nov. 30 Bal. 14,000 Nov. 30 Adj. 14,000 Nov. 30 Bal. 0
Interest Expense Nov. 30 Bal 3,465 Nov. 30 Adj. 315 Nov. 30 Bal 3,780
Common Shares Nov. 30 Bal. 10,000 Retained Earnings Nov. 30 Bal. 27,225
Advertising Expense Nov. 30 Bal. 825 Nov. 30 Adj. 260 Nov. 30 Bal 1,085
Fees Earned Nov. 30 Bal. 130,575 Nov. 30 Adj. 14,000 Nov. 30 Adj. 1,250 Nov. 30 Bal. 145,825
Depreciation Expense Nov. 30 Adj. 25,080 Supplies Expense Nov. 30 Adj. 665
Salaries Expense Nov. 30 Bal. 69,560 Nov. 30 Adj. 500 Nov. 30 Bal. 70,060
Insurance Expense Nov. 30 Adj. 4,880
Repairs and Maintenance Expense Nov. 30 Bal. 11,170
Solutions Manual .
Income Tax Expense Nov. 30 Bal 1,700 Nov. 30 Adj. 300 Nov. 30 Bal. 2,000
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-8A (CONTINUED) (c) WOLASTOQ TOURS LIMITED Adjusted Trial Balance November 30, 2018 Debit Cash ........................................................................................... Accounts receivable .................................................................... Supplies ...................................................................................... Prepaid rent ................................................................................ Prepaid insurance ....................................................................... Equipment ................................................................................... Accumulated depreciation—equipment ...................................... Vehicles ...................................................................................... Accumulated depreciation—vehicles .......................................... Accounts payable........................................................................ Salaries payable ......................................................................... Interest payable .......................................................................... Income tax payable ..................................................................... Bank loan payable, due 2021 ..................................................... Common shares.......................................................................... Retained earnings ....................................................................... Fees earned ................................................................................ Salaries expense ........................................................................ Depreciation expense ................................................................. Insurance expense...................................................................... Supplies expense........................................................................ Repairs and maintenance expense ............................................. Rent expense .............................................................................. Interest expense ......................................................................... Advertising expense .................................................................... Income tax expense .................................................................... Totals .......................................................................................
Credit
$ 15,800 8,890 300 1,200 2,440 13,440 $ 5,040 140,400 70,200 2,185 500 315 300 54,000 10,000 27,225 145,825 70,060 25,080 4,880 665 11,170 14,400 3,780 1,085 2,000 $315,590
$315,590
(Total debits = Total credits) LO 2,3,4 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-9A (a) 2018 Nov. 9
13 13 19 20 21 23 23 27 28 30
Salaries Payable .......................................................... Salaries Expense ......................................................... Cash ....................................................................
1,000 1,200
Cash ............................................................................ Common Shares .................................................
5,000
Cash ............................................................................ Accounts Receivable ...........................................
12,400
Cash ............................................................................ Service Revenue .................................................
11,400
Supplies ....................................................................... Accounts Payable ................................................
600
Accounts Payable ......................................................... Cash ....................................................................
4,600
Rent Expense ............................................................... Cash ....................................................................
600
Salaries Expense ......................................................... Cash ....................................................................
2,400
Accounts Receivable .................................................... Service Revenue .................................................
3,800
Dividends Declared ...................................................... Cash ....................................................................
500
Cash ............................................................................ Unearned Revenue .............................................
1,100
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2,200 5,000 12,400 11,400 600 4,600 600 2,400 3,800 500 1,100
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-9A (CONTINUED) (b) and (d) Cash Nov. 1 Bal. 15,580 Nov. 13 5,000 Nov. 9 Nov. 13 12,400 Nov. 21 Nov. 19 11,400 Nov. 23 Nov. 30 1,100 Nov. 23 Nov. 28 Nov. 30 Bal. 35,180 Accounts Receivable Nov. 1 Bal. 15,820 Nov. 27 3,800 Nov. 13 Nov. 30 Bal. 7,220
Nov. 30 Bal.
Supplies 4,000 600 4,600 Nov. 30 Adj. 1,000
Nov. 1 Bal.
Equipment 18,000
Nov. 1 Bal. Nov. 20 Nov. 30 Bal.
2,200 4,600 600 2,400 500
Nov. 9
Income Tax Payable Nov. 30 Adj. 12,400
Unearned Revenue Nov. 1 Bal. Nov. 30 Nov. 30 Bal. Nov. 30 Adj. 800 Nov. 30 Bal.
3,600
Nov. 21
Solutions Manual .
1,000 0 1,000 1,000
1,100
1,000 1,100 2,100 1,300
Common Shares Nov. 1 Bal. 10,000 Nov. 13 5,000 Nov. 30 Bal. 15,000 Retained Earnings Nov. 1 Bal.
Accumulated Depreciation— Equipment Nov. 1 Bal. 3,600 Nov. 30 Adj. 300 Nov. 30 Bal. 3,900 Accounts Payable Nov. 1 Bal. 4,600 Nov. 20 Nov. 30 Bal.
Salaries Payable Nov. 1 Bal. 1,000 Nov. 30 Bal. Nov. 30 Adj. Nov. 30 Bal.
Nov. 28
33,200
Dividends Declared 500 Service Revenue Nov. 19 11,400 Nov. 27 3,800 Nov. 30 Bal. 15,200 Nov. 30 Adj. 800 Nov. 30 Bal. 16,000
4,600 600 600
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-9A (CONTINUED) (b) and (d) (continued)
Nov. 23
Rent Expense 600
Income Tax Expense Nov. 30 Adj. 1,100 Salaries Expense Nov. 9 1,200 Nov. 23 2,400 Nov. 30 Bal. 3,600 Nov. 30 Adj. 1,000 Nov. 30 Bal. 4,600
Nov. 30 Adj.
Supplies Expense 3,600
Depreciation Expense Nov. 30 Adj. 300
(c) ALOU EQUIPMENT REPAIR CORP. Trial Balance November 30, 2018
Cash ........................................................................... Accounts receivable .................................................... Supplies ...................................................................... Equipment................................................................... Accumulated depreciation—equipment ...................... Accounts payable ....................................................... Unearned revenue ...................................................... Common shares ........................................................ Retained earnings ...................................................... Dividends declared ..................................................... Service revenue .......................................................... Salaries expense ........................................................ Rent expense.............................................................. Totals ....................................................................
Debit $35,180 7,220 4,600 18,000
500
Credit
$ 3,600 600 2,100 15,000 33,200 15,200
3,600 600 $69,700
0000 00 $69,700
(Total debits = Total credits)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-9A (CONTINUED) (d) 2018 1. Nov. 30
2.
3.
4.
5.
Solutions Manual .
30
30
30
30
Supplies Expense .................................. Supplies ($4,600 – $1,000) ...........
3,600
Salaries Expense ................................... Salaries Payable ...........................
1,000
3,600
1,000
Depreciation Expense ............................ 300 Accumulated Depreciation—Equipment ($18,000 ÷ 5 years x 1/12 months) Unearned Revenue ................................ Service Revenue ...........................
800
Income Tax Expense ............................. Income Tax Payable .....................
1,100
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300
800
1,100
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 4-9A (CONTINUED) (e) ALOU EQUIPMENT REPAIR CORP. Adjusted Trial Balance November 30, 2018
Debit Cash............................................................................. Accounts receivable ..................................................... Supplies ....................................................................... Equipment .................................................................... Accumulated depreciation—equipment........................ Accounts payable ......................................................... Salaries payable........................................................... Income tax payable ...................................................... Unearned revenue ....................................................... Common shares ........................................................... Retained earnings ........................................................ Dividends declared....................................................... Service revenue ........................................................... Salaries expense.......................................................... Rent expense ............................................................... Supplies expense ......................................................... Income tax expense ..................................................... Depreciation expense .................................................. Totals ........................................................................
Credit
$35,180 7,220 1,000 18,000 $ 3,900 600 1,000 1,100 1,300 15,000 33,200 500 16,000 4,600 600 3,600 1,100 300 $72,100
0,0 0 $72,100
(Total debits = Total credits)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-9A (CONTINUED) (f) (1) ALOU EQUIPMENT REPAIR CORP. Income Statement Month Ended November 30, 2018 Revenues Service revenue ............................................................. Expenses Salaries expense ........................................................... Supplies expense .......................................................... Rent expense................................................................. Depreciation expense .................................................... Total expenses ..................................................... Income before income tax ...................................................... Income tax expense................................................................ Net income .............................................................................
$16,000 $4,600 3,600 600 300 9,100 6,900 1,100 $ 5,800
[Revenues – Expenses = Net income or (Loss)]
(f) (2) ALOU EQUIPMENT REPAIR CORP. Statement of Changes in Equity Month Ended November 30, 2018 Common Shares
Retained Earnings
Balance, November 1 .................................................................... $10,000 $33,200 Issued common shares.................................................................. 5,000 Net income ................................................. 5,800 Dividends declared ........................................................................ 000000 (500) Balance, November 30 .................................................................. $15,000 $38,500
Total Equity $43,200 5,000 5,800 (500) $53,500
(Beginning equity ± Changes to equity = Ending equity)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-9A (CONTINUED) (f) (3)
ALOU EQUIPMENT REPAIR CORP. Statement of Financial Position November 30, 2018 Assets
Current assets Cash ............................................................................. Accounts receivable ...................................................... Supplies ........................................................................ Total current assets ............................................. Property, plant, and equipment Equipment................................................. $18,000 Less: Accumulated depreciation .............. 3,900 Total assets ...........................................................................
$35,180 7,220 1,000 43,400
14,100 $57,500
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ......................................................... Salaries payable ........................................................... Income tax payable ....................................................... Unearned revenue ........................................................ Total current liabilities .......................................... Shareholders’ equity Common shares ....................................... $15,000 Retained earnings..................................... 38,500 Total shareholders’ equity .................................... Total liabilities and shareholders’ equity ................................
$
600 1,000 1,100 1,300 4,000
53,500 $57,500
(Assets = Liabilities + Shareholders’ equity) LO 2,3,4 BT: AP Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-10A (a)
2018 Nov. 30
30
30
30
Service Revenue .................................. Income Summary ........................
16,000
Income Summary ................................. Salaries Expense ........................ Supplies Expense ....................... Rent Expense.............................. Depreciation Expense ................. Income Tax Expense...................
10,200
Income Summary ................................. Retained Earnings .......................
5,800
Retained Earnings................................ Dividends Declared .....................
500
16,000
4,600 3,600 600 300 1,100
5,800
500
(Income statement accounts are closed to the Income Summary account)
(b) Cash Nov. 1 Bal. 15,580 Nov. 13 5,000 Nov. 9 Nov. 13 12,400 Nov. 21 Nov. 19 11,400 Nov. 23 Nov. 30 1,100 Nov. 23 Nov. 28 Nov. 30 Bal. 35,180 Accounts Receivable Nov. 1 Bal. 15,820 Nov. 27 3,800 Nov. 13 Nov. 30 Bal. 7,220
Nov. 1 Bal. Nov. 20 Nov. 30 Bal. Nov. 30 Bal.
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Supplies 4,000 600 4,600 Nov. 30 Adj. 1,000
Nov. 1 Bal. 2,200 4,600 600 2,400 500
Equipment 18,000
Accumulated Depreciation— Equipment Nov. 1 Bal. 3,600 Nov. 30 Bal. 3,600 Nov. 30 Adj. 300 Nov. 30 Bal. 3,900
12,400 Nov. 21
Nov. 9 3,600
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Accounts Payable Nov. 1 Bal. 4,600 Nov. 20 Nov. 30 Bal. Salaries Payable Nov. 1 Bal. 1,000 Nov. 30 Bal. Nov. 30 Adj. Nov. 30 Bal.
4,600 600 600 1,000 0 1,000 1,000 Chapter 4
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-10A (CONTINUED) (b) (continued) Income Tax Payable Nov. 30 Adj. Unearned Revenue Nov. 1 Bal. Nov. 30 Nov. 30 Bal. Nov. 30 Adj. 800 Nov. 30 Bal.
Dividends Declared Nov. 28 500 Nov. 30 CE4 Nov. 30 Bal. 0
Common Shares Nov. 1 Bal. 10,000 Nov. 13 5,000 Nov. 30 Bal. 15,000
1,100
1,000 1,100 2,100
Retained Earnings Nov. 1 Bal. 33,200 Nov. 30 CE4 500 Nov. 30 CE3 5,800 Nov. 30 Bal. 38,500
1,300
Salaries Expense Nov. 9 1,200 Nov. 23 2,400 Nov. 30 Bal. 3,600 Nov. 30 Adj. 1,000 Nov. 30 Bal. 4,600 Nov. 30 CE2 Nov. 30 Bal. 0
500
Service Revenue Nov. 19 11,400 Nov. 27 3,800 Nov. 30 Bal. 15,200 Nov. 30 Adj. 800 Nov. 30 Bal. 16,000 Nov. 30 CE1 16,000 Nov. 30 Bal. 0 Rent Expense Nov. 23 600 Nov. 30 CE2 Nov. 30 Bal. 0 Income Tax Expense Nov. 30 Adj. 1,100 Nov. 30 CE2 Nov. 30 Bal. 0
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Supplies Expense 3,600 Nov. 30 CE2 Nov. 30 Bal. 0
4,600
Nov. 30 Adj.
Depreciation Expense Nov. 30 Adj. 300 Nov. 30 CE2 Nov. 30 Bal. 0
600
3,600
300
Income Summary Nov. 30 CE2 10,200 Nov. 30 CE1 16,000 Bal. 5,800 Nov. 30 CE3 5,800 Nov. 30 Bal. 0
1,100
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PROBLEM 4-10A (CONTINUED) (c) ALOU EQUIPMENT REPAIR CORP. Post-Closing Trial Balance November 30, 2018
Debit Cash ............................................................ Accounts receivable ..................................... Supplies ....................................................... Equipment .................................................... Accumulated depreciation—equipment ....... Accounts payable ......................................... Salaries payable .......................................... Income tax payable ...................................... Unearned revenue ....................................... Common shares........................................... Retained earnings ........................................ Totals ......................................................
Credit
$35,180 7,220 1,000 18,000
00 0000 $61,400
$ 3,900 600 1,000 1,100 1,300 15,000 38,500 $61,400
(Total debits for permanent accounts = Total credits for permanent accounts) LO 5 BT: AP Difficulty: S Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-11A (a) OZAKI CORP. Adjusted Trial Balance September 30, 2018
Debit Cash ........................................................................................... $ 3,250 Accounts receivable ................................................................... 8,435 Supplies ..................................................................................... 1,265 Equipment .................................................................................. 15,040 Accumulated depreciation—equipment ...................................... Accounts payable ....................................................................... Salaries payable ......................................................................... Interest payable .......................................................................... Income tax payable .................................................................... Unearned revenue...................................................................... Bank loan payable ...................................................................... Common shares ......................................................................... Retained earnings ...................................................................... Dividends declared ..................................................................... 700 Fees earned ............................................................................... Depreciation expense ................................................................. 750 Interest expense ......................................................................... 105 Rent expense ............................................................................. 1,500 Salaries expense ....................................................................... 13,840 Supplies expense ....................................................................... 485 Utilities expense ......................................................................... 820 Income tax expense ................................................................... 600 Totals................................................................................... $46,790
Credit
$
750 4,460 840 105 200 550 7,800 7,000 2,600
22,485
$46,790
(Total debits = Total credits)
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PROBLEM 4-11A (CONTINUED) (b) 2018 Sept. 30
30
30
30
Fees Earned ................................................. Income Summary .................................
22,485
Income Summary ........................................... Salaries Expense .................................. Rent Expense ....................................... Utilities Expense ................................... Depreciation Expense ........................... Supplies Expense ................................. Interest Expense ................................... Income Tax Expense ............................
18,100
Income Summary ........................................... Retained Earnings ................................
4,385
Retained Earnings ......................................... Dividends Declared ...............................
700
22,485
13,840 1,500 820 750 485 105 600
4,385
700
(Income statement accounts are closed to the Income Summary account)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-11A (CONTINUED) (c) OZAKI CORP. Post-Closing Trial Balance September 30, 2018
Debit Cash................................................................................... Accounts receivable ........................................................... Supplies ............................................................................. Equipment .......................................................................... Accumulated depreciation—equipment.............................. Accounts payable ............................................................... Salaries payable................................................................. Interest payable ................................................................. Income tax payable ............................................................ Unearned revenue ............................................................. Bank loan payable.............................................................. Common shares ................................................................. Retained earnings .............................................................. Totals.............................................................................
Credit
$ 3,250 8,435 1,265 15,040 $
0000 0 $27,990
750 4,460 840 105 200 550 7,800 7,000 6,285 $27,990
(Total debits for permanent accounts = Total credits for permanent accounts) LO 4,5 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-12A (a) 1.
2018 May 31
2. 3.
4.
5. 6. 7. 8. 9.
10.
11.
Solutions Manual .
31 31
31
31 31 31 31 31
31
31
Insurance Expense .................................... Prepaid Insurance............................. ($10,920 ÷ 12 months)
910
Supplies Expense ...................................... Supplies ($4,880 – $1,340)...............
3,540
Depreciation Expense................................ ($168,000 ÷ 20 years × 1/12 months) Accumulated Depreciation—Buildings
700
Depreciation Expense................................ ($33,600 ÷ 5 years × 1/12 months Accumulated Depreciation—Furniture
560
Unearned Revenue (25 × $100) ................ Rent Revenue ...................................
2,500
Rent Revenue............................................ Unearned Revenue...........................
2,800
Accounts Receivable ................................. Rent Revenue ...................................
1,780
Salaries Expense ....................................... Salaries Payable ...............................
1,590
Interest Expense ........................................ Interest Payable ................................
735
Utilities Expense ........................................ Accounts Payable .............................
2,240
Income Tax Expense ................................. Income Tax Payable .........................
1,000
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910
3,540
700
560 2,500 2,800 1,780 1,590 735
2,240
1,000
Chapter 4
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Financial Accounting, Seventh Canadian Edition
PROBLEM 4-12A (CONTINUED) (b) May 31 Bal.
Cash 6,400
Accumulated Depreciation—Furniture May 31 Bal. 19,600 May 31 Adj. 560 May 31 Bal. 20,160
Accounts Receivable May 31 Bal. 11,800 May 31 Adj. 1,780 May 31 Bal. 13,580
May 31 Bal. May 31 Bal.
Supplies 4,880 May 31 Adj. 1,340
Prepaid Insurance May 31 Bal. 4,550 May 31 Adj. May 31 Bal. 3,640
3,540
Accounts Payable May 31 Bal. May 31 Adj. May 31 Bal.
8,140 2,240 10,380
Salaries Payable May 31 Adj.
1,590
Interest Payable May 31 Adj.
735
Income Tax Payable May 31 Adj.
1,000
910
Land May 31 Bal. 106,370 Buildings May 31 Bal. 168,000 Accumulated Depreciation—Buildings May 31 Bal. 24,500 May 31 Adj. 700 May 31 Bal. 25,200 Furniture May 31 Bal. 33,600
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PROBLEM 4-12A (CONTINUED) (b) (continued) Unearned Revenue May 31 Bal. May 31 Adj. 2,500 May 31 Adj. May 31 Bal.
Interest Expense May 31 Bal. 9,240 May 31Adj. 735 May 31 Bal. 9,975
17,500 2,800 17,800
Insurance Expense May 31 Bal. 6,370 May 31 Adj. 910 May 31 Bal. 7,280
Mortgage Payable May 31 Bal. 126,000 Common Shares May 31 Bal.
60,000 Advertising Expense May 31 Bal. 1,000
Retained Earnings May 31 Bal.
Supplies Expense May 31 Adj. 3,540
41,580
Depreciation Expense May 31 Bal. 13,860 May 31 Adj. 700 May 31 Adj. 560 May 31 Bal. 15,120
Dividends Declared May 31 Bal. 2,000
May 31 Adj.
Rent Revenue May 31 Bal. 200,320 2,800 May 31 Adj. 2,500 May 31 Adj. 1,780 May 31 Bal. 201,800
Income Tax Expense May 31 Bal. 7,000 May 31 Adj. 1,000 May 31 Bal. 8,000
Salaries Expense May 31 Bal. 98,700 May 31 Adj. 1,590 May 31 Bal. 100,290
Utilities Expense May 31 Bal. 23,870 May 31 Adj. 2,240 May 31 Bal. 26,110
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PROBLEM 4-12A (CONTINUED) (c)
RAINBOW LODGE LTD. Adjusted Trial Balance May 31, 2018
Debit Cash .................................................................................. $ 6,400 Accounts receivable........................................................... 13,580 Supplies ............................................................................. 1,340 Prepaid insurance .............................................................. 3,640 Land ................................................................................... 106,370 Buildings ............................................................................ 168,000 Accumulated depreciation—buildings ................................ Furniture ............................................................................ 33,600 Accumulated depreciation—furniture ................................. Accounts payable .............................................................. Salaries payable ................................................................ Interest payable ................................................................. Income tax payable............................................................ Unearned revenue ............................................................. Mortgage payable, due 2021 ............................................. Common shares ................................................................ Retained earnings.............................................................. Dividends declared ............................................................ 2,000 Rent revenue ..................................................................... Salaries expense ............................................................... 100,290 Utilities expense................................................................. 26,110 Interest expense ................................................................ 9,975 Insurance expense ............................................................ 7,280 Advertising expense .......................................................... 1,000 Supplies expense .............................................................. 3,540 Depreciation expense ........................................................ 15,120 Income tax expense ........................................................... 8,000 Totals ............................................................................ $506,245
Credit
$ 25,200 20,160 10,380 1,590 735 1,000 17,800 126,000 60,000 41,580 201,800
000000 0 $506,245
(Total debits = Total credits)
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PROBLEM 4-12A (CONTINUED) (d) (1) RAINBOW LODGE LTD. Income Statement Year Ended May 31, 2018
Revenues Rent revenue ............................................ Expenses Salaries expense ...................................... Utilities expense........................................ Depreciation expense ............................... Interest expense ....................................... Insurance expense ................................... Supplies expense ..................................... Advertising expense ................................ Total expenses ................................ Income before income tax ................................. Income tax expense........................................... Net income ........................................................
$201,800 $100,290 26,110 15,120 9,975 7,280 3,540 1,000 163,315 38,485 8,000 $ 30,485
[Revenues – Expenses = Net income or (Loss)]
(d) (2) RAINBOW LODGE LTD. Statement of Changes in Equity Year Ended May 31, 2018
Common Shares Balance, June 1, 2017 ................................................................... $56,000 Issued common shares .................................................................. 4,000 Net income ........................................................ Dividends declared ........................................................................ 00 0000 Balance, May 31, 2018 .................................................................. $60,000
Retained Earnings $41,580 30,485 (2,000) $70,065
Total Equity $ 97,580 4,000 30,485 (2,000) $130,065
(Beginning equity ± Changes to equity = Ending equity)
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PROBLEM 4-12A (CONTINUED) (d) (3) RAINBOW LODGE LTD. Statement of Financial Position May 31, 2018 Assets Current assets Cash ............................................................. Accounts receivable...................................... Supplies ........................................................ Prepaid insurance ......................................... Total current assets ................................... Property, plant, and equipment Land .............................................................. Buildings ....................................................... Less: Accumulated depreciation .................. Furniture ....................................................... Less: Accumulated depreciation .................. Total property, plant, and equipment ......... Total assets ...........................................................
$ 6,400 13,580 1,340 3,640 $ 24,960 $106,370 $168,000 25,200 $33,600 20,160
142,800 13,440 262,610 $287,570
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ......................................... Salaries payable ........................................... Interest payable ............................................ Income tax payable ....................................... Unearned revenue ........................................ Total current liabilities ............................... Non-current liabilities Mortgage payable ......................................... Total liabilities............................................ Shareholders’ equity Common shares ........................................... Retained earnings......................................... Total shareholders’ equity ........................ Total liabilities and shareholders’ equity ................
$10,380 1,590 735 1,000 17,800 $ 31,505 126,000 157,505 $60,000 70,065 130,065 $287,570
(Assets = Liabilities + Shareholders’ equity)
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PROBLEM 4-12A (CONTINUED) (e)
The financial position and performance of a company can be evaluated in terms of its liquidity, profitability, and solvency. Liquidity Rainbow Lodge does not appear at first glance to have a healthy liquidity position. Although it has a positive cash balance of $6,400, the company has a current ratio of only 0.8:1 ($24,960 ÷ $31,505). This seems to indicate that there are insufficient current assets to repay the company’s current liabilities. It should be noted that simply looking at the current ratio does not tell the whole story and more investigation is required. For example, accounts receivable comprise a substantial amount of current assets—you would want to know if they are all expected to be collected. More importantly, of the total current liabilities, 56% ($17,800 ÷ $31,505) is made up of unearned revenue, which will not require the payment of cash. Consequently, the current ratio is stronger than it first appears in terms of measuring the company’s ability to repay its current liabilities. Profitability According to the income statement, Rainbow Lodge was profitable in 2018 with net income of $30,485. The lodge also has a positive balance in retained earnings, which indicates it has been profitable in the past. The company also declared dividends of $2,000 in the past year, which may be of interest to your friend if your friend is considering an income investment. Solvency The company has a large mortgage, which is in line with the cost of the property, plant, and equipment. Its total debt to assets is 54.8% ($157,505 ÷ $287,570). One would want to determine if that ratio is comparable to Rainbow Lodge’s competitors and industry. Overall, Rainbow Lodge appears to have a good financial position. Its liquidity and profitability appear reasonable, but its solvency is not significantly high. However, a more complete analysis should be performed. Reviewing prior years’ financial statements and some industry information would enable us to perform some comparative analysis to better evaluate Rainbow’s financial health.
LO 2,3,4 BT: AN Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-13A (a) May
31
31
31
31
Rent Revenue ................................................ Income Summary ..................................
201,800
Income Summary ........................................... Salaries Expense .................................. Utilities Expense ................................... Interest Expense ................................... Insurance Expense ............................... Supplies Expense ................................. Depreciation Expense ........................... Advertising Expense ............................. Income Tax Expense ............................
171,315
Income Summary ........................................... Retained Earnings ................................
30,485
Retained Earnings ......................................... Dividends Declared ...............................
2,000
201,800
100,290 26,110 9,975 7,280 3,540 15,120 1,000 8,000
30,485
2,000
(Income statement accounts are closed to the Income Summary account)
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PROBLEM 4-13A (CONTINUED) (b)
May 31 Bal.
Cash 6,400
Accumulated Depreciation—Furniture May 31 Bal. 19,600 May 31 Adj. 560 May 31 Bal. 20,160
Accounts Receivable May 31 Bal. 11,800 May 31 Adj. 1,780 May 31 Bal. 13,580
May 31 Bal. May 31 Bal.
Supplies 4,880 May 31 Adj. 1,340
Prepaid Insurance 4,550 May 31 Adj. May 31 Bal. 3,640
3,540
May 31 Bal.
910
Land May 31 Bal. 106,370 Buildings May 31 Bal. 168,000 Accumulated Depreciation—Buildings May 31 Bal. 24,500 May 31 Adj. 700 May 31 Bal. 25,200
8,140 2,240 10,380
Salaries Payable May 31 Adj.
1,590
Interest Payable May 31 Adj.
735
Income Tax Payable May 31 Adj.
1,000
Unearned Revenue May 31 Bal. May 31 Adj. 2,500 May 31 Adj. May 31 Bal.
17,500 2,800 17,800
Mortgage Payable May 31 Bal. 126,000 Common Shares May 31 Bal.
Furniture May 31 Bal. 33,600
Solutions Manual .
Accounts Payable May 31 Bal. May 31 Adj. May 31 Bal.
60,000
Retained Earnings May 31 Bal. 41,580 May 31 CE4 2,000 May 31 CE3 30,485 May 31 Bal. 70,065
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PROBLEM 4-13A (CONTINUED) (b) (continued) Dividends Declared May 31 Bal. 2,000 May 31CE4 May 31 Bal. 0
Insurance Expense May 31 Bal. 6,370 May 31 Adj. 910 May 31 Bal. 7,280 May 31 CE2 May 31 Bal. 0
2,000
Rent Revenue May 31 Bal. 200,320 May 31 Adj. 2,800 May 31 Adj. 2,500 May 31 Adj. 1,780 May 31 Bal. 201,800 May31CE1 201,800 May 31 Bal. 0
Advertising Expense May 31 Bal. 1,000 May 31 CE2 May 31 Bal. 0 Supplies Expense May 31 Adj. 3,540 May 31 CE2 May 31 Bal. 0
Salaries Expense May 31 Bal. 98,700 May 31 Adj. 1,590 May 31 Bal. 100,290 May 31 CE2 100,290 May 31 Bal. 0
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1,000
3,540
Depreciation Expense May 31 Bal. 13,860 May 31 Adj. 700 May 31 Adj. 560 May 31 Bal. 15,120 May 31 CE2 15,120 May 31 Bal. 0
Utilities Expense May 31 Bal. 23,870 May 31 Adj. 2,240 May 31 Bal. 26,110 May 31 CE2 26,110 May 31 Bal. 0
Interest Expense May 31 Bal. 9,240 May 31 Adj. 735 May 31 Bal 9,975 May 31 CE2 May 31 Bal. 0
7,280
Income Tax Expense May 31 Bal. 7,000 May 31 Adj. 1,000 May 31 Bal. 8,000 May 31 CE2 May 31 Bal. 0
9,975
8,000
Income Summary May 31 CE2 171,315 May 31 CE1 201,800 Bal. 30,485 May 31 CE3 30,485 May 31 Bal. 0
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PROBLEM 4-13A (CONTINUED) (c) RAINBOW LODGE LTD. Post-Closing Trial Balance May 31, 2018
Debit Cash .................................................................................. Accounts receivable .......................................................... Supplies............................................................................. Prepaid insurance ............................................................. Land .................................................................................. Buildings ............................................................................ Accumulated depreciation—buildings................................ Furniture ............................................................................ Accumulated depreciation—furniture................................. Accounts payable .............................................................. Salaries payable ................................................................ Interest payable ................................................................. Income tax payable ........................................................... Unearned revenue ............................................................. Mortgage payable .............................................................. Common shares ................................................................ Retained earnings .............................................................
$ 6,400 13,580 1,340 3,640 106,370 168,000
Totals ........................................................................
$332,930
Credit
$ 25,200 33,600 20,160 10,380 1,590 735 1,000 17,800 126,000 60,000 70,065 $332,930
(Total debits for permanent accounts = Total credits for permanent accounts) LO 5 BT: AP Difficulty: S Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-1B 1. (a) Jan.
2 Supplies ................................................. Cash.................................................
2,100
(b) Dec. 31 Supplies Expense ($2,100 – $550) ........ Supplies ...........................................
1,550
2. (a) Mar.
1 Equipment .............................................. Cash.................................................
(b) Dec. 31 Depreciation Expense ............................ Accumulated Depreciation—Equipment ($20,000 ÷ 5 years × 10/12 months)
3. (a) June
1 Prepaid Insurance .................................. Cash.................................................
(b) Dec. 31 Insurance Expense ($4,200 × 7/12 months) Prepaid Insurance ............................
2,100
1,550
20,000 20,000 3,333 3,333
4,200 4,200 2,450 2,450
4. (a) Nov. 15 Cash ....................................................... Unearned Revenue ..........................
1,275
(b) Dec. 31 Unearned Revenue ($425 × 2) ............... Revenue ...........................................
850
5. (a) Dec. 15 Prepaid Rent .......................................... Cash.................................................
2,500
1,275
850
2,500
(b) Dec. 31 No entry required LO 2 BT: AP Difficulty: S Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-2B 1. (a) (b)
2. (a)
(b)
3. (a) (b)
Nov. 30 Dec. 10
Nov. 30
Dec.
1
Nov. 30 Dec.
1
Dec. 21
4. (a) (b)
5. (a) (b)
Nov. 30 Dec.
1
Nov. 30 Dec. 18
Salaries Expense ................................................ Salaries Payable ($6,000 × 5/10 days) ...........
3,000
Salaries Payable .................................................. Salaries Expense ................................................ Cash................................................................
3,000 3,000
Interest Expense .................................................. Interest Payable .............................................. ($20,000 × 7% × 1/12 months)
117
Interest Payable ................................................... Cash................................................................
117
Accounts Receivable ............................................ Service Revenue ............................................
1,000
3,000
6,000
117
117
1,000
No entry required Cash ..................................................................... Accounts Receivable.......................................
1,000
Interest Receivable ............................................... Interest Revenue ............................................
10
Cash ..................................................................... Interest Receivable .........................................
10
1,000
10 10
Income Tax Expense ............................................ 1,000 Income Tax Payable ......................................
1,000
Income Tax Payable ............................................. Cash................................................................
1,000
1,000
LO 3 BT: AP Difficulty: S Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-3B 1. (a) (b)
2. (a) (b)
3. (a)
(b)
4. (a)
(b) (c)
5. (b) (c)
Mar. 1, 2018 Dec. 31, 2018
Jan. 2, 2018 Dec. 31, 2018
Aug. 2, 2018
Dec. 31, 2018
June 1, 2018
Dec. 31, 2018 Jan. 1, 2019
Dec. 31, 2018 Jan. 4, 2019
Solutions Manual .
Supplies................................................... Cash ................................................. Supplies Expense ($1,500 + $4,250 – $1,000) ..................... Supplies ............................................
4,250 4,250 4,750 4,750
Vehicles ................................................... Cash .................................................
120,000
Depreciation Expense ............................ Accumulated Depreciation—Vehicles ($120,000 ÷ 4 years)
30,000
Cash ........................................................ Unearned Revenue (600 × $360) .....
216,000
Unearned Revenue ($216,000 × 4/9) ...... Ticket Revenue .................................
96,000
Cash ........................................................ Bank Loan Payable...........................
30,000
Interest Expense ..................................... Interest Payable ($30,000 × 6% × 1/12)
150
Interest Payable ...................................... Cash .................................................
150
Salaries Expense .................................... Salaries Payable ($9,000 × 3/6) .......
4,500
Salaries Expense .................................... Salaries Payable ..................................... Cash .................................................
4,500 4,500
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120,000 30,000
216,000
96,000
30,000
150 150
4,500
9,000
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PROBLEM 4-3B (CONTINUED) 6. (b)
(c)
7. (b)
(c)
Dec. 31, 2018
Jan. 7, 2019
Dec. 31, 2018
Jan. 11, 2019
Accounts Receivable ............................... Rent Revenue ...................................
600
Cash ........................................................ Accounts Receivable ........................ Unearned Revenue...........................
1,200
Utilities Expense ...................................... Accounts Payable .............................
1,125
Accounts Payable .................................... Cash .................................................
1,125
600
600 600
1,125
1,125
LO 2,3 BT: AP Moderate: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-4B (a) 1. Mar. 31
2.
3.
4.
5.
6.
7.
Solutions Manual .
Service Revenue ........................................................ Unearned Revenue ............................................
20,000
Supplies Expense ($2,900 - $800) .............................. Supplies .............................................................
2,100
Insurance Expense ($3,360 x 3/12) ............................ Prepaid Insurance ..............................................
840
Utilities Expense ......................................................... Accounts Payable ..............................................
210
Salaries Expense ($100 x 4 x 2) ................................. Salaries Payable ................................................
800
Interest Expense ($12,000 x 7% x 3/12) .................... Interest Payable .................................................
210
Income Tax Expense .................................................. Income Tax Payable ..........................................
1,990
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20,000
2,100
840
210
800
210
1,990
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PROBLEM 4-4B (CONTINUED) (b) FLY RIGHT TRAVEL AGENCY LTD. Income Statement Quarter Ended March 31, 2018
Revenues Service revenue ($50,000 - $20,000) ................................... Expenses Salaries expense ($11,000 + $800) ...................................... Office expense ...................................................................... Supplies expense ................................................................. Advertising expense ............................................................. Insurance expense ............................................................... Utilities expense ($400 + $210) ............................................ Interest expense ................................................................... Depreciation expense ........................................................... Total expenses ............................................................ Income before income tax ............................................................. Income tax expense ...................................................................... Net income ....................................................................................
$30,000
$11,800 2,600 2,100 1,700 840 610 210 400 20,260 9,740 1,990 $ 7,750
[Revenues – Expenses = Net Income or (Loss)] LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-5B (a) 1.
Prepaid Advertising The monthly amount of advertising is calculated based on the annual contract amount paid of $8,400 divided by 12 months = $700.
2.
The advertising contract for one year was paid by the business on Feb. 1, 2018, for a period of 12 months starting March 1. The Prepaid Advertising account was debited at that date for $8,400. The unadjusted balance would have remained unchanged on October 31, 2018 as no adjusting entries would have been prepared and recorded.
3.
By October 31, 2018, after adjusting entries are prepared and posted to recognize the expiration of 8 months (8 ads running March 1 – October 1) of the contract ($8,400 x 8/12 = $5,600), the Prepaid Advertising account should have an adjusted balance of $2,800 ($8,400 – $5,600). This balance represents 4 months at $700 per month covering the period Nov. 1, 2018 to Feb. 1, 2019.
(b) 1.
Unearned Revenue The Unearned Revenue account has a balance of $135,000 because all amounts received during the year for leasing contracts were recorded into this account as follows:
Month
Term (in months)
Monthly Rent
Number of Leases
Unearned Revenue
Sept 1, 2018
6
$4,500
5
$135,000
This balance would have remained unchanged as no adjusting entries would have been prepared and recorded. 2.
By October 31, 2018, the company has earned $45,000 ($4,500 x 5 x 2). Consequently, the adjusted balance in the Unearned Revenue account is $90,000 ($135,000 - $45,000). This balance represents 4 months x 5 tenants at $4,500 per month.
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PROBLEM 4-5B (CONTINUED) (c) 1.
Interest Expense The monthly interest incurred on the bank loan is calculated as follows: $90,000 x 8% x 1/12 = $600
2.
Since the interest is payable at maturity, 7 months of interest have accrued to October 31, 2018. The total is $4,200 ($600 x 7).
3.
By April 1, 2019 a full year of interest will have accrued and will be payable in the amount of $7,200 ($600 x 12).
(d) 1.
Depreciation Expense The annual depreciation expense on the vehicles is calculated as follows: ($39,000 ÷ 5 years) = $ 7,800
2.
The purchase date of the vehicles was April 1, 2017. From April 1, 2017 to October 31, 2017, the depreciation expense recorded would have been $7,800 x 7/12 or $4,550. Consequently, the balance of the Accumulated Depreciation–Vehicles account (unadjusted) at October 31, 2018 would be $4,550. During this past fiscal year ended October 31, 2018, this balance would have remained unchanged as no adjusting entries would have been prepared and recorded.
3.
An annual amount of $7,800 would be recorded to Depreciation Expense for the year ended October 31, 2018. The adjusted balance of the Accumulated Depreciation–Vehicles account at October 31, 2018 would be $12,350 ($4,550 + $7,800).
(e) 1.
2018 Oct. 31
2.
3.
4.
31
31
31
Advertising Expense ($700 x 8)..................... Prepaid Advertising ..............................
5,600 5,600
Unearned Revenue ($4,500 x 5 x 2) ............. 45,000 Rent Revenue.....................................
45,000
Interest Expense ($90,000 × 8% × 7/12) .......... Interest Payable..................................
4,200 4,200
Depreciation Expense ($39,000 ÷ 5) ............. Accumulated Depreciation—Vehicles.
7,800 7,800
LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-6B Cash Balance, April 30, 2018 = $86,500 cash receipts – $80,920 cash payments = $5,580.
(a)
(b) (1)
THE SHARP EDGE LTD. Income Statement Six Months Ended April 30, 2018
Revenues Service revenue ($66,500 + $1,440).............................. Expenses Salaries expense ($14,200 + $4,240) ............................ Rent expense ($9,100 – $1,300) ................................... Depreciation expense ($47,040 ÷ 8 × 6/12) ................... Utilities expense............................................................. Insurance expense ($2,760 × 6/12) ............................... Advertising expense ...................................................... Total expenses ..................................................... Income before income tax ...................................................... Income tax expense ($5,000 + $800) ..................................... Net income .............................................................................
$67,940 $18,440 7,800 2,940 1,900 1,380 920 33,380 34,560 5,800 $28,760
[Revenues – Expenses = Net income or (Loss)]
(b) (2) THE SHARP EDGE LTD. Statement of Changes in Equity Six Months Ended April 30, 2018 Common Shares Balance, November 1, 2017 .......................................................... $ 0 Issued common shares ................................................................. 20,000 Net income .......................................................... 0000 00 Balance, April 30, 2018 ................................................................. $20,000
Retained Earnings
Total Equity
$
$ 0 20,000 28,760 $48,760
0
28,760 $28,760
(Beginning equity ± Changes to equity = Ending equity)
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PROBLEM 4-6B (CONTINUED) (b) (3) THE SHARP EDGE LTD. Statement of Financial Position April 30, 2018
Assets Current assets Cash .............................................................. Accounts receivable ...................................... Prepaid insurance ($2,760 – $1,380)............. Prepaid rent ................................................... Total current assets .............................. Property, plant, and equipment Equipment...................................................... Less: Accumulated depreciation ................... Total assets ............................................................
$ 5,580 1,440 1,380 1,300 9,700 $47,040 2,940
44,100 $53,800
Liabilities and Shareholders’ Equity Current liabilities Salaries payable ............................................ Income tax payable ........................................ Total current liabilities ........................... Shareholders’ equity Common shares ............................................ Retained earnings.......................................... Total shareholders’ equity ..................... Total liabilities and shareholders’ equity .................
$ 4,240 800 5,040 $20,000 28,760 48,760 $53,800
(Assets = Liabilities + Shareholders’ equity) LO 1,2,3,4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-7B (a)
Total service revenue ...................................... Total expenses: Repair equipment ..................................... Salaries expense ...................................... Rent expense............................................ Utilities expense........................................ Insurance expense .................................. Advertising expense ................................. Income tax expense .................................. Net loss on a cash basis ..................................
$ 66,500 $47,040 14,200 9,100 1,900 2,760 920 5,000
80,920 $(14,420)
(b)
Cash-based net loss ....................................... Accrual-based net income (from P4-6B) ......... Difference .......................................................
$(14,420) 28,760 $ 43,180
(c)
I recommend the accrual basis of reporting because the accrual-based income statement fairly portrays the performance of the business, with revenues and expenses recorded in the period they were earned and incurred.
LO 1 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-8B (a)
2018
1.
Dec. 31
2. 3.
4.
5. 6.
7.
8. 9 10.
31 31
31
31 31
31
31 31 31
Solutions Manual .
Insurance Expense ................................................. Prepaid Insurance ......................................... ($3,600 × 10/12 months)
3,000
Supplies Expense ................................................... Supplies ($2,500 – $570) ..............................
1,930
Depreciation Expense ............................................ Accumulated Depreciation—Vehicles............. ($58,000 ÷ 4 years)
14,500
Depreciation Expense ............................................ Accumulated Depreciation—Furniture ($16,000 ÷ 10)
1,600
Accounts Receivable .............................................. Service Revenue ...........................................
1,750
Interest Expense .................................................... Interest Payable ............................................. ($27,475 × 7% × 3/12 months)
481
Unearned Revenue ................................................ Service Revenue ........................................... ($600 × 2 months)
1,200
Salaries Expense (3 × $200) .................................. Salaries Payable............................................
600
Rent Expense ...................................................... Prepaid Rent ..............................................
1,150
Income Tax Expense ............................................. Income Tax Payable ($2,850 – $2,000)
850
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3,000
1,930
14,500
1,600
1,750 481
1,200
600 1,150 850
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PROBLEM 4-8B (CONTINUED) (b) Dec. 31 Bal.
Accumulated Depreciation— Furniture Dec. 31 Bal. 4,000 Dec. 31 Adj. 1,600 Dec. 31 Bal. 5,600
Cash 4,600
Accounts Receivable Dec. 31 Bal. 8,220 Dec. 31 Adj. 1,750 Dec. 31 Bal. 9,970
Dec. 31 Bal. Dec. 31 Bal.
Supplies 2,500 Dec. 31 Adj. 570
Prepaid Insurance Dec. 31 Bal. 3,600 Dec. 31 Adj. Dec. 31 Bal. 600
Dec. 31 Bal. Dec. 31 Bal.
Prepaid Rent 2,300 Dec. 31 Adj. 1,150
1,930
3,000
Salaries Payable Dec. 31 Adj.
600
Interest Payable Dec. 31 Adj.
481
Income Tax Payable Dec. 31 Adj.
850
Unearned Revenue Dec. 31 Bal. Dec. 31 Adj. 1,200 Dec. 31 Bal.
3,600 2,400
Bank Loan Payable Dec. 31 Bal.
27,475
Common Shares Dec. 31 Bal.
5,000
Retained Earnings Dec. 31 Bal.
7,600
1,150
Vehicles Dec. 31 Bal. 58,000 Accumulated Depreciation— Vehicles Dec. 31 Bal. 14,500 Dec. 31 Adj. 14,500 Dec. 31 Bal. 29,000
Dividends Declared Dec. 31 Bal. 3,800
Service Revenue Dec. 31 Bal.125,600 Dec. 31 Adj. 1,750 Dec. 31 Adj. 1,200 Dec. 31 Bal.128,550
Furniture Dec. 31 Bal. 16,000
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PROBLEM 4-8B (CONTINUED) (b) (continued) Salaries Expense Dec. 31 Bal. 67,000 Dec. 31 Adj. 600 Dec. 31 Bal. 67,600
Rent Expense Dec. 31 Bal. 12,650 Dec. 31 Adj. 1,150 Dec. 31 Bal. 13,800
Dec. 31 Bal. Dec. 31 Adj. Dec. 31 Bal.
Interest Expense 2,415 481 2,896
Dec. 31 Adj.
Supplies Expense 1,930
Depreciation Expense Dec. 31 Adj. 14,500 Dec. 31 Adj. 1,600 Dec. 31 Bal. 16,100
Repairs and Maintenance Expense Dec. 31 Bal. 4,690
Insurance Expense Dec. 31 Adj. 3,000 Income Tax Expense Dec. 31 Bal. 2,000 Dec. 31 Adj. 850 Dec. 31 Bal. 2,850
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PROBLEM 4-8B (CONTINUED) (c)
ORTEGA LIMO SERVICE LTD. Adjusted Trial Balance December 31, 2018
Debit Cash .....................................................................................$ 4,600 Accounts receivable .............................................................. 9,970 Supplies ................................................................................ 570 Prepaid insurance ................................................................. 600 Prepaid rent .......................................................................... 1,150 Vehicles ................................................................................ 58,000 Accumulated depreciation—vehicles .................................... Furniture ............................................................................... 16,000 Accumulated depreciation—furniture .................................... Salaries payable ................................................................... Interest payable .................................................................... Income tax payable ............................................................... Unearned revenue ................................................................ Bank loan payable, due September 1, 2021 ......................... Common shares.................................................................... Retained earnings ................................................................. Dividends declared ............................................................... 3,800 Service revenue .................................................................... Salaries expense .................................................................. 67,600 Depreciation expense ........................................................... 16,100 Rent expense ........................................................................ 13,800 Repairs and maintenance expense....................................... 4,690 Insurance expense................................................................ 3,000 Supplies expense.................................................................. 1,930 Interest expense ................................................................... 2,896 Income tax expense .............................................................. 2,850 Totals................................................................................. $207,556
Credit
$ 29,000 5,600 600 481 850 2,400 27,475 5,000 7,600 128,550
$207,556
(Total debits = Total credits) LO 2,3,4 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 4-9B (a) 2018 Sept. 4
6
11
12
17
21
24
25
26
27
28
28
Salaries Payable ........................................................ 1,400 Salaries Expense .............................................................................. 800 Cash .........................................................................................
2,200
Cash .......................................................................... Accounts Receivable .........................................
5,400 5,400
Cash .......................................................................... Service Revenue ...............................................
8,800
Cash .......................................................................... Common Shares ...............................................
5,000
Supplies ..................................................................... Accounts Payable ..............................................
2,000
Accounts Payable....................................................... Cash ..................................................................
7,000
Rent Expense ............................................................. Prepaid Rent .............................................................. Cash ..................................................................
1,000 1,000
Salaries Expense ....................................................... Cash ..................................................................
2,200
Accounts Receivable .................................................. Service Revenue ...............................................
1,600
Cash .......................................................................... Unearned Revenue ...........................................
1,300
Dividends Declared .................................................... Cash ..................................................................
500
Income Tax Expense .................................................. Cash ..................................................................
600
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8,800
5,000
2,000
7,000
2,000
2,200
1,600
1,300
500
600
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PROBLEM 4-9B (CONTINUED) (b) and (d) Cash Sept. 1 Bal. 9,760 Sept. 6 5,400 Sept. 4 Sept. 11 8,800 Sept. 21 Sept. 12 5,000 Sept. 24 Sept. 27 1,300 Sept. 25 Sept. 28 Sept. 28 Sept. 30 Bal. 15,760
2,200 7,000 2,000 2,200 500 600
Unearned Revenue Sept. 1 Bal. Sept. 27 Sept. 30 Bal. Sept. 30 Adj. 800 Sept. 30 Bal.
Sept. 4 Accounts Receivable Sept. 1 Bal. 7,440 Sept. 26 1,600 Sept. 6 Sept. 30 Bal. 3,640 Sept. 30 Adj. 600 Sept. 30 Bal. 4,240
5,400
Sept. 28
Sept. 21
Solutions Manual .
6,200 2,000 1,200
0 1,600 1,600
Dividends Declared 500 Service Revenue Sept. 11 8,800 Sept. 26 1,600 Sept. 30 Bal. 10,400 Sept. 30 Adj. 600 Sept. 30 Adj. 800 Sept. 30 Bal. 11,800
Equipment Sept. 1 Bal. 30,000
Accounts Payable Sept. 1 Bal. 7,000 Sept. 17 Sept. 30 Bal.
1,400
Retained Earnings Sept. 1 Bal. 17,400
Prepaid Rent 1,000
Accumulated Depreciation - Equipment Sept. 1 Bal. 3,000 Sept. 30 Adj. 250 Sept. 30 Bal. 3,250
1,300
Common Shares Sept. 1 Bal. 20,000 Sept. 12 5,000 Sept. 30 Bal. 25,000
Supplies Sept. 1 Bal. 1,600 Sept. 17 2,000 Sept. 30 Bal. 3,600 Sept. 30 Adj. 2,800 Sept. 30 Bal. 800
Sept. 24
Salaries Payable Sept. 1 Bal. 1,400 Sept. 30 Bal. Sept. 30 Adj. Sept. 30 Bal.
800 1,300 2,100
Depreciation Expense Sept. 30 Adj. 250 Supplies Expense Sept. 30 Adj. 2,800
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PROBLEM 4-9B (CONTINUED) (b) and (d) (continued) Salaries Expense Sept. 4 800 Sept. 25 2,200 Sept. 30 Bal. 3,000 Sept. 30 Adj. 1,600 Sept. 30 Bal. 4,600
Sept. 24
Rent Expense 1,000
Sept. 28
Income Tax Expense 600
(c) RIJO EQUIPMENT REPAIR CORP. Trial Balance September 30, 2018
Cash ........................................................... Accounts receivable.................................... Supplies ...................................................... Prepaid rent ................................................ Equipment .................................................. Accumulated depreciation—equipment ...... Accounts payable ....................................... Unearned revenue ...................................... Common shares ......................................... Retained earnings....................................... Dividends declared ..................................... Service revenue .......................................... Salaries expense ........................................ Rent expense ............................................. Income tax expense.................................... Totals ...................................................
Debit $15,760 3,640 3,600 1,000 30,000
Credit
$ 3,000 1,200 2,100 25,000 17,400 500 10,400 3,000 1,000 600 $59,100
000 000 $59,100
(Total debits = Total credits)
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PROBLEM 4-9B (CONTINUED) (d) 1.
2.
3.
4.
5.
(e)
2018 Sept. 30
30
30
30
30
Supplies Expense ..................................... Supplies ($3,600 – $800) .................
2,800 2,800
Salaries Expense ...................................... Salaries Payable ..............................
1,600
Accounts Receivable ................................ Service Revenue..............................
600
Depreciation Expense ............................... Accumulated Depreciation—Equipment ($30,000 ÷ 10 years ÷ 12 months)
250
Unearned Revenue ................................... Service Revenue..............................
800
1,600
600
250
800
RIJO EQUIPMENT REPAIR CORP. Adjusted Trial Balance September 30, 2018
Cash ......................................................................... Accounts receivable .................................................. Supplies .................................................................... Prepaid rent .............................................................. Equipment ................................................................. Accumulated depreciation—equipment .................... Accounts payable...................................................... Unearned revenue .................................................... Salaries payable ....................................................... Common shares........................................................ Retained earnings ..................................................... Dividends declared ................................................... Service revenue ........................................................ Salaries expense ...................................................... Supplies expense...................................................... Rent expense ............................................................ Depreciation expense ............................................... Income tax expense .................................................. Totals .................................................................
Debit $15,760 4,240 800 1,000 30,000
Credit
$ 3,250 1,200 1,300 1,600 25,000 17,400 500 11,800 4,600 2,800 1,000 250 600 $61,550
000 000 $61,550
(Total debits = Total credits) Solutions Manual .
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PROBLEM 4-9B (CONTINUED) (f) (1) RIJO EQUIPMENT REPAIR CORP. Income Statement Month Ended September 30, 2018
Service revenue ........................................................ Expenses Salaries expense ............................................. Supplies expense ............................................ Rent expense................................................... Depreciation expense ...................................... Total expenses ....................................... Income before income tax ........................................ Income tax expense.................................................. Net income ..............................................................
$11,800 $4,600 2,800 1,000 250 8,650 3,150 600 $ 2,550
[Revenues – Expenses = Net Income or (Loss)]
(f) (2)
RIJO EQUIPMENT REPAIR CORP. Statement of Changes in Equity Month Ended September 30, 2018
Common Shares Balance, September 1 ................................................................... $20,000 Issued common shares.................................................................. 5,000 Net income .................................................................................... Dividends declared ........................................................................ 00 0000 Balance, September 30 ................................................................. $25,000
Retained Earnings $17,400 2,550 (500) $19,450
Total Equity $37,400 5,000 2,550 (500) $44,450
(Beginning equity ± Changes to equity = Ending equity)
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PROBLEM 4-9B (CONTINUED) RIJO EQUIPMENT REPAIR CORP.
(f) (3)
Statement of Financial Position September 30, 2018
Assets Current assets Cash ............................................................................. Accounts receivable ...................................................... Supplies ........................................................................ Prepaid rent .................................................................. Total current assets ............................................. Property, plant, and equipment Equipment.................................................. $30,000 Less: Accumulated depreciation ............... 3,250 Total assets ...........................................................................
$15,760 4,240 800 1,000 21,800
26,750 $48,550
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ......................................................... Salaries payable ........................................................... Unearned revenue ........................................................ Total current liabilities .......................................... Shareholders’ equity Common shares ........................................ $25,000 Retained earnings...................................... 19,450 Total shareholders’ equity .................................... Total liabilities and shareholders’ equity ................................
$ 1,200 1,600 1,300 4,100
44,450 $48,550
(Assets = Liabilities + Shareholders’ equity) LO 2,3,4 BT: AP Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 4-10B (a)
2018 Sept.
30
30
30
30
Service Revenue ...................................... Income Summary ............................
11,800
Income Summary ..................................... Salaries Expense ............................ Supplies Expense ........................... Rent Expense.................................. Depreciation Expense ..................... Income Tax Expense.......................
9,250
Income Summary ..................................... Retained Earnings ...........................
2,550
Retained Earnings.................................... Dividends Declared ..........................
500
11,800
4,600 2,800 1,000 250 600
2,550
500
(Income statement accounts are closed to the Income Summary account) (b)
Cash Sept. 1 Bal. 9,760 Sept. 6 5,400 Sept. 4 Sept. 11 8,800 Sept. 21 Sept. 12 5,000 Sept. 24 Sept. 27 1,300 Sept. 25 Sept. 28 Sept. 28 Sept. 30 Bal. 15,760 Accounts Receivable Sept. 1 Bal. 7,440 Sept. 26 1,600 Sept. 6 Sept. 30 Bal. 3,640 Sept. 30 Adj. 600 Sept. 30 Bal. 4,240
Solutions Manual .
2,200 7,000 2,000 2,200 500 600
Supplies Sept. 1 Bal. 1,600 Sept. 17 2,000 Sept. 30 Bal. 3,600 Sept. 30 Adj. 2,800 Sept. 30 Bal. 800
Sept. 24
Prepaid Rent 1,000
Equipment Sept. 1 Bal. 30,000 5,400 Accumulated Depreciation - Equipment Sept. 1 Bal. 3,000 Sept. 30 Adj. 250 Sept. 30 Bal. 3,250
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PROBLEM 4-10B (CONTINUED) (b) (continued)
Sept. 21
Accounts Payable Sept. 1 Bal. 7,000 Sept. 17 Sept. 30 Bal.
Unearned Revenue Sept. 1 Bal. Sept. 27 Sept. 30 Bal. Sept. 30 Adj. 800 Sept. 30 Bal.
Sept. 4
Salaries Payable Sept. 1 Bal. 1,400 Sept. 30 Bal. Sept. 30 Adj. Sept. 30 Bal.
6,200 2,000 1,200
800 1,300 2,100 1,300
1,400 0 1,600 1,600
Common Shares Sept. 1 Bal. 20,000 Sept. 12 5,000 Sept. 30 Bal. 25,000 Retained Earnings Sept. 1 Bal. 17,400 Sept. 30 Bal. 17,400 Sept. 30 CE4 500 Sept. 30 CE3 2,550 Sept. 30 Bal. 19,450 Dividends Declared 500 Sept. 30 CE4 Sept. 30 Bal. 0
Financial Accounting, Seventh Canadian Edition
Service Revenue Sept. 11 8,800 Sept. 26 1,600 Sept. 30 Bal. 10,400 Sept. 30 Adj. 600 Sept. 30 Adj. 800 Sept. 30 Bal. 11,800 Sept. 30 CE1 11,800 Sept. 30 Bal. 0 Depreciation Expense Sept. 30 Adj. 250 Sept. 30 CE2 Sept. 30 Bal. 0
250
Supplies Expense Sept. 30 Adj. 2,800 Sept. 30 CE2 2,800 Sept. 30 Bal. 0 Income Tax Expense Sept. 28 600 Sept. 30 CE2 Sept. 30 Bal. 0
600
Rent Expense 1,000 Sept. 30 CE2 1,000 Sept. 30 Bal. 0 Sept. 24
Salaries Expense Sept. 4 800 Sept. 25 2,200 Sept. 30 Bal. 3,000 Sept. 30 Adj. 1,600 Sept. 30 Bal. 4,600 Sept. 30 CE 2 4,600 Sept. 30 Bal. 0
Sept. 28
500
Income Summary Sept. 30 CE2 9,250 Sept. 30 CE1 11,800 Bal. 2,550 Sept. 30 CE3 2,550 Sept. 30 Bal. 0 Solutions Manual .
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PROBLEM 4-10B (CONTINUED) (c) RIJO EQUIPMENT REPAIR CORP. Post-Closing Trial Balance September 30, 2018
Cash ............................................................. Accounts receivable ..................................... Supplies ....................................................... Prepaid rent.................................................. Equipment .................................................... Accumulated depreciation—equipment ........ Accounts payable ......................................... Unearned revenue ....................................... Salaries payable ........................................... Common shares ........................................... Retained earnings ........................................ Totals.....................................................
Debit $15,760 4,240 800 1,000 30,000
00 0000 $51,800
Credit
$ 3,250 1,200 1,300 1,600 25,000 19,450 $51,800
(Total debits for permanent accounts = Total credits for permanent accounts) LO 5 BT: AP Difficulty: S Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 4-11B (a) GRANT ADVERTISING AGENCY LIMITED Adjusted Trial Balance December 31, 2018
Cash ................................................................................... Held for trading investments ............................................... Accounts receivable ........................................................... Supplies ............................................................................. Prepaid insurance............................................................... Equipment .......................................................................... Accumulated depreciation—equipment .............................. Accounts payable .............................................................. Salaries payable ................................................................. Interest payable .................................................................. Unearned revenue .............................................................. Income tax payable ............................................................ Bank loan payable .............................................................. Common shares ................................................................ Retained earnings .............................................................. Dividends declared ............................................................. Fees earned ....................................................................... Salaries expense ................................................................ Depreciation expense ......................................................... Rent expense .................................................................... Supplies expense .............................................................. Insurance expense ............................................................. Interest expense ................................................................. Income tax expense ........................................................... Totals.........................................................................
Debit $ 11,000 10,850 19,750 1,265 800 66,000
Credit
$ 39,600 4,800 1,625 700 6,200 4,000 10,000 20,000 10,400 2,000 60,600 13,625 13,200 7,200 5,935 1,600 700 4,000 $157,925
000 0 00 $157,925
(Total debits = Total credits)
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PROBLEM 4-11B (CONTINUED) (b) 2018 Dec. 31
31
031
31
Fees Earned ............................................. Income Summary .............................
60,600
Income Summary ...................................... Salaries Expense ............................. Depreciation Expense ...................... Rent Expense .................................. Supplies Expense ............................ Insurance Expense .......................... Interest Expense .............................. Income Tax Expense .......................
46,260
Income Summary ...................................... Retained Earnings ...........................
14,340
Retained Earnings .................................... Dividends Declared ..........................
2,000
60,600
13,625 13,200 7,200 5,935 1,600 700 4,000
14,340
2,000
(Income statement accounts are closed to the Income Summary account)
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PROBLEM 4-11B (CONTINUED) (c) GRANT ADVERTISING AGENCY LIMITED Post-Closing Trial Balance December 31, 2018
Debit
Credit
Cash ...................................................................................$ 11,000 Held for trading investments............................................... 10,850 Accounts receivable ........................................................... 19,750 Supplies ............................................................................. 1,265 Prepaid insurance .............................................................. 800 Equipment .......................................................................... 66,000 Accumulated depreciation—equipment .............................. Accounts payable ............................................................... Salaries payable ................................................................. Interest payable .................................................................. Unearned revenue.............................................................. Income tax payable ............................................................ Bank loan payable .............................................................. Common shares ................................................................. Retained earnings .............................................................. 00 000 0 Totals ............................................................................. $109,665
$ 39,600 4,800 1,625 700 6,200 4,000 10,000 20,000 22,740 $109,665
(Total debits = Total credits) LO 4,5 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 4-12B (a) 1. 2. 3.
4.
5.
6. 7. 8. 9.
10.
Solutions Manual .
2018 Aug. 31 31 31
31
31
31 31 31 31
31
Insurance Expense ($12,720 × 3/12) ............. Prepaid Insurance .................................
3,180
Supplies Expense ($6,990 – $1,380) ............. Supplies ................................................
5,610
Depreciation Expense .................................... ($290,000 ÷ 50 years) Accumulated Depreciation—Buildings .
5,800
Depreciation Expense .................................... ($57,200 ÷ 10 years) Accumulated Depreciation—Furniture ..
5,720
Unearned Revenue........................................ Rent Revenue ....................................... [(355 – 45) × $200]
62,000
Salaries Expense ........................................... Salaries Payable ...................................
1,680
Utilities Expense ............................................ Accounts Payable .................................
3,120
Rent Revenue ................................................ Unearned Revenue ...............................
6,000
Interest Expense ............................................ Interest Payable ....................................
700
Income Tax Expense ..................................... Income Tax Payable .............................
2,000
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3,180 5,610
5,800
5,720 62,000
1,680 3,120 6,000 700
2,000
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PROBLEM 4-12B (CONTINUED) (b) Cash Aug. 31 Bal. 38,820 Supplies Aug. 31 Bal. 6,990 Aug. 31 Adj. 5,610 Aug. 31 Bal. 1,380
Unearned Revenue Aug. 31 Bal. 71,000 Aug. 31 Adj. 62,000 Aug. 31 Adj. 6,000 Aug. 31 Bal. 15,000
Prepaid Insurance Aug. 31 Bal. 12,720 Aug. 31 Adj. 3,180 Aug. 31 Bal. 9,540 Land Aug. 31 Bal. 70,000
Furniture Aug. 31 Bal. 57,200 Accumulated Depreciation— Furniture Aug. 31 Bal. 22,880 Aug. 31 Adj. 5,720 Aug. 31 Bal. 28,600 Accounts Payable Aug. 31 Bal. 13,000 Aug. 31 Adj. 3,120 Aug. 31 Bal. 16,120
Solutions Manual .
1,680
Interest Payable Aug. 31 Adj.
700
Income Tax Payable Aug. 31 Adj.
2,000
Mortgage Payable Aug. 31 Bal. 120,000
Buildings Aug.31 Bal. 290,000 Accumulated Depreciation— Buildings Aug. 31 Bal. 87,000 Aug. 31 Adj. 5,800 Aug. 31 Bal. 92,800
Salaries Payable Aug. 31 Adj.
Common Shares Aug. 31 Bal. 40,000 Retained Earnings Aug. 31 Bal. 72,000 Dividends Declared Aug. 31 Bal. 10,000 Rent Revenue Aug. 31 Adj. 6,000 Aug.31 Bal. 497,000 Aug. 31 Adj. 62,000 Aug. 31 Bal. 553,000 Salaries Expense Aug. 31 Bal. 306,000 Aug. 31 Adj. 1,680 Aug. 31 Bal. 307,680 Utilities Expense Aug. 31 Bal. 75,200 Aug. 31 Adj. 3,120 Aug. 31 Bal. 78,320 4-105
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PROBLEM 4-12B (CONTINUED) (b) (continued) Repairs and Maintenance Expense Aug. 31 Bal. 28,250 Insurance Expense Aug. 31 Adj. 3,180
Aug. 31 Adj.
Supplies Expense 5,610
Interest Expense Aug. 31 Bal. Aug. 31 Adj. Aug. 31 Bal.
7,700 700 8,400
Income Tax Expense Aug. 31 Bal. 20,000 Aug. 31 Adj.0 2,000 Aug. 31 Bal. 22,000
Depreciation Expense Aug. 31 Adj. 5,800 Aug. 31 Adj. 5,720 Aug. 31 Bal. 11,520
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PROBLEM 4-12B (CONTINUED) (c)
ROCKY MOUNTAIN RESORT INC. Adjusted Trial Balance August 31, 2018
Cash ........................................................................ Supplies ....................................................................... Prepaid insurance ........................................................ Land............................................................................. Buildings ...................................................................... Accumulated depreciation—buildings .......................... Furniture ...................................................................... Accumulated depreciation—furniture ........................... Accounts payable ........................................................ Salaries payable .......................................................... Interest payable ........................................................... Income tax payable...................................................... Unearned revenue ....................................................... Mortgage payable, due 2021 ....................................... Common shares .......................................................... Retained earnings........................................................ Dividends declared ...................................................... Rent revenue ............................................................... Salaries expense ......................................................... Utilities expense........................................................... Repairs and maintenance expense ............................. Depreciation expense .................................................. Interest expense .......................................................... Supplies expense ........................................................ Insurance expense ...................................................... Income tax expense..................................................... Totals ...............................................................
Debit $ 38,820 1,380 9,540 70,000 290,000
Credit
$ 92,800 57,200 28,600 16,120 1,680 700 2,000 15,000 120,000 40,000 72,000 10,000 553,000 307,680 78,320 28,250 11,520 8,400 5,610 3,180 22,000 $941,900
, 000000 0 $941,900
(Total debits = Total credits)
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PROBLEM 4-12B (CONTINUED) (d) (1)
ROCKY MOUNTAIN RESORT INC. Income Statement Year Ended August 31, 2018
Revenues Rent revenue ........................................... Expenses Salaries expense ..................................... Utilities expense....................................... Repairs and maintenance expense ......... Depreciation expense .............................. Interest expense ...................................... Supplies expense .................................... Insurance expense .................................. Total expenses ............................... Income before income tax ................................ Income tax expense.......................................... Net income ......................................................
$553,000 $307,680 78,320 28,250 11,520 8,400 5,610 3,180 442,960 110,040 22,000 $ 88,040
[Revenues – Expenses = Net income or (Loss)]
(d) (2)
ROCKY MOUNTAIN RESORT INC. Statement of Changes in Equity Year Ended August 31, 2018 Common Shares
Balance, September 1, 2017 ......................................................... $35,000 Issued common shares.................................................................. 5,000 Net income ....................................................... Dividends declared ........................................................................ 0000 00 Balance, August 31, 2018.............................................................. $40,000
Retained Earnings
Total Equity
$ 72,000
$107,000 5,000 88,040 (10,000) $190,040
88,040 (10,000) $150,040
(Beginning equity ± Changes to equity = Ending equity)
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PROBLEM 4-12B (CONTINUED) (d) (3)
ROCKY MOUNTAIN RESORT INC. Statement of Financial Position August 31, 2018
Assets Current assets Cash ........................................................ Supplies ................................................... Prepaid insurance .................................... Total current assets ........................... Property, plant, and equipment Land ......................................................... $ 70,000 Buildings .................................................. $290,000 Less: Accumulated depreciation ............. 92,800 197,200 Furniture .................................................. $57,200 Less: Accumulated depreciation ............. 28,600 28,600 Total property, plant, and equipment Total assets ........................................................
$ 38,820 1,380 9,540 49,740
295,800 $345,540
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ...................................... Salaries payable ........................................ Interest payable ......................................... Income tax payable .................................... Unearned revenue ..................................... Total current liabilities ....................... Non-current liabilities Mortgage payable ...................................... Total liabilities ................................... Shareholders’ equity Common shares ........................................ Retained earnings...................................... Total shareholders’ equity ................. Total liabilities and shareholders’ equity .............
$16,120 1,680 700 2,000 15,000 $ 35,500 120,000 155,500 $ 40,000 150,040 190,040 $345,540
(Assets = Liabilities + Shareholders’ equity)
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PROBLEM 4-12B (CONTINUED) (e)
The financial position and performance of a company can be evaluated in terms of its liquidity, profitability, and solvency. Liquidity Rocky Mountain Resort seems to being enjoying a strong liquidity position. It has a large cash balance of $38,820. The company has a positive current ratio of 1.4:1 ($49,740 ÷ $35,500) which would indicate that there are more than enough current assets on hand to meet currently maturing liabilities. It is also notable that current liabilities include a large amount (42.3%) of unearned revenue, which will not require a cash payment in future. Profitability According to the income statement, Rocky Mountain Resort was profitable in 2018 with net income of $88,040. The resort also has a positive balance in retained earnings, which indicates it has been profitable in the past. The company also declared dividends of $10,000 in the past year, which may be of interest to your friend if your friend is considering an income investment. Solvency The company has a large mortgage, but this represents less than half of the value of the property, plant, and equipment so the bank should not be worried about security for the loan. The company’s debt to assets ratio is 45% ($155,500 ÷ $345,540), so the level of debt held by the company is not extremely high which mitigates the risk of not being able to make interest payments. This, combined with strong liquidity and positive income, indicates that the company is not experiencing any solvency problems. Overall, Rocky Mountain Resort appears to have a healthy financial position. However, a more complete analysis should be performed before investing. Reviewing prior years’ financial statements and industry information would enable us to perform some comparative analysis to better evaluate Rocky’s financial health.
LO 2,3,4 BT: AN Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 4-13B (a) 2018 Aug. 31
31
031
31
Rent Revenue ............................................. Income Summary ...............................
553,000
Income Summary ........................................ Salaries Expense ............................... Utilities Expense ................................ Repairs and Maintenance Expense ... Depreciation Expense ........................ Interest Expense ................................ Supplies Expense .............................. Insurance Expense ............................ Income Tax Expense .........................
464,960
Income Summary ........................................ Retained Earnings .............................
88,040
Retained Earnings ...................................... Dividends Declared ............................
10,000
553,000
307,680 78,320 28,250 11,520 8,400 5,610 3,180 22,000
88,040
10,000
(Income statement accounts are closed to the Income Summary account)
(b) Cash Aug. 31 Bal. 38,820 Aug. 31 Bal. Aug. 31 Bal.
Supplies 6,990 Aug. 31 Adj. 1,380
Prepaid Insurance Aug. 31 Bal. 12,720 Aug. 31 Adj. Aug. 31 Bal. 9,540
Buildings Aug. 31 Bal.290,000 Accumulated Depreciation— Buildings Aug. 31 Bal. 87,000 Aug. 31 Adj. 5,800 Aug. 31 Bal. 92,800
5,610
3,180
Furniture Aug. 31 Bal. 57,200 Accumulated Depreciation— Furniture Aug. 31 Bal. 22,880 Aug. 31 Adj. 5,720 Aug. 31 Bal. 28,600
Land Aug. 31 Bal. 70,000
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PROBLEM 4-13B (CONTINUED) (b) (continued) Accounts Payable Aug. 31 Bal. 13,000 Aug. 31 Adj. 3,120 Aug. 31 Bal. 16,120 Unearned Revenue Aug. 31 Bal. 71,000 Aug. 31 Adj. 62,000 Aug. 31 Adj. 6,000 Aug. 31 Bal. 15,000 Salaries Payable Aug. 31 Adj.
1,680
Interest Payable Aug. 31 Adj.
700
Income Tax Payable Aug. 31 Adj.
2,000
Mortgage Payable Aug. 31 Bal. 120,000 Common Shares Aug. 31 Bal. 40,000 Retained Earnings Aug. 31 Bal. 72,000 Aug. 31 CE4 10,000 Aug. 31 CE3 88,040 Aug. 31 Bal. 150,040 Dividends Declared Aug. 31 Bal. 10,000 Aug. 31 CE4 10,000 Aug. 31 Bal. 0
Solutions Manual .
Rent Revenue Aug. 31 Bal. 497,000 Aug. 31 Adj. 6,000 Aug. 31 Adj. 62,000 Aug. 31 Bal. 553,000 Aug.31 CE1 553,000 Aug. 31 Bal. 0 Salaries Expense Aug. 31 Bal. 306,000 Aug. 31 Adj. 1,680 Aug. 31 Bal. 307,680 Aug.31 CE2 307,680 Aug. 31 Bal. 0 Utilities Expense Aug. 31 Bal. 75,200 Aug. 31 Adj. 3,120 Aug. 31 Bal. 78,320 Aug. 31 CE2 78,320 Aug. 31 Bal. 0 Repairs and Maintenance Expense Aug. 31 Bal. 28,250 Aug. 31 CE2 28,250 Aug. 31 Bal. 0 Insurance Expense Aug. 31 Adj. 3,180 Aug. 31 CE2 Aug. 31 Bal. 0 Supplies Expense Aug. 31 Adj. 5,610 Aug. 31 CE2 Aug. 31 Bal. 0
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5,610
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PROBLEM 4-13B (CONTINUED) (b) (continued) Depreciation Expense Aug. 31 5,800 Aug. 31 Adj. 5,720 Aug. 31 Bal. 11,520 Aug. 31 CE2 11,520 Aug. 31 Bal. 0
Income Tax Expense Aug. 31 Bal. 20,000 Aug. 31 2,000 Aug. 31 Bal. 22,000 Aug. 31 CE2 22,000 Aug. 31 Bal. 0 Income Summary
Interest Expense Aug. 31 Bal. Aug. 31 Adj. Aug. 31 Bal.
7,700 700 8,400 Aug. 31 CE2
Aug. 31 Bal. (c)
8,400
Aug.31 CE2 464,960 Aug.31 CE1 553,000 Bal. 88,040 Aug.31 CE3 88,040 Aug. 31 Bal. 0
0 ROCKY MOUNTAIN RESORT INC. Post-Closing Trial Balance August 31, 2018
Cash ............................................................................... Supplies ............................................................................. Prepaid insurance .............................................................. Land ................................................................................... Buildings ............................................................................. Accumulated depreciation—buildings ................................ Furniture ............................................................................. Accumulated depreciation—furniture ................................. Accounts payable ............................................................... Salaries payable ................................................................. Interest payable .................................................................. Income tax payable ............................................................ Unearned revenue.............................................................. Mortgage payable............................................................... Common shares ................................................................. Retained earnings .............................................................. Totals .........................................................................
Debit $ 38,820 1,380 9,540 70,000 290,000
Credit
$ 92,800 57,200
00 00000 $466,940
28,600 16,120 1,680 700 2,000 15,000 120,000 40,000 150,040 $466,940
(Total debits for permanent accounts = Total credits for permanent accounts) LO 5 BT: AP Difficulty: S Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
ACR4-1 ACCOUNTING CYCLE REVIEW (a) Aug.
1 3 6 10
13 15 17 22
24
27 29 31
Solutions Manual .
Prepaid Advertising ................................................... Cash .................................................................
400
Prepaid Rent ............................................................. Cash .................................................................
380
Cash ......................................................................... Accounts Receivable ........................................
3,200
Salaries Expense ...................................................... Salaries Payable ....................................................... Cash .................................................................
1,700 1,420
Cash ......................................................................... Service Revenue ..............................................
3,800
Equipment ................................................................. Accounts Payable .............................................
2,000
Accounts Payable ...................................................... Cash .................................................................
2,000
Supplies .................................................................... Accounts Payable .............................................
800
Salaries Expense ...................................................... Cash .................................................................
2,900
Accounts Receivable ................................................ Service Revenue ..............................................
4,760
Cash ......................................................................... Unearned Revenue ..........................................
780
Dividends Declared ................................................... Cash .................................................................
500
4-114
400 380 3,200
3,120 3,800 2,000 2,000 800
2,900
4,760 780 500
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED) (b), (d), and (g) Note Receivable
Cash Aug
Aug.
Aug. 1 Bal.
4,000
1 Bal.
6,020 Aug.
1
400
6
3,200
3
380
13
3,800
10
3,120
29
780
17
2,000
Aug. 1 Bal.
20
24
2,900
Aug. 31 Adj.
20
31
500
Aug. 31 Bal.
40
31 Bal.
Interest Receivable
4,500 Equipment
Accounts Receivable Aug. Aug.
1 Bal.
4,310 Aug. 6
27
4,760
31 Bal.
5,870
3,200
Aug. 1 Bal.
10,000
Aug. 15
2,000
Aug. 31 Bal.
12,000
Accumulated Depreciation—Equipment Prepaid Advertising Aug.
1
400
Aug.
31 Bal.
200
Aug. 31
Adj. 200
Aug.
1 Bal.
1,030 Aug. 31
22
800
31 Bal.
960
Adj. 870
Aug. 17
Prepaid Rent Aug.
3
380 Aug. 31
Aug.
31 Bal.
2,000
Aug. 31 Adj.
200
Aug. 31 Bal
2,200
Accounts Payable
Supplies Aug.
Aug. 1 Bal.
Adj. 380
Aug. 10
0
2,000 Aug. 1 Bal.
2,300
15
2,000
22
800
Aug. 31 Bal.
3,100
Salaries Payable 1,420 Aug. 1 Bal. 1,420 Aug. 31 Adj. 1,540 Aug. 31 Bal. 1,540
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED) (b), (d), and (g) (continued)
Interest Revenue Aug. 31 Adj.
Income Tax Payable
Aug. 31 CE
31 Adj. 300
Aug.
800
20 Aug.31
Aug. 1 Bal.
1,260
29
780
Aug. 31 Bal. 1,240
Aug. 10
1,700
24
2,900
Aug. 31 Adj.
1,540
Aug. 31 Bal.
6,140 Aug. 31 CE2
Common Shares Aug. 1 Bal. 12,000
Aug. 31 Bal.
6,140
0 Rent Expense
Retained Earnings
Aug. 31 CE4
Bal. 0
Salaries Expense
Unearned Revenue Aug. 31 Adj.
20
Aug. 1 Bal. 6,400 Aug. 31 CE3 1,290 500 Aug. 31 Bal.
Aug. 31 Adj.
380 Aug. 31 CE2
Aug. 31 Bal. 7,190
380
0 Supplies Expense
Aug. 31 Adj.
Dividends Declared Aug. 31
500 Aug. 31 CE4
Aug. 31 Bal.
Aug. 31 CE2
500 Aug. 31 Bal.
0
Aug. 13
3,800
27
4,760
31 Adj.
800
Aug. 31 Bal.
9,360
Aug.
0
31 Adj.
200 July 31 CE2
Aug. 31 Bal.
200
0
9,360 Aug. 31 Bal.
Solutions Manual .
870
Depreciation Expense
Service Revenue
Aug. 31 CE1
870
0
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED)
Advertising Expense Aug. 31 Adj.
(b), (d), and (g) (continued)
200 Aug 31
Income Tax Expense Aug. 31 Adj.
200
0
300 Aug 31 CE2
Aug. 31 Bal.
Aug. 31 Bal.
CE2
300 Income Summary
0 Aug. 31 CE 2 Aug. 31 CE 3
8,090 Aug. 31 CE1
9,380
Aug. 31 Bal.
1,290
Aug. 31 Bal.
0
1,290
(c)
TOBIQUE LTD. Trial Balance August 31, 2018 Cash ...................................................... Accounts receivable ............................. Prepaid advertising ............................... Supplies ................................................ Prepaid rent ........................................... Note receivable ...................................... Interest receivable ................................. Equipment ............................................. Accumulated depreciation—equipment . Accounts payable ................................. Unearned revenue ................................ Common shares ................................... Retained earnings ................................. Dividends declared ................................ Service revenue ..................................... Salaries expense .................................. Totals ..............................................
Debit $ 4,500 5,870 400 1,830 380 4,000 20 12,000
Credit
$ 2,000 3,100 2,040 12,000 6,400 500 8,560 4,600 $34,100
$34,100
(Total debits = Total credits)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED) (d) Aug. 31
31 31
31
31
Aug. 31
31
31
Solutions Manual .
Advertising Expense .................................................. Prepaid Advertising .......................................... ($400 × 1/2)
200
Rent Expense ............................................................ Prepaid Rent ....................................................
380
Salaries Expense ...................................................... Salaries Payable ..............................................
1,540
Depreciation Expense ............................................... Accumulated Depreciation—Equipment ...........
200
Supplies Expense...................................................... Supplies ($1,830 - $960) ..................................
870
Unearned Revenue ................................................... Service Revenue ..............................................
800
Interest Receivable.................................................... Interest Revenue .............................................. ($4,000 × 6% × 1/12)
20
Income Tax Expense ................................................. Income Tax Payable .........................................
300
4-118
200
380 1,540
200
870
800
20
300
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED) (e) TOBIQUE LTD. Adjusted Trial Balance August 31, 2018 Cash Accounts receivable ....................................... Prepaid advertising ......................................... Supplies .......................................................... Note receivable ................................................ Interest receivable ........................................... Equipment ....................................................... Accumulated depreciation—equipment ........... Accounts payable ........................................... Salaries payable ............................................. Income tax payable ........................................ Unearned revenue .......................................... Common shares ............................................. Retained earnings .......................................... Dividends declared .......................................... Service revenue .............................................. Interest revenue .............................................. Salaries expense ............................................ Rent expense ................................................. Supplies expense ........................................... Depreciation expense ..................................... Advertising expense ....................................... Income tax expense ....................................... Totals ........................................................
Debit $ 4,500 5,870 200 960 4,000 40 12,000
Credit
$ 2,200 3,100 1,540 300 1,240 12,000 6,400 500 9,360 20 6,140 380 870 200 200 300 $36,160
$36,160
(Total debits = Total credits)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED) (f) (1) TOBIQUE LTD. Income Statement Month Ended August 31, 2018
Revenues Service revenue .............................................. Interest revenue .............................................. Expenses Salaries expense ............................................ Supplies expense ............................................ Rent expense .................................................. Advertising expense ........................................ Depreciation expense ..................................... Total expenses ....................................... Income before income tax ........................................ Income tax expense ................................................. Net income ...............................................................
$9,360 20
$9,380
$6,140 870 380 200 200 7,790 1,590 300 $1,290
[Revenues – Expenses = Net Income or (Loss)]
(f) (2) TOBIQUE LTD. Statement of Changes in Equity Month Ended August 31, 2018 Common Retained Shares Earnings Balance, Aug. 1 ...................................................................... $12,000 $6,400 Net income.............................................................................. 1,290 00 0000 Dividends declared ................................................................. __ ____ (500) Balance, Aug. 31 .................................................................... $12,000 $7,190
Total Equity $18,400 1,290 (500) $19,190
(Beginning equity ± Changes to equity = Ending equity)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED) (f) (3) TOBIQUE LTD. Statement of Financial Position August 31, 2018 Assets Current assets Cash........................................................... Accounts receivable ................................... Note receivable, due October 31, 2018...... Interest receivable ...................................... Prepaid advertising .................................... Supplies ..................................................... Total current assets........................... Property, plant, and equipment Equipment .................................................. Less: Accumulated depreciation ................ Total assets.........................................................
$ 4,500 5,870 4,000 40 200 960 15,570 $12,000 2,200
9,800 $25,370
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ....................................... Salaries payable ........................................ Income tax payable .................................... Unearned revenue ..................................... Total liabilities .......................................
$3,100 1,540 300 1,240
Shareholders’ equity Common shares ......................................... Retained earnings ...................................... Total shareholders’ equity ................. Total liabilities and shareholders’ equity .............
$12,000 7,190
$ 6,180
19,190 $25,370
(Assets = Liabilities + Shareholders’ equity)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-1 (CONTINUED) (g) Aug. 31 Service Revenue ....................................................... Interest Revenue ....................................................... Income Summary .............................................
9,360 20
31 Income Summary ...................................................... Salaries Expense ............................................. Rent Expense ................................................... Supplies Expense ............................................. Depreciation Expense ...................................... Advertising Expense ......................................... Income Tax Expense ........................................
8,090
31 Income Summary ...................................................... Retained Earnings ............................................
1,290
31 Retained Earnings ..................................................... Dividends Declared ..........................................
500
9,380 6,140 380 870 200 200 300 1,290
500
(Income statement accounts are closed to the Income Summary account)
(h)
TOBIQUE LTD. Post-closing Trial Balance August 31, 2018 Cash ................................................................ Accounts receivable ........................................ Prepaid advertising ......................................... Supplies .......................................................... Note receivable ................................................ Interest receivable ........................................... Equipment Accumulated depreciation—equipment ........... Accounts payable ........................................... Salaries payable ............................................. Income tax payable ......................................... Unearned revenue .......................................... Common shares ............................................. Retained earnings ........................................... Totals..........................................................
Debit $ 4,500 5,870 200 960 4,000 40 12,000
000 000 $27,570
Credit
$ 2,200 3,100 1,540 300 1,240 12,000 7,190 $27,570
(Total debits for permanent accounts = Total credits for permanent accounts) LO 2,3,4,5 BT: AP Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-2 ACCOUNTING CYCLE REVIEW (a) July
3
4
5
6
6
Cash .......................................................................... Common Shares ..............................................
10,000
Prepaid Insurance ..................................................... Cash .................................................................
3,600
Prepaid Rent ............................................................. Cash .................................................................
8,000
Supplies .................................................................... Cash .................................................................
3,800
Equipment ................................................................. Cash ................................................................. Bank Loan Payable ..........................................
24,000
10,000
3,600
8,000
3,800
4,000 20,000
10
No entry required (consulting agreement)
12
Cash ......................................................................... Accounts Receivable ........................................
1,200
Unearned Revenue ................................................... Fees Earned .....................................................
1,120
Salaries Expense ...................................................... Cash .................................................................
11,000
Accounts Payable ...................................................... Cash .................................................................
400
Cash ......................................................................... Unearned Revenue ..........................................
12,000
Accounts Receivable ................................................ Fees Earned .....................................................
28,000
Professional Fees Expense ....................................... Accounts Payable .............................................
2,200
13
16
17
18
19
20
Solutions Manual .
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1,200
1,120
11,000
400
12,000
28,000
2,200
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (a) (continued) July 23
25
27
30
Unearned Revenue ................................................... Fees Earned .....................................................
10,000
Income Tax Expense ................................................. Income Tax Payable .................................................. Cash .................................................................
1,200 500
Cash ......................................................................... Accounts Receivable ........................................
15,000
Dividends Declared ................................................... Cash .................................................................
5,000
10,000
1,700 15,000
5,000
(b), (d), and (g) Cash July
July
Supplies
1 Bal.
15,230 July
4
3,600
3
10,000
5
8,000
12
1,200
6
3,800
18
12,000
6
4,000
27
15,000
16
11,000
17
400
25
1,700
July
5
8,000
30
5,000
July
31 Bal.
4,000
31 Bal.
July July
1 Bal.
690
6
3,800
31 Bal.
3,240
July 31 Adj. 1,250
Prepaid Rent July
31 Adj. 4,000
15,930 Equipment
Accounts Receivable July July
July
1 Bal.
1,200 July 12
1,200
19
28,000
15,000
31 Bal.
13,000
27
6
24,000
Accumulated Depreciation—Equipment July 31 Adj.
500
Prepaid Insurance July
4
3,600
July
31 Bal.
3,300
Solutions Manual .
July 31 Adj.
300
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Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (b), (d), and (g) (continued) Retained Earnings
Accounts Payable July 17
400 July 1 Bal. 20
July 1 Bal.
400 2,200
31 Adj.
800
July 31 Bal.
3,000
July 31 CE4
July 30 100
July 5,000 31 CE3
6
July 31 Bal.
13
Dividends Declared
Interest Payable July 31 Adj.
11,500
5,000 July
31 CE4
July 31 Bal.
5,000
0 Fees Earned July
Salaries Payable July 31 Adj.
11,000 July
Income Tax Payable July 25
1 Bal.
500
July 31 Bal.
0
500 July
July 31 CE1
13
1,120
19
28,000
23
10,000
31 Bal.
39,120
39,120 July 31 Bal. Salaries Expense
Unearned Revenue
July 16
July 13
1,120
July 1 Bal.
1,120
23
10,000
18
12,000
July 31 Bal.
2,000
July 31 Adj. 11,000 July 31 Bal. 22,000 July 31 CE2 July 31 Bal.
Bank Loan Payable July 6
20,000 July
Solutions Manual .
3,600
3
10,000
July 31 Bal.
13,600
22,000
0 Rent Expense
Common Shares July 1 Bal.
11,000
31 Adj.
4,000 July 31 CE2
July 31 Bal.
4-125
4,000
0
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) Insurance Expense (b), (d), and (g) (continued)
July
31 Adj. 300 July 31
Professional Fees Expense July 20
July
2,200 July 31 CE2
July 31 Bal.
31 Bal.
July
31 Adj.
July 31 July 31 CE2
1,250
July 31 Bal.
0
0 Income Tax Expense
July 25
Utilities Expense
1,200 July 31 CE2
800 July 31 CE2
July 31 Bal.
100
100
1,250
July 31 Adj.
CE2
0
Interest Expense
Supplies Expense
July 31 Bal.
300
2,200
0
July 31 Adj.
CE2
800
July 31 Bal.
1,200
0
0 Income Summary July 31 CE2
Depreciation Expense July
31 Adj.
39,120
Bal.
6,770
500 July 31
July
32,350 July 31 CE1
31 Bal.
Solutions Manual .
CE2
500
July 31 CE3
6,770 July 31 Bal.
0
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0
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (c) RIVER CONSULTANTS LTD. Trial Balance July 31, 2018 Cash ........................................................ Accounts receivable ................................ Prepaid insurance .................................... Supplies .................................................. Prepaid rent ............................................. Equipment ............................................... Accounts payable ................................... Unearned revenue .................................. Bank loan payable ................................... Common shares ..................................... Retained earnings ................................... Dividends declared .................................. Fees earned............................................. Salaries expense ..................................... Professional fees expense ....................... Income tax expense ................................. Totals...............................................
Debit $15,930 13,000 3,600 4,490 8,000 24,000
Credit
$ 2,200 2,000 20,000 13,600 11,500 5,000 39,120 11,000 2,200 1,200 $88,420
$88,420
(Total debits = Total credits)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (d) July 31
31 31
31
31
31 31
Solutions Manual .
Insurance Expense .................................................... Prepaid Insurance ............................................ ($3,600 × 1/12)
300
Rent Expense ............................................................ Prepaid Rent ....................................................
4,000
Supplies Expense...................................................... Supplies............................................................
1,250
Depreciation Expense ............................................... Accumulated Depreciation—Equipment ........... ($24,000 ÷ 4 × 1/12)
500
Interest Expense ....................................................... Interest Payable ............................................... ($20,000 × 6% × 1/12)
100
Salaries Expense ...................................................... Salaries Payable ..............................................
11,000
Utilities Expense ........................................................ Accounts Payable .............................................
800
4-128
300
4,000 1,250
500
100
11,000 800
Chapter 4
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (e) RIVER CONSULTANTS LTD. Adjusted Trial Balance July 31, 2018 Cash ............................................................. Accounts receivable ...................................... Prepaid insurance ......................................... Supplies ....................................................... Prepaid rent .................................................. Equipment ..................................................... Accumulated depreciation—equipment ........ Accounts payable ......................................... Interest payable ........................................... Salaries payable .......................................... Unearned revenue ....................................... Bank loan payable ........................................ Common shares ........................................... Retained earnings ........................................ Dividends declared ....................................... Fees earned ................................................. Salaries expense ......................................... Rent expense ............................................... Professional fees expense ........................... Supplies expense ......................................... Utilities expense ........................................... Depreciation expense .................................. Insurance expense ....................................... Interest expense .......................................... Income tax expense ..................................... Totals ........................................................
Debit $ 15,930 13,000 3,300 3,240 4,000 24,000
Credit
$
500 3,000 100 11,000 2,000 20,000 13,600 11,500
5,000 39,120 22,000 4,000 2,200 1,250 800 500 300 100 1,200 $100,820
$100,820
(Total debits = Total credits)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (f) (1) RIVER CONSULTANTS LTD. Income Statement Month Ended July 31, 2018
Revenues Fees earned .................................................... Expenses Salaries expense ............................................ Rent expense .................................................. Professional fees expense .............................. Supplies expense ............................................ Utilities expense .............................................. Depreciation expense ..................................... Insurance expense .......................................... Interest expense ............................................. Total expenses ....................................... Income before income tax ........................................ Income tax expense ................................................. Net income ...............................................................
$39,120 $22,000 4,000 2,200 1,250 800 500 300 100 31,150 7,970 1,200 $ 6,770
[Revenues – Expenses = Net income or (Loss)]
(f) (2) RIVER CONSULTANTS LTD. Statement of Changes in Equity Month Ended July 31, 2018 Common Retained Shares Earnings Balance, July 1 ............................................................................... $ 3,600 $11,500 Issued common shares .................................................................. 10,000 Net income ..................................................................................... 6,770 00 0000 Dividends declared ......................................................................... __ ____ (5,000) Balance, July 31 ............................................................................. $13,600 $13,270
Total Equity $15,100 10,000 6,770 (5,000) $26,870
(Beginning equity ± Changes to equity = Ending equity)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (f) (3) RIVER CONSULTANTS LTD. Statement of Financial Position July 31, 2018 Assets Current assets Cash........................................................... Accounts receivable ................................... Prepaid rent ............................................... Prepaid insurance ...................................... Supplies ..................................................... Total current assets........................... Property, plant, and equipment Equipment .................................................. Less: Accumulated depreciation ................ Total assets.........................................................
$15,930 13,000 4,000 3,300 3,240 39,470 $24,000 500
23,500 $62,970
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ....................................... Salaries payable ........................................ Interest payable ......................................... Unearned revenue ..................................... Total current liabilities ........................... Non-current liabilities Bank loan payable ..................................... Total liabilities.................................... Shareholders’ equity Common shares ......................................... Retained earnings ...................................... Total shareholders’ equity ................. Total liabilities and shareholders’ equity .............
$ 3,000 11,000 100 2,000 $16,100 20,000 36,100 $13,600 13,270 26,870 $62,970
(Assets = Liabilities + Shareholders’ equity)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ACR4-2 (CONTINUED) (g) July 31 31
31
31
Fees Earned .............................................................. Income Summary .............................................
39,120
Income Summary ...................................................... Salaries Expense ............................................. Rent Expense ................................................... Professional Fees Expense .............................. Supplies Expense ............................................. Utilities Expense ............................................... Depreciation Expense ...................................... Insurance Expense ........................................... Interest Expense .............................................. Income Tax Expense ........................................
32,350
Income Summary ...................................................... Retained Earnings ............................................
6,770
Retained Earnings ..................................................... Dividends Declared ..........................................
5,000
39,120 22,000 4,000 2,200 1,250 800 500 300 100 1,200 6,770
5,000
(Income statement accounts are closed to the Income Summary account)
(h)
Current ratio $39,470 $16,100
=
2.5:1
River Consultants has exceeded the benchmark of 2:1 for its current ratio. LO 2,3,4,5 BT: AP Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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CT4-1 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
Accounts appearing on North West’s balance sheet that may have been used in an adjusting entry for prepayments include:
Prepaid expenses Property and equipment
The related statement of earnings accounts that most likely include adjusting entries at the end of the year for prepayments include:
(b)
Selling, operating, and administrative expenses o Depreciation expense (which North West calls amortization expense) which would be part of selling, operating, and administrative expenses o Insurance expense included would be part of selling, operating, and administrative expenses o Other choices are also possible
Accounts appearing on North West’s balance sheet that may have been used in an adjusting entry for accruals include:
Accounts payable and accrued liabilities Income tax payable
The related statement of earnings accounts that most likely include adjusting entries at the end of the year for accruals include:
Solutions Manual .
Salaries expense which would be part of selling, operating, and administrative expenses Income tax expense Other choices are also possible
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Financial Accounting, Seventh Canadian Edition
CT4-1 (CONTINUED) (c)
The five-step process of revenue recognition includes: 1. 2. 3. 4.
Identify the contract with the client or customer. Identify the performance obligations in the contract. Determine the transaction price. Allocate the transaction price to the performance obligations in the contract. 5. Recognize revenue when (or as) the company satisfies the performance obligation. For North West: 1. The contract is created when the customer selects goods in the stores. 2. The performance obligation is the provision of goods. 3. The transaction price is labelled for each item in the stores. 4. The per item price fulfils the total performance obligation in the contract. 5. The revenue is recognized when the customer goes though the cash register system and pays for the purchase. LO 1,2 BT: C Difficulty: M Time: 20 min. AACSB: Communication and Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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CT4-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
Revenue and expense criteria require that revenue be recognized when earned and expenses when incurred. At the time of signing the three-year maintenance contact, the customer has not received any services and no revenue has been earned. Although $100,000 was collected at the time of signing the contract, the full amount should be recorded to the Unearned Revenue account. As the performance obligations of the contract (maintenance service) are delivered, revenue from the services provided can be recognized and the related unearned revenue reduced. This will ensure that the expenses incurred in the performance of the contract will be matched to the revenues recognized. The financial statements for 2017, 2018, and 2019 will be affected as follows:
For 2017, only statement of financial position accounts will be affected. Cash and Unearned Revenue will increase.
For 2018, the income statement will be affected. Revenue earned from the provision of the maintenance services will be recognized and there will be a corresponding entry to reduce the unearned revenue created when the cash was collected on Dec. 29, 2017. Related expenses will be recognized and matched to the revenues in the same accounting period. The second collection of $100,000 on Dec. 29, 2018 will affect the statement of financial position. Cash and Unearned Revenue will increase.
For 2019, the same effect for the income statement and the statement of financial position will occur as is described for 2018.
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT4-3
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a) 1.
To record the additional depreciation, the following would be recorded: Depreciation Expense Accumulated Depreciation—Furniture
2.
300,000
To accrue the additional salary expense, the following would be recorded: Salaries Expense Salaries Payable
3.
300,000
400,000 400,000
To increase the accrual for operating expenses by $80,000 ($230,000 – $150,000) the following entry would be made: Office Expense Accounts Payable
80,000 80,000
(b)
Income before income tax as originally determined Additional depreciation expense Additional salaries expense Additional office expense Income before income tax revised
(c)
Anna suggested that the useful life of the furniture be lowered to increase the amount of depreciation recorded in each year. This would lower income before income tax and strengthen management’s argument that the company could not afford to increase salaries.
(d)
In order to accrue an expense such as severance pay, it must have been incurred. Since the decision to shut down the stores has not yet been made, it would be inappropriate to record such an expense.
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CT4-3 (CONTINUED) (e)
It is not unusual for a company to have to accrue amounts for utilities prior to the invoice being received in order to record the expense in the appropriate period. The company should be able to make a reasonable estimate by calling the utility company and looking at past history. However, increasing the estimate from $150,000 to $230,000 appears to have been done without any adequate support or justification. This seems like an attempt to lower the net income of the company prior to negotiations with the union.
LO 2,3 BT: AN Difficulty: M Time: 30 min. AACSB: Ethics and Analytic CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT4-4 (a)
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
The stakeholders in this situation are:
Sundream’s controller Sundream’s Chief Executive Officer Sundream’s shareholders Sundream’s creditors.
(b)
By adding $12,000 to sales revenue and reducing interest expense by $3,000, net income increases by $15,000. Unearned revenue reduces by $12,000 and interest payable reduces by $3,000. Consequently, the current and total liabilities would reduce by $15,000 and the shareholders’ equity would increase by $15,000 on the statement of financial position. The Sundream Travel Agency’s liquidity improves as a result of the changes suggested by the CEO. The current ratio should be 1.9:1 ($400,000 ÷ $210,000) but it is now increased to 2.1:1 [($400,000 ÷ ($210,000 – $12,000 – $3,000)].
(c)
Intentionally misrepresenting the company’s financial condition and its results of operations is unethical and is also illegal. It is obvious from the request that the CEO’s intention is to manipulate the amount of the current liabilities, to ensure that the current ratio conforms to the 2:1 requirement of the bank loan.
(d)
Accounting standards are known and understood by the users and the preparers of the financial statements. Those who prepare the financial statements are bound by the accounting standards. An intentional breach of these standards, as is suggested by the CEO in this case, cannot be passed off as an oversight or ignorance of the fundamental rules of accounting. Consequently, the CEO is aware of the breach in the accounting standards when he suggests the changes to the controller. He knows that his behaviour is unethical and his suggestions should be challenged by his controller.
LO 1,2,3 BT: E Difficulty: M Time: 20 min. AACSB: Ethics and Analytic CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT4-5 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
Since First Capital Realty Inc. is required to release financial statements quarterly, it would need to post adjusting entries at least quarterly. Since Skyline Group of Companies only releases financial statements annually, it will need to prepare adjusting entries at least annually. Although external financial statements are released on a quarterly basis for First Capital and on an annual basis for Skyline, it is likely that management of both companies would need monthly financial statements so that they can assess the company’s performance on a timely basis. For this reason, it is likely that the adjusting entries are prepared on a monthly basis for each of the companies and that there are no significant differences in the accounting cycle for each company.
(b)
The criteria for, and timing of, revenue recognition may differ between the two companies, depending on their source of revenue. This is not likely though given that the two companies are both REITs, but it is possible depending on the terms of specific performance contracts. In terms of financial reporting, Skyline would not be required to prepare a statement of changes in equity, but rather would prepare a statement of retained earnings. Skyline would also not report other comprehensive income in the shareholders’ equity section of its statement of financial position and it would not prepare a statement of comprehensive income (we will learn more about comprehensive income in a later chapter). First Capital Realty would prepare a statement of changes in equity and a statement of comprehensive income (if it had any other comprehensive income). Otherwise, the remaining financial statements would be the same for each company. Compared with ASPE, additional disclosure is required by companies reporting under IFRS in the notes to the financial statements.
LO 2 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting
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CT4-6
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
(a) 1.
2.
3.
4.
5.
6.
7.
8.
June 30 Advertising Expense ................................................ Supplies .........................................................
600
30 Depreciation Expense ............................................. Accumulated Depreciation—Buildings ($165,000 ÷ 30 years)
5,500
30 Depreciation Expense ............................................. Accumulated Depreciation—Equipment. .........
7,070
30 Depreciation Expense ............................................. Accumulated Depreciation—Vehicles
4,200
30 Interest Expense ..................................................... Interest Payable ..............................................
50
30 Insurance Expense ($12,000 × 6/12 months) .......... Prepaid Insurance ..........................................
6,000
30 Utilities Expense ...................................................... Accounts Payable ..........................................
1,025
30 Accounts Receivable ............................................... Sales ...............................................................
1,600
30 Salaries Expense (2 × 20 × $25) ............................. Salaries Payable .............................................
1,000
30 Income Tax Expense ............................................... Income Tax Payable .......................................
5,000
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600
5,500
7,070
4,200
50
6,000
1,025
1,600
1,000
5,000
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Financial Accounting, Seventh Canadian Edition
CT4-6 (CONTINUED) (b)
Note: June balances were taken from the answer to CT3-6.
June Bal.
Cash 34,534
Accumulated Depreciation-Equipment June Bal. 14,000 30 Adj. 7,070 June Bal. 21,070
Accounts Receivable June Bal. 10,490 30 Adj. 1,600 June Bal. 12,090
June Bal.
June Bal. June Bal.
June Bal. June Bal.
June Bal.
Accumulated Depreciation-Vehicles June 30 Adj. 4,200
Inventory 16,250
Supplies 4,375 June 30 Adj. 3,775 Prepaid Insurance 12,000 June 30 6,000
Accounts Payable June Bal. 6,240 30 Adj. 1,025 June Bal. 7,265 Unearned Revenue June Bal.
600
Interest Payable June 30 Adj.
6,000
50
Income Tax Payable June 30 Adj. 5,000
Buildings June Bal. 165,000 Accumulated Depreciation-Buildings June Bal. 137,500 30 Adj. 5,500 June Bal. 143,000
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1,000
Salaries Payable June 30 Adj. 1,000
Land June Bal. 100,000
June Bal.
Vehicles 52,500
Bank Loan Payable June Bal.
22,500
Mortgage Payable June Bal.
53,200
Common Shares June Bal.
300
Retained Earnings June Bal. 146,788
Equipment 44,520 4-141
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CT4-6 (CONTINUED) (b) (continued) Insurance Expense June 30 Adj. 6,000
Dividends Declared June Bal. 30,000 Rent Revenue June Bal.
6,000
Sales June Bal. 638,758 30 Adj. 1,600 June Bal. 640,358 Cost of Goods Sold June Bal. 102,386 June Bal. 30 Adj. June Bal.
Salaries Expense 390,782 1,000 391,782
June Bal.
Property Tax Expense 5,950
Interest Expense June Bal. 5,299 30 Adj. 50 June Bal. 5,349 Income Tax Expense June Bal. 13,000 30 Adj. 5,000 June Bal. 18,000
Depreciation Expense June 30 Adj. 5,500 30 Adj. 7,070 30 Adj. 4,200 June Bal. 16,770
June Bal.
Office Expense 18,000
Utilities Expense June Bal. 12,200 30 Adj. 1,025 June Bal. 13,225 Advertising Expense June Bal. 9,000 30 Adj. 600 June Bal. 9,600
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CT4-6 (CONTINUED) (c) ANTHONY BUSINESS COMPANY LTD. Adjusted Trial Balance June 30, 2017 Debit Cash ......................................................................... Accounts receivable .................................................. Inventory ................................................................... Supplies .................................................................... Prepaid insurance ..................................................... Land .......................................................................... Buildings ................................................................... Accumulated depreciation—buildings ........................ Equipment ................................................................. Accumulated depreciation—equipment ..................... Vehicles .................................................................... Accumulated depreciation—vehicles ......................... Accounts payable ...................................................... Unearned revenue..................................................... Salaries payable ........................................................ Interest payable ......................................................... Income tax payable ................................................... Bank loan payable ..................................................... Mortgage payable ..................................................... Common shares ........................................................ Retained earnings ..................................................... Dividends declared .................................................... Rent revenue............................................................. Sales ......................................................................... Cost of goods sold..................................................... Salaries expense ....................................................... Depreciation expense................................................ Office expense .......................................................... Utilities expense ........................................................ Advertising expense .................................................. Insurance expense .................................................... Property tax expense ................................................ Interest expense ........................................................ Income tax expense .................................................. Totals .....................................................................
$
Credit
34,534 12,090 16,250 3,775 6,000 100,000 165,000 $ 143,000 44,520 21,070 52,500 4,200 7,265 1,000 1,000 50 5,000 22,500 53,200 300 146,788 30,000 6,000 640,358
102,386 391,782 16,770 18,000 13,225 9,600 6,000 5,950 5,349 18,000 $1,051,731
000 0000 $1,051,731
(Total debits = Total credits)
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CT4-6 (CONTINUED) (d) Revenues: Sales Rent revenue Expenses Cost of goods sold Salaries expense Depreciation expense Office expense Utilities expense Advertising expense Insurance expense Property tax expense Interest expense Income tax expense Net income
$640,358 6,000 $102,386 391,782 16,770 18,000 13,225 9,600 6,000 5,950 5,349 18,000
Net income Cash Difference
$646,358
587,062 $ 59,296
$59,296 34,534 $24,762
LO 2,3,4 BT: AP Difficulty: M Time: 70 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CHAPTER 5 MERCHANDISING OPERATIONS LEARNING OBJECTIVES 1. 2. 3. 4. 5. 6.
Identify the differences between service and merchandising companies. Prepare entries for purchases under a perpetual inventory system. Prepare entries for sales under a perpetual inventory system. Prepare a single-step and a multiple-step income statement. Calculate the gross profit margin and profit margin. Account and report inventory in a periodic inventory system (Appendix 5A).
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO 1. 2. 3. 4. 5.
1 1 1 1 1
BT
Item LO
BT
Item LO BT Questions
Item LO
BT
Item LO
BT
C C C C C
6. 7. 8. 9. 10.
C AP C C C
11. 12. 13. 14. 15.
16. 17. 18. 19. 20.
4 4 4 4 5
K C C C C
21. 22. 23. 24. 25.
5 5 6 6 6
C C C C C
2 2 2,3 2,3 2,3
2,3 3 3 3 4
C C C C C
Brief Exercises 1. 2.
1 1
C AN
5. 6.
2 3
AP AP
9. 10.
4 4,5
C AN
13. 14.
6 6
AP AP
3. 4.
2 2,3
AP AP
7. 8.
4 4
AP C
11. 12.
5 6
AN AP
15. 16.
6 6
AP AP
1. 2. 3. 4.
1 2,3 2,3 2
C AN AP AP
5. 6. 7. 8.
2 2 2,3,5 4
AP AN AP C
9. 10. 11. 12.
13. 14. 15. 16.
5 6 2,3,6 6
AN AP AP AN
17.
6
AN
1. 2. 3.
1 1,2,3 2,3
AN AN AP
4. 5. 6.
2,3 2,3,4 4
AP AP AN
5 1,6 6
AN AN AP
13. 14. 15.
6 5,6 6
AP AP AP
Exercises 4 4,5 4,5 4,6
AP AN AN AN
Problems: Set A and B 7. 8. 9.
4 5 4,5
AP AN AN
10. 11. 12.
Accounting Cycle Review 1.
2,3,4
AP
1. 2.
1,4,5 5
AN AN
Cases
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3. 4.
4,5 2,3,5
E E
5. 6.
2 4,5
5-1
C AN
Chapter 5
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Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
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ANSWERS TO QUESTIONS 1.
(a)
The operating cycle is the time it takes to go from cash to cash in producing revenues.
(b)
The normal operating cycle for a merchandising company is likely to be longer than that of a service company because, in a merchandising company, inventory must first be purchased and sold, and then the receivables must be collected whereas in a service company the services only need to be provided (not purchased first and then stored until sold) and then the receivables must be collected.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
(a)
The income measurement process of a merchandising company is the same as the service company in that net income is arrived at by deducting expenses from revenues.
(b)
The income measurement process of a merchandising company differs from that of a service company in that its revenue is derived from sales revenue, not service revenue. In addition, cost of goods sold is deducted from sales revenue to determine gross profit, before operating and other expenses similar to both types of companies are deducted (or other revenues are added).
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
The company needs to compare the cost of the detailed record keeping required in a perpetual inventory system to the benefits of having the additional information about the inventory. One of the benefits of a perpetual inventory system is the ability to answer questions from customers about merchandise availability. In a used clothing business, this may not be of much benefit unless each inventory item is unique. Another benefit is the monitoring of inventory quantities in order to avoid running out of stock. Again, this may not be of benefit since the company does not order recurring or similar merchandise, and may not have a supplier to order from. But if the company is selling used clothing on consignment it will need to track each item in order to determine which consignor to pay when an item is sold. The company should carefully determine the cost of the detailed record keeping required, in particular for a new company. A perpetual inventory system requires more record keeping and therefore is more expensive to use. For example, a perpetual inventory system usually requires an investment in a point-of-sale system that is integrated with the inventory system.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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4.
Financial Accounting, Seventh Canadian Edition
A physical count is an important control feature. By using a perpetual inventory system, a company knows what should be on hand. Performing a physical count and checking it to the perpetual records is necessary to detect any errors in record keeping and/or shortages in stock.
LO 1 BT: C Difficulty: M Time: 2 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
The key distinction between a periodic inventory system and a perpetual inventory system is whether or not information on inventory and cost of goods sold (units and dollars) are always (perpetually) available or only known when inventory counts are conducted (periodically). Because information on the cost of goods sold is only known after an inventory count has been carried out, under the periodic system no entry is made for the cost of goods sold at the time of each sale. Instead, cost of goods sold is a residual number, determined by subtracting ending inventory (as determined by the inventory account) from cost of goods available for sale. This means that any goods not included in ending inventory are assumed to have been sold. In order to arrive at the cost of goods available for sale, separate accounts are set up in the general ledger to keep track of the purchases, freight-in, purchase returns and allowances, and purchase discounts. Under the periodic inventory system, management is not able to look up in the general ledger accounts for the balance of inventory at a particular point in time. In order to arrive at the inventory value, a physical count of the inventory must be performed.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
The reason for recording the purchase of merchandise for resale in a separate account is to enable a company to determine its cost of goods sold and gross profit. This information is useful in managing costs and setting prices.
LO 2 BT: C Difficulty: M Time: 2 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
(a)
The value of the purchase discount to Butler’s Roofing is $480 ($48,000 × 1%).
(b)
Failing to take advantage of the discount terms is like paying the supplier an extra $480 in order to settle a $47,520 invoice 20 days later. This works out to 1.01% [$480 ÷ $47,520] every 20 days. On an annual basis this amounts to 18.4% [($480 ÷ $47,520 × (365 ÷ 20)]. Butler’s should take advantage of the cash discount offered.
LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
8.
(a)
Lebel Ltée should record the sale as revenue in June, when it is sold to a customer. When the merchandise was purchased in April, it should be recorded as an asset, inventory. It should be recorded as cost of goods sold (an expense) in June when the inventory is sold and the revenue is recognized. This is necessary in order to match the cost with the related revenue
(b)
Lebel’s customer should recognize the purchase in June, when the inventory is received.
LO 2,3 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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9.
Financial Accounting, Seventh Canadian Edition
(a)
FOB shipping point means that the goods are placed free on board by the seller at the point of shipping. The buyer pays the freight costs from the point of shipping to the buyer’s destination because title passes at shipping point. FOB destination means the goods are delivered by the seller to their destination, where the title passes. The seller pays for shipping to the buyer’s destination.
(b)
FOB shipping point will result in a debit to the Inventory account by the buyer because title has transferred at shipping point and the inventory is now owned by the buyer. FOB destination will result in a debit to Freight Out by the seller because they are paying for the freight.
LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
In a perpetual inventory system, purchase returns are credited to Inventory because the items purchased have been returned to the vendor and are no longer available to be sold to customers. Sales returns are not debited directly to the Sales account because this would not provide information about the goods returned. This information can be useful in making decisions. Debiting returns directly to sales may also cause problems in comparing sales for different periods.
LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
11.
(a)
A quantity discount gives a reduction in the price according to the volume of the purchase. A purchase discount is offered by a seller to a buyer for early payment of an invoice. When the buyer pays the invoice within the discount period, the amount of the discount decreases the Inventory account. A sales discount is the same as a purchase discount but from the seller’s point of view.
(b) Quantity discounts are not recorded or accounted for separately but become part of the recorded sales price. Buyers record purchase discounts taken as a credit to Inventory under the perpetual system or to Purchase Discounts when using the periodic system. The seller records a sales discount as a debit to the Sales Discounts account, which is a contra revenue account to Sales, when the invoice is paid within the discount period. LO 2,3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
Contra accounts are used to reduce the account they are contra to, such as accumulated depreciation reducing equipment. A debit (decrease) recorded directly to Sales would make it more difficult for management to determine the percentage of total sales that ends up being lost through sales returns and allowances, so a contra revenue account (sales returns and allowances) is used. Another example of a contra revenue account is sales discounts. This account keeps track of the costs incurred for discounts taken by customers for paying early, in accordance with the discount terms offered. The contra revenue accounts reduce sales to net sales, reported on the income statement.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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13.
Financial Accounting, Seventh Canadian Edition
If the merchandise is not resaleable, it cannot be included in inventory since it cannot be resold and it has no value. The cost remains in cost of goods sold since it is a cost of doing business. If the merchandise is resaleable, it still has value to the company. In this case, the cost of the merchandise is debited to inventory again and cost of goods sold is credited.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
The sales taxes are collected on behalf of the federal and provincial governments, and must be periodically remitted to these authorities. Sales taxes that are collected from selling a product or service are not recorded as revenue, instead they are recorded as a liability until they are paid to the government.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
In a single-step income statement, all data are classified into two categories: (1) revenues and (2) expenses. It is referred to as a single-step income statement because only a single step—subtracting expenses from revenues—is needed to determine income before income tax. A multiple-step income statement requires several steps to determine income before income tax. First, cost of goods sold is deducted from net sales to determine gross profit. Operating expenses are then deducted to calculate income from operations. Finally, other revenues and expenses are added or deducted to determine income before income tax. The deduction of income tax to calculate net income (loss) is the same under both formats. In addition, both formats produce the same profit amount for the period.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
North West Company uses a multiple-step income statement.
LO 4 BT: K Difficulty: S Time: 2 min. AACSB: None CPA: cpa-t001 CM: Reporting
17.
(a)
When classifying expenses by their nature, they are reported in accordance with their natural classification (for example, salaries, deprecation, and so on). When classifying expenses by their function, they are reported according to the activity (business function) for which they were incurred (for example, cost of goods sold, administrative, selling).
(b)
It does not matter whether a single-step or multiple-step income statement is prepared, expenses must be classified either by nature or by function.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
18.
Because the Overwaitea is a private enterprise, it can follow Accounting Standards for Private Enterprises (ASPE). Companies following ASPE can classify their expenses in whatever manner is useful to them. Loblaws, which follows IFRS, must classify its expenses by their nature or their function.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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19.
Financial Accounting, Seventh Canadian Edition
Interest expense is a non-operating expense because it relates to how a company’s operations are financed, not to the company’s main operations.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
20.
The difference between gross profit margin and profit margin is that the gross profit margin measures the amount by which the selling price exceeds the cost of goods sold while the profit margin measures the extent to which sales cover all expenses (including the cost of goods sold).
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
21.
Factors affecting a company’s gross profit margin include the selling price and the cost of the merchandise. Recall that gross profit = net sales − cost of goods sold. Selling products with a higher price or “mark-up” or selling products with a lower cost would result in an increased gross profit margin. Selling products with a lower price (perhaps due to increased competition that results in lower selling prices) or selling products with a higher cost (perhaps due to price increases from suppliers and shippers) would result in a lower gross profit margin.
LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
22.
High gross profit Computer services and software companies Pharmaceutical manufacturers Luxury goods retailers
Low gross profit Low-price retail companies such as Walmart Grocery stores Forestry and wood products
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
*23. (a) Added/Deducted Deducted Deducted Added
Accounts Purchase Returns and Allowances Purchase Discounts Freight In
(b) Normal Balance Credit Credit Debit
LO 6 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
*24.
Financial Accounting, Seventh Canadian Edition
Periodic System Cost of Goods Sold = Beginning Inventory + Cost of Goods Purchased (Purchases – Purchase Discounts – Purchase Returns and Allowances + Freight In) – Ending Inventory Ending inventory and cost of goods sold for the period are calculated at the end of the period. Perpetual System Cost of Goods Sold = the cost of the item(s) sold Cost of goods sold is calculated at the time of each sale and recorded as an increase (debit) to the Cost of Goods Sold account and a decrease (credit) to the Inventory account.
LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
*25.
The calculation of cost of goods sold is shown in detail in the income statement of a company using the periodic system. In a perpetual system, it is one line and amount only. Periodic System Cost of Goods Sold = 1. Add the cost of goods purchased (where the cost of goods purchased is equal to purchases less purchases discounts, and purchases returns and allowances plus freight in) to the cost of goods on hand at the beginning of the period (beginning inventory). The result is the cost of goods available for sale. 2. Subtract the cost of goods on hand at the end of the period (ending inventory) from the cost of goods available for sale. The result is the cost of goods sold. Perpetual System Cost of Goods Sold = one number, which is the total of cost of goods sold as previously determined and recorded for all sales.
LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
5-8
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 (a)
The company with the most efficient operating cycle is Company A as it uses the fewest number of days in its cycle to obtain cash.
(b)
The company which is most likely a service company is Company A as it does not have to manufacture or deliver inventory and consequently takes the fewest number of days to obtain cash. Company C, with the highest number of days in its operating cycle, is likely the manufacturing company, and the merchandising company would be in the middle (Company B) with neither the highest nor the lowest number of days in its operating cycle.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5-2 (a)
[1] Income before tax = $100 – $65 = $35 [2] Net income = $35 (from [1]) – $9 = $26 [3] Cost of goods sold = $100 – $60 = $40 [4] Operating expenses = $60 – $35 = $25 [5] Income tax expense = $35 – $26 = $9
(b)
Company A is the service company, since it has no cost of goods sold. Company B is the merchandising company, since it has cost of goods sold.
LO 1 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
5-9
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 5-3 Beginning Balance Purchases
Inventory 55,000 220,000 26,000 Purchase returns 9,700 Purchase discounts
Freight in
2,700
Ending Balance
24,000
218,000 Cost of goods sold
Although not required, the following are the journal entries of the transactions.
Purchases
Inventory .................................................................. 220,000 Accounts Payable ...............................................
220,000
Purchase Returns
Accounts Payable .................................................... Inventory .............................................................
26,000
Purchase Discounts
Accounts Payable ($220,000 – $26,000) ................. 194,000 Inventory ($194,000 × 5%) ................................. Cash ...................................................................
Freight In
Inventory .................................................................. Accounts Payable ...............................................
Cost of Sales
26,000
9,700 184,300
2,700 2,700
Cost of Goods Sold .................................................. 218,000 Inventory .............................................................
218,000
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5-4 Pocras Corporation (Buyer): Aug. 24 Inventory ................................................................. Accounts Payable ...............................................
32,000
Wydell Inc. (Seller): Aug. 24 Accounts Receivable................................................ Sales...................................................................
32,000
24
Cost of Goods Sold .................................................. Inventory .............................................................
32,000
32,000 14,400 14,400
LO 2,3 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 5-5 Jan.
2
Inventory ................................................................. Accounts Payable ...............................................
45,000 45,000
5
No entry necessary – Freight costs paid by Fundy Corp.
6
Accounts Payable .................................................... Inventory .............................................................
6,000
Accounts Payable ($45,000 - $6,000) ...................... Inventory ($39,000 × 2%) ................................... Cash ...................................................................
39,000
11
6,000
780 38,220
LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5-6 Jan.
2
2
5
6
6
11
Accounts Receivable................................................ Sales...................................................................
45,000
Cost of Goods Sold .................................................. Inventory .............................................................
25,200
Freight Out ............................................................... Cash ...................................................................
900
Sales Returns and Allowances................................. Accounts Receivable ..........................................
6,000
Inventory .................................................................. Cost of Goods Sold.............................................
3,360
Cash......................................................................... Sales Discounts ($39,000 × 2%) .............................. Accounts Receivable ($45,000 - $6,000) ............
38,220 780
45,000
25,200
900
6,000
3,360
39,000
LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
5-11
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 5-7 (a)
Sales ................................................................................. Less: Sales returns and allowances ................................ Sales discounts ...................................................... Net sales ...........................................................................
$1,110,000 $22,000 18,000
(b)
Net sales ........................................................................... Less: Cost of goods sold ................................................. Gross profit .......................................................................
(c)
Gross profit ....................................................................... Less: Administrative expenses ........................................ $160,000 Selling expenses .................................................... 110,000 Income from operations ....................................................
(d)
(e)
Income from operations .................................................... Add: Other revenues ...................................................... Less: Other expenses ...................................................... Income before income tax.................................................
40,000 $1,070,000 $1,070,000 658,000 $ 412,000 $412,000 270,000 $142,000 $142,000
$26,000 (35,000)
Income before income tax................................................. Less: Income tax expense ............................................... Net income .......................................................................
_ (9,000) $133,000 $133,000 27,000 $106,000
LO 4 BT: AP Difficulty: S Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5-8 As the name suggests, numerous steps are required in determining net income in a multiplestep statement. (a) (b) Item Single-Step Multiple-Step Depreciation expense Cost of goods sold Freight out Income tax expense Interest expense Interest revenue Rent revenue Salaries expense Sales Sales discounts Sales returns and allowances
Expenses Expenses Expenses Income tax expense Expenses Revenues Revenues Expenses Revenues Revenues Revenues
Operating expenses Cost of goods sold Operating expenses Income tax expense Other revenues and expenses Other revenues and expenses Other revenues and expenses Operating expenses Sales revenue Sales revenue Sales revenue
LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
5-12
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 5-9 (a)
The company is using a multiple-step form of income statement.
(b)
The company is classifying its expenses by their function. They are reported according to the activity (business function) for which they were incurred (for example, cost of goods sold, administrative, selling).
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5-10 (a) 2018 $250,000 137,500 112,500 50,000 62,500 ______ 62,500 20,000 $42,500
Sales Cost of goods sold Gross profit Operating expenses Income from operations Other revenues Income before income taxes Income tax expense Net income
2017 $200,000 114,000 86,000 40,000 46,000 10,000 56,000 15,000 $41,000
(b) 2018 Gross profit margin
Profit margin
(c)
2017
$112,500 $250,000
= 45.0%
$86,000 $200,000
=
43.0%
$42,500 $250,000
= 17.0%
$41,000
=
20.5%
$200,000
Modder Corporation’s gross profit margin increased in 2018 indicating an increase in the percentage mark-up, or a reduction in the cost of goods sold, or both. On the other hand, in 2018, the company’s profit margin dropped. The decrease in profit margin is caused by the other revenues in 2017 that were not available in 2018. Operating expenses were 20% of sales in both years.
LO 4,5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 and : cpa-t005CM: Reporting and Finance
Solutions Manual .
5-13
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 5-11 (a) ($ in millions) Gross profit margin
Profit margin
(b)
2015
2014
$12,279.6 – $7,747.1 $12,279.6
=
36.9%
$12,462.9 – $8,033.2 $12,462.9
= 35.5%
$735.9 $12,279.6
=
6.0%
$639.3 $12,462.9
= 5.1%
Canadian Tire Corporation’s gross profit margin increased in 2015. Although sales dropped 1.5%, [($12,279.6 - $12,462.9) ÷ $12,462.9] cost of goods sold dropped 3.6% [($7,747.1 - $8,033.2) ÷ $8,033.2] which lead to the increased gross profit margin. The profit margin also increased in 2015, but not as much. Operating expenses or interest or income tax expense must have increased as a percentage of sales.
LO 5 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
*BRIEF EXERCISE 5-12 Jan.
2
Purchases ................................................................ Accounts Payable ...............................................
45,000 45,000
5
No entry necessary - Freight costs paid by Fundy Corp.
6
Accounts Payable .................................................... Purchase Returns and Allowances .....................
6,000
Accounts Payable ($45,000 - $6,000) ...................... Purchase Discounts ($39,000 × 2%) .................. Cash ...................................................................
39,000
11
6,000
780 38,220
LO 6 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 5
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Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 5-13 Jan.
2
Accounts Receivable................................................ Sales...................................................................
45,000 45,000
2
No cost of goods sold entry at time of sale
5
Freight Out ............................................................... Cash ...................................................................
900
Sales Returns and Allowances................................. Accounts Receivable ..........................................
6,000
6
6
No cost of goods sold entry at the time of sale
11
Cash......................................................................... Sales Discounts ($39,000 × 2%) .............................. Accounts Receivable ($45,000 - $6,000) ............
900
6,000
38,220 780 39,000
LO 6 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*BRIEF EXERCISE 5-14 (a)
Sales ................................................................................. $1,860,000 Less: Sales returns and allowances ................................ $124,000 Sales discounts ...................................................... 28,000 152,000 Net Sales .......................................................................... $1,708,000
(b)
Purchases ......................................................................... Less: Purchase returns and allowances .......................... Purchase discounts ................................................ Net purchases...................................................................
$880,000 $13,000 14,000
27,000 $853,000
(c)
Net purchases................................................................... Add: Freight in ................................................................ Cost of goods purchased ..................................................
$853,000 16,000 $869,000
(d)
Beginning inventory .......................................................... Add: Cost of goods purchased ....................................... Cost of goods available for sale ........................................ Less: Ending inventory .................................................... Cost of goods sold ............................................................
$ 96,000 869,000 965,000 82,000 $883,000
(e)
Net sales ........................................................................... Less: Cost of goods sold................................................... Gross profit .......................................................................
$1,708,000 883,000 $825,000
LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 5-15 (a)
(b)
Cost of goods sold Beginning inventory .................................................. Purchases ................................................................. Less: Purchase returns and allowances ................... Purchase discounts ......................................... Net purchases........................................................... Add: Freight In .......................................................... Cost of goods purchased .......................................... Cost of goods available for sale ................................ Ending inventory ....................................................... Cost of goods sold ....................................................
$105,000 $195,000 $ 6,600 20,400
27,000 168,000 5,250 173,250 278,250 120,000 $158,250
There would be no difference in the remainder of the income statement for Halifax Limited whether the periodic or perpetual inventory systems were used. Purchases – Purchase returns and allowances – Purchase discounts + Freight-in = Cost of goods purchased (Beginning inventory+ Cost of goods purchased – Ending inventory = Cost of goods sold)
LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*BRIEF EXERCISE 5-16 Dec. 31
Inventory (ending) .................................................... 68,000 Cost of Goods Sold .................................................. 401,000* Purchase Discounts ................................................. 6,000 Inventory (beginning) .......................................... Purchases ........................................................... Freight In.............................................................
75,000 388,000 12,000
* Cost of goods sold = Beginning inventory + Purchases − Purchase discounts − Purchase returns and allowances + Freight in – Ending inventory Cost of goods sold = $75,000 + $388,000 − $6,000 + $12,000 – $68,000 = $401,000 LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 5
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 5-1 (a)
Toys “R” Us, Inc. is a merchandiser (retailer), Fasken Martineau LLP is a service company, and Atlantic Grocery Distributors Ltd. is a merchandiser (wholesaler).
(b)
The operating cycle of these three businesses will be different. The longest operating cycle will be experienced by the retailer, as the sales of merchandise will be the slowest. The organization with the shortest operating cycle will be the service firm that does not sell inventory. The third company, the distributing wholesaler, will have an operating cycle between that of the retailer and the law firm because its inventory is more likely to sell faster and the law firm has no inventory to sell.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5-2 Item (a) 1. Asset 2. Liability
Account Debited (b) Inventory
(c) (a) +$3,500 Asset
Account Credited (b) (c) Cash –$3,500
–$750 Asset
Inventory
–$750
3. Asset
Accounts Payable Inventory
+$4,000 Liability
+$4,000
4. Asset
Inventory
+$400 Asset
Accounts Payable Cash
5. Liability
Accounts Payable Accounts Receivable
–$3,500 Asset Asset +$10,000 Revenue
Cash Inventory Sales
–$3,430 –$70 +$10,000
+$4,000 Asset
Inventory
–$4,000
6. Asset
Expense Cost of Goods Sold 7. Contra Sales Returns Sales and Allowances 8. Expense Freight Out 9. Contra Sales Asset 10. Asset
Sales Returns and Allowances
Cash
+$750 Asset
Cash
–$750
+$600 Asset
Cash
–$600
+$1,000 Asset
Inventory
–$400
+$400 Expense +$6,000 Asset
Accounts Receivable
–$1,000
Cost of Goods Sold Accounts Receivable
–$400 –$6,000
LO 2,3 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-3 (a) Sept.
2 Inventory (750 × $20).................................................. Accounts Payable ..................................................
15,000
10 Accounts Payable (10 × $20)...................................... Inventory................................................................
200
11 Accounts Receivable (260 × $30) ............................... Sales .....................................................................
7,800
Cost of Goods Sold (260 × $20) ................................. Inventory................................................................
5,200
14 Sales Returns and Allowances (10 × $30) .................. Accounts Receivable .............................................
300
Inventory (10 × $20).................................................... Cost of Goods Sold ...............................................
200
21 Accounts Receivable (300 × $30) ............................... Sales .....................................................................
9,000
Cost of Goods Sold (300 × $20) ................................. Inventory................................................................
6,000
29 Accounts Payable ($15,000 – $200) ........................... Cash ......................................................................
14,800
30 Cash ($9,000 – $90) ................................................... Sales Discounts ($9,000 × 1%) .................................. Accounts Receivable .............................................
8,910 90
15,000
200
7,800
5,200
300
200
9,000
6,000
14,800
9,000
(b) Sept. 1 Bal. 2 14 Sept. 30 Bal.
Inventory 2,000 Sept.10 15,000 11 200 21 5,800
Cost of Goods Sold Sept. 11 5,200 Sept. 14 21 6,000 Sept. 30 Bal. 11,000
Solutions Manual .
5-18
200 5,200 6,000
200
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-3 (CONTINUED) (c) Ending Inventory: Number of calculators at September 30: 100 + 750 – 10 – 260 + 10 – 300 = 290 Cost of calculators at September 30: 290 × $20 = $5,800 Cost of Goods Sold: Number of calculators sold in September: 260 – 10 + 300 = 550 Cost of calculators sold in September: 550 x $20 = $11,000 LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 5-4 (a)
April
3
6
7
8
30
(b)
April
12
Inventory........................................................ Accounts Payable ....................................
28,000
Inventory........................................................ Cash.........................................................
700
Supplies......................................................... Accounts Payable ....................................
5,000
Accounts Payable .......................................... Inventory ..................................................
3,500
Accounts Payable ($28,000 – $3,500) .......... Cash ........................................................
24,500
Accounts Payable ($28,000 – $3,500) .......... Cash ($24,500 – $245) ............................ Inventory ($24,500 × 1%) .........................
24,500
28,000
700
5,000
3,500
24,500
24,255 245
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
5-19
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-5 (a)
April
3
April
28,000
Cost of Goods Sold ....................................... Inventory ..................................................
19,000
28,000
19,000
6
No entry necessary - Freight costs paid by Olaf.
7
No entry necessary.
8
Sales Returns and Allowances ...................... Accounts Receivable................................
3,500
Inventory........................................................ Cost of Goods Sold ..................................
2,300
Cash .............................................................. Accounts Receivable ($28,000 – $3,500)
24,500
Cash ($28,000 − $3,500 – $245) ................... Sales Discounts [($28,000 – $3,500) × 1%] .. Accounts Receivable ($28,000 – $3,500)
24,255 245
30
(b)
Accounts Receivable ..................................... Sales ........................................................
12
3,500
2,300
24,500
24,500
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 5-6 Boyle should choose to borrow cash at 8% after 10 days from the date of the invoice. The amount borrowed could be as little as the amount of the invoice less the purchase discount. This is the amount needed to settle the payment after 10 days from the date of the invoice and earn the purchase discount of 1%. The loan can then be repaid after 20 days, which would be the date the invoice would have been paid if the loan had not been obtained. The relevant period is 20 days because this is the amount of time a loan would be outstanding in order to make the choice to pay within the discount period. Converting a 1% discount for 20 days equals an annualized interest rate of 18.25% calculated as follows (1% × 365 ÷ 20) = 18.25%. Paying 8% to the bank to receive 18.25% from the supplier is the most favourable procedure to follow. LO 2 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
5-20
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-7 (a)
Dec.
3 Accounts Receivable .......................................... Sales .............................................................
68,000
3 Cost of Goods Sold............................................. Inventory........................................................
36,000
68,000
36,000
7 No entry necessary.
(b)
(c)
Dec.
8 Sales Returns and Allowances ........................... Accounts Receivable .....................................
2,100
Inventory ............................................................. Cost of Goods Sold .......................................
1,150
11 Cash ($65,900 – $1,318) .................................... Sales Discounts [($68,000 – $2,100) × 2%]........ Accounts Receivable ($68,000 – $2,100) ......
64,582 1,318
3 Inventory ............................................................. Accounts Payable ..........................................
68,000
7 Inventory ............................................................. Cash ..............................................................
900
8 Accounts Payable ............................................... Inventory........................................................
2,100
11 Accounts Payable ($68,000 – $2,100) ................ Inventory [($68,000 - $2,100) × 2%] .............. Cash ($65,900 – $1,318) ...............................
65,900
Sales ................................................................................... Less: Sales returns and allowances................................... Sales discounts ........................................................ Net sales ............................................................................. Cost of goods sold ($36,000 – $1,150) ............................... Gross profit .........................................................................
2,100
1,150
65,900
68,000
900
2,100
1,318 64,582
$68,000 $2,100 1,318
3,418 64,582 34,850 $29,732
LO 2,3,5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 5
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Financial Accounting, Seventh Canadian Edition
EXERCISE 5-8 Account
Statement
Classification
Accounts payable Accounts receivable Accumulated depreciation
Statement of financial position Current liabilities Statement of financial position Current assets Statement of financial position Property, plant, and equipment (contra account) Administrative expenses Income statement Operating expenses Buildings Statement of financial position Property, plant, and equipment Cash Statement of financial position Current assets Common shares Statement of financial position Shareholders’ equity Equipment Statement of financial position Property, plant, and equipment Income tax expense Income statement Income tax expenses Interest expense Income statement Other revenues and expenses Interest payable Statement of financial position Current liabilities Inventory Statement of financial position Current assets Land Statement of financial position Property, plant, and equipment Mortgage payable Statement of financial position Non-current liabilities Prepaid insurance Statement of financial position Current assets Property tax payable Statement of financial position Current liabilities Salaries payable Statement of financial position Current liabilities Sales Income statement Revenue Sales discounts Income statement Revenue (contra account) Sales returns and allowances Income statement Revenue (contra account) Unearned revenue Statement of financial position Current liabilities LO 4 BT: C Difficulty: S Time: 20 min. AACSB: Analytic CPA:cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
EXERCISE 5-9 (a) BLUE DOOR CORPORATION Income Statement (Single-Step) Year Ended December 31, 2018 Revenues Sales ................................................................................ $2,650,000 Less: Sales returns and allowances ................... $41,000 Sales discounts ........................................ 19,500 60,500 Net sales .......................................................................... 2,589,500 Interest revenue .............................................................. 30,000 Rent revenue ................................................................... 24,000 Expenses Cost of goods sold ........................................................... $1,172,000 Salaries expense.............................................................. 705,000 Depreciation expense ...................................................... 125,000 Interest expense............................................................... 62,000 Advertising expense ......................................................... 55,000 Freight out ........................................................................ 25,000 Insurance expense ........................................................... 23,000 Income before income tax ............................................................................ Income tax expense ..................................................................................... Net income ...................................................................................................
Solutions Manual .
5-23
$2,643,500
2,167,000 476,500 70,000 $ 406,500
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-9 (CONTINUED) (b) BLUE DOOR CORPORATION Income Statement (Multiple-Step) Year Ended December 31, 2018 Sales ........................................................................................................ $2,650,000 Less: Sales returns and allowances ................................. $41,000 Sales discounts....................................................... 19,500 60,500 Net sales .................................................................................................. 2,589,500 Cost of goods sold .................................................................................... 1,172,000 Gross profit ............................................................................................... 1,417,500 Operating expenses Salaries expense.......................................................... $705,000 Depreciation expense .................................................. 125,000 Advertising expense ..................................................... 55,000 Freight out .................................................................... 25,000 Insurance expense ....................................................... 23,000 Total operating expenses............................................................... 933,000 Income from operations ............................................................................ 484,500 Other revenues and expenses Interest revenue .......................................................... $30,000 Rent revenue................................................................ 24,000 Interest expense........................................................... (62,000) (8,000) Income before income tax ........................................................................ 476,500 Income tax expense ................................................................................. 70,000 Net income ............................................................................................... $ 406,500 (Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations)
(c)
Blue Door Corporation is classifying its expenses by nature, such as salaries, depreciation, and advertising. There is no classification of expenses into administrative or selling as would be the case if classifying expenses by functional areas. For smaller companies such as this one, the difference between classification of items on the income statement by function or nature is not significant.
LO 4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-10 (a)
Young Ltd. Sales ............................................................................................ $99,000 *Less: Sales returns and allowances [1] ...................................... 10,000 Net sales ...................................................................................... $89,000 Net sales ...................................................................................... $89,000 Less: Cost of goods sold .............................................................. 58,750 *Gross profit [2] ............................................................................ $30,250 Gross profit .................................................................................. $30,250 Less: Operating expenses ........................................................... 19,500 *Income from operations [3] ......................................................... $10,750 Income from operations ............................................................... $10,750 Add: Other revenues .................................................................... 750 *Income before income tax [4] ..................................................... $11,500 Income before income tax ............................................................ $11,500 Less: Income tax expense ........................................................... 2,300 *Net income [5]............................................................................. $ 9,200 Rioux Ltée *Sales [6] ...................................................................................... $105,000 Less: Sales returns and allowances ............................................. 5,000 Net sales ...................................................................................... $100,000 Net sales ...................................................................................... $100,000 *Less: Cost of goods sold [7] ....................................................... 60,000 Gross profit .................................................................................. $ 40,000 Gross profit .................................................................................. $40,000 *Less: Operating expenses [8] ..................................................... 22,000 Income from operations ............................................................... $18,000 Income from operations ............................................................... $18,000 Less: Other expenses .................................................................. 2,000 *Income before income tax [9] ..................................................... $16,000 Income before income tax ............................................................ $16,000 *Less: Income tax expense [10] ................................................... 3,200 Net income ................................................................................... $12,800 * Indicates missing amount
Solutions Manual .
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Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-10 (CONTINUED) (b)
Young
Rioux
Gross profit margin $30,250 ÷ $89,000 = 34.0%
$40,000 ÷ $100,000 = 40.0%
Profit margin
$12,800 ÷ $100,000 = 12.8%
$9,200 ÷ $89,000 = 10.3%
LO 4,5 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-11 (a)
Marchant Ltd. Sales ..................................................................................... Less: Sales returns and allowances ..................................... *Net sales [1] .........................................................................
$1,460,000 28,000 $1,432,000
Net sales ............................................................................... Less: Cost of goods sold ....................................................... *Gross profit [2] .....................................................................
$1,432,000 657,000 $ 775,000
Gross profit ........................................................................... Less: Operating expenses .................................................... *Income from operations [3] ..................................................
$775,000 580,000 $195,000
Income from operations ........................................................ Add: Other revenues ............................................................. *Income before income tax [4] ..............................................
$195,000 3,600 $198,600
Income before income tax ..................................................... Less: Income tax expense .................................................... *Net income [5]......................................................................
$198,600 38 600 $160,000
Dueck Ltd. *Sales [6] ............................................................................... Less: Sales returns and allowances ...................................... Net sales ...............................................................................
$2,178,000 48,000 $2,130,000
Net sales ............................................................................... *Less: Cost of goods sold [7] ................................................ Gross profit ...........................................................................
$2,130,000 1,172,000 $ 958,000
Gross profit ........................................................................... *Less: Operating expenses [8] .............................................. Income from operations ........................................................
$958,000 648,000 $310,000
Income from operations ........................................................ Less: Other expenses ........................................................... *Income before income tax [9] ..............................................
$310,000 _ 4,100 $305,900
Income before income tax ..................................................... *Less: Income tax expense [10] ............................................ Net income ............................................................................
$305,900 55,000 $250,900
* Indicates missing amount
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Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 5-11 (CONTINUED) (b)
Marchant Gross profit margin Profit margin
Dueck
$775,000 ÷ $1,432,000 = 54.1% $958,000 ÷ $2,130,000 = 45.0% $160,000 ÷ $1,432,000 = 1.2%
$250,900 ÷ $2,130,000 = 11.8%
LO 4,5 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 5-12 (a) MONTMORENCY LTÉE Income Statement (Multiple-step) Year Ended August 31, 2018 Sales ............................................................................... $7,200,000 Less: Sales discounts ....................................................... 110,000 Net sales .................................................................................................. Cost of goods sold .................................................................................... Gross profit ............................................................................................... Operating expenses Administrative expenses .............................................. $670,000 Selling expenses .......................................................... 260,000 Total operating expenses............................................................... Income from operations ............................................................................ Other revenues and expenses Interest expense.................................................................................. Income before income tax ........................................................................ Income tax expense ................................................................................. Net income ...............................................................................................
$7,090,000 4,030,000 3,060,000
930,000 2,130,000 270,000 1,860,000 560,000 $1,300,000
(Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations)
(b)
Expenses are classified by function (cost of goods sold, administrative, selling).
(c)
Gross profit margin
$3,060,000 ÷ $7,090,000 = 43.2%
Profit margin
$1,300,000 ÷ $7,090,000 = 18.3%
LO 4,6 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 5
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Financial Accounting, Seventh Canadian Edition
EXERCISE 5-13 (in USD millions) (a)
Gross profit margin 2016: ($39,528 – $30,334) ÷ $39,528 = 23.3% 2015: ($40,339 – $31,292) ÷ $40,339 = 22.4% 2014: ($40,611 – $31,212) ÷ $40,611 = 23.1% Profit margin (using net income) 2016: $807 ÷ $39,528 = 2.0% 2015: $1,246 ÷ $40,339 = 3.1% 2014: $695 ÷ $40,611 = 1.7%
(b)
The gross profit margin has been holding steady, with a slight deterioration in 2015. The trend is the opposite for the profit margin, where the results of 2015 exceeded those of 2014 and 2016.
(c)
Profit margin (using income from operations) 2016: $1,375 ÷ $39,528 = 3.5% 2015: $1,450 ÷ $40,339 = 3.6% 2014: $1,144 ÷ $40,611 = 2.8% The profit margin using income from operations has followed the same trend in 2014 and 2016 when compared to profit margin. On the other hand, profit margin using net income increased dramatically in 2015 while profit margin using income from operations increased only slightly for the same year. The major elements that are in the calculation of the profit margin ratio but are not in the profit margin using income from operations are other revenues and expenses, and income tax expense. In 2015, there must have been a significant other revenue, or possibly a gain that caused a substantial increase in profit margin compared to the year before and after 2015.
LO 5 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 5-14 Olaf Corp. (Buyer) (a) Apr. 3 Purchases ................................................................... Accounts Payable ..................................................
28,000
6 Freight In..................................................................... Cash ......................................................................
700
7 Supplies ...................................................................... Accounts Payable ..................................................
5,000
8 Accounts Payable ....................................................... Purchase Returns and Allowances ........................
3,500
30 Accounts Payable ($28,000 – $3,500) ........................ Cash .....................................................................
24,500
(b) Apr. 12 Accounts Payable ($28,000 – $3,500) ........................ Cash ($24,500 – $245) .......................................... Purchase Discounts ($24,500 × 1%) .....................
24,500
28,000
700
5,000
3,500
24,500
24,255 245
DeVito Ltd. (Seller) (a) Apr. 3 Accounts Receivable .................................................. Sales .....................................................................
28,000
8 Sales Returns and Allowances ................................... Accounts Receivable .............................................
3,500
30 Cash .......................................................................... Accounts Receivable ($28,000 – $3,500) ..............
24,500
(b) Apr. 12 Cash ($24,500 – $245) ............................................... Sales Discounts [($28,000 – $3,500) × 1%]................ Accounts Receivable ($28,000 – $3,500) ..............
24,255 245
28,000
3,500
24,500
24,500
LO 6 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 5
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 5-15 (a)
Duvall Ltd. (Seller) (1) Perpetual Inventory System June 10 Accounts Receivable ........................................ Sales ........................................................... Cost of Goods Sold........................................... Inventory......................................................
5,000 5,000 3,000 3,000
11 No entry 12 Sales Returns and Allowances ......................... Accounts Receivable ...................................
500
19 Cash ($4,500 – $45) ......................................... Sales Discounts ($4,500 × 1%) ........................ Accounts Receivable ($5,000 – $500).........
4,455 45
(2) Periodic Inventory System June 10 Accounts Receivable ........................................ Sales ...........................................................
500
4,500 5,000 5,000
11 No entry
Solutions Manual .
12 Sales Returns and Allowances ......................... Accounts Receivable ...................................
500
19 Cash ($4,500 – $45) ......................................... Sales Discounts ($4,500 × 1%) ........................ Accounts Receivable ($5,000 – $500).........
4,455 45
5-31
500
4,500
Chapter 5
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 5-15 (CONTINUED) (b)
Pele Ltd. (Buyer) (1) Perpetual Inventory System June 10 Inventory ............................................................. Accounts Payable ..........................................
5,000 5,000
11 Inventory (freight)................................................ Cash ..............................................................
250
12 Accounts Payable ............................................... Inventory (returns) .........................................
500
19 Accounts Payable ($5,000 – $500) ..................... Inventory ($4,500 × 1%) ................................ Cash ($4,500 – $45) ......................................
4,500
(2) Periodic Inventory System June 10 Purchases ......................................................... Accounts Payable ........................................
250
500
45 4,455 5,000 5,000
11 Freight In........................................................... Cash ............................................................
250
12 Accounts Payable ............................................. Purchase Returns and Allowances ..............
500
19 Accounts Payable ($5,000 – $500) ................... Purchase Discounts ($4,500 × 1%) ............. Cash ($4,500 – $45) ....................................
4,500
250
500 45 4,455
LO 2,3,6 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*EXERCISE 5-16 [1] [2] [3] [4] [5] [6] [7] [8] [9]
$1,420 = $1,550 = $1,750 = $270 = $270 = $1,950 = $230 = $2,030 = $1,950 =
($1,500 – $50 – $30) ($1,420 + $130) ($1,550 + $200) ($1,750 – $1,480) [4] (same as ending, Yr 1) ($100 + $50 + $1,800) ($2,030 [8] – $1,800) ($2,300 – $270 [5]) ($2,300 – $350)
[10] $7,560 = [11] $590 = [12] $8,800 = [13] $7,550 = [14] $1,250 = [15] $8,050 = [16] $8,600 = [17] $9,850 = [18] $8,350 =
($7,210 + $150 + $200) ($7,800 – $7,210) ($1,000 + $7,800) ($8,800 [12]) – $1,250) given (same as ending, Yr 1) ($8,550 – $400 – $100) ($8,050 [15] + $550) ($1,250 [14] + $8,600 [16]) ($9,850 [17] – $1,500)
LO 6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 5-17 (a)
LIVELY LIMITED Income Statement Year Ended February 28, 2018 Sales revenue Sales Less: Sales discounts Sales returns and allowances Net sales Cost of goods sold Inventory, beginning Purchases $273,000 Less: Purchase discounts 39,000 Purchase returns and allowances 20,800 Net purchases 213,200 Add: Freight in 8,450 Cost of goods purchased Cost of goods available for sale Less: Inventory, ending Cost of goods sold Gross profit Operating expenses Administrative expenses Selling expenses Total operating expenses Income from operations Other revenues and expenses Interest expense Income before income tax Income tax expense Net income
$435,500 $27,300 15,600
42,900 392,600
$ 54,600
221,650 276,250 79,300 196,950 195,650 $120,900 9,100 130,000 65,650 7,800 57,850 9,300 $ 48,550
(Beginning inventory + Net purchases + Freight-in = Cost of goods purchased)
(b) Feb. 28
Inventory (ending) .................................................... 79,300 Cost of Goods Sold .................................................. 196,950 Purchase Returns and Allowances .......................... 20,800 Purchase Discounts ................................................. 39,000 Inventory (beginning) .......................................... Purchases ........................................................... Freight In.............................................................
54,600 273,000 8,450
LO 6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 5-1A (a)
A company’s operating cycle is the average time it takes to go from cash to cash in producing revenues. The operating cycle for a merchandising company covers the period of time between when you purchase your inventory, to when you sell it, and to when you eventually collect the accounts receivable from a sale. The hair salon is having problems paying for its products because it purchases a twomonth supply, paying for it immediately, with cash flow from the current month’s operations. There is an insufficient cash float available to purchase two months of supply at one time, and to pay immediately rather than taking advantage of the 30-day payment period. The hair salon’s inventory is contributing to the problem of reduced cash flow and gross profit because some items have been in stock for a long period of time. This further extends the operating cycle for those items.
(b)
The physical inventory count comparison with the perpetual inventory record has flagged discrepancies. There is an issue concerning the way in which the perpetual record is being maintained and updated because staff members sometimes forget to scan the products that they use on customers. There may also be a possibility that goods are being stolen by customers or employees. Accounting errors could also be the source of the discrepancy, in which case the company’s procedures should be reviewed, and if necessary, internal controls should be strengthened. Possible solutions could be having the system require that items be scanned before a product sale can be rung in. In addition, the procedures taken to perform the physical inventory count should be reviewed to determine if the count is the source of the discrepancies. The count should be performed more frequently, not necessarily for all inventory items but particularly for those items that had discrepancies from the count performed at the end of six months. The results of the more frequent counts should be monitored to see if the discrepancies with the perpetual inventory records are diminishing. The hair salon should use the perpetual inventory system to help determine which inventory items are out-of-stock and which items are taking a long time to sell. By managing what inventory is purchased, fewer markdowns of the selling price will be required, and sales should increase as there will be less chance for a stock-out. Finally, the full 30 days should be taken on the terms with your supplier, in order to have more cash on hand when needed.
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Chapter 5
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-1A (CONTINUED) (c)
For control reasons, a physical inventory count must always be taken at least once a year, and ideally more often under the perpetual inventory system. By using a perpetual inventory system, a company knows what inventory should be on hand. Performing a physical count and checking it to the perpetual records is necessary to detect any errors in record keeping and/or shortages in stock. The staff may be forgetting to scan intentionally. Enforcing the scanning procedure will strengthen internal control over cash receipts. If staff can avoid scanning product, they may also attempt to avoid recording a cash sale altogether, pocketing the extra cash. This theft would lead to unrecorded revenues and would reduce the gross profit performance of the salon.
LO 1 BT: AN Difficulty: C Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 5
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-2A (a)
(b) June
Phantom Book Warehouse Ltd. is a wholesaler. Its suppliers are publishers and its customers are book stores.
1
3
5
8
9
11
12
17
22
Solutions Manual .
Inventory (180 × $16) ................................................... Accounts Payable ..............................................
2,880
Accounts Receivable (220 × $25) ................................ Sales .................................................................
5,500
Cost of Goods Sold (220 × $17)................................... Inventory............................................................
3,740
Accounts Payable ........................................................ Inventory (10 × $16) ..........................................
160
Accounts Receivable (80 × $22) .................................. Sales .................................................................
1,760
Cost of Goods Sold (80 × $17)..................................... Inventory............................................................
1,360
Sales Returns and Allowances..................................... Accounts Receivable (12 × $22)........................
264
Inventory (130 × $15) ................................................... Accounts Payable ..............................................
1,950
Cash ($5,500 – $110) .................................................. Sales Discounts ($5,500 × 2%) .................................... Accounts Receivable ........................................
5,390 110
Cash ($1,496 – $30) .................................................... Sales Discounts ($1,496 × 2%) .................................... Accounts Receivable ($1,760 – $264) ..............
1,466 30
Accounts Receivable (125 × $25) ................................ Sales .................................................................
3,125
Cost of Goods Sold (125 × $17)................................... Inventory............................................................
2,125
5-36
2,880
5,500
3,740
160
1,760
1,360
264
1,950
5,500
1,496
3,125
2,125
Chapter 5
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-2A (CONTINUED) (b) (continued) June
25
29
Sales Returns and Allowances..................................... Accounts Receivable (15 × $25)........................
375
Inventory (15 × $17) ..................................................... Cost of Goods Sold ...........................................
255
Accounts Payable ($2,880 – $160) .............................. Cash ..................................................................
2,720
375
255
2,720
(c) May 31* June 1 11 25 June 30 Bal.
Inventory 4,500 June 2,880 1,950 255 2,200
3 5 8 22
3,740 160 1,360 2,125
* (250 × $18)
(d)
Books on hand at June 30 = 250 + 180 – 220 – 10 – 80 + 130 – 125 + 15 = 140 Average cost per book = $2,200 ÷ 140 = $16
LO 1,2,3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-3A (a) Sept.
2
Equipment ...................................................................... Accounts Payable ................................................
65,000 65,000
3
No entry necessary.
4
Supplies ......................................................................... Cash ....................................................................
4,000
Inventory ........................................................................ Accounts Payable ................................................
65,000
Inventory ........................................................................ Cash ....................................................................
1,600
Accounts Payable .......................................................... Inventory..............................................................
5,000
Accounts Receivable...................................................... Sales ...................................................................
20,000
Cost of Goods Sold ........................................................ Inventory..............................................................
15,000
Freight Out ..................................................................... Cash ....................................................................
375
Cash ($20,000 – $400) .................................................. Sales Discounts ($20,000 × 2%) .................................... Accounts Receivable ...........................................
19,600 400
Accounts Payable ($65,000 – $5,000) ........................... Cash ($60,000 – $600) ........................................ Inventory ($60,000 × 1%) ....................................
60,000
Inventory ........................................................................ Cash ....................................................................
6,000
Accounts Receivable...................................................... Sales ...................................................................
27,000
Cost of Goods Sold ........................................................ Inventory..............................................................
20,000
6
7
8
9
10
17
20
21
22
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5-38
4,000
65,000
1,600
5,000
20,000
15,000
375
20,000
59,400 600
6,000
27,000 20,000
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 5-3A (CONTINUED) (a) (continued) Sept.
23
No entry necessary.
28
Sales Returns and Allowances....................................... Accounts Receivable ...........................................
10,000
Inventory ........................................................................ Cost of Goods Sold .............................................
7,500
Accounts Payable ($65,000 – $5,000) ........................... Cash ...................................................................
60,000
10,000
7,500
(b) Oct.
3
60,000
The cost of missing this purchase discount is the amount recorded as a reduction to the Inventory account when the payment was made within the discount period to September 21 ($60,000 × 1%) = $600. Expressing this in terms of an annual interest rate, it would be the equivalent of paying 24.6% ($600 ÷ $59,400 × 365/15) for the use of the money for 15 days. LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-4A (a) April
3
5
7
9
11
14
16
17
20
24
25
27
Solutions Manual .
Inventory .................................................................. Accounts Payable ...........................................
3,200
Inventory .................................................................. Cash ...............................................................
286
Accounts Receivable ............................................... Sales ...............................................................
9,750
Cost of Goods Sold.................................................. Inventory .........................................................
5,850
Accounts Payable .................................................... Inventory .........................................................
320
Accounts Payable ($3,200 – $320) .......................... Inventory ($2,880 × 1%) ................................. Cash ($2,880 – $29) .......................................
2,880
Cash ........................................................................ Accounts Receivable ......................................
4,150
Inventory .................................................................. Accounts Payable ...........................................
1,300
Accounts Payable .................................................... Inventory .........................................................
100
3,200
286
9,750
5,850
320
29 2,851
4,150
1,300
100
Accounts Receivable ............................................... 11,100 Sales ...............................................................
11,100
Cost of Goods Sold.................................................. Inventory .........................................................
6,200 6,200
Accounts Payable ($1,300 – $100).......................... Inventory ($1,200 × 2%) ................................. Cash ($1,200 – $24) .......................................
1,200
Cash ........................................................................ Accounts Receivable ......................................
4,375
Sales Returns and Allowances ................................ Accounts Receivable ......................................
85
5-40
24 1,176
4,375
85 Chapter 5
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-4A (CONTINUED) (b) Apr. 1 Bal. Apr. 14 Apr. 25 Apr. 30 Bal.
Cash 4,200 Apr. 5 4,150 Apr. 11 4,375 Apr. 24 8,412
Accounts Receivable Apr. 7 9,750 Apr. 14 Apr. 20 11,100 Apr. 25 Apr. 27 Apr. 30 Bal. 12,240
Apr. 1 Bal. Apr. 3 Apr. 5 Apr. 16
Apr. 30 Bal.
Inventory 19,500 Apr. 7 3,200 Apr. 9 286 Apr. 11 1,300 Apr. 17 Apr. 20 Apr. 24 11,763 Common Shares Apr. 1 Bal. Apr. 30 Bal.
(c)
286 2,851 1,176
Apr. 9 Apr. 11 Apr. 17 Apr. 24
Accounts Payable 320 Apr. 3 2,880 Apr. 16 100 1,200 Apr. 30 Bal.
0
Sales Apr. 7 9,750 Apr. 20 11,100 Apr. 30 Bal. 20,850
4,150 4,375 85
5,850 320 29 100 6,200 24
3,200 1,300
Sales Returns and Allowances Apr. 27 85 Apr. 30 Bal. 85 Cost of Goods Sold Apr. 7 5,850 Apr. 20 6,200 Apr. 30 Bal. 12,050 Retained Earnings Apr. 1 Bal. Apr. 30 Bal.
12,000 12,000
11,700 11,700
IN THE PINES GOLF SHOP Trial Balance April 30, 2018 Debit Cash .................................................................................. $ 8,412 Accounts receivable .......................................................... 12,240 Inventory ........................................................................... 11,763 Accounts payable .............................................................. Common shares ................................................................ Retained earnings ............................................................. Sales ................................................................................. Sales returns and allowances ........................................... 85 Cost of goods sold ............................................................ 12,050 $44,550
Credit
$12,000 11,700 20,850 00 0 00 $44,550
(Total debit account balances = Total credit account balances) LO 2,3 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 5-5A (a) May
1
3
4
7
8
9
11
14
15 18
Solutions Manual .
Inventory .................................................................. Accounts Payable ...........................................
5,800
Inventory .................................................................. Cash................................................................
145
Accounts Receivable................................................ Sales ...............................................................
3,500
Cost of Goods Sold .................................................. Inventory .........................................................
2,100
Freight Out ............................................................... Cash................................................................
90
Accounts Payable .................................................... Inventory .........................................................
200
Accounts Payable ($5,800 – $200) .......................... Inventory ($5,600 × 1%) .................................. Cash................................................................
5,600
Supplies ................................................................... Cash................................................................
400
Cash ($3,500 – $70) ................................................ Sales Discounts ($3,500 × 2%) ................................ Accounts Receivable.......................................
3,430 70
Cash ........................................................................ Accounts Receivable.......................................
1,000
Inventory .................................................................. Accounts Payable ...........................................
2,000
5-42
5,800
145
3,500
2,100
90
200
56 5,544
400
3,500
1,000 2,000
Chapter 5
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-5A (CONTINUED) (a) (continued) May
21
No entry required (freight paid by Harlow)
22
Cash ........................................................................ Sales ...............................................................
6,500
Cost of Goods Sold .................................................. Inventory .........................................................
3,900
Sales Returns and Allowances ................................ Cash................................................................
100
Inventory .................................................................. Cost of Goods Sold .........................................
60
Cost of Goods Sold .................................................. Inventory ......................................................... ($5,249* – $5,100 = $149 shortage)
149
29
31
6,500
3,900
100
60
149
* Unadjusted balance in Inventory account: $3,500 + $5,800 + $145 – $2,100 – $200 – $56 + $2,000 – $3,900 + $60 = $5,249 (b) May 1 Bal. May 14 May 15 May 22 May31 Bal.
Cash 7,000 May 3 3,430 May 7 1,000 May 9 6,500 May 11 May 29 11,651
145 90 5,544 400 100
Accounts Receivable May 1 Bal. 1,500 May 14 May 4 3,500 May 15 May 31 Bal. 500
3,500 1,000
Inventory 3,500 May 4 5,800 May 8 145 May 9 2,000 May 22 60 May 31 5,100
2,100 200 56 3,900 149
May 1 Bal. May 1 May 3 May 18 May 29 May 31 Bal. Solutions Manual .
May 11 May 31 Bal.
May 8 May 9
5-43
Supplies 400 400 Common Shares May 1 Bal. May 31 Bal.
8,000 8,000
Accounts Payable 200 May 1 5,600 May 18 May 31 Bal.
5,800 2,000 2,000
Sales May 4 May 22 May 31 Bal.
3,500 6,500 10,000
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Financial Accounting, Seventh Canadian Edition
P 5-5A (CONTINUED) (b) (continued)
Sales Returns and Allowances May 29 100 May 31 Bal. 100
May 7 May 31 Bal.
Freight Out 90 90
Cost of Goods Sold May 4 2,100 May 29 May 22 3,900 May 31 149 May 31 Bal. 6,089
Sales Discounts May 14 70 May 31 Bal. 70
Retained Earnings May 1 Bal. May 31 Bal.
60
4,000 4,000
(c) EAGLE HARDWARE STORE LTD. Income Statement (Partial) Month Ended May 31, 2018 Sales .................................................................................. Less: Sales returns and allowances .................................... Sales discounts ......................................................... Net sales .............................................................................. Cost of goods sold ............................................................... Gross profit...........................................................................
$10,000 $100 70
170 9,830 6,089 $ 3,741
(d) EAGLE HARDWARE STORE LTD. Statement of Financial Position (Partial) May 31, 2018 Assets Current assets Cash .......................................................................... Accounts receivable .................................................. Inventory.................................................................... Supplies..................................................................... Total current assets ........................................
$11,651 500 5,100 400 $17,651
LO 2,3,4 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-6A (a) CLUB CANADA WHOLESALE INC. Income Statement (Single-step) Year Ended December 31, 2018 Revenues Sales ........................................................................................ Less: Sales returns and allowances ...................... $23,560 Sales discounts ........................................... 14,265 Net sales ................................................................................. Interest revenue ...................................................................... Expenses Cost of goods sold................................................................... Administrative expenses ......................................................... Selling expenses ..................................................................... Interest expense ...................................................................... Income before income tax ........................................................... Income tax expense .................................................................... Net income ..................................................................................
Solutions Manual .
5-45
$1,099,200 37,825 1,061,375 2,400 $806,240 88,515 42,100 12,350
$1,063,775
949,205 114,570 17,200 $ 97,370
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 5-6A (CONTINUED) (b) CLUB CANADA WHOLESALE INC. Income Statement (Multiple-step) Year Ended December 31, 2018 Sales ..................................................................................... Less: Sales returns and allowances ............................... Sales discounts ..................................................... Net sales ........................................................................... Cost of goods sold .................................................................. Gross profit ............................................................................. Operating expenses Administrative expenses .............................................. Selling expenses .......................................................... Total operating expenses ........................................ Income from operations .......................................................... Other revenues and expenses Interest revenue ................................................................ Interest expense ................................................................ Income before income tax ....................................................... Income tax expense ................................................................ Net income ..............................................................................
$1,099,200 $23,560 14,265
37,825 1,061,375 806,240 255,135
$88,515 42,100 0 130,615 124,520 $(2,400) 12,350
9,950 114,570 17,200 $ 97,370
(Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations) (Income from operations + Other revenues – Other expenses = Income before income taxes)
(c)
Both income statements result in the same amount of net income. The multiple-step income statement provides the user with much more information than the single-step income statement does. The multiple-step income statement provides information on gross profit and income from operations, which is not included on the single-step income statement.
(d)
Club Canada Wholesale Inc. is classifying its expenses by their function. They are reported according to the activity (business function) for which they were incurred (for example, cost of goods sold, administrative, selling).
LO 4 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-7A (a) Dec. 31
31
31
31
31
31
31
31
Insurance Expense ($3,000 × 11/12) .................................... Prepaid Insurance ........................................................
2,750
Supplies Expense .................................................................. Supplies ($2,940 – $750) .............................................
2,190
Depreciation Expense ............................................................ Accumulated Depreciation—Buildings ......................... Accumulated Depreciation—Equipment ......................
10,500
Salaries Expense ................................................................... Salaries Payable .........................................................
750
Interest Expense .................................................................... Interest Payable ...........................................................
735
Unearned Revenue ($4,000 – $975) ...................................... Sales ............................................................................
3,025
Cost of Goods Sold ................................................................ Inventory ......................................................................
2,000
Income Tax Expense ............................................................. Income Tax Payable.....................................................
500
Cost of Goods Sold ................................................................ Inventory ...................................................................... ($28,750 – $2,000 = $26,750 – $23,800 = $2,950 shortage)
2,950
2,750
2,190
6,000 4,500
750
735
3,025
2,000
500
2,950
(b) Dec. 31 Dec.31 Bal.
Cash 17,000 17,000
Accounts Receivable Dec. 31 31,700 Dec.31 Bal. 31,700
Dec.31 Dec. 31 Bal. Solutions Manual .
Inventory 28,750 Dec. 31 Dec. 31 23,800
Dec. 31 Dec. 31 Bal.
Supplies 2,940 Dec. 31 750
2,190
Dec. 31 Dec. 31 Bal.
Prepaid Insurance 3,000 Dec. 31 250
2,750
2,000 Dec. 31 2,950 Dec.31 Bal.
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Land 30,000 30,000
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 5-7A (CONTINUED) (b) (continued)
Dec. 31 Dec.31 Bal.
Buildings 150,000 150,000
Bank Loan Payable Dec. 31 Dec.31 Bal.
147,100 147,100
Common Shares Dec. 31 Dec.31 Bal.
13,000 13,000
Retained Earnings Dec. 31 Dec.31 Bal.
31,425 31,425
Accumulated Depreciation— Buildings Dec. 31 24,000 Dec. 31 6,000 Dec. 31 Bal.30,000
Dec. 31 Dec.31 Bal.
Equipment 45,000 45,000
Accumulated Depreciation— Equipment Dec. 31 18,000 Dec. 31 4,500 Dec. 31 Bal. 22,500
Dec. 31
Accounts Payable Dec. 31 Dec.31 Bal.
33,735 33,735
Unearned Revenue 3,025 Dec. 31 Dec.31 Bal.
4,000 975
Salaries Payable Dec. 31 Dec. 31 Bal.
750 750
Interest Payable Dec. 31 Dec. 31 Bal.
735 735
Income Tax Payable Dec. 31 Dec. 31 Bal.
Solutions Manual .
500 500
Dividends Declared Dec. 31 2,000 Dec. 31 Bal. 2,000 Sales Dec. 31 Dec. 31 Dec.31Bal.
265,770 3,025 268,795
Sales Returns and Allowances Dec. 31 2,500 Dec. 31 Bal. 2,500 Sales Discounts Dec. 31 3,275 Dec. 31 Bal. 3,275
Dec. 31 Dec. 31 Dec. 31 Dec.31Bal.
Cost of Goods Sold 171,225 2,000 2,950 176,175
Dec. 31 Dec. 31 Dec. 31 Bal.
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Salaries Expense 30,950 750 31,700
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 5-7A (CONTINUED) (b) (continued) Depreciation Expense Dec. 31 10,500 Dec. 31 Bal. 10,500 Utilities Expense Dec. 31 5,100 Dec. 31 Bal. 5,100 Insurance Expense Dec. 31 2,750 Dec. 31 Bal. 2,750
Solutions Manual .
Supplies Expense Dec. 31 2,190 Dec. 31 Bal. 2,190
Dec. 31 Dec. 31 Dec. 31Bal.
Interest Expense 8,090 735 8,825
Income Tax Expense Dec.31 5,500 Dec. 31 500 Dec.31 Bal. 6,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-7A (CONTINUED) (c) MESA INC. Adjusted Trial Balance December 31, 2018 Cash............................................................................ Accounts receivable ................................................... Inventory ..................................................................... Supplies ...................................................................... Prepaid insurance ....................................................... Land ............................................................................ Buildings ..................................................................... Accumulated depreciation—buildings ......................... Equipment ................................................................... Accumulated depreciation—equipment....................... Accounts payable ........................................................ Unearned revenue ...................................................... Salaries payable ......................................................... Interest payable .......................................................... Income tax payable ..................................................... Bank loan payable ...................................................... Common shares.......................................................... Retained earnings ....................................................... Dividends declared ..................................................... Sales ........................................................................... Sales returns and allowances ..................................... Sales discounts ........................................................... Cost of goods sold ...................................................... Salaries expense ........................................................ Depreciation expense ................................................. Utilities expense .......................................................... Insurance expense ...................................................... Supplies expense........................................................ Interest expense ......................................................... Income tax expense .................................................... Totals .....................................................................
Debit $ 17,000 31,700 23,800 750 250 30,000 150,000
Credit
$ 30,000 45,000 22,500 33,735 975 750 735 500 147,100 13,000 31,425 2,000 268,795 2,500 3,275 176,175 31,700 10,500 5,100 2,750 2,190 8,825 6,000 $549,515
0000 000 $549,515
(Total debit account balances = Total credit account balances)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-7A (CONTINUED) (d) MESA INC. Income Statement Year Ended December 31, 2018 Sales revenue Sales.................................................................. Less: Sales returns and allowances ................. Sales discounts ....................................... Net sales............................................................ Cost of goods sold ...................................................... Gross profit ................................................................. Operating expenses Salaries expense ............................................... Depreciation expense ........................................ Utilities expense ................................................. Insurance expense ............................................. Supplies expense .............................................. Total operating expenses ................................... Income from operations .............................................. Other revenues and expenses Interest expense ................................................ Income before income tax .......................................... Income tax expense ................................................... Net income .................................................................
$268,795 $2,500 3,275
5,775 263,020 176,175 86,845
$31,700 10,500 5,100 2,750 2,190 52,240 34,605 8,825 25,780 6,000 $ 19,780
(Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations) (Income from operations + Other revenues – Other expenses = Income before income tax)
Statement of Changes in Equity Year Ended December 31, 2018
Balance, January 1 Issued common shares Net income Dividends declared Balance, December 31
Common Shares
Retained Earnings
$10,000 3,000
$31,425
0000 00 $13,000
19,780 (2,000) $49,205
Total Equity $41,425 3,000 19,780 (2,000) $62,205
(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings) Solutions Manual .
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PROBLEM 5-7A (CONTINUED) (d) (continued) MESA INC. Statement of Financial Position December 31, 2015 Assets Current assets Cash ................................................................................................ $17,000 Accounts receivable .................................................................. 31,700 Inventory ..................................................................................... 23,800 Supplies ...................................................................................... 750 Prepaid insurance ...................................................................... 250 Total current assets ........................................................... 73,500 Property, plant, and equipment Land........................................................ $ 30,000 Buildings ................................................. $150,000 Less: Accumulated depreciation ............. 30,000 120,000 Equipment .............................................. $45,000 Less: Accumulated depreciation ............. 22,500 22,500 Total property, plant, and equipment 172,500 Total assets ............................................................................... $246,000
Liabilities and Shareholders’ Equity Current liabilities Accounts payable ...................................................................... Unearned revenue ..................................................................... Salaries payable ........................................................................ Interest payable ......................................................................... Income tax payable ................................................................... Current portion of bank loan payable ......................................... Total current liabilities ...................................................... Non-current liabilities Bank loan payable ($147,100 – $9,800) .................................... Total liabilities ................................................................... Shareholders’ equity Common shares ..................................................... $13,000 Retained earnings .................................................. 49,205 Total shareholders’ equity................................................. Total liabilities and shareholders’ equity ....................................
$ 33,735 975 750 735 500 9,800 46,495 137,300 183,795
62,205 $246,000
LO 4 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-8A (a)
Gross profit margin
$255,135 ÷ $1,061,375 = 24.0%
Profit margin
$97,370 ÷ $1,061,375 = 9.2%
(b)
Existing balances
Net Sales
Gross Profit
Net Income
$1,061,375
$255,135
$97,370
27,000
27,000
Increase sales ($1,061,375 × 15%)
159,206
Increase in gross profit Increase in operating expenses
(13,500)
Increase in income tax expense
(2,700)
Revised amounts
$1,220,581
(c)
$282,135 ÷ $1,220,581 =
Revised gross profit margin Revised profit margin
$282,135
$108,170
23.1%
$108,170 ÷ $1, 220,581 = 8.9%
Both the gross profit margin and the profit margin have decreased, but the end result is an increase in net income, so the plan has merit. LO 5 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-9A (a) [1] [8]
Sales Accounts receivable
= $540,000 (given) = Sales × 30% = $540,000 × 30% = $162,000
(b) [2]
Cost of goods sold
[9]
Inventory
= 90% × inventory purchased = 90% × $300,000 = $270,000 = 10% × inventory purchased = 10% × $300,000 = $30,000 or purchases less cost of goods sold = $300,000 less $270,000 = $30,000 = 20% × inventory purchased = 20% ×$300,000 = $60,000
[10] Accounts payable
(c) [3]
Gross profit
[4] [5]
Operating expenses Income before income taxes
(d) [6]
Income tax expense
[7]
Net income
[11] Income tax payable
(e) Gross profit margin Profit margin (e)
= Sales – Cost of goods sold = $540,000 – $270,000 = $270,000 = $120,000 (given) = Gross profit – Operating expenses = $270,000 – $120,000 = $150,000
= Income before income taxes × 30% = $150,000 × 30% = $45,000 = Income before income taxes – Income tax expense = $150,000 – $45,000 = $105,000 = given as equal to income tax expense = $45,000
= $270,000 ÷ $540,000 = 50.0% = $105,000 ÷ $540,000 = 19.4%
If Psang Inc. has a higher than average gross profit margin, it is either because it is selling products at a higher price, (which is not the case), or because its cost of goods sold as a percentage of sales is smaller than its competitors. The resulting higher gross profit will be a contributing factor to a higher than average profit margin ratio. Other factors that could contribute to a higher than average profit margin ratio include lower than average operating expenses.
LO 4,5 BT: AN Difficulty: C Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-10A (a)
(in $ millions) 2015
Current ratio
$990.8 $635.1
Gross profit margin
($3,925.3 – $2,780.8) $3,925.3
Profit margin
$91.9 $3,925.3
(b)
2014 $902.6 $425.9
= 1.6:1
= 29.2%
= 2.3%
($3,347.6 – $2,201.9) $3,347.6
$221.8 $3,347.6
2013 =
2.1:1
= 34.2%
= 6.6%
$752.4 $440.5
=
($3,194.9 – $2,036.8) $3,194.9
1.7:1
= 36.2%
$250.5 $3,194.9
= 7.8%
Canfor’s current ratio increased (improved) in 2014 but then decreased (deteriorated) in 2015. Canfor’s gross profit experienced a constant decrease (deterioration) over the three-year period as did the profit margin.
(c)
Current ratio Gross profit margin Profit margin
2015 Industry Average 1.2:1 20.8% 2.6%
2015 Canfor Corporation 1.6:1 29.2% 2.3%
Canfor’s current ratio and gross profit margin are both better than those of the industry, and the profit margin is slightly worse than the industry. LO 5 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-11A (a) June
1
3
5
8
9
11
12
17
22 25
29
Solutions Manual .
Purchases (180 × $16) ............................................ Accounts Payable ...........................................
2,880
Accounts Receivable (220 × $25) ............................ Sales ...............................................................
5,500
Accounts Payable (10 × $16) ................................... Purchase Returns and Allowances .................
160
Accounts Receivable (80 × $22) .............................. Sales ...............................................................
1,760
Sales Returns and Allowances ................................ Accounts Receivable (12 × $22) .....................
264
Purchases (130 × $15) ............................................ Accounts Payable ...........................................
1,950
Cash ($5,500 – $110) ........................................... Sales Discounts ($5,500 × 2%) .............................. Accounts Receivable .............................................
5,390 110
Cash ($1,496 – $30) ........................................... Sales Discounts ($1,496 × 2%) .............................. Accounts Receivable ($1,760 – $264) ..................
1,466 30
Accounts Receivable (125 × $25) .......................... Sales ...........................................................
3,125
Sales Returns and Allowances............................... Accounts Receivable (15 × $25)..................
375
Accounts Payable ($2,880 – $160) ........................ Cash ............................................................
2,720
5-56
2,880
5,500
160
1,760
264
1,950
5,500
1,496 3,125 375
2,720
Chapter 5
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-11A (CONTINUED) (b)
The advantages of the periodic inventory system are that it is simpler and cheaper (in terms of equipment and systems) compared to a perpetual inventory system. There are fewer accounting entries and cash registers do not need to be able to read bar codes to apply the appropriate cost as is required in the perpetual inventory system. However, a perpetual inventory system enables management to monitor purchases and sales to make the optimum use of the money available for stocking inventory. Fewer stock-outs are experienced when using the perpetual system as reductions in inventory levels can be quickly identified and restocking done, possibly automatically, before the business runs out of inventory. With the perpetual system, cost of goods sold can be reported at any time and consequently, timely reporting of results can be achieved. Perpetual systems allow management to quantify the cost of goods lost to theft. When customers make inquiries concerning the availability of stock from a merchant, a quick reply can be obtained and provided when a perpetual inventory system is used. Finally, fewer inventory counts are required, saving salary costs and minimizing lost sales from having to close the business for inventory counts.
LO 1,6 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-12A (a) Sept.
2
Equipment ...................................................................... Accounts Payable .................................................
65,000 65,000
3
No entry necessary.
4
Supplies ......................................................................... Cash ......................................................................
4,000
Purchases ...................................................................... Accounts Payable .................................................
65,000
Freight In ........................................................................ Cash ......................................................................
1,600
Accounts Payable .......................................................... Purchase Returns and Allowances .......................
5,000
Accounts Receivable...................................................... Sales .....................................................................
20,000
Freight Out ..................................................................... Cash ......................................................................
375
Cash ($20,000 – $400) .................................................. Sales Discount ($20,000 × 2%)...................................... Accounts Receivable .............................................
19,600 400
Accounts Payable ($65,000 – $5,000) ........................... Cash ($60,000 – $600) ......................................... Purchase Discounts ($60,000 × 1%) .....................
60,000
Purchases ...................................................................... Cash ......................................................................
6,000
Accounts Receivable...................................................... Sales .....................................................................
27,000
6
7
8
9
10
17
20
21
22
23
No entry necessary.
28
Sales Returns and Allowances....................................... Accounts Receivable .............................................
Solutions Manual .
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4,000
65,000
1,600
5,000
20,000
375
20,000
59,400 600
6,000
27,000
10,000 10,000
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-12A (CONTINUED) (b) Oct.
3
Accounts Payable ($65,000 – $5,000) ................................. 60,000 Cash .........................................................................
60,000
The cost of missing this purchase discount is the amount recorded in the Purchase Discounts account when the payment was made within the discount period to September 21 ($60,000 × 1%) = $600. Expressing this in terms of an annual interest rate, it would be the equivalent of paying 24.6% ($600 ÷ $59,400 × 365/15) for the use of the money for 15 days. LO 6 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-13A (a) Apr.
3
5
7 9
11
14
16
17
20
24
25
27
Solutions Manual .
Purchases ....................................................................... Accounts Payable ..................................................
3,200
Freight In......................................................................... Cash ......................................................................
286
Accounts Receivable ...................................................... Sales ......................................................................
9,750
Accounts Payable ........................................................... Purchase Returns and Allowances ........................
320
Accounts Payable ($3,200 – $320) ................................. Purchase Discounts ($2,880 × 1%) ....................... Cash ($2,880 – $29) ..............................................
2,880
Cash ............................................................................... Accounts Receivable .............................................
4,150
Purchases ....................................................................... Accounts Payable ..................................................
1,300
Accounts Payable ........................................................... Purchase Returns and Allowances ........................
100
Accounts Receivable ...................................................... Sales ......................................................................
11,100
Accounts Payable ($1,300 – $100) ................................. Purchase Discounts ($1,200 × 2%) ....................... Cash ($1,200 – $24) ..............................................
1,200
Cash…………………………………………………………. Accounts Receivable………………………………...
4,375
Sales Returns and Allowances ....................................... Accounts Receivable .............................................
85
5-60
3200
286
9,750 320
29 2,851
4,150
1,300
100
11,100
24 1,176
4,375
85
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-13A (CONTINUED) (b)
Apr. 1 Bal. Apr. 14 Apr. 25 Apr. 30 Bal.
Cash 4,200 Apr. 5 4,150 Apr. 11 4,375 Apr. 24 8,412
Accounts Receivable Apr. 7 9,750 Apr. 14 Apr. 20 11,100 Apr. 25 Apr. 27 Apr. 30 Bal. 12,240
Sales Apr. 7 9,750 Apr. 20 11,100 Apr. 30 Bal. 20,850
286 2,851 1,176
Sales Returns and Allowances Apr. 27 85 Apr. 30 85
4,150 4,375 85
Apr. 3 Apr. 16 Apr. 30 Bal.
Inventory Apr. 1 Bal. 19,500 Apr. 30 Bal. 19,500
Apr. 9 Apr. 11 Apr. 17 Apr. 24
Accounts Payable 320 Apr. 3 2,880 Apr. 16 100 1,200 Apr. 30 Bal.
Purchase Returns and Allowances Apr. 9 320 Apr. 17 100 Apr. 30 Bal. 420
3,200 1,300
Purchase Discounts Apr. 11 Apr. 21 Apr. 30 Bal.
0
Common Shares Apr. 1 Bal. 12,000 Apr. 30 Bal. 12,000
Apr. 5 Apr. 30 Bal.
Retained Earnings Apr. 1 Bal. 11,700 Apr. 30 Bal. 11,700
Solutions Manual .
Purchases 3,200 1,300 4,500
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29 24 53
Freight In 286 286
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-13A (CONTINUED) (c)
IN THE PINES GOLF SHOP Trial Balance April 30, 2018 Debit $ 8,412 12,240 19,500
Cash ...................................................................................... Accounts receivable ............................................................... Inventory ................................................................................ Accounts payable………………………………………………… Common shares ..................................................................... Retained earnings .................................................................. Sales ...................................................................................... Sales returns and allowances ................................................ Purchases .............................................................................. Freight in ................................................................................ Purchase returns and allowances .......................................... Purchase discounts ................................................................
Credit
$ 12,000 11,700 20,850 85 4,500 286 00 000 $45,023
420 53 $45,023
(Total debit account balances = Total credit account balances) (d) Apr. 30
Inventory (ending) .................................................... Cost of Goods Sold .................................................. Purchase Returns and Allowances .......................... Purchase Discounts ................................................. Inventory (beginning) .......................................... Purchases ........................................................... Freight In.............................................................
11,763 12,050* 420 53 19,500 4,500 286
*Cost of goods sold = Beginning inventory + Purchases − Purchase discounts − Purchase returns and allowances + Freight in – Ending inventory Cost of goods sold = $19,500 + $4,500 – $53 – $420 + $286 – $11,763 = $12,050 LO 6 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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*PROBLEM 5-14A (a)
FEISTY LTD. Income Statement (Partial) Year Ended April 30, 2018 Sales revenue Sales .................................................................................. Less: Sales returns and allowances.................................. Net sales ............................................................................ Cost of goods sold Inventory, May 1, 2017 ...................................................... Purchases ................................................... $5,900,000 Less: Purchase discounts ........................... 40,000 Net purchases............................................. 5,860,000 Add: Freight in ........................................... 120,000 Cost of goods purchased ................................................... Cost of goods available for sale ......................................... Inventory, April 30, 2018 .................................................... Cost of goods sold ..................................................... Gross profit ............................................................................
$9,300,000 250,000 9,050,000 $ 600,000
5,980,000 6,580,000 700,000 5,880,000 $3,170,000
(Beginning inventory + Net purchases + Freight-in = Cost of goods purchased)
(b) Apr. 30
Inventory (ending) .................................................... Cost of Goods Sold .................................................. Purchase Discounts ................................................. Inventory (beginning) .......................................... Purchases ........................................................... Freight In.............................................................
700,000 5,880,000 40,000 600,000 5,900,000 120,000
(c) Gross profit margin: $3,170,000 $9,050,000
= 35.0%
Feisty’s gross profit margin of 35% is better than the industry average of 30%. This indicates that Feisty is making a higher gross profit from each dollar of sale than the industry average due to higher selling prices or lower costs for its inventory. LO 5,6 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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*PROBLEM 5-15A ACTIVE ATHLETIC WEAR INC. Income Statement Year Ended December 31, 2018
Sales revenue Sales ......................................................................................... Less: Sales discounts .............................................................. Sales returns and allowances ......................................... Net sales ................................................................................... Cost of goods sold Inventory, January 1 .................................................................. Purchases .......................................................... $602,400 Less: Purchase discounts .................................... 33,750 Purchase returns and allowances ............... 9,600 Net purchases ...................................................... 559,050 Add: Freight in ...................................................... 8,400 Cost of goods purchased .......................................................... Cost of goods available for sale ................................................ Less: Inventory, December 31 .................................................. Cost of goods sold .............................................................. Gross profit ...................................................................................... Operating expenses Administrative expenses ............................................................ Selling expenses........................................................................ Total operating expenses ................................................... Income from operations ................................................................... Other revenues and expenses Interest expense........................................................................ Income before income tax ............................................................... Income tax expense ........................................................................ Net Income .....................................................................................
$955,500 $22,500 12,000
34,500 921,000
$ 60,750
567,450 628,200 108,900 519,300 401,700 $271,350 11,250 282,600 119,100 15,600 103,500 24,000 $ 79,500
(Beginning inventory + Net purchases + Freight-in = Cost of goods available for sale)
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*PROBLEM 5-15A (CONTINUED) ACTIVE ATHLETIC WEAR INC. Statement of Changes in Equity Year Ended December 31, 2018 Common Shares Balance, January 1 Issued common shares Net income Dividends declared Balance, December 31
Retained Earnings
$ 75,000 37,500 000 0000 $112,500
$102,900 79,500 (12,000) $170,400
Total Equity $177,900 37,500 79,500 (12,000) $282,900
(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)
ACTIVE ATHLETIC WEAR INC. Statement of Financial Position December 31, 2018
Assets Current assets Cash ............................................................................................................ Accounts receivable ................................................................................... Inventory ...................................................................................................... Prepaid insurance ...................................................................................... Total current assets ............................................................................ Property, plant, and equipment Land..................................................................... $112,500 Buildings .............................................................. $285,000 Less: Accumulated depreciation .......................... 77,700 207,300 Equipment ........................................................... $165,000 Less: Accumulated depreciation .......................... 64,350 100,650 Total property, plant, and equipment ......... Total assets ...............................................................................................
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$ 25,500 66,300 108,900 3,600 204,300
420,450 $624,750
Chapter 5
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-15A (CONTINUED) Liabilities and Shareholders’ Equity Current liabilities Accounts payable ..................................................................... Salaries payable ....................................................................... Property tax payable ................................................................. Unearned revenue .................................................................... Current portion of mortgage payable ........................................ Total current liabilities ..................................................... Non-current liabilities Mortgage payable ($187,500 – $18,750) ................................. Total liabilities .................................................................. Shareholders’ equity Common shares .................................................... $112,500 Retained earnings ................................................. 170,400 Total shareholders’ equity................................................ Total liabilities and shareholders’ equity ....................................
$ 129,450 5,250 7,200 12,450 18,750 173,100 168,750 341,850
282,900 $624,750
LO 6 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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PROBLEM 5-1B (a)
A company’s operating cycle is the average time it takes to go from cash to cash in producing revenues. The operating cycle for a merchandising company covers the period of time between when you purchase your inventory, to when you sell it, and to when you eventually collect the accounts receivable from a sale. The Fashion Palace is having problems paying its bills because the period of time between sales and collection of accounts receivable is lengthened because many customers take more than one month to pay. The company’s inventory is contributing to the problem because some items have been in stock for a long period of time, which means a long operating cycle for those items.
(b)
The Fashion Palace should consider switching to a perpetual inventory system where detailed records of each inventory purchase and sale are maintained. This system continuously—perpetually—shows the quantity and cost of the inventory purchased, sold, and on hand. This system will help the company see which inventory items are out-of-stock, which items are taking a long time to sell, and provide management with the total inventory on hand each month to prepare its monthly financial statements, eliminating the need for a monthly count. The company will still need to perform at least one annual inventory count to ensure its accounting records agree with the physical inventory count.
(c)
For control reasons, a physical inventory count must always be taken at least one a year, and ideally more often under the perpetual inventory system. By using a perpetual inventory system, a company knows what inventory should be on hand. Performing a physical count and checking it to the perpetual records is necessary to detect any errors in record keeping and/or shortages in stock.
LO 1 BT: AN Difficulty: C Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
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PROBLEM 5-2B (a) (b) July
Travel Warehouse Ltd. is a wholesaler. Its suppliers are suitcase manufacturers and its customers are stores. 2
3
6
7
9
11
13
16
17
Solutions Manual .
Inventory (75 × $60) .......................................... Accounts Payable ...................................
4,500
Accounts Payable ............................................. Inventory (4 × $60) .................................
240
Accounts Receivable (55 × $90) ....................... Sales ......................................................
4,950
Cost of Goods Sold (55 × $50).......................... Inventory.................................................
2,750
Sales Returns and Allowances.......................... Accounts Receivable (3 × $90) ..............
270
Inventory ........................................................... Cost of Goods Sold (3 × $50) .................
150
Accounts Receivable (3 × $100) ....................... Sales ......................................................
300
Cost of Goods Sold (3 × $60)............................ Inventory.................................................
180
Accounts Payable ($4,500 – $240) ................... Inventory ($4,260 × 2%) ......................... Cash ($4,260 – $85) ...............................
4,260
Accounts Receivable (25 × $100) ..................... Sales ......................................................
2,500
Cost of Goods Sold (25 × $60).......................... Inventory.................................................
1,500
Inventory (70 × $62) .......................................... Accounts Payable ...................................
4,340
Sales Returns and Allowances.......................... Accounts Receivable (5 × $100).............
500
5-68
4,500
240
4,950
2,750
270
150
300
180
85 4,175
2,500
1,500
4,340
500
Chapter 5
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-2B (CONTINUED) (b) (continued) July
20
27
Cash ($4,980 – $100) ..................................... Sales Discounts ($4,980 × 2%) ......................... Accounts Receivable ($4,950 – $270 + $300) ..........................
4,880 100
Cash ($2,000 – $40) ......................................... Sales Discounts ($2,000 × 2%) ......................... Accounts Receivable ($2,500 – $500)....
1,960 40
4,980
2,000
(c) July
1* 2 7 16
July 31 Bal. *(60 × $50)
(d)
Inventory 3,000 4,500 150 4,340
July 3 6 9 11 13
240 2,750 180 85 1,500
7,235
Number of suitcases on hand at July 31 = 60 + 75 – 4 – 55 + 3 – 3 – 25 + 70 = 121 $7,235 ÷ 121 = $60
LO 1,2,3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 5-3B (a) Oct.
1
1
2
6
8
9
10
12
15
17
28
29
Solutions Manual .
Inventory ........................................................................... Accounts Payable ...................................................
86,000
Inventory ........................................................................... Cash .......................................................................
1,400
Accounts Payable ............................................................. Inventory.................................................................
4,000
Supplies ............................................................................ Cash .......................................................................
2,800
Accounts Receivable......................................................... Sales ......................................................................
140,000
Cost of Goods Sold ........................................................... Inventory ($86,000 + $1,400 – $4,000) ..................
83,400
Freight Out ........................................................................ Cash .......................................................................
2,300
Equipment ......................................................................... Accounts Payable ...................................................
62,000
Sales Returns and Allowances.......................................... Accounts Receivable ..............................................
3,500
Inventory ........................................................................... Cash .......................................................................
36,300
Cash ($136,500 – $2,730) ................................................ Sales Discounts [($140,000 – $3,500) × 2%] .................... Accounts Receivable ($140,000 – $3,500) .............
133,770 2,730
Accounts Receivable......................................................... Sales ......................................................................
30,000
Cost of Goods Sold ........................................................... Inventory.................................................................
18,000
86,000
1,400
4,000
2,800
140,000
83,400
2,300
62,000
3,500
36,300
136,500
30,000
18,000
No entry necessary.
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PROBLEM 5-3B (CONTINUED) (a) (continued) 30
31
Accounts Payable ($86,000 – $4,000) .............................. Cash .......................................................................
82,000
Sales Returns and Allowances.......................................... Accounts Receivable ..............................................
5,000
Inventory ........................................................................... Cost of Goods Sold ................................................
3,000
Accounts Payable ($86,000 – $4,000) ........................... Inventory ($82,000 × 1%) .................................... Cash ($82,000 – $820) ........................................
82,000
82,000
5,000
3,000
(b) Oct.
14
820 81,180
The cost of missing this purchase discount is the amount recorded as a reduction to the Inventory account when the payment was made within the discount period of October 14 ($820). Expressing this in terms of an annual interest rate, it would be the equivalent of paying 24.6% ($820 ÷ $81,180 × 365/15) for the use of the money for 15 days. LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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PROBLEM 5-4B (a) April
2
3
5
9
11
13
16
18
20
21
23
Solutions Manual .
Inventory ................................................................. Accounts Payable ...........................................
5,800
Inventory ................................................................. Cash ...............................................................
160
Accounts Payable.................................................... Inventory ........................................................
100
Supplies .................................................................. Cash ...............................................................
1,130
Accounts Payable ($5,800 – $100) ........................ Inventory ($5,700 × 2%) ................................. Cash ($5,700 – $114) ....................................
5,700
Inventory ................................................................. Cash ...............................................................
1,560
Inventory ................................................................. Cash ...............................................................
115
Cash ....................................................................... Inventory.........................................................
110
Accounts Receivable ............................................... Sales ..............................................................
11,100
Cost of Goods Sold ................................................. Inventory.........................................................
6,660
Sales Returns and Allowances ................................ Accounts Receivable ......................................
1,000
Inventory .................................................................. Cost of Goods Sold ........................................
600
5,800
160
100
1,130
114 5,586
1,560
115
110
11,100
6,660 1,000
Equipment ............................................................... 11,700 Accounts Payable ...........................................
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600
11,700
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-4B (CONTINUED) (a) (continued) 25
27
28
Accounts Receivable ............................................... Sales ...............................................................
9,800
Cost of Goods Sold.................................................. Inventory .........................................................
5,880
Cash ........................................................................ Accounts Receivable ......................................
9,800
Sales Returns and Allowances ............................... Accounts Receivable ......................................
150
9,800
5,880
9,800
150
(b) Apr. 1 Bal. Apr. 18 Apr. 27
Apr. 30 Bal.
Cash 16,400 Apr. 3 110 Apr. 9 9,800 Apr. 11 Apr. 13 Apr. 16 17,759
Accounts Receivable Apr. 20 11,100 Apr. 21 Apr. 27 9,800 Apr. 27 Apr. 28 Apr. 30 Bal. 9,950 Inventory Apr. 1 Bal. 16,200 Apr. 5 Apr. 2 5,800 Apr. 11 Apr. 3 160 Apr. 18 Apr. 13 1,560 Apr. 20 Apr. 16 115 Apr. 25 Apr. 21 600 Apr. 30 Bal. 11,571
Apr. 9 Apr. 30 Bal.
Supplies 1,130 1,130
Equipment Apr. 23 11,700 Apr. 30 Bal. 11,700 Solutions Manual .
160 1,130 5,586 1,560 115
Apr. 5 Apr. 11
1,000 9,800 150
100 114 110 6,660 5,880
Accounts Payable 100 Apr. 2 5,700 Apr. 23 Apr. 30 Bal.
5,800 11,700 11,700
Common Shares Apr. 1 Bal. Apr. 30 Bal.
20,000 20,000
Retained Earnings Apr. 1 Bal. Apr. 30 Bal.
12,600 12,600
Sales Apr. 20 Apr. 25 Apr. 30 Bal.
11,100 9,800 20,900
Sales Returns and Allowances Apr. 21 1,000 Apr. 28 150 Apr. 30 Bal. 1,150 Cost of Goods Sold Apr. 20 6,660 Apr. 21 Apr. 25 5,880 Apr. 30 Bal. 11,940
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PROBLEM 5-4B (CONTINUED) (c)
GRAND SLAM TENNIS SHOP Trial Balance April 30, 2018
Cash ................................................................................. Accounts receivable .......................................................... Inventory ........................................................................... Supplies ............................................................................ Equipment......................................................................... Accounts payable ............................................................. Common shares ............................................................... Retained earnings ............................................................. Sales ................................................................................. Sales returns and allowances ........................................... Cost of goods sold ............................................................
Debit $ 17,759 9,950 11,571 1,130 11,700
Credit
$ 11,700 20,000 12,600 20,900 1,150 11,940 $65,200
0 0000 $65,200
(Total debit account balances = Total credit account balances) LO 2,3 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 5-5B (a) Apr.
2
3
5
9
10
11
Inventory .................................................................. Accounts Payable ...........................................
8,900
Inventory .................................................................. Cash ...............................................................
225
8,900
225
Accounts Receivable ............................................... 11,600 Sales ...............................................................
11,600
Cost of Goods Sold.................................................. Inventory .........................................................
7,540 7,540
Freight Out ............................................................... Cash ...............................................................
290
Sales Returns and Allowances ................................ Accounts Receivable ......................................
1,600
Inventory .................................................................. Cost of Goods Sold .........................................
1,030
Inventory .................................................................. Accounts Payable ...........................................
4,200
290
1,600
1,030
4,200
12
No entry necessary
13
Accounts Payable .................................................... Inventory .........................................................
300
Cash ($10,000 – $200) ............................................ Sales Discounts ($10,000 × 2%) ............................. Accounts Receivable ($11,600 – $1,600) ..........
9,800 200
Accounts Payable .................................................... Inventory ($8,900 × 1%) ................................. Cash ...............................................................
8,900
Accounts Payable ($4,200 – $300)………… Inventory ($3,900 × 1%) ................................. Cash ($3,900 – $39) .......................................
3,900
14
17
20
Solutions Manual .
5-75
300
10,000 89 8,811
39 3,861
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-5B (CONTINUED) (a) (continued) Apr.
23
24
27
30
Cash ........................................................................ Sales...............................................................
6,400
Cost of Goods Sold ................................................. Inventory .........................................................
5,200
Sales Returns and Allowances ................................ Cash ...............................................................
400
Inventory .................................................................. Cash ...............................................................
6,100
Cash ........................................................................ Inventory .........................................................
500
6,400
5,200
400
6,100
500
(b) Apr. 1 Bal. Apr. 14 Apr. 23 Apr. 30
Apr. 30 Bal.
Cash 4,000 Apr. 3 9,800 Apr. 9 6,400 Apr. 17 500 Apr. 20 Apr. 24 Apr. 27 1,013
225 290 8,811 3,861 400 6,100
Accounts Receivable Apr. 1 Bal. 3,500 Apr. 10 Apr. 5 11,600 Apr. 14 Apr. 30 Bal. 3,500
1,600 10,000
Inventory 2,500 Apr. 5 8,900 Apr. 13 225 Apr. 17 1,030 Apr. 20 4,200 Apr. 23 6,100 Apr. 30 9,287
7,540 300 89 39 5,200 500
Apr. 1 Bal. Apr. 2 Apr. 3 Apr. 10 Apr. 11 Apr. 27 Apr. 30 Bal.
Common Shares Apr. 1 Bal. Apr. 30 Bal.
Solutions Manual .
Apr. 13 Apr. 17 Apr. 20
Accounts Payable 300 Apr. 2 8,900 Apr. 11 3,900 Apr. 30 Bal. Sales Apr. 5 Apr. 23 Apr. 30 Bal.
8,900 4,200 0
11,600 6,400 18,000
Sales Returns and Allowances Apr. 10 1,600 Apr. 24 400 Apr. 30 Bal. 2,000 Sales Discounts Apr. 14 200 Apr. 30 Bal. 200
Apr. 9 Apr. 30 Bal.
Freight Out 290 290
5,000 5,000
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PROBLEM 5-5B (CONTINUED) (b) (continued)
Apr. 5 Apr. 23
Cost of Goods Sold 7,540 Apr. 10 5,200
Apr. 30 Bal.
Retained Earnings Apr. 1 Bal. Apr. 30 Bal.
1,030
5,000 5,000
11,710
(c) NISSON DISTRIBUTING LTD. Income Statement Month Ended April 30, 2018 Sales ............................................................................... Less: Sales returns and allowances.............................. Sales discounts ................................................... Net sales ........................................................................... Cost of goods sold ............................................................ Gross profit .......................................................................
$18,000 $2,000 200
2,200 15,800 11,710 $ 4,090
(d) NISSON DISTRIBUTING LTD. Statement of Financial Position (Partial) April 30, 2018 Assets Current assets Cash............................................................................................ Accounts receivable .................................................................... Inventory ..................................................................................... Total current assets ..............................................................
$ 1,013 3,500 9,287 $13,800
LO 2,3,4 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 5-6B (a)
BRIGUS WHOLESALE LTD. Income Statement (Single-step) Year Ended November 30, 2018
Revenues Sales ........................................................................................ Less: Sales returns and allowances....................... $12,800 Sales discounts ............................................. 11,400 Net sales ................................................................................. Interest revenue ...................................................................... Expenses Cost of goods sold .................................................................. Administrative expenses ......................................................... Selling expenses ..................................................................... Interest expense ..................................................................... Income before income tax .......................................................... Income tax expense ................................................................... Net income ................................................................................. (b)
$2,234,800 24,200 2,210,600 2,800 $1,387,200 366,000 286,000 12,300
$2,213,400
2,051,500 161,900 32,400 $ 129,500
BRIGUS WHOLESALE LTD. Income Statement (Multiple-step) Year Ended November 30, 2018
Sales ..................................................................................... Less: Sales returns and allowances ............................... Sales discounts..................................................... Net sales ........................................................................... Cost of goods sold .................................................................. Gross profit ............................................................................. Operating expenses Administrative expenses .............................................. Selling expenses.......................................................... Total operating expenses........................................ Income from operations .......................................................... Other revenues and expenses Interest revenue ............................................................... Interest expense................................................................ Income before income tax ...................................................... Income tax expense ............................................................... Net income .............................................................................
$2,234,800 $12,800 11,400
24,200 2,210,600 1,387,200 823,400
$366,000 286,000 652,000 171,400 ($2,800) 12,300
9,500 161,900 32,400 $ 129,500
(Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations) (Income from operations + Other revenues – Other expenses = Income before income taxes)
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PROBLEM 5-6B (CONTINUED) (c)
Both income statements result in the same amount of net income. The multiple-step income statement provides the user with much more information than the single-step income statement does. The multiple-step income statement provides information on gross profit and income from operations which is not included on the single-step income statement.
(d)
Brigus is classifying its expenses by their function. They are reported according to the activity (business function) for which they were incurred (for example, cost of goods sold, administrative, selling).
LO 4 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 5-7B (a) Nov. 30
30
30 30
30
30
30
30
Insurance Expense ($1,800 × 4/12) ................................... Prepaid Insurance ......................................................
600
Supplies Expense .............................................................. Supplies ($1,650 – $950)...........................................
700
Depreciation Expense ........................................................ Accumulated Depreciation—Equipment ....................
5,360
Salaries Expense ............................................................... Salaries Payable ........................................................
1,210
Interest Expense ................................................................ Interest Payable .........................................................
175
Unearned Revenue ............................................................ Sales..........................................................................
2,400
Cost of Goods Sold ............................................................ Inventory ....................................................................
1,560
Income Tax Expense ......................................................... Income Tax Payable ..................................................
1,100
600
700
5,360 1,210
175
2,400
1,560
1,100
Cost of Goods Sold .............................................................. 940 Inventory .................................................................... ($27,500 – $1,560 = $25,940; $25,940 – $25,000 = $940 shortage)
940
(b) Nov. 30 Nov. 30 Bal.
Cash 22,000 22,000
Accounts Receivable Nov. 30 30,600 Nov. 30 Bal. 30,600
Nov. 30 Nov. 30 Bal.
Inventory 27,500 Nov. 30 Nov. 30 25,000
Solutions Manual .
1,560 940
Nov. 30 Nov. 30 Bal.
Supplies 1,650 Nov. 30 950
700
Nov. 30 Nov. 30 Bal.
Prepaid Insurance 1,800 Nov. 30 1,200
600
Long-term Investments Nov. 30 37,000 Nov. 30 Bal. 37,000
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PROBLEM 5-7B (CONTINUED) Dividends Declared Nov. 30 10,000 Nov. 30 Bal. 10,000
(b) (continued) Equipment Nov. 30 26,800 Nov. 30 Bal. 26,800
Sales Nov. 30 248,500 Nov. 30 2,400 Nov. 30 Bal. 250,900
Accumulated Depreciation— Equipment Nov. 30 10,720 Nov. 30 5,360 Nov. 30 Bal. 16,080 Accounts Payable Nov. 30 Nov. 30 Bal.
34,400 34,400
Salaries Payable Nov. 30 Nov. 30 Bal.
1,210 1,210
Interest Payable Nov. 30 Nov. 30 Bal.
175 175
Income Tax Payable Nov. 30 Nov. 30 Bal.
Nov. 30
Unearned Revenue 2,400 Nov. 30 Nov. 30 Bal. Bank Loan Payable Nov. 30 Nov. 30 Bal.
Sales Discounts Nov. 30 4,520 Nov. 30 Bal. 4,520 Cost of Goods Sold Nov. 30 157,000 Nov. 30 1,560 Nov. 30 940 Nov. 30 Bal. 159,500
Nov. 30 Nov. 30 Nov. 30 Bal.
1,100 1,100
Nov. 30 Nov. 30 Bal.
35,000 35,000
16,400 16,400
Retained Earnings Nov. 30 Nov. 30 Bal.
30,000 30,000
Salaries Expense 32,600 1,210 33,810
Depreciation Expense Nov. 30 5,360 Nov.30 Bal. 5,360
3,000 600
Common Shares Nov. 30 Nov. 30 Bal.
Solutions Manual .
Sales Returns and Allowances Nov. 30 4,600 Nov. 30 Bal. 4,600
Rent Expense 13,850 13,850
Advertising Expense Nov. 30 2,100 Nov. 30 Bal. 2,100 Supplies Expense Nov. 30 700 Nov. 30 Bal. 700
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PROBLEM 5-7B (CONTINUED) (b) (continued) Income Tax Expense Nov. 30 2,000 Nov. 30 1,100 Nov. 30 Bal. 3,100
Insurance Expense Nov. 30 600 Nov. 30 Bal. 600 Interest Expense Nov. 30 4,000 Nov. 30 175 Nov. 30 Bal. 4,175
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PROBLEM 5-7B (CONTINUED) (c) FASHION CENTRE LTD. Adjusted Trial Balance November 30, 2018
Cash ........................................................................... Accounts receivable .................................................... Inventory ..................................................................... Supplies ...................................................................... Prepaid insurance ....................................................... Long-term investments ............................................... Equipment................................................................... Accumulated depreciation—equipment ...................... Accounts payable ....................................................... Salaries payable ......................................................... Interest payable .......................................................... Income tax payable ..................................................... Unearned revenue ....................................................... Bank loan payable ...................................................... Common shares ......................................................... Retained earnings ....................................................... Dividends declared ..................................................... Sales ........................................................................... Sales discounts........................................................... Sales returns and allowances ...................................... Cost of goods sold ...................................................... Salaries expense ........................................................ Rent expense............................................................... Depreciation expense .................................................. Supplies expense ........................................................ Insurance expense ..................................................... Interest expense ......................................................... Advertising expense .................................................... Income tax expense .................................................... Totals ....................................................................
Debit $ 22,000 30,600 25,000 950 1,200 37,000 26,800
Credit
$ 16,080 34,400 1,210 175 1,100 600 35,000 16,400 30,000 10,000 250,900 4,520 4,600 159,500 33,810 13,850 5,360 700 600 4,175 2,100 3,100 $385,865
0000 000 $385,865
(Total debit account balances = Total credit account balances)
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PROBLEM 5-7B (CONTINUED) (d) FASHION CENTRE LTD. Income Statement Year Ended November 30, 2018
Sales revenue Sales........................................................................................... Less: Sales returns and allowances ........................ $4,600 Sales discounts .............................................. 4,520 Net sales..................................................................................... Cost of goods sold .............................................................................. Gross profit .......................................................................................... Operating expenses Salaries expense ..................................................... $33,810 Rent expense ............................................................ 13,850 Depreciation expense ............................................... 5,360 Advertising expense .................................................. 2,100 Supplies expense ...................................................... 700 Insurance expense ................................................... 600 Total operating expenses ................................................... Income from operations ....................................................................... Other revenues and expenses Interest expense ......................................................................... Income before income tax ................................................................... Income tax expense ............................................................................ Net income ..........................................................................................
$250,900 9,120 241,780 159,500 82,280
56,420 25,860 4,175 21,685 3,100 $ 18,585
(Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations) (Income from operations + Other revenues – Other expenses = Income before income tax)
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PROBLEM 5-7B (CONTINUED) (d) (continued) FASHION CENTRE LTD. Statement of Changes in Equity Year Ended November 30, 2018 Common Shares Balance, December 1, 2017 Issued common shares Net income Dividends declared Balance, November 30, 2018
$ 11,400 5,000 _______ $ 16,400
Retained Earnings $30,000 18,585 (10,000) $ 38,585
Total Equity $41,400 5,000 18,585 (10,000) $ 54,985
FASHION CENTRE LTD. Statement of Financial Position November 30, 2018
Assets Current assets Cash ........................................................................................ $22,000 Accounts receivable ................................................................ 30,600 Inventory ................................................................................... 25,000 Supplies .................................................................................... 950 Prepaid insurance .................................................................... 1,200 Total current assets .............................................................................. Long-term investments ........................................................................................... Property, plant, and equipment Equipment ................................................................................ $26,800 Less: Accumulated depreciation ............................................. 16,080 Total property, plant, and equipment.................................................... Total assets ...................................................................................................
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$ 79,750 37,000
10,720 $127,470
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-7B (CONTINUED) (d) (continued) Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................................................... Salaries payable ............................................................................................ Interest payable ............................................................................................. Income tax payable ....................................................................................... Unearned revenue ......................................................................................... Current portion of bank loan payable ............................................................. Total current liabilities .......................................................................... Non-current liabilities Bank loan payable* ........................................................................................ Total liabilities ....................................................................................... Shareholders’ equity Common shares ....................................................................... $16,400 Retained earnings .................................................................... 38,585 Total shareholders’ equity.................................................................... Total liabilities and shareholders’ equity .......................................................
$ 34,400 1,210 175 1,100 600 5,000 42,485 30,000 72,485
54,985 $127,470
*($35,000 – $5,000) LO 4 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 5-8B (a)
Gross profit margin
$823,400 ÷ $2,210,600 = 37.2%
Profit margin
$129,500 ÷ $2,210,600 = 5.9%
(b) Net Sales
Gross Profit
Net Income
Existing balances Increase sales ($2,210,600 × 10%) Increase in gross profit Increase in operating expenses Increase in income tax expense
$2,210,600 221,060
$823,400
$129,500
60,000
60,000 (32,000) (4,000)
Revised amounts
$2,431,660
$883,400
$153,500
(c)
Revised gross profit margin Revised profit margin
$883,400 ÷ $2,431,660 =
36.3%
$153,500 ÷ $2,431,660 = 6.3%
While the gross profit margin decreases slightly, the profit margin increases from 5.9% to 6.3%. The plan has increased net income, so it has merit. LO 5 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 5-9B (a) [1]
Sales
= $400,000 (given) [8]Accounts receivable = Sales × 20% = $400,000 × 20% = $80,000
(b) [2]
Cost of goods sold
[9]
Inventory
= 80% × inventory purchased = 80% × $200,000 = $160,000 = 20% × inventory purchased = 20% × $200,000 = $40,000 or purchases less cost of goods sold = $200,000 less $160,000 = $40,000 = 25% × inventory purchased = 25% × $200,000 = $50,000
[10] Accounts payable
(c) [3]
Gross profit
[4] [5]
Operating expenses Income before income taxes
(d) [6]
Income tax expense
[7]
Net income
[11] Income tax payable (e) Gross profit margin Profit margin
Solutions Manual .
= Sales – Cost of goods sold = $400,000 – $160,000 = $240,000 = $140,000 (given) = Gross profit – Operating expenses = $240,000 – $140,000 = $100,000 = Income before income taxes × 30% = $100,000 × 30% = $30,000 = Income before income taxes – Income tax expense = $100,000 – $30,000 = $70,000 = given as equal to income tax expense = $30,000 = $240,000 ÷ $400,000 = 60.0% = $70,000 ÷ $400,000 = 17.5%
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PROBLEM 5-9B (CONTINUED) (e)
Although Tsang Inc. may sell its product at the same price as other companies in the industry, its cost of goods sold percentage may be higher compared with other companies in the industry. Because the business is new, it might not yet enjoy the economies of scale and have strong relationships with suppliers that allow them to buy at competitive prices. Tsang may be unable to negotiate lower purchase prices for merchandise and therefore experiences lower gross profit margins compared to its competitors. Similarly, other competitors are likely larger businesses that enjoy cost savings through economies of scale. Tsang is a new business and does not enjoy this advantage and experiences higher operating costs yielding a lower profit margin.
LO 4,5 BT: AN Difficulty: C Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 5-10B (a)
[in SEK (Swedish krona) millions] 2015
Current ratio
Gross profit margin Profit margin
(b)
2014
2013
170,687 ÷ 155,860
177,302 ÷ 136,393
163,612 ÷ 140,316
= 1.1:1
= 1.3:1
= 1.2:1
(312,515 – 240,653) 312,515
(282,948 – 220,012) 282,948
(272,622 – 212,504) 272,622
= 23.0%
= 22.2%
= 22.1%
15,099 ÷ 312,515
2,235 ÷ 282,948
3,802 ÷ 272,622
= 4.8%
= 0.8%
= 1.4%
Volvo’s current ratio increased (improved) from 2013 to 2014 but decreased (deteriorated) in 2015. Volvo’s gross profit margin increased slightly in 2014 and experienced another increase (improvement) in 2015. On the other hand, the company’s profit margin was very low in 2013 and 2014, but then improved dramatically in 2015.
(c)
Current ratio Gross profit margin Profit margin
2015 Industry Average 1.2:1 16.3% 2.5%
2015 Volvo 1.1:1 23.0% 4.8%
Volvo’s 2015 current ratio is slightly lower (worse) and its gross profit margin considerably higher (better) than the industry averages, indicating that the company is performing much better than other companies in the industry. Its 2015 profit margin is also substantially higher (better) than the average company in the industry. LO 5 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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*PROBLEM 5-11B (a) July
2 3 6 7 9 11
13
16 17 20
27
Solutions Manual .
Purchases (75 × $60) ............................................. Accounts Payable ..........................................
4,500
Accounts Payable (4 × $60).................................. Purchase Returns and Allowances ...............
240
Accounts Receivable (55 × $90) ............................. Sales ..............................................................
4,950
Sales Returns and Allowances ............................... Accounts Receivable (3 × $90) ......................
270
Accounts Receivable (3 × $100) ............................. Sales ..............................................................
300
Accounts Payable ($4,500 – $240) ........................ Purchase Discounts ($4,260 × 2%) ............. Cash ($4,260 – $85) ....................................
4,260
Accounts Receivable (25 × $100)........................... Sales ...........................................................
2,500
Purchases (70 × $62) ............................................. Accounts Payable ........................................
4,340
Sales Returns and Allowances ............................... Accounts Receivable (5 × $100)..................
500
Cash ($4,980 – $100) .......................................... Sales Discounts $4,980 × 2%) ............................... Accounts Receivable ($4,950 – $270 + $300) ..............................
4,880 100
Cash ($2,000 – $40) ............................................... Sales Discounts ($2,000 × 2%) .............................. Accounts Receivable ($2,500 – $500).........
1,960 40
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4,500 240 4,950 270 300 85 4,175 2,500
4,340 500
4,980
2,000
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-11B (CONTINUED) (b)
The advantages of the periodic inventory system are that it is simpler and cheaper (in terms of equipment and systems) compared to a perpetual inventory system. There are fewer accounting entries and cash registers do not need to be able to read bar codes to apply the appropriate cost, as is required in the perpetual inventory system. However, a perpetual inventory system enables management to monitor purchases and sales to make the optimum use of the money available for stocking inventory. Fewer stock-outs are experienced when using the perpetual system as reductions in inventory levels can be quickly identified and restocking done, possibly automatically, before the business runs out of inventory. With the perpetual system, cost of goods sold can be reported at any time and consequently, timely reporting of results can be achieved. Perpetual systems allow management to quantify the cost of goods lost to theft. When customers make inquiries concerning the availability of stock from a merchant, a quick reply can be obtained and provided when a perpetual inventory system is used. Finally, fewer inventory counts are required, saving salary costs and minimizing lost sales from having to close the business for inventory counts.
LO 1,6 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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*PROBLEM 5-12B (a) Oct.
1
1
2
6
8
9
10
12
15
17
28
Purchases............................................................................. Accounts Payable ........................................................
86,000
Freight In .............................................................................. Cash ............................................................................
1,400
Accounts Payable ................................................................. Purchase Returns and Allowances ..............................
4,000
Supplies ................................................................................ Cash ............................................................................
2,800
Accounts Receivable ............................................................ Sales............................................................................
140,000
Freight Out............................................................................ Cash ............................................................................
2,300
Equipment ............................................................................ Accounts Payable ........................................................
62,000
Sales Returns and Allowances ............................................. Accounts Receivable ...................................................
3,500
Purchases............................................................................. Cash ............................................................................
36,300
Cash ($136,500 – $2,730) .................................................... Sales Discounts [($140,000 – $3,500) × 2%] ....................... Accounts Receivable ($140,000 – $3,500) .................
133,770 2,730
Accounts Receivable ............................................................ Sales ...........................................................................
30,000
86,000
1,400
4,000
2,800
140,000
2,300
62,000
3,500
36,300
136,500
30,000
29
No entry necessary.
30
Accounts Payable ($86,000 – $4,000) .................................. Cash............................................................................
82,000
Sales Returns and Allowances ............................................. Accounts Receivable...................................................
5,000
31
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82,000
5,000
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 5-12B (CONTINUED) (b) Oct.
14
Accounts Payable ($86,000 – $4,000) ........................... Purchase Discounts ($82,000 × 1%) ................... Cash ($82,000 – $820) ........................................
82,000 820 81,180
The cost of missing this purchase discount is the amount recorded as a purchase discount when the payment was made within the discount period to October 16 ($820). Expressing this in terms of an annual interest rate, it would be the equivalent of paying 24.6% ($820 ÷ $81,180 × 365/15) for the use of the money for 15 days. LO 6 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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*PROBLEM 5-13B (a) Apr.
2
3
5
9
11
13
16
18
20
21
23
25
27
28
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Purchases .................................................................. Accounts Payable ..............................................
5,800
Freight In .................................................................... Cash ..................................................................
160
Accounts Payable ....................................................... Purchase Returns and Allowances ....................
100
Supplies...................................................................... Cash ..................................................................
1,130
Accounts Payable ($5,800 – $100) ............................ Purchase Discounts ($5,700× 2%) .................... Cash ($5,700 – $114) ........................................
5,700
Purchases .................................................................. Cash ..................................................................
1,560
Freight In .................................................................... Cash ..................................................................
115
Cash .......................................................................... Purchase Returns and Allowances ....................
110
Accounts Receivable .................................................. Sales .................................................................
11,100
Sales Returns and Allowances .................................. Accounts Receivable ........................................
1,000
Equipment ................................................................. Accounts Payable .............................................
11,700
Accounts Receivable ................................................. Sales .................................................................
9,800
Cash .......................................................................... Accounts Receivable
9,800
Sales Returns and Allowances .................................. Accounts Receivable ........................................
150
5-95
5,800
160
100
1,130
114 5,586
1,560
115
110
11,100
1,000
11,700
9,800
9,800
150 Chapter 5
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*PROBLEM 5-13B (CONTINUED) (b)
Apr. 1 Bal. Apr. 18 Apr. 27
Apr. 30 Bal.
Cash 16,400 Apr. 3 110 Apr. 9 9,800 Apr. 11 Apr. 13 Apr. 16 17,759
Accounts Receivable 11,100 Apr. 21 9,800 Apr. 27 Apr. 28 Apr. 30 Bal. 9,950 Apr. 20 Apr. 25
160 1,130 5,586 1,560 115
1,000 9,800 150
Inventory Apr. 1 Bal. 16,200 Apr. 30 Bal. 16,200
Apr. 9 Apr. 30 Bal.
Supplies 1,130 1,130
Apr. 2 Apr. 13 Apr. 30 Bal.
Accounts Payable 100 Apr. 2 5,700 Apr. 23 Apr. 30 Bal.
5,800 11,700 11,700
Purchase Discounts Apr. 11 Apr. 30 Bal.
114 114
Apr. 3 Apr. 16 Apr. 30 Bal.
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20,000 20,000
Retained Earnings Apr. 1 Bal. Apr. 30 Bal.
12,600 12,600
Sales Apr. 20 Apr. 25 Apr. 30 Bal.
11,100 9,800 20,900
Sales Returns and Allowances Apr. 21 1,000 Apr. 28 150 Apr. 30 Bal. 1,150
Equipment Apr. 23 11,700 Apr. 30 Bal. 11,700
Apr. 5 Apr. 11
Common Shares Apr. 1 Bal. Apr. 30 Bal.
Purchases 5,800 1,560 7,360
Purchase Returns and Allowances Apr. 5 100 Apr. 18 110 Apr. 30 Bal. 210
Freight In 160 115 275
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(c) GRAND SLAM TENNIS SHOP Trial Balance April 30, 2018
Cash....................................................................................... Accounts receivable ............................................................... Inventory ................................................................................ Supplies ................................................................................. Equipment .............................................................................. Accounts payable ................................................................... Common shares..................................................................... Retained earnings .................................................................. Sales ...................................................................................... Sales returns and allowances ................................................ Purchases .............................................................................. Purchase returns and allowances .......................................... Purchase discounts ................................................................ Freight in ................................................................................
Debit $ 17,759 9,950 16,200 1,130 11,700
Credit
$11,700 20,000 12,600 20,900 1,150 7,360
275 $65,524
210 114 00 000 $65,524
(Total debit account balances = Total credit account balances)
(d) Apr. 30
Inventory (ending) .................................................... Cost of Goods Sold .................................................. Purchase Returns and Allowances .......................... Purchase Discounts ................................................. Inventory (beginning) .......................................... Purchases ........................................................... Freight In.............................................................
11,571 11,940* 210 114 16,200 7,360 275
*Cost of goods sold = Beginning inventory + Purchases – Purchase discounts – Purchase returns and allowances + Freight in – Ending inventory Cost of goods sold = $16,200 + $7,360 – $114 – $210 + $275 – $11,571 = $11,940 LO 6 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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*PROBLEM 5-14B (a) SEVERN LIMITED Income Statement (Partial) Year Ended June 30, 2018 Sales revenue Sales ............................................................................. $7,800,000 Less: Sales discounts .................................................. 100,000 Net sales ....................................................................... Cost of goods sold Inventory, July 1, 2017 .................................................. $ 520,000 Purchases .................................................. $6,280,000 Less: Purchase returns and allowances .... . 240,000 Net purchases............................................ .. 6,040,000 Add: Freight in .......................................... 80,000 Cost of goods purchased .............................................. 6,120,000 Cost of goods available for sale .................................... 6,640,000 Inventory, June 30, 2018 .............................................. 600,000 Cost of goods sold ................................................ Gross profit .......................................................................
$7,700,000
6,040,000 $1,660,000
(Beginning inventory + Net purchases + Freight-in = Cost of goods purchased)
(b) June 30
Inventory (ending) .................................................... Cost of Goods Sold .................................................. Purchase Returns and Allowances .......................... Inventory (beginning) .......................................... Purchases ........................................................... Freight In.............................................................
600,000 6,040,000 240,000 520,000 6,280,000 80,000
(c) Gross profit margin: $1,660,000 $7,700,000
= 21.6%
Severn’s gross profit margin of 21.6% is less than the industry average of 26%. This indicates that Severn is making less gross profit than the industry average on its sales. LO 5,6 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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*PROBLEM 5-15B THE GOODY SHOP LTD. Income Statement Year Ended November 30, 2018
Sales revenue Sales ......................................................................................... Less: Sales discounts .............................................................. Sales returns and allowances ......................................... Net sales ................................................................................... Cost of goods sold Inventory, December 1, 2017 .................................................... Purchases .......................................................... $684,700 Less: Purchase discounts .................................... 16,000 Purchase returns and allowances .............. 3,315 Net purchases ...................................................... 665,385 Add: Freight in ...................................................... 5,060 Cost of goods purchased .......................................................... Cost of goods available for sale ................................................ Inventory, November 30, 2018 .................................................. Cost of goods sold .............................................................. Gross profit ...................................................................................... Operating expenses Administrative expenses ............................................................ Selling expenses....................................................................... Total operating expenses ................................................... Income from operations ................................................................... Other revenues and expenses Interest expense ....................................................................... Income before income tax .............................................................. Income tax expense ....................................................................... Net income .....................................................................................
$989,000 $15,000 10,000
25,000 964,000
$ 34,360
670,445 704,805 37,350 667,455 296,545 $230,100 8,200 238,300 58,245 11,315 46,930 10,000 $ 36,930
(Beginning inventory + Net purchases + Freight-in = Cost of goods purchased)
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*PROBLEM 5-15B (CONTINUED) THE GOODY SHOP LTD. Statement of Changes in Equity Year Ended November 30, 2018 Common Shares Balance, December 1, 2017 Issued common shares Net income Dividends declared Balance, November 30, 2018
$ 1,000 25,000 000000 $26,000
Retained Earnings
Total Equity
$ 82,800
$ 83,800 25,000 36,930 (5,000) $140,730
36,930 (5,000) $114,730
(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)
THE GOODY SHOP LTD. Statement of Financial Position November 30, 2018
Assets Current assets Cash ...................................................................................................... Accounts receivable ............................................................................. Inventory ................................................................................................ Prepaid insurance .................................................................................. Total current assets ...................................................................... Property, plant, and equipment Land.................................................................................. $ 85,000 Buildings ..................................................... $175,000 Less: Accumulated depreciation ................. 61,200 113,800 Equipment .................................................. $57,000 Less: Accumulated depreciation ................. 19,880 ...... 37,120 Total property, plant, and equipment ........................................... Total assets ...........................................................................................
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$ 8,500 13,770 37,350 4,500 64,120
235,920 $300,040
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*PROBLEM 5-15B (CONTINUED) Liabilities and Shareholders’ Equity Current liabilities Accounts payable ............................................................................ Unearned revenue ........................................................................... Salaries payable .............................................................................. Property tax payable ........................................................................ Income tax payable ......................................................................... Current portion of mortgage payable ............................................... Total current liabilities ............................................................ Non-current liabilities Mortgage payable ($106,000 – $5,300) ......................................... Total liabilities ......................................................................... Shareholders’ equity Common shares ........................................................ $ 26,000 Retained earnings ..................................................... 114,730 Total shareholders’ equity....................................................... Total liabilities and shareholders’ equity ..........................................
$ 32,310 3,000 8,500 3,500 6,000 5,300 58,610 100,700 159,310
140,730 $300,040
LO 6 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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ACR5-1
Financial Accounting, Seventh Canadian Edition
ACCOUNTING CYCLE REVIEW
(a) Date
Account Titles
March 1
Cash ................................................................ Accounts Receivable ..............................
125,000
Accounts Payable ............................................ Inventory ................................................ Cash ($200,000 – $4,000) ......................
200,000
Inventory .......................................................... Accounts Payable ...................................
300,000
Cash ................................................................ Sales .......................................................
285,000
Cost of Goods Sold .......................................... Inventory .................................................
200,000
Accounts Payable ............................................ Inventory .................................................
25,000
2
5
6
7
4,000 196,000
300,000
285,000
200,000
25,000
No entry necessary
9
Accounts Receivable ....................................... Sales .......................................................
200,000
Cost of Goods Sold .......................................... Inventory .................................................
140,000
Freight Out....................................................... Cash .......................................................
5,000
Cash ................................................................ Unearned Revenue.................................
12,500
12
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Credit
125,000
8
9
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Debit
200,000
140,000
5,000
12,500
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ACR5-1 (CONTINUED) (a) (continued) Date
Account Titles
March 13
Sales Returns and Allowances ........................ Accounts Receivable ..............................
20,000
Inventory .......................................................... Cost of Goods Sold .................................
14,000
Accounts Payable ($300,000 – $25,000) ......... Inventory ($275,000 × 2%) ..................... Cash ($300,000 – $25,000 – $5,500)
275,000
Salaries Expense ............................................. Cash .......................................................
45,000
Cash ($200,000 – $20,000 – $3,600) ............. Sales Discounts ($180,000 × 2%) .................. Accounts Receivable ($200,000 – $20,000).......................
176,400 3,600
Cash ............................................................... Sales......................................................
255,000
Cost of Goods Sold ........................................ Inventory ................................................
179,000
Salaries Expense ............................................ Cash ......................................................
50,000
Rent Expense ................................................. Cash ......................................................
5,000
Utilities Expense ............................................. Accounts Payable ..................................
10,000
Salaries Expense ............................................ Salaries Payable ....................................
10,000
Interest Expense ............................................. Interest Payable .....................................
9,000
14
16
19
20
27 30
31
31
31
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Debit
Credit
20,000
14,000
5,500 269,500
45,000
180,000
255,000
179,000
50,000 5,000
10,000
10,000
9,000 Chapter 5
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (a) (continued) Date
Account Titles
March 31
Depreciation Expense..................................... Accumulated Depreciation—Equipment ($145,000 ÷ 10 years = $14,500)
14,500
Income Tax Expense ...................................... Income Tax Payable ..............................
50,000
31
Debit
Credit
14,500
50,000
(b), (d), and (g) CE = Closing entry Cash
Inventory
Feb. 28 Bal.
65,000
Feb. 28 Bal. 2,750,000
Mar.
1
125,000 Mar.
2
196,000
6
285,000
9
5,000
12
12,500
14
19
176,400
20
255,000
5
300,000 Mar.
2
4,000
13
14,000
6
200,000
269,500
7
25,000
16
45,000
9
140,000
27
50,000
14
5,500
30
5,000
20
179,000
Mar. 31 Bal. 348,400
Mar.
Mar. 31 Bal. 2,510,500
Accounts Receivable
Supplies
Feb. 28 Bal. 350,000 Mar.
9
200,000 Mar.
Mar. 31 Bal. 225,000
Solutions Manual .
1
125,000
13
20,000
19
180,000
Feb. 28 Bal.
7,500
Mar. 31 Bal.
7,500 Prepaid Rent
Feb. 28
Bal.
5,000
Mar. 31
Bal.
5,000
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (b), (d), and (g) (continued) Equipment
Income Tax Payable
Feb. 28 Bal.
145,000
Mar.
31
50,000
Mar. 31 Bal.
145,000
Mar.
31
Bal. 50,000
Accumulated Depreciation —Equipment
Common Shares
Feb.
28 Bal.
29,000
Mar.
31
14,500
Mar.
31 Bal.
43,500
Feb.
28
Bal.
200,000
Mar.
31
Bal.
200,000
Retained Earnings Accounts Payable Feb. Mar.
Feb.
28 Bal. 1,550,000
2
200,000 Mar.
5
300,000
7
25,000
31
10,000
14
275,000 Mar.
31 Bal. 1,360,000
Salaries Payable
Mar. 31 CE
50,000 Mar. Mar.
28 Bal.
550,500
31
570,900
CE
31 Bal. 1,071,400
Dividends Declared Feb . 28 Bal. Mar . 31 Bal.
50,000 50,000 Mar. 31 CE
Mar. 31
10,000
Mar. 31 Bal.
10,000
Mar . 31 Bal.
Interest Payable
50,000
0 Sales
Mar.
31
9,000
Feb. 28 Bal. 5,479,400
Mar.
31 Bal.
9,000
Mar.
Unearned Revenue Feb.
28 Bal.
35,000
Mar.
12
12,500
Mar.
31 Bal.
47,500
6
285,000
9
200,000
20
255,000
Mar. 31 Bal. 6,219,400 Mar. 31 CE 6,219,400 Mar. 31 Bal.
Bank Loan Payable
Solutions Manual .
Feb.
28 Bal. 450,000
Mar.
31 Bal. 450,000 5-105
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0
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (b), (d), and (g) (continued) Sales Returns and Allowances
Freight Out
Feb. 28 Bal. 107,000
Feb. 28 Bal. 180,000
Mar. 13
Mar.
20,000
Mar. 31 Bal. 127,000
5,000
Mar. 31 Bal. 185,000 Mar. 31
Mar. 31 Bal.
9
CE 127,000
0
Mar. 31 CE Mar. 31
Sales Discounts
Bal.
0
Depreciation Expense
Feb. 28 Bal.
65,000
Feb. 28 Bal.
Mar. 19
3,600
Mar. 31
14,500
Mar. 31 Bal.
68,600
Mar. 31 Bal.
14,500
Mar. 31 CE Mar. 31
Bal.
0
Mar. 31 CE Mar. 31
Bal.
200,000 Mar.
9
140,000
20
179,000
13
14,000
Feb. 28 Bal.
27,000
Mar. 31
9,000
Mar. 31 Bal.
36,000
Mar. 31
Bal.
Mar. 31 CE 4,348,900 Bal.
0
Advertising Expense Feb. 28 Bal.
75,000
Mar. 31 Bal.
75,000
Bal.
Solutions Manual .
0 Office Expense
Feb. 28 Bal.
26,000
Mar. 31 Bal.
26,000 Mar. 31 CE 26,000
Mar. 31 Mar. 31 CE
Mar. 31
0
Mar. 31 CE 36,000
Mar. 31 Bal. 4,348,900 Mar. 31
14,500
Interest Expense
Feb. 28 Bal. 3,843,900 6
0
68,600
Cost of Goods Sold Mar.
185,000
Bal.
0
75,000
0
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (b), (d), and (g) (continued) Rent Expense
Utilities Expense
Feb. 28 Bal.
55,000
Feb. 28
Mar. 30
5,000
Mar. 31
Mar. 31 Bal.
60,000
Mar. 31
Bal.
20,000 10,000
Bal.
30,000
Mar. 31 CE 60,000 Mar. 31
Bal.
0
Mar. 31 CE Mar. 31
Bal.
Salaries Expense
30,000
0 Income Tax Expense
Feb. 28
Bal. 360,000
Feb. 28
Bal.
150,000
Mar. 16
45,000
Mar. 31
50,000
27
50,000
Mar. 31 Bal.
200,000
31
10,000
Mar. 31
Bal. 465,000
Mar. 31 CE Mar. 31
Bal.
200,000
0
Mar. 31 CE 465,000 Mar. 31
Bal.
Income Summary
0
Mar. 31 CE 5,648,500 Mar. 31 CE 6,219,400 CE
Travel Expense Feb. 28
Bal.
12,500
Mar. 31
Bal.
12,500
Bal. Mar. 31 CE
Mar. 31
Bal.
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570,900 0
12,500
0
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (c) HERITAGE FURNITURE LIMITED Trial Balance March 31, 2018 Debit $ 348,400 225,000 2,510,500 7,500 5,000 145,000
Cash Accounts receivable Inventory Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Unearned revenue Bank loan payable—non-current Common shares Retained earnings Dividends declared Sales Sales returns and allowances Sales discounts Advertising expense Cost of goods sold Freight out Office expense Rent expense Salaries expense Travel expense Utilities expense Interest expense Income tax expense
Credit
$ 29,000 1,350,000 47,500 450,000 200,000 550,500 50,000 6,219,400 127,000 68,600 75,000 4,348,900 185,000 26,000 60,000 455,000 12,500 20,000 27,000 150,000 $8,846,400
000000v 0 $8,846,400
(Total debit account balances = Total credit account balances)
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (e)
HERITAGE FURNITURE LIMITED Adjusted Trial Balance March 31, 2018 Debit Cash $ 348,400 Accounts receivable 225,000 Inventory 2,510,500 Supplies 7,500 Prepaid rent 5,000 Equipment 145,000 Accumulated depreciation—equipment Accounts payable Salaries payable Interest payable Unearned revenue Bank loan payable Income tax payable Common shares Retained earnings Dividends declared 50,000 Sales Sales returns and allowances 127,000 Sales discounts 68,600 Cost of goods sold 4,348,900 Advertising expense 75,000 Freight out 185,000 Depreciation expense 14,500 Office expense 26,000 Rent expense 60,000 Salaries expense 465,000 Travel expense 12,500 Utilities expense 30,000 Interest expense 36,000 Income tax expense 200,000 $8,939,900
Credit
$ 43,500 1,360,000 10,000 9,000 47,500 450,000 50,000 200,000 550,500 6,219,400
000000v 0 $8,939,900
(Total debit account balances = Total credit account balances)
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (f) HERITAGE FURNITURE LIMITED Income Statement Year Ended March 31, 2018 Sales revenue Sales Less: Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit Operating expenses Salaries expense Freight out Advertising expense Rent expense Utilities expense Office expense Depreciation expense Travel expense Total operating expenses Income from operations Other revenues and expenses Interest expense Income before income tax Income tax expense Net income
$6,219,400 $127,000 68,600
195,600 6,023,800 4,348,900 1,674,900
$465,000 185,000 75,000 60,000 30,000 26,000 14,500 12,500 868,000 806,900 36,000 770,900 200,000 $ 570,900
(Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations) (Income from operations + Other revenues – Other expenses = Income before income taxes)
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (f) (continued) HERITAGE FURNITURE LIMITED Statement of Changes in Equity Year Ended March 31, 2018 Common Shares Balance, April 1, 2017 Issued common shares Net income Dividends declared Balance, March 31, 2018
$199,000 1,000 00 00000 $200,000
Retained Earnings
Total Equity
$ 550,500
$ 749,500 1,000 570,900 (50,000) $1,271,400
570,900 (50,000) $1,071,400
(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (f) (continued) HERITAGE FURNITURE LIMITED Statement of Financial Position March 31, 2018 Assets Current assets Cash Accounts receivable Inventory Supplies Prepaid rent Property, plant and equipment Equipment Less: Accumulated depreciation Total assets
$ 348,400 225,000 2,510,500 7,500 5,000 $145,000 43,500
$3,096,400
101,500 $3,197,900
Liabilities and Shareholders’ Equity Current liabilities Accounts payable Salaries payable Interest payable Unearned revenue Income tax payable Current portion of bank loan payable Total current liabilities Non-current liabilities* Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total liabilities and shareholders’ equity *($450,000 - $45,000 current)
Solutions Manual .
$1,360,000 10,000 9,000 47,500 50,000 45,000 1,521,500 405,000 1,926,500 $ 200,000 1,071,400
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Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (g) Date
Account Titles
March 31
Sales .............................................................. Income Summary ...................................
6,219,400
31 Income Summary ............................................. Sales Returns and Allowances ................ Sales Discounts ....................................... Advertising Expense ................................ Cost of Goods Sold .................................. Freight out ................................................ Depreciation Expense .............................. Interest Expense ...................................... Office Expense......................................... Rent Expense .......................................... Salaries Expense ..................................... Travel Expense ........................................ Utilities Expense ...................................... Income Tax Expense ...............................
5,648,500
31 Income Summary ............................................. Retained Earnings ..................................
570,900
31 Retained Earnings ........................................... Dividends Declared ..................................
50,000
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Debit
Credit
6,219,400
127,000 68,600 75,000 4,348,900 185,000 14,500 36,000 26,000 60,000 465,000 12,500 30,000 200,000
570,900
50,000
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR5-1 (CONTINUED) (h) HERITAGE FURNITURE LIMITED Post-Closing Trial Balance March 31, 2018 Debit $ 348,400 225,000 2,510,500 7,500 5,000 145,000
Cash Accounts receivable Inventory Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Salaries payable Interest payable Unearned revenue Bank loan payable Income tax payable Common shares Retained earnings
000000000 $3,241,400
Credit
$ 43,500 1,360,000 10,000 9,000 47,500 450,000 50,000 200,000 1,071,400 $3,241,400
(Total debit account balances = Total credit account balances) LO 2,3,4 BT: AP Difficulty: M Time: 90 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT5-1
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
The North West Company is a merchandising company because it buys products and resells them to the public.
(b)
The North West Company classifies its operating expenses by function since captions include titles like “selling, operating and administrative expenses.”
(c)
Other non-operating expenses reported include interest expense totalling $6,210,000 for the fiscal year ended January 31, 2016.
(d) and (e) ($ in thousands)
2016
2015
Gross profit margin
$522,614 $1,796,035
= 29.1%
$464,218 $1,624,400
=
28.6%
Profit margin
$69,779 $1,796,035
= 3.9%
$62,883 $1,624,400
=
3.9%
(f)
The company’s profitability has remained relatively constant for the fiscal year ended January 31, 2016, with a slight increase in gross profit margin. With an increase in the gross profit margin and an unchanged profit margin, we can conclude that North West either had increased operating expenses or interest expenses. In fact it was the result of increased operating expenses.
LO 1,4,5 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT5-2 (a)
1.
2.
Percentage change in sales
Gross profit margin
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE The North West Company (in millions)
Sobeys (in millions)
($1,796.0 – $1,624.4) $1,624.4
($24,618.8 – $23,928.8) $23,928.8
= 10.6%
= 2.9%
($1,796.0 – $1,273.4) $1,796.0
(24,618.8 - $18,661.2) $24,618.8
= 29.1%
= 24.2%
(b)
North West had the bigger increase in sales. In fiscal 2015, North West’s gross profit was 28.6% ($464,218 ÷ $1,624,400). North West was able to increase its gross profit margin. We can conclude that North West is doing well managing its purchasing and pricing policies.
(c)
Sobeys experienced an increase in sales but had a decreased gross margin. Gross margin was $5,962.5 (23,928.8 – 17,966.3) in 2015 and dropped slightly to $5,957.6 (24,618.8 – 18,661.2) in 2016. This could have been caused by mismanagement of inventory, lower selling prices, or purchasing price constraints.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT5-3
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
The main difference between these two income statements is that Happy Coffee presents its expense items by function (such as general and administrative expenses) while Country Coffee presents its expenses by nature of the expense item. Under IFRS, Happy Coffee is required to also disclose the total depreciation expense and salaries and benefits expense in the notes to the financial statements.
(b)
Under IFRS both formats of expense presentation, by nature or by function, are acceptable. ASPE does not have a requirement on how to report expenses. Expenses under ASPE can be classified in any manner that would be useful to the key stakeholders. The method that classifies expenses by function can require a higher degree of judgement since expenses have to be allocated to each of the functional categories (depending on how many functional categories are present). In the case of Happy Coffee, there are three categories—cost of goods sold, selling expenses, and administrative expenses. This method provides better information to the reader despite the requirement for increased judgement.
(c)
The difference in format could make it difficult to compare expense items. For example, expense items as a percentage of sales would not be comparable. However, Country Coffee can still easily compare the key profitability measures of gross profit margin and profit margin. These profitability ratios are not dependent on the expense classifications.
(d)
No, comparability of the gross profit margin and profit margin will not be impacted. The definitions of gross profit and net income do not change when preparing the income statements with a different format.
(e)
Country Coffee can change the presentation of its income statement and begin classifying its expenses by function. This would be an acceptable presentation under ASPE. Under IFRS, if a company chooses to report its expenses by function it must still disclose total depreciation and salaries and benefit expense in the note disclosures. Country Coffee could use this additional information from the notes of Happy Coffee for improved comparability.
LO 4,5 BT: E Difficulty: C Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT5-4
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a)
The CEO asked for three inappropriate adjustments to be made to the financial statements. By recording a purchase return as an increase in sales revenue, the sales revenue is now overstated and cost of goods sold is also overstated. By recording freight-in relating to inventory that has now been sold as an operating expense, it overstates operating expense while understating cost of goods sold. Finally by recording a sales return as an operating expense, it overstates sales and overstates operating expenses. All of these adjustments were designed to boost gross profit in order to increase the bonus of the CEO. If we reverse the adjustments made, we get: 2018 Draft Adjustments 2018 Revised $(7,000) $113,000 (6,000) $100,000 5,000 62,000 (7,000) 60,000 51,000 (11,000) 40,000 (6,000) 21,000 (5,000) 10,000 30,000 0 30,000 9,000 0 9,000 $ 21,000 $ 0 $ 21,000
Net sales Cost of goods sold Gross profit Operating expenses Income from operations Income tax expense Net income Gross profit margin: $51,000 ÷ $113,000 Gross profit margin: $40,000 ÷ $100,000
45.1% 40.0%
When we calculate the gross profit margin using the revised amounts, we can see that it has not risen by more than 3% compared to the prior year of 40% ($32,000 ÷ $80,000) and because of this, the CEO will not eligible for his bonus.
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Financial Accounting, Seventh Canadian Edition
CT5-4 (CONTINUED) (b)
The profit margin in 2018 is 21.0% ($21,000 ÷ $100,000) which is unchanged from the prior year ($16,800 ÷ $80,000). However, in the first draft of the income statement, the profit margin was 18.6% ($21,000 ÷ $113,000), which is lower than the 21.0% determined using the correct amounts. This is because net sales were overstated even though overall profit was not.
(c)
Harm was done to the users of the financial statements. Assuming no corrections were made, the income statement would have been adjusted for the bonus given to the CEO. Many of the elements except for income tax expense reported in the statement are false and misleading. Users of the financial statements would not have obtained a true reflection of the performance trends of Peshawar Inc. and may have made inappropriate decisions based on misleading financial statements. Furthermore, the CEO would have been awarded a bonus that he did not deserve, thereby taking assets away from the company and its shareholders.
LO 2,3,5 BT: E Difficulty: C Time: 40 min. AACSB: Analytic and Ethics CPA: cpa-t001, cpa-e001, cpat005 CM: Reporting, Ethics, and Finance
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CT5-5
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
(a)
Rita Pelzer, as a new employee, is placed in a position of responsibility and is pressured by her supervisor to continue an unethical practice previously performed by him. The unethical practice is taking unearned cash discounts. Her dilemma is either to follow her boss’s unethical instructions or offend her boss and maybe lose the job she just assumed.
(b)
The stakeholders (affected parties) are: Rita Pelzer, the assistant controller Jamie Caterino, the controller (he looks good to superiors because of increased income) Zaz Stores Ltd., the company benefited Creditors of Zaz Stores Ltd. (suppliers harmed) Canada Post employees (those blamed harmed)
(c)
Ethically Rita should not continue the practice started by Jamie. She has several choices in that she could: 1.
Tell the controller (her boss) that she will attempt to take every allowable cash discount by preparing and mailing cheques within the discount period—the ethical thing to do. This will offend her boss and may jeopardize her continued employment.
2.
Comply with Jamie’s directions and continue the unethical practice of taking unearned cash discounts.
3.
Go over her boss’s head and take the chance of receiving just and reasonable treatment from an officer superior to Jamie. The company may not condone this practice. Rita definitely has a choice, but probably not without consequence. To continue the practice is definitely unethical. If Rita submits to this request, she may be asked to perform other unethical tasks. If Rita stands her ground and refuses to participate in this unethical practice, she probably won’t be asked to do other unethical things—if she isn’t fired. Maybe nobody has ever challenged Jamie’s unethical behaviour and his reaction may be one of respect rather than anger and retribution. Being ethically compromised is no way to start a new job.
LO 2 BT: C Difficulty: M Time: 30 min. AACSB: Ethics CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT5-6 (a) June
30
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
Inventory...................................................................... 1,750 Cost of Goods Sold ............................................ ($18,000 physical count – $16,250 perpetual record = $1,750 overage)
1,750
Note to instructors: June balances were taken from the answer to CT4-6.
June Bal.
Cash 34,534 (Ch. 4)
Accounts Receivable June Bal. 12,090 (Ch. 4) Inventory June Bal. 16,250 (Ch. 4) 30 AJE 1,750 June Bal. 18,000
June Bal.
Vehicles 52,500 (Ch. 4)
Accumulated Depreciation—Vehicles (Ch. 4) June Bal. 4,200
(Ch. 4)
Accounts Payable June Bal.
7,265
(Ch. 4)
Unearned Revenue June Bal.
1,000
(Ch. 4)
Salaries Payable June Bal.
1,000
Interest Payable June Bal.
50
June Bal.
Supplies 3,775 (Ch. 4)
June Bal.
Prepaid Insurance 6,000 (Ch. 4)
(Ch. 4)
Land Bal. (Ch. 4)
(Ch. 4)
Income Tax Payable June 30 AJE 5,000
(Ch. 4)
Bank Loan Payable June Bal.
22,500
(Ch. 4)
Mortgage Payable June Bal.
53,200
(Ch. 4)
Common Shares June Bal.
300
(Ch. 4)
Retained Earnings June Bal. 146,788
June 100,000
June 165,000
Buildings Bal. (Ch. 4)
Accumulated Depreciation—Buildings (Ch. 4) June Bal. 143,000
June 44,520
Equipment Bal. (Ch. 4)
Accumulated Depreciation—Equipment (Ch. 4) Bal. 21,070
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT5-6 (CONTINUED) (a) (continued)
Dividends Declared June Bal. 30,000 (Ch. 4)
(Ch. 4)
(Ch. 4)
Rent Revenue June 6,000 Sales June Bal.
Bal.
640,358
Cost of Goods Sold June Bal. 102,386 (Ch. 4) June 30 AJE 1,750 June Bal. 100,636
June Bal.
Salaries Expense 391,782 (Ch. 4)
Depreciation Expense June Bal. 16,770 (Ch. 4)
June Bal.
Office Expense 18,000 (Ch. 4)
June Bal.
Utilities Expense 13,225 (Ch. 4)
June Bal.
Advertising Expense 9,600 (Ch. 4)
Insurance Expense June Bal. 6,000 (Ch. 4)
June Bal.
Property Tax Expense 5,950 (Ch. 4)
June Bal.
Interest Expense 5,349 (Ch. 4)
June Bal.
Income Tax Expense 18,000
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT5-6 (CONTINUED) (b)
ANTHONY BUSINESS COMPANY LTD. Adjusted Trial Balance June 30, 2017 Debit Cash .............................................................................. Accounts receivable ....................................................... Inventory ........................................................................ Supplies ......................................................................... Prepaid insurance .......................................................... Land............................................................................... Buildings ........................................................................ Accumulated depreciation—buildings ............................ Equipment...................................................................... Accumulated depreciation—equipment .......................... Vehicles ......................................................................... Accumulated depreciation—vehicles.............................. Accounts payable........................................................... Unearned revenue ......................................................... Salaries payable ............................................................ Interest payable ............................................................. Income tax payable ........................................................ Bank loan payable ......................................................... Mortgage payable .......................................................... Common shares............................................................. Retained earnings .......................................................... Dividends declared ........................................................ Rent revenue ................................................................. Sales.............................................................................. Cost of goods sold ......................................................... Salaries expense ........................................................... Depreciation expense .................................................... Office expense ............................................................... Utilities expense ............................................................. Advertising expense ....................................................... Insurance expense......................................................... Property tax expense ..................................................... Interest expense ............................................................ Income tax expense ....................................................... Totals .....................................................................
$
Credit
34,534 12,090 18,000 3,775 6,000 100,000 165,000 $ 143,000 44,520 21,070 52,500 4,200 7,265 1,000 1,000 50 5,000 22,500 53,200 300 146,788 30,000 6,000 640,358
100,636 391,782 16,770 18,000 13,225 9,600 6,000 5,950 5,349 18,000 $1,051,731
000 0000 $1,051,731
(Total debit account balances = Total credit account balances)
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Financial Accounting, Seventh Canadian Edition
CT5-6 (CONTINUED) (c)
ANTHONY BUSINESS COMPANY LTD. Income Statement Year Ended June 30, 2017 Sales ............................................................................................................ Cost of goods sold ....................................................................................... Gross profit ..................................................................................................
$640,358 100,636 539,722
Operating expenses Salaries expense ............................................................ $391,782 Depreciation expense ...................................................... 16,770 Office expense................................................................. 18,000 Utilities expense .............................................................. 13,225 Advertising expense ........................................................ 9,600 Insurance expense .......................................................... 6,000 Property tax expense ...................................................... 5,950 Total operating expenses ........................................................... Income from operations ................................................................................
461,327 78,395
Other revenues and expenses Rent revenue ................................................................... $6,000 Interest expense.............................................................. 5,349 Income before income tax ............................................................................. Income tax expense ...................................................................................... Net income ...................................................................................................
651 79,046 18,000 $ 61,046
(Income from operations + Other revenues – Other expenses = Income before income taxes)
ANTHONY BUSINESS COMPANY LTD. Statement of Changes in Equity Year Ended June 30, 2017 Common Shares Balance, July 1, 2016 Net income Dividends declared Balance, June 30, 2017
$300 0000 $300
Retained Earnings
Total Equity
$146,788 61,046 (30,000) $177,834
$147,088 61,046 (30,000) $178,134
Note to instructors: Although ABC would most likely prepare a statement of retained earnings rather than a statement of changes in equity since it has been assumed that it is using ASPE, the statement of retained earnings is not explained in detail until Ch. 11 which is why we chose to require a statement of changes in equity here instead.
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Financial Accounting, Seventh Canadian Edition
CT5-6 (CONTINUED) (c) (continued) ANTHONY BUSINESS COMPANY LTD. Statement of Financial Position
June 30, 2017 Assets
Current assets Cash ................................................................................................................. Accounts receivable ......................................................................................... Inventory ........................................................................................................... Supplies ............................................................................................................ Prepaid insurance ............................................................................................. Total current assets ...............................................................................
$34,534 12,090 18,000 3,775 6,000 74,399
Property, plant, and equipment Land ........................................................................ $100,000 Buildings ................................................................. $165,000 Less: Accumulated depreciation.............................. 143,000 22,000 Equipment ............................................................... $44,520 Less: Accumulated depreciation.............................. 21,070 23,450 Vehicles .................................................................. $52,500 Less: Accumulated depreciation.............................. 4,200 48,300 Total property, plant, and equipment ..................................................... Total assets ...............................................................................................................
193,750 $268,149
Liabilities and Shareholders’ Equity
Current liabilities Accounts payable .............................................................................................. Unearned revenue ............................................................................................ Salaries payable ............................................................................................... Interest payable ................................................................................................ Income tax payable ........................................................................................... Current portion of bank loan payable................................................................. Current portion of mortgage payable ................................................................. Total current liabilities ............................................................................
$
7,265 1,000 1,000 50 5,000 7,500 5,000 26,815
Non-current liabilities Bank loan payable ($22,500 – $7,500) ............................................................. Mortgage payable ($53,200 – $5,000) .............................................................. Total liabilities .........................................................................................
15,000 48,200 90,015
Shareholders’ equity Common shares ............................................................................... $ 300 Retained earnings ............................................................................ . 177,834 Total shareholders’ equity....................................................................... Total liabilities and shareholders’ equity .....................................................................
Solutions Manual .
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178,134 $268,149
Chapter 5
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT5-6 (CONTINUED) (d) ABC
Competitor
Current ratio
$74,399 = 2.8:1 $26,815
2.5:1
Gross profit margin
$539,722 = 84.3% $640,358
75%
Current ratio
$61,046 = 9.5% $640,358
8%
(1)
Compared to its competitor, ABC’s ratios are better in every respect. ABC has better liquidity and profitability than its competitor.
(2)
We must recall that ABC is a small, family company while its competitor is a large, publicly-traded company. They likely have different product lines, cost structures, and other differences affecting its financial results.
LO 4,5 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
CHAPTER 6 REPORTING AND ANALYZING INVENTORY LEARNING OBJECTIVES 1. 2.
Describe the steps in determining inventory quantities. Apply the cost formulas using specific identification, FIFO, and average cost under a perpetual inventory system. 3. Explain the effects on the financial statements of choosing each of the inventory cost formulas. 4. Identify the effects of inventory errors on the financial statements. 5. Demonstrate the presentation and analysis of inventory. 6.* Apply the FIFO and average cost inventory cost formulas under a periodic inventory system (Appendix 6A).
Solutions Manual .
6-1
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT
Item LO
BT
Item LO
C
11.
2
BT
Item LO
BT
Item LO
BT
C
16.
5
C
21.
2,6
C
22.
2,6
C
Questions 1.
1
C
6.
2
2.
1
C
7.
2
K
12.
4
C
17.
5
K
3.
1
K
8.
2
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13.
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18.
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C
4.
1
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9.
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14.
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19.
2,6
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5.
2
C
10.
3
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15.
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C
20.
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C
C
10.
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AP
13.
6
AP
Brief Exercises 1.
1
K
4.
2
AN
7.
3
2.
1
AP
5.
2
AN
8.
4
C
11.
5
AP
14.
2,6
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3.
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AP
6.
2
AP
9.
4
AN
12.
5
AN
15.
2,6
AP
13.
3,6
AP
Exercises 1.
1
C
5.
2
AN
9.
4
AN
2.
1
AN
6.
2,3
AN
10.
5
AP
14.
6
AN
3.
2,3
AN
7.
2,3
AN
11.
5
AN
15.
2,6
AP
4.
2,3
AN
8.
4
AN
12.
3,5
AN
16.
2,6
AP
AP
Problems: Set A and B 1
AP
5.
2,3
2.
2
AP
6.
3.
2,3
AP
7.
4.
2,4
AN
8.
1.
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9.
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10.
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14.
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4,5
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11.
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AP
15.
2,6
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4,5
AN
12.
5
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16.
2,6
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2,3
AN
Accounting Cycle Review 1.
2
AN
1.
3
AN
3.
1,2,3,6
E
5.
2,3
AN
2.
5
AN
4.
4,5
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6.
1,2
E
Cases
Solutions Manual .
6-2
7.
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
Solutions Manual .
6-3
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
Taking a physical inventory involves actually counting, weighing or measuring each kind of inventory on hand. Retailers, such as hardware stores, generally have thousands of different items to count. This is normally done when the store is closed to minimize errors due to the movement of merchandise. Tom will probably count items and mark the quantity, description, and inventory number on pre-numbered inventory tags (unless the company has more advanced technology that can read bar codes on inventory products – we will assume that they do not). He should only include items in the inventory that are in saleable condition. Ideally, strong internal control should be exerted over the physical inventory count. For example, Tom should not have responsibility for the custody or record-keeping for the inventory. He should also count in teams of two, or there should be a second counter checking the accuracy of the count. Adjustments may also have to be made to the physical inventory count for any goods in transit. For example, inventory purchased FOB shipping point that is still in transit will have to be included in inventory. Inventory that has been shipped by Kikujiro to customers FOB destination and not received by the customer before year-end will also have to be included in the count. Finally, any of Kikujiro’s inventory held by other retailers on consignment will have to be included in the count as well.
LO 1 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
In a consignment agreement, the consignor is the business that owns the goods, and the consignee is the business that will sell the goods, without having to purchase and own the goods before they are sold. The consignee will sell the goods for the consignor for a fee or a percentage of the sales price. Only the owner of goods, the consignor, includes the goods in its inventory even though the goods are physically located on the consignee’s premises.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
(a)
The goods will be included in Janine Ltd.’s (the seller’s) inventory if the terms of sale are FOB destination.
(b)
The goods will be included in Fastrak Corporation’s (the buyer’s) inventory if the terms of sale are FOB shipping point.
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
4.
Financial Accounting, Seventh Canadian Edition
(a)
Include: the inventory items belong to Kingsway as Kingsway is the consignor.
(b)
Include: the inventory items belong to Kingsway while in transit because the terms are FOB shipping point.
(c)
Exclude: the customer has purchased the inventory item and legal ownership has passed to the customer.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
(a)
The unit cost of an inventory item is needed in order to prepare the entry to record the cost of goods sold and remove the cost of the items sold from inventory. Because units of the same inventory item are typically purchased at different prices, it is necessary to determine which unit costs to use in the calculation of the cost of the goods sold.
(b)
When using the perpetual system, an entry to record the cost of goods sold and remove the cost of the items sold from inventory is recorded at the same time as the sales transaction. The information from the perpetual system is updated, using the cost formula adopted by the business. The cost formula is also used in the detailed perpetual records for every increase in inventory caused by purchases, freight-in, etc. transactions. On the other hand, since a record is not kept of the individual inventory item transactions, under the periodic system, the entry to record the cost of goods sold and remove the cost of the items sold from inventory can only be made at the end of a reporting period, when ending inventory is determined by a physical count.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
(a)
(b)
The specific identification formula tracks the physical flow of individual inventory items, matching the cost of the actual item sold against the revenue from that item. The FIFO inventory cost formula assumes the first inventory purchased is the first inventory sold. The most recent purchases are assumed to remain in ending inventory. The average cost formula assumes that all goods available for sale are indistinguishable or homogeneous. An example of inventory where the specific identification would be appropriate would be for goods that are not ordinarily interchangeable, such as automobiles with unique vehicle identification numbers. Inventory such as groceries could be accounted for using the FIFO cost formula as older items are normally sold first. Inventory such as hardware could be accounted for using an average cost formula.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
6-5
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
7.
Financial Accounting, Seventh Canadian Edition
(a) Average cost or FIFO can be used if the goods available for sale are identical. Specific identification cannot be used if the goods are not specifically identifiable. (b) FIFO assumes that the first goods purchased are the first to be sold. (c) Specific identification merchandise.
matches
the
actual
physical
flow
of
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
8.
A new weighted average unit cost must be calculated after each purchase because a new cost amount is added to the “cost pool”. This changes the total dollars in the cost pool and the quantity of units on hand in the cost pool. A sale withdraws units and total dollars from the cost pool at the weighted average cost. This does not affect the weighted average cost of the remaining units. That is, the weighted average cost of the remaining units is unchanged after a sale.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
A company should consider: •
Whether the goods are interchangeable or not, or whether they are produced or segregated for specific projects;
•
Whether the formula corresponds most closely to the physical flow of goods;
•
Whether the formula reports inventory on the statement of financial position that is close to the inventory’s most recent cost; and
•
Whether the formula is used for other inventories with a similar nature and usage.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
Average cost produces the better income statement valuation because the cost of goods sold is determined using more recent inventory prices. This better matches current costs with current revenues. FIFO produces the better valuation on the statement of financial position because the ending inventory is determined using the most recent prices. Since the normal intent is to replace the inventory after it is sold, the most recent prices are more relevant for decision-making.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
11.
Financial Accounting, Seventh Canadian Edition
(a)
No effect – cash is not affected by the choice of inventory cost formulas.
(b)
In a period of declining prices, FIFO will produce a lower ending inventory as inventory is determined using the most recent (lower) prices. Average cost will produce a higher ending inventory as ending inventory incorporates the higher older prices.
(c)
The cost of goods sold effect is opposite to that of ending inventory. Hence, cost of goods sold will be higher under FIFO and lower under the average cost formula.
(d)
Because of the effect on the cost of goods sold as outlined in (c), net income will be lower under FIFO and higher under average cost.
(e)
The impact on retained earnings will be the same as the impact on net income and ending inventory—lower in a period of declining prices using FIFO and higher using average cost.
LO 2 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
The error should be corrected if it will change the figures presented on the financial statements. While retained earnings may not change, other financial statement items and comparative figures may change. This information may impact a user’s decision.
LO 4 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
(a)
(b) (c)
(d)
(e)
(f)
Solutions Manual .
Mila Ltd.’s 2018 income before tax will be understated by $43,000. This is because an understatement of ending inventory will result in an overstatement of cost of goods sold. If cost of goods sold is overstated, then income before tax will be understated. 2018 retained earnings will be understated by $43,000 because net income is understated (see (1) above). 2018 total shareholders’ equity will be understated by $43,000 because the retained earnings balance is understated (see (b) above). 2019 net income will be overstated $43,000. This is because beginning inventory is understated by $43,000, which will result in an understatement of cost of goods sold (recognizing that 2018 ending inventory is 2019 beginning inventory). If cost of goods sold is understated, then income before tax will be overstated. 2019 retained earnings will be correct because the understatement in net income in 2018 and overstatement in 2019 will cancel each other. 2019 total shareholders’ equity will be correct because the retained earnings balance is correct.
6-7
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
LO 4 BT: C Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
14.
(a)
At the end of the fiscal year, before the inventory is adjusted to the inventory count, Shediac’s assets (Inventory) would be overstated and its liabilities would be overstated (Accounts Payable). There would be no effect on shareholders’ equity.
(b)
Since the merchandise is not on hand at the time of the inventory count, the shipment from Bathurst would not be counted. This in turn would cause the inventory count to be lower than the perpetual inventory record. Normally when such a discrepancy arises, the Inventory account will be adjusted downward with a credit to reflect the amount of merchandise actually on hand. The corresponding debit in this adjusting entry would be to Cost of Goods Sold. The summary effect of the initial error and the count adjustment would be an overstatement in Cost of Goods Sold and Accounts Payable. Because Cost of Goods Sold is overstated, gross profit and net income are understated as well as Retained Earnings. At the end of Shediac’s current year, after the adjustment is made for the results of the inventory count, the overall impact on the accounting equation is no effect on assets, an overstatement of liabilities (Accounts Payable), and an understatement of shareholders’ equity (Retained Earnings).
LO 4 BT: C Difficulty: C Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
(a)
Cost refers to the original cost of inventory as determined by using specific identification, or the FIFO or average cost formulas. Net realizable value is the selling price less any costs required to make the goods ready for sale.
(b)
The lower of cost and net realizable value rule should be applied at the end of the accounting period, before financial statements are prepared.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
(a)
Cost of Goods Sold is debited when recording a decline in inventory value under the lower of cost and net realizable value rule and the asset account Inventory is credited.
(b)
These declines are usually considered part of the risk associated with carrying inventory and part of the costs of carrying a variety and quantity of goods on hand. Since the inventory has specifically been purchased for resale, the net realizable value becomes the most relevant measure of the asset on the statement of financial position.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
17.
Financial Accounting, Seventh Canadian Edition
An increase in the days in inventory ratio from one year to the next would be seen as deterioration in the company’s efficiency in managing inventory. It means that the inventory is being held for a longer period of time, which increases the risk of spoilage and obsolescence.
LO 5 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 cpa-t005 CM: Reporting
18.
(a)
An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory shortages may also cause customer ill will and result in lost future sales.
(b)
If the inventory turnover is too low, it may indicate that the company is having difficulty selling its inventory and the inventory may become obsolete.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 and cpa-t005. CM: Reporting and Finance
*19.
Periodic and perpetual inventory systems differ in the accounting treatment for inventories. Under a perpetual inventory system, inventory records are updated for every purchase and sale transaction. The cost of goods sold is recorded each time a sale is made. Under a periodic system, the inventory is only updated at the end of the period when a physical inventory count is performed. Inventory purchases throughout the year are debited to a Purchases account in a periodic inventory system rather than an Inventory account. When a sale is recorded in a periodic inventory system, no entry is made to record the cost of the sale. Cost of goods sold is calculated separately, after the physical inventory count is performed.
LO 2,6 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
*20.
Ending inventory is known as a result of the physical inventory count. To determine cost of goods sold, the total amount of inventory available for sale needs to be determined first in order to determine what inventory has been sold (goods available for sale – ending inventory = cost of goods sold). Goods sold are not tracked separately in a periodic inventory system.
LO 6 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
*21.
In both systems, the first (oldest) costs are the costs assigned to the goods sold. No matter what system is used, the cost of goods sold will always consist of the oldest units and these units are assumed to be on hand when using either formula.
LO 2,6 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
*22.
Financial Accounting, Seventh Canadian Edition
In a perpetual system, the average cost per item is recalculated every time a purchase transaction takes place. In a periodic system, the average cost is determined based on the total goods available for sale during the period. If there are cost changes during the period, the average cost per item will differ in a perpetual and periodic inventory system.
LO 2,6 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 (a)
Ownership of the goods belongs to the consignor (Helgeson). Thus, these goods should be included in Helgeson’s inventory.
(b)
Goods held on consignment belong to the other company and should not be included in Helgeson’s inventory.
(c)
The goods in transit belong to Helgeson because ownership does not transfer until the customer receives the goods. They should be included in Helgeson’s inventory.
(d)
The goods purchased belong to the buyer, Helgeson as the terms of shipment are FOB shipping point. Title transferred to Helgeson as soon as the goods were shipped, so even though they have not been received, they should be included in Helgeson’s inventory.
(e)
The goods in transit belong to the customer as the terms of shipment are FOB shipping point. They should not be included in Helgeson’s inventory because title transferred to the customer as soon as the goods were shipped.
(f)
The goods in transit should not be included in the inventory count because ownership by Helgeson does not occur until the goods reach the buyer.
(Legal title determines if an item should be included in inventory) LO 1 BT: K Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 6-2 $95,000 (7,500) (1,000) 5,000
Count Held on consignment Sold August 28 shipment plus freight, FOB shipping point ($4,750 + $250) $91,500 Correct inventory cost LO 1 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 6-3 (a)
Cost of Goods Available for Sale 3 electric pianos @ $600 = $1,800 2 electric pianos @ $475 = 950 $2,750 Ending Inventory (a) Specific Identification
2 pianos @ $600 = 1 piano @ $475 =
$1,200 475 $1,675
Cost of Goods Sold $2,750 – $1,675 = $1,075 (Proof: 1 piano @ $600 + 1 piano @ $475 = $1,075)
(b)
If management wished higher net income, it could have sold two pianos from the last shipment that had a lower cost. If it wished lower net income, it could have sold two of the first pianos purchased.
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 6-4 [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18]
$450 ÷ 30 = $15 15 (from April 1) $18 (from April 1) 30 (from April 6) $15 (from April 6) (15 @ $18) + (30 @ $15) = $720 $18 (from April 1) $15 (from April 6) (15 @ $18) + (10 @ $15) = $420 15 + 30 – 15 – 10 = 20 $15 20 @ $15 = $300 $144 ÷ 12 = $12 20 $15 12 $12 (20 @ $15) + (12 @ $12) = $444
LO 2 BT: AN Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 6-5 [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13]
$200 ($6,000 ÷ 30) 45 (15 + 30) $8,700 ($2,700 + $6,000) $193.3333 ($8,700 (from [3]) ÷ 45 (from [2])) $193.33 (from [4]) 25 x $193.3333 = $4,833.33 45 (from [2]) – 25 sold = 20 $8,700.00 (from [3]) – $4,833.33 (from [6]) = $3,866.67 $3,866.67 (from [8]) ÷ 20 (from [7]) = $193.3333 rounded to equal [4]. Notice how the average cost does not change after a sale. $2,460 ÷ $205 = 12 20 (from [7]) + 12 (from [10]) = 32 $3,866.67 (from [8]) + $2,460.00 = $6,326.67 $6,326.67 (from [12]) ÷ 32 (from [11]) = $197.708 rounded to $197.71
LO 2 BT: AN Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 6-6 (a)
FIFO cost formula
Date Description
Purchases
Aug. 2 Purchase
250 $ 70
3 Purchase
500
Cost of Goods Sold
$ 17,500
100
50,000
10 Sale 15 Purchase
900
120
$175,500
250 250 500
$ 70 70 100
$ 17,500 17,500 50,000
100 100 120 100 120
45,000 45,500 108,000 12,500 108,000
250 50
$70 100
$22,500
325
100
32,500
450 450 900 125 900
$55,000
1,025
108,000
25 Sale 1,650
Ending Inventory
625
$120,500
Check: $55,000 + $120,500 = $175,500 (b) Date
Average cost formula
Description
Aug. 2 Purchase 3 Purchase
Purchases
Ending Inventory
250 $ 70.00 $17,500.00
250 $ 70.00 $ 17,500.00
500 100.00
750
90.00
67,500.00
450
90.00
040,500.00
50,000.00
10 Sale 15 Purchase
Cost of Goods Sold
300 $90.00 $27,000.00 900 120.00 108,000.00
25 Sale
1,350 325 110.00 35,750.00 1,025
1,650
$175,500.00 625
$62,750.00 1,025
110.00 5148,500.00 110.00
112,750.00 $112,750.00
Check: $62,750 + $112,750 = $175,500 LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
6-15
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 6-7 (a)
Average cost. The ending inventory is valued at the average of the cost of the product, including earlier costs. Since this cost formula yields a higher ending inventory than FIFO when prices are falling, the result will not be closer to replacement cost. This result is achieved with the FIFO cost formula.
(b)
FIFO. The cost of goods is valued using the earlier, higher costs. Since the revenue reflects current lower prices, the FIFO cost formula does not match current costs against revenue when prices are falling. This result is better achieved by the average cost formula.
(c)
One of the guidelines that management should consider is choosing an inventory cost formula that corresponds as closely to the physical flow of goods as possible. A cost formula that provides an ending inventory cost close to the inventory’s recent cost is also preferable.
LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 6-8 Total assets in the statement of financial position will be overstated by the amount that ending inventory is overstated, $25,000. When the purchase of inventory was recorded, an account payable would have been created, so total liabilities will also be overstated by $25,000 (assuming the “supplier” was not paid). Shareholders’ equity will not be affected. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 6-9 When items are not counted, an adjustment would be made to lower the balance in the Inventory account to reflect the difference between the amount counted (which is lower) and the amount recorded in the account. This would be done by crediting Inventory. The offsetting debit would be to Cost of Goods Sold, thereby overstating this account and reducing net income. In the following year, assuming that these goods are sold, their cost is zero so cost of goods sold would be understated and net income overstated. Assuming that there are no errors when counting inventory at the end of next year, this net income overstatement when combined with the previous year net income understatement, would cancel each other out and make retained earnings correctly stated at the end of next year. These effects are summarized below.
Assets Liabilities Shareholders’ equity
Current Year Understated $7,000 No impact Understated $7,000
Next Year No impact No impact No impact
LO 4 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 6-10 (a) Inventory Categories Desktops Tablets and readers Laptops Accessories and parts Total valuation
Cost $347,000 168,700 221,020 97,400 $834,120
NRV $326,000 224,000 285,000 94,300 $929,300
LCNRV $326,000 168,700 221,020 94,300 $810,020
The lower of cost and net realizable value is $810,020. (b) Cost of Goods Sold ................................................................. 24,100 Inventory ...................................................................... $834,120 – $810,020 = $24,100
24,100
LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
6-17
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 6-11 (a) Cost of Goods Sold ............................................................ 2,200 Inventory ....................................................................... $54,700 – $52,500 = $2,200
2,200
(b) $54,700 LO 5 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 6-12 (a) Inventory Turnover (2015) Days in Inventory (2015)
365 = 79 days 4.6
Inventory Turnover (2014)
$8,033.2 = 5.2 times ($1,623.8 + $1,481.0) ÷ 2
Days in Inventory (2014)
(b)
$7,747.1 = 4.6 times ($1,764.5 + $1,623.8) ÷ 2
365 = 70 days 5.2
The inventory management deteriorated in 2015 as evidenced by the increase in number of days in inventory from 70 days in 2014 to 79 days in 2015. This was corroborated by the declining inventory turnover. This deterioration signifies that it took longer to sell the inventory in 2015.
LO 5 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance
Solutions Manual .
6-18
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 6-13 Beginning inventory Purchases (370 @ $9) + (700 @ $12) + (800 @ $11) Goods available for sale Ending inventory Goods sold (a)
Units 0
Dollars $ 0
1,870 1,870 (600) 1,270
20,530 $20,530
FIFO Ending inventory: (600 units @ $11) = $6,600 Cost of goods sold = Goods available for sale – ending inventory $20,530 – $6,600 = $ 13,930 Proof: Cost of goods sold = (370 × $9) + ( 700 × $12) + (200 x $11) = $ 13,930
(b)
Average cost Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Weighted average cost = $20,530 ÷ 1,870 = $10.98 Ending inventory: 600 × $10.98 = $ 6,587.17 Cost of goods sold = Goods available for sale – ending inventory $20,530 – $ 6,587.17 = $ 13,942.83 Proof: Cost of goods sold = 1,270 × ($20,530 ÷ 1,870) = $ 13,942.83
LO 6 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*BRIEF EXERCISE 6-14 (a)
Ending Inventory: (1,300 × $45.00) + (200 × $50.00) = $68,500 Cost of goods sold = Goods available for sale – ending inventory $216,000 – $68,500 = $147,500 Proof: Cost of goods sold = (1,500 × $45.00) + (1,600 × $50.00) = $147,500
(b)
No, the answer under a perpetual system would be the same as the first goods purchased are assumed to be the first goods sold.
LO 2,6 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 6-15 (a)
FIFO Perpetual
Jan.
3
3
9
15
15
Accounts Receivable ............................................ Sales (700 × $12).........................................
8,400
Cost of Goods Sold (700 × $5) ............................. Inventory ......................................................
3,500
Inventory (1,000 × $6) .......................................... Accounts Payable ........................................
6,000
Cash ..................................................................... Sales (800 x $11) .........................................
8,800
Cost of Goods Sold [(200 × $5) + (600 × $6)] ...... Inventory ......................................................
4,600
8,400
3,500
6,000
8,800
4,600
(b) FIFO Periodic Jan.
3
9
15
Accounts Receivable ............................................. Sales ............................................................
8,400
Purchases ............................................................. Accounts Payable .........................................
6,000
Cash ...................................................................... Sales .............................................................
8,800
8,400
6,000
8,800
LO 2,6 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 6-1 1.
Do not include – Shippers Ltd. does not own items held on consignment. These goods will be recorded in the owner’s inventory.
2.
Include in inventory – Shipping terms FOB destination means that Shippers Ltd. owns the items until they reach the customer.
3.
Include in inventory – Shippers Ltd. still owns the items as they were only shipped on consignment.
4.
Do not include in inventory. Freight costs on goods shipped to customers are included in Freight Out or Delivery Expense.
5.
Do not include in inventory – The shipping terms are FOB destination point so ownership has not transferred to the buyer. Shippers Ltd. should not record anything until the goods arrive.
6.
Include in inventory – Shipping terms FOB shipping point means that ownership transferred at the time of shipping and therefore, Shippers Ltd. owns the goods in transit.
7.
Do not include in inventory. The shipping terms are FOB shipping point so Shippers Ltd. no longer owns the goods. They will be part of cost of sales on the income statement.
(Legal title determines if an item should be included in inventory.) LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-2 (a) Ending inventoryphysical count ............................................................ 1. Add to inventory. Title remains with Novotna until purchaser receives goods ..................................................................................... 2. Add to inventory. Title passed to Novotna when goods were shipped . 3. Add to inventory. Title passed to Novotna when goods were shipped . 4. No effect. Title passes to purchaser upon shipment when terms are FOB shipping point .............................................................................. 5. Add to inventory. Novotna owns the goods out on consignment ......... 6. Deduct from inventory. Obsolete inventory should be written off to cost of goods sold. ............................................................................... Correct inventory ......................................................................................
$285,000 35,000 95,000 28,000 0 30,500 (15,000) $458,500
(Legal title determines if an item should be included in inventory)
(b)
Since inventory is usually the largest current asset on a company’s statement of financial position, errors can have a significant impact. In making a decision to grant a short-term bank loan, the bank will be looking at Novotna’s liquidity by calculating the current ratio as well as the inventory turnover and days sales in inventory. Any error in the inventory count will affect these ratios. In addition, the errors will also affect Novotna’s profitability by impacting the cost of goods sold on the income statement.
LO 1 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-3 (a)
The company would identify, by serial number, the items remaining in inventory. The sum of the cost of the items remaining in inventory would become the ending inventory balance. Then, the company would identify the cost of the items sold, again by using serial numbers to determine the cost of each item sold. The total cost of items sold would become the cost of goods sold.
(b)
It could choose to sell specific units purchased at specific costs if it wished to impact net income selectively. If it wished to minimize net income it would choose to sell the units purchased at higher costs–in which case the cost of goods sold would be $4,300 ($2,400 + $1,900) and gross profit would be $900 [($2,600 x 2) – $4,300]. If it wished to maximize net income it would choose to sell the units purchased at lower costs; in which case the cost of goods sold would be $3,580 ($1,900 + $1,680) and gross profit would be $1,620 [($2,600 x 2) – $3,580].
(c)
Discount Electronics should consider the nature of the inventory items. The specific identification system is best suited to inventory items are clearly identified from each other and that are not ordinarily interchangeable, or to products that are produced and segregated for specific projects. The specific identification system produces the most accurate measure of ending inventory and matching of cost of goods sold to sales. It is however more time-consuming and expensive to apply. If the inventory items are interchangeable, Discount Electronics would not be able to use specific identification and would have to use either the FIFO or average cost flow formulas.
LO 2,3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-4 (a) Date
Description
Purchases
Cost of Goods Sold
Apr. 1 Beg. inventory
50 $210 100 225 $33,000 50 $210 25 225 $ 16,125
3 Sale 10 Purchase
75 75 200
225 225 275
16,875
25 25 300
275 275 290
6,875 93,875
57,625 125
290
36,250
200 $275 $ 55,000
17 Sale 24 Purchase
300
290
500
75 175
225 275
25 175
275 290
65,000
87,000
30 Sale 30 Balance
Ending Inventory
$142,000 525
$138,750 125
71,875
290 $36,250
Check: $138,750 + $36,250 = $175,000 ($33,000 + $142,000) (b) Sales Apr. 3
Units 75
Sales Price/Unit $400
Total $ 30,000
17
250
400
100,000
30
200
400
80,000 $210,000
Gross profit = $210,000 – $138,750 = $71,250 Gross profit margin = $71,250 ÷ $210,000 = 33.9% (c)
The gross profit is higher than if the average cost formula had been used in a perpetual inventory system because cost of goods sold is lower under FIFO in a period of rising prices than it would be using the average cost formula. Under FIFO, ending inventory is higher, cost of goods sold is lower and gross profit is higher.
LO 2,3 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
6-24
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-5 (a)
Date
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation.
Description
Purchases
Cost of Goods Sold
June 1 Beginning
Ending Inventory 500 $125.00 $ 62,500.00
6 Purchase
1,200 $127.00 $152,400.00
10 Sale
1,000
14 Purchase
1,800
128.00
‘230,400.00
16 Sale
1,600
26 Purchase
1,000
30 Balance
4,000
129.00
$126.41 $126,411.76
127.56
204,088.47
129,000.00 $511,800.00 2,600
1,700
126.41
214,900.00
700
126.41
88,488.24
2,500
127.56
318,888.24
900
127.56
114,799.77
1,900
128.31
243,799.77
$330,500.23 1,900
$243,799.77
Check: $330,500.23 + $243,799.77 = $574,300 ($62,500 + $511,800) (b)
Sales = (1,000 @ $200) + (1,600 @ $205) = $528,000 Gross profit = $528,000 – $330,500 = $197,500 Gross profit margin = $197,500 ÷ $528,000 = 37.4%
(c)
The gross profit is lower than it would be using the FIFO cost formula because the cost of the product being purchased is rising.
LO 2 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
6-25
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-6 (a) (1) FIFO Date Purchases Cost of Goods Sold June 1 Beginning inventory 12 2,300 @ $6 = $13,800 15 16 23 27 Total
Balance 1,500 @ $5 = $ 7,500 1,500 @ $5 2,300 @ $6 = 21,300
1,500 @ $5 1,000 @ $6 = $13,500 1,300 @ $6 = 7,800 4,500 @ $7 = 31,500 1,300 @ $6 4,500 @ $7 = 39,300 1,500 @ $8 = 12,000 1,300 @ $6 4,500 @ $7 1,500 @ $8 = 51,300 1,300 @ $6 100 @ $7 4,400 @ $7 = 38,600 1,500 @ $8 = 12,700 $57,300 $52,100 $12,700
Check: $52,100 + $12,700 = $64,800 ($7,500 + $57,300) (a) (2) Average cost Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Date June 1 12 15 16 23 27 Total
Purchases Beginning inventory 2,300 @ $6 = $13,800.00
Cost of Goods Sold
2,500 @ $5.61 = $14,013.16 4,500 @ $7 = 31,500.00 1,500 @ $8 = 12,000.00 $57,300.00
5,700 @ $6.96 = 39,655.48 $53,668.64
Balance 1,500 @ $5.00 = $ 7,500.00 3,800 @ $5.61 = 21,300.00 1,300 @ $5.61 = 7,286.84 5,800 @ $6.69 = 38,786.84 7,300 @ $6.96 = 50,786.84 1,600 @ $6.96 = 11,131.36 $11,131.36
Check: $53,668.64 + $11,131.36 = $64,800 ($7,500 + $57,300) (b)
The average cost formula results in a higher cost of goods sold because the cost of inventory is rising.
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-6 (CONTINUED) (c)
The FIFO cost formula results in a higher net income because it produces the lower cost of goods sold when prices are rising as the lower costs from earlier units are assigned to cost of goods sold, while the higher costs are assigned to ending inventory.
(d)
The FIFO cost formula results in a higher ending inventory because the cost of inventory is rising and these higher unit prices are used to determine ending inventory.
(e)
Both cost formulas result in the same pre-tax cash flow. The cost formulas do not change the pre-tax cash flows of a company.
LO 2,3 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-7 (a)
Date Oct. 2 15
FIFO cost formula
Units 9,000 15,000
Purchases Cost Total $12 $108,000 14 210,000
29
(b)
Date Oct. 2 15 29
Cost of Goods Sold Units Cost Total
9,000 13,000
$12 14
$290,000
Balance Cost Total $12 $108,000 12 14 318,000
Units 9,000 9,000 15,000 2,000
14
28,000
Average cost formula
Units 9,000 15,000
Purchases Cost Total $12 $108,000 14 210,000
Cost of Goods Sold Units Cost Total
22,000
$13.25
$291,500
Units 9,000 24,000 2,000
Balance Cost Total $12.00 $108,000 13.25 318,000 13.25 26,500
(c)
Sales Cost of goods sold (from above) Gross profit Operating expenses Income before income tax Income tax expense (30%) Net income
(d)
(1)
FIFO $525,000 290,000 235,000 200,000 35,000 10,500 $ 24,500
Average Cost $525,000 291,500 233,500 200,000 33,500 10,050 $ 23,450
Currently, as shown in (a) above, FIFO results in a higher net income than the average cost formula. This is anticipated when costs are rising, as is the case above. If instead costs fall, the use of the FIFO cost formula will result in a lower net income compared to the average cost formula. The cost of goods sold will then be composed of higher costs than the average cost formula and this will generate lower net incomes.
(2)
If costs remain stable, the two cost formulas will produce the same net incomes.
LO 2,3 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-8 (a)
Corrected inventory 2017 = $30,000 + $4,000 = $34,000 2018 = $37,000 – $2,000 = $35,000 Corrected cost of goods sold 2017 = $154,000 – $4,000 = $150,000 2018 = $168,000 + $2,000 + $4,000 = $174,000
(b)
(1) and (2) Cost of goods sold and income before income tax: The inventory error for 2017 will cause the cost of goods sold to be overstated by $4,000, which will cause net income and retained earnings to be understated by the same amount. Assuming that the error was not corrected, when it reverses in 2018, cost of goods sold will be understated and net income will be overstated by $4,000. Over the two years the error will reverse and therefore the retained earnings balance will be correct at the end of 2018 (with respect to this particular error taken alone). The $2,000 overstatement of inventory in 2018 will cause the cost of goods sold to be understated and the net income and retained earnings to be overstated by $2,000. When the two errors are taken together, in 2018 cost of goods sold will be understated by $6,000 ($4,000 for 2017 error and $2,000 for 2018 error). Net income will be overstated by $6,000 in 2018. (3)
The inventory error for 2017 will cause the inventory—an asset account—to be understated by $4,000. The inventory error for 2018 will cause the inventory (asset) account to be overstated by $2,000.
(4)
The errors will not affect liabilities.
(5)
As explained above in (1) and (2), retained earnings is understated by $4,000 in 2017. In 2018, retained earnings is overstated by $2,000. Because of this, shareholders’ equity will be understated by $4,000 in 2014 and overstated by $2,000 in 2018. 2017 2018
(c)
A U$4,000 O$2,000
= = =
L NE NE
+ + +
SE U$4,000 O$2,000
Errors should be corrected as soon as they are discovered so that users have a more accurate account of inventory on hand, gross profit and net income.
LO 4 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-9 (a) Sales ....................................................................................... Cost of goods sold (see 1 and 2) ............................................ Gross profit .............................................................................
2018 $265,000 213,000 $ 52,000
2017 $250,000 186,000 $ 64,000
(1) $194,000 – $8,000 = $186,000 (2) $205,000 + $8,000 = $213,000 (b)
The cumulative effect on total gross profit for the two years is zero as shown below: Incorrect gross profits: Correct gross profits: Difference
(c)
Gross profit margin
$56,000 + $60,000 = $64,000 + $52,000 =
$116,000 116,000 $ 0
2018
2017
Before correction
$60,000 ÷ $265,000 = 22.6%
$56,000 ÷ $250,000 = 22.4%
After correction
$52,000 ÷ $265,000 = 19.6%
$64,000 ÷ $250,000 = 25.6%
LO 4 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 6-10 Units Cost/Unit Cameras: Sony Canon Light Meters: Gossen Sekonic Total (b) Dec. 31
(c) Dec. 31
Total Cost
NRV/Unit
Total NRV
(a) LCNRV
4 8
$175 150
$ 700 1,200
$160 152
$ 640 1,216
$ 640 1,200
12 10
135 115
1,620 1,150 $4,670
139 110
1,668 1,100 $4,624
1,620 1,100 $4,560
Cost of Goods Sold ($4,670 – $4,560) ............................... Inventory ....................................................................
110
Cost of Goods Sold (2 × $150) ........................................... Inventory ....................................................................
300
110
300
LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-11 (a) Inventory Turnover (2016):
$2,229,130 = 2.7 times ($851,033 + $779,407)÷2
Days in Inventory (2016):
365 = 135 days 2.7
Gross Profit Margin (2016):
($2,959,238 - $2,229,130) = 24.7% $2,959,238
Inventory Turnover (2015):
$1,701,311 = 2.5 times (779,407 + $595,794)÷2
Days in Inventory (2015):
Gross Profit Margin (2015):
(b)
365 = 146 days 2.5
($2,359,994 - $1,701,311) = 27.9% $2,359,994
In 2016, Gildan Activewear experienced an improvement in liquidity but a deterioration in profitability. The liquidity has been improved due to the decrease in time required to turn over its inventory, from 146 days to 135 days. The company has experienced deteriorated profitability due to a significant drop in its gross profit margin from 27.9% to 24.7%.
LO 5 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 6-12 (a) Inventory turnover (FIFO)
$750,000 = 3.4 times $222,500
Inventory turnover (Average Cost)
$735,000 = 3.2 times $227,500
(b) Current ratio (FIFO)
($450,000 + $222,500) = 1.9 times $350,000
Current ratio (Average Cost)
($450,000 + $227,500) = 1.9 times $350,000
(c)
The FIFO cost formula appears to show a slightly better turnover ratio because it has a lower ending inventory. The current ratios are the same. The two cost formulas will generally yield the same overall assessment of liquidity when combining the inventory turnover ratio and the current ratio. The trend analysis for the inventory turnover and the current ratio produced by either formula will be the same since the formulas involve allocating the same costs. In reality, there is no economic difference between the two formulas and any differences in ratios are artificial ones caused solely by the different cost formulas. Consequently, there is no real difference in liquidity.
LO 3,5 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005. CM: Reporting and Finance
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Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 6-13 (a) FIFO Beginning inventory ($2,000 ×$20) ........................................ Purchases Oct. 9 (5,000 × $21) ..................................................... $105,000 Oct. 12 (4,000 × $20.50) .............................................. 82,000 Oct. 25 (4,000 × $20.80) .............................................. 83,200 Cost of goods available for sale (15,000 units) ....................... Less: Ending inventory (4,000 × $20.80) ............................... Cost of goods sold (11,000 units) ...........................................
$ 40,000
270,200 310,200 83,200 $ 227,000
(b) Average cost Beginning inventory ($2,000 ×$20) ........................................ Purchases Oct. 9 (5,000 × $21) ..................................................... $105,000 Oct. 12 (4,000 × $20.50) .............................................. 82,000 Oct. 25 (4,000 × $20.80) .............................................. 83,200 Cost of goods available for sale (15,000 units) ....................... Less: Ending inventory (4,000 × $20.68*) .............................. Cost of goods sold (11,000 units) ...........................................
$ 40,000
270,200 310,200 82,720 $ 227,480
*$310,200 ÷ 15,000 units = $20.68/unit (c)
FIFO would result in a slightly higher gross profit, since its cost of goods sold is lower.
LO 3,6 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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*EXERCISE 6-14
(a) (1)
FIFO
Beginning inventory (1,500 × $5) ..................................................... Purchases June 12 (2,300 × $6) .................................................................... June 16 (4,500 × $7) .................................................................... June 23 (1,500 × $8) .................................................................... Cost of goods available for sale (9,800 units) .................................. Less: Ending inventory [(1,500 × $8) + (100 × $7)] .......................... Cost of goods sold (8,200 units) ...................................................... (2)
$ 7,500 $13,800 31,500 12,000
57,300 64,800 12,700 $52,100
Average cost
Note: Unrounded numbers have been used in the average cost calculation, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Cost of Goods Available for Sale $64,800
÷
Total Units Available for Sale 9,800
=
Weighted Average Unit Cost $6.612245
Ending inventory = 1,600 × $6.612245 = $10,579.59 Cost of goods sold = $64,800.00 – $10,579.59 = $54,220.41 Proof: (9,800 – 1,600) × ($64,800 ÷ 9,800) = $54.220.41 (b)
The average unit cost is not $6.50 because the average unit cost is not a simple straight average but is a weighted average based on the number of units purchased at each price.
(c)
(1)
FIFO – The perpetual system will give the same ending inventory and cost of goods sold as the periodic system.
(2)
Average cost – The perpetual system will have a different ending inventory and cost of goods sold because the cost of goods sold is calculated based on the weighted average at the time of each sale under the perpetual system.
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 6-15 (a)
(1)
Date
FIFO Purchases
Nov. 1
Sales
Beginning inventory
(30 @ $295) = $8,850
5 25 @ $300 = $7,500
12
(30 @ $295) + (25 @ $300) = $16,350 (30 @ $295) + (12 @ $300) = $12,450
19 40 @ $305 = $12,200
22
Balance
(13 @ $300) = $3,900
(13 @ $300) + (40 @ $305) = $16,100 (13 @ $300) + (37 @ $305) = $15,185
25 30 @ $310 = $9,300
(3 @ $305) = $915
(3 @ $305) + (30 @ $310) = $10,215
Cost of Goods Sold: $12,450 + $15,185 = $27,635 Ending Inventory: $10,215 Check: $27,635 + $10,215 = $37,850 ($8,850 + $7,500 + $12,200 + $9,300)
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 6-15 (CONTINUED) (a)
(2)
Average cost
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Date
Purchases
Nov. 1
Sales
Beginning inventory
30 @ $295 = $8,850.00
5 25 @ $300 = $7,500 12
55 @ $297.27 = $16,350.00 42 @ $297.27 = $12,485.45
19 40 @ $305 = $12,200 22
Balance
13 @ $297.27 = $3,864.55 53 @ $303.10 = $16,064.55
50 @ $303.10 = $15,155.23
25 30 @ $310 = $9,300
3 @ $303.10 = $909.31 33 @ $309.37 = $10,209.31
Cost of Goods Sold: $12,485.45 + $15,155.24 = $27,640.69 Ending Inventory: $10,209.31 Check: $27,640.69 + $10,209.31 = $37,850 ($8,850 + $7,500 + $12,200 + $9,300) (b) FIFO Beginning inventory (30 × $295) ........................................................ Purchases Nov. 5 (25 × $300) ......................................................................... Nov. 19 (40 × $305) ....................................................................... Nov. 25 (30 × $310) ....................................................................... ...................................................................................................... Cost of goods available for sale (125 units) ....................................... Less: Ending inventory (3 × $305) + (30 × $310) .............................. Cost of goods sold ............................................................................. AVERAGE COST Cost of goods available for sale (125 units) ....................................... Less: Ending inventory (33 × $302.801)............................................. Cost of goods sold ............................................................................. 1
$ 8,850 $ 7,500 12,200 9,300 29,000 37,850 10,215 $27,635 $37,850.00 9,992.40 $27,857.60
$37,850 ÷ 125 = $302.80
LO 2,6 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 6-16 (a)
Nov. 5 Inventory Accounts Payable 12 Cash Sales 12 Cost of Goods Sold Inventory 19 Inventory Accounts Payable 22 Cash Sales 22 Cost of Goods Sold Inventory 25 Inventory Accounts Payable
(1) FIFO Dr. Cr. 7,500 7,500 19,320 19,320 12,450 12,450 12,200 12,200 23,500 23,500 15,185 15,185 9,300 9,300
(2) Average Cost Dr. Cr. 7,500.00 7,500.00 19,320.00 19,320.00 12,485.45 12,485.45 12,200.00 12,200.00 23,500.00 23,500.00 15,155.23 15,155.23 9,300.00 9,300.00
(1) FIFO Dr. Cr. 7,500 7,500 19,320 19,320 12,200 12,200 23,500 23,500 9,300 9,300
(2) Average Cost Dr. Cr. 7,500 7,500 19,320 19,320 12,200 12,200 23,500 23,500 9,300 9,300
(b)
Nov. 5 Purchases Accounts Payable 12 Cash Sales 19 Purchases Accounts Payable 22 Cash Sales 25 Purchases Accounts Payable
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 6-1A (a)
1.
The unsold consignment inventory should be included in Kananaskis’ inventory. Include $900 ($1,800 – $900) in inventory.
2.
The sale will be recorded on February 19. The goods (cost, $980) should be excluded from Kananaskis’ inventory at the end of February.
3.
The inventory has been sold to the customer so the customer has ownership. Exclude.
4.
Exclude the items from Kananaskis’ inventory. Craft Producers Ltd. still owns the inventory.
5.
Kananaskis owns the goods once they are shipped on February 26. Include inventory of $1,445 ($1,350 + $95).
6.
Title of the goods does not transfer to Kananaskis until March 4. Exclude this amount from the February 28 inventory.
7.
Title to the goods does not transfer to the customer until March 7. Include the $1,900 in ending inventory. The freight charge is a delivery expense.
8.
Include $1,950 in inventory.
(Legal title determines if an item should be included in inventory)
(b)
The revised ending inventory is: Unadjusted inventory Adjustments 1. February 1 5. February 25 7. February 27 8. February 28 Adjusted inventory
$218,000 $ 900 1,445 1,900 1,950
6,195 $224,195
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Chapter 6
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-2A (a) Cost of Goods Sold
Model
VIN #
Cost/ Unit $
Focus Mustang 18 Mustang F-150 Flex Escape
C81362 G62313 G71891 F1921 X3892 E21202
24,000 29,000 28,000 29,000 31,000 29,000
Apr. 8
Ending Inventory Sales price/ Unit $ 26,000 32,000 33,000 32,500 34,000 32,000
VIN #
Cost/ Unit $
1 F-150 F1883 12 Mustang G71811 Flex X4214 Flex X4212 23 Focus C81528 Escape E28268
25,000 30,000 31,000 30,000 27,000 30,000
Model Apr.
170,000 189,500
173,000
(b)
Gross profit
= $189,500 – $170,000 = $19,500
(c)
The specific identification formula is likely the most appropriate formula for Dean’s Sales Ltd. because the vehicles are large dollar value items that are specifically identifiable by vehicle identification number.
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Chapter 6
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-3A (a)
(1)
FIFO
Date Description
Purchases
May 1 Purchase
120 $100 $12,000
3 Sale 8 Purchase
100
110
11,000 40 40
60
115
Ending Inventory 120
80
13 Sale 15 Purchase
Cost of Goods Sold
6,900
$100 $12,000
$100 $ 8,000 040 40 100 100 110 8,400 60 60 60
100 100 110
4,000
110 110 115
13,500
15,000 6,600
20 Sale
60
110
6,600
60
115
6,900
27 Sale
40
115
4,600
20
115
2,300
$27,600
20
31 Balance
280
$29,900 260
$ 2,300
Check: $27,600 + $2,300 = $29,900
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Chapter 6
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-3A (CONTINUED) (a)
(2)
Average cost
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Date Description
Purchases
May 1 Purchase
120 $100.00 $12,000.00
3 Sale
Cost of Goods Sold
120 $100.00 $12,000.00 80 $100.00 $8,000.00
8 Purchase
100 110.00 11,000.00
13 Sale
80 107.14
15 Purchase
60 115.00
Ending Inventory
8,571.43
6,900.00
40
100.00
4,000.00
140
107.14 15,000.00
60
107.14
120
111.07 13,328.57
6,428.57
20 Sale
60 111.07
6,664.29
60
111.07
6,664.29
27 Sale
40 111.07
4,442.86
20
111.07
2,221.43
$27,678.57
20
31 Balance
280
$29,900.00 260
$2,221.43
Check: $27,678.57 + $2,221.43 = $29,900.00 (b)
Save-Mart should consider the physical flow of its goods, the amount to be reported on the statement of financial position, and the nature and use of its goods.
(c)
The FIFO cost formula produces a slightly higher gross profit and net income as results in cost of goods sold being lower during periods of rising prices.
(d)
FIFO produces a higher ending inventory during periods of rising prices.
(e)
The pre-tax cash flows are the same no matter which cost formula is used.
LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-4A (a) Date Apr. 1
Description
Purchases
Cost of Goods Sold
Beg. Inventory
6 Purchase
15
$45 $ 675 30 5
9 Sale 14 Purchase
20
40
10 15 20
30 Total
55
35
$1,725
800
20 Sale 28 Purchase
50 45
45 40
1,050
700 $2,175
60
$2,775
Ending Inventory 30
$50
$1,500
30 15
50 45
2,175
10 10 20
45 45 40
5 5 20
40 40 35
200
25
,
$ 900
450 1,250
900
Check: $2,775 + $900 = $3,675 ($1,500 + $2,175) (b)
It needs to consider whether the change will result in more relevant and reliable presentation in the financial statements. This may only occur if the physical flow, or nature and use, of the inventory changes.
(c)
I would expect the ending inventory under the average cost formula to be higher when prices are falling as the inventory will be valued at an average cost. Under FIFO, ending inventory would be lower when prices are falling as the inventory will be valued at the last (and lowest) price. Cost of goods sold under the average cost formula would be lower.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-5A (a)
Date Apr. 1
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Description
Purchases
Cost of Goods Sold
Beg. Inventory
6 Purchase
30 $50.00 $1,500.00
15 $45 $ 675.00
9 Sale
35 $48.33 $1,691.67
14 Purchase
Ending Inventory
20
40
800.00
20 Sale
25
28 Purchase
20
30 Balance
55
35
42.78 1,069.44
700.00 $2,175.00
60
$2,761.11
45
48.33 2,175.00
10
48.33
30
42.78 1,283.33
5
42.78
213.89
25
36.56
913.89
25
483.33
$ 913.89
Check: $2,761.11 + $913.89 = $3,675.00 ($1,500.00 + $2,175.00)
(b) Cost of Goods Sold ...................................................... Inventory (1 × $36.56) .......................................
(c)
36.56 36.56
Three accounts would be affected—Inventory, Cost of Goods Sold, and Retained Earnings. The Inventory account would be overstated by $36.56. This would result in the statement of financial position sub-totals of current assets and total assets also being overstated. The Cost of Goods Sold account would be understated by $36.56. This would lead to the income statement sub-totals of gross profit and net income being overstated by $36.56. The Retained Earnings account would also be overstated by $36.56.
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Chapter 6
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-6A (a) April
1
No entry
6
Inventory (110 × $90) ............................................ Cash .............................................................
9,900.00
Cash (130 × $120)................................................. Sales .............................................................
15,600.00
Cost of Goods Sold (130 × $86.88*)...................... Inventory .......................................................
11,293.75
Inventory (120 × $70) ........................................... Cash .............................................................
8,400.00
Cash (120 × $100)................................................. Sales .............................................................
12,000.00
Cost of Goods Sold (120 × $73.38*)...................... Inventory .......................................................
8,805.00
Inventory (20 × $60) .............................................. Cash .............................................................
1,200.00
8
15
20
27
9,990.00
15,600.00
11,293.75
8,400.00
12,000.00
8,805.00 1,200.00
* These numbers have been rounded to the nearest cent for presentation purposes, but not for calculation purposes. See detailed calculations in part (b).
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-6A (CONTINUED) (b)
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation.
Date Description
Purchases
Cost of Goods Sold
Apr. 1 Beginning 6 Purchase
50 $80.00 $ 4,000.00 110 $90 $ 9,900
8 Sale 15 Purchase
Ending Inventory
130 $86.88 $11,293.75 120
70
8,400
20 Sale
120
27 Purchase
20
30 Balance
250
60
73.38
8,805.00
1,200 $19,500 250
$20,098.75
160
86.88 13,900.00
30
86.88
150
73.38 11,006.25
30
73.38
2,201.25
50
68.03
3,401.25
50
2,606.25
$ 3,401.25
Check: $20,098.75 + $3,401.25 = $23,500 ($4,000 + $19,500)
(c)
Ending inventory should be valued at $2,500 (50 x $50) which is the lower of cost and net realizable value. Cost = $3,401.25 (50 units @ 68.025) NRV = $2,500.00 (50 units @ $50)
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Chapter 6
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-7A
(a) (b) (c) (d) (e) (f) (g)
2018 Cash No effect Cost of goods sold Overstated Net income Understated Retained earnings No effect Ending inventory No effect Gross profit margin ratio Understated Inventory turnover ratio Understated*
2017 No effect Understated Overstated Overstated Overstated Overstated Understated
*Although the cost of goods sold is overstated in 2018, this is not as significant (in percentage terms) as the overstatement in average inventory, which is the denominator in the inventory turnover ratio so this ratio remains understated in 2018. LO 4,5 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-8A (a)
(INCORRECT) KMETA INC. Income Statement Year Ended July 31
Sales Cost of goods sold Gross profit Operating expenses Income before income tax
2018 $340,000 233,000 107,000 68,000 $ 39,000
2017 $320,000 220,000 100,000 64,000 $ 36,000
2016 $300,000 209,000 91,000 64,000 $ 27,000
Statement of financial position: Inventory
$40,000
$40,000
$24,000
(CORRECT) KMETA INC. Income Statement Year Ended July 31 Sales Cost of goods sold Gross profit Operating expenses Income before income tax
2018 $340,000 233,0003 107,000 68,000 $ 39,000
2017 $320,000 229,0002 91,000 64,000 $ 29,000
2016 $300,000 200,0001 100,000 64,000 $ 36,000
Statement of financial position: Inventory
$40,000
$55,0004
$33,0003
1
$209,000 – $9,000 = $200,000 $220,000 + $9,000 (2016 error) + $0* (2017 error) = $229,000 3 $24,000 + $9,000 = $33,000 4 $40,000 + $15,000 = $55,000 2
* - Purchases understated by $15,000 and inventory understated by $15,000, so nil effect on cost of goods sold.
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PROBLEM 6-8A (CONTINUED) (b)
Retained earnings before correction = $27,000 + $36,000 + $39,000 = $102,000 Retained earnings after correction = $36,000 + $27,000 + $39,000 = $102,000 The retained earnings balance at the end of 2018 is unaffected and remains at $102,000 because by that time, all errors have been corrected.
(c)
Inventory turnover
(INCORRECT) Inventory turnover (2018)
Inventory turnover (2017)
$233,000 = 5.8 times ($40,000 + $40,000) ÷ 2 $220,000 = 6.9 times ($40,000 + $24,000) ÷ 2
(CORRECT) Inventory turnover (2018)
Inventory turnover (2017)
$233,000 = 4.9 times ($40,000 + $55,000) ÷ 2 $229,000 = 5.2 times ($55,000 + $33,000) ÷ 2
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-9A (a)
Type of Bean Coffea arabica Coffea robusta
(b)
(c)
Dec. 31
Quantity
Unit Cost
13,000 bags 5,000 bags
$5.60 3.40
Total Cost
NRV
Total NRV
LCNRV
$72,800 17,000 $89,800
$5.55 3.50
$72,150 17,500 $89,650
$72,150 17,000 $89,150
Cost of Goods Sold ($89,800 – $89,150)........... Inventory .....................................................
650 650
Tascon’s operations involve the sale of coffee beans. The users of the financial information are aware of the volatility of the cost of the beans due to weather conditions in the countries where the beans are grown. Users expect and appreciate that the lower of cost and net realizable value (LCNRV) requirement in accounting because they know that inventory and income are not overstated. Adjustments Tascon would need to make by applying the item-by-item approach of the LCNRV would not be minor in amount. The item-by-item is always the more conservative method (that is, lower inventory amount reported) because net realizable values above cost are never included in the calculations. Under these sets of circumstances, Tascon should apply the LCNRV rule on an item-by-item basis for coffee beans. One argument in support of both types of coffee beans being considered as part of one inventory grouping is that the accounting values that are reported under LCNRV on an item-by-item basis are not neutral and unbiased measures of income and inventory. Recognizing net realizable values only when they are lower than cost, is an inconsistent treatment that can lead to distortions in reported net income. Another argument can be made on the basis of the cost versus benefit constraint of accounting. Although not appropriate in this case, due to the type of inventory, the costs incurred in arriving at the net realizable value on an item-by-item basis may far outweigh the benefit derived by applying LCNRV on an item-by-item basis.
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PROBLEM 6-10A (a)
(1) June 30 (2) July 31 (3) August 31
Total Cost $12,640,0001 14,195,0002 12,632,5003
Total NRV $13,600,0004 13,610,5005 12,245,0006
LCNRV $12,640,000 13,610,500 12,245,000
1
16,000 x $790 = $12,640,000 16,700 x $850 = $14,195,000 3 15,500 x $815 = $12,632,500 4 16,000 x $850 = $13,600,000 5 16,700 x $815 = $13,610,500 6 15,500 x $790 = $12,245,000 2
(b)
(1) June 30
No entry
(2) July 31
Cost of Goods Sold .......................................... Inventory ........................................... ($14,195,000 – $ 13,610,500 = $584,500)
584,500
Cost of Goods Sold ........................................ Inventory ............................................ ($12,632,500– $12,245,000 = $387,500)
387,500
(3) Aug. 31
584,500
387,500
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PROBLEM 6-11A (a) (in USD millions)
2015
2014
Inventory Turnover
Days In Inventory
Current Ratio
$17,482 = 5.8 times ($2,902 + $3,100)÷2
365 = 63 days 5.8 times
$33,395 = 1.2 : 1 $26,930
$17,889 = 5.6 times ($3,100 + $3,277)÷2
365 = 65 days 5.6 times
$32,986 = 1.0 : 1 $32,374
Coca-Cola’s current ratio improved in 2015 and is slightly below the industry average of 1.3:1. This ratio indicates that the company has fewer current assets to cover its current liabilities compared to other companies in the industry. Coca-Cola’s inventory turnover has improved but continues to be significantly worse than the rest of the industry. (b)
Coca-Cola has different types of inventory that likely have different physical flows of inventory For example, beverages likely flow on a FIFO basis (especially for beverages with “best before” dates). Other components of inventory including raw materials such as sugar may be accounted for on an average basis.
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PROBLEM 6-12A (a)
Both companies have current ratios that exceed the industry average and therefore enjoy greater liquidity. Wendy’s has a lower current ratio and higher inventory turnover ratio than McDonald’s, so it may be more liquid than McDonald’s. McDonald’s has a lower inventory turnover than the industry. Since inventory is a large component of current assets, an inventory turnover ratio lower than the industry means that more inventory is kept on hand and therefore increases current assets and the current ratio. As a result, the higher than average current ratios may not translate into higher liquidity.
(b)
Both companies’ gross profit margin exceeds the industry average, with McDonald’s having the better ratio of the two companies. Where the differences in ratios is more noticeable is in the profit margin. In the case of Wendy’s, its profit margin is well below the industry average. For McDonald’s, the profit margin is double that of Wendy’s and well above the industry average. This indicates that McDonald’s has succeeded in translating a higher gross profit margin into a higher profit margin by controlling its expenses.
LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 6-13A (a)
Cost Of Goods Available For Sale Date Jan. 1 Mar. 15 July 20 Sept. 4 Dec. 2
(b)
(1)
Explanation Beginning inventory Purchase Purchase Purchase Purchase Total
Units 250 700 500 450 100 2,000
Unit Cost $160 150 145 135 125
Total Cost $ 40,000 105,000 72,500 60,750 12,500 $290,750
FIFO
Step 1: Ending Inventory Date Units Unit Cost Sept. 4 100 $135 Dec. 2 100 125 200
Total Cost $13,500 12,500 $26,000
Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$290,750 26,000 $264,750
Proof: Cost of Goods Sold Unit Total Units Cost Cost 250 $160 $ 40,000 700 150 105,000 500 145 72,500 350 135 47,250 1,800 $264,750
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*PROBLEM 6-13A (CONTINUED) (b)
(2)
Average Cost
Step 1: Ending Inventory Weighted Average Units Unit Cost 200 $145.38* =
Total Cost $29,075.00
*$290,750 ÷ 2,000 = $145.38 (rounded)
Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory (200 x $145.38 rounding) Cost of goods sold
$290,750 29,075 $261,675
Proof: Cost of goods sold 1,800 × ($290,750 ÷ 2,000) = $261,675 LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 6-14A (a) KANE LTD. Partial Income Statements
Sales (1,800 × $200) ....................................... Cost of goods sold Beginning inventory................................. Cost of goods purchased ........................ Cost of goods available for sale .............. Ending inventory ..................................... Cost of goods sold .................................. Gross profit ......................................................
FIFO
Average Cost
$360,000
$360,000
40,000 250,750 290,750 26,000 264,750 95,250
40,000 250,750 290,750 29,075 261,675 98,325
(b) KANE LTD. Partial Statement of Financial Position
Assets Current assets Inventory ....................................................
(c)
FIFO
Average Cost
$26,000
$29,075
FIFO uses the most recent inventory prices to value the ending inventory. Since prices are declining, FIFO results in the lowest cost for ending inventory. FIFO results in the higher cost of goods sold, lower gross profit, and lower net income because FIFO values the cost of goods sold at the oldest higher prices.
LO 5,6 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 6-15A (a) (1)Periodic Inventory System COST OF GOODS AVAILABLE FOR SALE Date Aug. 1 4 18 28
Explanation Beginning inventory Purchase Purchase Purchase Total
Units 50 180 70 40 340
Unit Cost $90 92 94 95
Total Cost $ 4,500 16,560 6,580 3,800 $31,440
Units Sold = 160 + 100 = 260 Units in Ending inventory = 340 – 260 = 80
Step 1: Ending Inventory Unit Total Units Cost Cost 40 $95 $3,800 40 94 3,760 80 $7,560
Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$31,440 7,560 $23,880
Proof: Cost of Goods Sold
Units 50 180 30 260
Solutions Manual .
Unit Cost $90 92 94
Total Cost $ 4,500 16,560 2,820 $23,880
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 6-15A (Continued) (a)
(2)
Perpetual Inventory System
Date Description
Purchases
Cost of Goods Sold
Aug 1 Beginning inventory 4 Purchase
180 $92 $16,560 50 110
10 Sale 18 Purchase
70 94
6,580 70 30
25 Sale 28 Purchase
40 95
31 Balance
290
$90 92 $14,620
92 94
9,260
3,800 $26,940 260
$23,880
Ending Inventory
50 50 180
$90 $ 4,500 90 92 21,060
70 70 70
92 92 94
40 40 40
94 94 95
80
6,440 13,020 3,760 7,560
, $ 7,560
Check: $23,880 + $7,560 = $31,440 ($4,500 + $26,940)
(b) Perpetual $23,880 7,560 $31,440
Cost of goods sold Ending inventory Cost of goods available for sale
Periodic $23,880 7,560 $31,440
The results under FIFO in a perpetual system are the same as in a periodic system. Under both inventory systems, the first costs in inventory are the ones assigned to the cost of goods sold. LO 2,6 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 6-16A (a)
(1)
Perpetual Inventory System
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Date Description
Purchases
Cost of Goods Sold
Nov. 1 Beginning inventory 4 Purchase
500 $42 $21,000
11 Sale 16 Purchase
450 750
44
33,000
20 Sale
800
27 Purchase
600
30 Balance
1,850
46
$41.67 $18,750.00
43.61
34,888.89
27,600 $81,600 1,250
$53,638.89
Ending Inventory
100 $40.00
$ 4,000.00
600 41.67
25,000.00
150 41.67
6,250.00
900 43.61
39,250.00
100 43.61
4,361.11
700 45.66
31,961.11
700
$31,961.11
Check: $53,638.89 + $31,961.11 = $85,600 ($4,000 + $81,600)
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 6-16A (CONTINUED) (a)
(2)
Periodic Inventory System COST OF GOODS AVAILABLE FOR SALE
Date Nov 1 4 16 27
Explanation Beginning inventory Purchase Purchase Purchase Total
Units 100 500 750 600 1,950
Unit Cost $40 42 44 46
Total Cost $ 4,000 21,000 33,000 27,600 $85,600
Average cost per unit = $85,600 ÷ 1,950 = $43.90 Units Sold = 450 + 800 = 1,250 Units in Ending inventory = 1,950 – 1,250 = 700 Step 1: Ending Inventory 700 units @ $43.90 = $30,728.21
Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$85,600.00 30,728.21 $54,871.79
Proof: Cost of Goods Sold 1,250 × ($85,600 ÷ 1,950) = $54,871.79 (b) Average Cost Periodic
Perpetual
Cost of goods sold
$54,871.79
$53,638.89
Ending inventory Cost of goods available for sale
30,728.21 $85,600.00
31,961.11 $85,600.00
The results are different because the perpetual system recalculates (changes) the average unit cost after each purchase where the average cost is calculated only once at the end of the period in the periodic system. LO 2,6 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-1B (a)
1.
The goods on consignment belong to Kananaskis and should not be included in Banff’s ending inventory.
2.
$2,650 ($2,500 + $150) should be included in inventory as the goods were shipped FOB shipping point on February 21st.
3.
The goods should not be included in inventory as they were shipped FOB shipping point and shipped before February 28. Title to the goods transfers to the customer at shipping. Banff should have recorded the transaction in the Sales and Accounts Receivable accounts. Freight charges are paid by the customer.
4.
Include $1,100 ($2,200 ÷ 2) in inventory as Banff has title to this inventory.
5.
The amount should not be included in inventory as the goods were shipped FOB destination and not received until March 2. The seller still owns the inventory. No entry is recorded. The seller is responsible for the freight costs.
6.
The sale will be recorded on March 3. The goods should be included in inventory at the end of February at their cost of $1,800. The freight is a selling expense.
7.
Include $2,100 in inventory as it has not been sold.
8.
Inventory should be decreased by $800 to record these goods at lower of cost and net realizable value, which is zero.
(Legal title determines if an item should be included in inventory)
(b)
The revised ending inventory is: Unadjusted inventory Adjustments 2. February 19 4. February 23 6. February 26 7. February 27 8. February 28 Adjusted inventory
$161,000 $ 2,650 1,100 1,800 2,100 (800)
6,850 $167,850
LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-2B (a) Cost of Goods Sold
Aug. 10 18
Ending Inventory
Supplier Suzuki
Serial # SZ5828
Cost/ Sales price/ Unit Unit $ $ 1,900 3,000
Supplier Kawai
Serial # KG1520
Cost/ Unit $ 900
Kawai
KG1268
1,800
2,100
Suzuki
SZ5716
1,400
Yamaha
YH4418
1,600
2,400
Steinway
ST0944
2,500
Steinway ST8411
2,900
4,000
Suzuki
SZ6148
1,900
Suzuki
SZ6132
2,100
3,200
Yamaha
YH6318
1,800
2,800
Yamaha
YH5632
1,900
2,900
14,000
20,400
26
Aug.
1
22
6,700
(b)
Gross profit = $20,400 – $14,000 = $6,400
(c)
The specific identification formula is likely the most appropriate formula for the Piano Studio Ltd. because the pianos are large dollar value items that are specifically identifiable by serial number.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-3B (a)
(1)
FIFO
Date Description May 1 Purchase 6 Purchase
Purchases
Cost of Goods Sold
110 $190 $20,900 140
220
30,800 110 $190 90 220 $40,700
11 Sale 14 Purchase
80
230
18,400 50 50
21 Sale 27 Purchase
50
31 Balance
380
250
220 230 22,500
12,500 $82,600 300
$63,200
Ending Inventory 110 110 140
$190 $20,900 190 220 51,700
50 50 80
220 220 230
11,000
30 30 50
230 230 250
6,900
80
29,400
19,400 $19,400
Check: $63,200 + $19,400 = $82,600 (2) Average Cost Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. Date Description
Purchases
May 1 Purchase
110 $190 $20,900
110 $190.00 $20,900.00
6 Purchase
140 220 30,800
250 206.80 51,700.00
11 Sale 14 Purchase
200 $206.80 $41,360.00 80 230 18,400
21 Sale 27 Purchase
Cost of Goods Sold
50 206.80 10,340.00 130 221.08 28,740.00
100
221.08
22,107.69
50 250 12,500
30 221.08
6,632.31
80 239.15 19,132.31
31 Balance 380 $82,600 300 Check: $63,467.69 + $19,132.31 = $82,600
Solutions Manual .
Ending Inventory
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$63,467.69
80
$19,132.31
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 6-3B (CONTINUED) (b)
Family Appliance Mart should select the formula that: • corresponds most closely to the physical flow of goods • results in a cost on the statement of financial position that is close to the inventory’s most recent cost
(c)
Because prices are rising, FIFO produces the higher gross profit and net income.
(d)
Because the ending inventory is determined using the most recent prices, the FIFO cost formula produces the higher ending inventory.
(e)
Pre-tax cash flow will be the same under both cost formulas.
LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-4B (a)
FIFO
Date Description April 1 Beg. inventory
Purchases
Cost of Goods Sold
6 Purchase
35 $240 $ 8,400 50 $230 5 240 $12,700
9 Sale 14 Purchase
40
245
9,800 30 20
20 Sale 28 Purchase
30
30 Balance
105
250
240 245
12,100
7,500 $25,700 105
$24,800
Ending Inventory 50 $230 $11,500 50 230 35 240 19,900 30 30 40
240 240 245
20 20 30
245 245 250
7,200 17,000 4,900 12,400
50
$12,400
Check: $24,800 + $12,400 = $37,200 ($11,500 + $25,700)
(b)
It needs to consider whether the change will result in more relevant and reliable presentation in the financial statements. This may only occur if the physical flow, or nature and use of the inventory changes.
(c)
I would expect that, under the average cost formula, the ending inventory would be lower, because under FIFO, when prices are rising, the inventory with the highest cost would have been purchased last and would remain in inventory. Under average cost, ending inventory includes some lower cost goods purchased earlier. I would expect cost of goods sold to be higher under average cost since the average cost would include the cost of more recently purchased goods. Notice that average cost will give higher cost of goods sold while having ending inventory that is lower than under FIFO.
LO 2,4 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-5B (a)
Date
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation.
Description
Purchases
Cost of Goods Sold
April 1 Beg. inventory
Ending Inventory 50 $230.00 $11,500.00
6 Purchase
35 $240 $ 8,400
9 Sale
55 $234.12 $12,876.47
14 Purchase
40
245
9,800
20 Sale
50
28 Purchase
30
30
105
250
240.34
12,016.81
7,500 $25,700 105
$24,893.28
85 234.12
19,900.00
30 234.12
7,023.53
70 240.34
16,823.53
20 240.34
4,806.72
50 246.13
12,306.72
50
$12,306.72
Check: $24,893.28 + $12,306.72 = $37,200 ($11,500 + $25,700)
(b)
It should write-off the rod: April 30
(c)
Cost of Goods Sold.................................. Inventory .......................................
246.13 246.13
Three accounts would be affected—Inventory, Cost of Goods Sold, and Retained Earnings. The Inventory account would be overstated by $246.13. This would result in the statement of financial position sub-totals of current assets and total assets also being overstated. The Cost of Goods Sold account would be understated by $246.13. This would lead to the income statement sub-totals of gross profit and net income being overstated by $246.13. The Retained Earnings account would also be overstated by $246.13.
LO 2,3 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 6-6B (a) Oct.
1
No entry required
5
Inventory (100 × $130) .......................................... Accounts Payable ........................................
13,000
Accounts Receivable ............................................. Sales (120 × $200)........................................
24,000
Cost of Goods Sold ............................................... Inventory [(60 × $140) + (60 × $130)] ...........
16,200
Inventory (35 × $120) ............................................ Accounts Payable .........................................
4,200
Accounts Receivable ............................................. Sales (60 × $160)..........................................
9,600
Cost of Goods Sold ............................................... Inventory [(40 × $130) + (20 × $120)] ...........
7,600
Inventory (15 × $110) ............................................ Accounts Payable ........................................
1,650
8
15
20
26
(b) Date Oct. 31
Ending Inventory Unit Units Cost 15 @ $110 15 @ $120 30
13,000
24,000
16,200
4,200
9,600
7,600
1,650
Total Cost $1,650 1,800 $3,450
*60 + 100 – 120 + 35 – 60 + 15 = 30 (c)
The inventory should be valued at $3,240. This is the lower of cost and net realizable value. Cost = $3,450.00 (see (b)) NRV = $3,240.00 (30 @ $108)
LO 2,5 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-7B (a) (b) (c) (d) (e) (f) (g)
Cash Cost of goods sold Net income Retained earnings Ending inventory Gross profit margin ratio Inventory turnover ratio
2018 No effect Understated Overstated No effect No effect Overstated Overstated*
2017 No effect Overstated Understated Understated Understated Understated Overstated
* Although the cost of goods sold is understated in 2018, this is not as significant (in percentage terms) as the understatement in average inventory, which is the denominator in the inventory turnover ratio so this ratio remains overstated in 2018. LO 4,5 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-8B (a)
(INCORRECT) PELLETIER INC. Income Statement Year Ended July 31
Sales Cost of goods sold Gross profit Operating expenses Income before income tax
2018 $320,000 187,000 133,000 52,000 $ 81,000
2017 $312,000 203,000 109,000 52,000 $ 57,000
2016 $300,000 170,000 130,000 50,000 $ 80,000
Statement of financial position: Inventory
$37,000
$24,000
$37,000
(CORRECT) PELLETIER INC. Income Statement Year Ended July 31 Sales Cost of goods sold Gross profit Operating expenses Income before income tax
2018 $320,000 187,000 3 133,000 52,000 $ 81,000
2017 $312,000 193,0002 119,000 52,000 $ 67,000
2016 $300,000 180,0001 120,000 50,000 $ 70,000
Statement of financial position: Inventory
$37,000
$19,0004
$27,0003
1
$170,000 + $10,000 = $180,000 $203,000 – $10,000 (2016 error) + $0* (2017 error) = $193,000 3 $37,000 – $10,000 = $27,000 4 $24,000 + $5,000 = $29,000 2
* Purchases understated by $5,000 and inventory understated by $5,000, so nil effect on cost of goods sold.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-8B (CONTINUED) (b)
Before correction = $81,000 + $57,000 + $80,000 = $218,000 After correction = $81,000 + $67,000 + $70,000 = $218,000
(c)
Inventory turnover
(INCORRECT) Inventory turnover (2018)
Inventory turnover (2017)
$187,000 = 6.1 times ($37,000 + $24,000)÷2 $203,000 = 6.7 times ($24,000 + $37,000)÷2
(CORRECT) Inventory turnover (2018)
Inventory turnover (2017)
$187,000 = 6.7 times ($37,000 + $19,000)÷2 $193,000 = 8.4 times ($19,000 + $27,000)÷2
LO 4,5 BT: AN Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-9B (a)
Product A B C
(b)
Quantity 25 30 60
Unit Cost $7 6 11
Net Realizable Total Cost Value $ 175 $7 180 8 660 10 $1,015
Total NRV $ 175 240 600 $1,015
March 31 Cost of Goods Sold ................................................... Inventory ...................................................... ($1,015 - $955 = $60)
Lower of Cost and NRV $175 180 600 $955
60 60
LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-10B (a)
(1) (2) (3)
March 31 April 30 May 31
Tonnes
Total Cost
Total NRV
LCNRV
30,000
$21,750,0001
$22,200,0004
$21,750,000
25,000 28,000
17,875,0002 20,300,0003
17,750,0005 20,300,0006
17,750,000 20,300,000
1
30,000 x $725 = $21,750,000 25,000 x $715 = $17,875,000 3 28,000 x $725 = $20,300,000 4 30,000x $740 = $22,200,000 5 25,000 x $710 = $17,750,000 6 28,000 x $725 = $20,300,000 2
(b) (1)
March 31 No entry
(2)
April 30
(3)
May 31
Cost of Goods Sold ....................................... Inventory ................................................. ($17,875,000 – $17,750,000 = $125,000)
125,000 125,000
No entry
LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-11B (a) (in USD millions)
2015
2014
Inventory Turnover
Days In Inventory
Current Ratio
$28,384 = 9.7 times ($2,720 + $3,143)÷2
365 = 38 days 9.7 times
$23,031 = 1.3 : 1 $17,578
$30,884 = 9.4 times ($3,143 + $3,409)÷2
365 = 39 days 9.4 times
$20,663 = 1.1 : 1 $18,092
PepsiCo’s current ratio improved in 2015 and is equal to the industry average of 1.3:1. This ratio indicates that the company has the same amount of current assets to cover its current liabilities as does the average company in this industry. The increase in the current ratio however follows the trend experienced by the industry and may be due to the same economic factors as experienced by other companies in the same industry. PepsiCo’s inventory turnover has improved, and is above the industry average. This trend is opposite to the industry trend which declined from 2014 to 2015. (b)
PepsiCo has different types of inventory that likely have different physical flows. For example, drinks with “best before dates” likely flow first-in, firstout, which make the FIFO inventory cost formula an appropriate choice. Other components of inventory, including raw materials such as sugar, may be accounted for on an average cost basis.
LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 6-12B (a)
Magna’s inventory turnover outpaces its industry counterparts by a large margin while Dana is below the industry standard in this respect. On the other hand, Dana has a much stronger current ratio compared to its industry counterparts while Magna is slightly under industry average for this measure of liquidity.
(b)
While the gross profit margins are similar between Magna and Dana, their gross profit margins fall well short of the industry average. This could be due in part to the product mix for each company compared to its industry peers. As for profit margin, Magna does a better job than Dana controlling costs as its gross profit is 1.9% less than Dana’s, but its profit margin is only 0.1% less. Both Magna and Dana are under the industry average for profit margin.
(c)
Since inventory is a large component of current assets, a higher inventory turnover as is the case for Magna would normally decrease its current ratio, which appears to be case. Dana experienced the opposite trend as it has a lower inventory turnover than Magna. Dana should have a higher current ratio, which also appears to be the case. One can therefore conclude: other factors remaining equal, the more inventory kept on hand, the greater the current assets and the current ratio.
LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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*PROBLEM 6-13B (a)
(b)
Cost Of Goods Available For Sale Date Jan. Feb. May Aug. Dec.
1 20 5 12 8
(1)
FIFO
Explanation Beginning inventory Purchase Purchase Purchase Purchase Total
Step 1: Ending Inventory Date Units Unit Cost Dec. 8 400 22
Units 400 1,200 1,000 1,200 600 4,400
Unit Cost $18 19 21 20 22
Total Cost $ 7,200 22,800 21,000 24,000 13,200 $88,200
Total Cost $ 8,800
Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$88,200 8,800 $79,400
Proof: Cost of Goods Sold
Units 400 1,200 1,000 1,200 200 4,000
Solutions Manual .
Unit Cost $18 19 21 20 22
Total Cost $ 7,200 22,800 21,000 24,000 4,400 $79,400
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*PROBLEM 6-13B (CONTINUED) (b)
(2)
Average Cost
Step1: Ending Inventory
Units 400
Weighted Average Unit Cost $20.05* =
Total Cost $8,018.18
*$88,200 ÷ 4,400 = $20.05
Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$88,200.00 8,018.18 $80,181.82
Proof: 4,000 × ($88,200 ÷ 4,400) = $80,181.82 LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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*PROBLEM 6-14B (a) STEWARD INC. Partial Income Statements
Sales (4,000 × $40) ......................................... Cost of goods sold Beginning inventory................................. Cost of goods purchased ........................ Cost of goods available for sale .............. Ending inventory ..................................... Cost of goods sold .................................. Gross profit ......................................................
FIFO
Average Cost
$160,000
$160,000
7,200 81,000 88,200 8,800 79,400 80,600
7,200 81,000 88,200 8,018 80,182 79,818
(b) STEWARD INC. Partial Statement of Financial Position
Assets Current assets Inventory ..................................................
(c)
FIFO
Average Cost
$8,800
$8,018
FIFO uses the latest inventory prices to determine the cost of the ending inventory and, therefore, results in the higher amount for ending inventory in periods of rising prices. FIFO results in the lowest cost of goods sold and higher net income because FIFO values the cost of goods sold at the earliest and lowest prices.
LO 5,6 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPAL cpa-t001 CM: Reporting
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*PROBLEM 6-15B (a)
(1)
Perpetual
Date Description
Purchases
Cost of Goods Sold
May 1 Beg. inventory 6 Purchase
14 Purchase
15,000 $2.30 $ 34,500 15,000 2.30 40,000 2.35 128,500
40,000 $2.35 $ 94,000
11 Sale 50,000 2.40
120,000
21 Sale 27 Purchase
40,000 2.45
31 Balance
130,000
98,000
Ending Inventory
15,000 $2.30 15,000 2.35 $ 69,750 25,000 25,000 50,000 25,000 2.35 40,000 2.40 154,750 10,000 10,000 40,000
$312,000 95,000‘
$224,500 50,000
2.35 2.35 2.40 2.40 2.40 2.45
58,750 178,750 24,000 122,000 $122,000
Check: $224,500 + $122,000 = $346,500 ($34,500 + $312,000)
(2)
Periodic
Step 1: Ending Inventory Date Units Unit Cost May 14 10,000 $2.40 May 27 40,000 2.45 50,000
Total Cost $ 24,000 98,000 $122,000
Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$346,500 122,000 $224,500
Proof: Cost of Goods Sold Unit Total Units Cost Cost 15,000 $2.30 $ 34,500 40,000 2.35 94,000 40,000 2.40 96,000 95,000 $224,500
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*PROBLEM 6-15B (CONTINUED) (b)
FIFO Perpetual $224,500 122,000 $346,500
Cost of goods sold Ending inventory Cost of goods available for sale
Periodic $224,500 122,000 $346,500
Both the periodic and perpetual systems result in the same ending inventory and cost of goods sold under the FIFO cost formula because the most recently purchased goods remain in inventory. LO 2,6 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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*PROBLEM 6-16B (a)
Note: Unrounded numbers have been used in the average cost calculations, although the numbers have been rounded to the nearest cent for presentation purposes. Because of this, some amounts may not appear to multiply exactly because of the rounding in the presentation. (1)
Date
Average Cost – Perpetual
Description
Purchases
Cost of Goods Sold
Oct. 1 Beg. inventory 9 Purchase
50 $240.00 $12,000.00 125 $260 $32,500
15 Sale 20 Purchase
175
254.29 44,500.00
25
254.29
95
265.86 25,257.14
14,622.56
40
265.86 10,634.59
$52,765.41
40
$10,634.59
150 $254.29 $38,142.86 70 270 18,900
29 Sale 30 Balance
Ending Inventory
55 195
$51,400 205
265.86
6,357.14
Check: $52,765.41 + $10,634.59 = $63,400 ($12,000 + $51,400)
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*PROBLEM 6-16B (CONTINUED) (a)
(2)
Average Cost – Periodic
Cost of Goods Available for Sale Date Oct.
Explanation Beginning inventory Purchase Purchase
1 9 20
Total
Ending Inventory Date Oct. 31
Unit Total Units Cost Cost 40 $258.78* $10,351.02
Units 50 125 70 245
Unit Cost $240 260 270
Total Cost $12,000 32,500 18,900 $63,400
Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$63,400.00 10,351.02 $53,048.98
$63,400 ÷ 245 = $258.78
*
Proof: Cost of Goods Sold 205 × ($63,400 ÷ 245) = $53,048.98
(b) Average Cost Perpetual Periodic Cost of goods sold
$52,765.41
$53,048.98
Ending inventory Cost of goods available for sale
10,634.59 $63,400.00
10,351.02 $63,400.00
The results for the average cost formula differ depending on whether a perpetual or periodic system is used. This is because, using a perpetual system, the average cost is recalculated (changes) after each purchase. In a periodic system, it is calculated only once at the end of the period. LO 2,6 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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ACR6-1 (a)
Dec.
1
4
6
Financial Accounting, Seventh Canadian Edition
ACCOUNTING CYCLE REVIEW
Cash ................................................................. Accounts Receivable.................................
315,000
Rent Expense.................................................... Cash..........................................................
14,000
Accounts Payable ............................................. Cash..........................................................
375,000
315,000 14,000
375,000
Accounts Receivable......................................... 2,121,000 Sales ......................................................... Cost of Goods Sold (4,200 x $278)*.................. 1,167,600 Inventory ................................................... *Dec. 1 balance ÷ Dec. 1 units = $2,780,000 ÷ 10,000 = $278
15 18 21
Inventory (6,000 x $290) ................................... 1,740,000 Accounts Payable ..................................... Salaries Expense .............................................. Cash..........................................................
27
1,740,000 125,000
Accounts Receivable ........................................ 4,092,000 Sales .........................................................
Advertising Expense ......................................... Cash..........................................................
1,167,600
125,000
Cost of Goods Sold ........................................... 2,250,400 Inventory (5,800* x $278) + (2,200** x $290) * remaining units (10,000 – 4,200 Dec. 6) ** additional (8,000 – 5,800 = 2,200) 24
2,121,000
4,092,000 2,250,400
32,000
Inventory (5,000 x $300) ................................... 1,500,000 Accounts Payable .....................................
32,000 1,500,000
(b) Part (b) is combined with part (d).
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ACR6-1 (CONTINUED) (c) RETRO PRODUCTIONS LIMITED Unadjusted Trial Balance December 31, 2018 Debit Cash Accounts receivable Inventory Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Unearned revenue Bank loan payable—non-current Common shares Retained earnings Dividends declared Sales Sales returns and allowances Sales discounts Cost of goods sold Advertising expense Freight out Office expense Rent expense Salaries expense Travel expense Utilities expense Interest expense Income tax expense
Solutions Manual .
Credit
$ 190,100 7,288,000 2,602,000 39,000 14,000 1,350,000 $ 35,625 4,095,000 96,000 1,240,000 600,000 1,239,275 120,000 22,893,000 56,000 166,800 12,592,000 437,000 980,000 78,000 168,000 3,561,000 46,000 61,000 70,000 380,000 $30,198,900
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Financial Accounting, Seventh Canadian Edition
ACR6-1 (CONTINUED) (d) Adjusting journal entries (AJE) Dec.
31
31 31
31
31
31
Solutions Manual .
Utilities Expense................................................ Accounts Payable .....................................
6,000
Salaries Expense .............................................. Salaries Payable .......................................
140,000
Interest Expense ............................................... Interest Payable ........................................
6,200
Depreciation Expense ....................................... Accumulated Depreciation—Equipment.... ($1,350,000 ÷ 8 = $168,750)
168,750
6,000
140,000 6,200
168,750
Cost of Goods Sold ........................................... 8,000 Inventory ($2,602,000* - $2,594,000)........ * Refer to Inventory T account below part (b) and (d) Income Tax Expense ........................................ Income Tax Payable .................................
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8,000
112,000 112,000
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Financial Accounting, Seventh Canadian Edition
ACR6-1 (CONTINUED) (b) and (d) AJE = Adjusting Journal Entry Cash Nov. 30 Bal. 421,100 Dec. 1 14,000 Dec. 4 Dec. 1 315,000 Dec. 4 375,000 Dec. 18 125,000 Dec. 24 32,000 Dec. 31 Bal. 190,100
Nov. 30 Bal. Dec. 6 Dec. 21 Dec. 31 Bal.
Nov. 30 Bal. Dec. 15 Dec. 27 Unadj. Bal. Dec. 31 Bal.
Accounts Receivable 1,390,000 Dec. 1 2,121,000 4,092,000 7,288,000 Inventory 2,780,000 Dec. 6 1,740,000 Dec. 21 1,500,000 2,602,000 Dec. 31 AJE 2,594,000
Nov. 30 Bal. Dec. 31 Bal.
Supplies 39,000 39,000
Nov. 30 Bal. Dec. 31 Bal.
Prepaid Rent 14,000 14,000
Nov. 30 Bal. Dec. 31 Bal.
315,000
1,167,600 2,250,400
8,000
Equipment 1,350,000 1,350,000
Accumulated Depreciation-Equipment Nov. 30 Bal. 35,625 Unadj. Bal. 35,625 Dec. 31 AJE 168,750 Dec. 31 Bal. 204,375 Solutions Manual .
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Accounts Payable 375,000 Nov. 30 Bal. Dec. 15 Dec. 27 Unadj. Bal. Dec. 31 AJE Dec. 31 Bal.
1,230,000 1,740,000 1,500,000 4,095,000 6,000 4,101,000
Income Tax Payable Nov. 30 Bal. Unadj. Bal. Dec. 31 AJE Dec. 31 Bal.
0 0 112,000 112,000
Interest Payable Nov. 30 Bal. Unadj. Bal. Dec. 31 AJE Dec. 31 Bal.
0 0 6,200 6,200
Salaries Payable Nov. 30 Bal. Unadj. Bal. Dec. 31 AJE Dec. 31 Bal.
0 0 140,000 140,000
Unearned Revenue Nov. 30 Bal. Dec. 31 Bal.
96,000 96,000
Bank Loan Payable Nov. 30 Bal. Dec. 31 Bal.
1,240,000 1,240,000
Common Shares Nov. 30 Bal. Dec. 31 Bal.
600,000 600,000
Chapter 6
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Financial Accounting, Seventh Canadian Edition
ACR6-1 (CONTINUED) (b) and (d) (continued) Retained Earnings Nov. 30 Bal. Dec. 31 Bal.
Nov. 30 Bal. Dec. 31 Bal.
Dividends Declared 120,000 120,000 Sales Nov. 30 Bal. Dec. 6 Dec. 21 Dec. 31 Bal.
Sales Returns and Allowances Nov. 30 Bal. 56,000 Dec. 31 Bal. 56,000
Nov. 30 Bal. ec. 31 Bal.
Sales Discounts 166,800 166,800
Nov. 30 Bal. Dec. 6 Dec. 21 Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Cost of Goods Sold 9,174,000 1,167,600 2,250,400 12,592,000 8,000 12,600,000
Nov. 30 Bal. Dec. 24 Dec. 31 Bal.
1,239,275 1,239,275
Advertising Expense 405,000 32,000 437,000
Solutions Manual .
16,680,000 2,121,000 4,092,000 22,893,000
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Depreciation Expense 0 0 168,750 168,750
Nov. 30 Bal. Dec. 31 Bal.
Freight Out 980,000 980,000
Nov. 30 Bal. Dec. 31 Bal.
Office Expense 78,000 78,000
Nov. 30 Bal. Dec. 1 Dec. 31 Bal.
Rent Expense 154,000 14,000 168,000
Nov. 30 Bal. Dec. 18 Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Salaries Expense 3,436,000 125,000 3,561,000 140,000 3,701,000
Nov. 30 Bal. Dec. 31 Bal.
Travel Expense 46,000 46,000
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Utilities Expense 61,000 61,000 6,000 67,000
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ACR6-1 (CONTINUED) (b) and (d) (continued)
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Interest Expense 70,000 70,000 6,200 76,200
Solutions Manual .
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
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Income Tax Expense 380,000 380,000 112,000 492,000
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Financial Accounting, Seventh Canadian Edition
ACR6-1 (CONTINUED) (e) RETRO PRODUCTIONS LIMITED Adjusted Trial Balance December 31, 2018 Debit Cash Accounts receivable Inventory Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Income tax payable Interest payable Salaries payable Unearned revenue Bank loan payable—non-current Common shares Retained earnings Dividends declared Sales Sales returns and allowances Sales discounts Cost of goods sold Advertising expense Depreciation expense Freight out Office expense Rent expense Salaries expense Travel expense Utilities expense Interest expense Income tax expense
Solutions Manual .
Credit
$ 190,100 7,288,000 2,594,000 39,000 14,000 1,350,000 $ 204,375 4,101,000 112,000 6,200 140,000 96,000 1,240,000 600,000 1,239,275 120,000 22,893,000 56,000 166,800 12,600,000 437,000 168,750 980,000 78,000 168,000 3,701,000 46,000 67,000 76,200 492,000 $30,631,850
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Financial Accounting, Seventh Canadian Edition
ACR6-1 (CONTINUED) (f) (1) RETRO PRODUCTIONS LIMITED Income Statement Year Ended December 31, 2018 Sales Less: Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit Operating expenses Salaries expense Freight out Advertising expense Depreciation expense Rent expense Office expense Utilities expense Travel expense Total operating expenses Income from operations Other expenses Interest expense Income before income tax Income tax expense Net income
$22,893,000 $ 56,000 166,800
222,800 22,670,200 12,600,000 10,070,200
$3,701,000 980,000 437,000 168,750 168,000 78,000 67,000 46,000 5,645,750 4,424,450 76,200 4,348,250 492,000 $3,856,250
(f) (2) RETRO PRODUCTIONS LIMITED Statement of Changes in Equity Year Ended December 31, 2018
Balance, January 1 Net income 0000 000 Dividends declared Balance, December 31
Solutions Manual .
Common Shares $600,000 0000 000 $600,000
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Retained Earnings $1,239,275 3,856,250 (120,000) $4,975,525
Total Equity $1,839,275 3,856,250 (120,000) $5,575,525
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Financial Accounting, Seventh Canadian Edition
ACR6-1 (CONTINUED) (f) (3) RETRO PRODUCTIONS LIMITED Statement of Financial Position December 31, 2018 Assets Current assets Cash Accounts receivable Inventory Supplies Prepaid rent Total current assets Property, plant and equipment Equipment Less: Accumulated depreciation Total assets
$
190,100 7,288,000 2,594,000 39,000 14,000 10,125,100
$1,350,000 204,375
1,145,625 $11,270,725
Liabilities and Shareholders’ Equity Current Liabilities Accounts payable Salaries payable Income tax payable Interest payable Unearned revenue Total current liabilities Bank loan payable Total Liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
Solutions Manual .
$ 4,101,000 140,000 112,000 6,200 96,000 4,455,200 1,240,000 5,695,200 $ 600,000 4,975,525 5,575,525 $11,270,725
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ACR6-1 (CONTINUED) (g) Closing entries (CE) Dec.
31
31
31
31
Sales ................................................................. Sales Discounts ........................................ Sales Returns and Allowances.................. Income Summary ......................................
22,893,000
Income Summary .............................................. Cost of Goods Sold ................................... Advertising Expense ................................. Depreciation Expense ............................... Freight Out ................................................ Office Expense .......................................... Rent Expense............................................ Salaries Expense ...................................... Travel Expense ......................................... Utilities Expense........................................ Interest Expense ....................................... Income Tax Expense ................................
18,813,950
Income Summary .............................................. Retained Earnings.....................................
3,856,250
Retained Earnings............................................. Dividends Declared ...................................
120,000
CE = Closing Entry
Dec. 31 CE
Nov. 30 Bal. Dec. 31 Bal.
Dec. 31 CE Dec. 31 CE
Retained Earnings Nov. 30 Bal. Dec. 31 Bal. 120,000 Dec. 31 CE Dec. 31 Bal. Dividends Declared 120,000 Dec. 31 CE Income Summary 18,813,950 Dec. 31 CE 3,856,250 Dec. 31 Bal. Dec. 31
Solutions Manual .
1,239,275 1,239,275 3,856,250 4,975,525
120,000
22,670,200 3,856,250 -
Dec. 31 CE
166,800 56,000 22,670,200
12,600,000 437,000 168,750 980,000 78,000 168,000 3,701,000 46,000 67,000 76,200 492,000
3,856,250
120,000
Sales Nov. 30 Bal. Dec. 6 Dec. 21 22,893,000 Dec. 31 Bal. Dec. 31
16,680,000 2,121,000 4,092,000 22,893,000 -
Sales Returns and Allowances Nov. 30 Bal. 56,000 Dec. 31 Bal. 56,000 Dec. 31 CE Dec. 31 Bal -
Nov. 30 Bal. Dec. 31 Bal. Dec. 31 Bal
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Sales Discounts 166,800 166,800 Dec. 31 CE -
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56,000
166,800
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR6-1 (CONTINUED) (g) (continued) Cost of Goods Sold Nov. 30 Bal. 9,174,000 Dec. 6 1,167,600 Dec. 21 2,250,400 Unadj. Bal. 12,592,000 Dec. 31AJE 8,000 Dec. 31 Bal. 12,600,000 Dec. 31 CE 12,600,000
Nov. 30 Bal. Dec. 24 Dec. 31 Bal.
Advertising Expense 405,000 32,000 437,000 Dec. 31 CE
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Depreciation Expense 168,750 168,750 Dec. 31 CE
Nov. 30 Bal. Dec. 31 Bal.
Freight Out 980,000 980,000 Dec. 31 CE
Nov. 30 Bal. Dec. 31 Bal.
Office Expense 78,000 78,000 Dec. 31 CE
Nov. 30 Bal. Dec. 1 Dec. 31 Bal.
Rent Expense 154,000 14,000 168,000 Dec. 31 CE
Solutions Manual .
Nov. 30 Bal. Dec. 18 Unadj. Bal. Dec. 31 AJE Dec. 31 Bal.
Salaries Expense 3,436,000 125,000 3,561,000 140,000 3,701,000 Dec. 31 CE
3,701,000
Nov. 30 Bal. Dec. 31 Bal.
Travel Expense 46,000 46,000 Dec. 31 CE
46,000
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Utilities Expense 61,000 61,000 6,000 67,000 Dec. 31 CE
67,000
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Interest Expense 70,000 70,000 6,200 76,200 Dec. 31 CE
76,200
Nov. 30 Bal. Unadj. Bal. Dec. 31AJE Dec. 31 Bal.
Income Tax Expense 380,000 380,000 112,000 492,000 Dec. 31 CE
492,000
437,000
168,750
980,000
78,000
168,000
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ACR6-1 (CONTINUED) (h) RETRO PRODUCTIONS LIMITED Post-Closing Trial Balance December 31, 2018 Debit Cash Accounts receivable Inventory Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Income tax payable Interest payable Salaries payable Unearned revenue Bank loan payable—non-current Common shares Retained earnings
Credit
$ 190,100 7,288,000 2,594,000 39,000 14,000 1,350,000
__________ $11,475,100
$ 204,375 4,101,000 112,000 6,200 140,000 96,000 1,240,000 600,000 4,975,525 $11,475,100
LO 2 BT: AN Difficulty: M Time: 100 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT6-1
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(Note: All amounts are in thousands) (a)
Inventories were $211,736 in 2016 and $204,812 in 2015.
(b)
Inventory
2016 $211,736
2015 $204,812
Current assets
335,581
315,840
Inventory as a % of current assets
63.1%
64.8%
Increase $6,924
As a Percentage 3.4%
Inventory has increased at a modest pace from the end of 2015 to the end of 2016. There was, on the other hand, a decrease in inventory as a percentage of current assets, in spite of the increase in current assets. (c)
When choosing the average cost formula for inventory in the warehouse and FIFO cost formula for food, North West, whose product is interchangeable, considered the flowing guidelines: 1.
Choose a formula that corresponds as closely as possible to the physical flow of goods.
2.
Report an inventory cost on the statement of financial position that is close to the inventory’s recent cost.
3.
Use the same formula for all inventories having a similar nature and usage in the company.
Due to the nature of the product sold, particularly the food items, which often have best before dates, North West would normally want to sell the oldest items in inventory first, so using FIFO cost formula for food makes sense. In terms of the other items it sells which include appliances and household items, the average cost formula is the best choice in terms of meeting the above guidelines.
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Financial Accounting, Seventh Canadian Edition
CT6-1 (CONTINUED) (d)
North West wrote down its inventory to net realizable value in both fiscal years ending January 31, 2016 and 2015. The journal entry for 2016 in thousands of dollars was as follows: Cost of Goods Sold ................................................................. Inventory ....................................................................
1,392 1,392
The amount of the write down in 2015 of $4,223 thousand was significantly higher than in 2016. LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting and Finance
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CT6-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
Current ratio
North West (in thousands)
Sobeys (in millions)
$335,581 = 2.2 : 1 $155,501
$2,581.4 = 1.0 : 1 $2,707.4
North West (in thousands)
Sobeys (in millions)
(b)
Inventory turnover
Days in inventory
(c)
$1,273,421 ($211,736 + $204,812) ÷ 2
$18,661.2 ($1,287.3 + $1,260.3) ÷ 2
= 6.1 times
= 14.7 times
365 = 60 days 6.1 times
365 = 25 days 14.7 times
North West has the better current ratio of the two companies as it’s ratio is double that of Sobeys and well ahead of the industry average. On the other hand, because Sobey’s inventory is mostly food, it has an inventory turnover twice that of North West, which also sells merchandise other than food, which moves more slowly. North West also sells much of its food in sites in the far North, so inventory would be in transit longer than would be the case for Sobeys. The Industry average falls between these two companies.
LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT6-3 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
There are no significant differences in the accounting standards relating to the management of inventory for ASPE and IFRS. Although not discussed in this introductory course, analysts should be aware that there are differences in the standards when accounting for specific types of inventory. Examples of types of inventory which do have differences are construction in progress and biological assets at the point of harvest.
(b)
Yes, the use of the two different inventory systems could affect the comparison of the financial statements of each company. For example, when the perpetual inventory system is used, any costs related to inventory shrinkage are identified. The company can then record the shrinkage in cost of goods sold as is normally done but if the amount is significant, a company could record the shrinkage in a separate account. With the periodic system, these costs are not separately identified and would ultimately be buried in cost of goods sold when the inventory count is performed. The use of the FIFO cost formula, used by Global Lumber, will not result in any financial differences between a periodic and perpetual inventory system. The use of the average cost formula, used by Gibson Lumber, will normally result in different financial results between a periodic and perpetual inventory system because the average unit cost is determined only at the end of a period in the periodic system compared to continually adjusting it in a perpetual inventory system. That said, these differences are likely minor if costs are changing by small amounts.
(c)
Yes, the use of the different cost formulas would affect the comparison of the financial statements. This effect is greater in periods where inventory costs are changing. Global Lumber measures its inventory using the FIFO cost formula and therefore its inventory is valued at the most current price. Gibson uses the average cost formula and therefore its inventory is valued at the average cost of all inventory purchased or produced during the period. Therefore, in a period of rising (or declining) prices Global Lumber's would be recorded at a higher (or lower) per unit value than that of Gibson.
LO 1,2,3,6 BT: E Difficulty: C Time: 40 min. AACSB: Reflec. Thinking CPA: cpa-t001 CM: Reporting
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CT6-4 (a)
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
The cost of goods available for sale in December can be calculated as follows (notice that the goods in transit are not included as title has not yet passed because terms were FOB destination):
December 1 – purchase from DDI Second purchase Third purchase
(b)
Doors
Cost
Total
2,600 800 600 4,000
310 240 190
$ 806,000 192,000 114,000 $1,112,000
The cost of ending inventory at the end at December 31 can be calculated as follows: The average cost, or carrying amount, of a door is $1,112,000 ÷ 4,000 = $278 per door. The number of units in ending inventory is the 800 doors counted. The 100 doors in transit should not be included in inventory because title did not pass while in transit. Title passes at destination and the doors have not yet reached their destination. Consequently, ending inventory is 800 × $278 = $222,400.
(c)
Because there is an error in the ending inventory balance, the Inventory account will have to be adjusted along with a corresponding adjustment to Cost of Goods Sold. The error can be calculated as follows: Inventory balance per Kevin 900 × $310 Inventory correct balance (see above) Difference
$279,000 222,400 $ 56,600
As this will directly affect operating income for the month of December, Kevin’s bonus should be reduced by $5,660 (10% of $56,600).
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Financial Accounting, Seventh Canadian Edition
CT6-4 (CONTINUED) (d)
The error in ending inventory has an impact on the bank loan. The loan limit is 80% of the carrying amount of inventory. Since the correct inventory balance is $222,400 and 80% of this amount is $177,920 that is the maximum loan balance that the bank will now allow. Since the loan outstanding is currently at $200,000, the bank will want ABS to pay down the loan by $22,080 ($200,000 − $177,920). Had Kevin’s amounts for ending inventory been used, there would have been enough security for the loan.
(e)
Kevin’s actions may be considered unethical for two major reasons. First of all, he apparently increased the number of doors in ending inventory by the 100 doors that were in transit even though title had not passed. Secondly, he did not apply the average cost formula appropriately. It is also interesting to note that the motivation for doing this was probably to maximize his bonus but it could also have been done to maintain the level of current funding from the bank. One can also wonder why ABS purchased the inventory when it acquired DDI at an average cost per door of $310 when the cost of doors appeared to be falling dramatically.
(f)
If the selling price, which is the net realizable value of a door, fell to $240 each, then the carrying amount of $278 each would be higher. Since inventory is valued at the lower of cost or net realizable value, the amount per door should be reduced from $278 to $240 each, representing a write-down of $800 × ($278 − $240) = $30,400. Cost of goods sold will be increased by $30,400 and this will decrease gross profit by the same amount. This would further reduce Kevin’s bonus by $3,040 and would mean that the bank loan balance would also have to be reduced by $24,320 (80% × $30,400).
LO 4,5 BT: E Difficulty: M Time: 45 min. AACSB: Ethics and Communication CPA: cpa-t001, cpa-e001, cpa-e003 CM: Reporting, Ethics, and Comm.
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CT6-5 (a)
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
Specific Identification (1) Maximize Gross Profit
(2) Minimize Gross Profit
$561,0001 2 366,100 $194,900
“$561,0001 3 366,800 “$194,200
Sales ................................................................. Cost of goods sold ............................................ Gross profit ....................................................... 1
Sales = (170 × $800) + (500 × $850) = $561,000
Goods Available for Sale Date Units Cost Total Mar. 1 140 $500 $ 70,000 3 200 540 108,000 10 340 570 193,800 $371,800 Specific Identification–Maximize gross profit (minimize cost of sales by deciding to sell the handbags purchased at the lowest cost) Cost of Goods Sold Date Units Mar. 5 140 30 25 170 330
Cost 0$500 ,,,,540 …540 570
Total $ 70,000 16,200 91,800 188,100 2 $366,100
Ending Inventory Date Units Mar. 25 10
Cost $570
Total $5,700
Specific Identification–Minimize gross profit (maximize cost of sales by selling the handbags purchased at the highest cost) Cost of Goods Sold Date Units Mar. 5 170 25 340 30 130
Solutions Manual .
Cost ,,$540 570 540 500
Total $ 91,800 193,800 16,200 65,000 3 $366,800
6-99
Ending Inventory Date Units Mar. 1 10
Cost $500
Total $5,000
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT6-5 (CONTINUED) (b)
The stakeholders are the shareholders, customers, and staff of Swag Bags. There is not really anything unethical in selecting which handbag to sell, unless it is done solely on a desire to manipulate profits.
(c)
Average Cost Sales ................................................................. Cost of goods sold ............................................ Gross profit .......................................................
March 1 Beginning inventory 3 Purchase
140 200 340 (170) 170 340 510 (500) 10
5 Sale 10 Purchase 25 Sale 31 Balance 4
(d)
$561,000 366,255 4 $194,745
$500.00 540.00 523.53 523.53 523.53 570.00 554.51 554.51
$ 70,000 108,000 178,000 (89,000) 89,000 193,800 282,800 (277,255) $ 5,545
Cost of Goods Sold = (170 × $523.53) + (500 × $554.51) = $366,255 Swag Bags should select the average cost method, given that the inventory is homogeneous and not individually distinguishable. The specific identification formula is not a permissible choice for the company given the type and physical flow of inventory it carried. The average cost formula also has the advantage of not being subject to manipulation.
LO 2,3 BT: AN Difficulty: M Time: 45 min. AACSB: Ethics and Communication CPA: cpa-t001, cpa-e001, cpa-e003 CM: Reporting, Ethics, and Comm.
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CT6-6
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
(a)
Internal control measures should be in place to help ensure: • All goods received are placed into inventory and the perpetual record is updated promptly to ensure that items are not taken by the receiving clerk • Put control tags on each inventory item so that customers do not leave the store without paying for them • Have staff watch for suspicious conduct by customers or other staff members • Establish clear policies concerning the handling on inventory and monitor the adherence to these policies by staff members. • Have small merchandise in locked display cases that can be accessed only by staff. For larger items such as laptops, use locking devises so that they cannot be stolen.
(b)
The inventory should be counted more frequently than once a year, particularly for high-end products. Through visual inspection and counting of items on hand when compared to the perpetual record, one can quickly establish if there are issues concerning the accuracy of the perpetual record or if theft and pilferage is occurring. If there is high activity (purchase and/or sale) of a particular product, a sample count of that product can be done as frequently as deemed reasonable and prudent to establish proper internal control over the inventory. Assuming the physical count is less than the count on the books, the loss would increase the Cost of Goods Sold account on the income statement and decrease both the Inventory and Retained Earnings accounts on the statement of financial position. The opposite would be true if there proved to be an overage established by the inventory count.
(c)
The tablets and laptops are unique and identifiable through their serial number. Specific identification formula of costing inventory is recommended for this type of inventory. Using this formula will better track the items on an individual basis, helping narrow down errors in recording or pinpointing the pilferage of specific inventory items. This formula will also allow for better management of the selling price of items and the tracking of gross profit on the sale of specific items. For items that are of lesser value and interchangeable, such as the cases and bags, FIFO or average cost would be a better choice as there is no need to have as stringent control over these less expensive items.
LO 1,2 BT: E Difficulty: C Time: 35 min. AACSB: Communication CPA: cpa-t001, cpa-e003 CM: Reporting and Comm.
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Financial Accounting, Seventh Canadian Edition
CT6-7
SERIAL CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a) Time Management Software Inventory - FIFO 2017
Purchases
Date July 4
Units 10
Cost of Goods Sold
Cost
Total
$550.00
$5,500.00
14 Aug. 1
550.00
9 10
539.00
3,300.00
550.00
4,950.00
5,390.00
27
5
550.00
3
539.00
4,367.00
Units
Cost
Total
10
$550.00
$5,500.00
4
550.00
2,200.00
14
550.00
7,700.00
5
550.00
2,750.00
5
550.00
10
539.00
8,140.00
7
539.00
3,773.00
10
539.00
5,390.00
7
539.00
10
528.22
5,282.20
10
539.00
10
528.22
10
539.00
10
528.22
27
Total
550.00
Total
5,500.00
28
Oct. 3
Cost
6 10
Sept. 4
Units
Balance
7
50
Solutions Manual .
$27,062.20
539.00
30
6-102
3,773.00
$16,390.00
20
14,445.20
10,672.20 $10,672.20
Chapter 6
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Financial Accounting, Seventh Canadian Edition
CT6-7 (CONTINUED) (b) July
4 14
14 25 Aug.
1 28
29 Sept.
4 27
29 Oct.
3 27
Solutions Manual .
Inventory (10 × $550) ............................................ Accounts Payable .........................................
5,500.00
Cash (6 × $995) .................................................... Sales .............................................................
5,970.00
Cost of Goods Sold (6 × $550) .............................. Inventory .......................................................
3,300.00
Accounts Payable .................................................. Cash .............................................................
5,500.00
Inventory (10 × $550) ........................................... Accounts Payable .........................................
5,500.00
Cash (9 × $995) .................................................... Sales .............................................................
8,955.00
Cost of Goods Sold (9 × $550) .............................. Inventory .......................................................
4,950.00
Accounts Payable .................................................. Cash ............................................................
5,500.00
Inventory (10 × $539) ........................................... Accounts Payable .........................................
5,390.00
Accounts Receivable (8 × $995)............................ Sales .............................................................
7,960.00
Cost of Goods Sold [(5 × $550) + (3 × $539)] ....... Inventory .......................................................
4,367.00
Accounts Payable .................................................. Cash .............................................................
5,390.00
Inventory [(10 × $539) + (10 × $528.22)] .............. Accounts Payable .........................................
10,672.20
Cash (7 × $995) .................................................... Sales .............................................................
6,965.00
Cost of Goods Sold (7 × $539) .............................. Inventory .......................................................
3,773.00
6-103
5,500.00 5,970.00
3,300.00 5,500.00 5,500.00 8,955.00 4,950.00 5,500.00 5,390.00 7,960.00 4,367.00 5,390.00 10,672.20 6,965.00 3,773.00
Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT6-7 (CONTINUED) (c) 2017
Time Management Software Inventory – Average Cost Purchases Cost of Goods Sold
Balance
Units
Cost
Total
10
$550.00
$5,500.00
4
550.00
2,200.00
14
550.00
7,700.00
5
550.00
2,750.00
15
542.67
8,140.00
7
542.67
3,798.67
Date
Units
Cost
Total
July 4
10
$550.00
$5,500.00
14 Aug. 1
6 10
550.00
9 10
539.00
8
3,300.00
550.00
4,950.00
542.67
4,341.33
10
539.00
5,390.00
17
540.51
9,188.67
10
528.22
5,282.20
27
535.96
14,470.87
3,751.71
20
535.96
10,719.16
$16,343.04
20
27 Total
550.00
Total
5,390.00
27 Oct. 3
Cost
5,500.00
28 Sept. 4
Units
7 50
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$27,062.20
30
6-104
535.96
$10,719.16
Chapter 6
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Financial Accounting, Seventh Canadian Edition
CT6-7 (CONTINUED) (d) July
4
14
25
Aug.
1
28
29 Sept.
4
27
29
Oct.
3
25
Solutions Manual .
Inventory (10 × $550) ............................................ Accounts Payable .........................................
5,550.00
Cash ($995 x 6) ..................................................... Sales .............................................................
5,970.00
Cost of Goods Sold (6 × $550) .............................. Inventory .......................................................
3,300.00
Accounts Payable .................................................. Cash .............................................................
5,500.00
Inventory (10 × $550) ........................................... Accounts Payable .........................................
5,500.00
Cash (9 × $995) .................................................... Sales .............................................................
8,955.00
Cost of Goods Sold (9 × $550) .............................. Inventory .......................................................
4,950.00
Accounts Payable .................................................. Cash .............................................................
5,500.00
Inventory (10 × $539) ........................................... Accounts Payable .........................................
5,390.00
Accounts Receivable (8 × $995)............................ Sales .............................................................
7,960.00
Cost of Goods Sold (8 × $542.67) ......................... Inventory .......................................................
4,341.33
Accounts Payable .................................................. Cash .............................................................
5,390.00
Inventory [(10 × $539) + (10 × $528.22)] .............. Accounts Payable .........................................
10,672.20
Cash (7 × $995) ................................................... Sales .............................................................
6,965.00
Cost of Goods Sold (7 × $535.96) ......................... Inventory .......................................................
3,751.71
6-105
5,550.00
5,970.00
3,300.00
5,500.00
5,500.00
8,955.00
4,950.00
5,500.00 5,390.00
7,960.00
4,341.33
5,390.00
10,672.20
6,965.00
3,751.71 Chapter 6
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT6-7 (CONTINUED) (e)
Sales Cost of goods sold Gross profit
FIFO $29,850 16,390 13,460
Gross profit margin
45.1%
(1)
(f)
(1)
Average Cost $29,850 16,343 13,507 45.2%
Sales = $5,970 + $8,955 + $7,960 + $6,965 = $29,850
Emily should consider: • Whether the goods are interchangeable or not, or whether they are produced or segregated for specific projects; • Whether the formula corresponds most closely to the physical flow of goods; • Whether the formula reports inventory on the statement of financial position at an amount close to the inventory’s most recent cost; and • Whether the formula is used for other inventories with a similar nature and usage. For Emily, the inventory of time management software consists of goods that are interchangeable. As such, ABC cannot use specific identification. The nature of the items is not subject to a particular flow of goods or deterioration over time. Under the FIFO cost formula, the cost of the ending inventory is determined using the most recent costs and is closer to replacement cost. However, since the software is identical and there is no issue of obsolescence, the average cost formula may better suit this type of inventory. In addition, it is the same method used for ABC’s other inventories, LO 2,3 BT: Difficulty: M Time: 60 min. AACSB: Analytic CPA CM: Reporting
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CHAPTER 7 INTERNAL CONTROL AND CASH LEARNING OBJECTIVES 1. Explain the primary components of an internal control system, including its control activities and limitations. 2. Apply the key control activities to cash receipts and payments. 3. Prepare a bank reconciliation. 4. Explain the reporting and management of cash.
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Questions 1.
1
C
6.
1
C
11.
2
C
16.
2,3
C
21.
3
K
2.
1
C
7.
1
C
12.
2
C
17.
3
C
22.
4
C
3.
1
C
8.
13.
2
C
18.
3
C
23.
4
C
1
K
9.
1 1
C
4.
C
14.
2
C
19.
3
C
24.
4
C
5.
1
C
10.
2
C
15.
2,3
C
20.
3
C
25.
4
C
13.
4
AP
Brief Exercises 1.
1
C
4.
1,2
K
7.
3
AN
10.
3
AP
2.
1
K
5.
3
C
8.
3
AN
11.
3
AP
3.
1,2
K
6.
3
AN
9.
3
AP
12.
4
C
Exercises 1.
1
C
4.
1,2
C
7.
3
AP
10.
4
AN
2.
1
C
5.
3
AP
8.
3
AP
11.
4
E
3.
1,2
C
6.
3
AP
9.
3
AP
Problems: Set A and B 1.
1,2
C
4.
1,2
AN
7.
3
AP
10.
4
C
2.
1,2
AN
5.
3
AP
8.
3.
1,2
AN
6.
3
AP
9.
3
AP
11.
4
C
4
AN
Accounting Cycle Review 1.
3,4
AP
1.
1
C
3.
1
C
5.
4
E
2.
4
C
4.
1,2
S
6.
1,2
C
Cases
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Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file.
LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
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Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
The five primary components of a good internal control system include the control environment, risk assessment, control activities, information and communication, and monitoring. A control environment encourages integrity and a high standard of ethical behaviour. Risk assessment involves identification and management of key business risks. Control activities are policies and procedures to help mitigate the business risks. Information and communication ensures that the internal control system captures and communicates the appropriate information to internal and external users. Monitoring the internal control system for its adequacy is a recurring process.
LO 1 BT: C Difficulty: S Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
Management is responsible for establishing a company’s control environment. Since management is responsible for the preparation and delivery of accurate and fair financial statements, it follows that management should also be responsible for the internal control system that generates the financial information communicated to the users of that information.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
When designing and explaining to all employees the system of internal control of the company, management must be clear as to their expectations concerning what actions all employees must take and the consequences of not following management’s policies and procedures. Those individuals in top management must set the correct tone by strictly adhering to the company policies and procedures and providing a consistent example and message to all employees. This conformance will demonstrate commitment on the part of management to the importance of the internal control system and environment for all concerned and the pledge to administer consequences to anyone not following their lead.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
4.
The five control activities that apply to most companies are assignment of responsibility, segregation of duties, documentation, physical controls, and review and reconciliation.
LO 1 BT: K Difficulty: S Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
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5.
Financial Accounting, Seventh Canadian Edition
Documentation procedures contribute to good internal control by providing evidence of the occurrence of transactions and events and, when signatures (or initials) are added, the documents establish responsibility for the transactions. The prompt transmittal of documents to the accounting department contributes to recording transactions in the proper period, and the pre-numbering of documents helps to ensure that a transaction is recorded only once.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
Independent review and reconciliation by internal auditors is necessary because employees can forget to, or intentionally fail to, follow internal controls, or they might become careless if there is no one to observe and evaluate their performance. Segregating the physical custody of assets from accounting record keeping is not enough to ensure that nothing has been stolen or recorded incorrectly. A performance review still needs to be done to ensure these controls were working effectively.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t004 CM: Reporting and Audit
7.
External auditors are required to be independent of the organization they audit. This independence provides the reassurance needed by external users and owners of the organization about the financial condition and performance of the business depicted in the financial statements. Independence provides the proper environment to arrive at appropriate accounting and disclosure conclusions, particularly when judgement is involved. Internal auditors are not independent of the organization as they are employees of the organization. Their role is to assist management in their responsibility to provide a proper internal control system and environment.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t004 CM: Reporting and Audit
8.
A company’s system of internal control can only give reasonable assurance that assets are properly safeguarded and that accounting records are reliable because the cost of a perfect system outweighs its benefits. For example, if a company wanted flawless accounting records, they could double the number of accountants on staff and have the new accountants check all of the work that was done by experienced accountants but the benefit of this is outweighed by the costs. Absolute assurance is too costly. Furthermore, even if cost was not a factor, human error and collusion cannot be eliminated.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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9.
Financial Accounting, Seventh Canadian Edition
Collusion occurs when two or more employees agree to circumvent procedures or controls or get around control activities in an organization in order to gain an advantage or to cover up theft or fraud. The internal control activity that is most affected by collusion is the segregation of employees’ duties.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
Electronic funds transfers normally result in better internal control since no cash or cheques are handled by employees, thereby limiting the possibility of misappropriation. However, controls over EFT payments (and collections) do need to be put in place.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
11.
This is a violation of the assignment of responsibility control activity. Each cash register should only be used by one employee and an independent verification of the cash in each register at the end of each shift should be compared to the total of the sales recorded in the cash register plus the float (coins and paper currency for making change) in the register. If a discrepancy arises, the employee responsible for that register can be held responsible.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
Cash registers are visible to the customer. Thus, they prevent the sales clerk from ringing up a lower amount for the price and pocketing the difference. In addition, the customer receives an itemized receipt, and the cash register tape
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
This statement is true if the alternative to a cheque payment is a cash payment. It is not always practical to make all payments by cheque but payment by cheque contributes to effective internal control over cash disbursements as it provides a record of all payments. Also, having only authorized individuals sign the cheques reduces the likelihood of payments being made for unauthorized amounts or to unauthorized vendors.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
The receptionist has an opportunity to commit fraud. In the case of an appointment where the customer pays cash, the cash can be pocketed by the receptionist. The receptionist can then cancel the appointment, leaving no trace in the accounting records of the revenue generated by the service. This is a clear case of lack of segregation of duties.
LO 2 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
An employee who has no other responsibilities that relate to cash should
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Financial Accounting, Seventh Canadian Edition
prepare the bank reconciliation. If a person had responsibility for handling cash and also prepared the bank reconciliation, they could use the bank reconciliation to hide fraud by falsifying the bank balance or misstating reconciling items. LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
A bank contributes significantly to internal control over cash because it: (1) safeguards cash on deposit, (2) minimizes the amount of cash that must be kept on hand, and (3) provides another record of all bank transactions.
LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
17.
The lack of agreement between the cash balances may be due to either: (1) Timing differences—caused by recording a transaction on the company’s books in one month and the bank recording it another month (example – outstanding cheque) or the bank recording a transaction first which the company will record after completing the bank reconciliation (example – a bank service charge, or an NSF cheque). (2) Errors—made by either the company or the bank. For example, a cheque for $110 is recorded by the depositor at $101.
LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
18.
(a)
(b)
(c)
An NSF cheque is a cheque issued by a customer that was recorded by the company when it was received and then deposited in the bank only to discover later that the customer did not have the funds to cover the cheque payment. An NSF cheque makes the bank balance lower than the book balance and requires the book balance to be updated. Consequently, it is deducted from the balance per books. An NSF cheque results in an entry in the company’s books, as a debit to Accounts Receivable and a credit to Cash (assuming the cheque deposited was a collection on account). The debit to Accounts Receivable includes any additional charge that the bank may add for their services with respect to the NSF cheque or the company may add for late payment.
LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
19.
Since the March cheque has still not cleared the bank at April 30, it must be included in the April 30th bank reconciliation as an outstanding cheque.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-6
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
20.
Financial Accounting, Seventh Canadian Edition
When performing a bank reconciliation, outstanding cheques are subtracted from the bank balance to “move” that balance closer to the one recorded on the company’s books. Since the bank balance is lower than the book balance by the amount of this fraud, Sam will understate the amount of outstanding cheques on the reconciliation. For example, if there was no fraud, let’s assume that the bank balance would be $5,000 and that the outstanding cheques were $3,000 so the book balance should be $2,000. After the fraud the book balance is still $2,000 but the bank balance is now $3,300 instead of $5,000. When Sam prepares the reconciliation he has to make sure that the $3,300 will reconcile to $2,000 so he will list the outstanding cheques as only $1,300, thereby understating them by the amount of cash he has stolen. The real outstanding cheques of $3,000 less the stolen amount of $1,700, equals $1,300.
LO 3 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
21.
Cash includes cash on hand and cash in bank accounts. Cash equivalents include short-term, highly liquid held-for-trading investments less any bank overdrafts. Together, these two amounts combine and are reported as cash and cash equivalents in the current assets section of the statement of financial position.
LO 3 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
22.
Restricted cash is not available for general use as it is restricted for a special purpose. When the restricted purpose is of a long-term nature, the restricted cash is reported as a non-current asset. If it is expected to be used within one year of the statement of financial position date, it would be classified as a current asset and disclosed in the financial statements. Compensating balances are minimum cash balances which lenders specify that a borrower must maintain in the borrower’s bank account to provide support for a loan. A compensating balance should be reported as a non-current asset and the details of the loan conditions should be disclosed in the notes to the financial statements.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
23.
The line of credit facility of $16 million does not represent a liability until Brandon Corporation borrows (or draws) money under the line of credit. In the notes to the financial statements, the terms of the line of credit and its available limit of $16 million should be reported to demonstrate how the business is well positioned to deal with future cash flow demands or to take advantage of investment opportunities.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-7
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
24.
Financial Accounting, Seventh Canadian Edition
The basic principles of cash management are: (1) increase the speed of collection on receivables, (2) keep inventory levels low, (3) delay payment of liabilities, (4) plan the timing of major expenditures, (5) invest idle cash, and (6) prepare a cash budget. The first three principles are ways to increase cash on hand. The last three principles focus on making sure management understands when cash balances will be high so that investment income can be earned from idle cash and when cash balances will be low so that bank loans or other financing can be obtained.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
25.
Having too much cash on hand may hinder a business’ performance if the cash cannot be used effectively and therefore not give a proper return to the shareholders. Effective uses of cash can include upgrading existing property, plant, and equipment, expanding the business, paying down debt, repurchasing shares, or paying dividends.
LO 4 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-8
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 Control Activity
Example
Assignment of Responsibility
One person operates the cash register at the exit of the parking garage.
Segregation of duties
Tickets are provided to those entering the garage by an automated machine. This ticket is given to the attendant on exiting the parking garage. In this way, the attendant does not authorize the parking and collect the cash.
Documentation
The time on the ticket is entered into a machine to determine the amount owed, which is keyed into the cash register before the gate will open. In this way the total time in the parking garage is recorded.
Physical controls
Cash is kept in a cash register.
Review and reconciliation
If a customer is overcharged, they will complain. Review to make sure parking gate is not being raised prior to payment being received. Reconcile the number of parking tickets issued to the amount of cash received.
LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-2 (a) (b) (c) (d)
3 4 5 1
(e)
2
All transactions should include original, detailed receipts. Undeposited cash should be stored in the company safe. Surprise cash counts are performed by internal audit. Responsibility for related activities should be assigned to specific employees. Cheque signers are not allowed to record cash transactions
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-9
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 7-3 1. 2. 3. 4. 5.
Documentation and physical controls Review and reconciliation Segregation of duties Assignment of responsibility Physical controls
LO 1,2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-4 1. 2. 3. 4. 5. 6.
Documentation Review and reconciliation Physical controls Assignment of responsibility Segregation of duties Physical controls
LO 1,2 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-5 1. 2. 3. 4. 5. 6.
Bank – NA Bank + Book – Bank + Book –
7. 8. 9. 10. 11. 12.
Book + Bank – Book – Book – Bank – Book +
LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-10
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 7-6 January deposits in transit: Deposits in transit at beginning of month ........................................... Add: Deposits recorded in company books this month ...................... Less: Deposits recorded on this month’s bank statement ................. Deposits in transit at end of month ....................................................
$
0 5,000 4,000 $1,000
February deposits in transit: Deposits in transit at beginning of month ........................................... Add: Deposits recorded in company books this month ...................... Less: Deposits recorded on this month’s bank statement ................. Deposits in transit at end of month ....................................................
$1,000 5,600 4,600 $2,000
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-7 November outstanding cheques: Outstanding cheques at beginning of month ..................................... Add: Cheques recorded in company books this month ..................... Less: Cheques recorded on this month’s bank statement ................. Outstanding cheques at end of month ...............................................
$ 0 27,100 25,900 $ 1,200
December outstanding deposits: Outstanding cheques at beginning of month ..................................... Add: Cheques recorded in company books this month ..................... Less: Cheques recorded on this month’s bank statement ................. Outstanding cheques at end of month ...............................................
$1,200 23,200 19,700 $ 4,700
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-11
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 7-8 (a)
Kashechewan should correct its books for the error in recording the cheque by reducing cash by $90 ($659 – $569). The cheque in the amount of $415 mistakenly deducted by the bank should be added back to the bank balance since it is the bank’s error.
(b)
Accounts Payable ..................................................................... Cash ...........................................................................
90 90
No entry is necessary for the cheque mistakenly deducted by the bank, although the bank should be notified of this error. LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-9 June 30, reconciled cash balance per bank reconciliation ............... Add: Cash receipts in July ............................................................... Less: Cash disbursements in July ................................................... July 31, unreconciled cash balance .................................................
$18,920 21,700 24,300 $16,320
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-10 Cash balance per bank Add: Deposits in transit
$19,260 1,450 20,710 3,630 $17,080
Less: Outstanding cheques Reconciled cash balance per bank Cash balance per books (as per BE7-9) Add: EFT collections on account
$16,320 2,170 18,490
Less: Bank service charge NSF cheque and fee ($1,270 + $50)
$ 90 1,320 1,410 $17,080
Reconciled cash balance per books
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-12
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 7-11 July 31
Cash ......................................................................... Accounts Receivable.........................................
2,170
Bank Charges Expense ............................................ Cash ..................................................................
90
Accounts Receivable ................................................ Cash ..................................................................
1,320
2,170
90
1,320
LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-12 Ouellette Ltée should report the cash in the bank, the payroll bank account, and the cash register floats as cash. The held-for-trading investments would be reported as cash equivalents because they mature within 90 days. Cash and cash equivalents are recorded as a current asset. Assuming the restricted cash is not expected to be used during the next year, the restricted cash for the plant expansion should be reported as a non-current asset. The compensating balance should also be reported as a non-current asset and disclosed in the notes. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 7-13 (a) Cash in savings account Less compensating balance Cash on hand Cash in chequing account Cash reported as a current asset
$22,000 5,000
$17,000 1,700 14,000 $32,700
(b) Compensating balance reported as non-current asset and disclosed in the notes.
5,000
Income tax refund, current assets: Income Tax Receivable
2,000
Postdated cheques received from customers of $1,000 are not yet valid and represent underlying current assets of accounts receivable. LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-13
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 7-1 (a) Control Strength or Weakness 1.
(b) Suggested Improvements
No establishment of responsibility over the cash – weakness
The employees should use separate cash drawers.
Cash counts not independently – weakness
performed
Cash counts should be performed by a supervisor at the end of the shift and the totals compared to the cash register reading.
2.
By shredding the receipts there is no record maintained of sales for independent internal or external verification – weakness
Retain supporting information until such time as all independent verification is complete (a comparison of the receipts to the sales recorded in the accounting records). Shred the receipts only after the verification is complete.
3.
Cash receipts procedures appear to illustrate good internal control – the segregation of duties between receiving, recording, and depositing cash greatly reduces the likelihood of cash being stolen or recorded incorrectly – strength
NA
4.
Improper segregation of duties could result in the misappropriation of cash and the ability to misstate the accounting records to cover up the misappropriation – weakness
Different individuals should receive cash, record cash receipts, and deposit the cash.
The procedures in place to conduct the physical inventory count appear to be reasonable – strength
NA
5.
In a small business this may be impossible; therefore, it is imperative that management take an active role in the operations and supervision of the business to enable detection of any accounting irregularities.
LO 1 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-14
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-2 1.
2.
3.
(a)
It is possible to detect this type of fraud by comparing the amount of inventory consumed during the evening with the sales that were recorded in cash registers.
(b)
This fraud can be prevented by segregating the duties of those individuals handling the drinks to those individuals having access to the cash register. If additional staff is not available, the floor supervisor should keep a close eye on the bartender or inventory could be counted once a day.
(a)
It is possible to detect this type of fraud as the bottles of liquor sold to establishments are not the same as those sold at a liquor store. A special label is attached, which can be detected at the end of the shift. As well, if the additional empty bottles are on hand at the end of the shift, when the inventory consumed (including the bartender’s bottle) at the end of the bartender’s shift is compared to sales, a discrepancy will be noticed.
(b)
This fraud can be prevented by segregating the duties of those individuals handling the drinks to those individuals having access to the cash register. If additional staff is not available, the floor supervisor should keep a close eye on the bartender and do a bottle count at the end of the shift.
(a)
It is possible to detect this type of fraud if someone notices that the number of appointments and services given by the spa does not reconcile to the revenue deposited in the bank account for the day. Most businesses of this nature will have someone comparing the bank deposit slips with the appointment schedule (often the schedule will be printed off a day or two prior to the scheduled date).
(b)
This fraud can be prevented by segregating the duties of those individuals handling the appointments, to those handing the cash, and again to those individuals making the bank deposit. If additional staff is not available, the owner of the spa should at least make the bank deposit and require that the scheduling software not allow appointment changes on the day of the appointment.
Solutions Manual .
7-15
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-2 (CONTINUED) 4.
(a)
It is possible to detect this type of fraud but likely only after the first instance of fraud. The individual in charge of approving the bank reconciliation could insist on looking at the cheques returned by the bank and detect the unauthorized cheque.
(b)
This fraud can be prevented by segregating the duties of those individuals handling the cheques with the individual preparing the bank reconciliation, and by being vigilant in scrutinizing the bank reconciliation and its supporting documents.
LO 1 BT: C Difficulty: C Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 7-3 (a) Weakness
Control Activity
(b) Recommended Improvement
1.
Inability to fix responsibility for cash to a specific clerk.
Assignment of responsibility
There should be separate cash drawers and register pass codes for each clerk.
2.
Cash is not adequately protected from theft.
Physical controls
Cash should be stored in a locked safe until it is deposited in the bank.
3.
Cash is not independently counted.
Review and reconciliation
A cashier office supervisor should count cash and reconcile the amount of cash received to the cash register reading.
4.
The accountant should not handle cash and record cash transactions.
Segregation of duties
An employee not otherwise handling cash or the accounting records should make the deposits.
5.
Some sales will not be recorded so that they can be independently verified later; cash is not adequately protected from theft.
Documentation and physical controls
All sales should be entered in the cash register to provide evidence the transaction has occurred. In addition, the loose change box should be locked to keep it safe until the funds are deposited.
LO 1,2 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
7-16
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-4 (a) Weakness
Control Activity
(b) Recommended Improvement
1.
Cheques are not stored in a secure area.
Physical controls
Cheques should be stored in a safe or locked file drawer.
2.
The approval of and payment to suppliers is done by the wrong employee.
Assignment of responsibility and segregation of duties
The purchasing manager should not approve bills for payment nor should this manager have signing authority. An employee, other than one involved with purchasing, who is aware of delivery of goods and services, should be authorizing the payment and another member of senior management should be assigned cheque signing duties.
3.
Blank cheques are signed.
Assignment of responsibility
Establish a second signing authority with the bank.
4.
Cheques are not prenumbered.
Documentation
Cheques should be prenumbered and their serial continuity subsequently tested for completeness.
5.
The bank reconciliation is not independently prepared.
Review and reconciliation
A person independent of the accountant should prepare the bank reconciliation. If this is not possible, then the accountant can prepare the reconciliation but the owner not the store manager (because they can access cash) should approve it.
LO 1,2 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-17
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-5 (a) August 31 reconciled cash balance per bank reconciliation ............. Add: (4) Cash deposits in September ............................................. Less: (1) Cheques issued ................................................ $176,978 (2) Salaries deposited to employee accounts ......... 39,170 (3) Monthly EFT payment for rent ........................... 2,600 September, unreconciled cash balance ............................................ (b)
$ 34,780 199,680
218,748 $ 15,712
None of the above items would be included in the bank reconciliation as they are included in the starting (unreconciled) cash balance and already have been recorded by the company.
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-18
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-6 Item 1. Deposits in transit at the end of April 2. Deposits in transit at the beginning of April that cleared the bank in April 3. Outstanding cheques at the beginning of April that cleared the bank in April 4. Outstanding cheques at the end of April 5. Bank service charges 6. Deposit of $400 made in error by the bank to the company’s account 7. Cheque written for $250 recorded in error as $520 on the books 8. NSF cheque received from customer 9. EFT collection on account not previously recorded by company 10. Interest earned on bank account
Bank Add Deduct (Credit) (Debit)
Books Add Deduct (Debit) (Credit)
Not Applicable
√
Journal Entry Required No
√ No √ No √
No √
√
Yes No
√
Yes √
Yes
√
Yes
√
Yes
LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-19
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-7 (a)
(b)
Deposits in transit: July 31 Deposits in transit, June 30 .................................................. Add: Deposits recorded in company books in July .............. Less: Deposits recorded on bank statement in July............. Deposits in transit, July 31 ....................................................
$ 2,000 14,750 15,820 $ 930
Deposits in transit: August 31 Deposits in transit, July 31 .................................................... Add: Deposits per books in company books in August ........ Less: Deposits recorded on bank statement in August ........ Deposits in transit, August 31 ...............................................
$ 930 22,900 22,500 $ 1,330
Outstanding cheques: July 31 Outstanding cheques, June 30 ............................................. Add: Cheques recorded in company books in July ............... Less: Cheques recorded on July bank statement ................. Outstanding cheques, July 31...............................................
$ 570 18,200 17,200 $ 1,570
Outstanding cheques: August 31 Outstanding cheques, July 31............................................... Add: Cheques recorded in company books in August .......... Less: Cheques recorded on August bank statement ............ Outstanding cheques, August 31 ..........................................
$ 1,570 22,700 23,520 $ 750
LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-20
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-8 (a) NEOPOLITAN LTD. Bank Reconciliation July 31
Cash balance per bank statement Add: Deposits in transit
$10,670 1,968 12,638 2,359 $10,279
Less: Outstanding cheques Reconciled cash balance per bank Cash balance per books Add: Cheque No. 373 error ($980 – $890) EFT deposits
$ 8,953 90 1,276 10,319 40 $10,279
Less: Bank service charges Reconciled cash balance per books
(b)
July 31
31
Cash ................................................................. Office Supplies ............................................
90
Cash ................................................................. Accounts Receivable ...................................
1,276
Bank Charges Expense .................................... Cash ............................................................
40
90
1,276
40
LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-21
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-9 (a)
Outstanding deposit of May 31
(b)
Outstanding Cheques: Cheque No. 003 – March 14 Cheque No. 005 – March 18 Cheque No. 007 – March 22 Cheque No. 008 – March 23
$1,675 360 2,130 525
$ 4,690
Returned cheque – NSF S. Gillis – deduct NSF fee – deduct Bank service charges – deduct
1,350 25 40
$ 1,415
May1, beginning balance ........................................................ Add: Cash receipts in May ...................................................... Less: Cash disbursements in May .......................................... May 31, unreconciled cash balance........................................
$ 0 37,470 26,819 $10,651
(c)
(d)
$ 7,820
(e) SHARP MANUFACTURING LTD. Bank Reconciliation May 31
Cash balance per bank statement Add: Deposits in transit
$6,106 7,820 13,926 4,690 $9,236
Less: Outstanding cheques Reconciled cash balance per bank Cash balance per books Less: Returned cheque – NSF S. Gillis NSF fee Bank service charges Reconciled cash balance per books
$ 10,651 1,350 25 40
1,415 $9,236
LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-22
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 7-10 (a) Items that are considered cash but not cash equivalents would include: 1. 2. 3. 5. 7. 9.
Currency and coin Royal Bank chequing account Royal Bank savings account Undeposited April customer cheques Over-the-counter receipts ($1,735 + $1,230) Cash register floats Total cash
$
123 4,325 5,000 750 2,965 500 $13,663
(b)
4.
The $25,000 government treasury bill is considered a cash equivalent because it matures within 90 days and the value at which it will mature at is certain.
(c)
Cash and cash equivalents = $13,663 [from (a)] + $25,000 = $38,663
(d)
6. 8.
Post-dated cheque—Accounts Receivable; Statement of Financial Position IOU from company receptionist—Advances to Employees; Statement of Financial Position
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 7-11 Suggestions to improve cash management practices for Tory, Hachey, and Wedunn: 1. 2. 3. 4.
5. 6. 7. 8. 9.
Prepare a cash budget. Adopt a time docketing accounting system that will track work performed on files for individual clients. Invoice clients monthly as work progresses using the accounting records established for docketing time. To the extent practicable, ask clients for retainers before work on files begins. Use the retainers received to apply payments for monthly invoices sent to clients. When retainers are used up, request additional retainers until the case is completed. Establish an operating line of credit with the bank for day-to-day operations. Arrange a non-current loan for renovations and equipment with repayment terms structured to coincide with expected future cash inflows. Negotiate terms with suppliers that allow for delayed payments. To the extent necessary, obtain additional investments from the three lawyers to ensure payment to suppliers and employees are made on time.
LO 4 BT: E Difficulty: C Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-23
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 7-1A (a)
(b)
Control Activities
Application to Cash Receipts
Assignment of responsibility
Only cashiers are authorized to sell tickets. Only the manager and cashier can handle cash. Only ushers authorize entrance.
Segregation of duties
The duties of receiving cash and admitting customers are assigned to the cashier and to the doorperson. The manager maintains custody of the cash, and the company accountant records the cash.
Documentation
Tickets are prenumbered. Cash count sheets are prepared and initialled. Deposit slips are prepared.
Physical controls
Cash is deposited in a bank vault nightly. Prenumbered tickets are locked into the machine by the manager and the machine is used to issue tickets.
Review and reconciliation
Cash counts are made by the manager at the end of each cashier’s shift. Daily comparisons are made by the head cashier and accounting department of cash received, deposited, and recorded.
Actions by the usher and cashier to collaborate to misappropriate cash include: 1. 2.
Instead of tearing the tickets, the usher could return the tickets to the cashier who could resell them, and the two could divide the cash. The cashier could issue a lower priced ticket than paid for and the usher would admit the customer. The difference between the ticket issued and the cash received could be divided between the usher and cashier.
LO 1,2 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
7-24
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-2A (a) Control Weaknesses
(b) Improvements
Fred or Asmaa can order goods John or Rehana should take on (assignment of responsibility) and the responsibility for the approve invoices for payment (up to purchase of goods. $20,000 for Fred and up to $5,000 for Asmaa). Fred is the sole signer of cheques less than $20,000. Fred could purchase items for personal use or create and pay invoices to companies that he owns. Fred signs cheques and prepares the bank reconciliation. Fred could write a cheque to himself and cover it up in the bank reconciliation and/or through journal entries.
Someone who does not record cash transactions or has access to cash and cheques should prepare the bank reconciliation. If this is not possible, then one of the owners should either prepare or at least review and approve the reconciliation.
One person can sign cheques
At least two individuals should sign each cheque to prevent inappropriate expenditures.
LO 1,2 BT: AN Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-25
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-3A (a) Control Weaknesses
(b) Recommendations
1. No segregation of duties between receiving the cash and admitting students to the lessons. The instructor could admit students for free or charge extra and pocket the difference or report fewer students and pocket the extra money.
The duties of receiving cash and admitting students should be assigned to separate individuals.
2. There is no segregation of duties in the accounting function. The general manager could prepare fictitious invoices for payment or write cheques to himself and not be detected because the general manager also prepares the bank reconciliation.
An independent person should approve the invoices for payment and prepare the bank reconciliations.
3. Each salesperson is responsible for determining credit policies and they receive a commission based on sales. They could provide credit to customers who should not receive credit in order to earn the commission on the sale.
An independent and experienced person should be responsible for setting credit limits for customers. Credit limit criteria should be determined by the company and consistently applied.
4. All programmers have access to the accounting software which could provide unauthorized changes to the accounting records (such as wage rates).
Access to the accounting records should be restricted and protected with password or biometric restrictions.
5. Eliminating receiving reports and purchase orders causes problems when invoices from suppliers are received. Accountants will not be able to verify if the invoice pertains to items that have actually been received or approved. Incorrect or fictitious invoices may be paid or unauthorized orders made.
Receiving reports and purchase orders should be reinstated.
LO 1,2 BT: AN Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-26
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-4A (a) Control Weaknesses
(b) Improvements
The tickets were unnumbered so there is Tickets should be prenumbered so no way of knowing if duplicates were that the students could be held more made and sold. accountable for the tickets and a final reconciliation could be performed between cash receipts and sales. No record was kept of which students took tickets to sell or how many they took so there is no way of knowing if tickets were given away for free and how many tickets were actually sold.
Roger should have kept a record of which tickets were issued to each student for resale. (Note: This problem could have been largely avoided if the tickets had been sold at the door on the day of the dance.)
There was no control over unsold tickets. This deficiency made it possible for students to sell tickets, keep the cash, and tell Roger that they had disposed of the unsold tickets.
Students should have been required to return the unsold tickets to Roger as well as the cash. In each case, the students should have been issued a receipt for the cash they turned in and the tickets they returned.
Did not receive a receipt from Obnoxious A receipt should have been obtained Al. Without a receipt, there is no way to from Obnoxious Al. verify how much Obnoxious Al was actually paid. For example, it is possible that he was only paid $100 and that Roger took the rest.
Solutions Manual .
7-27
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-4A (CONTINUED) (a) and (b) (continued)
(a) Control Weaknesses
(b) Improvements
Inadequate control over the cash box.
Only Roger should have had access to the key and disbursed funds when necessary for purchases.
Praveen Patel counted the funds, made out the deposit slip, and took the funds to the bank. Praveen could have taken some of the money.
Roger should have counted the funds, with someone observing him. Then he could have made out the deposit slip and had Praveen deposit the funds.
Students taking money for decorations Roger should reimburse each were not required to have a receipt and student when a receipt is provided. had unrestricted access to the cash box to pay for their purchases. Sara Wu was collecting tickets and There should have been one receiving cash for additional tickets sold. person selling tickets at the door and a second person collecting tickets. The tickets collected times the price per ticket could then be compared to the cash collected. Net cash receipts anticipated.
were
less
than A final reconciliation should have been performed between cash on hand, ticket sales, and purchase receipts.
LO 1,2 BT: AN Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-28
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-5A (a)
BEAUPRÉ LTD. Bank Reconciliation July 31
Cash balance per bank statement .............................................. Less: Outstanding cheques ($2,738 – $2,162) .......................... Deposit incorrectly posted by bank ................................. Reconciled cash balance per bank .............................................
$21,722 $ 576 3,100
Cash balance per books ............................................................. Add: EFT collections ................................................................
3,676 $18,046 $12,934 5,230 18,164 118 $18,046
Less: Bank service charges ....................................................... Reconciled cash balance per books ........................................... The salaries are not a reconciling item because they were recorded by both the bank and the company. (b)
July
31
31
Cash ....................................................................... Accounts Receivable .....................................
5,230
Bank Charges Expense .......................................... Cash ..............................................................
118
5,230
118
LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-29
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-6A (a)
HIRJI HOLDINGS LTD. Bank Reconciliation October 31
Cash balance per bank statement ........................ Add: Outstanding deposits.................................... ............................................................................... Less: Outstanding cheques .................................. Reconciled cash balance per bank .......................
$16,780 6,300 23,080 2,650 $20,430
Cash balance per books ........................................ Add: Note receivable collection ............................ Interest receivable collection on note ...........
$19,070 $ 2,000 180
2,180 21,250
Less: NSF cheque ................................................ Cheque #3421 error ($860 - $680) ............... Bank service charges ................................... Reconciled cash balance per books ....................... (b)
Oct. 31
31
31
31
$
575 180 65
Cash ................................................... Notes Receivable ..................... Interest Receivable ...................
2,180
Accounts Receivable .......................... Cash ..........................................
575
Utilities Expense ................................. Cash ..........................................
180
Bank Charges Expense ...................... Cash ..........................................
65
820 $20,430
2,000 180
575
180
65
LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-30
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-7A (a)
February 28, reconciled cash balance per bank reconciliation Add: Cash receipts in March.................................................... Less: Cash disbursements in March ........................................ March 31, unreconciled cash balance .....................................
(b)
Deposits in transit: $4,012 (dated March 31).
(c)
Outstanding cheques: #3473 for $4,947 (dated March 29).
$17,029 9,249 7,912 $18,366
(d) YAP LTD. Bank Reconciliation March 31 Balance per bank statement .......................................... Add: Deposits in transit [from (b)] .............................. Error in recording cheque #3472 ($1,823 – $1,283) .........................................
$17,163 $4,012 540
Less: Outstanding cheques No. 3473 [from (c)] ........................................... Reconciled cash balance per bank ...............................
4,947 $16,768
Balance per books [from (a)] ........................................ Add: EFT collection—Boudreault ............................. Less:
Service charges ................................................ NSF cheque and fee—Mustafa ($870 + $35) ... EFT loan payment ............................................ Reconciled cash balance per books ..............................
Solutions Manual .
7-31
4,552 21,715
$18,366 610 18,976 $ 89 905 1,214
2,208 $16,768
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-7A (CONTINUED) (e)
Mar.
31
31
31
31
Cash ....................................................... Accounts Receivable ......................
610
Bank Charges Expense .......................... Cash ...............................................
89
Accounts Receivable .............................. Cash ...............................................
905
Bank Loan Payable ................................ Interest Expense..................................... Cash ...............................................
1,130 84
610
89
905
1,214
LO 3 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-32
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-8A (a) October 31, reconciled cash balance per bank reconciliation ....... Add: Cash receipts in November .................................................. Less: Cash disbursements in November ...................................... November 30, unreconciled cash balance .................................... (b)
$23,812 21,438 30,968 $14,282
HAMPTONS LIMITED Bank Reconciliation November 30
Balance per bank statement ......................................... Add: Deposits in transit (Nov. 30 cash receipt) ........... Less: Outstanding cheques No. 2474 ........................................................ No. 2480 ........................................................ No. 2482 ........................................................ Reconciled cash balance per bank ...............................
$18,958 2,676 21,634 $1,008 1,224 1,660
Balance per books [from (a)] ........................................ Add: EFT collection .................................................. Less:
NSF cheque and fee ($500 + $80) ................... Bank service charges ....................................... Error in recording cheque No. 2476 ($4,760 – $5,660) ............................................ Error in Nov. 20 deposit ($5,908 – $5,890) ...... Reconciled cash balance per books .............................
Solutions Manual .
7-33
3,892 $17,742 $14,282 5,008 19,290
$580 50 900 18
1,548 $17,742
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-8A (CONTINUED) (c)
Nov. 30
30
30
30
30
Cash ..................................................................... Notes Receivable ........................................ Interest Revenue ..........................................
5,008
Bank Charges Expense ........................................ Cash .............................................................
50
Accounts Receivable (Giasson Developments) .... Cash .............................................................
580
Accounts Payable ................................................. Cash .............................................................
900
Accounts Receivable............................................. Cash .............................................................
18
4,400 608
50
580
900
18
LO 3 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-34
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-9A (a) and (b) Cash and cash equivalents (reported in Current Assets section) Cash: 1. Cash on hand ............................................................... $ 2,920 2. Commercial bank savings account............................... 57,800 Commercial bank chequing account ............................ 25,000 U.S. bank account (Canadian equivalent) .................... 27,000 Total cash ............................................................................... 112,720 Cash equivalents: 5. Government of Canada Bond....................................... Total cash and cash equivalents ............................................. (c)
50,000 $162,720
3.
Restricted cash would be reported as a current or non-current asset, depending on the timing of the equipment replacement.
4.
Amounts due from employees (travel advances) of $8,700 would be classified as other receivables in an account called Advances to Employees.
5.
Held-for-trading investments would be listed separately in the current assets section of the statement of financial position and would include the term deposit that matures in 120 days (to be a cash equivalent it would have to mature in 90 days or less) and the shares of Loblaw Companies Limited. The classification of the shares could also be non-current depending on management’s intentions for holding the shares.
6.
NSF cheques would be included in Accounts Receivable, assuming the company expects collection. If collection is doubtful, they might have been provided for as part of Bad Debts Expense and related Allowance for Doubtful Accounts or written off as uncollectible.
7.
This amount would be reported as restricted cash in the noncurrent assets section of the statement of financial position.
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-35
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-10A (a)
Cash includes cash on hand, and money in bank accounts. Cash equivalents are short-term, highly liquid (easily sold) trading investments that are subject to insignificant risk of changes in value less any bank overdrafts. Examples of trading investments that would be classified as cash equivalents include debt investments such as government treasury bills (T-bills) that mature in 90 days or less, money market funds, and 90-day bank term deposits. These two categories are often combined as they are the cash either currently available or the cash that is readily available for use by the company. The classification as current or non-current would depend on the nature of the restriction.
(b)
Restricted cash will most likely be reported in the non-current assets section of the statement of financial position as it can likely not be used to meet current liabilities.
(c)
It is necessary to report restricted cash separately because the cash cannot be used for regular operations and has been set aside for a specific purpose. As such, it is not available for use. Separate classification assists users of the statement of financial position in assessing the flexibility available to the business in managing its cash and obligations to pay cash.
LO 4 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-36
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-11A Accelerating collection of receivables - currently only a minimal deposit of $50 is received from the customers. Increase the deposit to cover cost of decorations so that this money is received up front - have final payment due immediately following the function - both of these will improve cash flow as cash receipts will be accelerated - Bev will have to check with other decorating companies to see what their terms are in order to remain competitive - if final payment cannot be received immediately due to competitive pressures, Bev must monitor collections better and actively contact customers whose payments are overdue so that cash can be collected more promptly Delay payment of liabilities - Bev can apply for credit which will delay payment by 30 days giving her use of this cash for 30 more days LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-37
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-1B Control Activities
Application to Cash Payments
Assignment of responsibility
Only the controller and assistant controller are authorized to sign cheques. Invoices are approved by the purchasing agent and goods received are approved by the receiving department supervisor.
Segregation of duties
The purchasing agent has only an approval function and does not work in the receiving or accounting areas. The receiving department supervisor has access to the assets but does not order or record purchases. Payment can only be made by the controller or assistant controller, and the cheque signers do not record the cash disbursement transactions. The bank reconciliation is not done by someone who records payments.
Documentation
Cheques are prenumbered. Following payment, the invoices are stamped “PAID”.
Physical controls
Blank cheques are kept in a safe in the controller’s office. Only the controller and assistant controller have access to the safe. A computer is used for printing cheques.
Review and reconciliation
The cheque signer compares the cheque with the approved invoice prior to issue. A staff accountant reconciles the bank and book balances monthly.
LO 1,2 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-38
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-2B (a)
The weaknesses in control activities in the handling of collections include: • • • • • • • • •
(b)
Each usher could take cash from the collection plates en route to the basement office. The head usher counts the cash alone so no one would ever know if the head usher stole cash. The head usher’s notation of the count is left in the safe with the cash so no one other than the financial secretary will know if the cash placed in the safe was ever deposited. The financial secretary recounts the cash alone. The financial secretary withholds $200 per week – this is an unapproved payment. The cash is vulnerable to robbery when kept in the unlocked safe overnight. Cheques are made payable to “Cash” so anyone can cash them. The financial secretary has custody of the cash, maintains church records, and prepares the bank reconciliation. No annual audits of cash receipts procedures are performed.
The improvements should include the following: (1) Head usher • The head usher and a finance committee member should take the cash to the office. The cash should be counted by the head usher and the financial secretary in the presence of the finance committee member. The amount counted should be written down on a cash count sheet and copies kept by the secretary and finance committee member. (2) Ushers • The ushers should transfer their cash collections to a cash pouch (or bag) held by the head usher. The transfer should be witnessed by a member of the finance committee.
Solutions Manual .
7-39
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-2B (CONTINUED) (b) (continued) (3) Financial Secretary • Following the count, the financial secretary should prepare a deposit slip in duplicate for the total cash received, and the secretary should immediately deposit the cash in the bank’s night deposit vault. A copy of the deposit slip should be given to a finance committee member. • A “petty” or small cash fund should be established for the financial secretary to be used for weekly cash expenditures and requests for replenishment of the fund should be sent to the chairperson of the finance committee for approval. Receipts for items paid from this fund along with the unused cash should be kept in a locked cash box. Periodic counts of the cash box should be performed by a finance committee member to ensure that the cash on hand plus receipts for cash expenditures total the limit (for example, $200) established for the fund. (4) Finance Committee • A reconciliation of the cash count sheet and the bank deposit slip should be done every time a deposit is made to ensure all cash counted was actually deposited. • Members should make their cheques payable to the church, and not to cash. • At the end of each month, a member of the finance committee should prepare the bank reconciliation. • Annual audits should be performed. LO 1,2 BT: AN Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-40
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-3B (a) Control Weaknesses
(b) Recommendations
1. Cash is collected and kept in the car. This could result in theft.
Cash should be deposited in the bank each day.
2. The person purchasing the merchandise is the same person that verifies receipt of the goods and approves invoices for payment. Because this person is responsible for all activities related to purchasing, errors and theft could occur.
An independent person should verify the receipt of goods. The purchaser should approve bills for payment by the controller.
3. All three cashiers use the same cash drawer. This could result in difficulty establishing responsibility for errors.
Each employee should use a separate cash drawer.
4. The office manager opens the mail, deposits the cash and cheques, and posts the entry in the accounting records. This could result in the office manager depositing cheques into his/her own account, taking the cash, and not posting the entry for accounting purposes or posting a debit to an expense rather than cash.
Mail should be opened by someone not responsible for making the bank deposit. The bank deposit slip should be reconciled to the accounting records (and perhaps a list of cheques kept by the mail room) on a daily basis to ensure all cash received was deposited and recorded. Cash payments from customers should also not be accepted through the mail.
5. The sales staff provide the product to the customer for small orders, receive the cash or cheques from the customers, and restock their own inventory. This could result in the sales staff keeping the payment from the customer and/or taking the product themselves.
All sales staff should be provided with a set amount of product. Replacement product for product sold should only be provided to the sales staff by warehouse personnel after the sales staff submit the money collected (cash or cheque) for the product being replaced.
LO 1,2 BT: AN Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-41
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-4B (a) Control Weaknesses
(b) Improvements
Bank statements are not being reviewed as is evidenced by the fact that the bank statements have not been opened.
Bank statements should be reviewed on a regular basis and all deposits on the statement compared to accounting records. As well, cheques should be scrutinized to ensure they have been recorded and written to valid vendors and that appropriate endorsements (signatures) have been provided.
Accounting records have not been created nor updated regularly. The lack of accounting records means that the charity cannot meet its mandate of having financial records available for the public to examine. Reconciliations cannot be performed if there are no accounting records to compare to the bank statement. Finally, it is impossible for the charity to know if its resources are being spent on charitable activities if there is no record of total cash receipts maintained.
An accounting system should be implemented immediately and all transactions recorded on a timely basis by an individual who does not have responsibility over the collection or deposit of cash receipts and the authorization or signing of cheques for cash disbursements.
Receipts are only issued for amounts over $20.
Prenumbered receipts should be issued for all donations and reconciled by a representative of the charity at the end of the day to the actual cash collected.
Solutions Manual .
7-42
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-4B (CONTINUED) (a) and (b) (continued) (a) Control Weaknesses
(b) Improvements
Collections are made by volunteers who work on a short-term basis.
This is a problem facing many charities and one that cannot easily be solved. Some charities will screen their volunteers for any criminal background. However, the use of prenumbered receipt books is often the only available control.
Drivers collect cash. There is a possibility that the driver could misappropriate cash and not report the collection.
The volunteer and the driver should count all cash receipts at the end of the day. A reconciliation of the cash per the receipt books and the deposit should be prepared. An independent person (not the driver) should make the deposit daily. The reconciliation should be sent back to the charity’s head office to be used as a source document to update the accounting records.
The driver uses money from cash collections to pay expenses. This means that cash receipts, cash deposits, and cash disbursements may not be recorded correctly.
All cash receipts should be deposited intact. Cash disbursements should be by cheque only after appropriate approval has been obtained. A special cash fund, also known as a petty cash fund, could be established to allow for smaller cash disbursements.
Because no reconciliation was made of the cash receipts to the tickets printed for the dance, there is a possibility that the tickets could have been sold by the volunteers and the cash never remitted to the charity.
The dance tickets should have been prenumbered and the numbers of tickets taken by each volunteer recorded. Cash receipts from the ticket sales should have been reconciled to the tickets. Any unsold tickets should have been returned to the charity and accounted for in the reconciliation.
LO 1,2 BT: AN Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-43
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-5B (a) O’HEARNE LIMITED Bank Reconciliation May 31 Cash balance per bank statement .................................. Add: Deposit in transit ................................................. Bank error—O’Bearne cheque............................
$15,230 $1,926 1,200
Less: Outstanding cheques ($2,900 – $2,240 + $1,892) Reconciled cash balance per bank ................................
3,126 18,356 2,552 $15,804
Cash balance per books ................................................ Add: EFT collections ..................................................
$13,126 4,188 17,314
Less: NSF cheque and service charge ($1,350 + $80) Bank service charge ...................................................... Reconciled cash balance per books ..............................
(b)
May
31
31
31
$1,430 80
1,510 $15,804
Cash ....................................................... Accounts Receivable ......................
4,188
Accounts Receivable .............................. Cash ...............................................
1,430
Bank Charges Expense .......................... Cash ...............................................
80
4,188
1,430
80
LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-44
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-6B (a) ISLAND MILLING LTD. Bank Reconciliation October 31 Cash balance per bank statement ......................... Add: Deposit in transit .......................................
$17,230 3,600 20,830 6,200
Less: Outstanding cheques ................................ Reconciled cash balance per bank ....................... Cash balance per books ....................................... Add: Cheque #1926 error ($3,760 - $3,670)...... EFT collections..........................................
(b)
$14,630
2,650
Less: NSF cheque ........................................... Bank service charge .................................. Reconciled cash balance per books ....................
65
Oct.
Cash ............................................... Professional Fees Expense ...
90
Cash ............................................... Accounts Receivable ..............
2,650
31
31
$14,565 $ 90 2,740 17,305 $2,610 2,675 $14,630
90
2,650
31
Accounts Receivable ...................... Cash .......................................
2,610 2,610
31
Bank Charges Expense .................. Cash .......................................
65 65
LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
7-45
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-7B (a)
April 30, reconciled cash balance per bank reconciliation ......... Add: Cash receipts in May ......................................................... Less: Cash disbursements in May ............................................. May 31, unreconciled cash balance ..........................................
(b)
Deposits in transit: $1,524 (dated May 31).
(c)
Outstanding cheques #545 for $1,535 (dated May 31)
$14,000 5,457 6,201 $13,256
(d) RIVER ADVENTURES LTD. Bank Reconciliation May 31 Balance per bank statement ............................................. Add: Bank error cheque #543 ($2,210 – $2,120) .......... Deposits in transit [from (b)] .................................
$12,480 $ 90 1,524
Less: Outstanding cheques No. 545 [from (c)]................................................. Reconciled cash balance per bank ...................................
1,535 $12,559
Balance per books [from (a)] ............................................ Add: EFT collection A. Osborne ...................................
$13,256 1,475 14,731
Less:
Service charges ................................................... EFT insurance payment ...................................... NSF cheque and fee ($1,105 + $45) ................... Reconciled cash balance per books ................................. (e)
1,614 14,094
$
95 927 1,150
Cash ...................................................................... Accounts Receivable ...................................
1,475
Accounts Receivable ............................................. Cash ..............................................................
1,150
Bank Charges Expense ......................................... Cash ..............................................................
95
Prepaid Insurance.................................................. Cash ..............................................................
927
2,172 $12,559
1,475
1,150
95
927
LO 3 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
7-46
Chapter 7
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 7-8B (a)
November 30, reconciled cash balance per bank reconciliation ....... Add: Cash receipts in December ...................................................... Less: Cash disbursements in December .......................................... December 31, unreconciled cash balance ........................................
(b)
RACINE LIMITED Bank Reconciliation December 31 Cash balance per bank statement ............................. Add: Deposits in transit ............................................ Less: Outstanding cheques No. 3474 ..................................................... No. 3478 ..................................................... No. 3483 ..................................................... Reconciled cash balance per bank ............................
$10,395 1,197 11,592 $1,050 538 1,390
Cash balance per books [from (a)]............................. Add: EFT collection R. Nishimura ............................. Less:
(c)
$12,743 8,955 15,148 $ 6,550
$6,550 3,145 9,695
NSF cheque and fee ($987 + $40) ............... Bank service charges ................................... Error in Dec. 17 deposit ($2,954 – $2,945)... Reconciled cash balance per books ..........................
$1,027 45 9
Dec. 31
Cash ..................................................... Accounts Receivable ....................
3,145
Accounts Receivable............................. Cash .............................................
1,027
Bank Charges Expense ........................ Cash .............................................
45
Accounts Receivable............................. Cash .............................................
9
31
31
31
2,978 $ 8,614
1,081 $8,614
3,145
1,027
45
9
LO 3 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 7-9B (a) and (b)
(c)
Cash: 1. Cash on hand ........................................................................ 2. Bank chequing account ......................................................... 5. US dollar account (Canadian equivalent) .............................. Total cash balance ...........................................................
$ 1,600 7,460 2,241 11,301
Cash equivalents: 3. Government of Ontario bond ................................................ Cash and cash equivalents............................................................
5,000 $16,301
4.
The cash due from the customer should be recorded as an account receivable, and reported as a current asset on the statement of financial position. The remainder of the entry should update inventory (current asset), sales (revenue), and cost of goods sold (assuming a perpetual inventory system).
6.
The deposit with Hydro One should be recorded as an advance or deposit in the current assets section of the statement of financial position as it is very similar to a receivable that the company hopes to collect once the credit history is established.
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 7-10B (a)
The security deposits were not included in cash as these amounts are not available for use by the company. They are held in trust for the tenants and are therefore a form of restricted cash. They are segregated on the statement of financial position.
(b)
Segregated tenants’ security deposits would most likely be classified in the non-current assets section of the statement of financial position. Because of the length of the related apartment leases and the operating cycle of the business, it is unlikely that the deposits would be repaid in the current accounting cycle.
LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 7-11B Accelerating collection of receivables - Currently, no deposit is received from the customers and billing is done at the end of the contract which is four months after the contract started - Jackie should ask customers for a large upfront deposit before the items are purchased on behalf of the customer - Jackie should also consider billing on a monthly basis throughout the contract so that cash is received earlier Delaying payment of liabilities - Jackie is currently paying for items purchased immediately. She can apply for credit and pay for the purchases on account, probably 30 days later than she is currently paying LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
ACR7-1 ACCOUNTING CYCLE REVIEW 2018 (a) Jan.
1
8 13
15
17 18
21 24 26
Jan.
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31
Bank Loan Payable ........................................... Interest Payable ($2,000,000 x 3% x 1/12) ....... Cash..........................................................
20,000 5,000
Cash ................................................................. Accounts Receivable.................................
178,000
Accounts Receivable......................................... Sales .........................................................
216,000
Cost of Goods Sold ........................................... Inventory ...................................................
122,000
Inventory ........................................................... Accounts Payable .....................................
75,000
Accounts Payable ............................................. Cash..........................................................
120,000
Salaries Payable ............................................... Salaries Expense .............................................. Cash..........................................................
34,000 36,000
Supplies ........................................................... Accounts Payable .....................................
1,500
Inventory ........................................................... Accounts Payable .....................................
98,000
Cash ................................................................. Accounts Receivable......................................... Sales .........................................................
68,000 58,000
Cost of Goods Sold ........................................... Inventory ...................................................
68,000
Cash ($50,000 - $25,000) ................................. Unearned Revenue ........................................... Sales .........................................................
25,000 25,000
Cost of Goods Sold ........................................... Inventory ...................................................
35,000
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25,000 178,000 216,000 122,000 75,000
120,000
70,000 1,500 98,000
126,000 68,000
50,000 35,000
Chapter 7
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Financial Accounting, Seventh Canadian Edition
ACR7-1 (CONTINUED) (b)
MATCHETT FABRICATIONS LTD. Bank Reconciliation January 31, 2018 Cash balance per bank statement ......................... Add: Deposits in transit ........................................
$161,162 25,000 186,162 12,000 $174,162
Less: Outstanding cheques .................................. Reconciled cash balance per bank ........................ Cash balance per books [refer to (c)]..................... Less: NSF cheque ................................... Bank service charges ............................... Reconciled cash balance per books ...................... Jan.
31
$184,000 $9,800 38
9,838 $174.162
Bank Charges Expense ............................. Cash...................................................
38
Accounts Receivable.................................. Cash...................................................
9,800
38 9,800
(c) and (e) Cash Dec. 31, 2017 Jan. 8 Jan. 26 Jan. 31 Jan. 31
Jan. 31 Bal.
128,000 Jan. 1 178,000 Jan. 17 68,000 Jan. 18 25,000 184,000 Jan. 31 Jan. 31 174,162
Accounts Receivable Dec. 31, 2017 920,000 Jan. 8 Jan. 13 216,000 Jan. 26 58,000 Jan. 31 9,800 Bal. 31 Bal 1,025,800
Dec. 31, 2017 Jan. 21 Bal. 31 Bal Solutions Manual .
Supplies 3,000 1,500 Jan. 31 1,300
25,000 120,000 70,000
38 9,800
Dec. 31, 2017 Jan. 15 Jan. 24 Jan. 31 Bal.
Dec. 31, 2017
Inventory 457,000 Jan. 13 75,000 Jan. 26 98,000 Jan. 31 405,000
122,000 68,000 35,000
Equipment 2,280,000
Accumulated Depreciation—Equipment Dec. 31, 2017 380,000 Jan. 31 31,667 Jan. 31 Bal. 411,667
178,000
Jan. 17
3,200
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Accounts Payable 120,000 Dec. 31, 2017 Jan. 15 Jan. 21 Jan. 24 Jan. 31 Bal. Chapter 7
410,000 75,000 1,500 98,000 464,500
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR7-1 (CONTINUED) (c) and (e) (continued)
Jan. 1
Jan. 18
Jan. 31
Jan. 1
Interest Payable 5,000 Dec. 31, 2017 Jan. 31 Jan. 31 Bal.
5,000 4,950 4,950
Salaries Payable 34,000 Dec. 31, 2017 Jan. 31 Jan. 31 Bal.
34,000 36,000 36,000
Unearned Revenue 25,000 Dec. 31, 2017 Jan. 31 Bal.
120,000 95,000
Income Tax Payable Jan. 31 Jan. 31 Bal.
16,000 16,000
Bank Loan Payable 20,000 Dec. 31, 2017 Jan. 31 Bal. Common Shares Dec. 31, 2017
2,000,000 1,980,000
Jan. 18 Jan. 31 Jan. 31 Bal.
Salaries Expense 36,000 36,000 72,000
Jan. 31
Depreciation Expense 31,667
Jan. 31
Interest Expense 4,950
Jan. 31
Supplies Expense 3,200
Jan. 31
Bank Charges Expense 38
Jan. 31
Income Tax Expense 16,000
250,000
Retained Earnings Dec. 31, 2017
589,000
Sales Jan. 13 Jan. 26 Jan. 31 Jan. 31 Bal.
216,000 126,000 50,000 392,000
Solutions Manual .
Jan. 13 Jan. 26 Jan. 31 Jan. 31 Bal.
Cost of Goods Sold 122,000 68,000 35,000 225,000
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Financial Accounting, Seventh Canadian Edition
ACR7-1 (CONTINUED) (d)
2018 Jan.
31
31
31
31
31
Solutions Manual .
Depreciation Expense ....................................... Accumulated Depreciation—Equipment ... ($2,280,000 ÷ 6 × 1/12 = $31,667)
31,667
Interest Expense ............................................... Interest Payable .................................... [($2,000,000 - $20,000) x 3% x 1/12)] = $4,950
4,950
Supplies Expense ............................................. Supplies .................................................... ($3,000 + $1,500 – $1,300 = $3,200)
3,200
Salaries Expense .............................................. Salaries Payable ......................................
36,000
Income Tax Expense ........................................ Income Tax Payable ................................
16,000
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31,667
4,950
3,200
36,000
16,000
Chapter 7
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Financial Accounting, Seventh Canadian Edition
ACR7-1 (CONTINUED) (f) MATCHETT FABRICATIONS LTD. Adjusted Trial Balance January 31, 2018 Debit $ 174,162 1,025,800 1,300 405,000 2,280,000
Cash Accounts receivable Supplies Inventory Equipment Accumulated depreciation—equipment Accounts payable Interest payable Salaries payable Unearned revenue Income tax payable Bank loan payable Common shares Retained earnings Sales Cost of goods sold Salaries expense Depreciation expense Interest expense Supplies expense Bank charges expense Income tax expense
Solutions Manual .
Credit
411,667 464,500 4,950 36,000 95,000 16,000 1,980,000 250,000 589,000 392,000 225,000 72,000 31,667 4,950 3,200 38 16,000 $4,239,117
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000000000 $4,239,117
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Financial Accounting, Seventh Canadian Edition
ACR7-1 (CONTINUED) (g) (1) MATCHETT FABRICATIONS LTD. Income Statement Month Ended January 31, 2018 Sales Cost of goods sold Gross profit Operating expenses Salaries expense Depreciation expense Supplies expense Bank charges expense Total operating expenses Income from operations Other revenues and expenses Interest expense Total other revenues and expenses Income before income tax Income tax expense Net income
$392,000 225,000 167,000 $72,000 31,667 3,200 38 106,905 60,095 (4,950) (4,950) 55,145 16,000 $ 39,145
(g) (2) MATCHETT FABRICATIONS LTD. Statement of Changes in Equity Month Ended January 31, 2018
Balance, January 1 Net income Balance, January 31
Solutions Manual .
Common Shares $250,000 0000 000 $250,000
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Retained Earnings $589,000 39,145 $628,145
Total Equity $839,000 39,145 $878,145
Chapter 7
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Financial Accounting, Seventh Canadian Edition
ACR7-1 (CONTINUED) (g) (3) MATCHETT FABRICATIONS LTD. Statement of Financial Position January 31, 2018 Assets Current assets Cash Accounts receivable Supplies Inventory Total current assets Property, plant, and equipment Equipment Less: Accumulated depreciation Total assets
$ 174,162 1,025,800 1,300 405,000 1,606,262 $2,280,000 411,667
1,868,333 $3,474,595
Liabilities and Shareholders’ Equity Current liabilities Accounts payable Interest payable Salaries payable Unearned revenue Income tax payable Bank loan payable – current portion * Total current liabilities Bank loan payable Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$464,500 4,950 36,000 95,000 16,000 240,000 $
856,450 1,740,000** 2,596,450
$ 250,000 628,145 878,145 $3,474,595
* $20,000 principal payment per month x 12 months = $240,000 ** Balance $1,980,000 less current portion of $240,000 = $1,740,000 LO 3,4 BT: AP Difficulty: M Time: 90 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT7-1 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
The second paragraph of the Management’s Responsibility for Financial Statements clearly states that management is responsible for establishing and maintaining an appropriate system of internal controls. In addition, a statement is made in this paragraph that the role of internal auditors of the company is to perform a review and evaluation of internal controls to provide management with the reasonable assurance that assets are safeguarded, transactions are authorized and recorded and that the financial records are reliable. In the Independent Auditor’s Report, the auditor considers the internal controls relevant to the company’s preparation and fair presentation of the financial statements. Following this study of internal controls, the auditor designs audit procedures that are appropriate under the circumstances in order to express an opinion on the financial statements.
(b)
Management has the primary responsibility for the system of internal control as indicated in the answer to (a) above. The auditor points out in the second paragraph of the Independent Auditor’s Report that management is responsible for internal control that will enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. The auditor is not responsible for the design or effectiveness of internal controls and does not express an opinion as to their effectiveness. Nonetheless, the auditor does consider the internal controls in the design of their audit, as noted in (a) above.
(c)
Management has the primary responsibility for the preparation and presentation of the financial statements. This responsibility is mentioned in both reports. The very first sentence of the Management’s Responsibility for Financial Statements states this responsibility and then the auditor repeats the statement in the second paragraph of the auditor’s report.
LO 1 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001, cpa-t004 CM: Reporting and Audit
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CT7-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
North West’s cash reported at January 31, 2016 is $37,243,000.
(b)
Sobeys reported cash and cash equivalents at May 7, 2016 of $258.8 million.
(c)
North West Cash January 31, 2016 North West Cash January 31, 2015 Increase in cash for 2016 Increase as a % ($8,114 ÷ $29,129)
$37,243,000 29,129,000 8,114,000 27.9%
Sobeys May 7, 2016 Sobeys May 2, 2015 Decrease in CCE Decrease as a % ($36,800 ÷ $295,600)
$258,800,000 295,600,000 (36,800,000) 12.4%
North West’s cash position has improved while Sobeys’ has declined. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT7-3
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
Generally, the accounting standards a company follows should not have a significant impact on its internal controls. However, since IFRS is more principles-based and relies more upon professional judgment than ASPE, companies need to have controls in place to assess decisions that have been made when making various calculations. These types of controls would rely heavily upon review, reconciliation, and approval.
(b)
Strong internal controls are essential for proper recording of transactions and the preparation of financial statements to ensure the usefulness of this information for decision-making by external users. Publicly traded companies have more external users of their financial statements than do private companies. By reporting on the effectiveness of their internal controls over financial reporting, public companies provide their stakeholders with important information on the quality of the process used to produce the financial statements. Also, because management must prepare a report, it must assess the effectiveness of controls on an ongoing basis. Many people argue that this will help identify any weaknesses in the systems, as well as fraud and error, on a timely basis.
LO 1 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting
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CT7-4 (a)
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
Vanessa should report several internal control weaknesses for the hotel operations to her father Patrick Chen: 1. For the room rental portion of operations: • The opportunity exists for unrecorded room rental revenues. Patrons who pay cash may have access and use of the room but the revenue from the rental remains unreported and the desk clerk pockets the cash collected. • Friends can gain access to rooms and related services without any charges and without any revenue to the hotel. 2. For bar revenues: • The bartender has the opportunity to bring in inventory purchased personally and resold at the bar, while keeping the cash receipts from sales. • Revenue from bar sales may go unrecorded as the bartender is too busy to enter sales in the cash register. 3. For parking lot revenues: • The opportunity exists for the attendant to understate the amount of parking revenue collected, while pocketing the cash. • Friends of the attendant may be allowed parking without having to pay any fees.
(b)
It will not always be possible to establish how much money has been lost or stolen from the hotel. While some errors or omissions can be measured, such as room rentals, unrecorded liquor sales will be very difficult to measure since the liquor sold may not have come from inventory purchased.
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CT7-4 (CONTINUED) (c) A general recommendation concerning hiring family members applies in this case for all of the hotel’s operations. Collusion between management and its employees to defraud the hotel is heightened when the employees are members of the general manager’s family. In addition, the following steps can be taken to avoid the possibility of fraud in the future: 1. For the room rental portion of operations: • A daily reconciliation should be prepared, by someone other than the desk clerk, which compares the report for the number rooms cleaned to the number of room rented. 2. For bar revenues: • A division of duty should be established between the person having access to inventory and the person handling cash receipts. • Supervision of the handing of the inventory and the handling of the cash should be done whenever possible. Any change in the normal procedures, such as was the case in the handling of the tequila, should be cause for termination. • A daily check should be made comparing the amount of revenues reported from bar sales to the inventory consumed. 3. For parking lot revenues: • Install the automated payment system which will remove the attendant’s opportunity to understate revenues and pocket cash. LO 1,2 BT: S Difficulty: C Time: 40 min. AACSB: Communication CPA: cpa-t001 CM: Reporting
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CT7-5
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
(a)
The stakeholders are the customers affected by the policy, the shareholders of the banks who want to see higher net income, and the management of the banks who make the decisions regarding fees and cheque processing policies.
(b)
(1)
If the bank processes cheque #3158 for $1,510 first it will bounce due to non-sufficient funds as the balance in the account is only $1,500. All of the other cheques to be processed after that will also bounce so consequently all 5 cheques will bounce and the total NSF processing fees charged by the bank will be $225 (5 × $45).
(2)
If the bank processes the smallest cheques first, the 3 smallest cheques will clear processing and the 2 largest ones will bounce. By processing the cheques in this way, the bank will earn a processing fee of only $90 (2 x $45).
(c)
Whether this is ethical is subject to debate. On the one hand, it can be argued that customers have a responsibility to maintain an adequate balance in their accounts. Some customers are frequently overdrawn; thus only severe penalties will persuade them to maintain an adequate balance. However, it could also be argued that processing cheques from largest to smallest is “gouging” and takes unfair advantage of the customer.
(d)
In deciding what approach to take, the bank must consider its relationship with the customer. For customers who do not write NSF cheques frequently, it probably does not matter which approach is taken. Any customer that is frequently overdrawn may not be the type of customer that the bank is willing to deal with over the long term so it may be beneficial to other account holders to treat those who are always overdrawn as severely as possible. If the “largest to smallest” policy is used by all banks, customers won’t gain an advantage by switching accounts to other banks if this policy angers them.
(e)
Answer will vary depending on students’ opinions.
LO 4 BT: E Difficulty: M Time: 30 min. AACSB: Ethics and Analysis CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT7-6
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a)
The strengths in ABC’s system of internal control and related control activity are as follows: Control Activity
Strength 1. Password access to the cash register
Physical controls
Cash register calculates the pricing of the Documentation goods and prints receipt Physical controls
2. Cash is deposited daily
Owners are involved in the reconciliation Review and reconciliation of cash with totals from the cash register Review and reconciliation 3. Inventory is counted monthly Doug or Bev authorize the purchase of Assignment of responsibility inventory 4. The monthly payroll schedule is Review and reconciliation reconciled to actual salaries paid 5. Invoices are prepared when the services Documentation have been performed
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CT7-6 (CONTINUED) (b)
The weaknesses in ABC’s system of internal control and the control activities violated are as follows: Control Activity
Weaknesses
1. Employees share one cash register and Assignment of responsibility management currently is unable to affix responsibility for cash to a specific employee Segregation of duties Cashier is handling cash and inventory
2.
3.
4. 5.
Entering transactions can be performed by incorrect cashier, due to no logging off No mention of supervision of employees entering sales and handling inventory No mention of procedures for voided transactions or pricing adjustments on sales Reconciliation of sales is not done daily and so one cannot establish who has made an error on a sale Inventory is counted monthly to determine what products to reorder, but should also be used to determine unrecorded sales No system in place to avoid duplication of purchases Documentation of authorized overtime is not obtained Invoices for services are not prenumbered
Physical controls Segregation of duties Assignment of responsibility
Review and reconciliation
Review and reconciliation
Review and reconciliation Documentation Documentation
Invoices are not issued in duplicate - Documentation photocopies have to be made and if staff forget to make a photocopy, sales could go unrecorded
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CT7-6 (CONTINUED) (b) (continued) In order to address the weaknesses, improvements that ABC’s management should consider include: 1. 2. 3. 4. 5. 6. 7. 8. 9.
Program the cash register such that a new transaction cannot be entered without the operator logging off from the previous transaction. Reconcile the sales to the deposit daily and establish the responsibility of errors to the particular employee causing the error. Provide supervision of employees or install cameras to ensure that all sales are recorded. Design procedures involving owners for voiding or altering the pricing for transactions entered. Compare and reconcile the reduction of inventory to the sales recorded daily. Implement the use of pre-numbered invoices that are printed in duplicate copies that cannot be altered. Account for the numerical sequence of invoices. Consider automating the production of invoices. Install a log of purchase orders made to avoid duplication of orders.
LO 1,2 BT: Difficulty: C Time: 50 min. AACSB: Communication CPA CM: Reporting
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CHAPTER 8 REPORTING AND ANALYZING RECEIVABLES LEARNING OBJECTIVES 1. 2. 3. 4. 5.
Identify the types of receivables and record accounts receivable transactions. Account for bad debts. Account for notes receivable. Explain the statement presentation of receivables. Apply the principles of sound accounts receivable management.
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT
Item LO
BT
Item LO BT Questions
Item LO
BT
Item LO
BT
1.
1
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6.
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11.
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Brief Exercises 1.
1
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4.
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AP
7.
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10.
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13.
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2.
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3.
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6.
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9.
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15.
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13.
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Exercises 1.
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4.
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Problems: Set A and B 1.
1,2,4
AP
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AP
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Accounting Cycle Review 1. 1,2,3,4 AP
Cases 1.
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Legend: The following abbreviations will appear throughout the solutions manual file.
LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
Three types of receivables along with examples follow: (a) Type (1) Accounts receivable
(b) Examples Accounts receivable from trade customers
(2) Notes receivable
Notes receivable from trade customers Notes receivable obtained when selling property
(3) Other receivables
Interest receivable, loans to company officers, advances to employees, sales tax recoverable, and income tax receivable
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
Trade receivables are the result of sales transactions while nontrade receivables are the result of transactions other than sales (or service revenue in a non-merchandising business) transactions of the business, such as interest receivable, income tax receivable, and similar types of receivables.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
(a)
For a service company, a receivable is recorded when the revenue is
considered to be earned, which occurs when the service is provided. In a merchandising company, a receivable is recorded when revenue is considered to be earned, which occurs when the merchandise is sold (normally at the point of sale). (b)
The five-step process used to measure and report revenue: 1. 2. 3. 4. 5.
Identify the contract with the client or customer. Identify the performance obligations in the contract. Determine the transaction price. Allocate the transaction price to the performance obligations in the contract. Recognize revenue when (or as) the company satisfies the performance obligations.
The timing of the recognition of revenue will determine the point at which the account receivable will be recognized in the accounts. LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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4.
(a)
Financial Accounting, Seventh Canadian Edition
The advantages of accepting credit cards are: (1) (2) (3) (4) (5) (6)
The credit card issuer makes the credit card investigation of the customer. The issuer maintains individual customer accounts. The issuer undertakes the collection process and absorbs any losses from uncollectible accounts. The retailer receives cash more quickly from the credit card issuer than it would from individual customers. It allows the company to remain competitive (as competitors accept credit cards). It increases sales as customers are able to make purchases when they don’t have the required cash.
Debit cards: The advantage of the debit card is that the cash is deducted immediately from the customer’s account. There are no credit checks or collection concerns so the service charges are normally lower than for a bank credit card. By accepting credit cards and debit cards, Canadian Tire provides more options to its customers, increases its revenue, and reduces its risk. (b)
Bank credit cards: To record a bank credit card transaction, the seller records a debit to Cash and a credit to Sales. Debit cards: To record a debit card transaction, the seller records a debit to Cash and
Bank charges expense for debit card and bank credit card fees must also be recorded LO 1 BT: C Difficulty: C Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
(a)
Using an accounts receivable subsidiary ledger makes it possible to determine the balance owed by an individual customer at any point in time. This makes it easier to manage receivables, answer customer inquiries, follow up on payments, and decide if additional credit should be granted.
(b)
The general ledger control account should agree with the total of the individual accounts in the subsidiary ledger.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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6.
Financial Accounting, Seventh Canadian Edition
(a)
An aging schedule shows the receivables in various stages outstanding 0–30 days, 31
(b)
The aging schedule is used to apply percentages to outstanding receivables in each age category to determine the total estimated uncollectible accounts.
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
(a)
The purpose of the account Allowance for Doubtful Accounts is to show an estimate of the accounts receivable expected to become uncollectible. The allowance account is used because the amount is only an estimate and we do not know for certain which customers will not pay, so we cannot reduce specific customer accounts in the subsidiary ledger or the related accounts receivable control account in the general ledger. Instead we increase the allowance account balance.
(b)
The account can be in a debit balance if the amount of actual write offs exceeds previous provisions for bad debts. A debit balance will arise during the period when these write offs are recorded, but by the end of the reporting period, adjusting entries will be made that will bring the balance in the allowance account back into a credit position. The credit entry to this account is offset with a debit to Bad Debts Expense.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
8.
Debit balances in the Allowance for Doubtful Account occur during the year when the amou the end of the previous period is based on estimates, it is possible that this situation could occur. The excess amount of write offs beyond the opening balance of the allowance account could relate to accounts receivable that were outstanding at the end of the previous period. To the extent that this is the case, the financial statements of the previous period had an understatement in the Bad Debts Expense account as well as an understatement of Allowance for Doubtful Accounts balance, and therefore overstatement of net accounts receivable. This situation is treated as a change in estimate and is not considered an error in the previous period financial statements.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
The Bad Debts Expense account reflects only the current year’s estimates while the Allowance for Doubtful Accounts is a cumulative result of estimates, write offs, and subsequent recoveries from the current and prior periods.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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10.
Financial Accounting, Seventh Canadian Edition
The write off of an uncollectible account reduces both Accounts Receivable and the Allowance for Doubtful Accounts by the same amount. Thus, net carrying amount (which is the difference between accounts receivable and allowance for doubtful accounts) does not change. Carrying amount will change, however, when an adjusting entry is made to record the estimate of uncollectible accounts because only the Allowance account is affected in this entry.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
11.
Two journal entries are required because the first journal entry has to restore the previously written off accounts receivable and the second journal entry records the actual receipt of payment on the account. This way, there is a record that the person did eventually pay, and that may affect future credit decisions. Furthermore, the date on which the determination that the receivable is actually collectible and the date it is actually collected may be different and this would necessitate the separate recording of these events.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
(a)
The similarities between accounts receivable and notes receivable are that they are both credit instruments, both can be sold, and both are valued at their carrying amount.
(b)
Differences between accounts receivable and notes receivable include the following. An accounts receivable is an informal promise to pay, while a note receivable is a written promise giving the payee a stronger legal claim. A note receivable is a negotiated instrument that can be transferred to another party. An account receivable arises from credit sales, while a note receivable can arise for a number of reasons such as the financing of a purchase, lending money, or extending the terms of an account receivable. An account receivable is usually due within a short period of time, while a note receivable can extend for longer periods of time (which is why it bears interest). An account receivable does not incur interest unless the account is overdue while a note usually bears interest for the entire period.
LO 1,3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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13.
(a)
(b)
Financial Accounting, Seventh Canadian Edition
(1)
Interest is normally recorded for an account receivable if a customer does not pay in full within a specified period of time (usually 30 days). The invoice will specifically state the amount or percentage of interest due on overdue accounts.
(2)
In the case of notes receivable, the amount of interest accrues starting from the date of the issuance of the note and continues to the maturity date of the note. Interest earned is recorded when accrued at the end of each accounting period or when collected, whichever comes first.
(1)
Accounts Receivable is normally debited for interest accrued on overdue balances. This accomplishes two goals: updating a particular customer’s balance in the subsidiary ledger to allow management to decide if additional credit should be granted if overdue balances are not yet paid; it also allows the company to easily send a statement of transactions to the customer that includes interest charges so that the customer will be aware of them.
(2)
In the case of notes receivable, when accrued, Interest Revenue is credited and Interest Receivable is debited. The Note Receivable account is for the amount of the principal balance of the loan, whereas the interest is recorded and reported separately.
LO 1,3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
Notes are not recorded at their maturity value (which would include interest) because the interest on the note is not receivable when the note is first recorded. The interest is earned over time and is recorded when earned.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
Cobden Inc., as the party making the promise to pay, is the maker of the note. It would record a note payable. Scotiabank, as the party who will be paid, is the payee. It would record a note receivable.
LO 3 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
When a note receivable is honoured at maturity it is paid in full, while a dishonoured note is not paid in full at maturity. A dishonoured note receivable is no longer negotiable. The payee still has a claim against the maker of the note and if eventual collection is expected, an accounts receivable is recorded.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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17.
Financial Accounting, Seventh Canadian Edition
These notes should be reported at their carrying amount. An entry should be made to debit Bad Debts Expense for the 10% expected to be uncollectible and to credit Allowance for Doubtful Notes for the same amount.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
18.
Both the gross amount of receivables and the allowance for doubtful accounts must be reported either on the statement of financial position or in the notes to the financial statements. It is usual to report the receivables on the statement of financial position at their carrying amount and to provide additional information about the allowance in the notes to the statements.
LO 4 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
19. Current assets Accounts receivable Less: Allowance for doubtful accounts Carrying amount of accounts receivable Notes receivable (due in three months) Less: Allowance for doubtful notes Carrying amount of short-term notes
$xxx xxx $xxx $xxx xxx
Sales tax recoverable Income tax receivable
xxx xxx xxx
Non-current assets Notes receivable (due in two years)
$xxx
LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
20.
(a) Account (1) Sales or Service Revenue (2) Bad Debt Expense (3) Interest Revenue
(b) Classification Revenues Operating expenses Other revenues and expenses
LO 4 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
21.
The steps involved in good receivables management are: (1) Determine to whom credit is extended. (2) Establish a payment period. (3) Monitor collections. (4) Evaluate the liquidity of receivables.
LO 5 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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22.
Financial Accounting, Seventh Canadian Edition
To help in determining whether High Liner’s receivables management has improved or worsened the average collection period should be determined. Average collection period
2016 365 = 28.1 days 13.0
2015 365 = 28.5 days 12.8
High Liner’s receivable management has improved slightly. The receivables turnover has increased from 12.8 times to 13.0 times, indicating a slightly faster collection of receivables. The average collection period shows this more clearly; the average time it takes to collect a receivable has been lowered from 28.5 days to 28.1 days. LO 5 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
23.
(a)
An increase in the current ratio does not necessarily mean that the liquidity of a company has improved. In order to determine if liquidity has improved, we need to understand why the current ratio rose. If it rose because the company has more cash, then the company is more liquid. On the other hand if the cash has fallen but inventory has risen by a larger amount because of declining sales, the current ratio will rise but this does not mean that the company is more liquid. It simply means that the company has some inventory that it cannot sell and the company has less liquidity. The same is true if net accounts receivable increase because of a slowdown in collections not fully adjusted for in the estimate of uncollectible accounts.
(b)
Other ratios that focus on specific current assets rather than current assets in total (as the current ratio does) give us insight into the components of working capital and allow us to understand liquidity in more detail. Examples include the receivables turnover ratio and the inventory turnover ratio. In general, if these ratios are rising, liquidity is improving because cash is being received more quickly.
LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
24.
If the receivables turnover is significantly higher than its competitors, it means the company is collecting its receivables faster, indicating it may have an earlier payment due date. Customers may move to a competitor that does not collect its receivables as quickly to better manage their cash flow. If a company has a receivables turnover that is significantly lower than its competitors, it may be at a competitive disadvantage because it is financing its customers’ purchases for a longer time and delaying the time it takes to receive cash.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 (a) (b) (c) (d) (e) (f)
Notes receivable Accounts receivable Other receivables Other receivables Notes receivable Other receivables
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 8-2 (a)
(b)
(c)
(d)
July 1
July 8
July 9
Accounts Receivable ................................................. Sales ....................................................................
58,000
Cost of Goods Sold ................................................... Inventory ..............................................................
32,000
Sales Returns and Allowances .................................. Accounts Receivable............................................
6,400
Inventory .................................................................... Cost of Goods Sold ..............................................
4,320
Cash ($51,600 – $1,032) ........................................... Sales Discounts ($51,600 × 2%) ............................... Accounts Receivable ($58,000 – $6,400) ............
50,568 1,032
Aug. 31 Accounts Receivable ................................................. Interest Revenue [($58,000 – $6,400) × 24% × 1/12]
58,000
32,000
6,400
4,320
51,600 1,032 1,032
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 8-3 (a)
(b)
(c)
(d)
(e)
April 28 Accounts Receivable ................................................. Sales ....................................................................
26,000
Cost of Goods Sold ................................................... Inventory ..............................................................
18,000
May 1 Accounts Receivable ................................................. Sales ....................................................................
35,000
Cost of Goods Sold ................................................... Inventory ..............................................................
24,000
May 3 Sales Returns and Allowances .................................. Accounts Receivable............................................
1,200
Inventory .................................................................... Cost of Goods Sold ..............................................
850
Cash ($24,800 - 496)................................................. Sales Discounts ($24,800 × 2%) ............................... Accounts Receivable ($26,000 – $1,200) ............
24,304 496
Accounts Receivable ................................................. Interest Revenue ($35,000 × 18% × 1/12) ..........
525
May 6
June 1
26,000
18,000
35,000
24,000
1,200
850
24,800
525
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 8-4 Accounts Receivable Subsidiary Ledger Chiu Corp. Jan. 7 1,800 Jan. 17 Jan. 31 Bal. 1,100
700
Lewis Corp. Jan. 23 3,700 Jan. 29 Jan. 31 Bal. 0
3,700
General Ledger Control Account Accounts Receivable Elbaz Inc. Jan. 11,500 31 24 Jan.31 15 6,000 Jan. Jan. Jan. Jan.31Bal. 31 Bal. 5,100 4,000
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
6,400 2,000
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 8-5 Number of Days Outstanding
Accounts Receivable
Estimated Percentage Uncollectible
0–45 days
$726,000
2%
$14,520
46–90 days
248,000
5%
12,400
Over 90 days
112,000
16%
17,920
Total
(a)
(b)
$1,086,000
Total Estimated Uncollectible Accounts
$44,840 Required Ending Allowance for Doubtful Accounts balance
Bad Debts Expense ................................................................. Allowance for Doubtful Accounts .................................... ($44,840 – $13,175)
31,665
Bad Debts Expense ................................................................. Allowance for Doubtful Accounts .................................... ($44,840 + $8,920)
53,760
31,665
53,760
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 8-6 (a) Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total (b) Dec. 31
(c) Dec. 31
Estimated Percentage Uncollectible 1% 4% 10% 20%
Accounts Receivable $368,000 120,000 72,000 40,000 $600,000
Total Estimated Uncollected Accounts $ 3,680 4,800 7,200 8,000 $23,680
Bad Debts Expense ($23,680 – $3,600) .......................... Allowance for Doubtful Accounts ...........................
20,080
Bad Debts Expense ($23,680 + $5,400) .......................... Allowance for Doubtful Accounts ...........................
29,080
20,080
29,080
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 8-7 (a)
Jan. 24
Allowance for Doubtful Accounts ........................... Accounts Receivable .....................................
(b)
(1) Accounts receivable Allowance for doubtful accounts Carrying amount
Before Write Off $480,000 29,000 $451,000
11,000 11,000
(2)
After Write Off $469,000 18,000 $451,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 8-8 Mar. 4
4
Accounts Receivable ........................................................ Allowance for Doubtful Accounts ...........................
11,000
Cash ................................................................................. Accounts Receivable .............................................
11,000
11,000
11,000
LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 8-9 Aug.
1
Aug. 31
Sept. 30
Oct.
1
Notes Receivable ............................................................ Accounts Receivable ..............................................
26,000
Interest Receivable ($26,000 × 6% × 1/12)..................... Interest Revenue ....................................................
130
Interest Receivable ($26,000 × 6% × 1/12)..................... Interest Revenue ....................................................
130
Cash ............................................................................... Interest Receivable ................................................. Notes Receivable ....................................................
26,260
26,000
130
130
260 26,000
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 8-10 Jan.
Feb.
2
1
April 30
July
1
Accounts Receivable ...................................................... Sales .......................................................................
48,000
Cost of Goods Sold ......................................................... Inventory .................................................................
32,000
Notes Receivable ............................................................ Accounts Receivable ..............................................
48,000
Interest Receivable ($48,000 × 7% × 3/12)..................... Interest Revenue ....................................................
840
Cash ............................................................................... Interest Receivable ................................................. Notes Receivable .................................................... Interest Revenue ($48,000 × 7% × 2/12) ................
49,400
48,000
32,000
48,000
840
840 48,000 560
LO 1,3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 8-11 2017 April 1
Dec. 31
Notes Receivable ............................................................ Sales .......................................................................
10,000
Cost of Goods Sold ......................................................... Inventory .................................................................
6,000
Interest Receivable ($10,000 × 9% × 9/12)..................... Interest Revenue ....................................................
675
10,000 6,000 675
(At the end of each year, interest is accrued for the time elapsed since the date of a note)
2018 Mar 31
Cash ............................................................................... Interest Receivable ................................................. Notes Receivable .................................................... Interest Revenue ($10,000 × 9% × 3/12) ................
10,900 675 10,000 225
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 8-12 (a) Apr. 1 Notes Receivable ......................................................... Accounts Receivable ...........................................
40,000
July 1 Cash ............................................................................ Notes Receivable ................................................ Interest Revenue ($40,000 × 6% × 3/12) ............
40,600
(b) Apr. 1 Notes Receivable ......................................................... Accounts Receivable ...........................................
40,000
July 1 Accounts Receivable .................................................... Notes Receivable ................................................ Interest Revenue ($40,000 × 6% × 3/12) ............
40,600
(c) Apr. 1 Notes Receivable ......................................................... Accounts Receivable ...........................................
40,000
July 1 Allowance for Doubtful Notes ....................................... Notes Receivable ................................................
40,000
40,000 40,000 600 40,000 40,000 600 40,000 40,000
Note that no interest revenue is recorded in (c) because it is unlikely that it will be collected. LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 8-13 NIAS CORPORATION Statement of Financial Position (Partial) February 28, 2018 Assets Current assets Cash ......................................................................... Held for trading investments..................................... Accounts receivable ................................................. Less: Allowance for doubtful accounts ..................... Notes receivable (due Nov. 1, 2018) ........................ Sales tax recoverable ............................................... Inventory .................................................................. Prepaid rent.............................................................. Total current assets ..................................................
$ 150,000 330,000 $470,000 30,000
440,000 300,000 38,000 380,000 8,000 $1,646,000
LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 8-14 (a) ($ in thousands) Receivables turnover Average collection period
(b)
2015 $3,292,932 = $25,537 + $20,498 2 365 = 143.1
Net credit sales
÷
Days in year
÷
143.1 times 2.6 days
Average gross accounts receivable Accounts receivable turnover
2014 $3,157,241 $20,498 + $37,173 2 365 109.5
=
109.5 times
=
3.3 days
=
Accounts receivable turnover
=
Average collection period in days
The receivables turnover is better in 2015 and the average collection period is correspondingly reduced by a fraction of a day.
LO 5 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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BRIEF EXERCISE 8-15 (a) ($ in millions) Receivables turnover Average collection period
(b)
2015 $3,925.3 $196.3 + $95.0 2 365 27.0
Net credit sales
÷
Days in year
÷
=
27.0 times
=
13.5 days
Average gross accounts receivable Accounts receivable turnover
2014 $3,347.6 $95.0 + $115.3 2 365 31.8
=
31.8 times
=
11.5 days
=
Accounts receivable turnover
=
Average collection period in days
The receivables turnover is worse in 2015 and the average collection period is correspondingly slower by 2.0 days.
LO 5 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 8-1 (a) Jan.
Compton Limited 6 Accounts Receivable. ..................................................... Sales .......................................................................
45,200
Cost of Goods Sold ......................................................... Inventory .................................................................
26,500
Cash ($45,200 – $904) ................................................... Sales Discounts (2% × $45,200)..................................... Accounts Receivable. .............................................
44,296 904
Singh Inc. 6 Inventory ......................................................................... Accounts Payable ...................................................
45,200
15
45,200
15
(b) Jan.
45,200
Accounts Payable ........................................................... Inventory ................................................................. Cash .......................................................................
26,500
45,200
45,200
904 44,296
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
EXERCISE 8-2 (a) Feb.
2
4
5
8
10
14
17
Solutions Manual .
Accounts Receivable (Andrew Noren) ............................ Sales .......................................................................
1,140
Cost of Goods Sold ......................................................... Inventory .................................................................
765
Sales Returns and Allowances ....................................... .... Accounts Receivable (Andrew Noren) ....................
140
1,140 765 140
Inventory ......................................................................... Cost of Goods Sold .................................................
85
Accounts Receivable (Dong Corporation) ....................... Sales .......................................................................
760
Cost of Goods Sold ......................................................... Inventory .................................................................
490
Cash ............................................................................... Sales .......................................................................
842
Cost of Goods Sold ......................................................... Inventory .................................................................
622
Cash ............................................................................... Sales .......................................................................
920
Cost of Goods Sold ......................................................... Inventory .................................................................
680
Cash ($760 – $15) .......................................................... Sales Discount ($760 × 2%) ................................... Accounts Receivable (Dong Corporation) ...............
745 15
Accounts Receivable (Andrew Noren) ............................ Sales .......................................................................
696
Cost of Goods Sold ......................................................... Inventory .................................................................
410
8-19
85 760 490 842 622 920 680
760 696 410
Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-2 (CONTINUED) (a) (continued) Feb. 22
28
(b)
Accounts Receivable (Batstone Corporation) ................. Sales .....................................................................
1,738
Cost of Goods Sold ......................................................... Inventory ...............................................................
1,105
Cash ............................................................................... Accounts Receivable (Andrew Noren) ..................
1,000
1,738 1,105 1,000
Accounts Receivable Subsidiary Ledger
Andrew Noren Feb. 2 1,140 Feb. 4 17 696 28 Feb. 28 Bal. 696
140 1,000
Dong Corporation Feb. 5 760 Feb. 14 Feb. 28 Bal. 0
760
Batstone Corporation Feb. 22 1,738 Feb. 28 Bal. 1,738 General Ledger Control Account Accounts Receivable Feb. 2 1,140 Feb. 4 5 760 14 17 696 28 22 1,738 Feb. 28 Bal. 2,434 (c)
140 760 1,000
Subledger listing Andrew Noren ................................................................................ Dong Corporation .......................................................................... Batstone Corporation ..................................................................... Total...............................................................................................
$ 696 0 1,738 $2,434
Balance per general ledger control account ..................................
$2,434
LO 1 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
8-20
Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-3 (a)
(b)
Dec. 31
Dec. 31
Bad Debts Expense ($36,000 – $4,400) .............. Allowance for Doubtful Accounts..................
31,600
Bad Debts Expense ($36,000 + $2,400) .............. Allowance for Doubtful Accounts..................
38,400
31,600
38,400
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 8-4 (a)
Age of Accounts 0-30 days 31-60 days 61-90 days Over 90 days
(b)
Mar. 31
(c)
Amount $260,000 50,400 34,000 25,600
% 2 10 30 50
Estimated Uncollectible $ 5,200 5,040 10,200 12,800 $33,240
Bad Debts Expense ............................................. Allowance for Doubtful Accounts.................. ($33,240 – $8,800)
24,440 24,440
The carrying amount of the accounts receivable at March 31 is as follows: Accounts receivable ................................................................ Less: Allowance for doubtful accounts .................................... Carrying amount .....................................................................
$370,000 33,240 $336,760
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-5 (a) 2017 Dec. 31
Bad Debts Expense ........................................................ Allowance for Doubtful Accounts.............................. ($16,800 + $2,000)
18,800
Allowance for Doubtful Accounts .................................... Accounts Receivable ................................................
1,900
Accounts Receivable ...................................................... Allowance for Doubtful Accounts..............................
1,900
Cash ............................................................................... Accounts Receivable ................................................
1,900
18,800
2018 May 11
Nov. 12
1,900
1,900
1,900
(b)
Accounts receivable Less: Allowance for doubtful accounts Carrying amount
Dec. 31 2017
May 11 2018
Nov.12 2018
$300,000 16,800 $283,200
$298,100 14,900 $283,200
$298,100 16,800 $281,300
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
8-22
Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-6 (a) March 1 Balance Sales March 31 Balance
Accounts Receivable 30,000 40,000 Collections Write offs 32,000
35,000 (1)
(1) Write offs: $30,000 + $40,000 – $35,000 – $32,000 = $3,000
Write offs
Allowance for Doubtful Accounts March 1 Balance Bad debts (1) March 31 Balance
5,000 (2) 4,500
(1) Write offs: $30,000 + $40,000 – $35,000 – $32,000 = $3,000 (2) Bad debts: $4,500 – [$5,000 – $3,000 (from (1) above)] = $2,500 (b) To record write offs: Allowance for Doubtful Accounts ....................................... Accounts Receivable .............................................
3,000 3,000
(c) To record bad debts expense: Bad Debts Expense ........................................................... Allowance for Doubtful Accounts...........................
2,500 2,500
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-7 Nov.
Dec.
1
1
15
Feb.
1
28
Notes Receivable............................................................ Cash .......................................................................
116,000
Notes Receivable............................................................ Sales .......................................................................
22,600
Cost of Goods Sold......................................................... Inventory .................................................................
13,200
Notes Receivable............................................................ Accounts Receivable ..............................................
24,000
Cash ............................................................................... Notes Receivable .................................................... Interest Revenue ($22,600 × 6% × 2/12) ................
22,826
Interest Receivable ......................................................... Interest Revenue ....................................................
3,780
116,000
22,600
13,200
24,000
22,600 226
3,780
Calculation of interest revenue on February 28: Bouchard note: Aquilina note: Total accrued interest
28
$116,000 × 9% × 4/12 $24,000 × 6% × 2.5/12
= $3,480 =. 300 $3,780
Bad Debt Expense .......................................................... Allowance for Doubtful Notes..................................
18,200 18,200
LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
8-24
Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-8 May
1
June 30
July
31
Aug. 31
Sept. 30
Oct.
Nov.
31
1
Notes Receivable............................................................ Accounts Receivable ..............................................
12,000
Interest Receivable ($12,000 × 5% × 2/12) .................... Interest Revenue ....................................................
100
Notes Receivable............................................................ Cash .......................................................................
10,000
Cash ............................................................................... Interest Revenue ($10,000 × 7% × 1/12) ................
58
Cash ............................................................................... Interest Revenue ....................................................
58
Cash ............................................................................... Notes Receivable .................................................... Interest Revenue ....................................................
10,058
Bad Debts Expense ........................................................ Note Receivable ..................................................... Interest Receivable .................................................
12,100
12,000
100
10,000
58
58
10,000 58
12,000 100
LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 8-9 FINNING INTERNATIONAL INC. Statement of Financial Position (partial) December 31, 2015 (in millions) Assets Current assets Receivables Trade accounts receivable ............................................. Less: Allowance for doubtful accounts ......................... Other receivables .......................................................... Suppliers claims receivable ............................................ Value added tax receivable ............................................ Income tax recoverable .................................................. Total receivables
$748 23
$ 725 112 76 11 1 $925
LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-10
Accounts payable Accounts receivable Advances to employees Allowance for doubtful accounts Allowance for doubtful notes (current) Bad debts expense Cash Interest expense Interest revenue Inventory Notes receivable (current) Notes receivable (non-current) Prepaid insurance Sales Sales discounts Sales tax recoverable
$22,600 18,200 2,900 1,300 5,000 2,000 7,500 2,400 6,000 26,400 25,000 75,000 1,500 370,000 12,000 3,150
(a) SFP or IS SFP SFP SFP SFP SFP IS SFP IS IS SFP SFP SFP SFP IS IS SFP
(b) Classification
Operating expense Non-operating expense Non-operating revenue
Operating revenue Contra operating revenue
(c) APOLLO CORPORATION Statement of Financial Position (partial) November 30, 2018 Assets Current assets Cash .............................................................................. Accounts receivable ....................................................... $18,200 Less: Allowance for doubtful accounts ........................... 1,300 Notes receivable ............................................................ $25,000 Less: Allowance for doubtful notes ..................................... 5,000 Advances to employees ........................................................................ Sales tax recoverable............................................................................ Inventory ............................................................................................... Prepaid insurance ................................................................................. Total current assets ...................................................................
$ 7,500 16,900 20,000 2,900 3,150 26,400 1,500 $78,350
LO 4 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-11 (a)
($ in millions)
2015 Current ratio =
$2,153 $2,998
= 0.7 : 1
Current Assets Current Liabilities
Receivables turnover =
Net credit sales
÷
$12,611 ($885 + $937) ÷ 2 Average gross accounts receivable
Average collection period =
Days in year
÷
Accounts receivable turnover
2014 Current ratio =
=
365 days 13.8 times
Accounts receivable turnover
= 26.4 days
Average collection period in days
=
$1,993 $2,201
= 0.9 : 1
Receivables turnover =
$12,134 ($937 + $822) ÷ 2
Average collection period =
365 days 13.8 times
(b)
= 13.8 times
= 13.8 times
= 26.4 days
In 2015, accounts receivable decreased 5.5% [($937 − $885) ÷ $937] while revenues increased 3.9% [($12,611 − $12,134) ÷ $12,134]. The receivables turnover ratio and the average collection period are unchanged, though. This indicates that CN is likely selling less on account and is doing a consistent job of collecting its receivables. The current ratio has declined from 0.9:1 in 2014 to 0.7:1 in 2015. However, this decrease is not due to slow-collection of receivables (or slow-moving inventory). This decrease can be attributed to the 36% [($2,998 – $2,201) $2,201] increase in current liabilities compared to the modest increase in current assets of 8% [($2,153 – $1,993) $1,993].
LO 5 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-12 (a)
(US $ in millions)
2015 Current ratio =
$1,553 $1,747
= 0.9 : 1
Current Assets Current Liabilities
Receivables turnover =
Net credit sales
÷
$6,279 ($475 + $715) ÷ 2 Average gross accounts receivable
Average collection period =
Days in year
÷
2014 Current ratio =
Accounts receivable turnover
=
$1,938 $2,198
Accounts receivable turnover
=
365 days 10.6 times
= 34 days
Average collection period in days
= 0.9 : 1
Receivables turnover =
$7,115 ($715 + $507) ÷ 2
Average period =
365 days 11.6 times
collection
= 10.6 times
= 11.6 times
= 31 days
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-12 (CONTINUED) (b)
In 2015, accounts receivable decreased 33.6% [($715 − $475) ÷ $715] while revenues decreased 11.7% [($7,115 − $6,279) ÷ $7,115]. The receivables turnover ratio and the average collection period indicate that the company’s management of receivables has deteriorated slightly. The turnover has decreased from 11.6 times in 2014 to 10.6 times in 2015. The average collection period has increased from 31 days in 2014 to 34 days in 2015 so cash is being collected more slowly. Overall, Potash appears to be selling less on account (i.e., the decrease in accounts receivable was greater than the decrease in sales in spite of the deteriorating accounts receivable turnover ratio). The current ratio has remained unchanged at 0.9:1. This lack of change in the ratio occurred because the 20.5% [($2,198 – $1,747) $2,198] decrease in current liabilities almost matched the decrease in current assets of 19.9% [($1,938 – $1,553) $1,938].
LO 5 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 8-13 (a)
At first glance, the increase in the current ratio might lead to the conclusion that Lin’s liquidity has improved in 2018. When looking further and noting a deterioration in the receivables and inventory turnover ratios in the same period, one must conclude that the increase in the current ratio does not mean that Lin’s liquidity has improved. In this case, total current assets have increased in comparison to current liabilities because of increases in accounts receivable and inventory.
(b)
Lin must determine the source of the deterioration of both the receivables and inventory turnover ratios. If the deterioration is a result of specific policy changes in the way in which Lin is managing its accounts receivable, by for example extending its credit terms, the deterioration of the accounts receivable turnover is not a surprising result. Similarly, if the deterioration of the inventory turnover is a result of a management strategy to improve sales and profitability, the outcome is also not a surprise to management. On the other hand, if Lin establishes that there have been no direct causes to the change that can be readily explained through the actions of management, specific measures to improve the management of its accounts receivable and inventory must be undertaken immediately. These measures could include the following for accounts receivable: 1. 2. 3.
Establishment of credit policies and credit limits for certain customers. Initiate the use of a cash discount to encourage early payment of receivables. Aggressively monitor collections to encourage customers to pay on time.
These measures could include the following for inventory: 1. 2. 3.
Monitor its inventory levels carefully and only reorder when inventory is selling and additional inventory is required. Limit the amount of inventory by improving its purchasing relationships with suppliers. If possible, move to a just-in-time system where inventory is only purchased as needed.
LO 5 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 8-1A (a)
1.
2.
3.
4.
5.
6.
7.
Accounts Receivable .................................................... 5,400,000 Sales .....................................................................
5, 400,000
Cost of Goods Sold....................................................... 2,970,000 Inventory ...............................................................
2,970,000
Sales Returns and Allowances ..................................... Accounts Receivable ............................................
80,000
Inventory ...................................................................... Cost of Goods Sold ...............................................
44,000
80,000
44,000
Cash ............................................................................. 5,400,000 Accounts Receivable ............................................ Accounts Receivable .................................................... Interest Revenue ..................................................
400,000
Allowance for Doubtful Accounts .................................. Accounts Receivable ............................................
160,000
Accounts Receivable .................................................... Allowance for Doubtful Accounts ..........................
72,000
Cash ............................................................................. Accounts Receivable ............................................
72,000
Bad Debts Expense ...................................................... Allowance for Doubtful Accounts ................................ $104,000 – ($118,000 – $160,000 + $72,000) = $74,000
74,000
5,400,000
400,000
160,000
72,000
72,000
74,000
(b) Bal. (1) (4) (6) Bal
Solutions Manual .
Accounts Receivable 1,760,000 5,400,000 (2) 80,000 400,000 (3) 5,400,000 72,000 (5) 160,000 (6) 72,000 1,920,000
(5)
Allowance for Doubtful Accounts Bal. 118,000 160,000 (6) 72,000 (7) 74,000
Bal.
8-31
104,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-1A (CONTINUED) (c)
January 1, 2018 Accounts receivable ................................................................ Less: Allowance for doubtful accounts .................................... Carrying amount .....................................................................
$1,760,000 118,000 $1,642,000
December 31, 2018 Accounts receivable ................................................................ Less: Allowance for doubtful accounts .................................... Carrying amount .....................................................................
$1,920,000 104,000 $1,816,000
(d)
UNDERWOOD IMPORTS INC. Statement of Financial Position (partial) December 31, 2018 Assets
Current assets Accounts receivable ..................................................... Less: Allowance for doubtful accounts .........................
(e)
$1,920,000 104,000
$1,816,000
UNDERWOOD IMPORTS INC. Income Statement (partial) Year Ended December 31, 2018
Sales....................................................................................... $5,400,000 Less: Sales returns and allowances ....................................... 80,000 Net sales........................................................................................................... Less: Cost of goods sold * ............................................................................... Gross profit ....................................................................................................... Operating expenses Bad debts expense ................................................................................ Other revenues and expenses Interest revenue ..................................................................................... * ($2,970,000 – $44,000) = $2,926,000
$5,320,000 2,926,000 2,394,000 74,000 400,000
LO 1,2,4 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-2A (a)
(b)
(c)
(d)
Accounts Receivable...................................................... Sales ..........................................................................
4,300,000
Cost of Goods Sold ........................................................ Inventory ....................................................................
3,100,000
Cash............................................................................... Accounts Receivable .................................................
5,200,000
Allowance for Doubtful Accounts ................................... Accounts Receivable .................................................
185,000
Accounts Receivable...................................................... Allowance for Doubtful Accounts ...............................
28,000
Cash............................................................................... Accounts Receivable .................................................
28,000
Bad Debts Expense [see (e)] ......................................... Allowance for Doubtful Accounts ...............................
98,000
4,300,000
3,100,000
5,200,000
185,000
28,000
28,000
98,000
(e) Accounts Receivable Beg. Bal. 2,100,000 Sales 4,300,000 Collections Recovery 28,000 Write off Collections End Bal. 1,015,000
5,200,000 185,000 28,000
Allowance for Doubtful Accounts Beg. Bal 144,000 Write off 185,000 Recovery 28,000 Bad debts 98,000 End Bal 85,000
Before bad debts expense was recorded, the Allowance account had a debit balance of $13,000 ($144,000 – $185,000 + $28,000). To adjust this to $85,000 requires a credit to this account of $98,000 with an offsetting debit to Bad Debts Expense.
(f)
AZIM ENTERPRISES LTD. Statement of Financial Position (partial) Assets Current assets Accounts receivable ............................................................... Less: Allowance for doubtful accounts ................................... Carrying amount.....................................................................
$1,015,000 85,000 930,000
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-3A
Beg. bal.
End. bal.
Accounts Receivable 18,000 (a) 78,000 (c) 40,000
55,000 (b) 1,000
Allowance for Doubtful Accounts 1,800 Beg. bal. 1,000 Unadj. bal. 800 (d) 1,200 End. bal. (e) 2,000 Sales 78,000 Bad Debts Expense (f) 1,200
(a)
Addition to accounts receivable (from Sales) = $78,000
(b)
Write offs of accounts receivable obtained from reduction of allowance for doubtful accounts $1,000
(c)
$18,000 + $78,000 (a) – $1,000 (b) – $55,000 = $40,000, the ending balance
(d)
$1,800 – $1,000 + (d) = $2,000 (e); (d) = $1,200 and this represents the credit side of the bad debts expense entry.
(e)
Allowance for doubtful accounts = $2,000 (given)
(f)
Bad debts expense = Adjustment to allowance for doubtful accounts = $1,200 [from (d)]
LO 2 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-4A (a)
Total estimated allowance for doubtful accounts:
Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total
(b)
Accounts Receivable $ 780,000 340,000 115,000 76,000 $1,311,000
Estimated Percentage Uncollectible 2% 6% 12% 22%
Estimated Uncollectible Accounts $ 15,600 20,400 13,800 16,720 $66,520
(1) Bad Debts Expense ................................................................ Allowance for Doubtful Accounts ....................................... [$66,520 – $12,360] (2)
(c)
(d)
54,160 54,160
If the allowance for doubtful accounts had an unadjusted debit balance of $12,360, the bad debts expense in the entry above would be $78,880 ($66,520 + $12,360)
Allowance for Doubtful Accounts .............................................. Accounts Receivable .........................................................
45,730
Accounts Receivable ................................................................ Allowance for Doubtful Accounts .......................................
8,850
Cash ......................................................................................... Accounts Receivable .........................................................
8,850
45,730
8,850
8,850
LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-5A (a)
Total estimated allowance balance at Dec. 31, 2017:
Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total
Accounts Receivable $320,000 114,000 76,000 50,000 $560,000
Estimated Percentage Uncollectible 3% 6% 12% 24%
Estimated Uncollectible Accounts $ 9,600 6,840 9,120 12,000 $37,560
Total estimated allowance balance at Dec. 31, 2018:
Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total
Accounts Receivable $300,000 64,000 86,000 130,000 $580,000
Estimated Percentage Uncollectible 3% 6% 12% 24%
Estimated Uncollectible Accounts $ 9,000 3,840 10,320 31,200 $54,360
Total accounts receivable increased slightly from 2017 to 2018. However, the estimated allowance balance increased significantly. Amounts outstanding over 90 days more than doubled while amounts less than 60 days decreased significantly. This implies the receivables are less likely to be collected because they are increasing in age. (b)
(c)
(d)
Bad Debts Expense .................................................................. Allowance for Doubtful Accounts ....................................... ($37,560 – $9,000)
28,560
Allowance for Doubtful Accounts .............................................. Accounts Receivable .........................................................
42,000
Accounts Receivable ................................................................ Allowance for Doubtful Accounts .......................................
3,000
Cash ......................................................................................... Accounts Receivable .........................................................
3,000
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28,560
42,000
3,000
3,000
Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-5A (CONTINUED) (e)
Bad Debts Expense .................................................................. Allowance for Doubtful Accounts ....................................... $54,360 – (balance in the allowance before adjustment): $54,360 – ($37,560 – $42,000 + $3,000) = $55,800
(f) Accounts receivable.................................................................. Less: Allowance for doubtful accounts...................................... Carrying amount .....................................................................
55,800 55,800
2018 $580,000 54,360 $525,640
2017 $560,000 37,560 $522,440
LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-6A Feb.
1
3
26
Mar.
Mar.
Apr.
May
6
27
3
27
31
Accounts Receivable ....................................................... Sales ..................................................................
8,000
Cost of Goods Sold ........................................................ Inventory ................................................................
6,000
Notes Receivable ........................................................... Sales ......................................................................
13,400
Cost of Goods Sold ........................................................ Inventory ................................................................
8,800
Accounts Receivable ...................................................... Sales ......................................................................
12,000
Cost of Goods Sold ........................................................ Inventory ................................................................
7,600
Accounts Receivable ...................................................... Sales ......................................................................
4,000
Cost of Goods Sold ........................................................ Inventory ................................................................
3,000
Notes Receivable ........................................................... Accounts Receivable..............................................
12,000
Cash ($13,400 + $134) .................................................. Notes Receivable ................................................... Interest Revenue ($13,400 × 6% × 2/12) ...............
13,534
Accounts Receivable ($12,000 + $140) ........................ Notes Receivable ................................................... Interest Revenue ($12,000 × 7% × 2/12) ...............
12,140
Interest Receivable ($8,000 × 24% × 3/12) .................... Interest Revenue ....................................................
480
8,000
6,000
13,400
8,800
12,000
7,600
4,000
3,000
12,000
13,400 134 12,000 140
480
LO 1,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-7A (a)
Nov.
Dec.
1
1
31
Jan.
Feb.
(b)
Nov.
Dec.
1
1
1
1
31
Jan.
Feb.
1
1
Notes Receivable ...................................... Accounts Receivable.........................
60,000
Cash .......................................................... Interest Revenue ............................... ($60,000 × 9% × 1/12)
450
Interest Receivable ($60,000 × 9% × 1/12) Interest Revenue ...............................
450
Cash .......................................................... Interest Receivable ...........................
450
60,000
450
450
450
Cash .......................................................... Interest Revenue ($60,000 × 9% × 1/12) Notes Receivable ..............................
60,450
Accounts Payable ..................................... Notes Payable ...................................
60,000
Interest Expense ....................................... Cash ($60,000 × 9% × 1/12) .............
450
Interest Expense ($60,000 × 9% × 1/12) ... Interest Payable ................................
450
Interest Payable ........................................ Cash..................................................
450
Notes Payable ........................................... Interest Expense ($60,000 × 9% × 1/12) ... Cash..................................................
60,000 450
Accounts Receivable................................. Interest Revenue ............................... Notes Receivable ..............................
60,450
Bad Debts Expense .................................. Notes Receivable .............................. Interest Revenue……………………..
60,450
450 60,000
60,000
450
450
450
60,450
(c) (1)
(2)
Feb.
Feb.
1
1
450 60,000
60,000 450
LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 8-8A (a)
Notes receivable total $61,000 and interest receivable $603 at September 30, 2018: RES Inc. Ihara Ltd. Dragon Limited MGH Corp. Total
(b)
Oct.
1
31
31
31
31
Solutions Manual .
$17,000 × 6% × 6/12 = 17,500 × 4% × 1/12 = 6,000 × 7% × 1/12 = 20,500 × 5% × 0/12 = $61,000
$510 58 35 0 $603
Cash ($17,500 × 4% × 1/12) ..................... Interest Receivable ...........................
58
Accounts Receivable................................. Notes Receivable .............................. Interest Receivable ($6,000 × 7% × 1/12) ........................ Interest Revenue ($6,000 × 7% × 1/12) ........................
6,070
Cash .......................................................... Notes Receivable .............................. Interest Receivable ($17,000 × 6% × 6/12) ...................... Interest Revenue ($17,000 × 6% × 1/12) ......................
17,595
Interest Receivable ................................... Interest Revenue ............................... Ihara Ltd. $17,500 × 4% × 1/12 = $ 58 MGH Corp. $20,500 × 5% × 1/12 = 85 Total $143
143
Bad Debts Expense .................................. Allowance for Doubtful Notes ............
17,500
8-40
58
6,000 35 35
17,000 510 85
143
17,500
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-8A (CONTINUED) (c)
Bal. see (a) Oct. 31 Bal.
Bal.
Interest Receivable 603 Oct. 1 143 31 31 143
58 35 510
Notes Receivable Bal. see (a) 61,000 Oct. 31 31 Bal.
6,000 17,000
38,000
Allowance for Doubtful Notes 0 Oct. 31 17,500 Bal. 17,500
(d) TARDIF CORPORATION Statement of Financial Position (partial) October 31, 2018 ________________________________________________________________________ Assets Current assets Notes receivable .......................................................... Less: Allowance for doubtful notes .............................. Interest receivable........................................................
$38,000 17,500
$20,500 143
LO 2,3,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-9A CANADIANA CORPORATION Statement of Financial Position (Partial) December 31, 2018 (in thousands) Assets Current assets Cash Held for trading investments Accounts receivable Less: Allowance for doubtful accounts Notes receivable Income tax receivable Inventory Supplies Total current assets Non-current assets Notes receivable Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Total assets
$ $1,630 32
592 196 1,598 2,481 99 1,902 85 6,953
101 $ 1,077 $2,734 960 $737 488
1,774 249
3,100 $10,154
LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-10A (a) Nike (in US $ millions)
Receivables turnover
$30,601 ($3,475+$3,358) [ ] 2 =9.0 times
Average collection period
365 = 41 days 9.0
(b)
Adidas (in euro millions) €16,915 (€2,085+€2,198) [ ] 2 =7.9 times 365 = 46 days 7.9
Net credit sales
÷
Average gross accounts receivable
=
Accounts receivable turnover
Days in year
÷
Accounts receivable turnover
=
Average collection period in days
Nike has a better turnover than Adidas, but both companies fall short of the industry average. Adidas’ collection experience is weaker (meaning that it collects its receivables more slowly).
LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 8-11A (a)
2018
2017
2016
Average collection period
365 = 45 days 8.2
365 = 49 days 7.4
365 = 54 days 6.7
Days in inventory
365 = 37 days 9.9
365 = 42 days 8.7
365 = 49 days 7.5
(b)
At first glance, it appears that Pampered Pets’ liquidity has improved over the past two years since the company’s current ratio has increased from 2.1:1 to 2.6:1. The current ratio aggregates all current assets together. To get a better understanding of why this increase in the current ratio occurred, we need to analyze specific accounts that are included in this ratio. To do this, we can examine the receivables and inventory turnover ratios. The increase in the receivables turnover ratio indicates that the company is collecting its receivables faster and this improves cash flow and liquidity. As well, the company appears to be moving its inventory more quickly as evidenced by the higher inventory turnover ratio and this also improves cash flow and liquidity. Therefore, it does appear that the company’s overall liquidity is improving.
(c)
Changes in the turnover ratios indirectly affect profitability. Improvements in the receivables turnover and inventory turnover speed up the cash cycle, which provides the company with better cash flow and decreases the need for outside financing , thus decreasing interest expense. Furthermore, improvements in the receivables turnover usually arise as a direct result of improvements in credit management and better collection efforts. These improvements result in fewer defaults and decreases in bad debts expense. Improvements in the inventory turnover improve profitability by reducing carrying charges associated with stocking inventory (such as warehousing costs). Improved inventory turnover also reduces the risk of merchandise not selling and becoming obsolete or selling at reduced prices. Obsolete inventory lowers profitability because the cost of this type of inventory has to be written off.
(d)
Changes in the turnover ratios directly affect cash flow. Improvements in the receivables turnover and inventory turnover speed up the cash cycle, which provides the company with better cash flow and less need for outside financing.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-11A (CONTINUED) (e)
There are several steps that Pampered Pets could consider to improve its receivables and inventory management: Receivables The company could establish credit policies and credit limits for certain customers, if it doesn’t already have them. The company could initiate the use of a cash discount to encourage early payment of receivables. The company could more aggressively monitor collections to encourage customers to pay on time. Inventory Pampered Pets should monitor its inventory levels carefully and only reorder when inventory is selling and additional quantities are required. If inventory is not selling (e.g., not in favour or in season), it should mark it down quickly to get rid of it rather than risk it not selling at all and having to pay carrying costs for obsolete inventory. The company could limit the amount of inventory by improving its purchasing relationships with suppliers. If inventory could be purchased more frequently, high levels of inventory will not have to be carried and stored. Also, were it possible to move to a system where inventory is only purchased as needed (called “just-in-time”), Pampered Pets could reduce the amount of inventory it had to carry and improve the turnover ratio. However, there is some risk to this option as sales could be lost if stock-outs occur.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 8
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 8-1B (a)
1.
2.
3.
4.
5.
6.
7.
Accounts Receivable ................................................. Sales ................................................................
1,800,000
Cost of Goods Sold ................................................... Inventory ..........................................................
1,044,000
Sales Returns and Allowances .................................. Accounts Receivable .......................................
280,000
Inventory ................................................................... Cost of Goods Sold ..........................................
162,000
Cash ......................................................................... Accounts Receivable .......................................
1,600,000
Accounts Receivable ................................................. Interest Revenue .............................................
125,000
Allowance for Doubtful Accounts............................... Accounts Receivable .......................................
51,000
Accounts Receivable ................................................. Allowance for Doubtful Accounts .....................
12,000
Cash ......................................................................... Accounts Receivable .......................................
12,000
Bad Debts Expense .................................................. Allowance for Doubtful Accounts ............ $31,000 – ($42,000 – $51,000 + $12,000) = $28,000
28,000
1,800,000
1,044,000
280,000
162,000
1,600,000
125,000
51,000
12,000
12,000
28,000
(b)
Bal. (1) (4) (6) Bal.
Accounts Receivable 510,000 1,800,000 (2) 280,000 125,000 (3) 1,600,000 12,000 (5) 51,000 (6) 12,000 504,000
Solutions Manual .
(5)
Allowance for Doubtful Accounts Bal. 42,000 51,000 (6) 12,000 (7) 28,000
Bal.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-1B (CONTINUED) (c)
January 1, 2018 Accounts receivable ...................................................................... Less: Allowance for doubtful accounts .......................................... Carrying amount ...........................................................................
$510,000 42,000 $468,000
December 31, 2018 Accounts receivable ...................................................................... Less: Allowance for doubtful accounts .......................................... Carrying amount ...........................................................................
$504,000 31,000 $473,000
(d) BORDEAUX INC. Statement of Financial Position (partial) December 31, 2018 Assets Current assets Accounts receivable .................................................. Less: Allowance for doubtful accounts ......................
$504,000 31,000
$473,000
(e) BORDEAUX INC. Income Statement (partial) Year Ended December 31, 2018 Sales .................................................................................. $1,800,000 Less: Sales returns and allowances .................................... 280,000 Net sales.................................................................................................. Less: Cost of goods sold * ....................................................................... Gross Profit.............................................................................................. Operating expenses Bad debts expense ....................................................................... Other revenues and expenses Interest revenue ............................................................................
$1,520,000 882,000 638,000 28,000 125,000
* ($1,044,000 - $162,000) = $882,000 LO 1,2,4 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-2B (a)
(b)
(c)
(d)
Accounts Receivable...................................................... Sales ..........................................................................
4,700,000
Cost of Goods Sold ........................................................ Inventory ....................................................................
2,900,000
Cash............................................................................... Accounts Receivable .................................................
4,800,000
Allowance for Doubtful Accounts ................................... Accounts Receivable .................................................
146,000
Accounts Receivable...................................................... Allowance for Doubtful Accounts ...............................
3,000
Cash............................................................................... Accounts Receivable .................................................
3,000
Bad Debts Expense (see (e) below) .............................. Allowance for Doubtful Accounts ...............................
101,000
4,700,000
2,900,000
4,800,000
146,000
3,000
3,000
101,000
(e) Accounts Receivable Beg. Bal. 945,000 Sales 4,700,000 Collections Recovery 3,000 Write off Collections End Bal. 699,000
4,800,000 146,000 3,000
Allowance for Doubtful Accounts Beg. Bal. 139,000 Write off 146,000 Recovery 3,000 Bad Debts 101,000 End Bal. 97,000 Before bad debts expense was recorded, the balance in the Allowance account was a debit $4,000 ($139,000 – $146,000 + $3,000). To adjust this balance to a credit of $97,000 requires a credit to the Allowance of $101,000 with an offsetting debit to Bad Debts Expense.
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-2B (CONTINUED) (f) HUANG LTD. Statement of Financial Position (partial) Assets Current assets Accounts receivable .............................................................. Less: Allowance for doubtful accounts .................................. Carrying amount ...................................................................
$699,000 97,000 602,000
LO 1,2,4 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-3B Beg. bal.
End. bal.
Accounts Receivable (a) 27,750 (b) 250 230,000
225,000 22,500
Allowance for Doubtful Accounts 1,000 Beg. bal. 250 Unadj. bal. 750 (c) 400 End. bal. (d) 1,150 Sales (e) 225,000 Bad Debts Expense (f) 400
(a)
Solving for the opening Accounts Receivable balance (a) we get: (a) + $225,000 – $230,000 – $250 (b) = $22,500 (a) = $27,750
(b)
Write offs of accounts receivable obtained from reduction of allowance for doubtful accounts $250.
(c)
This amount represents the increase in the Allowance for Doubtful Accounts caused by recorded bad debt expense: Unadjusted balance $750 + (c) = $1,150 (we know the $1,150 balance (d) – it was given) (c) = $400
(d)
Allowance for doubtful accounts = $1,150 (given)
(e)
Addition to Accounts receivable (arising from credit sales) = $225,000
(f)
Bad debts expense = Adjustment to allowance for doubtful accounts = $400 (from (c))
LO 2 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 8
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-4B (a)
Total estimated allowance for doubtful accounts:
Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total (b)
Accounts Receivable $280,000 90,000 45,000 18,000 $433,000
Estimated Percentage Uncollectible 1% 3% 10% 15%
Estimated Uncollectible Accounts $2,800 2,700 4,500 2,700 $12,700
(1) Bad Debts Expense .................................................................. Allowance for Doubtful Accounts ....................................... ($12,700 + $4,300 = $17,000) (2)
(c)
(d)
17,000 17,000
If the allowance for doubtful accounts had an unadjusted credit balance of $4,300, the bad debts expense in the entry above would be $8,400 ($12,700 – $4,300)
Allowance for Doubtful Accounts .............................................. Accounts Receivable .........................................................
4,200
Accounts Receivable ................................................................ Allowance for Doubtful Accounts .......................................
2,300
Cash ......................................................................................... Accounts Receivable .........................................................
2,300
4,200
2,300
2,300
LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-5B (a)
Total estimated allowance balance at Dec. 31, 2017:
Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total
Accounts Receivable $220,000 86,000 52,000 22,000 $380,000
Estimated Percentage Uncollectible 3% 6% 12% 20%
Estimated Uncollectible Accounts $ 6,600 5,160 6,240 4,400 $22,400
Total estimated allowance balance at Dec. 31, 2018:
Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total
Accounts Receivable $240,000 104,000 62,000 34,000 $440,000
Estimated Percentage Uncollectible 3% 6% 12% 20%
Estimated Uncollectible Accounts $ 7,200 6,240 7,440 6,800 $27,680
Accounts receivable has increased and so has the allowance balance. The increase in the accounts receivable appears to be spread throughout the aging analysis and is not concentrated in any of the aging categories. Thus, the increase in the allowance is attributable to a general increase in accounts receivable rather than to increased age.
(b)
(c)
(d)
(e)
Bad Debts Expense .................................................................. Allowance for Doubtful Accounts ....................................... ($22,400 – $3,000)
19,400
Allowance for Doubtful Accounts .............................................. Accounts Receivable .........................................................
28,000
Accounts Receivable ............................................................ Allowance for Doubtful Accounts .......................................
3,000
Cash ......................................................................................... Accounts Receivable .........................................................
3,000
19,400
28,000
3,000
3,000
Bad Debts Expense .................................................................. 30,280 Allowance for Doubtful Accounts ....................................... 30,280 $27,680 – balance in allowance before adjustment ($22,400 – $28,000 + $3,000)
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-5B (CONTINUED) (f) Accounts receivable.................................................................. Less: Allowance for doubtful accounts...................................... Carrying amount ....................................................................
2018 $440,000 27,680 $412,320
2017 $380,000 22,400 $357,600
LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-6B Jan.
2
5
20
Feb.
Mar.
20
20
May
2
25 Aug.
1
25
Sept. 30
Notes Receivable ........................................................... Cash .......................................................................
10,000
Accounts Receivable ...................................................... Sales ......................................................................
11,000
Cost of Goods Sold ........................................................ Inventory ................................................................
6,700
Notes Receivable ........................................................... Accounts Receivable..............................................
11,000
Cash ............................................................................... Interest Revenue ($11,000 × 9% × 1/12) ...............
83
Cash ($11,000 + $83) .................................................... Notes Receivable ................................................... Interest Revenue ($11,000 × 9% × 1/12) ...............
11,083
Cash ............................................................................... Note Receivable ..................................................... Interest Revenue ($10,000 × 8% × 4/12) ...............
10,267
Notes Receivable ........................................................... Accounts Receivable..............................................
3,000
Accounts Receivable ....................................................... Sales ..................................................................
6,000
Cost of Goods Sold ........................................................ Inventory ................................................................
4,000
Bad Debts Expense ....................................................... Notes Receivable ............................................ Interest Revenue ($3,000 × 8% × 3/12)...........
3,060
Accounts Receivable ($6,000 × 24% × 1/12) ................. Interest Revenue ....................................................
120
10,000
11,000
6,700
11,000
83
11,000 83
10,000 267
3,000 6,000
4,000
3,000 60
120
LO 1,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-7B (a)
Aug.
1
31
Sept.
Oct.
(b)
Aug.
1
1
1
31
Sept.
Oct.
1
1
Notes Receivable ...................................... Accounts Receivable .........................
30,000
Interest Receivable .................................... Interest Revenue ............................... ($30,000 × 4% × 1/12)
100
Cash ......................................................... Interest Receivable ............................
100
Cash .......................................................... Notes Receivable .............................. Interest Revenue ...................................... ($30,000 × 4% × 1/12)
30,100
Accounts Payable ...................................... Notes Payable ...................................
30,000
Interest Expense ($30,000 × 4% × 1/12) ... Interest Payable ................................
100
Interest Payable ........................................ Cash ..................................................
100
Notes Payable ........................................... Interest Expense ($30,000 x 4% x 1/12).... Cash .................................................
30,000 100
Accounts Receivable ................................. Notes Receivable .............................. Interest Revenue ............................... ($30,000 × 4% × 1/12)
30,100
Bad Debts Expense ................................... Notes Receivable .............................. Interest Revenue ............................... ($30,000 × 4% × 1/12)
30,100
30,000
100
100
30,000 100
30,000
100
100
30,100
(c) (1)
(2)
Oct.
Oct.
1
1
30,000 100
30,000 100
LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-8B (a)
Total notes receivable are $58,000 and total interest receivable $918 at November 30, 2018: Kootenay Inc. Cassiar Ltd. Namu Limited Siska Corp. Total
(b)
Dec.
1
31
31
31
31
Solutions Manual .
$17,000 × 6% × 8/12 = 15,000 × 4% × 1/12 = 6,000 × 7% × 3/12 = 20,000 × 5% × 1/12 = $58,000
$680 50 105 83 $918
Cash ($50 + $83) ...................................... Interest Receivable ...........................
133
Allowance for Doubtful Notes ................... Notes Receivable .............................. Interest Receivable ($6,000 × 7% × 3/12) ........................
6,105
Cash .......................................................... Notes Receivable .............................. Interest Receivable ($17,000 × 6% × 8/12) ...................... Interest Revenue ($17,000 × 6% × 1/12) ......................
17,765
Interest Receivable ................................... Interest Revenue ............................... Cassiar Ltd. $15,000 × 4% × 1/12 = $ 50 Siska Corp. $20,000 × 5% × 1/12 = 83 Total ................................................ $133 Bad Debts Expense .................................. Allowance for Doubtful Notes ............
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133
6,000 105
17,000 680 85 133 133
20,000 20,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-8B (CONTINUED) (c) Interest Receivable Bal. See (a) 918 Dec. 1 Dec. 31 133 31 31 Bal. 133
Bal.
133 105 680
Notes Receivable Bal. See (a) 58,000 Dec. 31 31 Bal.
6,000 17,000
35,000
Allowance for Doubtful Notes 0 Dec. 31 20,000 Bal. 20,000
(d) KITIMAT CORPORATION Statement of Financial Position (partial) December 31, 2018 ________________________________________________________________________ Assets Current assets Notes receivable .......................................................... Less: Allowance for doubtful notes .............................. Interest receivable........................................................
$35,000 20,000
$15,000 133
LO 2,3,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-9B OUTAOUAIS INC. Statement of Financial Position (Partial) January 31, 2018 (in thousands) Assets Current assets Accounts receivable Less: Allowance for doubtful accounts Notes receivable Income tax receivable Inventory Supplies Total current assets Non-current assets Notes receivable Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Goodwill
$2,468 268
$2,200 50 20 3,000 50 5,320
300 $200 $1,000 250 $750 375
Total assets
750 375
1,325 100 $7,045
LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-10B (a) Rogers (in millions)
Shaw (in millions)
Receivables turnover
$13,414 ($1,689 + $1,878) [ ] 2 = 7.5 times
$5,488 ($525 + $494) [ ] 2 = 10.8 times
Average collection period
365 = 49 days 7.5
365 = 34 days 10.8
(b)
Net credit sales
÷
Average gross accounts receivable
=
Accounts receivable turnover
Days in year
÷
Accounts receivable turnover
=
Average collection period in days
Shaw’s receivables turnover was considerably better than that of Rogers’, which means Shaw was more efficient than Rogers in collecting its receivables. However, both companies collect their receivables at a slower pace than does the industry. Shaw takes about 4 days longer than the industry average to collect its receivables, while Rogers takes about 19 days longer.
LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 8-11B (a)
2018
2017
2016
Average collection period
365 = 46 days 8
365 = 52 days 7
365 = 61 days 6
Days in inventory
365 = 61 days 6
365 = 52 days 7
365 = 46 days 8
(b)
At first glance it appears that Tianjin’s liquidity had remained stable over the past year since the company’s current ratio has remained at 1.5:1. However, the company is taking less time to collect its accounts receivable as evidenced by the increasing receivables turnover ratio and decreasing collection period. In contrast, it appears to be moving its inventory less quickly as evidenced by the lower inventory turnover ratio and increasing days in inventory. It is possible that the stable current ratio is due to the fact that the improving collections and deteriorating inventory turnover ratios are offsetting.
(c)
Changes in the turnover ratios indirectly affect profitability. Improvements in the receivables turnover and inventory turnover speed up the cash cycle, which provides the company with better cash flow and decreases the need for outside financing, thus decreasing interest expense. Furthermore, improvements in the receivables turnover usually arise as a direct result of improvements in credit management and better collection efforts. These improvements result in fewer defaults and decreases in bad debts expense. Improvements in the inventory turnover improve profitability by reducing carrying charges associated with stocking inventory (such as warehousing costs). Improved inventory turnover also reduces the risk of merchandise not selling and becoming obsolete or selling at reduced prices. Obsolete inventory lowers profitability because the cost of this type of inventory has to be written off.
(d)
Changes in the turnover ratios directly affect cash flow. Improvements in the receivables turnover and inventory turnover speed up the cash cycle, which provides the company with better cash flow and less need for outside financing.
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PROBLEM 8-11B (CONTINUED) (e)
There are several steps that Tianjin might have taken to improve its receivables and inventory management: Receivables The company could establish credit policies and credit limits for certain customers, if it doesn’t already have them. The company could initiate the use of a cash discount to encourage early payment of receivables. The company could more aggressively monitor collections to encourage customers to pay on time. Inventory Tianjin should monitor its inventory levels carefully and only reorder when inventory is selling and additional quantities are required. If inventory is not selling (e.g., not in favour or in season), it should mark it down quickly to get rid of it rather than risk it not selling at all and having to pay carrying costs for obsolete inventory. The company could limit the amount of inventory by improving its purchasing relationships with suppliers. If inventory could be purchased more frequently, required inventory levels could be reduced. Further, were it possible to move to a system where inventory is only purchased as needed (called “just-in-time”), Tianjin could reduce the amount of inventory it had to carry and improve the turnover ratio. However, there is some risk to this option as sales could be lost if stock-outs occur.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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ACR8-1 (a)
Jan. 4
6
8
10
12
14
14
15
17
19
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Financial Accounting, Seventh Canadian Edition
ACCOUNTING CYCLE REVIEW
Cash ................................................................. Accounts Receivable.................................
236,000
Inventory ........................................................... Accounts Payable .....................................
150,000
Cash ................................................................. Notes Receivable ...................................... Interest Receivable ................................... Interest Revenue ....................................... [($50,000 x 12% x 2/12) less $900] = $100
51,000
Account Receivable .......................................... Unearned Revenue ........................................... Sales .........................................................
188,000 10,000
Cost of Goods Sold ........................................... Inventory ...................................................
102,000
Salaries Payable ............................................... Salaries Expense .............................................. Cash..........................................................
16,000 10,000
Allowance for Doubtful Accounts....................... Accounts Receivable.................................
18,000
Accounts Payable ............................................. Inventory ................................................... Cash..........................................................
150,000
Notes Receivable ............................................. Accounts Receivable.................................
20,000
Sales Returns and Allowances.......................... Accounts Receivable.................................
4,000
Inventory ........................................................... Cost of Goods Sold ...................................
2,400
Accounts Receivable......................................... Allowance for Doubtful Accounts...............
9,000
Cash ................................................................. Accounts Receivable.................................
9,000
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236,000
150,000
50,000 900 100
198,000
102,000
26,000
18,000
3,000 147,000
20,000
4,000
2,400
9,000
9,000
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Financial Accounting, Seventh Canadian Edition
ACR8-1 (CONTINUED) (a) (continued) Jan.
23
25
26
31
Cash ................................................................. Accounts Receivable......................................... Sales .........................................................
92,000 92,000
Cost of Goods Sold ........................................... Inventory ...................................................
98,000
Accounts Payable ............................................. Cash..........................................................
117,000
Inventory ........................................................... Accounts Payable .....................................
138,000
Bank Loan Payable ........................................... Interest Expense ($800,000 x 3% x 1/12) ......... Cash..........................................................
15,000 2,000
184,000
98,000
117,000
138,000
17,000
Total estimated allowance balance at Jan. 31, 2018: Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total
(e)
Jan.
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31
Accounts Receivable $280,000 130,000 40,000 20,000 $470,000
Estimated Percentage Uncollectible 2% 5% 6% 12%
Estimated Uncollectible Accounts $ 5,600 6,500 2,400 2,400 $16,900
Bad Debts Expense .......................................... Allowance for Doubtful Accounts............... Required balance $16,900 above less unadjusted Balance $4,000 [from T account part (b]
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12,900 12,900
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Financial Accounting, Seventh Canadian Edition
ACR8-1 (CONTINUED) (c)
DITURI DESIGNS LTD. Bank Reconciliation January 31, 2018
Balance per bank statement ...........................................
$332,772
Less: Outstanding cheques ........................................... Reconciled cash balance per bank .................................
67,000 $265,772
Balance per books [from T account part (b] ....................
$278,000
Less:
NSF cheque ...................................................... Bank service charges ......................................... Reconciled cash balance per books ...............................
(d)
Jan.
31
Accounts Receivable......................................... Bank Charges Expense .................................... Cash..........................................................
$12,100 128
12,228 $265,772
12,100 128 12,228
(b) and (e)
Dec. 31 Bal. Jan. 4 Jan. 8 Jan. 19 Jan. 23 Unadj. Bal. Bal. Jan. 31
Cash 197,000 Jan. 12 236,000 Jan. 14 51,000 Jan. 25 9,000 Jan. 31 92,000 278,000 Jan. 31 AJE 265,772
Accounts Receivable Dec. 31 Bal. 468,000 Jan. 4 Jan. 10 188,000 Jan. 14 Jan. 19 9,000 Jan. 15 Jan. 23 92,000 Jan. 17 Jan. 19 Unadj. Bal. 470,000 Jan. 31 AJE 12,100 Bal. Jan. 31 482,100
Solutions Manual .
Allowance for Doubtful Accounts Dec. 31 Bal. 13,000 Jan. 14 18,000 Jan. 19 9,000 Unadj. Bal. 4,000 Jan. 31 AJE 12,900 Jan. 31 Bal. 16,900
26,000 147,000 117,000 17,000
12,228 Dec. 31 Bal. Jan. 15 Bal. Jan. 31 236,000 18,000 20,000 4,000 9,000
Notes Receivable 50,000 Jan. 8 20,000 20,000
Inventory Dec. 31 Bal. 2,682,000 Jan. 10 Jan. 6 150,000 Jan. 14 Jan. 17 2,400 Jan. 23 Jan. 26 138,000 Bal. Jan. 31 2,769,400
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50,000
102,000 3,000 98,000
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Financial Accounting, Seventh Canadian Edition
ACR8-1 (CONTINUED) (b) and (e) (continued)
Bal. Jan. 31
Prepaid Insurance 14,000 14,000 Jan. 31 AJE 12,250
Dec. 31 Bal. Unadj. Bal. Jan. 31 AJE Bal. Jan. 31
Interest Receivable 900 Jan. 9 0 75 75
Dec. 31 Bal. Unadj. Bal.
Jan. 10
Unearned Revenue 10,000 Dec. 31 Bal. Jan. 31 Bal.
44,000 34,000
Jan. 31
Bank Loan Payable 15,000 Dec. 31 Bal. Jan. 31 Bal.
800,000 785,000
Common Shares Dec. 31 Bal. Jan. 31 Bal.
600,000 600,000
1,750
900
Equipment Dec. 31 Bal. 1,560,000 Jan. 31 Bal. 1,560,000
Retained Earnings Dec. 31 Bal. 2,128,900 Jan. 31 Bal. 2,128,900
Accumulated Depreciation-Equipment Dec. 31 Bal. 972,000 Unadj. Bal. 972,000 Jan. 31 AJE 13,000 Jan. 31 Bal. 985,000
Jan. 14 Jan. 25
Jan. 12
Accounts Payable 150,000 Dec. 31 Bal. 117,000 Jan. 6 Jan. 26 Jan. 31 Bal.
398,000 150,000 138,000 419,000
Income Tax Payable Jan. 31 AJE
24,000
Salaries Payable 16,000 Dec. 31 Bal. Unadj. Bal. Jan. 31 AJE Jan. 31 Bal.
Solutions Manual .
Sales Jan. 10 Jan. 23 Jan. 31 Bal.
198,000 184,000 382,000
Sales Returns and Allowances Jan. 17 4,000 Jan. 31 Bal. 4,000
16,000 0 36,000 36,000
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Jan. 10 Jan. 23 Jan. 31 Bal.
Cost of Goods Sold 102,000 Jan. 17 98,000 197,600
Jan. 12 Unadj. Bal. Jan. 31 AJE Jan. 31 Bal.
Salaries Expense 10,000 10,000 36,000 46,000
2,400
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Financial Accounting, Seventh Canadian Edition
ACR8-1 (CONTINUED) (b) and (e) (continued)
Interest Revenue Jan. 8 Unadj. Bal. Jan. 31 AJE Jan. 31 Bal.
Depreciation Expense Jan. 31 AJE 13,000
Jan. 31 AJE
Insurance Expense 1,750
Bank Charges Expense Jan. 31 AJE 128
Jan. 31 AJE
Bad Debts Expense 12,900
Jan. 31
Jan. 31 AJE
100 100 75 175
Interest Expense 2,000 Income Tax Expense 24,000
Adjusting journal entries (AJE) Jan. 31
31
31
31
31
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Depreciation Expense ................................................ Accumulated Depreciation—Equipment ............ ($1,560,000 ÷ 10 x 1/12)
13,000
Insurance Expense ..................................................... Prepaid Insurance ............................................. ($14,000 ÷ 8)
1,750
Salaries Expense........................................................ Salaries Payable ...............................................
36,000
Interest Receivable ..................................................... Interest Revenue ............................................... ($20,000 x 9% x .5/12)
75
Income Tax Expense .................................................. Income Tax Payable .........................................
24,000
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13,000
1,750
36,000
75
24,000
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Financial Accounting, Seventh Canadian Edition
ACR8-1 (CONTINUED) (f) DITURI DESIGNS LTD. Adjusted Trial Balance January 31, 2018 Debit 265,772 482,100
Cash Accounts receivable Allowance for doubtful accounts Notes receivable Inventory Prepaid insurance Interest receivable Equipment Accumulated depreciation—equipment Accounts payable Income tax payable Salaries payable Unearned revenue Bank loan payable Common shares Retained earnings Sales Sales returns and allowances Cost of goods sold Depreciation expense Salaries expense Insurance expense Bad debts expense Bank charges expense Interest revenue Interest expense Income tax expense
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Credit
16,900 20,000 2,769,400 12,250 75 1,560,000
985,000 419,000 24,000 36,000 34,000 785,000 600,000 2,128,900 382,000
4,000 197,600 13,000 46,000 1,750 12,900 128 175 2,000 24,000 $5,410,975
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________ $5,410,975
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Financial Accounting, Seventh Canadian Edition
ACR8-1 (CONTINUED) (g) (1) DITURI DESIGNS LTD. Income Statement Month ended January 31, 2018 Sales Less: Sales returns and allowances Net sales Cost of goods sold Gross profit Operating expenses Salaries expense Depreciation expense Bad debts expense Insurance expense Bank charges expense Total operating expenses Income from operations Other expenses and revenues Interest revenue Interest expense Income before income tax Income tax expense Net income
$382,000 4,000 378,000 197,600 180,400 $46,000 13,000 12,900 1,750 128 73,778 106,622 ($175) 2,000
1,825 104,797 24,000 $ 80,797
(g) (2) DITURI DESIGNS LTD. Statement of Changes in Equity Month ended January 31, 2018
Balance, January 1 Net income Balance, January 31
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Common Shares $600,000 0000 000 $600,000
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Retained Earnings $2,128,900 80,797 $2,209,697
Total Equity $2,728,900 80,797 $2,809,697
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Financial Accounting, Seventh Canadian Edition
ACR8-1 (CONTINUED) (g) (3) DITURI DESIGNS LTD. Statement of Financial Position January 31, 2018 Assets Current assets Cash Accounts receivable $482,100 Less: Allowance for doubtful accounts 16,900 Notes receivable Interest receivable Inventory Prepaid insurance Total current assets Property, plant and equipment Equipment $1,560,000 Less: Accumulated depreciation 985,000 Total assets Liabilities and Shareholders’ Equity Current Liabilities Accounts payable Salaries payable Income tax payable Unearned revenue Current portion of bank loan payable* Total current liabilities Bank loan payable Total Liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity *$15,000 x 12 months = $180,000
$
265,772 465,200 20,000 75 2,769,400 12,250 3,532,697
575,000 $4,107,697
$ 419,000 36,000 24,000 34,000 180,000 693,000 605,000 1,298,000 $ 600,000 2,209,697 2,809,697 $4,107,697
LO 1,2,3,4 BT: AP Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT8-1 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
The North West Company Inc. reports $79,373,000 accounts receivable on its January 31, 2016 balance sheet. From note 5, we can see that this amount is made up of: Trade accounts receivable Corporate and other accounts receivable Less: Allowance for doubtful accounts
$78,190,000 13,566,000 (12,383,000) $79,373,000
(b) ($ in thousands)
(c)
2016
Receivables turnover
$1,796,035 $79,373 + $72,506 2
Average collection period
365 23.7
2015 =
23.7 times
$1,624,400 $72,506 + $70,527 2
=
15 days
365 22.7
Net credit sales
÷
Average net accounts receivable
=
Accounts receivable turnover
Days in year
÷
Accounts receivable turnover
=
Average collection period in days
=
22.7 times
=
16 days
North West has exhibited relatively consistent performance in the collection of its accounts receivable. It showed an improvement in its receivables management in 2016. It should also be noted that an average collection period of less than 30 days is normally an excellent collection period, depending on the terms of sale.
LO 1,5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT8-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a) ($ in thousands) Current ratio
North West ($ in thousands) $335,581 $155,501
=
Receivables turnover
$1,796,035 $79,373 + $72,506 2
Average collection period
365 23.7
(b) Ratio Current ratio Receivables turnover Average collection period
2.2:1
23.7 = times
=
Sobeys ($ in millions) $2,581.4 $2,707.4
$24,618.8 $489.4 + $499.7 2
15 days
North West 2.2:1 23.7 times 15 days
365 49.8
Sobeys 1.0:1 49.8 times 7 days
=
1.0:1
=
49.8 times
=
7 days
Industry 1.18:1 24.2 times 15 days
Sobeys demonstrates superior management of accounts receivable as shown by its receivables turnover and average collection period ratios, which are better than those of North West and the industry average. It should be noted that North West sells appliances and other household items, which Sobeys and other industry competitors do not. The credit terms granted to customers on these purchases may be longer, explaining why their average collection period is also longer. On the other hand, Sobeys’ current ratio is less than half that of North West and below the industry average. Further investigation as to why Sobeys’ current ratio is so low is warranted (for example, is their inventory turnover slower?) before drawing a conclusion about its liquidity. LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT8-3
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
Both Lava and Flow provide the information on the carrying amount of the trade receivables, but Lava provides disclosure of the amount of the allowance for doubtful accounts. Lava also provides more detail as to the aging of its accounts receivable, which is useful in assessing credit risk. The analyst can see that over 70% ($1,322 ÷ $1,854) of Lava’s receivables are current in 2018.
(b)
Since Lava is a publicly traded company with many shareholders and creditors, it is to its benefit to provide more information for the users of the financial statements to help them to assess credit and collection risks and management’s policies with respect to accounts receivable.
(c)
Big Bank would want an aging analysis of Flow. In addition, here are some examples of additional information Big Bank would need in order to assess credit risk:
Normal payment terms for the company and industry; An analysis by major customers; Details on how creditworthiness is evaluated; and Details on how Lava and Flow follow up on receivables that are past due for a significant amount of time.
LO 2,4 BT: E Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT8-4
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a)
Current ratio 2018: 1.6:1 ($10,600,000 ÷ $6,800,000) 2017: 2.1:1 ($10,500,000 ÷ $5,100,000) Yes, the current ratio exceeds the bank’s requirement of a current ratio of 1.5:1 in both years.
(b) Allowance for Doubtful Accounts Bal. 2017 2018 write offs 100,000 Bal. 2018
500,000 400,000
Notes Receivable Bal. 2017 2,000,000 2018 New notes 1,500,000 2018 Collections 800,000 Bal. 2018 2,700,000 (c)
It is difficult to say whether the Allowance for Doubtful Accounts is adequate or not. It is noteworthy that in 2017 the allowance was 10% of the royalties receivable ($500,000 ÷ $5,000,000). In 2018, after the write off, the allowance is 6.7% of the royalties receivable ($400,000 ÷ $6,000,000). It is quite likely, given the increase in sales from $50 million to $60 million and the increase in receivables from $5 million to $6 million, that the allowance should also increase proportionately unless there is evidence to the contrary. HHL should prepare an aging of its accounts (royalty) receivable and monitor its collection history so that it can ensure that it provides for the appropriate level of allowance.
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CT8-4 (CONTINUED) (d)
Yes, I believe an allowance should be recorded for notes receivable. As the notes are due in one year, and all of the notes issued during 2018 which amounted to $1.5 million, are still outstanding at the end of the year, we need to determine what happened to the $2 million of notes that were outstanding at the beginning of the year. Since $800,000 of these notes has been collected, the remaining $1.2 million ($2,700,000 − $1,500,000) must have been dishonoured. An argument can be made for an allowance being recorded for the full amount of the $1.2 million dishonoured notes as past experience indicates that they will probably not be collected. To record this, the following journal entry would be required: Bad Debts Expense Allowance for Doubtful Notes
1,200,000 1,200,000
One could possibly argue that the outstanding notes that were issued in 2018 amounting to $1.5 million should have an allowance provided for them but at this time it may be difficult to quantify this. (e)
If an Allowance for Doubtful Notes of $1.2 million is recorded, this would lower current assets to $9.4 million ($10.6 million − $1.2 million) and the current ratio would now be 1.4:1 ($9.4 million ÷ $6.8 million). This would violate the terms on the bank loan.
(f)
Accounts receivable turnover ratio (calculated using ending balances rather than average balances) 2018: 10.0 times ($60,000,000 ÷ $6,000,000) 2017: 10.0 times ($50,000,000 ÷ $5,000,000) The liquidity of the company has deteriorated based on the decline in the current ratio calculated in (a). The cash balance is lower in 2018 while current liabilities are higher. While the accounts (royalties) receivable turnover is unchanged in 2018, the collectability of the accounts receivable as well as the notes receivable arising from dishonoured notes is suspect because of the reluctance of the vice-president to write off dishonoured notes.
LO 2,3,5 BT: E Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT8-5 (a)
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
The stakeholders in this situation are: The controller of Encounter Limited, Sam Wong The president of Encounter Limited, Suzanne Chen The company’s bank The shareholders of this publicly traded company Any other parties who rely upon the company’s financial statements
(b)
The president of the company likely made the request to improve the current ratio to show that the company is more liquid than it really is for the benefit of the bank. In this way, the bank’s expectations will be met.
(c)
Yes. The controller has an ethical dilemma—should Sam follow the president's “suggestion” and prepare misleading financial statements by understating the allowance for doubtful accounts and bad debt expense or should Sam attempt to stand up to and possibly anger the president by preparing a fair (realistic) statement of financial position.
(d)
No. Encounter’s liquidity should be measured using fair financial statements. The controller should not prepare financial statements with the objective of achieving or sustaining a predetermined level of liquidity. The current ratio should be a product of proper estimates made by management and operating results, not of “creative accounting.”
LO 1 BT: C Difficulty: M Time: 20 min. AACSB: Ethics CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT8-6 (a)
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
Software Solutions is currently adhering to ABC’s credit terms of 30 days but have asked for an increase to 60 days. Several major clients, however, have extended their payment period to 45 days. Advantages to Anthony Business Company (ABC) of enforcing credit terms of 30 days for its clients:
Cash flow will increase and the stress of ensuring that there are adequate funds on hand to purchase additional inventory and pay for salaries and salary related costs will be alleviated with respect to those clients currently taking longer than 30 days to pay.
Will provide ABC with a consistent credit policy. When negotiating terms with new customers it may wish to offer credit to, it will be able to say that it has a credit policy that is consistent with what is being offered to current customers—whether major or not.
Disadvantages to ABC of enforcing credit terms of 30 days for clients: Software Solutions and other major clients wishing a payment period of longer than 30 days may choose to go elsewhere. Not only would ABC lose its current contractual commitment but also the additional revenues it expects to earn from these clients in the future.
(b)
Since some clients have been delaying payment to 45 days in the past without any consequences, enforcing a 30-day payment period may be problematic. If ABC feels that a particular client in this situation is loyal and is a major source of its profitability and growth, it may have to consider whether the cost equals the benefits of enforcing credit terms of 30 days.
I do not believe that ABC should reduce its credit terms to 15 days. Because ABC is a young growing company, it should be very careful about its customer relations. For existing customers, particularly Software Solutions, ABC should not disturb their current terms. In the case of ABC, 15 day terms are not likely standard in its industry and would likely turn new customers away. ABC should consider the delays in collection as a cost of doing business and arrange for the proper financing of the cash flow demands of the future. It is better to incur interest costs and retain clients than pay staff who are not assigned billable work. Advantages to (ABC) of reducing credit from 30 to 15 days: If in fact clients can meet these credit terms, cash flow will increase.
Will provide ABC with a consistent credit policy.
If ABC needs to borrow money, it can demonstrate to its creditor that it has good control over the collection of accounts receivable.
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CT8-6 (CONTINUED) (b) (continued) Disadvantages to ABC of reducing credit from 30 to 15 days: 30 days may be a consistent policy in this industry. It should check this out before making any change.
(c)
Some clients may in fact agree to a 15-day payment period and still take 45 days to pay. ABC will have to be clear on what the penalty is for late payment (interest, for example) and what enforcement measures it is prepared to take.
ABC may experience down time (or not as productive performance) from its employees through loss of customers.
ABC may experience a loss of reputation. ABC may be perceived as being cash strapped and consequently customers may incorrectly conclude that ABC is not a reliable source of service.
Implications of the doubling services for Software Solutions on operations and cash flows. Doug, Bev, and Emily must carefully consider the company’s cash flow requirements. ABC will need to hire additional staff as a result of the planned increase in services. These additional costs will have to be considered when determining cash flows. All employee related costs will increase as a consequence of the additional staff. For example, electricity costs will increase and expenditures for more equipment may be necessary. Payments for payroll and related costs cannot be delayed. Since ABC is selling services and not inventory to Software Solutions, it cannot pass on to its own suppliers delays in payment.
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CT8-6 (CONTINUED) (d)
Alternatives:
Consider not extending credit for the purchase of goods. Perhaps clients might consider payment by using a corporate credit card. Although this is an alternative for the sale of goods, it may not be one that clients would accept, considering some are currently taking 45 days to pay their ABC invoices. In addition, not all clients may have a corporate credit card nor wish to acquire one. It is not as common as a personal credit card. ABC would also have to consider the costs of accepting payment by credit card. The issuing credit card company or bank will charge a processing fee. This may be more costly than allowing selected clients to pay in 45 days.
Consider providing clients an incentive or discount to paying quickly, for example a 1% discount. Again, a valid alternative but might be a costly one to ABC. This cost should be compared to the cost of credit card fees and potential interest paid if cash was borrowed by ABC to finance operations.
Consider the sale of receivables to an organization that will collect the receivable (a factor). Although a valid alternative, this one may be a costly one to ABC as the fees charged by a factor can be significant and likely far more significant than any savings it would occur from receiving the collection of an account 15 days (45 days – 30 days) earlier. In addition, it may make ABC look desperate and could lead clients to the perception that ABC has a poor financial position.
LO 5 BT: E Difficulty: C Time: 45 min. AACSB: Communication CPA: cpa-t001, cpa-t005, cpa-e003 CM: Reporting, Finance and Comm.
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CHAPTER 9 REPORTING AND ANALYZING LONG-LIVED ASSETS LEARNING OBJECTIVES 1. 2. 3. 4. 5. 6.
Determine the cost of property, plant, and equipment. Explain and calculate depreciation. Account for the derecognition of property, plant, and equipment. Identify the basic accounting issues for intangible assets and goodwill. Illustrate how long-lived assets are reported in the financial statements. Describe the methods for evaluating the use of assets
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT Item LO
BT Item LO BT Item LO Questions
BT Item LO
BT
1.
1
C
6.
2
C
11.
3
AP
16.
4
C
21.
5
C
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1
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7.
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K
12.
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17.
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AN
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Brief Exercises 1.
1
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9.
2
AP
13.
4
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4,5
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AP
Exercises 1.
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Problems: Set A and B 1.
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1,2,3
AP
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Accounting Cycle Review 1. 1,2,3,4,5 AP
Cases 1.
2,4,5
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1,2,4,6
E
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Solutions Manual .
9-1
7.
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
Solutions Manual .
9-2
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
(a)
Accounting standards require property, plant, and equipment to be recorded initially at cost, which consists of the purchase price, less any discounts or rebates and any other expenditures necessary to acquire the asset and make it ready for its intended use at its intended location of use.
(b)
Operating expenditures are expensed in the period they are incurred. They help maintain an asset but do not add additional value, useful life, or economic benefits. Capital expenditures are included as part of the cost of the new equipment. They are incurred to make an asset ready for use or to enhance its productivity or extend its life.
(c)
An asset retirement cost is an estimate of the cost of an obligation to dismantle, remove, or restore a long-lived asset when it is retired. These costs are included in the cost of property, plant, and equipment and depreciated over the life of the asset.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
Land improvements are structural additions made to the land such as parking lots and fences as they are depreciable assets. Clearing and grading the land are not land improvements but are part of the land cost as they are required to get the land ready for its intended use. They would therefore be capitalized (recorded) in the Land account.
LO 1 BT: C Difficulty: S Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
An operating lease allows the lessee to account for the leasing transaction as a rental and so the lease payments are recorded to Rent Expense, an income statement account. As a result, neither the asset nor the liability related to the asset is recorded on the company’s books. For a finance lease, both the asset and the liability related to the leased asset are recorded on the company’s books even though the asset is not legally owned by the party leasing the asset. The asset account involved would be Equipment under Finance Leases, for example, and the related liability account would be Finance Lease Liability.
LO 1 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-3
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
4. (1) Depreciation Expense
(2) Net Income
(3) Accumulated Depreciation
(4) Carrying Amount
Declines at a constant amount each year
(a) Early years Straight-line
Same each year Constant charge (depreciation expense) to income
Increases at a constant amount each year
Units-ofproduction
Varies with number of units produced
Impact on income will vary with the number of units produced
Increases at a Declines at a variable amount variable amount based on number of units produced
Diminishingbalance
Decreases each year
Increasing income each year because depreciation expense is lower each year
Increases at a diminishing amount each year
Declines at a higher amount in the early years
All three result in the same total depreciation expense
All three result in the same total impact on net income
All three result in the same total accumulated depreciation
All three result in the same ending carrying amount
(b) Total life Straight-line, units-ofproduction, diminishingbalance
LO 2 BT: AN Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
If the residual value was deducted for the diminishing balance method, the carrying value would never reach the residual value. Applying a fixed percentage rate to a diminishing balance will always result in an undepreciated balance because a portion of the depreciable amount will always remain at the end of the period. Residual value is considered in the diminishing-balance method by ensuring that the asset is never depreciated below its residual value. In this way, we always make sure that the undepreciated balance (carrying amount) is adjusted to equal residual value at the end of the asset’s useful life. Residual value is subtracted from the cost when using the other methods because the resulting depreciable cost is needed to determine the annual depreciation expense.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-4
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
6.
Financial Accounting, Seventh Canadian Edition
The straight-line and diminishing-balance methods use annual depreciation rates in their depreciation calculations. Therefore, the result must be adjusted for any period less than one year. The units-ofproduction method does not need to be adjusted for partial periods as this method multiplies the depreciable amount per unit by the actual units produced in the period. This reflects how much the asset was used during the period. For example, if an asset was purchased July 1 and produced 10,000 units for the period July through December, it can only produce units for that six-month period (the company could not have produced units before it purchased the asset) and therefore no adjustment for the half-year ownership period is needed.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
(a)
A company should choose the depreciation method it believes will best reflect the pattern over which the asset’s future economic benefits are expected to be consumed. The depreciation method must be revised if the expected pattern of consumption of the future economic benefits has changed.
(b)
Private companies using ASPE would not be allowed to use the revaluation model and therefore must use the cost model. Publicly traded companies, which must follow IFRS, can choose to use the cost model or the revaluation model. Factors to consider when choosing the revaluation model over the cost model are whether fair values are more relevant than cost (such as in the real estate industry), whether reliable measures of fair value can be obtained, and whether the benefits from the revaluation model exceed the additional costs involved in determining the value of the assets each year.
LO 2 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-5
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
8.
Financial Accounting, Seventh Canadian Edition
(a)
Companies need to calculate an impairment loss when an asset becomes obsolete or when a competitive market causes a decline in sales of products produced by that asset. The impairment loss is the amount by which the carrying amount of the asset exceeds its recoverable amount. The loss is recorded with debit to Impairment Loss and a credit to the Accumulated Depreciation account of the asset or the asset itself if a contra account is not used.
(b)
Some companies attempt to record asset impairments in fiscal years where the company is experiencing poor results and the additional charge for the impairment will not be noticed or will be received in a better light by the financial statement users. Once the carrying amounts of the assets are reduced from the recording of the impairment loss, subsequent depreciation is correspondingly reduced. Since management’s judgement is involved in arriving at the amount of impairment loss, the timing of the recording of the loss may be the result of management’s objective to manipulate current and future years’ financial results. This approach becomes problematic to the financial statement users who are looking to compare results over several fiscal years to properly identify and assess financial trends.
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
When recording depreciation every year, cash is not involved in the transaction. The purpose of recording depreciation is to allocate the cost of the long-lived asset over the accounting periods the asset is used to assist in producing revenue and earning income. Although cash is paid when the asset is purchased, when recording depreciation, no cash is set aside for the purpose of replacing the asset at the end of the useful life. That is why the financial statements must disclose the cost and the accumulated depreciation of the long-lived assets in order for the reader to predict the future cash flows that will be involved when a retirement and replacement of the asset takes place.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
Depreciation must be updated for the period that has elapsed since depreciation was last recorded to the date of the sale because the depreciation expense must properly reflect the total period over which the asset’s economic benefits are used. Updating depreciation also aids in determining the correct amount of the gain or loss on disposition.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-6
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
11.
Financial Accounting, Seventh Canadian Edition
In a disposal of property, plant, and equipment, the carrying amount of the asset is compared to the proceeds received from the disposal. If the proceeds of the disposal exceed the carrying amount of the asset, a gain on disposal occurs. If the proceeds of the sale are less than the carrying amount of the asset sold, a loss on disposal occurs. The calculation is the same for an asset that is retired if proceeds, such as a residual value, are received. Often there are no proceeds received when an asset is retired. If no proceeds are received, a gain will never occur.
LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
The machine and related accumulated depreciation should continue to be reported on the statement of financial position without further depreciation or adjustment until the asset is retired. Reporting the asset and related accumulated depreciation on the statement of financial position informs the reader of the financial statements that the company is still using the asset. Once an asset is fully depreciated, even if it is still being used, no additional depreciation should be taken on this asset. In no situation can the accumulated depreciation on the asset exceed the cost of the asset.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
Tangible and intangible assets have similar characteristics, in that they are purchased for use in the operations and not for resale, have usefulness beyond one fiscal year, and are depreciated or amortized, with the exception of land and indefinite life intangible assets. Tangible and intangible assets are also similar in that their cost includes all of the necessary outlays that are made to get the asset ready for its intended use. They differ in their physical substance in that intangible assets have no physical substance.
LO 2,4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
Since finite intangible assets have limited usefulness to the business, each period of benefit should be charged with the allocation of the amortizable cost of the intangible asset used to generate revenue. Indefinite life intangible assets cannot have a systematic allocation of their amortizable cost allocated against revenues as the period of benefit is indeterminable. Rather, these assets are tested for impairment more frequently to ensure that their recoverable amount continues to exceed their carrying amount.
LO 4 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
15.
Financial Accounting, Seventh Canadian Edition
(a)
The accountant’s argument is not valid. The cost of intangible assets with finite lives should be amortized over the shorter of that asset's useful life (the period of time when operations are benefited by use of the asset) or its legal life. In many instances, reasonable estimates must be arrived at in order to record the necessary transactions and adjusting entries at the end of an accounting period. Having an alternative to the estimate that is more certain does not make the information more relevant.
(b)
If useful life is shorter than legal life, amortizing the asset over its legal life would be inappropriate because the amortization each year would be too low and the asset would have a carrying amount shown on the statement of financial position after its useful life had passed.
LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
Goodwill and intangible assets have similar characteristics, in that they are recorded at cost, purchased for use in the operations of the business and not for resale, have usefulness beyond one fiscal year, and have no physical substance. They differ in that goodwill does not exist on its own, is unidentifiable and cannot be separated from a business entity and so it cannot be sold; nor is it based on contractual or legal rights. Goodwill is not amortized as it has an indefinite life and is only derecognized if the business as a whole is resold. Goodwill can also be reduced from impairment.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
17.
The legal fees should be added to the cost of the patent and amortized over the patent’s remaining useful life as they prove the patent’s validity and add to, or ensure the continuation of, the future economic benefits to be generated by the patent.
LO 4 BT: C Difficulty: S Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
18.
Goodwill is the value of many favourable attributes that are intertwined in the business enterprise. Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill can only be sold if the entire business is sold.
LO 4 BT: C Difficulty: M Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-8
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
19.
Financial Accounting, Seventh Canadian Edition
(a)
Long-lived assets are normally reported on the statement of financial position under the headings “property, plant, and equipment”, “intangible assets”, and “goodwill.” The balances of the major classes of assets should be disclosed, as well as the accumulated depreciation and accumulated amortization, either on the statement of financial position or in the notes to the financial statements.
(b)
The income statement reports, in the operating expenses section, depreciation expense, amortization expense, any gain or loss on disposal of property, plant, and equipment, and any impairment losses.
(c)
The statement of cash flows reports, in the investing activities section, any cash paid to purchase long-lived assets and any cash received on their disposal.
LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
20.
The notes to the financial statements should disclose the balance of the major classes of assets as well as the accumulated depreciation and amortization for depreciable and amortizable assets if this information has not been reported directly in the financial statements. The depreciation and amortization method(s) used and the useful lives or rates should also be described. Under IFRS, companies must disclose if they are using the cost or revaluation model for each class of long-lived assets and include a reconciliation of the carrying amount at the beginning and end of period for each class of long-lived assets. If the revaluation model is used, disclosure of any increases and decreases from revaluation, as well as other information, is required. Information relating to any impairment recorded must also be disclosed. For companies using ASPE, the disclosure requirements are substantially reduced because the revaluation model cannot be used.
LO 5 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
21.
Gains and losses recorded on the disposal of property, plant, and equipment are classified in the operating section of the income statement because they are basically an adjustment to deprecation, which is classified as an operating expense.
LO 5 BT: C Difficulty: M Time: 3 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
22.
Financial Accounting, Seventh Canadian Edition
(a)
Accounting firms, like any professional services firm, do not need a significant amount on long-lived assets to operate. Consequently, the asset turnover will be high for accounting firms. In addition, the profit margin will most likely be higher due to lower amounts of depreciation compared to other types of businesses like grocery stores. Furthermore, accounting firms attract clients due to the quality of their work and the relationships they develop with clients and unlike other companies are not as subject to pricing pressures in a competitive market that could reduce profit margins.
(b)
Grocery stores usually have a high asset turnover and a low profit margin. This is typical in industries that have high sales relative to assets and are in an industry where there are many competitors. Food must have a high inventory turnover and store premises are often obtained using operating leases. These factors result in reduced assets, compared to capital intensive industries (although a grocery store would most likely be more capital intensive than an accounting firm).
LO 6 BT: AN Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
23.
The return on assets ratio measures the return being generated by each dollar invested in the business (net income ÷ average total assets). The return on assets can also be calculated by multiplying the profit margin by the asset turnover ratio. The profit margin measures how effective the business is at generating net income from its sales and the asset turnover measures how well the company can generate sales from a given level of assets. Together, the two ratios can be combined to measure how effective a company is at generating net income from a given level of assets (return on assets). Therefore, if a company wants to improve its return on assets, it can do so either by increasing the margin it generates from each dollar of sales (profit margin) or by increasing the volume of goods that is sells (asset turnover).
LO 6 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
9-10
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
24. ($ in millions) Return on assets
Asset turnover
2015
2014
$880 = 6.3% $13,907
$5,488 = 0.4 times $13,907
$887 = 6.8% $12,991
$5,421 = 0.4 times $12,991
Shaw’s return on assets deteriorated and the asset turnover ratio remained the same in 2015 compared to 2014. LO 6 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
9-11
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 All of the expenditures, except the fence, should be included in the cost of the land. Therefore, the cost of the land is $490,000 (cash price of $450,000 + legal fees of $8,500 + removal of old building $25,000 + clearing and grading costs of $6,500). The fence would be included in the cost of land improvements. LO 1 BT: AP Difficulty: S Time: 3 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-2 The cost of the truck is $43,750 (invoice price $42,000 + installation of trailer hitch $1,000 + painting and lettering $750). The expenditures for insurance and motor vehicle licence are annual costs that do not benefit future periods and should be expensed and not added to the cost of the truck. LO 1 BT: AP Difficulty: S Time: 3 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-3 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
O C C C C O O C C O
LO 1 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-4 (a)
The depreciable amount is $72,000 ($80,000 – $8,000). With a 4-year useful life, annual depreciation is $18,000 ($72,000 ÷ 4). Under the straight-line method, depreciation expense is the same each year.
(b)
Total depreciation over the truck’s life will be $18,000 per year × 4 years = $72,000
LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-12
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 9-5 Depreciation expense for 2018 = $18,000 × 8/12 = $12,000 Depreciation expense for 2019 = $18,000 LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-6 (a) Depreciation rate = 1 ÷ 4 = 25% x 2 = 50% January 1 Carrying amount 2018 2019 2020 2021
$80,000 40,000 20,000 10,000
Rate
Depreciation expense
50% 50% 50% to residual value
December 31 Carrying amount
$40,000 20,000 10,000 2,000 $72,000
$40,000 20,000 10,000 8,000
Calculations:
2018 Depreciation expense = $80,000 × 50% = $40,000 2019 Depreciation expense = ($80,000 – $40,000) × 50% = $20,000 2020 Depreciation expense = ($80,000 – $40,000 – $20,000) × 50% = $10,000 2021 Depreciation expense = ($80,000 – $40,000 – $20,000 – $10,000) × 50% =$5,000 (amount c As explained in the chapter, the double-diminishing-balance method can require an adjustment in the final year of depreciating an asset in order for the carrying amount to equal the residual value. In the scenario illustrated in the question, the company stopped depreciating the asset at the end of Year 4. This relatively short life was chosen for the purposes of this comparative problem and resulted in a very small amount of depreciation expense in Year 4. This can occur when the double-diminishing-balance method is used to depreciate an asset with a short life. Because of this effect, the double-diminishing-balance method is often used on assets with longer lives. In situations like this in real life, a company would revise the useful life of the asset if it anticipated continuing to use the asset beyond Year 4. (b)
Total depreciation expense = $40,000 + $20,000 + $10,000 + $2,000 = $72,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-13
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 9-7 (A) Carrying amount 2018 $80,000 2019 ($80,000 – $13,333) = $66,667
(B) (1 ÷ 4) Rate
(C) # of months
25% 25%
8 12
[(A) × (B) × (C)] ÷12 Depreciation expense $13,333 16,667
LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-8 The depreciable amount per unit is $0.10 per km. calculated as follows: (Cost – Residual value) ÷ total km = ($33,000 – $500) ÷ 325,000 = $0.10 2017 2018
125,000 km × $0.10 = $12,500 depreciation expense 105,000 km × $0.10 = $10,500 depreciation expense
LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-9 (a) Carrying amount ($200,000 – $20,000) ÷ 5 = $36,000 × 2 = $72,000; $200,000 – $72,000 = $128,000 (b) Carrying amount Recoverable amount Impairment loss
$128,000 100,000 $ 28,000
LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-14
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 9-10 (a)
(b)
Depreciation Expense [(($144,000 – $4,000) ÷ 5) × 9/12] ........ Accumulated Depreciation—Equipment .............................
21,000
Cash ......................................................................................... Accumulated Depreciation—Equipment ................................... Loss on Disposal ...................................................................... Equipment........................................................................
42,000 77,000 25,000
Proceeds from sale Cost of equipment Less: Accumulated depreciation Carrying amount at date of disposal Loss on disposal
21,000
144,000 $42,000
$144,000 77,000* 67,000 $(25,000)
* Depreciation Jan. 1, 2016 – Dec. 31, 2017 ($144,000 – $4,000) ÷ 5 = $28,000 × 2 years Depreciation Jan. 1, 2018 – Sept. 30, 2018 $28,000 × 9/12 Accumulated depreciation
$56,000 21,000 $77,000
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-11 (a)
(b)
Accumulated Depreciation—Equipment ................................... Equipment ............................................................................
42,000
Accumulated Depreciation—Equipment ................................... Loss on Disposal ...................................................................... Equipment ............................................................................
40,000 2,000
Proceeds from sale Cost of equipment Less: Accumulated depreciation Carrying amount at date of disposal Loss on disposal
42,000
42,000 $
0
$42,000 40,000 2,000 $(2,000)
LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-15
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 9-12 (a) (1) Apr. 2 Patents................................................................. Cash ............................................................
180,000
(2) Dec. 31 Amortization Expense ($180,000 5 = $36,000 × 9/12) ......................... Accumulated Amortization—Patents ........... (b)
180,000 27,000 27,000
SURKIS CORPORATION Statement of Financial Position (Partial) December 31, 2018 Assets
Intangible assets Patents Less: Accumulated amortization Carrying amount
$180,000 27,000 153,000
LO 4,5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-13 (a) (1) June 1 Trademarks.......................................................... Cash ............................................................ (2) Dec. 1 (b)
Trademarks.......................................................... Cash ............................................................
1,000 1,000 10,000 10,000
The trademarks do not need to be amortized as these normally have an indefinite life.
LO 4 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 9-14 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) (p) (q)
PPE (contra asset) PPE PPE PPE I NA (current asset) NA (shareholders’ equity) NA (expense) PPE PPE PPE I NA (expense) I NA (expense) PPE I
LO 5 BT: K Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 9-15 SAPUTO INC. Statement of Financial Position (Partial) March 31, 2015 (in millions) Property, plant, and equipment Land ........................................................................................ Buildings .............................................................. $ 759 Less: Accumulated depreciation .......................... 218 Furniture, machinery, and equipment .................. 2,339 Less: Accumulated depreciation .......................... 887 Total property, plant, and equipment ................ Intangible assets Finite-life intangible assets .................................. 246 Less: Accumulated amortization .......................... 57 Indefinite-life intangible assets................................................. Total intangible assets .......................................................... Goodwill ....................................................................................... Total long-lived assets ...................................................
$ 66 541 1,452 $2,059
189 318 507 2,125 $4,691
LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-17
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 9-16 (a)
(1) (2)
Pepsi has a better return on assets ratio. Pepsi has a better asset turnover ratio.
(b)
Profit margin × Asset turnover = Return on assets Coke: Profit margin × 0.5 = 7.8%; Solving for profit margin = 15.6% Pepsi: Profit margin × 0.9 = 8.8%; Solving for profit margin = 9.8% Coke has the better profit margin.
LO 6 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 9-17 (a) ($ in U.S. millions)
2015
2014
(1) Asset turnover
$2,415 $2,911 + $2,593 ( ) 2 = 0.9 times
$2,360 $2,593 + $2,044 ( ) 2 = 1.0 times
(2) Profit margin
$237 = 9.8 % $2,415
$360 = 15.3 % $2,360
(3) Return on assets
$237 $2,911 + $2,593 ( ) 2 = 8.6%
$360 $2,593 + $2,044 ( ) 2 = 15.5%
(b)
The return on assets changed primarily due to a change in profit margin.
LO 6 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
9-18
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 9-1 (a)
Under the cost principle, the acquisition cost for property, plant, and equipment includes all expenditures necessary to acquire the asset and make it ready for its intended use. For example, the cost of factory equipment includes the purchase price, freight costs paid by the purchaser, insurance costs during transit, and expenditures required in assembling, installing, and testing the equipment.
(b)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Land Land Land Land Improvements Buildings Buildings Vehicles Vehicles Vehicles Expense Prepaid Insurance
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 9-2 (a)
Cost of equipment = $75,000 + $500 delivery + $200 insurance in transit + $2,800 testing and installation = $78,500 The one-year insurance payment is for an annual expense and unlike the insurance for the equipment in transit, was not incurred to get the asset ready for use. Training costs are also expensed as they were incurred to get staff ready to use the machinery. These costs were not incurred on the machinery itself.
(b)
April 1, 2018 because that is the date when the asset was ready for use.
(c)
The company should use the straight-line method since the economic benefits are expected to be consumed evenly over the equipment’s useful life.
(d)
Depreciation expense in 2018 would be $5,888 ($78,500 ÷ 10 × 9/12).
LO 1,2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 9-3 (a) (1)
Straight-line method ($172,000 – $16,000) Depreciation = 4
=
$39,000
2014 expense = $39,000 × 9/12 =
$29,250
2015, 2016, 2017 expense =
$39,000 each year
2018 expense = $39,000 × 3/12 =
$9,750
(2)
Double-diminishing-balance rate = 1 ÷ 4 = 25% × 2 = 50% January 1 Carrying amount
2014 2015 2016 2017 2018
$172,000 107,500 53,750 26,875 16,000
Depreciation expense
Rate
December 31 Carrying amount
50% $86,000 × 9/12 = $64,500 50% 53,750 50% 26,875 to residual value 10,875 0
$107,500 53,750 26,875 16,000 16,000
Depreciation ceases in 2018 as the carrying amount cannot fall below residual value. (3)
Units of production: Depreciation expense per unit = ($172,000 – $16,000) 10,000 hours
2014 2015 2016 2017 2018
(b)
Units Used 1,500 2,200 2,300 2,100 1,900 10,000
=
$15.60
Expense Per Unit $15.60 15.60 15.60 15.60 15.60
Depreciation Expense $ 23,400 34,320 35,880 32,760 29,640 $156,000
All three methods result in the same amount depreciation expense over the life of the asset and so the same income will be experienced as well. The choice of depreciation method will have no impact on cash flow.
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-20
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 9-4 (a) Cost Less: Residual value Depreciable cost
Machine 1 $800,000 40,000 $760,000
Useful life in years
(b)
(c)
Machine 2 $120,000 5,000 $115,000
Cost Less: Residual value Depreciable cost
20
5
Annual depreciation $760,000 ÷ 20 = $38,000
$115,000 ÷ 5 = $23,000
Accumulated depreciation, December 31, 2017 Machine 1 ($38,000 × 10 years) Machine 2 ($23,000 × 2 years)
$380,000 46,000
Carrying amount, December 31, 2017 Machine 1 ($800,000 – $380,000) Machine 2 ($120,000 – $46,000)
$420,000 74,000
If the company accepts Lindy’s proposed changes in useful life and residual value, the 2018 depreciation expense for Machine 1 will be lower and the depreciation expense for Machine 2 will be higher than for 2017. The depreciation expense for Machine 1 will be lower due to the estimated longer useful life and higher residual value. The depreciation expense for Machine 2 will be higher due to the shorter estimated useful life and lower residual value.
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-21
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 9-5 (a)
The amount paid for the equipment is $1,100.
Jan.
1
(b)
1,100
Depreciation Expense ................................................... Accumulated Depreciation—Equipment ................
100 100
The amount of the gain on disposal is $50 and is derived from the disposal entry that follows.
Dec. 31
(d)
1,100
The amount of depreciation expense is $100.
Dec. 31
(c)
Equipment ..................................................................... Cash ......................................................................
Cash .............................................................................. Accumulated Depreciation—Equipment ........................ Gain on Disposal ................................................... Equipment .............................................................
450 40 50 440
The amount of the impairment loss on the remaining equipment is $55.
Dec. 31
Impairment Loss ............................................................ Accumulated Depreciation—Equipment ................
55 55
LO 2,3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-22
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 9-6 (a) (1)
Straight-line method $17,000 - $1,000
=
$4,000
each year
4 (2)
Double-diminishing-balance (DDB) method
DDB Rate: 1 ÷ 4 = 25% × 2 = 50% Year 1: $17,000 × 50% = $8,500 Year 2: ($17,000 – $8,500) × 50% = $4,250 Year 3: ($17,000 – $8,500 – $4,250) × 50% = $2,125
Year 1 Year 2 Year 3 Total
(b)
(1)
Straight-Line Depreciation Carrying Expense Amount $4,000 $13,000 4,000 9,000 4,000 5,000 $12,000
Double Diminishing-Balance Depreciation Carrying Expense Amount $8,500 $8,500 4,250 4,250 2,125 2,125 $14,875
Straight-line method
Proceeds – carrying amount = Gain $5,800 – $5,000 = $800 (2)
Double diminishing-balance method
Proceeds – carrying amount = Gain $5,800 – $2,125 = $3,675
Solutions Manual .
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Chapter 9
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Financial Accounting, Seventh Canadian Edition
EXERCISE 9-6 (CONTINUED) (c) (1)
Straight-line method Depreciation expense: $12,000 - Gain: $800 = $11,200
(2)
Double-diminishing balance method Depreciation expense: $14,875 – Gain: $3,675 = $11,200
Note: There is no difference in the total expense over the life of the asset. (d)
Because of the nature of the asset in question, a boardroom table, it would be most appropriate to use the straight-line method of depreciation. There is typically no change in the usefulness of the asset over the fouryear life and so an equal deprecation charge allows for the best matching of the expense to the usefulness of the asset to the business over the four-year period.
LO 2,3 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-24
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 9-7 (a) Jan.
Sept
1
1
1
Dec. 30
30
(b)
Cash .............................................................................. Accumulated Depreciation—Vehicles ([$62,000 – $6,000] ÷ 4 × 3) .......................................... Loss on Disposal [$18,000 – ($62,000 – $42,000)] ....... Vehicles ................................................................
18,000
Depreciation Expense ($10,980 ÷ 3 × 8/12) .................. Accumulated Depreciation—Equipment ................
2,440
Cash .............................................................................. Accumulated Depreciation—Equipment ($10,980 ÷ 3 × 2 = $7,320; $7,320 + $2,440) ................ Loss on Disposal [$500 – ($10,980 – $9,760)] .............. Equipment .............................................................
500
Depreciation Expense ($150,000 ÷ 10) ......................... Accumulated Depreciation—Equipment ................
42,000 2,000 62,000
2,440
9,760 720 10,980 15,000
Accumulated Depreciation—Equipment [($150,000 ÷ 10) × 10] ................................................... 150,000 Equipment .............................................................
15,000
150,000
The accounts that are affected by the error include: Miscellaneous Revenue Overstated Accumulated Depreciation—Vehicles Overstated Vehicles Overstated Depreciation Expense Overstated Loss on Disposal Understated
LO 3 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-25
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 9-8 1.
Depreciation is the process of allocating the cost of a long-lived asset to expense over the asset’s useful life. Because the value of land generally does not decline with time and usage, its usefulness and economic benefits do not decline. In addition, the useful life of land is indefinite so the expected useful life is not determinable. Therefore, it would be incorrect for the student to depreciate the land.
2.
Trademarks are intangible assets with indefinite lives. Under both ASPE and IFRS, trademarks are not amortized but reviewed annually for impairment. If a decline in the trademarks’ recoverable amount has occurred, the trademarks’ carrying amounts are reduced by recording an impairment loss which appears on the income statement. Therefore, the amortization entry should be reversed and no reduction in carrying amount recorded unless an impairment has occurred.
3.
International Financial Reporting Standards (IFRS) permit companies to use the revaluation model for the subsequent measurement of property, plant, and equipment. To qualify for the revaluation model, the fair value of the building must be reliably measurable, the revaluations must be carried out on an ongoing basis, and the entire category of buildings must be revalued to fair value. Using the revaluation model for one building is therefore not appropriate. It is also unlikely that the revaluation model will be relevant to all users of Chin’s financial statements. This fair value adjustment should be reversed and the building carried at cost, less accumulated depreciation.
LO 2,4 BT: AP Difficulty: C Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 9
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Financial Accounting, Seventh Canadian Edition
EXERCISE 9-9 (a) Jan.
Mar.
1
1
Sept. 1
1
(b) Dec. 31
31
Copyrights ....................................................................... 120,000 Cash .......................................................................
120,000
Franchises ...................................................................... 540,000 Cash ....................................................................... Bank Loan Payable .................................................
40,000 500,000
Trademarks ..................................................................... Cash .......................................................................
75,000 75,000
Trademarks..................................................................... Cash .......................................................................
35,000
Amortization Expense ..................................................... Accumulated Amortization—Copyrights.................. ($120,000 ÷ 6 = $20,000)
20,000
Amortization Expense ..................................................... Accumulated Amortization—Franchises ................. [($540,000 ÷ 9) × 10/12 = $50,000]
50,000
35,000
20,000
50,000
No amortization recorded on the trademark purchased Sept. 1 LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 9
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Financial Accounting, Seventh Canadian Edition
EXERCISE 9-10 (a) Jan.
April
July
Sept.
2
1
1
1
30
Dec. 31
Patents............................................................................ Cash .......................................................................
40,000 40,000
Goodwill .......................................................................... 300,000 Cash .......................................................................
300,000
Franchises ...................................................................... 250,000 Cash .......................................................................
250,000
Research Expenses ........................................................ 150,000 Cash .......................................................................
150,000
Development Costs......................................................... Cash .......................................................................
50,000 50,000
Amortization Expense ..................................................... Accumulated Amortization—Patents....................... ($40,000 ÷ 5 = $8,000)
8,000 8,000
31
Given that recoverable amount exceeded carrying amount for intangible assets, no impairment loss is recognized.
31
Impairment Loss ............................................................. Goodwill ..................................................................
30,000 30,000
(b) COLLINS LTD. Statement of Financial Position (Partial) December 31, 2018 Intangible assets Patents ................................................................ Less: Accumulated amortization .......................... Franchise ............................................................. Development costs .............................................. Total intangible assets ................................................ Goodwill ......................................................................
$40,000 8,000
$ 32,000 250,000 50,000 332,000 270,000
LO 4,5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
9-28
Chapter 9
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Financial Accounting, Seventh Canadian Edition
EXERCISE 9-11 (a) Account
Financial Statement
Section
Accumulated amortization— software
Statement of Financial Position
Intangible assets
Accumulated depreciation— buildings
Statement of Financial Position
Property, plant, and equipment
Accumulated depreciation— fixtures and equipment
Statement of Financial Position
Property, plant, and equipment
Accumulated depreciation— leasehold improvements
Statement of Financial Position
Property, plant, and equipment
Amortization expense
Income Statement
Operating expenses
Buildings
Statement of Financial Position
Property, plant, and equipment
Depreciation expense
Income Statement
Operating expenses
Fixtures and equipment
Statement of Financial Position
Property, plant, and equipment
Goodwill
Statement of Financial Position
Goodwill
Impairment loss
Income Statement
Operating expenses
Land
Statement of Financial Position
Property, plant, and equipment
Leasehold improvements
Statement of Financial Position
Property, plant, and equipment
Operating leases
Income Statement
Operating expenses
Reversal of impairment loss
Income Statement
Operating expenses
Software assets
Statement of Financial Position
Intangible
Trademarks assets
Statement of Financial Position
Intangible
Solutions Manual .
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Chapter 9
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Financial Accounting, Seventh Canadian Edition
EXERCISE 9-11 (CONTINUED) (b) REITMANS (CANADA) LIMITED Statement of Financial Position (Partial) January 31, 2015 (in thousands)
Property, plant, and equipment Land ...................................................................... Buildings ................................................................ Less: Accumulated depreciation ............................ Fixtures and equipment ......................................... Less: Accumulated depreciation ............................ Leasehold improvements ...................................... Less: Accumulated depreciation ............................ Total property, plant, and equipment Intangible assets Software ................................................................ Less: Accumulated amortization ............................ Trademarks ........................................................... Total intangible assets ..................................
$ 5,860 $ 45,633 19,096 131,073 68,010 140,188 83,299
26,537 63,063 56,889 152,349
28,261 8,184
20,077 499 20,576
Goodwill ..........................................................................
42,426
LO 5 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 9-12 Company A: Costco (retail) Company B: Suncor (oil and gas) The company most likely operating in the retail industry is Company A (Costco) because it has the higher asset turnover and lower profit margin. It is reasonable to expect retail companies like Costco to sell goods at a higher rate (volume) at a lower profit margin than a company in the oil and gas industry. The oil and gas industry requires a higher investment in long-lived assets and can be expected to have a lower asset turnover ratio and a higher profit margin. LO 6 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 9
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Financial Accounting, Seventh Canadian Edition
EXERCISE 9-13 (a) ($ in millions)
(b)
(1) Return on assets
=
(2) Asset turnover
=
(3) Profit margin
=
$550 ($7,200 + $6,800) 2 $14,000 ($7,200 + $6,800) 2 $550 $14,000
=
7.9%
=
2.0 times
=
3.9%
Profit Margin × Asset Turnover = Return on Assets [(net income ÷ net sales) × (net sales ÷ average total assets)] = net income ÷ average total assets = ($550 ÷ $14,000) × [$14,000 ÷ (($7,200 + $6,800) ÷ 2)] = ($550 ÷ $14,000) × [$14,000 ÷ $7,000] = 0.0392857 × 2.0 = 0.0785714 = 7.85714%
(c)
Ajax’s ratios are better than the industry averages in every respect. Ajax can generate a higher return on assets through higher volume of sales or greater efficiencies in using its asset base to generate those sales. Overall Ajax is performing better than its industry.
LO 6 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 9-1A Account Debited
Explanation
1.
Equipment
Makes the equipment more productive or efficient.
2.
Land improvements
Non-permanent land expenditure.
3.
Buildings
Capital expenditure, which makes the office more productive. If the air conditioning system had a significant cost and different useful life from the building an argument could be made to treat it as a separate asset (component).
4.
Repair and maintenance Does not extend the life of the building or make it more expense productive or efficient. If the loss was considered to be significant, it would be recorded separately as a loss due to labour dispute, rather than as repair and maintenance expense.
5.
Equipment
Cost to prepare the equipment for use.
6.
Repair and maintenance Does not extend the life of the machinery or make it more expense productive or efficient. If the damage was covered by insurance, a receivable (from the insurance company) account would be debited. If the loss was considered to be significant, it would be recorded separately as a loss due to damages, rather than as repair and maintenance expense.
7.
Repair and maintenance Does not extend the life of the truck or make it more expense productive or efficient.
8.
Repair and maintenance Does not extend the life of the building or make it more expense productive or efficient. Painting is a recurring expense over time.
9.
Vehicles
The future operating costs will be substantially reduced.
10. Repair and maintenance Light bulbs are replaced frequently. expense LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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PROBLEM 9-2A (a) Feb.
7
9
15
16
28
Mar.
July
2
2
3
Aug. 29
Solutions Manual .
Land ............................................................................. 1,100,000 Cash ..................................................................... Mortgage Payable ................................................ Note: There is no intention of using the old building so the purchase price relates to only the land. Land ............................................................................. Cash .....................................................................
22,000
Land ............................................................................. Cash .....................................................................
60,000
Cash ............................................................................. Land .....................................................................
16,000
Land ............................................................................. Cash .....................................................................
4,000
Buildings....................................................................... Cash .....................................................................
72,000
22,000
60,000
16,000
4,000
72,000
Buildings....................................................................... 2,600,000 Cash ..................................................................... Bank Loan Payable ............................................. Prepaid Insurance ........................................................ Cash .....................................................................
10,000
Land Improvements ..................................................... Cash .....................................................................
48,000
9-33
300,000 800,000
680,000 1,920,000
10,000
48,000
Chapter 9
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-2A (CONTINUED) (b) Date
Land
Feb. 7 9 15 16 28 Mar. 2 July 2 Aug. 29
$1,100,000 22,000 60,000 (16,000) 4,000
$1,170,000 (c)
Land Improvements
Buildings
$48,000 $48,000
$ 72,000 2,600,000 000000000 $2,672,000
Land is not depreciated, so no depreciation is calculated on this asset. The building and land improvements would be depreciated once the asset is available for use. In the case of the building, it appears that its construction is completed on July 2 and the land improvements are available for use on August 29. If depreciation is calculated to the nearest month, then the building would be depreciated effective July 1 and the land improvements September 1.
LO 1,2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 9-3A (a) Invoice price Delivery cost Installation and testing Total cost
$360,000 2,000 8,000 $370,000
The one-year insurance policy is not included as it benefits only the current period. It would be recorded as Prepaid Insurance and allocated to Insurance Expense throughout the period. (b)
(1) Straight-line depreciation expense (per year) ($370,000 – $80,000) 5
=
$58,000
STRAIGHT-LINE DEPRECIATION Calculation Year
Depreciable Cost
2018 2019 2020 2021 2022 2023
$290,0001 0,290,000 0, 290,000 290,000 290,000 290,000
1 2
×
Depreciation Rate 2 20% × 8/12 20% 20% 20% 20% 20% × 4/12
End of Year =
Depreciation Expense
Accumulated Depreciation
Carrying Amount
$38,667 58,000 58,000 58,000 58,000 19,333
$ 38,667 96,667 154,667 212,667 270,667 290,000
$331,333 273,333 215,333 157,333 99,333 80,000
$370,000 – $80,000 = $290,000 1 ÷ 5 years = 20%
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-3A (CONTINUED) (b)
(2) DOUBLE-DIMINISHING–BALANCE DEPRECIATION Calculation
Year
Opening Carrying Amount
2018 2019 2020 2021 2022 2023
$370,000 271,333 162,800 97,680 80,000 80,000
×
End of Year
Depreciation Rate1
Depreciation Expense
Accumulated Depreciation
Carrying Amount
40% × 8/12 40% 40% 40% 40% 40%
$ 98,667 108,533 65,120 17,6802 0 0
$ 98,667 207,200 272,320 290,000 290,000 290,000
$271,333 162,800 97,680 80,000 80,000 80,000
1
1 ÷ 5 years = 20% × 2 = 40%
2
Depreciation will cease in 2021 once the total accumulated depreciation is $290,000. This makes the carrying amount $80,000 which is equal to the residual value. No depreciation is taken on assets once the carrying amount has reached the residual value.
(b)
(3)
UNITS-OF-PRODUCTION DEPRECIATION Calculation Year
2018 2019 2020 2021 2022 1
Units-ofProduction
940 1,460 1,400 1,300 1,100
×
Depreciation Cost/Unit 1
$46.77 46.77 46.77 46.77 *
End of Year =
Depreciation Expense
$43,964 68,284 65,478 60,801 51,473
Accumulated Depreciation
Carrying Amount
$ 43,964 112,248 177,726 238,527 290,000
$370,000 326,036 257,752 192,274 131,473 80,000
Depreciable cost per unit = ($370,000 – $80,000) ÷ 6,200 units = $46.77 per unit
* (Carrying amount less residual value) $131,173 - $80,000 = $51,473 Net income is lowest in the earlier years of the machine’s useful life when the double- diminishing-balance method is used.
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PROBLEM 9-3A (CONTINUED) (c)
Yes, the cost to recycle the machine at the end of its useful life would need to be estimated. The cost to recycle would be added to the cost of the machine and allocated over its useful life, increasing the annual depreciation charge.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-4A (a)
(1) STRAIGHT-LINE DEPRECIATION Calculation Year
2018 2019 2020 2021 2022 1 2
(a)
Depreciable Cost
$240,000 240,000 240,000 240,000 240,000
×
2
Depreciation Rate1
25% × 9/12 25% 25% 25% 25% × 3/12
End of Year Depreciation Expense
Accumulated Depreciation
Carrying Amount
$ 45,000 105,000 165,000 225,000 240,000
$244,000 199,000 139,000 79,000 19,000 4,000
$45,000 60,000 60,000 60,000 15,000
1 ÷ 4 years = 25% $244,000 – $4,000 = $240,000 (2) DOUBLE DIMINISHING–BALANCE DEPRECIATION Calculation
1 2
Year
Opening Carrying Amount
2018 2019 2020 2021 2022
$244,000 152,500 76,250 38,125 19,062
×
End of Year
Depreciation Rate1
Depreciation Expense
Accumulated Depreciation
Carrying Amount
50% × 9/12 50% 50% 50% 50% × 3/122
$91,500 76,250 38,125 19,063 15,0622
$ 91,500 167,750 205,875 224,938 240,000
$244,000 152,500 76,250 38,125 19,062 4,000
1 ÷ 4 years = 25% × 2 = 50% Adjusted so that carrying amount would equal residual value of $4,000 ($19,062 × 50% × 3/12 = $2,383; $19,062 – $4,000 = $15,062) at the end of the useful life.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-4A (CONTINUED) (a)
(3) UNITS-OF-PRODUCTION DEPRECIATION Calculation Year
2018 2019 2020 2021 2022 1
Units-ofProduction
×
Depreciation Cost/Unit 1
14,800 20,400 19,800 20,000 5,000
$3 3 3 3 3
End of Year =
Depreciation Expense
$44,400 61,200 59,400 60,000 15,000
Accumulated Depreciation
Carrying Amount
$ 44,400 105,600 165,000 225,000 240,000
$244,000 199,600 138,400 79,000 19,000 4,000
Depreciable cost per unit = ($244,000 – $4,000) ÷ 80,000 units = $3 per unit
(b)
Total depreciation expense Accumulated depreciation
StraightLine
Units-ofProduction
DoubleDiminishingBalance
$240,000 240,000
$240,000 240,000
$240,000 240,000
(c)
The estimates used in determining the depreciation amount include the useful life of the asset, the total number of units of production expected, and the residual value when the business has completed its use of the asset. Management’s ability to arrive at accurate estimates depends on past experience with similar assets and to some extent to what will happen in the future, particularly with respect to the continued use of the asset. If the way the asset is used changes or if management’s intention concerning how long the asset will be used changes, the estimates will need revision.
(d)
Depreciation is a non-cash expense so the cash flows are not affected.
(e)
I would recommend the units-of-production method as it best reflects the pattern of the economic benefits produced by the equipment given the variability of usage each year.
LO 2 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-5A (a)
Equipment $80,000 0 80,000 ÷ 8 $ 10,000
Cost, January 1, 2016 Less: Residual value Depreciable cost Useful life in years Annual depreciation
The equipment’s accumulated depreciation on January 1, 2018 will be $20,000 ($10,000 × 2 years) and the carrying amount will be $60,000 ($80,000 – $20,000). (b)
Proceeds from cash sale Carrying amount of equipment sold ($ 60,000 x ¼ )* Gain on disposal *Carrying amount of equipment sold: Cost ($ 80,000 x ¼ ) Accumulated Depreciation to date of sale ($20,000 ÷ 8 x 2) Carrying amount ($ 60,000 x ¼ )
(c)
(d)
$18,000 15,000 $ 3,000
$20,000 5,000 $15,000
Depreciation on remaining equipment: Depreciable cost ($80,000- $20,000) Original useful life in years Annual depreciation
$60,000 ÷ 8 7,500
Depreciation for 10 months ($7,500 x 10/12)
$6,250
Depreciation on old equipment for 2 months ($7,500 x 2/12) Depreciation on new equipment: Cost ÷ useful life x 2/12 $10,000 ÷ 8 x 2/12= Total depreciation for 2 months
Total equipment depreciation for 2018 (for part e)
Solutions Manual .
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$1,250
208 $1,458 $ 7,708
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-5A (CONTINUED) (e) Equipment Jan. 1, 2018 Nov. 1, 2018 Dec. 31, 2018
80,000 10,000 58,000
Disposal Jan. 1, 2018 (b) Disposal Dec. 31, 2018
20,000 12,000
Accumulated Depreciation-Equipment Disposal Jan. 1, 2018 (b) Disposal Dec. 31, 2018
5,000 6,500
Jan. 1, 2018 Depreciation (d)
20,000 7,708
Dec. 31, 2018
16,208
Cost of equipment sold (derived above)................ Accumulated depreciation (derived above) ........... Net carrying amount .............................................. Loss on disposal ................................................... Cash proceeds from sale ......................................
$12,000 6,500 5,500 _3,000 $2,500
LO 2,3 BT: AP Difficulty: C Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 9
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-6A (a)
2016 Mar.
1
Equipment ............................................................ Cash.............................................................
(b)
130,000 130,000
DIMINISHING–BALANCE DEPRECIATION Calculation
Year
Opening Carrying Amount
2016 2017 2018 Nov./18
$130,000 117,000 93,600 74,880
1
×
End of Year
Depreciation Rate 1
Depreciation Expense
Accumulated Depreciation
Carrying Amount
20% × 6/12 20% 20% 20% × 3/12
$13,000 23,400 18,720 3,744
$13,000 36,400 55,120 58,864
$117,000 93,600 74,880 71,136
1 ÷ 5 years = 20%
2016 Aug.
2017 Aug.
2018 Aug.
Solutions Manual .
31
31
31
Depreciation Expense .......................................... Accumulated Depreciation—Equipment.......
13,000
Depreciation Expense .......................................... Accumulated Depreciation—Equipment.......
23,400
Depreciation Expense .......................................... Accumulated Depreciation—Equipment.......
18,720
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13,000
23,400
18,720
Chapter 9
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-6A (CONTINUED) (c) 2018 (1, 2, 3) Nov. 30
(1) Nov. 30
Depreciation Expense .......................................... Accumulated Depreciation—Equipment .....
3,744
Cash .................................................................... Accumulated Depreciation—Equipment ............... Loss on Disposal .................................................. Equipment...................................................
60,000 58,864 11,136
Cash proceeds ............................................. Carrying amount ........................................... Loss on disposal ........................................... (2) Nov. 30
(3) Nov. 30
80,000 58,864 8,864 130,000
$80,000 71,136 $ 8,864
Accumulated Depreciation—Equipment ............... Loss on Disposal .................................................. Equipment...................................................
Cash proceeds ............................................. Carrying amount ........................................... Loss on disposal ...........................................
130,000
$ 60,000 71,136 $(11,136)
Cash .................................................................... Accumulated Depreciation—Equipment ............... Gain on Disposal ........................................ Equipment...................................................
Cash proceeds ............................................. Carrying amount .......................................... Gain on disposal ...........................................
3,744
58,864 71,136 130,000
$
0 71,136 $(71,136)
LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-7A (a) (1)
Straight-line
Depreciation Expense = ($70,000 – $10,000) 3 2018 Mar. 1
Dec. 31
2019 Nov. 30
30
Solutions Manual .
=
$20,000
Equipment............................................................................ Cash ..........................................................................
70,000
Depreciation Expense .......................................................... Accumulated Depreciation—Equipment .................... ($20,000 × 10/12 = $16,667)
16,667
Depreciation Expense .......................................................... Accumulated Depreciation—Equipment .................... ($20,000 × 11/12 = $18,333)
18,333
70,000
16,667
18,333
Cash .................................................................................... 18,000 Accumulated Depreciation—Equipment ($16,667 + $18,333) 35,000 Loss on Disposal ................................................................. 17,000 Equipment .................................................................
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70,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-7A (CONTINUED) (a) (2)
Double-diminishing-balance
Depreciation Rate = 1 ÷ 3 years = 33% X 2 = 67% (note textbook convention to round rates to two decimal points) 2018 Mar. 1 2018 Dec. 31
2019 Nov. 30
Nov. 30
Solutions Manual .
Equipment............................................................................ Cash ..........................................................................
70,000
Depreciation Expense .......................................................... Accumulated Depreciation—Equipment .................... ($70,000 × 67% × 10/12 = $39,083)
39,083
Depreciation Expense .......................................................... Accumulated Depreciation—Equipment .................... [($70,000 – $39,083) × 67% × 11/12 = $18,988]
18,988
70,000
39,083
18,988
Cash .................................................................................... 18,000 Accumulated Depreciation—Equipment ($39,083 + $18,988) 58,071 Gain on Disposal ....................................................... Equipment .................................................................
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6,071 70,000
Chapter 9
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-7A (CONTINUED) (a) (3)
Units-of-Production Depreciable cost per unit = ($70,000 – $10,000) 12,000
2018 Mar. 1
Dec. 31
2019 Nov. 30
Nov. 30
=
$5.00
Equipment............................................................................ Cash ..........................................................................
70,000
Depreciation Expense .......................................................... Accumulated Depreciation—Equipment .................... (4,900 × $5 = $24,500)
24,500
Depreciation Expense .......................................................... Accumulated Depreciation—Equipment .................... (5,600 × $5 = $28,000)
28,000
70,000
24,500
28,000
Cash .................................................................................... 18,000 Accumulated Depreciation—Equipment ($24,500 + $28,000) 52,500 Gain on Disposal ....................................................... Equipment .................................................................
500 70,000
(b)
Depreciation expense 2018 2019 Total depreciation for two years + Loss (or – gain) on disposal = Net expense for two years
Straight -Line
DoubleDiminishing -Balance
Units-ofProduction
$16,667 18,333
$39,083 18,988
$24,500 28,000
35,000 17,000
58,071 (6,071)
52,500 (500)
$52,000
$52,000
$52,000
LO 2,3 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 9
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-8A (a)
April
May
1
1
1
June
July
1
1
Dec. 31
Dec. 31
31
Land ........................................................... Cash................................................... Mortgage Payable ..................................
4,400,000
Depreciation Expense ................................ Accumulated Depreciation—Equipment ($2,800,000 ÷ 10 × 4/12 = $93,333)
93,333
Cash ........................................................... Accumulated Depreciation—Equipment ..... Loss on Disposal ........................................ Equipment ..........................................
300,000 2,333,333 166,667
Cost Accumulated depreciation—equipment [($2,800,000 ÷ 10) × 8 + $93,333)] Carrying amount Cash proceeds Loss on disposal
$2,800,000
Cash ........................................................... Notes Receivable ....................................... Land ................................................... Gain on Disposal ................................
900,000 2,700,000
Equipment .................................................. Cash...................................................
2,200,000
Depreciation Expense ................................ Accumulated Depreciation—Equipment ($1,000,000 ÷ 10 = $100,000)
100,000
Accumulated Depreciation—Equipment ..... Equipment ..........................................
1,000,000
1,100,000 3,300,000
93,333
2,800,000
2,333,333 466,667 300,000 $ (166,667)
1,400,000 2,200,000
2,200,000
100,000
1,000,000
Impairment Loss ($23,000,000* – $20,000,000) 3,000,000 Land ...................................................
3,000,000
*Carrying amount = $20,000,000 + $4,400,000 – $1,400,000 = $23,000,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-8A (CONTINUED) (b)
Dec.
31
31
Depreciation Expense ................................ Accumulated Depreciation—Buildings ($97,400,000 ÷ 40 = $2,435,000)
2,435,000
Depreciation Expense ................................ Accumulated Depreciation—Equipment
14,730,000
$146,200,000* ÷ 10 $2,200,000 ÷ 10 × 6/12
$14,620,000 110,000 $14,730,000
2,435,000
14,730,000
* $150,000,000 – $2,800,000 – $1,000,000 = $146,200,000 31
31
Interest Expense ........................................ Interest Payable ................................. ($3,300,000 × 6% × 9/12 = $148,500)
148,500
Interest Receivable .................................... Interest Revenue ................................ ($2,700,000 × 5% × 7/12 = $78,750)
78,750
148,500
78,750
(c) YOUNGSTOWN LIMITED Statement of Financial Position (Partial) December 31, 2018 Property, plant, and equipment1 Land .................................................................. Buildings ............................................................ Less: Accumulated depreciation ........................ Equipment ......................................................... Less: Accumulated depreciation ........................ Total property, plant, and equipment .......... 1
$ 20,000,000 $97,400,000 64,635,000 148,400,000 65,590,000
32,765,000 82,810,000 $135,575,000
See T accounts on the following page.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-8A (CONTINUED) (c) (continued) Land Jan. 1, 2018 April 1, 2018
20,000,000 4,400,000
Dec. 31, 2018
Bal. 20,000,000
June 1, 2018 Dec. 31, 2018
1,400,000 3,000,000
Buildings Jan. 1, 2018 Dec. 31, 2018
97,400,000 Bal. 97,400,000
Equipment Jan. 1, 2018 July 1, 2018 Dec. 31, 2018
150,000,000 2,200,000
May 1, 2018 Dec. 31, 2018
2,800,000 1,000,000
Bal. 148,400,000
Accumulated Depreciation—Buildings Jan. 1, 2018 Dec. 31, 2018
62,200,000 2,435,000
Dec. 31, 2018
Bal. 64,635,000
Accumulated Depreciation—Equipment May 1, 2018 Dec. 31, 2018
2,333,333 1,000,000
Jan. 1, 2018 May 1, 2018 Dec. 31, 2018 Dec. 31, 2018
54,000,000 93,333 100,000 14,730,000
Dec. 31, 2018
Bal. 65,590,000
LO 2,3,5 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-9A (a)
(b)
(c)
(d)
1.
yes
Goodwill
not amortized
2.
no
N/A
N/A
Not reported on the Statement of Financial Position. Rent (Lease) Expense, Income Statement, Operating expenses.
3.
yes
Copyright
amortized
N/A
4.
yes
Trademarks
not amortized
N/A
5.
no
N/A
N/A
Not reported on the Statement of Financial Position Research Expenses, Income Statement, Operating expenses
6.
no
N/A
N/A
Not recorded or reported
7.
no
N/A
N/A
Assets under Finance Leases, Statement of Financial Position, Property, plant, and equipment
8.
yes
Patents
amortized
N/A
9.
no
N/A
N/A
Professional Fees Expense, Income Statement, Operating expenses
10.
yes
Development Costs
amortized
N/A
N/A
LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-10A (a)
Jan.
July
5
1
1
Sept.
Oct.
1
1
Dec. 31
(b)
Dec. 31
31
31
Solutions Manual .
Trademarks ............................................................ Cash ................................................................
7,000 7,000
Research Expenses ............................................... 210,000 Cash ................................................................
210,000
Development Costs ................................................ Cash ................................................................
50,000 50,000
Advertising Expense .............................................. Cash ................................................................
60,000 60,000
Copyrights .............................................................. 180,000 Cash ................................................................
180,000
Impairment Loss ($90,000 – $125,000) ................. Goodwill...........................................................
35,000 35,000
Amortization Expense ($36,000 ÷ 4) ...................... Accumulated Amortization—Copyrights ..........
9,000
Amortization Expense ............................................ Accumulated Amortization—Copyrights .......... ($180,000 ÷ 4 × 3/12 = $11,250)
11,250
9,000
11,250
Amortization Expense ............................................ 1,250 Accumulated Amortization—Development Costs ($50,000 ÷ 20 × 6/12 = $1,250)
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1,250
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-10A (CONTINUED) (c) GHANI CORPORATION Statement of Financial Position (Partial) December 31, 2018 Intangible Assets and Goodwill Finite life intangible assets Development costs .............................................. $50,000 Less: Accumulated amortization .......................... 1,250 Copyrights ............................................................ 216,0001 Less: Accumulated amortization .......................... 38,2502 Indefinite life intangible assets Trademarks ............................................................................... Goodwill ............................................................................................ Total intangible assets and goodwill ............................... 1
Copyrights: $36,000 + $180,000 = $216,000
2
Accumulated amortization Copyright (#1): $18,000 + $9,000 Copyright (#2)
3
Trademarks: $54,000 + $7,000 = $61,000
4
Goodwill: $125,000 – $35,000 = $90,000
$ 48,750 177,750 61,0003 90,0004 $377,500
$27,000 11,250 $38,250
LO 4,5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-11A (a)
Wal-Mart (4 ..................................... Target (in US $ millions) ............................ (in U.S. $ millions)
(1) Profit margin
(2) Asset turnover
(3) Return on assets
$16,363 = 3.4% $482,229
$2,449 = 3.4 % $72,618
$485,651 $203,706 + $204,751 ( ) 2 = 2.4 times
$72,,618 $78,315 + $79,651 ( ) 2 = 0.9 times
$16,363 $203,706 + $204,751 ( ) 2 = 8.0%
$2,449 $78,315 + $79,651 ( ) 2 = 3.1%
(b)
The profit margin is essentially the same (Wal-Mart is slightly ahead) and above the industry average. Similarly, when compared to industry averages, the two companies are not using assets as effectively as others in the industry, nor are they generating as high a return on assets. Due to the nature of the merchandise being sold, which includes food products, the profit margins are very small, because of the strong competition for these goods. The most significant difference between Wal-Mart and Target can be seen in the asset turnover ratio which shows that Wal-Mart is more effective in generating revenues – this is partly because gasoline, which provides a high turnover of goods with low profit margins, is sold by Wal-Mart and partly because Wal-Mart is known for its very efficient supply chain. However, the asset turnover ratio can also be high if assets are leased rather than owned and if more conservative depreciation policies are used.
(c)
Some additional information about long-lived assets that would assist in the comparisons include the accounting policies chosen concerning the calculation of depreciation and amortization, the estimates arrived at for the useful lives and residual values of the assets being depreciated, and details concerning the costs and accumulated depreciation or amortization recorded to date. The latter information would indicate the age of the long-lived assets and whether the company owned or leased these assets.
LO 4,6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 9-12A (a) (in thousands)
Delicious ................................... Scrumptious
(1) Profit margin 2018
$350 = 11.3% $3,100
$180 = 9.5% $1,900
Profit margin 2017
$150 = 10.0% $1,500
$200 = 11.8% $1,700
(2) Asset turnover 2018
$3,100 $2,000 + $1,100 ( ) 2 = 2.0 times
$1,900 $800 + $900 ( ) 2 = 2.2 times
Asset turnover 2017
$1,500 $1,100 + $1,000 ( ) 2 = 1.4 times
$1,700 $900 + $1,000 ( ) 2 = 1.8 times
(3) Return on assets 2018
$350 $2,000 + $1,100 ( ) 2 = 22.6%
$180 $800 + $900 ( ) 2 = 21.2%
Return on assets 2017
$150 $1,100 + $1,000 ( ) 2 = 14.3%
$200 $900 + $1,000 ( ) 2 = 21.1%
(b)
Delicious Limited increased its profit margin from 10.0% to 11.3% and its asset turnover from 1.4 times to 2.0 times. The increases in these two ratios multiplied to generate a substantial increase in Delicious’ return on assets (return on assets = profit margin × asset turnover). Conversely, Scrumptious Limited suffered a decrease in its profit margin from 11.8% to 9.5%. This decrease was offset by an increase in its asset turnover from 1.8 times to 2.2 times. The decrease in the profit margin was offset by the increase in the asset turnover and resulted in no substantial change in the return on assets.
LO 6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-1B Account Debited
Explanation
1.
Equipment
Capital expenditure, which makes the equipment more productive and/or extends its useful life.
2.
Repair and Maintenance Operating expenditure that does not make the equipment Expense more productive nor extend its useful life. Likely benefits only the current period.
3.
Equipment
4.
Repair and Maintenance Operating expenditure that does not make the equipment Expense more productive nor extend its useful life.
5.
Training Expense
6.
Repair and Maintenance Operating expenditure that does not make the equipment Expense more productive nor extend its useful life. Painting is a recurring expense.
7.
Prepaid Insurance
Operating expenditure as it benefits the current period only.
8.
Salaries Expense
Reorganization of the warehouse is an ongoing activity so should be expensed even though efficiency should increase.
9.
Equipment
Capital expenditure: a one-time cost that will benefit more than one period of time, and likely allows the operator to use the equipment longer and more productively.
Capital expenditure, which makes the equipment more productive.
Operating expenditure that does not increase the productivity of the equipment and current accounting policies do not recognize the cost of human capital.
10. Repair and Maintenance Operating expenditure that does not make the equipment Expense more productive nor extend its useful life. LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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PROBLEM 9-2B (a) Jan.
22
24
Land ................................................................................ Cash .....................................................................
18,000
Land ................................................................................ Cash .....................................................................
100,000
Land ................................................................................ Cash .....................................................................
32,000
28 Cash ............................................................................... Land .....................................................................
30,000
31
Feb. 13
Mar. 14
Apr.
20
June 15
Sept. 28
Oct.
Land ................................................................................ 880,000 Cash ..................................................................... Mortgage Payable ................................................ Note: There is no intention of using the old building so the purchase price really relates to only the land.
1
Solutions Manual .
220,000 660,000
18,000 100,000
32,000
30,000
Buildings ......................................................................... Cash .....................................................................
136,000
Buildings ......................................................................... Cash .....................................................................
68,000
136,000
68,000
Buildings ......................................................................... 1,200,000 Cash ..................................................................... Bank Loan Payable ..............................................
300,000 900,000
Buildings ......................................................................... 1,200,000 Cash ..................................................................... Bank Loan Payable ..............................................
400,000 800,000
Land Improvements ........................................................ Cash .....................................................................
168,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-2B (CONTINUED) (b)
(c)
Date
Land
Jan. 22 24 31 Feb. 13 28 Mar. 14 Apr. 20 June 15 Sept. 28 Oct. 1
$880,000 18,000 100,000 32,000 (30,000)
Land Improvements
00 00 000 $1,000,000
$168,000 $168,000
Buildings
$ 136,000 68,000 1,200,000 1,200,000 000000000 $2,604,000
Land is not depreciated, so no depreciation is calculated on this asset. The building and land improvements would be depreciated once the asset is available for use. The building would start being depreciated when construction is completed. This may not necessarily correspond with the dates the bills are received. Both the building and the land improvements would be depreciated starting on October 1, if depreciation is calculated to the nearest month.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-3B (a)
Cost: Cash price Delivery costs Installation and testing Total cost
$187,800 1,200 7,000 $196,000
The one-year insurance policy is not included as it benefits only the current period. It would be recorded as Prepaid Insurance and allocated to Insurance Expense throughout the period. (b)
Straight-line depreciation expense (per year) $196,000 = $49,000 4 STRAIGHT-LINE DEPRECIATION Calculation Year
Depreciable Cost
2018 2019 2020 2021 2022
$196,0001 0,196,000 0, 196,000 196,000 196,000
1 2
×
Depreciation Rate 2
End of Year =
25% × 3/12 25% 25% 25% 25% × 9/12
Depreciation Expense
Accumulated Depreciation
Carrying Amount
$12,250 49,000 49,000 49,000 36,750
$ 12,250 61,250 110,250 159,250 196,000
$196,000 183,750 134,750 85,750 36,750 0
$196,000 cost – $0 residual value = $196,000 1 ÷ 4 years = 25%
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-3B (CONTINUED) (b) (continued) DOUBLE-DIMINISHING–BALANCE DEPRECIATION Calculation
Year
Opening Carrying Amount
2018 2019 2020 2021 2022
$196,000 171,500 85,750 42,875 21,437
×
End of Year
Depreciation Rate1
Depreciation Expense
Accumulated Depreciation
Carrying Amount
50% × 3/12 50% 50% 50% 50% × 9/12
$ 24,500 85,750 42,875 21,438 21,4372
$ 24,500 110,250 153,125 174,563 196,000
$196,000 171,500 85,750 42,875 21,437 0
1
Double-diminishing-balance depreciation rate = 1 ÷ 4 = 25% × 2 = 50%
2
Depreciation expense in 2022 is calculated to equal $8,039 ($21,437 50% 9/12). However, this amount must be adjusted to $21,437 to make the carrying amount at the end of 2022 nil, or equal to the residual value.
UNITS-OF-PRODUCTION DEPRECIATION Calculation Year
Units-ofProduction
2018 2019 2020 2021 2022
2,500 10,300 9,900 8,800 8,500
1
×
Depreciation Rate 1
$4.90 ……4.90 ,,,,,,,,4.90 ,,,,,,,,4.90 4.90
End of Year =
Depreciation Expense
Accumulated Depreciation
Carrying Amount
$12,250 50,470 48,510 43,120 41,650
$ 12,250 62,720 111,230 154,350 196,000
$196,000 183,750 133,280 84,770 41,650 0
Depreciation rate (per unit): $196,000 40,000
=
$4.90
The double-diminishing-balance depreciation causes net income to be lower in the early years of the asset’s life because the depreciation expense is higher in 2019 and 2020 than under the other two methods.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-3B (CONTINUED) (c)
Yes, there would be an impact. The cost to recycle the machine at the end of its useful life would need to be estimated. The estimated cost would then be added to the cost of the machine and allocated over its useful life, increasing the depreciation charge.
LO 1,2 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-4B (a)
(1)
Year
Depreciable Cost
2018 2019 2020 2021 2022
$150,0001 150,000 150,000 150,000 150,000
STRAIGHT-LINE DEPRECIATION Calculation End of Year Depreciation # of Depreciation Accumulated Carrying Rate 2 Mos. Expense Depreciation Amount 25% 25% 25% 25% 25%
1/12 12/12 12/12 12/12 11/12
1
$165,000 – $15,000 = $150,000
2
1 ÷ 4 years = 25%
(a)
$ 3,125 37,500 37,500 37,500 34,375
$ 3,125 40,625 78,125 115,625 150,000
$161,875 124,375 86,875 49,375 15,000
(2) DOUBLE-DIMINISHING-BALANCE DEPRECIATION Calculation
Year
Carrying Amount Beg. of Year
2018 2019 2020 2021 2022
$165,000 158,125 79,062 39,531 19,765
End of Year
Depreciation Rate 1
# of months
Depreciation Expense
Accumulated Depreciation
Carrying Amount
50% 50% 50% 50% 50%
1/12 12/12 12/12 12/12
$ 6,875 79,063 39,531 19,766 4,7652
$ 6,875 85,938 125,469 145,235 150,000
$158,125 79,062 39,531 19,765 15,000
1
1 ÷ 4 years × 2 = 25% × 2 = 50%
2
Adjusted so that the carrying amount at the end of the useful life equals $15,000 ($19,765 × 50% × 11/12 = $9,059 was not used as it would make the carrying amount lower than the residual value; $19,765 – $15,000 = $4,765).
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PROBLEM 9-4B (CONTINUED) (a)
(3) UNITS-OF-PRODUCTION DEPRECIATION Calculation Year
Units-ofProduction
2018 2019 2020 2021 2022
7,500 100,000 62,500 95,000 35,000
1
(b)
×
Depreciable Cost/Unit 1 $0.50 0.50 0.50 0.50 0.50
End of Year =
Depreciation Expense
Accumulated Depreciation
Carrying Amount
$ 3,750 50,000 31,250 47,500 17,500
$ 3,750 53,750 85,000 132,500 150,000
$161,250 111,250 80,000 32,500 15,000
Depreciable cost per unit = ($165,000 – $15,000) ÷ 300,000 km = $0.50 per kilometre Total depreciation: Straight -Line $150,000 150,000
Depreciation expense Accumulated depreciation
DiminishingBalance $150,000 150,000
DoubleUnits-ofProduction $150,000 150,000
(c)
The estimates used in determining the depreciation amount include the useful life of the asset, the total number of units of production expected, and the residual value when the business has completed its use of the asset. Management’s ability to arrive at accurate estimates depends on past experience with similar assets and to some extent to what will happen in the future, particularly with respect to the continued use of the asset. If the way the asset is used changes or if management’s intention concerning how long the asset will be used changes, the estimates will need revision.
(d)
Depreciation is a non-cash expense so the cash flows are not affected.
(e)
I would recommend the units-of-production method as it best reflects the pattern of the economic benefits produced by the bus, given the variability of usage each year.
LO 2 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 9-5B (a) Cost, January 1, 2016 Less: Residual value Depreciable cost Useful life in years Annual depreciation ($55,500 ÷ 5)
Equipment $60,000 0 60,000 ÷ 5 $12,000
The equipment’s accumulated depreciation on January 1, 2018 will be $24,000 ($12,000 × 2 years) and the carrying amount will be $36,000 ($60,000 – $24,000).
(b)
Proceeds from cash sale Carrying amount of equipment sold ($36,000 x 1/3)* Gain on disposal *Carrying amount of equipment sold: Cost ($60,000 x 1/3) Accumulated Depreciation to date of sale ($20,000 ÷ 5 x 2) Carrying amount ($36,000 x 1/3)
(c)
(d)
Depreciation from Jan. 1, 2018 to Sept. 30, 2018 Annual amount of depreciation ($40,000 / 5) Number of months Depreciation expense Depreciation on new equipment: Cost ÷ useful life x 3/12 $10,000 ÷ 5 x 3/12=
$17,000 12,000 $ 5,000 $20,000 8,000 $12,000
$ 8,000 x 9/12 $ 6,000
$ 500
Depreciation on remaining equipment: ($40,000 / 5) Number of months Depreciation expense
$8,000 x 3/12 $ 2,000
Total depreciation for Oct 1 to Dec 31
$ 2,500
Total equipment depreciation for 2018 (for part e)
$ 8,500
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PROBLEM 9-5B (CONTINUED) (e) Equipment Jan. 1, 2018 Oct. 1, 2018 Dec. 31, 2018
60,000 10,000 38,000
Disposal Jan. 1, 2018 (b) Disposal Dec. 31, 2018
20,000 12,000
Accumulated Depreciation-Equipment Disposal Jan. 1, 2018 (b) Disposal Dec. 31, 2018
8,000 6,500
Jan. 1, 2018 Depreciation (d)
24,000 8,500
Dec. 31, 2018
18,000
Cost of equipment sold (derived above)................ Accumulated depreciation (derived above) ........... Net carrying amount .............................................. Loss on disposal ................................................... Cash proceeds from sale ......................................
$12,000 6,500 5,500 _2,000 $ 3,500
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-6B (a)
2016 Jan. 1
Equipment ............................................................ 170,000 Accounts Payable ........................................
(b)
DIMINISHING–BALANCE DEPRECIATION Calculation
Year
Opening Carrying Amount
2016 2017 Aug/18
$170,000 144,500 115,600
1
×
170,000
End of Year
Depreciation Rate 1
Depreciation Expense
Accumulated Depreciation
Carrying Amount
20% × 9/12 20% 20% × 10/12
$ 25,500 28,900 19,267
$25,500 54,400 73,667
$144,500 115,600 96,333
1 ÷ 5 years = 20%
2016 Sept. 30
2017 Sept. 30
Solutions Manual .
Depreciation Expense .......................................... Accumulated Depreciation—Equipment.......
25,500
Depreciation Expense .......................................... Accumulated Depreciation—Equipment.......
28,900
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25,500
28,900
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-6B (CONTINUED) (c)
2018 (1, 2, 3) Aug. 1 (1)
Aug. 1
Depreciation Expense .......................................... Accumulated Depreciation—Equipment.......
Aug. 1
Aug. 1
80,000 73,667 16,333 170,000
$ 80,000 96,333 $(16,333)
Accumulated Depreciation—Equipment ............... Loss on Disposal .................................................. Equipment...................................................
Cash proceeds ................................................... Carrying amount ................................................. Loss on disposal .................................................
170,000 18,667
$115,000 96,333 $ 18,667
Cash .................................................................... Accumulated Depreciation—Equipment ............... Loss on Disposal .................................................. Equipment...................................................
Cash proceeds ................................................... Carrying amount ................................................. Loss on disposal .................................................
(3)
19,267
Cash .................................................................... 115,000 Accumulated Depreciation—Equipment .............. 73,667 Equipment................................................... Gain on Disposal ........................................
Cash proceeds ................................................... Carrying amount ................................................. Gain on disposal ................................................. (2)
19,267
73,667 96,333 170,000
$
0 96,333 $ (96,333)
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PROBLEM 9-7B (a)
(1)
Straight-line
Depreciation Expense = ($50,000 – $10,000) 3 2018 Feb. 1
Dec. 31
2019 Oct. 31
31
Solutions Manual .
=
$13,333
Equipment .............................................................. Cash ................................................................
50,000
Depreciation Expense ............................................ Accumulated Depreciation—Equipment .......... ($13,333 × 11/12 = $12,222)
12,222
Depreciation Expense ............................................ Accumulated Depreciation—Equipment .......... ($13,333 × 10/12 = $11,111)
11,111
Cash ....................................................................... Accumulated Depreciation—Equipment ($12,222 + $11,111) ............................................... Loss on Disposal. ................................................... Equipment ..............................................................
12,000
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50,000
12,222
11,111
23,333 14,667 50,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-7B (CONTINUED) (a)
(2)
Double-diminishing-balance
Depreciation rate = 1/3 x 2 = 67% (note textbook convention to round rates to two decimal spots 0.67 or 67%) 2018 Feb. 1
Dec. 31
2019 Oct. 31
31
Solutions Manual .
Equipment .............................................................. Cash ................................................................
50,000
Depreciation Expense ............................................ Accumulated Depreciation—Equipment .......... ($50,000 × 67% × 11/12 = $30,708)
30,708
Depreciation Expense ............................................ Accumulated Depreciation—Equipment .......... [($50,000 – $30,708) × 67% × 10/12 = $10,771]
10,771
Cash ...................................................................... Accumulated Depreciation—Equipment ($30,708 + $10,771) ............................................... Gain on Disposal ............................................. Equipment .......................................................
12,000
9-68
50,000
30,708
10,771
41,479 3,479 50,000
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PROBLEM 9-7B (CONTINUED) (a)
(3)
Units-of-Production
Depreciable cost per unit = ($50,000 – $10,000) 10,000 2018 Feb. 1
Dec. 31
2019 Oct. 31
31
=
$4.00
Equipment .............................................................. Cash ................................................................
50,000
Depreciation Expense ............................................ Accumulated Depreciation—Equipment .......... (4,000 × $4 = $16,000)
16,000
Depreciation Expense ............................................ Accumulated Depreciation—Equipment .......... (5,000 × $4 = $20,000)
20,000
Cash ....................................................................... Accumulated Depreciation—Equipment ($16,000 + $20,000) ............................................... Loss on Disposal .................................................... Equipment ..........................................................
12,000
50,000
16,000
20,000
36,000 2,000 50,000
(b)
Depreciation expense 2018 2019 Total depreciation for two years + Loss (or – gain) on disposal = Net expense for two years
Straight -Line
DoubleDiminishing -Balance
Units-ofProduction
$12,222 11,111
$30,708 10,771
$16,000 20,000
23,333 14,667
41,479 (3,479)
36,000 2,000
$38,000
$38,000
$38,000
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PROBLEM 9-8B (a)
April
May
1
1
1
Land ........................................................... Cash................................................... Mortgage Payable ..............................
3,800,000
Depreciation Expense ................................ Accumulated Depreciation—Equipment ($1,500,000 ÷ 10 × 4/12 = $50,000)
50,000
Cash ........................................................... Accumulated Depreciation—Equipment ..... Loss on Disposal ........................................ Equipment ..........................................
700,000 650,000 150,000
Cash proceeds Cost Accumulated depreciation—equipment [($1,500,000 ÷ 10) × 4 + $50,000)] Carrying amount Loss on disposal June
July
Sept.
1
1
2
Dec. 31
31
31
Solutions Manual .
950,000 2,850,000
50,000
1,500,000 $ 700,000 $1,500,000 650,000 850,000 $(150,000)
Cash ........................................................... Notes Receivable ....................................... Land ................................................... Gain on Disposal ................................
760,000 1,640,000
Equipment .................................................. Accounts Payable ..................................
2,000,000
Accounts Payable ...................................... Cash...................................................
2,000,000
Depreciation Expense ................................ Accumulated Depreciation—Equipment ($940,000 ÷ 10 = $94,000)
94,000
Accumulated Depreciation—Equipment ..... Equipment ..........................................
940,000
600,000 1,800,000
2,000,000
2,000,000 94,000
Impairment Loss......................................... 200,000 Land ................................................... (8,000,000 +3,800,000 – 600,000 = $11,200,000) ($11,200,000 – $11,000,000 = $200,000)
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940,000
200,000
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PROBLEM 9-8B (CONTINUED) (b)
Dec.
31
31
Depreciation Expense ................................ Accumulated Depreciation—Buildings ($57,000,000 ÷ 40 = $1,425,000)
1,425,000
Depreciation Expense ................................ Accumulated Depreciation—Equipment
9,456,000
$93,560,000* ÷ 10 $2,000,000 ÷ 10 × 6/12
$9,356,000 100,000 $9,456,000
1,425,000
9,456,000
*$96,000,000 – $1,500,000 – $940,000 = $93,560,000 31
31
(c)
Interest Expense ........................................ Interest Payable ................................. ($2,850,000 × 6% × 9/12 = $128,250)
128,250
Interest Receivable .................................... Interest Revenue ................................ ($1,640,000 × 6% × 7/12 = $57,400)
57,400
128,250
57,400
HAMMERSMITH LIMITED Statement of Financial Position (Partial) December 31, 2018 Property, plant, and equipment* Land .................................................................. Buildings ............................................................ Less: Accumulated depreciation ........................ Equipment ......................................................... Less: Accumulated depreciation ........................ Total property, plant, and equipment ..........
$11,000,000 $57,000,000 25,625,000 $95,560,000 38,010,000
31,375,000 57,550,000 $99,925,000
*See T accounts on the following page.
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PROBLEM 9-8B (CONTINUED) (c) (continued) Land Jan. 1, 2018 April 1, 2018
8,000,000 3,800,000
Dec. 31, 2018
Bal. 11,000,000
June 1, 2018 Dec. 31, 2018
600,000 200,000
Buildings Jan. 1, 2018 Dec. 31, 2018
57,000,000 Bal. 57,000,000
Equipment Jan. 1, 2018 July 1, 2018 Dec. 31, 2018
96,000,000 2,000,000
May 1, 2018 Dec. 31, 2018
1,500,000 940,000
Bal. 95,560,000
Accumulated Depreciation—Buildings Jan. 1, 2018 Dec. 31, 2018
24,200,000 1,425,000
Dec. 31, 2018
Bal. 25,625,000
Accumulated Depreciation—Equipment May 1, 2018 Dec. 31, 2018
650,000 940,000
Jan. 1, 2018 May 1, 2018 Dec. 31, 2018 Dec. 31, 2018
30,000,000 50,000 94,000 9,456,000
Dec. 31, 2018
Bal. 38,010,000
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PROBLEM 9-9B (a)
(b)
(c)
(d)
1.
yes
Goodwill
not amortized N/A
2.
no
N/A
N/A
Assets under Finance Leases, Statement of Financial Position, Property, plant, and equipment
3.
yes
Software
amortized
N/A
4.
yes
Patents
amortized
N/A
5.
no
N/A
N/A
Professional Fees Expense, Income Statement, Operating expenses
6.
no
N/A
N/A
Not recorded or reported because it was internally generated and not purchased
7.
no
N/A
N/A
Rent Expense, Income Statement, Operating expenses
8.
yes
Trademarks
not amortized N/A
9.
yes
Trademarks
not amortized N/A
10.
no
N/A
N/A
Research Expenses, Income Statement, Operating expenses
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PROBLEM 9-10B (a)
Jan.
July
1
1
1
Sept.
Oct.
1
1
Dec. 31
(b)
Dec. 31
31
31
31
Solutions Manual .
Patents ................................................................... Cash ................................................................
22,500
Research Expenses ............................................... Cash ................................................................
220,000
Development Costs ................................................ Cash ................................................................
60,000
Advertising Expense .............................................. Cash ................................................................
11,000
Copyrights .............................................................. Cash ................................................................
16,000
Impairment Loss ($175,000 – $210,000) ............... Goodwill...........................................................
35,000
Amortization Expense (given) ................................ Accumulated Amortization—Patents ...............
9,812
Amortization Expense ............................................ Accumulated Amortization—Development Costs ($60,000 ÷ 20 × 6/12 = $1,500)
1,500
Amortization Expense ............................................ Accumulated Amortization—Copyrights .......... ($48,000 ÷ 10 = $4,800)
4,800
Amortization Expense ............................................ Accumulated Amortization—Copyrights .......... ($16,000 ÷ 5 × 3/12 = $800)
800
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22,500
220,000
60,000
11,000
16,000
35,000
9,812
1,500
4,800
800
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PROBLEM 9-10B (CONTINUED) (c) IP CORP. Statement of Financial Position (partial) December 31, 2018 Intangible Assets and Goodwill Finite life intangible assets Patents................................................................. Less: Accumulated amortization .......................... Copyrights ............................................................ Less: Accumulated amortization .......................... Development costs .............................................. Less: Accumulated amortization .......................... Goodwill ....................................................................... Total intangible assets and goodwill ....................
$92,5001 23,8122 64,0003 34,4004 60,000 1,500
1
Patents: $70,000 + $22,500 = $92,500
2
Accumulated amortization: $14,000 + $9,812 = $23,812
3
Copyrights: $48,000 + $16,000 = $64,000
4
Accumulated amortization Copyright (original): $28,800 + $4,800 = Copyright (additional):
5
$ 68,688 29,600 58,500 175,0005 $331,788
$33,600 800 $34,400
Goodwill: $210,000 – $35,000 = $175,000
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PROBLEM 9-11B (a) (in millions) Bay
Dollarama ................................... Hudson’s
Profit margin
$295 = 12.7% $2,331
$238 = 2.9% $8,169
Asset turnover
$ 2,331 $1,567 + $1,701 ( ) 2 = 1.4 times
$8,169 $7,942 + $9,072 ( ) 2 = 1.0 times
Return on assets
$295 $1,567 + $1,701 ( ) 2 = 18.1%
$238 $7,942 + $9,072 ( ) 2 = 2.8%
(b)
Based on the profit margin we can see that Dollarama is far more profitable than Hudson’s Bay. Both companies have profit margins that are higher than the average company in the industry (0.9%). The asset turnover measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. Dollarama’s asset turnover ratio is higher than Hudson’s Bay’s but neither company has a turnover in line with the average company in the industry (1.6 times). The return on assets ratio indicates that Dollarama is generating a much higher return than Hudson’s Bay based on the amount of assets invested in the business. Based on the industry average of 1.4%, both companies are performing better than the industry average.
(c)
Some additional information about long-lived assets that would assist in the comparisons include the accounting policies chosen concerning the calculation of depreciation and amortization, the estimates arrived at for the useful lives and residual values of the assets being depreciated, and details concerning the costs and accumulated depreciation or amortization recorded to date. The latter information would indicate the age of the long-lived assets.
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PROBLEM 9-12B (a) (in thousands)
NAL .......................................... BRI
Profit margin 2018
$220 = 8.8% $2,500
$250 = 13.9% $1,800
Profit margin 2017
$150 = 10.0% $1,500
$150 = 10.0% $1,500
Asset turnover 2018
$2,500 $2,500 + $1,100 ( ) 2 = 1.4 times
$1,800 $1,100 + $1,050 ( ) 2 = 1.7 times
Asset turnover 2017
$1,500 $1,100 + $1,000 ( ) 2 = 1.4 times
$1,500 $1,050 + $1,000 ( ) 2 = 1.5 times
Return on assets 2018
$220 $2,500 + $1,100 ( ) 2 = 12.2%
$250 $1,100 + $1,050 ( ) 2 = 23.3%
Return on assets 2017
$150 $1,100 + $1,000 ( ) 2 = 14.3%
$150 $1,050 + $1,000 ( ) 2 = 14.6%
(b)
Brew Right increased its profit margin from 10.0% to 13.9% and its asset turnover from 1.5 times to 1.7 times. The increases in these two ratios multiplied to generate a substantial increase in Brew Right’s return on assets from 14.6% to 23.3% (return on assets = profit margin × asset turnover). Northern Ale suffered a decrease in its profit margin from 10.0% to 8.8%. The company’s asset turnover remained the same during this time period at 1.4 times. Combining the two ratios resulted in a decrease in the return on assets.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 9-12B (CONTINUED) (c)
Brew Right has been more successful in executing its strategy. Its strategy of cutting costs has allowed it to boost its profit margin while simultaneously increasing its sales volume. The increase in sales was proportionately higher than the increase in assets over the two-year period and resulted in an increase in the asset turnover. Streamlining operations has resulted in more efficient use of assets and a higher return on assets. Northern Ale’s strategy of expansion has resulted in a larger asset base. While its sales volume did increase from 2017 to 2018, the net income per dollar of sale decreased, as evidenced by the decrease in profit margin. It appears to be accepting a higher volume of sales to the detriment of profit margin. While the company maintained its asset turnover due to the increase in sales volume, the decrease in profit margin resulted in a decrease in the return on assets. Given the company’s lower return on assets ratio, this strategy does not appear to be successful.
LO 6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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ACR9-1 (a)
Aug.
1
2
3
8
9
10
Financial Accounting, Seventh Canadian Edition
ACCOUNTING CYCLE REVIEW
Office Expense .................................................. Cash..........................................................
20,000
Rent Expense.................................................... Cash..........................................................
3,600
Notes Receivable .............................................. Accounts Receivable.................................
100,000
Accounts Receivable......................................... Sales .........................................................
500,000
Cost of Goods Sold ........................................... Inventory ...................................................
270,000
Allowance for Doubtful Accounts....................... Accounts Receivable.................................
70,000
Cash ............................................................... Sales Discounts ($306,122 x 2%) ..................... Accounts Receivable ($300,000 ÷ .98) .....
300,000 6,122
Cash ............................................................... Accumulated Depreciation—Equipment ............ Loss on Disposal ............................................... Equipment .................................................
6,000 36,169 1,831
Cash proceeds Cost Accumulated depreciation—equipment Carrying amount Loss on disposal 14 21
31
Solutions Manual .
20,000
3,600
100,000
500,000
270,000
70,000
306,122
44,000 $ 6,000 $44,000 36,169 7,831 $(1,831)
Income Tax Expense ........................................ Cash..........................................................
10,000
Patents .............................................................. Cash..........................................................
24,000
Cash ............................................................... Sales .........................................................
75,000
Cost of Goods Sold ........................................... Inventory ...................................................
35,000
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10,000 24,000
75,000 35,000
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Financial Accounting, Seventh Canadian Edition
ACR9-1 (CONTINUED) (a) (continued) Aug.
31
31
31
31
31
31
Interest Expense ............................................... Bank Charges Expense .................................... Cash..........................................................
1,500 1,130
Bad Debt Expense ............................................ Allowance for Doubtful Accounts............... [$320,000 – ($300,000 - $70,000)] = $90,000
90,000
Depreciation Expense ....................................... Accumulated Depreciation—Equipment.... ($150,000 ÷ 4 × 1/12 = $3,125)
3,125
Salaries Expense .............................................. Cash..........................................................
100,000
Interest Receivable ........................................... Interest Revenue ....................................... ($100,000 x 8% X 1/12)
667
Amortization Expense ....................................... Accumulated Amortization—Patents ......... ($24,000 ÷ 5 X 1/12) =$400
400
2,630
90,000
3,125
100,000
667
400
(b)
July 31, 2018 Aug. 9 Aug. 10 Aug. 31
Aug. 31 Bal.
Cash 170,000 Aug. 1 300,000 Aug. 1 6,000 Aug. 14 75,000 Aug. 21 Aug. 31 Aug. 31 390,770
Accounts Receivable July 31, 2018 2,700,000 Aug. 2 Aug. 3 500,000 Aug. 8 Aug. 9 Bal. 31 Bal 2,723,878
Solutions Manual .
Allowance for Doubtful Accounts 20,000 3,600 10,000 24,000 2,630 100,000
100,000 70,000 306,122
Aug. 8
70,000 July 31, 2018
300,000
Aug. 31
90,000
Aug. 31 Bal.
320,000
Interest Receivable Aug. 31
667
Aug. 31 Bal.
667 Notes Receivable
Aug. 2
100,000
Aug. 31 Bal.
100,000
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Financial Accounting, Seventh Canadian Edition
ACR9-1 (CONTINUED) (b) (continued) Inventory July 31, 2018 Aug. 31 Bal.
Common Shares
500,000 Aug. 3
270,000
31
35,000
Aug.
31 Bal.
Retained Earnings
July 31, 2018
194,000 Aug. 10
Aug. 31 Bal.
150,000
July 31, 2018 1
44,000
Aug. 31 Bal. Sales
Accumulated Depreciation—Equipment
Aug.
36,169 July 31, 2018 73,669 31
3,125
Aug. 31 Bal.
40,625
Aug. 21
24,000
Aug. 31 Bal.
24,000
31 Aug.
Aug. 9
6,122
Aug. 31 Bal.
6,122
31 Bal.
Interest Revenue
Accumulated Amortization—Patents Aug. 31
400
Aug. 31 Bal.
400
Aug. 31
667
Aug. 31 Bal.
667
Cost of Goods Sold
Accounts Payable July 31, 2018 1,009,000 Aug. 31 Bal.
3
Sales Discounts
Patents
July 31, 2012
31, 2018
195,000 Equipment
Aug. 10
July
1,009,000
Aug. 3
270,000
Aug. 31
35,000
Aug. 31 Bal.
305,000
260,000 Bank Loan Payable
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Depreciation Expense
July 31, 2018
350,000 Aug. 31
3,125
Aug. 31 Bal.
350,000 Aug. 31 Bal.
3,125
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1
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Financial Accounting, Seventh Canadian Edition
ACR9-1 (CONTINUED) (b) (continued) Bank Charges Expense
Amortization Expense Aug. 31
400
Aug.
31
1,130
Aug. 31 Bal.
400
Aug.
31 Bal.
1,130 Interest Expense
Salaries Expense Aug.
31
100,000
Aug.
31
1,500
Aug.
31 Bal.
100,000
Aug.
31 Bal.
1,500
Bad Debts Expense
Loss on Disposal
Aug.
31
90,000
Aug.
10
1,831
Aug.
31 Bal.
90,000
Aug.
31 Bal.
1,831
Office Expense Aug.
1
20,000
Aug.
31 Bal.
20,000
Income Tax Expense Aug.
14
10,000
Aug.
31 Bal.
10,000
Rent Expense Aug.
1
3,600
Aug.
31 Bal.
3,600
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Financial Accounting, Seventh Canadian Edition
ACR9-1 (CONTINUED) (c) CLEAR IMAGES LTD. Adjusted Trial Balance August 31, 2018 Debit $ 390,770 2,723,878
Cash Accounts receivable Allowance for doubtful accounts Notes receivable Interest receivable Inventory Equipment Accumulated depreciation—equipment Patents Accumulated amortization—patents Accounts payable Bank loan payable Common shares Retained earnings Sales Sales discounts Interest revenue Cost of goods sold Depreciation expense Amortization expense Salaries expense Bad debts expense Office expense Rent expense Bank charges expense Interest expense Loss on disposal Income tax expense
Solutions Manual .
Credit
$ 320,000 100,000 667 195,000 150,000 40,625 24,000 400 1,009,000 350,000 300,000 1,531,331 575,000 6,122 667 305,000 3,125 400 100,000 90,000 20,000 3,600 1,130 1,500 1,831 10,000 $4,127,023
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000000000 $4,127,023
Chapter 9
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR9-1 (CONTINUED) (d) (1) CLEAR IMAGES LTD. Income Statement Month Ended August 31, 2018 Sales Less: Sales discounts Cost of goods sold Gross profit Operating expenses Salaries expense Bad debts expense Office expense Rent expense Bank charges expense Depreciation expense Amortization expense Loss on disposal Total operating expenses Income from operations Other revenues and expenses Interest revenue Interest expense Total other revenues and expenses Income before income tax Income tax expense Net income
Solutions Manual .
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$575,000 6,122
$568,878 305,000 263,878
100,000 90,000 20,000 3,600 1,130 3,125 400 1,831 220,086 43,792 667 (1,500) (833) 42,959 10,000 $ 32,959
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Financial Accounting, Seventh Canadian Edition
ACR9-1 (CONTINUED) (d) (2) CLEAR IMAGES LTD. Statement of Changes in Equity Month Ended August 31, 2018
Balance, August 1 Net income Balance, August 31
Common Shares $300,000 0000 000 $300,000
Retained Earnings $1,531,331 32,959 $1,564,290
Total Equity $1,831,331 32,959 $1,864,290
(d) (3) CLEAR IMAGES LTD. Statement of Financial Position August 31, 2018 Assets Current assets Cash Accounts receivable Less: Allowance for doubtful accounts Interest receivable Notes receivable Inventory Total current assets Property, plant, and equipment Equipment Less: Accumulated depreciation Intangible assets Patents Less: Accumulated amortization Total assets
$ 390,770 $2,723,878 320,000
150,000 40,625 24,000 400
2,403,878 667 100,000 195,000 3,090,315
109,375
23,600 $3,223,290
Liabilities and Shareholders’ Equity Liabilities Accounts payable $1,009,000 Bank loan payable 350,000 Total liabilities $1,359,000 Shareholders’ equity Common shares 300,000 Retained earnings 1,564,290 Total shareholders’ equity 1,864,290 Total liabilities and shareholders’ equity $3,223,290 LO 1,2,3,4,5 BT: AP Difficulty: M Time: 90 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT9-1
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
The North West Company Inc. uses a straight-line method of depreciating its property and equipment. Instead of using the term depreciation, North West uses the term amortization.
(b)
($ in thousands) (1) Cost January 31, 2016 Land Buildings Leasehold improvements Fixtures and equipment Computer equipment
January 31, 2015 Land Buildings Leasehold improvements Fixtures and equipment Computer equipment
$ 16,935 417,182 64,055 294,922 77,142 $870,236
$ 16,041 377,061 51,845 265,706 73,151 $783,804
(2) Accumulated Depreciation
(3) Impairment Losses
(4) Carrying Amount
$232,202 34,811 207,004 67,413 $541,430
$ 16,935 184,980 29,244 87,918 9,729 $328,806
$209,584 30,296 186,617 62,074 $488,571
$ 16,041 167,477 21,549 79,089 11,077 $295,233
(c)
Net change in accumulated amortization Amortization recorded in 2016 Difference from disposals and effect of movements in foreign exchange
$52,859 40,216 $12,643
(d)
North West has a balance of Goodwill at January 31, 2016 of $37,260,000
(e)
At January 31, 2016, North West report intangibles including: Software, Cost-U-Less banner, and Other for a total carrying amount of $32,610,000. There were no impairment losses recorded for intangibles for the year ended January 31, 2016, nor were any fully depreciated intangibles written off during the year.
LO 2,4,5 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic and Communication CPA: cpa-t001 CM: Reporting
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CT9-2 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Rosewood follows IFRS, which allows companies to reverse impairment losses. This means it would record the following entry and adjust the carrying amount of the buildings from $5,000,000 to $5,800,000: Resort Property ................................................................. Impairment Loss........................................................
800,000 800,000
(b)
Blaze Mountain Resort follows ASPE, which does not allow companies to reverse impairment losses. Therefore, no adjustment is required for Blaze Mountain.
(c)
Before considering any adjustments for impairment loss reversals, a preliminary calculation of profit margin and return on assets is as follows:
1. Profit Margin 2. Asset Turnover 3. Return on Assets
Rosewood (without impairment reversal) $180,000 ÷ $2,250,000 = 8.0% $2,250,000 ÷ $9,000,000 = 0.3 times $180,000 ÷ $9,000,000 = 2.0%
Blaze Mountain (without impairment reversal) $200,000 ÷ $2,500,000 = 8.0% $2,500,000 ÷ $10,000,000 = 0.3 times $200,000 ÷ $10,000,000 = 2.0%
If we take into consideration the adjustment Rosewood made above to reverse the impairment loss, income would now increase by $800,000 to $980,000 while average assets would increase by $400,000 ($800,000 ÷ 2). We are dividing this last term by two because the denominator pertains to average assets, not assets at the end of the year. The adjusted ratios for Rosewood are as follows: Rosewood (with impairment reversal) 1. Profit Margin 2. Asset Turnover 3. Return on Assets
Solutions Manual .
$980,000 ÷ $2,250,000 = 43.6% $2,250,000 ÷ $9,400,000 = 0.2 times $980,000 ÷ $9,400,000 = 10.4%
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Blaze Mountain (without impairment reversal) $200,000 ÷ $2,500,000 = 8.0% $2,500,000 ÷ $10,000,000 = 0.3 times $200,000 ÷ $10,000,000 = 2.0%
Chapter 9
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Financial Accounting, Seventh Canadian Edition
CT9-2 (CONTINUED) (d)
When looking at the profit margin and return on assets, it appears that Rosewood is performing better. However, that preliminary analysis does not account for the fact that the companies are using different accounting standards. One needs to be cautious when comparing companies that follow different standards. Different accounting policies can make direct comparability difficult. Generally, if you are comparing financial statements of companies that do not follow the same standards, you would make adjustments so that the financial statements are comparable.
(e)
Examples of additional information that would help assess the nature and performance of long-lived assets would include: Specific ratios adjusted to remove accounting standard differences. The hotel star rating of the resorts to help assess the quality and popularity of the resorts (this will help you assess future cash flows and potential impairment). Budgets and forecasts along with details on room occupancy rates would also help assess future cash flows. The condition and age of the buildings. Whether significant renovations or other large expenses are expected in the near future.
LO 2,6 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic and Communication CPA: cpa-t001, cpat005 CM: Reporting and Finance
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CT9-3
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a)
Land – no depreciation is recorded on this asset because its useful life is infinite and the cost cannot be allocated over the useful life. Buildings – as usage of buildings is uniform over their useful life, the straight-line method would be appropriate in this case. Drilling rigs – since the use of these rigs is seasonal in nature, it would make sense to use the units-of-production method for these assets so that depreciation would be higher during periods when the rigs are being used the most and lower in periods when the rigs are not used as much. Furniture – as usage of these assets is uniform over their useful life, the straight-line method would be the most appropriate method.
(b)
Intangible assets with definite lives should be amortized. Amortization is typically recorded using the straight-line method and is recorded over the lesser of the intangible’s legal life and useful life. In this case, a patent has a 20-year legal life but the useful life of the patent is likely to be five years given the length of the royalty contract with the drill bit manufacturer.
(c)
Since the company is planning to have its shares trade on a public stock exchange sometime over the next 3 years, it may be better to prepare its financial statements under IFRS now rather than converting from ASPE to IFRS when the company goes public.
(d)
When a bank lends money to a company, the bank wants security or collateral for its loan. The best collateral includes assets that can retain their value over time and are not easily moved. If the company defaulted on its loan payments, the bank could seize these assets. Therefore, the bank would want to use land and buildings for collateral. The bank would be least likely to use an intangible asset because it is difficult to determine its value and this value could fall rapidly over time. Furniture is unlikely to serve as collateral because it can be moved and would be hard for the bank to seize such an asset. In addition, furniture has little resale value.
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Financial Accounting, Seventh Canadian Edition
CT9-3 (CONTINUED) (e)
The asset turnover ratio is calculated by dividing sales revenue by average total assets. Next year, the numerator is not expected to change. If the company is not planning to purchase any new rigs or other assets, because these assets are depreciated each year, their carrying amounts will fall and consequently, the denominator of this ratio will decline. Therefore, the asset turnover ratio will rise. Normally an increase in this ratio would lead one to conclude that the company is generating more revenues with its assets, but in this case the increase simply means that the company has decided not to replace some of its aging assets.
LO 1,2,4,6 BT: E Difficulty: C Time: 20 min. AACSB: Analytic and Communication CPA: cpa-t001, cpa-e003 CM: Reporting and Comm.
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CT9-4
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
(a)
The stakeholders in this situation are: Benny Benson, president of Imporia Container Ltd. Yeoh Siew Hoon, controller. The shareholders and creditors of Imporia Container Ltd. Potential investors and creditors in Imporia Container Ltd.
(b)
Income before income tax in 2018 (the year of change) will increase by implementing the president’s proposed changes because increasing the useful life and residual value will decrease the depreciation expense. The change will not affect net income for 2017.
(c)
The proposed changes in useful life and residual value will increase the profit margin because the depreciation expense has been reduced, causing the increased profit. The proposed change will also cause an increase in the average assets without changing net sales. An increase in average assets decreases the asset turnover.
(d)
The intentional misstatement of the life and residual value of an asset is unethical and would represent an attempt at income manipulation. There is nothing unethical about changing the estimate of either the life of an asset or its residual value if the change is an attempt to better reflect the pattern of consumption of economic benefits. In this case, it is clear that the revisions in the life and residual value are intended only to improve income, which would be unethical.
LO 2,6 BT: E Difficulty: M Time: 15 min. AACSB: Ethics and Communication CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT9-5 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
In order to solve, one must work backward to calculate income before interest, taxes, and depreciation (EBITDA). For Luxor: Net income Income taxes ($175,000 / .78 x .22) Income before income taxes ($175,000 / .78) Add: Interest expense ($2,800,000 x 4%) $112,000 Depreciation expense ($1,700,000 ÷ 20) 85,000 Income before interest, taxes, and depreciation For Cale: Income before interest, taxes, and depreciation Less: Interest expense ($350,000 x 4%) $14,000 Depreciation expense ($100,000 ÷ 5) 20,000 Rent expense ($17,000 x 12) 204,000 Income before income taxes Income tax expense ($183,359 x 22%) Net Income
(b)
Total assets Luxor Dec. 31, 2018 Less: Land Buildings net of accumulated depreciation ($1,700,000 – $85,000) Remaining assets Dec. 31, 2018:
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197,000 $ 421,359 $421,359
238,000 183,359 40,339 $143,020 $3,025,000
$800,000 1,615,000
Assets for Cale Equal to remaining assets of Luxor Add: Leasehold improvements net of accumulated Depreciation ($100,000 - $ 20,000) Total assets Cale Dec. 31, 2018:
Solutions Manual .
$175,000 49,359 224,359
2,415,000 $ 610,000
$610,000 80,000 $690,000
Chapter 9
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Financial Accounting, Seventh Canadian Edition
CT9-5 (CONTINUED) (c)
Asset turnover Luxor
Cale $3,000,000 = 4.3 times $690,000
$3,000,000 = 1.0 times $3,025,000
Despite the fact that the assets used by these two businesses are essentially the same, the turnover ratio is dramatically different because the land and building is owned by Luxor and leased by Cale. This example demonstrates how financial information may be misinterpreted by financial statement users. This example also demonstrates the need for change in the accounting standards, to those proposed for implementation in 2019, for public companies. (d)
Profit margin Luxor
Cale $175,000 = 5.8% $3,000,000
$143,020 = 4.8% $3,000,000
Luxor manages to outpace Cale by a full percentage point on profit margin because, although it incurred additional interest expense, its depreciation expense was far lower than Cale’s combined interest and rent expense. (e)
Return on assets Luxor
Cale $175,000 = 5.8% $3,025,000
$143,020 = 20.7% $690,000
Because the lease of the premises by Cale is treated as an operating lease, large amounts for land and building are not included on the statement of financial position as assets. Consequently, Cale has a much better return on asset ratio than Luxor.
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Financial Accounting, Seventh Canadian Edition
CT9-5 (CONTINUED) (f)
Because the lease of the premises by Cale is treated as an operating lease, large amounts for land and building are not included on the statement of financial position as assets. In addition, although there is a commitment to pay $17,000 per month for the next 4 years, no liability appears on the statement of financial position. Therefore, it is more difficult for readers of the financial statements to assess Cale’s financial position and profitability.
(g)
The revaluation method under IFRS affects the amount reported for property, plant, and equipment on the statement of financial position. Cale has treated the lease as an operating lease and so the assets are not capitalized and therefore not available for revaluation. Cale’s ratios would not change. In the case of Luxor, the revaluation model could affect the ratios. For example, if land is revalued at a higher amount, the return on assets and asset turnover ratios would reduce and become worse, but the profit margin would remain unchanged as gains on revalued assets are recorded in other comprehensive income, not net income.
(h)
Because the accounting recommendations concerning leases has been adopted effective 2019, Cale would need to capitalize the building on its statement of financial position. This would increase total assets and cause the asset turnover ratio to reduce and therefore become worse.
LO 2,6 BT: S Difficulty: C Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT9-6
Financial Accounting, Seventh Canadian Edition
STUDENT VIEW CASE
(a)
Option 1: $760.54 × 36 months = $27,379.44 total costs incurred $27,379.44 – $25,000 = $2,379.44 costs of financing
(b)
Option 2 (lease): $608.43 × 36 months = $21,903.48 total costs incurred
(c)
Option 2 (purchase): $21,903.48 (from (b) above) + $7,500 = $29,403.48 total costs incurred. You would own the three-year old truck after having purchased it for $7,500.
(d)
Option 2 of leasing the truck with no purchase at the end of its useful life appears, at least initially, to be the least expensive alternative. However, at the end of three years, you do not own a truck. Option 1, purchasing the truck rather than leasing it, would appear to be a reasonable choice as you own the truck that you can continue to use for a number of years without making any additional loan payments beyond the three-year loan period.
LO 1 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT9-7 (a)
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
The following costs should be capitalized: Purchase new server Purchase equipment Furniture Shipping (furniture) Total costs to be capitalized
$25,000 4,500 2,500 500 $32,500
The additional yearly software usage license for the new employees, the additional insurance, and painting the office should be expensed.
(b)
Jan.
2
2
Depreciation Expense .................................... Accumulated Depreciation—Equipment. ($15,000 ÷ 5 × 6/12 = $1,500)
1,500
Accumulated Depreciation—Equipment. ........ Loss on Disposal ............................................ Equipment .......................................
12,000 3,000
1,500
15,000
Accumulated depreciation—equipment: [($15,000 ÷ 5) × 3.5] + $1,500 = $12,000 The equipment has been in use for four years so on the date of disposal its accumulated depreciation is $12,000 (4 years at $3,000 per year). (c)
Jan.
2
Equipment ...................................................... Furniture ......................................................... Office Expense ............................................... Prepaid Insurance .......................................... Repair and Maintenance Expense ................. Cash.......................................................
29,500 3,000 2,000 1,000 2,850 38,350
LO 1,2,3 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
CHAPTER 10 REPORTING AND ANALYZING LIABILITIES LEARNING OBJECTIVES 1. 2. 3. 4.
Account for current liabilities. Account for instalment notes payable. Identify the requirements for the financial statement presentation and analysis of liabilities. Account for bonds payable (Appendix 10A).
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT
Item LO
BT
Item LO BT Questions
Item LO
BT
Item LO
BT
17.
4
C
17.
4
AP
1.
1
K
5.
1
C
9.
2
C
13.
3
C
2.
1
C
6.
1,2
C
10.
2
C
14.
3
C
3.
1
C
7.
2
K
11.
3
K
15.
3
C
8.
2
C
12.
3
C
16.
4
K
13.
4
AP
4.
1
C
Brief Exercises 1.
1
AP
5.
1
AN
9.
2
AP
2.
1
AP
6.
2
AN
10.
3
K
14.
4
AP
3.
1
AP
7.
2
AP
11.
3
AP
15.
4
AP
4.
1
AP
8.
2
AP
12.
3
AN
16.
4
AP
Exercises 1.
1
AN
4.
1
C
7.
2
AN
10.
3
AN
13.
4
AP
2.
1
AP
5.
2
AP
8.
3
AP
11.
4
AN
14.
4
AP
3.
1
AP
6.
2
AP
9.
3
AN
12.
4
AP
1.
1,3
AP
3.
2
AP
5.
2,3
AP
7.
3
AN
9.
4
AP
2.
1,3
AP
4.
2,3
AP
6.
1,3
K
8.
3
AN
10.
3,4
AP
2,3
AP
Problems: Set A and B
Accounting Cycle Review 1.
1,3
AP
Cases 1.
3
AN
3.
3
S
5.
3
S
2.
3
AN
4.
3
S
6.
3
AN
Solutions Manual .
10-1
7.
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
Solutions Manual .
10-2
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
Accounts payable and short-term notes payable are both forms of credit used by a business to acquire the items or services they need to operate. Both represent obligations of the business to repay amounts in the future and are therefore considered to be liabilities. However, an account payable is normally for a shorter period of time (e.g., 30, 60, 90 days) than a note payable. A note payable usually provides for a longer period of time to settle the amount owing. A note payable involves a more formal arrangement than an account payable. A note payable is an obligation in written form and will provide documentation if legal action is required to collect the debt. As well, a note payable often requires the payment of interest because it is generally used when credit is to be granted for a longer period of time than for an account payable.
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
An operating line of credit, or credit facility, is used by a business to overcome short-term cash demands or temporary cash shortfalls that invariably happen during the operating cycle. It is not usually intended to be a permanent type of financing and is generally used for operations. When needed, the funds are used and then repaid as the liquidity improves and cash becomes available from operations. Short-term bank loans are also liabilities of the business and are often structured in such a way to deal with short-term cash needs of the business. Short-term bank loans could be used to finance inventory and accounts receivable. Bank loans are for specific amounts that have structured terms for the repayment of the principal.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
Disagree. The company only serves as a collection agent for the taxing authority. It does not keep and report sales tax as revenue; it merely forwards the amount paid by the customer to the government. Therefore, until it is remitted to the government, sales tax is reported as a current liability on the statement of financial position.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-3
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
4.
Financial Accounting, Seventh Canadian Edition
Unearned revenue should be recognized when sales of gift cards are made to customers. When a gift card is presented to pay for items or services received by the customer, the unearned revenue is reduced and the sales or service revenue increased. If there is a legally permissible expiration date on the gift card, once that date is reached, any unused balances on gift cards should be recognized as revenue and the related unearned revenue eliminated.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
When determining whether an uncertain liability should be accrued as a provision, management must first assess the level of uncertainty concerning the outcome of a future event that will confirm either the existence of the liability or the amount payable or both. Under IFRS, if the outcome of a future event is probable and a reasonable estimate can be made of the amount expected to be paid, the amount will appear as a current liability on the statement of financial position. Probable, in this case means “more likely than not” which is normally interpreted to mean that there is more than a 50% probability of occurring. The details of the reasons for the accrual will also be outlined in the financial statement notes. If the outcome is not probable or if the amount cannot be reasonably estimated, the details of the uncertain liability will be disclosed in the notes to the financial statements. An uncertain liability that is disclosed rather than recorded is known under IFRS as a contingent liability. On the other hand, if the company is reporting under ASPE, the probability needs to be “likely” ASPE does not use the term “provision”. If the liability is recorded it is referred to as a, contingent liability and there is no special term for just having the contingency disclosed in a note to the financial statements rather than recording it. This is a higher level of probability that the standard used in IFRS.
LO 1 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
Current liabilities include those payments that are going to be due for payment in one year from the financial statement date. Non-current liabilities are to be paid beyond that period. Included in current liabilities would be the principal portion of any loans or debt that will be paid in the next year. Consequently, care must be taken to disaggregate balances of such non-current loans or mortgages to ensure that the current portion of the debt is properly classified as a current liability.
LO 1,2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-4
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
7.
Financial Accounting, Seventh Canadian Edition
Long-term instalment notes are similar to short-term notes in that they both provide written documentation of a debtor’s obligation to the lender. The main difference between the two types of notes is that long-term instalment notes have maturities that extend beyond one year and have principal repayments included in the periodic payments required by the note. For both types of notes, interest expense is calculated by multiplying the outstanding principal balance by the interest rate. However, because a portion of the principal balance is usually repaid periodically throughout the term of a long-term instalment note, the outstanding principal balance will change (decrease). In contrast, the principal balance does not change throughout the term of a short-term note.
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
8.
Instalment notes usually require the borrower to pay down a portion of the principal through fixed periodic payments relating to the principal along with any interest that was due at that time. Each time a payment is made, a constant amount of principal repayment is deducted from the note. The total payment amount will decline over time as the interest expense portion decreases due to reductions in the principal amount of the note. An instalment note with a blended principal and interest payment is repayable in equal periodic amounts and results in changing amounts of interest and principal being applied to the note. The total payment remains the same over the life of the note but the portion applied to the principal increases over time as the interest portion decreases due to reductions in the principal amount of the note.
LO 2 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
(a)
A student choosing the floating rate loan will initially pay a lower interest rate, but if the prime lending rate changes so does the interest rate that is charged on the balance of the loan. Since the loan repayment typically takes several years, a floating interest rate reduces the risk to the financial institution and provides a market return on their loan to the student. With the fixed interest rate, the initial interest rate paid is higher, but the rate does not change over the term of the loan.
(b)
If, in the view of the student, interest rates are expected to rise, the fixed rate of interest is the better choice. On the other hand, if interest rates are expected to remain steady or fall, the variable rate loan would be the better choice.
LO 2 BT: C Difficulty: C Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
10-5
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
10.
Financial Accounting, Seventh Canadian Edition
Doug is incorrect because the amount of interest paid each month will decrease as payments are made and the outstanding (remaining) principal balance decreases. The amount of interest is calculated as a percentage of the outstanding principal amount. Because the monthly cash payment remains constant, over time, greater portions of the payment will be applied to the principal thereby more rapidly reducing the balance of the mortgage.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
11.
(a)
Current liabilities should be presented in the statement of financial position with each major type shown separately. They are normally listed in order of maturity, although other listing orders are also possible. The notes to the financial statements should indicate the terms, including interest rates, maturity dates, and other pertinent information such as assets pledged as collateral.
(b)
The nature and the amount of each non-current liability should be presented in the statement of financial position or in schedules included in the accompanying notes to the statements. The notes should also indicate the interest rates, maturity dates, conversion privileges, and assets pledged as collateral.
LO 3 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
Liquidity ratios measure the short-term ability of a company to repay its maturing obligations. Ratios such as the current ratio, receivables turnover, and inventory turnover can be used to assess liquidity. In all three ratios, an increase in the ratio demonstrates an improvement. Solvency ratios measure the ability of a company to repay its total debt and survive over a long period of time. Ratios that are commonly used to measure solvency include debt to total assets and times interest earned ratios. In the case of debt to total assets ratio, an increase in the ratio is often interpreted as a deterioration in solvency, while for the times interest earned ratio, an increase demonstrates an improvement.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
10-6
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
13.
Financial Accounting, Seventh Canadian Edition
An operating line of credit, or credit facility, is used by a business to overcome short-term cash demands that invariably happen during the operating cycle. It is not usually intended to be a permanent type of financing and is generally used for operations. When needed, the funds are used and then repaid as the liquidity improves and cash becomes available from operations. This type of financing is extremely flexible because interest charges are only incurred for the actual amount of cash borrowed for the needed period of time when there is a cash shortfall from daily operations. As a consequence, the business does not incur the constant charge for interest on a long-term bank debt or mortgages and can save on interest costs. The liquidity issues of a business can therefore be effectively dealt with using an operating line of credit.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
14.
A company’s debt to total asset ratio should be measured in terms of its ability to manage its debt. A company may have a high debt to total asset ratio but still be able to meet its interest payments because of high income. Alternatively, a company with a low debt to total assets may find itself in financial difficulty if it does not have sufficient net income to cover required interest payments. Therefore, it is important to interpret these two ratios in conjunction with one another.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
15.
A company with significant operating leases has obligations that are reported in the notes to the financial statements rather than on the statement of financial position. This is referred to as off-balance sheet financing. The existence of these off-balance sheet forms of financing highlights the importance of including the information contained in the notes in any analysis of a company’s solvency. These notes also help the financial statement user forecast the amount of the future cash outflows that will occur to satisfy these lease commitments.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-7
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
*16.
Financial Accounting, Seventh Canadian Edition
(a)
A bond is a form of a long-term note payable. They are similar in that both have fixed maturity dates and pay interest. The most significant difference between a note payable and a bond is that bonds are often traded on publicly whereas few notes are. In addition, bonds tend to be issued for much larger amounts than notes. Because of these differences, generally only large companies use bonds as a form of debt financing.
(b)
When it comes to large sums of money, a business would consider the issue of shares or bonds for obtaining the necessary cash. Both would be traded publicly.. Bonds are classified as debt on the statement of financial position and common shares are classified as equity. Bonds require principal and interest payments; common shares do not have to be repaid. The board of directors may choose to pay dividends to the common shareholders, however.
LO 4 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-8
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
*17.
Financial Accounting, Seventh Canadian Edition
(a)
When a bond is sold at a discount, the proceeds received are less than the face value of the bond because the stated rate of interest that the bond offers is lower than the market interest rate. This has made the bond less attractive to investors who will increase the return they get from the bond by paying less than its face value. The bond discount is considered to be an additional cost of borrowing. This additional cost of borrowing should be recorded as additional interest expense over the term of the bond through a process called amortization. Initially, the discount is recorded by showing the Bond Payable at an amount lower than its face value, but over time this account is increased (credited) so that it will be equal to its face value by the time it matures. The offsetting debit is made to interest expense. This is the additional interest expense incurred by the company for selling a bond at a discount. When interest is actually paid, this amount is added to interest expense. So interest expense will consist of a portion that is paid and a portion relating to the amortization of the discount thereby making it greater than the cash interest paid.
(b)
When a bond is sold at a premium, the proceeds received are greater than the face value of the bond because the stated rate of interest that the bond offers is higher than the market interest rate. This has made the bond very attractive to investors who will be prepared to pay a higher price for the bond than its face value. The bond premium is considered to be a reduction in interest. This benefit should be recorded through reductions to interest expense over the term of the bond through a process called amortization. Initially, the premium is recorded by showing the Bond Payable at an amount higher than its face value, but over time this account is decreased (debited) so that it will be equal to its face value by the time it matures. The offsetting credit is made to interest expense. This lowers interest expense to reflect the benefit of the premium. When interest is actually paid, this amount is added to interest expense. So interest expense will consist of a portion that is paid minus a portion relating to the amortization of the premium thereby making it lower than the interest paid.
LO 4 BT: C Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-9
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 (a) Oct.
1
Cash ($6,000 + $780)............................................. Sales ............................................................. Sales Tax Payable ($6,000 × 13%) ...............
6,780
Cash ($6,000 + $899)............................................. Sales ............................................................. Sales Tax Payable [($6,000 × 5%) + ($6,000 × 9.975%)] .....................................
6,899
6,000 780
(b) Oct.
1
6,000 899
LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-2 (a) Apr. 30
Property Tax Expense ($36,000 ÷ 12 × 4) ................ Property Tax Payable........................................
12,000
Property Tax Payable ................................................ Property Tax Expense ($36,000 ÷ 12 × 2.5) ............. Prepaid Property Tax ($36,000 ÷ 12 × 5.5) ............... Cash..................................................................
12,000 7,500 16,500
Property Tax Expense ............................................... Prepaid Property Tax ........................................
16,500
12,000
(b) July 15
36,000
(c) Dec. 31
16,500
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-10
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 10-3 (a)
(b)
(c)
Aug. 24
Aug. 24
Sept. 3
Salaries Expense ................................................... 15,000 Employee Income Tax Payable ..................... CPP Payable ................................................. EI Payable ..................................................... Cash ($15,000 – $6,258 – $743 – $282) ....... Employee Benefits Expense................................... CPP Payable ................................................. EI Payable .....................................................
1,138
Employee Income Tax Payable .............................. CPP Payable ($743 + $743) ................................... EI Payable ($282 + $395) ....................................... Cash ($6,258 + $1,486 + $677) .....................
6,258 1,486 677
6,258 743 282 7,717 743 395
8,421
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-4 (a)
July
1
(b) (1) Aug. 1
(2) Aug. 31 (3) Sept. 1 (4) Oct.
(c)
Oct.
1
1
Cash ...................................................................... 60,000 Bank Loan Payable ....................................... Interest Expense ($60,000 × 5% × 1/12) ................ Cash ..............................................................
250
Interest Expense .................................................... Interest Payable.............................................
250
Interest Payable ..................................................... Cash ..............................................................
250
Interest Expense .................................................... Cash ..............................................................
250
60,000 250
250 250
Bank Loan Payable ................................................ 60,000 Cash .............................................................
250
60,000
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-11
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 10-5 IFRS a) Record and disclose a provision (likely is a higher level of probability than probable, liability, which in turn, is more likely than not) b) Not recorded, disclose only c) Not recorded nor disclosed d) Not recorded, disclose only e) Not recorded, disclose only
ASPE Record and disclose a contingent
Not recorded, disclose only Not recorded nor disclosed Not recorded, disclose only Not recorded, disclose only
LO 1 BT: AN Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-6 a)
The advantage of the fixed interest rate option is that the rate will not change during the 10-year period, regardless of what happens to interest rates in the future. One could view this feature as a disadvantage in that a decline in interest rates will not result in a reduction of interest costs. In order to lock in the interest rate for such a long period of time, the monthly instalment payment and the amount of interest is higher. The disadvantage of the fixed interest rate option becomes the advantage of the floating interest rate option. When interest rates decline, the loan interest and the monthly instalment payment are reduced. The disadvantage is that if interest rates increase, the opposite will occur.
b)
Students generally have limited income upon graduation and so the additional risk of possible increases in instalment payments for student loans should be avoided. The fixed interest rate is recommended. Alternately, choosing the floating rate makes the initial monthly payments smaller, during the time when earnings may be at their lowest. As long as rates do not increase too much, it could be the less expensive alternative.
LO 2 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-12
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 10-7 (a)
(b)
[1] $50,000 × 7% = $3,500 [2] $13,500 – $3,500 = $10,000 [3] $12,800 – $2,800 = $10,000 or same as [2] as fixed principal reduction [4] $40,000 – $10,000 = $30,000 (or $2,100 ÷ 7% = $30,000) [5] $10,000 fixed principal reduction [6] + $2,100 = $12,100 [6] $10,000 fixed principal reduction [7] $30,000 [4] – $10,000 [6] = $20,000 [8] $11,400 – $1,400 = $10,000 fixed principal reduction or $20,000 [7] – $10,000 [9] $10,700 – $700 = $10,000 fixed principal reduction [10] $10,000 – $10,000 = $0 The current portion of the note at the end of period 3 is the amount of principal reduction in the next year (period 4), which is $10,000. This leaves $10,000 ($20,000 less current portion of $10,000) as the noncurrent portion of the debt.
LO 2 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-8 (a)
[1] [2] [3] [4] [5] [6] [7] [8] [9] [10]
$50,000 × 7% = $3,500 $12,195 fixed cash payment $12,195 [2] – $2,891 = $9,304 or $41,305 – $32,001 $12,195 fixed cash payment $12,195 [4] – $9,955 = $2,240 or $32,001 × 7% $32,001 – $9,955 = $22,046 $12,195 fixed cash payment $12,195 [7] – $1,543 = $10,652 or $22,046 [6] – $11,394 = $10,652 $12,195 fixed cash payment $11,394 – $11,394 = $0
(b)
The current portion of the note at the end of period 3 is the amount of principal reduction in the next year (period 4), which is $10,652 [8]. This leaves $11,394 ($22,046 [6] less current portion of $10,652) as the noncurrent portion of the debt.
LO 2 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-13
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 10-9 (a)
Fixed principal payment
Monthly Interest Period
(A) Cash Payment (B) + (C)
(B) Interest Expense (D) × 4% ÷ 12 months
(C) Reduction of Principal ($300,000 ÷ 120)
(D) Principal Balance (D) ̶ (C)
Nov. 30, 2017
$300,000
Dec. 31, 2017
$3,500
$1,000
$2,500
297,500
Jan. 31, 2018
3,492
992
2,500
295,000
2017 Nov. 30
Cash .........................................................................
300,000
Mortgage Payable ............................................ Dec.
31
300,000
Interest Expense .......................................................
1,000
Mortgage Payable .....................................................
2,500
Cash.................................................................
3,500
2018 Jan.
31
Interest Expense .......................................................
992
Mortgage Payable .....................................................
2,500
Cash.................................................................
Solutions Manual .
10-14
3,492
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 10-9 (CONTINUED) (b)
Blended principal and interest payment
Monthly Interest Period Nov. 30, 2017 Dec. 31, 2017 Jan. 31, 2018 2017 Nov. 30
Dec.
31
2018 Jan. 31
(A) Cash Payment
(B) Interest Expense (D) × 4% ÷ 12 mos.
$3,037 3,037
$1,000 993
(C) Reduction of Principal (A) – (B) $2,037 2,044 01476.73
(D) Principal Balance (D) – (C) $300,000 297,963 295,919 22,000
Cash .................................................................. Mortgage Payable .....................................
300,000
Interest Expense ................................................ Mortgage Payable .............................................. Cash..........................................................
1,000 2,037
Interest Expense ................................................ Mortgage Payable .............................................. Cash..........................................................
993 2,044
300,000
3,037
3,037
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-15
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 10-10 a. b. c. d.
e. f. g. h. i. j. k.
Non-current liability Current liability Current liability Neither – any unused portion is not a liability and no balance is outstanding but line of credit limits should be disclosed in the notes to the financial statements Current liability Neither – obligations are reported in the notes to the financial statements Non-current liability Current liability Neither – current asset Current liability for the $5,000 due next year. The remaining $70,000 balance is a non-current liability. Neither – because the outcome has a remote probability, it is neither recorded nor disclosed
LO 3 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-11 (in $ millions) (a)
Current ratio $443 = $423
(b) Debt to total assets (c)
1.0:1
=
$1,014 = $1,563
Times interest earned =
64.9%
$76 + $19 + $28 $19
=
6.5 times
LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
10-16
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 10-12 (a)
Debt to total assets Times interest earned
Improvement Deterioration
(b)
Although Fromage’s debt to total assets ratio improved in 2018, its times interest earned ratio deteriorated. Fromage’s overall solvency appears to have deteriorated because even though liabilities relative to assets has fallen, the company is generating less income before income tax and interest relative to its interest expense than it did in the prior year.
LO 3 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
*BRIEF EXERCISE 10-13 (a)
The proceeds received from the issue of the bonds = face value of the bonds X price. $200,000 x 96 = $192,000
(b)
Interest expense on the first semi-annual interest payment = bond carrying amount x effective interest rate x 6/12 $192,000 x 7% x 6/12 = $6,720
(c)
The semi-annual interest payment based on the coupon rate of 6% x face value of the bonds x 6/12 = $200,000 x 6% x 6/12 = $6,000 The amortization of the bond discount is $6,720 less $6,000 or $720 The amortization of the bond discount is added to the bond carrying amount of $192,000 making the carrying amount after the first interest payment $192,720.
LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-17
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 10-14 (a)
The proceeds received from the issue of the bonds = face value of the bonds X price. $100,000 x 109 = $109,000
(b)
Interest expense on the first semi-annual interest payment = bond carrying amount x effective interest rate x 6/12 $109,000 x 3% x 6/12 = $1,635
(c)
The semi-annual interest payment based on the coupon rate of 5% x face value of the bonds x 6/12 = $100,000 x 5% x 6/12 = $2,500 The amortization of the bond premium is $2,500 less $1,635 or $865 The amortization of the bond premium is deducted from the bond carrying amount of $109,000 making the carrying amount after the first interest payment $108,135.
LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-18
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 10-15 (a)
Key inputs:
Future value (FV) = $500,000 Market interest rate (i) = 2.5% (5% × 6/12) Interest payment (PMT) = $15,000 ($500,000 × 6% × 6/12) Number of semi-annual periods (n) = 10 (5 years × 2)
Present value of $500,000 received in 10 periods ($500,000 × 0.78120) (n = 10, i = 2.5%) Present value of $15,000 received each of 10 periods ($500,000 × 3% × 8.75206) (n = 10, i = 2.5%) Present value (issue price) of the bonds (b)
Key inputs:
Key inputs:
131,281 $521,881
Future value (FV) = $500,000 Market interest rate (i) = 3% (6% × 6/12) Interest payment (PMT) = $15,000 ($500,000 × 6% × 6/12) Number of semi-annual periods (n) = 10 (5 years × 2)
Present value of $500,000 received in 10 periods ($500,000 × 0.74409) (n = 10, i = 3%) Present value of $15,000 received each of 10 periods ($500,000 × 3% × 8.53020) (n = 10, i = 3%) Present value (issue price) of the bonds (rounded to $500,000) This is rounded because we know that there would be no discount or premium because the market and stated rate are equal (c)
$390,600
$372,045 127,953 $500,000
Future value (FV) = $500,000 Market interest rate (i) = 3.5% (7% × 6/12) Interest payment (PMT) = $15,000 ($500,000 × 6% × 6/12) Number of semi-annual periods (n) = 10 (5 years × 2)
Present value of $500,000 received in 10 periods ($500,000 × 0. 70892) (n = 10, i = 3.5%) Present value of $15,000 received each of 10 periods ($500,000 × 3% × 8.31661) (n = 10, i = 3.5%) Present value (issue price) of the bonds
$354,460 124,749 $479,209
Note to the instructor: Rounding discrepancies may arise depending on whether present value tables, calculators, or spreadsheet programs are used to determine the present value. LO 4 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-19
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 10-16 (a)
CARVEL CORP. Bond Premium Amortization
Semiannual Interest Periods Jan. 1/18 July 1/18 Jan. 1/19
(A) Interest Payment (6% × 6/12 = 3%) $15,000 15,000
(B) Interest Expense (5% × 6/12 = 2.5%)
$13,047 12,998
(b)
(C) Premium Amortization (A) – (B)
(D) Unamortized Premium (D) – (C)
(E) Bond Carrying Amount ($500,000 + D)
$1,953 2,002
$21,881 19,928 17,926
$521,881 519,928 517,926
CARVEL CORP.
Semiannual Interest Periods Jan. 1/18 July 1/18 Jan. 1/19
Interest Payment (6% × 6/12 = 3%) $15,000 15,000
(c)
Semiannual Interest Periods Jan. 1/18 July 1/18 Jan. 1/19
Interest Expense (6% × 6/12 = 3%)
Bond Carrying Amount ($500,000)
$15,000 15,000
$500,000 500,000 500,000
CARVEL CORP. Bond Discount Amortization (A) Interest to Be Paid (6% × 6/12 = 3%)
$15,000 15,000
(B) Interest Expense (7% × 6/12 = 3.5%)
(C) Discount Amortization (A) – (B)
$16,772 16,834
$1,772 1,834
(D) Unamortized Discount (D) – (C)
(E) Bond Carrying Amount ($500,000 – D)
$20,791 19,019 17,185
$479,209 480,981 482,815
LO 4 BT: AP Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-20
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 10-17 (a) Jan.
July
1
1
Dec. 31
Cash ........................................................... Bonds Payable ...................................
521,881
Interest Expense ......................................... Bonds Payable ............................................ Cash ...................................................
13,047 1,953
Interest Expense ......................................... Bonds Payable ............................................ Interest Payable..................................
12,998 2,002
Cash ........................................................... Bonds Payable ...................................
500,000
Interest Expense ......................................... Cash ...................................................
15,000
Interest Expense ......................................... Interest Payable..................................
15,000
Cash ........................................................... Bonds Payable ...................................
479,209
Interest Expense ......................................... Bonds Payable ................................... Cash ...................................................
16,772
Interest Expense ......................................... Bonds Payable ................................... Interest Payable..................................
16,834
521,881
15,000
15,000
(b) Jan.
July
1
1
Dec. 31
500,000
15,000
15,000
(c) Jan.
July
1
1
Dec. 31
479,209
1,772 15,000
1,834 15,000
LO 4 BT: AP Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-21
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 10-1 Assets
Liabilities
+ NE NE + NE NE + NE
+ NE + + + + + + -
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Shareholders’ Equity NE NE NE + NE +
Revenues
Expenses
NE NE NE NE + NE NE NE NE +
NE NE + NE NE + + + NE NE
Net Income NE NE NE + NE +
LO 1 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-22
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-2 (a) Mar. 17
May
July
1
1
Aug. 15
15
22
Oct.
1
(b) Dec. 31
31 (c) April
1
Cash ............................................................ Sales .................................................... Sales Tax Payable ($2,500 + $3,500)..
56,000
Property Tax Expense ($52,800 ÷ 12 × 4) ... Property Tax Payable ..........................
17,600
Property Tax Expense ($52,800 ÷ 12 × 2) ... Prepaid Property Tax ($52,800 ÷ 12 × 6) ..... Property Tax Payable .................................. Cash ....................................................
8,800 26,400 17,600
Salaries Expense ......................................... CPP Payable ....................................... EI Payable ........................................... Employee Income Tax Payable ........... Pension Payable .................................. Cash ....................................................
81,000
Employee Benefits Expense ........................ CPP Payable ....................................... EI Payable ...........................................
6,142
CPP Payable ($4,010 + $4,010) .................. EI Payable ($1,523 + $2,132) ...................... Employee Income Tax Payable ................... Cash ....................................................
8,020 3,655 16,020
Cash ............................................................ Bank Loan Payable ..............................
100,000
Property Tax Expense ................................. Prepaid Property Tax ...........................
26,400
Interest Expense ($100,000 × 4% × 3/12) .. Interest Payable ..................................
1,000
Bank Loan Payable........................................... Interest Payable ................................................ Interest Expense ............................................... Cash ........................................................
100,000 1,000 1,000
50,000 6,000
17,600
52,800
4,010 1,523 16,020 6,400 53,047
4,010 2,132
27,695
100,000
26,400
1,000
102,000
LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
10-23
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-3 (a)
Dougald Construction
(1)
Oct. 1, 2017
(2)
(3)
Cash ........................................................ 250,000 Bank Loan Payable ...........................
Dec. 31, 2017 Interest Expense ...................................... Interest Payable ................................ ($250,000 × 5% × 3/12)
3,125
July 1, 2018
6,250
Interest Expense ($250,000 × 5% × 6/12) Interest Payable ................................
250,000 3,125
6,250
Bank Loan Payable .................................. 250,000 Interest Payable ($3,125 + $6,250).......... 9,375 Cash ..................................................
259,375
Notes Receivable ..................................... 250,000 Cash ..................................................
250,000
(b) TD Bank (1) (2)
(3)
Oct. 1, 2017
Dec. 31, 2017 Interest Receivable .................................. Interest Revenue ............................... ($250,000 × 5% × 3/12) July 1, 2018
3,125 3,125
Interest Receivable ($250,000 × 5% × 6/12) 6,250 Interest Revenue ..............................
6,250
Cash ........................................................ 259,375 Interest Receivable ($3,125 + $6,250) Notes Receivable ..............................
9,375 250,000
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 10-4 (a)
Since the obligation for providing maintenance on the aircraft exists at the time of signing the lease, the provision must be recorded at that time. When the provision is established (by crediting that account), the offsetting debit is recorded as an asset that is amortized over the period of the lease.
(b)
The provision for aircraft maintenance is based on estimates of the costs that are expected to be incurred when the maintenance work will be performed in the future. Consequently, the amount estimated is subject to change. In the case of accounts payable, the amounts owed are fixed and determinable.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
10-24
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-5 (a) and (b) (1)
Fixed principal payment (A) Cash Payment (B) + (C)
Semi-annual Interest Period Dec. 31, 2017 June 30, 2018 Dec. 31, 2018
$11,250 11,063 01
(B) Interest Expense (D) × 5% × 6/12
(C) Reduction of Principal ($150,000 ÷ 20)
(D) Principal Balance (D) – (C)
$3,750 3,3,,53,563
$7,500 7,500 01476.73
$150,000 142,500 135,000 22,000
Issue of Mortgage 2017
Dec.
31
Cash ................................................... Mortgage Payable ......................
150,000 150,000
First Instalment Payment 2018
June
30
Interest Expense ($150,000 × 5% × 6/12) Mortgage Payable ............................... Cash ...........................................
3,750 7,500 11,250
Second Instalment Payment Dec.
31
Interest Expense [($150,000 – $7,500) × 5% × 6/12] Mortgage Payable ............................... Cash ...........................................
3,563 7,500 11,063
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-25
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-5 (CONTINUED) (a) and (b) (continued) (2)
Blended principal and interest payment
Semi-annual Interest Period
(A) Cash Payment
Dec. 31, 2017 June 30, 2018 Dec. 31, 2018
2017
(B) Interest Expense (D) × 5% × 6/12
$9,622 9,622 01 Dec.
31
$3,750 3,603 0 Issue of Mortgage
(C) Reduction of Principal (A) – (B)
(D) Principal Balance (D) – (C) $150,000 144,128 138,109 22,000
$5,872 6,019 01476.73
Cash ................................................... Mortgage Payable ......................
150,000 150,000
First Instalment Payment 2018
June
30
Interest Expense ($150,000 × 5% × 6/12) ................... Mortgage Payable ............................... Cash ...........................................
3,750 5,872 9,622
Second Instalment Payment Dec.
(c)
31
Interest Expense [($150,000 – $5,872) × 5% × 6/12] ................... Mortgage Payable ............................. Cash .........................................
3,603 6,019 9,622
Interest expense for the six-month period ended June 30, 2018 is the same amount of $3,750 whether the payment is blended or based on fixed principal payments because for this first period, the amount of the principal balance of the loan is the same, at the initial amount of $150,000. Once the six-month period is completed, the principal balance of the mortgage payable on which interest charges are applied changes by a different amount based on whether the principal payment is fixed or is blended with interest, based on the repayment terms of the loan. Thereafter, the interest expense will differ under the two approaches.
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-26
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-6 (a) Annual Interest Period
(A) Cash Payment
(B) Interest Expense (D) × 4%
(C) Reduction of Principal (A) – (B)
July 1, 2017 June 30, 2018 June 30, 2019
$7,953 7,953
$600 306
$7,353 7,647
(b) (1) (2) (3)
2017 July 1 Dec. 31 2018 June 30
(D) Principal Balance (D) – (C) $15,000 7,647 0
Cash ........................................................... Notes Payable ....................................
15,000
Interest Expense ($600 × 6/12) .................. Interest Payable .................................
300
Interest Expense......................................... Interest Payable ......................................... Notes Payable ............................................ Cash ...................................................
300 300 7,353
15,000 300
7,953
(c) On December 31, 2018 another accrual for interest expense would be made as follows: Dec. 31
Interest Expense ($306 × 6/12) .................. Interest Payable .................................
153 153
After making the above entry the company would have two current liabilities relating to the note as follows: Current liability Interest payable Note payable
$153 7,647
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-27
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-7 (a)
This is a blended principal and interest payment schedule, as the cash payment is constant at $23,097.48 each year.
(b)
The interest rate is 5% ($5,000 ÷ $100,000).
(c)
Interest Expense .................................................... Bank Loan Payable ................................................ Cash .............................................................
(d)
5,000.00 18,097.48 23,097.48
Current portion = $19,952.47 Non-current portion = $20,950.10 + $21,997.60 = $42,947.70
LO 2 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-28
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-8 (a)
Current liabilities would likely include: Accounts payable and accrued liabilities Current portion of long-term debt Income taxes payable Dividends payable Deferred (unearned) tenant deposits Non-current liabilities would likely include: Long-term debt Deferred income taxes Finance lease obligations Depending on when the liability will become due, some items listed above under non-current could instead be current; an example: finance lease obligations. As well, some items listed above as current could be noncurrent or portions of the balances could be non-current; an example: deferred (unearned) tenant deposits.
(b) DOLLARAMA INC. Statement of Financial Position (partial) February 1, 2015 (in thousands) Current liabilities Accounts payable and accrued liabilities ................. Dividends payable ................................................... Income taxes payable .............................................. Deferred (unearned) tenant deposits ....................... Current portion of long-term debt ............................. Total current liabilities .................................. Non-current liabilities Long-term debt ........................................................ Deferred income taxes ............................................. Finance lease obligations ........................................ Total non-current liabilities ........................... Total liabilities ...................................................................
$ 175,739 10,480 25,427 60,475 3,846 275,967 560,641 122,184 1,566 684,391 $960,358
LO 3 BT: AP Difficulty: S Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-29
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-9 ($ in thousands) (a)
Current ratio 2018:
(b)
$4,744 $3,011
= 1.6:1
2017:
$4,298 $2,989
= 1.4:1
(1)
Based only on the current ratio, Fruition’s liquidity is improving in 2018. There are proportionately more current assets to pay the current liabilities.
(2)
To make a proper assessment, information concerning the due dates for the liabilities and the type of current assets that make up the remaining assets would need to be scrutinized. For example, if current assets consisted mainly of cash rather than inventory, we would conclude that the company had greater liquidity. Knowing the quality of receivables and the turnover of the inventory would be useful.
Current ratio for 2018: Before: $4,744 $3,011
= 1.6:1
After: $4,744 - $1,000 = 1.9:1 $3,011 - $1,000 Paying off the $1 million improves Fruition’s current ratio from 1.6:1 to 1.9:1. This is because $1 million represents a greater percentage of the denominator than it does the numerator. The greater percentage decrease to the denominator makes the ratio rise.
Solutions Manual .
10-30
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-9 (CONTINUED) (c)
Having access to an operating line of credit means that cash is available on a short-term basis and therefore the assessment of the company’s short-term liquidity is better than it first appeared. Although the ability to access cash improves the liquidity position, it does not necessarily mean that drawing down the operating line of credit will improve the current ratio. If the unused line of credit were to be fully drawn down, Fruition’s current assets would increase by the addition of $4 million of cash. At the same time, the current liabilities would increase by the addition of a $4 million bank loan payable. As is demonstrated in the calculation below, the current ratio would deteriorate to 1.2:1. $4,744 + $4,000 $3,011 + $4,000
= 1.2:1
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
10-31
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 10-10 ($ in millions) (a) 2014 Debt to total assets =
$2,258 $3,900
Times interest earned =
$218 + $58 + $28 = $28
Debt to total assets =
$2,559 $4,388
Times interest earned =
$234 + $32 + $55 = $55
=
57.9%
10.9 times
2015 =
58.3%
5.8 times
Open Text Corporation’s debt to total assets ratio deteriorated slightly in 2015, with the increase from 57.9% to 58.3%. The company’s times interest earned ratio decreased significantly from 10.9 times in 2014 to 5.8 times in 2015. This reveals a deterioration in Open Text’s solvency. (b)
Having access to an operating line of credit means that cash is available on a short-term basis. None of the total line of credit available in the amount of $300 million has been drawn down at the date of the financial statements. Since no liability exists at the end of the year, only a note disclosure of the available operating line of credit will be needed.
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-32
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 10-11 (a)
The Province of Manitoba bonds are trading at a discount.
(b)
The Loblaw Companies Limited bonds are trading at a premium.
(c)
Cash (0.999 × $100,000) ............................................ Bonds Payable ........................................................
99,900
Cash (1.4409 × $100,000) .......................................... 144,090 Bonds Payable .....................................................
99,900
144,090
(d)
When initially issued, both Loblaws and the Province of Manitoba would have an understanding of the rate of interest demanded by the market, for equivalent risk, and would consequently set the coupon rate of interest on their bonds at a level that would be very close to the market interest rate at that time. When the market rate and the coupon rate are the same, the bonds are issued at par or 100% of the face value of the bond. When issued at par, there are is no premiums or discounts to amortize.
(e)
The major reason for the change in the price of the bonds since they were issued is the market rate changes that have occurred since the date of issuance. If the market rate (yield demanded by bondholders) increases, the price of the bonds will fall and they will trade at a discount. If the market rate decreases, the price of the bonds will rise and they will trade at a premium.
LO 4 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-33
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 10-12 (a)
2018 1. Oct.
1
2. Dec. 31
2019 3. Apr.
1
Cash ......................................................... 800,000 Bonds Payable ................................
800,000
Interest Expense ($800,000 × 5% × 3/12) Interest Payable................................
10,000 10,000
Interest Expense ($800,000 × 5% × 3/12) Interest Payable ........................................ Cash ($800,000 × 5% × 6/12) ..........
10,000 10,000 20,000
(b) December 31, 2018 Current liabilities Interest payable .................................................... $ 10,000 Non-current liabilities Bonds payable, due 2028 ....................................
800,000
LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-34
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 10-13 (a)
[1] $25,000 + $2,768 = $27,768 [2] $74,387 – $2,768 = $71,619 [3] $27,851 – $25,000 = $2,851 [4] $928,381 + $2,851[3] = $931,232 or $1,000,000 – $68,768 [5] $25,000 same as previous semi-annual payments [6] $27,937 – $25,000 = $2,937 [7] $68,768 – $2,937 [6] = $65,831
(b)
$1,000,000 face value ($925,613 carrying amount plus unamortized discount $74,387 at issue date)
(c)
The bonds were issued at a discount as the carrying amount of $925,613 is lower than the $1,000,000 face value of the bond at the issue date.
(d)
Coupon interest rate: Semi-annual payments are $25,000 × 2 divided by the face value $1,000,000 = 5% per year Market interest rate: Interest expense April 30 (item [1] of part (a) $27,768) divided by carrying amount at issue date $925,613 × 2 = 3% × 2 = annual rate of 6%
(e)
The effective rate of interest of 6% is greater than the coupon rate. Interest expense is calculated using the market rate of interest and cash interest paid is calculated using the coupon rate. Therefore, interest expense is greater than cash interest paid.
(f)
Interest expense is calculated by multiplying the carrying value of the bonds by the market rate of interest. With each semi-annual payment, the carrying amount of the bonds increases, from the semi-annual amortization of the discount, and consequently, the amount of interest expense increases.
(g)
The carrying amount of the bonds will be equal to the face value of the bonds of $1,000,000 as the entire amount of the discount will have been amortized.
LO 4 BT: AP Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
10-35
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 10-14 (a)
(b)
(c)
(d)
Jan. 1
July
1
Dec. 31
Cash ......................................................................... Bonds Payable.................................................. Interest Expense ($925,617× 6% × 6/12) ................. Bonds Payable ($27,769 – $25,000) ................ Cash ($1,000,000 × 5% × 6/12) ........................ Interest Expense [($925,617 + $2,769) × 6% × 6/12] Bonds Payable ($27,852 – $25,000) ................ Interest Payable ($1,000,000 × 5% × 6/12) ......
Key inputs:
925,617 925,617 27,769 2,769 25,000 27,852 2,852 25,000
Future value (FV) = $1,000,000 Market interest rate (i) = 3% (6% × 6/12) Interest payment (PMT) = $25,000 ($1,000,000 × 5% × 6/12) Number of semi-annual periods (n) = 20 (10 years × 2)
Present value of $1,000,000 received in 20 periods ($1,000,000 × 0.55368) (n = 20, i = 3%) Present value of $25,000 received each of 20 periods ($1,000,000 × 2.5% × 14.87747 (n = 20, i = 3%) Present value (issue price) of the bonds
$553,680 371,937 $925,617
One year later, December 31, 2019, the carrying amount of the bond is $925,617 + $2,769 + $2,852 = $931,238 Key inputs:
Future value (FV) = $1,000,000 Market interest rate (i) = 3% (6% × 6/12) Interest payment (PMT) = $25,000 ($1,000,000 × 5% × 6/12) Number of semi-annual periods (n) = 18 (9 years × 2)
Present value of $1,000,000 received in 18 periods ($1,000,000 × 0.58739) (n = 18, i = 3%) Present value of $25,000 received each of 18 periods ($1,000,000 × 2.5% × 13.75351 (n = 18, i = 3%) Present value (issue price) of the bonds
$587,390 343,838 $931,228
Note to the instructor: Rounding discrepancies may arise depending on whether present value tables, calculators, or a spreadsheet programs are used to determine the present value. LO 4 BT: AP Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
10-36
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 10-1A (a)
Mar. 2
5
Accounts Payable .................................... Notes Payable ..................................
10,000
Cash ......................................................... Sales ................................................ Sales Tax Payable ($40,000 × 13%)
45,200
Cost of Goods Sold .................................. Inventory ..........................................
24,000
10,000
40,000 5,200
24,000
9
Property Tax Expense ($18,000 × 3/12) .. 4,500 Property Tax Payable....................... As we are now in the third month, expense 3 months of property taxes. 12
13
16
27
Mar. 30
30
(b)
Mar. 31
Solutions Manual .
4,500
Unearned Revenue .................................. 11,300 Service Revenue .............................. Sales Tax Payable ($11,300 ÷ 1.13 × 13%) .
10,000 1,300
Sales Tax Payable ................................... Cash.................................................
5,800 5,800
CPP Payable ($1,340 + $1,340) .............. EI Payable ($468 + $655) ........................ Income Tax Payable ................................ Cash.................................................
2,680 1,123 5,515
Accounts Payable ..................................... Cash.................................................
30,000
9,318
30,000
Salaries Expense ....................................... 16,000 CPP Payable ..................................... EI Payable ......................................... Employee Income Tax Payable......... Cash.................................................. Employee Benefits Expense ..................... CPP Payable ..................................... EI Payable .........................................
1,213
Interest Expense ....................................... Interest Payable .................................... ($10,000 × 6% × 1/12)
50
10-37
792 301 5,870 9,037 792 421
50
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 10-1A (CONTINUED) (c) MOLEGA LTD. Statement of Financial Position (partial) March 31, 2018 Current liabilities Accounts payable ($42,500 – $10,000 – $30,000) ................. Notes payable ......................................................................... Unearned revenue ($15,000 – $11,300) ................................. Employee income tax payable ($5,515 – $5,515 + $5,870) .... Property tax payable ............................................................... Sales tax payable ($5,800 + $5,200 + $1,300 - $5,800) ......... CPP payable ($2,680 – $2,680 + $792 + $792)...................... EI payable ($1,123 – $1,123 + $301 + $421).......................... Interest payable ...................................................................... Total current liabilities .................................................
$ 2,500 10,000 3,700 5,870 4,500 6,500 1,584 722 50 $35,426
LO 1,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 10-2A (a)
Sept.
1
30
Oct.
1
2
Nov.
1
1
Dec.
1
1
3
31
Solutions Manual .
Inventory ................................................. Accounts Payable ..........................
15,000
Bank Loan Payable ................................. Interest Expense ($12,000 × 3% × 3/12) Cash...............................................
12,000 90
Accounts Payable ................................... Notes Payable ................................
15,000
Buildings ................................................. Bank Loan Payable ........................
25,000
Interest Expense ($15,000 × 4% × 1/12) Cash...............................................
50
Interest Expense ($25,000 × 3% × 1/12) Cash...............................................
63
Interest Expense ($15,000 × 4% × 1/12) Cash...............................................
50
Interest Expense ($25,000 × 3% × 1/12) Cash...............................................
63
Vehicles .................................................. Bank Loan Payable ........................ Cash...............................................
28,000
Interest Expense ($50* + $63** + $50***) Interest Payable ............................. * $15,000 × 4% × 1/12 = $50 ** $25,000 × 3% × 1/12 = $63 *** $20,000 × 3% × 1/12 = $50
163
10-39
15,000
12,090
15,000
25,000
50
63
50
63
20,000 8,000
163
Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-2A (CONTINUED) (b) Sept. 1 Bal. Sept. 30 Nov. 1 Nov. 1 Dec. 1 Dec. 1 Dec. 31 Dec.31 Bal.
Interest Expense 0 90 50 63 50 63 163 479 Interest Payable Sept. 1 Bal. Dec. 31 Dec. 31Bal.
Sept. 30 0 163 163
Notes Payable Sept. 1 Bal. Oct.1 Dec. 31Bal.
0 15,000 15,000
Bank Loans Payable Sept. 1 Bal. 12,000 Oct. 2 Dec. 3 Dec. 31Bal.
12,000 25,000 20,000 45,000
(c) CLING-ON LTD. Income Statement (partial) Year Ended December 31, 2018 Other revenues and expenses Interest expense .........................................................................
$479
(d) CLING-ON LTD. Statement of Financial Position (partial) December 31, 2018 Current liabilities Bank loans payable .................................................................... $45,000 Notes payable ............................................................................. 15,000 Interest payable .......................................................................... 163 LO 1,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-3A (a)
Table not required but source for detailed calculations
Quarterly Interest Period
Cash Payment
Interest Expense 4% × 3/12
Reduction of Principal
Principal Balance
Sept. 30, 2017
$1,000,000
Dec. 31, 2017
$93,333
$10,000
$83,333
916,667
Mar. 31, 2018
92,500
9,167
83,333
833,334
June 30, 2018
91,666
8,333
83,333
750,001
2017 Sept. 30
(b)
(c)
2017 Nov. 30
2017 Dec. 31
2018 Mar. 31
Solutions Manual .
Equipment .................................................. Cash .................................................. Bank Loan Payable ...........................
Interest Expense ($10,000 × 2/3) ............... Interest payable.................................
1,100,000 100,000 1,000,000
6,667 6,667
Interest Payable ......................................... Interest Expense ........................................ Bank Loan Payable .................................... Cash ..................................................
Interest Expense ...................................... Bank Loan Payable .................................. Cash ................................................
10-41
6,667 3,333 83,333 93,333
9,167 83,333 92,500
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 10-3A (CONTINUED) (d)
Table not required but source for detailed calculations
Quarterly Interest Period
Cash Payment
Interest Expense 4% × 3/12
Reduction of Principal
Sept. 30, 2017
Principal Balance $1,000,000
Dec. 31, 2017
$88,849
$10,000
$78,849
921,151
Mar. 31, 2018
88,849
9,212
79,637
841,514
June 30, 2018
88,849
8,415
80,434
761,080
2017 Nov. 30
Dec. 31
2018 Mar. 31
Interest Expense ($10,000 × 2/3) ................. Interest Payable ..................................
6,667
Interest Expense .......................................... Interest Payable ........................................... Bank Loan Payable ...................................... Cash ....................................................
3,333 6,667 78,849
Interest Expense .......................................... Bank Loan Payable ...................................... Cash ....................................................
9,212 79,637
6,667
88,849
88,849
LO 2 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-4A (a) Semi-annual Interest Period
Cash Payment
Interest Expense 6.5% × 6/12
June 30, 2017 Dec. 31, 2017 June 30, 2018 Dec. 31, 2018 June 30, 2019
$48,145 48,145 48,145 48,145
$22,750 021,925 021,073 020,193
(b)
(e)
2017 June 30 2017; Dec. 31
2018 June 30
Reduction of Principal
Principal Balance
$25,395 26,220 27,072 27,952
$700,000 0674,605 0648,385 621,313 0593,361
Cash ........................................................ Mortgage Payable ...........................
700,000
Interest Expense ...................................... Mortgage Payable .................................... Cash ................................................
22,750 25,395
Interest Expense ...................................... Mortgage Payable .................................... Cash ................................................
021,925 26,220
700,000
48,145
48,145
(d) STARLIGHT GRAPHICS LTD. Statement of Financial Position (Partial) June 30, 2018 Current liabilities Current portion of mortgage payable ...............................
$ 55,024*
Non-current liabilities Mortgage payable ............................................................
0593,361
*($27,072 + $27,952) = $55,024 LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-5A (a)
Period
(A)
(B)
(C)
Cash
Interest
Principal
(D)
Payment
Expense
Reduction
Balance
(B) + (C)
(D) × 9% × 3/12
$240,000 ÷ 12
(D) – (C)
Apr. 30, 2018
$240,000
July 31, 2018
$25,400
$5,400
$20,000
220,000
Oct. 31, 2018
24,950
4,950
20,000
200,000
Jan. 31, 2019
24,500
4,500
20,000
180,000
Apr. 30, 2019
24,050
4,050
20,000
160,000
July 31, 2019
23,600
3,600
20,000
140,000
Oct. 31, 2019
23,150
3,150
20,000
120,000
Jan. 31, 2020
22,700
2,700
20,000
100,000
Apr. 30, 2020
22,250
2,250
20,000
80,000
July 31, 2020
21,800
1,800
20,000
60,000
Oct. 31, 2020
21,350
1,350
20,000
40,000
Jan. 31, 2021
20,900
900
20,000
20,000
Apr. 30, 2021
20,450
450
20,000
0
$35,100
$240,000
Total
(b) 2018 Apr.
30
Cash ............................................... Notes Payable ........................
240,000
Notes Payable ................................ Interest Expense ............................. Cash .......................................
20,000 5,400
Notes Payable ................................ Interest Expense ............................. Cash .......................................
20,000 4,950
240,000
(c) July
Oct.
Solutions Manual .
31
31
10-44
25,400
24,950
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-5A (CONTINUED) (d) BISTRO SALLY INC. Statement of Financial Position (Partial) October 31, 2018 Current liabilities Current portion of 9% notes payable ....................
$80,000*
Non-current liabilities Notes payable, 9%, due in 2021 ($200,000 – $120,000)................................ Total liabilities
120,000 $200,000
*$20,000 × 4 = $80,000
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-5A (CONTINUED) (e)
Had the repayment of the note been based on blended payments of principal and interest, the instalment schedule would have been as follows.
Period
(B)
(C)
(A)
Interest
Principal
(D)
Cash
Expense
Reduction
Balance
Payment
(D) × 9% × 3/12
(A) – (B)
(D) – (C)
Apr. 30, 2018
$240,000
July 31, 2018
$23,044
$ 5,400
$17,644
222,356
Oct. 31, 2018
23,044
5,003
18,041
204,315
Jan. 31, 2019
23,044
4,597
18,447
185,868
Apr. 30, 2019
23,044
4,182
18,862
167,006
July 31, 2019
23,044
3,758
19,286
147,720
Oct. 31, 2019
23,044
3,324
19,720
128,000
Jan. 31, 2020
23,044
2,880
20,164
107,836
Apr. 30, 2020
23,044
2,426
20,618
87,218
July 31, 2020
23,044
1,962
21,082
66,136
Oct. 31, 2020
23,044
1,488
21,556
44,580
Jan. 31, 2021
23,044
1,003
22,041
22,539
Apr. 30, 2021
23,044
505
22,539
0
$36,528
$240,000
Total
Interest expense would only be the same on July 31, 2018. After the first payment, the principal reduction would be lower under the blended payment method for all future payments. Correspondingly, the total interest expense over the term of the note will be higher by $1,428 ($36,528 – $35,100) when paying using the blended payment method. This is because the fixed principal payments earlier in the term of the note under the fixed principal payment method are larger than with the blended payments method shown above. LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-6A (a)
1. Current liabilities
Property tax payable (paid in May)
2. Current liabilities
Interest payable ($200,000 × 7% × 6/12) Current portion of note payable
Non-current liabilities
$ 0 7,000 40,000
Notes payable ($200,000 – $40,000)
160,000
3. Current liabilities
Accounts payable
120,000
4. Current liabilities
Unearned revenue (earned in January)
10,000
5. Current liabilities
Sales tax payable ($8,000 × 13%)
1,040
6. Current liabilities
Salaries payable [($18,000 × 1/5 days) – $175 – $68 – $1,200] CPP payable ($175 + employer share $175) EI payable ($68 + employer share $95 (1.4 × $68) Employee income tax payable
2,157
7. Contingent liability
Not on statement of financial position
8. Current liabilities
Income tax payable ($50,000 – $45,000)
9. Current liabilities Non-current liabilities
Debt due within one year Non-current debt ($250,000 – $30,000)
350 163 1,200 0 5,000
30,000 220,000
10. Not on the financial statements as not drawn on
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-6A (CONTINUED) (b)
The notes should disclose information on the contingent liability – the lawsuit, including the fact that the likelihood of the loss cannot be determined. Information on the note payable should also be disclosed, including the interest rate and repayment terms and payments required in each of the next five years. Details of Wendell’s non-current debt should be disclosed, including interest rates, maturity dates, conversion privileges, and any assets pledged as collateral. Details of the operating line of credit terms and maximum balance should be disclosed in the notes to the financial statements, even though no funds have yet been drawn.
LO 1,3 BT: K Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-7A (a)
(in millions) 1. Current ratio
2015 $1,962 = 1.7:1 $1,179
2. Receivables turnover
$10,658 $785 + $807 2
3. Inventory turnover
$7,688 $1,006 + $933 2
4. Debt to total assets
= 13.4 times
= 7.9 times
$3,172 = 46.6% $6,800
5. Times interest earned $613+$237+$73 $73
Solutions Manual .
2014
= 12.6 times
10-49
$1,896 = 1.1:1 $1,725
$9,223 $807 + $625 2
$6,518 $933 + $770 2
= 12.9 times
= 7.7 times
$3,518 = 55.3% $6,357
$534+$225+$69 $69
= 12.0 times
Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-7A (CONTINUED) (b)
Saputo’s current ratio has improved significantly and is more in line with industry averages in 2015. The receivables turnover ratio also improved from 12.9 times in 2014 to 13.4 times in 2015 and now matches the industry average. The inventory turnover improved as well from 7.7 times in 2014 to 7.9 times in 2015. In this respect, Saputo is well ahead of industry averages. This means that Saputo is collecting its receivables and moving its inventory more quickly in 2015 than in 2014. Improvements in the receivable and inventory turnover ratios likely lead to the improvement in the current ratio in 2015 because as the turnovers improved, cash was collected faster and used to pay down current liabilities. It is the reduction in the denominator of this ratio that caused the most significant change in the current ratio increase in 2015. . Overall, Saputo’s 2015 liquidity ratios are quite healthy. During 2015, Saputo’s debt to total assets ratio improved from 55.3% in 2014 to 46.6% in 2015. The company’s times interest earned ratio also improved. In comparison to the industry average, Saputo is carrying less debt compared to total assets (partly due to the lower current liabilities mentioned in the previous paragraph), and its times interest earned ratio is significantly higher. This indicates that the company appears to be earning more than enough net income to make the required debt interest payments or the majority of the debt is non-interest bearing. Therefore, there do not appear to be any significant concerns regarding Saputo’s solvency in 2015.
(c)
Saputo has secured a line of credit that helps it through short-term liquidity problems during its operating cycle. The fact that it has used only 15% of the $1.1 billion line of credit as of the end of 2015 demonstrates that it is not in great need of cash to meet its obligations. Saputo is ready to take advantage of opportunities that may come up in the future that would require significant amounts of cash. As for the rise in the U.S. dollar relative to the Canadian dollar in 2015, this has a detrimental effect on Saputo as the business must purchase U.S. dollars to repay the debt. In addition, balances for any U.S. dollar debt would be reported at higher exchange rates as of the date on the statement of financial position.
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-7A (CONTINUED) (d)
When assessing Saputo’s liquidity and solvency it is necessary to look at operating lease commitments that will require cash payments in the same way as all liabilities in the coming years. The fact that the amounts do not appear as liabilities on the statement of financial position does not erase the commitment to pay the amounts under those contracts in the future. The absence of these commitments on the statement of financial position artificially improves the company’s solvency. Upon further analysis, and with the inclusion of these amounts, one can better assess the company’s liquidity and solvency.
LO 3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-8A (a)
When reviewing the liquidity ratios for the two companies, it would appear that Sun-Oil is less liquid than Petro-Zoom. Sun-Oil has a lower current ratio than Petro-Zoom. Although it is turning its receivables over faster than Petro-Zoom, Petro-Zoom is able to move its inventory much more quickly than Sun-Oil. Furthermore, neither Petro-Zoom’s nor Sun-Oil’s receivables turnover ratios are of particular concern. Both are collecting their receivables within an average 30-day collection period (365 days divided by either 12 or 13 is approximately 30 days). What is of concern is Sun-Oil’s inventory turnover of 10 times which is well below Petro-Zoom’s of 16 times and the industry average of 19 times. This may be of concern to a lender or other creditor as a company will not be able to generate cash in the short-term if it cannot sell its inventory. Based on the concerns over Sun-Oil’s inventory turnover, I would think that Petro-Zoom is the more liquid of the two companies. I would be more inclined to lend money to Petro-Zoom.
(b)
In reviewing the solvency of these two companies we see that PetroZoom’s debt to total assets ratio is marginally higher (worse) than SunOil’s ratio, indicating that Petro-Zoom has a higher percent of its assets financed by debt. Sun-Oil also appears to be in a better position to make its interest payments, as indicated by the higher times interest earned ratio (24 times for Sun-Oil compared to 21 times for Petro-Zoom). When compared to the industry, we can see that both companies have debt to total assets ratios higher than the industry average. On the other hand, these ratios are not far off the industry average and their high times interest earned ratios leave little doubt that both companies are able to make their respective interest payments on the debt. Based on the debt to total assets ratio and times interest earned ratio, Sun-Oil seems to be the more solvent of the two. However, both companies appear to be generating sufficient income to cover interest payments so I would not be significantly concerned about the solvency of either company.
LO 3 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 10-9A (a) Able Limited – issued at par or 100 with coupon rate 6%: 2018 Jan. 1 Cash .................................................. 100,000 Bonds Payable .......................... (b) Dec. 31 Interest Expense ($100,000 × 6%) ..... 6,000 Cash .......................................... (a) Beta Corp. – issued at a discount price 94 with coupon rate 4%: 2018 Jan. 1 Cash ($100,000 × .94)........................ 94,000 Bonds Payable .......................... (b) Dec. 31 Interest Expense ($94,000 × 6%) ....... 5,640 Bonds Payable ($5,640 – $4,000) Cash ($100,000 × 4%) ............... (a) Charles Inc. – issued at a premium price 105 with coupon rate 7%: 2018 Jan. 1 Cash ($100,000 × 1.05) ........................ 105,000 Bonds Payable ............................ (b) Dec. 31 Interest Expense ($105,000 × 6%) ....... 6,300 Bonds Payable ($7,000 – $6,300) ........ 700 Cash ($100,000 × 7%).................
Solutions Manual .
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100,000
6,000
94,000
1,640 4,000
105,000
7,000
Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-9A (CONTINUED) (c)
As seen in parts (a) and (b), Able is the only company that issued the bonds at par. This occurred because its coupon rate matched the market rate of interest, both at 6% and therefore the interest expense it records is equal to the interest paid. In the case of Beta Corp., since its coupon rate of 4% allows it to pay less interest than the market rate of interest, it must issue the bond at a discount and receive less than the face value of the bond at the date of issuance. The discount is the mechanism that the investor uses to obtain a return on the bond equal to the market interest rate. The difference between the $94,000 Beta received at issuance and the $100,000 that will be paid at the maturity of the bond will be allocated to interest expense over the term of the bond. This will make the interest expense greater than the amount of interest paid. In the case of Charles Inc., since its coupon rate of 7% forces it to pay more interest than the market rate of interest, it will issue the bond at a premium and receive more than the face value of the bond at the date of issuance. The difference between the $105,000 that Charles received and the $100,000 that will be paid at the maturity of the bond will be allocated to interest expense over the term of the bond and reduce the expense. This will make the interest expense less than the amount of interest paid.
(d)
Balance in Bonds Payable account December 31, 2018: Able Limited: Bond issue January 1, 2018 No premium or discount Dec. 31, 2018
$100,000 $100,000
Beta Corp: Bond issue January 1, 2018 Plus amortization of bond discount Balance Dec. 31, 2018
$94,000 1,640 $95,640
Charles Inc.: Bond issue January 1, 2018 Less amortization of bond premium Balance Dec. 31, 2018
$105,000 700 $104,300
LO 4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 10-10A (a)
GLOBAL SATELLITES CORPORATION Bond Premium Amortization
Semiannual Interest Periods
July 1/17 Jan. 1/18 July 1/18 Jan. 1/19 July 1/19
(b)
July
1
(A) Interest to Be Paid (7% × 6/12 = 3.5%)
(B) Interest Expense to Be Recorded (6% × 6/12 = 3%)
(C) Premium Amortization (A) – (B)
(D) Unamortized Premium (D) – (C)
(E) Bond Carrying Amount ($1,500,000 + D)
$52,500 52,500 52,500 52,500
$48,348 48,223 48,095 47,963
$4,152 4,277 4,405 4,537
$111,587 107,435 103,158 98,753 94,216
$1,611,587 1,607,435 1,603,158 1,598,753 1,594,216
2017 Cash ................................................. Bonds Payable ........................
1,611,587 1,611,587
Note: Interest would also be recorded January 1, 2018 and July 1, 2018 (not illustrated here)
(c)
Dec. 31
Solutions Manual .
2018 Interest Expense .............................. Bonds Payable ................................. Interest Payable.......................
10-55
48,095 4,405 52,500
Chapter 10
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 10-10A (CONTINUED) (d) GLOBAL SATELLITES CORPORATION Statement of Financial Position (Partial) December 31, 2018 Current liabilities Interest payable
$
Non-current liabilities Bonds payable, due 2027
(e)
(f)
Jan.
1
Key inputs:
52,500
1,598,753
2019 Interest Payable ............................. Cash ......................................
52,500 52,500
Future value (FV) = $1,500,000 Market interest rate (i) = 3% (6% × 6/12) Interest payment (PMT) = $52,500 ($1,500,000 × 7% × 6/12) Number of semi-annual periods (n) = 20 (10 years × 2)
Present value of $1,500,000 received in 20 periods ($1,500,000 × 0.55368) (n = 20, i = 3%) Present value of $52,500 received each of 20 periods ($1,500,000 × 3.5% × 14.87747) (n = 20, i = 3%) Present value (issue price) of the bonds
$ 830,520 781,067 $1,611,587
Note to the instructor: Rounding discrepancies may arise depending on whether present value tables, calculators, or a spreadsheet program are used to determine the present value. When using a calculator, students should determine the present value to be $1,611,581. LO 3,4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-1B (a)
Jan.
5
13
13
14
15
19
22
28
Jan. 29
29
Solutions Manual .
Cash ....................................................................... Sales ............................................................. Sales Tax Payable [($20,000 × 5%); + ($20,000 × 7%)] .....................................
22,400
Cost of Goods Sold................................................. Inventory ........................................................
14,000
Sales Tax Payable .................................................. Cash ..............................................................
20,000 2,400
14,000 7,500 7,500
Sales Tax Payable .................................................. Cash ..............................................................
10,500
CPP Payable ($1,905 + $1,905) ............................. EI Payable ($666 + $932) ....................................... Employee Income Tax Payable .............................. Cash ..............................................................
3,810 1,598 7,700
Cash ....................................................................... Bank Loan Payable .......................................
18,000
10,500
13,108
18,000
Unearned Revenue................................................. 11,200 Service Revenue ........................................... Sales Tax Payable [($10,000 × 5%) + ($10,000 × 7%)] Service revenue before sales tax was $11,200 ÷ 1.12 = $10,000 Accounts Payable ................................................... Cash .............................................................. Property Tax Expense ($4,200 ÷ 12) ...................... Property Tax Payable ....................................
32,000 32,000 350 350
Salaries Expense .................................................... CPP Payable ................................................. EI Payable ..................................................... Employee Income Tax Payable ..................... Cash ..............................................................
40,000
Employee Benefits Expense ................................... CPP Payable ................................................. EI Payable .....................................................
3,033
10-57
10,000 1,200
1,980 752 9,474 27,794
1,980 1,053
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 10-1B (CONTINUED) (b)
Jan. 31
(c)
Interest Expense ($18,000 × 6% × 0.5/12) ............. Interest Payable .............................................
45 45
BURLINGTON INC. Statement of Financial Position (partial) January 31, 2018 Liabilities Current liabilities Accounts payable ($52,000 – $32,000) .................................................. Bank loan payable .................................................................................. Unearned revenue ($16,000 – $11,200) ................................................ Employee income tax payable ($7,700 – $7,700 + $9,474) ................... CPP payable ($3,810 – $3,810 + $1,980 + $1,980) ............................... EI payable ($1,598 – $1,598 + $752 + $1,053) ...................................... Sales tax payable ($18,000 + $2,400 – $7,500 – $10,500 + $1,200) ..... Property tax payable .............................................................................. Interest payable...................................................................................... Total current liabilities .......................................................................
$20,000 18,000 4,800 9,474 3,960 1,805 3,600 350 45 $62,034
LO 1,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-2B (a)
Mar.
2
31
Apr.
May
1
1
2
June
1
2
29
30
Solutions Manual .
Equipment ................................................... Bank Loan Payable ............................
16,000
Notes Payable............................................. Interest Expense ($30,000 × 5% × 6/12) .... Cash...................................................
30,000 750
Land ........................................................... Notes Payable ....................................
50,000
Interest Expense ($50,000 × 4% × 1/12) .... Cash...................................................
167
Cash ........................................................... Bank Loan Payable ............................
36,000
Interest Expense ($50,000 × 4% × 1/12) .... Cash...................................................
167
Bank Loan Payable ..................................... Interest Expense ($16,000 × 3% × 3/12) .... Cash...................................................
16,000 120
Vehicles ...................................................... Cash................................................... Bank Loan Payable ............................
10,000
Interest Expense ($167 + $180*) ................ Interest Payable ................................. ($50,000 × 4% × 1/12 - $167) (*$36,000 × 3% × 2/12 = $180)
347
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16,000
30,750
50,000
167
36,000
167
16,120
1,000 9,000
347
Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-2B (CONTINUED) (b)
Mar. 1 Bal. Mar.31 May 1 June 1 June 2 June 30 June 30 Bal.
Interest Expense 0 750 167 167 120 347 1,551 Interest Payable Mar. 1 Bal. June 30 June 30 Bal.
0 347 347
Notes Payable Mar. 31 30,000 Mar. 1 Bal. April 1 June 30 Bal.
30,000 50,000 50,000
Bank Loans Payable Mar. 1 Bal. Mar. 2 May 2 16,000 June 29 June 30 Bal.
0 16,000 36,000 9,000 45,000
June 2
(c) SPARKY’S MOUNTAIN BIKES LTD. Income Statement (partial) Year Ended June 30, 2018 Other revenues and expenses Interest expense ...............................................................
$1,551
(d) SPARKY’S MOUNTAIN BIKES LTD. Statement of Financial Position (partial) June 30, 2018 Current liabilities Bank loans payable .......................................................... Notes payable ................................................................... Interest payable ................................................................
$45,000 50,000 347
LO 1,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-3B (a) July
(b)
31
Equipment ................................................ Bank Loan Payable .......................... Cash ................................................
750,000 700,000 50,000
Note that instalment schedule is not required. It is included for information only.
Monthly Interest Period Issue Date Aug. 31/18 Sept. 30/18 Oct. 31/18 Nov. 30/18 Dec. 31/18 Jan. 31/19 Feb. 28/19 Mar. 31/19 Apr. 30/19 May 31/19 June 30/19 July 31/19 Aug. 31/19 Sept. 30/19
Aug. 31
Sept. 30
Solutions Manual .
(A) Cash Payment
(B) Interest Expense (D) × 4% × 1/12
(C) Reduction of Principal (A) – (B)
$15,805 15,805 15,805 15,805 15,805 15,805 15,805 15,805 15,805 15,805 15,805 15,805 15,805 15,805
$2,333 2,288 2,243 2,198 2,153 2,107 2,062 2,016 1,970 1,924 1,877 1,831 1,784 1,738
$13,472 13,517 13,562 13,607 13,652 13,698 13,743 13,789 13,835 13,881 13,928 13,974 14,021 14,067
Interest Expense ($700,000 × 4% × 1/12) ......... Bank Loan Payable ($15,805 – $2,333)............. Cash ......................................................... Interest Expense [($700,000 – $13,472) × 4% × 1/12] .................. Bank Loan Payable ($15,805 – $2,288)............. Cash .........................................................
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(D) Principal Balance (D) – (C) $700,000 686,528 673,011 659,449 645,842 632,190 618,492 604,749 590,960 577,125 563,244 549,316 535,342 521,321 507,254
2,333 13,472 15,805
2,288 13,517 15,805
Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-3B (CONTINUED) (c)
Note that instalment schedule is not required. It is included for information only.
Monthly Interest Period Issue Date Aug. 31/18 Sept. 30/18 Oct. 31/18 Nov. 30/18 Dec. 31/18 Jan. 31/19 Feb. 28/19 Mar. 31/19 Apr. 30/19 May 31/19 June 30/19 July 31/19 Aug. 31/19 Sept. 30/19
Aug.
Sept.
31
30
(A) Cash Payment (B) + (C)
(B) Interest Expense (D) × 4% × 1/12
(C) Reduction of Principal ($700,000 ÷ 48)
$16,916 16,868 16,819 16,771 16,722 16,673 16,625 16,576 16,527 16,479 16,430 16,382 16,333 16,284
$2,333 2,285 2,236 2,188 2,139 2,090 2,042 1,993 1,944 1,896 1,847 1,799 1,750 1,701
$14,583 14,583 14,583 14,583 14,583 14,583 14,583 14,583 14,583 14,583 14,583 14,583 14,583 14,583
Interest Expense ($700,000 × 4% × 1/12) ............ Bank Loan Payable ............................................... Cash ($2,333 + $14,583) .......................... Interest Expense [($700,000 – $14,583) × 4% × 1/12] ..................... Bank Loan Payable ............................................... Cash .........................................................
(D) Principal Balance (D) – (C) $700,000 685,417 670,834 656,251 641,668 627,085 612,502 597,919 583,336 568,753 554,170 539,587 525,004 510,421 495,838
2,333 14,583 16,916
2,285 14,583 16,868
LO 2 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-4B (a) Semi-annual Interest Period Dec. 31, 2017 June 30, 2018 Dec. 31, 2018 June 30, 2019 Dec. 31, 2019 (b)
(c)
2017 Dec. 31 2018 June 30
Dec. 31
(d)
Cash Payment
Interest Expense 8% × 6/12
Reduction of Principal
$90,000 088,000 086,000 084,000
$40,000 38,000 36,000 34,000
$50,000 50,000 50,000 50,000
Principal Balance $1,000,000 0950,000 0900,000 0850,000 0800,000
Cash ....................................................... Mortgage Payable ..........................
1,000,000
Interest Expense ..................................... Mortgage Payable ................................... Cash ...............................................
40,000 50,000
Interest Expense ..................................... Mortgage Payable ................................... Cash ...............................................
38,000 50,000
1,000,000
90,000
088,000
BEAUMONT BUILDING SUPPLIES LIMITED Statement of Financial Position (Partial) December 31, 2018 Liabilities Current liabilities Current portion of mortgage payable ...............................
$100,000
Non-current liabilities Mortgage payable ............................................................
800,000*
* $900,000 – $100,000 = $800,000 or see Dec. 31, 2019 balance. LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-5B
Period
(B)
(C)
(A)
Interest
Principal
(D)
Cash
Expense
Reduction
Balance
Payment
(D) × 8%
(A) – (B)
(D) – (C)
April 1, 2017
$200,000
March 31, 2018
$ 60,384
$16,000
$ 44,384
155,616
March 31, 2019
60,384
12,449
47,935
107,681
March 31, 2020
60,384
8,614
51,770
55,911
March 31, 2021
60,384
4,473
55,911
0
$241,536
$41,536
$200,000
Total
(b) April 1/17
Cash ................................................... Loan Payable ...............................
200,000
Loan Payable Interest Expense .................................. Cash ............................................
44,384 16,000
Loan Payable ....................................... Interest Expense .................................. Cash ............................................
47,935 12,449
200,000
(c) March 31/18
March 31/19
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60,384
60,384
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-5B (CONTINUED) (d)
ALPINE GOLF COURSE LTD. Statement of Financial Position (Partial) March 31, 2019
Liabilities
(e)
Current liabilities Current portion of 8% loan payable
$51,770
Non-current liabilities Loan payable, 8%, due in 2021 ($107,681 – $51,770)
55,911
Had the repayment of the loan been in fixed principal payments, the instalment schedule would have been as follows.
Period
(A)
(B)
(C)
Cash
Interest
Principal
(D)
Payment
Expense
Reduction
Balance
(B) + (C)
(D) × 8%
($100,000 ÷ 4)
(D) – (C)
April 1, 2017
$200,000
March 31, 2018
$ 66,000
$16,000
$ 50,000
150,000
March 31, 2019
62,000
12,000
50,000
100,000
March 31, 2020
58,000
8,000
50,000
50,000
March 31, 2021
54,000
4,000
50,000
0
$240,000
$40,000
$200,000
Total
As can be seen, the total amount of the interest expense over the term of the loan would be slightly lower as the fixed principal payments earlier in the term of the loan are larger than with the blended payments demonstrated in (a) above. LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-6B (a)
1. Current liabilities
Property tax payable ($12,000 × 4/12)
2. Current liabilities
Interest payable ($30,000 × 6% × 1/12) Bank loan payable ($35,000 – $5,000)
$ 4,000 150 30,000
3. Current liabilities
Accounts payable
7,000
4. Current liabilities
Sales tax payable ($15,000 × 5%)
750
5. Current liabilities
Unearned revenue
25,000
6. Current liabilities
Salaries payable [($40,000 × 1/5 days) – $393 – $150 – $3,200] CPP payable ($393 + employer share $393) EI payable [$150 + employer share $210 (1.4 × $150)] Employee income tax payable
4,257
7. Not a liability (contingent liability)
8. Current liabilities
Solutions Manual .
360 3,200
Not reported on statement of financial position. Disclosed only in the notes to the financial statements Income tax payable ($95,000 - $80,000)
9. Current liabilities Debt due within one year Non-current liabilities Non-current liabilities ($150,000 – $15,000) 10. Not a liability
786
15,000 15,000 135,000
Since the operating line of credit has not yet been drawn on, it would be disclosed only in the notes to the financial statements [see (b)] and not recorded.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-6B (CONTINUED) (b)
The notes should disclose information on the bank loan payable, including the interest rate and repayment terms. The notes should also disclose pertinent details regarding the environmental lawsuit, including management’s assessment of the likely outcome. Details of Iqaluit’s non-current debt should be disclosed including interest rates, maturity dates, conversion privileges, and any assets pledged as collateral. Details of the operating line of credit terms and maximum balance should be disclosed in the notes to the financial statements even though no funds have yet been drawn.
LO 1,3 BT: K Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-7B (a)
(in USD millions)
2015
1. Current ratio
$2,707 $2,415
2. Receivables turnover
$34,530 $1,195 + $1,726 2
3. Inventory turnover
$29,262 $860 + $848 2
4. Debt to total assets
$6,931 $10,838
5. Times interest earned
$933 + $306 + $92 $92
Solutions Manual .
2014
= 1.1:1
= 23.6 times
= 34.3 times
= 64.0%
= 14.5 times
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$3,215 $2,663
$37,962 $1,726 + $1,616 2
$32,974 $848 + $846 2
$6,568 $10,545
$812 + $134 + $111 $111
= 1.2:1
= 22.7 times
= 38.9 times
= 62.3%
= 9.5 times
Chapter 10
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-7B (CONTINUED) (b)
During the year Couche-Tard’s liquidity has deteriorated slightly. It has a lower current ratio (1.1:1 in 2015 compared to 1.2:1 in 2014). The company’s receivables are being collected slightly more quickly as evidenced by the receivables turnover ratio which increased from 22.7 times in 2014 to 23.6 times in 2015. In addition, the inventory turnover ratio deteriorated from 38.9 times in 2014 to 34.3 times in 2015, indicating that inventory is not selling as quickly as it did in the prior year. When compared to the industry average, Couche-Tard has a much lower current ratio and receivables turnover ratio, but its inventory turnover ratio is significantly ahead of the industry average. In 2015, the company’s solvency deteriorated slightly because the debt to total assets ratio increased from 62.3% in 2014 to 64.0% in 2015. This ratio remains significantly higher (worse) than other companies in the industry as the industry average is only 44%. Couche-Tard showed a strong times interest earned ratio of 14.5 times in 2015 which is well ahead of its industry peers for that year. We can therefore conclude that although this company has taken on more debt, it is using those borrowed funds to increase profitability and in turn, the times interest earned ratio.
(c)
A bank would be willing to provide a line of credit to a company if it believed that the company had sufficient income to pay the interest on the line of credit. In this case, with an increasing times interest earned ratio, Alimentation Couche-Tard would likely have no problem getting a bank to offer such a form of financing. A line of credit helps the business through short-term liquidity problems during its operating cycle. The fact that none of the $3 billion line of credit has been used by Couche-Tard as of the end of 2015 demonstrates that it is not in great need of cash to meet its obligations. The company is ready to take advantage of opportunities that may come up in the future that would require significant amounts of cash. The bank understands the purpose of the line of credit and expects it to be used for short periods of time and for the purposes described above. Should the line of credit be used for immediate large transactions, those transactions can later be refinanced with more permanent type financing, either by issuing bonds, shares, or by borrowing using term loans with the bank.
LO 3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 10-8B (a)
When reviewing the liquidity ratios for the two companies, we can see that the current ratios are similar although slightly lower than the industry average. The receivables turnover ratio shows that Grab ’N Gab is turning its receivables over faster than Chick ’N Lick, which indicates that the company is able to convert sales to cash more quickly. However, Chick ’N Lick is moving its inventory faster than Grab ’N Gab, as indicated by the inventory turnover ratio. I would be more likely to lend money to Chick ‘N Lick because of its higher inventory turnover. In a fast food industry, inventory turnover is the most important ratio. This is especially true when you note that a receivables turnover ratio of 38 times (365 ÷ 38 = 10 days) is still excellent, even if it is lower than that of its competition. Fast food businesses are, after all, primarily cash businesses.
(b)
In reviewing the solvency of these two companies, we see that Chick ’N Lick’s debt to total assets ratio is the better of the two companies. However, although Grab ’N Gab has a higher debt to total assets ratio, its higher times interest earned ratio of 10 times indicates that the company is able to support this level of debt. Chick ’N Lick’s times interest earned ratio is significantly lower than Grab ’N Gab’s and somewhat lower than the industry average. Nonetheless, the company does not appear to be having solvency problems as it is carrying less debt and still has reasonable interest coverage. Based on this analysis, I would not be significantly concerned about the solvency of either business.
LO 3 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 10-9B (a) Delta Limited – issued at par or 100 with coupon rate 5%: 2018 Jan. 1 Cash ...................................................... 200,000 Bonds Payable .............................. (b) Dec. 31 Interest Expense ($200,000 × 5%) ......... 10,000 Cash ..............................................
(a) Founders Corp. – issued at a discount price 94 with coupon rate 3%: 2018 Jan. 1 Cash ($200,000 × .94)............................ 188,000 Bonds Payable .............................. (b) Dec. 31 Interest Expense ($188,000 × 5%) ......... 9,400 Bonds Payable ($9,400 – $6,000) . Cash ($200,000 × 3%)................... (a) Grand Inc. – issued at a premium price 108 with coupon rate 7%: 2018 Jan. 1 Cash ($200,000 × 1.08) .......................... 216,000 Bonds Payable .............................. (b) Dec. 31 Interest Expense ($216,000 × 5%) ......... 10,800 Bonds Payable ($14,000 – $10,800) ...... 3,200 Cash ($200,000 × 7%)...................
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200,000
10,000
188,000
3,400 6,000
216,000
14,000
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 10-9B (CONTINUED) (c)
As seen in parts (a) and (b), Delta is the only company that issued bonds at par. This occurred because its coupon rate matched the market rate of interest, both at 5% and therefore, the interest expense it records is equal to the interest paid. In the case of Founders, since its coupon rate of 3% allows it to pay less interest than the market rate of interest, it must issue the bond at a discount and receive less than the face value of the bond at the date of issuance. The discount is the mechanism that the investor uses to obtain a return on the bond equal to the market interest rate. The difference between the $188,000 Founders received and the $200,000 that will be paid at the maturity of the bond will be allocated to interest expense over the term of the bond. This will make the interest expense greater than the amount of interest paid. In the case of Grand, since its coupon rate of 7% forces it to pay more interest than the market rate of interest, it will issue the bond at a premium and receive more than the face value of the bond at the date of issuance. The difference between the $216,000 Grand received and the $200,000 that will be paid at the maturity of the bond will be allocated to interest expense over the term of the bond and reduce the expense. This will make the interest expense less than the amount of interest paid.
(d)
Balance in Bonds Payable account December 31, 2018: Delta Limited: Bond issue January 1, 2018 No premium or discount Dec. 31, 2018
$200,000 $200,000
Founders Corp: Bond issue January 1, 2018 Plus amortization of bond discount Balance Dec. 31, 2018
$188,000 3,400 $191,400
Grand Inc.: Bond issue January 1, 2018 Less amortization of bond premium Balance Dec. 31, 2018
$216,000 3,200 $212,800
LO 4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 10-10B (a)
PONASIS CORPORATION Bond Discount Amortization
Semiannual Interest Periods July 1/17 Jan.1/18 July 1/18 Jan.1/19
(A) Interest to Be Paid (6% × 6/12 = 3%)
(B) Interest Expense (7% × 6/12 = 3.5%)
(C) Discount Amortization (A) – (B)
$30,000 30,000 30,000
$32,513 32,601 32,692
$2,513 2,601 2,692
(b) July
1
2017 Cash .............................................. Bonds Payable ......................
(D) Unamortized Discount (D) – (C)
(E) Bond Carrying Amount ($1,000,000 – D)
$71,058 68,545 65,944 63,252
$928,942 931,455 934,056 936,748
928,942 928,942
Note: Interest would also be recorded December 31, 2017 and July 1, 2018 (not illustrated here)
(c)
Dec. 31
2018 Interest Expense ............................ Bonds Payable ...................... Interest Payable.....................
32,692 2,692 30,000
(d) PONASIS CORPORATION Statement of Financial Position (Partial) December 31, 2018 Liabilities Current liabilities Interest payable .......................................................
$ 30,000
Non-current liabilities Bonds payable, due 2027 ....................................... Total liabilities .................................................
936,748 $966,748
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 10-10B (CONTINUED) (e)
(f)
Jan.
1
Key inputs:
2019 Interest Payable ........................ Cash .................................
30,000 30,000
Future value (FV) = $1,000,000 Market interest rate (i) = 3.5% (7% × 6/12) Interest payment (PMT) = $30,000 ($1,000,000 × 6% × 6/12) Number of semi-annual periods (n) = 20 (10 years × 2)
Present value of $1,000,000 received in 20 periods ($1,000,000 × 0.50257) (n = 20, i = 3.5%) Present value of $30,000 received each of 20 periods ($1,000,000 × 3% × 14.21240) (n = 20, i = 3.5%) Present value (issue price) of the bonds
$502,570 426,372 $928,942
Note to the instructor: Rounding discrepancies may arise depending on whether present value tables, calculators, or a spreadsheet programs are used to determine the present value. When using a calculator, students should determine the amount to be $928,938. LO 4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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ACR10-1
Financial Accounting, Seventh Canadian Edition
ACCOUNTING CYCLE REVIEW
(a) and (c)
12,000 24,000 92,000 218,548 9,000 350,000 4,000
Bal.
Cash 80,000 #1 780,000 #3 #5 #6 #7 #13 #16 150,452
Dec. 31 #8 Bal.
Accounts Receivable 480,000 #9 745,000 #10 429,000
780,000 16,000
Dec. 31 #9
#10
#13
#1
#5
Allowance for Doubtful Accounts Dec. 31 24,000 16,000 #11 22,000 Bal. 30,000
Dec. 31 #12 Bal.
Inventory 356,000 #8 250,000 #15 334,750
#5
270,000 1,250 #5
Dec. 31 #3 Bal.
Prepaid Insurance 0 24,000 # 3 22,000
Dec. 31
Equipment 1,800,000
2,000
Accumulated Depreciation-Equipment Dec. 31 480,000 #4 44,000 Bal. 524,000
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Accounts Payable Dec. 31 350,000 #12 #12 Bal.
321,000 250,000 49,000 270,000
Interest Payable 4,000 Dec. 31 #2 Bal.
4,000 3,973 3,973
Employee Income Tax Payable 52,000 Dec. 31 52,000 #6 52,000 Bal. 52,000 CPP Payable 28,000 Dec. 31 #6 #6 Bal.
28,000 14,000 14,000 28,000
EI Payable 12,000 Dec. 31 #6 #6 Bal.
12,000 5,452 7,633 13,085
Provisions Dec. 31 #14 Bal.
35,000 20,000 55,000
Unearned Revenue 5,000 Dec. 31 Bal.
12,000 7,000
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR10-1 (CONTINUED) (a) and (c) (continued)
#1
Bank Loan Payable 8,000 Dec. 31 Bal.
1,200,000 1,192,000
Common Shares Dec. 31
60,000
Retained Earnings Dec. 31
#16
#6
Salaries Expense 290,000
#6
Employee Benefits Expense 21,633
#3
Insurance Expense 2,000
#4
Depreciation Expense 44,000
#11
Bad Debts Expense 22,000
#2
Interest Expense 3,973
#7
Income Tax Expense 9,000
488,000
Dividends Declared 4,000 Sales #8 #15 Bal.
#8 #15 Bal.
#12 #14 Bal.
Administrative Expenses 49,000 20,000 69,000
Cost of Goods Sold 270,000 1,250 271,250
Solutions Manual .
745,000 5,000 750,000
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Financial Accounting, Seventh Canadian Edition
ACR10-1 (CONTINUED) (b) Transactions: Item 1
3
5
6
7
8
9
10
11
Solutions Manual .
Account Titles
Debit
Interest Payable ........................................................ Bank Loan Payable ................................................... Cash ................................................................. *(1,200,000 x .04 x 1/12 = 4,000)
4,000* 8,000
Prepaid Insurance ..................................................... Cash .................................................................
24,000
CPP Payable ............................................................. EI Payable................................................................. Employee Income Tax Payable ................................ Cash .................................................................
28,000 12,000 52,000
Salaries Expense ...................................................... CPP Payable .................................................... EI Payable ........................................................ Employee Income Tax Payable........................ Cash .................................................................
290,000
Employee Benefits Expense ..................................... CPP Payable .................................................... EI Payable ........................................................
21,633
Income Tax Expense ................................................ Cash .................................................................
9,000
Accounts Receivable................................................. Sales ................................................................
745,000
Cost of Goods Sold ................................................... Inventory ..........................................................
270,000
Cash ......................................................................... Accounts Receivable........................................
780,000
Allowance for Doubtful Accounts .............................. Accounts Receivable........................................
16,000
Bad Debts Expense .................................................. Allowance for Doubtful Accounts...................... [$30,000 - ($24,000 – $16,000)]
22,000
10-77
Credit
12,000
24,000
92,000
14,000 5,452 52,000 218,548
14,000 7,633
9,000
745,000
270,000
780,000
16,000
22,000
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR10-1 (CONTINUED) (b) (continued) Transactions: Item 12
13
16
Account Titles
Debit
Inventory ................................................................... Accounts Payable ............................................
250,000
Administrative Expenses ........................................... Accounts Payable ............................................
49,000
Accounts Payable ..................................................... Cash .................................................................
350,000
Dividends Declared ................................................... Cash .................................................................
4,000
Credit
250,000
49,000
350,000
4,000
Adjusting Entries 2
3
4
14
15
Solutions Manual .
Interest Expense ....................................................... Interest Payable ............................................... ($1,200,000- $8,000) x 4% x 1/12
3,973
Insurance Expense ($24,000 ÷ 12) ........................... Prepaid Insurance ............................................
2,000
Depreciation Expense ............................................... Accumulated Depreciation—Equipment .......... ($1,800,000 - $480,000 x 40% x 1/12
44,000
Administrative Expenses ........................................... Provisions.........................................................
20,000
Unearned Revenue ($12,000 - $7,000)..................... Sales ................................................................
5,000
Cost of Goods Sold ($5,000 x 25%) .......................... Inventory ..........................................................
1,250
10-78
3,973
2,000
44,000
20,000
5,000
1,250
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR10-1 (CONTINUED) (d) WASCANA LTD. Adjusted Trial Balance January 31, 2018 Cash Accounts receivable Allowance for doubtful accounts Inventory Prepaid insurance Equipment Accumulated depreciation–equipment Accounts payable Interest payable Employee income tax payable CPP payable EI payable Provisions Unearned revenue Bank loan payable Common shares Retained earnings Dividends declared Sales Cost of goods sold Administrative expenses Salaries expense Employee benefits expense Insurance expense Depreciation expense Bad debts expense Interest expense Income tax expense
Solutions Manual .
$150,452 429,000 $30,000 334,750 22,000 1,800,000 524,000 270,000 3,973 52,000 28,000 13,085 55,000 7,000 1,192,000 60,000 488,000 4,000 750,000 271,250 69,000 290,000 21,633 2,000 44,000 22,000 3,973 9,000 $3,473,058
10-79
____ ____ $3,473,058
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ACR10-1 (CONTINUED) (e) (1) WASCANA LTD. Income Statement Month Ended January 31, 2018 Sales ......................................................................... Cost of goods sold ...................................................... Gross profit ................................................................ Operating expenses Administrative expenses .................................... Salaries expense ............................................... Employee benefits expense............................... Insurance expense ............................................ Depreciation expense ........................................ Bad debts expense ............................................ Income from operations .............................................. Other revenues and expenses Interest expense ................................................ Income before income tax .......................................... Income tax expense ................................................... Net income .................................................................
$750,000 271,250 478,750 $ 69,000 290,000 21,633 2,000 44,000 22,000
448,633 30,117 3,973 26,144 9,000 $17,144
(e) (2) WASCANA LTD. Statement of Changes in Equity Month Ended January 31, 2018 Common Shares
Retained Earnings
$60,000
$488,000 17,144 (4,000) $501,144
Balance, January 1, 2017 ..................... Net income ........................................... Dividends declared ............................... Balance, January 31, 2017 ...................
Solutions Manual .
00 000 $60,000
10-80
Total Equity $ 548,000 17,144 (4,000) $561,144
Chapter 10
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Financial Accounting, Seventh Canadian Edition
ACR10-1 (CONTINUED) (e) (3) WASCANA LTD. Statement of Financial Position January 31, 2018 Assets Current assets Cash ................................................................... Accounts receivable............................................ $429,000 Less: allowance for doubtful accounts ................ 30,000 Inventory ............................................................. Prepaid insurance ............................................... Total current assets ................................... Property, plant, and equipment Equipment .......................................................... $1,800,000 Less: Accumulated depreciation—equipment.... 524,000 Total assets ..................................................................
$150,452 399,000 334,750 22,000 906,202
1,276,000 $2,182,202
Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................... Employee taxes payable................................................ CPP payable .................................................................. EI payable...................................................................... Provisions ...................................................................... Interest payable ............................................................. Unearned revenue ......................................................... Current portion of bank loan payable ............................. Total current liabilities ........................................... Non-current liabilities Bank loan payable ......................................................... Total liabilities ....................................................... Shareholders’ equity Common shares ............................................................ Retained earnings.......................................................... Total shareholders’ equity ..................................... Total liabilities and shareholders’ equity .................................
$ 270,000 52,000 28,000 13,085 55,000 3,973 7,000 96,000 525,05 1,096,000 1,621,058 60,000 501,144 561,144 $2,182,202
LO 1,3 BT: AP Difficulty: C Time: 75 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT10-1 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
The North West Company Inc. shows the following current and noncurrent liabilities on its consolidated balance sheet at January 31, 2016: Current liabilities: Accounts payable and accrued liabilities Current portion of long-term debt (for previous comparative year only) Income tax payable Non-current liabilities: Long-term debt Deferred benefit plan obligation Deferred tax liabilities Other long-term liabilities
(b)
There is no current portion for long-term debt at January 31, 2006. The most significant component of the long-term debt balances are revolving loan facilities.
(c)
North West has chosen both fixed and floating interest rates when negotiating terms for their long-term senior notes payable. A floating rate loan will initially pay less interest, but as the prime lending rate changes so does the amount of interest that is charged on the balance owed on the notes. Since the senior notes repayment is typically several years in length, this changing of interest rate reduces the risk to the financial institution to get a proper return on their loan to North West. With the fixed interest rate, the initial interest rate paid is higher, but the rate does not change over the term of the loan. Using this strategy, North West has protected itself to some degree against the effects of changing interest rates.
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT10-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a) Ratios 1. Current ratio
2. Receivables turnover
3. Inventory turnover
4. Debt to total assets
5. Times interest earned
Solutions Manual .
North West ($ in thousands) $335,581 $155,501
= 2.2:1
$1,796,035 = 23.7 times $79,373 + $72,506 2
$1,273,421 = 6.1 times $211,736 + $204,812 2
$436,183 $793,795
= 54.9%
Sobeys ($ in millions) $2,581.4 $2,707.4
$24,618.8 $489.4 + $499.7 2
= 1.0:1
= 49.8 times
$18,661.2 = 14.7 times $1,287.3 + $1,260.3 2
$5,230.9 $7,960.6
= 65.7%
$69,779 + $31,332 + $(2,119.2) + $(463.4) Not $6,210 + $134.6 = 17.3 times = Applicable $6,210 $134.6
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Financial Accounting, Seventh Canadian Edition
CT10-2 (CONTINUED) (b)
Liquidity: Based on the current ratio, North West is more liquid than Sobeys. As for receivable and inventory turnovers, Sobey’s is far ahead of North West. North West must be offering terms on some of their sales, which is not the case for Sobeys. This may in part be due to higher amounts of accounts receivable for North West as indicated by its lower receivables turnover. On the other hand, North West’s inventory turnover is much lower than Sobeys. Compared to the industry average, North West has a higher current ratio while Sobeys is lower than the industry average. The opposite is true for both the receivables turnover and inventory turnover ratios, where Sobey’s ratios are higher than the industry while North West’s are lower. All of the ratios are important for the assessment. Solvency: The higher a company’s percentage of debt to total assets is, the greater the risk that this company may be unable to meet its maturing obligations. North West’s debt to total assets ratio of 54.9% is higher (worse) than that of the industry average of 47.1%, but Sobey’s is even higher at 65.7%. North West has a times interest earned ratio that is much higher than the industry average which means that the company is very able to make its interest payments. Sobeys on the other hand, has a negative (not measureable) ratio due to the loss it reported. Both ratios are important, but the high level of Sobey’s debt is most alarming.
LO 3 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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CT10-3
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a) Current Assets: Cash Accounts receivable Inventory
2018 2,000 20,000 30,000 52,000
2017 $10,000 5,000 7,500 22,500
Property, plant and equipment, net Total assets
60,000 $112,000
50,000 $72,500
Current liabilities: Accounts payable Non-current liabilities Total liabilities
$ 30,930 40,000 $ 70,930
$16,550 30,000 $46,550
$24,000 (1)
$20,000 (2)
$
Income before taxes and interest (1) $100,000 – $50,000 – $26,000 (2) $50,000 – $20,000 – $10,000
Solutions Manual .
10-85
Average $6,000 12,500 18,750 37,250
Chapter 10
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Financial Accounting, Seventh Canadian Edition
CT10-3 (CONTINUED) (a) (continued) Please note that when calculating turnover ratios, amounts from the current year statement of financial position are used as given in the instructions. 2018
in thousands
2017
1. Current ratio
$52,000 $30,930
2. Receivables turnover
$100,000 $20,000
3. Inventory turnover
$50,000 $30,000
= 1.7 times
$20,000 $7,500
= 2.7 times
4. Debt to total assets
$70,930 $112,000
= 63.3%
$46,550 $72,500
= 64.2%
5. Times interest earned
$24,000 $2,400
Solutions Manual .
= 1.7:1
= 5.0 times
= 10.0 times
10-86
$22,500 $16,550
$50,000 $5,000
$20,000 $1,500
= 1.4:1
= 10.0 times
= 13.3 times
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT10-3 (CONTINUED) (b)
Although Jim might conclude that profitability and liquidity has improved, a closer scrutiny of all ratios reveals issues with the liquidity and solvency of Atlas Limited. The current ratio has increased from 1.4:1 to 1.7:1 in 2018 but this was due to the high levels of accounts receivable and inventory. The receivables turnover has deteriorated substantially from 10 times in 2017 to only 5 times in 2018. The inventory turnover has also deteriorated, from 2.7 times to 1.7 times. Atlas needs to improve its collection of receivables and its inventory turnover. Furthermore, Jim needs to keep in mind that some cash has been retained by negotiating an interest-only loan that will end in 2020. This advantage will not continue forever. From a solvency point of view, Atlas has a very similar debt to total assets ratio in both years but the ratio remains rather high given that more than 60% of the company’s assets have been purchased with debt financing. In addition, Atlas’ times interest earned ratio had diminished from 13.3 times in 2017 to 10 times in 2018, indicating a strong, but reduced, capability to pay the interest on the loan. Furthermore, it is likely that the existing loan is secured by the plant and equipment. The loan now represents 67% of the plant and equipment balance, up from 60% of the year before. This increase arises because the carrying value of plant and equipment is declining.
(c)
Some of the underlying causes for the slowdown in the turnover of accounts receivable might be that Atlas has given its customers too generous terms for payment, possibly to improve sales or there has been a lack of attention paid to delinquent accounts. In looking at the income statement, the banker will notice that gross profit did not rise as much as sales. This is due in part to the fact that cost of goods sold is now 50% of sales in 2018 compared to 40% of sales in 2017. Also, although sales have doubled, operating expenses more than doubled and lastly, it appears that the interest rate on the loan has risen to 6% from 5%. These factors that have decreased profitability will concern the banker. A final area of concern for the banker will be the future settlement of the contingent liability stemming from the lawsuit launched against Atlas. Although no amount could be accrued for this contingency as no reasonable estimate could be arrived at, the mere mention of this looming potential obligation will rightly bring doubt as to Atlas’ ability to deal with any related payments in the near future.
LO 3 BT: S Difficulty: C Time: 40 min. AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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CT10-4
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
(a)
The likely explanation why shareholders’ equity increased in spite of a loss incurred during the year is the issuance of shares.
(b)
Before the issuance of shares, debt was used to finance the expansion. Once shares were issued, the cash was used in part to retire debt.
(c)
When a company expands through the use of debt, interest is charged on that debt. It is therefore critical for such a company to earn sufficient income from the projects that were financed with this debt in order to pay the interest on this debt. However, when oil prices began to fall, the company realized that it would be difficult to pay interest on its loans, so to decrease that burden on the company’s cash flows, it needed to pay down its debt quickly in order to reduce interest payments. The best way to do that was to issue shares to obtain cash to pay down that debt.
(d)
It would have been difficult for Baytex to be successful in issuing additional shares after the downturn in the oil prices. It is more likely that the issue occurred before the downturn. Following the drop in oil prices and related losses, the stock would have dropped in value as shareholders exited their investment in Baytex.
LO 3 BT: S Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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CT10-5
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
(a) 1. Debt to total assets
$45,000 $100,000
=
45%
2. Times Interest earned
$120,000 $20,000
=
6 times
(b) Error Error description
Accounts affected
Direction
Amount
1.
Interest not accrued
Interest Expense Interest Payable
Understated Understated
$2,500 2,500
2.
Posting of interest payment
Interest Expense Bank Loan Payable
Understated Understated
1,800 1,800
3.
Sale of gift cards
Sales Unearned Revenue
Overstated Understated
2,700 2,700
(c)
Effect of error on income before taxes (net) Overstatement of Sales $2,700 Understatement of Interest Expense 2,500 Understatement of Interest Expense 1,800 Total overstatement of income before taxes 7,000 Income taxes at 30% 2,100 Net income effect $(4,900) Income Tax Expense overstated by Income Tax Payable overstated by
Solutions Manual .
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2,100 2,100
Chapter 10
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CT10-5 (CONTINUED) (d)
All of the errors identified above will affect the calculation of debt but none of the errors affect assets. Therefore, the revised debt is:
As originally determined Correct error #1 – interest not accrued Correct error #2 – loan payment not allocated to interest Correct error #3 – unearned revenue understated Correct error #4 – overstatement of income tax Corrected balance
$45,000 2,500 1,800 2,700 (2,100) $49,900
Only error #3 will affect the numerator (net income before interest and income tax) of the times interest earned ratio because this ratio excludes interest and income tax from the numerator and errors #1, #2, and #4 affect interest or income tax. Therefore, the revised numerator is $120,000 – the effect of error #3 of $2,700 = $117,300. Interest expense (the denominator in the times interest earned ratio) will be revised as follows: As originally determined Correct error #1 – interest not accrued Correct error #2 – loan payment not allocated to interest Corrected balance
1. Debt to total assets
2. Times Interest earned
$20,000 2,500 1,800 $24,300
$49,900 = 49.9% $100,000
$120,000 - $2,700 $20,000 + $2,500 + $1,800
= 4.8 times
(e)
Based on the revised calculations, ABC is close to breaching the covenant pertaining to debt to total assets, and below the requirement for times interest earned.
(f)
Although all the errors affected the elements in the two ratios in adverse ways, it is unlikely that the errors were intentional. An indication of this conclusion is that the errors were soon detected by Jennifer Woo.
LO 3 BT: S Difficulty: C Time: 10 min. AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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CT10-6
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
(a)
The stakeholders in this situation include: Shareholders The bank and other creditors Employees Management
(b)
Currently, operating lease payments are treated as rent expense. The details of the amount of the future payments under the lease contract are reported in the notes to the financial statements. On the other hand, a finance lease is treated as a means of financing the acquisition of the asset and so the asset being leased is added to the assets and the total obligations under the lease appear in the liabilities section of the statement of financial position. Payments on finance lease obligations are treated as part interest expense and part debt repayment. A finance lease causes increased interest expense and debt on the financial statements and so the debt to total assets ratio and the times interest earned ratio are adversely affected.
(c)
There are many ways to structure a lease so that it is accounted for as an operating lease. Many of these ways are legitimate while other ways can be unethical. For example, if a lease is structured to last for 360 days, it will most likely be accounted for as an operating lease and doing so is completely appropriate. If an option exists in the lease agreement for the lessee to purchase the asset at the end of the lease at a “bargain price, the lease should not be accounted for as an operating lease. But if management has negotiated such an option in a document separate from the lease agreement but claims that such an option does not exist thereby allowing the company to account for the lease as an operating lease, this would be unethical. Such behaviour could be construed as a type of financial engineering which is designed to deceive others and remove obligations that occur as a result of a transaction. In this case, management must meet some specific financial conditions with respect to its debt covenants with the bank. Following through with the plan might put the bank at a disadvantage in obtaining recourse under its loan agreement with Crown Point Inc.
(d)
Analysts are not fooled by financial engineering involving leases. Notwithstanding the application of the current rules surrounding the capitalization of leases, analysts will make the necessary adjustments to the financial results to interpret the impact of the treatment of operating versus finance leases.
LO 3 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic and Ethics CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
Solutions Manual .
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT10-7 (a)
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
The balance of the mortgage payable at November 25, 2018 is $46,718 as calculated below. (B)
(b)
Interest
(C)
(D)
(A)
Expense
Reduction
Principal
Monthly
Cash
(D) × 5%
of Principal
Balance
Interest Period
Payment
× 1/12
(A) – (B)
(D) – (C)
June
25, 2018
Balance
$49,050
July
25, 2018
$667
$204
$463
48,587
Aug.
25, 2018
667
202
465
48,122
Sept.
25, 2018
667
201
466
47,656
Oct.
25, 2018
667
199
468
47,188
Nov.
25, 2018
667
197
470
46,718
The $46,718 balance of the mortgage payable at November 25, 2018 will increase by $25,000 to a total of $71,718 after the mortgage is renegotiated. Nov. 25, 2018
Solutions Manual .
Cash ................................................................. 25,000 Mortgage Payable .....................................
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25,000
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Financial Accounting, Seventh Canadian Edition
CT10-7 (CONTINUED) (c) (B) Interest
(C)
(D)
(A)
Expense
Reduction
Principal
Monthly
Cash
(D) × 4%
of Principal
Balance
Interest Period
Payment
× 1/12
(A) – (B)
(D) – (C)
Nov.
25, 2018
Dec.
25, 2018
$1,320
$239
$1,081
70,637
Jan.
25, 2019
1,320
235
1,085
69,552
Feb.
25, 2019
1,320
232
1,088
68,464
Mar.
25, 2019
1,320
228
1,092
67,372
Apr.
25, 2019
1,320
225
1,095
66,277
May
25, 2019
1,320
221
1,099
65,178
June
25, 2019
1,320
217
1,103
64,075
July
25, 2019
1,320
214
1,106
62,969
Aug.
25, 2019
1,320
210
1,110
61,859
Sept.
25, 2019
1,320
206
1,114
60,745
Oct.
25, 2019
1,320
202
1,118
59,627
Nov.
25, 2019
1,320
199
1,121
58,506
Dec.
25, 2019
1,320
195
1,125
57,381
Jan.
25, 2020
1,320
191
1,129
56,252
Feb.
25, 2020
1,320
188
1,132
55,120
Mar.
25, 2020
1,320
184
1,136
53,984
Apr.
25, 2020
1,320
180
1,140
52,844
May
25, 2020
1,320
176
1,144
51,700
June
25, 2020
1,320
172
1,148
50,552
Solutions Manual .
Balance
$71,718
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Financial Accounting, Seventh Canadian Edition
CT10-7 (CONTINUED) (d) First Instalment Payment 2018
Dec. 25 Interest Expense ................................................... Mortgage Payable....................................... Cash .................................................
239 1,081 1,320
Second Instalment Payment 2019
Jan. 25 Interest Expense ................................................... Mortgage Payable....................................... Cash .................................................
(e)
235 1,085 1,320
ANTHONY BUSINESS COMPANY LTD. Statement of Financial Position (Partial) June 30, 2019
Liabilities Current liabilities Current portion of 4% mortgage payable ($64,075 – $50,552) Non-current liabilities Mortgage payable, 4%, due in 2023 Total liabilities
$13,523
50,552 64,075
LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic and Communication CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
CHAPTER 11 REPORTING AND ANALYZING SHAREHOLDERS’ EQUITY LEARNING OBJECTIVES Identify and discuss the major characteristics of a corporation. Record share transactions. Prepare the entries for cash dividends, stock dividends, and stock splits, and understand their financial impact. 4. Indicate how shareholders’ equity is presented in the financial statements. 5. Evaluate dividend and earnings performance. 1. 2. 3.
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO
BT
Item LO
BT
Item LO BT Questions
Item LO
BT
Item LO
BT
C C K C
25. 26. 27. 28.
5 5 5 5
C C AN C
17. 18.
5 5
AP AP
13. 14. 15.
5 5 5
AN AN AN
1. 2. 3. 4.
1 1 1 1
C AP C C
7. 8. 9. 10.
2 2 2 2
C K K C
13. 14. 15. 16.
3 3 3 3
K C C AP
19. 20. 21. 22.
4 4 4 4
5.
1
C
11.
2
AP
17.
3
K
23.
5
K
6.
2
C
12.
2
C
18.
4
K
24.
5
AN
Brief Exercises 1. 2.
1 2
C AP
5. 6.
2 3
AN AP
9. 10.
3 4
AN AN
13. 14.
5 5
AN AN
3.
2
AP
7.
3
AP
11.
4
AP
15.
5
AP
4.
2
AP
8.
3
AN
12.
4
AP
16.
5
AP
10. 11. 12.
4 5 5
AP AN AP
5 5
AN AN
Exercises 1. 2. 3.
1 2 2
AN AP AN
4. 5. 6.
2 2,3 3
AN AP AP
1. 2. 3.
2,3,4 2,3,4 2,3,4
AN AN AN
4. 5. 6.
2,3,4 2,3,4 3
AP AP AN
1.
2,3,4
AP
1. 2.
3,4 1,2,5
C C
7. 8. 9.
2,3,4 4 4
AN C AP
Problems: Set A and B 7. 8. 9.
3,4 5 5
AP AP AN
10. 11.
Accounting Cycle Review Cases
Solutions Manual .
3. 4.
2,4 3
S C
5. 6.
5 2,3,4
3-1
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Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
(a) (1) Separate legal existence. A corporation is separate and distinct from its shareholders (owners) and acts in its own name rather than in the name of its shareholders. In addition, the acts of the shareholders do not bind the corporation unless the shareholder is a duly appointed agent of the corporation. This is an advantage to the corporate form of organization. (2) Limited liability of shareholders. Because of its separate legal existence, creditors of a corporation ordinarily have recourse only to corporate assets to satisfy their claims. Thus, the liability of shareholders is normally limited to their investment in the corporation. This is an advantage to the corporate form of organization. (3) Transferable ownership rights. Ownership of a corporation is shown in shares, which are transferable. Shareholders may dispose of part or all of their interest by simply selling their shares. The transfer of ownership to another party is entirely at the discretion of the shareholder. This is an advantage to the corporate form of organization. (4) Ability to acquire capital. Corporations can raise capital quite easily by issuing shares. Public corporations have an almost unlimited ability to acquire capital. Investors find shares of corporations to be attractive since they need not invest large sums of money to become shareholders. In addition, shareholders benefit from limited liability. This is an advantage to the corporate form of organization. (5) Continuous life. Since a corporation is a separate legal entity, its continuance as a going concern is not affected by the withdrawal, death, or incapacity of a shareholder, employee, or officer. This is an advantage to the corporate form of organization. (6) Separation of management and ownership. Although the shareholders of a corporation are its owners, it is the board of directors that decides on the operating policies of the company. The shareholders seldom get involved in the company’s day-today activities. This is normally seen to be an advantage to the corporate form of organization.
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1.
Financial Accounting, Seventh Canadian Edition
(a) (continued) (7) Government regulations. Corporations in Canada may incorporate federally or provincially. Government regulations usually provide guidelines for issuing shares, distributing net income, and reacquiring shares. Provincial securities commissions also govern the sale of share capital to the general public. When a corporation’s shares are listed or traded on a stock exchange, it must adhere to the reporting requirements of that exchange. This may be a disadvantage to the corporate form of organization because it adds extra cost and complexity to the organization. (8) Income tax. Corporations must pay federal and provincial income tax as separate legal entities. However, corporations usually benefit from more favourable tax rates than do the owners of partnerships or proprietorships. The shareholders of the corporation do not pay tax on the corporation’s net income unless they receive dividends from the corporation. This is often seen to be an advantage to the corporate form of organization. (b)
While public corporations have an almost unlimited ability to acquire capital, this is not the case for private corporations. In addition, transferring ownership rights can be much more limited given that private corporation shares are not publicly traded. Private companies do not have as stringent reporting and disclosure requirements as public companies.
LO 1 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001, cpa-t006 CM: Reporting and Tax
2.
(a)
Letson has 60,000 shares issued and is eligible to issue an additional 40,000 shares (100,000 – 60,000).
(b)
Only issued shares are recorded in the general journal. The number of authorized shares is disclosed but not recorded until issued.
LO 1 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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3.
Financial Accounting, Seventh Canadian Edition
When Richard purchased the original shares as part of lululemon’s initial public offering, he purchased these shares directly from the corporation. The $1,800 (100 × $18) he spent to buy the shares went directly to lululemon and increased the company’s assets (Cash) and shareholders’ equity (Common Shares). There was no impact on the company’s liabilities. In the subsequent purchase, Richard bought shares in the secondary market from another investor or investors. The proceeds from this sale went to the seller and not to lululemon. Therefore, there was no impact on lululemon’s assets, liabilities, or shareholders’ equity a result of the second purchase.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
4.
Market capitalization is the measure of the fair value of a corporation’s equity. It is calculated by multiplying the number of shares issued by the share market price at any given date. It should not be confused with a corporation’s legal capital which represents the amount paid to the corporation on the initial and any subsequent issue of shares and consequently is the amount that appears on the statement of financial position. Dollarama Inc.’s market capitalization decreased in 2015. There are two primary reasons for a decrease in the market capitalization of a company, which may happen separately or in combination. First, the number of shares may have decreased because the company repurchased some of its shares. If this is the case, assets (Cash) and shareholders’ equity (Common Shares) would decrease as a result of the repurchase. Liabilities would be unaffected. The second and more likely reason for the decrease in the market capitalization is the decrease in the market price of the shares. Decreases in the market price of the shares can result from a number of reasons but are most likely due to the market’s perception of the future ability of the corporation to earn income. As a result, investors bid down the price paid for the shares on the market. This possible reason for the change in market capitalization does not affect any element on the statement of financial position.
LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
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5.
Financial Accounting, Seventh Canadian Edition
Legal capital is the portion of a company’s share capital that cannot be distributed to shareholders. Legal capital is created largely for the protection of creditors. (b) The proceeds received by the company when issuing shares determine the carrying amount of the shares recorded in the accounts. The proceeds are considered to be legal capital that must remain invested in the company for the protection of corporate creditors. (c) Par value is very common in the United States and very rare in Canada. Federally incorporated companies and most provincially incorporated companies have no par value shares. (d) Legal capital is kept separate from retained earnings because retained earnings may be distributed to shareholders in the form of dividends, whereas legal capital may not be distributed to shareholders until the company is liquidated.
(a)
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
(a)
Preferred shareholders have priority over common shareholders with respect to the distribution of dividends and, in the event of liquidation, over the distribution of assets. Preferred shareholders do not usually have the voting rights that the common shareholders have.
(b)
Companies issue preferred shares for a permanent type of equity financing for the company.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
When shares are issued for a consideration other than cash, such as goods or services, IFRS requires that the transaction be recorded at the fair value of the consideration received. If the fair value of the consideration received cannot be reliably determined, then the fair value of the consideration given up (for example, shares) can be used. When shares are issued for a noncash consideration in a private company following ASPE, the valuation of the shares can be slightly different than that described above for a publicly traded company following IFRS. The shares of a private company should be recorded at the most reliable of the two values—the fair value of the consideration (such as goods or services) received or fair value of the consideration given up (such as shares). Quite often, the fair value of the consideration received is the most reliable value because a private company’s shares seldom trade and therefore do not have a ready market value.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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8.
Financial Accounting, Seventh Canadian Edition
(a)
A normal course issuer bid is synonymous with the reacquisition of shares. In a normal course issuer bid, a company is allowed to repurchase up to a certain percentage of its shares subject to regulatory approval. It can purchase the shares gradually over a period of time, such as one year. This repurchasing strategy allows the company to buy when its shares are favourably priced.
(b)
A corporation may acquire its own shares (1) to increase trading of the corporation's shares in the stock market, in the hopes of enhancing its market value, (2) to reduce the number of shares issued and increase basic earnings per share and return on equity ratios, (3) to eliminate hostile shareholders by buying their shares, and (4) to have additional shares to issue if required to compensate employees using stock options, or to acquire other businesses.
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
9.
Because companies cannot realize a gain or incur a loss from share transactions with their own shareholders, these amounts are not reported on the income statement. They are seen instead as an excess or deficiency that belongs to the remaining shareholders and are recorded directly into the shareholders’ equity accounts such as Contributed Surplus or Retained Earnings.
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10.
When reacquiring shares, if the amount paid by the company is less than the average cost of the shares on hand, the difference is credited to Contributed Surplus, increasing it. If the opposite is true (i.e., the amount paid to reacquire the shares is greater than the average cost of the shares on hand), the difference is applied to reduce (debit) Contributed Surplus, but because that account cannot have a negative (debit) balance, if the debit arising from the reacquisition is greater than the balance in the Contributed Surplus account, then the remainder of the debit is applied against the Retained Earnings account, reducing it.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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11.
Financial Accounting, Seventh Canadian Edition
David should expect to receive a dividend in the amount of $295.00 (1,000 shares × $1.18 ÷ 4) each quarter. When the Royal Bank resets the dividend rate, it will be adjusted to more closely reflect market interest rates. If David invested in the preferred shares because he hoped to earn a more attractive return from dividends compared to the rate of return he could receive from interest earned on a debt investment, he may be disappointed when the dividend rate is reset at the lower market interest rate. On the other hand, because the resetting of the dividend rate occurs only periodically, if David believes that interest rates will fall, he may be very pleased to own these preferred shares (at least until the dividend rate is reset at the same level as the lower interest rates). Furthermore, if David believes that the interest rates will be volatile in the future, the reset feature will make the investment in the preferred shares more appealing because at least until the next reset, David will know what his rate of return will be.
LO 2 BT: AP Difficulty: C Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
12.
(a)
Redeemable (or callable) preferred shares give the issuing corporation the right to purchase these shares from shareholders at specified future dates and prices. Retractable preferred shares are similar to redeemable or callable preferred shares, except that it is at the shareholder’s option, rather than the corporation’s option, that the shares are redeemed. This usually occurs at an arranged price and date.
(b)
Preferred shares are cumulative or noncumulative with respect to their dividend provisions. Cumulative preferred shares entitle the shareholder to any previous years’ dividends that have not yet been paid, as well as their current dividend, before common shareholders can receive any dividends.
(c)
Dividends in arrears can only arise from cumulative preferred shares. If a dividend is not declared for a noncumulative preferred share, the dividend entitlement is erased and does not carry forward into the future. On the other hand, if a dividend is not declared for a cumulative preferred share, the amount of the dividend shortfall becomes dividends in arrears which must be paid first from any dividend declared in the future.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
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13.
Financial Accounting, Seventh Canadian Edition
Cash dividends cannot exceed the balance of the Retained Earnings account. For a cash dividend to be paid, a corporation must meet a solvency test to ensure that it has sufficient cash to be able to pay its liabilities as they become due after the dividend is declared and paid. The test essentially requires the net realizable value of the assets of a company to exceed the total of its liabilities and share capital. In addition, a formal dividend declaration by the board of directors is required. Also, any required preferred dividends must be paid before common dividends are paid.
LO 3 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
On the declaration date, the board of directors formally authorizes the cash dividend and announces it to shareholders. The declaration of a cash dividend commits the corporation to a binding legal obligation. On the record date, ownership of the shares is determined. On the payment date, dividends are paid to the shareholders. The table below demonstrates the effect of three events on the financial statement elements.
(1) (2) (3) (4) (5) (6)
Assets Liabilities Share capital Retained earnings Total shareholders' equity Number of shares
(a) Declaration date No effect Increase No effect Decrease Decrease No effect
(b) Record date No effect No effect No effect No effect No effect No effect
(c) Payment date Decrease Decrease No effect No effect No effect No effect
LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
(1) (2) (3) (4) (5) (6)
Assets Liabilities Share capital Retained earnings Total shareholders' equity Number of shares
(a) Cash dividend Decrease No effect No effect Decrease Decrease No effect
(b) Stock dividend No effect No effect Increase Decrease No effect Increase
(c) Stock split No effect No effect No effect No effect No effect Increase
LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
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16.
Financial Accounting, Seventh Canadian Edition
(a)
In a stock split, the number of shares issued is increased. In the case of Bella Corporation, the number of shares issued will increase from 10,000 to 30,000 (10,000 × 3).
(b)
The effect of a split on market value is generally inversely proportional to the size of the split. In this case, the market price would fall to approximately $40 per share ($120 3).
LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
17.
Cash and stock dividends are recorded in the general journal because the financial position of the company changes. In the case of a cash dividend, the account dividends declared is increased, which in turn decreases retained earnings. Cash is also reduced when a cash dividend is paid. In the case of a stock dividend, the dividends declared account is increased, which in turn decreases retained earnings. Common Shares are increased in the case of a stock dividend when the distribution date is reached. In the case of stock splits, there is no change in the financial position of the company. No accounts are affected. Only the number of shares held by shareholders will change, typically by a multiple (for example, 2 for 1).
LO 3 BT: K Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
18.
(a)
All six accounts appear individually on the statement of changes in equity, along with the details of the transactions that increased and decreased the accounts during the year being reported.
(b)
The first three accounts (preferred shares, common shares, and stock dividends distributable) would be reported under the subheading of share capital in the shareholders’ equity section of the statement of financial position with balances at the reporting date. The remaining accounts would be reported separately in the shareholders’ equity section of the statement of financial position, after the total share capital.
LO 4 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
19.
The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends. Restrictions may result from the following causes: legal, contractual, or voluntary. Although not reported separately on the statement of changes in equity or statement of financial position, the portion of retained earnings that is restricted is disclosed in a note to the financial statements.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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20.
Financial Accounting, Seventh Canadian Edition
Comprehensive income is the sum of net income (loss) and other comprehensive income and appears on the statement of comprehensive income. Other comprehensive income (or loss) is made up of temporary accounts added to, or deducted from, the opening balance of accumulated other comprehensive income by closing entries at the end of the year. These changes to the accumulated other comprehensive income account are detailed on the statement of changes in equity. Accumulated other comprehensive income is a permanent equity account and its ending balance appears in the shareholders’ equity section of the statement of financial position.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
21.
(a)
The statement of retained earnings shows all of the changes to retained earnings for the accounting period being reported. The statement of retained earnings must be prepared by private companies following ASPE. The statement of changes in equity shows the changes in retained earnings, similar to the statement of retained earnings. However, it also shows the changes in amounts in share capital, as well as the changes in all of the remaining equity accounts. This is a required statement for companies following IFRS.
(b) The statement of retained earnings shows the changes that determine the ending balance of retained earnings, which is only one of the accounts that appears in the shareholders’ equity section of the statement of financial position. The statement of changes in equity shows the changes that determine each of the shareholders’ accounts (for example, preferred shares, common shares, retained earnings, and accumulated other comprehensive income). Each of these accounts appears in the shareholders’ equity section of the statement of financial position. LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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22.
Financial Accounting, Seventh Canadian Edition
(a)
Private companies that report using ASPE usually have a simpler capital structure than publicly traded companies who use IFRS. Consequently, the shareholders’ equity section of the statement of financial position has fewer accounts with ASPE. For example, private companies are not required to report accumulated other comprehensive income, which publicly traded companies are required to report.
(b)
Private companies using ASPE would prepare the following financial statements: statement of financial position, income statement, statement of retained earnings, and statement of cash flows. For companies using ASPE, fewer equity account transactions occur that need to be explained and consequently there is no requirement to prepare a statement of changes in equity. Rather, only a statement of retained earnings is required, linking the income statement to the retained earnings account shown in the shareholders’ equity section of the statement of financial position. Publicly traded companies using IFRS would prepare the following financial statements: statement of financial position, income statement and/or statement of comprehensive income, statement of changes in equity, and statement of cash flows. Under IFRS, a statement of comprehensive income is required (in combination with, or along with the income statement) when there is other comprehensive income during the year.
LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
23.
(a) (b) (c) (d)
Unfavourable Favourable Unfavourable Favourable
LO 5 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
24.
Pepsi had the higher share price. The market price of the share can be determined by dividing the dividend per share by its dividend yield.
Ratio
CocaCola
Pepsi
Dividend per share Dividend yield
$1.32 2.9%
$2.76 2.7%
Market price per share
$45.52
$102.22
LO 5 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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25.
Financial Accounting, Seventh Canadian Edition
The weighted average number of shares is a more realistic measure of the number of shares that the corporation had throughout the year and the use of the assets generated from these shares. The net income generated on the share issue proceeds during the year, or reduced by the shares repurchased during the year, is for only part of the year so the number of shares should be weighted by the same partial year factor. Given that companies routinely issue and retire shares, using the number of shares at a specific point in time (such as year end) may not provide a true representation of the company’s basic earnings per share.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
26.
Companies must use the income available to common shareholders (net income – preferred dividends) in the calculation of their basic earnings per share figures because preferred shareholders receive preferential treatment with respect to the distribution of the company’s dividends. That is, common shareholders would not receive any dividends before the preferred shareholders receive theirs. Similarly, the preferred shareholders’ entitlement must be subtracted from both the numerator (net income – preferred dividends) and denominator (total shareholders’ equity – preferred shares) in the calculation of return on common shareholders’ equity. Consequently, both ratios use income available to common shareholders in their numerators.
LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
27.
(a)
Company B pays out the higher proportion of its net income in dividends and these dividends give shareholders the higher dividend yield, when compared to Company A. Therefore, Company B is the better choice for an investor interested in a steady dividend income.
(b)
If an investor had purchased the shares for growth, Company A would have been preferred by the investor as Company A is not using up as much cash to pay dividends and is reinvesting more of its net income back into the business to grow operations.
LO 5 BT: AN Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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28.
Financial Accounting, Seventh Canadian Edition
Two companies can have the same return on assets but a different return on common shareholders’ equity for a number of reasons. Since neither company has issued preferred shares, both ratios will have the same numerator, so any difference in these two ratio values will arise from differences in the denominator. The difference between a company’s assets (the denominator in the return on assets ratio) and a company’s common shareholders’ equity (the denominator in the return on common shareholders’ equity ratio) consists of either liabilities or preferred shares but in this case will consist of only liabilities. Therefore, a company that has a significant amount of liabilities will tend to have a more significant difference between its return on assets and its return on common shareholders’ equity. Company A likely has a higher portion of its assets financed with liabilities than Company B has. In taking on more liabilities, Company A can become more profitable and have a higher return on common shareholders’ equity only if the after-tax rate of interest paid to creditors is lower than the return on assets that were purchased with funds borrowed from creditors. The difference between the return on these assets and the interest paid on the funds borrowed to buy these assets will go (be attributed to) to the common shareholders, increasing the return on common shareholders’ equity.
LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 (a)
At Hydro One Limited’s initial public offering, the shares issued were purchased from the corporation. The $20.50 per share received goes directly to Hydro One and increases assets (cash) and shareholders’ equity (share capital).
(b)
At the March 2016 date, the market price of $24.00 per share is a result of the buying and selling of shares occurring in the secondary market. The proceeds from the sale of shares go to the seller and not to Hydro One. Therefore, there is no impact on Hydro One Limited’s financial position as a result of the trading occurring on the stock market subsequent to the IPO.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 11-2 (a) May
2
June 15 Nov.
1
Dec. 15
Cash ............................................................. Common Shares (2,000 × $15) ............
30,000
Cash ............................................................. Common Shares (1,000 × $17) ............
17,000
Cash ............................................................. Preferred Shares (200 × $30) ..............
6,000
Cash ............................................................. Preferred Shares (200 × $35) ..............
7,000
30,000
17,000 6,000
7,000
(b)
(1) Preferred shares (2) Common shares
Number of shares authorized 200,000 Unlimited
Number of shares issued (200+200) 400 (2,000 + 1,000) 3,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 11-3 (a)
Average cost of common shares on: Balance Common Number of Date Shares Shares June 8
$300,000
Aug. 19 Bal.
$90,000 $390,000
Average Cost
÷
60,000
=
$5.00
÷
15,000 75,000
=
$5.20
Nov. 2 Bal.
$(31,200) (1) $358,800 ÷
(6,000) 69,000
=
$5.20
Dec. 7 Bal.
$(41,600) (2) $317,200 ÷
(8,000) 61,000
=
$5.20
(1) 6,000 shares x average cost $5.20 = $31,200 (2) 8,000 shares x average cost $5.20 = $41,600 (b) June 8 Aug. 19 Nov. 2
Dec. 7
Cash .................................................................. Common Shares ........................................ Cash .................................................................. Common Shares ........................................ Common Shares (1) above .................................. Contributed Surplus ($31,200 - $ 28,800).. Cash ..........................................................
300,000
Common Shares (2) above .................................. Contributed Surplus (balance).............................. Retained Earnings ................................................ Cash ..........................................................
41,600 2,400 8,000
300,000 90,000 90,000 31,200 2,400 28,800
52,000
LO 2 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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BRIEF EXERCISE 11-4 (a) Mar. 8
April 20
(b)
150,000
Land ................................................................. Preferred Shares (3,000 shares) ..............
110,000
150,000
110,000
If the current value of the land could not be determined, the fair value of the consideration given up ($35 per share multiplied by 3,000 shares or $105,000) would be used. The journal entry would be as follows:
April 20
(c)
Cash ................................................................. Preferred Shares (5,000 × $30)................
Land ................................................................. Preferred Shares (3,000 × $35)................
105,000 105,000
If Daschen Inc. was a private company using ASPE, the value of the shares would not be as easily obtained since they do not trade on a stock exchange. Consequently, the amount recorded on the exchange of preferred shares for land will more likely be determined by the value of the consideration received, which is the current value of the land. In this case, the entry would not change since the current value of the land is the more clearly determinable value in the exchange.
LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 11-5 (a)
Dividends in arrears at the end of the current year = 20,000 × $2 = $40,000
(b)
Dividends in arrears are not accrued as liabilities. The amount of the dividends in arrears is disclosed in the notes to the financial statements.
(c)
Dividends in arrears can only arise from cumulative preferred shares. If a dividend is not declared for a noncumulative preferred share, the dividend entitlement does not carry forward into the future.
LO 2 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 11-6 Nov. 15
Cash Dividends (60,000 × $2 ÷ 4) .................... Dividends Payable ...................................
Dec. 10
30,000 30,000
No entry required
31
Dividends Payable ........................................... Cash .........................................................
30,000 30,000
LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 11-7 Dec.
1
Jan.
Dividends Declared (100,000 × 5% × $15) Stock Dividends Distributable ..............
20
No entry required
10
Stock Dividends Distributable ....................... Common Shares ..................................
75,000 75,000
75,000 75,000
(Stock Dividends = Number of shares issued × Market price per share when declared) LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 11-8 (a)
Before the stock split: 19,500,000 shares After the stock split: 19,500,000 × 3 = 58,500,000 shares
(b)
Likely stock price after the stock split: $67.30 ÷ 3 = $22.43
(c)
There would be no journal entry recorded for the stock split. Details of the stock split would be discussed in the notes to the financial statements.
LO 3 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 11-9 Transaction
Assets
Liabilities
Shareholders’ Equity
Number of Shares
(a) (b) (c) (d) (e)
NE NE NE NE
+ NE NE NE
NE +/+/NE
NE NE NE + +
LO 3 BT: AN Difficulty: C Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 11-10 [1] [2] [3] [4] [5] [6] [7] [8]
$2,050,000 – $1,500,000 – $110,000 = $440,000 $440,000 same as [1] $3,505,000 – $3,000,000 + $135,000 – $750,000 = $(110,000) or same as the amount of increase in Common Shares $0 $750,000 (same amount as increase in Retained Earnings) $125,000 – $100,000 = $25,000 $500,000 (no change from beginning balance) $5,100,000 + $440,000 [2] – $135,000 + $750,000 [5] + $25,000 = $6,180,000 or taken from ending balances $2,050,000 + $500,000 [7] + $3,505,000 + $125,000 = $6,180,000
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 11-11 LUXAT CORPORATION Statement of Financial Position (Partial) December 31, 2018 Shareholders' equity Contributed capital Common shares, unlimited number of shares authorized, 550,000 issued ............................................. Contributed surplus ............................................................... Total contributed capital .................................................. Retained earnings ....................................................................... Accumulated other comprehensive income ................................ Total shareholders' equity ..................................................................
$2,050,000 500,000 2,550,000 3,505,000 125,000 $6,180,000
LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 11-12 STIRLING FARMS LIMITED
(a)
Statement of Retained Earnings Year Ended December 31, 2018 Retained earnings, January 1 .................................................... Add: Net income ...................................................................... Less: Cash dividends................................................................ Retained earnings, December 31 ..............................................
$490,000 150,000 640,000 90,000 $550,000
(Ending retained earnings = Beginning retained earnings + Net income – Dividends declared)
(b)
If Stirling were a publicly traded corporation, a statement of changes in equity would be required instead of a statement of retained earnings. It would report the changes in each of the shareholders’ equity accounts, not just retained earnings.
LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 11-13 (a)
Payout ratio last year
$60,000 $600,000
= 10%
(Payout ratio = Cash dividends declared ÷ Net income)
(b)
Dividends paid this year = $2,000,000 × 10% = $200,000 (assuming the same payout ratio).
(c)
(Not required) Dividends paid next year = $700,000 × 10% = $70,000 (assuming the same payout ratio). Maintaining a constant dividend payout ratio may or may not be a sound business practice. Many factors, including the corporation’s cash flow and the type of investor involved would have to be taken into consideration. Because dividend amounts are relatively fixed (or with small increases), the payout ratio tends to fluctuate with profits. Maintaining a constant dividend payout ratio when net income fluctuates will result in variable dividend amounts being paid to shareholders, which may not be wise from a cash flow or growth perspective. It is also difficult to determine in advance exactly what the net income for the year will be. Trying to keep exactly the same payout ratio is therefore not always possible.
LO 5 BT: AN Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 11-14 (a)
Canadian National Railway
Canadian Pacific Railway
$1.25 $80.00 = 1.6%
$1.40 $168.00 = 0.8%
Dividend yield
(Dividend yield = Dividends declared per share ÷ Market price per share)
(b)
Investors would prefer Canadian National Railway because of its higher dividend yield if they wished to purchase shares for the purpose of earning dividend income.
LO 5 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 11-15 Weighted average number of shares: January 1 May 1 August 31 November 30
(a) (b)
34,000 × 12/12 = (3,000) x 8/12 = 9,000 × 4/12 = 6,000 × 1/12 = 46,000
34,000 (2,000) 3,000 500 35,500
The number of common shares issued at December 31, 2018 is 46,000. The weighted average number of common shares for 2018 is 35,500.
LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 11-16 Basic earnings per share
$370,000 – $20,000* 35,500
= $9.86
*10,000 × $2 = $20,000 (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares) LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 11-17 (a) Basic earnings per share
$800,000 – $100,000* = $2.33 300,000
*50,000 × $2 = $100,000 (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares)
(b)
Same amount as in (a) $2.33
(c) Basic earnings per share
$800,000 300,000
= $2.67
LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 11-18 (a)
Return on common shareholders’ equity:
$14,000 12.4% ($104,000 $122,000) 2 (Return on common shareholders’ equity = (Net income – preferred dividends) ÷ Average common shareholders’ equity)
(b)
Had Salliq issued preferred shares and paid dividends to the preferred shareholders, the amount of income available to common shareholders would be reduced by the amount of the preferred dividend, reducing the return on common shareholders’ equity ratio.
LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 11-1 (a)
High Low Increase
$44.56 $32.87 $11.69 x 100 shares = $1,169.00 income
(b)
$0.56 per share
(c)
1,000 × $43.56 = $43,560
(d)
$43.56 - $0.19 = $43.37
(e)
216,740 shares
LO 1 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 11-2 (a)
(b)
June 12 Cash (50,000 × $6) .................................... Common Shares ................................
300,000
July 11 Cash (1,000 × $25) .................................... Preferred Shares ...............................
25,000
Oct.
1 Land ........................................................... Common Shares (10,000 shares) ......
75,000
Nov. 15 Cash (25,000 × $28) .................................. Preferred Shares ...............................
700,000
300,000
25,000
75,000
700,000
Preferred: 2,500 + 1,000 + 25,000 = 28,500 shares $55,000 + $25,000 + $700,000 = $780,000 Common: 140,000 + 50,000 + 10,000 = 200,000 shares $700,000 + $300,000 + $75,000 = $1,075,000
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 3
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-3 (a)
Jan.
6
12
17
18
24
31
Cash ............................................................. Common Shares (200,000 × $1.50)......
300,000
Cash ............................................................. Common Shares (50,000 × $1.75) .......
87,500
Cash ............................................................. Preferred Shares (10,000 × $25) ..........
250,000
Cash ............................................................. Common Shares (500,000 × $2.00)......
1,000,000
Common Shares (200,000 × $1.85) ............. Retained Earnings ($380,000 - $370,000) .... Cash (200,000 × $1.90) ........................
370,000* 10,000
Professional Fees Expense........................... Common Shares (10,000 shares) .........
15,000
300,000
87,500
250,000
1,000,000
380,000
15,000
*Refer to part (b) $1,387,500 ÷ 750,000 = $1.85; $1.85 x 200,000 = $370,000 (b)
For preferred shares, there was only the one transaction on January 17 and so the number of shares is 10,000 and the average cost is $25.00 at January 31. For common shares: Number of shares Date issued
Contributed Capital
January 6
200,000
$1.50
$300,000
January 12
50,000
$1.75
87,500
January 18
500,000
$2.00
1,000,000
Sub. Total
750,000
January 24
(200,000)
January 31
10,000
15,000
560,000
$1,032,500
Balance Solutions Manual .
Issue price
1,387,500 $1.85
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Average cost
$1.85
(370,000)
$1.844 Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 11-3 (CONTINUED) (c)
If Moosonee were a publicly traded company, the per-share value of the shares issued in exchange for the legal services would be easily obtained as they are traded every business day. When shares are issued for a consideration other than cash, such as goods or services, IFRS requires that the transaction be recorded at the fair value of the consideration received. If the current value of the consideration received cannot be reliably determined, then the current value of the consideration given up (shares in this case) can be used. In this case, the value of the services was given so the journal entry would not be any different under IFRS .
LO 2 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 11-4 (a)
Total annual preferred dividend should be 400,000 × $2 per share or $800,000.
(b)
Dividends in arrears at the end of Year 1 are $200,000 ($800,000 annual dividend less dividends declared of $600,000). By the end of Year 2, the dividends paid of $400,000 are first allocated to the $200,000 dividends in arrears from Year 1 and the remaining $200,000 is for Year 2. Consequently, by the end of Year 2, dividends in arrears at that time are $600,000. ($800,000 - $200,000)
(c)
Dividends in arrears are not accrued as a liability. Rather, the amount of any dividends in arrears is disclosed in the notes to the financial statements.
(d)
The corporation has no obligation to pay any dividends regardless of whether the preferred shares are cumulative or noncumulative. What is different with the noncumulative preferred shares is that in Year 2 the corporation is not obligated to pay any dividends in arrears before it can pay dividends for the current year. No arrears would exist in either of Year 1 or 2 if the shares had been noncumulative.
(e)
Since undeclared dividends are lost completely in the case of noncumulative preferred shares, from a perspective of an investor, cumulative shares are preferred because the investor does not lose the right to receive an undeclared dividend. Since cumulative preferred shares are more attractive to investors, they will be easier to sell by the company.
LO 2 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-5 (a)
Apr.
2
June 15 July 10 Aug. 21
Cash ............................................................... Common Shares (5,000 × $20) ..............
100,000
Dividends Declared (85,000 × $0.25) ............. Dividends Payable ................................
21,250
Dividends Payable ......................................... Cash.......................................................
21,250
Dividends Declared ........................................ Stock Dividends Distributable ................ (80,000 + 5,000 = 85,000 × 5% = 4,250 × $22)
93,500
100,000 21,250 21,250 93,500
(Stock Dividends = Number of shares issued × Market price per share on declaration date)
Sept. 20 Nov.
1
Dec. 20
Stock Dividends Distributable......................... Common Shares ...................................
93,500
Cash ............................................................... Common Shares (3,000 × $25) ..............
75,000 75,000
Dividends Declared ........................................ 27,675 Dividends Payable ................................. 27,675 ((80,000 + 5,000 + 4,250 + 3,000) x $0.30 = 92,250 × $0.30)
(b)
Number of common shares at the end of the year: 80,000 + 5,000 + 4,250 + 3,000 = 92,250
LO 2,3
BT: AP
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93,500
Difficulty: M
Time: 20 min.
AACSB: Analytic
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CM: Reporting
Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 11-6 Before Action
(1) After Cash Dividend
(2) After Stock Dividend
(3) After Stock Split
Total assets
$1,250,000
$1,200,000
$1,250,000
$1,250,000
Total liabilities
$ 250,000
$ 250,000
$ 250,000
$ 250,000
Common shares Retained earnings Total shareholders' equity Total liabilities and shareholders’ equity
600,000 400,000 1,000,000
600,000 350,000 950,000
670,000* 330,000 1,000,000
600,000 400,000 1,000,000
$1,250,000
$1,200,000
$1,250,000
$1,250,000
Number of common shares
100,000
100,000
105,000
200,000
* $600,000 + (100,000 shares × 5% × $14) = $670,000 (Contributed capital is increased by the total amount of the stock dividend) LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 11-7
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Assets + NE + + NE NE NE NE +
Liabilities NE + NE NE NE NE NE NE NE
Share Capital + NE NE + + NE + +/NE NE
Shareholders’ Equity Accumulated Other Total Retained Comprehensive Shareholders’ Earnings Income Equity NE NE + NE NE NE NE + NE NE NE + NE NE NE NE +/NE NE +/NE NE NE NE NE + +
LO 2,3,4 BT: AN Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-8 Statement of Changes in Equity Other Financial Statement Statement of financial position NE
Classification Current assets
OCI: Revaluation gain
NE
NE
NE
NE
Non-current assets
NE
NE
Statement of financial position NE
Retained earnings NE
NE
NE
NE
NE
Income statement
Retained earnings NE NE
NE
NE
Operating expenses (reduction of) NE
NE NE
NE NE
NE NE
Share Capital NE
Retained Earnings NE
AOCI NE
2. Common shares 3. Other comprehensive income– Revaluation gain from revaluing property, plant, and equipment to fair value 4. Long-term investments
Common shares NE
NE
NE
NE
NE
5. Preferred shares 6. Retained earnings 7. Gain on disposal
Preferred shares NE
Account 1. Cash
8. Cash dividends 9. Stock split 10. Stock dividends distributable
NE
NE NE Common shares*
NE
NE
Legend: AOCI : Accumulated Other Comprehensive Income OCI: Other Comprehensive Income * Note to instructors: Preferred shares is also an acceptable answer here although common shares are more often issued as stock dividends. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-9 OZABAL INC. Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Contributed capital Share capital $1.25 Preferred shares, noncumulative, 100,000 authorized, 10,000 shares issued ............................ Common shares, unlimited number of shares authorized, 250,000 shares issued .......................... Stock dividends distributable ................................... Contributed surplus ...................................................... Total contributed capital ...................................................... Retained earnings (Note R)................................................. Accumulated other comprehensive loss .............................. Total shareholders’ equity............................................................
$250,000 500,000 50,000
$ 800,000 25,000 825,000 900,000 (50,000) $1,675,000
Note R: Retained earnings restricted for plant expansion, $100,000. LO 4 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-10 (a) THE BLUE CANOE LIMITED Statement of Changes in Equity Year Ended December 31, 2018
Balance Jan. 1 Issued common shares Common shares reacquired Net income Dividends declared Other comprehensive income Balance Dec. 31
Common Shares $800,000 180,000
Contributed surplus $540,000
(200,000)
(40,000)
Retained Earnings $1,500,000
Accumulated Other Comprehensive Income $90,000
(240,000) 400,000 (70,000)
400,000 (70,000)
$780,000
$500,000
$1,830,000
Total $2,930,000 180,000
(25,000)
(25,000)
$65,000
$3,175,000
(b) THE BLUE CANOE LIMITED Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Contributed capital Common shares.............................................................. Contributed surplus ........................................................ Total contributed capital ...................................................... Retained earnings ............................................................... Accumulated other comprehensive income......................... Total shareholders’ equity............................................................
$780,000 500,000 $1,280,000 1,830,000 65,000 $3,175,000
LO 4 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-11 (a) Nike (in millions of USD) (1) Payout ratio (2) Dividend yield
$931 ÷ $3.273 = 28.4% $1.08 ÷ $62.50 = 1.7%
Adidas (in millions of euros) €320 ÷ €634 = 50.5% €1.60 ÷ €89.91 = 1.8%
(Payout ratio = Cash dividends declared ÷ Net income) (Dividend yield = Dividends declared per share ÷ Market price per share)
(b)
Investors would likely prefer Adidas for dividend income purposes because of its slightly higher dividend yield, but if the difference between these two yields is not important to an investor, they may prefer Nike because its lower payout ratio indicates that it retains a larger portion of its income to foster future growth.
LO 5 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 11-12 (a)
Income available to common shareholders = Net income – Preferred share dividends = $963,750 – (60,000 × $1 × ¼) = $948,750
(b)
Weighted average number of common shares Dec. 1 180,000 × 12/12 = 180,000 Feb. 28 45,000 × 9/12 = 33,750 Nov. 1 18,000 × 1/12 = 1,500 215,250
(c)
Basic earnings per share = Income available to common shareholders ÷ Weighted average number of common shares = $948,750 ÷ 215,250 = $4.41
LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-13 (a) ($ in millions) (1) Payout ratio
2015 $1,708 = $3,531
2014 48.4%
$1,567 = $3,131
50.0%
(2) Dividend yield
$4.30 = 4.3% $100.28
$3.94 = 3.8% $102.89
Basic earnings per share
$3,531 = $8.89 397
$3,131 = $7.87 398
Return on common (4) = 18.6% $3,531 shareholders' ($20,360 + $17,588) ÷ 2 equity
= 18.3% $3,131 ($17,588 + $16,546) ÷ 2
(3)
(1) (Payout ratio = Cash dividends declared ÷ Net income) (2) (Dividend yield = Dividends declared per share ÷ Market price per share) (3) (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares) (4) (Return on common shareholders’ equity = (Net income – preferred dividends ÷ Average common shareholders’ equity)
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-13 (CONTINUED) (b)
The dividends paid by CIBC in 2015 increased in absolute amount. However, when dividends are expressed as a percentage of the net income, the result—the payout ratio—decreased from 50.0% to 48.4%. This is because net income increased at a higher rate than did dividends. The dividend yield increased from 3.8% in 2014 to 4.3% in 2015. This occurred not just because of an increase in dividends but also because of a slight decrease in the market price of a share. Both of these effects will cause the dividend yield to increase. CIBC’s net income improved in 2015 both in total amount and on a pershare basis. Its return on common shareholders’ equity also improved slightly from 18.3% to 18.6%. In spite of the improved profitability, the bank’s shareholders were not willing to pay a higher market price for the common shares in 2015 ($100.28) compared to 2014 ($102.89). This decrease may be due to perceived risk on the part of shareholders.
LO 5 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 11-14 As an investor interested in an income-oriented investment, the dividend ratios will carry a great deal of weight when choosing between Stanley and Snap-on. The dividend payout of Stanley is much stronger than that of Snap-on. Stanley is also a better choice based on the dividend yield ratio. The choice between the two companies should not be based on the basic earnings per share, which are not comparable between companies. The earnings per share can only be interpreted in conjunction with the market price of the share (for example, the price-earnings ratio) or the dividends paid per share (for example, the dividend payout ratio). The return on common shareholders’ equity ratio, while a profitability ratio of interest, would not be a primary ratio relied upon to assess whether to purchase a company’s shares for income (dividend) purposes. For investors seeking future price appreciation in the shares of these companies, Snap-On has a better chance for future price appreciation. It is retaining a higher percentage of its income, and its return on common shareholders’ equity is higher. LO 5 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
EXERCISE 11-15 (a)
Income from operations
No-Debt Option $80,000
Interest expense (4%)
0
10,000
[7]
Income before income tax
$80,000
[1]
$70,000
[8]
Income tax expense (30%)
24,000
[2]
21,000
[9]
Net income
$56,000
[3]
$49,000
[10]
Average total assets
$500,000
$500,000
Average common shareholders’ equity
$500,000
$250,000
Number of common shares
50,000
25,000
Basic earnings per share
$1.12
[4]
$1.96
[11]
$56,000
[3]
$49,000
[10]
Payout ratio
100%
[5]
100%
[12]
Return on common shareholders’ equity
11.2%
[6]
19.6%
[13]
Cash dividends
[1] [2] [3] [4] [5] [6]
Debt Option $80,000
$80,000 - $0 = $80,000 $80,000 x 30% = $24,000 $80,000 - $24,000 = $56,000 $56,000 ÷ 50,000 = $1.12 Given as 100% of Net Income [3] above $56,000 ÷ $500,000 = 11.2%
(b)
[7] [8] [9] [10] [11] [12] [13]
$250,000 x 4% = $10,000 $80,000 - $10,000 = $70,000 $70,000 x 30% = $21,000 $70,000 - $21,000 = $49,000 $49,000 ÷ 25,000 = $1.96 Given as 100% of Net Income [10] above $49,000 ÷ $250,000 = 19.6%
The main factors affecting the ratio results include the interest expense for the debt option and the corresponding tax savings from the deductible interest expense. The other main factor affecting the ratios is the number of shares issued to obtain half the financing needed of $250,000. Other scenarios, with different proportions of debt and equity financing, different interest rates, and different tax rates will provide different results. The only ratio that remains unchanged is the payout ratio which is based on the assumptions given.
LO 5 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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SOLUTIONS TO PROBLEMS PROBLEM 11-1A
Shareholders’ Equity Share Capital
1. 2. 3. 4.
Assets -$240,0001 +140,000 +70,0003 +100,000
Liabilitie s NE NE NE NE
5. 6.
-42,0004 -5,000
NE NE
1 2 3 4
Preferred Shares NE NE NE +$100,00 0 NE NE
Common Retained Earnings Shares 2 -$160,000 -$80,000 +140,000 NE +70,000 NE NE NE NE -42,000 NE NE
Accumulated Other Comprehensive Income NE NE NE NE NE -$5,000
20,000 × $12 = $240,000 ($4,000,000 ÷ 500,000) x 20,000 = $160,000 5,000 × $14 = $70,000 (6,000 + 1,000) × $6 = $42,000
LO 2,3,4 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-2A (a)
Transaction entries: Jan. Mar. May June
10 1 1 1
Cash (1,000,000 × $2) ......................................... Common Shares ..........................................
2,000,000
Cash (20,000 × $50) ............................................ Preferred Shares .........................................
1,000,000
Cash (250,000 × $3) ............................................ Common Shares ..........................................
750,000
Common Shares (10,000 x $2.20 below) ............. Cash (10,000 x $2.00) ................................. Contributed Surplus ($22,000 - $20,000).....
22,000
Date Jan. 10 May 1
July
Sept.
Nov.
24
4
1
Nov. 20
Solutions Manual .
Balance Common Shares $2,000,000 750,000 $2,750,000
÷
Number of Shares 1,000,000 250,000 1,250,000
2,000,000 1,000,000 750,000 20,000 2,000
Average Cost
=
$2.20
Cash .................................................................... Equipment (at current value) ................................ Common Shares (33,500 shares) ................
120,000 16,000
Cash (10,000 × $5) .............................................. Common Shares .........................................
50,000
Cash (4,000 × $50) .............................................. Preferred Shares .........................................
200,000
Common Shares (15,000 x $2.27 below) ............. Contributed Surplus (balance from June 1).......... Retained Earnings * ............................................. Cash (15,000 x $4.00) ................................. *($60,000 - $34,050 - $2,000) = $23,950
34,050 2,000 23,950
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136,000 50,000
200,000
60,000
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PROBLEM 11-2A (CONTINUED) (a) (continued)
Date Jan. 10 May 1 June 1 July 24 Sept. 4
Dec. 14
Balance Common Shares $2,000,000 750,000 (22,000) 136,000 50,000 $2,914,000
÷
Number of Shares 1,000,000 250,000 (10,000) 33,500 10,000 1,283,500
Average Cost
=
$2.27
Dividends Declared .............................................. Dividends Payable ......................................
72,000
Closing entries: Dec. 31 Retained Earnings................................................ Dividends Declared ...................................... 31
Income Summary ................................................. Retained Earnings .......................................
72,000
72,000 72,000 1,300,000 1,300,000
(b) Preferred Shares Mar. 1 1,000,000 Nov. 1 200,000 Dec. 31 Bal. 1,200,000 June 1 Nov. 20
Common Shares 22,000 Jan. 10 2,000,000 34,050 May 1 750,000 July 24 136,000 Sept. 4 50,000 Dec. 31 Bal.2,879,950
Contributed Surplus Nov. 20 2,000 June 1 Dec. 31 Bal. 0
Solutions Manual .
Dec. 14 Dec. 31 Bal.
Dividends Declared 72,000 Dec. 31 CE 0
72,000
Retained Earnings 23,950 72,000 Dec. 31 CE 1,300,000 Dec. 31 Bal. 1,204,050 CE: Closing entry Nov. 20 Dec. 31 CE
2,000
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PROBLEM 11-2A (CONTINUED) (c)
Number of preferred shares: 20,000 + 4,000 = 24,000 Number of common shares: 1,000,000 + 250,000 – 10,000 + 33,500 + 10,000 – 15,000 = 1,268,500 REMMERS CORPORATION Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Share capital $3 Preferred shares, noncumulative, unlimited number authorized, 24,000 shares issued ................... Common shares, unlimited number authorized, 1,268,500 shares issued .............................................. Total share capital ............................................................. Retained earnings ............................................................. Total shareholders’ equity ......................................................
$ 1,200,000 2,879,950 4,079,950 1,204,050 $5,284,000
LO 2,3,4 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-3A (a)
Transaction entries: Feb. 6 Cash ............................................................... Preferred Shares (10,000 shares) ..........
600,000
April
Cash ............................................................... Common Shares (20,000 shares) ..........
570,000
Common Shares (3,000 x $18.00 below) ....... Cash (3,000 x $17.00) ........................... Contributed Surplus ($54,000 - $51,000).
54,000
April
6 27
Date Jan. 1 Bal. April 6
May
29
Balance Common Shares $1,050,000 570,000 $1,620,000
÷
Number of Shares 70,000 20,000 90,000
Dividends Declared ........................................ Dividends Payable [(8,000 + 10,000) × $4 × 6/12]................
600,000 570,000 51,000 3,000
Average Cost
=
$18.00 36,000 36,000
June 12
No entry required
July
Dividends Payable ......................................... Cash.......................................................
36,000
Buildings ........................................................ Common Shares (9,000 shares) ............ Closing entries: Dec. 31 Income Summary ........................................... Retained Earnings..................................
165,000
Aug.
1
22
31
Solutions Manual .
Retained Earnings.......................................... Dividends Declared ................................
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36,000
165,000 582,000 582,000 36,000 36,000
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PROBLEM 11-3A (CONTINUED) (b) Preferred Shares Jan. 1 Bal. 440,000 Feb. 6 600,000 Dec. 31 Bal. 1,040,000
Contributed surplus Jan. 1 Bal. Apr. 27 Dec. 31 Bal.
Dividends Declared May 29 36,000 Dec. 31 CE Dec. 31 Bal. 0
Apr. 27
Common Shares 54,000 Jan.1 Bal. 1,050,000 April 6 570,000 Aug. 22 165,000 Dec. 31 Bal. 1,731,000
25,000 3,000 28,000
36,000
Retained Earnings Jan. 1 Bal. Dec. 31CE 36,000 Dec. 31 CE Dec. 31 Bal.
800,000 582,000 1,346,000
Accumulated Other Comprehensive Income Jan. 1 Bal. 10,000 Dec. 31 Bal. 10,000 CE: Closing entry
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PROBLEM 11-3A (CONTINUED) (c) LARGENT CORPORATION Statement of Changes in Equity Year Ended December 31, 2018
Contributed surplus
Retained Earnings
Accumulated Other Comprehensive Income
$1,050,000
$25,000
$ 800,000
$10,000
735,000 (54,000)
3,000 (36,000) 582,000 $1,346,000
$10,000
Share Capital Preferred Common Shares Shares Balance Jan. 1 Issued preferred shares Issued common shares Repurchased common shares Dividends declared Net income Balance Dec. 31
Solutions Manual .
$ 440,000 600,000
$1,040,000
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$1,731,000
$28,000
Chapter 3
Total $2,325,000 600,000 735,000 (51,000) (36,000) 582,000 $4,155,000
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 11-3A (CONTINUED) (d)
Number of preferred shares: 8,000 + 10,000 = 18,000 Number of common shares: 70,000 + 20,000 + 9,000 – 3,000 = 96,000 LARGENT CORPORATION Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Share capital $4 Preferred shares, cumulative, 200,000 shares authorized, 18,000 issued ............................ Common shares, unlimited number of shares authorized, 96,000 issued ......................................................... Contributed surplus .................................................................... Total share capital ........................................................................... Retained earnings ........................................................................... Accumulated other comprehensive income..................................... Total shareholders’ equity ....................................................................
$1,040,000 1,731,000 28,000 2,799,000 1,346,000 10,000 $4,155,000
Note: Dividends of $36,000 (18,000 × $4 × 6/12) are in arrears on the cumulative preferred shares. LO 2,3,4 BT: AN Difficulty: C Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-4A (a)
Transaction entries: Jan. 2 Cash .......................................................... Preferred Shares (200,000 × $25) .... Feb. Mar.
April
8 5
July Sept.
Oct.
Oct. Dec.
Dec.
Solutions Manual .
5,000,000
Land ......................................................... Common Shares (100,000 shares) ...
210,000
Dividends Declared (200,000 × $1 × 3/12) Dividends Payable ............................
50,000
210,000 50,000
20
No entry required
2
Dividends Payable .................................... Cash .................................................
50,000
Cash (400,000 × $3) ................................. Common Shares ...............................
1,200,000
Dividends Declared (200,000 × $1 × 3/12) Dividends Payable ............................
50,000
18 June
5,000,000
5
50,000 1,200,000 50,000
20
No entry required
1
Dividends Payable .................................... Cash .................................................
50,000
Dividends Declared (200,000 × $1 × 3/12) Dividends Payable ............................
50,000
5
50,000 50,000
20
No entry required
1
Dividends Payable .................................... Cash .................................................
50,000
Cash ......................................................... Preferred Shares (40,000 × $25) ......
1,000,000
Dividends Declared (240,000* × $1 × 3/12) Dividends Payable ............................ *200,000 + 40,000 = 240,000 shares
60,000
4 5
14
50,000
1,000,000
Dividends Declared (3,500,000* × $0.50) . 1,750,000 Dividends Payable ............................ *3,000,000 + 100,000 + 400,000 = 3,500,000 shares
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60,000
1,750,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-4A (CONTINUED) (a) (continued) Closing entries: Dec. 31 Income Summary ...................................... Retained Earnings............................. 31
1,000,000 1,000,000
Retained Earnings..................................... Dividends Declared ...........................
1,960,000 1,960,000
(b) Preferred Shares Jan. 1 Bal. 0 Jan. 2 5,000,000 Oct. 4 1,000,000 Dec. 31 Bal. 6,000,000 Retained Earnings Jan. 1 Bal. 3,800,000 Dec. 31CE 1,960,000 Dec. 31 CE 1,000,000 Dec. 31 Bal. 2,840,000
Common Shares Jan. 1 Bal. 3,000,000 Feb. 8 210,000 April 18 1,200,000 Dec. 31 Bal. 4,410,000 Dividends Declared Jan. 1 Bal. 0 Dec. 31 CE Mar. 5 50,000 June 5 50,000 Sept. 5 50,000 Dec. 5 60,000 Dec. 14 1,750,000 Dec. 31 Bal. 0
1,960,000
CE: Closing entry
(c) CONWAY LTD, Statement of Retained Earnings Year Ended December 31, 2018 Retained earnings, January 1 .................................................. Add: Net income .................................................................... Less: Dividends declared.......................................................... Retained earnings, December 31 ...............................................
$3,800,000 1,000,000 4,800,000 1,960,000 $2,840,000
(Ending retained earnings = Beginning retained earnings + Net income – Dividends declared)
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PROBLEM 11-4A (CONTINUED) (d) CONWAY LTD. Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Share capital $1 Preferred shares, noncumulative, unlimited number authorized, 240,000 shares issued ........................ Common shares, unlimited number authorized, 3,500,000 shares issued ................................................... Total share capital ......................................................................... Retained earnings ......................................................................... Total shareholders’ equity......................................................................
(e)
$6,000,000 4,410,000 10,410,000 2,840,000 $13,250,00
If Conway Ltd. was a public company, it would be reporting under IFRS. The transaction concerning the purchase of the land on February 8 would still be recorded at the current value of the land of $210,000 even if the shares had a reliable value. As well, under IFRS requirements, Conway would report a statement of changes in equity rather than a statement of retained earnings. The statement of changes in equity follows (optional): CONWAY LTD. Statement of Changes in Equity Year Ended December 31, 2018 Share Capital Preferred Common Shares Shares
Balance Jan, 1 Issued preferred shares Issued common shares Dividends declared Net income Balance Dec. 31
$3,000,000
Retained Earnings $3,800,000
$6,000,000 1,410,000
$6,000,000
$4,410,000
(1,960,000) 1,000,000 $2,840,000
Total $6,800,000 6,000,000 1,410,000 (1,960,000) 1,000,000 $13,250,000
LO 2,3,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-5A (a) Preferred Shares Jan. 1 Jan. 1 Dec. 31
Balance Issue Balance
Common Shares Jan. 1 Oct. 1 Dec. 31
Balance Issue Balance
Dividends Declared Jan. 1 Balance 0 During year Cash dividend* 100,000 Dec. 31 Stock dividend declared** 407,000 Dec. 31 CE Dec. 31 Balance 0
Solutions Manual .
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2,700,000 1,000,000 3,700,000
507,000
Stock Dividends Distributable Dec. 31 Declaration** Retained Earnings Jan. 1 Dec. 31 CE Dividends declared**507,000 Dec. 31 Dec. 31 * 20,000 × $5 = $100,000 ** 370,000 × 5% × $22 = $407,000
500,000 500,000 1,000,000
Balance CE Net income Balance
407,000
2,980,000 872,000 3,345,000
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PROBLEM 11-5A (CONTINUED) (b)
ROBICHAUD CORPORATION Statement of Financial Position (Partial) December 31, 2018
Shareholders’ equity Share capital $5 Preferred shares, noncumulative, unlimited number of shares authorized, 20,000 issued ............ Common shares, unlimited number of shares authorized, 370,000 issued .................................... Stock dividends distributable, 18,500 common shares Total share capital .......................................................... Retained earnings (Note A) ............................................ Total shareholders’ equity .....................................................
$1,000,000 $3,700,000 407,000
4,107,000 5,107,000 3,345,000 $8,452,000
(Contributed capital is increased by the total amount of the stock dividend)
Note A: On December 31, 2018, the Board of Directors authorized a $500,000 restriction of retained earnings for a plant expansion. LO 2,3,4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-6A (a)
(1)
Assets
(2)
Liabilities
(3)
Common shares
Cash Dividend $16,000,000 – $600,000a = $15,400,000 No effect $6,000,000 No effect $2,000,000
(4)
Retained earnings
$8,000,000 – $600,000 = $7,400,000
(5)
Total $10,000,000 – $600,000 shareholders’ = $9,400,000 equity
(6)
Number of shares a b c
Solutions Manual .
No effect 400,000
Stock Dividend No effect $16,000,000 No effect $6,000,000 $2,000,000 + $600,000b = $2,600,000 $8,000,000 – $600,000 = $7,400,000 No effect $10,000,000 + $600,000 – $600,000 = $10,000,000 20,000 increase (20,000 + 400,000 = 420,000)
Stock Split No effect $16,000,000 No effect $6,000,000 No effect $2,000,000 No effect $8,000,000 No effect $10,000,000
200,000c increase (400,000 + 200,000 = 600,000)
400,000 × $1.50 = $600,000 400,000 × 5% x $30 = 20,000 × $30 = $600,000 400,000 ÷ 2 x 3 = 200,000 × 3 = 600,000 after the 3-for-2 stock split
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PROBLEM 11-6A (CONTINUED) (b) Cash Dividend Advantages: Share price will likely fall slightly (in proportion to dividend). May make shares slightly more affordable and attract new investors Makes shares attractive for investors wanting dividend income Disadvantages: Reduces cash
Stock Dividend
Stock Split
Retains cash Share price will likely fall slightly (in proportion to dividend). May make shares slightly more affordable and attract new investors Converts retained earnings to share capital
Reduces basic earnings per share More shares on which to pay future cash dividends
Retains cash Share price reduces significantly making shares more affordable to a broader number of investors Share price generally starts increasing after split
Reduces basic earnings per share More shares on which to pay future cash dividends
LO 3 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-7A (a)
Transaction entries: Jan. 15 Dividends Declared (220,000 × $1)................ Dividends Payable .................................
Feb. Apr.
220,000 220,000
31
No entry required
15
Dividends Payable ......................................... Cash ......................................................
220,000
Dividends Declared (22,000* × $15) .............. Stock Dividends Distributable ................ *(220,000 × 10% = 22,000)
330,000
16
220,000 330,000
(Stock Dividends = Number of shares issued × Market price per share at date of declaration)
May Oct.
30
No entry required
15
Stock Dividends Distributable ........................ Common Shares ....................................
1
Solutions Manual .
330,000
No journal entry (memorandum entry only: 242,000 (220,000 + 22,000) common shares × 2 = 484,000 common shares)
Closing entries: Dec. 31 Income Summary ........................................... Retained Earnings ................................. 31
330,000
Retained Earnings.......................................... Dividends Declared................................ ($220,000 + $330,000 = $550,000)
3-50
700,000 700,000 550,000 550,000
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PROBLEM 11-7A (CONTINUED) (b)
CE: Closing entry Common Shares Jan. 1 Bal. 2,200,000 Apr. 16 330,000 Dec. 31 Bal.2,530,000
Dividends Declared Jan. 15 220,000 Dec. 31 CE Apr. 16 330,000 Dec. 31 Bal. 0
550,000
Retained Earnings Jan. 1 Bal. 1,080,000 Dec. 31 CE 550,000 Dec. 31 CE 700,000 Dec. 31 Bal. 1,230,000
Accumulated Other Comprehensive Income Jan. 1 120,000
Stock Dividends Distributable May 15 330,000 Apr. 16 330,000 Dec. 31 Bal. 0
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PROBLEM 11-7A (CONTINUED) (c) WIRTH CORPORATION Statement of Changes in Equity Year Ended December 31, 2018
Balance Jan, 1 Cash dividends declared Declared and issued stock dividends Net income Balance Dec. 31
Common Shares
Retained Earnings
$2,200,000
$1,080,000
330,000 $2,530,000
Accumulated Other Comprehensive Income $120,000
Total $3,400,000
(220,000)
(220,000)
(330,000) 700,000 $1,230,000
0 700,000 $3,880,000
$120,000
(A stock dividend reduces retained earnings by the number of shares issued × market price per share) Note that some companies may combine the information above pertaining to cash and stock dividends and report them on a single line on this statement with a breakdown between the amount of the stock and cash dividends shown in a note to the financial statements.
(d)
Number of common shares: 220,000 + 22,000 + 242,000 = 484,000 WIRTH CORPORATION Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Common shares, unlimited number of shares authorized, 484,000 issued ................................................. Retained earnings............................................................... Accumulated other comprehensive income ........................ Total shareholders’ equity ..........................................
$2,530,000 1,230,000 120,000 $3,880,000
LO 3,4 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-8A (a)
Weighted Average Number of Shares Aug. 1 Oct. 1 Dec. 1 Feb. 1
(b)
350,000 × 12/12 = (24,000) × 10/12 = 60,000 × 8/12 = 10,000 × 6/12 = 396,000
350,000 (20,000) 40,000 5,000 375,000
Basic Earnings per Share = Income available to common shareholders ÷ Weighted average number of common shares = ($1,280,000 – $100,000*) ÷ 375,000 = $3.15 *Preferred dividend: $1 × 100,000 = $100,000
(c)
A weighted average number of shares is used in the basic EPS calculation because the issue of shares and other activities affecting the number of shares issued during the period changes the amount of net assets upon which net income can be earned. Using the number of shares at a point in time such as year end to calculate basic earnings per share does not take into account the year’s economic activity and other factors that might have impacted the number of shares issued during the period.
(d)
Because the preferred shares are noncumulative, the dividend would not be deducted in the calculation of income available to common shareholders. The basic earnings per share would be as follows: = Income available to common shareholders ÷ Weighted average number of common shares = $1,280,000 ÷ 375,000 = $3.41
LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-9A (a)
The common dividends per share can be calculated as follows:
A. Basic EPS B. Payout ratio
2015 $2.13 72.3%
2014 $1.21 122.3%
2013 $1.33 106.0%
2012 $1.98 67.2%
Common dividends per share (A × B)
$1.54
$1.48
$1.41
$1.33
We can see from the calculation above that any change in the payout ratio was more likely caused by changes in basic earnings per share rather than changes in dividends per share because the latter increased gradually in each of the four years shown above Although net income was almost double on a per-share basis in 2015, as demonstrated by the basic earnings per share ratio, the dividends per share changed only slightly, resulting in a lower payout ratio in 2015 compared to the two previous years. Cineplex is likely trying to give its shareholders a stable dividend per year, in good years and in bad. This goes a long way towards satisfying investors. (b)
As explained in (a) above, Cineplex is likely trying to give its shareholders a stable dividend per share each year so changes in the payout ratio in this case are more attributable to changes in basic earnings per share rather than changes in dividends per share. Because the earnings per share fell in 2013, this caused the payout ratio to rise as dividends per share that year were increased despite the drop in basic earnings per share.
(c)
Because of the nature of the business, creditors should not be overly concerned with the company’s continued payment of dividends and the fact that the dividend payout exceeded basic earnings per share. The creditors are likely drawing on past experience with Cineplex which would have given them the reassurance that the company would return to stronger profitability. Creditors would carefully scrutinize the source for the decline in profitability in 2013 and 2014 and reassess their risk in holding debt due from Cineplex. Although creditors are generally more concerned with cash flow than net income, Cineplex’s poor net income performance of 2013 and 2014 would almost certainly result in decreased cash flows from operating activities. The company’s continuous payment of dividends in the midst of decreased cash flows would put creditors on watch to ensure that this did not hinder Cineplex’s ability to repay its debt.
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PROBLEM 11-9A (CONTINUED) (d) A. Common dividends per share B. Dividend yield
2015 $1.54 3.2%
2014 $1.48 3.3%
Market price per share (A ÷ B)
$48.13
$44.85
When the basic earnings per share rose 76% in 2015, the share price increased less than 10%. This most likely occurred because investors in Cineplex shares are more focused on common dividends per share rather than basic earnings per share. Since the dividends increased only slightly in 2015, so did the share price. It would appear that share price movements, at least for this company, are more correlated with common dividends per share rather than basic earnings per share. LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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PROBLEM 11-10A (a)
(in millions, except per-share information) 2015
Ratio
2014
1. Payout ratio
$672 $1,574
= 42.7%
$616 $1,498
= 41.1%
2. Dividend yield
$2.04 $43.31
= 4.7%
$1.88 $52.68
= 3.6%
3. Basic earnings per share
$1,574 333.1
= $4.73
$1,498 331.1
= $4.52
4. Return on common shareholders' equity
$1,574 $9,806
= 16.1%
$1,498 $8,778
= 17.1%
(1) (Payout ratio = Cash dividends declared ÷ Net income) (2) (Dividend yield = Dividends declared per share ÷ Market price per share) (3) (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares) (4) (Return on common shareholders’ equity = (Net income – preferred dividends) ÷ Average common shareholders’ equity)
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PROBLEM 11-10A (CONTINUED) (b)
National Bank’s payout ratio rose in 2015 because the dividend increase was greater than the increase in net income. The board of directors makes the decision to increase dividends and they must have felt that it was prudent to increase the dividend at a slightly faster rate than the rise in net income. Despite the increased dividend, the company’s share price fell in 2015 and both of these effects caused the dividend yield to rise that year. The basic earnings per share increased because net income increased (the denominator in this ratio, which is the weighted average number of common shares, did not change significantly enough to affect basic EPS). Return on common shareholders’ equity decreased despite the slight increase in net income because shareholders’ equity rose by a larger percentage than the net income did. Compared to its industry, National Bank’s 2015 dividend yield and return on common shareholders’ equity ratios exceed its peers with the payout ratio slightly below the industry average.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-11A (a)
Together, the profit margin and the asset turnover explain the return on assets ratio. When multiplying the profit margin by the asset turnover, we obtain the return on assets ratio. For example, in the case of Petro-Boost, profit margin x asset turnover = 10.0% x 1.1 times = 11.0% return on assets ratio. For World Oil, the much higher asset turnover overcomes the lower profit margin, compared to Petro-Boost, to come up with the higher return on assets ratio.
(b)
World Oil has the largest difference between its return on shareholders’ equity and its return on assets. The most likely reason is that World Oil has proportionately the least amount of equity and the highest amount of liabilities. The heavier debt level also negatively affects net income and the profit margin.
(c)
Petro-Boost would be the better investment for someone interested in generating a regular income from his or her investment. Petro-Boost has a higher payout ratio (12.3% versus 9.9% for World Oil) and dividend yield (1.9% versus 0.7% for World Oil), which is good for an investor who needs a regular income from their investment.
(d)
The higher price-earnings ratio of 17.1 times indicates that investors have higher expectations of future profitability for World Oil than Petro-Boost. Therefore, an investor interested in experiencing a return in the form of future capital gains would have a better chance of attaining those gains by investing in World Oil.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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PROBLEM 11-1B Shareholders’ Equity
Preferred
Assets Liabilities -$520,0001 NE +300,000 NE
1. 2. 3.
+50,0003 +29,000 -71,0004 +5,000
4. 5. 6. 1 2 3 4
NE NE NE NE
Shares NE NE +$50,00 0 NE NE NE
Common Shares -$320,0002 +300,000 NE
Retained Earnings -$200,000 NE NE
Accumulated Other Comprehensive Income NE NE NE
+29,000 NE NE
NE -71,000 NE
NE NE +$5,000
20,000 × $26 = $520,000 ($2,400,000 ÷ 150,000) x 20,000 = $320,000 500 × $100 = $50,000 (35,000 + 500) × $2 = $71,000
LO 2,3,4 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-2B (a)
Transaction entries: June 5 Cash (240,000 × $4) ................................. Common Shares ............................... Aug.
21
Sept. 15 Oct.
20
Mar.
20
9
1,500,000
Land ......................................................... Common Shares (60,000 shares) .....
285,000
Common Shares (20,000 x $4.15 below) .. Cash (20,000 x $4.00) ...................... Contributed Surplus ($83,000 - $80,000).
83,000
Balance Common Shares $ 960,000 285,000 $1,245,000
÷
Number of Shares 240,000 60,000 300,000
1,500,000 285,000 80,000 3,000
Average Cost
=
$4.15
Cash (220,000 × $4.95) ............................ Common Shares ...............................
1,089,000
Common Shares (25,000 x $4.50 below) .. Contributed Surplus (balance from Oct. 20) Retained Earnings * .................................. Cash (25,000 x $5.00) ...................... *($125,000 - $112,500 - $3,000) = $9,500
112,500 3,000 9,500
Date June 5 Sept. 15 Oct. 20 Nov. 20
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960,000
Cash (15,000 × $100) ............................... Preferred Shares ..............................
Date June 5 Sept. 15
Nov.
960,000
Balance Common Shares $ 960,000 285,000 (83,000) 1,089,000 $2,251,000 ÷
3-60
Number of Shares 240,000 60,000 (20,000) 220,000 500,000
1,089,000
125,000
Average Cost
=
$4.50
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-2B (CONTINUED) (a) (continued) April May
16 15
Cash (6,000 × $100) ................................. Preferred Shares ..............................
600,000
Dividends Declared [(15,000 + 6,000) × $4] . Dividends Payable ...........................
84,000
Closing entries: May 31 Retained Earnings..................................... Dividends Declared ........................... 31
Income Summary ...................................... Retained Earnings.............................
600,000 84,000
84,000 84,000 250,000 250,000
(b)
Oct. 20 Mar.9
Preferred Shares Aug. 21 Apr. 16 May 31 Bal.
1,500,000 600,000 2,100,000
Common Shares 83,000 June 5 112,500 Sept. 15 Nov. 20 May 31 Bal.
960,000 285,000 1,089,000 2,138,500
Mar. 9 Dec. 31 Bal.
Contributed Surplus 3,000 Oct. 20 0
3,000
May 15 May 31 Bal.
Dividends Declared 84,000 May 31 CE 0
84,000
Retained Earnings Mar. 9 9,500 May. 31 CE 84,000 May 31 CE May 31 Bal. CE: Closing entry
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250,000 156,500
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PROBLEM 11-2B (CONTINUED) (c)
Number of preferred shares: 15,000 + 6,000 = 21,000 Number of common shares: 240,000 + 60,000 – 20,000 + 220,000 - 25,000 = 475,000 WETLAND CORPORATION Statement of Financial Position (Partial) May 31, 2018
Shareholders’ equity Share capital $4 Preferred shares, cumulative, unlimited number authorized, 21,000 shares issued .................. Common shares, unlimited number authorized 475,000 shares issued ............................................. Total share capital ............................................................ Retained earnings ............................................................. 9 Total shareholders' equity .......................................................
$ 2,100,000 2,138,500 4,238,500 156,500 $4,395,000
LO 2,3,4 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-3B (a)
Transaction entries: Feb. 28 Cash .......................................................... Preferred Shares (1,500 shares) ....... April May
11 25
Nov. 26
Jan.
31
15
3,500,000
Land .......................................................... Common Shares (2,500 shares) .......
85,000
Common Shares (10,000 x $26.87 below) Contributed Surplus*......................... Cash (10,000 x $24.00) .................... *($268,700 - $240,000) = $28,700
268,700
Balance Common Shares $ 1,050,000 3,500,000 85,000 $4,635,000
÷
Number of Shares 70,000 100,000 2,500 172,500
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3,500,000 85,000
28,700 240,000
Average Cost
=
$26.87
Dividends Declared ................................... Dividends Payable ............................ (44,000 + 1,500) × $2.50 = $113,750
113,750 113,750
No entry required
Closing entries: Jan. 31 Retained Earnings..................................... Dividends Declared ........................... 31
150,000
Cash .......................................................... Common Shares (100,000 shares) ...
Date Feb. 1 Bal. April 11 May 25
Dec.
150,000
Retained Earnings..................................... Income Summary ..............................
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113,750 113,750 5,000 5,000
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PROBLEM 11-3B (CONTINUED) (b)
CE: Closing entry Preferred Shares Feb. 1 Bal. Feb. 28 Jan. 31 Bal.
Nov. 26
Common Shares 268,700 Feb.1 Bal. 1,050,000 April 11 3,500,000 May 25 85,000 Jan. 31 Bal. 4,366,300 Contributed surplus Feb. 1 Bal. Nov. 26 Jan. 31 Bal
Jan. 31 CE Jan. 31 CE
440,000 150,000 590,000
75,000 28,700 103,700
Retained Earnings Feb. 1 Bal. 1,000,000 113,750 5,000 Jan. 31 Bal. 881,250
Accumulated Other Comprehensive Income Feb. 1 Bal. 65,000 Jan. 31 Bal. 65,000
Dec 31 Jan 31 Bal.
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Dividends Declared 113,750 Jan 31 CE 0
113,750
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PROBLEM 11-3B (CONTINUED) (c) UJJAL CORPORATION Statement of Changes in Equity Year Ended January 31, 2019 Share Capital Preferred Common Shares Shares Balance Feb. 1, 2018
$440,000
Issued preferred shares Issued common shares Repurchased common shares Dividends declared Net loss Balance Jan. 31, 2019
150,000
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$1,050,000
3,585,000 (268,700)
$590,000
$4,366,300
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Contributed surplus
Retained Earnings
Accumulated Other Comprehensive Income
$75,000
$1,000,000
$65,000
$2,630,000
$65,000
150,000 3,585,000 (240,000) (113,750) (5,000) $6,006,250
28,700
$103,700
(113,750) (5,000) $881,250
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-3B (CONTINUED) (d)
Number of preferred shares: 44,000 + 1,500 = 45,500 Number of common shares: 70,000 + 100,000 + 2,500 – 10,000 = 162,500
UJJAL CORPORATION Statement of Financial Position (Partial) January 31, 2019 Shareholders’ equity Contributed capital Share capital $5 Preferred shares, noncumulative, unlimited number of shares authorized, 45,500 issued .............. $ 590,000 Common shares, unlimited number of shares authorized, 162,500 issued ......................................... 4,366,300 Contributed surplus ........................................................................... Total contributed capital ....................................................................... Retained earnings ................................................................................ Accumulated other comprehensive income.......................................... Total shareholders’ equity ...........................................................................
$4,956,300 103,700 5,060,000 881,250 65,000 $6,006,250
LO 2,3,4 BT: AN Difficulty: C Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-4B (a)
Transaction entries: Jan. 2 Cash .......................................................... Preferred Shares (20,000 × $50) ...... Mar.
April June
July Aug.
10
Dividends Declared (20,000 × $2 × 3/12).. Dividends Payable ............................
10,000 10,000
No entry required
2
Dividends Payable .................................... Cash..................................................
10,000
Dividends Declared (20,000 × $2 × 3/12).. Dividends Payable ............................
10,000
10
10,000 10,000
22
No entry required
2
Dividends Payable .................................... Cash..................................................
10,000
Cash .......................................................... Common Shares (10,000 × $7.30) ....
73,000
Dividends Declared (20,000 × $2 × 3/12).. Dividends Payable ............................
10,000
12
Sept. 22
No entry required
Oct.
Dividends Payable .................................... Cash..................................................
Oct.
1,000,000
22
Sept. 10
Oct.
1,000,000
1 8 15
10,000 73,000 10,000
10,000 10,000
Cash .......................................................... 500,000 Preferred Shares (10,000 shares x $50)
500,000
Equipment ................................................. Common Shares (2,000 shares) .......
15,000
15,000
The value of the equipment is a more reliable amount to measure the value of this transaction rather than the value the shares traded at in the past. Closing entries: Dec. 31 Retained Earnings..................................... Income Summary .............................. 31
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50,000 50,000 30,000 30,000 Chapter 3
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PROBLEM 11-4B (CONTINUED) (b) Preferred Shares Jan. 2 Oct. 8
Retained Earnings Jan. 1 Bal. Dec. 31 CE 30,000 Dec. 31 CE 50,000 Dec. 31 Bal.
Common Shares Jan. 1 Bal. Aug. 12 Oct. 15 Dec. 31 Bal.
1,000,000 500,000 1,500,000
990,000
910,000
300,000 73,000 15,000 388,000
Dividends Declared Jan. 1 Bal. 0 Dec. 31 CE Mar. 10 10,000 June 10 10,000 Sept. 10 10,000 Dec. 31 Bal. 0
30,000
CE: Closing entry (c) SCHIPPER LTD. Statement of Retained Earnings Year Ended December 31, 2015 Retained earnings, January 1 .................................................... Less: Loss ............................................................................... Less: Dividends declared ........................................................ Retained earnings, December 31 ..............................................
$990,000 50,000 940,000 30,000 $910,000
(Ending retained earnings = Beginning retained earnings + Net income – Dividends declared)
(d) SCHIPPER LTD. Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Share capital $2 Preferred shares, noncumulative, unlimited number authorized, 30,000 issued ............................................. Common shares, unlimited number authorized, 212,000* issued .......................................... Total share capital ............................................................. Retained earnings ............................................................. Total shareholders’ equity .................................................
$ 1,500,000 388,000 1,888,000 910,000 $2,798,000
*Number of common shares: 200,000 + 10,000 + 2,000 = 212,000
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PROBLEM 11-4B (CONTINUED) (e)
If Schipper Ltd. was a public company, the transaction concerning the purchase of the equipment on October 15 would still be recorded at the current value of the equipment of $15,000 even if the shares had a reliable value. As well, under IFRS requirements, Schipper would report a statement of changes in equity rather than a statement of retained earnings. The statement of changes in equity follows (optional):
SCHIPPER LTD. Statement of Changes in Equity Year Ended December 31, 2018 Share Capital Preferred Common Shares Shares Balance Jan, 1 Issued preferred shares Issued common shares Dividends declared Net loss Balance Dec. 31
$300,000
Retained Earnings $990,000
(30,000) (50,000)
$1,290,000 1,500,000 88,000 (30,000) (50,000)
$910,000
$2,798,000
$1,500,000 88,000
$1,500,000
$388,000
Total
LO 2,3,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-5B (a) Preferred Shares Jan. 1 Dec. 31
Balance Balance
Common Shares Jan. 1 Balance Mar. 1 Issue Sept. 25 Stock dividend Dec. 31 Balance Mar. 30 Jun. 30 Aug. 18 Sept. 30 Dec. 31 Dec. 31
Sept. 25
Dec. 31
Declaration Declaration Declaration Declaration Declaration15,000 Balance
Issue
CE Dividends
Dividends Declared 15,0002 15,000 297,0002 15,000 Dec. 31 CE 0
3,210,000 350,0001 297,000 3,857,000
357,000
Stock Dividends Distributable 297,000 Aug. 18 Declaration Dec. 31 Balance Retained Earnings Jan. 1 357,000 Dec. 31 Dec. 31
750,000 750,000
Balance CE Net income Balance
297,0002 0 980,000 750,000 1,373,000
1
Common Shares: 20,000 × $17.50 = $350,000 Preferred Shares:15,000 × $4 × ¼ = $15,000 3 Common Shares: (255,000 + 20,000) × 6% x $18 = 16,500 × $18 = $297,000. Note that the stock dividend was declared on August 18 (thus the debit to Dividends Declared) and distributed on September 25 (thus the credit to Common Shares). 2
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PROBLEM 11-5B (CONTINUED) (b) MAGGIO CORPORATION Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Share capital $4 Preferred shares, cumulative, unlimited number of shares authorized, 15,000 issued ............................ Common shares, unlimited number of shares authorized, 291,500 issued .......................................... Total share capital .................................................................. Retained earnings (Note X) .................................................... Total shareholders’ equity .............................................................
$ 750,000 3,857,000 4,607,000 1,373,000 $5,980,000
(A stock dividend reduces retained earnings by the number of shares issued × market price per share)
Note X: $200,000 of retained earnings are restricted by a debt covenant. LO 2,3,4 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-6B (a) (1)
Assets
(2)
Liabilities
(3)
Common shares
(4)
Retained earnings
(5)
Total shareholders’ equity
(6)
Number of shares
a b
Cash Dividend $9,000,000 – $500,000a = $8,500,000 No effect = $2,500,000 No effect = $3,000,000 $3,500,000 – $500,000 = $3,000,000 $6,500,000 – $500,000 = $6,000,000
No effect = 500,000
Stock Dividend No effect = $9,000,000
Stock Split No effect = $9,000,000
No effect = $2,500,000 $3,000,000 + $375,000b = $3,375,000 $3,500,000 – $375,000 = $3,125,000 No effect ($6,500,000 + $375,000 – $375,000 = $6,500,000) 25,000 increase (25,000 + 500,000 = 525,000)
No effect = $2,500,000 No effect = $3,000,000 No effect = $3,500,000 No effect = $6,500,000
500,000 increase (500,000 × 2 = 1,000,000)
500,000 × $1.00 = $500,000 500,000 × 5% × $15 = $375,000
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PROBLEM 11-6B (CONTINUED) (b) Cash Dividend Advantages: Share price will likely fall slightly (in proportion to dividend). May make shares slightly more affordable and attract new investors May attract investors looking for dividend income
Disadvantages: Reduces cash
Stock Dividend
Stock Split
Retains cash Share price will likely fall slightly (in proportion to dividend). May make shares slightly more affordable and attract new investors Converts retained earnings to share capital
Reduces basic earnings per share More shares on which to pay future cash dividends
Retains cash Share price reduces significantly, making shares more affordable to a broader number of investors Share price generally starts increasing after split
Reduces basic earnings per share More shares on which to pay future cash dividends
LO 3 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-7B (a)
Transaction entries: Feb. 1 Dividends Declared (150,000 × $1)................ Dividends Payable .................................
Mar.
15
No entry required
1
Dividends Payable ......................................... Cash ......................................................
150,000 150,000
150,000 150,000
Apr.
2
No journal entry required (memorandum entry only)
July
2
Dividends Declared (22,500* × $14) .............. 315,000 Stock Dividends Distributable ............... *150,000 shares × 3 x 5% = 450,000 × 5% = 22,500
315,000
(Stock Dividends = Number of shares issued × Market price per share)
July
16
No entry required
31
Stock Dividends Distributable ........................ Common Shares ....................................
Closing entries: Dec. 31 Income Summary ........................................... Retained Earnings ................................. 31
Retained Earnings.......................................... Dividends Declared................................ ($150,000 + $315,000 = $465,000)
315,000 315,000 800,000 800,000 465,000 465,000
(b) Common Shares Jan. 1 Bal. 3,400,000 July 31 315,000 Dec. 31 Bal.3,715,000
Stock Dividends Distributable July 31 315,000 July 2 315,000 Dec. 31 Bal. 0
Feb. 1 July 2
Retained Earnings Jan. 1 Bal. 1,800,000 Dec. 31 CE 465,000 Dec. 31 CE 800,000 Dec. 31 Bal. 2,135,000
Accumulated Other Comprehensive Loss Jan. 1 250,000
Dividends Declared 150,000 Dec. 31 CE 465,000 315,000
Dec. 31 Bal.
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PROBLEM 11-7B (CONTINUED) (c) STENGEL CORPORATION Statement of Changes in Equity Year Ended December 31, 2018
Balance Jan, 1 Cash dividends declared Stock dividends declared and distributed Net income Balance Dec. 31
Common Shares
Retained Earnings
$3,400,000
$1,800,000
315,000 $3,715,000
Accumulated Other Comprehensive Loss $(250,000)
Total $4,950,000
(150,000)
(150,000)
(315,000) 800,000 $2,135,000
0 800,000 $5,600,000
$(250,000)
(Ending retained earnings = Beginning retained earnings + Net income – (Stock dividends + Cash dividends declared) Note that some companies may combine the information above pertaining to cash and stock dividends and report them on a single line on this statement with a breakdown between the amount of the stock and cash dividends shown in a note to the financial statements.
(d)
Number of common shares: 150,000 × 3 = 450,000 + 22,500 = 472,500 STENGEL CORPORATION Statement of Financial Position (Partial) December 31, 2018 Shareholders’ equity Common shares, unlimited number of shares authorized, 472,500 issued .............................. Retained earnings..................................................... Accumulated other comprehensive loss ................... Total shareholders’ equity .................................................
$3,715,000 2,135,000 (250,000) $5,600,000
LO 3,4 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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PROBLEM 11-8B (a)
Weighted Average Number of Shares April 1 May 1 June 1 July 1
(b)
500,000 × 12/12 = (12,000) × 11/12 = 6,000 × 10/12 = 50,000 × 9/12 = 544,000
500,000 (11,000) 5,000 37,500 531,500
Basic Earnings per Share = ($1,016,750 – $78,000*) ÷ 531,500 = $1.77 *Preferred dividend: 78,000 × $1 = $78,000 (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares)
(c)
It is important to use the income available to common shareholders because the preferred shareholders must receive any dividends to which they are entitled before the common shareholders receive their dividends. The corporation’s preferred shareholders also have a prior claim on the corporation’s assets in the event of its liquidation.
(d)
Because the preferred shares are cumulative, there would be no change in the calculation of the basic earnings per share if the dividend had not been declared to the preferred shareholders during the year.
LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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PROBLEM 11-9B (a)
We can derive the dividend per share by taking the basic earnings per share and multiplying it by the payout ratio as follows:
Basic EPS (A) Payout ratio (B)
2015 $1.01 32.7%
2014 $1.48 15.5%
2013 $1.32 13.6%
Dividends per share (A x B)
$0.33
$0.23
$0.18
The amount of dividends per share that a company pays out is based entirely upon the discretion of the board of directors and their assessment of whether the shareholders should receive this distribution of income taking into consideration how much cash needs to be retained in the business for future growth. (b)
As noted, in 2015 basic EPS decreased and depending on the reason for the decline in net income, a company may or may not decrease their dividends when net income falls. For example, if the decline in net income is from recording an impairment of goodwill, this reduction in net income will not bring about a decline in cash generated from operating activities. In that case, the company may decide to keep the dividend at the same levels in spite of a decline in the basic earnings per share because cash has been unaffected by the decline in net income. If, on the other hand, the decline in net income has a corresponding decline in cash generated from operating activities, a company would be far more inclined to reduce or even suspend dividends, depending on the seriousness of the liquidity position of the business. In this case, the dividends per share were increased despite a decreasing earnings per share so the board must have felt that the company has sufficient cash to do so.
(c)
We can derive the share price by dividing the dividends per share by the dividend yield as follows Dividends per share (A) Dividend yield (B)
2015 $0.33 0.84%
2014 $0.23 0.75%
2013 $0.18 0.75%
Market share price (A÷B)
$39.29
$30.67
$24.00
The dividend yield increased in 2015 because the amount of the dividends per share was increased more than the increase in the market price of the company’s shares. Solutions Manual .
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PROBLEM 11-9B (CONTINUED) (d)
Investors seeking dividend income would likely be happy with the corporation’s dividend policy as dividends per share increased every year even when earnings per share fell in 2015. On the other hand, the dividend yield, even though it rose in 2015, was still below 1% and many investors could have probably earned that type of return with a fixed income investment like a GIC or term deposit. However, this is a company with a significantly growing share price so investors are not just rewarded with dividends. The rising share price reflects the growing nature of this business and that growth would not have been possible if a high level of dividends had been declared.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-10B (a)
(in millions, except for per share information) Ratio
2015
2014
1. Payout ratio
$3,289 $7,213
= 45.6%
$3,110 $7,298
= 42.6%
2. Dividend yield
$2.72 $61.49
= 4.4%
$2.56 $69.02
= 3.7%
3. Basic earnings per share
$7,213 1,210
= $5.96
$7,298 1,214
= $6.01
4. Return on common shareholders' equity
$7,213 $47,025
= 15.3%
$7,298 $42,565
= 17.1%
(1) (Payout ratio = Cash dividends declared ÷ Net income) (2) (Dividend yield = Dividends declared per share ÷ Market price per share) (3) (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares) (4) (Return on common shareholders’ equity = (Net income – preferred dividends) ÷ Average common shareholders’ equity)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-10B (CONTINUED) (b)
During 2015, Bank of Nova Scotia (BNS)’s payout ratio increased primarily because, in spite of the bank’s slight decline in net income, there were fewer shares on which cash dividends were paid and so the amount of dividends paid per share increased from $2.56 in 2014 to $2.72 in 2015. BNS’s payout ratio is very similar to the industry average in 2015. BNS’s dividend yield increased, primarily because of the decline in share price combined with the increase in the absolute amount of dividends paid per share. The trend showing an increase in the dividend yield from 2014 to 2015 is very consistent with the industry average. The basic earnings per share for BNS dropped slightly from 2014 to 2015. BNS’s return on common shareholders’ equity declined in 2015. This decline in the ratio is steeper than the decline in income available to common shareholders. This result is due to a substantial increase in its average shareholders’ equity in 2015. BNS’s decline in return on common shareholders’ equity is consistent with the industry average, although it is better than the industry average in both years.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 11-11B (a)
Together, the profit margin and the asset turnover explain the return on assets ratio. By multiplying the profit margin with the asset turnover, we obtain the return on assets ratio. For example, in the case of Discount Paradise profit margin x asset turnover = 3.5% x 2.5 times = 8.8% return on assets ratio. For Bargain Hunters, the much higher profit margin overcomes the lower asset turnover, compared to Discount Paradise to come up with the highest return on assets ratio. Bargain Hunters has the largest difference between its return on common shareholders’ equity and its return on assets because it is using the advantage of leverage. When a company increases its liabilities by taking on more debt (rather than issuing shares and increasing equity) and uses that debt to increase income, there will be an increase in the return on common shareholders’ equity to a much greater extent than the increase in the return on assets ratio, causing a widening of the difference between these two ratios. This spread increases because the denominators in these ratios are widening as assets increase faster than equity when debt is taken on.
(b)
Discount Paradise would be the better investment for someone interested in generating a regular income from his or her investment. Discount Paradise has a much higher payout ratio than Bargain Hunters (25% versus 9.4% for Bargain Hunters), indicating that it has a policy of paying out more net income as dividends which is good for an investor who needs a regular income from their investment. The dividend yield provided by Discount Paradise is also superior to Bargain Hunters, at about three times the amount.
(c)
Even though Discount Paradise is paying out more of its net income as dividends than Bargain Hunters, it has the higher price-earnings ratio. This indicates that investors have higher expectations for future growth for Discount Paradise but this may not be the case given its high payout ratio. Bargain Hunters may have greater growth in the future and its lower price-earnings ratio indicates that Bargain Hunters’ share price is cheaper relative to its earnings. There is no clearly superior choice here.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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ACR11-1
Financial Accounting, Seventh Canadian Edition
ACCOUNTING CYCLE REVIEW
(a) Summary Transaction Entries: 1.
Cash .............................................................................. Preferred Shares ......................................................
50,000
Cash .............................................................................. Common Shares ......................................................
30,000
Accounts Receivable ..................................................... Cash .............................................................................. Sales ........................................................................
320,000 100,000
Cost of Goods Sold ....................................................... Inventory ..................................................................
250,000
Cash .............................................................................. Accounts Receivable ................................................
296,000
Supplies ......................................................................... Accounts Payable ....................................................
35,100
Inventory ........................................................................ Accounts Payable ....................................................
330,000
Accounts Payable .......................................................... Inventory (2% × $322,000) ....................................... Cash .........................................................................
322,000
Salaries Expense ........................................................... Cash .........................................................................
88,200
Allowance for Doubtful Accounts ................................... Accounts Receivable ................................................
1,700
10. Interest Expense............................................................ Mortgage Payable ......................................................... Cash .........................................................................
4,000 2,000
11. Dividends Declared ($1,400 + $4,200) .......................... Dividends Payable ...................................................
5,600
2.
3.
4.
5.
6.
7.
8.
9.
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50,000
30,000
420,000
250,000
296,000
35,100
330,000
6,440 315,560
88,200
1,700
6,000
5,600
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Financial Accounting, Seventh Canadian Edition
ACR11-1 (CONTINUED) (c) Adjusting Journal Entries: 1. Dec.31
2.
31
3.
31
4.
31
5.
31
6.
31
Supplies Expense ($4,400 + $35,100 – $5,900) ....... Supplies ...........................................................
33,600
Bad Debts Expense ($1,500 – $1,700 + $3,500) ...... Allowance for Doubtful Accounts......................
3,700
Depreciation Expense ............................................... Accumulated Depreciation—Buildings ............. ($142,000 – $10,000) ÷ 30
4,400
Interest Expense ....................................................... Interest Payable ...............................................
350
Bank Charges Expense ............................................ Cash .................................................................
3,000
Income Tax Expense ................................................ Income Tax Payable ........................................
6,000
33,600
3,700
4,400
350
3,000
6,000
(b), (c), and (f) Cash Jan. 1
Bal.
Allowance for Doubtful Accounts
24,000
Summary
1,700 Jan. 1
Bal.
1,500
Summary
50,000 Summary
315,560
Dec. 31
Adj.
3,700
Summary
30,000 Summary
88,200
Dec. 31
Bal.
3,500
Summary
100,000 Summary
6,000
Summary
296,000 Adj.
3,000
Dec. 31
Bal.
87,240
Inventory Jan. 1
Bal.
Summary Accounts Receivable Jan. 1
Bal.
Summary Dec. 31
Dec. 31
45,500 Summary
296,000
320,000 Summary
1,700
Bal.
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70,000 Summary 330,000
Bal.
Summary
143,560
67,800
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Financial Accounting, Seventh Canadian Edition
ACR11-1 (CONTINUED) (b), (c), and (f) (continued)
Salaries Expense Summary
88,200
Dec. 31 Bal.
Dec. 31 CE
Bank Charges Expense 88,200
0
Dec. 31 Adj.
3,000
Dec. 31 Bal.
0
Dec. 31
CE
3,000
CE
4,350
Interest Expense Supplies Expense
Summary
Dec. 31 Adj.
33,600
Dec. 31 Adj.
350
Dec. 31 Bal.
0
Dec. 31 Bal.
0
Dec. 31 CE 33,600
4,000 Dec. 31
Depreciation Expense Dec. 31 Adj. Dec.
4,400
31 Bal.
Dec. 31 CE
Income Tax Expense
4,400
0
Dec. 31
Adj.
6,000
Dec. 31
Bal.
0
Bad Debts Expense Dec. 31 Adj. Dec.
31 Bal.
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3,700 0
Dec. 31 CE
Dec. 31 CE
6,000
Income Summary 3,700
Dec. 31
CE
393,250
Dec. 31
CE
26,750
Dec. 31
Bal.
0
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Dec. 31 CE 420,000
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ACR11-1 (CONTINUED) (d)
HAMPTON CORPORATION Adjusted Trial Balance December 31, 2018 Debit Cash Accounts receivable Allowance for doubtful accounts Inventory Supplies Land Buildings Accumulated depreciation—buildings Accounts payable Interest payable Dividends payable Income tax payable Mortgage payable Preferred shares Common shares Retained earnings Accumulated other comprehensive income Dividends declared Sales Cost of goods sold Salaries expense Supplies expense Depreciation expense Bad debts expense Bank charges expense Interest expense Income tax expense
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Credit
$ 87,240 67,800 $ 3,500 143,560 5,900 40,000 142,000 26,400 98,700 350 5,600 6,000 78,000 50,000 60,000 127,400 9,400 5,600 420,000 250,000 88,200 33,600 4,400 3,700 3,000 4,350 6,000 $885,350
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ACR11-1 (CONTINUED) (e) (1) HAMPTON CORPORATION Income Statement Year Ended December 31, 2019
Sales........................................................................ Cost of goods sold ................................................... Gross profit Operating expenses Salaries expense ............................................ Supplies expense ........................................... Depreciation expense ..................................... Bad debts expense ......................................... Bank charges expense ................................... Total operating expenses....................... Income from operations ........................................... Other revenues and expenses Interest expense ............................................. Income before income tax ....................................... Income tax expense................................................. Net income ..............................................................
$420,000 250,000 $170,000 $88,200 33,600 4,400 3,700 3,000 132,900 37,100 4,350 32,750 6,000 $ 26,750
(e) (2) HAMPTON CORPORATION Statement of Changes in Equity Year Ended December 31, 2018
Balance Jan. 1 Issued preferred shares Issued common shares Dividends declared Net income Balance Dec. 31
Share Capital Preferred Common Shares Shares
Retained Earnings
Accumulated Other Comprehensive Income
$30,000
$127,400
$9,400
(5,600) 26,750 $148,550
$9,400
$50,000 30,000
$50,000
$60,000
Total $166,800 50,000 30,000 (5,600) 26,750 $267,950
(Ending retained earnings = Beginning retained earnings + Net income – Dividends declared)
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ACR11-1 (CONTINUED) (e) (3) HAMPTON CORPORATION Statement of Financial Position December 31, 2018 Assets Current assets Cash .......................................................... Accounts receivable ................................... Less: Allowance for doubtful accounts ...... Inventory .................................................... Supplies ..................................................... Total current assets ............................. Property, plant and equipment Land ........................................................... Buildings .................................................... $142,000 Less: Accumulated depreciation ............... 26,400 Total property, plant, and equipment .. Total assets ........................................................ Liabilities and Shareholders’ Equity Current liabilities Accounts payable ...................................... Interest payable ......................................... Dividends payable ..................................... Income tax payable .................................... Current portion of mortgage payable ......... Total current liabilities ....................... Non-current liabilities Mortgage payable ...................................... Total liabilities ................................... Shareholders’ equity Share capital $2.80 Preferred shares, cumulative, 50,000 shares authorized, 500 issued .............................. Common shares, unlimited number of shares authorized, 3,500 issued ........................................ Total share capital .......................................................... Retained earnings ......................................................... Accumulated other comprehensive income.................... Total shareholders’ equity ............................................. Total liabilities and shareholders’ equity ..............
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$ 87,240 $67,800 3,500
64,300 143,560 5,900 301,000
$ 40,000 115,600 155,600 $456,600
$98,700 350 5,600 6,000 2,500 $113,150 75,500 188,650
$ 50,000 60,000 110,000 148,550 9,400 267,950 $456,600
Chapter 3
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Financial Accounting, Seventh Canadian Edition
ACR11-1 (CONTINUED) (f)
Closing Entries:
2018 Dec. 31
31
031
31
Sales ............................................................... Income Summary ...................................
420,000
Income Summary ............................................ Cost of Goods Sold ................................ Salaries Expense ................................... Supplies Expense .................................. Depreciation Expense ............................ Bad Debts Expense ............................... Bank Charges Expense ......................... Interest Expense .................................... Income Tax Expense .............................
393,250
Income Summary ............................................ Retained Earnings .................................
26,750
Retained Earnings .......................................... Dividends Declared ................................
5,600
420,000
250,000 88,200 33,600 4,400 3,700 3,000 4,350 6,000
26,750
5,600
LO 2,3,4 BT: AP Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT11-1 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
1.
The North West Company Inc. reported $1.44 basic earnings per share for the year ended January 31, 2016 and $1.30 for the year ended January 31, 2015.
2.
North West reported a weighted average number of common shares of 48,509,000 in 2016, and 48,432,000 in 2015.
(b) (Number shares in thousands) 1. Number of common shares authorized 1. Number of preferred shares authorized 2. Number of common shares issued 2. Number of preferred shares issued
2016 unlimited N/A 48,523,341 N/A
2015 unlimited N/A 48,497,199 N/A
Although very close in amount, the number of common shares issued does not correspond to the weighted average number of common shares because the number of shares issued is the actual number of shares issued as at the end of the fiscal year while the weighted average number of shares weights shares issued and repurchased during each fiscal year for the proportion of the year they have been outstanding.
(c)
3.
The dollar amount showing in Note 15 for the Common Shares account is $167,910,000 and this is the amount received by the company when it issued the 48,523,341 common shares that are currently outstanding. The company would have received on average $3.46 per share ($167,910,000 ÷ 48,523,341).
1.
North West reported other comprehensive income in the amount of $11,953,000 for the 2016 fiscal year and other comprehensive income of $11,384,000 for the 2015 fiscal year.
2.
North West declared dividends to common shareholders in the amount of $58,210,000 for the 2016 fiscal year and $56,180,000 for fiscal 2015.
LO 3,4 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT11-2 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Companies choose different types of ownership structures for a variety of reasons. One of the most common reasons companies choose to go public is to access the funds available through the capital markets. However, this access to capital comes with costs. Once a company goes public, it must follow the securities regulations, which results in additional costs and requirements such as filing quarterly financial statements, audited annual financial statements, expanded disclosure requirements, and various other reports. Also, because public companies must publicly disclose financial information, competitors may have access to useful information. Although private companies may have more difficulty accessing large amounts of capital, some choose to remain private in order to retain control over the company. Once a company is public, it is answerable to a variety of stakeholders. Consequently, some companies choose to remain private in order to avoid revealing information to the general public, in particular to their competitors.
(b)
Public companies should record noncash transactions at the fair value (or current value) of the consideration received (the new restaurant). If that consideration cannot be reliably determined, the fair value of the consideration given up (the shares) should be used instead. Since Boston Pizza is a public company, it can easily obtain an objective measure of the fair value of its shares through the TSX (the exchange where it is listed). Private companies should record noncash transactions at the most reliable fair value of what was received or given up. When private companies such as Pizza Pizza, whose shares are not publicly traded, need to determine the fair value of their shares, they often hire a business valuation expert to provide them a valuation. It is more usual that they find the fair value of the consideration received (that is, of the new restaurant) to be more reliable and relevant to use than the current value of the consideration given up, given the lack of a readily available share price.
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CT11-2 (CONTINUED) (c)
When the standard setters developed ASPE, a major focus was on the objectives and needs of the users of the financial statements. The users generally fall into two broad groups: lenders and other creditors, and private shareholders. The two groups are generally more focused on shorter-term cash flows, liquidity, balance sheet strength, interest coverage, and solvency issues. Given these users’ needs, basic earnings per share (EPS) is not usually considered to be relevant. In addition, the shares are usually very closely held. Therefore, ASPE does not require that private companies report EPS (but if the company thinks EPS is relevant information, it is free to report it).
LO 1,2,5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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CT11-3
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS.
At the beginning of the year: Assets Liabilities Shareholders' equity
Option 1
Option 2
Option 3 Debt and equity
All equity
All debt
$1,000,000 1,000,000
$1,000,000 999,999 1
$2,000,000 1,000,000 1,000,000
Option 1
Option 2
All equity
All debt
Option 3 Debt and equity
$1,000,000 850,000 150,000 150,000
$1,000,000 850,000 150,000 60,000 90,000
$2,000,000 1,700,000 300,000 60,000 240,000
37,500 $ 112,500
22,500 $ 67,500
60,000 $ 180,000
(a) Projected income statements:
Revenue (= to assets) Operating expenses (85% of revenue) Income from operations Interest expense (6% of liabilities) Income before income tax Income tax expense (25% of income before income tax) Net income
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CT11-3 (CONTINUED) The return on common shareholders’ equity for each option is calculated below. Note that because the net income will be paid out as dividends, the retained earnings at the end of the year will be zero so the average common shareholders’ equity at the end of the year will be the same amount that it was at the beginning of the year. Option 1 Option 2 Option 3 Debt and All equity All debt equity Net income for the year $ 112,500 $67,500 $ 180,000 Common shareholder's equity, beg. of year 1,000,000 1 1,000,000 Common shareholder's equity, end of year 1,000,000 1 1,000,000 Average shareholder's equity for the year 1,000,000 1 1,000,000 Return on common shareholders’ equity 11.3% 6,750,000% 18.0% (b)
The option with the lowest return is the one with the lowest level of debt relative to equity. When no debt is taken out, a company cannot take advantage of leverage, which means that the company does not profit by using the bank’s money. As a result, the best return is the one with all debt, Option 2. Because the denominator is so low (only $1 of equity), the return appears to be astronomically high. (c)
The amount of cash that Depinder would have before income tax is calculated in the table below. He will have the most cash under Option 3 if he borrows money from the bank and buys the larger restaurant. Option 1 All equity $112,500
Option 2 Option 3 All debt Debt and equity Dividends received by Depinder $ 67,500 $180,000 Interest received by Depinder 60,000 $127,500 (d) If the operating expenses are greater than the revenues, then the company will have a loss. The return on common shareholders’ equity will be negative. If the company has more debt, additional interest will have to be paid to the bank and this will make the loss greater and the return on common shareholder’s equity lower than it would have been otherwise. (e)
If the bank loan was replaced with preferred shares, there would be no interest expense on the income statement and net income would rise. The preferred dividends would be reported on the statement of changes in shareholders’ equity and not on the income statement. The net income for the large restaurant would be exactly double what is currently reported on the income statement for Option 1, the purchase of the small restaurant.
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CT11-3 (CONTINUED) (f)
The preferred shares that the uncle would purchase would be considered to be retractable since he has the right to require the company buy back the shares. This makes the shares similar to debt because there is a contractual obligation to pay an amount in the future (this is in essence the definition of a liability). Because of this, the preferred shares would be shown as a liability rather an equity item. Consequently, the dividends on those shares would be treated as interest on the income statement rather than as dividends on the statement of changes in equity for consistency with its presentation on the statement of financial position.
(g)
If the business was not incorporated, the income statement would still be prepared but income tax expense would not apply and therefore not be shown. This is because the net income of the business is taxed at the personal level as the business is not a separate legal entity.
LO 2,4 BT: S Difficulty: C Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT11-4 (a)
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
The stakeholders in this situation are: Vince Ramsey, president of Flambeau Corporation Janice Rahn, financial vice-president The shareholders of Flambeau Corporation
(b)
The stock dividend results in a decrease in retained earnings and an increase of the same amount in share capital with no change in total shareholders’ equity. There is no change in total assets and no change in total liabilities and shareholders’ equity.
(c)
The 5% stock dividend will likely reduce the value at which the shares are trading by around 5%—at least in the immediate future. Since essentially nothing has changed in the company’s financial position, the only effect a 5% stock dividend will have on the market value of the shares is to allocate the equity of the business over 5% more shares.
(d)
There is nothing unethical in declaring and issuing a stock dividend. However, the president’s order to write a press release convincing the shareholders that the stock dividend is just as good as a cash dividend is unethical. A stock dividend is not a cash dividend and does not necessarily leave the shareholders in the same position. A stock dividend is a “paper” dividend—the company issues a certificate, not a cheque (cash).
LO 3 BT: C Difficulty: M Time: 20 min. AACSB: Analytic, Ethics, and Communication CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT11-5
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a) Alternative 1 (Borrow $50,000)
Alternative 2 (Issue $50,000 common shares)
Alternative 3 (Issue $50,000 preferred shares)
Debt to total assets
$71,980 ÷ $195,280 = 36.9%
$31,980 ÷ $207,680 = 15.4%
$31,980 ÷ $204,680 = 15.6%
Return on common shareholders’ equity
$21,600 ÷ [[($50,000 + $51,700) + ($50,000 + $73,300)] ÷ 2)] = 19.2%
$24,000 ÷ [[($50,000 + $51,700) + ($100,000 + $75,700)] ÷ 2)] = 17.3%
($24,000 – $3,000) ÷ [[($50,000 + $51,700) + ($50,000 + $72,700)] ÷ 2)] = 18.7%
$24,000 ÷ 1,000 = $24.00
($24,000 - $3,000) ÷ 500 = $42.00
Basic earnings $21,600 ÷ 500 per share = $43.20
(Debt to assets ratio = Total liabilities ÷ Total assets) (Return on common shareholders’ equity = (Net income – preferred dividends) ÷ Average common shareholders’ equity) (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares)
(b)
Alternatives 2 and 3 provide for the least amount of debt—$31,980 instead of $71,980 reported in Alternative 1. Instead of borrowing, the company has issued shares in Alternatives 2 and 3.
(c)
Alternative 1, borrowing instead of issuing shares, provides for the highest return on equity and the highest basic earnings per share.
(d)
If I were John, I would choose Alternative 1. This alternative would generate a smaller amount of net income because of the amount of aftertax interest expense paid on the loan; however, the return on common shareholder’s equity and basic earnings per share would increase because the distribution of net income is limited to current shareholders.
LO 5 BT: E Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Chapter 3
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CT11-6 (a)
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
June 15 Dividends Declared .................................... Dividends Payable ..............................
60,000
June 30 Dividends Payable ....................................... Cash ...................................................
60,000
60,000
60,000
Since the date of record on the declaration of the dividend is June 20, 2018, only shareholders on that date are eligible to receive dividends. Bev, Doug, and Emily each receive one-third of the dividend and will each receive $20,000. (b)
June 30 Cash ............................................................ 125,000 Common Shares (100 × $1,250) .........
(c)
125,000
ANTHONY BUSINESS COMPANY LTD. Statement of Retained Earnings Year Ended June 30, 2018
Retained earnings, July 1, 2017 ....................................................................... Add: Net income ............................................................................................ ........................................................................................................................ Less: Dividends declared ................................................................................ Retained earnings, June 30, 2018 ...................................................................
$177,834 156,069 333,903 60,000 $273,903
(Ending retained earnings = Beginning retained earnings + Net income – Dividends declared)
If ABC followed IFRS rather than ASPE, a statement of changes in equity explaining the changes in each component of shareholder’s equity would be required instead of a statement of retained earnings. (d)
ANTHONY BUSINESS COMPANY LTD. Statement of Financial Position (Partial) June 30, 2018 Shareholders’ equity Common shares, unlimited number authorized, 400 issued ... Retained earnings .................................................................. Total shareholders’ equity ..............................................................
$125,300 273,903 $399.103
($300 + $125,000 = $125,300) LO 2,3,4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 3
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
CHAPTER 12 REPORTING AND ANALYZING INVESTMENTS LEARNING OBJECTIVES 1. 2. 3. 4. 5.
Identify reasons to invest, and classify investments. Account for non-strategic investments. Account for strategic investments. Explain how investments are reported in the financial statements. Compare the accounting for a bond investment and a bond payable (Appendix 12A).
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO 1.
BT
Item LO
BT
Item LO BT Questions
Item LO
BT
Item LO
BT
C
11.
3
K
16.
4
C
21.
5
C
1
K
6.
2
2.
1
C
7.
2
C
12.
3
C
17.
4
K
22.
2,5
C
3.
1,4
C
8.
2
AP
13.
3
C
18.
4
C
23.
5
C
4.
2
C
9.
2
AP
14.
3
C
19.
4
C
5.
2
C
10.
2
C
15.
3
K
20.
3,4
AP
Brief Exercises 1.
1
K
4.
2
AP
7.
3
AP
10.
4
C
13.
4
C
2.
2
AP
5.
2
AP
8.
2,3,4
AP
11.
4
C
14.
5
AP
3.
2
AP
6.
3
AP
9.
2,3,4
AP
12.
4
AP
Exercises 1.
1
K
4.
2
AP
7.
3
AP
10.
4
AN
2.
1,4
K
5.
2,4
AP
8.
2,3,4
AP
11.
5
AN
3.
2
AP
6.
2,3
AP
9.
2,3,4
AP
1.
2,4
AP
4.
2,4
AN
7.
2,3,4
AN
10.
5
AP
2.
2,4
AP
5.
2,3,4
C
8.
2,3,4
AN
11.
5
AN
3.
2,4
AP
6.
2,3,4
AN
9.
2,3,4
AN
Problems: Set A and B .
Cases 1.
1,4
2. 1,2,3,4
Solutions Manual .
K
3.
3,4
E
5.
2,3,4
S
C
4.
2,3,4
E
6.
3
C
12-1
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
Solutions Manual .
12-2
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
Companies invest primarily for two reasons: to earn investment income such as interest, dividends, and the appreciation in the value of an investment or to influence or control other companies through the acquisition of large amounts of common shares.
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
A non-strategic investment is made for the purposes of generating investment income. A strategic investment is purchased to influence or control the operations of another company in some way.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
(a)
This equity investment should be classified as a non-strategic investment as the company intends to sell its Suncor Energy shares if the need for cash arises.
(b)
The investment would most likely be classified as a current asset (although judgement must be exercised here) as it was not purchased with the intent of holding it for a long period of time.
LO 1,4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
4.
For most debt and equity investments, their fair value is determined by the stock and bond markets. Adjustments in the carrying amount of investments are made for increases and decreases in fair value and the adjustments generate unrealized gains and losses from holding the investments. For inventory, the valuation for reporting is at the lower of cost and net realizable value. Inventory cannot be written up beyond historical cost. In other words, there cannot be unrealized gains for inventory due to fair value adjustments. The same holds true for accounts receivable that are reported at realizable value by establishing an allowance for doubtful accounts.
LO 2 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
(a)
Common shares in a publicly traded company that will be sold within a year are valued at fair value.
(b)
Bond investments that will be held until maturity are valued at amortized cost.
(c)
Shares in a private company that do not have a determinable fair value are valued at cost.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
12-3
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
6.
Financial Accounting, Seventh Canadian Edition
Management might prefer to account for a bond investment at amortized cost because the reasons for purchasing the bond were to hold it to maturity and earn interest income. If management does not intend to trade the bond or earn gains from the appreciation in the price of the bond, then information pertaining to the fair value of the bond is not relevant so its carrying amount does not have to be adjusted to fair value. By not adjusting the bond to its fair value, the company would not be recording any unrealized gains or losses pertaining to the bond and this would eliminate the volatility in the amounts that are reported in the financial statements caused in turn by the volatility of the interest rate environment affecting the bond market.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
7.
Realized gains (losses) are the differences between fair values and the carrying amounts when the investments are actually sold. Unrealized gains (losses) are the differences between the fair values and carrying amounts of investments still held or owned by the investor.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
8.
(a)
The $10,000 difference between the carrying amount of $245,000 and the fair value of $255,000 should be recorded as an unrealized gain and reported in the other revenues and expenses section in the income statement.
(b)
Yes, the answer would be different if the fair value could not be determined. No unrealized gain would be reported and the investment would be valued at cost.
LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
9.
(a)
The bonds would be shown at their fair value of $1,050,000.
(b)
The interest revenue earned on the bonds would be reported as other revenue under the other revenue and expenses section of the statement of income.
LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-4
Chapter 12
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10.
Financial Accounting, Seventh Canadian Edition
Management might prefer to account for an equity investment at the fair value through other comprehensive income model rather than using the fair value through profit or loss model when users of the financial statements are not evaluating management or the company’s performance on the appreciation in the value of the investment. Although this model will result in the investment being recorded at fair value, unrealized gains or losses will have no impact on net income or earnings per share, two measures of management and company performance. Using this model will eliminate the volatility in net income that can arise from recording unrealized gains and losses in net income rather than in OCI. . If the particular investment is subject to above average volatility, it would be preferable to management that the unrealized increases and decreases in the investment’s carrying amount not affect net income and basic earnings per share.
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
11.
(a)
Under the cost model, the carrying amount of the company’s investment is equal to its cost. The investment account is not affected by the earnings of the entity into which the investment is made which it is under the equity method. Furthermore, dividends received do not affect the investment account when using the cost model as they do when using the equity method. In the cost model, the investing company records any dividends received as investment revenue, leaving the carrying amount (usually cost) of the investment intact.
(b)
Under the equity method, the investment is also recorded at cost on the day when the investment is purchased. However, the investment account is increased or decreased by the investor’s share of the investee company’s net income or loss for the period, respectively. The investing company would reduce the carrying amount of its investment by any dividends received from the investee, since the value of the latter’s net assets decreases as it declares dividends.
(c)
Under the fair value through profit or loss model, the recording of the strategic investment is at cost at the date of purchase, but at all subsequent reporting periods, the carrying amount is adjusted to the investment’s fair value at that date. The investing company records any dividends received as investment revenue.
LO 3 BT: K Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-5
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
12.
Financial Accounting, Seventh Canadian Edition
When an investor exercises significant influence over its associate, it is in a position to affect some of the operational decisions of the associate through membership on the board of directors. Because this degree of influence has been achieved, it is deemed appropriate for the investor to record, in an account called Income from Associates, the investor’s proportionate share of the net income or loss reported by the associate. This recording of income is done even if the associate has paid no dividends to the investor. If the associate does pay a dividend to the investor, the dividend cannot be recorded in the income statement because the dividend is simply a distribution of the previously recorded income from the associate. Consequently, dividends received are treated as a return of the investment (reduction of the investment account) instead of revenue.
LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
13.
(a)
(b)
(c)
Under the cost model, the investor has little to no influence over the investee, due to its relatively small ownership interest. Therefore, the only entry the investor would make relative to this investment is to record any cash dividends it receives from the investee as investment revenue or any realized gains or losses when selling the investment. The equity method is used when the investor exercises significant influence over the investee (known as an associate if it is significantly influenced). Consequently, the investor has played a role in the determination of any net income or loss experienced by the investee. As the investee earns income, its value will increase. Thus the investor’s carrying amount of its investment in the investee should reflect this reality. Consequently, the investor records investment revenue (loss) when the investee reports net income (or loss) and does not wait for the distribution of income by way of dividends to record income from the investee. The investment is reduced by the amount of dividends received and does not result in the recording of dividend revenue. This is done because the dividend is simply a distribution of income that has already been recorded. Furthermore, when the investee (also known as associate) distributes a dividend, the value of the associate falls and a corresponding reduction in the investment account balance is appropriate. Under the fair value through profit or loss model, as with the cost model, the investor would record, in the income statement, any cash dividends it receives from the investee as investment revenue along with any realized gains or losses when selling the investment. In addition, unrealized holding gains or losses are recorded in the income statement at the end of each reporting period.
LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-6
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
14.
(a)
(b)
Financial Accounting, Seventh Canadian Edition
Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, material inter-company transactions, interchange of managerial personnel, or technological dependency. An investment (direct or indirect) of 20% or more of the voting shares of an investee constitutes significant influence, unless there exists evidence to the contrary. Control on the other hand exists when one entity holds more than 50% of the voting shares of the investee. Companies are required to use judgement rather than to blindly follow the 20% and 50% guidelines. For example, 25% ownership in a company that is 75% controlled by another company would not necessarily indicate significant influence. Similarly, a single investor holding 45% ownership in a public company that has the remaining 55% ownership spread over thousands of shareholders could have control over the investee.
LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
15.
Consolidated (combined) financial statements are prepared when a parent company owns a subsidiary (ownership with control). Consolidated financial statements show the combined assets and liabilities of both the parent and subsidiary companies. In order to avoid duplication, the investment account is eliminated and replaced with the assets and liabilities of the subsidiary.
LO 3 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
16.
(a)
Held for trading investments are classified as current assets under the assumption that management intends to trade them actively, thereby implying that they will be sold fairly soon.
(b)
Investment in associates is classified as a long-term investment under the assumption that if an investor has gone to the trouble of obtaining a large enough block of shares to significantly influence the investee, they would want to hold onto the investment for more than one year.
(c)
Debt investments held to maturity are classified as long-term investments except in the year of maturity, when the securities would be classified as current assets.
LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-7
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
17. Account
Financial Statement
Classification
(a)
Unrealized Gain on Held for Trading Investments
Income Statement
Other revenues and expenses
(b)
Realized Loss on Held for Trading Investments
Income Statement
Other revenues and expenses
(c)
Income from Associates
Income Statement
Other revenues and expenses
(d)
Investment in Associates
Statement of Financial Position
Non-current assets
LO 4 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
18.
Comprehensive income includes all changes to shareholders’ equity during a period except changes resulting from investments by shareholders and dividends declared. Net income is one component of comprehensive income. The other component is other comprehensive income, which includes the current period’s unrealized gains/losses on securities accounted for using the fair value through other comprehensive income model and certain other unrealized gains/losses such as revaluation gains under the revaluation model for property, plant, and equipment that was covered in Chapter 9. Net income and other comprehensive income can be reported separately in two statements although the preferred approach is to report both in a single statement known as the statement of comprehensive income. Accumulated other comprehensive income is the cumulative total of each period’s other comprehensive income/loss. Just as net income is closed out to retained earnings at the end of the year, other comprehensive income is closed out to accumulated other comprehensive income at the end of the year. The changes to accumulated other comprehensive income are reported in the statement of changes in equity, and the ending balance of accumulated other comprehensive income is reported in the shareholders’ equity section of the statement of financial position.
LO 4 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
19.
Financial Accounting, Seventh Canadian Edition
Net income reported on the income statement is a component of comprehensive income. Net income along with other comprehensive income is reported in the statement of comprehensive income (if the company chooses to report both under a single statement). Net income (loss) increases (decreases) retained earnings. Other comprehensive income (loss) increases (decreases) accumulated other comprehensive income which, like retained earnings, is an equity account. Changes in both retained earnings and accumulated other comprehensive income are reported in the statement of changes in equity. Total shareholders’ equity is reported in the statement of financial position (assets = liabilities + shareholders’ equity).
LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
20.
(a)
When George Weston Ltd. owned 63% of the common shares of Loblaw Companies Ltd., it was required to consolidate the Loblaw financial statements. George Weston would have created an investment account when it first purchased Loblaw. Upon consolidation, the investment account would be replaced with the assets and liabilities of Loblaw in creating consolidated financial statements. Because the investment account is eliminated in the consolidation process, it really does not matter whether the investment account is accounted for using the equity or cost method prior to consolidation.
(b)
At that time, George Weston Ltd. was the parent and Loblaw was the subsidiary because the parent exercised control over the subsidiary since it owned 63% of the voting shares of Loblaw.
(c)
Consolidated financial statements were prepared. When consolidated financial statements were prepared, George Weston eliminates its investment account from its own records and replaces this with the specific assets and liabilities of Loblaw. The consolidated financial statements would include all of George Weston’s assets and liabilities at their carrying amount in addition to the assets and liabilities of Loblaw.
(d)
Following the purchase of Shoppers Drug Mart by Loblaw, and the decrease in the ownership percentage of George Weston in Loblaw to 46%, George Weston would presumably no longer have control of Loblaw. It would however still be able to exercise significant influence. In this case, consolidation would normally not be required and the investment account would be accounted for using the equity method (it would not be eliminated anymore when consolidation occurred). However, George Weston, even though it does not own a majority of the voting shares of Loblaw, still controls Loblaw because it has the right to acquire more shares in that company (although a discussion of the detailed reasons for this covers material beyond the scope of this textbook).
Solutions Manual .
12-9
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
20. (continued) (e)
Based on the facts provided, Loblaw would now be an associate and not a subsidiary of George Weston. However, as stated above, George Weston does exercise control (for reasons beyond the scope of this text) and still continues to treat Loblaw as a subsidiary despite the fact that it only owns 46% of the voting shares.
LO 3,4 BT: AP Difficulty: C Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
*21.
The accounting treatment for an investment in bonds is essentially the inverse of the recording required for a bond liability. In both cases, the bond is recorded at its issue price, with any premium or discount netted with the bond account. The premium or discount is amortized using the effective interest method, unless the bond is held for trading. Debt investments in bonds that are held for trading are re-valued to fair value at year-end, whereas bond liabilities are not because it is extremely rare for them to have been issued for the purposes of trading (because they are liabilities, not investments).
LO 5 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
*22.
Premiums and discounts must be amortized when using the amortized cost model because the amortization of the discount or premium provides the proper matching of interest revenue to the periods the investment is held and reflects the effective interest rate in the financial statements. When using the fair value model for debt securities, the investment is held for a short time and any misstatement of interest caused from not amortizing the discount/premium is not considered material.
LO 2,5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
*23.
When the bonds are sold by the investor on the open market, the investor must record the sale. The investee is not affected by the sale since an independent third party purchases the bonds on the market, and as such, that transaction is occurring between two investors and has nothing to do with the company that originally issued the debt. The liability has not been settled, but rather, the amount of the bonds owing is simply payable to a different investor.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-10
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12-1 (a) Debt or Equity Investment? 1.
120-day treasury bill
Debt
(b) Non-Strategic or Strategic Investment? Non-Strategic
2.
A few common shares of a small oil company purchased with a temporary surplus of cash that will be held temporarily 30% of the common shares of a company purchased in order to obtain a position on the board of directors Bonds purchased with a temporary cash surplus that will be held to maturity 100% of the common shares of a company purchased to combine its operations with those of the investor Five-year bonds intended to be held for the entire term of the bonds
Equity
Non-Strategic
Equity
Strategic
Influence the operations of the other company
Debt
Non-Strategic
Interest revenue
Equity
Strategic
Control the operations of the other company
Debt
Non-Strategic
Interest revenue over the long term
3.
4.
5.
6.
(c) Reason for Making the Investment? Interest revenue for 120 days Share price appreciation (capital gain) and dividend revenue
LO 1 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 12-2 (a) Jan.
1
(b) July (c) Dec.
Dec.
1
31
31
Held for Trading Investments .................................. 200,000 Cash...............................................................
200,000
Cash ....................................................................... Interest Revenue ($200,000 × 10% × 6/12) ...
10,000 10,000
Interest Receivable ................................................. Interest Revenue ($200,000 × 10% × 6/12) ..
10,000
Unrealized Loss on Held for Trading Investments .. Held for Trading Investments ........................ ($200,000 – [$200,000 × 97%])
6,000
10,000
6,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 12-3 2019 Jan.
2
Cash ....................................................................... 194,000 Held for Trading Investments .........................
194,000
The investment is already carried at fair value so no gain or loss will result on this sale. LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 12-4 (a) Aug.
(b) Dec.
(c) Dec.
1
28
31
Held for Trading Investments. ................................. Cash...............................................................
45,000
Cash ....................................................................... Dividend Revenue ..........................................
1,000
45,000
Held for Trading Investments .................................. 4,000 Unrealized Gain on Held for Trading Investments
1,000
4,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 12-5 (a) Feb.
(b) Feb.
1
1
Cash ............................................................................... Realized Loss on Held for Trading Investments ………... Held for Trading Investments ............................. Cash ........................................................................... Realized Loss on Held for Trading Investments ………... Held for Trading Investments .............................
47,000 2,000 49,000 44,000 5,000 49,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 12-6 (a) Jan.
Dec.
1
31
31
(b)
Investment in Associates .............................................. 800,000 Cash.....................................................................
800,000
Cash (25% × $40,000).................................................. Investment in Associates .....................................
10,000 10,000
Investment in Associates (25% × $80,000) .................. Income from Associates .....................................
20,000 20,000
Rook would report $20,000 of revenue from its investment in Hook for the year.
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 12-7 (a) Jan.
Dec.
1
31
Investment in Associates .............................................. 800,000 Cash.....................................................................
800,000
Cash (25% × $40,000).................................................. Dividend Revenue ................................................
10,000
10,000
(b)
Since Rook uses the cost model to account for its investment, the only revenue that Rook should report is its pro-rata share of any dividends declared by Hook, which amounts to $10,000 (25% × $40,000).
(c)
Accounting for the investment using the cost model is different from using the equity method which records a pro-rata share of income from Hook and records receipt of dividends as a reduction of the investment account on the statement of financial position.
LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 12-8 (a)
Significant influence – The balance in the equity investment account at December 31, would be $287,000. The investment would be reported as an investment in associates in long-term investments. Cost of investment Add: Share of Dong’s net income (20% × $350,000) Less: Dividends received from Dong (20% × $40,000)
$225,000 70,000 (8,000) $287,000
(b)
Without significant influence, the investment would be reported at the fair value of $275,000 in long-term investments.
(c)
Under the cost model, the investment would be reported at its purchase price of $225,000. It would be reported as an investment in associates in long-term investments.
LO 2,3,4 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 12-9 (a)
(b)
(c)
Statement of Financial Position: Long-term investments
Significant Influence Equity Method
NoSignificant Influence FVTPL Model*
$287,000
$275,000
$225,000
0 $70,000
$ 8,000 0
$8,000 0
0
50,000
0
Income Statement: Other revenues and expenses Dividend revenue Income from associates Unrealized gain on longterm investments
Cost Model
*Fair value through profit or loss model LO 2,3,4 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-15
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 12-10 Financial Statement
Classification
A bond investment that will mature next year
Statement of financial position
Current assets
Dividend revenue from a held for trading investment
Income statement
Other revenues and expenses
Investment in associate
Statement of financial position
Long-term investments
Investment of a few hundred Statement of financial common shares in a large publicly position traded company that is held for trading purposes
Current assets
A bond investment that management intends to hold for 10 years
Statement of financial position
Long-term investments
Realized gain on a held for trading investment
Income statement
Other revenues and expenses
Unrealized gain on a held for trading investment
Income statement
Other revenues and expenses
Dividends received from a strategic investment accounted for using the equity method
Statement of financial position
Long-term investments (Investment in Associate is reduced)
Interest earned on a held for trading investment
Income statement
Other revenues and expenses
LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-16
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 12-11 Include in net income or OCI?
Item Realized gain on long-term investments Unrealized loss on held for trading investments Income from associates
Net income Net income Net income
For investments that are non-strategic and not held for trading, Rosewater can elect to report unrealized gains and losses in other comprehensive income. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 12-12 SABRE CORPORATION Statement of Financial Position (Partial) December 31, 2018 Assets Current assets Held for trading investments……………… ................................
$ 45,000
Long-term investments Long-term investments .............................................................. Investment in associates ...........................................................
870,000 * 233,600 **
* **
$870,000 = $550,000 (equity investment in Epee at fair value) + $320,000 (bond investment held to maturity at amortized cost) $233,600 = $220,000 + ($50,000 × 40%) – ($16,000 × 40%)
LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-17
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 12-13 Brookfield’s purchase of investment in associates should be reported on the company’s statement of cash flows as a cash outflow in investing activities. The amount would also be included in the statement of financial position in longterm investments as an investment in associates. Brookfield’s share of income from associates would be reported on the company’s income statement in the other revenues and expenses section. The amount would also cause an increase in the investment in associates account in the long-term investments section on the statement of financial position. Dividends received from associates would be reported on the company’s statement of cash flows as a cash inflow as an operating activity or an investing activity. The amount would also reduce the investment in associates account on the statement of financial position. The year-end balance of investment in associates would be reported on the statement of financial position in long-term investments. LO 4 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*BRIEF EXERCISE 12-14 (a)
Investor
June
30
Dec.
31
Long-Term Investments .......................................... Cash...............................................................
138,960
Cash ($150,000 × 10% × 6/12) ............................... Long-Term Investments .......................................... Interest Revenue ($138,960 × 12% × 6/12) ...
7,500 838
(b)
Investee
June
30
Dec.
31
138,960
8,338
Cash ....................................................................... Bonds Payable ...............................................
138,960
Interest Expense ($138,960 × 12% × 6/12) ............ Cash............................................................... Bonds Payable ...............................................
8,338
138,960 7,500 838
LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-18
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 12-1 (a) Debt or Equity Investment? Equity Debt Equity Debt Equity
1. 2. 3. 4. 5.
(b) Non-Strategic or Strategic Investment? Strategic Non-Strategic Strategic Non-Strategic Non-Strategic
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 12-2 (a) 1.
10-year BCE bonds
2.
10-year GE bonds
3.
5-year Government of Canada bonds 180-day treasury bill
4. 5.
Bank of Montreal preferred shares*
6.
Common shares
NonStrategic NonStrategic NonStrategic NonStrategic NonStrategic
NonStrategic
(b) Held until maturity Held for trading Held for trading Held for trading Neither held for trading or held to maturity Held for trading
(c) Non-current Current Current Current Non-current
Current
* Note that if Kroshka is a public company, it has the choice and can elect to value this asset using the fair value through other comprehensive income model. If Kroshka reports under ASPE, the investment would be carried using the fair value through income or loss model. LO 1,4 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-19
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-3 (a) July (b) Dec.
1
31
Held for Trading Investments ($1,000,000 × 108.5%) Cash...............................................................
1,085,000
Interest Receivable ................................................. Interest Revenue ($1,000,000 × 4% × 6/12) ..
20,000
Adjustment to fair value: Dec. 31 Unrealized Loss on Held for Trading Investments .. ($1,000,000 × 107%) – $1,085,000 Held for Trading Investments .........................
1,085,000
20,000
15,000 15,000
LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-20
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-4 (a) Transactions Apr. 1 Held for Trading Investments....................................... Cash ....................................................................... July
210,000 210,000
1 Cash (2,000 × $5 ÷ 4) .................................................. Dividend Revenue ..................................................
2,500
02 Cash ............................................................................ Realized Gain on Held for Trading Investments .... Held for Trading Investments ................................ [($210,000 ÷ 2,000) × 500]
57,000
1 Cash [(2,000 – 500) × $5 ÷ 4] ...................................... Dividend Revenue ..................................................
1,875
(b) Adjusting entries Dec. 31 Dividends Receivable .................................................. Dividend Revenue ..................................................
1,875
Oct.
31 Held for Trading Investments....................................... Unrealized Gain on Held for Trading Investments.. (1,500 × $115) – ($210,000 – $52,500) (a) Transactions (continued) Jan. 31 Cash (700 x $89) ......................................................... Realized Loss on Held for Trading Investments .......... Held for Trading Investments ................................. (Carrying amount = $115 × 700) Feb. 15 Cash (500 × $117) ....................................................... Realized Gain on Held for Trading Investments ..... Held for Trading Investments ................................. (Carrying amount = $115 × 500) (c)
2,500
4,500 52,500
1,875
1,875 15,000 15,000
62,300 18,200 80,500
58,500 1,000 57,500
After the Feb. 15, 2019 sale, McCormick held 300 Starr preferred shares (2,000 – 500 – 700 –500) at carrying amount $34,500 (carrying amount per share $115 x 300) or ($210,000 – $52,500 + $15,000 – $80,500 – $57,500). The fair value of the 300 Starr shares was $35,100 (300 x $117) at Feb. 15, 2019.
LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-21
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-5 (a) Dec.
31 Held for Trading Investments .............................. 2,000 Unrealized Gain on Held for Trading Investments ($54,000 – $52,000)
2,000
(b) YANIK INC. Statement of Financial Position (Partial) December 31, 2018
Current assets Held for trading investments ................................................... $54,000 YANIK INC. Income Statement (Partial) Year Ended December 31, 2018
Other revenues and expenses Unrealized gain on held for trading investments .............
(c) Mar.
22 Cash ........................................................................... Realized Gain on Held for Trading Investments .... Held for Trading Investments ................................
$2,000
22,000 1,000 21,000
LO 2,4 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-22
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-6 Jan.
Mar.
June
June
Dec.
Dec.
1 Investment in Associates .................................... Cash (60,000 × 40% × $16) .........................
384,000 384,000
18 Long-Term Investments ....................................... 1,680,000 Cash (400,000 × 15% × $28) ........................ 15 Cash ($140,000 × 40%) ....................................... Investment in Associates .............................
56,000
30 Cash ($300,000 × 15%) ....................................... Dividend Revenue .........................................
45,000
31 Investment in Associates .................................... Income from Associates............................... ($300,000 × 40%)
120,000
31 Unrealized Loss on Long-Term Investments [($1,680,000 – (60,000 × $26)] ............................ Long-Term Investments ................................
1,680,000
56,000
45,000
120,000
120,000 120,000
When the equity method is used to account for investment in associates, the investment account is not adjusted to fair value. LO 2,3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-23
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-7 (a) Oct.
1
Dec.
31
(b) Oct.
1
Dec.
31
Investment in Associates .................................. Cash (200,000 × $2.50) ...............................
500,000
Dividend Receivable ($80,000 × 20%*)..... ……. Investment in Associates .............................
16,000
Investment in Associates .................................. Revenue from Investment in Associates ($200,000 × 20%*) .......................................
40,000
Long-Term Investments .................................... Cash (200,000 × $2.50) ...............................
500,000
Dividend Receivable ($80,000 × 20%*)............. Dividend Revenue .......................................
16,000
500,000
16,000
40,000
500,000
16,000
No entry
* 200,000 shares / 1,000,000 shares LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-24
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-8 (a) and (b) Income Statement: Other revenues and expenses Dividend revenue Income from associates Realized gain on held for trading investments Unrealized loss on held for trading investments
$10,000 40,000 15,000 (10,000) $55,000
(A) (B) (C) (D)
(b) Calculations:
Account Balance, beginning of year (given) Purchases of investments during the year Carrying amount of investments sold during the year (given)
Held for Trading Investments
Investment in Associates
$120,000
$500,000
50,000
120,000
(30,000)
Dividends received (given)
(60,000)
(B) Share of associates’ income (derived)
40,000
($600,000 - $500,000 - $120,000 +$60,000) (D) Fair value adjustment (derived) ($130,000−$120,000 + $30,000 −$50,000)
(10,000)
Balance, end of year (given)
$130,000
$600,000
(A) Given for held for trading investments (C) Proceeds from sale of held for trading investments $45,000 less carrying amount of $30,000 LO 2,3,4 BT: AP Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-25
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-9 (a)
Account
Balance, beginning of year Purchases of investments during the year Carrying amount of investments sold during the year
Held for Trading Investments
Investment in Associates
$100,000
$300,000
30,000
40,000
(43,000)*
(42,000)**
Dividends received
(8,000)
Share of associates’ income Fair value adjustment derived($94,000−$100,000 - $30,000 +$43,000)
43,000
Balance, end of year * $55,000 less gain of $12,000 ** $32,000 plus loss of $10,000 (b)
7,000 $94,000
Held for Trading Investments Held for Trading Investments ...................................... Cash ..................................................................
$333,000
30,000 30,000
Cash .......................................................................... Realized Gain on Held for Trading Investments Held for Trading Investments .............................
55,000
Cash .......................................................................... Dividend Revenue..............................................
3,000
Held for Trading Investments ...................................... Unrealized Gain on Held for Trading Investments
7,000
Investment in Associates Investment in Associates ............................................ Cash ..................................................................
12,000 43,000
3,000
7,000
40,000 40,000
Cash .......................................................................... Realized Loss on Investment in Associates ................ Investment in Associates ...................................
32,000 10,000
Cash ........................................................................... Investment in Associates ...................................
8,000
Investment in Associates ............................................ Income from Associates ....................................
43,000
Solutions Manual .
12-26
42,000
8,000
43,000 Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 12-9 (CONTINUED) (c) Held for Trading Investments Statement of Financial Position: Held for trading investments Investment in associates
Investment in Associates
$94,000 $333,000
Income Statement: Realized gain on held for trading investments Unrealized gain on held for trading investments Dividend revenue Income from associates Realized loss from investment in associates
$12,000 7,000 3,000 $43,000 (10,000)
LO 2,3,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 12-10 (a)
100% Cameco Europe – equity method but then investment is eliminated when the subsidiary accounts are consolidated together with those of the parent company. 20.3% UEX – equity method 24% GE-Hitachi Global – equity method Unnamed public company – fair value through profit or loss model All of the first three investments exceed 20% ownership in each corporation. Control is exerted over Cameco Europe and significant influence over the other two investees’ operations by Cameco is assumed. Other factors should be examined to determine if significant influence does exist regardless of the percentage of ownership. If there is significant influence, the equity method would be used. For the insignificant investment in an unnamed public company, the fair value through profit or loss model is used for this long-term investment. Fair value is easily determined as the investee is a public company.
(b)
Cameco Europe should be consolidated with Cameco’s operations because Cameco is the parent company of a fully owned subsidiary, Cameco Europe.
LO 4 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-27
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 12-11 (a) Key inputs:
Future value (FV) = $500,000 Market interest rate (i) = 3% (6% × 6/12) Interest payment (PMT) = $12,500 ($500,000 × 5% × 6/12) Number of semi-annual periods (n) = 20 (10 years × 2)
Using present value tables Semi-annual interest payments $500,000 × 2.5% Present value factor for annuity, 3% for 20 periods Present value of interest payments Present value of $500,000, in 20 periods at 3% $500,000 × 0.55368 Issue price of the bonds
$ 12,500 × 14.87747 185,968 276,840 $462,808
Note to the instructor: Rounding discrepancies may arise depending on whether present value tables, calculators, or a spreadsheet program is used to determine the present value. (b)
Investor
2018 July
2
Dec.
31
2019 Jan. 1
July
1
Solutions Manual .
Long-Term Investments .......................................... Cash...............................................................
462,808
Interest Receivable ($500,000 × 5% × 6/12) ........... Long-Term Investments .......................................... Interest Revenue ($462,808 × 6% × 6/12) .....
12,500 1,384
Cash ....................................................................... Interest Receivable ........................................
12,500
462,808
13,884
Cash ($500,000 × 5% × 6/12) ................................. 12,500 Long-Term Investments .......................................... 1,426 Interest Revenue (($462,808 + $1,384) × 6% × 6/12)
12-28
12,500
13,926
Chapter 12
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Financial Accounting, Seventh Canadian Edition
*EXERCISE 12-11 (CONTINUED) (c)
Investee
2019 July
2
Dec.
31
2019 Jan. 1
July
(d)
1
Cash ....................................................................... Bonds Payable ...............................................
462,808
Interest Expense ($462,808 × 6% × 6/12) .............. Interest Payable ............................................. Bonds Payable ...............................................
13,884
Interest Payable ...................................................... Cash...............................................................
12,500
Interest Expense (($462,808 + $1,384) × 6% × 6/12) Cash............................................................... Bonds Payable ...............................................
13,926
462,808
12,500 1,384
12,500
12,500 1,426
The response to (a) would differ in that the bond purchase would be recorded in a Held for Trading Investments account. Companies can amortize the discount and then adjust for the change in fair value but the separation of these two items for reporting purposes is usually not done so for our purposes we will not do this. The $12,500 accrual for the interest would be recorded as interest revenue. The collection of interest at January 1, 2019 would be the same. The bonds’ carrying amount would be adjusted to the fair value of $465,000 ($500,000 × 93%) at December 31, 2018. An unrealized gain of $2,192 would be reported on the income statement. [$465,000 (fair value) – $462,808 (carrying amount) = $2,192]. There would be no changes to how the investee recorded the bonds or interest.
LO 5 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-29
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 12-1A (a)
Feb.
Aug.
1
1
2
Dec. 31
31
Held for Trading Investments ............................. Cash ($200,000 × 1.04) .............................
208,000
Cash ($200,000 × 3% × 6/12) ............................ Interest Revenue .......................................
3,000
208,000
3,000
Cash ($80,000 × 1.02) ....................................... 81,600 Realized Loss on Held for Trading Investments 1,600 Held for Trading Investments ($208,000 × 40%*) *80,000/200,000 = 40% Interest Receivable ($120,000 × 3% × 5/12) ..................................... Interest Revenue .......................................
1,500
Unrealized Loss on Held for Trading Investments ($208,000 – $83,200) – $120,000 ..................... Held for Trading Investments .....................
4,800
83,200
1,500
4,800
(b) GIVARZ CORPORATION Statement of Financial Position (Partial) December 31, 2018 Current assets Interest receivable .............................................................. Held for trading investments ...............................................
$ 1,500 120,000
(c) GIVARZ CORPORATION Income Statement (Partial) Year Ended December 31, 2018 Other revenues and expenses Interest revenue ($3,000 + $1,500) ................................... Unrealized loss on held for trading investments ................ Realized loss on held for trading investments ...................
$4,500 $4,800 1,600
(6,400) $(1,900)
LO 2,4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-30
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-2A (a)
Feb. 1
Mar. 1
Apr.
July
1
1
Aug. 1
Sept. 1
Oct.
1
1
Held for Trading Investments ............................. 36,000 Cash .........................................................
36,000
Held for Trading Investments ............................. 24,000 Cash ..........................................................
24,000
Held for Trading Investments ............................. 60,000 Cash .........................................................
60,000
Cash ($3 × 600) ................................................. Dividend Revenue......................................
1,800
1,800
Cash ($58 × 200) .............................................. 11,600 Realized Loss on Held for Trading Investments 400 Held for Trading Investments ..................... [($36,000 ÷ 600) × 200] Cash ($1.50 × 800) ............................................ Dividend Revenue......................................
1,200
Cash ($60,000 × 7% × 6/12) .............................. Interest Revenue .......................................
2,100
12,000
1,200
Cash ................................................................... 62,000 Realized Gain on Held for Trading Investments ($62,000 – $60,000)................................... Held for Trading Investments .....................
2,100
2,000 60,000
Dec. 31
Unrealized Loss on Held for Trading Investments ($48,000 – $46,800) ....................................... 1,200 Held for Trading Investments ................. 1,200 Security Cost Fair Value CBF common $24,000* $22,000 (400 × $55) RSD common 24,000 24,800 (800 × $31) $48,000 $46,800 *$36,000 $12,000 = $24,000
Solutions Manual .
12-31
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-2A (CONTINUED) (b)
KAKISA FINANCIAL CORPORATION Statement of Financial Position (Partial) December 31, 2018 Current assets Held for trading investments.............................................
(c)
$46,800
KAKISA FINANCIAL CORPORATION Income Statement (Partial) Year Ended December 31, 2018 Other revenues and expenses Dividend revenue ($1,800 + $1,200) ................................. Interest revenue ................................................................ Realized gain on held for trading investments ................... Unrealized loss on held for trading investments ..... $1,200 Realized loss on held for trading investments .......... 400
$3,000 2,100 2,000 7,100 1,600 $5,500
Note that it would not be wrong to combine realized gains and losses for a specific category of investments for presentation purposes. LO 2,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-32
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-3A (a) Mar.
1
June
1
Sept.
1
Oct.
Dec.
1
31
Cash ......................................................................... Realized Gain on Held for Trading Investments Held for Trading Investments ...........................
23,600
Held for Trading Investments ................................... Cash ................................................................
28,000
Cash ($1.50 × 800) .................................................. Dividend Revenue............................................
1,200
Cash ........................................................................ Realized Gain on Held for Trading Investments Held for Trading Investments (400 × $31) .......
12,500
1,600 22,000
28,000
1,200
100 12,400
Unrealized Loss on Held for Trading Investments.... 5,200 Held for Trading Investments ($40,400 – $35,200) Security
Carrying Amount
Fair Value
$12,400* 28,000 $40,400
$13,200 22,000 $35,200
RSD common KEF common
5,200
(400 × $33) (2,000 × $11)
*$24,800 – $12,400 = $12,400
(b)
KAKISA FINANCIAL CORPORATION Statement of Financial Position (Partial) December 31, 2019 Current assets Held for trading investments..............................................
Solutions Manual .
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$35,200
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-3A (CONTINUED) (c)
KAKISA FINANCIAL CORPORATION Income Statement (Partial) Year Ended December 31, 2019
Other revenues and expenses Realized gain on held for trading investments ($1,600 + $100)....... Dividend revenue .......................................................................... Unrealized loss on held for trading investments ..............................
$1,700 1,200 (5,200) (2,300)
LO 2,4 BT: AP Difficulty: M Time: 30min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-34
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-4A (a) Debt Securities Dominion bonds Government of Canada bonds Sub-total
Equity Securities Bank of Calgary Matco Inc. Argenta Corp. Sub-total Total (b)
(c)
4,000
Cost Unit Total $100 $400,000
Fair Value Unit Total $ 97 $388,000
2,000
100
135
Quantity
Quantity 4,000 10,000 10,000
200,000 600,000
Cost Unit Total $55 $220,000 29 290,000 36 360,000 870,000 $1,470,000
270,000 658,000
Fair Value Unit Total $61 $244,000 32 320,000 40 400,000 964,000 $1,622,000
1.
If Val d’Or’s entire portfolio is comprised of held for trading investments, they would be carried at their fair value of $1,622,000.
2.
An unrealized gain of $152,000 ($1,622,000 – $1,470,000) would appear under other revenues and expenses on the company’s income statement.
1.
If Val d’Or intends to hold the debt securities to maturity, this portion of the portfolio should be reported at amortized cost on the statement of financial position. The premium or discount would be amortized and the carrying amount of the bonds would be adjusted. If the bonds were purchased at par, they would be carried at their cost of $600,000. The portfolio of debt securities would be classified as a long-term investment.
2.
No unrealized gains or losses would be recognized for the debt portfolio on the income statement for the bonds. The equity securities would be carried at fair value of $964,000. The portfolio of equity securities would be classified as current assets. An unrealized gain of $94,000 ($964,000 – $870,000) would appear under other revenues on the company’s income statement for the equity securities.
(d)
If Val d’Or cannot obtain fair value information relating to the securities in its portfolio, the portfolio should be reported at amortized cost on the statement of financial position. No unrealized gains or losses would be recognized on the income statement.
LO 2,4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-5A (a)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
(b)
Statement of Financial Position Income Statement Shareholders’ Other Other Net Assets Liabilities Equity Revenues Expenses Income NE NE NE NE NE NE (+/-) + NE + + NE + NE NE NE NE NE NE (+/-) + NE + + NE + NE NE + (+/-) NE NE NE NE NE NE (+/-) NE NE + NE NE NE NE NE NE (+/-) NE NE + NE NE NE NE NE NE
Under IFRS, Lai could have accounted for the bonds using the fair value through profit or loss model and the following transaction would change:
Statement of Financial Position Income Statement Shareholders’ Other Other Net Assets Liabilities Equity Revenues Expenses Income 10. + NE + + NE + (c)
Under ASPE, using the cost model to account for investment in associates is allowed if the fair value of the investment is not known. Under these circumstances, the following transactions would change:
Statement of Financial Position Income Statement Shareholders’ Other Other Assets Liabilities Equity Revenues Expenses Net Income 7. NE NE NE NE NE NE 8. + NE + + NE + LO 2,3,4 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-6A (a) Jan.
Mar.
No significant influence 1 Long-Term Investments ................................. 3,600,000 Cash ......................................................... 15
June 15
Sept. 15
Dec. 15
31
(b) Jan.
Mar.
Cash (200,000 x $.50) ................................... Dividend Revenue ....................................
100,000
Cash (200,000 x $.50) ................................... Dividend Revenue ...................................
100,000
Cash (200,000 x $.50) ................................... Dividend Revenue ....................................
100,000
Cash (200,000 x $.50) ................................... Dividend Revenue ....................................
100,000
100,000
100,000
100,000
100,000
Unrealized Loss on Long-Term Investments [$3,600,000 – (200,000 × $17)] ...................... Long-Term Investments ............................
200,000
Significant influence 1 Investment in Associates ............................... Cash .........................................................
3,600,000
15
June 15
Sept. 15
Dec. 15
31
Solutions Manual .
200,000
3,600,000
Cash (200,000 x $.50) ................................... Investment in Associates
100,000
Cash (200,000 x $.50) ................................... Investment in Associates ..........................
100,000
Cash (200,000 × $0.50) ................................. Investment in Associates ..........................
100,000
Cash (200,000 x $.50) ................................... Investment in Associates ..........................
100,000
Investment in Associates ............................... Revenue from Investment in Associates ($2,200,000 × 25%) ...............................
550,000
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3,600,000
100,000
100,000
100,000
100,000
550,000
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-6A (CONTINUED) (c)
Several factors should be examined to determine whether one company can exercise significant influence over another. Although an ownership interest of 20% or more implies significant influence, this is just a rule of thumb. Other factors should be taken into consideration. One factor would be the presence of a member of the investor’s management on the investee’s board of directors. A second factor to be considered would be whether or not the investor influences the investee’s policy-making process. Third, the presence of material transactions between the investor and investee might indicate significant influence. Fourth, there is an exchange of managerial personnel. Fifth, the investor is providing key technical information to the investee. Another consideration is the distribution of the investee’s common shares. That is, are the investee’s shares widely held or owned by relatively few shareholders? If someone owns 20% of the outstanding shares and none of the shareholders holding the other 80% owns more than 1% of the shares, there is probably significant influence, but if there is only one other shareholder who owns 80%, there may not be significant influence.
(d)
Cost model
Jan.
1
Mar.
15
June 15
Sept. 15
Dec. 15
Solutions Manual .
Long-Term Investments ....................................... 3,600,000 Cash ............................................................... Cash (200,000 x $.50) ......................................... Dividend Revenue ..........................................
100,000
Cash (200,000 x $.50) ......................................... Dividend Revenue ..........................................
100,000
Cash (200,000 x $.50) ......................................... Dividend Revenue ..........................................
100,000
Cash (200,000 x $.50) ......................................... Dividend Revenue ..........................................
100,000
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3,600,000
100,000
100,000
100,000
100,000
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-6A (CONTINUED) (e)
ASPE is a set of standards developed for use primarily by private companies. Private companies are more likely to invest in other private companies and the shares of such companies do not trade actively on public stock exchanges. It is therefore more common for private companies to have difficulty reporting investments at fair value because such values are not readily obtained. So, if fair value cannot be determined, ASPE allows the use of the cost method. Under ASPE, companies can choose to use the cost model rather than the equity method to account for investments subject to significant influence if the fair value of the shares is not known. Private companies often have few users of the financial statements and the information provided by the equity method may not be relevant.
(f) No Significant Influence Statement of Financial Position: Long-term investments: Purchase price Receipt of dividends ($100,000 × 4) Investee’s income Fair value adjustment Carrying amount Income Statement: Dividend revenue Income from associates Unrealized loss on longterm investments
Significant Influence
Cost Model
$3,600,000
$3,600,000
$3,600,000
0 0 (200,000) $3,400,000
(400,000) 550,000 0 $3,750,000
0 0 0 $3,600,000
$400,000
$0
$400,000
0
550,000
0
(200,000)
0
0
LO 2,3,4 BT: AN Difficulty: C Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-7A (a)
1.
2017 Oct.
3
2018 Sept. 30
30
(a)
Under situation 1, it is unlikely that significant influence has been achieved as the percentage of Hat’s total shares outstanding that is held by CT Inc. is too low at 12.5%. (25,000 ÷ 200,000 = 12.5% ownership)
Long-Term Investments .................................... 1,250,000 Cash (25,000 × $50) .................................... Cash ($0.25 × 25,000) ...................................... Dividend Revenue .......................................
6,250
Long-Term Investments .................................... Unrealized Gain on Long-Term Investments ([$53 – $50] × 25,000) ..........
75,000
1,250,000
6,250
75,000
2. Situation 1
Statement of Financial Position: Long-term investments: Beginning balance Purchase price Fair value adjustment Carrying amount end of year Income Statement: Dividend revenue Unrealized gain on long-term investments
Solutions Manual .
12-40
$ 0 1,250,000 75,000 $1,325,000 $ 6,250 75,000
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-7A (CONTINUED) (b)
1.
2017 Oct.
3
2018 Sept. 30
30
(b)
Under situation 2, it is likely that significant influence has been achieved as the percentage of Hat’s total shares outstanding that is held by CT Inc. is 35%. (70,000 ÷ 200,000 = 35% ownership)
Investment in Associates .................................. 3,500,000 Cash (70,000 × $50) .................................... Cash ($0.25 × 70,000) ...................................... Investment in Associates .............................
17,500
Investment in Associates .................................. Income from Associates ($575,000 × 35%) ........................................
201,250
3,500,000
17,500
201,250
2. Situation 2
Statement of Financial Position: Investments in Associates: Beginning balance Purchase price Receipt of dividends Investee’s income Carrying amount end of year Income Statement: Dividend revenue Income from associates Unrealized gain on long-term investments
(c)
$ 0 3,500,000 (17,500) 201,250 $3,683,750 $ 0 201,250 0
Under IFRS, CT Inc. has no option but to account for its investment in Hat using the equity method when significant influence has been achieved. On the other hand, under ASPE, CT Inc. has options. If the fair value of the shares of the investee is known, CT Inc. can account for the investment using the equity method or fair value through profit or loss. If fair value is not known, CT Inc. can choose the equity method or the cost model.
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-7A (CONTINUED) (d)
In Situation 3, under IFRS, consolidated financial statements are required for financial reporting purposes because CT Inc. owns 100% of Hat. Under IFRS, CT Inc. has no option but to prepare consolidated financial statements. Under ASPE, CT Inc. can choose not to consolidate its subsidiary and instead use the equity method or the cost model unless the fair value of Hat’s shares is available, in which case the fair value through profit or loss method or equity method would be used.
(e)
Consolidated financial statements show the combined assets and liabilities of both the parent and subsidiary companies. In order to avoid duplication, the investment account is eliminated. The (parent) investor’s name: CT Inc. will appear on the consolidated financial statements.
(f)
For situation 1, because the fair value of the Hat shares is unknown, CT Inc. would only be able to use the cost model. For situation 2, CT Inc. can choose the equity method or the cost model. Under situation 3, CT Inc. can choose not to consolidate its subsidiary and instead use the equity method or the cost model.
LO 2,3,4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-8A (a)
Kang purchased 30,000 shares [($1,320,000 – $120,000) ÷ $40]
(b)
Kang owns 25% (30,000 ÷ 120,000) of Sandhu shares.
(c)
The cash dividend per share was $3.00 ($90,000 ÷ 30,000 shares)
(d)
The fair value per share was $44 ($1,320,000 ÷ 30,000)
(e)
Because Kang can exercise significant influence over Sandhu Travel Agency, the equity method will be used to account for the long-term investment. Accordingly, the investment account will be increased for the acquisition of shares and for Kang‘s share of Sandhu’s income for the year that it held the investment in Sandhu. The investment account will be decreased when Sandhu pays dividends. Accordingly, the investment account contains the following: Investment in Sandhu Travel Agency (30,000 shares × $40) Less: cash dividends received Plus: 25% of Sandhu Travel Agency’s income for the year that the investment was owned - derived ($1,400,000 – $1,110,000) Balance of investment, December 31, 2018
$1,200,000 (90,000) 1,110,000
290,000 $1,400,000
If $290,000 is 25% of Sandhu’s income for the year, then Sandhu Travel Agency must have earned $1,160,000 throughout the year ($290,000 ÷ 25%). (f)
Under the equity method, Kang would report its share of Sandhu Travel Agency’s income as follows: KANG INC. Income Statement (Partial) Year Ended December 31, 2018 Other revenues and expenses Income from associates ...................................................
Solutions Manual .
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$290,000
Chapter 12
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Financial Accounting, Seventh Canadian Edition
PROBLEM 12-8A (CONTINUED) (g)
Under the cost model, Kang would report only the dividends received as revenues as follows: KANG INC. Income Statement (Partial) Year Ended December 31, 2018 Other revenues and expenses Dividend revenue................................................................
$90,000
LO 2,3,4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-9A (a) Held for Trading Investments $50,000 (3,500)
Balance, beginning of year Unrealized loss Dividends earned and received Share of income Carrying amount of investments sold Balance, end of year
Investments in Associates $250,000
Long-Term Investments (at cost) $30,000
(6,000)*
(7,000) 22,000 ______
(8,300)**
$40,500
$265,000
$21,700
Held for Trading Investments
Investments in Associates $22,000
Long-Term Investments (at cost)
*(Proceeds $10,000 - gain $4,000) ** (Proceeds $6,300 + loss $2,000)
(b) Income statement
Income from associates Interest revenue Dividend revenue Realized gain on held for trading investments Realized loss on long-term investments Unrealized loss on held for trading investments
$1,200 1,000 4,000 (3,500) $2,700
$ 800
_______ $22,000
(2,000) _______ $(1,200)
LO 2,3,4 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 12-10A (a) Jan.
(b)
1
Long-Term Investments .................................... Cash ............................................................
1,515,397
Bond Amortization Schedule
Semi-Annual Interest Period
(c) July
1,515,397
Interest Received 1.5%
Interest Revenue 2%
Discount Amortization
Amortized Cost
Jan. 1
2018
July 1
2018
$24,000
$30,308
$6,308
1,521,705
Jan. 1
2019
24,000
30,434
6,434
1,528,139
July 1
2019
24,000
30,563
6,563
1,534,702
Jan. 1
2020
24,000
30,694
6,694
1,541,396
July 1
2020
24,000
30,828
6,828
1,548,224
Jan. 1
2021
24,000
30,964
6,964
1,555,188
July 1
2021
24,000
31,104
7,104
1,562,292
Jan. 1
2022
24,000
31,246
7,246
1,569,538
July 1
2022
24,000
31,391
7,391
1,576,929
Jan. 1
2023
24,000
31,539
7,539
1,584,468
July 1
2023
24,000
31,689
7,689
1,592,157
Jan. 1
2024
24,000
31,843
7,843
1,600,000
1
(d) Sept. 30
Solutions Manual .
$1,515,397
Cash ................................................................. Long-Term Investments .................................... Interest Revenue ........................................
24,000 6,308
Interest Receivable ($24,000 × 3/6) .................. Long-Term Investments .................................... Interest Revenue ($30,434 × 3/6) ...............
12,000 3,217
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30,308
15,217
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 12-10A (CONTINUED) (e) JACKSON CORP. Statement of Financial Position (Partial) September 30, 2018 Current assets Interest receivable .................................................
$ 12,000
Long-term investments ................................................... 1,524,922 ($1,515,397 + $6,308 + $3,217) (f) 2024 Jan. 1
Cash .................................................................. 1,600,000 Long-Term Investments ...............................
1,600,000
Note that interest would also be received on January 1, 2018. LO 5 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 12-11A (a)
Feb.
Aug.
(b)
Feb.
Aug.
(c)
Feb.
Aug.
(d)
1 Long-Term Investments ............................... 2,880,000 Cash ($3,000,000 × 96%)....................... 1 Cash ($3,000,000 × 4% × 6/12) ................... Long-Term Investments ............................... Interest Revenue ($2,880,000 × 4.9% × 6/12) ....................
60,000 10,560 70,560
1 Held for Trading Investments ....................... 2,880,000 Cash ($3,000,000 × 96%) ...................... 1 Cash ($3,000,000 × 4% × 6/12) ................... Interest Revenue ....................................
2,880,000
60,000 60,000
1 Cash ............................................................ 9,600,000 Bonds Payable ...................................... ($10,000,000 × 96%)
1 Interest Expense ($9,600,000 × 4.9% × 6/12) ......................... Bonds Payable ....................................... Cash ($10,000,000 × 4% × 6/12) ...........
2,880,000
9,600,000
235,200 35,200 200,000
When the bonds are purchased with the intention of holding them to maturity, the recording of the bonds for the investor and investee are mirror images. The bonds have the same proportionate carrying amount. This is not the case if the bonds were purchased by Otutye on the open market. The purchase price would reflect a different effective rate than the rate that existed at issuance of the bond and would be different than the selling price obtained by UHL when the bond was issued. There are also differences in accounting for the investor and investee when the bonds are purchased for trading purposes. Any premium or discount is not amortized by the investor even though the company issuing the bonds would continue to amortize any discount or premium. If the bonds are held at year-end, their carrying amount would be adjusted to fair value on the investor’s books while the issuer would carry the liability at amortized cost. If Otutye had sold its bonds on the open market, the issuer, UHL, would not have been affected by this transaction because it took place between Otutye and another company.
LO 5 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-1B (a)
Jan.
July
1
1
2
Dec. 31
31
Held for Trading Investments ............................... 192,000 Cash ($200,000 × .96) ................................. Cash ($200,000 × 3% × 6/12) .............................. Interest Revenue .........................................
192,000
3,000 3,000
Cash ($50,000 x .99) ........................................... 49,500 Held for Trading Investments ($50,000 *.96) Realized Gain on Held for Trading Investments
48,000 1,500
Interest Receivable ($150,000 × 3% × 6/12) ........ Interest Revenue .........................................
2,250
2,250
Held for Trading Investments ([$150,000 × 1.01] – $144,000*) .......................... 7,500 Unrealized Gain on Held for Trading Investments *$192,000 – $48,000 = $144,000 $150,000 x .96 = $144,000
7,500
(b) LIU CORPORATION Statement of Financial Position (Partial) December 31, 2018 Current assets Interest receivable ............................................................ Held for trading investments ............................................ (c)
$ 2,250 151,500
LIU CORPORATION Income Statement (Partial) Year Ended December 31, 2018 Other revenues and expenses Interest revenue ($3,000 + $2,250) ................................... Realized gain on held for trading investments ................... Unrealized gain on held for trading investments ................
$5,250 1,500 7,500 14,250
LO 2,4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-2B (a)
Feb. 1
Mar. 1
Apr.
July
1
1
Aug. 1
Sept. 1
Oct.
1
1
Dec. 31
Held for Trading Investments ................................... Cash ................................................................
30,000
Held for Trading Investments ................................... Cash ................................................................
29,000
Held for Trading Investments ................................... Cash ...............................................................
90,000
Cash ($2 × 1,000) .................................................... Dividend Revenue............................................
2,000
Cash (350 × $33) ..................................................... Realized Gain on Held for Trading Investments Held for Trading Investments [($30,000 1,000) × 350]................................
11,550
Cash ($1.50 × 500) .................................................. Dividend Revenue............................................
750
Cash ($90,000 × 6% × 6/12) .................................... Interest Revenue .............................................
2,700
Cash ........................................................................ Realized Loss on Held for Trading Investments ....... Held for Trading Investments ...........................
86,000 4,000
Held for Trading Investments ................................... Unrealized Gain on Held for Trading Investments ($49,200 – $48,500) .........................................
700
Security IBF Common RST Common
Cost $19,500* 29,000 $48,500
Fair Value $18,200 31,000 $49,200
30,000
29,000
90,000
2,000
1,050 10,500
750
2,700
90,000
700
(650 × $28) (500 × $62)
*$30,000 – $10,500 = $19,500
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
PROBLEM 12-2B (CONTINUED) (b)
CHEQUE MART LTD. Statement of Financial Position (Partial) December 31, 2018 Current assets Held for trading investments..........................................
(c)
$49,200
CHEQUE MART LTD. Income Statement (Partial) Year Ended December 31, 2018 Other revenues and expenses Dividend revenue ($2,000 + $750) ................................. Interest revenue ............................................................. Realized gain on held for trading investments ................ Unrealized gain on held for trading investments ............. Realized loss on held for trading investments ................
$2,750 2,700 1,050 700 (4,000) 3,200
Note that it would not be wrong to combine realized gains and losses for a specific category of investments for presentation purposes. LO 2,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
PROBLEM 12-3B (a) Mar.
1
June
1
Sept.
1
Oct.
Dec.
1
31
Security RST Common DEF Common
Cash ......................................................................... Realized Gain on Held for Trading Investments Held for Trading Investments ...........................
22,100
Held for Trading Investments ................................... Cash ................................................................
18,000
Cash ($1.50 × 500) .................................................. Dividend Revenue............................................
750
Cash ........................................................................ Realized Loss on Held for Trading Investments ....... Held for Trading Investments ........................... (250 × $62)
14,250 1,250
3,900 18,200
18,000
750
15,500
Held for Trading Investments ................................... 4,500 Unrealized Gain on Held for Trading Investments (See below: $38,000 – $33,500) Carrying Amount $15,500* 18,000 $33,500
Fair Value $14,000 24,000 $38,000
4,500
(250 × $56) (2,000 × $12)
*$31,000 – $15,500 = $15,500 which is the same as 250 × $62
(b)
CHEQUE MART LTD. Statement of Financial Position (Partial) December 31, 2019 Current assets Held for trading investments..........................................
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$38,000
Chapter 12
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Financial Accounting, Seventh Canadian Edition
PROBLEM 12-3B (CONTINUED) (c)
CHEQUE MART LTD. Income Statement (Partial) Year Ended December 31, 2019 Other revenues and expenses Unrealized gain on held for trading investments .............................. Realized gain on held for trading investments ................................. Dividend revenue .......................................................................... Realized loss on held for trading investments .................................
$4,500 3,900 750 (1,250) 7,900
Note that it would not be wrong to combine realized gains and losses for a specific category of investments for presentation purposes. LO 2,4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
PROBLEM 12-4B (a) Security
Quantity
Cost
9,400 5,000 600
$ 100,4001 36,0002 60,0003 $ 196,400
Ajax Ltd. shares Beta Corp. shares Citrus Inc. bonds 1
(3,000 × $12) + (2,400 × $11) + (2,000 × $9) + (2,000 × $10) = $100,400 2 (4,000 × $7) + (1,000 × $8) = $36,000 3 (600 × $100) = $60,000 Security
Quantity
Fair Value
9,400 5,000 600
$
Ajax Ltd. shares Beta Corp. shares Citrus Inc. bonds
56,4001 45,0002 64,2003 $ 165,600
1
9,400 × $6 = $56,400 5,000 × $9 = $45,000 3 600 × $100 × 1.07 = $64,200 2
(b)
1.
If Sturge’s entire portfolio is comprised of held for trading investments, they would be carried at their fair value of $165,600.
2.
An unrealized loss of $30,800 ($196,400 – $165,600) would be reported under other revenues and expenses on the company’s income statement.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 12-4B (CONTINUED) (c)
1.
If Sturge’s intends to hold the Citrus bonds to maturity, this portion of the portfolio should be reported at amortized cost on the statement of financial position. The premium or discount would be amortized and the carrying amount of the bonds would be adjusted. If the bonds were purchased at par, they would be carried at their cost of $60,000. The portfolio of debt securities would be classified as a long-term investment.
2.
No unrealized gains or losses would be recognized for the Citrus bonds on the income statement. Only on the equity portion of the investment would an unrealized loss be recorded at $35,000 [($100,400 + $36,000) – ($56,400 + $45,000)] under other revenues and expenses on the income statement. The equity securities would be carried at fair value of $101,400 ($165,600 – $64,200) or ($56,400 + $45,000) and would be classified as a current investment.
(d)
If Sturge cannot obtain fair value information relating to the securities in its portfolio, the portfolio should be reported at cost on the statement of financial position. No unrealized gains or losses would be recognized on the income statement.
LO 2,4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
PROBLEM 12-5B (a)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. (b)
Statement of Financial Position Income Statement Shareholders’ Other Other Net Assets Liabilities Equity Revenues Expenses Income NE NE NE NE NE NE (+/-) + NE + + NE + NE NE NE NE NE NE (+/-) + NE + + NE + + NE + + NE + (+/-) NE NE NE NE NE NE (+/-) + NE + + NE + NE NE NE NE NE NE (+/-) + NE + + NE + NE NE NE NE NE NE Under IFRS, Olsztyn could have accounted for the bonds using the fair value through profit or loss model and the following transaction would change:
Statement of Financial Position Income Statement Shareholders’ Other Other Net Assets Liabilities Equity Revenues Expenses Income 10. NE NE + (c)
Under ASPE, using the cost model to account for the investment in associates is an allowed alternative if the fair value of the investment is not known. Under these circumstances, the following transactions would change: Statement of Financial Position Income Statement Shareholders’ Other Other Net Assets Liabilities Equity Revenues Expenses Income 7. NE NE NE NE NE NE 8. + NE + + NE +
LO 2,3,4 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-6B (a)
No significant influence Jan. 1 Long-Term Investments ................................. Cash ...................................................... June
Dec.
30
31
31
(b)
Dec.
30
31
31
Solutions Manual .
6,000,000
Cash (200,000 × $0.50) ................................. Dividend Revenue .................................
100,000
Cash (100,000 × $0.50) ................................. Dividend Revenue .................................
100,000
Long-Term Investments ($31 × 200,000) – $6,000,000 ........................ Unrealized Gain on Long-Term Investments .......................................
Significant influence Jan. 1 Investment in Associates ............................... Cash ...................................................... June
6,000,000
100,000
100,000
200,000 200,000
6,000,000 6,000,000
Cash (200,000 × $0.50) ................................. Investment in Associates .......................
100,000
Cash (100,000 × $0.50) ................................. Investment in Associates .......................
100,000
Investment in Associates ............................... Income from Associates ($3,360,000 × 20%) ...............................
672,000
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100,000
100,000
672,000
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-6B (CONTINUED) (c)
Several factors should be examined to determine whether one company can exercise significant influence over another. Although an ownership interest of 20% or more implies significant influence, this is just a rule of thumb. Other factors should be taken into consideration. One factor would be the presence of a member of the investor’s management on the investee’s board of directors. A second factor to be considered would be whether or not the investor influences the investee’s policy-making process. Third, the presence of material transactions between the investor and investee might indicate significant influence. Fourth, there is an exchange of managerial personnel. Fifth, the investor is providing key technical information to the investee. Another consideration is the distribution of the investee’s common shares. That is, are the investee’s shares widely held or owned by relatively few shareholders? If someone owns 20% of the outstanding shares and none of the shareholders holding the other 80% owns more than 1% of the shares, there is probably significant influence, but if there is only one other shareholder who owns 80%, there may not be significant influence.
(d)
Cost model Jan.
June
Dec.
(e)
1
30
31
Long-Term Investments ................................. Cash ......................................................
6,000,000
Cash (200,000 × $0.50) ................................. Dividend Revenue .................................
100,000
Cash (200,000 × $0.50) ................................. Dividend Revenue .................................
100,000
6,000,000
100,000
100,000
ASPE is a set of standards developed for use primarily by private companies. Private companies are more likely to invest in other private companies and the shares of such companies do not trade actively on public stock exchanges. It is therefore more common for private companies to have difficulty reporting investments at fair value because such values are not readily obtained. So if fair value cannot be determined, ASPE allows the use of the cost method. Under ASPE, companies can choose to use the cost model rather than the equity method to account for investments subject to significant influence if the fair value of the shares is not known. Private companies often have few users of the financial statements, and the information provided by the equity method may not be relevant.
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-6B (CONTINUED) (f)
Statement of Financial Position: Long-term investments: Purchase price Receipt of dividends ($100,000 × 2) Investee’s income Fair value adjustment Carrying amount Income Statement: Dividend revenue Income from associates Unrealized gain on longterm investments
No Significant Influence
Significant Influence
Cost Model
$6,000,000
$6,000,000
$6,000,000
0 0 200,000 $6,200,000
(200,000) 672,000 0 $6,472,000
0 0 0 $6,000,000
$200,000
$0
$200,000
0
672,000
0
200,000
0
0
LO 2,3,4 BT: AN Difficulty: C Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-59
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-7B (a)
1.
2018 Jan.
Dec.
(a)
Under situation 1, it is unlikely that significant influence has been achieved as the percentage of Sub’s total shares outstanding that is held by Partridge is too low at 12%. (60,000 ÷ 500,000 = 12% ownership)
2 Long-Term Investments ............................... Cash (60,000 × $10) ...........................
600,000
31 Cash (60,000 × $0.50) ................................. Dividend Revenue ..............................
30,000
31 Long-Term Investments ............................... Unrealized Gain on Long-Term Investments ($12 – $10) × 60,000
120,000
600,000
30,000
120,000
2. Situation 1
Statement of Financial Position: Long-term investments: Beginning balance Purchase price Fair value adjustment Carrying amount end of year Income Statement: Dividend revenue Unrealized gain on long-term investments
Solutions Manual .
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$ 0 600,000 120,000 $720,000 $ 30,000 120,000
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-7B (CONTINUED) (b)
1.
2018 Jan.
Dec.
(b)
Under situation 2, it is likely that significant influence has been achieved as the percentage of Sub’s total shares outstanding that is held by Partridge is 25%. (125,000 ÷ 500,000 = 25% ownership)
2 Investment in Associates ............................. 1,250,000 Cash (125,000 × $10) ....................... 31 Cash (125,000 × $0.50) ............................... Investment in Associates ..................
62,500
31 Investment in Associates ............................. Income from Associates ($350,000 × 25%) ......
87,500
1,250,000
62,500
87,500
2. Situation 2
Statement of Financial Position: Investments in Associates: Beginning balance Purchase price Receipt of dividends Investee’s income Carrying amount end of year Income Statement: Dividend revenue Income from associates Unrealized gain on long-term investments
(c)
$ 0 1,250,000 (62,500) 87,500 $1,275,000 $ 0 87,500 0
Under IFRS, Partridge has no option but to account for its investment in Sub using the equity method when significant influence has been achieved. On the other hand, under ASPE, Partridge has options. If fair value of the shares of the investee is known, Partridge can account for the investment using either the equity method or fair value through profit or loss. If fair value is not known, Partridge can choose the equity method or the cost model.
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-7B (CONTINUED) (d)
In Situation 3, under IFRS, consolidated financial statements are required for financial reporting purposes because Partridge owns 100% of Sub. Under IFRS, Partridge has no option but to prepare consolidated financial statements. Under ASPE, Partridge can choose not to consolidate its subsidiary and instead use the equity method or the cost model unless the fair value of Sub’s shares is available, in which case the fair value through profit or loss method or equity method would be used.
(e)
Consolidated financial statements show the combined assets and liabilities of both the parent and subsidiary companies. In order to avoid duplication, the investment account is eliminated. The (parent) investor’s name (Partridge Inc.) will appear on the consolidated financial statements.
(f)
For situation 1, because the fair value of the Sub shares is unknown, Partridge would only be able to use the cost model. For situation 2, Partridge can choose the equity method or the cost model. Under situation 3, Partridge can choose not to consolidate its subsidiary and instead use the equity method or the cost model.
LO 2,3,4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-8B (a)
Hadley’s accountant used the equity method to account for the investment which resulted in Hadley recognizing 20% of Letourneau’s income as revenue ($200,000 ÷ $1,000,000). Therefore, Hadley Inc. must own 20% of the common shares of Letourneau Cycles Corp.
(b)
Hadley would have received 20% of any dividends declared by Letourneau, or $40,000 ($200,000 × 20%).
(c)
Hadley purchased 80,000 common shares of Letourneau Cycles Corp. This amount could be calculated as follows: Balance in long-term investment account, Dec. 31 Less: Hadley’s share of Letourneau’s income Add: Hadley’s share of Letourneau’s dividends 1 Investment account (at cost)
$960,000 (200,000) 40,000 $800,000*
*Since the cost of the investment was $800,000 and the issue price of Letourneau’s shares was $10 per share, it follows that 80,000 shares were purchased. 1
(d)
Part (b) above
Among the questions that should be considered in determining an investor’s influence are whether:
the investor has representation on the investee’s board of directors the investor participates in the investee’s policy-making process there are material transactions between the investor and the investee the investor and investee are exchanging managerial personnel the investor is providing key technical information to the investee
In addition, we should also consider whether the common shares held by other shareholders are concentrated or dispersed. Companies are required to use judgement in determining if significant influence exists instead of blindly following the guideline of 20% or greater ownership.
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-8B (CONTINUED) (e)
If significant influence does not exist, Hadley should use the fair value method to account for the investment in Letourneau Cycles Corp. Under the fair value method, Hadley would report the investment in Letourneau Cycles Corp. as follows: HADLEY INC. Statement of Financial Position (Partial) December 31, 2018 Investments Long-term investments ..............................................
$950,000
HADLEY INC. Income Statement (Partial) Year Ended December 31, 2018 Other revenue Dividend revenue ....................................................... Unrealized gain on long-term investments ................. ($950,000 – $800,000)
(f)
$ 40,000 150,000
Under the cost model, Hadley would report the investment at cost of $800,000 on the statement of financial position and only the dividends received of $40,000 as Other revenue on the income statement.
LO 2,3,4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
12-64
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 12-9B (a) Held for Trading Investments $100,000 (8,200)
Balance, beginning of year Unrealized loss Dividends earned and received Share of income Carrying amount of investments sold Balance, end of year
(12,000)* $79,800
Investments in Associates $500,000
Long-Term Investments (at cost) $60,000
(15,000) 37,000 _______ $522,000
(17,600)** $42,400
*(Proceeds $21,000 - gain $9,000) ** (Proceeds $12,600 + loss $5,000)
(b) Income statement Held for Trading Investments Income from associates Interest revenue Dividend revenue Realized gain on held for trading investments Realized loss on long-term investments Unrealized loss on held for trading investments
Investments in Associates $37,000
$2,800 3,000 9,000 (8,200) $6,600
Long-Term Investments (at cost)
$1,200
_______ $37,000
(5,000) _______ $(3,800)
LO 2,3,4 BT: AN Difficulty: C Time: 30 min. AACSB: Analytic CPAL cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 12-10B (a) Jan.
(b)
1
Long-Term Investments .................................... Cash ............................................................
850,916
Bond Amortization Schedule
Semi-Annual Interest Period
(c) July
850,916
Interest Received 1%
Interest Revenue 1.5%
Discount Amortization
Amortized Cost
Jan. 1
2018
July 1
2018
$9,000
$12,764
$3,764
854,680
Jan. 1
2019
9,000
12,820
3,820
858,500
July 1
2019
9,000
12,878
3,878
862,378
Jan. 1
2020
9,000
12,936
3,936
866,314
July 1
2020
9,000
12,995
3,995
870,309
Jan. 1
2021
9,000
13,055
4,055
874,364
July 1
2021
9,000
13,115
4,115
878,479
Jan. 1
2022
9,000
13,177
4,177
882,656
July 1
2022
9,000
13,240
4,240
886,896
Jan. 1
2023
9,000
13,303
4,303
891,199
July 1
2023
9,000
13,368
4,368
895,567
Jan. 1
2024
9,000
13,433
4,433
900,000
1
(d) Oct. 31
Solutions Manual .
$850,916
Cash ................................................................. Long-Term Investments .................................... Interest Revenue ........................................
9,000 3,764
Interest Receivable ($9,000 × 4/6) .................... Long-Term Investments ($3,820 × 4/6) ............. Interest Revenue ($12,820 × 4/6) ................
6,000 2,547
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12,764
8,547
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 12-10B (CONTINUED) (e) MORRISETTE INC. Statement of Financial Position (Partial) October 31, 2018 Current assets Interest receivable ............................................................ $ 6,000
Long-term investments ............................................................ 857,227 ($850,916 + $3,764+ $2,547) (f) 2024 Jan. 1
Cash .................................................................. Long-Term Investments ...............................
900,000 900,000
Note that interest would also be received on January 1, 2024. LO 5 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 12-11B (a)
Densmore Consulting — Held for Trading Jan. 1 Held for Trading Investments ....................... Cash ($200,000 × 1.02) .......................... June
July
(b)
1
Cash ($200,000 × 4% × 6/12) ...................... Interest Revenue ...................................
July
30
1
CASB Jan. 1
June
Dec.
Solutions Manual .
30
31
204,000 4,000 4,000
Cash ($200,000 × 1.03) ............................... 206,000 Realized Gain on Held for Trading Investments Held for Trading Investments .................
Densmore Consulting — Hold to Maturity Jan. 1 Long-Term Investments ............................... Cash....................................................... June
(c)
30
204,000
204,000 204,000
Cash ($200,000 × 4% × 6/12) ...................... Long-Term Investments.......................... Interest Revenue .................................... ($204,000 × 3.5% × 6/12)
4,000
Cash ($200,000 × 1.03) ............................... Long-Term Investments ($204,000 – $430) ................................. Realized Gain on Long-Term Investments
206,000
Cash ($1,000,000 × 1.02) ............................ Bonds Payable .......................................
1,020,000
430 3,570
203,570 2,430
1,020,000
Interest Expense ($1,020,000 × 3.5% × 6/12) ......................... Bonds Payable ............................................. Cash ($1,000,000 × 4% × 6/12) .............
17,850 2,150
Interest Expense .......................................... ([$1,020,000 – $2,150] × 3.5% × 6/12) ... Bonds Payable ............................................. Cash ($1,000,000 × 4% × 6/12) .............
17,812 2,188
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2,000 204,000
20,000
20,000
Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 12-11B (CONTINUED) (d)
When the bonds are purchased with the intention of holding them to maturity, the recording of the bonds for the investor and investee are mirror images. The bonds have the same proportionate carrying amount. This would not be the case if the bonds were purchased by Densmore on the open market. The purchase price would reflect a different effective rate than the rate that existed at issuance of the bond and would be different than the selling price received by CASB when the bonds were issued. There are also differences in accounting for the investor and investee when the bonds are purchased for trading purposes. Any premium or discount is not amortized by the investor even though the company issuing the bonds would continue to amortize any discount or premium. If the bonds are held at year-end, their carrying amount would be adjusted to fair value on the investor’s books while the issuer would carry the liability at amortized cost. When Densmore sold its bonds on the open market, the issuer, CASB, was not affected by this transaction because it took place between Densmore and another company.
LO 5 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT12-1
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
North West does not have held for trading securities. According to note 10 titled Other Assets, North West has a 50% interest in a jointly controlled entity discussed in note 23 called Transport Nanuk Inc. This is a strategic investment in a company that supplies freight handling and shipping services.
(b)
The companies mentioned in note 23 are subsidiaries of North West. The balances in the investment accounts for these companies have been eliminated when the financial statements of these subsidiaries were consolidated along with their parent company. This is why the financial statement titles include the word “consolidated.”
LO 1,4 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT12-2 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
1.
North West has an investment in a jointly controlled entity as listed in note 23. North West owns 50% of the Canadian Arctic shipping company, Transport Nanuk Inc. The equity method is used to account for the 50% ownership of Transport Nanuk Inc., as discussed in note 3 (A) titled Basis of Consolidation.
2.
Sobeys has an investment in an associate (affiliate) ECL Developments Limited, a private company. The investment is accounted for using the cost method because the investment is in preferred shares whose fair value cannot be reliably measured as they are not publicly traded.
(b)
Any income earned from investments in subsidiaries is embedded within the specific revenue and expense accounts of the consolidated financial statements and is not shown on a separate line. North West would have investment income from an associate for its share of the net income of Transport Nanuk Inc. because it is using the equity method. In the case of Sobeys, dividend revenue from its investment in the preferred shares of ECL Developments Limited would be reported on the income statement. Because the income statements are condensed and appear in millions of dollars in the case of Sobeys and thousands of dollars in the case of North West, the amounts involved are likely very small and it was not relevant to list them separately on the respective income statements.
(c)
North West has other comprehensive income of $11,953,000, which exceeded that of Sobeys, which had $3,900,000. North West ended the year with a balance of $30,418,000 in Accumulated Other Comprehensive Income (AOCI). In the case of Sobeys, the balance was a loss of $3,200,000. Other Comprehensive Income is closed to Accumulated Other Comprehensive Income at the end of the year.
LO 1,2,3,4 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT12-3 (a)
1.
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
ARP’s investment in CPS is strategic, but ARP is not exercising significant influence even though it owns 20% of the outstanding voting shares. ARP does not have representation on CPS’s board of directors, and Adam and Robert have not been involved in any decisions related to CPS’s operations. Long-term investments that do not involve significant influence must be accounted for using the fair value method if the value of the shares trade in an active market. Under ASPE, if the investment was subject to significant influence, ARP would have the choice between two accounting methods, the equity method and the fair value model if the shares trade in an active market. If the shares did not trade in an active market, ASPE allows a choice of the equity method or the cost model. The cost model is therefore not an acceptable method under ASPE for this investment because the shares do trade actively.
2.
Recording the investment using the cost model means that the carrying amount of the investment remains at its original cost of $100,000. Revenues are derived from dividends received from CPS. Since no dividends were received during the year, no revenue has been reported on ARP’s income statement. The cost model does not record unrealized gains or losses from fair value adjustments at year end. Had ARP applied the fair value method, the income statement would report an unrealized loss of $10,000 ([fair value of $4.50/ share × 20,000 shares] – cost of $100,000). If ARP had applied the equity method, the income statement would report a loss from its associate of $6,000 (20% × loss of $30,000). This loss would reduce income. Robert would prefer the cost model to keep income higher by $10,000 for 2018 because the financial statements will be presented to the bank to obtain financing for expansion. The bank would likely find out about the unrecorded unrealized loss by inquiring about the status of the investment.
(b)
If ARP reported its financial results under IFRS, it would apply the fair value method and would be prohibited from using the cost method because the shares trade in an active market.
LO 3,4 BT: E Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 12
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
CT12-4 (a)
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
The three investments held by Bering Limited fall into three categories: 1. Debt investment with the intention to be held to maturity — for the Government of Alberta bonds. 2. Non-strategic held for trading investments purchased with the expectation of active trading of the security — for the Atlas Inc. common shares. 3. Strategic investment in an associate where Bering exercises significant influence over the investee — for the CH Resources Inc. common shares. Because each investment has a different purpose and management has a different intention in holding the investment, IFRS provides some alternatives in how to account for each of the three investments. Debt securities such as the Government of Alberta bonds will normally be accounted for using the amortized cost model. The option exists under IFRS to account for the bonds using fair value through profit or loss. Since the board of directors wishes to choose the model that will maximize Bering’s financial position and profitability, the amortized cost model is chosen because the bonds’ fair value at December 31, 2018 falls below the amortized cost. Using the amortized cost model will avoid recording an unrealized loss on long-term investments in the amount of $10,000. Non-strategic held for trading investments must be reported at their fair value. A choice is available under IFRS to report any unrealized gains or losses in the income statement or in other comprehensive income in the statement of comprehensive income. The fair value though profit or loss is recommended because the board of directors wishes to choose the model that will maximize Bering’s financial position and profitability. An unrealized gain on the held for trading investments in the amount of $5,000 is therefore recognized as other revenue on the income statement.
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
CT12-4 (CONTINUED) (a) (continued) The investment in the CH Resources Ltd. is a strategic investment in an associate and Bering under IFRS must account for the investment using the equity method because it holds 40% of the common shares and exercises significant influence over CH Resources. Bering will recognize revenue from investment in associates and an increase in its investment in this associate in the amount of its share of the net income reported by CH Resources for the fiscal year of $4,000 (40% × $10,000). The investment in associates account will be reduced by the amount dividends received from CH Resources during the year in the amount of $800 (40% × $2,000) and cash will be increased. Consequently, the balance of the investment in associate account reported on the statement of financial position will be $103,200 ($100,000 + $4,000 – $800). If it can be demonstrated that Bering does not have significant influence over CH Resources, then the investment should be reported at fair value. An unrealized gain of $11,000 would be recorded on long-term investments on the income statement or an unrealized gain reported as other comprehensive income on the statement of comprehensive income if Bering elected to use this model. The dividend received in the amount of $800 would be reported as other revenue on the income statement. Since the board of directors wishes to choose the model that will maximize Bering’s financial position and profitability, they may argue that Bering does not have a significant influence position over CH Resources and would not elect to show unrealized gains and losses as other comprehensive income. The relationship between the investor and investee would need to be supported by evidence in order to use the fair value model for this investment. The recommendation is to account for CH Resources using the equity method.
Solutions Manual .
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Chapter 12
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Financial Accounting, Seventh Canadian Edition
CT12-4 (CONTINUED) (a) (continued) Based on the above, the financial statements will show the following: BERING LIMITED Statement of Financial Position (Partial) December 31, 2018 Current assets Held for trading investments......................................... Non-current assets Long-term investments ................................................. Investment in associates ..............................................
$105,000
100,000 103,200
BERING LIMITED Income Statement (Partial) Year Ended December 31, 2018 Other revenue Income from associates ................................................. Interest revenue ............................................................ Unrealized gain on held for trading investments ............
$4,000 3,000 5,000 12,000
The choices among the different models will not affect the statement of cash flows.
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Financial Accounting, Seventh Canadian Edition
CT12-4 (CONTINUED) (b)
Under ASPE, the accounting for the three investments would be done using the following models and methods: 1. Debt investment with the intention to be held to maturity — the Government of Alberta bonds will be accounted for using the amortized cost model. However, an option does exist as under IFRS to value this investment at fair value, but it must be fair value through profit or loss. This option would most likely not be taken as it would result in recording an unrealized loss. 2. Non-strategic held for trading investments purchased with the expectation of active trading of the security — the Atlas Inc. common shares will be reported using the fair value through profit or loss because the shares’ market value is available (as under IFRS), but Bering cannot report their investments using the fair value through the other comprehensive income model. 3. Strategic investment in an associate where Bering exercises significant influence over the investee — the CH Resources Ltd. common shares are accounted for using the equity method (as under IFRS). Bering also has the choice to account for this investment using the cost model if the shares had not been traded actively or fair value if the shares are traded actively and fair value can be obtained. Based on the information given, the financial statements would show the same amounts and classifications as was recommended in part (a) under IFRS.
LO 2,3,4 BT: E Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT12-5
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
(a)
Lemke’s position would show unrealized gains, dividend revenue, and interest revenue on the income statement, but would not report unrealized losses. Her position would mask unrealized losses by overstating the carrying amount of certain investments that had declined in value. Her approach does not reflect the nature of the investments as strategic or non-strategic. Her approach would also result in financial results that are not comparable because as investments fluctuate from increasing in value to decreasing in value, the model used would need to change. She understands the implications of using different models for financial statement presentation purposes, but she is not applying the models in the correct manner.
(b)
Greenwood’s position does not show any unrealized gains or losses, but reports revenue from associates where significant influence does not exist. Her position would also mask unrealized losses by overstating the carrying amount of certain investments that had declined in value. Her approach also does not reflect the nature of the investments as strategic or non-strategic. Her approach would also result in financial results that are not comparable, because as equity investments fluctuate from increasing in value to decreasing in value, the model used would need to change. She understands the implications of using different models for financial statement presentation purposes, but she is not applying the models in the correct manner.
(c)
By selling its held for trading investments that had risen in value just prior to year end, Kreiter Financial Services would report realized gains on its income statement. The held for trading investments that decline in value would be reported at fair value with the unrealized losses also reported on the income statement. When the declining investments are sold immediately after year end, a realized gain or loss is reported based on the difference between the selling price and the year-end carrying amount of the investment, which in this case would probably be insignificant as the sale occurs so soon after year end. Had Kreiter sold these investments just prior to year end, a realized loss equal to the reported unrealized loss would be reported on the company’s income statement. By properly classifying its trading portfolio, decisions as to the timing of selling these investments will not allow management to manipulate net income because investments are reported at fair value.
LO 2,3,4 BT: S Difficulty: M Time: 30 min. AACSB: Ethics and Communication CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT12-6 (a)
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
If Software Solutions succeeds in purchasing all of the shares of Anthony Business Company Ltd (ABC), Software Solutions would record the investment in its accounting records using the equity method. However, there would be a requirement to consolidate the ABC accounts into Software Solutions’ financial statements using consolidation techniques that would remove the investment account and replace it with the assets and liabilities of ABC. ABC would be a wholly owned subsidiary company and Software Solutions would be the parent company. The purchase of the shares would not necessarily require a change in ABC’s accounting records, but some parent companies do require their subsidiaries to make changes to their accounting policies or systems and processes to improve consistency with those used by the parent and facilitate consolidation of the financial statements. Another change that might be required is to make ABC’s fiscal year end match that of its parent.
(b)
If Compuhelp succeeds in purchasing Bev and Doug’s (50%) of the shares of ABC, but control is retained by Emily and Daniel, Compuhelp would account for the investment using the equity method. This reflects Compuhelp’s significant influence over the operations of ABC. The purchase of the shares would likely not require a change in ABC’s accounting records since the relationship between Compuhelp and ABC is one of significant influence and not control.
(c)
Offer from Software Solutions: The offer from Software Solutions may result in reduced hours of work for Emily and Daniel. This could be a significant advantage because of the work involved in running the business. In addition, the sale of the shares will provide them with a substantial amount of cash that if invested wisely, could yield benefits for many years. The transition of Emily and Daniel from shareholders to employees would also result in some disadvantages, such as loss of control. Software Solutions will exercise control over ABC’s operations and will not likely be willing to let Emily and Daniel participate in the decision-making process. Their employment contract is also limited to 2 years, leaving uncertainty about their relationship with Software Solutions at the end of the employment period. The nature of the income received would also change. Emily and Daniel currently receive a management salary plus dividends as shareholders of ABC. This income fluctuates based on the financial results of the company. As employees, the income that they receive will be more stable, but they will no longer participate in the net income of the business.
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Financial Accounting, Seventh Canadian Edition
CT12-6 (CONTINUED) (c) (continued) Offer from Compuhelp: The offer from Compuhelp will keep Emily and Daniel in control of the operations of ABC. It will also allow them to participate in their share of the net income of the business since they retain 50% ownership of the company. The company could also benefit from integration of services and opportunities through the relationship with Compuhelp, as well as taking advantage of the expertise of the Compuhelp management team. The offer would not result in reduced hours of work for Emily and Daniel, as they would be responsible for running the business. In addition, they would be subject to the significant influence of Compuhelp rather than dealing with Bev and Doug. They would also not receive a large cash payment for the sale of their shares as would Bev and Doug. Finally, if the business relationship with Compuhelp did not work out, it may be difficult to find another investor to purchase the shares held by Emily and Daniel. The comparative financial rewards to Bev and Doug are not stated in this case. LO 6 BT: C Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
CHAPTER 13 STATEMENT OF CASH FLOWS LEARNING OBJECTIVES 1. 2. 3. 4. 5.
Describe the content and format of the statement of cash flows. Prepare the operating activities section of a statement of cash flows using the indirect method. Prepare the investing and financing activities sections and complete the statement of cash flows. Use the statement of cash flows to evaluate a company. Prepare the operating activities section of a statement of cash flows using the direct method (Appendix 13A).
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Ite m
LO BT Item
LO
BT Item LO
1. 2. 3. 4. 5.
1 1 1 1 1
C C C C K
6. 7. 8. 9. 10.
1 1 2 2 2
K C C C K
1. 2. 3. 4.
1 1 1 2
K C C C
5. 6. 7. 8.
2 3 3 3
AP AN AP AN
9. 10. 11. 12.
1. 2. 3.
1 1 2
C C C
4. 5. 6.
2 2,3 2,3
AP C AN
7. 8. 9.
BT Item LO
BT Item LO BT
Questions 11. 12. 13. 14. 15.
2 2 3 3 3
C C C AP C
16. 17. 18. 19. 20.
4 4 4 4 5
C C C C C
21. 22.
5 5
C C
AP AN AN AP
13. 14. 15. 16.
5 5 5 5
AP AP AP AP
AP AN AN
10. 11. 12.
4 4 5
AN AN C
13. 14. 15.
5 5 3,5
AP AP AP
.
Brief Exercises 3 4 4 5
Exercises 2,3 2,3,4 2,3,4
Problems: Set A and B 1. 2. 3.
1 2 3,4
C AP AN
4. 5. 6.
3,4 2,3 2,3
AN AN AN
7. 8. 9.
1. 2.
1,4 1,4
AN AN
3. 4.
4 4
E AN
5. 6.
2,3 4 4
AN AN AN
10. 11. 12.
2,5 5 5
AN AN AN
C AN
7.
4
E
Cases
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Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
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Financial Accounting, Seventh Canadian Edition
ANSWERS TO QUESTIONS 1.
The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during a period, in a format that reconciles the beginning and ending cash balances. The statement of cash flows is useful to all readers because it allows them to assess the following aspects of a company’s financial position:
the reasons for the difference between net income and cash provided (used) by operating activities the cash generated by (used in) investing and financing transactions during a period the company’s ability to generate future cash flows
Creditors in particular are concerned about the borrower’s ability to generate cash to repay loans and service debt. The cash flow statement helps creditors assess risk. LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
2.
Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash. Generally, only debt investments with original maturities of three months or less qualify under this definition. Bank overdrafts that are repayable on demand are also included in (deducted from) cash equivalents. The statement of cash flows may be prepared using cash, or cash and cash equivalents as its base. If the latter, cash equivalents must be clearly defined.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
3.
Operating activities include the cash flow activities arising from a company’s principal revenue-producing activities and all other activities that are not investing or financing activities. Investing activities are those arising from the acquisition and disposal of non-current assets. Financing activities include those resulting in changes in the size and composition of the equity and borrowings of a company.
LO 1 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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4.
Financial Accounting, Seventh Canadian Edition
Companies following ASPE classify interest paid, interest revenue, and dividend revenue, as part of operating activities because they are disclosed on the income statement as part of net income. Dividend payments are classified as financing activities. This is the most common practice for both publicly traded and private companies. Companies following IFRS may classify interest and dividend revenue as either investing activities or operating activities, and interest and dividend payments as either financing activities or operating activities. Companies select where these payments and receipts will be presented and must apply the presentation consistently.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
5.
Examples of noncash transactions include the issue of shares or a mortgage to purchase property, plant, and equipment. In both cases, cash is not involved. Noncash transactions should be reported in the notes to the financial statements and crossreferenced to the statement of cash flows, but not reported as investing and financing activities in the body of the statement of cash flows.
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
6.
Although the approaches and format are different, both the direct and indirect methods will produce the same net cash provided by operating activities.
LO 1 BT: Difficulty: S Time: 2 min. AACSB: None CPA CM: Reporting
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7.
Financial Accounting, Seventh Canadian Edition
(a) and (b) (1) The adjusted trial balance is not required to prepare the statement of cash flows because it does not provide necessary data. (2)
A comparative statement of financial position is required to obtain the changes in individual asset, liability, and equity balances. Changes in the noncash working capital (current) accounts may affect the operating activities, changes in shortterm investment and long-lived asset accounts may affect the investing activities, and changes in non-current liability and equity accounts may affect the financing activities reported in the statement of cash flows.
(3)
The income statement is required to obtain the elements of operating activities, which will be converted from the accrual basis to the cash basis. The income statement is also required to identify noncash revenues and expenses such as depreciation and amortization expenses and accounting gains and losses.
(4)
The statement of comprehensive income is needed to reconcile certain fair-valued assets (e.g., revaluation of the fair value of land) and equity (e.g., accumulated other comprehensive income) accounts appearing in the statement of financial position. However, changes in comprehensive income do not affect cash and are not reported on the statement of cash flows.
(5)
The statement of changes in equity will provide details of the changes in the share capital and retained earnings accounts. From these, the cash effects of financing transactions with shareholders, such as the issue or reacquisition of shares and/or payment of dividends, can be determined and reported as financing activities on the statement of cash flows.
LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
8.
The indirect method involves converting accrual-based net income to net cash provided by operating activities. This is done by starting with accrual-based net income from the income statement and adding or subtracting noncash items included in net income. Examples of adjustments include adding back noncash expenses, such as depreciation, and removing any noncash gains or losses from net income. Then changes in the balances of noncash current asset and current liability accounts from one period to the next are added or subtracted.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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9.
Financial Accounting, Seventh Canadian Edition
A number of factors could have caused a positive amount of net cash provided by operating activities in spite of the fact that Clearwater reported a net loss. These include (1) a high amount of collections of unearned revenue; (2) large amounts of depreciation or amortization; and (3) accounting losses or impairments. These are non-cash items deducted in arriving at net income (in this case a net loss) so they are now added back to net loss when determining net cash flow provided by operating activities, thereby making it positive.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
10. Under the indirect method, depreciation and amortization expense is added back to net income to reconcile net income to net cash provided by operating activities because depreciation and amortization are expenses that have reduced net income, but do not result in the use of cash. Adding them back cancels the expenses reported in the income statement, as accrual net income is the starting point under the indirect method. Example: Income before depreciation Less: Depreciation expense (1,000) Income 4,000 Add: Depreciation expense 1,000 Cash provided by operating activities $5,000
$5,0
LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
11.
Under the indirect method, a gain on disposal of equipment is deducted from net income to reconcile net income to net cash provided by operating activities. A gain is the difference between the cash proceeds received when the asset is sold and the carrying amount of the asset. This gain is not a cash receipt or payment. Therefore, the noncash gain, which was included in net income, must be deducted from net income on the statement of cash flows to convert net income to net cash provided by operating activities. The total cash proceeds received when the asset is disposed of would be reported in the statement of cash flows as an investing activity.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
12.
When a business invests money, it does so outside of its main revenue-generating operations. It might have excess cash, which it wants to put to use in producing some interest or dividend revenue. Since the intention is to earn a return on its investment, the buying and selling of investments is generally reported as investing activities in the statement of cash flows. The exception occurs when the investments are held for trading purposes, in which case they are treated similarly to inventory acquired for resale. These types of investments are reported as operating activities.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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13.
Financial Accounting, Seventh Canadian Edition
The principal amount advanced by the bank and later repaid involves borrowing and repayment transactions that need to be reported under financing activities in the statement of cash flows. The timing of the loan principal repayments will lead to a portion of the loan principal being classified as current liabilities. This classification does not change the nature of the cash activity with the bank. Both the current and non-current principal portions are treated together for cash flow reporting purposes.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
14.
Dividends declared reduce retained earnings once the declaration is made by the board of directors. For the cash flow statement, only dividends paid are reported in the financing activities section of the statement. Similar to the adjustments made for the change in working capital account in the indirect format of the statement of cash flows, any increase or decrease in the Dividends Payable account will adjust dividends declared (accrual basis) to dividends paid (cash basis). For this example, the amount of the increase of $2,000 ($10,000 - $8,000) in dividends payable will be deducted from the amount of dividends declared of $40,000 to arrive at cash paid for dividends of $38,000.
LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
15.
The statement of cash flows is prepared from detailed information about the changes in account balances that occurred between two periods of time, as shown on the other financial statements. Unlike the other financial statements, it is not prepared from an adjusted trial balance. In particular, the information to prepare the statement of cash flows comes from a comparative statement of financial position, the income statement, the statement of changes in equity, and additional information concerning specific transactions such as disposals of property, plant, and equipment.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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16.
(a) (b)
Financial Accounting, Seventh Canadian Edition
The corporate life cycle consists of four phases: introductory, growth, maturity, and decline. In the introductory and growth phases, we don’t usually expect to see a company generate positive cash from its operating activities until part way through the growth phase. Because the company is making significant investments in its long-lived assets, cash will be used by investing activities. During the first two phases, cash generated by financing activities is usually positive as debt and equity are issued to pay for the investments and cover the operating activities shortfall. These patterns reverse in the maturity and decline phases of the cycle. In the decline phase, cash from operating activities decreases. Cash from investing activities is positive as the company sells off its excess assets, before starting to decline. Cash is used for financing activities as the company continues to pay off its debt.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
17.
A company that just commenced its operations would be expected to report low or negative cash flows from operating activities. Later, when the company is growing and healthy, the cash from operating activities will become positive. The company would also usually show cash used in investing activities as it invests in its productive capacity. At this stage, the company will also usually show cash inflows in financing activities to finance the purchase of productive assets not covered from operating activities.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
18.
Creditors may be concerned about the company’s ability to repay its obligations over the long-term. The lack of cash flows from operating activities may be of concern to investors for several reasons. First, the decrease in cash flows may have an adverse effect on the company’s share price. In addition, some investors may be concerned that the company will not generate enough cash to pay dividends in the future. This concern is supported by the declining free cash flow, which also indicates the company is generating less cash from operating activities to pay future dividends and to expand the business.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
19.
If net capital expenditures and dividends paid exceed cash provided by operating activities, then free cash flow will be negative.
LO 4 BT: C Difficulty: M Time: 2 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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*20.
Financial Accounting, Seventh Canadian Edition
Net cash provided by operating activities under the direct method is the difference between cash revenues and cash expenses. The direct method adjusts the accrual-based revenues and expenses directly to reflect the cash-based revenues and expenses, which combine to equal "net cash provided by operating activities."
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
*21.
Depreciation and amortization expenses are not listed in the operating activities section under the direct method because they are not cash flow items—they do not affect cash. Recall the journal entry to record depreciation: debit Depreciation Expense and credit Accumulated Depreciation. The entry to record amortization is similar. As you can see, there is no cash involved in this journal entry. This is different from the indirect method, which uses net income as its starting point and must add back depreciation and amortization as noncash items included in the determination of net income.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
*22.
The gain on disposal of equipment and the loss on the sale of land would not appear on the statement of cash flows prepared using the direct method because these are not cash flow items. However, the gross proceeds received when the assets are sold would be reported in the statement of cash flows, as investing activities.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Chapter 13
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 (a) (b) (c) (d) (e) (f)
– – NE + – +
(g) (h) (i) (j) (k)
NE – – NE ̶
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 13-2 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)
F O if reporting under ASPE but if reporting under IFRS a choice exists between showing this as an operating or financing activity NC – an exchange of land (investing activity) for shares (financing activity) that does not involve cash F O O Not a cash activity – a reduction of retained earnings and an increase in dividends payable F if reporting under ASPE but if reporting under IFRS a choice exists between showing this as a financing or operating activity O Not a cash activity – a cost allocation F
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 13-3 (a) 1. 2. 3. 4. 5. 6. (b)
F O I F F O Linamar uses the indirect method as indicated by the change in noncash operating working capital items and the depreciation expense.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 13-4 (a) + (b) – (c) + (d) + (e) N/A (f) – (g) – (h) + (i) N/A for ASPE, possibly – for IFRS (j) + (k) + unless designated as a cash equivalent in which case it does not appear LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 13-5 DUPIGNE CORPORATION Statement of Cash Flows (Partial)—Indirect Method Year Ended March 31, 2018 Operating activities Net income ................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense ........................................... Loss on disposal of land ....................................... Accounts receivable increase ............................... Inventory increase ................................................ Accounts payable decrease .................................. Net cash provided by operating activities ...............................
$275,000
$60,000 15,000 (20,000) (5,000) (5,000)
45,000 $320,000
[Adjustments to net income include depreciation (+); loss (+); increase in noncash current assets (–); and decrease in current liabilities (−)]. Dividends pertain to financing activities. LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 13-6 Original cost of equipment sold ........................................................... Less: Accumulated depreciation ......................................................... Carrying amount of equipment sold ..................................................... Less: Loss on disposal ....................................................................... Cash received from disposal of equipment ..........................................
$20,000 (5,500) 14,500 (1,500) $13,000
The following journal entry may be helpful in understanding this brief exercise: Cash ............................................................................ Accumulated Depreciation—Equipment ...................... Loss on Disposal ......................................................... Equipment .........................................................
13,000 5,500 1,500 20,000
(a)
Cash provided by disposal of equipment = $13,000
(b)
Investing activities for the proceeds; Operating activities for the loss as it is shown on the income statement.
LO 3 BT: AN Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 13-7 ($ in thousands) Investing activities Purchase of long-term investments ($150 – $100) ................ Disposal of equipment ........................................................... Purchase of equipment [$500 – ($400 – $100)] ..................... Net cash used by investing activities ..............................................
$ (50) 60 * (200) $(190)
Equipment 400 XXX 100 500 *Cost of equipment sold ......................................................... *Accumulated depreciation ($100 – carrying amount of $50) *Carrying amount ................................................................... *Gain on disposal................................................................... *Cash proceeds from disposal ...............................................
$100 50 50 10) $ 60)
LO 3 BT: AP Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 13-8 ($ in millions) Beginning balance, retained earnings ......................... Add: Net income .......................................................... Less: Ending balance, retained earnings ..................... Dividends paid .............................................................
$4,075.1 735.9 (4,172.0) $ 639.0
Retained Earnings 4,075.1 735.9 639.0 4,172.0 The answer would change if the Dividends Payable account increased during the year. In this case, the $639.0 decrease in Retained Earnings would be reduced by the increase in Dividends Payable to arrive at the amount of dividends paid. LO 3 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 13-9 ($ in thousands) Financing activities Payment of cash dividends .................................................... Repayment of bank loan payable .......................................... Issue of common shares ($600 – $400) ................................ Net cash used by financing activities ..............................................
$(195) 1 (200)2 200 $(195)
Note X to the Statement of Cash Flows: During the year, the company purchased equipment costing $500 by paying $200 cash and issuing a $300 bank loan payable. 1
Beginning balance, retained earnings................. Add: Net income ................................................. Less: Ending balance, retained earnings ............ Dividends declared .............................................
$500 400 (700) $200
Beginning balance, dividends payable................ Add: Dividends declared (from above) ............... Less: Ending balance, dividends payable ........... Dividends paid ....................................................
$ 10 200 (15) $195
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 13-9 (CONTINUED) 2
Beginning balance, bank loan ($200 + $300) ..... Additional borrowings ......................................... Ending balance, bank loan ($200 + $400) .......... Loan payments made .........................................
$500 300 800 (600) $200
(Financing activity cash flows = Issuance/repayment of long-term debt, issuance/repurchase of shares, and payment of cash dividends) LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 13-10 (a)
Free cash flow = $325,000 – $200,000 – $25,000 = $100,000
(b)
Free cash flow provides better information than net cash provided by operating activities because it includes the corporation’s ability to sustain capital asset replacements and additions, and its ability to distribute dividends to its shareholders.
LO 4 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 13-11 (a)
Based on the changes in cash flows from 2014 and 2015, Apple Inc. is likely in the growth stage of the corporate life cycle. This is due to the continued increases in cash used by investing activities and the decline in cash used by financing activities.
(b)
Free cash flow in millions of US dollars: 2015: $81,266 – $11,831 – $11,561 = $57,874 2014: $59,713 – $9,571 – $11,126 = $39,016
(c)
As a shareholder of Apple Inc., I would be pleased with the large increase in the free cash flow generated in 2015 compared to 2014.
(d)
The amount of the dividends paid exceeds the amount of capital expenditures because all necessary capital expenditures have been made throughout the previous years, as needed and also because of the nature of Apple’s business, which is not capital intensive.
LO 4 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
13-14
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 13-12 Cash receipts from customers
=
Sales revenues
+ Decrease in accounts receivable – Increase in accounts receivable
Thus, cash receipts from customers must have equalled = $160,000 [$170,000 – ($24,000 – $14,000)]. LO 5 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*BRIEF EXERCISE 13-13 (in USD millions) + Increase in inventory Cash payments to = Cost of goods suppliers
+ Decrease in accounts payable
– Decrease in inventory – Increase in accounts payable
Thus, the cash payments to suppliers must have equalled = $1,338,712 ($1,252,680 + $88,987 – $2,955). LO 5 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*BRIEF EXERCISE 13-14 Cash payments for operating expenses
=
Operating expenses (excluding depreciation and amortization)
+ Increase in prepaid expenses – Decrease in prepaid expenses and + Decrease in accrued expenses payable – Increase in accrued expenses payable
Thus, the cash payments for operating expenses must have equalled = $184,000 ($200,000 – $30,000 – $5,000 + $1,000 + $13,200 + $4,800). LO 5 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-15
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*BRIEF EXERCISE 13-15 (a) Income tax expense Less: Increase in income tax payable Cash payments for income tax
$50,000 (4,000) $46,000
(b) Income tax expense Add: Decrease in income tax payable Cash payments for income tax
$50,000 3,000 $53,000
LO 5 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
*BRIEF EXERCISE 13-16 Operating activities Cash receipts from customers .................................................. Cash payments To suppliers ........................................................................... For operating expenses ......................................................... For income tax ....................................................................... Net cash provided by operating activities .......................................
$830,0001 $474,0002 212,0003 10,0004
696,000* $134,000*
1
$850,000 – $20,000 = $830,000 $475,000 – $6,000 + $5,000 = $474,000 3 $230,000 – $20,000 + $2,000 = $212,000 4 $15,000 – $5,000 = $10,000 2
LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-16
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 13-1
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. *
**
(a) Cash Effect
(b) Classification
+ $50,000 – $5,000 + $16,000 – $25,000 + $18,000 + $1,000 – $18,000 – $100,000 NE + $1,000 – $25,000
F I / NC* O F I O O O ** O F
Investing activity; Cash payment of $5,000. Also requires note disclosure of the $25,000 noncash transaction acquisition of machine in exchange for long-term note payable. No effect on cash flows; increase in inventory offset by increase in accounts payable.
LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-17
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-2 1.
An impairment loss on goodwill involves the recording of a loss and a reduction of the asset account Goodwill. This transaction does not involve cash in any way. This would not be reported on the statement of cash flows when using the direct method but the impairment might be discussed in the accompanying notes. (The amount would be shown as an adjustment to net income to reverse this loss in the operating activities section prepared using the indirect method.)
2.
Depreciation is a cost allocation technique. The cash transaction occurred with the purchase of the property, plant, and equipment. Depreciation charges the cost to expense as the assets are being consumed. This transaction does not involve cash. This would not be reported on the statement of cash flows or in the accompanying notes. (The amount would be shown as an adjustment to net income to reverse this expense in the operating activities section prepared using the indirect method.)
3.
The recording of the fair value adjustment through net income or loss for an unrealized gain on a trading investment does not involve cash, but increases net income for the gain that is accrued and the carrying amount of the investment on the statement of financial position. This would not be reported on the statement of cash flows if the direct method was used or shown in the accompanying notes. (The amount would be shown as reduction in net income in the operating activities section prepared using the indirect method.)
4.
The reduction of inventory to net realizable value is similar to the recording of an impairment in item 1 above. This transaction does not involve cash in any way. This would not be reported on the statement of cash flows when using the direct method but the charge to cost of goods sold might be discussed in the accompanying notes. (The amount would be included in the change in inventory amount that appears as an adjustment to net income in the operating activities section prepared using the indirect method.)
5.
A stock dividend results in the reduction of Retained Earnings and the increase of the share capital account and does not involve cash. This would not be reported on the statement of cash flows or in the accompanying notes concerning the statement of cash flows, but would be reported in the statement of changes in equity.
6.
A stock split results in additional shares being issued and does not involve cash in any way. This would not be reported on the statement of cash flows, but would be reported in the statement of changes in equity and the notes to the financial statements.
Solutions Manual .
13-18
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-2 (CONTINUED) 7.
The conversion occurs as a result of non-payment of the outstanding receivable and does not involve cash. This would not be reported separately on the statement of cash flows or in the accompanying notes. (The amount would be included in the change in accounts receivable and the change in notes receivable that appear as adjustments to net income in the operating activities section prepared using the indirect method.)
8.
The equipment was purchased by paying with common shares rather than cash. Since this transaction does not involve cash directly, it is not reported on the statement of cash flows. This is, however, an example of a significant noncash investing (acquisition of equipment) and financing (issue of shares) activity and would be disclosed in the notes to the financial statements.
LO 1 BT: C Difficulty: C Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 13-3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Transaction Sold inventory for cash at a higher price than cost. Collected cash in advance from a customer for a service to be provided in the future. Purchased inventory on account in a perpetual inventory system. Declared and paid dividends. Recorded and paid salaries. Recorded income tax payable. Accrued interest receivable. Recorded depreciation expense. Paid an amount owing on account to a supplier. Collected an amount owing from a customer.
Net income +
Cash Provided (Used) by Operating Activities +
NE
+
NE
NE
NE – – + – NE NE
NE – NE NE NE – +
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-19
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-4 JUNO LTD. Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2018
Operating activities Net income ............................................................................ Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense ................................................... Loss on disposal of equipment ..................................... Decrease in accounts receivable .................................. Increase in inventory ..................................................... Increase in prepaid expenses ....................................... Increase in accounts payable ....................................... Increase in income tax payable .................................... Increase in accrued liabilities ........................................ Net cash provided by operating activities .......................................
$21,000
$11,000 5,000 5,000 (1,400) (500) 1,250 400 1,000
21,750 $42,750
Note: The current portion of the bank loan payable was not included because this bank loan was issued for borrowing purposes rather than trade. [Adjustments to net income include depreciation (+); loss (+); decrease in noncash current assets (+); increase in noncash current assets (-); and increase in current liabilities (+)] LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-20
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-5
1. 2. 3. 4. 5. 6.
7. 8. 9. 10.
Transaction Purchased inventory for cash. Sold inventory on account.
Operating Activities –
Investing Activities NE
Financing Activities NE
Noncash Activities NE
(+/–) NE
NE
NE
NE
+ + NE
+ NE NE
NE NE –
NE NE NE
+
NE
NE
NE
+
NE
NE
NE
NE
NE
+
NE
NE
NE
–
NE
NE
NE
NE
+/–
Sold equipment for cash at a loss. Recorded depreciation on equipment. Paid dividends. Recorded an unrealized loss on a long-term equity investment carried at fair value through profit or loss. Collected an account from a customer. Signed and received a mortgage payable. Paid, in full, the current portion of a mortgage payable. Purchased land by issuing common shares.
LO 2,3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-21
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-6 DUPRÉ CORP. Statement of Cash Flows (Partial) Year Ended December 31
Investing activities Proceeds from disposal of equipment.................................... Purchase of land .................................................................... Purchase of equipment [$70,000 + ($53,000 – $43,000)] ...... Net cash used by investing activities ..............................................
$ 6,000* (6,000) (80,000) $(80,000)
Financing activities Payment of cash dividends** .................................................
nil
*Cost of equipment sold ......................................................... *Accumulated depreciation .................................................... *Carrying amount ................................................................... *Loss on disposal of equipment ............................................. *Cash proceeds .....................................................................
$39,000 30,000 9,000 3,000) $ 6,000)
Cash ................................................................................ Accumulated Depreciation—Equipment .......................... Loss on Disposal ............................................................. Equipment ...................................................................
6,000 30,000 3,000 39,000
Notes to the financial statements: Equipment of $53,000 was purchased by paying $10,000 cash and issuing a bank loan payable for $43,000. **
For this year, no dividends were paid. We know this because the dividends declared are equal to the increase in the Dividends Payable account. The amount of dividends paid is equal to dividends declared plus any decrease in the Dividends Payable account or minus any increase in the Dividends Payable account. In this case the dividends paid = $4,000 - $4,000 = $0.
LO 2,3 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-22
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-7 PUFFY LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018
Operating activities Net income.................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Gain on sale of long-term investments................. $ (5,000) Depreciation expense .......................................... 34,000 Increase in accounts receivable ($80,000 – $76,000).......................................... (4,000) Decrease in inventory ($189,000 – $185,000) ..... 4,000 Decrease in accounts payable ($47,000 – $39,000) (8,000) Net cash provided by operating activities .............................. Investing activities Proceeds from sale of long-term investments ............... Purchase of equipment ................................................. Net cash used by investing activities ..................................... Financing activities Payment of cash dividends ($134,000 + $115,000 – $199,000)............................ Repayment of bank loan .............................................. Issue of common shares ............................................... Net cash used by financing activities .....................................
$115,000
21,000 136,000
$35,000* (65,000) (30,000)
$(50,000) (50,000) 25,000
Net increase in cash .............................................................. Cash, January 1..................................................................... Cash, December 31 ...............................................................
(75,000) 31,000) 22,000) $ 53,000)
* Cash proceeds received from sale of long-term investments: Cash ........................................................................ 35,000 Long-Term Investments ($100,000 – $70,000) 30,000 Gain on Disposal ............................................ 5,000 LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-23
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-8 (a)
CHARMAINE RETAILERS LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018
Operating activities Net income.................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense .......................................... $21,000 Increase in accounts receivable ($50,000 – $42,000).......................................... (8,000) Increase in inventory ($168,000 – $143,000)....... (25,000) Increase in accounts payable ($45,000 – $35,000) 10,000 Net cash provided by operating activities .............................. Investing activities Purchase of furniture ($163,000 – $80,000) ................. Net cash used by investing activities .....................................
(b)
$62,000
(2,000) 60,000
$(83,000) (83,000)
Financing activities Increase in bank loans ($103,000 + $10,000 – $76,000) $37,000 Repayment of bank loan .............................................. (10,000) Issue of common shares ($60,000 – $55,000).............. 5,000 Net cash provided by financing activities ...............................
32,000
Net increase in cash .............................................................. Cash, January 1..................................................................... Cash, December 31 ...............................................................
9,000) 9,000) $18,000)
The company was able to generate a sufficient amount of operating cash flows and to obtain bank financing and use both of these sources of cash to purchase additional furniture. The net cash from operating activities seems sufficiently large enough to make any loan payments in the future. One needs to ask why the inventory rose as much as it did because it did lower cash from operating activities.
LO 2,3,4 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-24
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-9 (a)
DAGENAIS RETAILERS LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018
Operating activities Net income.................................................................... Adjustments to reconcile net income to net cash used by operating activities Gain on disposal of furniture ................................ $ (2,000) Depreciation expense .......................................... 19,000 Increase in accounts receivable ($77,000 – $50,000).......................................... (27,000) Increase in inventory ($219,000 – $168,000)....... (51,000) Increase in accounts payable ($68,000 – $45,000) 23,000 Net cash used by operating activities .................................... Investing activities Proceeds from disposal of furniture (see below) ........... Net cash provided by investing activities ............................... Financing activities Payment of cash dividends ($173,000 - $32,000 – $146,000) .............................. Repurchase of common shares .................................... Repayment of bank loan ($103,000 – $90,000) ............ Net cash used by financing activities ..................................... Net decrease in cash ............................................................. Cash, January 1..................................................................... Bank overdraft, December 31 ................................................
$32,000
(38,000) (6,000)
$6,000 6,000
$(5,000) (10,000) (13,000) (28,000) (28,000) 18,000) $(10,000)))
The bank overdraft is considered a cash equivalent.
Solutions Manual .
13-25
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-9 (CONTINUED) Calculations: Transactions involving Furniture: Furniture Dec. 31, 2017
163,000
Dec. 31, 2018
130,000
Disposal
33,000
Accumulated Depreciation—Furniture Disposal (derived)
29,000
Dec. 31, 2017 Depreciation Dec. 31, 2018
45,000 19,000 35,000
Cost of equipment sold (derived) ..................................... Accumulated depreciation (derived) ................................ Net carrying amount (derived) ......................................... Add: Gain on disposal of furniture .................................. Cash proceeds from disposal ..........................................
$33,000 29,000 4,000 2,000 $ 6,000
Cash ................................................................................ Accumulated Depreciation—Furniture ............................. Gain on Disposal ........................................................ Furniture ......................................................................
6,000 29,000
(b)
2,000 33,000
In 2018, Dagenais suffered a significant decline in cash. This decline was principally caused by the repurchase of common shares and the mismanagement of accounts receivable and inventory. The increase in accounts receivable is most likely attributable to difficulty in collecting these receivables and the increase in inventory has probably occurred because of slowing inventory turnover. Under the circumstances, management could have postponed the payment of dividends. This year the negative cash from operations may have led to the disposal of furniture in an attempt to generate cash to finance day to day operations. When a company cannot generate positive cash flows from its operating activities and drains its cash balances, bankruptcy will follow without the support of creditors like a bank or the support of shareholders who are willing to provide more equity to the company.
LO 2,3,4 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-26
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 13-10 (a)
Company A is the best at managing non-cash working capital as demonstrated by the largest increase in cash beyond net income to arrive at cash provided by operating activities of $100,000
(b)
When a company has cash provided by investing activities, it arises from an excess of cash proceeds received from the sale of non-current assets such as long-term investments or property, plant, and equipment over amounts paid to purchase these assets. This can occur for a number of reasons, including the timing of these cash flows. For example, if a company sells such assets first but then replaces them later in a subsequent year, cash provided from investment activities will be shown. Another reason why this may occur is because the company is not generating sufficient cash flows from operations and must sell off noncurrent assets in order to obtain funds.
(c)
Company A is the most likely to have sufficient cash flows to pay down debt or pay out dividends because it is the only company of the three that has provided positive cash flows from operations.
(d)
Company A is the most capable of growing the size of its business operations as its operations have generated the most cash and this made it able to spend $50,000 in investing activities, to pay out cash for financing activities, and still increase its cash position by the end of the year.
LO 4 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 13-11 Category of Cash Flow Affected Collect accounts receivable more quickly and Operating and use the cash received to buy equipment. Investing Pay accounts payable more slowly and use Operating and the cash saved to pay dividends. Financing Issue common shares and use the proceeds to Financing and pay down bank loans. Financing Sell non-current bond investments and use the Investing and proceeds to pay a larger bonus to employees Operating to improve retention rates.
Impact on Cash Flow (Increase or Decrease) Increase and Decrease Increase and Decrease Increase and Decrease Increase and Decrease
LO 4 BT: AN Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-27
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 13-12 Part (a) Add to (+) or Deduct from (–) Income Statement Account
Income Statement Account
Change in Current Asset / Current Liability Account
Part (b) Related Cash Receipt or Payment
1. Sales revenue
Decrease in accounts receivable
+
Cash receipts from customers
2. Dividend revenue
Increase in dividends receivable
–
Cash receipts from dividends
3. Interest revenue
Decrease in interest receivable
+
Cash receipts from interest
4. Rent revenue
Decrease in unearned rent
–
Cash receipts from customers
5. Cost of goods sold
Decrease in inventory
–
Cash payments to suppliers
6. Cost of goods sold
Decrease in accounts payable
+
Cash payments to suppliers
7. Insurance expense
Decrease in prepaid insurance
–
Cash payments for operating expenses
8. Salaries expense
Decrease in salaries payable
+
Cash payments to employees
9. Interest expense
Increase in interest payable
–
Cash payments for interest
10. Income tax expense
Decrease in income tax payable
+
Cash payments for income tax
LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-28
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 13-13 (a)
Sales revenue Add: Decrease in accounts receivable Add: Increase in unearned revenue Cash receipts from customers
$160,000 2,000 3,000 $165,000
(b)
Cost of goods sold Add: Increase in inventory Less: Increase in accounts payable Cash payments to suppliers
$85,000 1,700 (3,200) $83,500
(c)
Salaries expense Less: Increase in salaries payable Cash payments to employees
$45,000 (1,175) $43,825
(d)
Operating expenses Add: Decrease in accrued expenses payable Less: Decrease in prepaid expenses Cash payments for operating expenses
$50,000 300 (450) $49,850
LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-29
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 13-14 JUNO LTD. Statement of Cash Flows (Partial)—Direct Method Year Ended December 31, 2018
Operating activities Cash receipts from customers .................................................. Cash payments To suppliers ........................................................................... For operating expenses ......................................................... For interest ............................................................................ For income tax ....................................................................... Net cash provided by operating activities .......................................
$195,0001 $114,1502 33,5003 1,200 3,4004
152,250 $ 42,750
Note: The current portion of the bank loan payable was not included because this bank loan was issued for lending purposes rather than trade. 1
$190,000 + $5,000 = $195,000 $114,000 + $1,400 – $1,250 = $114,150 3 $50,000 – $11,000 – $5,000 + $500 – $1,000 = $33,500 4 $3,800 – $400 = $3,400 2
LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-30
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*EXERCISE 13-15 PUFFY LTD. Statement of Cash Flows—Direct Method Year Ended December 31, 2018
Operating activities Cash receipts from customers* ..................................... Cash payments To suppliers** ......................................................... $755,000 For operating expenses .......................................... 43,000 For interest ............................................................. 14,000 For income tax ........................................................ 26,000 Net cash provided by operating activities .............................. Investing activities Sale of long-term investments*** .................................. Purchase of equipment ................................................. Net cash used by investing activities ..................................... Financing activities Payment of cash dividends ($134,000 + $115,000 – $199,000) .............................. Repayment of bank loan ............................................... Issue of common shares ............................................... Net cash used by financing activities .....................................
$974,000
838,000 136,000
$35,000 (65,000) (30,000)
$(50,000) (50,000) 25,000 (75,000)
Net increase in cash .............................................................. Cash, January 1..................................................................... Cash, December 31 ...............................................................
31,000) 22,000 $ 53,000)
Calculations: * Cash receipts = sales – increase in accounts receivable = $978,000 – $4,000 = $974,000 ** Cash payments to suppliers = cost of goods sold – decrease in inventory + decrease in accounts payable $751,000 – $4,000 + $8,000 = $755,000 *** Cash proceeds received from sale of long-term investments: Cash ........................................................................ 35,000 Long-Term Investments ($100,000 – $70,000) 30,000 Gain on Disposal ............................................ 5,000 LO 3,5 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-31
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 13-1A
(a)
(c) (b) Cash Flow – +
Transaction 1. Paid salaries to employees. 2. Sold land for cash, at a gain.
Classification O I
3. Purchased a building by making a down payment in cash and signing a mortgage payable for the balance.
I (for the cash downpayment) NC (for the exchange) F
– (for the cash downpayment)
–
NE
O F I
– + –
– NE NE
F O
– NE
NE +
NE
NE
–
4. Made a principal repayment on the mortgage. 5. Paid interest on the mortgage. 6. Issued common shares for cash. 7. Purchased shares of another company to be held as a long-term non-strategic investment. 8. Paid dividends to shareholders. 9. Sold inventory on account, at a price greater than cost. The company uses a perpetual inventory system. 10. Wrote down the cost of the remaining inventory to its net realizable value. (d)
Net Income – + (gain increases income) NE
Because of the accrual basis of accounting, it is not surprising that transactions can impact cash and net income differently. For example, in transaction #6 above, cash was received from the issue of common shares without net income being affected in any way. In transaction #9 above, revenue and net income were affected by the sale of inventory but because it was sold on account, cash was not affected.
LO 1 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
Solutions Manual .
13-32
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-2A (a)
WHISTLER LTD. Statement of Cash Flows (Partial)—Indirect Method Year Ended November 30, 2018
Operating activities Net income ............................................................. Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense .................................... Impairment loss on property, plant, and equipment.......................................... Increase in accounts receivable..................... Decrease in inventory .................................... Increase in prepaid expenses ........................ Decrease in accounts payable ....................... Decrease in accrued liabilities ....................... Decrease in interest payable ......................... Decrease in unearned revenue...................... Increase in income tax payable ..................... Net cash provided by operating activities ........................
(b)
$600,000
$ 75,000 100,000 (190,000) 50,000 (40,000) (180,000) (90,000) (10,000) (17,000) 20,000
(282,000) $318,000
If Whistler were a publicly traded company following IFRS, it could choose to disclose interest expense as part of financing activities rather than in operating activities. Reporting interest paid as in part (a) in the operating activities section above is the usual practice for a publicly traded company and the required practice followed by a private company using ASPE.
LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-3A (a)
Cash receipts and payments related to property, plant, and equipment in 2018: Land purchase Equipment purchase Proceeds from disposal of equipment
$(40,000) (10,000) 8,000*
* Cost of equipment sold: $240,000 + $75,000 – $300,000 = $15,000 Accumulated depreciation of equipment sold $96,000 + $60,000 – $144,000 = $12,000 Cash proceeds = Carrying amount (cost $15,000 – accumulated depreciation $12,000) + gain $5,000 = $8,000 Note to instructor–some students may find journal entries helpful in understanding this problem. Equipment .............................................................................................. Bank Loan Payable ........................................................................ Cash ...............................................................................................
75,000
Land ....................................................................................................... Cash ...............................................................................................
40,000
Cash ....................................................................................................... Accumulated Depreciation—Equipment ................................................. Gain on Disposal ............................................................................ Equipment ......................................................................................
8,000 12,000
65,000 10,000
40,000
5,000 15,000
(b) Land purchase Equipment purchase Proceeds from equipment disposal
Investing activities (use) Investing activities (use) Investing activities (source)
Also include the following note to the financial statements: Note: During the year the company purchased equipment costing $75,000 by paying $10,000 cash and issuing a bank loan payable for $65,000.
(c)
A growing company must invest in productive assets so it would normally be using cash in its investing activities.
LO 3,4 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-4A (a)
Cash receipts:
Issue of common shares $550,000 – $400,000 +$100,000 = $250,000 Issuance of preferred shares $325,000 – $275,000 = $50,000
Cash payments:
Repurchase of common shares 10,000 shares at $11 per share = $110,000 Payment of dividends = $15,626
Note to instructor: Students may find summary journal entries helpful in understanding this problem. Cash .................................................................................... Preferred Shares ($325,000 – $275,000) .................... To record issue of preferred shares
50,000
Common Shares [10,000 x ($400,000 ÷ 40,000)] ................ Retained Earnings ($110,000 - $100,000) ........................... Cash (10,000 x $11) .................................................... To record the repurchase of common shares
100,000 10,000
Cash .................................................................................... Common Shares ($550,000 – $400,000 + $100,000) .. To record the issue of common shares
250,000
Dividends Declared .............................................................. Dividends Payable ($4,062 – $3,438) .......................... Cash ............................................................................ To record the payment of dividends
16,250
50,000
110,000
250,000
624 15,626
(b)
All of the above activities would be classified as financing activities on the statement of cash flows.
(c)
A growing company would usually be generating cash from its financing activities. Cash is needed to invest in productive assets, such as buildings and equipment and most companies are not able to generate sufficient cash from their operating activities. To finance these purchases, companies normally have to issue debt or shares.
LO 3,4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-5A (a)
E-PERFORM INC. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018
Operating activities Net income ............................................................................ Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense ................................................... Loss on disposal of equipment ..................................... Unrealized gain on held for trading investments ........... Increase in accounts receivable.................................... Increase in inventory..................................................... Decrease in prepaid expenses ..................................... Increase in accounts payable ....................................... Increase in accrued liabilities ........................................ Net cash provided by operating activities ....................................... Investing activities Proceeds from disposal of equipment.................................... Purchase of equipment (Note X) ........................................... Net cash used by investing activities .............................................. Financing activities Sale of common shares ......................................................... Repayment of bank loan payable .......................................... Payment of cash dividends ($105,450 + $155,180 – $248,000) ............................. Net cash used by financing activities ..............................................
$155,180
$46,500 7,500 (14,000) (32,800) (29,650) 7,600 15,700 4,500
5,350 160,530
$ 1,500 (25,000) (23,500) $ 25,000 (100,000) (12,630) (87,630)
Net increase in cash ....................................................................... Cash, January 1 ............................................................................. Cash, December 31 ........................................................................
49,400 48,400 $ 97,800
Note X to the Statement of Cash Flows: During the year, the company purchased equipment costing $85,000 by paying $25,000 cash and issuing a $60,000 bank loan payable. (b)
E-Perform’s cash position has increased primarily because of significant amounts of cash generated from its operating activities. Cash from operating activities increased the company’s cash account by $160,530. Some of this cash was used to purchase equipment, repay its bank loans and pay dividends, but sufficient cash remained at the end of the year to increase its cash position by $49,400.
LO 2,3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6A (a)
SYLVESTER LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018 Operating activities Net income....................................................................... Adjustments to reconcile net income to net cash provided(used) by operating activities Depreciation expense (3) ........................................ Gain on disposal of land ......................................... Gain on disposal of building (1) .............................. Loss on disposal of equipment (2) .......................... Decrease in accounts receivable ............................ Decrease in inventory ............................................. Increase in accounts payable ................................. Decrease in interest payable .................................. Increase in income tax payable .............................. Net cash provided by operating activities .................................
$57,000
$ 74,000 (7,000) (38,000) 4,000 11,000 21,000 17,000 (1,000) 1,000
82,000 139,000
Investing activities Purchase of building (1) ................................................... $(364,000) Purchase of equipment (2) .............................................. (65,000) Proceeds from disposal of land ($110,000 – $100,000 + $7,000 gain) .................... 17,000 Proceeds from disposal of equipment (2) ........................ 5,000 Proceeds from disposal of building (1)............................. 50,000 Net cash used by investing activities ........................................
(357,000)
Financing activities Issue of common shares ($198,000 – $88,000)............... Additions to bank loan ..................................................... Repayments of bank loan (5) ........................................... Dividends paid (4) ............................................................ Net cash provided by financing activities ..................................
249,000
Net increase in cash ................................................................. Bank overdraft, January 1 ......................................................... Cash, December 31 ..................................................................
Solutions Manual .
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$110,000 210,000 (36,000) (35,000)
31,000 (8,000) $ 23,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6A (CONTINUED) (a) (continued) Calculations: (1) Transactions involving Buildings: Buildings Dec. 31, 2017 Purchases Dec. 31, 2018
263,000 364,000 527,000
Disposal
100,000
Accumulated Depreciation—Buildings Disposal (derived)
88,000
Dec. 31, 2017 Depreciation Dec. 31, 2018
100,000 55,000 67,000
Cost of building sold (derived) ......................................... Accumulated depreciation ............................................... Net carrying amount (derived) ......................................... Add: Gain on disposal of buildings (derived) .................. Cash proceeds from disposal ..........................................
$100,000 88,000 12,000 38,000 $50,000
Cash ................................................................................ Accumulated Depreciation—Buildings ............................. Gain on Disposal ........................................................ Buildings......................................................................
50,000 88,000
Solutions Manual .
13-38
38,000 100,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6A (CONTINUED) (2) Transactions involving Equipment: Equipment Dec. 31, 2017 Purchases Dec. 31, 2018
40,000 65,000 85,000
Disposal
20,000
Accumulated Depreciation—Equipment Disposal
11,000
Dec. 31, 2017 Depreciation Dec. 31, 2018
10,000 19,000 18,000
Cost of equipment sold (derived) ..................................... Accumulated depreciation ............................................... Net carrying amount ........................................................ Less: Loss on disposal ................................................... Cash proceeds from disposal ..........................................
$20,000 11,000 9,000 4,000 $ 5,000
Cash ................................................................................ Accumulated Depreciation—Equipment .......................... Loss on Disposal ............................................................. Equipment ...................................................................
5,000 11,000 4,000
(3)
(4)
Total depreciation recorded during the year: For buildings .......................................................... For equipment ........................................................ Total depreciation expense for the year: ................
20,000
$55,000 19,000 $74,000
Transactions involving Retained Earnings: Retained Earnings Dividends declared (derived)
Dec. 31, 2017 37,000 Net income Dec. 31, 2018
30,000 57,000 50,000
Dividends Payable Dividends paid
Solutions Manual .
Dec. 31, 2017 35,000 Dividends declared Dec. 31, 2018
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1,000 37,000 3,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6A (CONTINUED) (a) (continued)
(5)
Transactions involving Bank Loan Payable:
Bank loan balance Dec. 31, 2017: Current portion ........................................................... $ 20,000 Non-current portion .................................................... 212,000 Total ........................................................................... $232,000 Bank loan balance Dec. 31, 2018: Current portion ........................................................... $ 26,000 Non-current portion .................................................... 380,000 Total ........................................................................... $406,000 Net increase during the year ($406,000 – $232,000) ...... $174,000 Additions to the bank loans during the year (given) ......... 210,000 Repayments made on bank loans during the year .......... $ 36,000
(b)
On the surface, Sylvester Ltd. looks as if it is managing its noncash working capital efficiently. It decreased its accounts receivable and inventory while at the same time increased its accounts payable. A creditor might find this alarming because suppliers don’t look as if they are being paid on time. As well, a decline in inventory might not necessarily mean that the company is making sure that inventory is on hand to secure sales.
(c)
The purchase of the building was financed partially from the issuance of common shares and mostly from increasing the bank loan. The amount of the investment for the building is disproportionate to the amount of the retained earnings, which in turn was substantially depleted from a large dividend payment. Net income is modest and is made up of a one-time gain realized on the disposal of the old building. The net income level will decline in the future as a result of servicing the additional debt. Sylvester Ltd. could not afford to purchase the building without external financing.
LO 2,3 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7A (a)
ALTON LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018
Operating activities Net income....................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense (4) ........................................ Loss on disposal of land ......................................... Gain on disposal of building (1) .............................. Loss on disposal of equipment (2) .......................... Increase in accounts receivable .............................. Increase in inventory ............................................... Decrease in accounts payable ................................ Increase in interest payable .................................... Decrease in income tax payable ............................. Net cash used by operating activities .......................................
$10,000
$ 73,000 21,000 (15,000) 11,000 (35,000) (31,000) (43,000) 5,000 (2,000)
(16,000) (6,000)
Investing activities Purchase of building (1) ................................................... $(520,000) Purchase of equipment (2) .............................................. (72,000) Proceeds from disposal of land (3) .................................. 29,000 Proceeds from disposal of equipment (2) ........................ 21,000 Proceeds from disposal of building (1) ............................. 40,000 Net cash used by investing activities ........................................
(502,000)
Financing activities Repurchase of common shares ($180,000 – $160,000) .. $ (20,000) Additions to bank loan ..................................................... 512,000 Repayments of bank loan (6) ........................................... (25,000) Dividends paid (5) ............................................................ (32,000) Net cash provided by financing activities ..................................
435,000
Net decrease in cash and cash equivalents ............................. Cash and cash equivalents, January 1 ..................................... Cash and cash equivalents, December 31 ...............................
(73,000) 78,000 $ 5,000
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7A (CONTINUED) (a) (continued)
Calculations: (1) Transactions involving Buildings: Buildings Dec. 31, 2017 Purchases Dec. 31, 2018
524,000 520,000 923,000
Disposal
121,000
Accumulated Depreciation—Buildings Disposal (derived)
96,000
Dec. 31, 2018 Depreciation Dec. 31, 2018
190,000 42,000 136,000
Cost of building sold (derived) ......................................... Accumulated depreciation (derived) ................................ Net carrying amount ....................................................... Add: Gain on disposal of buildings ................................. Cash proceeds from disposal ..........................................
$121,000 96,000 25,000 15,000 $40,000
Cash ................................................................................ Accumulated Depreciation—Buildings ............................. Gain on Disposal ........................................................ Buildings......................................................................
40,000 96,000
Solutions Manual .
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15,000 121,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7A (CONTINUED) (a) (continued)
(2) Transactions involving Equipment: Equipment Dec. 31, 2017 Purchases Dec. 31, 2018
70,000 72,000 100,000
Disposal
42,000
Accumulated Depreciation—Equipment Disposal
10,000
Dec. 31, 2017 Depreciation (der.) Dec. 31, 2018
20,000 31,000 41,000
Cost of equipment sold .................................................... Accumulated depreciation (derived) ................................ Net carrying amount ........................................................ Less: Loss on disposal ................................................... Cash proceeds from disposal .........................................
$42,000 10,000 32,000 11,000 $ 21,000
Cash ................................................................................ Accumulated Depreciation—Equipment .......................... Loss on Disposal ............................................................. Equipment ...................................................................
21,000 10,000 11,000 42,000
(3) Transaction involving Land: Cash (derived) ................................................................. Loss on Disposal ............................................................. Land ($230,000 - $180,000) ........................................
(4) Total depreciation recorded during the year: For buildings ................................................................ For equipment ............................................................. Total depreciation expense for the year: .....................
Solutions Manual .
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29,000 21,000 50,000
$42,000 31,000 $73,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7A (CONTINUED) (a) (continued)
(5) Transactions involving Retained Earnings: Retained Earnings Dividends declared (derived)
Dec. 31, 2017 32,000 Net income Dec. 31, 2018
72,000 10,000 50,000
(6) Transactions involving Bank Loan Payable: Bank loan balance Dec. 31, 2017: Current portion ........................................................... $ 40,000 Non-current portion .................................................... 420,000 Total ........................................................................... $460,000 Bank loan balance Dec. 31, 2018: Current portion ........................................................... $ 56,000 Non-current portion .................................................... 891,000 Total ........................................................................... $947,000 Net increase during the year ($947,000 – $460,000) ...... $487,000 Additions to the bank loans during the year (given) ......... 512,000 Repayments made on bank loans during the year .......... $ 25,000
Total Bank Loan Loan payments
Solutions Manual .
Dec. 31, 2017 25,000 New loans Dec. 31, 2018
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460,000 512,000 947,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7A (CONTINUED) (b)
Alton Ltd. did not manage its noncash working capital efficiently. It increased both its accounts receivable and inventory while at the same time decreased its accounts payable. A creditor might find this an alarming trend. Alton runs the increased risk of not being able to collect receivables and sell its entire inventory in the future.
(c)
The banker would be worried for the reasons mentioned in part (b) but also for Alton’s poor performance in obtaining cash from operating activities. The purchase of the building was financed completely with debt and no equity. Although some cash was obtained from selling land, this sale was done at a large loss. Cash paid in dividends was more than three times the size of the net income and additional cash was spent buying back common shares. The amount of the investment for the building is disproportionate to the amount of the retained earnings, which in turn was substantially depleted from the large dividend payment. The net income level will decline in the future as a result of servicing the additional debt and depreciating the new building. Alton Ltd. could not afford to purchase the building without external financing.
LO 2,3 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-8A (a) ($ in thousands)
Reitmans
Le Château
$34,770 – $33,291 – $12,782
$(14,161) – $9,115 – $0
= $(11,303)
= $(23,276)
Free cash flow
Both companies have negative free cash flow, but Reitmans has the least negative amount and therefore is in the better free cash flow position. (b)
It is possible that a negative free cash flow is generated by a company, particularly during the introductory and growth phases of its life cycle. A negative free cash flow does not necessarily lead to overall cash flows that are negative. For example, there may be large increases in cash during the year from the sale of investments, issuance of shares, or borrowing of funds. In addition, large capital expenditures can turn overall positive cash flow into negative free cash flow.
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-9A (a)
Although Second Cup had a loss from the year, it managed to generate positive cash flows from operating activities. The overall decrease in cash was absorbed by the high beginning balance of cash leaving an ending cash balance that is severely reduced. Starbucks provided cash from operating activities that nearly equalled the amount of cash consumed by investing and financing activities. The company generated 36% more cash from operating activities than net income [($3,749.1 – $2,757.4) ÷ $2,757.4]. Cash decreased modestly by the end of the year.
(b)
Starbucks appears to be in the stronger cash position based on its ability to generate sufficient cash flow from operations to cover the uses of cash from investing and financing activities, concluding with a small reduction of cash for the year.
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-10A (a) (1)
TREMBLANT LIMITED Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2018
Operating activities Net income ...................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense ............................................. Amortization expense ............................................. Loss on disposal of equipment ............................... Increase in accounts receivable............................... Decrease in prepaid expenses ................................ Decrease in accounts payable ................................. Decrease in salaries payable ................................... Increase in unearned revenue ................................. Increase in interest payable ..................................... Decrease in income tax payable .............................. Net cash provided by operating activities ..................................
(a) (2)
$111,750
$50,000 15,000 26,000 (10,000 ) 3,000 (5,000 ) (500 ) 3,000 1,250 (5,250)
77,500 $189,250
TREMBLANT LIMITED Statement of Cash Flows (Partial)—Direct Method Year Ended December 31, 2018
Operating activities Cash receipts from customers .......................................... Cash payments For operating expenses ........................................... $(112,000) (2) To employees .......................................................... (500,500) (3) For interest............................................................... (73,750) (4) For income tax ......................................................... (42,500) (5) Net cash provided by operating activities ..................................
$918,000 (1)
(728,750) $189,250
Note: Calculations follow below.
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-10A (CONTINUED) (1)
(2)
(3)
(4)
(5)
(b)
Cash receipts from customers Revenues Add: Increase in unearned revenues Less: Increase in accounts receivable ($57,000 – $47,000) Cash receipts from customers
$925,000 3,000 (10,000) $918,000
Cash payments for operating expenses Administrative expenses Add: Decrease in accounts payable ($41,000 – $36,000) Deduct: Decrease in prepaid expenses ($12,000 – $15,000) Cash payments for operating expenses
$110,000 5,000 (3,000) $112,000
Cash payments to employees Salaries expense Add: Decrease in salaries payable ($20,000 – $19,500) Cash payments to employees
$500,000 500 $500,500
Cash payments for interest expense Interest expense per income statement Deduct: Increase in interest payable ($6,250 – $5,000) Cash payments for interest
$75,000 (1,250) $73,750
Cash payments for income tax Income tax expense per income statement Add: Decrease in income tax payable ($4,000 – $9,250) Cash payments for income tax
$37,250 5,250 $42,500
Both methods are acceptable under both IFRS and ASPE. I would recommend that the company use the direct method to prepare its operating activities section. Users usually find this method to be more informative because it shows cash receipts from customers and other sources and cash payments for major categories. It is also the preferred method by the standard setters. Nonetheless, many companies prefer to use the indirect method because it is easier to prepare and their accounting system may not be adapted to capture the transaction data required in the direct method.
LO 2,5 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-11A (a) WHISTLER LTD. Statement of Cash Flows (Partial)—Direct Method Year Ended November 30, 2018
Operating activities Cash receipts from customers ................................ Cash payments To suppliers ................................................... $(5,130,000) (2) For operating expenses ................................. (1,955,000) (3) For interest..................................................... (110,000) (4) For income tax ............................................... (280,000) (5) Net cash provided by operating activities ........................
(1)
(2)
(3)
$7,793,000 (1)
(7,475,000) $ 318,000
Cash receipts from customers Sales Deduct: Decrease in unearned revenue Deduct: Increase in accounts receivable Cash receipts from customers
$8,000,000 (17,000) (190,000) $7,793,000
Cash payments to suppliers Cost of goods sold Deduct: Decrease in inventory Cost of purchases Add: Decrease in accounts payable Cash payments to suppliers
$5,000,000 (50,000) 4,950,000 180,000 $5,130,000
Cash payments for operating expenses Operating expenses Deduct: Depreciation expense Deduct: Impairment loss Operating expenses, net of depreciation and impairment Add: Increase in prepaid expenses Decrease in accrued liabilities Cash payments for operating expenses
Solutions Manual .
13-50
$2,000,000 (75,000) (100,000) 1,825,000 $40,000 90,000
130,000 $1,955,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-11A (CONTINUED) (a) (continued)
(4)
(5)
(b)
Cash payments for interest Interest expense Add: Decrease in interest payable Cash payments for interest
$100,000 10,000 $110,000
Cash payments for income tax Income tax expense Deduct: Increase in income tax payable Cash payments for income tax
$300,000 (20,000) $280,000
If Whistler were a publicly traded company following IFRS, it could choose to disclose interest expense as part of financing activities rather than in operating activities. Reporting interest paid as in part (a) in the operating activities section above is the usual practice for a publicly traded company and the required practice followed by a private company using ASPE.
LO 5 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-12A (a)
E-PERFORM, INC. Statement of Cash Flows—Direct Method Year Ended December 31, 2018
Operating activities Cash receipts from customers (1) ..................................... Cash payments To suppliers (2) ........................................................ For operating expenses (3) ...................................... For income tax ......................................................... For interest............................................................... Net cash provided by operating activities ..................................
$459,980 $(199,410) (50,310) (45,000) (4,730)
Investing activities Disposal of equipment .................................................... Purchase of equipment (Note X) .................................... Net cash used by investing activities .......................................
$ 1,500 (25,000)
Financing activities Sale of common shares .................................................. Repayment of bank loan payable ................................... Payment of cash dividends ............................................. Net cash used by financing activities .......................................
$ 25,000 (100,000) (12,630)
Net increase in cash ................................................................ Cash, January 1 ...................................................................... Cash, December 31 .................................................................
(299,450) 160,530
(23,500)
(87,630) 49,400 48,400 $ 97,800
Note X to the Statement of Cash Flows: During the year, the company purchased equipment costing $85,000 by paying $25,000 cash and issuing a $60,000 bank loan payable. Note: Calculations follow below.
Solutions Manual .
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Chapter 13
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-12A (CONTINUED) (a) (continued)
Calculations (1)
Cash receipts from customers Sales .................................................................................................. Deduct: Increase in accounts receivable .......................................... Cash receipts from customers ...........................................................
$492,780 (32,800) $459,980
Cash payments to suppliers Cost of goods sold ............................................................................. Add: Increase in inventory ................................................................ Cost of purchases .............................................................................. Deduct: Increase in accounts payable .............................................. Cash payments to suppliers...............................................................
$185,460 29,650 215,110 (15,700) $199,410
(3) Cash payments for operating expenses Operating expenses from income statement ..................................... Deduct: Depreciation expense ........................................................ Loss on disposal of equipment .......................................... Decrease in prepaid expenses .......................................... Increase in accrued liabilities ............................................. Cash payments for operating expenses ............................................
$116,410 (46,500) (7,500) (7,600) (4,500) $ 50,310
(2)
(b)
E-Perform’s cash position has increased primarily because of significant amounts of cash generated from its operating activities. Cash from operating activities increased the company’s cash account by $160,530. Some of this cash was used to purchase equipment, repay its bank loans, and pay dividends, but sufficient cash remained at the end of the year to increase its cash position by $49,400.
LO 5 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-1B (a) Classification O
(b) Cash Flow +
(c) Net Income NE
I
+
NE
NE
– (loss decreases income) +
NC
NE
NE
O
NE
–
6. Paid dividends to preferred shareholders.
F
–
NE
7. Recorded depreciation expense. 8. Issued preferred shares for cash.
NE
NE
–
F
+
NE
9. Purchased inventory for cash. The company uses a perpetual inventory system. 10. Provided services on account.
O
–
NE
NE
NE
+
Transaction 1. Collected an account receivable. 2. Sold equipment for cash, at a loss.
3. Recorded an unrealized gain on a held for trading investment. 4. Acquired land by issuing common shares. 5. Expired prepaid insurance.
(d)
Because of the accrual basis of accounting, it is not surprising that transactions can impact cash and profit differently. For example, in transaction #8 above, cash was received from the issue of preferred shares without profit being affected in any way. In transaction #10 above, revenue and profit were affected by providing services but because they were provided on account, cash was not affected.
LO 1 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-2B (a) GUM SAN LTD. Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2018
Operating activities Net income .................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense ........................................... Gain on disposal ................................................... Increase in accounts receivable............................ Decrease in inventory ........................................... Increase in prepaid expenses ............................... Increase in accounts payable ............................... Decrease in accrued liabilities .............................. Increase in interest payable .................................. Increase in unearned revenue .............................. Decrease in income tax payable ........................... Net cash provided by operating activities ...............................
(b)
$768,000
$150,000 (12,000) (500,000) 220,000 (170,000) 50,000 (165,000) 5,000 8,000 (16,000)
(430,000) $338,000
If Gum San were a publicly traded company following IFRS, it would have the choice to disclose interest expense as part of financing activities rather than in operating activities. Reporting interest paid as in part (a) in the operating activities section above is the usual practice for a publicly traded company and the required practice followed by a private company using ASPE.
LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-3B (a)
Cash receipts and payments related to property, plant, and equipment 2018: Equipment purchase Land purchase Proceeds from equipment disposal
$(80,000) (20,000) 24,000*
* Cost of equipment sold: $480,000 + $80,000 – $500,000 = $60,000 Accumulated depreciation removed from accounts = ($192,000 + $128,000 – $288,000) = $32,000 Carrying amount = $60,000 Cost – Accumulated depreciation $32,000 = $28,000 Cash proceeds = Carrying amount $28,000 – Loss on disposal $4,000 = $24,000
Note to instructor: Students may find journal entries helpful in understanding this problem. Equipment .............................................................................................. Cash ...............................................................................................
80,000
Land ....................................................................................................... Cash ............................................................................................... Mortgage Payable ..........................................................................
50,000
Cash (calculated) .................................................................................... Accumulated Depreciation—Equipment ................................................. Loss on Disposal .................................................................................... Equipment ......................................................................................
24,000 32,000 4,000
(b)
Equipment purchase Land purchase Proceeds from equipment disposal
80,000
20,000 30,000
Investing activities (use) Investing activities (use) Investing activities (source)
60,000
$(80,000) $(20,000) $24,000
Also include the following note to the financial statements: Note: During the year the company purchased land for $50,000 by paying $20,000 cash and issuing a mortgage payable for $30,000.
(c)
A growing company must invest in productive assets so it can be expected to use cash in its investing activities.
LO 3,4 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-4B (a)
Cash receipts: Issue preferred shares $25,000 Cash payments: Payment of cash dividends, $7,500 Repurchase of common shares, $30,000
Share repurchase
Common Shares 200,000 Beg. balance 30,000 20,400 Stock dividends distributed (not a cash flow) 190,400 End. balance
Journal entry for share repurchase: Common Shares 3,000 x ($200,000 ÷ 20,000) .................. Cash (3,000 x $10) .....................................................
30,000 30,000
Journal entry for stock dividend: (20,000 - 3,000) 17,000 shares x 10% = 1,700 shares at $12 = $20,400 Dividends Declared ............................................................ Common Shares .........................................................
20,400 20,400
The T-account for Retained Earnings is provided to illustrate that all transactions have been considered:
Cash dividends declared Stock dividends declared
Retained Earnings 250,000 Beg. balance 7,500 20,400 37,500 Net income 259,600 End. balance
(b)
All of the above activities (issuance of preferred shares, payment of cash dividends, and repurchase of shares) would be classified as financing activities on the statement of cash flows.
(c)
A growing company would usually be generating cash from its financing activities, whereas Mathur has used cash of $12,500. Cash is needed to invest in productive assets, such as buildings and equipment, and most companies are not able to generate sufficient cash from their operating activities. To finance these purchases, companies have to issue debt or shares.
LO 3,4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Chapter 13
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-5B (a) NACKAWIC INC. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018
Operating activities Net income ............................................................................ Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense ................................................... Loss on sale of long-term investments ......................... Gain on disposal of equipment ..................................... Increase in accounts receivable.................................... Increase in inventory..................................................... Increase in accounts payable ....................................... Decrease in accrued liabilities ...................................... Net cash provided by operating activities ....................................... Investing activities Proceeds from sale of long-term investments........................ Proceeds from disposal of equipment.................................... Purchase of equipment .......................................................... Net cash used by investing activities ..............................................
$87,810
$58,700 7,500 (8,750) (43,800) (29,250) 14,420 (6,730)
(7,910) 79,900
$ 5,000 15,550 (71,000) (50,450)
Financing activities Issue of common shares ($240,000 – $200,000) .................. $40,000 Payment of cash dividends ($121,790 + $87,810 – $175,600) (34,000) Net cash provided by financing activities ........................................
6,000
Net increase in cash ....................................................................... Cash, January 1 ............................................................................. Cash, December 31 ........................................................................
35,450 47,250 $82,700
Note X to the Statement of Cash Flows: Equipment costing $141,000 was purchased by paying $71,000 cash and issuing a bank loan payable for $70,000. (b)
Nackawic’s cash position has increased primarily because of the amount of cash generated from its operating activities. Cash from operating activities increased the company’s cash account by $79,900. Some of this cash was used to purchase equipment and pay dividends with additional cash generated from selling common shares. Sufficient cash remained at the end of the year to increase its cash position by $35,450.
LO 2,3 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6B (a)
ANDERSON LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018 Operating activities Net income....................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense (3) ........................................ Gain on disposal of land ......................................... Gain on disposal of building (1) .............................. Loss on disposal of equipment (2) .......................... Increase in accounts receivable .............................. Increase in inventory ............................................... Decrease in accounts payable ................................ Decrease in interest payable .................................. Increase in income tax payable .............................. Net cash provided by operating activities .................................
$53,000
$ 74,000 (14,000) (28,000) 5,000 (18,000) (14,000) (26,000) (1,000) 1,000
(21,000) 32,000
Investing activities Purchase of building (1) ................................................... $(304,000) Purchase of equipment (2) .............................................. (125,000) Proceeds from disposal of land ($110,000 – $95,000 + $14,000 gain) .................... 29,000 Proceeds from disposal of equipment (2) ........................ 4,000 Proceeds from disposal of building (1) ............................. 40,000 Net cash used by investing activities ........................................
(356,000)
Financing activities Issue of common shares .................................................. $ 10,000 Repurchase of common shares (6) .................................. (8,000) Additions to bank loan ..................................................... 350,000 Repayments of bank loan ................................................ (36,000) Dividends paid (4) ............................................................ (33,000) Net cash provided by financing activities ..................................
283,000
Net decrease in cash ................................................................ Cash, January 1........................................................................ Bank overdraft, December 31 ...................................................
(41,000) 36,000 $ ( 5,000)
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6B (CONTINUED) (a) (continued)
Calculations:
(1) Transactions involving Buildings: Buildings Dec. 31, 2017 Purchases Dec. 31, 2018
263,000 304,000 477,000
Disposal
90,000
Accumulated Depreciation—Buildings Disposal (derived)
78,000
Dec. 31, 2017 Depreciation Dec. 31, 2018
100,000 45,000 67,000
Cost of building sold (derived) ......................................... Accumulated depreciation ............................................... Net carrying amount (derived) ......................................... Add: Gain on disposal..................................................... Cash proceeds from disposal ..........................................
$90,000 78,000 12,000 28,000 $40,000
Cash ................................................................................ Accumulated Depreciation—Buildings ............................. Gain on Disposal ........................................................ Buildings......................................................................
40,000 78,000
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28,000 90,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6B (CONTINUED) (a) (continued)
(2) Transactions involving Equipment: Equipment Dec. 31, 2017 Purchases Dec. 31, 2018
40,000 125,000 135,000
Disposal
30,000
Accumulated Depreciation—Equipment Disposal
21,000
Dec. 31, 2017 Depreciation Dec. 31, 2018
10,000 29,000 18,000
Cost of equipment sold (derived) ..................................... Accumulated depreciation ............................................... Net carrying amount ........................................................ Less: Loss on disposal ................................................... Cash proceeds from disposal ..........................................
$30,000 21,000 9,000 5,000 $ 4,000
Cash ................................................................................ Accumulated Depreciation—Equipment .......................... Loss on Disposal ............................................................. Equipment ...................................................................
4,000 21,000 5,000
(3) Total depreciation recorded during the year: For buildings: ............................................................... For equipment: (derived) ............................................. Total depreciation expense for the year: .....................
30,000
$45,000 29,000 $74,000
(4) Transactions involving Retained Earnings: Retained Earnings Dividends (derived)
Solutions Manual .
33,000
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Dec. 31, 2017 Net income Dec. 31, 2018
30,000 53,000 50,000
Chapter 13
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 13-6B (CONTINUED) (a) (continued)
(5) Transactions involving Bank Loan Payable: Bank loan balance Dec. 31, 2017: Current portion ........................................................... $ 20,000 Non-current portion .................................................... 212,000 Total ........................................................................... $232,000 Bank loan balance Dec. 31, 2018: Current portion ........................................................... $ 26,000 Non-current portion .................................................... 520,000 Total ........................................................................... $546,000 Net increase during the year ($546,000 − $232,000) ...... $314,000 Additions to the bank loans during the year (given) ......... 350,000 Repayments made on bank loans during the year .......... $ 36,000
(6) Transactions involving Common Shares: Common Shares Repurchase (derived)
8,000
Dec. 31, 2017 Issued (given) Dec. 31, 2018
88,000 10,000 90,000
(b)
Anderson Ltd. did not manage its noncash working capital efficiently. It increased its accounts receivable and inventory while at the same time decreasing its accounts payable. Taken together this shows a bad trend and possible issues with overstocking or slowing sales.
(c)
The purchase of the building was financed primarily through the use of bank loans, which are now at a fairly high level. The required repayments to the bank loan this year were $26,000 and this may rise in the future because of the additional debt incurred this year. To pay for this, the company has only generated $32,000 from operating activities. The bank will be concerned about this. Furthermore, the bank will notice that dividends paid were $1,000 greater than the amount of cash derived from operating activities and the bank may ask for dividends to be reduced.
LO 2,3 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7B (a)
SUMMERVILLE LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2018 Operating activities Net income....................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense (4) ........................................ Gain on disposal of land ......................................... Gain on disposal of building (1) .............................. Loss on disposal of equipment (2) .......................... Decrease in accounts receivable ............................ Decrease in inventory ............................................. Increase in accounts payable ................................. Increase in interest payable .................................... Increase in income tax payable .............................. Net cash provided by operating activities .................................
$89,000
$ 76,000 (7,000) (78,000) 10,000 10,000 42,000 18,000 4,000 2,000
77,000 166,000
Investing activities Purchase of building (1) ................................................... $(564,000) Purchase of equipment (2) .............................................. (140,000) Proceeds from disposal of land (3) .................................. 27,000 Proceeds from disposal of equipment (2) ........................ 15,000 Proceeds from disposal of building (1) ............................. 90,000 Net cash used by investing activities ........................................
(572,000)
Financing activities Repurchase of common shares ....................................... $ (26,000) Issuance of common shares (7)....................................... 250,000 Additions to bank loan ..................................................... 300,000 Repayments of bank loan (6) ........................................... (33,000) Dividends paid (5) ............................................................ (28,000) Net cash provided by financing activities ..................................
463,000
Net increase in cash and cash equivalents ............................... Cash and cash equivalents, January 1 ..................................... Cash and cash equivalents, December 31 ...............................
57,000 12,000 $69,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7B (CONTINUED) (a) (continued)
Calculations:
(1) Transactions involving Buildings: Buildings Dec. 31, 2017 Purchases Dec. 31, 2018
466,000 564,000 943,000
Disposal (derived) 87,000
Accumulated Depreciation—Buildings Disposal (derived)
75,000
Dec. 31, 2018 Depreciation Dec. 31, 2018
150,000 55,000 130,000
Cost of building sold (derived) ......................................... Accumulated depreciation ............................................... Net carrying amount (derived) ......................................... Add: Gain on disposal of buildings ................................. Cash proceeds from disposal ..........................................
$87,000 75,000 12,000 78,000 $90,000
Cash ................................................................................ Accumulated Depreciation—Buildings ............................. Gain on Disposal ........................................................ Buildings......................................................................
90,000 75,000
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78,000 87,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7B (CONTINUED) (a) (continued)
(2) Transactions involving Equipment: Equipment Dec. 31, 2017 Purchases Dec. 31, 2018
80,000 140,000 190,000
Disposal (derived)
30,000
Accumulated Depreciation—Equipment Disposal
5,000
Dec. 31, 2017 20,000 Depreciation (derived) 21,000 Dec. 31, 2018 36,000
Cost of equipment sold (derived) ..................................... Accumulated depreciation ............................................... Net carrying amount ........................................................ Less: Loss on disposal ................................................... Cash proceeds from disposal (derived) ...........................
$30,000 5,000 25,000 10,000 $15,000
Cash ................................................................................ Accumulated Depreciation—Equipment .......................... Loss on Disposal ............................................................. Equipment ...................................................................
15,000 5,000 10,000 30,000
(3) Transaction involving land: Cash (derived) ................................................................. Gain on Disposal ........................................................ Land ($220,000 - $200,000) ........................................
(4) Total depreciation recorded during the year: For buildings ................................................................ For equipment ............................................................. Total depreciation expense for the year: .....................
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27,000 7,000 20,000
$55,000 21,000 $76,000
Chapter 13
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7B (CONTINUED) (a) (continued)
(5) Transactions involving Retained Earnings: Retained Earnings Dividends declared (derived)
Dec. 31, 2017 29,000 Net income Dec. 31, 2018
60,000 89,000 120,000
Dividends Payable Dividends paid
Dec. 31, 2017 28,000 Dividends declared Dec. 31, 2018
2,000 29,000 3,000
(6) Transactions involving Bank Loan Payable: Bank loan balance Dec. 31, 2017: Current portion ........................................................... $ 40,000 Non-current portion .................................................... 418,000 Total ........................................................................... $458,000 Bank loan balance Dec. 31, 2018: Current portion ........................................................... $ 52,000 Non-current portion .................................................... 673,000 Total ........................................................................... $725,000 Net increase during the year ($725,000 – $458,000) ...... $267,000 Additions to the bank loans during the year (given) ......... 300,000 Repayments made on bank loans during the year .......... $ 33,000 Total Bank Loan Loan payments
33,000
Dec. 31, 2017 New loans Dec. 31, 2018
458,000 300,000 725,000
(7) Transactions involving Common Shares: Common Shares Shares repurchase
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26,000
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Dec. 31, 2017 Shares issued Dec. 31, 2018
172,000 250,000 396,000
Chapter 13
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-7B (CONTINUED) (b)
Summerville Ltd. did a great job managing its noncash working capital efficiently. It decreased both its accounts receivable and inventory while at the same time increased its accounts payable. A creditor might find this alarming because suppliers don’t look as if they are being paid on time. As well, a decline in inventory might not necessarily mean that the company is making sure that inventory is on hand to secure sales.
(c)
Summerville financed the majority of the purchase of the building by issuing common shares for $250,000 and by borrowing $300,000 from the bank. These two amounts are well balanced between debt and equity. Summerville had excellent performance in obtaining cash from operating activities. The amount of dividends paid is reasonable given the net income for the year.
LO 2,3 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-8B (a) (USD millions)
Microsoft
Free cash flow
$26,024 – $9,915 – $0 = $16,109
$33,325 – $23,950 – $11,006 = $(1,631)
Although Microsoft has a negative free cash flow, this result can be explained by the distribution of cash for a large dividend and the substantial amount of capital expenditures made during the year. Had Google done proportionate investments and distributions, it too would have experienced a negative free cash flow. The results of the calculation do indicate that Google has a better free cash flow, because it is positive. (b)
Microsoft has been profitable for many years during its growth phase of its life cycle and has amassed significant amounts of cash allowing it to pay dividends. Microsoft is currently in the mature phase of its life cycle, with less growth year over year in its stock price. Consequently, shareholders are demanding a return on their investments in the form of dividends. Google, on the other hand is in the growth phase of its life cycle and needs to use the cash it generates from operations to finance its growth. It is not unusual in that situation for companies not to pay dividends.
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 13-9B (a)
Both companies generated cash from operating activities. McDonald’s made significant investments back into the business, while Wendy’s obtained more cash from disposals than the amounts it spent on capital investments. For financing activities, the cash flow trends for these two companies were also opposite. While McDonald’s managed to increase its cash from financing activities, Wendy’s used substantial amounts of cash in financing activities. Both companies produced more cash from operating activities than net income with McDonald’s showing the larger proportion of cash from operating activities to net income. Overall increases in cash were modest for Wendy’s while close to tripling in the case of McDonald’s. ($ in USD millions) Net income Net cash provided by operating activities Net cash provided by operating activities in excess of net income Net cash provided by operating activities as a % of net income % increase in cash from prior year
(b)
McDonald’s $4,529.3 $6,539.1
Wendy’s $161.1 $212.5
$2,009.8
$51.4
144%
132%
270%
22%
McDonald’s is in the stronger position. One would need to look at the detailed information behind the totals of each activity. Specific large transactions may have offsetting effects in a particular cash flow activity. As a consequence, the netting of amounts masks the real effects of those transactions, which may have been unique to that fiscal year. More information in terms of past trends would also be helpful to properly compare these two companies.
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-10B (a) (1) HANALEI INTERNATIONAL INC. Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2018
Operating activities Net income ....................................................................... Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense .............................................. Amortization expense .............................................. Gain on disposal ...................................................... Decrease in accounts receivable ............................. Decrease in prepaid insurance ................................ Increase in accounts payable .................................. Increase in salaries payable .................................... Decrease in unearned revenue................................ Increase in income tax payable ............................... Net cash provided by operating activities ..................................
(2)
$142,500
$45,000 5,000 (25,000) 10,000 3,000 9,000 3,000 (4,000) 1,000
47,000 $189,500
HANALEI INTERNATIONAL INC. Statement of Cash Flows (Partial)—Direct Method Year Ended December 31, 2018
Operating activities Cash receipts from customers ............................ Cash payments For operating expenses ............................. To employees ............................................ For interest expense .................................. For income tax ........................................... Net cash provided by operating activities ....................
$571,000 (1) $(28,000) (2) (297,000) (3) (10,000) (46,500) (4)
(381,500) $189,500
Note: Calculations follow below.
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-10B (CONTINUED) (a) (continued)
Calculations (1)
(2)
(3)
(4)
(b)
Cash receipts from customers Revenues.................................................................................. Add: Decrease in accounts receivable ($60,000 – $50,000) ... Deduct: Decrease in unearned revenue ($14,000 – $10,000) .. Cash receipts from customers ..................................................
$565,000 10,000 (4,000) $571,000
Cash payments for operating expenses Administrative expenses ........................................................... Deduct: Decrease in prepaid expenses .................................... Increase on accounts payable .................................... Cash payments for operating expenses ...................................
$40,000 (3,000) (9,000) $28,000
Cash payments to employees Salaries expense ...................................................................... Deduct: Increase in salaries payable ($10,000 – $7,000) ....... Cash payments to employees...................................................
$300,000 (3,000) $297,000
Cash payments for income tax Income tax expense .................................................................. Deduct: Increase in income tax payable ($4,000 – $3,000) .... Cash payments for income tax .................................................
$47,500 (1,000) $46,500
Both methods are acceptable under both IFRS and ASPE. I would recommend that the company use the direct method to prepare its operating activities section. Users usually find this method to be more informative because it shows cash receipts from customers and other sources, and cash payments for major categories. It is also the preferred method by the standard setters. Nonetheless, many companies prefer to use the indirect method because it is easier to prepare and their accounting system may not be adapted to capture the transaction data required in the direct method.
LO 2,5 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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Financial Accounting, Seventh Canadian Edition
*PROBLEM 13-11B (a) GUM SAN LTD. Statement of Cash Flows (Partial)—Direct Method Year Ended December 31, 2018
Operating activities Cash receipts From customers .................................... Cash payments To suppliers .......................................... For operating expenses ........................ For interest............................................ For income tax ...................................... Net cash provided by operating activities ...............
$4,008,000 (1) $(2,120,000) (1,267,000) (7,000) (276,000)
(2) (3) (4) (5)
(3,670,000) $ 338,000
Calculations (1)
(2)
(3)
Cash receipts from customers Sales ....................................................................................... Add: Increase in unearned revenue ........................................ Deduct: Increase in accounts receivable ................................ Cash receipts from customers ................................................
$4,500,000 8,000 (500,000) $4,008,000
Cash payments to suppliers Cost of goods sold .................................................................. Deduct: Decrease in inventory ............................................... Cost of purchases ................................................................... Deduct: Increase in accounts payable ................................... Cash payments to suppliers....................................................
$2,390,000 (220,000) 2,170,000 (50,000) $2,120,000
Cash payments for operating expenses Operating expenses ................................................................ Add: Gain on disposal .............................................................. Decrease in accrued liabilities ....................................... Increase in prepaid expenses ........................................ Deduct: Depreciation expense ............................................... Cash payments for operating expenses ..................................
$1,070,000 12,000 165,000 170,000 (150,000) $1,267,000
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*PROBLEM 13-11B (CONTINUED) (a) (continued)
(4)
(5)
(b)
Cash payments for interest Interest expense ...................................................................... Deduct: Increase in interest payable ........................................ Cash payments for interest ......................................................
$12,000 (5,000) $ 7,000
Cash payments for income tax Income tax expense ............................................................... Add: Decrease in income tax payable .................................. Cash payments for income tax ..............................................
$260,000 16,000 $276,000
If Gum San were a publicly traded company following IFRS, it could choose to disclose interest expense as part of financing activities rather than operating activities. Reporting interest paid as in part (a) in the operating activities section above is the usual practice for a publicly traded company and the required practice followed by a private company using ASPE.
LO 5 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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*PROBLEM 13-12B (a) NACKAWIC INC. Statement of Cash Flows—Direct Method Year Ended December 31, 2018
Operating activities Cash receipts from customers (1) ......................................... Cash payments To suppliers (2) ............................................................ $(114,290) For operating expenses (3) .......................................... (38,900) For interest................................................................... (12,940) For income tax ............................................................. (27,670) Net cash provided by operating activities ....................................... Investing activities Sale of long-term investments ............................................... Disposal of equipment ........................................................... Purchase of equipment .......................................................... Net cash used by investing activities ..............................................
$273,700
(193,800) 79,900
$ 5,000 15,550 (71,000) (50,450)
Financing activities Issue of common shares ($240,000 – $200,000) .................. $40,000 Payment of cash dividends ($121,790 + $87,810 – $175,600) (34,000) Net cash provided by financing activities ........................................
6,000
Net increase in cash ....................................................................... Cash, January 1 ............................................................................. Cash, December 31 ........................................................................
35,450 47,250 $ 82,700
Note X to the Statement of Cash Flows: Equipment costing $141,000 was purchased by paying $71,000 cash and issuing a bank loan payable for $70,000. Note: Calculations follow below.
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*PROBLEM 13-12B (CONTINUED) (a) (continued)
Calculations (1)
(2)
(3)
(b)
Cash receipts from customers Revenues.................................................................................. Deduct: Increase in accounts receivable ................................. Cash receipts from customers ..................................................
$317,500 (43,800) $273,700
Cash payments to suppliers Cost of goods sold .................................................................. Add: Increase in inventory ..................................................... Cost of purchases ................................................................... Deduct: Increase in accounts payable ................................... Cash payments to suppliers....................................................
$ 99,460 29,250 128,710 (14,420) $114,290
Cash payments for operating expenses Operating expenses .................................................................. Add: Decrease in accrued liabilities ........................................ Gain on disposal ............................................................ Deduct: Depreciation expense ................................................ Cash payments for operating expenses ....................................
$82,120 6,730 8,750 (58,700) $38,900
Nackawic’s cash position has increased primarily because of the amount of cash generated from its operating activities. Cash from operating activities increased the company’s cash account by $79,900. Some of this cash was used to purchase equipment and pay dividends with additional cash generated from selling common shares. Sufficient cash remained at the end of the year to increase its cash position by $35,450.
LO 5 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
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CT13-1
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a)
The North West Company Inc. uses the indirect method of calculating operating activities.
(b)
North West generated cash from operating activities in the amount of $132,987,000 for the year ended January 31, 2016 and $115,086,000 for the year ended January 31, 2015.
(c)
The most significant investing activity for North West is cash used for the purchase of property and equipment, in the amount of $63,179,000 The largest use of cash from financing activities was from the payment of dividends, in the amount of $58,210,000.
(d)
Cash increased by $8,114,000 for the year ended January 31, 2016, and by $6,776,000 for the year ended January 31, 2015.
(e)
North West increased its spending for property and equipment for the year ended January 31, 2016 by approximately $14 million compared to the previous year. Dividends increased by about $2 million. These increases were made possible by an increase of about $18 million in the amount of cash generated by operating activities.
(f)
North West used the cash generated from operating activities to increase capital expenditures and dividends paid, as mentioned in (e) above. An increase in long-term debt was closely offset by intangible asset additions of $12,804,000. Besides these three differences, other cash trends were similar when comparing the two years.
LO 1,4 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic and Communication CPA: cpa-t001 CM: Reporting
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CT13-2
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
(a)
Companies following ASPE classify interest paid, interest revenue, and dividend revenue, as part of operating activities because they are disclosed on the income statement as part of net income. Dividend payments are classified as financing activities. This is the most common practice for both publicly traded and private companies. Companies following IFRS may classify interest and dividend revenue as either investing activities or operating activities; and interest and dividend payments as either financing activities or operating activities. In order to present the strongest (largest) performance for cash obtained from operating activities, Discount Ltd.’s management probably chose to classify interest and dividend revenue as operating activities as these can only be positive cash flows and likely would have chosen to classify interest and dividend payments under financing activities as these can only be negative cash flows.
(b)
Increasing the cash flows from operating activities by using the classification choices described in part (a) will provide for a larger (better) free cash flow as the amount of cash flow from operating activities will be larger, leaving more cash remaining after covering capital expenditures and dividend payments.
LO 1,4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT13-3
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS. (a)
During 2017, the purchase of property, plant, and equipment in the amount of $2 billion dollars was financed differently by the three companies. While some of the financing came from using cash generated from operations, A Limited chose to finance the balance needed with a blend of debt and equity financing that was similar in amount. B Limited chose to use only equity and C Limited financed with mostly debt. For 2018, expansion continued at an even greater pace for A Limited, which spent $2,350 million on property, plant, and equipment, while B and C acquired far fewer of these assets. A Limited financed this higher level of expenditures by using net cash from operating activities and by issuing more common shares. Because the majority of the investments in 2017 made by C Limited were financed with debt, even though C Limited was able to pay down some of this debt in 2018 and reduce it to a lower amount than the debt held by A Limited, relative to its assets, of the three companies, C Limited still has the greatest percentage of its assets financed with debt as the other two companies have used equity more extensively than C Limited.
(b)
C Limited is the only company that had a decrease in the net cash from its operating activities in 2018. This happened because too much cash was tied up in accounts receivable and inventory. The increases in these current assets, particularly during 2018, caused a large reduction of cash that could have been used instead to reduce the high levels of debt.
(c)
C Limited likely did not have a choice to pay down its bank loans in 2018. It was forced to do so by the bank. C Limited had poor performance in managing accounts receivable and inventory that in turn caused a shortage of cash needed to satisfy the bank’s concerns with regard to its liquidity and solvency. C Limited resorted to the desperate measure of selling off some its non-current assets at a loss of $70 million to raise the cash needed to pay down the bank loans.
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CT13-3 (CONTINUED) (d)
As a shareholder interested in dividends and not in growth in the value of my investment, I would consider investing in B Limited. The amount of dividends paid by B Limited in 2018 was $120 million, which is 10% of the total value of shares issued. This percentage is lower for the other two companies so shareholders in B Limited are receiving the largest dividend relative to the amount invested.
(e)
A Limited is the company most committed to growth as demonstrated by the large investment in property, plant, and equipment that continued into 2018. So long as shareholders feel that the cash spent provides for growth in the market value of the common shares issued, the pace of expansion is not excessive since it was financed with equity, which will not cause a reduction in cash flow due to interest payments.
(f)
C Limited has the highest free cash flow.
Net cash provided by operating activities Purchases of property, plant, and equipment Dividends paid Free cash flow (g)
A Limited $1,030 (2,350) (100) $(1,420)
B Limited $980 (830) (120) $30
C Limited $820 (430) (5) $385
If I was interested in owning the shares of one of these companies, I would likely not invest in C Limited due to the build up of inventory and accounts receivable shown in the operating activities section of the statement of cash flows. I would also be concerned about a management team that raised funds in 2017 to buy non-current assets, and then sold some of them in 2018 at a loss. As an investor I would like the fact that A Limited is growing, but I would like to know at what point the expansion occurred in 2018. If it occurred early in the year, one would expect, given the larger asset base of this company, that net income would be higher. However, if the expansion occurred very late in 2018, the extra asset base could trigger much higher amounts of net income next year compared to 2018. On the other hand, B Limited seems to be conservatively financed with little debt, so it has the potential to expand very easily in the future. So before making a decision, I would need more information about the success of A Limited’s 2018 expansion before buying their shares. It should be noted that B Limited is probably the safest company to lend money to, given its low level of debt and its reasonably high operating cash flows.
LO 4 BT: E Difficulty: C Time: 45 min. AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT13-4
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
(a)
Based on the changes in cash flows in the 10-year period, Apple was in its introductory phase of its operating cycle in 2005 and by 2010 through to 2015 continued to be in the growth phase of its operating cycle. In 2005 no dividends were paid, to assist in financing investments that exceeded cash generated from operations. In 2010 there were no dividends paid but Apple could likely have made such a payment and was under pressure from some shareholders to do so. Investors were satisfied with increases in stock prices and most shareholders bought the stock for price appreciation potential. By 2015 Apple was still growing but the stock price declined or increased more modestly, which likely did not satisfy shareholders. Dividends had to be paid to provide shareholders with a return on their investment.
(b)
Free cash flow in millions of US dollars: Cash provided by operating cash flows
2015 $81,266
2010 $18,595
2005 $2,535
Capital expenditures paid during the year Dividends paid during the year Free cash flow As a % of cash from operating cash flows
11,831 11,561 $57,874 71.2%
2,759 ______ $15,836 85.2%
281 _____ $2,254 88.9%
The free cash flow as a percentage of operating cash flows is declining but not at the same rate as the rate of increase in the cash provided by operating cash flows. We can conclude that the amount of investments and distributions are in line with the performance of the business and its ability to generate cash from operations. Apple is reacting to the needs of its shareholders, which is consistent with the responses in part (a) above. LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT13-5 (a)
ETHICS CASE
A company’s dividend policy should be based on several factors other than the requirement to pay the “usual” dividend. Some of these factors include:
(b)
Financial Accounting, Seventh Canadian Edition
Legal requirements such as the Business Corporations Acts for the jurisdiction in which the company is incorporated. For example, the Canada Business Corporations Act specifies certain requirements that must be met in order for companies to be able to pay dividends; these requirements include solvency and a positive (credit) balance in Retained Earnings. Creditor or other contractual requirements: some creditor loan agreements can specify financial ratios that must be maintained or limit the amounts of dividends that can be paid out to shareholders. The company’s short-term and long-term budgets and goals. The payment of dividends uses the company’s cash, and management has to ensure that sufficient cash remains to operate the business and meet its short-term and long-term goals, such as property, plant, and equipment purchases, expansion, and debt repayment.
The stakeholders in this situation are: Phil Monat, president and CEO of Onwards and Upwards Corporation Leland Yee, controller The board of directors The shareholders of Onwards and Upwards Corporation
(c)
The president’s statement, “We must get that amount above $1 million,” puts undue pressure on the controller. This statement along with his statement, “I know you won’t let me down, Leland,” encourages Leland to do something unethical. Controller Leland Yee’s reclassification (intentional misclassification) of cash payments from interest as an operating activity to a financing activity is inappropriate and unethical. Although companies reporting under IFRS have the choice to show interest payments under either operating or financing activities, the presentation must be consistent from year to year.
(d)
Yes. Under IFRS, it is permissible to show interest paid as a financing rather than an operating cash payment but such a change should be consistent from year to year. Companies reporting under ASPE must classify interest paid as part of operating activities and do not have the choice to show these payments as part of financing activities.
LO 1 BT: C Difficulty: M Time: 30 min. AACSB: Ethics and Communication CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics
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CT13-6 (a)
Financial Accounting, Seventh Canadian Edition
STUDENT VIEW CASE
Statement of Cash Flows—Direct Method Year Ended (date) Operating activities Cash receipts from salary ..................................... Cash payments For rent and utilities ..................................... For interest................................................... For car expenses ......................................... For food, entertainment, and recreation ....... Net cash provided by operating activities ......................
$45,000 $(16,600) (1,400) (4,800) (6,000)
Investing activities Purchase of car..................................................... Purchase of investments ...................................... Purchase of computer ........................................... Disposal of computer ............................................ Disposal of motorcycle .......................................... Net cash used in investing activities ..............................
$(20,000 ) (5,500) (1,500) 100 1,000
Financing activities Increase in credit card debt ($2,500 – $1,000) ...... Decrease in line of credit ($2,500 – $1,200) ......... Car loan obtained .................................................. Repayment of student loan ($15,000 – $10,000) ... Net cash provided by financing activities ........................
$ 1,500 (1,300) 15,000 (5,000)
(28,800 ) 16,200
(25,900)
10,200
Net increase in cash ....................................................... Cash, beginning of year .................................................. Cash, end of year ...........................................................
(b)
500 500 $ 1,000
Depending on the level of security for the large investment made during the year, your friend should likely consider the benefits of eliminating some interest expenses by reducing debt that carries a higher interest rate than the yield obtained from the investment.
LO 5 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-e003 CM: Reporting and Comm.
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CT13-7
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
(a)
Free cash flow
(b)
ABC Ltd. $225,279 – $54,000 – $80,000 = $91,279
Software Solutions Inc. $6,821,000 – $3,414,000 – $580,000 = $2,827,000
Compuhelp Limited $159,400 – $144,800 – $0 = $14,600
ABC is able to generate a significant amount of cash from its operating activities—in excess of its net income. It uses cash for both its investing activities and financing activities. The use of cash in investing activities indicates that ABC is investing in its property and equipment, which is a good sign for future growth. Its use of cash in financing activities indicates that it is either repaying more debt than it is raising (through debt or equity) or are using cash for dividends. From the additional information, we can determine that an $80,000 dividend was paid. Software Solutions is also generating a significant amount of cash from its operating activities—far in excess of its net income. It is also using cash in both its investing and financing activities. From this, it appears to be in the maturity stage of its corporate life cycle. Compuhelp’s cash flows tell a bit of a different story. Although it is also generating a significant amount of cash from its operating activities in excess of its net income, it is insufficient to cover the investing and financing activities. It does not pay a dividend so most of its cash used for financing activities is likely repaying debt on its capital expenditures. All of this has resulted in a net decrease in cash during the year, leaving the company with a low ending cash balance and an inability to declare dividends.
(c)
As we saw above, ABC is generating positive cash from its operating activities. While its free cash flow is reduced (because of its investment in capital expenditures and relatively large dividend), it has little debt and is able to pay a generous dividend. Overall, the company appears to report strong net income and cash flow, which are likely two of the financial reasons Software Solutions and Compuhelp are interested in acquiring ABC, in addition to strategic reasons discussed earlier.
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CT13-7 (CONTINUED) (d)
The Anthonys will likely favour Software Solutions over Compuhelp. Software Solutions appears to have a stronger financial position. It has more cash available to pay for its investment in ABC. Compuhelp does not pay a dividend and has decreased its overall cash position during 2019. Compuhelp’s free cash flow is significantly less than that of Software Solutions. Other issues the Anthony family should consider before finalizing their decision could include:
Determining what percentage of ownership Emily and Daniel will have going forward. How will Emily and Daniel feel about the change in control? Will they be paid in cash for the purchase of their shares or will they be asked to take back a note or preferred shares in partial payment? What are the income tax consequences of this sale?
LO 4 BT: E Difficulty: M Time: 45 min. AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005, cpa-e003 CM: Reporting, Finance, and Comm.
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CHAPTER 14 PERFORMANCE MEASUREMENT LEARNING OBJECTIVES 1. 2. 3. 4. 5.
Explain and apply comparative analysis. Calculate and interpret ratios that are used to analyze liquidity. Calculate and interpret ratios that are used to analyze solvency. Calculate and interpret ratios that are used to analyze profitability. Understand the limitations of financial analysis.
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO 1. 2. 3.
BT
1 1 1
C C C
4.
1
5.
1
Item LO
BT
Item LO BT Questions
Item LO
BT
Item LO
BT C K C
6. 7. 8.
1 1,2 2
C C C
11. 12. 13.
3 3 3
C C C
16. 17. 18.
4 4 2,3,4
C C C
21. 22. 23.
5 5 5
C
9.
2
C
14.
4
C
19.
5
C
24.
5
C
K
10.
2
C
15.
4
C
20.
5
C
25.
4,5
C
10. 11. 12.
3,4 4 4
AN AN AN
13. 14. 15.
4 4,5 5
AN AN AN
13. 14. 15. 16.
4 2,3,4 5 5
AN AN AN AN
2,3,4 2,3,4
AN AN
9.
5
AN
2,3,4
E
Brief Exercises 1. 2. 3.
1 1 1
AP AN AP
4. 5. 6.
1 1 2
AP AN AN
7. 8. 9.
1. 2. 3. 4.
1 1 1 2,3,4
AN AN AN C
5. 6. 7. 8.
2 2 2 3
AN AN AN AN
9. 10. 11. 12.
1. 2.
1 1
AN AN
3. 4.
1 2,3,4
AN AN
2 2 3
AN AN AN
Exercises 3 3 4 4
AN AN AN AN
Problems: Set A and B 5. 6.
2,3,4 2,3,4
AN AN
7. 8.
Accounting Cycle Review 1. 1,2,3,4 AN
Cases 1. 1,2,3,4 AN 2. 2,3,4 E
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3. 4.
2,3,4,5 AN 1,2,3,4 AN
5. 6.
1,2,3,5 C 4 AN
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Financial Accounting, Seventh Canadian Edition
Legend: The following abbreviations will appear throughout the solutions manual file. LO
Learning objective
BT
Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation
Difficulty:
Level of difficulty S Simple M Moderate C Complex
Time:
Estimated time to prepare in minutes
AACSB
Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflec. Thinking Reflective Thinking
CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006
CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation
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ANSWERS TO QUESTIONS 1. (a)
An answer cannot be calculated for the percentage change when there is no value in a base year, because division by 0 is mathematically impossible. However, the absolute dollar value of the change from the base year can be determined.
(b)
An answer cannot be calculated for the percentage change when there is a negative value in a base year and a positive value in the next year. However, the absolute dollar value of the change from the base year can be determined.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
2.
Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one statement is compared with the amount of that same item on one or more earlier statements. Horizontal analysis measures items across years (or periods). Vertical analysis (also called common size analysis) expresses each item within a financial statement in terms of a percent of a relevant total, usually the largest item within the same statement. Vertical analysis measures items within the same year (or period).
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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3.
Financial Accounting, Seventh Canadian Edition
(a)
Horizontal percentage of a base-period amount is accomplished by using a base year for comparative purposes, which is assumed to be 100. The results of any subsequent year are compared to the base year by dividing the results from the year in question by the results from the base year. For example, assume that XYZ Inc. reported net income of $200,000 and $220,000 for 2017 and 2018, respectively. If 2017 is assumed to be the base year, the percent of base period amount is calculated as follows: $220,000 ÷ $200,000 = 110%, and expressed as a percentage.
(b)
Horizontal percentage change for a period is calculated by dividing the dollar amount of the change between the specific year under analysis and the base year by the base-year amount. In calculating the percentage change for a period, each prior year is set as the base year in order to assess trends in changes between years. In the above example discussed in (a), the horizontal percentage change for the period would be 10% (($220,000$200,000)/$200,000).
(c)
In vertical percentage of a base amount, each item in a financial statement is expressed as a percentage of a base amount in the same financial statement, providing analysis of data within the same year. The base amount commonly used for the statement of financial position is total assets and the base amount commonly used for the income statement is net sales or revenues. For example, assume that XYZ Inc. reported merchandise inventory of $200,000 and total assets of $5,000,000 for 2017. The percent of base amount is calculated as $200,000 ÷ $5,000,000 = 4%, and expressed as a percentage.
LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
4.
Trend analysis is made difficult when a limited amount of information is available to the ge years that are being analyzed. Vertical analysis may be less problematic because it is based on percentages determined with reference to a base amount in the current year.
LO 1 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
5.
(a)
The base amount assigned a 100% value in a vertical analysis of a statement of financial position is usually total assets.
(b)
The base amount assigned a 100% value in a vertical analysis of an income statement is usually net sales.
LO 1 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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6.
Financial Accounting, Seventh Canadian Edition
Yes. Companies competing in the same industry that are different sizes and in different countries with different currencies can be compared. For instance, a company may want to know whether its gross profit margin percentage is in line with that of its competition. Vertical analysis uses percentages to place the results of both companies side by side, which allows for a comparison despite differences such as size and currency.
LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
7.
(a)
Comparison of financial information can be made on an intracompany basis, intercompany basis, and industry average basis (using predetermined norms). • • •
The intracompany basis compares an item or financial relationship within the current year or with one or more prior periods, within the same company. The intercompany basis compares the same item or relationship with one or more competing companies. The industry average basis compares an item or relationship with that of the industry.
These three bases of comparison should be used together. LO 1,2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
7.
(b) Horizontal analysis is useful in detecting significant trends within a company and in assessing the impact of economic changes that affect the industry. It is best used in intracompany comparisons, although it can also be used to compare with one or more competing companies. Vertical analysis is useful in detecting changes in financial relationships between years, with competitors and between companies in the same industry. It is best used in intercompany comparisons, although it can also be used to compare the company’s data on an intracompany basis. Ratio analysis is useful to evaluate the significance of financial data within the same company across different years and to provide insight into a company's position relative to other companies and to the industry. Ratio analysis can be used with all three bases of comparisons— intracompany, intercompany, and industry averages.
LO 1,2 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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8.
Financial Accounting, Seventh Canadian Edition
A high current ratio is usually a good indicator of a company’s liquidity. However, it might be hiding liquidity problems with regard to inventory or accounts receivable. For example, a high level of inventory will cause the current ratio to increase. Increases in inventory can be because inventory is not selling and may be obsolete. Increases in the current ratio will also occur if the company’s accounts receivable increase. An increase in accounts receivable could indicate the company is having trouble collecting its overdue accounts, which again would mean liquidity problems for the business.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
9.
A lower result is better in the case of the following liquidity ratios: average collection period and days in inventory. The longer assets are held before they are converted to cash, the longer the business needs to finance these assets.
LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
10.
Increasing the inventory turnover will reduce the amount of inventory reported at cost on the statement of financial position, because the inventory is being sold more quickly. The accounts receivable are increased at the selling price of the inventory being turned over more quickly. Independent of the above, if the accounts receivable turnover increases, the cash will be increased more quickly and the accounts receivable will reduce more quickly from earlier collections. Taken together, total current assets should increase, by the amount of the additional gross profit that is being recorded more quickly. Consequently, the current ratio will improve (increase).
LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
11.
A lower result is better in the case of the debt to total assets solvency ratio because debt gives rise to servicing charges such as interest and also requires principal repayments, which will have to be paid with the use of cash. For the remaining solvency ratios, including times interest earned and free cash flow, a higher result is better.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
12.
Magna has a lower (better) debt to total assets ratio than the industry average and a much higher (better) times interest earned ratio than the industry average. As a result, Magna’s solvency is better than other businesses in the same auto parts industry.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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13.
Financial Accounting, Seventh Canadian Edition
Amber has likely used the additional debt for investments in long-lived assets which in turn have increased income from operations. Although Amber would have incurred more interest expense from the increased debt, this additional debt (leverage) was used to produce a greater amount of income than the additional interest costs. Baxter on the other hand did not invest the additional debt in a way that increased net income as much as the additional interest expense incurred which caused the times interest earned ratio to fall. For example, the additional debt may have been used to buy unproductive assets or to pay dividends.
LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
14.
The profit margin and the asset turnover ratio combine mathematically (when multiplied) to equal the return on assets ratio. To increase its return on assets, a company can increase its profit margin or increase its asset turnover, or both at the same time.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
15.
The return on common shareholders’ equity is affected by both the return on assets and the debt to total assets ratio. To increase its return on common shareholders’ equity, a company can increase its return on assets or increase its leverage (as measured by the debt to total assets ratio). Leverage, however, should only be increased if the increased interest expense on the increased level of debt can be covered by higher income.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
16.
The difference between CIBC’s return on assets of 0.8% and the return on common shareholders’ equity of 18.7% means that the company must be using a substantial amount of debt to finance their assets and is using leverage effectively. This debt is likely in the form of customers’ bank accounts, which are in turn lent out to others to earn a higher rate of interest than the one paid to customers on their deposits.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-7
Chapter 14
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17.
Financial Accounting, Seventh Canadian Edition
(a)
To consider how investors view a company’s growth potential, investors would focus primarily on the price-earnings ratio. If this ratio is high, it means that the market expects the company to grow rapidly.
(b)
To consider income potential, this generally refers to receiving dividends from the company. Investors would focus on the payout ratio to determine the extent to which the company pays dividends from the income earned and consider the dividend yield to measure the rate of return that a dividend gives the investor relative to the share’s price.
LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
18.
(a) (b) (c) (d) (e) (f) (g)
Asset turnover Inventory turnover, days in inventory Return on common shareholders’ equity Times interest earned Current ratio Payout ratio Price-earnings ratio
LO 2,3,4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
19.
The factors that can limit the usefulness of financial analysis are the use of alternative accounting policies, professional judgement, comprehensive income, diversification, inflation, and economic factors. The use of different accounting policies can impact a company’s results and, therefore, lessen comparability. The use of professional judgement may introduce the possibility of bias and impacts the many estimates made in preparing financial statements. Significant sources of comprehensive income should be considered in assessing a company’s profitability, even though OCI is not typically used in ratios. Many companies are diversified, which makes it difficult to compare them since they cannot be classified to a single industry. Inflation is not considered in the preparation of financial statements so assessment of growth rates and trends may not be accurate if inflation is significant. Understanding the effect of the economy is also important in correctly interpreting financial information.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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20.
Financial Accounting, Seventh Canadian Edition
When using a conservative approach in estimating expenses, a company would select the estimate that produced the higher (larger) expense. Consequently, this approach would lead to a lower profit margin ratio.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
21.
(a)
Discontinued operations refers to disposal, or availability for sale, of an identifiable component or segment of a business, which comprises a major line of business or geographical area of operations.
(b)
A component of an entity is a separate major line of business or major geographical area of operations. It must be clearly distinguishable, operationally and financially, from the rest of the company.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
22.
Other comprehensive income is excluded in the determination of profitability ratios.
LO 5 BT: K Difficulty: S Time: 2 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
23.
The use of IFRS and ASPE consist of several areas where accounting policies are different and where certain ratios are not available (e.g., price-earnings ratio for a private company). This limits comparability between companies and for comparison of a company’s results to industry averages.
LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
24.
Management uses the Management Discussion and Analysis (MD&A) portion of the annual report to the shareholders to show information considered to be more effective in communicating performance. MD&A contains information such as the company’s mission, strategy, goals and objectives as well as progress reports on long-term strategies. The measures used in the MD&A reporting go beyond those measurements used under IFRS or ASPE and are often non-GAAP measures.
LO 5 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-9
Chapter 14
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25.
Financial Accounting, Seventh Canadian Edition
(a)
Potash Corporation’s profitability has deteriorated as its profit margin including or excluding other comprehensive income has decreased from 2014 to 2015.
(b)
It is common practice to calculate profitability ratios using net income rather than comprehensive income. Typically, items recorded in OCI are not largely significant and may not be a reflection of the operations of a company. Sometimes they consist of non-recurring items. Another reason for excluding OCI from ratios is because companies reporting under ASPE do not use OCI so comparing a profitability ratio of a public company based on comprehensive income with a private company that reports only net income would not give a fair comparison. Nonetheless, if a public company does have a significant amount of OCI, we should strive to understand its impact on the company.
LO 4,5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-10
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 (a)
Horizontal percentage of a base-year amount
Cash Accounts receivable Inventory Property, plant, and equipment Intangible assets
2018
2017
2016
200.0%5 133.3%6 111.4%7 109.8%8
233.3%1 88.9%2 85.7%3 98.2%4
100% 100% 100% 100%
—
—
—
1
$175,000 = 233.3% $75,000
5
$150,000 = 200.0% $75,000
2
$400,000 = 88.9% $450,000
6
$600,000 = 133.3% $450,000
3
$600,000 = 85.7% $700,000
7
$780,000 = 111.4% $700,000
4
$2,800,000 = 98.2% $2,850,000
8
$3,130,000 = 109.8% $2,850,000
Solutions Manual .
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Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-1 (CONTINUED) (b)
Horizontal percentage change for each year
Cash Accounts receivable Inventory Property, plant, and equipment Intangible assets
2018
2017
(14.3)%5 50.0%6 30.0%7 11.8%8 (10.0)%9
133.3%1 (11.1)%2 (14.3)%3 (1.8)%4 —
2016 0% 0% 0% 0% —
1
($175,000 – $75,000) = 133.3% $75,000
6
($600,000 – $400,000) = 50.0% $400,000
2
($400,000 – $450,000) = (11.1)% $450,000
7
($780,000 – $600,000) = 30.0% $600,000
3
($600,000 – $700,000) = (14.3)% $700,000
8
($3,130,000 – $2,800,000) = 11.8% $2,800,000
4
($2,800,000 – $2,850,000) = (1.8)% $2,850,000
9
($90,000 – $100,000) = (10.0)% $100,000
5
($150,000 – $175,000) = (14.3)% $175,000
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 14-2 Comparing the percentages presented results in the following conclusions: The net income for Coastal decreased in 2017 over 2016. Cost of goods sold and operating expenses increased faster than net sales. In addition, income tax expense declined indicating that income from operations also declined, assuming no change in the income tax rate. Net income in 2018 increased over 2017. Sales increased faster than did cost of goods sold and operating expenses, which actually declined. Income tax expense increased indicating that income from operations also increased, assuming no change in the income tax rate. LO 1 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-3 (a) 2018 125%
2017 96%
2016 100%
Property, plant, and equipment
110%
98%
100%
Goodwill
117%
100%
100%
Current assets
Total assets
We did not calculate the change in goodwill since there was no goodwill in 2016. (b) 2018 Current assets
Amount $1,530,000
Percentage 32.2%
Property, plant, and equipment
3,130,000
65.9%
90,000
1.9%
$4,750,000
100.0%
Goodwill Total assets
2017 Current assets Property, plant, and equipment Goodwill Total assets
Amount $ 1,175,000
Percentage 28.8%
2,800,000
68.7%
100,000 $ 4,075,000
2.5% 100.0%
2016 Current assets Property, plant, and equipment Goodwill Total assets
Amount $ 1,225,000
Percentage 30.1%
2,850,000
69.9%
-
0.0%
$ 4,075,000
100.0%
LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-13
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-4 Net sales Cost of goods sold Gross profit Operating expenses Income before income tax Income tax expense Net income
2018 Amount Percentage $1,914 100.0% 1,612 84.2% 302 15.8% 218 11.4% 84 4.4% 17 0.9% $ 67 3.5%
2017 Amount Percentage $2,073 100.0% 1,674 80.8% 399 19.2% 210 10.1% 189 9.1% 38 1.8% $ 151 7.3%
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 14-5 Net income as a percentage of sales for Waubon decreased in 2017 because cost of goods sold and operating expenses increased. The decrease in income tax expense was too small to offset the increase in the other expenses. Net income as a percentage of sales increased in 2018 as both cost of goods sold and operating expenses as a percentage of sales decreased. The increase in income tax expense was too small to offset the decrease in other expenses. For information, the calculated net income as a percentage of sales is: 2016 = 16% (100% – 60% – 20% – 4%) 2017 = 15.3% (100% – 60.5% – 20.4% – 3.8%) 2018 = 16.8% (100% – 59.4% – 19.6% – 4.2%). LO 1 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-14
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-6 (a) Current ratio Receivables turnover Inventory turnover 1
2
3
2018 2.1 : 1 8.0 times 4.5 times 4
$2,100,000 = 2.1 :1 $1,000,000 $2,000,000 = 1.8 :1 $1,100,000 $6,420,000 = 8.0 times ($850,000 + $750,000) ÷ 2 (b)
5
6
1 3 5
2017 1.8 : 1 8.9 times 5.0 times
2 4 6
$6,240,000 = 8.9 times ($750,000 + $650,000) ÷ 2 $4,540,000 = 4.5 times ($1,020,000 + $980,000) ÷ 2 $4,550,000 = 5.0 times ($980,000 + $840,000) ÷ 2
The company’s current ratio has improved from 2017 to 2018. However, the receivables turnover and inventory turnover have both deteriorated. Even though at first glance, the company’s liquidity seems to have improved based on the improvement of the current ratio, an examination of the liquidity of the major current assets, accounts receivable and inventory, indicates that liquidity has deteriorated. The deterioration in the turnover of receivables and inventory leads to an increase in these assets and increases the current ratio.
LO BT: AN Difficulty: M Time: min. AACSB: CPA: CM:
BRIEF EXERCISE 14-7 Optimus Ltd. has experienced a decrease in sales. Because the volume of inventory sold has increased and the cost of that inventory remains the same as in the past, there will be an increase in the company’s cost of goods sold. Meanwhile because customers have more time to pay, the company’s accounts receivable will increase even though sales have decreased and as stated, the company’s inventory has fallen. Because of the above, if we were to calculate receivables turnover (Net credit sales ÷ Average gross accounts receivable), we would find that the ratio has fallen because the net credit sales have decreased while the gross accounts receivable have increased. If we were to calculate inventory turnover (Cost of goods sold ÷ Average inventory), we would find that the ratio has increased because cost of goods sold has increased because more products were sold, while the average inventory would have decreased because inventory levels fell. LO 2 BT: AN Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-8 Holysh’s liquidity is probably deteriorating. The increase in the current ratio is likely caused by the deteriorating turnover of receivables and inventory. The decrease in the receivables turnover ratio may mean that the company is not collecting its accounts receivable on as timely a basis as in the past, or that some balances may be uncollectible. The decrease in the inventory turnover ratio implies the company is not selling its inventory as quickly as in the past or that it has too much inventory on hand at year end, or has increasing amounts of obsolete inventory. Further investigation into the cause for the slowdown in collections and inventory turnover will have to be made before it is possible to assess the company’s liquidity. LO 2 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 14-9 New Flyer’s solvency deteriorated in 2015 because of the increase in its debt to total assets ratio. However, there has been a substantial improvement in the times interest earned ratio (higher), likely due to an increase in profitability that outpaced the increase in debt. So although the solvency has deteriorated, it has actually improved profitability. There is a small decrease in the free cash flow. LO 3 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 14-10 (a)
The company’s investment in assets financed by debt is assumed to have been extremely successful. Success is measured by increases in profitability in spite of the increase in depreciation and interest expense. (1)
Debt to total assets will increase. Normally debt is smaller than assets so if both the numerator and denominator of this ratio are increased by the same amount, the numerator will increase by a greater percentage causing the overall ratio value to rise. For example, assume a company has total liabilities of $50 and total assets of $100 so the total debt to asset ratio will be 50%. Now if both liabilities and assets are increased by $50, the ratio will now be 67%.
(2)
Interest coverage is likely to increase as the amount of increased income from the new assets will exceed any increase in interest expense.
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-10 (3) There is not enough information to clearly determine the impact on free cash flow. Recall that free cash flow is equal to net cash from operating activities (this would have risen) less net capital expenditures (this would also have risen) less dividends paid (the company does not pay out dividends). However, since the capital expenditures were quite large it is likely that the free cash flow would have decreased. (b)
Because of the increased net income, it is likely that both the return on assets ratio and return on common shareholder’s equity ratio will increase. The increase in the return on common shareholder’s equity ratio (which has a smaller denominator) will far outpace the increase in return on assets ratio because of the presence of leverage.
LO 3,4 BT: AN Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 14-11 (a)
(b)
Return on assets is driven by profit margin and asset turnover. The increase in profit margin has increased the return on assets while the decrease in asset turnover has decreased the return on assets ratio. Because the increase in profit margin far outpaced the decrease in asset turnover ratio, the return on assets had an overall increase for the year. Return on common shareholders’ equity is affected by return on assets and debt to total assets. The return on assets has increased while the debt to total asset ratio has decreased. Because the decrease in debt to total assets ratio outpaced the increase in the return on assets ratio, the return on common shareholders’ equity had an overall decrease for the year.
LO 4 BT: AN Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 14-12 For growth, I would purchase the shares of Amazon.com, Inc. as the priceearnings ratio is higher, suggesting investors are willing to pay more for the shares because the company has higher prospects for growth and income in the future. For income, I would purchase the shares of the Bank of Montreal as the dividend yield is higher. It should be noted that if a company pays out a larger portion of its net income as a dividend, less funds are available to invest in assets and grow the size of the company, so it is more likely that a company that pays out high dividends will tend to have a lower price-earnings ratio. LO 4 BT: AN Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-13 (a)
It is likely that the return on common shareholder’s equity ratio increased more in 2018. Because the increased net income of 20% is attributed to the successful investment in a new manufacturing plant financed mostly by debt, it is likely that the return on assets ratio and return on common shareholder’s equity ratio will both increase. The increase in the return on common shareholder’s equity ratio will outpace the increase in return on assets ratio because of the presence of leverage.
(b)
The payout ratio will decrease because the percentage increase in net income of 20% is greater than the percentage increase in dividends in 2018 of 3%. The price-earnings ratio will decrease because the market price of the shares increased only 6% when the net income increased by 20%. Finally, the dividend yield will decrease because the 6% increase in the market price of the shares outpaced the 3% increase in dividends.
LO 4 BT: AN Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-14 (a) (in U.S. $ millions) With OCI: Profit margin
2015
2014
$815
2013
93
$12,209
6.7%
$12,607
$387 =
0.7%
$12,702
=
3.0%
=
1.5%
= Without OCI: Profit margin
$1,311 $12,209
(b)
$1,959 =
10.7%
$12,607
$185 =
15.5%
$12,702
Most financial ratios exclude total comprehensive income, or other comprehensive income, from the analysis. Profitability ratios, including industry averages, generally use data from the income statement and not from the statement of comprehensive income, which includes both net income and other comprehensive income. In addition, there are no standard ratio formulas incorporating comprehensive income. Consequently, the profit margin without other comprehensive gain or loss should be used in reliable financial analysis.
LO 4,5 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-19
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
BRIEF EXERCISE 14-15 Able Ltd. has adopted accounting policies and has used estimates that are different from those used by the industry. Using FIFO rather than an average cost formula for inventories in times of rising prices will result in lower cost of goods sold because older, cheaper inventory will be sold first, leaving more expensive, recently acquired inventory on the statement of financial position. This will increase gross profit and net income and produce higher inventory values on the statement of financial position along with higher retained earnings. By using an estimated useful life of equipment that is longer than the industry, Able will show lower depreciation expense, higher net income, and higher carrying amounts for equipment on its statement of financial position along with higher retained earnings. (a)
Inventory turnover will be lower because the cost of goods sold will be lower and the average inventory will be higher.
(b)
Asset turnover will be lower because the inventory will be higher by a greater amount as will the equipment because it will not have been depreciated as much due to its longer estimated useful life.
(c)
Profit margin will be higher because cost of goods sold and depreciation expense will be lower.
(d)
Return on assets will be higher. Recall that this ratio is determined by net income divided by average total assets. Both the numerator and denominator of this ratio will increase by approximately the same amount due to the changes made but, because net income is usually much smaller than total assets, the change made to the numerator is more significant and the ratio will increase. For example, if net income prior to the changes made was $100 and average total assets was $1,000 and then we increased both amounts by $50, the return on total assets would increase from 10% to 14.3%.
(e)
Return on common shareholders’ equity will be higher because of the overall increase in net income.
LO 5 BT: AN Difficulty: C Time: 15 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-20
Chapter 14
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO EXERCISES EXERCISE 14-1 (a)
DRESSAIRE INC. Horizontal Analysis of Statement of Financial Position (% of base-year amount)
Current assets Non-current assets Current liabilities Non-current liabilities Common shares Retained earnings
(c)
2018
2017
2016
115.0 133.3 115.8 75.0 110.0 241.2
110.0 110.0 105.3 91.7 100.0 152.9
100.0 100.0 100.0 100.0 100.0 100.0
Dressaire shareholders should be pleased with the more than doubling of retained earnings in two years while at the same time steadily reducing total liabilities.
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
EXERCISE 14-1 (CONTINUED) (b) DRESSAIRE INC. Horizontal Analysis of Statement of Financial Position (% change between periods)
2018
Increase (Decrease) Amount %
2017
Increase (Decrease) Amount %
2016
Assets Current assets Non-current assets Total assets Liabilities and Shareholders’ Equity Liabilities Current liabilities Non-current liabilities Total liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity
$115,000 400,000 $515,000
$ 5,000 70,000 $75,000
4.5% 21.2% 17.0%
$110,000 330,000 $440,000
$10,000 30,000) $ 40,000)
10.0% 10.0 % 10.0 %
$100,000 300,000 $400,000
$110,000 90,000 200,000
$10,000 (20,000) (10,000)
10.0% (18.2%) (4.8%)
$100,000 110,000 210,000
$ 5,000 (10,000) (5,000)
5.3% (8.3%) (2.3%)
$ 95,000 120,000 215,000
110,000 205,000 315,000
10,000 75,000 85,000
10.0% 57.7% 37.0%
100,000 130,000 230,000
0 45,000 45,000
0% 52.9% 24.3%
100,000 85,000 185,000
$515,000
$75,000
17.0%
$440,000
($40,000)
10.0%
$400,000
LO 1 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-22
Chapter 14
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Financial Accounting, Seventh Canadian Edition
EXERCISE 14-2 (a) FLEETWOOD CORPORATION Vertical Analysis of Income Statement 2018
2017
Net sales Cost of goods sold
Amount $800,000 550,000
Percent 100.0% 68.8%
Amount $600,000 375,000
Percent 100.0% 62.5%
Gross profit Operating expenses
250,000 155,000
31.3% 19.4%
225,000 125,000
37.5% 20.8%
Income before income tax Income tax expense
95,000 15,000
11.9% 1.9%
100,000 20,000
16.7% 3.3%
Net income
$80,000
10.0%
$80,000
13.3%
Note: The percentages shown in the above table do not add perfectly because of discrepancies that occur from rounding the results to one decimal place.
(b)
The cost of goods sold percentage is increasing, and the gross profit percentage is decreasing as is the operating expenses percentage. Both income before income taxes and net income percentages are decreasing. The income tax expense has a lower percentage because the tax rate has decreased and the net sales have increased.
LO 1 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-23
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-3 (a)
LABELLE LTD. Horizontal Analysis of Income Statement (% of base-year amount) Year Ended December 31
2018
2017
2016
Sales
133.3
116.7
100
Cost of goods sold
150.0
125.0
100
Gross profit
116.7
108.3
100
Operating expenses
130.0
102.5
100
Income from operations
90.0
120.0
100
Interest expense
200.0
125.0
100
Income before income tax
62.5
118.8
100
Income tax expense
62.5
120.0
100
Net income
62.5
118.3
100
(b) LABELLE LTD. Vertical Analysis of Income Statement 2016 Amount Sales
Percent
$1,200
100.0%
Cost of goods sold
600
50.0%
Gross profit
600
50.0%
Operating expenses
400
33.3%
Income from operations
200
16.7%
Interest expense
40
3.3%
Income before income tax
160
13.3%
Income tax expense
40
3.3%
$ 120
10.0%
Net income
Solutions Manual .
14-24
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-3 (CONTINUED) (b) (continued) LABELLE LTD. Vertical Analysis of Income Statement 2017 Amount Sales
Percent
$ 1,400
100.0%
Cost of goods sold
750
53.6%
Gross profit
650
46.4%
Operating expenses
410
29.3%
Income from operations
240
17.1%
Interest expense
50
3.6%
Income before income tax
190
13.6%
Income tax expense
48
3.4%
$142
10.1%
Net income
LABELLE LTD. Vertical Analysis of Income Statement 2018 Amount Sales
Percent
$1,600
100.0%
Cost of goods sold
900
56.3%
Gross profit
700
43.8%
Operating expenses
520
32.5%
Income from operations
180
11.3%
Interest expense
80
5.0%
Income before income tax
100
6.3%
Income tax expense
25
1.6%
$ 75
4.7%
Net income
Note: The percentages shown in the above table do not add perfectly because of discrepancies that occur from rounding the results to one decimal place. Solutions Manual .
14-25
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-3 (CONTINUED) (c)
Comparing 2016 to 2018, we can use the horizontal analysis of part (a) which demonstrates to us how dramatically sales increased. Unfortunately, the increase in sales was far outpaced by the increase in cost of goods sold. We can see this effect when we look at the vertical analysis which shows a steady decline in the gross profit ratio from 50% in 2016 to 43.8% in 2018. The operating expenses increased, but at a slower rate than the increase in sales. The decline in gross profit resulted in a decline in income from operations from 16.7% in 2016 to 11.3% in 2018. Interest costs kept climbing and finally, after taxes the profit margin fell from 10% to 4.7%. Management should be pleased with the increase in sales, but it must investigate the source of the increases in costs, which brought about disproportionate costs of goods sold.
LO 1 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 14-4 Asset turnover Average collection period Basic earnings per share Current ratio Days in inventory Debt to total assets Dividend yield Free cash flow Gross profit margin Inventory turnover Payout ratio Price-earnings ratio Profit margin Receivables turnover Return on assets Return on common shareholders’ equity Times interest earned Working capital
(a) P L P L L S P S P L P P P L P P S L
(b) B W B B W W N B B B N N B B B B B B
LO 2,3,4 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA:cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-26
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-5 ($ in millions) (a) 2018 Working capital = $1,430 – $890 = $540
2017 = $1,314 – $825 = $489
Current ratio = 1.61:1 ($1,430 ÷ $890)
= 1.59:1 ($1,314 ÷ $825)
Receivables turnover = 6.2 times ($4,190 ÷ [($676 + $50) + ($586 + $45) ÷ 2])
= 6.8 times ($3,940 ÷ [($586 + $45) + ($496 + $40)) ÷ 2])
Collection period = 59 days (365 ÷ 6.2 times)
= 54 days (365 ÷ 6.8 times)
Inventory turnover = 5.0 times ($2,900 ÷ [($628 + $525) ÷ 2])
= 4.8 times ($2,650 ÷ [($525 + $575) ÷ 2])
Days sales in inventory = 73 days (365 ÷ 5.0 times)
= 76 days (365 ÷ 4.8 times)
(b) Working capital Current ratio Receivables turnover Collection period Inventory turnover Days sales in inventory
Better Better Worse Worse Better Better
LO 2 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-27
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-6 (a)
The company’s collection of its accounts receivable has deteriorated as it is taking the company longer to collect receivables as evidenced by the decrease in the accounts receivable turnover.
(b)
The company is selling its inventory slower as the inventory turnover is declining.
(c)
Overall, the company’s liquidity has deteriorated. The increase in the current ratio is caused by the increase in inventory and receivables due to the slowdown in the movement of these assets. Even though the company’s current ratio is higher, if the underlying assets cannot be converted to cash to repay current liabilities, then liquidity has deteriorated.
LO 2 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 14-7 (a)
Company #4 has the highest current ratio.
(b)
Company #2 has the lowest number of days in inventory.
(c)
Company #1 has the lowest average collection period.
(d)
Company #3 has the lowest current ratio.
LO 2 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-28
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-8 (a) 2018 Debt to total assets
Free cash flow Interest coverage
=
$2,175 $3,890
=
55.9%
=
$850 – $400 – $110 =
$340
=
($405 + $15 + $175) $15
=
39.7
=
53.0%
= $580 – $300 – $90
=
$190
($375 + $25 + $150) $25
=
22.0
times
2017 Debt to total assets
Free cash flow Interest coverage (b)
=
=
$1,960 $3,700
Debt to total assets Free cash flow Interest coverage
times
Worse Better Better
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-29
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-9 (a)
The debt to total assets ratio has deteriorated over the past three years as the proportion of total debt to total assets has increased.
(b)
The increase in the times interest earned ratio indicates that it has improved over the past three years. This means that the company’s income before interest and taxes has risen more than the increase in interest expense. The two main factors that could have lead to this result are: 1) a reduction in interest rates or 2) the more likely reason which is the income before interest and taxes has been increasing over the period.
(c)
The company’s solvency initially appears to be worsening as evidenced by its increased reliance on debt. However, the company’s times interest earned is improving, so the company appears to be able to handle this increasing level of debt. Because of the offsetting impact of these two ratios, solvency has not deteriorated.
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 14-10 (a)
Company #1 has a substantial reduction in its debt to total assets ratio and succeeded in increasing its times interest earned ratio. The debt reduction strategy was successful.
(b)
Company #3 has the highest percentage increase in its debt to total assets ratio and succeeded in increasing both its times interest earned and free cash flow ratios in the same year.
(c)
Company #2’s solvency decreased the most in 2018 because all three ratios are worse in 2018 when compared to 2017.
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-30
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-11 (a) ($ in thousands) 2018 Gross profit margin
Profit margin
($500 - $375) $500
2017 = 25.0%
($400 - $290) $400
= 27.5%
$33.5 $500
= 6.7%
$30.0 $400
= 7.5%
Asset turnover
$500 ($350 + $275) 2
= 1.60 times
$400 ($275 + $274) 2
= 1.46 times
Return on assets
$33.5 ($350 + $275) 2
Return on common shareholders’ equity
$33.5 ($133.5 + $100) 2
(b)
= 10.7%
= 28.7%
Gross profit margin Profit margin Asset turnover Return on assets Return on common shareholders’ equity
$30.0 ($275 + $274) 2 $30.0 ($100 + $50) 2
= 10.9%
= 40.0%
Worse Worse Better Worse Worse
LO 4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-31
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-12 Overall, BetaCom is more profitable. While Top’s gross profit margin is higher than BetaCom’s and the industry, BetaCom’s profit margin, return on common shareholder’s equity, and return on assets are higher than Top’s. Both company’s ratios are better than the industry average with the exception of BetaCom’s gross profit margin. LO 4 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 14-13 (a)
A likely cause of the high amount of profitability in 2013 is a gain from the sale of long-lived assets.
(b)
Return on assets is influenced by the profit margin and asset turnover. Since asset turnover remains essentially constant, the main driver of the company’s return on assets is its profit margin. The unusually high profit margin for 2013 is explained in part (a) above. From 2014 to 2015, the return on assets increased because of small increases in both the profit margin and the asset turnover.
(c)
Return on common shareholders’ equity is influenced by return on assets and debt to total assets. The return on assets ratio, more specifically the profit margin, was the primary driver of the improvement in the return on common shareholders’ equity ratio. As mentioned in parts (a) and (b) above, the unusually high profit margin in 2013 is likely caused by a gain from the sale of long-lived assets. From 2014 to 2015, Metro’s increase in return on assets resulted from small increases in the profit margin and the asset turnover. The debt to total assets ratio rose considerably in 2014 and had a more modest increase from 2014 to 2015 so it is less of an influence on return on common shareholders’ equity.
LO 4 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-32
Chapter 14
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Financial Accounting, Seventh Canadian Edition
EXERCISE 14-14 (a)
Nyarboro is the more liquid of the two despite Archers’ current ratio being higher than that of Nyarboro and closer to the industry average. Nyarboro’s receivables and inventory turnover ratios are substantially higher than Archers’, which essentially means that it converts its receivables and inventory to cash much more quickly than does Archers. Although more information would be helpful before reaching a conclusion, Archers’ higher current ratio could be the result of higher accounts receivable (possible collection problem) and higher inventory (slow moving due to lower demand).
(b)
It appears that Archers is the more solvent of the two. Because Nyarboro has a lower debt to total assets ratio, which is indicative of greater solvency, one would expect it to have a higher times interest earned ratio, indicating a greater ability to meet its interest commitments (because of the lower debt level). Yet, it is Archers that has a higher times interest earned ratio despite having a higher level of debt.
(c)
Archers is clearly the more profitable of the two, as all of its profitability ratios are superior to those of Nyarboro and exceed the industry average.
(d)
Investors seem to favour Nyarboro as indicated by the price-earnings ratio. This ratio is higher than Archers’ although not as high as the industry average. This finding is not consistent with the assessment of solvency and profitability. Investors believe that Nyarboro has the better prospects for future growth. Their assessment of a company’s prospects is usually based on expectations of future results rather than an assessment based on historical results. Because the price-earnings ratio of Archers is lower, its shares are relatively cheaper than Nyarboro’s shares, and because Archers has better profitability, an investor may be more likely to buy shares in Archers.
LO 2,3,4 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-33
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
EXERCISE 14-15 (a) 1.
Realized gain on the sale of long-term investments
Included
2.
A loss caused by a labour strike
Included
3.
Other comprehensive income arising from the revaluation of a building
Excluded
4.
An operating loss from a discontinued component of an entity, held for immediate and probable sale
Included
5.
An impairment loss on goodwill
Included
(b)
If management felt that the items included in net income, as listed in part (a) above, distorted the measurement of the company’s performance, non-GAAP measures such as normalized net income could be calculated for analysis. Management can also measure performance using adjusted earnings before income tax and depreciation (adjusted EBITDA) to exclude the effects of tax refunds and depreciation.
LO 5 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
EXERCISE 14-16 (a) Event Increased estimate of allowance for doubtful accounts Increased useful life of equipment Recorded an increase in other comprehensive income when adjusting an investment to its fair value
(b) Ratio Receivables turnover Current ratio Profit margin Asset turnover Gross profit margin Profit margin Profit margin Return on assets
Effect Unchanged Decrease Decrease Decrease Unchanged Increase Unchanged Decrease
LO 5 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-34
Chapter 14
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Financial Accounting, Seventh Canadian Edition
SOLUTIONS TO PROBLEMS PROBLEM 14-1A (a)
TWC ENTERPRISES LIMITED Horizontal Analysis of Statement of Financial Position (% of base-year amount) December 31 2015
2014
2013
Current assets Non-current assets Total assets
346.3 104.6 108.1
125.7 101.9 102.2
100.0 100.0 100.0
Liabilities and Shareholders’ Equity Liabilities Current liabilities Non-current liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity
220.1 90.9 104.6 116.5
209.1 88.9 101.6 103.8
100.0 100.0 100.0 100.0
108.1
102.2
100.0
Assets
Solutions Manual .
14-35
Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-1A (CONTINUED) (a) (continued) TWC ENTERPRISES LIMITED Horizontal Analysis of Statement of Comprehensive Income (% of base-year amount) Year Ended December 31
Revenue Operating expenses Income from operations Interest expense Other expense* Income before income tax Income tax expense Net income Other comprehensive income Comprehensive income
2015
2014
2013
106.4 108.9 94.9 95.5 7,377.8 40.3 60.6 32.4 368.6 131.9
99.7 103.9 81.0 100.0 4,578.5 26.2 25.8 26.3 157.0 65.0
100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
*In instances where the amounts are so large they become a distraction, as is the case for other expenses, the practice is not to show the figures so that the readers can concentrate exclusively on the relevant information, while still being informed why a blank entry appears in the analysis.
(b)
By expressing the amounts in the statements as a percentage of a base year amount, we can see that in the statement of financial position the most substantial change was the increase in current assets in 2015 and current liabilities in 2014. Although the changes in percentage terms are large, the amounts involved are not and so should not be given a great deal of weight in the analysis. The remaining elements on the statement of financial position show increases in line with the increased volume of business demonstrated on the income statement. The most significant change on the income statement arose from other expenses. The increase in operating expenses increased by more than the increase in revenues in 2014, resulting in decreased income from operations. The income tax expense increased relative to income before income tax in 2015, possibly due to non-deductible expenses in 2015.
LO 1 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-36
Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-2A (a) BRICK BREWERY COMPANY LTD. Vertical Analysis of Statement of Financial Position January 31 (in thousands) 2016 Cash Accounts receivable Inventory Prepaids Assets held for sale Current assets Non-current assets Total assets Liabilities Current liabilities Non-current liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity
Solutions Manual .
2015
2014
$ 394 6,176 3,291 355 0 10,216 38,624 48,840
% 0.8% 12.6% 6.7% 0.7% 0.0% 20.9% 79.1% 100.0%
$ 595 6,492 3,401 350 0 10,838 34,096 44,934
% 1.3% 14.4% 7.6% 0.8% 0.0% 24.1% 75.9% 100.0%
0 5,865 3,951 396 3,406 13,618 32,751 46,369
% 0.0% 12.6% 8.5% 0.9% 7.3% 29.4% 70.6% 100.0%
6,855 6,460 13,315 35,525
14.0% 13.2% 27.3% 72.7%
6,335 4,217 10,552 34,382
14.1% 9.4% 23.5% 76.5%
9,302 4,554 13,856 32,513
20.1% 9.8% 29.9% 70.1%
48,840
100.0%
44,934
100.0%
46,369
100.0%
14-37
$
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 14-2A (CONTINUED) (a) (continued) BRICK BREWERY COMPANY LTD. Vertical Analysis of Income Statement Year Ended January 31 (in thousands)
Net sales Cost of sales Gross profit Operating expenses Gain on sale of non-current assets Income from operations Interest expense Income before income tax Income tax expense Net income
2016 $ % 37,610 100.0 27,076 72.0 10,534 28.0 8,008 21.3
2015 % $ 36,333 100.0 26,136 71.9 10,197 28.1 8,075 22.2
2014 $ % 37,674 100.0 27,857 73.9 9,817 26.1 8,399 22.3
(205) 2,731 479 2,252 658 1,594
(436) 2,558 535 2,023 628 1,395
0 1,418 692 726 201 525
(0.5) 7.3 1.3 6.0 1.7 4.2
(1.2) 7.0 1.5 5.6 1.7 3.8
3.8 1.8 1.9 0.5 1.4
Note: The percentages shown in the above table do not add perfectly because of discrepancies that occur from rounding the results to one decimal place.
(b)
The most significant change in Brick Brewing’s statement of financial position has been the disposal at a gain of the assets held for sale. These assets made up a large portion of current assets in 2014. Brick is investing in non-current assets steadily and is managing its inventory levels well. Brick’s solvency is not an issue as demonstrated by the portion of total assets financed by liabilities (27.3% in 2016) compared to the amount financed by equity of 72.7%. The company’s gross profit increased significantly in 2015 compared to 2014 and remained steady thorough 2016. Operating expenses as a percentage of sales is declining slightly so that overall there was an improvement in the profit margin percentage in 2015 and 2016.
LO 1 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-38
Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-3A (a)
Although the operating expenses have been increasing over the past four years, when these are expressed as a percentage of revenues in the vertical analysis, it is clear that their proportion as a percentage of revenue is smaller in 2018 than in 2015, demonstrating that the company has a good control over the operating expenses.
(b)
The change in income before income tax, income tax expense, and net income is the same because the income tax rate has not changed. Therefore, the absolute amount of the tax expense will change in the same proportion as the change in income before income taxes. As demonstrated in the vertical analysis statement, when compared to revenues, the absolute amount of income tax expense will change since other variables, such as operating expenses, reduce revenues in different amounts and proportions each year.
(c)
Although most expenses have grown in similar proportions to the increase in revenue, this is not the case for interest expense. Interest expense is decreasing over the four-year period. This reduction is likely due to the reduction in interest rates charged and the amount of the debt on the statement of financial position. Although the horizontal analysis draws attention to a major increase in the other revenues, that attention is later diminished when inspecting the vertical analysis income statement. This statement reveals that in absolute terms, the amount of other revenue involved is very small and so a major increase of 240% over a three-year period turns out to have a modest effect on the income.
(d)
Horizontal and vertical analysis of the statement of financial position, as well as the financial statements themselves, can be useful in assessing this company’s performance and financial position. In addition, ratio analysis would help complete the picture. Comparisons of this company to other businesses in the industry, as well as understanding any external economic or other factors, would also be useful.
LO 1 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
14-39
Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4A (a) Receivables turnover
Net credit sales
=
Average gross accounts receivable
2016
Receivables turnover
=
2017
Receivables turnover
=
2018
Receivables turnover
=
$500
+ 2
$500
$700
$4,000 + 2
$500
$900
$4,500 + 2
$700
=
7.2 times
=
6.7 times
=
5.6 times
Cost of goods sold Average inventory
Inventory turnover
=
2016
Inventory turnover
=
2017
Inventory turnover
=
2018
Inventory turnover
=
Solutions Manual .
$3,600
$500
$1,800 + 2
$500
$800
$2,100 + 2
$500
$2,500 $1,200 + 2
$800
14-40
=
3.6 times
=
3.2 times
=
2.5 times
Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4A (CONTINUED) (a) (continued)
Current ratio
=
Current assets Current liabilities
2016
Current ratio
=
$1,200 $500
=
2.4
2017
Current ratio
=
$1,580 $550
=
2.9
2018
Current ratio
=
$2,130 $600
=
3.6
Pronghorn’s liquidity has deteriorated because both the receivable and inventory turnovers have steadily decreased. On the other hand, the current ratio has improved steadily. Overall the liquidity has deteriorated.
(b) Gross profit margin
=
Gross profit Net sales
2016
Gross profit margin
=
$1,800 $3,600
=
50.0%
2017
Gross profit margin
=
$1,900 $4,000
=
47.5%
2018
Gross profit margin
=
$2,000 $4,500
=
44.4%
Although the cost to Pronghorn of the goods being sold has remained constant, the gross profit margin has deteriorated. Because of selling price competition, Pronghorn had to reduce its selling prices. Consequently, the gross profit margin reduced from 50% in 2016 to 44.4% in 2018.
Solutions Manual .
14-41
Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4A (CONTINUED) (c) Profit margin
=
Net income Net sales
2016
Profit margin
=
$180 $3,600
=
5.0%
2017
Profit margin
=
$220 $4,000
=
5.5%
2018
Profit margin
=
$270 $4,500
=
6.0%
The profit margin has increased steadily from 5.0% in 2016 to 6.0% in 2018. This improvement is in the opposite direction of the trend experienced with the declining gross profit margin calculated in part (b) above. These opposing trends can only be achieved by reducing operating expenses. In spite of increasing interest costs, income tax expense, and sales, Pronghorn managed to have declining operating expenses over the three-year period.
Solutions Manual .
14-42
Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4A (CONTINUED) (d) Debt to total assets
= Total liabilities Total assets
2016
Debt to total assets
=
$2,000 $4,400
=
45.5%
2017
Debt to total assets
=
$2,870 $5,380
=
53.3%
2018
Debt to total assets
=
$3,670 $6,230
=
58.9%
Times interest earned
=
Net income + Interest expense + Income tax expense (EBIT) Interest expense
2016
Times interest earned
=
$180 + $70 + $60 $70
=
4.4
times
2017
Times interest earned
=
$220 + $130 + $75 $130
=
3.3
times
2018
Times interest earned
=
$270 + $190 + $90 $190
=
2.9
times
Pronghorn has been using debt to finance operations. As demonstrated by the comparisons of the return on assets ratio with the return on shareholders’ equity ratio, [refer to part (g) below], Pronghorn has used leverage to produce additional income in excess of the cost to service the debt. Pronghorn is less solvent in 2018 than it was in 2016 because the debt to total assets ratio increased and the times interest earned decreased.
Solutions Manual .
14-43
Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4A (CONTINUED) (e) 2016 $1,300 180 (1,400) $80
2017 $1,400 220 (1,510) $110
2018 $1,510 270 (1,560) $220
Cash dividends declared Net income 2016
2017
2018
44.4%
50.0%
81.5%
Beginning balance retained earnings Add: Net income Less Ending balance retained earnings Dividends declared and paid Payout ratio
=
Payout ratio
The payout ratio increased over the three-year period at a much higher rate than the level of increase in net income. Net income increased 22% in 2017 [$220 - $180) ÷ $180] and 23% in 2018 [$270 - $220) ÷ $220]. On the other hand, the amount of dividends declared and paid increased by 38% [$110 - $80) ÷ $80] in 2017 and 100% in 2018 [$220 - $110) ÷ $110]. Since there was no change in the share ownership in the threeyear period, shareholders would have likely insisted that more dividends be paid out as net income improved. The dividends paid would have adversely affected the liquidity of the business at the time of payment but overall the liquidity improved over the three years as is demonstrated in part (a) above for the current ratio.
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4A (CONTINUED) (f) Asset Turnover
Net sales
=
Average total assets
2016
Asset turnover
=
2017
Asset turnover
=
2018
Asset turnover
=
Asset turnover X Profit margin (c) above = Return on assets
$3,600 $4,400 + $4,400 2 $4,000 $5,380 + $4,400 2 $4,500 $6,230 + $5,380 2 2016 .82 5.0% 4.1%
=
0.82 times
=
0.82 times
=
0.78 times
2017 .82 5.5% 4.5%
2018 .78 6.0% 4.7%
The major driver of the return on assets is the profit margin.
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4A (CONTINUED) (g) Return on common shareholders’ equity
=
Net income – Preferred dividends declared Average common shareholders’ equity
2016
Return on common shareholders' equity
=
2017
Return on common shareholders' equity
=
2018
Return on common shareholders' equity
=
$180 $2,400 + $2,400 2
$2,510
$220 + $2,400 2 $270
$2,560
=
7.5%
=
9.0%
=
10.7%
+ $2,510 2
The return on common shareholders’ equity is higher each year than the return on assets due to the presence of leverage. Pronghorn has used debt to produce additional net income in an amount that exceeds the cost of the debt. The difference between the two ratios is increasing each year as the company is making more effective use of leverage. LO 2,3,4 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-5A (a) 2018
2017
1. Current ratio
$180,000 = 2.1 :1 $85,000
$150,000 = 1.9 :1 $80,000
2. Receivables turnover
$700,000 = 12.8 times $60,000* + $49,500* � � 2
$450,000 = 8.8 times $49,500* + $52,800* � � 2
$240,000 = 32.7% $735,000
$165,000 = 28.0% $590,000
3. Inventory turnover
4. Debt to total assets
$450,000 = 4.9 times $100,000 + $85,000 � � 2
$300,000 = 4.0 times $85,000 + $64,000 � � 2
5. Times interest earned
$100,000 = 10.0 times $10,000
$66,000 = 16.5 times $4,000
6. Free cash flow
$102,000 - $180,000 - $32,000** = ($110,000)
$119,600 – $150,000 - $7,600 *** = ($38,000)
7. Gross profit margin
$250,000 = 35.7% $700,000
$150,000 = 33.3% $450,000
8. Profit margin
$72,000 = 10.3% $700,000
$49,600 = 11.0% $450,000
9. Asset turnover
10. Return on assets
$700,000 = 1.1 times $735,000 + $590,000 � � 2 $72,000 = 10.9% $735,000 + $590,000 � � 2
$450,000 = 0.9 times $590,000 + $433,000 � � 2 $49,600 = 9.7% $590,000 + $433,000 � � 2
* 2. Receivables turnover—Gross accounts receivable: 2018: $55,000 + $5,000 2017: $45,000 + $4,500 2016: $48,000 + $4,800 ** Dividends 2018: $165,000 – $125,000 – $72,000 = $32,000 *** Dividends 2017: $125,000 – $83,000 – $49,600 = $7,600 Solutions Manual .
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Chapter 14
Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley
Financial Accounting, Seventh Canadian Edition
PROBLEM 14-5A (CONTINUED) (b)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Current ratio Receivables turnover Inventory turnover Debt to total assets Times interest earned Free cash flow Gross profit margin Profit margin Asset turnover Return on assets
(c)
Overall:
Better Better Better Worse Worse Better Better Worse Better Better
(1)
Liquidity improved in 2018. The current, accounts receivable turnover, and inventory turnover ratios were all better.
(2)
Solvency deteriorated because the debt to total assets ratio and the times interest earned ratio trends were worse but negative free cash flow reduced.
(3)
Profitability improved because the gross profit margin ratio trend was better, as were the asset turnover and return on assets ratios. On the other hand, the profit margin ratio trend was worse. Overall, the profitability improved as the profit increased by a substantial amount in 2018.
LO 2,3,4 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6A (a)
We do not normally include the effects of other comprehensive income in the calculation of profitability ratios.
(b)
Liquidity 2018
Working capital 1
2017
$319,000 – $185,000 = $134,000
$303,000 – $182,000 = $121,000
Current ratio
$319,000 = 1.7 :1 $185,000
$303,000 = 1.7 :1 $182,000
Receivables turnover
$𝟗𝟗𝟗𝟗𝟗𝟗, 𝟎𝟎𝟎𝟎𝟎𝟎 𝐱𝐱 𝟕𝟕𝟕𝟕% $𝟖𝟖𝟖𝟖𝟖𝟖, 𝟎𝟎𝟎𝟎𝟎𝟎 𝐱𝐱 𝟕𝟕𝟕𝟕% ($𝟗𝟗𝟗𝟗, 𝟎𝟎𝟎𝟎𝟎𝟎 + $𝟓𝟓, 𝟎𝟎𝟎𝟎𝟎𝟎 + $𝟗𝟗𝟗𝟗, 𝟎𝟎𝟎𝟎𝟎𝟎 + $𝟒𝟒, 𝟎𝟎𝟎𝟎𝟎𝟎) ($90,000 + $4,000 + $88,000 + $3,000) � � � � 𝟐𝟐 2 = 𝟕𝟕. 𝟎𝟎 𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐬𝐬 = 𝟔𝟔. 𝟖𝟖 𝐭𝐭𝐭𝐭𝐦𝐦𝐞𝐞𝐞𝐞
Average collection period Inventory turnover
Days in inventory 1
365 = 52 days 7.0
365 = 54 days 6.8
$𝟔𝟔𝟔𝟔𝟔𝟔, 𝟎𝟎𝟎𝟎𝟎𝟎 = 𝟒𝟒. 𝟕𝟕 𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐭 $𝟏𝟏𝟏𝟏𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎 + $𝟏𝟏𝟏𝟏𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎 � � 𝟐𝟐
$𝟓𝟓𝟓𝟓𝟓𝟓, 𝟎𝟎𝟎𝟎𝟎𝟎 = 𝟒𝟒. 𝟖𝟖 𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐭𝐭 $𝟏𝟏𝟏𝟏𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎 + $𝟏𝟏𝟏𝟏𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎 � � 𝟐𝟐
365 = 78 days 4.7
365 = 76 days 4.8
Current assets, 2018 = $70,000 + $95,000 + $130,000 + $24,000 = $319,000 Current assets, 2017 = $65,000 + $90,000 + $125,000 + $23,000 = $303,000 Current liabilities, 2018 = $45,000 + $30,000 + $110,000 = $185,000 Current liabilities, 2017 = $42,000 + $40,000 + $100,000 = $182,000
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6A (CONTINUED) (b) (continued) Solvency 2018
2017
Debt to total assets
$385,000 = 51.1 % $754,000
$332,000 = 51.2 % $648,000
Times interest earned
$116,000 = 3.9 times $30,000
$105,000 = 5.3 times $20,000
Free cash flow
$96,000 – $125,000 – $8,000 = $(37,000)
$85,000 – $50,000 – $8,000 = $27,000
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6A (CONTINUED) (b) (continued) Profitability 2018
2017
Return on common shareholders’ equity
$64,000 $369,000 + $316,000 � � 2 = 18.7%
$65,000 $316,000 + $259,000 � � 2 = 22.6%
Return on assets
$64,000 $754,000 + $648,000 � � 2 = 9.1%
$65,000 $648,000 + $630,000 � � 2 = 10.2%
Profit margin
Asset turnover
$64,000 = 7.1 % $900,000
$65,000 = 7.7 % $840,000
$900,000 $754,000 + $648,000 � � 2 = 1.3 times
$840,000 $648,000 + $630,000 � � 2 = 1.3 times
Gross profit margin
$300,000 = 33.3 % $900,000
$265,000 = 31.5 % $840,000
Basic earnings per share
$64,000 = $3.20 20,000
$65,000 = $3.25 20,000
Payout
$8,000 = 12.5% $64,000
$8,000 = 12.3% $65,000
Solutions Manual .
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6A (CONTINUED) (c)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Working capital Current ratio Receivables turnover Average collection period Inventory turnover Days in inventory Debt to total assets Times interest earned Free cash flow Return on common shareholders’ equity Return on assets Profit margin Asset turnover Gross profit margin Basic earnings per share Payout
Better Unchanged Better Better Worse Worse Better Worse Worse Worse Worse Worse Unchanged Better Worse Higher
(d)
(1)
Clack’s liquidity has not changed significantly. The current ratio has remained constant while the receivables turnover ratio has improved slightly and the inventory turnover ratio has deteriorated slightly.
(2)
Overall, solvency has deteriorated slightly. While the debt to total assets ratio has improved slightly, the times interest earned and free cash flow ratios have deteriorated.
(3)
Clack’s profitability has deteriorated as indicated by the decrease in the return on common shareholders’ equity, return on assets, profit margin, and basic earnings per share ratios. The asset turnover has remained constant. The gross profit margin has increased slightly.
LO 2,3,4 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-7A (a)
Accounts receivable management can be assessed by reviewing a company’s average collection period, which indicates how long the company is taking to collect its accounts receivable. Bureau Nouveau’s average collection period of 31 days is excellent when compared to its credit terms of 30 days. As well, Bureau Nouveau’s average collection period is better than Supplies Unlimited.
(b)
A company’s ability to manage its inventory can be measured by the days in inventory ratio. Currently Bureau Nouveau is taking 61 days to turn over its inventory, which can also be expressed as approximately every 6 times per year (365 ÷ 61 days). When compared to the days in inventory for Supplies Unlimited of 122 days it is clear that Bureau Nouveau is turning over its inventory much faster.
(c)
Supplies Unlimited has a higher current ratio than Bureau Nouveau. This would normally indicate a greater level of liquidity but in this case, it probably does not. The reason for the higher current ratio is likely due to higher accounts receivable because of a longer collection period and higher inventory due to its higher days in inventory. If a company is slower at collecting its accounts receivables and selling its inventory, it is less liquid. Therefore, Bureau Nouveau is more liquid.
(d)
Supplies Unlimited appears to be the more solvent of the two companies. Supplies Unlimited has a lower debt to total assets ratio indicating that Supplies Unlimited has a lower percentage of its assets financed by debt. As well, Supplies Unlimited has a higher times interest earned ratio indicating that Supplies Unlimited has a better ability to service its debt as interest payments become due.
(e)
Supplies Unlimited likely has a higher gross profit margin because it sells a product that has a higher price relative to its cost allowing it to earn a higher gross profit margin. It is also possible to have a higher gross profit because the company can purchase inventory at a lower cost. The profit margin incorporates all of the elements of the gross profit margin in addition to operating expenses, other revenues and expenses, and income tax. If Supplies Unlimited, which has a higher gross profit margin, also has a lower profit margin, then it is most likely due to operating expenses, other expenses, and/or income tax expense being larger relative to sales for this company and this has caused the profit margin to fall.
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-7A (CONTINUED) (f)
The return on assets can be calculated by multiplying the profit margin by asset turnover. Bureau Nouveau’s higher return on assets is almost equally due to its higher profit margin and asset turnover ratios, which are both approximately 17%-18% higher than those of Supplies Unlimited.
(g)
If a company’s return on common shareholders’ equity is greater than its return on assets, this excess arose from the advantage of leverage. The return on assets is 14.3% while the return on common shareholders’ equity is 26.1%. The 11.8% difference arose because of that company’s use of debt. The equivalent difference for Supplies Unlimited is only 2.6% because it uses much less debt. Therefore, the use of debt is the larger contributing factor to the return on common shareholders’ equity than the return on assets.
(h)
Bureau Nouveau may have a lower payout ratio than Supplies Unlimited because Bureau Nouveau’s management has decided to retain income in the business to finance future growth.
(i)
Market price per share = Price-earnings ratio × Basic earnings per share Bureau Nouveau’s market price per share = 29 × $3.50 = $101.50 Supplies Unlimited’s market price per share = 45 × $2.40 = $108.00
(j)
The price-earnings ratio reflects investors’ assessment of the future prospects of a company. As indicated by its higher price-earnings ratio, investors appear to believe that Supplies Unlimited has the better possibility for growing its income.
LO 2,3,4 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
Solutions Manual .
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Chapter 14
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-8A (a)
Despite the fact that Mac’s has a higher current ratio, one may argue that Mac’s has less liquidity than King’s or the industry average because of its lower receivables and inventory turnovers. Each company’s receivables turnover is lower than the industry average. However, Mac’s inventory turnover is more in line with the industry average, while King’s is well ahead of the industry average.
(b)
Mac’s is more solvent than King’s. Although its debt to total assets ratio is higher than King’s, which indicates more of its assets are financed by debt, Mac’s times interest earned is much better than King’s and is also better than the industry average. King’s times interest earned ratio is significantly lower than the industry average. This indicates that Mac’s has a higher capacity to service its debt because its income before income tax and interest is much higher relative to its interest expense.
(c)
Mac’s is the more profitable of the two companies. Mac’s has a significantly higher gross profit margin and profit margin than King’s. Mac’s is better than the industry average while King’s is below the industry average for the gross profit margin and profit margin. Mac’s also has a better return on common shareholders’ equity and a higher return on assets. While King’s has a slightly higher asset turnover, all other profitability ratios indicate that Mac’s is more profitable than King’s and the industry.
(d)
Investors seem to favour Mac’s as it has a slightly higher price-earnings ratio and significantly higher dividend yield. King’s price-earnings ratio is lower than the industry average, showing that investors on average favour other restaurants in the industry and this is most likely due to King’s lower profitability. Because Mac’s is so much more profitable than King’s and the industry average as shown by its very high return on common shareholders’ equity, one would expect Mac’s to have a higher price-earnings ratio. Although it is higher than King’s, it is not higher than the industry average, which is surprising. This would indicate that the market does not think that the growth prospects of Mac’s are any better than those of the average company in the industry.
LO 2,3,4 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-9A (a) and (b) (a) Higher
(b)
(1) Current ratio
Company A
no impact
(2) Debt to total assets
Company Company A
B
(3) Profit margin
Company Company B
A
Higher
(c)
Yes. The impact the different accounting policies and estimates will have on each company’s net income and ratios must be considered so that the comparison is meaningful.
(d)
Companies may calculate and measure performance using non-GAAP techniques to arrive at normalized income. These measures are used to exclude non-recurring items and assist users of the financial information in making comparisons of current performance against past performances and to predict future earnings.
(e)
An analyst must also consider the use of professional judgement by management in determining the estimates it makes in preparation of the financial statements and whether the company is involved in more than one industry, (that is, how diversified the company is).
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-1B (a)
LULULEMON ATHLETICA INC. Horizontal Analysis of Statement of Financial Position (% of base-year amount) January 31 2016
2015
2014
Assets Current assets Non-current assets Total assets
97.2 129.3 105.1
100.8 112.4 103.7
100.0 100.0 100.0
Liabilities and Shareholders’ Equity Liabilities Current liabilities Non-current liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity
198.2 156.4 187.6 93.6
140.4 120.5 135.3 99.3
100.0 100.0 100.0 100.0
105.1
103.7
100.0
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-1B (CONTINUED) (a) (continued) LULULEMON ATHLETICA INC. Horizontal Analysis of Comprehensive Income Statement (% of base-year amount) Year Ended January 31 2016 Net revenue Cost of goods sold Gross profit Operating expenses Income from operations Other income (expense) Income before income tax Income tax expense Net income Other comprehensive loss Comprehensive income
(b)
129.5 141.5 118.7 139.9 94.4 (16.7) 92.7 87.2 95.0 72.2 105.8
2015 112.9 117.6 108.8 119.8 96.2 116.7 96.5 123.1 85.4 116.7 70.5
2014 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
The primary driver of the company’s net income appears to be the increase in revenues. In 2015 and 2016, cost of goods sold increased at a faster rate than did revenues, which resulted in a decrease in the gross profit margin ratio. For the line item Other income (expense), because the actual amounts are so small, they are often left out of the horizontal analysis because their presence becomes a distraction. The practice is not to show the figures so that the reader can concentrate exclusively on the relevant information, while still being informed why a blank entry appears in the analysis.Alternately, the amounts are grouped with operating expenses. In the statement of financial position, total liabilities increased at a faster rate than did total assets. Shareholders’ equity decreased in large part due to other comprehensive loss. The remaining elements on the statement of financial position show increases in line with the increased volume of business demonstrated on the income statement.
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PROBLEM 14-2B (a)
CANADIAN PACIFIC RAILWAY LIMITED Vertical Analysis of Statement of Financial Position December 31 (in millions) 2015
2014
%
$
650 645 242 1,537 18,100 19,637
3.3 3.3 1.2 7.8 92.2 100.0
Liabilities and Shareholders’ Equity Liabilities Current liabilities 1,447 Non-current liabilities 13,394 Total liabilities 14,841 Shareholders’ equity 4,796 Total liabilities and shareholders’ equity 19,637
Assets Cash Accounts receivable Supplies and other Current assets Non- current assets Total assets
Solutions Manual .
$
2013
%
$
%
226 702 293 1,221 15,329 16,550
1.4 4.2 1.8 7.4 92.6 100.0
887 580 562 2,029 15,031 17,060
5.2 3.4 3.3 11.9 88.1 100.0
7.4 68.2 75.6 24.4
1,411 9,529 10,940 5,610
8.5 57.6 66.1 33.9
1,378 8,585 9,963 7,097
8.1 50.3 58.4 41.6
100.0
16,550
100.0
17,060
100.0
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-2B (CONTINUED) (a) (continued) CANADIAN PACIFIC RAILWAY LIMITED Vertical Analysis of Statement of Comprehensive Income Year Ended December 31 (in millions) 2015 Revenues Operating expenses Income from operations Interest expense Other expense Income before income tax Income tax expense Net income Other comprehensive Income (loss) Comprehensive income
$ 6,712 4,024 2,688 394 335 1,959 607 1,352 742 2,094
2014 100.0 60.0 40.0 5.9 5.0 29.2 9.0 20.1
$ 6,620 4,281 2,339 282 19 2,038 562 1,476
11.1 31.2
(716) 760
%
2013 100.0 64.7 35.3 4.3 0.3 30.8 8.5 22.3
$ 6,133 4,713 1,420 278 17 1,125 250 875
100.0 76.8 23.2 4.5 0.3 18.3 4.1 14.3
(10.8) 11.5
1,265 2,140
20.6 34.9
%
%
Note: The percentages shown in the above table do not add perfectly because of discrepancies that occur from rounding the results to one decimal place.
(b)
Canadian Pacific Railway operates in very capital-intensive industry. Noncurrent assets are expected to be very high, as is debt to finance these assets. The percentage of assets dedicated to non-current assets increased in 2014 and remained steady thereafter. On the other hand, the percentage of non-current liabilities climbed in 2014 but also increased even more significantly in 2016. The shareholders’ equity percentage experienced the opposite trend to total liabilities On the comprehensive income statement, we note that income from operations, as a percentage of revenue, is increasing steadily. This trend is repeated in net income in 2014. The most significant charge against shareholders’ equity occurred in 2014 with an other comprehensive loss that exceeded 10% of revenues. This result contrasts with the other comprehensive income of over 20% of revenues reported in 2013.
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PROBLEM 14-3B (a)
The horizontal and vertical analysis statements demonstrate that the company’s control over cost of goods sold was steady in 2016 and 2017 but went somewhat out of control in 2018, when costs of goods sold increased by 2.4% of revenue.
(b)
Although the income before income tax has remained constant as a percentage of each year’s revenue over the past four years, the amounts have increased in absolute terms each year, as shown in the horizontal analysis statement. This demonstrates that the percentage increase in income before income tax is increasing at about the same pace as the percentage increase in revenue.
(c)
Although most expenses have grown in proportion to the increase in revenue, this is not the case for interest expense. Interest expense is decreasing over the four-year period. This reduction is likely due to the reduction in interest rates charged and the amount of the debt on the statement of financial position. Operating expenses have been growing at a faster rate than revenue. Although the horizontal analysis draws attention to a major increase in the other revenues, that attention is later diminished when inspecting the vertical analysis income statement. That statement reveals that in absolute terms, the amount of other revenue involved is very small and so a major increase of 140% over a three-year period turns out to have a modest effect on the net income.
(d)
The financial statements themselves, along with some ratio analysis, would also be useful in assessing this company’s performance and financial position. Comparisons of this company to other businesses in the industry, as well as understanding any external economic or other factors, would also be useful.
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PROBLEM 14-4B (a) Receivables turnover
Net credit sales
=
Average gross accounts receivable
2016
Receivables turnover
=
2017
Receivables turnover
=
2018
Receivables turnover
=
Inventory turnover
=
2016
Inventory turnover
=
2017
Inventory turnover
=
2018
Inventory turnover
=
Solutions Manual .
$3,600 $500
+ 2
$500
$550
$4,000 + 2
$500
$600
$4,500 + 2
$550
$800
$1,800 + 2
$800
$700
$1,900 + 2
$800
$700
$2,000 + 2
$700
=
7.2
times
=
7.6
times
=
7.8 times
Cost of goods sold Average inventory
14-62
=
2.3 times
=
2.5 times
=
2.9 times
Chapter 14
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PROBLEM 14-4B (CONTINUED) (a) (continued)
Current ratio
=
Current assets Current liabilities
2016
Current ratio
=
$1,380 $400
=
3.5
2017
Current ratio
=
$1,480 $500
=
3.0
2018
Current ratio
=
$1,680 $600
=
2.8
St. Lawrence’s liquidity has improved because both the receivable and inventory turnovers have steadily increased. On the other hand, the current ratio has deteriorated steadily. Overall the liquidity has improved.
(b) Gross profit margin
=
Gross profit Net sales
2016
Gross profit margin
=
$1,800 $3,600
=
50.0%
2017
Gross profit margin
=
$2,100 $4,000
=
52.5%
2018
Gross profit margin
=
$2,500 $4,500
=
55.6%
St. Lawrence must have negotiated reduced prices for the goods they purchase because the gross profit margin keeps improving. The gross profit margin increased from 50% in 2016 to 55.6% in 2018.
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PROBLEM 14-4B (CONTINUED) (c) Profit margin
=
Net income Net sales
2016
Profit margin
=
$180 $3,600
=
5.0%
2017
Profit margin
=
$250 $4,000
=
6.3%
2018
Profit margin
=
$320 $4,500
=
7.1%
The profit margin has increased steadily from 5.0% in 2016 to 7.1% in 2018. This improvement is consistent with the direction of the trend experienced with the increasing gross profit margin calculated in part (b) above.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4B (CONTINUED) (d) Debt to total assets
= Total liabilities Total assets
2016
Debt to total assets
=
$2,180 $4,580
=
47.6%
2017
Debt to total assets
=
$2,810 $5,380
=
52.2%
2018
Debt to total assets
=
$3,470 $6,280
=
55.3%
Times interest earned
=
Net income + Interest expense + Income tax expense (EBIT) Interest expense
2016
Times interest earned
=
$180 + $70 + $60 $70
=
4.4
times
2017
Times interest earned
=
$250 + $80 + $90 $80
=
5.3
times
2018
Times interest earned
=
$320 + $100 + $110 $100
=
5.3
times
St. Lawrence has been using debt to finance operations. As demonstrated by the comparisons of return on assets ratio with the return on shareholders’ equity ratio, [refer to part (g) below], St. Lawrence has used leverage to produce additional income in excess of the cost to service the debt. St. Lawrence is less solvent in 2018 than it was in 2016 because the debt to total assets ratio increased but the times interest earned increased.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4B (CONTINUED) (e) 2016 $1,300 180 (1,400) $80
2017 $1,400 250 (1,570) $80
2018 $1,570 320 (1,810) $80
Cash dividends declared Net income 2016
2017
2018
44.4%
32.0%
25.0%
Beginning balance retained earnings Add: Net income Less Ending balance retained earnings Dividends declared and paid Payout ratio
=
Payout ratio
The payout ratio decreased over the three-year period in spite of increasing net income in the same period. Net income increased 39% in 2017 [$250 - $180) ÷ $180] and 28% in 2018 [$320 - $250) ÷ $250]. On the other hand, the amount of dividends declared and paid remained at $80 each year. Since net income increased and the amount of dividends remained the same, the payout ratio decreased. There was no change in the share ownership in the three-year period. Shareholders are likely satisfied with receiving the same amount of dividends each year. The payment of the dividends would have adversely affected the liquidity of the business at the time of payment but overall the current ratio remains extremely strong as demonstrated in part (a) above.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4B (CONTINUED) (f) Asset Turnover
Net sales
=
Average total assets
2016
Asset turnover
=
2017
Asset turnover
=
2018
Asset turnover
=
Asset turnover X Profit margin (c) above = Return on assets
$3,600 $4,580 + $4,580 2 $4,000 $5,380 + $4,580 2 $4,500 $6,280 + $5,380 2 2016 .79 5.0% 4.0%
=
0.79 times
=
0.80 times
=
0.77 times
2017 .80 6.3% 5.0%
2018 .77 7.1% 5.5%
The major driver of the return on assets is the profit margin.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-4B (CONTINUED) (g) Return on common shareholders’ equity
=
Net income – Preferred dividends declared Average common shareholders’ equity
2016
Return on common shareholders' equity
=
2017
Return on common shareholders' equity
=
2018
Return on common shareholders' equity
=
$180 $2,400 + $2,400 2 $250 $2,570 + $2,400 2 $320 $2,810 + $2,570 2
=
7.5%
=
10.1%
=
11.9%
The return on common shareholders’ equity is higher each year than the return on assets due to the presence of leverage. St. Lawrence has used debt to produce additional net income in an amount that exceeds the cost of the debt. The difference between the two ratios is increasing each year as the company is making more effective use of leverage. LO 2,3,4 BT: AN Difficulty: C Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-5B (a) 2018
2017
1
2
1. Current ratio
$265,000 = 4.2 :1 $63,500
$194,000 = 3.8 :1 $51,000
2. Receivables turnover
$890,000 = 13.0 times $83,650* + $52,750* � � 2
$800,000 = 14.8 times $52,750* + $55,400* � � 2
$490,000 = 7.5 times $85,000 + $45,000 � � 2
$450,000 = 9.5 times $45,000 + $50,000 � � 2
5. Times interest earned
$134,000 = 4.8 times $27,750
$90,000 = 10.3 times $8,750
6. Free cash flow
$107,500 - $325,000 - $30,000** = ($247,500)
$91,000 – $75,000 - $15,000 *** =$1,000
7. Gross profit margin
$400,000 = 44.9% $890,000
$350,000 = 43.8% $800,000
8. Profit margin
$85,000 = 9.6% $890,000
$65,000 = 8.1% $800,000
3. Inventory turnover
4. Debt to total assets
9. Asset turnover
10. Return on assets
Solutions Manual .
$308,500 = 32.1% $960,000
$890,000 = 1.1 times $960,000 + $615,000 � � 2 $85,000 = 10.8% $960,000 + $615,000 � � 2
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$116,000 = 18.9% $615,000
$800,000 = 1.4 times $615,000 + $540,000 � � 2 $65,000 = 11.3% $615,000 + $540,000 � � 2
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-5B (CONTINUED) (a) (continued)
1. Current ratio: 1 Current assets 2018 = $30,000 + $80,000 + $85,000 + $70,000 = $265,000 2 Current assets 2017 = $24,000 + $50,000 + $45,000 + $75,000 = $194,000 2. Receivables turnover—Gross accounts receivable: * 2018: $80,000 + $3,650 = $83,650 * 2017: $50,000 + $2,750 = $52,750 * 2016: $53,000 + $2,400 = $55,400 ** Dividends 2018: $235,000 – $180,000 – $85,000 = $30,000 *** Dividends 2017: $180,000 – $130,000 – $65,000 = $15,000
(b)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Current ratio Receivables turnover Inventory turnover Debt to total assets Times interest earned Free cash flow Gross profit margin Profit margin Asset turnover Return on assets
c)
Overall:
Better Worse Worse Worse Worse Worse Better Better Worse Worse
(1)
Liquidity deteriorated in 2018. In spite of the improvement in the current ratio, accounts receivable turnover, and inventory turnover ratios were worse.
(2)
Solvency deteriorated because the debt to total assets ratio, the times interest earned ratio trends and free cash flow is a large negative amount compared to essentially nil in 2017.
(3)
Profitability improved because the gross profit and profit margin ratios trends were better. On the other hand, the asset turnover and return on assets ratios are worse. Overall, the profitability improved as the profit increased by a substantial amount in 2018.
LO 2,3,4 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6B (a)
We do not normally include the effects of other comprehensive income in the calculation of profitability ratios.
(b)
Liquidity 2018
Working capital 1
Current ratio
2017
$575,000 – $443,750 = $131,250
$460,000 – $265,000 = $195,000
$575,000 = 1.3 :1 $443,750
$460,000 = 1.7 :1 $265,000
Receivables turnover
$1,100,000 $950,000 ($100,000 + $10,000 + $87,000 + $5,000) ($87,000 + $5,000 + $80,000 + $3,000) � � � � 2 2 = 10.9 times = 10.9 times
Average collection period
365 = 33 days 10.9
365 = 33 days 10.9
$650,000 = 1.9 times $400,000 + $300,000 � � 2
$635,000 = 2.0 times $300,000 + $320,000 � � 2
365 = 192 days 1.9
365 = 183 days 2.0
Inventory turnover
Days in inventory 1
Current assets, 2018 = $50,000 + $100,000 + $400,000 + $25,000 = $575,000 Current assets, 2017 = $42,000 + $87,000 + $300,000 + $31,000 = $460,000 Current liabilities, 2018 = $150,000 + $245,000 + $48,750 = $443,750 Current liabilities, 2017 = $50,000 + $190,000 + $25,000 = $265,000
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6B (CONTINUED) (b) (continued) Solvency 2018
2017
Debt to total assets
$643,750 = 48.0 % $1,340,000
$390,000 = 39.6 % $985,000
Times interest earned
$165,000 = 5.5 times $30,000
$100,000 = 10.0 times $10,000
Free cash flow
$223,000 – $92,000 – $4,000 = $127,000
$135,500 – $50,000 – $4,000 = $81,500
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6B (CONTINUED) (b) (continued) Profitability 2018
2017
Return on common shareholders’ equity
$101,250 $67,500 $696,250 + $595,000 $595,000 + $531,500 � � � � 2 2 = 15.7% = 12.0%
Return on assets
$101,250 $1,340,000 + $985,000 � � 2 = 8.7%
$67,500 $985,000 + $1,075,000 � � 2 = 6.6%
Profit margin
$101,250 = 9.2 % $1,100,000
$67,500 = 7.1 % $950,000
Asset turnover
$1,100,000 $1,340,000 + $985,000 � � 2 = 0.9 times
$950,000 $985,000 + $1,075,000 � � 2 = 0.9 times
Gross profit margin
$450,000 = 40.9 % $1,100,000
$315,000 = 33.2 % $950,000
Basic earnings per share
$101,250 = $1.01 100,000
$67,500 = $0.68 100,000
Payout
$4,000 = 4.0% $101,250
$4,000 = 5.9% $67,500
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-6B (CONTINUED) (c)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Working capital Current ratio Receivables turnover Average collection period Inventory turnover Days in inventory Debt to total assets Times interest earned Free cash flow Return on common shareholders’ equity Return on assets Profit margin Asset turnover Gross profit margin Basic earnings per share Payout
Worse Worse Unchanged Unchanged Worse Worse Worse Worse Better Better Better Better Unchanged Better Better Lower
(d)
(1)
Track’s overall liquidity has declined in 2018. Its working capital and current ratio have declined and it is taking longer to turn over its inventory. The receivables turnover and average collection period have stayed the same.
(2)
Track’s overall solvency has deteriorated. This is evidenced by the increase in debt to total assets ratio and the decrease in times interest earned.
(3)
Track’s overall profitability has improved as evidenced by the increase in return on common shareholders’ equity, return on assets, profit margin, gross profit margin, and basic earnings per share. The asset turnover ratio has remained constant.
LO 2,3,4 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-7B (a)
Accounts receivable management can be assessed by reviewing each company’s receivables turnover ratio and average collection period. Flavour’s receivables turnover of 10.4 times yields an average collection period of 35 days (365 ÷ 10.4) days. This is reasonable when compared to its credit terms of 30 days. Refresh’s average collection period of 37 days (365 ÷ 9.8) days is worse than that of Flavour.
(b)
Flavour appears to be managing its inventories better than Refresh with days in inventory of 37 (365 ÷ 9.9) versus 63 (365 ÷ 5.8). This is assessed by reviewing the inventory turnover ratio and the average number of days in inventory.
(c)
Refresh likely has a higher current ratio than Flavour because of its lower receivables and inventory turnover as shown above. It is likely that the higher current ratio is therefore due to higher accounts receivable and higher inventory and not due to higher cash or lower current liabilities. In this case, having a higher current ratio is unfavourable.
(d)
Refresh appears to be the more solvent of the two companies. Refresh has a lower debt to total assets ratio, indicating that Refresh has a lower percentage of its assets financed by debt. As well, Refresh has a higher times interest earned ratio indicating that Refresh has a better ability to service its debt as interest payments become due.
(e)
Refresh could have a higher gross profit margin because it either sells its products at a higher price or obtains these products at a lower cost. It would have a lower profit margin because any advantage received from the higher gross profit margin was lost due to higher operating expenses, interest expense, or income tax expense, which caused the profit margin to be lower for this company. Refresh may sell a product that is more expensive and commands a higher gross profit margin. A clue to this is its significantly slower inventory turnover. On the other hand, to achieve sales of high priced items, more expenses have to be incurred in obtaining the sales, such as advertising, which then leads to a lower profit margin.
(f)
The asset turnover is the same for both companies. Therefore, Flavour’s higher return on assets is attributable to Flavour’s higher profit margin.
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-7B (CONTINUED) (g)
If a company’s return on common shareholders’ equity is greater than its return on assets, this excess arose from the advantage of leverage. The return on assets is only 10.2% while the return on common shareholders’ equity is 29.8%. The difference between the two is 19.6% and arose because of that company’s use of debt. The equivalent difference for Refresh is 16.4%. Therefore, the use of debt is a greater contributing factor to the return on common shareholders’ equity than the return on assets.
(h)
Refresh may have a lower payout ratio than Flavour because Refresh’s management decided to retain income in the business to finance future growth.
(i)
Market price per share Refresh = Price-earnings ratio × Basic earnings per share = 14.3 × $0.98 = $14.01 Flavour = Price-earnings ratio × Basic earnings per share = 20.3 × $1.37 = $27.81
(j)
The price-earnings ratio reflects investors’ assessment of the future prospects of a company. As indicated by its higher price-earnings ratio, investors appear to believe that Flavour has the better possibility for growing its net income in the future.
LO 2,3,4 BT: AN Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-8B (a)
Best Tools appears to be more liquid. Although Snappy Tools’ current ratio is higher than Best Tools’, its receivables turnover and inventory turnover are much lower than Best Tools’. This indicates that some of the key current assets may not be as liquid and are inflating the current ratio.
(b)
By reviewing the debt to total assets ratio, we can see Snappy Tools has significantly more debt than Best Tools relative to its assets and a level of double the industry average. However, Snappy Tools has a higher times interest earned ratio which indicates it has a better ability to service its debt as interest payments become due and appears to be the more solvent of the two companies.
(c)
Snappy Tools has a higher return on common shareholders’ equity, return on assets, profit margin, and gross profit margin than Best Tools and the industry. Best Tools’ return on common shareholders’ equity, return on assets, and profit margin ratios are lower than the industry average. All of this indicates that Snappy Tools is the more profitable company.
(d)
Investors seem to favour Snappy Tools as it has the higher priceearnings ratio, large payout ratio, and much higher dividend yield. This is consistent with (c), as you would expect investors to favour the more profitable company. Investors must be anticipating better future profitability from Snappy Tools.
LO 2,3,4 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Financial Accounting, Seventh Canadian Edition
PROBLEM 14-9B (a) and (b) (1)
Current ratio
(a) Higher No impact
(b) Higher No impact
(2)
Debt to total assets
Company B
Company A
(3)
Profit margin
Company A
No impact
(c)
Yes. The impact the different accounting policies will have on each company’s net income and ratios must be considered. Otherwise, the comparison would not be as meaningful.
(d)
Companies may calculate and measure performance using non-GAAP techniques to arrive at normalized income. These measures are used to exclude non-recurring items and assist users of the financial information in making comparisons of current performance against past performances and to predict future earnings.
(e)
An analyst must also consider the use of professional judgement by management in determining the estimates it makes in preparation of the financial statements and whether the company is involved in more than one industry, (that is, how diversified the company is).
LO 5 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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ACR14-1
Financial Accounting, Seventh Canadian Edition
ACCOUNTING CYCLE REVIEW
(a) MANUTECH LTD. Vertical Analysis of Income Statement Year Ended December 31 2018 Amount Percent
2017 Amount
Percent
$1,470,000
100.0%
$1,100,000
100.0%
Cost of goods sold
735,000
50.0%
655,000
59.5%
Gross profit
735,000
50.0%
445,000
40.5%
Operating expenses
313,500
21.3%
270,000
24.5%
Income from operations
421,500
28.7%
175,000
15.9%
Interest expense
61,500
4.2%
53,600
4.9%
Income before income tax Income tax expense
360,000 90,000
24.5% 6.1%
121,400 30,350
11.0% 2.8%
$ 270,000
18.4%
91,050
8.3%
Net sales
Net income
$
Note: The percentages shown in the above table do not add perfectly because of discrepancies that occur from rounding the results to one decimal place.
As demonstrated in the vertical analysis above, the profit margin has increased as a percentage of sales from 8.3% to 18.4%. The most apparent explanation for the substantial increase in profit margin is the 9.5% reduction in cost of goods sold as a percentage of sales. This may be a result of Manutech’s investment in a customer relationship management system. It appears that the use of this system has resulted in a recovery from the decline in 2017 sales. The system should be able to provide management with the necessary feedback on purchasing trends and from repeat sales that have generated these positive results.
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Financial Accounting, Seventh Canadian Edition
ACR14-1 (CONTINUED (b) Ratio
Manutech Ltd.
$292,000
Current ratio
Industry
= 1.6:1
2.0:1
$185,000
Receivables turnover
$1,470,000 ($150,000 + $105,000) 2
Average collection period
= 11.5 times
365 = 32 days 11.5
Inventory
$735,000
turnover
($112,000 + $90,000)
28 days
= 7.3 times
2
Days in inventory
365 = 50 days 7.3
40 days
Compared to the industry average, Manutech has a lower current ratio, and is slower than the industry in collecting its accounts receivable and selling its inventory. Manutech is less liquid than the industry average.
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Financial Accounting, Seventh Canadian Edition
ACR14-1 (CONTINUED) (c) Ratio
Debt to total assets
Times interest earned
Manutech Ltd.
$815,000
Industry
= 53.9%
50.0%
$1,512,000
$421,500 = 6.9 times $61,500
5.0 times
Manutech slightly exceeds the industry average in the amount of assets financed by debt but can cover its interest costs more comfortably than others in its industry. (d) Ratio Gross profit margin
Manutech Ltd.
$735,000
Industry
= 50.0%
44.5%
$1,470,000 Profit margin
$270,000 $1,470,000
= 18.4%
15.1%
Asset turnover
$1,470,000 ($1,512,000 + $1,359,500) 2
= 1.0 times
0.8 times
Return on assets
$270,000 ($1,512,000 + $1,359,500) 2
= 18.8%
12.5%
Compared to the industry averages, Manutech is stronger on all profitability ratios. Solutions Manual .
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ACR14-1 (CONTINUED) (e) MANUTECH LTD. Statement of Cash Flows—Partial Year Ended December 31, 2018
Net cash provided by operating activities
$355,500
Investing activities Purchase of management system Net cash used in investing activities
$(300,000)
Financing activities Issue of bank loan Repayment of mortgage payable Payment of dividends Net cash used in financing activities
$ 85,000 (20,000) (170,000)
(300,000)
(105,000)
Net decrease in cash Cash, January 1 Cash, December 31
(49,500) 79,500 $ 30,000
As was explained in part (a), the major improvements in the profitability for Manutech were achieved following the $300,000 investment in a customer relationship management system. Although some of this investment seems to have been financed through a bank loan, the remainder was obtained from operations. In addition to this, almost half of the cash generated from operations was disbursed in dividends. The total amount of the dividends is extremely high compared to net income. These two factors are the main reasons why the cash position was not higher. LO 1,2,3,4 BT: AN Difficulty: M Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT14-1
Financial Accounting, Seventh Canadian Edition
FINANCIAL REPORTING CASE
(a) THE NORTH WEST COMPANY INC. Horizontal Analysis of Income Statement (% of base-year amount) Year Ended December 31 (in thousands)
Income statement Sales Cost of goods sold Gross profit Selling, operating, and administrative expenses Income from operations Interest expense Income tax expense Net income
Statement of financial position Current assets Non-current assets Current liabilities Non-current liabilities Shareholders’ equity
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2016
2015
2014
116.4 117.0 114.8 117.0 107.3 79.8 111.8 108.6
105.3 106.6 102.0 103.3 97.4 85.7 99.6 97.9
100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
2016
2015
2014
112.2 123.4 74.1 202.9 110.9
105.6 110.0 69.7 179.8 102.1
100.0 100.0 100.0 100.0 100.0
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Financial Accounting, Seventh Canadian Edition
CT14-1 (CONTINUED) (b) (1)
THE NORTH WEST COMPANY INC. Vertical Analysis of Income Statement Year Ended December (thousands) 2016
Sales Cost of goods sold Gross profit Selling, operating, and administrative expenses Income from operations Interest expense Income tax expense Net income
2015
2014
$
%
$
%
$
%
1,796,035 1,273,421 522,614
100.0 70.9 29.1
1,624,400 1,160,182 464,218
100.0 71.4 28.6
1,543,125 1,088,071 455,054
100.0 70.5 29.5
415,293
23.1
366,752
22.6
354,994
23.0
107,321 6,210 31,332
6.0 0.3 1.7 3.9
97,466 6,673 27,910
6.0 0.4 1.7 3.9
100,060 7,784 28,013
6.5 0.5 1.8 4.2
69,779
62,883
64,263
(2) THE NORTH WEST COMPANY INC. Vertical Analysis of Statement of Financial Position (thousands) 2016 2015 $ % $ % Current assets Non-current assets Total assets Current liabilities Non-current liabilities Total liabilities Shareholders' equity Liabilities and shareholders' equity
2014 $
%
335,581 458,214 793,795 155,501
42.3 57.7 100.0 19.6
315,840 408,459 724,299 146,275
43.6 56.4 100.0 20.2
299,071 371,441 670,512 209,738
44.6 55.4 100.0 31.3
280,682 436,183 357,612
35.4 54.9 45.1
248,741 395,016 329,283
34.3 54.5 45.5
138,334 348,072 322,440
20.6 51.9 48.1
793,795
100.0
724,299
100.0
670,512
100.0
Note: The percentages shown in the above table do not add perfectly because of discrepancies that occur from rounding the results to one decimal place. Solutions Manual .
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CT14-1 (CONTINUED) (c)
The horizontal analysis of part (a) highlights how increases in sales over the two years are outpaced slightly by increases in cost of goods sold and selling, operating, and administrative expenses in 2016. On the statement of financial position, we can see liquidity improving with increases in current assets while at the same time decreases in current liabilities. To some extent the vertical analysis of part (b) echoes the highlights of part (a). Whereas the gross profit ratio declined in 2015, income from operations is holding constant and the profit margin has declined due to the reduced gross profit in 2015 and increases in operating expenses in 2016. Similarly, the dollar increase in current assets and decrease of current liabilities is demonstrated in the vertical analysis. In spite of the steady increase in non-current liabilities, North West is enjoying strong solvency with debt to equity proportions remaining close to a 55:45 split by the end of 2015 and 2016.
LO 1,2,3,4 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT14-2 (a)
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
Liquidity ratios: NORTH WEST (thousands)
Current ratio
Receivables turnover Average collection period Inventory turnover
$335,581 = 2.2 :1 $155,501
$2,581.4 = 1.0 :1 $2,707.4
$1,796,035 = 23.7 times ($79,373 + $72,506) � � 2
$24,618.8 = 49.8 times ($489.4 + $499.7) � � 2
365 = 15 days 23.7
365 = 7 days 49.8
$1,273,421 = 6.1 times $211,736 + $204,812 � � 2
$18,661.2 = 14.7 times $1,287.3 + $1,260.3 � � 2
365 = 60 days 6.1
Days in inventory
SOBEYS (millions)
365 = 25 days 14.7
Liquidity: Comparing the current ratios, North West is far more liquid than Sobeys. Sobeys sells products to consumers in larger population centres while North West sells products in remote regions and has more commercial customers so it has more credit sales and higher receivables. In addition, the nature of the inventory of Sobeys, which could include a higher proportion of perishable goods, may explain why the inventory turns over more quickly at Sobeys along with the fact that it takes longer for North West to move inventory through its distribution channels given the remote locations that it operates in. Overall North West is more liquid because Sobeys has more current liabilities than current assets.
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CT14-2 (CONTINUED) (b)
Solvency ratios: NORTH WEST (thousands)
SOBEYS (millions)
Debt to total assets
$436,183 = 54.9% $793,795
$5,230.9 = 65.7 % $7,960.6
Free cash flow
$132,987 – $63,179 – $58,210 = $11,598 (thousands)
$837.7 - $616.2 - $130.3 = $91.2 million
Times interest earned
$69,779 + $6,210 + $31,332 $6,210 = 17.3 times
Not applicable due to loss
Solvency: The higher a company’s percentage of debt to total assets is, the greater the risk that this company may be unable to meet its maturing obligations. North West’s debt to total assets ratio of 54.9% is lower than Sobeys’ at 65.7%. For North West, there is sufficient income before income tax and interest expense to service the interest on its debt, as evidenced by its high times interest earned ratio of 17.3. The solvency ratio of times interest earned cannot be calculated for Sobeys due to the operating loss and negative earnings. North West is the more solvent of the two companies. Both companies generate free cash flow which means that cash is available to pay down debt or expand operations.
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CT14-2 (CONTINUED) (c)
Profitability ratios: (1) In spite of the reporting of a loss from operations and a net loss for Sobeys, it is appropriate to calculate and compare some of the profitability ratios that can be calculated. NORTH WEST (thousands)
SOBEYS (millions)
Gross profit margin
$522,614 = 29.1 % $1,796,035
$24,618.8 – $18,661.2 = 24.2% $24,618.8
Profit margin
$69,779 = 3.9 % $1,796,035
Not applicable due to loss
Asset turnover
$1,796,035 $793,795 + $724,299 � � 2 = 2.4 times
$24,618.8 $7,960.6 + $10,261.0 � � 2 = 2.7 times
Return on assets
$69,779 $793,795 + $724,299 � � 2 = 9.2%
Not applicable due to loss
Return on common shareholders’ equity
$69,779 $357,612 + $329,283 � � 2
Not applicable due to loss
= = 20.3%
Profitability: Although we only have two ratios to compare, we see that Sobey’s gross profit margin is lower (worse) than that of North West. On the other hand, Sobey’s asset turnover is higher (better) than that of North West.
(2)
In order to complete the comparison and perform further analysis, it would be possible to make an assumption ignoring the impairment loss recorded by Sobeys in 2016. This is a non-recurring item that was extremely large. North West had no non-recurring items that could be excluded.
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CT14-2 (CONTINUED) (d)
Other useful information would include the industry averages to determine each company’s performance in relation to other companies in the same industry. In addition, previous years’ financial results would show any trends that are affecting the company’s performance. Other useful information contained in the annual report, but not the financial statements, would indicate management’s assessment of financial performance, discussion of economic conditions, and discussion of strategies that would explain the reasons behind some of the changes in the financial ratios.
LO 2,3,4 BT: E Difficulty: C Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT14-3
Financial Accounting, Seventh Canadian Edition
FINANCIAL ANALYSIS CASE
(a)
FLL is reporting under IFRS because it uses the Other Comprehensive Income account, which is not used under ASPE. It also reversed an impairment loss and revalued equipment to fair value, both of which are allowed only under IFRS. Lastly, the company recorded a “provision,” which is a term used only under IFRS. DLL has recorded none of these items allowed under IFRS and reports using ASPE.
(b)
Not all of the differences that are described relate to the use of IFRS and ASPE. The choice of inventory cost formulas is available under both sets of standards.
(c)
Current ratio: Due to the rising cost of inventory, FIFO will yield a higher value in inventory and so FLL will have a higher current ratio than DLL. Inventory turnover: Cost of goods sold will be lower under FIFO in times of rising prices and ending inventory will be higher. Therefore, FLL will likely experience a lower inventory turnover ratio. Debt to total assets ratio: FLL will likely have a lower debt to total assets ratio because the equipment value has been increased to fair value, and because the reversal of the impairment loss on some of the equipment has caused assets to increase. Offsetting this increase in property, plant, and equipment may be the reduction of those assets involved in the other comprehensive loss recorded during the year which might not be triggered under ASPE. Profit margin: FLL will have a higher profit margin because of its choice to use FIFO, as explained in the inventory turnover ratio above. As well the reversal of the impairment loss on some of the equipment will increase net income. Asset turnover: FLL will have higher total assets as explained in the debt to total assets ratio above. Consequently, its asset turnover ratio can be expected to be lower than DLL’s.
LO 2,3,4,5 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT14-4
Financial Accounting, Seventh Canadian Edition
PROFESSIONAL JUDGEMENT CASE
Company A is WestJet Airlines Ltd. – clues to its identity include: • Discount airline would have a low gross profit • Administrative costs would be minimal as most employees would work on the airplanes or in maintenance – salaries for pilots, attendants, mechanics etc. would be included in cost of goods sold • WestJet has a December 31 year-end, which is right after the very busy Christmas travel season so cash levels are very high • Accounts receivable would be very low as most customers pay with credit cards • Inventories would be minimal as products are not sold to customers except food on airplanes, and there may be some spare parts inventory for planes and equipment • Property, plant, and equipment would be high as the company operates airplanes • Current liabilities would be high because a large portion of this would be unearned revenue as tickets are sold in advance Company B is BlackBerry Limited – clues to its identity include: • The only company with research and development costs • Products are not sold to consumers but retailers, and these types of sales are more likely to be on credit so accounts receivable would be fairly high • This is the company most likely to have intangible assets for the patents on its products • High tech companies usually do not rely as much on bank financing as other companies because they tend to have less tangible collateral, so we would expect to see lower levels of non-current liabilities Company C is Loblaw Companies Ltd. – clues to its identity include: • The grocery industry is competitive so we would expect a lower gross profit margin and a lower profit margin ratio • Despite lower margins, such a company is less likely to be unprofitable given the predictability of revenues and expenses and the constant demand for its products • Selling costs should be a higher percentage of sales compared to other companies because grocery stores advertise (so do furniture companies but they would have higher gross profits). • Inventory would be high but not the highest of the five companies as inventory turnover would have to be high enough to prevent too much spoilage • Because it has private labels, it should have some intangible assets
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CT14-4 (CONTINUED) Company D is Canadian Natural Resources Limited – clues to its identity include: • Oil prices are high this year so a high gross profit margin is expected along with a high profit margin • Depreciation is the largest expense because the business is so capital intensive – oil sands plants are very expensive – this correlates with the large percentage of assets represented by property, plant, and equipment • Due to the large proportion of non-current assets, one would expect to see a correspondingly larger proportion of non-current liabilities compared to current liabilities • Due to the riskiness of oil prices it is more likely for an oil and gas company to have lower debt relative to liabilities than companies with more stable revenue streams like an airline or grocery chain Company E is Leon’s Furniture – clues to its identity include: • Large selling expenses due to significant advertising that occurs in this industry • This company should have a reasonably high level of inventory as its turnover would be slower than the grocery chain • Accounts receivable would be low as sales are made to individuals and any special sales where payment is not needed for a certain period of time give rise to receivables that are often sold to financial institutions • A company that has operated for over 100 years may be more likely to have a higher level of retained earnings and equity and be less in need of bank financing than the other companies and would not need as many non-current liabilities LO 1,2,3,4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT14-5 (a)
Financial Accounting, Seventh Canadian Edition
ETHICS CASE
The stakeholders in this case are: Vern Fairly, president of Flex Industries Anne Saint-Onge, vice-president of communications You, as controller of Flex Industries Shareholders of Flex Industries Potential investors in Flex Industries Any readers of the press release
(b)
The president’s press release is deceptive and incomplete and to that extent, his actions are unethical.
(c)
As controller you should at least inform Anne Saint-Onge, the vicepresident of communications, about the biased content of the release. She should be aware that the information she is about to release, while factually accurate, is deceptive and incomplete. Both the controller and the vice-president of communications (if she agrees) have the responsibility to inform the president of the bias in the about-to-bereleased information.
LO 1,2,3,5 BT: C Difficulty: M Time: 20 min. AACSB: Ethics CPA: cpa-t001, cpa-e001, cpa-t005 CM: Reporting, Ethics, and Finance
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CT14-6
Financial Accounting, Seventh Canadian Edition
STUDENT VIEW CASE
(a)
The software company should have a higher price-earnings ratio because the market expects this company to have opportunities to grow faster than a more established company.
(b)
More established companies like this bank tend to have stable income and cash flows and are not in the same growth phase that a newly public company would be. Consequently, such a company can distribute some of its cash flows to shareholders by paying out a dividend. A newly public company typically obtains a listing on a stock exchange to raise capital from investors to expand their operations and would therefore, be using all available cash for expansion and would not want to diminish available cash by returning any to shareholders through dividends.
(c)
The software company has yet to reach its normal levels of activity and profitability so one would expect such a company to have low income (and perhaps even losses), which in turn will make any ratio based on profitability, such as return on common shareholders’ equity or return on assets, lower than more established companies with a record of profitability.
(d)
A bank uses leverage (borrowed funds) extensively. Every savings account that a bank has is a liability on the bank’s statement of financial position. Therefore, the debt that a bank has is usually much larger than its equity. Normally, the bank will earn a higher return on the borrowed money than it pays to its customers in interest. Because of this, the return on common shareholders’ equity will be higher than the return on assets.
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CT14-6 (CONTINUED) (e)
There really is no “right” answer to this question. It really depends on how much risk an investor is willing to undertake. The bank may provide a nice dividend and its share price may rise in the future but not at a very fast rate because the ability of a bank to grow rapidly is limited due to the large number of competing banks that exist. On the other hand, if the software company makes a very good game and there exists a large demand for that game, then the software company’s share price will rise dramatically. However, there is a risk that the game may not be popular and the share price may then collapse. Such a drop in share price may not occur for the bank’s shares given the steady demand that exists for its services. So, if you feel comfortable with the risk implicit in buying the software company’s shares and believe that their games will indeed be popular, buy those shares. If you are more conservative and don’t mind earning a more modest income or incurring a modest rather than severe loss, you may want to buy the bank shares. Your aversion to risk may also be a function of age. For example, a senior should probably not invest extensively in software company shares because if the price falls dramatically, that lost income can’t be replaced because the senior may be unable to work. Furthermore, the senior may need dividend income to meet living expenses, whereas a younger person can take on more risk with their investments because they have alternative sources of income.
LO 4 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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CT14-7
Financial Accounting, Seventh Canadian Edition
SERIAL CASE
(a)
At first glance, Software Solutions appears to be more liquid than Micro Inc. Its current ratio is significantly higher than the industry ratio. However, the current ratio may be artificially high because its receivables turnover and inventory turnover are both lower than those of Micro and the industry average. This indicates that Software Solutions is collecting its accounts receivable and turning over its inventory less quickly than its competitor. It would be important to look at the composition of Software Solutions’ current assets and current liabilities. It could be that it is the stronger of the two companies—it depends on what other types of assets, besides receivables and inventory, make up its total current assets and how liquid they are.
(b)
It appears that Software Solutions is the less solvent of the two companies. Micro has a lower debt to total assets ratio, which is indicative of greater solvency and has a higher times interest earned ratio. Micro’s higher times interest earned ratio indicates that it can service its debt load. Micro’s and Software Solutions’ times interest earned ratio fall short of the industry average. Nonetheless, Software Solutions debt to total assets ratio is not far off that of the industry and it is still able to handle its interest with a strong times interest earned ratio of 10.8 times.
(c)
Software Solutions is clearly the more profitable of the two companies, as all of its profitability ratios are superior to those of Micro and of the industry.
(d)
Investors who are interested in receiving dividend income rather than appreciation in the share price would favour Software Solutions as indicated by its higher dividend yield ratio. Their dividend yield ratio is also higher than the industry average.
(e)
Investors who are interested in appreciation in the share price rather than receiving dividend income would favour Micro as indicated by its higher price-earnings ratio. This means that investors have positive expectations of Micro’s performance in the future.
(f)
Emily and Daniel should be aware that financial statements prepared under IFRS can contain accounting policy choices and financial statement items (such as other comprehensive income) that may be different from those applied by companies using ASPE. Consequently, some of the above ratios might not be comparable. They should also inquire whether the industry averages are applicable given that they likely relate only to publicly-traded competitors. In preparing their analysis, they should also be aware of what items under IFRS may be subject to additional volatility and how they will interpret the change in the trends for the ratios affected.
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CT14-7 (CONTINUED) (g)
Emily and Daniel should consider some of the following factors related to making an investment in Software Solutions: -
their risk tolerance (can they tolerate the fluctuations inherent in share investments). their profile as investors (are they investing for growth or income). their goals for this investment (are they investing for short-term appreciation or long-term growth). is this the right time to be purchasing the shares (are they currently overvalued by other investors)?
In addition, before concluding their analysis, Emily and Daniel should obtain additional information to supplement the ratio analysis. This could include detailed financial statements, a horizontal and vertical analysis, as well as relevant non-financial information. They likely already have a very good understanding of the business and the economy from their involvement with Anthony Business Company Ltd (ABC). LO 2,3,4 BT: E Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance
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Part 2 CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS LEARNING OBJECTIVES 1.
Identify the uses and users of accounting information.
2.
Describe the primary forms of business organization.
3.
Explain the three main types of business activity.
4.
Describe the purpose and content of each of the financial statements.
Instructor’s Manual
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER OUTLINE Learning Objective 1 – Identify the Uses and Users of Accounting information Accounting is the information system that identifies and records the economic events of an organization, and then communicates them to a wide variety of interested users. Teaching suggestion – Ask students to try to identify situations where accounting matters. The users of financial information fall into two categories—internal users and external users. ⧫
Internal users – users within the organization who have access to internal accounting information to help them make decisions required to run the company.
⧫
External users – users who are outside the organization. These users are not involved in managing a company and do not have access to accounting information other than that which is available to the general public. ▪ Investors (also known as shareholders) ▪ Lenders (also known as creditors) ▪ Other creditors ▪ Others (i.e., Canada Revenue Agency, security commissions and other regulatory agencies, labour unions, potential employees, current employees not involved in managing a company, etc.)
Teaching suggestion – Ask students to assume they are managers of XYZ Corp., and consider possible questions they might have that could be answered using financial information (for example, the ability to earn income, generate future cash flows to meet obligations, produce satisfactory return on investment). Next, ask them to assume they are potential lenders or other creditors and think of questions they might have that could be answered using financial information.
Learning Objective 2 – Describe the Primary Forms of Business Organization A business may be organized as proprietorships, partnerships, or corporations. ⧫
Proprietorship or sole proprietorship – a business owned by one person ▪ Advantages • simple to establish • owner controlled • small amount of capital is needed • owner receives any net income ▪ Disadvantages • proprietor personally liable • financing may be difficult to obtain
Instructor’s Manual
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•
transfer of ownership may be difficult
⧫
Partnership – a business owned by two or more people ▪ Advantages • simple to establish • broader skills and resources • shared financial resources • shared control ▪ Disadvantages • partners personally liable • transfer of ownership may be difficult
⧫
Corporation – a separate legal entity owned by shareholders ▪ Advantages • easy to sell or transfer ownership • greater capital raising potential • legal liability limited to the net assets of the corporation • some favourable income tax advantages • indefinite life ▪ Disadvantages • more expensive and complex to set up • must file corporate income tax returns annually ▪ Distinguish between public and private corporations • public companies list and trade their shares on public stock exchanges • private companies do not make their shares available to the general public nor trade their shares on public stock exchanges
Teaching suggestion – There is a passage in the text, which states, "Although the combined number of proprietorships and partnerships in Canada is more than the number of corporations, the revenue produced by corporations is far greater." Most of the largest companies in Canada— for example, Manulife Financial, Power, Weston, Loblaw, Alimentation Couche-Tard, Royal Bank, Suncor, and Empire—are corporations. Why do you think this is true? ▪
▪
▪
Business records must be kept separate from those related to the proprietor’s, partners’, and shareholders’ personal activities in a proprietorship, partnership, and corporation, respectively. The reporting entity concept requires that the economic activity that can be identified with a company be kept separate and distinct from the activities of the owner(s) and of all other economic entities. Generally accepted accounting principles (GAAP) are the broad policies and practices as well as rules and procedures that have substantive authoritative support and agreement about how to record and report economic events. Principles are also commonly known as policies or standards. Publicly traded corporations must use international financial reporting standards
(IFRS). ASPE comparison – Private corporations can choose to follow ASPE (Accounting Standards for Private Enterprises) or IFRS. Once the selection has been made the accounting standards must be consistently applied.
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Teaching suggestion – Provide some examples of local private companies and discuss whether it would make sense for the company to should follow ASPE or IFRS.
Learning Objective 3 – Explain the Three Main Types of Business Activity There are three types of business activity: financing, investing, and operating. Stress to students that these will be covered in more detail later in the book when the statement of cash flows is discussed in Chapter 13. ⧫
Financing activities – to start or expand a business, the company quite often needs cash from outside sources. The two primary sources are: ▪ Debt: Borrowing money from lenders and other creditors which creates a liability • bank loan • debt securities (bonds) • goods on credit from suppliers ▪ Equity: Issuing (selling) ownership interests (shares) in the corporation to shareholders
⧫
Investing activities – purchasing (or selling) assets needed to operate the business (such as equipment, land, etc.) and purchasing or selling shares or debt securities (such as bonds) of other companies. (in long-term investments, for example).
Teaching suggestion – At this point, ask students to assume they have extra money to invest and ask them how they would prefer to invest the money. Would they consider loaning money to a corporation or would they rather buy shares in the company? Then ask students why they made the decision to lend or buy? Teaching suggestion – Explain to students that investing does not just mean investments. For most companies, the vast majority of investing activities are normally related to the purchase and sale of long-term assets, rather than investments in shares or debt securities of other companies. ⧫
Operating activities – comprise the primary activities for which the organization is in business. ▪ Income results from increases in economic resources – normally an increase in an asset but sometimes a decrease in a liability – that result from the sale of a product or service in the normal course of business.
Teaching suggestion – Stress the fact that just because a business is earning income it is no reason to assume that the business has a lot of cash in the bank. Focus students’ attention on the three types of business activity and let them think about what could have happened to the money the business has made. You might also ask students how a business reporting a loss could have money in the bank.
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Teaching suggestion – Ask students to think about some of the ‘dotcom’ businesses. Many of these companies received large amounts of cash from stockholders and creditors (financing activities). The cash was spent on salaries, advertising, entertainment, equipment and other expenses and assets (investing and operating activities). Unfortunately, many of these businesses were unable to generate sufficient revenues. When the cash ran out, many of the businesses went under. Many shareholders lost their investments and many creditors were unable to collect on debts.
Learning Objective 4 – Describe the Purpose and Content of Each of the Financial Statements Accountants communicate with users through four financial statements: ⧫
Income Statement ▪ Reports success or failure of the company’s operations over a specific period of time. ▪ Summarizes all revenue and expenses for the period—month, quarter, or year. If revenues exceed expenses, the result is a net income. If expenses exceed revenues, the result is a net loss. ▪ Also commonly known as the statement of earnings or statement of profit and loss. Net income is also known as profit, or net earnings. ▪ Must be prepared first as net income is a required component to complete the statement of changes in equity.
⧫
Statement of Changes in Equity ▪ Shows the amounts and causes of the changes in total shareholders’ equity for the period as well as changes in each component of shareholders’ equity during the period. ▪ Reconciles changes in share capital, retained earnings and any other equity accounts (such as accumulated other comprehensive income) from the beginning to the end of the period. ▪ Covers the same period of time as the income statement. ▪ Must be completed after the income statement and prior to the statement of financial position as ending shareholders’ equity is a required component of the statement of financial position.
ASPE comparison – A statement of retained earnings is presented that shows the change in only one component – the retained earnings – of shareholders’ equity. Under IFRS the statement of changes in equity shows changes in all components of shareholders’ equity including share capital and retained earnings, and any other equity items. ⧫
Statement of Financial Position ▪ Shows the relationship between assets, liabilities and equities on a particular date at the end of a period, rather than for a period of time. ▪ Assets = Liabilities + Shareholders’ Equity. ▪ Also commonly known as the balance sheet (especially for companies reporting under ASPE).
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Teaching suggestion – Give examples of assets (i.e. cash, accounts receivable, inventories, furniture and fixtures, and equipment). Explain the difference between accounts receivable and notes receivable. Teaching suggestion – Discuss the concept that assets are the resources that are used by the firm to create more money than what was paid for the assets. Liabilities and shareholders’ equity is how the assets were acquired by the business. ⧫
Statement of Cash Flows ▪ Reports the cash effects (receipts and payments) of a company’s activities for a period of time. ▪ Shows cash increases and decreases for each business activity; operating, investing, and financing activities. ▪ Indicates net increase or decrease in cash during the period as well as ending cash balance. ▪ Covers the same period of time as the income statement and statement of changes in equity. ▪ Ending cash in this statement agrees to the ending cash reported in the statement of financial position.
Teaching suggestion – Using the statements in the North West Company illustration, show the interrelationships between the financial statements and the sequence of preparation. (Note: the arrows in the example help to illustrate this.) 1. Income statement (net income to statement of changes in equity). 2. Statement of changes in equity (net income from income statement added to retained earnings account. Ending shareholders’ equity for each account and in total from statement of changes in equity to shareholders’ equity section of statement of financial position). 3. Statement of financial position (ending shareholders’ equity for each account and in total from statement of changes in equity). 4. Statement of cash flows (ending cash agrees with cash shown on statement of financial position). Teaching suggestion – Ask students to open their books to the “Sierra Corporation” financial statements found in the “Communicating with Users” section of the text. Follow the example to illustrate how the statements link together. Teaching suggestion – Ask students to prepare selected financial statements including the income statement, statement of changes in equity, statement of financial position, and/or statement of cash flows. This is an activity that can kindle thinking. In addition, students may be pleasantly surprised to find that cash outflows they previously thought of as expenses are actually investment activities (such as payments to purchase a car).
Instructor’s Manual
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Why does Canada have different accounting standards for different types of corporations?
Shouldn’t all companies follow the same set of accounting standards?
Why would a private company decide to adopt ASPE instead of IFRS?
If you had a private company, what accounting standard—ASPE or IFRS—would you select?
Why are there different terms to describe the same concept?
Do you think that a business needs a code of ethics?
If you were setting up a business, how would you structure the business?
Why would two businesses structure their companies in different ways?
Why would a bank require financial information when examining whether to loan your company money? Should the bank consider your personal, as well as business, information in the determination of whether to offer your business a loan?
Is “business ethics” an oxymoron?
Instructor’s Manual
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. One of these questions may be given at the beginning of the class and count for ½ to 1 mark.
Name two of the external users of accounting information. Answer: External users: Investors, lenders, other creditors, regulators, customers, labour unions, potential employees, current employees not involved in managing a company, and the like.
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
VOCABULARY QUIZ 1.
The amount by which expenses exceed revenues.
2.
An association of two or more persons to carry on as co-owners of a business for profit.
3.
A financial statement that reports the assets, liabilities, and shareholders’ equity at a specific date.
4.
A business owned by one person.
5.
Users of financial information that use the information to determine whether or not to lend money.
6.
Assets = Liabilities + Shareholders’ equity.
7.
Debts and obligations of a business.
8.
A report prepared by management that presents financial and non-financial information about the company.
9.
The amount of accumulated net income that has been retained in the corporation.
10.
The cost of assets consumed or services used in ongoing operations to generate revenues.
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO VOCABULARY QUIZ 1.
Loss (or net loss)
2.
Partnership
3.
Statement of financial position
4.
Proprietorship
5.
Lenders and other creditors
6.
The accounting equation
7.
Liabilities
8.
Annual report
9.
Retained earnings
10.
Expenses
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
MULTIPLE CHOICE QUIZ 1.
All of the following are characteristics of a sole proprietorship, except a. a business owned by one person. b. owner has control of the business. c. a separate legal entity. d. owner has unlimited legal liability. e. none of the above
2.
All of the following are characteristics of a corporation, except a. a separate legal entity. b. ownership evidenced by shares. c. produce far more revenue than sole proprietorships and partnerships in Canada. d. shareholders have unlimited liability. e. none of the above
3.
Corporations may issue several classes of shares, but the shares representing the primary ownership interest are a. common shares. b. retained earnings. c. financing activity. d. dividends declared.
4.
Resources owned by a business and used in carrying out its operating activities are a. liabilities. b. shareholders’ equity. c. revenues. d. assets.
5.
Acquiring property, plant, and equipment necessary to operate the business is called a(n) a. financing activity. b. operating activity. c. revenue activity. d. investing activity.
6.
The term used to describe the amount that a company earns in exchange for its products is a. cash. b. revenue. c. inventory. d. accounts receivable.
7.
The financial statement which presents a picture of what a business owns and owes at a point in time is a(n) a. income statement.
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Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
b. statement of changes in equity. c. statement of financial position. d. statement of cash flows.
8.
Net income shown on the income statement is added to the beginning balance of retained earnings in the a. income statement. b. statement of changes in equity. c. statement of financial position. d. statement of cash flows.
9.
To report the success or failure of the company’s operations during the period is the purpose of the a. income statement. b. statement of changes in equity. c. statement of financial position. d. statement of cash flows.
10.
Borrowing money is considered what type of business activity? a. operating activity b. financing activity c. borrowing activity d. investing activity
11.
Paying dividends declared is considered what type of business activity? a. operating activity b. financing activity c. payment activity d. investing activity
12.
Purchasing a building is considered what type of business activity? a. operating activity b. financing activity c. buying activity d. investing activity
13.
A publicly traded corporation needs to follow which type of accounting standards? a. International financial reporting standards b. Accounting standards for private enterprises c. Not-for-profit accounting standards d. Public company standards
14.
Which of the following variations of the accounting equation is incorrect? a. Assets = Liabilities - Shareholders’ Equity b. Assets - Liabilities = Shareholders’ Equity
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
c. Assets - Shareholders’ Equity = Liabilities d. Assets - Shareholders’ Equity - Liabilities = 0 e. none of the above
15.
The statement of financial position is also commonly called the a. Income statement. b. Statement of changes in financial position. c. Balance sheet. d. Statement of changes in equity.
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO MULTIPLE CHOICE QUIZ 1.
c
2.
d
3.
a
4.
d
5.
d
6.
b
7.
c
8.
b
9.
a
10.
b
11.
b
12.
d
13.
a
14.
a
15.
c
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
Accounting is an information system that identifies, records, and communicates economic events of an organization to interested users.
True
False
2.
Internal users include investors, lenders, and creditors.
True
False
3.
Issuing shares is considered an investing activity.
True
False
4.
Private companies have a choice of whether to follow ASPE or IFRS.
True
False
5.
The statement of financial position covers a period of time.
True
False
6.
The reporting entity concept requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities.
True
False
7.
The income statement can be prepared monthly, quarterly, or annually.
True
False
8.
The statement of financial position is also known as the balance sheet.
True
False
9.
Liabilities represent the ownership claim on total assets.
True
False
10.
A sale of a delivery truck previously used in the company’s operations is an example of an operating activity.
True
False
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
Multiple Choice 11.
Which one of the following groups uses accounting information to determine whether the company’s net income will result in a share price increase? a. investors b. auditors c. creditors d. production managers e. none of the above
12.
A company’s earning of revenues is an example of a(n) a. operating activity. b. investing activity. c. financing activity. d. statement of financial position activity.
13.
A business organized as a corporation a. is not a separate legal entity in most provinces. b. requires that shareholders be personally liable for the debts of the business. c. is not owned by its shareholders. d. has an indefinite life. e. all of the above
14.
Which of the following accounts would be found on an income statement? a. Sales, Salary Expense, and Dividends Declared b. Service Revenue and Salary Expense c. Sales, Salary Expense, and Cash d. Salary Expense, Dividends Declared, and Cash
15.
The financial statement that reports the assets, liabilities, and shareholders’ equity at a specific date is the a. income statement. b. statement of changes in equity. c. statement of financial position. d. statement of cash flows.
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #1
True/False 1.
True
2.
False
3.
False
4.
True
5.
False
6.
True
7.
True
8.
True
9.
False
10.
False
Multiple Choice 11.
a
12.
a
13.
d
14.
b
15.
c
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #2 1.
Identify the different forms of business organization.
2.
Identify two internal users and two external users of the financial statements.
3.
Classify each of the following items first as a financing, investing, or operating activity, and then indicate whether the transaction increases or decreases cash. a. Inventory is purchased for cash. b. A company sells services for cash. c. A company buys equipment for cash. d. A company sells equipment for cash. e. Employees are paid. f. A company borrows money from the bank. g. A company issues shares. h. A company repays a loan.
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #2 1.
The three forms are business organization are: 1. Proprietorship 2. Partnership 3. Corporation (public and private)
2.
Internal users could include: • Finance directors • Marketing managers • Human resource personnel • Production supervisors • Company officers External users could include: • Investors • Lenders • Creditors • Canada Revenue Agency (CRA) • Government • Union • Potential employees • Current employees not involved in managing the company
3.
Classify each of the following items first as a financing, investing, or operating activity, and then indicate whether the transaction increases or decreases cash. a. Operating activity; cash is decreased. b. Operating activity; cash is increased. c. Investing activity; cash is decreased. d. Investing activity; cash is increased. e. Operating activity; cash is decreased. f. Financing activity; cash is increased. g. Financing activity; cash is increased. h. Financing activity; cash is decreased.
Quizzes
Chapter 1 – The Purpose and Use of Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 2 A FURTHER LOOK AT FINANCIAL STATEMENTS LEARNING OBJECTIVES 1. Identify the sections of a classified statement of financial position.
2.
Identify and calculate ratios for analyzing a company’s liquidity, solvency, and profitability.
3.
Describe the framework for the preparation and presentation of financial statements.
Instructor’s Manual
Chapter 2 – A Further Look at Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER OUTLINE Learning Objective 1 – Identify the Sections of a Classified Statement of Financial Position In a classified statement of financial position (commonly known as the balance sheet), companies often group similar assets and similar liabilities together as they have similar economic characteristics. The groupings help users to determine (1) whether the company has enough assets to pay its debts as they come due and (2) the claims of short-and long-term lenders and other creditors on the company’s total assets. A classified statement of financial position generally contains the following standard classifications:
Current Assets ▪ Assets that are expected to be converted to cash or will be sold or used up within one year of the company’s financial statement date or its operating cycle, whichever is longer. ▪ The operating cycle of a company is the average period of time it takes for a business to pay cash to obtain products or services and then receive cash from customers for these products or services. ▪ Examples of current assets include: cash, held for trading investments, accounts receivables, notes receivable including loans receivable, inventory, supplies, and prepaid expenses. ▪ On the statement of financial position, current assets are normally listed in order of liquidity although some international companies use an order of reverse-liquidity.
Teaching suggestion – Ask students if a company can have too much cash? How can having too much cash be bad? Can a company have too much money tied up in inventory? Are there expenses incurred in carrying large amounts of inventory? Teaching suggestion – (a) Discuss the difference between notes receivable and accounts receivable; different types of prepaid expenses; and the fact that inventory, supplies, and prepaid expenses will become expenses when they are used up. Explain why these assets are classified as current. (b) Discuss the concept of short-term investments.
Non-Current Assets ▪ Assets that are not expected to be converted into cash, sold, or used up by the business within one year of the financial statement date or its operating cycle. ▪ Examples of non-current assets include: long-term investments, property, plant, and equipment, intangible assets, goodwill, and other assets.
Long-Term Investments ▪ Multi-year investments in debt securities that management intends to hold to earn interest and equity securities of other companies that management plans to hold for many years to generate investment revenue or for strategic reasons. ▪ These assets are normally classified as non-current because they are not readily marketable or because management is not intending to see the investment and convert
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Chapter 2 – A Further Look at Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
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it into cash within one year. Examples are investments in shares, loans, notes, bonds or mortgages.
Teaching suggestion – Explain to students that in large companies there are individuals who do nothing but take care of long-term investments. Discuss the difference between short-term and long-term investments in stocks and bonds of other corporations. Example: A homebuilder has the following assets: (1) lots in a subdivision that are ready for sale to buyers; (2) land on which the corporate office building sits; and (3) land several miles north of town on which it plans a new subdivision in 5 years. Ask students where each of these parcels of land would go on a statement of financial position. This shows that the classification depends on the use by the company. Also, ask students how they would classify a certificate of deposit that will mature in 5 years and be used to pay for the new subdivision.
Property, Plant, and Equipment ▪ Assets with relatively long useful lives with physical substance (tangible). ▪ Assets used in operating the business. ▪ Examples include land, buildings, machinery, equipment, furniture, computers, and vehicles. ▪ Sometimes known as capital assets or fixed assets. ▪ Property, plant, and equipment are normally listed based on permanency, with land usually being the most permanent.
Teaching suggestion – Explain that items listed as property, plant, and equipment are recorded as assets and then depreciated (with the exception of land) over the life of the asset. It is possible to revalue the assets to current value using the revaluation model. The revaluation method will be discussed in Chapter 9. Explain that depreciation is not a valuation of assets. It is the allocation of their cost over the periods in which they will benefit the business. Many students believe the statement of financial position shows the value of the business. Stress that accounting (with a few exceptions) records cost – not value. ▪
Intangible Assets and Goodwill • Non-current assets. • Assets which have no physical substance but represent a privilege or right granted to, or held by, a company that will result in a future economic benefit to the company. • Examples are patents, copyrights, franchises, trademarks, trade names, and licences. • Goodwill is an asset that can only result from the acquisition of another company, when the price paid to acquire the company is higher than the fair value of the purchased company’s net identifiable assets. • Goodwill is similar to intangible assets in that it has no physical substance and will generate future value. It differs from intangible assets in that it cannot be separated
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Chapter 2 – A Further Look at Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
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from the company and sold. Goodwill is not amortized. Goodwill is usually reported separately from other intangible assets.
Teaching suggestion – What is a patent? Encourage students to think about companies that have a lot of money invested in intangible assets. Sony Canada and Blackberry are companies that spend a great deal of money on patents. ASPE comparison – Under IFRS, depreciation refers to the allocation of the cost of property, plant, and equipment over their useful lives while amortization refers to the allocation of cost of intangible assets over their useful lives. Under ASPE, amortization is used for the allocation of the cost for both tangible and intangible assets. Warn students that in practice, these terms are often used interchangeably. ▪
Other assets • Other assets can include: non-current receivables, deferred income tax assets, and property held for sale. • Deferred income tax assets arise due to differences between accounting and tax treatment and represent the income tax that is expected to be recovered in a subsequent period due to deductions that a company will be able to take when preparing its corporate income returns in future periods. • Other assets are usually separately reported so that users can get a better idea of their nature and are accompanied by an explanatory note to the financial statements.
Liabilities are obligations that result from past transactions and will result in the future transfer of an economic resource.
Current Liabilities ▪ Obligations that are to be paid or settled within one year of the company’s statement date or its operating cycle, whichever is longer. ▪ Common examples are bank indebtedness, accounts payable, unearned revenue, notes payable including bank loans payable, and current maturities of long-term debt. ▪ Companies often list current liabilities in the order in which they are expected to be paid (order of liquidity by due date). However, some companies list current liabilities in a reverse order of liquidity.
Teaching suggestion – Discuss the different types of payables: bank indebtedness, accounts payable and accrued liabilities, salaries payable, interest payable, income tax payable, current maturities of non-current debt, etc. Discuss how notes payable can be current or long-term, depending on the maturity date.
Non-Current Liabilities ▪ Obligations expected to be paid or settled after one year. ▪ Liabilities in this category include notes payable including bank loans payable, mortgage payable, bonds payable, lease obligations, pension and benefit obligations, and deferred income tax liabilities. ▪ Sometimes known as long-term liabilities.
Instructor’s Manual
Chapter 2 – A Further Look at Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
Teaching suggestion – Bonds have been mentioned several times. Students need to understand the difference between notes payable and bonds payable. Also discuss the difference between interest payable and notes or bonds payable.
Shareholders’ Equity ▪ A residual amount and is the difference between a company’s assets and its liabilities. ▪ Share capital – results when shares representing ownership in the business are sold to investors. ▪ Retained earnings – cumulative profits retained for use in the company. ▪ Note that other equity items (for example accumulated other comprehensive income (loss)) will be introduced in later chapters.
Teaching suggestion – Spend a few minutes discussing the statement of financial position of Frenette Corporation in Illustration 2-10. It might be useful to display this on your computer or on an overhead projector as many students don’t bring their textbook to class. Teaching suggestion – Discuss with students the order of items in the statement of financial position using the North American order of liquidity and the international order of reverseliquidity. Ask them if it makes a difference how accounts are ordered?
Learning Objective 2 – Identify and Calculate Ratios for Analyzing a Company’s Liquidity, Solvency, and Profitability
Ratio analysis expresses the relationships between selected items of financial statement data. Ratios shed light on company performance ▪ Intracompany comparisons – covers two years for the same company ▪ Intercompany comparisons – based on comparisons with a competitor in the same industry ▪ Industry-average comparisons – based on average ratios for particular industries
Teaching suggestion – Discuss your preference for rounding. Explain how to compute percentages. Encourage students to use a spreadsheet for computations and presentation. Also encourage them to see if their answers are reasonable and to always reflect on what the computation means – not to just make the computation and then fail to understand what it tells a user. Teaching suggestion – Discuss ways for students to find industry averages and ratios from sources on the web and in the library. Encourage them to start watching shows on the financial networks and reading business periodicals as well as the business section of newspapers. Ask them to share interesting information with the class.
Liquidity ratios measure a company’s short-term ability to pay its maturing obligations (usually its current liabilities), and to meet unexpected needs for cash. ▪ Working capital • Measure of short-term ability to pay obligations.
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Chapter 2 – A Further Look at Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
▪
• Excess of current assets over current liabilities. • Positive working capital indicates the likelihood for paying liabilities is favourable. Current ratio • Measure of short-term ability to pay obligations. • Calculated by dividing current assets by current liabilities. • More dependable indicator of liquidity than working capital. • Make sure students are cautious in interpreting this ratio because it does not take into account the composition of current assets and can be artificially high because of slow moving inventory and receivables.
Teaching suggestion – Explain that a 1.6:1 current ratio means that for every $1 in current liabilities, the company has $1.60 in current assets to pay the liabilities. Also, students need to be aware of the fact that the composition of the assets may be very important. For example, if a company had most of its current assets in cash it could be more certain of its liquidity position than a company with the majority of its current assets in inventory. What happens if the company cannot sell the inventory?
Solvency ratios measure a company’s ability to survive over a long period of time by having enough assets to settle its liabilities as they fall due. ▪ Debt to Total Assets Ratio • Measures the percentage of assets financed by lenders and other creditors rather than shareholders. • The higher the percentage of debt financing, the riskier the business and the lower a company’s solvency. • Calculated by dividing total debt (both current and non-current liabilities) by total assets.
Teaching suggestion – Compare ratios to tests performed by a doctor. Each test provides information. The doctor must ask the patient questions and then review the results of all tests before making a diagnosis. Students need to realize that ratios are indicators and must be analyzed properly before a decision can be made regarding the financial condition of a company. For example, a negative working capital does not always mean potential bankruptcy. The results of other ratios, as well as specific company information, must be analyzed. A discussion around very successful companies such as Dell and Amazon could be entertained, as these companies work with negative working capital, due to the fact that cash sales are collected from customers upfront before purchases have to be made. Teaching suggestion – Help students calculate working capital, current ratio, and the debt to total assets ratio. Discuss whether a higher or lower ratio is better. You may also want to discuss the importance of comparing these ratios to the industry standards to inform the analysis. Investors, lenders, and other creditors are interested in evaluating profitability. Profitability is frequently used as a test of management’s effectiveness.
Profitability ratios – measure a company’s operating success for a given period of time. ▪ Basic Earnings per Share • Measures the income earned on each common share.
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Chapter 2 – A Further Look at Financial Statements
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
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Calculated by dividing the income available to the common shareholders by the weighted average number of common shares issued during the year. Provides a useful perspective for determining investment return.
ASPE comparison – Under IFRS, earnings per share (EPS) is required to be presented in the financial statements, however ASPE does not require EPS to be included in the financial statements. Help students understand why this is the case. Teaching suggestion – Ask students to watch one of the financial channels for at least 30 minutes and report on the references to basic earnings per share. If you use a discussion board, students can post their comments on it. This is an efficient way to share the information with the class without taking up too much classroom time. ▪
Price-Earnings Ratio • Measures the ratio of the market price of each common share to its basic earnings per share. • Calculated by dividing the market price per share by the basic earnings per share.
Teaching suggestion – Walk through the calculation of the price-earnings ratio for CT REIT and compare it to the industry average. Provide an explanation of what this ratio reveals – a general guideline in gauging share values.
Learning Objective 3 – Describe the Framework for the Preparation and Presentation of Financial Statements
The conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting statements.
The basic objective of financial reporting is to provide financial information useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company. ▪ The users identified in the conceptual framework are all external users and, as such, do not have access to the same financial information as internal users do and it is important that the financial information they do receive is as useful as possible. ▪ Financial statements are prepared using the accrual basis of accounting. Under the accrual basis of accounting, the effects of transactions on a company’s economic resources and claims are recorded in the period when a transaction occurs and not when cash is received or paid.
In order to be useful, financial information should possess the following fundamental qualitative characteristics: ▪ Relevance – if knowledge of it will influence a user’s decision. • Financial statements help predict future events thereby providing predictive value. • Accounting information is also relevant to business decisions because it confirms or corrects prior predictions or expectations, thereby providing confirmatory value.
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Chapter 2 – A Further Look at Financial Statements
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Materiality is an important component of relevance because if an amount is too small to influence the decision, it may be omitted. Information is considered material if its omission or misstatement could influence the decision users.
Teaching suggestion – When you were trying to decide what to wear to class, did it matter whether you were going to an English class or an accounting class? No. That information was not relevant. On the other hand, when you were making the decision, the outside temperature did make a difference. Therefore the temperature was a relevant factor. Teaching suggestion – Materiality allows firms to modify GAAP. Assume a firm buys a new electric pencil sharpener that is expected to last for 6 years for $18. GAAP say that the pencil sharpener, because it is expected to last for 6 years, should be listed as an asset and depreciated—or charged off—over 6 years at a rate of $3 per year. The materiality constraint allows the firm to expense the pencil sharpener immediately because the $18 expense will not make a difference to the users of financial statements. ▪
Faithful Representation – information is useful when it faithfully represents what really exists or happened. The information represents the economic reality of the situation. Financial reporting must present the economic substance of a transaction not just legal form. To be a faithful representation information must be: ▪ Complete – nothing important was omitted. ▪ Neutral – not biased toward one position or another. ▪ Free from error – it provides an accurate description and no errors were made in the process used to determine it.
Teaching suggestion – Financial statements must be a faithful representation to be of value. Securities regulators require companies listed on an organized stock exchange to have financial statements audited. The audit ensures a faithful representation; therefore, the public can feel more comfortable about information contained in audited financial statements.
In addition to the two fundamental qualities of relevance and faithful representation, the conceptual framework also describes four enhancing qualities of useful information: ▪ Comparability • Comparability – users can identify and understand similarities in, and differences among, items. • Comparability enhances the usefulness of financial information because it allows users to compare results from the same company from one period to the next or compare results across different companies as they make investing or lending decisions.
Teaching suggestion – Ask students how comparability might be impacted by allowing public and private companies in Canada to utilize two different accounting standards – IFRS and ASPE. ▪ ▪
Verifiability – if different knowledgeable and independent users can reach consensus that the information is faithfully represented. In order to be relevant accounting information must have timeliness; therefore, it must
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▪
be available to decision makers before it loses its ability to influence decisions. Understandability – classified, characterized, and presented clearly and concisely. Understandable information means that users with a reasonable knowledge of business can interpret the information and comprehend its meaning.
Teaching suggestion - Identify the various levels of understanding that might exist among users of financial information.
Cost constraint - the value of the information provided in financial reporting must exceed the cost of providing it.
Teaching suggestion – Try to think of accounting examples where the cost may exceed the benefit. For example, it wouldn’t make sense for a company to spend $30,000 to hire a security guard to protect $20,000 worth of inventory.
Going concern assumption – assumes that a company will continue in operation for the foreseeable future.
Teaching suggestion – Ask students what would happen to a company if users assumed it wasn’t going to survive past the current period? For example, all liabilities would become current and the original cost of an asset would not be relevant. Teaching suggestion – Use this topic as a way to discuss some of the decisions the CPA must make about risk. What would be some of the factors that the CPA as an auditor would look for to support the going concern assumption?
Financial statements portray the financial effects of transactions and other events by grouping them into broad categories or classes according to their economic characteristics. These broad classes are termed the elements of financial statements, which include assets, liabilities, equity, income (including gains), and expenses (including losses).
Using the objective of financial reporting, the qualitative characteristics, and the underlying assumptions, standard setters developed foundational principles (GAAP) that describe which, when, and how the elements of financial statements should be recognized, measured, and reported.
Generally Accepted Accounting Principles (GAAP) are widely recognized and have authoritative support through the Canadian and provincial business corporations acts and securities legislation.
Teaching suggestion – Remind students that financial statements consist of the income statement, statement of changes in equity, statement of financial position, and statement of cash flows. Again, it may be good to remind them that there are internal and external users.
The historical cost basis of accounting requires assets and liabilities to be recorded at their cost at the time of acquisition, as cost is a faithful representation. Cost is objective, easily verifiable and is neutral.
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It continues to be applied until the asset is sold or until the going concern assumption no longer applies.
Teaching suggestion – Ask students to assume they just bought a delivery van for their business. The van had a sticker price of $18,000. A neighbour purchased an identical van last week for $16,500. The student gave $15,000 for the van. At which price should the van be recorded?
The current value basis of accounting states that certain assets and liabilities should be recorded and reported at current value (the price that would be paid to purchase the same asset or paid to settle the same liability).
Teaching suggestion – Ask students to assume that they purchased shares at $10. At the end of the year the shares are now trading for $20. Which value is more relevant? The students should consider what would happen if they sold the shares today.
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Chapter 2 – A Further Look at Financial Statements
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Why should an owner’s personal assets not be included with the assets of the company?
Discuss why a business would want to produce financial statements more than once a year.
Consider what types of companies would have assets that should be re-valued to current value on an annual basis?
If the students owned a business, would they want to use the current value basis of accounting or the historical cost basis of accounting?
Why should a classified statement of financial position be prepared? Wouldn’t totals for assets, liabilities, and equity be sufficient for users?
Does it matter whether a classified statement of financial position is listed in order of liquidity or reverse-liquidity? Identify when each type of listing order might be useful to users.
Is it possible to provide too much information within the financial statements? What would happen if competitors had access to this information?
If you owned a business, would you want to use another company’s financial statements to compare your operating results to?
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Chapter 2 – A Further Look at Financial Statements
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CHAPTER 2 A FURTHER LOOK AT FINANCIAL STATEMENTS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
The primary objective of financial reporting is to provide a. useful information for making predictions about the future. b. financial statements. c. an annual report. d. useful information to those users making investment and credit decisions. Answer: d
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Chapter 2 – A Further Look at Financial Statements
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VOCABULARY QUIZ 1.
Tangible assets that are being used in the business and are not intended for resale.
2.
The quality of information that indicates the information makes a difference in a decision.
3.
A measure used to evaluate a company’s liquidity and short-term debt-paying ability, calculated by dividing current assets by current liabilities.
4.
The basis of accounting that states assets should be recorded at their cost at the time of acquisition.
5.
If information is important enough to influence the decision of an investor or creditor then the information is said to be this.
6.
Assets not expected to be converted into cash, sold, or consumed in operations within the next year or operating cycle.
7.
Obligations reasonably expected to be paid from existing current assets within the next year or operating cycle.
8.
The excess of current assets over current liabilities.
9.
Measures the ratio of the market price of each common share to its basic earnings per share.
10.
Assets that are expected to be realized in cash, sold or consumed in the business within one year or operating cycle.
Quizzes
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ANSWERS TO VOCABULARY QUIZ 1.
Property, plant, and equipment
2.
Relevance
3.
Current ratio
4.
Historical cost (basis of accounting)
5.
Material
6.
Non-current assets
7.
Current liabilities
8.
Working capital
9.
Price-earnings ratio
10.
Current assets
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Chapter 2 – A Further Look at Financial Statements
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MULTIPLE CHOICE QUIZ 1.
All of the following are current assets except a. accounts receivable. b. cash. c. patents. d. short-term investments. e. inventory.
2.
Current liabilities include a. obligations to be paid within the year or operating cycle. b. accounts payable. c. salaries payable. d. unearned revenue. e. all of the above
3.
Shareholders’ equity includes a. share capital. b. long-term investments. c. advances from shareholders. d. goodwill. e. both a and d
4.
Current assets may be listed in the order of a. liquidity. b. reverse liquidity. c. permanency. d. both a and b e. a, b, and c
5.
Working capital is a. current assets less current liabilities. b. current assets divided by current liabilities. c. net income divided by average assets. d. net income divided by net sales. e. current liabilities less current assets.
6.
The current ratio is a a. solvency ratio. b. profitability ratio. c. liquidity ratio. d. none of the above e. both a and c
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7.
Under ASPE, the allocation of the cost of assets over their useful lives is known as a. amortization for both tangible and intangible assets. b. depreciation for both tangible and intangible assets. c. amortization for tangible assets and depreciation for intangible assets. d. depreciation for tangible assets and amortization for intangible assets. e. none of the above
8.
Selected financial information for ACE Corporation has been provided: Current assets Property, plant, and equipment Current liabilities Non-current liabilities Common shares
$100,000 250,000 50,000 200,000 10,000
ACE Corporation’s debt to total assets ratio is a. 14.3%. b. 50.0%. c. 69.4%. d. 71.4%. e. none of the above
9.
Selected financial information for ACE Corporation has been provided: Current assets Property, plant, and equipment Current liabilities Non-current liabilities Common shares
$100,000 250,000 50,000 200,000 10,000
ACE Corporation’s current ratio is a. $50,000. b. 0.4:1. c. 0.5:1. d. 2.0:1. e. none of the above
10.
Basic earnings per share a. are reported for both public and private companies. b. are reported only by companies following IFRS. c. are reported only by companies following ASPE. d. are optional. e. are reported by companies following both IFRS and ASPE.
11.
Materiality in accounting implies a. that everything is important.
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b. the value of information must exceed the cost of producing it. c. GAAP does not always have to be followed. d. investors should not be influenced by financial statements. e. none of the above
12.
The following are fundamental qualitative characteristics: a. relevance and verifiability. b. relevance and faithful representation. c. faithful representation and verifiability. d. relevance, verifiability, and faithful representation. e. none of the above
13.
The following are enhancing qualitative characteristics: a. comparability and faithful representation. b. verifiability and relevance. c. comparability, timeliness, verifiability, and understandability. d. relevance, verifiability, comparability, and faithful representation. e. none of the above
14.
Which of the following characteristics is not necessary in order for accounting information to be a faithful representation? a. complete b. neutral c. cost constraint d. free from error e. none of the above
15.
The elements of financial statements include a. assets, liabilities, and equity. b. income and expenses. c. the going concern assumption. d. both a and b e. a, b, and c
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Chapter 2 – A Further Look at Financial Statements
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
c
2.
e
3.
a
4.
d
5.
a
6.
c
7.
b
8.
d
9.
d
10.
b
11.
c
12.
b
13.
c
14.
c
15.
d
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Chapter 2 – A Further Look at Financial Statements
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CHAPTERS 1 & 2 MULTIPLE CHOICE QUIZ 1.
The objective of financial reporting is met in large part by a set of financial statements. Of the following, which is not one of these statements? a. Income tax return b. Income statement c. Statement of financial position d. Statement of cash flows e. both a and b
2.
The system that guides decisions about what to present in financial statements, alternative ways of reporting economic events, and appropriate ways of communicating this information is called a. the conceptual framework. b. accounting standards for private enterprises. c. the statement of financial accounting concepts. d. Canadian standards for public accountants. e. generally accepted accounting principles.
3.
A statement of financial position is designed to show the financial position of a business a. at a single point in time. b. over a period of time such as a year or a quarter. c. at December 31 of the current year. d. at January 1 of the coming year. e. none of the above
4.
Which financial statement is prepared first? a. Statement of financial position b. Income statement c. Statement of changes in equity d. Statement of cash flow e. The order does not matter
5.
The Sun and Snow Shop Ltd. started the year with total assets of $60,000 and total liabilities of $40,000. During the year the business recorded $100,000 in car repair revenues, $65,000 in expenses, and dividends of $10,000. The net income reported by The Sun and Snow Shop Ltd. for the year is a. $20,000. b. $35,000. c. $45,000. d. $90,000. e. $100,000.
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6.
Which financial statement reports the cash effects of the company’s operating, investing and financing activities for a period of time? a. Income statement b. Statement of changes in equity c. Statement of financial position d. Statement of cash flows e. Both a and d
7.
The ability to pay obligations that are expected to become due within the next year or operating cycle is called a. working capital. b. profitability. c. solvency. d. liquidity. e. both a and d
8.
Which of the following is considered an intangible asset on a statement of financial position? a. accounts receivable b. cash c. goodwill d. short-term investments e. inventory
9.
Assets total $16,000 and shareholders’ equity totals $11,000. What is the dollar amount of liabilities? a. $23,000 b. $17,000 c. $11,000 d. $5,000 e. none of the above
10.
Borrowing money from a bank is considered to be a(n) a. merchandising activity. b. financing activity. c. operating activity. d. investing activity. e. both c and d
11.
Buying a cash register for a fast food business is an example of a(n) a. merchandising activity. b. financing activity. c. operating activity. d. investing activity. e. both c and d
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12.
Relevant information is considered a. timely. b. predictive and material. c. predictive, confirmatory, and material. d. confirmatory and timely. e. timely and predictive.
13.
Faithful representation is considered a. complete and neutral. b. complete and free from errors. c. neutral and free from errors. d. complete, neutral, and free from errors. e. none of the above
14.
The basic earnings per share ratio is a a. solvency ratio. b. profitability ratio. c. liquidity ratio. d. none of the above e. a, b, and c are correct
15.
Selected financial information from ACE Corporation has been provided: Common shares Net income Market price per share Weighted average number of common shares
$10,000 $80,000 $25 100,000
ACE Corporation’s basic earnings per share is a. $0.80. b. $8.00. c. $10.00. d. $25.00. e. none of the above
Quizzes
Chapter 2 – A Further Look at Financial Statements
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ANSWERS TO CHAPTERS 1 & 2 MULTIPLE CHOICE QUIZ 1.
a
2.
a
3.
a
4.
b
5.
b
6.
d
7.
d
8.
c
9.
d
10.
b
11.
d
12.
c
13.
d
14.
b
15.
a
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Chapter 2 – A Further Look at Financial Statements
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
The operating cycle of a company is the average period of time it takes for a business to pay cash to obtain products or services and then receive cash from customers for these products or services.
True
False
2.
Bonds payable is a current liability.
True
False
3.
The basic objective of financial reporting is to provide useful information to investors and lenders to make decisions about providing resources to the company.
True
False
4.
Solvency ratios measure a company’s ability to survive over a long period of time by having enough assets to settle its liability as they fall due.
True
False
5.
According to the cost constraint, assets should be reported at their historical cost.
True
False
6.
Accounting information has faithful representation if knowledge of it will influence a user’s decision.
True
False
7.
Unearned revenue represents cash received in advance from a customer before revenue is earned.
True
False
8.
Working capital is a liquidity ratio.
True
False
9.
Liabilities represent the ownership claim on total assets.
True
False
10.
The going concern assumption assumes that a company will liquidate in the near future.
True
False
Quizzes
Chapter 2 – A Further Look at Financial Statements
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Multiple Choice 11.
Which of the following is considered a current asset on a classified statement of financial position? a. marketable securities b. notes receivable, due in three years c. building d. patent e. goodwill
12.
Which of the following is not an enhancing qualitative characteristic of useful information? a. comparability b. completeness c. verifiability d. timeliness e. both a and b
13.
Net income available to common shareholders is $140,000 and weighted average number of common shares during the year is 80,000. The market price of each common share is $8.75. The price-earnings ratio is a. 5. b. 4. c. 4.375. d. 16. e. 1.75
14.
Which ratio measures the percentage of assets financed by creditors rather than by shareholders? a. Current ratio b. Basic earnings per share ratio c. Debt to total assets ratio d. Price-earnings ratio e. Working capital
15.
Accounting information should be neutral in order to be a. complete. b. relevant. c. understandable. d. a faithful representation of what really exists or happened. e. reliable.
Quizzes
Chapter 2 – A Further Look at Financial Statements
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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
True
2.
False
3.
True
4.
True
5.
False
6.
False
7.
True
8.
True
9.
False
10.
False
Multiple Choice 11.
a
12.
b
13.
a
14.
c
15.
d
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Chapter 2 – A Further Look at Financial Statements
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20-MINUTE QUIZ #2 1.
Selected components of the conceptual framework are shown below: 1. Going concern 2. Predictive value 3. Neutral 4. Understandability 5. Verifiability 6. Timeliness 7. Faithful representation 8. Comparability 9. Confirmatory value 10. Cost constraint 11. Materiality
Match each of the following statements with one of the items on the above list. a. b. c. d. e. f. g. h. i. j. k.
Quizzes
Information has this quality if different knowledgeable and independent users can reach consensus that the information is faithfully represented. Accounting information that is not biased toward one group of users or another. Information that is presented must portray what really exists or happened. Information has this quality if it is classified, characterized, and presented clearly and concisely. Relevant information helps users make predictions about future events. Accounting information must be available to decision makers before it loses its ability to influence their decisions. The company will remain in operation for the foreseeable future. Information has this quality if users can identify and understand similarities in, and differences among, items. Information has this quality if it provides users with feedback regarding their previous predictions or expectations. The value of the information provided in financial reporting information should justify the cost of providing it. This is an important component of relevance, which requires accountants to consider whether omission or misstatement of the information could influence the decisions of users.
Chapter 2 – A Further Look at Financial Statements
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2.
Consider the following data from Meadows Corporation:
Current assets Total assets Current liabilities Total liabilities Net sales Net income available to common shareholders Market price per common share Weighted average number of common shares
2018 $ 61,000 108,000 47,000 80,000 200,000 30,000 9.00 30,000
2017 $ 50,000 85,000 39,000 62,000 180,000 20,000 6.40 25,000
Calculate the following and explain what the results mean: a. Working capital for 2018 and 2017 b. Current ratio for 2018 and 2017 c. Debt to total assets for 2018 and 2017 d. Basic earnings per share for 2018 and 2017 e. Price-earnings ratio for 2018 and 2017 3.
The following presents December 31, 2018, year-end balances for the Variety Corporation: Cash Accounts payable Accumulated depreciation—equipment Prepaid insurance Common shares Intangible assets Accounts receivable Retained earnings Equipment Land Inventory Long-term loan payable Salaries payable
$ 5,900 3,300 13,500 1,400 25,000 5,500 13,600 49,300 63,000 10,500 14,400 20,000 3,200
Prepare a classified statement of financial position in order of liquidity.
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Chapter 2 – A Further Look at Financial Statements
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ANSWERS TO 20-MINUTE QUIZ #2 1.
2. a.
a.
5
b.
3
c.
7
d.
4
e.
2
f.
6
g.
1
h.
8
i.
9
j.
10
k.
11
Working Capital = Current Assets – Current Liabilities 2018: $61,000 – $47,000 = $14,000 2017: $50,000 – $39,000 = $11,000 Working capital is a measure of liquidity. Since this company’s working capital is positive, there is a greater likelihood that it will be able to pay its current liabilities.
b.
Current Ratio = Current Assets ÷ Current Liabilities 2018: $61,000 ÷ $47,000 = 1.30:1 2017: $50,000 ÷ $39,000 = 1.28:1 The current ratio is another measure of liquidity. In 2018, the company had $1.30 of current assets for every dollar of current liabilities. In 2017, it had $1.28 of current assets for every dollar of current liabilities; therefore, the company’s current ratio improved slightly.
c.
Debt to Total Assets = Total Debt ÷ Total Assets 2018: $80,000 ÷ $108,000 = 74% 2017: $62,000 ÷ $85,000 = 73% This ratio measures the percentage of assets that is financed by creditors rather than by shareholders. In 2018, $0.74 of every dollar invested in assets was provided by creditors. In 2017, $0.73 of every dollar invested in assets was provided by creditors. In general, a higher percentage of debt to total assets means there is greater risk that the company will be unable to pay its debts as they come due.
Quizzes
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d.
Basic Earnings per Share = Net Income Available to Common Shareholders ÷ Weighted Average Number of Common Shares 2018: $30,000 ÷ 30,000 = $1.00 2017: $20,000 ÷ 25,000 = $0.80 This ratio is a measure of profitability. It measures the net income earned for each common share, and provides a useful perspective of shareholder investment return.
e.
Price-Earnings Ratio = Market Price per Share ÷ Basic Earnings per Share 2018: $9.00 ÷ $1.00 = 9 times 2017: $6.40 ÷ $0.80 = 8 times This ratio reflects investors’ assessment of the company’s future profitability. This ratio will be higher if investors think that the company’s current net income level will persist or increase in the future.
3. VARIETY CORPORATION Statement of Financial Position December 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Current assets Cash .................................................................................. $ 5,900 Accounts receivable .......................................................... 13,600 Inventory ........................................................................... 14,400 Prepaid insurance ............................................................. 1,400 Total current assets .................................................... $ 35,300 Non-current assets Property, plant, and equipment Land ........................................................................... $10,500 Equipment .................................................................. $63,000 Less: accumulated depreciation—equipment ............. 13,500 49,500 Total property, plant, and equipment ................................. 60,000 Intangible assets ............................................................... 5,500 Total assets ....................................................................... $100,800 Liabilities and Shareholders’ equity Current liabilities Accounts payable .............................................................. $ 3,300 Salaries payable ................................................................ 3,200 Total current liabilities ................................................. $ 6,500 Non-current liabilities Loan payable ..................................................................... 20,000 Total non-current liabilities .......................................... 20,000 Total liabilities ............................................................. $26,500 Shareholders’ equity Common shares ................................................................ $25,000 Retained earnings ............................................................. 49,300 Total shareholders’ equity ........................................... 74,300 Total liabilities and shareholders’ equity ............................ $100,800
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CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM LEARNING OBJECTIVES 1.
Analyze the effects of transactions on the accounting equation.
2.
Explain how accounts, debits, and credits are used to record transactions.
3.
Journalize transactions in the general journal.
4.
Post transactions to the general ledger.
5.
Prepare a trial balance.
Instructor’s Manual
Chapter 3 – The Accounting Information System
3-1
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CHAPTER OUTLINE Learning Objective 1 – Analyze the Effect of Transactions on the Accounting Equation
Accounting information system – the system that collects and processes transaction data and communicates financial information to decision makers. It begins with the determination of which events should be recorded and reported as accounting transactions.
Accounting cycle – a series of nine steps used to account for, and report, transactions. The First four steps are covered in this chapter, the remaining steps are covered in Chapter 4.
Accounting transactions – accounting transactions occur when assets, liabilities, or shareholders’ equity items change in a measureable way (affects assets, liabilities, or shareholders’ equity) as a result of some economic event.
Teaching suggestion – Provide students with examples of accounting transactions—the purchase of equipment, payment of rent, payment of utilities, payment of salaries; as well as internal events such as the use of supplies or property, plant, and equipment. Contrast this with events that do not result in a change in assets, liabilities, or equity such as hiring an employee or performing an inventory count. Teaching suggestion – Discuss terms: on account, on credit, paid cash, received cash. Review the difference between accounts receivable and accounts payable. Although these may seem obvious, many students struggle with the concepts.
Transaction analysis – the process of considering the transaction or event that has taken place and identifying how the transaction is going to impact the accounting equation.
Teaching suggestion – Illustrate transaction analysis by going through events 1 to 13 for Sierra Corporation.
Teaching suggestion – Walk students through the following transaction analysis. 1.
On July 1, Big Corporation issued $120,000 of common shares. Both Cash and Common Shares would increase by $120,000.
2.
On July 1, Big Corporation borrowed $500,000 from Scotiabank to purchase equipment. Big Corporation agreed to repay the bank loan plus 4 percent interest in 6 months. Both Equipment and Bank Loan Payable would increase by $500,000.
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3.
On July 2, Big Corporation paid its office rent for the month of October in cash, $1,500. Cash is decreased by $1,500 while Rent Expense would increase. Expenses decrease shareholders’ equity (through the Retained Earnings account).
4.
On July 5, Big Corporation paid $1,200 for a one-year insurance policy that will expire next year on June 30. Cash would decrease and another asset, Prepaid Insurance would increase. [Explain to students why Prepaid Insurance would be debited and not Insurance Expense.]
5.
On July 7, Big Corporation hired ten new factory employees. This is not a business transaction.
6.
On July 9, Big Corporation purchased advertising materials on account from Grand Office Supplies for $3,500. Both Supplies and Accounts Payable would increase by $3,500.
7.
On July 13, Big Corporation shipped $240,000 of products to Big Retailing Ltd. A bill is sent to Big Retailing Ltd. for these services. Accounts Receivable is increased indicating an increase in the amount owed by Big Retailing Ltd. to Big Corporation. Product Revenue is increased (increasing Retained Earnings and consequently Shareholders’ Equity).
8.
On July 19, Big Corporation received a $10,000 cash advance from Knight Distributor, a client, for a special manufacturing order that is not expected to be completed until September. Both Cash and Unearned Revenue, a liability, would increase by $10,000.
9.
On July 22, Big Corporation makes a partial payment of $2,000 owing to Grand Office Supplies (see transaction 6). Both Cash and Accounts Payable, would decrease by $2,000.
10.
Employees have worked two weeks, earning $34,000 in salary, which was paid on July 23. Cash would decrease and Salaries Expense would increase (decreasing Retained Earnings).
11.
On July 26, Big Corporation declared and paid a $25,000 cash dividend. Cash would decrease and Dividends Declared would increase (decreasing Retained Earnings).
12.
On July 30, Big Retailing Ltd. pays Big Corporation $150,000 of the amount owing (see transaction 7). This increases Cash and decreases Accounts Receivable by $150,000.
13.
On July 30, Big Corporation paid a monthly income tax instalment of $2,000. Cash is decreased by $2,000 while the Income Tax Expense is increased by $2,000 which decreases Retained Earnings and Shareholders’ Equity by $2,000.
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Learning Objective 2 – Explain How Accounts, Debits, and Credits are used to Record Transactions
Account – an individual accounting record of increases and decreases in a specific asset, liability, or shareholders’ equity item along with opening and ending balances. ▪ An account consists of three parts: (1) the title of the account, (2) a left or debit side, and (3) a right or a credit side. ▪ Because segments of the account resemble the letter T, it is often referred to as a T account.
Teaching suggestions – Draw a T account on your computer, the board, or on an overhead transparency and show students the three parts. Explain to students that we were able to evaluate and record Sierra’s transactions using the extended accounting equation. However, there were only twelve transactions to be recorded. As Sierra’s business expands, will this method be sufficient for recording transactions? What about Tim Hortons—would the expanded accounting equation be sufficient for recording their transactions? No, of course not. We must become more sophisticated; therefore, we use the account to classify transactions. Teaching suggestions – Make sure that students understand the importance of using proper account titles in their journal entries and for their T accounts. They should not use phrases such as ‘paid cash’, ‘bought supplies’, ‘performed services’ as account titles. These phrases represent descriptions of the events. Also, tell them to capitalize the first letter of the account name when referring to a specific account. Discuss the chart of accounts.
The term debit means left, and credit means right. ▪ Debit is abbreviated Dr. and credit is abbreviated Cr. ▪ The act of entering an amount of the left side of an account is called debiting. Entering an amount on the right side is called crediting. ▪ The normal balance of an account is always on its increase side. ▪ Assets are on the left side of the accounting equation and T account shown above. Consequently, if the normal balance of an account is always on its increase side, asset accounts normally have debit (left-side) balances. Increases in asset accounts are entered on the left or debit side of a T account while decreases in assets are entered on the right or credit side. ▪ Liabilities are on the right side of the accounting equation so liability accounts normally have credit (right-side) balances. Increases in liability accounts are entered on the right or credit side of a T account while decreases in liability accounts are entered on the left or debit side. Credits to a specific liability account should exceed debits to that account, which results in a normal credit balance. ▪ Common shares and retained earnings both increase shareholders’ equity. Retained earnings (and shareholders’ equity in turn) are increased by revenues. Consequently, the common shares, retained earnings, and revenue accounts are increased by credits and decreased by debits. The normal balance in these accounts is a credit balance. ▪ Debits increase assets, dividends declared, and expenses while they decrease liabilities, common shares, and revenues. ▪ Credits decrease assets, dividends declared, and expenses. Conversely, they increase liabilities, common shares, and revenues. ▪ When the totals of the two sides of a T account are compared, an account will have a have a debit balance if the left side is greater. Conversely, the account will have a credit balance if the right side is greater. In double-entry accounting system, for every debit there must be an equal credit. The accounting equation must also be kept in balance.
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Teaching suggestion – Review with students Illustration 3-6 which summarizes the normal balances
Teaching suggestion – Show students how to record transactions in two T accounts using the information for Big Corporation. On July 1, $120,000 was invested in Big Manufacturing Corporation common shares. Both Cash and Common Shares would increase by $120,000. Cash 120,000
Common Shares 120,000
Note that an entry to the right hand side of one T account is matched with an entry to the left hand side of another account. We will learn more about recording transactions such as these in the next two learning objective sections of the chapter. Encourage students not to try to memorize the rules of debit and credit. Rather they need to understand the process. Ask them to think of the accounting equation: Assets = Liabilities + Shareholders’ Equity A debit, or a left hand entry, increases accounts on the left of the equation. A credit, or a right hand entry, increases accounts on the right of the equation. Now introduce the Expanded Accounting Equation (see illustration 3-7). Three of these elements: Common Shares, Retained Earnings, and Revenue increase shareholders’ equity. Therefore these three accounts—Common Shares, Retained Earnings, and Revenue are increased by credit entries and decreased by debit entries. The fourth and fifth elements—Expenses and Dividends Declared, decrease shareholders’ equity. Therefore Expenses and Dividends Declared are increased by debit entries and decreased by credit entries. Teaching suggestion – Students have trouble with the rules of debits and credits based on their bank statements. Explain why the banks show debits and credits differently.
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Learning Objective 3 – Journalize Transactions in the General Journal The basic steps in the accounting process are: Analyze each transaction in terms of its effect on the accounts. ▪ A source document, such as a sales slip, a cheque, a bill, or a cash register tape provides evidence of the transaction.
Enter the transaction information in a journal.
Transfer the journal information to the appropriate accounts in the general ledger.
The Journal
Transactions are entered in the journal in chronological order (by date) before being transferred to the accounts.
The journal has a place to record the debit and credit effects on specific accounts for each transaction.
Companies may use various types of journals, but every company has the most basic form of journal, a general journal. In a computerized accounting system, journals are kept as files and accounts are maintained in computer databases.
The journal makes several contributions to the recording process: ▪ The journal discloses in one place the complete effect of a transaction. ▪ The journal provides a chronological record of transactions. ▪ The journal helps prevent or locate errors because the debit and credit amounts for each entry can be readily compared.
Teaching suggestion – What is a journal? Where have you heard this term before? We typically think of foreign correspondents keeping journals. Journals are actually diaries. We can think of the journal used in accounting as a diary that has a chronological listing of the financial transactions of a business. You may want to explain to students that the journal, alone, is of limited use. Accounts facilitate the classification of financial information. For example, all of the transactions pertaining to cash may be found in the cash account. The same is true for all of the other accounts such as accounts receivable, inventory, etc.
Entering transaction data in the general journal is known as journalizing.
Teaching suggestion – Show the students examples of journal entries by returning to the example of Sierra (see Illustration 3-10)
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Teaching suggestion – Show the students examples of journal entries. Return to the example of Big Manufacturing Corporation. On July 1, $120,000 of cash was invested in the business, in exchange for Sierra Corporation common shares. Both Cash and Common Shares would increase by $120,000. This transaction would be recorded in the following manner:
Date July 1
Account Titles and Explanation
Debit
Credit
Cash 120,000 Common Shares 120,000 (Issued common shares)
Learning Objective 4 – Post Transactions to the General Ledger The Ledger The entire group of accounts maintained by a company is referred to as the ledger.
The general ledger contains all of the asset, liability and shareholders’ equity accounts, as well as dividends declared, revenue and expense accounts.
Information in the ledger provides management with the balances (or subtotals) in various accounts.
Most companies use a computerized accounting system where the entries from the journal are automatically recorded in the ledger by the software.
Accounts in the general ledger are listed in the chart of accounts.
Posting
Posting is the process of transferring journal entries to the general ledger accounts. With the help of accounting software, this step is done automatically.
Posting accumulates the effects of journal transactions in the individual ledger accounts.
Many general ledger account balances will have balances carried over from the prior period and pasting will include only the transactions for the current period
Teaching suggestion – Ask students to compare the information in the General Journal in the textbook with the information in the General Ledger. Which is more useful? Teaching suggestion – Show journal entries for each of the transactions analyzed earlier.
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Learning Objective 5 – Prepare a Trial Balance
A trial balance is a list of accounts and their balances at a specific time.
The primary purpose of the trial balance is to prove the mathematical equality of debits and credits after posting.
A trial balance uncovers errors in journalizing and posting.
A trial balance is useful in the preparation of financial statements.
A trial balance is limited in that it will balance, and therefore not uncover errors, when: ▪ A transaction is not journalized, ▪ A correct journal entry is not posted, ▪ A journal entry is posted twice, ▪ Incorrect accounts are used in journalizing or posting, or ▪ Offsetting errors are made in recording the amount of a transaction.
Teaching suggestion – Students often have a difficult time getting their trial balance to actually balance. Provide your students with some tips for finding their error. First, calculate the difference between the total debits and total credits, and then look for this amount in either the question or solution that they prepared. Next, divide the difference by 2, and check to see whether a debit for this amount has been recorded as a credit, or vice-versa. Finally, divide the difference by 9. If it divides evenly (with no decimals) check for a transposition error: two digits may have been reversed. For example $752 may have been written as $725.
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
What type of accounting system would your business require if you were just starting up a new business?
Would an accounting system differ based on the type of company? For example would a large public company need a different system than a small corner store?
How often would you want to produce a trial balance for your business?
How often should a business record its accounting transactions? Will the frequency depend on the size of the business? How often would you want to record transactions for your business?
What are some examples of events which would not need to be recorded as accounting transactions?
If debits must equal credits, how is it possible that more than two accounts can be impacted with one journal entry?
Does an accountant spend all of their time figuring out how to record transactions and then posting the specific transactions?
Why does debit mean left and credit mean right?
Since most companies will use a computer to record transactions, how will learning about the steps in the accounting process be useful?
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CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
A list of accounts and their balances at a given time is called a(n): a. Statement of financial position. b. Trial balance. c. Annual report. d. Source document. Answer: b
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VOCABULARY QUIZ 1.
The entire group of accounts maintained by a company.
2.
A list of accounts and the account numbers which identify their location in the general ledger.
3.
The procedure of entering transaction data in the journal.
4.
Events that require recording in the financial statements because they involve an exchange affecting assets, liabilities, or shareholders’ equity.
5.
Shows the debit and credit effects on specific accounts.
6.
An individual accounting record of increases and decreases in a specific asset, liability, and shareholders’ equity items.
7.
A system that records the dual effect of each transaction in appropriate accounts.
8.
The procedure of transferring journal entries to the general ledger accounts.
9.
The left side of an account.
10.
A list of accounts and their balances at a given time.
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ANSWERS TO VOCABULARY QUIZ 1.
Ledger
2.
Chart of accounts
3.
Journalizing
4.
Transactions
5.
Journal
6.
Account
7.
Double-entry system
8.
Posting
9.
Debit
10.
Trial balance
Quizzes
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MULTIPLE CHOICE QUIZ 1.
The process of identifying the specific affected accounts and the amount of the change in each account is referred to as a. posting. b. transaction analysis. c. journalizing. d. balancing. e. none of the above
2.
A cash payment by a corporation to its shareholders by way of a distribution of net income is a. recorded as an advance to shareholders. b. recorded as salaries expense. c. recorded as an investment. d. recorded as dividends declared.
3.
Dividends declared which have been paid are shown on the a. income statement. b. statement of changes in equity. c. statement of cash flows. d. both b and c above
4.
Items such as a sales slip, a cheque, a bill, or a cash register tape are examples of a. statement of financial position accounts. b. income statement accounts. c. cost of goods sold. d. source documents.
5.
The process of entering transaction data into the journal is called a. posting. b. journalizing. c. balancing. d. none of the above
6.
Which of the following is not a contribution of the general journal to the recording process? a. determining net income b. disclosing in one place the complete effect of a transaction c. providing a chronological record of transactions d. helping to prevent or locate errors
7.
The basic steps in the recording process are a. analyze the transaction, enter the transaction in the journal, and transfer the information to the general ledger. b. enter the transaction in the journal, analyze the transaction, and transfer the information to the
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general ledger. c. analyze the transaction, enter the transaction in the financial statements, and enter the transaction in the journal. d. none of the above
8.
All of the following accounts have normal debit balances, except a. Cash. b. Salaries Expense. c. Unearned Revenue. d. Prepaid Insurance. e. none of the above
9.
All of the following accounts would have normal credit balances, except a. Accounts Payable. b. Bank Loan Payable. c. Unearned Revenue. d. Dividends Declared. e. none of the above
10.
Which of the following mistakes will a trial balance most likely detect? a. A transaction is not journalized. b. A debit balance is recorded as a credit balance. c. A journal entry is posted twice. d. Incorrect amounts are used in journalizing or posting. e. none of the above
11.
Which of the following is incorrect? a. A trial balance is a list of general ledger accounts. b. A trial balance lists balances at a specific time. c. A trial balance is prepared at the end of the accounting period. d. A trial balance is prepared after the financial statements. e. none of the above
12.
Rebuilt Inc. purchased a new building in order to open a new store. Rebuilt Inc. paid $250,000 in cash for the purchase. How would this transaction impact the accounting equation? a. Cash and Buildings would increase. b. Cash would decrease and Buildings would increase. c. Cash would decrease and Building expense would increase. d. Cash and Buildings Expense would increase.
13.
What is the classification, debit effect, and normal balance for the Unearned Revenue account? Classification Debit Effect Normal balance a. Liability decrease credit b. Liability increase debit c. Shareholders’ equity (revenue) decrease credit d. Shareholders’ equity (revenue) increase debit
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14.
Which of the following would not qualify as an accounting transaction? a. receiving a new computer b. paying monthly office rent c. obtaining a quote for repairs d. buying business insurance e. none of the above
15.
Which of the following is incorrect? a. A trial balance proves that debits equal credits. b. A trial balance is a list of accounts with their balances. c. A trial balance may be prepared monthly, quarterly, or annually. d. A trial balance will identify when a journal entry has not been posted. e. none of the above
Quizzes
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
b
2.
d
3.
d
4.
d
5.
b
6.
a
7.
a
8.
c
9.
d
10.
b
11.
d
12.
b
13.
a
14.
c
15.
d
Quizzes
Chapter 3 – The Accounting Information System
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
Assets and liabilities are both decreased by credits.
True
False
2.
Accounting transactions occur when assets, liabilities, or shareholders’ equity items change as a result of some economic event.
True
False
3.
An account will have a credit balance if the total debit amounts exceed the total credit amounts.
True
False
4.
The ledger is also known as the book of original entry.
True
False
5.
The basic steps in the recording process are (1) analyze each transaction, (2) enter the transaction in a journal, and (3) transfer the journal information to the appropriate ledger accounts.
True
False
6.
The posting phase of the recording process makes it possible to accumulate the effects of journalized transactions in individual accounts.
True
False
7.
Assets = Liabilities + Common Shares + Revenues – Expenses – Dividends Declared is a correct form of the expanded basic accounting equation.
True
False
8.
The general journal helps to prevent and locate errors because the debit and credit amounts for each entry can be quickly compared.
True
False
9.
When the columns of the trial balance equal each other, it proves no errors occurred in recording and posting.
True
False
10.
The trial balance helps to identify when a transaction is not journalized.
True
False
Quizzes
Chapter 3 – The Accounting Information System
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Multiple Choice 11.
Transactions are initially recorded in the a. general ledger. b. general journal. c. trial balance. d. statement of financial position. e. none of the above
12.
The right side of an account is referred to as the a. negative side. b. positive side. c. debit side. d. credit side. e. none of the above
13.
If a company receives cash from a customer before performing services for the customer, then a. assets increase, and liabilities decrease. b. assets increase, and shareholders’ equity increases. c. assets decrease, and liabilities increase. d. assets increase, and liabilities increase.
14.
The equality of the accounting equation can be determined by preparing a a. trial balance. b. journal. c. general ledger. d. T account.
15.
If an account is debited in a journal entry, then a. that account will be credited in the general ledger. b. that account will be both debited and credited in the general ledger. c. that account will be debited in the general ledger. d. None of the above is correct.
Quizzes
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ANSWERS TO 20-MINUTE QUIZ #1
True/False 1.
False
2.
True
3.
False
4.
False
5.
True
6.
True
7.
True
8.
True
9.
False
10.
False
Multiple Choice 11.
b
12.
d
13.
d
14.
a
15.
c
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20-MINUTE QUIZ #2 1.
Fill in the blanks with debit or credit to complete the following sentences correctly. a. Assets are increased by a ______. b. Liabilities are increased by a ______. c. The normal balance of a revenue account is a ______. d. A ______ would decrease a liability account. e. A ______ would increase an expense account.
2.
Prepare journal entries in good form for each of the following transactions concerning the business J. Morris, Architect: a. On July 5, Morris prepared a set of drawings for a customer and billed the customer $1,500. b. On July 10, bought $300 of drafting supplies for cash. c. On July 15, paid $800 in salaries for the assistant. d. On July 18, collected $900 from the July 5 transaction. e. On July 20, paid $600 for a one-year insurance policy in advance. f. On July 22, a cash advance of $800 is received from a client for services to be performed in August.
3.
Should the following transactions be recorded and why? a. The manager of a company purchases a computer for personal use. b. A company provides services to one of its customers on account. c. A company purchases a machine and pays with cash. d. A company places an order with one of its suppliers for inventory to be shipped next month.
Quizzes
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ANSWERS TO 20-MINUTE QUIZ #2
1.
Fill in the blanks with debit or credit to complete the following sentences correctly. a. debit b. credit c. credit d. debit e. debit
2.
Prepare journal entries in good form for each of the following transactions concerning the business J. Morris, Architect:
a.
b.
c.
d.
e.
f.
Quizzes
Jul 5
Jul 10
Jul 15
Jul 18
Jul 20
Jul 22
Accounts Receivable Service Revenue Invoiced customer for architect drawings
1,500
Supplies Cash Purchased supplies
300
Salaries Expense Cash Paid the assistant
800
Cash Accounts Receivable Received cash on account
900
Prepaid Insurance Cash Paid for insurance in advance
600
Cash Unearned Revenue Received cash in advance from a client.
800
Chapter 3 – The Accounting Information System
1,500
300
800
900
600
800
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3.
Should the following transactions be recorded and why? a. Assuming the manager purchased the computer with his/her own funds, this is not a transaction of the company as it is a personal transaction. b. This is a business transaction and should be recorded since an asset has increased (accounts receivable) and revenue has been earned. c. This is a business transaction and should be recorded since an asset (machine) is purchased in exchange for another asset (Cash). d. This is not a business transaction and should not be recorded. An order was placed but no purchase has occurred.
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CHAPTER 4 ACCRUAL ACCOUNTING CONCEPTS LEARNING OBJECTIVES 1.
Explain the accrual basis of accounting and the reasons for adjusting entries.
2.
Prepare adjusting entries for prepayments.
3.
Prepare adjusting entries for accruals.
4.
Prepare an adjusted trial balance and financial statements.
5.
Prepare closing entries and a post-closing trial balance.
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CHAPTER OUTLINE Learning Objective 1: Explain the Accrual Basis of Accounting and the Reasons for Adjusting Entries
Accounting divides the economic life of a company into time periods which are generally one month, one quarter, or one year. The accounting time periods of one year are known as a fiscal year; shorter time periods are known as interim periods.
Revenues arise in the course of ‘ordinary’ activities but can also arise from activities that are not part of the company’s ordinary activities such as gains from the sale of equipment or investment income from sources such as interest or dividends. Note that the term revenue is often used interchangeably with the term income.
Teaching suggestion – The type of revenue that is ordinary for one company may not be for another company. Consider a construction company that sells a vehicle. This type of revenue would not be ordinary for the construction company. However, when a car dealership sells a car it is ordinary income. Ask students to come up with other examples of revenue that is ordinary for one company but not for another company.
Revenues result from changes in assets and liabilities. When revenue is incurred, an asset will increase or a liability will decrease. Consequently, revenues result in increases in future economic benefits.
Under IFRS, revenue is recognized (recorded) when the following five steps have been completed: 1. Identify the contract with the client or customer. 2. Identify the performance obligations in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to the performance obligations in the contract. 5. Recognize revenue when (or as) the company satisfies the performance obligation. In general, assuming the first four steps above have been determined, revenue is recognized for by service companies when the service has been performed and by merchandising companies when the goods have been delivered.
Teaching suggestion – Jack purchased season tickets to support his University’s new hockey team. Season tickets are paid prior to the start of the season. Jack paid $150 in July. There are 30 games played from the middle of September to the middle of February. 1. Identify the contract with the client or customer. Jack has a ticket to each game played between the middle of September and the middle of February. Payment is due for season tickets prior to the start of the season. 2. Identify the performance obligations in the contract. The hockey will play 30 games, each of which Jack has the ability to watch. Instructor’s Manual
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3. Determine the transaction price. The transaction price is the amount that Jack paid of $150. 4. Allocate the transaction price to the performance obligations in the contract. There are 30 games in the season. Based on the price of $150, this equates to $5 per game. 5. Recognize revenue when (or as) the company satisfies the performance obligation. The hockey team would satisfy its performance when each game is played. $5 should be recognized each time the team plays a game. Teaching suggestion – Does Air Canada record revenue when you buy a plane ticket on May 1 for a flight on June 15? Has the service been provided? The answer to both questions is “no”. Air Canada cannot recognize revenue on May 1 because the performance obligation is not complete (the service has not been provided). The revenue will be recognized on June 15 when the ticket holder takes the flight.
Expense recognition is linked to revenue recognition when there is a direct association between the expenses incurred and the generation of revenue. This is commonly known as matching as the effort (expenses) is matched with the results (revenues).
Expense recognition is not tied to the payment of cash. Expenses are recognized when incurred regardless of whether cash is paid or not.
Expenses are the costs of assets that are consumed or services used in a company’s ordinary business activities. Expenses result in changes in assets and liabilities. When an expense is incurred, an asset will decrease or a liability will increase. Consequently, expenses are related to decreases in future economic benefits.
Teaching suggestion - Suppose sales personnel are paid every two weeks in a retail store. When preparing financial statements for May, the accountant realizes that employees were last paid on Friday, May 22. By May 31, nine days have elapsed and many of the employees have worked seven or more days. The salaries of these employees must be included in expenses. The same accountant also notices that on May 1 the retail store renewed its insurance coverage by paying the $12,000 premium on a one-year insurance policy. Is all of the $12,000 an expense of May? No. The policy will be in effect for 12 months; therefore, $1,000 ($12,000 ÷ 12 months) should be recognized as an expense each month.
Accrual basis accounting means that transactions affecting a company’s financial statements are recorded in the periods in which the events occur, rather than when the company actually receives or pays cash.
Accrual basis accounting requires accountants to adhere to revenue and expense recognition guidelines.
With cash basis accounting, revenue is recorded when cash is received. Expenses are recorded only when cash is paid.
Cash basis accounting is not permitted for use in Canada.
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Teaching suggestion – Return to the illustration of Air Canada shown above. If the cash basis of accounting was used, Air Canada would recognize revenue on May 1 when the ticket was purchased. All expenses would be recorded when cash was paid. Point out that with the cash basis accounting, the income figure is easy to manipulate.
Adjusting entries are needed to ensure that revenue recognition and expense recognition are applied and make it possible to produce up-to-date and relevant financial information at the end of the accounting period.
Due to the fact that many of the amounts listed in the trial balance are incomplete until adjusting entries are prepared, this trial balance is commonly referred to as an unadjusted trial balance. Unadjusted trial balance means it is prepared before adjusting entries have been made.
Adjusting entries are required every time financial statements are prepared, and often are prepared more frequently.
Adjusting entries can be classified as either prepayments or accruals. Each of these classes has two subcategories; prepayments can be classified as prepaid expenses or unearned revenues and accruals can be classified as accrued expenses or accrued revenues.
ASPE comparison – Under IFRS, public companies need to release quarterly financial statements so adjusting entries have to be made at least quarterly, although many companies will record adjusting entries every month. Under ASPE, private companies normally release financial statements to their banker at least on an annual basis so adjusting entries may only be completed at year end, although many companies will record adjusting entries more frequently.
Learning Objective 2: Prepare Adjusting Entries for Prepayments
Prepayments increase current assets such as prepaid expenses and also affect certain types of non-current assets such as buildings and equipment. A prepayment can also be received rather than paid, in which case the prepayment increases the current liabilities such as unearned revenues. Prepayments fall into two categories—prepaid expenses and unearned revenues.
Prepaid expenses - expenses paid in cash and recorded as assets until they are used or consumed. Prepaid expenses expire with the passage of time (for example rent and insurance) or through use (for example supplies).
Teaching suggestion – A cost can be an asset or an expense. If the cost has future benefit (that is, the benefits have not yet expired), it is an asset. If the cost has no future benefit (that is, benefits have expired), it is an expense.
The transaction journal entry to record prepaid expenses normally involves a debit to an asset (prepaid expense) account and a credit to the Cash account.
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An adjusting entry for prepaid expenses will result in an increase or a debit to an expense account and a decrease or a credit to an asset account.
Until prepaid expenses are adjusted at the end of the accounting period, assets are overstated and expenses are understated. If expenses are understated, then net income and shareholders’ equity will be overstated.
Depreciation is the process of allocating the cost of a long-lived asset to expense over its useful life.
Teaching suggestion – Depreciation is an allocation concept, not a valuation concept. When a company depreciates an asset to allocate its cost to the periods over which it is used, it is not an attempt to record a change in the actual value of the asset.
Unearned revenues - cash received in advance and recorded as liabilities before the revenues are earned.
The transaction journal entry to record unearned revenues normally involves a debit to an assets (Cash) account and a credit to the liability account (Unearned Revenue).
An adjusting entry for unearned revenues will result in a decrease or a debit to a liability account and an increase or a credit to a revenue account.
An adjusting entry for prepayments (prepaid expenses or unearned revenues) will decrease a statement of financial position account and increase an income statement account.
Teaching suggestion - Go through the examples of adjusting entries for the following prepayments including: supplies, insurance, depreciation, and unearned revenue. Review the concepts of depreciation, depreciation expense, and accumulated depreciation. Teaching suggestion – Discuss the effects on the income statement and statement of financial position if adjustments are not made.
Learning Objective 3: Prepare Adjusting Entries for Accruals
Accruals fall into two categories—accrued expenses and accrued revenues. ▪ Accrued expenses - expenses incurred but not yet paid in cash or recorded at the statement date. ▪ Accrued expenses are also referred to as accrued payables because both are created in the same adjusting entry. ▪ An adjusting entry for accrued expenses results in a debit or an increase to an expense account and a credit or an increase to a liability account. ▪ Accrued revenues - revenues earned but not yet received in cash or recorded at the statement date. ▪ Accrued revenues are also referred to as accrued receivables because both are created in the same adjusting entry. ▪ An adjusting entry for accrued revenue will result in a debit or an increase in an
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▪
asset account and an increase or a credit to a revenue account. An adjusting entry for accruals (accrued revenues or accrued expenses) will increase both a statement of financial position account and an income statement account.
Teaching suggestion - Go through the examples of adjusting entries for accrued interest, accrued salaries, and accrued revenues. Teaching suggestion – Discuss the effects on the income statement and statement of financial position if adjustments are not made. Summary of basic relationships: Type of Adjustment Accounts Before Adjustment Prepaid expenses Assets overstated Expenses understated Unearned revenues Liabilities overstated Revenues understated Accrued revenues Assets understated Revenues understated Accrued expenses Expenses understated Liabilities understated
Adjusting Entry Dr. Expenses Cr. Assets Dr. Liabilities Cr. Revenues Dr. Assets Cr. Revenues Dr. Expenses Cr. Liabilities
Teaching suggestion – Emphasize to students that adjusting entries never involve the cash account. In the case of prepayments, cash has already been received or paid and recorded in the original journal entry; therefore it is not possible to adjust the Cash account. The adjusting entry reallocates, or adjusts, amounts between a statement of financial position account and an income statement account. In the case of accruals, cash has not yet been received or paid and because of this, the transaction has not yet been recorded. The adjusting entry simply records the receivable or payable and the related revenue or expense.
Learning Objective 4: Prepare an Adjusted Trial Balance and Financial Statements
The adjusted trial balance is prepared after all adjusting entries have been journalized and posted.
The adjusted trial balance shows the balances of all accounts, including those that have been adjusted at the end of the accounting period.
The purpose of the adjusted trial balance is to prove the equality of the total debit balances and total credit balances in the ledger after the adjusting entries have been posted.
Financial statements can be prepared from the adjusted trial balance.
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Teaching suggestion - Show students an adjusted trial balance and demonstrate how easy it is to prepare financial statements from the information contained in the adjusted trial balance. Remind students that common shares shown in the unadjusted and adjusted trial balances is the ending balance and that the opening balance will be used in the statement of changes in equity. In contrast, retained earnings shown in the unadjusted and adjusted trial balances is still the opening balance of retained earnings and will remain so until the temporary accounts have been closed.
Learning Objective 5: Prepare Closing Entries and a PostClosing Trial Balance
Temporary accounts are all expense and revenue accounts and the Dividends Declared account. These accounts are used to temporarily to record activity for one accounting period and their balances are not carried forward into future accounting periods. The normal balance for revenue is a credit while the normal balance for expenses is a debit, and the normal balance for Dividends Declared is a debit.
Permanent accounts are asset, liability, and shareholders’ equity accounts. These accounts are not closed at the end of the period because their balances are carried forward into future accounting periods. The normal balance for asset accounts is a debit, the normal balance for liability accounts is a credit, and the normal balance for shareholders’ equity accounts differ depending on the component. For example, the normal balance of common shares is a credit and the normal balance for retained earnings is a credit while the components of retained earnings have varying normal balances (revenues have normal credit balances, expenses debit balances, and dividends declared debit balances).
Closing entries are used to transfer the balances in the revenue, expense, and Dividends Declared accounts to the Retained Earnings account. Closing entries produce a zero balance in each temporary account and update Retained Earnings to its ending balance. ▪ ▪ ▪ ▪ ▪
To close revenue accounts, debit each specific revenue account and credit Income Summary for their total. To close expense accounts, credit each specific expense account and debit Income Summary for their total. If the net result is a credit balance in Income Summary, then there is a net income, and Income Summary is debited and Retained Earnings is credited with that balance. A debit balance in Income Summary means there is a loss and a credit to Income Summary and a debit to Retained Earnings is necessary. Dividends Declared are closed with a credit for the balance in that account and a debit to Retained Earnings.
Teaching suggestion - Tell students to look at the date on the income statement. The date is "Period (for example month, Year, and so on) Ending October 31, 2018." How can one be sure the revenue and expenses reported on the income statement are just for that period? Closing entries transfer the temporary account balances to the shareholders' equity account and reduce the balances in the temporary accounts to zero. Therefore, at the beginning of the period the temporary accounts have a balance of zero and the revenue and expenses accumulated are for that particular period. Instructor’s Manual
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A post-closing trial balance is prepared after the closing process has been completed. Only permanent (statement of financial position accounts) should appear in the postclosing trial balance as all temporary accounts should have balances of zero.
Teaching suggestion – Remind students that retained earnings shown in the post-closing trial balance is the ending balance after all closing entries have been recorded and posted. Compare this to the amount shown for retained earnings in the unadjusted and adjusted trial balances. Summary of the Accounting Cycle (Steps 1-9)
Analyze business transactions.
Journalize the transactions.
Post to the ledger accounts.
Prepare a trial balance.
Journalize and post adjusting entries: prepayments and accruals.
Prepare an adjusted trial balance.
Prepare financial statements: ▪ Income statement ▪ Statement of changes in equity ▪ Statement of financial position ▪ Statement of cash flows
Journalize and post-closing entries.
Prepare a post-closing trial balance.
Teaching suggestion - Encourage students not to try to memorize the steps in the accounting cycle. Rather, they should think about what must be done in order to "capture" the financial transactions and to make sure the transactions are ultimately reported in the financial statements.
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Your friend contends that when a business is relatively small, adjustments will not make “too significant” an impact on the financial condition of the business and as a result that adjusting journal entries should not be prepared. Do you agree or disagree and why?
Identify some local businesses that would have unearned revenue.
A company is planning on going to the bank for a loan but the current year’s revenues have been lower than in the prior year. Your boss has asked you to record an initial fee payment as revenue. The contract requires that half the fee be received upon signing the agreement while the remaining fee is paid when the contract is complete. Work on the project will not start until the contract is signed. How will you handle this situation?
Since a company can select how often to prepare its financial statements, why not prepare them on a daily basis and always have timely, updated information?
Should expenses be allocated to the revenue that they help to earn? Explain.
If the cash basis of accounting doesn’t follow revenue and expense recognition guidelines, why do some companies still use it to record their transactions?
Why would a company want to prepay for expenses such as insurance policies? Doesn’t this negatively impact the company’s cash flow?
Are there times when a non-refundable deposit should be considered revenue instead of unearned revenue? Explain.
If a company prepares their financial statements on a monthly basis, should they close their books monthly as well?
At what point in time would your business recognize revenues and expenses? Does this depend on what type of company you are operating?
Why is a prepaid expense not included as an expense in the income statement when almost all other expenses are included on the income statement? Should this term be changed to something less confusing?
Why do adjusting entries never impact the Cash account?
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CHAPTER 4 ACCRUAL ACCOUNTING CONCEPTS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
Explain why adjusting entries are needed and identify the major types of adjusting entries. Answer: Adjusting entries are needed to ensure that revenue and expense recognition guidelines are followed. The two major types of adjusting entries are: prepayments and accruals.
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VOCABULARY QUIZ 1.
Expenses paid in cash and recorded as assets before they are used.
2.
Entries at the end of an accounting period that transfer the balances of temporary accounts to the permanent shareholders' equity account, Retained Earnings.
3.
The process of allocating the cost of equipment to expense over its useful life.
4.
Cash received before a company earns revenue and recorded as a liability until the services are performed.
5.
Revenue, expense, and dividend declared accounts whose balances are transferred to Retained Earnings at the end of an accounting period.
6.
Accounting basis in which transactions that change a company's financial statements are recorded in the periods in which the events occur, rather than in the periods in which the company receives or pays cash.
7.
A process whereby revenue is recognized when the contract terms, price, promises, and performance obligation are satisfied.
8.
Journal entries made at the end of an accounting period to ensure that proper recognition of revenues and expenses has been adhered to.
9.
An account that is offset against an asset account on the statement of financial position.
10.
Accounting basis in which revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.
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ANSWERS TO VOCABULARY QUIZ 1.
Prepaid expenses
2.
Closing entries
3.
Depreciation
4.
Unearned revenues
5.
Temporary accounts
6.
Accrual basis of accounting
7.
Revenue recognition
8.
Adjusting entries
9.
Contra asset account
10.
Cash basis of accounting
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CHAPTER 4 QUIZ Spot Out Cleaning Services Ltd. was incorporated July 1, 2018. At July 31, the trial balance shows the following balances for selected accounts: Prepaid insurance Supplies Equipment Income tax payable Bank loan payable Unearned revenue Service revenue
$ 4,500 1,500 36,000 -020,000 4,500 1,600
Additional information is as follows: 1. The company purchased a one-year insurance policy for $4,500, effective July 1. 2. The Supplies account shows a balance of $1,500 but a physical count shows only $300 of supplies remaining. 3. The equipment costing $36,000 is estimated to have a 10-year useful life. 4. The bank loan payable was signed July 1. It is a six-month, 6% loan. Interest is payable on the first of each month. 5. Spot Out had performed services for a client totalling $500 but has not yet billed the client or recorded the transaction. 6. Nine customers paid for the company’s six-month dry cleaning package of $500 beginning in July. These customers received dry cleaning services in July. 7. Income tax expense for July is estimated to be $150. Instructions Prepare the adjusting journal entries for the month of July. Show your calculations.
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ANSWER TO CHAPTER 4 QUIZ SPOT OUT CLEANING SERVICES LTD. 2018 July 31
31
31
31
31
31
31
Quizzes
General Journal Account Titles and Explanations Insurance Expense Prepaid Insurance (To record insurance expired: $4,500 x 1/12 = $375 per month)
Debit
Credit 375 375
Supplies Expense Supplies (To record supplies used: $1,500 - $300 = $1,200)
1,200
Depreciation Expense Accumulated Depreciation - Equipment (To record monthly depreciation: $36,000 ÷ 10 years x 1/12)
300
Interest Expense Interest Payable (To accrue interest on bank loan payable: $20,000 x 6% x 1/12 = $100)
100
Accounts Receivable Service Revenue (To accrue revenue earned but not yet billed or collected)
500
Unearned Revenue Service Revenue (To record revenue earned: $500 ÷ 6 mos. X 9 customers = $750)
750
Income Tax Expense Income Tax Payable (To accrue income tax payable)
150
Chapter 4 – Accrual Accounting Concepts
1,200
300
100
500
750
150
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MULTIPLE CHOICE QUIZ 1.
Which of the following are permanent accounts? i. Accumulated Depreciation ii. Unearned Revenue iii. Depreciation Expense iv. Dividends Declared a. i, and iv b. ii, iii and iv c. i and ii d. i,ii, and iv
2.
Which of the following is not true concerning the cash basis of accounting? a. It does not follow GAAP. b. It records revenue when cash is received. c. It records expenses in the period they were incurred. d. It records expenses when cash is paid.
3.
In order for revenues and expenses to be recorded in the appropriate period a. adjusting entries are made. b. the cash basis of accounting is used. c. closing entries are made. d. none of the above
4.
Unearned revenues are a. prepayments. b. liability accounts. c. temporary accounts. d. revenue accounts. e. none of the above
5.
Which of the following are prepaid expenses? i. prepaid rent ii. prepaid insurance iii. supplies iv. unearned revenue a. iv b. iii and iv c. i, ii, and iv d. i, ii, and iii
6.
Depreciation is a. the wearing away of an asset. b. the process of an asset becoming obsolete. c. a valuation process. d. the process of allocating the cost of a long-lived asset to expense over its useful life.
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7.
Accumulated depreciation is a(n) a. contra asset account. b. contra revenue account. c. unearned revenue account. d. expense account. e. none of the above
8.
Which of the following companies would probably not have unearned revenue? a. Air Canada b. Amazon.ca c. Pizza Hut d. Allstate Insurance Company of Canada e. none of the above
9.
Adjusting entries for accruals a. are required in order to record revenues earned and expenses incurred in the current accounting period that have not been recognized through daily entries and thus are not yet reflected in the accounts. b. will increase both a statement of financial position account and an income statement account. c. are not required. d. both a and b above
10.
Which of the following are temporary accounts? i. Prepaid Insurance ii. Rent Expense iii. Dividends Declared iv. Retained Earnings a. ii and iii b. iii and iv c. i, iii, and iv d. ii, iii, and iv
11.
Which of the following is incorrect? a. At year end, temporary account balances are transferred to Retained Earnings. b. Closing entries produce a zero balance in each temporary account. c. Permanent accounts are not closed because the future benefits and obligations still exist. d. Dividends Declared are closed to the Income Summary account along with expenses. e. none of the above
12.
Under ASPE revenue recognition occurs when a. sales or performance effort is substantially complete. b. the amount is determinable. c. collection is reasonably assured. d. all of the above
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13. Which of the following statements is incorrect? a. Revenue is recorded when there is an increase in future economic benefits. b. Expense recognition is tied to changes in assets and liabilities. c. Expense recognition will often coincide with revenue recognition. d. Revenue can never be recognized without an associated expense also being recognized. e. none of the above 14. Shelly’s Salon Limited borrowed $10,000 from the bank on November 1, at an interest rate of 5%. Interest is due at maturity, three months hence, on February 1. Shelly’s Salon adjusts its financial statement on an annual basis. What would be the amount of interest expense recorded on December 31? a. $42 b. $83 c. $125 d. $500
15. Which of the following statements is incorrect? a. Adjusting journal entries impact the Cash account. b. An adjusting entry for accrued expenses debits an expense account. c. Accruals increase both a statement of financial position account and an income statement account. d. An adjusting entry for prepaid expenses credits an asset account. e. none of the above
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
c
2.
c
3.
a
4.
b
5.
d
6.
d
7.
a
8.
c
9.
d
10.
a
11.
d
12.
d
13.
d
14.
b
15.
a
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
An adjusted trial balance is prepared from the financial statements.
True
False
2.
Accrued revenues have been received but not yet earned.
True
False
3.
Payments of expenses that will benefit more than one accounting period are referred to as prepaid expenses.
True
False
4.
To close the Income Summary account when a company has a loss, debit the Income Summary account and credit the Retained Earnings account.
True
False
5.
The adjusting entry for unearned revenues results in a debit to an asset account and a credit to a revenue account.
True
False
6.
When the accrual basis of accounting is applied, adjusting entries are not necessary.
True
False
7.
Examples of accrued expenses are interest, rent, salaries, property taxes, and income taxes.
True
False
8.
Under IFRS, companies must prepare quarterly financial statements which means they must prepare adjusting entries quarterly.
True
False
9.
The adjusted trial balance shows the balances of all accounts at the end of the accounting period.
True
False
10.
After the closing entries have been posted, the balance in the shareholders’ equity account should equal the ending balance of the shareholders’ equity account as reported on the statement of financial position.
True
False
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Multiple Choice 11.
The recording of salaries earned but not yet paid is an example of an adjustment that a. recognizes an accrued expense. b. recognizes an unrecorded revenue. c. allocates revenues between two or more periods. d. allocates estimated costs between two or more periods. e. none of the above
12.
A list of the accounts and their balances after all adjustments have been made is known as a(n) a. trial balance. b. adjusted trial balance. c. general ledger. d. statement of financial position. e. none of the above
13.
Prior to recording adjusting entries, revenues exceed expenses by $60,000. Adjusting entries for accrued salaries of $5,000 and depreciation expense of $5,000 were made. Net income for the year would be a. $60,000. b. $55,000. c. $50,000. d. $70,000. e. none of the above
14.
Revenue is not recorded in the accounting period when a. there is an increase in assets or a decrease in liabilities. b. the service has been performed or the goods have been sold and delivered. c. the revenue can be reliably measured and collection is reasonably certain. d. there is a decrease in assets or an increase in liabilities. e. none of the above
15.
A post-closing trial balance will a. be prepared before closing entries are posted to the ledger. b. contain both income statement and statement of financial position accounts. c. contain only statement of financial position accounts. d. contain only income statement accounts. e. none of above
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ANSWERS TO 20-MINUTE QUIZ #1
True/False 1.
False
2.
False
3.
True
4.
False
5.
False
6.
False
7.
True
8.
True
9.
False
10.
True
Multiple Choice 11.
a
12.
b
13.
c
14.
d
15.
c
Quizzes
Chapter 4 – Accrual Accounting Concepts
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20-MINUTE QUIZ #2 1. HR Plumbing Services Ltd. was hired by a customer in late December to provide plumbing services. The work was performed in January. The bill was sent to the customer in February. Payment in full was received from the customer in March. (a) In which month should the revenue be recognized by HR? (b) In which month should the expense be recognized by HR?
2.
Fill in the blanks in the following sentences using either before or after where appropriate: a. When unearned revenue exists, it is because the cash inflow occurs ______ the revenue is recognized. b. When accrued revenue exists, it is because the cash inflow occurs ______ the revenue is recognized. c. When a prepaid expense exists, it is because the cash outflow occurs ______ the expense is incurred. d. When an accrued expense exists, it is because the cash outflow occurs ______ the expense is incurred.
3.
Prepare year-end adjusting entries for each of the following: a. The Supplies account has a balance of $900. A physical count indicates that $350 of supplies are still on hand. Dec. 31
b. A $30,000 6-month 5% bank loan payable was signed November 1. Interest is payable at maturity. Record the interest that has accrued by December 31. Dec. 31
c. $12,000 was paid on August 1 for a one year insurance policy. The premium was charged to Prepaid Insurance on August 1. Record Insurance Expense for the year. Dec. 31
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #2 1. HR Plumbing Services Ltd. was hired by a customer in late December to provide plumbing services. The work was performed in January. The bill was sent to the customer in February. Payment in full was received from the customer in March. (a) In which month should the revenue be recognized by HR? (b) In which month should the expense be recognized by HR? (a) January (b) January 2.
Fill in the blanks in the following sentences using either before or after where appropriate: a. When unearned revenue exists, it is because the cash flow occurs before the revenue is recognized. b. When accrued revenue exists, it is because the cash flow occurs after the revenue is recognized. c. When a prepaid expense exists, it is because the cash flow occurs before the expense is incurred. d. When an accrued expense exists, it is because the cash flow occurs after the expense is incurred.
3.
Prepare year-end adjusting entries for each of the following: a. The Supplies account has a balance of $900. A physical count indicates that $350 of supplies are still on hand. Dec 31
Supplies Expense Supplies $900 – $350 = $550
550 550
b. A $30,000 6-month 5% bank loan payable was issued November 1. Interest is payable at maturity. Record the interest that has accrued by December 31. Dec 31
Interest Expense Interest Payable $30,000 x 5% x 2/12 = $250
250 250
c. $12,000 was paid on August 1 for a one year insurance policy. The premium was charged to Prepaid Insurance on August 1. Record Insurance Expense for the year. Dec. 31
Quizzes
Insurance Expense Prepaid Insurance $12,000 x 5/12 = $5,000
Chapter 4 – Accrual Accounting Concepts
5,000 5,000
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CHAPTERS 3 & 4 MULTIPLE CHOICE QUIZ 1.
Financial statements can be prepared directly from the a. unadjusted trial balance. b. adjusted trial balance. c. post-closing trial balance. d. reversing trial balance.
2.
Which of the following statements related to the trial balance is incorrect? a. The trial balance usually lists the accounts in the same order as the chart of accounts. b. Total debits must equal total credits. c. The trial balance is prepared at a point in time. d. Credit balances are listed in the left column and debit balances are listed in the right column.
3.
Which of the following is true? a. Only permanent accounts are closed. b. Both permanent and temporary accounts are closed. c. Neither permanent nor temporary accounts are closed. d. Only temporary accounts are closed. e. none of the above
4.
Which of the following are permanent accounts? i. Accumulated Depreciation ii. Unearned Revenue iii. Common Shares iv. Depreciation Expense a. i, ii, and iii b. i and iv c. ii and iii d. I, ii, iii, and iv
5.
The entire group of accounts maintained by a company is referred to as the a. general ledger. b. trial balance. c. income statement. d. general journal.
6.
Posting refers to transferring amounts from a. the ledger to the journal. b. T accounts to the ledger. c. the journal to the ledger. d. the ledger to T accounts.
7.
Cash received and recorded as a liability before revenue is earned is called a. accrued revenue.
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b. unearned revenue. c. unrecorded revenue. d. none of the above
8.
A debit is a. an increase in an account. b. the left-hand side of a T account. c. the right-hand side of a T account. d. a decrease in an account.
9.
For a prepaid expense, the adjusting entry a. would result in a debit to an expense and a credit to an asset account. b. will increase both a statement of financial position and an income statement account. c. would decrease cash. d. both a and b above
10.
An account has $500 on the debit side and $200 on the credit side. The overall balance in the account is a. a credit of $200. b. a debit of $300. c. a credit of $300. d. a debit of $500.
11.
Joe decides to purchase a bus ticket in advance to return home for Christmas. How would this transaction impact the accounting equation for the bus company on the date of purchase? a. Decrease unearned revenue. b. Increase unearned revenue. c. Decrease revenues. d. Increase revenues. e. none of the above
12.
Which of the following statements is incorrect? a. An unadjusted trial balance is prepared after journalizing the transactions. b. A trial balance is usually listed in the same order as the general ledger. c. The total debits must equal the total credits. d. An unadjusted trial balance assists in preparation of the financial statements. e. none of the above
13.
A closing entry for the Dividends Declared account will require a. a debit to Income Summary. b. a debit to the Retained Earnings account. c. a debit to the Dividends Declared account. d. a credit to the Retained Earnings account.
14.
Collins and Collins Inc. received a $5,000 prepayment for future services. Collins and Collins also paid $12,000 for their annual insurance policy. Which of the following statements is correct?
Quizzes
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a. The $5,000 is revenue under the accrual basis. b. The $5,000 is unearned revenue under the cash basis. c. The $12,000 is an expense under the cash basis and accrual basis. d. The $12,000 is a prepaid expense under the accrual basis.
15.
Which of the following statements related to revenue recognition is incorrect? a. For a merchandising company, revenue is generally recognized when merchandise is sold and delivered. b. Recognizing revenue too early overstates current period revenues. c. For a service company, revenue is generally recognized when the service is performed. d. Revenue is recognized when there is a decline in future economic benefits. e. none of the above
Quizzes
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ANSWERS TO CHAPTERS 3 & 4 MULTIPLE CHOICE QUIZ 1.
b
2.
d
3.
d
4.
a
5.
a
6.
c
7.
b
8.
b
9.
a
10.
b
11.
b
12.
a
13.
b
14.
d
15.
d
Quizzes
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CHAPTER 5 MERCHANDISING OPERATIONS LEARNING OBJECTIVES 1.
Identify the differences between service and merchandising companies.
2.
Prepare entries for purchases under a perpetual inventory system.
3.
Prepare entries for sales under a perpetual inventory system.
4.
Prepare a single-step and a multiple-step income statement.
5.
Calculate the gross profit margin and profit margin.
6.
Account for and report inventory in a periodic inventory system (Appendix 5A).
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Chapter 5 – Merchandising Operations
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CHAPTER OUTLINE Learning Objective 1 – Identify the Differences between Service and Merchandising Companies
Merchandising involves purchasing products (inventory) to resell
A merchandising company that sells directly to consumers is called a retailer while a merchandising company that sells to a retailer is known as a wholesaler.
Companies that produce goods for sale are called manufacturers. A manufacturer has inventory classified into: raw materials, work in process, and finished goods.
In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales.
Unlike expenses for a service company, expenses for a merchandising company are divided into two categories: ▪ Cost of goods sold – the total cost of merchandise sold during the period. • Sales revenue less cost of goods sold is called gross profit. ▪ Operating expenses – expenses that are incurred in the process of earning sales revenues. • Gross profit less operating expenses is net income (or loss) before income taxes.
Teaching suggestion – Students also need to be told that for a merchandising company the cost of goods sold is an expense and, traditionally, the largest expense item the company will have. Point out that the gross profit is the amount a merchandising company has left to cover the operating expenses of the company after it pays for the merchandise it sold. Teaching suggestion – Ask students to give examples of service companies and merchandising companies in the local area. Direct students to examples other than those offered in the text. Consider hair salons, banks, service stations, funeral homes, etc. as service companies. Consider department stores, grocery stores, bookstores, etc. as merchandising companies. The yellow pages of the phone book can be a good resource to help identify local companies.
Two systems to account for inventory: ▪ Perpetual • Detailed records of the cost of each product that is purchased and sold are maintained. • Cost of goods sold and the reduction in inventory quantity and cost are determined each time a sale occurs. • Provides better control over inventory. Inventory records are up-to-date and this helps make it possible for management to monitor merchandise availability and maintain optimum inventory levels. ▪ Periodic • Detailed records are not kept throughout the period.
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•
Cost of goods sold determined only at the end of the accounting period, when a physical inventory count is taken.
Teaching suggestion – You may wish get the students to think about type of businesses that use perpetual and periodic inventory systems. Automobile dealers and jewellers use a particular type of perpetual inventory system where they track specific items of inventory. Large retailers (grocery stores and department stores) scan merchandise when it is sold, and can easily keep track of the numbers of inventory items. The small corner store may not have the same ability, and may use a periodic inventory system. Teaching suggestion – Explain to students that even with sophisticated computer systems, scanners, and software, not all companies use a perpetual system to keep up with inventory costs. Some companies will use a perpetual system to keep up with inventory quantities and a periodic system to keep up with costs.
Learning Objective 2 – Prepare Entries for Purchases under a Perpetual Inventory System The buyer normally records purchases when the goods are transferred from the seller.
Every purchase should be supported by documentation that provides written or electronic evidence of the transaction. ▪ Invoices, purchase orders, receiving documents, and receipts are all examples of documentation that would be used to evidence inventory purchases.
Cash purchases are recorded by an increase in Inventory and a decrease in Cash.
Credit purchases are recorded by an increase in Inventory and an increase in Accounts Payable.
Note: Most merchandising and service companies pay sales taxes on the goods and services they purchase. They are later remitted to the government. For simplicity, accounting transactions in this chapter are presented without the added complication of sales taxes.
Freight costs are the cost of transporting the goods to the buyer's place of business. ▪ Shipping terms determine whether the buyer pays the freight costs or not. ▪ FOB destination means that the seller pays the freight costs from the shipping point until the goods reach their destination and is responsible for any loss or damage that occurs along the way. The goods would be included in the seller’s inventory until they are delivered. ▪ FOB shipping point means that the buyer pays the freight costs—that is, the seller pays the costs incurred until the goods reach the point of shipping (e.g., train station, loading dock. etc.) and the buyer pays the costs incurred from the shipping point to the buyer’s destination. The buyer is responsible for any loss or damage that occurs along the way. The goods become part of the buyer’s inventory at the point of shipping even though it may take weeks to arrive at their destination.
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Goods that are damaged, defective, or of inferior quality may be returned to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. The transaction described is a purchase return and is recorded by decreasing Accounts Payable and decreasing Inventory. ▪ The purchaser may choose to keep the goods, which are damaged, defective, or of inferior quality provided the seller will grant a discount referred to as a purchase allowance.
The credit terms of a purchase on account may allow the buyer to claim a discount if payment is made within a certain time. Credit terms are normally written 2/10, n/30 which means a 2 percent purchase discount may be taken if the invoice is paid within 10 days of the invoice date. Net amount of the invoice is due within 30 days. When payment is made within the discount period, the amount of the discount decreases the Inventory account. The entry to record a payment would require the purchaser to decrease Accounts Payable, Decrease Cash, and decrease Inventory. A quantity discount may be deducted from the purchase price for a bulk purchase but is not separately recorded.
Teaching suggestion – Explain to students that not all purchases constitute purchases of inventory. Rather, a purchase of a cash register to be used in a clothing business would not be a purchase of merchandise for resale, but a purchase of equipment to be used in operations. However, if Dixie Cash Register Inc. purchased a cash register for resale, the transaction would be considered a purchase of inventory. Ask students to recall examples of merchandising companies discussed earlier. What types of merchandise would these companies consider inventory? Miller Construction was able to take a purchase discount of $600 by paying within 10 days for a $30,000 purchase. If Miller Construction had passed up the discount, it would be paying 2% for the use of $30,000 for 20 days. This equals an annual interest rate of 36.5%. Discuss the importance of companies taking discounts using this example.
Learning Objective 3 – Prepare Entries for Sales under a Perpetual Inventory System
For a merchandising company, revenue will be recognized when the company satisfies its performance obligation(s), the fifth step in the recognition process. Sales revenues are recorded when goods are transferred from the seller to the buyer.
Sales may be made on credit or for cash.
Each sales transaction should be supported by documentation, which provides written or electronic evidence of the sale. ▪ Cash register tapes provide evidence of cash sales. ▪ A sales invoice provides written evidence of a credit sale.
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Teaching suggestion - Emphasize the need for two journal entries to be recorded at the time of sale in a perpetual inventory system. The first journal entry records the sale (at the sale price). The second journal entry records the cost of the sale (at cost) to match against the sales revenue recorded in the first journal entry. In addition, the cost of the merchandise sold is removed from the Inventory account and entered into Cost of Goods Sold Expense.
Cash sales are recorded by increasing Cash and increasing Sales.
Credit sales are recorded by increasing Accounts Receivable and increasing Sales.
Freight costs incurred by the seller (FOB destination) are an operating expense, and are debited to an account called Freight Out.
Sales Returns and Allowances, a contra revenue account to Sales, may be used to record credit for returned goods and allowances.
Two entries are required to record the credit for Sales Returns and Allowances. ▪ The first entry is an increase in Sales Returns and Allowances and a decrease in Accounts Receivable. ▪ The second entry is an increase in Inventory and a decrease in Cost of Goods Sold.
A sales discount may be offered by the seller to the customer for the prompt payment of the balance due. No separate entry is made to record quantity discounts. Sales are recorded at the full invoice price (full retail price, or sale price, or volume discount price).
A sales discount (offered as an incentive for quick payment) is based on the invoice price less any returns and allowances.
Sales Discounts is a contra revenue account to Sales and is used instead of debiting Sales directly, so as to provide visibility as to the amount of discounts provided.
Teaching suggestion – Explain to students the importance of having the net sales figure as well as the amounts in the contra revenue accounts—Sales Returns and Allowances and Sales Discounts. Tell students that a Sales Returns and Allowances account is used rather than decreasing sales directly because the users of the financial statements (investors and creditors) will want to know about the amount of merchandise being returned. Likewise, a Sales Discounts account is used in order disclose the amount of cash discounts taken by customers. Also, it is good to reinforce the notion that both the Sales Returns and Allowances account and the Sales Discounts account are contra revenue accounts to the Sales account. Because they are contra revenue accounts, they will have normal debit balances.
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Learning Objective 4 – Prepare a Single-Step and a MultipleStep Income Statement Two forms of the income statement are widely used by companies:
Single-step income statement – one step is required in determining net income before income tax—subtract total expenses from total revenues. ▪ Revenues – include both operating revenues and non-operating revenues. ▪ Expenses – include cost of goods sold, operating expenses, as well as non-operating expenses such as interest and losses. ▪ Income tax expense is reported separately. ▪ Operating expenses must be classified by nature or function under IFRS. Classifying an expense by its nature means that the expenses are reported based on natural classification such as salaries, transportation, depreciation, or advertising. Classifying an expense by function means that expenses are reported according to the activity for such they are incurred such as cost of goods sold, administrative expenses, and selling expenses. ASPE comparison – Under ASPE, companies do not need to list their expenses in any particular order whereas under IFRS companies must classify their expenses by either their nature or function.
Multiple-step income statement ▪ More useful as it highlights the components of income separately. ▪ Distinguishes between operating and non-operating activities. ▪ This statement includes the following five main steps: • Net sales (gross sales – sales returns and allowances – sales discounts) • Gross profit (net sales – cost of goods sold) • Income from operations (gross profit – operating expenses) • Income before tax (income from operations plus non-operating revenues and less non-operating expenses) • Net income (income before income tax – income tax expense)
Net sales – the income statement for a merchandising company typically presents gross sales revenues for the period and deducts the contra revenue accounts (Sales Returns and Allowances and Sales Discounts) to arrive at net sales.
Gross profit – Cost of goods sold is deducted from net sales to determine gross profit. Gross profit is the merchandising profit of the company.
Teaching suggestion – Students also need to be told that for a merchandising company, cost of goods sold is an expense and, traditionally, the largest expense item the company will have. Point out that the gross profit is the amount a merchandising company has left after it pays for the merchandise it sold and that it is not a measure of overall net income; operating expenses must still be deducted. ▪
Income from operations – Operating expenses is deducted from gross profit to
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▪
determine profit from operations. Reporting income from operations as a separate number from overall net income helps users in understanding the profitability of the company’s continuing operations or typical business activities. Non-operating (Other) Revenues and Expenses – unrelated to the company's main operations. They include: • Other revenues and gains – Interest revenue, rent revenue, and investment revenue. • Other expenses and losses – Finance (interest) expense and losses that are infrequent and unusual.
Teaching suggestion – Ask students whether they would rather have a single-step or multiplestep income statement if they were a manager or a potential investor. Why? If trying to predict future net income, is net income or income from operations the more relevant figure?
Learning Objective 5 – Calculate the Gross Profit Margin and Profit Margin
Gross Profit Margin, a measure of profitability, is expressed as a percentage and calculated by dividing gross profit by net sales.
Profit Margin, a measure of how much the selling price covers all expenses (including cost of goods sold), is calculated by dividing net income by net sales and measures the percentage of each dollar of sales that results in net income.
Teaching suggestion – Discuss with students how profit margin can be improved by increasing gross profit margin or by controlling operating expenses (or by doing both). Also discuss the trade-off between margin (gross profit) and inventory turnover. When going into business, one has to determine a strategy. Think of businesses in your locality which are diametrically opposed (i.e., a grocery store with very low prices, low margin, and high turnover, and a dealer in expensive luxury automobiles with high margin and low turnover). Teaching suggestion – Ask students to suggest ways in which a company can either improve its profit margin or control its operating expenses. Have them consider the following questions: What types of business are more likely to have high profit margins? What types of business are more likely to have lower profit margins? What tends to happen in industries that have high profit margins? Teaching suggestion – Ask students to consider the following problem: Smith Company has had gross profit percentages of 20 – 22% for the past 5 years. The current gross profit percentage is 14%.
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What are some possible causes of this change in gross profit percentage? What should the management of Smith Company do? Ask students to suggest ways in which a company can improve its gross profit percentage.
Learning Objective 6 – Account for and Report Inventory in a Periodic Inventory System (Appendix 5A) In both perpetual and periodic systems, revenues from the sale of merchandise are recorded when the performance obligation is complete—generally upon delivery of the merchandise.. This entry is no different under a periodic or perpetual system.
On the date of sale, no attempt is made to record the cost of the merchandise sold.
The following accounts are used to record purchases of merchandise: ▪ Purchases account (an expense) is increased and accounts payable increased when merchandise is purchased. ▪ Freight in (an expense) is increased and accounts payable are increased or cash decreased when the buyer pays freight for merchandise purchased. Freight is part of the cost of goods purchased in a periodic inventory system. ▪ Purchase returns and allowances, a contra expense account to Purchases, is increased and accounts payable decreased when merchandise is returned or an allowance is given. ▪ Purchase discounts, a contra expense account to Purchases, is increased and accounts payable decreased when discounts are earned.
Teaching suggestion – Explain to students that business organizations using the periodic inventory system do not, as a general rule, have sophisticated computerized inventory systems required to calculate cost of goods sold when a sale is made. Use Illustration 5A-4 to compare the treatment of entries for both the perpetual and periodic inventory systems.
To determine cost of goods sold: ▪ Add the cost of goods purchased to the cost of goods on hand at the beginning of the period (beginning inventory) giving you the cost of goods available for sale. Subtract the cost of goods on hand at the end of the period (ending inventory) from the cost of goods available for sale. This will give you the cost of goods sold. Adjusting entry at period end ▪ No entries are posted to the Inventory account during the period. An adjusting entry is needed at the end of each period to update the amounts in the Inventory and Cost of Goods Sold accounts. ▪ Inventory is debited for the ending inventory amount and credited for the beginning inventory amount, purchase related accounts are zeroed out, and Cost of Goods Sold is debited for the amount calculated.
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Discuss some of the different types of inventory that is sold at retail establishments that you patronize.
Why wouldn’t it be easier for companies to get rid of the Sales Returns and Allowances account and instead deduct these amounts directly from Sales Revenue? What would motivate a company to want to decrease sales directly?
If you owned a merchandising company, what factors would influence you in deciding whether to take advantage of a purchase discount?
If you had the option of buying in bulk and receiving a quantity discount why would you not want to take advantage of the discount? Why would you want to take advantage of the discount?
If you owned a merchandising company, would you rather sell to consumers or retailers? Why?
If you were starting your own business, would you rather have a business that offered low prices but had a high volume of sales or a business that offered high prices but had a low volume of sales? Why?
If you owned a company that utilized a periodic inventory system, how often would you complete a physical inventory count?
If you were starting up a business what factors would influence you when deciding whether to implement a periodic or perpetual inventory system? Which inventory system would you prefer and why?
If you utilized a perpetual inventory system within your business, how often would you count the inventory? What could cause differences between what the system said was included in inventory and what was actually included in inventory?
Why should a manufacturing company track raw materials, work in process, and finished goods? Wouldn’t it be easier to only use one inventory account?
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CHAPTER 5 MERCHANDISING OPERATIONS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
What are the two systems that are used to account for inventory? Answer: Perpetual system and Periodic system
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Chapter 5 – Merchandising Operations
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VOCABULARY QUIZ 1.
A detailed inventory system in which the cost of each inventory item is maintained and the records continuously show the inventory that should be on hand.
2.
A reduction given by a seller for early payment of a credit sale.
3.
A measure of the percentage of each dollar of sales that results in net income.
4.
The cost of merchandise sold during the period.
5.
An inventory system in which detailed records are not maintained and the cost of goods sold is determined only at the end of an accounting period.
6.
Sales less sales returns and allowances and sales discounts.
7.
The main source of revenue for a merchandising company.
8.
The excess of net sales over the cost of goods sold.
9.
A cash discount claimed by a buyer for early payment of a balance due.
10.
An account that is offset against a revenue account on the income statement.
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ANSWERS TO VOCABULARY QUIZ 1.
Perpetual inventory system
2.
Sales discount
3.
Profit margin
4.
Cost of goods sold
5.
Periodic inventory system
6.
Net sales
7.
Sales revenue
8.
Gross profit
9.
Purchase discount
10.
Contra revenue account
Quizzes
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MULTIPLE CHOICE QUIZ 1.
Sears is an example of which type of organization? a. merchandising company b. manufacturing company c. service organization d. limited partnership e. none of the above
2.
Under the perpetual inventory system, purchases of merchandise for sale are recorded in an account called a. Purchases. b. Cost of Goods Sold. c. Inventory. d. Finished Goods. e. Raw Materials.
3.
A purchaser, dissatisfied with merchandise received, may return the goods to the seller for credit. This transaction is known as a a. sales return. b. purchase return. c. sales allowance. d. purchase allowance. e. purchase discount.
4.
The journal entry to adjust for a shortage in inventory after a physical inventory count does not agree with the perpetual inventory accounting records would include a. a debit to Cost of Goods Sold. b. a debit to Inventory. c. a debit to Loss on Inventory. d. no entry would be made for a physical inventory count in a perpetual inventory system. e. a credit to Cost of Goods Sold.
5.
In a periodic inventory system, the cost of goods sold is determined a. at the end of the accounting period. b. each time a sale occurs. c. each time a purchase occurs. d. none of the above. e. both a and b
6.
Freight costs incurred by the seller on outgoing merchandise are considered a. operating expenses to the seller.
Quizzes
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b. part of inventory. c. part of purchases. d. part of cost of goods sold. e. both a and d
7.
If a sales invoice shows credit terms of 2/10, n/30, the discount period is a. 10 days. b. 2 days. c. 30 days. d. 20 days. e. cannot be determined from the information given.
8.
The revenue recognition process requires that sales revenues be recognized a. when cash is received. b. when the merchandise is ordered. c. when the goods are transferred from the seller to the buyer. d. none of the above
9.
Sales returns and allowances and sales discounts are a. contra asset accounts. b. contra liability accounts. c. expense accounts. d. contra revenue accounts. e. contra expense accounts.
10.
The income statement of a merchandising company contains the following unique features compared to a service company a. sales revenue, operating expenses, and income tax expense. b. sales revenue, interest expense, and gross profit. c. sales revenue, interest revenues, and net income. d. sales revenue, cost of goods sold, and gross profit. e. sales revenue, cost of goods sold, operating expenses, and income tax expense.
11.
Profit margin is calculated by a. subtracting cost of goods sold from net sales. b. dividing net income by net sales. c. dividing gross profit by net sales. d. subtracting operating expenses from net sales. e. subtracting cost of goods sold and operating expenses from net sales.
12.
Which of the following would not be included as an operating expense on the income statement? a. loss on sale of equipment b. interest expense
Quizzes
Chapter 5 – Merchandising Operations
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c. insurance expense d. utilities expense e. depreciation expense
13.
Which of the following inventory accounts would a manufacturing company not likely have? a. Inventory b. Raw Materials c. Finished Goods d. Work in Process e. both b and c
14.
Burn’s Heating Inc. has provided the following information for 2018: Sales revenues Sales returns and allowances Sales discounts Cost of goods sold Rent expense Salaries expense
$100,000 5,000 5,000 40,000 15,000 10,000
What is Burn’s Heating Inc.’s gross profit margin? a. 27.8% b. 44.4% c. 55.6% d. 60.0% e. none of the above
*15. Bagot Limited purchased merchandise on account for $10,000 with terms 2/10, n/30. Bagot utilizes the periodic inventory system. How would the payment of the invoice be recorded assuming the invoice is paid within the discount period? a. Debit Accounts Payable $10,000, credit Cash $9,800, and credit Purchase Discounts $200. b. Debit Accounts Payable $9,800, credit Cash $9,800. c. Debit Accounts Payable $10,000, credit Cash $9,800, and credit Inventory $200. d. Debit Accounts Payable $10,000, credit Cash $9,800, and credit Purchase Allowances $200. e. Debit Accounts Payable $10,000, credit Cash $10,000.
Quizzes
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
a
2.
c
3.
b
4.
a
5.
a
6.
a
7.
a
8.
c
9.
d
10.
d
11.
b
12.
b
13.
a
14.
c
*15. a
Quizzes
Chapter 5 – Merchandising Operations
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
For merchandising companies, operating expenses are expenses that are incurred in the process of earning sales revenue.
True
False
2.
Cost of goods sold is a contra revenue account.
True
False
3.
The normal balance in the Sales Returns and Allowances account is a credit.
True
False
4.
Under IFRS, companies must classify operating and other expenses based on either the nature of the expenses or their function within the company.
True
False
5.
A purchase order details the types, quantities, and agreed prices of products or services the seller will provide to the buyer.
True
False
6.
Freight costs for items shipped FOB destination are paid by the buyer.
True
False
7.
A quantity discount is offered to customers who pay their invoices promptly.
True
False
8.
Profit margin measures the percentage of each dollar of sales that results in net income.
True
False
9.
In a single-step income statement, gross profit and income from operations are shown on the income statement.
True
False
10.
An adjusting entry prepared to account for the difference between actual inventory on hand and inventory according to the accounting records includes an adjustment of cost of goods sold.
True
False
Multiple Choice 11.
Quizzes
Sales Returns and Allowances a. is a contra revenue account. b. has a normal debit balance. c. appears on the income statement. d. both a and b. e. a, b, and c Chapter 5 – Merchandising Operations
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12.
Income is $15,000, operating expenses are $20,000, income tax expense is $3,000, and net sales are $75,000. Gross profit margin is a. 47%. b. 49%. c. 51%. d. 73%. e. none of the above
13.
Which of the following is a non-operating expense? a. finance expense b. rent expense c. delivery expense d. office expense e. depreciation expense
14.
Which of the following statements is false? a. Freight costs paid by the seller are debited to Delivery Expense. b. Freight costs for goods shipped FOB destination are paid by the seller. c. Freight costs for goods shipped FOB shipping point are paid by the purchaser. d. Freight costs paid by the purchaser are debited to Delivery Expense. e. none of the above statements are false
15.
When a company uses the perpetual inventory system, the a. Inventory account balance does not change until the end of the year. b. Inventory account is debited when inventory is purchased. c. sale of inventory requires a credit to Cost of Goods Sold. d. acquisition of merchandise requires a debit to Purchases. e. none of the above
Quizzes
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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
True
2.
False
3.
False
4.
True
5.
True
6.
False
7.
False
8.
True
9.
False
10.
True
Multiple Choice 11.
e
12.
c
13.
a
14.
d
15.
b
Quizzes
$15,000 + $3,000 + $20,000 = $38,000 of gross profit $38,000 ÷ $75,000 = 51% (rounded)
Chapter 5 – Merchandising Operations
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20-MINUTE QUIZ #2 1.
Baker Department Store uses a perpetual inventory system. Prepare journal entries to record the following transactions for Baker: a. Baker bought ten stoves from a manufacturer on account, at a cost of $300 each. b. Baker returned two of the stoves to the manufacturer because they were defective. c. Baker sold a stove to a customer for $650 cash. d. Baker paid the manufacturer for the stoves.
2.
Freight on goods shipped FOB shipping point is the responsibility of the ____________.
3.
What is the formula to calculate Gross Profit Margin?
4.
Using the account balances listed in the following table, calculate the following: a. Net Sales _________________ b. Gross Profit _________________ c. Income from Operations _________________ d. Net income _________________ Cost of goods sold Sales returns and allowances Non-operating expenses
Quizzes
$500 Sales $ 30 Operating expenses $150 Inventory
Chapter 5 – Merchandising Operations
$950 $110 $ 60
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ANSWERS TO 20-MINUTE QUIZ #2 1.
Baker Department Store uses a perpetual inventory system. Prepare journal entries to record the following transactions for Baker. a. Baker bought ten stoves from a manufacturer on account, at a cost of $300 each. b. Baker returned two of the stoves to the manufacturer, because they were defective. c. Baker sold a stove to a customer for $650 cash. d. Baker paid the manufacturer for the stoves.
a.
Inventory....................................................................................... Accounts Payable .................................................................. (Purchased 10 stoves)
3,000
Accounts Payable ......................................................................... Inventory ................................................................................ (Returned 2 defective stoves)
600
Cash ............................................................................................. Sales .....................................................................................
650
Cost of Goods Sold ...................................................................... Inventory ................................................................................ (Sold a stove)
300
Accounts Payable ......................................................................... Cash ...................................................................................... (Paid the manufacturer)
2,400
b.
c.
d.
3,000
600
650
300
2,400
2.
Freight on goods shipped FOB shipping point is the responsibility of the buyer.
3.
What is the formula to calculate Gross Profit Margin? Gross Profit ÷ Net Sales = Gross Profit Margin
4.
Using the account balances listed in the table, calculate the following: a. Net Sales $920 ($950 – $30) b. Gross Profit $420 ($920 – $500) c. Income from operations $310 ($420 – $110) d. Net income $160 ($310 – $150) Cost of goods sold Sales returns and allowances Non-operating expenses
Quizzes
$500 $30 $150
Sales Operating expenses Inventory
Chapter 5 – Merchandising Operations
$950 $110 $60
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CHAPTER 6 REPORTING AND ANALYZING INVENTORY LEARNING OBJECTIVES 1.
Describe the steps in determining inventory quantities.
2.
Apply the cost formulas using specific identification, FIFO, and average cost under a perpetual inventory system.
3.
Explain the effects on the financial statements of choosing each of the inventory cost formulas.
4.
Identify the effects of inventory errors on the financial statements.
5.
Demonstrate the presentation and analysis of inventory.
6.
Apply the FIFO and average cost formulas under a periodic inventory system (Appendix 6A).
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CHAPTER OUTLINE Learning Objective 1 – Describe the Steps in Determining Inventory Quantities
Determining ownership of goods. ▪ Goods in transit should be included in the inventory of the company that has legal title to the goods. • Ownership of goods shipped FOB (free on board) destination remains with the seller until the goods reach the buyer and should be included in the inventory of the seller. • Ownership of goods shipped FOB (free on board) shipping point passes to the buyer when the public carrier accepts the goods from the seller. Therefore, goods should be counted in the inventory of the buyer. ▪ Consigned goods are counted in the inventory of the consignor (owner) rather than the consignee.
Taking a physical inventory of goods on hand. ▪ Involves actually counting, weighing, or measuring each kind of inventory on hand. ▪ Quantity of each kind of inventory is multiplied by its cost to determine total cost of the inventory. ▪ Inventory counts are part of a company’s system of internal control • Counting inventory is an example of a control activity which enables management to determine the extent of shrinkage or theft. • To combat theft management can use physical controls such as garment sensors and security cameras.
Teaching suggestion – Remind students about the shipping terms, FOB shipping point and destination, first learned in Chapter 5. Provide them with examples of FOB shipping point and goods sent FOB destination, using your city as the destination and the name of another city as the shipping point. Also, students need concrete examples of goods which are sold on consignment. Jewellery, magazines, newspapers, Christmas decorations, and garden seeds are good examples of merchandise sold on consignment in retail operations or on the Internet. The used bookstore at many college and university campuses is another good example.
Learning Objective 2 – Apply the Cost Formulas Using Specific Identification, FIFO, and Average Cost Under a Perpetual Inventory System Determining ending inventory can be complicated if the units on hand for a specific item of inventory have been purchased at different prices. Therefore, there are a number of cost formulas that can be used:
Specific identification should be used when goods are not ordinarily interchangeable, and
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for goods that are produced and segregated for specific projects. A company must be able to identify which particular units were sold and which are still in ending inventory.
This formula matches the cost of goods sold against sales revenues and reports ending inventory at its actual cost. However, specific identification may be too time consuming and expensive to apply for other types of goods (e.g., that are ordinarily interchangeable).
When inventory items are interchangeable with one another, one of the two cost formulas may be used: ▪ First-in, first-out (FIFO) ▪ Average Cost
The first-in, first-out (FIFO) cost formula assumes that the earliest goods purchased are the first to be sold and recognized as cost of goods sold.
The cost formula chosen by a company does not have to match the actual physical movement of merchandise; however, it should correspond as closely as possible.
Since the perpetual system records two journal entries for each sale (the actual sale and a reduction of inventory), the cost of the oldest goods on hand before each sale is allocated to the cost of goods sold.
The results under FIFO in a perpetual system are the same as in a periodic system.
Teaching suggestion – Illustrate the perpetual inventory system using hypothetical figures for a bicycle shop. Beginning inventory Purchases June 2 June 8 June 25 Cost of goods available
0 500 400 350 1,250
@ 100 @ 125 @ 130
= = = =
$0 50,000 50,000 45,500 $145,500
300 units were sold on June 6, 250 units were sold on June 16, and 450 units were sold on June 28; ending inventory is 250 units Teaching suggestion – Use the bicycle shop example to illustrate FIFO under a perpetual system. Date
Purchases
Cost of Goods Sold
Ending Inventory
Beginning inventory June 2
$0 (500 @ $100) 50,000
June 6 June 8
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50,000 (300 @ $100) $30,000
(400 @ 125) 50,000
Chapter 6 – Reporting and Analyzing Inventory
20,000 70,000
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June 16
June 25
(200 @ $100) $20,000 (50 @ $125) 6,250 26,250 (350 @ 130) 45,500
June 28
89,250 (350 @ $125) $43,750 (100 @ $130) 13,000 56,750
Total cost of goods sold
43,750
32,500
$113,000
The average cost formula assumes that it is not possible to measure a specific physical flow of inventory when the goods available for sale are homogeneous or non-distinguishable. Under the average cost formula, allocation of the cost of goods available for sale between cost of goods sold and ending inventory is made based on the weighted average unit cost of merchandise available for sale.
A new average, also known as a moving average, is calculated after each purchase. The weighted average cost is calculated by dividing the cost of goods available for sale by the number of units on hand. ▪ The average cost is then applied to: • the units sold to determine cost of goods sold. • the remaining units on hand to determine the cost of the ending inventory.
Teaching suggestion – Use the University Soccer Shirt example to illustrate the average cost formula under a perpetual system. Cost of Ending Date Purchases Goods Sold Inventory Beginning inventory June 2
$0 (500 @ $100) 50,000
June 6 June 8
(300 @ $100) $30,000 (400 @ 125) 50,000
June 16 June 25
(350 @ 130) 45,500
Total cost of goods sold
20,000 70,000
(200 @ $116.67) $23,340
June 28
Instructor’s Manual
50,000
46,660 92,160
(350 @ $122.88) $43,008
49,152
$96,348
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Teaching suggestion – Explain to students how rounding discrepancies can change the results in the average cost formula. Make sure they understand that whether averages are rounded to the nearest cent or the actual decimal spot doesn’t really matter, because it is an allocation method only and an exact level of accuracy is not necessary.
Learning Objective 3 – Explain the Effects on the Financial Statements of Choosing Each of the Inventory Cost Formulas If a company’s goods are not ordinarily interchangeable, or have been produced and segregated for specific projects, then the company must use specific identification when determining the cost of its inventory. Otherwise the company can choose either FIFO or average cost. In determining whether to use FIFO or average cost, the company should consider: ▪ whether the method corresponds to the physical flow of goods, ▪ whether the inventory cost on the statement of financial position is close to the inventory’s recent costs, and ▪ the same method needs to be used for all inventory of a similar nature and usage. Whatever formula a company chooses, it should be used consistently from one accounting period to another.
Income statement effects—In periods of increasing prices, FIFO reports the highest net income and average results in the lowest net income. In periods of decreasing prices, the opposite is true, FIFO will report the lowest net income and average will report the highest net income. ▪ Compared to FIFO, average will result in more recent costs being reflected in the cost of goods sold resulting in a better match between revenues and expenses, thereby resulting in a better measure of net income on the income statement. However, the specific identification formula still results in the best match of costs and revenues, as it exactly matches each cost with the revenue it generates.
Statement of financial position effects—FIFO results in costs being allocated to ending inventory that will approximate the inventory items’ current or replacement cost. As a result, FIFO provides the most relevant ending inventory value on the statement of financial position. In a period of inflation, the costs allocated to ending inventory using average will understate the ending inventory on the statement of financial position as older costs will be included in the weighted average.
Teaching suggestion – Ask students which method of inventory they would choose to use if they were a high-end car dealership, a hardware store, or a clothing retailer. Ask students which formula they would choose to use if they were: CEO of a company just going public or CEO of a company short on cash. Remind students that management chooses the inventory cost formula. The company must follow it consistently, but there are procedures for making a change.
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Ask students what policies around inventory management could be taken to minimize the financial statement effect of choosing between different valuation formulas.
Learning Objective 4 – Identify the Effects of Inventory Errors on the Financial Statements When inventory errors occur, they affect both the income statement and the statement of financial position. Errors can include: ▪ an error in the quantity or costs assigned to inventory being incorrect, ▪ an error in recording goods in transit at the end of an accounting period Inventory errors cause misstatements in cost of goods sold, gross profit, net income, current assets, total assets, and shareholders’ equity.
Errors made when determining the cost of inventory ▪ An error made in determining the cost of inventory at the end of one period will result in an error in the following period. ▪ An error in the ending inventory of one period becomes an error in the beginning inventory of the next period and has a reverse effect on net income of the next period. • The effect on the statement of financial position is balanced. The over or understatement in the Inventory account equals the over or understatement error in the Retained Earnings account. Errors made when recording goods in transit at period end ▪ This could involve the company failing to record goods that it owned but that were in transit. Alternatively, it could involve the company incorrectly including goods in transit in its inventory when they were not owned by the company. ▪ These errors will cause the Inventory and Accounts Payable accounts to be misstated.
Teaching suggestion – Use Illustration 6-8 to show students that inventory errors offset each other and that the combined total net income for a two year period are correct.
Learning Objective 5 – Demonstrate the Presentation and Analysis of Inventory Valuing Inventory at the Lower of Cost and Net Realizable Value When the net realizable value of inventory is lower than its cost, the inventory is written down by valuing the inventory at the lower of cost and net realizable value in the period in which the price decline occurs. ▪ Under the lower of cost and net realizable value basis, net realizable value is the selling price, less any costs required to make the goods ready for sale. ▪ The lower of cost and net realizable value basis should be applied to individual or groups of inventory items as opposed to total inventory. In certain cases the lower of cost and net realizable value can be applied to groups of similar items.
The direct method results in the Inventory account being directly credited (reduced) when
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adjusting for the decline in inventory value. The Cost of Goods Sold account is debited.
When conditions that caused the write down no longer exist, or when there is clear evidence of an increase in net realizable value because of changed economic circumstances, the amount of the inventory write down can be reversed. The reversal can only be written back up to the original cost.
Teaching suggestion – Ask students to think about instances where lower of cost and net realizable value may be needed. For example the fair value of a 2018 model SUV may decline below its cost in 2019 when a newer more fuel efficient vehicle is being sold by the dealership. Reporting Inventory
Ending inventory is reported as a current asset in the statement of financial position at its lower of cost and net realizable value. Most companies do not separately disclose the cost and net realizable value of their inventory.
The following disclosures are disclosed in the financial statements or in the notes to the statements: ▪ total amount of inventory, ▪ cost of goods sold, ▪ the cost formula(s) used (specific identification, FIFO, or average cost), ▪ the amount of any writedown to net realizable value or reversals of previous writedowns, including the reason why the writedown was reversed. ▪ The amount of inventory pledged as security
Inventory turnover is calculated by dividing cost of goods sold by average inventory. It measures the number of times the inventory turns over during the period. ▪ Days in inventory, calculated by dividing 365 days by the inventory turnover ratio, indicates the number of days on average that an item remains in inventory.
One way to manage the amount of inventory on hand is to use the just-in-time approach. A company places an order when the item is needed for a specific order. The company is then able to record the receipt and sale of the inventory items at or about the same time.
Teaching suggestion – Provide examples of merchandise which may have a relatively long shelf life (boxed macaroni and canned goods) as well as examples of merchandise with extremely short lives (apples and bananas). Would a retailer or wholesaler want to turn merchandise over rapidly? Why?
Learning Objective 6 – Apply the FIFO and Average Cost Formulas Under a Periodic Inventory System (Appendix 6A) Each of the inventory cost determination formulas described in Chapter 6 for a perpetual inventory system may be used in a periodic inventory system.
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The first-in, first-out (FIFO) cost formula assumes the cost of the earliest goods on hand before each sale is charged to cost of goods sold.
When using a periodic inventory system, the different dates of each of the sales are ignored. Instead, at the end of the period, the entire pool of costs is assumed to be available for allocation.
Cost of goods sold can be calculated by first determining the value of ending inventory. ▪ The cost of ending inventory is determined by taking the unit cost of the most recent purchase and working backwards until all the units of inventory have been costed. ▪ Then determine cost of goods sold by subtracting the ending inventory value from the cost of all goods available for sale (the pool of costs). ▪ The cost of all goods available for sale is equal to the beginning inventory value added to all purchases made during the period. ▪ The cost of goods sold can be separately proven by starting with the first item of beginning inventory and counting forward until the total number of units sold is reached, assuming there is no theft or shrinkage.
Note that FIFO under a periodic inventory system will yield the same results as under a perpetual inventory system.
Teaching suggestion – Continue with the bicycle shop example to illustrate FIFO and the methods for determining ending inventory and cost of goods sold: Beginning inventory Purchases June 2 June 8 Nov 27 Cost of goods available
0 500 400 350 1,250
@ 100 @ 125 @ 130
= = = =
$0 50,000 50,000 45,500 $145,500
A physical inventory count determines that ending inventory is 250 units. The value of ending inventory is calculated by starting with the last purchase: Ending Inventory
250
@ 100
$25,000
Cost of goods sold is then calculated: Cost of goods available Less: Ending inventory Cost of goods sold This can be verified: Beginning inventory: Purchases
Cost of goods sold
$145,500 25,000 $120,500
250 400 350
@ 100 @ 125 @ 130
= = = =
$0 25,000 50,000 45,500 $ 120,500
The average cost formula assumes that the goods available for sale are homogeneous or nonInstructor’s Manual
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distinguishable and allocates the cost of goods available for sale on the basis of weighted average unit cost incurred. The weighted average unit cost is then applied to the units on hand to determine the cost of the ending inventory. The cost of goods sold is then calculated by subtracting ending inventory from the value of good available for sale. The main difference between the perpetual inventory system and the periodic inventory system is that in the perpetual inventory system the average cost is recalculated after each purchase, whereas for the periodic inventory system the weighted average cost is only determined at the end of the period. Average yields different results under a periodic and perpetual inventory system. Teaching suggestion – Use the bicycle shop example to illustrate the average cost formula. Beginning inventory0 Purchases June 2 Aug. 24 Nov. 27 Cost of goods available
500 400 350 1,250
@ 100 @ 125 @ 130
= = = =
$0 50,000 50,000 45,500 $145,500
Average cost 145,500 ÷ 1,250 = $116.40 per unit Ending Inventory $116.40 x 250 = $29,100 Cost of goods available for sale Less: Ending inventory Cost of goods sold
$145,500 29,100 $116,400
We can check our work multiplying the units sold by the weighted average unit cost: 1,000 x $116.4 = $116,400. Teaching suggestion – Point out that the sum of cost of goods sold and ending inventory should equal the cost of goods available.
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Do you think that a grocery store uses the FIFO cost formula in costing their inventories due to the fact that the inventory is perishable (produce, bakery goods, meat and dairy products)?
Assume you work as a staff accountant for a merchandising company. Sales have far exceeded expectations for the year and you have been told by the controller to tell the shipping clerk to delay a shipment of a large order of merchandise until the beginning of the next year, which is only a week away. Why have you been asked to do this and how would you handle the situation?
After taking the physical inventory count, you realized that inventory in one small warehouse had not been counted. What effect will this have on the financial statements? Would there be any differences if the company was using a periodic versus a perpetual inventory system?
How does the impact of shoplifting show up on a company’s financial statements?
If you were starting up a business would you consider selling your inventory on consignment? Why or why not?
Why should there be different types of inventory cost formulas? Wouldn’t it be easier if all companies followed the same method?
Has anyone ever had to take an inventory count before? What were the major challenges in counting inventory? How accurate do you think you were? Was anyone asked to double check your count?
If inventory errors offset in future periods, would it still be necessary to adjust inventory if you know about the errors?
If you were starting a company, which inventory cost formula would you use and why? Would your decision be based on the type of inventory that you were selling?
In adjusting for the lower of cost and net realizable value, why is the Cost of Goods Sold account debited for a decline in value even if the goods have not been sold?
Why is it bad to have a low inventory turnover? Why would it be bad to have a high inventory turnover? Which would you rather have and why?
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Chapter 6 – Reporting and Analyzing Inventory
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CHAPTER 6 REPORTING AND ANALYZING INVENTORY 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
Which of the inventory cost formulas often parallels the physical flow of goods? Answer: Specific identification parallels the actual physical flow of goods.
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VOCABULARY QUIZ 1.
An inventory cost formula that assumes that the costs of the first goods purchased are the first to be allocated to cost of goods sold.
2.
Measure of the average number of days inventory is held; (calculated as 365 divided by inventory turnover ratio).
3.
Goods held for sale by one party (the consignee), although ownership of the goods is retained by another party (the consignor).
4.
The method and measures adopted within an organization to help it achieve reliable financial reporting, effective and efficient operations, and compliance with relevant laws and regulations.
5.
A basis whereby inventory is written down for declines in value.
6.
The ratio that is calculated as cost of goods sold divided by average inventory.
7.
Freight terms indicating that the goods are placed free on board at the buyer's place of business, and the seller pays the freight cost. Goods belong to the seller while in transit.
8.
The selling price of an inventory item, less any costs required to make the item saleable.
9.
The cost of goods available for sale divided by the units available for sale.
10.
An inventory cost formula used when goods are distinguishable and not ordinarily interchangeable.
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ANSWERS TO VOCABULARY QUIZ 1.
First-in, first-out (FIFO) cost formula
2.
Days in inventory
3.
Consigned goods
4.
Internal control
5.
Lower of cost and net realizable value
6.
Inventory turnover ratio
7.
FOB destination
8.
Net realizable value
9.
Average unit cost
10.
Specific identification formula
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MULTIPLE CHOICE QUIZ 1.
In order to be classified as inventory, merchandise must be a. owned by the company. b. in a form ready for sale to customers in the ordinary course of business. c. shipped FOB destination. d. both a. and b. above e. both a. and c. above
2.
Which of the following financial statements are affected by the use of the lower of cost and net realizable value basis? a. the statement of financial position b. the income statement c. both the statement of financial position and the income statement d. neither the statement of financial position nor the income statement
3.
If an inventory error exists and the beginning inventory is understated, cost of goods sold will be a. overstated. b. correct. c. understated. d. not applicable.
4.
Ownership of goods passes to the buyer when the public carrier accepts the goods from the seller, when the terms are a. FOB shipping point. b. on consignment. c. FOB destination. d. goods in transit.
5.
In some lines of business, it is customary to hold the goods of other parties and try to sell the goods for them for a fee. These goods are called a. goods in transit. b. inventory turnover. c. inventory. d. consigned goods.
6.
When legal title of the goods remains with the seller until the goods reach the buyer, the terms are said to be a. consigned goods. b. FOB destination. c. FOB shipping point. d. none of the above.
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7.
The cost formulas are a. specific identification and FIFO. b. FIFO and average cost. c. perpetual and periodic. d. specific identification, average cost, and FIFO. e. none of the above
8.
Which of the following statements is not true regarding FIFO? a. FIFO assumes the first goods purchased are the first to be sold. b. FIFO often coincides with the actual physical flow of inventory. c. Ending inventory is based on the cost of the most recent units purchased. d. Ending inventory is obtained by taking the unit cost of the earliest goods available for sale and working forward until all units of inventory have been costed. e. None of the statements above are false.
9
In a period of increasing prices, the inventory cost formula that will yield the highest net income is a. periodic. b. FIFO. c. average. d. perpetual. e. specific identification.
10.
When a company uses the perpetual inventory system, which of the following would be the entry to adjust inventory to the lower of cost and net realizable value basis? a. Debit Purchases and credit Inventory. b. Debit Inventory and credit Purchases. c. Debit Cost of Goods Sold and credit Inventory. d. Debit Loss on Write Down of Inventory and credit Inventory. e. Debit Inventory and credit Cost of Goods Sold.
11.
When deciding between the FIFO and average cost formulas, a company would consider a. the method that matches the physical flow of goods. b. reporting the inventory’s most recent cost. c. using the same formula for similar inventory. d. all of the above. e. none of the above
12.
Which of the following statements is not true? a. During periods of rising prices, FIFO results in the highest net income. b. During periods of rising prices, the average cost formula results in the highest cost of goods sold. c. During periods of rising prices, FIFO has the highest retained earnings. d. During periods of rising prices, the average cost formula has the highest ending inventory.
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e. none of the above
13.
Net realizable value is a. the selling price of the goods. b. the salvage value of the goods. c. the price paid for the goods. d. the selling price less any costs required to make the goods ready for sale. e. none of the above
14.
Used Cars Inc. has the following inventory of vehicles:
Vehicle A Vehicle B Vehicle C Vehicle D
Cost NRV $ 25,000 $ 25,500 50,000 40,000 16,000 18,000 22,000 21,500 $113,000 $105,000
In applying the lower of cost and net realizable value rule, by how much would Used Cars need to adjust its inventory? a. Write down inventory by $2,500. b. Write down inventory by $8,000. c. Write down inventory by $10,500. d. Write up inventory by $8,000. e. No inventory adjustment is needed.
*15. K&K Distributors Ltd. provided the following purchases and sales for the month of January. K&K Distributors uses a periodic inventory system. Date Jan. 1 Jan. 12 Jan. 14 Jan. 15 Jan. 20
Explanation Units Unit Cost Total Cost Beginning inventory 200 $10 $2,000 Purchase 50 12 600 Sale 150 Purchase 150 14 2,100 Purchase 200 15 3,000
Assuming the use of the average cost formula, what is the cost of the ending inventory? a. $1,500 b. $1,925 c. $5,775 d. $6,200
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
d
2.
c
3.
c
4.
a
5.
d
6.
b
7.
d
8.
d
9.
b
10.
c
11.
d
12.
d
13.
d
14.
c
*15. c
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20-MINUTE QUIZ #1 Circle the correct answer: True/False 1.
Goods in transit shipped FOB destination belong to the seller.
True
False
2.
Goods on consignment are owned by the holder of the goods (consignee).
True
False
3.
An error in ending inventory of the current period will have a reverse effect on the net income of the next period.
True
False
4.
Under FIFO, the assignment of cost to merchandise sold is in the same order in which the merchandise was purchased.
True
False
5.
Taking a physical inventory involves actually counting, weighing, or measuring each kind of inventory on hand.
True
False
6.
Specific identification does not track the actual physical flow of the goods in a perpetual system.
True
False
7.
In a period of rising prices, FIFO results in a lower net income and lower ending inventory than the average cost method.
True
False
8.
Specific identification is used for high-volume, low-cost items.
True
False
9.
Inventory is written down to net realizable value if the net realizable value is lower than its cost.
True
False
10.
In a perpetual system, the calculation for weighted average unit cost is Cost of Goods Sold divided by the total units available for sale.
True
False
Multiple Choice 11.
If the ending inventory is overstated, a. net income will be understated. b. net income will be overstated. c. net income will be correct. d. gross profit will be understated. e. none of the above
12.
A company that uses a perpetual inventory system must still take a physical inventory count at year end, for the following reasons:
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a. to determine cost of goods sold. b. to check the accuracy of the perpetual inventory records and to determine the amount of inventory lost due to theft or shrinkage. c. to determine the amount of inventory on hand. d. to determine ownership of the goods. e. there is no need to take a physical inventory count.
13.
In a period of rising prices, a. Cost of Goods sold is higher using average cost, compared with FIFO. b. Compared with average cost, FIFO results in lower gross profit. c. Compared with average cost, FIFO has lower ending inventory. d. Compared with FIFO, average cost has higher shareholders’ equity. e. none of the above
14.
Which of the following statements is not true? a. Specific identification exactly matches costs and revenues. b. Average cost tends to smooth out price changes. c. FIFO assigns an amount to inventory that is the lower of cost or net realizable value. d. FIFO assigns the oldest costs incurred to cost of goods sold. e. none of the above
15.
In the notes to the financial statements, the following information should not be included: a. the major inventory classifications b. the cost determination method (FIFO, specific identification, or average cost) c. the fact that inventory is valued at the lower of cost or net realizable value d. the amount inventory is written up above its original cost e. none of the above
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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
True
2.
False
3.
True
4.
True
5.
True
6.
False
7.
False
8.
False
9.
True
10.
False
Multiple Choice 11.
b
12.
b
13.
a
14.
c
15.
d
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20-MINUTE QUIZ #2 1.
Acme has the following information about its inventory. Beginning inventoryMay 1 Purchase- May 2 Sold units – May 15 Purchase – May 20
Units 120
Unit Cost $ 3.00
Balance 120 units
280 300 450
2.80
400 units 100 units 550 units
2.20
Using a perpetual inventory system, calculate the costs to be assigned to the ending inventory and to goods sold under: a. Average cost b. FIFO
2.
Paddy Company, which uses a perpetual inventory system, miscounted its ending inventory in Year 1, causing it to be understated. The error was not detected. Using the symbols U, O, and NE to represent understated, overstated, and no effect, indicate the impact of the error on each of the following items. Item Year 1 cost of goods sold Year 1 gross profit Year 1 ending shareholders’ equity Year 2 cost of goods sold Year 2 net income
3.
Given the following information for Delta Company, calculate the inventory turnover ratio: Cost of Goods Sold Opening Inventory Ending Inventory
*4.
Effect
$945,230 $278,560 $303,457
A company just starting business made the following four inventory purchases in August: August 1 300 units $1,560 August 12 400 units 2,340 August 24 400 units 2,520 August 30 300 units 1,980 1,400 units $8,400 On August 24, there were a total of 900 units sold. Using the FIFO inventory cost method for a periodic inventory system, what is the amount allocated to cost of goods sold for August?
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ANSWERS TO 20-MINUTE QUIZ #2 1. Average Cost Method: Purchases Beginning inventoryMay 1 Purchase- May 2
120 @ $3.00 $360 280 @ $2.80 $784
Sold units – May 15 Purchase – May 20
Cost of Goods Sold
$858 (300@ $2.86) 450 @ $2.20 $990
Balance $360 (120 @ $3.00) $1,144 (400@$2.86) $286 (100 @ $2.86) $1,276 (550@$2.32)
Cost of Ending Inventory using the Average costing method is $1,276 Cost of Goods Sold using the Average costing method is $858 FIFO: Purchases Beginning inventoryMay 1 Purchase- May 2
120 @ $3.00 = $360 (280 @ $2.80) = $784
Sold units – May 15
Purchase – May 20
Cost of Goods Sold
Balance 120 @ $3.00 $360
120 @ $3.00 = $360 180 @ $2.80 = =$504 450 @ $2.20 = $990
120 @ $3.00 $360 280 @ $2.80 $784 $1,144 100 @ $2.80 $280
100 @ $2.80 $280 450 @ $2.20 $990 $1,270
Cost of Ending Inventory using the FIFO costing method is $1,270 Cost of Goods Sold using the FIFO costing method is $864
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2.
Paddy Company, which uses a perpetual inventory system, miscounted its ending inventory in Year 1, causing it to be understated. The error was not detected. Using the symbols U, O, and NE to represent understated, overstated, and no effect, indicate the impact of the error on each of the following items. Item Year 1 cost of goods sold Year 1 gross profit Year 1 ending shareholders’ equity Year 2 cost of goods sold Year 2 net income
3.
Effect O U U U O
Given the following information for Delta Company, calculate the inventory turnover ratio: Cost of Goods Sold Opening Inventory Ending Inventory
$945,230 $278,560 $303,457
= $945,230 ÷ (($278,560+$303,457) ÷ 2) = $945,230 ÷ $291,008.5 = 3.25 times 4.
August 1 300 units cost $1,560 August 12 400 units cost $2,340 August 24 200 units cost (2,520/400) = $6.3 per unit x 200 = $1,260 Total cost of goods sold = $1,560 + $2,340 + $1,260 = $5,160
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CHAPTER 7 INTERNAL CONTROL AND CASH LEARNING OBJECTIVES 1.
Explain the components of an internal control system, including its control activities and limitations.
2.
Apply the key control activities to cash receipts and payments.
3.
Prepare a bank reconciliation.
4.
Explain the reporting and management of cash.
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Chapter 7 – Internal Control and Cash
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CHAPTER OUTLINE Learning Objective 1 – Explain the Components of an Internal Control System, Including Its Control Activities and Limitations Internal control consists of all the related methods and measures adopted within a company to help it achieve reliable financial reporting, effective and efficient operations, and compliance with relevant laws and regulations. Internal control is used to prevent and/or detect errors (unintentional misstatements) and play a key role in prevention and detection of intentional errors and theft (fraud). Good internal control systems have the five primary components:
Control environment: It is the responsibility of the board of directors and management to make it clear that the organization values integrity, and that unethical activity will not be tolerated (often referred to as “setting the tone at the top”).
Risk assessment: Management must identify and analyze the various factors that create risk for the business and determine how to manage these risks.
Control activities: To reduce the occurrence of unintentional and intentional errors, management must design policies and procedures to address the specific risks faced by the company.
Information and communication: The internal control system must capture and communicate all pertinent information to the appropriate internal and external users.
Monitoring activities: Internal control systems must be monitored periodically for their adequacy. Significant deficiencies need to be reported to management and/or the board of directors.
Control Activities
Assignment of responsibility – Control is most effective when only one person is authorized to perform a specific task and requires management to determine the activities that each employee (or manager) is responsible for.
Segregation of Duties ▪ Responsibility of related activities should be assigned to different individuals. ▪ When the same individual is responsible for related activities, the potential for unintentional and intentional errors increases. ▪ The following activities should be separated from one another: • Authorization of transactions and activities • Recording of transactions • Custody of assets
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Teaching suggestion – Ask students if they have noticed instances of two or more employees working out of the same cash register. If they have, ask why this violates internal control activities. When a cashier at the grocery store ends a shift, does the cashier walk out and let someone else work out of the same cash drawer? What is the usual procedure? Teaching suggestion – Ask students to recall a trip to the bank. Does the teller receiving the money for deposit take the money to the accounting department and record the deposit? Why not?
Documentation – Documents provide evidence that transactions and events have occurred at specified times and at specified amounts. ▪ Documents should be sequentially prenumbered (such as receipts and cheques) and all documents should be accounted for. ▪ Original documents (source documents) for accounting entries should be promptly forwarded to the accounting department to help ensure timely recording of the transaction.
Teaching suggestion – Ask why cheques and invoices are sequentially numbered. Prenumbering helps to prevent a transaction from being recorded more than once or from not being recorded at all. What happens to voided cheques?
Physical Controls – physical controls can be used to safeguard assets and enhance reliability of accounting records. Examples of these controls include: ▪ Safes, vaults, and safety deposit boxes for cash and business papers. ▪ Locked warehouses and storage cabinets for inventory and records. ▪ Computer facilities with password or biometric access. ▪ Alarms to prevent break-ins. ▪ Television monitors and garment sensors to deter theft. ▪ Time clocks for recording time worked.
Teaching suggestion – Ask why you receive a cash register receipt at a fast food restaurant, a grocery store, or a department store. Why do some stores post signs that say “if you do not receive a receipt, we will pay you $5?” What would a movie theatre do with its Saturday night receipts? Discuss the importance of internal controls over cash transactions. Teaching suggestion – Explain to students that insurance companies bond employees of other companies who handle cash. Bonding employees is much like having an insurance policy that will reimburse the company if an employee steals money.
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Review and reconciliation – the four control activities: assignment of responsibility, segregation of duties, documentation, and physical controls must be reviewed independently and frequently. ▪ Internal Reviews • Independent review is necessary because employees can forget or intentionally fail to follow internal controls, or they might become careless if there is no one to observe and evaluate their performance. • Verification should be made periodically on a surprise basis. • Verification should be done by someone who is independent of the personnel responsible for the information. • Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action. • Verification can be done internally, by internal auditors, or a company supervisor. ▪ External Reviews • External auditors are independent of the company and report on whether or not the company’s financial statements fairly present its financial position and results of operations.
Teaching suggestion – Ask if any of the students have worked as a cashier. Did they count the money in the cash drawer at the end of the workday? Why or why not?
Limitations of Internal Control ▪ Internal control is designed to provide reasonable assurance that assets are properly safeguarded and that the accounting records are accurate and reliable. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit. ▪ The cost/benefit considerations is the limitation that the costs of establishing control activities should not exceed the benefits that are expected to result from their use. ▪ The size of the business may impose limitations on internal control. A small company may find it difficult to apply segregation of duties and independent internal verification because of the small number of employees. ▪ The impact of human error is important in internal control. A good system can become ineffective as a result of lack of training, employee fatigue, carelessness, or indifference. Employees may become tired and not bother to count inventory. Or two or more employees may work together in order to get around prescribed controls (collusion). ▪ The act of collusion can lead to fraud. Fraud is an intentional act to misappropriate (steal) assets or misstate financial information. ▪ As management is responsible for a company’s internal controls, it is also possible for management to override them. Managers may be able to ignore internal control policies and procedures without detection if they also provide the oversight function related to them.
Teaching suggestion – Ask students if they would expect a very small company to have as sophisticated a system of internal control as that of a much larger company. Why not?
Learning Objective 2 – Apply the Key Control Activities to Instructor’s Manual
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Cash Receipts and Payments
Cash is the asset most susceptible to theft. ▪ It is the one asset that is readily convertible into any other type of asset. ▪ Effective control over cash receipts is essential.
Cash includes: Coins, currency, cheques, and money orders.
Cash does not generally include: post-dated, stale-dated or returned cheques.
Cash receipts may result from over-the-counter receipts, electronic receipts, or cheque receipts (cheques received either at the time of sale or at a later date by mail).
Cash receipts – internal control over cash receipts is more effective when cash receipts are deposited intact into the bank account on a daily basis or are made by electronic funds transfer. ▪ Bank deposits should be made by an authorized employee.
Electronic funds transfer (EFT) is a way of transferring money electronically from one bank account directly to another without any paper money changing hands. ▪ Electronic funds transfers normally result in better internal control since no cash or cheques are handled by company employees.
Cheque receipts – when cheques are received in the mail, the cheque is accompanied by a remittance advice. The mailroom clerk will send the remittance advices to the accountants responsible for recording the bank deposit while sending the cheques to the clerk that will deposit the cheques.
The following control activities explained earlier apply to cash receipts transactions as shown: ▪ Assignment of responsibility—Only designated personnel (cashiers) authorized to handle cash receipts. ▪ Segregation of duties—Different individuals recording cash receipts and holding the cash. ▪ Documentation—Use remittance advice, cash register tapes, and deposit slips or confirmations. ▪ Physical controls—Store cash in safes and bank vaults; limit access to storage areas; use cash registers. ▪ Review and reconciliation—Supervisors count cash receipts daily; an accountant compares total receipts to bank deposits daily.
Teaching suggestion – Explain to students how cash registers can greatly enhance control over cash sales.
Cash is disbursed to pay expenses, to settle liabilities, or to purchase assets.
Internal control over cash payments is more effective when payments are made by cheque or by electronic funds transfer, rather than in cash.
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Teaching suggestion – Ask students why internal control over cash payments would be more effective when payments are made by cheque or by electronic funds transfer rather than by cash.
The control activities apply to cash payments as follows: ▪ Assignment of responsibility—Only designated personnel authorized to sign cheques or approve electronic payments. ▪ Segregation of duties—Different individuals approve and make payments; cheque signers do not record payments. ▪ Documentation—Use prenumbered cheques and account for them in sequence; each cheque must have an approved invoice. ▪ Physical controls—Store blank cheques in safes and bank vaults with limited access; restrict access to blank cheques and signing machines; use electronic payments
▪
when possible. Review and reconciliation—Compare cheques to invoices; reconcile bank statements monthly.
Learning Objective 3 – Prepare a Bank Reconciliation The use of a bank account: ▪ Contributes significantly to good internal control over cash. ▪ Minimizes the amount of cash that must be kept on hand. ▪ Facilitates the control of cash because a double record is maintained of all bank transactions—one by the business and one by the bank. Bank statements – Each month the company receives a bank statement showing: ▪ Dates. ▪ A description of each transaction. ▪ The amounts deducted (debited) from the bank account (for example cheques and other payments). ▪ The amounts added (credited) to the bank account (for example deposits and other receipts). ▪ The account balance after each transaction. Teaching suggestion – Ask the students if they noticed whether their bank statement or bank books show a debit or credit balance. Ask how a credit balance can show that they have deposited cash in the bank. Point out that their asset (a bank account) is a debit for them, but a liability or credit for the bank. ▪
Debits are amounts deducted from a bank account including cheques and other payments.
The bank and the company maintain independent records of the chequing account. The two balances are seldom the same because of: Timing Differences that prevent one of the parties from recording the transaction in a different period than the other.
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Errors by either party in recording transactions.
Reconciliation Procedure
To get the most benefit from a bank reconciliation, the reconciliation should be prepared by an employee who has no other responsibilities pertaining to cash.
In reconciling the bank account it is customary to reconcile the balance per books and balance per bank to the reconciled (correct) cash balance.
The reconciliation is divided into two sections—balance per bank and balance per books. The following steps should reveal all the reconciling items causing the difference between the two balances:
Reconciling items per bank ▪ Compare the individual deposits on the bank statement with (1) the deposits in transit from the preceding bank reconciliation and (2) with the deposits recorded in the books. Deposits recorded by the depositor that have not been recorded by the bank represent deposits in transit and are added to the balance per bank. ▪ Compare the paid cheques shown on the bank statement or returned with the bank statement with (a) cheques outstanding from the preceding bank reconciliation and (b) cheques issued by the company. Issued cheques recorded by the company that have not been paid by the bank represent outstanding cheques that are deducted from the balance per bank. ▪ Note any errors made by the bank that have been discovered in the previous steps. All errors made by the company are reconciling items in determining the reconciled cash balance per company’s books. In contrast, all errors made by the bank are reconciling items in determining the reconciled cash balance per bank.
Teaching suggestion – Help students understand the impact of deposits in transit and outstanding cheques from the prior period. Explain that if they don’t clear the bank in the current period, they are still outstanding.
Reconciling items per books ▪ Compare the other deposits on the bank statement with the company records. Any unrecorded amounts should be added to the balance per books, for example, an electronic funds transfer. ▪ Any unrecorded payments should be deducted from the balance per books, for example, NSF cheques or service charges. ▪ Note any errors made by the company that have been discovered in the previous steps. Make sure to include errors made by the company as reconciling items in determining the reconciled cash balance per company’s books.
Teaching suggestion – In the future will there be more transfers made by Electronic Fund Transfers? Why or why not?
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Teaching suggestion – Illustrate preparation of a bank reconciliation using the following example: The June bank statement for McMann Limited indicates a balance on June 30 of $8,450. Assume that McMann has a cash balance in its records on June 30 of $9,670. In comparing McMann’s books to those of the bank the following items were found: A deposit of $1,890 was mailed to the bank on June 29. Two cheques written in June have not been paid by the bank. The cheques are #502 in the amount of $50 and #503 in the amount of $215. Along with the bank statement was an electronic deposit made by a customer on account in the amount of $650. Also returned with the bank statement was an NSF (not sufficient funds) cheque for $230. The cheque had been received from a customer named E. Collins. A regular monthly service charge of $15 was recorded in the bank statement. The bank was reconciled as follows: Cash balance per bank June 30 Add: Deposits in transit Deduct: Outstanding cheques
$ 8,450 1,890 # 502 503
$ 50 215
Reconciled cash balance June 30 Cash balance per company’s books June 30 Add: Electronic accounts receivable Less: Bank service charge NSF cheque—E. Collins Reconciled cash balance June 30
265 $10,075 $ 9,670 650
$ 15 230
245 $10,075
Entries from Bank Reconciliation
Each reconciling item which arises from determining the reconciled cash balance per company’s books should be recorded by the company. If these items are not journalized and posted, the Cash account will not show the correct balance.
Any errors on the company’s book side generate accounting entries as well. Errors on the bank side must be brought to the notice of the bank so it can make the necessary corrections.
Teaching suggestion – Illustrate the process of making journal entries from the bank reconciliation using the entries to adjust McMann’s Cash account: June 30
Cash
650 Accounts Receivable (To record electronic collection of accounts)
Accounts Receivable Cash Instructor’s Manual
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(To re-establish accounts receivable for E. Collins for NSF cheque) Bank Charges Expense Cash (To record bank service charge)
15 15
Stop and check that the general ledger Cash account balance agrees with the reconciled cash balance in the bank reconciliation after the above entries have been posted.
Learning Objective 4 – Explain the Reporting and Management of Cash
Cash is reported in both the statement of financial position and the statement of cash flows. The statement of financial position shows the amount of cash available at a given point in time. The statement of cash flows shows the receipts and payments of cash during a period of time.
Teaching suggestion – Which statement, the income statement, the statement of retained earnings, the balance sheet, or the statement of cash flows, provides the user with the most information about cash? Discuss the benefits of each statement where cash is reported or reported.
Cash is the most liquid asset and listed first in the current assets section of the statement of financial position.
Some companies combine cash with cash equivalents in reporting cash. Cash equivalents are short-term, highly liquid held-for-trading investments that that are subject to an insignificant risk of changes in value. Generally only debt investments due within three months qualify as investments for this purpose.
A cash deficit or overdraft is shown as a credit balance and is reported as a current liability called bank indebtedness.
A company may have cash that is not available for general use because it is restricted for a special purpose: ▪ In making loans to depositors, banks commonly require borrowers to maintain minimum cash balances, called compensating balances. ▪ If they are not expected to be used within the next year, restricted cash or compensating balances should be reported as a non-current asset.
A company can improve its chances of having adequate cash by following six basic principles of cash management: 1. Increase the speed of collection on receivables. 2. Keep inventory levels low. 3. Delay payment of liabilities. 4. Plan the timing of major expenditures. 5. Invest idle cash.
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6.
Prepare a cash budget.
Teaching suggestion – Ask students what they would do to increase the speed of collection on receivables. Teaching suggestion – Ask students if they budget their cash. Although students do not have a written record of their budget, most of them will have thought about when they will receive money and what they will use the money for. This is, although very informal, a form of budgeting. Ask students if they think they would save more money if they budgeted. Why or why not?
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Peachville is a small rural town. The Bank of Peachville closes its doors to the public at 5:00 p.m. every afternoon. After closing, the two tellers go into the back room where they perform the cash reconciliation of their till. Discuss whether the practice followed by The Bank of Peachville provides an adequate system of internal control.
You have just accepted the position of Treasurer of a local competitive sport club. It has about 100 family members and about 210 participants between the ages of 8 and 20 years old. With an annual fee of approximately $300 per participant and fundraising activities, the annual revenues of the club are in the $80,000 range. The club’s goal is to break even. How would you manage both the volume and timing of cash? How might the six principles of cash management apply to the sport club?
Consider the internal controls at your favourite fast food restaurant. Discuss what controls you can observe. What other controls do you think exist which you do not see?
Why does a small business rely so much on the owner or manager to provide oversight?
Do you think that a small business or a large business is more likely to have fraud? Why?
Why do businesses still experience losses even though they have implemented internal controls?
If a bank experiences timing differences, then why would the bank account need to be reconciled? Shouldn’t the effect reconcile on its own?
Even though the company can improve its cash management by keeping inventory low, should a company consider this as an effective strategy and lower their inventory levels?
Would it be more effective to delay paying liabilities or to take advantage of receiving a discount for early payments?
If you owned your own business, what type of controls would you put in place? How would you evaluate whether the controls were cost effective?
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CHAPTER 7 INTERNAL CONTROL AND CASH 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
On which two financial statements is cash reported? Answer: Statement of financial position and statement of cash flows
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VOCABULARY QUIZ 1.
All the related methods and measures adopted within a business to achieve reliable financial reporting, effective and efficient operations, and compliance with relevant laws and regulations.
2.
Resources that consist of coins, currency, cheques, and money orders.
3.
The responsibility for related activities assigned to different individuals.
4
The document sent by a bank each month showing the company’s bank transactions and balances.
5.
Short-term, highly liquid held-for-trading investments that can be easily sold.
6.
Deposits made and recorded by a company that have not yet been received or recorded by the bank.
7.
Company employees who evaluate on a continuous basis the effectiveness of the company’s system of internal control.
8.
A cheque that is not paid by a bank because of insufficient funds in a customer’s bank account.
9.
Cheques issued and recorded by a company that have not yet been paid by the bank.
10.
Cash that is not available for general use, but instead is restricted for a particular purpose.
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ANSWERS TO VOCABULARY QUIZ 1.
Internal control
2.
Cash
3.
Segregation of duties
4.
Bank statement
5.
Cash equivalents
6.
Deposits in transit
7.
Internal auditors
8.
NSF cheque
9.
Outstanding cheques
10.
Restricted cash
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MULTIPLE CHOICE QUIZ 1.
Control activities consist of all of the following except a. assignment of responsibility. b. segregation of duties. c. generally accepted accounting principles. d. documentation. e. none of the above
2.
The following measure is recommended to obtain maximum benefit from review and reconciliation. a. Internal reviews of performance should be made periodically on a surprise basis. b. Internal reviews of performance should be done by someone who is independent of the personnel responsible for the information. c. Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action. d. all of the above
3.
The concept of reasonable assurance rests on the premise that a. employees’ duties should be rotated. b. employees should take vacations. c. the cost of establishing control procedures should not exceed their expected benefit. d. there should be physical controls. e. none of the above
4.
Cash consists of a. coins, currency and postage stamps. b. coins, currency, cheques, and money orders. c. coins, currency, postage stamps, and money orders. d. all of the above
5.
Control activities over cash payments are more effective when payments are made by a. cheque. b. cash. c. cheque and by electronic funds transfer. d. cash and electronic funds transfer. e. none of the above
6.
The bank would debit the customer’s bank account for all of the following items, except a. cheques drawn on the account.
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b. monthly service charge. c. electronic deposit. d. NSF cheque deposited by customer. e. none of the above
7.
The principles of cash management do not include a. accelerating the collection of receivables. b. hoarding idle cash. c. keeping inventory low. d. preparing a cash budget. e. none of the above
8.
Which of the following is not one of the components of a good internal control system? a. monitoring b. risk assessment c. materiality d. control activities e. none of the above
9.
Which of the following describes the internal control component “control environment”? a. Internal control systems must be monitored periodically. b. It is the responsibility of the board of directors and management to make it clear that the organization values integrity and that unethical activity will not be tolerated. c. To reduce fraud, management must design policies and procedures to address the specific risks faced by the company. d. A company must identify and analyze its risks in order to determine how to manage these risks. e. none of the above
10.
A cheque was written by a business for $245 but recorded in the books as $542. How would this error be included on the bank reconciliation? a. a deduction on the bank side b. an addition on the bank side c. an addition on the book side d. a deduction on the book side
11.
Which of the following is false related to control activities over cash receipts? a. Internal control over cash receipts is more effective when cash receipts are deposited on a daily basis. b. Electronic funds transfers normally result in better internal control since no cash or cheques are handled by employees. c. A remittance and cheque are sent to the accountant for deposit. d. Employees should ensure that the cash in the register is equal to the float plus
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the cash sales recorded by the system. e. none of the above
12.
Which of the following is false related to cash? a. Cash that has a restricted use should be reported separately on the statement of financial position. b. A compensating balance is shown as a current asset on the statement of the financial position. c. A negative cash balance is shown as a current liability on the statement of the financial position. d. The cash balance on the statement of financial position must equal the cash balance on the statement of cash flows. e. none of the above
13.
Which of the following is not an example of control activities over cash payments? a. Cheques should be signed by authorized personnel. b. The cheque signer records the cash payment. c. Cheques should be prenumbered and accounted for in sequence. d. The cash account should be reconciled monthly with the bank statement. e. none of the above
14.
Which of the following is not part of reconciling the items per the bank? a. Compare the deposits per the bank statement with the deposits recorded in the books. b. Note errors made by the bank and inform the bank of these errors. c. Compare the cheques per the bank statement with the cheques issued by the company. d. Note errors made by the company and inform the bank of these errors. e. none of the above
15.
When reconciling the balance per the company’s books, the following adjustments are made to the Cash balance per the company’s books: a. add deposits in transit and deduct outstanding cheques. b. add any unrecorded electronic receipts from customers. c. add any debit and credit card fees and other service changes. d. deduct deposits in transit and add outstanding cheques. e. none of the above
Quizzes
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
c
2.
d
3.
c
4.
b
5.
c
6.
c
7.
b
8.
c
9.
b
10.
c
11.
c
12.
b
13.
b
14.
d
15.
b
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
Keeping inventory levels high and delaying payments of liabilities will help a company to manage its cash flows.
True
False
2.
When one individual is responsible for all of the related activities, the potential for errors is increased.
True
False
3.
Independent reviews should occur periodically and should be done by someone who is independent of the employee responsible for the information.
True
False
4.
Cash includes debit and credit cards, postdated cheques, coins, currency, and money orders.
True
False
5.
Cash equivalents are short-term, highly liquid held-for-trading investments, net of bank overdrafts.
True
False
6.
Adjusting entries are prepared for items affecting the book balance of a bank reconciliation.
True
False
7.
Deposits in transit get deducted as a reconciling item per the bank.
True
False
8.
An outstanding cheque that was also outstanding the previous month should not be included in the reconciliation of the bank statement this month.
True
False
9.
A compensating balance is a form of restricted cash.
True
False
10.
EFT transactions have resulted in better internal control.
True
False
Multiple Choice 11.
Each of the following is a control activity except a. a sound marketing plan. b. segregation of duties. c. establishment of responsibility. d. review and reconciliation.
12.
A company issues a cheque for $75 but records it incorrectly as $57. On the bank reconciliation, the $18 error should be a. deducted from the balance per bank.
Quizzes
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b. added to the balance per bank. c. deducted from the balance per books. d. added to the balance per books. e. none of the above
13.
Bourque Company has the following assets at the statement of financial position date: Cash in bank—savings account $ 5,000 Amounts due from customers 14,000 Postdated cheques 4,000 Chequing account balance 10,000 Which amount should be reported as cash in the statement of financial position? a. $10,000 b. $15,000 c. $19,000 d. $24,000
14.
If use of a portion of cash is restricted, but will be used within the next year, the portion of cash that is restricted should be a. included with Cash on the statement of financial position. b. reported as a current liability on the statement of financial position. c. reported as a non-current asset on the statement of financial position. d. reported as a current asset separate from Cash and Cash Equivalents on the statement of financial position. e. none of the above
15.
The following explain limitations of internal control except a. lack of proper employee training. b. the size of the company which makes segregation of duties difficult. c. collusion occurring between two or more employees. d. if a company requires its employees to take vacations.
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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
False
2.
True
3.
True
4.
False
5.
True
6.
True
7.
False
8.
False
9.
True
10.
True
Multiple Choice 11.
a.
12.
c.
13.
b.
14.
d.
15.
d.
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20-MINUTE QUIZ #2 1.
List five of the control activities that apply to most companies.
2.
The table below contains items that would be used in the preparation of a bank reconciliation. Put a plus sign (+) or a minus sign (–) in the appropriate column to indicate whether the item would be added or subtracted from the beginning bank or book balance. Item Bank service charge
Bank Balance
Book Balance
Deposits in transit Cheques outstanding Interest earned Automatic loan payment Bank posts another customer’s cheque to the company’s bank account EFT receipt from a customer One of the company cheques written properly for $990 recorded in the books as $909 NSF cheque from a customer
3.
Quizzes
You have been asked to help Basil Corporation with its internal control problems. Basil has 12 employees. There has not been any staff rotation among employee positions for at least six years because management believes that the training costs associated with implementing staff rotation would be too high. In addition to its main store, Basil has a small showroom store staffed by one person who also works in Basil’s accounting department. This person orders and receives goods and pays invoices. A different person in the accounting department records all sales and makes deposits to the bank when the deposit is large enough to make it worthwhile to go to the bank. This person also opens the mail and holds all cash and cheques in a desk drawer until a deposit is made. Identify three weaknesses in Basil’s internal control system and make recommendations to correct them.
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ANSWERS TO 20-MINUTE QUIZ #2 1.
Provide five examples of control activities that apply to most companies. • assignment of responsibility • segregation of duties • documentation • physical controls • review and reconciliation
2.
3. 1.
Item Bank service charge
Bank Balance
Deposits in transit
+
Cheques outstanding
–
Book Balance –
Interest earned
+
Automatic loan payment Bank posts another customer’s cheque to the company’s bank account EFT receipt from a customer One of the company cheques written properly for $990 recorded in the books as $909 NSF cheque from a customer
– + + – –
There is no rotation of employees, which means that Basil is more susceptible to employee fraud. Basil should institute an employee duty rotation system and have a few employees change jobs at a time. This would deter employee fraud as it would be more difficult to permanently conceal fraudulent activity.
2.
Having one person order and receive goods and pay invoices does not provide adequate segregation of duties. These three activities are referred to as “related activities.” Having inadequate segregation of duties increases the potential for errors and irregularities. To remedy this weakness, Basil should assign these different functions to different employees. If Basil cannot afford to hire the required number of additional employees, it should reorganize to at least separate the invoice paying function from the ordering and receiving functions. The invoice paying function could be assigned to the employee who handles the sales and cash deposit functions, and perhaps the mail handling function could be assigned to an employee in the main store.
3.
Not depositing cash to the bank daily and keeping cash in an unlocked desk drawer does not provide adequate physical controls over cash receipts. Cash should be deposited to the bank daily unless the amount of cash on hand is insignificant. In any event, cash should be stored in a locked safe or locked filing cabinet. Basil should also consider the possibility of having its customers
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pay their accounts through EFT, as this would limit the amount of cash on hand. 4.
Quizzes
Mail containing cash receipts should be opened with two people present. This would prevent the possibility of an employee keeping a cash receipt. A supervisor or another person should be present when mail is opened.
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CHAPTER 8 REPORTING AND ANALYZING RECEIVABLES LEARNING OBJECTIVES 1.
Explain the types of receivables and record accounts receivable transactions.
2.
Account for bad debts.
3.
Account for notes receivable.
4.
Explain the statement presentation of receivables.
5.
Apply the principles of sound accounts receivable management.
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CHAPTER OUTLINE Learning Objective 1 – Explain the Types of Receivables and Record Accounts Receivable Transactions Types of Receivables
The term receivables refers to amounts that are due to a business from customers, employees, the government, and others.
Receivables are frequently classified as: ▪ Accounts receivable • Amounts owed by customers on account • Result from the sale of goods and services • Expected to be collected within 30 days • Classified as current assets ▪
Notes receivable • Formal instruments of credit issued as evidence of debt • Normally require payment of interest and extend for 30 days or longer • May be current or non-current assets depending on their due dates • Accounts and notes receivable resulting from sales are called trade receivables
▪
Other receivables • Nontrade receivables that do not result from the operations of the business • Include interest receivable, loans to company officers, advances to employees, sales taxes recoverable, and income tax receivable
Teaching suggestion – Give transactions and ask students to identify what type receivable would be impacted. For example: The vice-president of manufacturing is sending his youngest child to a prestigious university and is getting a loan from his company of $25,000. Is this an account receivable, a note receivable, or other receivable for his company? Customer buys merchandise on account. Does this transaction result in an account receivable, a note receivable, or other receivable? A customer's account receivable has been outstanding for some time and the customer is asked to sign a note for the amount of the balance. Does this transaction lead to an account receivable, a note receivable, or other receivable? Subsidiary Ledgers
A subsidiary ledger is a ledger that is used to manage detailed information that would be difficult to track in a general ledger account.
Individual customer balances are organized and tracked.
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All transactions are posted twice, once to the general ledger and once to the subsidiary ledger.
In computerized systems, the entries to the two ledgers—subsidiary and general—are simultaneous.
Interest Revenue
If the customer does not pay in full before a specified period of time, most retailers will add an interest charge to the balance due.
These charges result in an increase to Interest Revenue and an increase in the Account Receivable owed by the customer.
Learning Objective 2 – Account for Bad Debts Uncollectible Accounts Receivable
Credit losses are debited to Bad Debt Expense. Credit losses are considered a normal and necessary risk of having credit sales.
The Allowance Method of accounting for bad debts estimates the uncollectible accounts at the end of each period and shows this estimate in the Allowance for Doubtful Accounts.
The Allowance for Doubtful Accounts is a contra asset account with a credit balance.
The allowance is an estimate of the amount of receivables that are expected to become uncollectible in the future.
Measuring and Recording Estimated Uncollectible Accounts ▪ While there are several acceptable methods, most companies use a percentage of receivables method to determine the balance of Allowance for Doubtful Accounts. ▪ Under the percentage of receivables, management estimates the percentage of receivables that is likely to be uncollectible. ▪ The percentages can be applied to the receivables in total, or the receivables may be divided (stratified) based on the age of the receivable. ▪ Aging of accounts receivable method classifies the outstanding accounts by age and applies percentages to these categories based on past experience.
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Teaching suggestion – Assume Hampson Furniture has credit sales of $1,200,000 in 2017, of which $200,000 remains uncollected at December 31. The credit manager estimates that $12,000 of these sales will prove uncollectible. The adjusting entry to record the estimated uncollectibles is: Dec. 31 Bad Debts Expense ........................................ 12,000 Allowance for Doubtful Accounts ........... 12,000 (To record estimate of uncollectible accounts) ▪ ▪
Bad Debt Expense is reported in the income statement as an operating expense. Allowance for Doubtful Accounts is a contra asset account that shows the receivables that are expected to become uncollectible.
The balance in Allowance for Doubtful Accounts is deducted from Accounts Receivable in the current assets section of the statement of financial position. Teaching suggestion – Hampson’s balance sheet would report accounts receivable as follows: Accounts Receivable ................................................... $200,000 Less: Allowance for Doubtful Accounts ....................... 12,000 Carrying amount.......................................................... $188,000 The $188,000 represents the expected carrying amount of the Accounts Receivable.
Writing off Uncollectible Accounts ▪ Write offs should be formally approved in writing by managers who have been assigned this responsibility. To adhere to the appropriate internal control activity, the responsibility to authorize write offs should not be given to someone who also has daily responsibilities related to cash or receivables. ▪ Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off as uncollectible. • Under the allowance method, every bad debt write-off is debited to the allowance account and not to Bad Debts Expense.
Teaching suggestion – Assume that the vice-president of finance of Hampson Furniture on March 1, 2018, authorizes a write-off of a $500 balance owed by R. A. Ware. The entry to record the write-off is: Allowance for Doubtful Accounts..................... 500 Accounts Receivable ............................. 500 Note that this entry does not change the carrying amount of the accounts receivable, as both Accounts Receivable and Allowance for Doubtful Accounts have been decreased by the same amount.
Collecting Uncollectible Accounts ▪ When a bad debt is recovered, two entries are required: • The entry made in writing off the account is reversed to reinstate the customer’s account. If a partial payment is received, only that amount is reinstated. • The subsequent cash collection is recorded in the usual manner.
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Teaching suggestion – When R. A. Ware pays Hampson the $500, two journal entries are required to record the collection: Accounts Receivable ...................................... 500 Allowance for Doubtful Accounts ........... 500 (To reverse write-off of R. A. Ware account) Cash ............................................................... Accounts Receivable ............................. (To record collection from R. A. Ware)
500 500
Accounts Receivable and the Allowance for Doubtful Accounts both increase in entry (1) for two reasons: First the company made an error in judgment when it wrote off the account receivable. Second, R. A. Ware did pay, and therefore the Accounts Receivable account should show this collection for possible future credit purposes. Ask students why the allowance method is required for financial statement reporting? Does the allowance method conform to the expense recognition principle? Does the allowance method follow GAAP? Why or why not? Summary of the Allowance Method
Allowance method has three essential features: ▪ Estimated uncollectible accounts receivable are determined by using a percentage of total receivables or an aging schedule. ▪ Accounts Receivable are written off at the specific time they are determined to be uncollectible. ▪ If accounts that have been previously written off are collected, the original write-off is reversed and the collection is recorded.
Teaching suggestion – Use the Illustration concerning Abrams Furniture Ltd. shown in the text to review all the entries required to record bad debts using the allowance method.
Learning Objective 3 – Account for Notes Receivable
A promissory note is a written promise to pay a specified amount of money on demand or at a fixed date in the future.
Promissory notes may be used when: ▪ individuals and companies lend or borrow money, ▪ when the amount of the transaction and the credit period exceed normal limits, ▪ in settlement of accounts receivable.
The party making the promise to pay is the maker; the party to whom payment is to be made is called the payee.
Recording Notes Receivable
At the time a note is received, it is recorded at the principal value with no interest added.
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Teaching suggestion – Wilma Company accepts a note receivable to settle an open account with Brent Company. The terms are a $1,000, two-month, 8% promissory note dated May 1. The entry for the receipt of the note by Wilma Company is as follows: May 1 Notes Receivable ............................................ 1,000 Accounts Receivable .............................. 1,000 (To record acceptance of Brent Company’s two-month, 8% note) If the note had been exchanged for cash, the credit would have been to Cash.
As time passes, interest revenue accrues on the note. Note that interest rates are always stated as an annual rate and must be adjusted for partial periods.
Interest = Principal amount of the Note × Annual Interest Rate × Time in Terms of One Year
Interest rates may be set as a fixed rate over the period of the note or as a floating (variable) rate that changes monthly over the duration of the note.
Teaching suggestion – Go through some calculations of interest: Terms of Note Interest Computation $ 730, 12%, 120 days $730 x 12% x 20/365 = $1,000, 9%, 6 months $1,000 x 9% x 6/12 = $2,000, 6%, 1 year $2,000 x 6% x 1/1 =
$ 28.80 $ 45.00 $120.00
Note while interest on an overdue account receivable is debited to Accounts Receivable, interest on a note receivable is NOT debited to the Notes Receivable account. Since the note is a formal credit instrument, its recorded principal must remain unchanged.
Uncollectible Notes Receivable
Notes receivable are reported at their carrying amount. Each note must be analyzed to determine its probability of collection. If the collection is in doubt, Bad Debts Expense and an Allowance For Doubtful Notes must be recorded in the same way they are recorded for Accounts Receivable.
Derecognizing Notes Receivable
A note is derecognized (or removed from the books) when the principal amount of the note receivable and its accrued interest is collected.
A note is honoured when interest and principal is paid in full, usually at maturity.
The entry to record the receipt of the $10,000 principal and $200 interest would be:
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Teaching suggestion – Assume that Wolder Co. lends Higley, Inc. $10,000 on June 1, accepting a 5-month, 9% interest note. If Wolder presents the note to Higley Inc. on November 1, the maturity date, the entry by Wolder to record the collection is: Nov. 1
Cash................................................................ 10,375 Notes Receivable ................................... Interest Revenue .................................... (To record collection of Higley Inc. note and interest) *$10,000 x 9% x 5/12 = $375
10,000 375*
If Wolder prepares financial statements as of September 30, the following adjusting entry would be made to accrue interest revenue. Sept. 30
Interest Receivable.......................................... Interest Revenue .................................... (To accrue 4 months’ interest on Higley note)
300 300
When interest has been accrued, the entry to record the honouring of Higley’s note on November 1 is: Nov. 1
Cash................................................................ 10,375 Notes Receivable ................................... Interest Receivable ................................ Interest Revenue .................................... (To record collection of Higley Inc. note and interest) *$10,000 x 9% x 1/12 = $75
10,000 300 75*
If a note is not paid in full at maturity, it is called a dishonoured note.
Learning Objective 4 – Explain the Statement Presentation of Receivables
Each of the major types of receivables should be identified in the statement of financial position or in the notes to the financial statements.
Short-term receivables are reported in the current assets section of the statement of financial position following cash and held for trading investments if items are presented from most to least liquid.
Trade receivables must be reported separately from other types of receivables and are reported at their carrying amount.
Both the gross amount of receivables and the allowance for doubtful accounts must be reported either in the statement of financial position or in the notes to the financial statements.
Receivables due more than a year from the statement of financial position date must be presented separately in the non-current assets section of the statement.
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Chapter 8 – Reporting and Analyzing Receivables
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Teaching suggestion – You may wish to review the Canadian Tire Corporation’s balance sheet (statement of financial position) for presentation of receivables shown in Illustration 8-4.
Bad debts expense is recorded in the operating expense section of the income statement and interest revenue in the non-operating section.
Learning Objective 5 – Apply the Principles of Sound Accounts Receivable Management There are four steps to managing receivables: 1. Determine to whom to extend credit. ▪ A critical part of managing receivables is determining who should receive credit. ▪ A credit policy that is too tight may lose revenues. ▪ A credit policy that is too loose may increase bad debts. ▪ Risky customers might be required to provide letters of credit or bank guarantees. ▪ Risky customers might be required to pay a deposit in advance or cash on delivery (COD). ▪ Ask potential customers for references from banks and suppliers and check the references to determine their payment history. ▪ Periodically check the financial health of existing customers. 2.
Establish a payment period. ▪ Determine a required payment period and communicate that policy to customers. ▪ Make sure company's payment period is consistent with that of competitors.
3.
Monitor collections. ▪ Prepare accounts receivable aging schedule at least monthly. ▪ Monitor credit policies and collection experience not only in comparison with past experience but also in light of current economic conditions.
Teaching suggestion – Stress the importance of having competent personnel working in the credit department and the collections department. 4.
Evaluate the liquidity of receivables. ▪ Liquidity is measured by how quickly certain assets can be converted into cash. The ratio used to assess the liquidity of the receivables is the receivables turnover ratio. • The ratio measures the number of times, on average, that receivables are collected during the year. • The receivables turnover is calculated by dividing net credit sales (net sales less cash sales) by the average gross accounts receivable during the year. Note that the gross amount of accounts receivable should be used if it is available/disclosed, otherwise the net accounts receivable is used.
Teaching suggestion – Show the students how Canadian Tire’s receivables turnover ratio for 2016 and 2015 were calculated from Illustration 8-5.
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▪ ▪
In a popular variant of the receivables turnover ratio, the turnover ratio is converted into an average collection period in terms of days. This is calculated by dividing the receivables turnover into 365 days. The collection period should not greatly exceed the credit term period.
Teaching suggestion – Show the students how Canadian Tire’s receivables turnover ratio for 2016 and 2015 were calculated from Illustration 8-6.
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Chapter 8 – Reporting and Analyzing Receivables
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Your sister and brother-in-law have just opened a boutique specializing in shoes and accessories. The upscale shop will provide store credit for customers. The accountant who helped to set up the books for the boutique included an account entitled Allowance for Doubtful Accounts. Your sister and brother-in-law do not want to use the allowance account, electing to write off bad debts as they are deemed to be uncollectible. What would you say to convince them of the importance of estimating bad debts and the allowance account?
Is it a good idea to issue credit?
If you had a small business would you issue credit directly to the customer or would you accept major credit cards instead such as VISA or MasterCard?
If you had a small business would you rather have a tight credit policy or a loose credit policy? How would this impact your business?
What type of action would you take if a customer was not able to repay its amounts owing?
Why do banks often provide an operating line of credit that considers only a portion of the Accounts Receivable balance?
Does it matter whether a classified statement of financial position is listed in order of liquidity or reverse-liquidity? Identify when each type of listing order might be useful to users.
Instructor’s Manual
Chapter 8 – Reporting and Analyzing Receivables
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CHAPTER 8 REPORTING AND ANALYZING RECEIVABLES 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
The adjusting journal entry to record estimated uncollectible accounts involves debiting which account? Answer: Bad Debts Expense
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8-1
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
VOCABULARY QUIZ 1.
A note that is not paid in full at maturity.
2.
Amounts owed by customers on account.
3.
Notes and accounts receivable that result from the sale of transactions.
4.
A group of accounts that provide details of a control account in the general ledger.
5.
A measure of the liquidity of receivables, calculated by dividing net credit sales by average gross accounts receivable.
6.
The average amount of time that a receivable is outstanding, calculated by dividing 365 days by the receivables turnover.
7.
A written promise to pay a specified amount of money on demand or at a definitive time.
8.
A method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period.
9.
The difference between the balances in the Accounts Receivable and Allowance for Doubtful Accounts.
10.
An analysis of customer balances by the length of time they have been unpaid.
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8-2
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO VOCABULARY QUIZ 1.
Dishonoured note
2.
Accounts receivable
3.
Trade receivables
4.
Subsidiary ledger
5.
Receivables turnover ratio
6.
Average collection period
7.
Promissory notes
8.
Allowance method
9.
Carrying amount
10.
Aging the accounts receivable
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8-3
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MULTIPLE CHOICE QUIZ 1.
To ensure receivables are not overstated on the statement of financial position, they are reported a. at gross amount. b. at their carrying amount. c. less interest revenue, if any. d. plus bank charges expense, if any. e. none of the above
2.
Which of the following is the most liquid asset listed? a. unearned revenue b. equipment c. accounts receivable d. goodwill e. land
3.
Receivables are often classified as a. accounts, notes, long-lived. b. accounts, notes, other. c. accounts, notes, inventory. d. accounts and notes. e. none of the above
4.
All of the following are "other receivables," except a. trade receivables. b. interest receivable. c. income tax receivable. d. advances to employees. e. loans to company officers.
5.
Which of the following is not a step in managing accounts receivable effectively? a. determine who to extend credit to b. allow customers to pay when they can c. monitor collections d. evaluate the liquidity of receivables e. establish a payment period
6.
The aging of accounts receivable a. applies a percentage to total accounts receivable to determine the total estimated bad debts. b. averages all the due dates of the accounts receivable to determine the average age of total accounts receivable. c. groups accounts by their due dates and applies varying percentages to each
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8-4
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category, depending on the number of days outstanding. d. none of the above. e. both b and c above.
7.
When the allowance method is used and an account is subsequently written off as uncollectible, the following account is debited: a. Bad debt expense. b. Allowance for doubtful accounts. c. Accounts receivable. d. Sales. e. both b and c
8.
The balance in the Allowance for Doubtful Accounts must be considered when recording a(n) a. write off of an uncollectible accounts receivable. b. subsequent recovery of a previously written off accounts receivable. c. bad debt expense for the period. d. none of the above e. both a and b above
9.
Notes receivable a. earn interest. b. give the holder a stronger legal claim on assets than accounts receivable. c. are negotiable instruments. d. all of the above e. both a and c above
10.
Where would accounts receivable be recorded on the statement of financial position? a. before cash b. after held for trading investments c. before held for trading investments d. after inventory e. after property, plant, and equipment
11.
Rayan Ltd. accepts a 8-month, $10,000 note with interest at 10% on June 1. Rayan Ltd.’s year end is August 31. When the note is honoured how much interest revenue will be recorded? a. $250 b. $417 c. $667 d. $1,000 e. none of the above
12.
Rayan Ltd. accepts an 8-month, $10,000 note with interest at 10% on June 1. Rayan
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Chapter 8 – Reporting and Analyzing Receivables
8-5
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Ltd.’s year end is August 31. What is the amount that the Allowance for Doubtful Notes will be debited by if the note is dishonoured and collection is not expected? a. $10,000 b. $10,250 c. $10,417 d. $10,667 e. none of the above
13.
The receivables turnover ratio is used to analyze a. creditworthiness. b. profitability. c. solvency. d. liquidity. e. both b and d
Use the following information for questions 14–15. The balance of accounts receivable is $655,000. The company uses the percentage of receivables method to estimate uncollectible accounts. A partial aging of accounts receivable is presented below: Days Outstanding
Amount
0-30 days 31-60 days 61-90 days 91-120 days Over 120 days
$200,000 250,000 150,000 45,000 10,000
Percentage Uncollectible 1% 5% 10% 25% 50%
14.
Assuming the Allowance for Doubtful Accounts has a starting credit balance of $2,500, the Allowance for Doubtful Accounts will be credited by a. 43,250. b. 45,570. c. 48,070. d. none of the above
15.
Assuming the Allowance for Doubtful Accounts has a starting debit balance of $5,500, the Allowance for Doubtful Accounts will be credited by a. 40,070. b. 45,570. c. 51,250. d. none of the above
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8-6
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO MULTIPLE CHOICE QUIZ 1.
b
2.
c
3.
b
4.
a
5.
b
6.
c
7.
b
8.
c
9.
d
10.
c
11.
b
12.
b
13.
d
14.
a
15.
c
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8-7
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
Receivables are classified as accounts receivable and notes receivable. The carrying amount of the receivables is calculated by subtracting the Allowance for Doubtful Accounts from the Accounts Receivable.
True
False
True
False
3.
As part of extending credit, companies need to establish a payment period.
True
False
4.
An aging schedule shows a required balance in Allowance for Doubtful Accounts of $9,600. If there is a credit balance in the allowance account of $2,500 prior to adjustment, the adjustment amount is $7,100.
True
False
5.
The percentage of receivables method is the most common method used by companies in estimating uncollectible accounts
True
False
6.
Under the allowance method, every accounts receivable write off is debited to Bad Debts Expense.
True
False
7.
The amount of cash collected at maturity on a $4,000 note is $4,200. If $120 of the interest has been accrued prior to maturity, the entry to record the honouring of the note at maturity should include a credit to Interest Revenue for $80.
True
False
8.
The principal amount of a 7% note receivable is $500,000. The note is dated January 1, 2018 and is due January 1, 2021. The interest revenue to be recognized on December 31, 2018, the company’s year end, is $105,000.
True
False
9.
Short-term receivables are reported in the statement of financial position immediately following cash and held for trading investments.
True
False
2.
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8-8
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10.
The higher the receivables turnover, the less liquid are the company’s receivables.
True
False
Multiple Choice 11.
When a firm writes off a bad debt under the allowance method of accounting for bad debts, a. the carrying amount of accounts receivable decreases. b. total net current assets will decrease. c. the cash account will decrease. d. the carrying amount of accounts receivable will not change. e. the carrying amount of accounts receivable increases.
12.
A company has a balance in Accounts Receivable of $600,000 at the end of the year and it estimates that uncollectible accounts will be 2% of accounts receivable. If Allowance for Doubtful Accounts has a credit balance of $1,000 prior to adjustment, its balance after adjustment will be a credit of a. $12,000. b. $13,000. c. $11,000. d. none of the above
13.
Interest receivable and loans to company officers are included in a. trade receivables. b. other receivables. c. notes receivable. d. accounts receivable. e. none of the above
14.
When an interest bearing note is dishonoured at maturity and ultimate collection of the principal and interest is expected, the entry for the dishonouring—assuming no previous accrual of interest—should include a. a debit to Allowance for Doubtful Accounts. b. only a credit to Notes Receivable. c. a credit to Notes Receivable and Interest Revenue. d. a credit to Notes Receivable and Interest Receivable. e. none of the above
15.
Net credit sales are normally sold on terms of n/30. Net credit sales total $50,000 and average gross accounts receivable total $5,000 in the current period. The collection period is a. 10 days. b. 30 days. c. 20 days. d. 36 days.
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Chapter 8 – Reporting and Analyzing Receivables
8-9
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e. 73 days.
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8 - 10
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
False
2.
True
3.
False
4.
True
5.
True
6.
False
7.
True
8.
False
9.
True
10.
False
Multiple Choice 11.
d
12.
a
13.
b
14.
c
15.
d
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Chapter 8 – Reporting and Analyzing Receivables
8 - 11
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #2 1.
A company’s partial statement of financial position, as at December 31, appears as follows: 2018 Current Assets Cash Held for trading investments Accounts receivable Less: Allowance for doubtful accts Notes receivable Other current assets Total current assets
2017 $ 50,000 40,000
$90,000 15,000
75,000
$ 60,000 30,000 $80,000 10,000
80,000 90,000 $335,000
70,000 75,000 95,000 $330,000
Calculate the receivables turnover and the average collection period for 2018, assuming net credit sales for 2018 are $501,500.
2.
Before adjustments, Amie Corporation had the following balances on December 31, 2018: Accounts Receivable .................................................................. Allowance for Doubtful Accounts ................................................ Net Credit Sales .........................................................................
$ 65,000 3,000 credit 550,000
a. Prepare the journal entry to record the estimated uncollectible accounts assuming Amie uses the percentage of receivables method. An aging of the accounts receivable estimated the collectible amount of the receivables at December 31, 2018 at $57,800. b. On March 5, 2019 Amie decided that the $500 receivable from a customer, Baker Company, was uncollectible. Prepare the journal entry to write off the account. c. On July 1, 2019 Amie receives a payment of $500 from Baker for the amount that had been previously written off on March 5, 2018. Prepare the required journal entries.
3.
On November 1, 2018, Amie Corporation accepted a $6,000, 6-month, 5% note from a customer as payment of an outstanding account receivable. Amie’s year end is December 31. a. Prepare the November 1 journal entry. b. How much interest would Amie earn in 2018? c. How much interest would Amie earn in 2019?
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
8 - 12
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ANSWERS TO 20-MINUTE QUIZ #2 1. Receivables turnover
Average collection period
_ $501,500 ($90,000 + $80,000) ÷2
= 5.9 times
365 = 62 days 5.9
2. a.
b.
c.
Dec 31
Mar 5
Jul 1
Jul 1
Bad Debts Expense Allowance for Doubtful Accounts $65,000 – $57,800 = $7,200 required allowance; $7,200 – 3,000 = $4,200 adjustment
4,200 4,200
Allowance for Doubtful Accounts Accounts Receivable Write off Baker’s account
500
Accounts Receivable Allowance for Doubtful Accounts To reverse the above write off
500
Cash Accounts Receivable To record collection from Baker
500
500
500
500
3. a.
Nov 1
Notes Receivable Accounts Receivable 6-month, 5% note
b. Interest in 2018
= $6,000 x 5% x 2/12 = $50
c. Interest in 2019
= $6,000 x 5% x 4/12 =$100
Quizzes
Chapter 8 – Reporting and Analyzing Receivables
6,000 6,000
8 - 13
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 9 REPORTING AND ANALYZING LONG-LIVED ASSETS LEARNING OBJECTIVES 1.
Determine the cost of property, plant, and equipment.
2.
Explain and calculate depreciation for plant and equipment.
3.
Account for the derecognition of property, plant, and equipment.
4.
Identify the basic accounting issues for intangible assets and goodwill.
5.
Illustrate how long-lived assets are reported in the financial statements.
6.
Describe the methods for evaluating the use of assets.
Instructor’s Manual
Chapter 9 – Reporting and Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER OUTLINE Learning Objective 1 – Determine the Cost of Property, Plant, and Equipment
Property, plant, and equipment are long-lived resources that a company controls, that have physical substance (a definite size and shape), and are not intended for sale to customers. They are used for the production and sale of goods or services to customers, for rental to others, or for administrative purposes.
Known by various names: property, plant, and equipment, fixed assets, capital assets, land, building, and equipment.
Property, plant, and equipment are originally recorded at historical cost.
Cost consists of: ▪ the purchase price, including certain kinds of non-refundable taxes and duties, less any discounts or rebates, ▪ all expenditures necessary to bring the asset to its required location and make it ready for its intended use, ▪ an estimate of any future obligations related to dismantling, removing, or restoring the asset at the end of its useful life, ▪ all of these costs are capitalized (recorded as property, plant, and equipment) if it is probable that the company will receive an economic benefit in the future from the asset and this benefit can be measured.
Costs which benefit only a current period are expensed, and are referred to as operating expenditures. Operating expenditures are required to maintain an asset in its normal condition and often recur, although not always annually.
Costs that benefit future periods are included in the asset account, and are referred to as capital expenditures. Capital expenditures include costs that increase the life of an asset or its productivity or efficiency. These costs are normally larger than operating expenditures and occur less frequently.
Teaching suggestion – Provide students with examples of operating and capital expenditures. The installation of air conditioning in a delivery van that did not have air conditioning previously is a good example of a capital expenditure. Having an oil change in the delivery van is an example of an operating expenditure.
Asset Retirement Costs – The cost of property, plant, and equipment must include an estimate of the cost of any obligation to dismantle, remove, or restore the long-lived asset when it is retired. When the costs for the retirement of long-lived assets are significant, they are estimated in advance and recorded as an asset, using present value concepts. A liability is also set up to show the asset retirement obligation. These costs, and the liability, are recorded in the period when the legal obligation is created, which can be at the time the asset is acquired, or later when the asset is used.
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ASPE comparison – Under IFRS, the term decommissioning provision is used to describe an asset retirement obligation whereas under ASPE the asset retirement obligation is used instead of decommissioning costs.
Determining which costs to capitalize is important.
Property, Plant and Equipment is often subdivided into four classes. ▪ Land – The cost of land can include: • the cash purchase price. • closing costs such as title search, legal fees, and survey costs. • costs incurred to prepare the land for its intended use such as clearing, draining, grading, and filling. • when land has a building on it that must be removed to make the site suitable for construction of a new building, all demolition and removal costs, less any proceeds from residual materials, are added to the Land account. • when land has been purchased to construct a building, all costs that are incurred up to the time of excavation for the new building are considered to be part of the costs that are necessary to prepare the land for its intended use. • once the land is ready for its intended use, recurring costs, such as annual property taxes, are recorded as operating expenditures. • The cost of land is not depreciated because it has an unlimited useful life. ▪ Land improvements – The cost of structural additions to land that will decline in service potential, and require maintenance and replacement to keep their value are land improvements. Examples are driveways, fences, lighting, sidewalks, and parking lots. o Land improvements are recorded separately from land and depreciated.
Teaching suggestion – Students often confuse the cost to get land ready for its intended use with land improvements. For example, removing an old building or grading are sometimes considered to be “improving” the land, and thus students incorrectly reason that these costs should be land improvements. Make sure you clarify that one-time costs that are required for getting the land ready for use are always charged to the Land account, not the Land Improvement account. ▪
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Buildings – All necessary expenditures relating to the purchase or construction of a building are charged to the Building account. • When a building is purchased, such costs include the purchase price, closing costs, and all costs to make the building ready for its intended use. Costs for making the building ready for use can include expenditures for: remodelling rooms and offices, and for replacing or repairing the roof, floors, electrical wiring, and plumbing. • When a new building is constructed, its cost consists of the contract price plus payments made by the owner for architect's fees, building permits, and excavation costs. • Interest costs incurred to finance a construction project can be included in the cost of the asset, and are limited to the construction period. • If land and a building are purchased together for a single price, the fair (appraised) value of each must be determined and the cost of each recorded separately (according to their relative fair values) since the building will be depreciated. Equipment – The “equipment” classification is a broad one that can include: delivery equipment, office equipment, machinery, vehicles, furniture and fixtures and other similar
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assets. The cost of equipment consists of the purchase price, freight charges, insurance during transit, as well as expenditures required in assembling, installing, and testing the unit. • Annual costs such as licenses and insurance are operating expenditures. Teaching suggestion – Ask students to name some companies with which they are familiar. Now ask them what types of property, plant, and equipment they would expect to see on the statement of financial position of these companies.
To Buy or Lease ▪ The party that loans the assets to be leased is known as the lessor, and the party that is paying to use the asset is known as the lessee. ▪ Advantages of leasing include: (1) reduced risk of obsolescence, (2) 100% financing (leases do not usually require down payments), (3) income tax advantages, and ▪ Under a finance lease, both the asset and liability are shown on the statement of financial position. The lessee depreciates the asset similar to other depreciable longlived assets. The economic substance of the transaction indicate that the lessee enjoy the same risks and rewards provided by legal ownership. ▪ An operating lease is viewed as a rental transaction. The risks and rewards of ownership are not transferred to the lessee. The lessee accounts for the transaction as a rental and therefore does not record an asset or liability on the company’s books. Rental expense is recorded when payments are made. ▪ Factors such as whether the lease includes a certain type of option for the lessee to purchase the property at the end of the lease term or whether the lease term is long enough to allow the lessee to derive the major part of the benefits offered by the asset are considered to determine whether the lease is an operating lease or a finance lease. ▪ Companies often incur costs when they renovate leased property. These costs are charged to the Leasehold Improvements account. Leasehold improvements are depreciated over the remaining life of the lease or the useful life of the improvements, whichever is shorter.
ASPE comparison – Under IFRS, long-term leases that are essentially the purchase of an asset are called finance leases whereas under ASPE the lease would be called a capital lease. Teaching suggestion – Ask students to explain whether they own their home or rent their home. Next ask students to explain what benefits they receive from renting versus owning their own home. Finally ask the students whether or not their home would appear on a statement of financial position of their personal finances. Teaching suggestion – Provide students with examples of additions and improvements. The installation of air conditioning in a delivery van that did not have air conditioning previously is a good example of an addition. The overhaul of a truck engine is an example of an improvement. Discuss how frequently these types of expenditures occur and how difficult it is to properly classify them. Accountants must ask questions about the nature of the work performed. It is an exciting aspect of accounting.
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Learning Objective 2 – Explain and Calculate Depreciation for Plant and Equipment
Under IFRS, companies will have two models they can choose between to account for their property, plant, and equipment: ▪ the cost model ▪ the revaluation model
ASPE comparison – Under IFRS, companies are able to select the cost model or revaluation model whereas under ASPE only the cost model is allowed.
The cost model records property, plant, and equipment at cost at acquisition. Subsequent to acquisition, depreciation is recorded each period and the assets are carried at cost less the accumulated depreciation (carrying amount).
Depreciation is the systematic allocation of the cost of property, plant, and equipment over its useful life. The cost is allocated to expense over the asset’s useful life so that expenses are properly matched with the pattern in which the asset’s future economic benefits are expected to be attained.
Teaching suggestion – Reinforce the idea that depreciation is simply a systematic way of allocating the cost of the asset over its life. Depreciation does not attempt to bring the asset to fair value. Think of buildings that are very old and have been owned by an individual or a company for a long time. The carrying amount of these assets (cost less accumulated depreciation) is probably small, while the fair value is large.
Depreciation is a process of cost allocation, not a process of asset valuation. ▪ Under the cost model, an increase in the asset’s current fair value is not considered relevant, because property, plant, and equipment are not held for resale. The carrying amount (cost less accumulated depreciation) of property, plant, and equipment may be very different from its fair (market) value.
Depreciation neither uses up nor provides cash to replace the asset.
Teaching suggestion – Remind students of the adjusting entry used to record depreciation: Dr. Depreciation Expense; Cr. Accumulated Depreciation. There is no Cash account involved in this journal entry. ASPE comparison – Under IFRS, depreciation is used to describe cost allocation for property, plant, and equipment whereas under ASPE the term amortization is used instead.
Factors in calculating depreciation: ▪ Cost—purchase price plus all costs necessary to get the asset ready for use. ▪ Useful life—the period of time over which an asset is expected to be available for use or the number of units of production or units of output that are expected to be obtained
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from an asset. Useful life is an estimate based on such factors as the intended use of the asset and how vulnerable the asset is to wearing out or becoming obsolete. Residual value—an estimate of the amount that a company would obtain from the disposal of the asset at the end of its useful life.
Depreciation is generally calculated using one of these methods: ▪ Straight-line ▪ Diminishing-balance ▪ Units-of-production
Management must choose the depreciation method that it believes will best reflect the pattern in which the asset’s future economic benefits are expected to be consumed. The depreciation method must be reviewed at least once a year. If the expected pattern of consumption of the future economic benefits has changed, the depreciation method must be changed.
Straight-line depreciation is the most widely used method of depreciation.
Teaching suggestion – Discuss with students why the most widely used method of depreciation is straight-line depreciation (simple, and results in equal depreciation expense each year).
Under the straight-line method, an equal amount of depreciation is expensed each year of the asset’s useful life as long as the cost of the asset, the useful life, and the residual value did not change.
To calculate the annual depreciation under the straight-line method, divide the depreciable amount (the cost of the asset less its residual value) by the asset's estimated useful life measured in years.
Teaching suggestion – Using the following example of a used delivery truck purchased by Bill’s Pizzas on January 1, 2017: Cost ........................................................................... Expected salvage value ............................................. Estimated useful life (in years) ................................... Estimated useful life (in miles) ....................................
$13,000 $1,000 5 100,000
Computation of straight-line depreciation: ($13,000 - $1,000) / 5 years = $2,400 per year Rate: 100% / 5 years = 20% per year Depreciation Schedule Assuming Straight-Line Depreciation Depreciation Accumulated Carrying Year Expense Depreciation Amount $12,000 1 $2,400 $ 2,400 10,600 2 2,400 4,800 8,200 3 2,400 7,200 5,800 4 2,400 9,600 3,400 5 2,400 12,000 1,000 Instructor’s Manual
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Total $12,000 Show students that the depreciation was the same for each year. The total depreciation taken on the used delivery truck was $12,000, which is the depreciable amount of the truck ($13,000 – $1,000). Also point out that the used delivery truck has a remaining carrying amount of $1,000 which is the amount of its estimated residual value.
The annual rate of depreciation is calculated by dividing the years in the life of the asset into 100% or 1. For the delivery truck, the annual rate is 1 ÷ 5 or 20%.
If an asset is purchased during the year rather than on January 1, the annual depreciation is prorated for the proportion of the year it is used.
Accelerated methods of depreciation result in more depreciation in the early years of an asset's life than does the straight-line approach, and decreasing annual depreciation over an asset’s useful life.
The diminishing-balance method is an accelerated method. The diminishing-balance method produces a decreasing annual depreciation expense over the useful life of the asset. ▪ The calculation of periodic depreciation is based on a declining carrying amount of the asset (cost less accumulated depreciation). ▪ The depreciation rate remains constant from year to year, but the carrying amount to which the rate is applied declines each year. ▪ A depreciation method that is often used is double the straight-line rate, also referred to as the double-diminishing-balance method. Teaching suggestion – Again, using the example above of a used delivery truck purchased by Bill’s Pizzas on January 1, 2017, work through the depreciation, this time using the double diminishing-balance method. Remember, when calculating depreciation using the diminishingbalance method, the residual value is ignored in the beginning. However, the asset cannot be amortized below its residual value. With the diminishing-balance method the annual depreciation rate is used. The rate for Bill’s Pizzas used delivery truck was 1 ÷ 5 years = 20%. The diminishingbalance approach can be applied at different rates (for example 125%, 150%, 200%, and so on). The higher the rate, the greater the annual depreciation expense in early years. In this illustration double- diminishing-balance is used. Thus, we double the annual rate: 20% x 2 = 40%. The depreciation schedule assuming double-diminishing-balance depreciation is presented for comparison purposes.
Year
Depreciation Expense
1 2 3 4 5 Total
$5,200 3,120 1,872 1,123 685* $12,000
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Accumulated Depreciation $5,200 8,320 10,192 11,315 12,000
Carrying Amount $13,000 7,800 4,680 2,808 1,685 1,000*
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*The asset cannot be depreciated below its residual value of $1,000.
Under the units-of-production method, the life of an asset is expressed in terms of the total units of production or the total use expected from the asset.
Production levels used to measure depreciation include units of output, machine hours, kilometres driven, tonnes, cubic metres, or hours used. ▪ It is ideally suited to equipment whose production can be measured in units of output, kilometres driven, or hours in use. ▪ The calculation of periodic depreciation is based on the estimated total units of production for the entire useful life and this amount is divided into the depreciable amount (cost less residual value) to determine the depreciation amount per unit. The depreciation amount per unit is then multiplied by the units produced or used during the year to arrive at annual depreciation.
Teaching suggestion – Returning to the example of Bills Pizzas used delivery truck, the units-ofproduction depreciable amount per unit would be calculated as follows: the estimated residual value of $1,000 would be subtracted from the amortizable cost of $13,000, and then divided by the estimated useful life of 100,000 kilometres. The depreciable amount per unit is $0.12. If the delivery truck is driven 15,000 kilometres in the first year, then depreciation expense is $1,800 (15,000 km x $0.12). The units-of-production schedule, assuming units-of-production depreciation, is presented below for comparison purposes.
Year
Activity
1 2 3 4 5
15,000 30,000 20,000 25,000 10,000 100,000
Depreciation Expense $1,800 3,600 2,400 3,000 1,200 $12,000
Accumulated Depreciation $1,800 5,400 7,800 10,800 12,000
Carrying Amount $13,000 11,200 7,600 5,200 2,200 1,000
Teaching suggestion – Students need to have an understanding of the effects different methods of depreciation have on the Income Statement and the Statement of Financial Position. Assume that Bills Pizza has net income before depreciation of $75,000. Comparison of Depreciation Expense and Net Income
Year 1 2 3 4 5
Straight-Line Net Double-DiminishingNet Units-of-Production Net Method Income Balance Method Income Method Income $ 2,400 $ 72,600 $ 5,200 $ 69,800 $ 1,800 $ 73,200 2,400 72,600 3,120 71,880 3,600 71,400 2,400 72,600 1,872 73,128 2,400 72,600 2,400 72,600 1,123 73,877 000 72,000 2,400 72,600 685 74,315 1,200 73,800 $12,000 $363,000 $12,000 $363,000 $12,000 $363,000
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Income Statement: The diminishing-balance method results in a higher expense in the early years, compared to straight-line. Consequently, it will also result in lower net income in the early years and higher net income in the later years, compared to the straight-line method. It is difficult to compare the effects of the units-of-production method, because the effect is dependent upon the amount of use. Note that over the total life of the asset, there is no difference among the three methods. Statement of Financial Position: The diminishing-balance method results in a lower carrying amount on the statement of financial position, compared to straight-line. Note that at the end of the useful life of the asset, the carrying amount is the same for each method. Teaching Suggestion – Ask students which depreciation method they would use if they were trying to minimize income taxes. Which method would they choose if they wanted to maximize net income? Suppose they wanted to do both?
Management should choose the method that best matches the estimated pattern in which the benefits of the asset are expected to be consumed. ▪ If the economic benefit of an asset is fairly consistent over time, the straight-line method is appropriate. ▪ The diminishing-balance method is appropriate if the company receives more economic benefit in the early years of the asset’s useful life than in the later years. ▪ The units-of-production method is appropriate for assets whose usage varies over time. ▪ Because companies have more than one type of asset, they often use more than one depreciation method.
Other Depreciation Issues Significant Components When an item of property, plant, and equipment includes individual components that have different useful lives, the cost should be allocated to the asset’s significant components and each component should be depreciated separately. Depreciation and Income Tax The Canada Revenue Agency (CRA) allows corporate taxpayers to deduct a specified amount of depreciation when calculating taxable income. ▪ Income tax regulations require taxpayers to use a specific depreciation method – single diminishing-balance – on the tax return, regardless of which method is used in preparing financial statements. ▪ The CRA also groups assets into various classes and specifies the depreciation rates for these assets. ▪ Depreciation for accounting purposes is usually different from depreciation for income tax purposes. ▪ Depreciation for income tax purposes is called capital cost allowance (CCA), not depreciation expense. CCA is an optional deduction from taxable income, but depreciation expense is not optional for calculating net income. Impairments The carrying amount of property, plant, and equipment is the asset’s cost less any accumulated depreciation since acquisition. The carrying amount is rarely the same as its fair value. The fair value is not relevant since the assets are not purchased for resale but rather Instructor’s Manual
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for use in operations over the long term.
It is accepted that long-lived assets such as property, plant, and equipment may be undervalued on the statement of financial position; however, it is not appropriate if property, plant, and equipment is overvalued when using the cost model.
Property, plant, and equipment are considered impaired if the carrying amount of the asset exceeds its recoverable amount. The recoverable amount is the greater of the asset’s fair value less costs to sell and the assets value in use. If the carrying value exceeds the recoverable amount, an impairment loss must be recorded.
Impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. ▪ Companies must review their assets regularly for possible impairment, and do so whenever a change in circumstances affects fair value. ▪ The amount of the impairment loss is determined by comparing the asset’s carrying amount to its recoverable amount. ▪ The impairment loss is reported on the income statement as an operating expense. ▪ The Accumulated Depreciation account is credited for the impairment loss, rather than an asset account, in order to preserve the asset’s original cost. ▪ International financial reporting standards allow the reversal of a previously recorded impairment loss whereas under ASPE the impairment losses cannot be reversed.
ASPE comparison – Under IFRS, companies need to determine each year if indicators of impairment are present and if so perform an impairment test. Under ASPE, there is no annual requirement to determine if indicators of impairment exist, but when it is apparent they exist, an impairment test must be done. Under IFRS, reversals of impairment losses are allowed whereas under ASPE impairment losses cannot be reversed. Revaluation Model ▪ Under the revaluation model, the carrying amount of property, plant, and equipment is adjusted to reflect its recoverable amount. This model can be applied only to assets whose fair value can be reliably measured, and revaluations must be carried out often enough so that the carrying amount is not materially different from the asset’s current value at the statement of financial position date. Revising Periodic Depreciation There are several reasons why periodic depreciation may need to be revised during an asset’s useful life. These include:
Capital expenditures during the asset’s useful life ▪ Companies incur costs as it continues to use the asset. ▪ If a cost, such as ordinary repairs and maintenance, benefits the company only in the current period the cost is an operating expense. ▪ If a cost, such as a replacement of a major part or an addition to a building, will benefit future periods, then it is a capital expenditure and is added to the cost of the asset. ▪ The capital expenditures will increase the cost of the asset, which requires the depreciation to be revised.
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Impairment losses ▪ An impairment loss will result in a reduction of the asset’s carrying amount. With a lower carrying amount, the depreciation calculation will need to be revised.
Changes in the estimated useful life or residual value ▪ When wear and tear or obsolescence indicates annual depreciation is too little or not enough, then the depreciation expense should be revised, by revising useful life and/or residual value.
Changes to the pattern in which the economic benefits of the asset are consumed ▪ Management will annually review the choice of depreciation methods and if the pattern in which the future benefits will be consumed is expected to change, the depreciation method must change as well. Any change to the depreciation method will result in revisions to depreciation calculations.
Revising depreciation is known as a change in estimate. ▪ When a change in an estimate is required, the change is made in current and future years but not to prior periods. Thus, when a change is made, there is no adjustment of previously recorded depreciation expense, and depreciation expense for current and future years is revised. ▪ The rationale for this treatment is that the original estimate was based on the best information known at the time the asset was purchased. ▪ Significant changes in estimates must be disclosed in the notes to the financial statements.
Learning Objective 3 – Account for the Derecognition of Property, Plant, and Equipment
Property, plant, and equipment is derecognized or removed from the accounts, at the time of sale or retirement without sale.
There are four steps that must be performed to record the sale or retirement of property, plant, or equipment: ▪ Update depreciation. If disposal occurs mid-year, the depreciation for the fraction of the year to the date of disposal must be recorded. ▪ Calculate the carrying amount. Carrying amount is the difference between the cost of the asset and its accumulated depreciation. ▪ Calculate the gain or loss. The gain or loss is the difference between the proceeds and the carrying amount. If the proceeds exceed the carrying amount a gain on disposal occurs. Conversely, if proceeds from the sale are less than the carrying amount a loss on disposal occurs. ▪ Record the disposal. Debit (decrease) Accumulated Depreciation for the total depreciation associated with that asset and credit (decrease) the specific asset account for the cost of the asset. Record any proceeds by debiting cash, and record the gain or loss (if any) by debiting the loss account or crediting the gain account. Alternatively, the debit may be to a receivable or other asset account. ▪ Retirement of an asset is recorded as a special case of a sale, one where no or little
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cash is received. If the asset is retired before it is fully depreciated, there is a loss on disposal that is equal to the asset’s carrying amount at the date of retirement. If no proceeds are received in a retirement, a gain will never occur. Even if the carrying amount is zero, a journal entry is still required to remove the accounts related to the retired asset. If the company is still using a fully depreciated asset, the asset and its accumulated depreciation will continue to be reported on the statement of financial position, without further depreciation, until the asset is retired.
Teaching suggestion – Assume equipment was purchased at a cost of $100,000 has accumulated depreciation of $40,000 to December 31, 2016. Annual depreciation is $10,000, and the asset is sold July 1, 2017 for $60,000 cash. The first step is to update the depreciation ($10,000 x 6/12 = $5,000) with the following entry: Depreciation Expense ................................................ Accumulated Depreciation—Equipment ............
5,000 5,000
After the Accumulated Depreciation is updated, the entry to record the sale of the Equipment is: Cash .......................................................................... Accumulated Depreciation—Equipment* .................... Equipment ......................................................... Gain on Disposal** ............................................
60,000 45,000 100,000 5,000
* $ 40,000 + $5,000 = $45,000 ** $ 100,000 – $45,000 = $55,000; $ 60,000 – $55,000 = $5,000 gain. Now assume instead of receiving $60,000 in cash, Keystone only receives $50,000. After the Accumulated Depreciation is updated, the entry to record the sale of the Equipment is: Cash .......................................................................... Accumulated Depreciation—Equipment* .................... Loss on Disposal** ..................................................... Equipment .........................................................
50,000 45,000 5,000 100,000
* $ 40,000 + $5,000 = $45,000 ** $ 100,000 – $45,000 = $55,000; $ 50,000 – $55,000 = $5,000 loss.
Learning Objective 4 – Identify the Basic Accounting Issues for Intangible Assets and Goodwill
Intangible assets must be identified, which means it must meet one of the two following criteria: ▪ It can be separated from the company and sold whether or not the company intends to do so.
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It is based on contractual or legal rights, regardless of whether or not it can be separated from the company.
Intangible assets are recorded at cost including all costs of acquisition and costs needed to make the asset ready for its intended use including legal fees and similar charges.
Companies have a choice of following the cost model or revaluation model when accounting for intangible assets.
Only certain types of intangible assets are amortized: ▪ If an intangible asset has a finite (limited) life, its amortizable amount (cost less residual value) should be allocated over the shorter of the 1) estimated useful life 2) legal life Normally, the useful life of an intangible asset is the shorter period and intangible assets rarely have a residual value. ▪ The company must use the amortization method that best matches the pattern in which the asset’s future economic benefits are expected to be consumed. If that pattern cannot be reliably determined, the straight-line method is used. ▪ Amortization expense is recognized on the income statement as an operating expense. ▪ Most companies will combine depreciation and amortization for reporting purposes.
Intangible assets with indefinite (unlimited) lives are not amortized.
All intangible assets must be reviewed and tested for impairment whenever circumstances make this appropriate. Indefinite-life assets should be tested for impairment at least annually.
If an asset is impaired, its recoverable amount falls below its carrying amount, resulting in a write down to its recoverable amount.
Impairment losses can be reversed under IFRS (except for goodwill).
A revision of amortization is done if there is a change in cost or useful life, or an impairment loss, and the revision is treated as a change in estimate.
At disposal, the carrying amount is eliminated and a gain or loss, if any, is recorded.
Intangible assets with finite (limited) lives: ▪ Patents—an exclusive right issued by the Canadian Intellectual Property Office of Industry Canada that allows the patent holder to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the application. The initial cost of a patent is the price paid to acquire the patent. Legal costs of successfully defending a patent in an infringement suit are added to the Patent account and amortized over the remaining life of the patent. The cost of a patent should be amortized over its 20-year legal life or its useful life, whichever is shorter. ▪ Copyrights—are granted by the Canadian Intellectual Property Office giving the owner the exclusive right to reproduce and sell artistic or published work. Copyrights extend for the life of the creator plus 50 years. Generally, the useful life of a copyright is significantly shorter than its legal life, and the copyright is amortized over its useful life. The cost of a copyright includes the cost of acquiring and the cost of defending it.
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Teaching suggestion – Discuss the illegal downloading of music or movies from the internet and point out that it is a copyright issue. Teaching suggestion – Sometimes the acquisition of a copyright can be very expensive. Michael Jackson paid millions of dollars for the copyrights to the Beatles music. However, the cost of a copyright for a created work is a fairly inexpensive fee. ▪
Research and development costs—not intangible assets, but they may lead to patents, copyrights, or other intangible assets. There are uncertainties in identifying the costs related to a specific project and the extent and timing of the future benefit of these expenditures. As a result, research costs are always recorded as an expense when incurred (Research Expense), whether the research is successful or not. Certain development costs with reasonably assured future benefits can be capitalized to Development Costs (asset); otherwise, they must also be expensed. The following conditions must be met for development costs to be capitalized: • The project is technically feasible. • The company intends to complete development. • The product developed can be used or sold by the company. • The company has adequate resources to complete development. • The company can reliably measure the costs incurred. • A market exists for the product that will provide future economic benefits.
Teaching suggestion – Discuss the fact that some accountants argue that expensing R&D costs leads to understated assets and net income. On the other side, some accountants argue that capitalizing these costs would lead to highly speculative assets on the balance sheet.
Intangible assets with indefinite lives: ▪ Trademarks (trade names)—a trademark or trade name is a word, phrase, jingle, or symbol that distinguishes or identifies a particular business or product. Trade names like Blue Jays, Big Mac, Nike, and CBC create immediate product identification and generally help the sale of the product. ▪ The creator or original user may obtain exclusive legal right to the trademark or trade name by registering it with the Canadian Intellectual Properties Office. The registration provides 15 years' protection and may be renewed as long as the trademark or trade name is in use. ▪ Franchises and Licenses—A franchise is a contractual agreement under which the franchisor grants the franchisee the right to sell certain products, to render specific services, or to use certain trademarks or trade names, usually within a designated geographic area. Another type of franchise, granted by a governmental body permits the company to use public property in performing its services (for example the use of airwaves for radio or TV broadcasting). Such operating rights are referred to as licenses.
Teaching suggestion – Ask students to identify well-known franchises. If starting a new business would you consider a franchise arrangement? What are the advantages and disadvantages of franchises? ▪
Goodwill—is an asset that represents that the future economic benefits arising from the
Instructor’s Manual
Chapter 9 – Reporting and Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
▪
purchase of a business that are not individually identified and separately recognized. It represents the value of favourable attributes including exceptional management, a desirable location, good customer relations, skilled employees, high-quality products, fair pricing policies, harmonious relations with labour unions, etc. Goodwill can be identified only with the business as a whole, and is recorded only it can be measured objectively which involves the purchase of an entire business. When an entire business is purchased, goodwill is the excess of the purchase price over the fair market value of the net identifiable assets (assets less liabilities) acquired. Because goodwill has an indefinite life, goodwill is not amortized. It must be tested regularly for impairment. Impairment losses for goodwill are never reversed.
Teaching suggestion – Think of businesses in your area that have goodwill. Do you patronize a dry cleaner or drugstore that you particularly like and would not think of leaving? What is it about this business that makes it special? ▪
Goodwill and indefinite-life intangible assets must be tested for impairment annually regardless of whether there is any indication of impairment. This is different from finitelife intangible assets. Finite-life intangible assets are assessed for indications of impairment at the end of each year, and are tested only if the assessment shows that an impairment may exist.
ASPE comparison – Under IFRS, companies must perform an impairment test annually. Under ASPE, there is no annual requirement to determine if indicators of impairment exist, but when it is apparent they exist, an impairment test must be done. An impairment test occurs in two steps: (1) determine that the cash flows from the asset do not exceed its carrying value, and (2) calculate the impairment loss. Under IFRS, impairment losses can be reversed on intangible assets but not on goodwill, whereas under ASPE impairment losses cannot be reversed.
Learning Objective 5 – Illustrate how Long-lived Assets Are Reported in the Financial Statements
Long-lived assets are normally reported in the statement of financial position under the headings Property, Plant, and Equipment, and Intangible Assets. Goodwill must be separately disclosed. Other intangibles can be grouped together for reporting purposes. Some companies combine property, plant, and equipment and intangible assets other than goodwill under one heading called Capital Assets.
The cost of the major classes of assets (for example land, buildings, and equipment) and accumulated depreciation or accumulated amortization by major classes should be disclosed in the statement of financial position or in the notes to the financial statements. In addition, the methods of depreciation and amortization and the useful lives and rates should be disclosed.
Under IFRS, companies also have to disclose whether they are using the cost or the revaluation model for each class of assets, and include a reconciliation of the carrying amount at the beginning and end of the period for each class of long-lived assets in the notes to the financial statements. Companies must show: (1) additions, (2) disposals, (3) depreciation or
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Chapter 9 – Reporting and Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
amortization (4) impairment losses, and (5) reversals of impairment losses.
Depreciation expense, gains and losses on disposal, and impairment losses are presented in the operating section of the income statement.
Cash flows from the purchase and sale of long-lived assets are reported in the investing activities section of the statement of cash flows.
Teaching suggestion – Students may not understand why a fully depreciated asset remains on the statement of financial position. Assume a company is using equipment that is fully depreciated. If the equipment were not listed on the statement of financial position, the financial statement user would not fully understand the amount of equipment that the company is using. Also, seeing the relationship between cost and accumulated depreciation allows the user to determine if depreciable assets are getting old and thus may need to be replaced or may require excessive repairs.
Learning Objective 6 – Describe the Methods for Evaluating the Use of Assets
Two measures by which assets can be evaluated are: ▪ Return on assets—an overall measure of profitability. This ratio is calculated by dividing net income by average total assets. ▪ The return on assets ratio indicates the amount of net income generated by each dollar invested in assets. ▪ Asset turnover—indicates how efficiently a company is able to generate sales with a given amount of assets, in other words, how many dollars of sales are generated by each dollar invested in assets. This ratio is calculated by dividing net sales by average total assets.
Together, the profit margin and asset turnover explain the return on assets ratio. Profit margin is calculated by dividing net income by net sales. It tells how effectively a company is in turning its sales into net income. ▪ There are two ways a company can increase its return on assets: • Increase the margin it generates for each dollar of goods that it sells—measured by profit margin ratio. • Increase the volume of goods it sells—measured by the asset turnover ratio.
Teaching suggestion – Refer students to Illustrations 9-10, 9-11 and 9-12 for examples of calculations of each of these ratios. With most businesses there is a trade-off between margin and turnover. If a business has a high margin, turnover will be low, and vice-versa. Give examples of businesses in your area, one of which has a high margin and low turnover, and another with a high turnover and low margin.
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Should small not-for-profit organizations be allowed to expense their property, plant, and equipment instead of capitalizing the costs?
Research Emotion has just successfully applied for and obtained a patent for an invention that will measure emotional well-being. As an employee in the accounting department, you have been asked to report on the treatment considered appropriate for the cost incurred in obtaining this invention. You have ascertained that there is a ready market for this product, and that useful life will exceed the 20 year legal life of the patent. Discuss which costs may be included in the value of the patent, and how these costs should be treated.
If you owned property, would you want to value it using the cost model or revaluation model?
What additional costs are involved in revaluing assets under the revaluation model? Is this the best use of a company’s resources?
Why would a company prefer to rent assets as opposed to owning them? Does it make a difference what type of asset is being utilized?
Why shouldn’t a company just use Capital Cost Allowance (CCA) for accounting depreciation instead of using another method such as straight-line, diminishing-balance, or units-of-production?
What would be involved in separately depreciating each component of an asset?
Would management be able to influence the calculation of depreciation based on their personal bias?
Why should the legal costs of successfully defending a patent be capitalized? Should this be recorded as an operating expense instead?
For greater consistency shouldn’t ASPE enable impairment losses to be reversed?
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Chapter 9 – Reporting and Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 9 REPORTING AND ANALYZING LONG-LIVED ASSETS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
Which of the following should not be classified as property, plant, and equipment? a. a building used as a factory b. land used in ordinary business operations c. a truck held for resale by an automobile dealership d. land improvements, such as parking lots and fences Answer: c
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
VOCABULARY QUIZ 1.
A depreciation method in which useful life is expressed in terms of the total units of production or use expected from the asset.
2.
The systematic allocation of the cost of equipment over its useful life.
3.
A loss incurred when the carrying amount of an asset exceeds its recoverable amount.
4.
The value of all favourable attributes that relate to a company.
5.
A method in which periodic depreciation is the same for each year of the asset's useful life.
6.
A word, phrase, jingle, or symbol that distinguishes or identifies a particular company or product.
7.
Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.
8.
The cost of property, plant, and equipment less its residual value.
9.
Resources that have physical substance, are long-lived assets that a company controls, and are not intended for sale to customers.
10.
Expenditures that are immediately charged against revenue as an expense.
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO VOCABULARY QUIZ 1.
Units-of-production method
2.
Depreciation
3.
Impairment loss
4.
Goodwill
5.
Straight-line method
6.
Trademark (trade name)
7.
Intangible assets
8.
Depreciable amount
9.
Property, plant, and equipment
10.
Operating expenditures
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
MULTIPLE CHOICE QUIZ 1.
The cost of an asset less its residual value is referred to as a. carrying amount. b. fair value. c. depreciable amount. d. historical cost. e. none of the above
2.
An exclusive right issued by the Canadian Intellectual Property Office that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of application is a a. trademark. b. license. c. goodwill. d. patent. e. none of the above
3.
The most widely used method of depreciation is the a. straight-line method. b. diminishing-balance method. c. units-of-production method. d. effective-interest method.
Use the following information to answer questions 4–6. The Blooming Miracles Flower Shop Ltd. bought a delivery van on January 1, 2017. The van cost $28,000 and had an expected residual value of $3,000. The life of the van was estimated to be 5 years or 150,000 kms.
4.
The depreciable amount of the van is a. $28,000. b. $25,000. c. $5,000. d. $3,000. e. none of the above
5.
The depreciation expense for a full year of use using the straight-line method of depreciation is a. $5,000. b. $5,600. c. $3,000. d. none of the above
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
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6.
The carrying amount of the van at the beginning of the third year under the straightline method of depreciation would be: a. $12,000. b. $15,000. c. $18,000. d. $6,000.
7.
Which of the following methods is(are) accelerated method(s) of depreciation? a. straight-line b. diminishing-balance method c. units-of-production method d. both b and c above e. both a and c above
8.
Depreciation is dependent on a number of estimates. When a change in an estimate is required, the change is made a. in the current year. b. in the future year. c. to prior periods. d. both a and b above e. a, b, and c, above
9.
All of the following are intangible assets, except a. franchises. b. trademarks. c. land improvements. d. patents. e. a and d above
10.
An exclusive right to reproduce and sell artistic or published work is a a. patent. b. copyright. c. license. d. franchise. e. none of the above
11.
Which of the following costs would be considered an operating expenditure? a. insurance to ship new equipment to the company b. replacing tires on a truck c. grading land d. remodelling offices e. none of the above
12.
Which of the following is false?
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
a. Tax depreciation is called capital cost allowance. b. Significant components should be depreciated separately. c. Impairment losses can always be reversed. d. Under IFRS companies can select the cost or revaluation model.
13.
Which of the following is false? a. Depreciation needs to be updated when an asset is sold part way through the year. b. When the proceeds are more than the carrying amount, there is a gain on disposal. c. When no proceeds are received on retirement of an asset, a gain can never be recorded. d. When an asset is fully depreciated, it is removed from the accounting records.
14.
Which of the following is true? a. Equipment purchased under a finance lease is recorded as a depreciable asset and depreciated. b. An impairment loss is calculated by deducting the carrying amount of an asset from its recoverable amount. c. Total depreciation over the life of a piece of equipment will differ depending on which depreciation method is used. d. The straight-line method of depreciation results in an equal amount of pre-tax cash flow for each year of a depreciable asset’s life while the diminishing-balance method results in a higher pre-tax cash flow in the early years of the asset’s life. e. none of the above
15.
The ratio which indicates the amount of net income generated by each dollar invested in assets is a. return on assets. b. asset turnover. c. profit margin. d. none of the above
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
9-6
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO MULTIPLE CHOICE QUIZ 1.
c
2.
d
3.
a
4.
b
5.
a
6.
c
7.
b
8.
d
9.
c
10.
b
11.
b
12.
c
13.
d
14.
a
15.
a
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Chapter 9 – Reporting and Analyzing Long-Lived Assets
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
The cost of property, plant, and equipment includes all expenditures that are necessary in order to acquire the asset and make it ready for its intended use.
True
False
2.
Interest costs incurred to finance construction of a building are not included as part of the cost of the building.
True
False
3.
The depreciable amount of an asset equals its cost less residual value.
True
False
4.
Under the diminishing-balance method of depreciation, an asset may not be depreciated below its estimated residual value.
True
False
5.
Operating expenditures are capitalized within the statement of financial position.
True
False
6.
The cost of an addition is debited to the appropriate asset account.
True
False
7.
When the proceeds exceed the carrying amount of a piece of equipment being sold, the excess is debited to Loss on Disposal.
True
False
8.
Fully depreciated assets continue to be reported in the accounting records.
True
False
9.
Only intangible assets with indefinite lives are amortized.
True
False
10.
Asset turnover is calculated by dividing average total assets by net sales.
True
False
Multiple Choice 11.
Quizzes
The cost of a factory machine includes all of the following costs except a. invoice price. b. shipping costs paid by the buyer. c. one-year insurance policy on the machine. d. testing and installation cost. e. a and c above Chapter 9 – Reporting and Analyzing Long-Lived Assets
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12.
On January 1, Year 1, a machine with a useful life of 5 years and a residual value of $1,000 was purchased for $20,000. What is the depreciation expense in Year 2 under the double-diminishing-balance method? a. $4,800 b. $4,560 c. $3,200 d. $3,040 e. none of the above
13.
On June 1, Year 1, a machine costing $45,000 was acquired. The machine is expected to produce 90,000 units over a 5-year period, after which it will be scrapped. The machine produced 20,000 units during Year 1. The company’s fiscal year end is December 31. Which statement is true? a. Using the units-of production method, depreciation expense for Year 1 is $5,000. b. Using the units-of production method, depreciation expense for Year 1 is $10,000. c. Using the units-of production method, depreciation expense for Year 1 is $5,833. d. Using the straight-line method, depreciation expense for Year 1 is $4,500. e. none of the above
14.
An asset that cost $20,000 and has accumulated depreciation of $15,000 is sold for $2,000. The journal entry would include a a. debit to Loss on Disposal of $5,000. b. debit to Loss on Disposal of $3,000. c. credit to Gain on Disposal of $3,000. d. credit to Accumulated Depreciation for $15,000. e. none of the above
15.
The exclusive right to publish and sell artistic or published work is called a a. patent. b. trademark. c. license. d. copyright. e. b and d above
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
9-9
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
False
2.
False
3.
True
4.
True
5.
False
6.
True
7.
False
8.
True
9.
False
10.
False
Multiple Choice 11.
c
12.
a
13.
b
14.
b
15.
d
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
9 - 10
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #2 1.
Name three advantages of leasing an asset over purchasing the asset.
2.
On October 1, 2017, Bartow Corporation purchased a delivery truck for $45,000. It is estimated that the truck will be driven 320,000 km during a five-year period, after which it will be sold for $5,000. The truck was driven 30,000 km in 2017. Calculate a. depreciation for 2017 using the straight-line method. b. depreciation for 2017 using the double-diminishing balance method. c. depreciation for 2018 using the double-diminishing balance method. d. depreciation for 2017 using the units-of-production method.
3.
On April 30, 2017, Wilson Limited sold a used piece of manufacturing equipment for $6,500. The equipment had been purchased on January 1, 2014 for $50,000. The equipment was estimated to have a useful life of 4 years, with a residual value of $2,000. The equipment had been depreciated using the straight-line method. Depreciation was last recorded for the year ended December 31, 2015. a. Calculate the carrying amount of the asset on December 31, 2016. b. Record the depreciation for 2017. c. Calculate the gain or loss on disposal. d. Record the sale of the equipment on Apr 30, 2017.
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
9 - 11
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #2 1.
2. a.
Advantages of leasing an asset include: • reduced risk of obsolescence, • 100% financing, • income tax advantages, • off-balance sheet financing.
Depreciation for 2017 using the straight-line method: $45,000 – $5,000 = $40,000 $40,000 ÷ 5 years = $8,000 $8,000 x 3/12 = $2,000
b.
Depreciation for 2017 using the double-diminishing balance method: 100% ÷ 5 x 2 = 40% $45,000 x 40% x 3/12 = $4,500
c.
Depreciation for 2018 using the double-diminishing balance method: ($45,000 – $4,500) x 40% = $16,200
d.
Depreciation for 2017 using the units-of-production method: $45,000 – $5,000 = $40,000 $40,000 ÷ 320,000 km = $0.125 per km $0.125 per km x 30,000 km = $3,750
3. a.
Carrying amount on December 31, 2016: $14,000 ($50,000 – $2,000) ÷ 4 = $12,000 annual depreciation $12,000 x 3 = $36,000 accumulated depreciation $50,000 – $36,000 = $14,000
b. Record the depreciation for 2017. Apr 30 Depreciation Expense ............................................................ Accumulated Depreciation .............................................. Four months depreciation. ($12,000 x 4/12) c. Gain or loss on disposal: $3,500 loss Carrying amount on April 30 ($14,000 – $4,000) ..... Proceeds .................................................................. Loss on disposal.......................................................
Quizzes
4,000 4,000
$10,000 6,500 $ 3,500
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d. Record the sale of the equipment on Apr 30, 2017. Apr 30 Cash ...................................................................................... Accumulated Depreciation ($36,000 + $4,000) ...................... Loss on Disposal ................................................................... Equipment....................................................................... Sold used equipment
Quizzes
Chapter 9 – Reporting and Analyzing Long-Lived Assets
6,500 40,000 3,500 50,000
9 - 13
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 10 REPORTING AND ANALYZING LIABILITIES LEARNING OBJECTIVES 1.
Account for current liabilities.
2.
Account for instalment notes payable.
3.
Identify the requirements for the financial statement presentation and analysis of liabilities.
4.
Account for bonds payable (Appendix 10A).
Instructor’s Manual
Chapter 10 – Reporting and Analyzing Liabilities
10 - 1
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER OUTLINE Learning Objective 1: Account for Current Liabilities
Liabilities are defined as present obligations that result from past transactions.
Obligations (debt) must be settled or paid at some time in the future by the transfer of assets or through the provision of services.
One type of liability is a financial liability. These liabilities have contractual obligations to pay cash in the future.
A current liability is a debt that will be paid within one year from existing current assets or through the creation of other current liabilities.
Debts that do not meet both of the aforementioned criteria are classified as non-current or long-term liabilities.
The different types of current liabilities include operating lines of credit, accounts payable, accrued liabilities such as income taxes, salaries, and interest, unearned revenue, notes, and the current portion of non-current debt.
Teaching suggestion – Ask students if they have personal liabilities. Are those liabilities current liabilities or non-current liabilities? Why is it important that the student know whether they are current or non-current? If the student were going to the bank to borrow money would it be important to the banker to know which of the liabilities were current and which were not current?
Operating line of credit (also known as a credit facility) – pre-authorization by the bank that allows companies to borrow money up to a pre-set limit, when it is needed. Often part of a credit facility arrangement made with the bank. ▪ Interest is usually charged at a floating interest rate on any amounts used from the line of credit. A floating or variable interest rate changes as market rates change and is usually based on the prime borrowing rate. ▪ Security, called collateral, is usually required by the bank as protection in the event of default on the loan and normally includes some or all of the company’s current assets but may also include some non-current assets. ▪ A bank indebtedness is a negative or credit bank balance (debit to the bank) which is reported as a current liability on the statement of financial position.
Sales taxes are expressed as a percentage of the sales price. ▪ The retailer collects the sales tax from the customer when the sale occurs and periodically remits the Goods and Services Tax (GST) and the Provincial Sales Tax (PST) (QST in Quebec) or Harmonized Sales Tax (HST) collected to the designated federal and provincial collecting authorities (usually monthly). ▪ In the case of GST and HST, collections may be offset against payments (i.e., sales tax payments made by the company on its own eligible purchases). Only the net amount owing or recoverable will be paid or refunded. ▪ The amount of the sales tax collected and the amount of the sale are usually rung up separately on the cash register.
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Chapter 10 – Reporting and Analyzing Liabilities
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Teaching suggestion – Show an example of an entry that a company would make to record their sales and relates sales taxes. Assume that the cash register reading shows sales of $25,000 and HST of $3,250 on May 25. May 25
Cash Sales Sales Tax Payable ($25,000 x 13%)
28,250 25,000 3,250
When the sales taxes are remitted to the government, the Sales Tax Payable account is decreased (debited) and Cash is credited.
Property taxes – Businesses pay property taxes annually. ▪ Taxes are charged by the municipal and provincial governments and are calculated at a specified rate for every $100 of the assessed value of the property (i.e., land and building). ▪ Property taxes are generally for the calendar year, though bills are not usually issued until the spring.
Teaching suggestion – Walk through an illustration, which assumes that Regional Manufacturing owns land and a building. Regional Manufacturing’s year end is December 31 and it makes annual adjusting entries. Regional Manufacturing receives its property tax bill of $8,000 on March 1, and it is due to be paid on May 31. In March, when Regional Manufacturing receives the property tax bill the entry is: Mar 1
Property Tax Expense ($8,000 x 2/12) 1,333 Property Tax Payable (To record property tax expense for Jan and Feb)
1,333
In May, when Regional Manufacturing pays the property tax bill, the entry also records the expense incurred from March to May. May 31
Property Tax Payable 1,333 Property Tax Expense ($8,000 x 3/12) 2,000 Prepaid Property Tax ($8,000 x 7/12) 4,667 Cash (To record payment of property tax for Jan through Dec)
8,000
At the December 31 year end, Regional Manufacturing will adjust the prepaid property tax with the entry: Dec 31
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Property Tax Expense 4,667 Prepaid Property Tax (To record property tax expense for Jun through Dec)
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Payroll Every employer incurs three types of liabilities related to employees’ salaries or wages: (1) the net pay owed to employees, (2) employee payroll deductions, and (3) employer payroll obligations. ▪ The amount of salary or wages owed to employees—management personnel are normally paid salaries, which are expressed as a specific amount per week, per two weeks, per month, or per year. Part-time employees or employees paid on an hourly basis or by the work produced are normally paid wages. ▪ The total amount of salaries or wages earned by the employee is called gross pay. ▪ Some payroll deductions are required by law to be withheld from employees’ gross pay. Mandatory payroll deductions include amounts withheld for federal and provincial income taxes, Canadian Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums. Companies may also withhold voluntarily deductions for health and pension plans, union dues, and charitable donations. ▪ An employee’s gross pay, or total earnings, less any employee payroll deductions withheld from the employee’s earnings is known as net pay. This is the amount that the company (the employer) must pay to the employee. Many of us call this “take home pay.” ▪ Employers also need to pay payroll costs such as the employer’s share of CPP and EI. In addition, employers also fund the worker’s compensation plan. ▪ All of these contributions, plus items such employer-sponsored health plans and pensions and compensated absences (such as statutory holidays and vacation pay) are referred to together as employee benefits. The employer’s share of these costs is recorded as an employee benefits expense. • Until these payroll deductions and costs are remitted to the third parties that they are collected for, they are reported as current liabilities. Teaching suggestion – Ask students if they work 40 hours a week during the summer making $10 per hour, is their pay cheque for the week $400. Why not? If the employer pays the student $10 an hour for the 40 hours or $400, is this all of the expense the employer has relative to the student’s work week? Why not? Work through an example concerning the entry for the accrual and payment of a $25,000 payroll on which a corporation withholds taxes from its employees’ wages and salaries: May 7 Salaries Expense 25,000 CPP Payable 1,238 EI Payable 445 Employee Income Tax Payable 5,107 United Way Payable 599 Union Dues Payable 259 Salaries Payable 17,352 (To record payroll and employee deductions for week ending May 7) With every payroll the employer incurs liabilities to pay various payroll costs, such as Canada Pension Plan, Employment Insurance and funding of worker’s compensation plan. The employer’s share of payroll benefits would be recorded with the following entry: May 7
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Employee Benefits Expense 2,809 CPP Payable EI Payable Worker’s Compensation Payable Health Insurance Benefits Payable (To record employer’s payroll costs on May 7 payroll) Chapter 10 – Reporting and Analyzing Liabilities
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The following entry is made to pay employees: Mar y
Salaries Payable Cash (To record payment of the May 7 payroll)
17,352 17,352
The corporation is only paying its employees in this entry and not its payroll deductions. Employee and employer deductions will be remitted later in the month when they are due to government authorities or other third parties. Normally payroll deductions must be remitted no later than the 15th day of the month following the monthly pay period.
Short-term notes payable – obligations in the form of written notes. Notes payable are often used instead of accounts payable because they give the lender written documentation of the obligation, which helps if legal remedies are needed to collect the debt. ▪ Notes and loans are sometimes used interchangeably and interest expense is also referred to as a finance cost. ▪ Notes payable are frequently issued to meet short-term financing needs and usually require the borrower to pay interest. ▪ Notes that are due for payment within one year are classified as current liabilities. ▪ Short-term notes can have a floating interest rate; however, it is more common for them to have a fixed interest rate. A fixed interest rate is a constant rate for the entire term of the note.
Teaching suggestion – Ask students to list some similarities and differences between Notes Payable and Accounts Payable. Ask students if a Note Payable is more binding on a debtor than an Accounts Payable. Why? You should emphasize the difference between an accounts payable and a notes payable as many students do not clearly understand the difference between the two liabilities. Accounts payable are informal promises to pay, whereas notes payable are written promises to pay that gives the payee a stronger legal claim. Accounts payable arises only from credit purchases, whereas notes payables can be used for credit purchases, extending an accounts payable beyond normal amounts or due dates, or to borrow money. An accounts payable is usually due in a short period of time, whereas notes payable can extend for longer periods of time. Accounts payable will only incur interest when the account is overdue, whereas notes payable bear interest from the signing date to the maturity date. Teaching suggestion – Walk through an illustration., Assume that HSBC bank agrees to lend $250,000 on March 1, if Regional Manufacturing signs a $250,000, 4%, four-month bank loan maturing on July 1 (interest payable at maturity). The entry made by Regional Manufacturing upon receipt of cash and after note is signed: Mar 1
Cash
250,000 Bank Loan Payable 250,000 (To record issue of four-month, 6% bank loan from HSBC)
Interest accrues over the life of the bank loan and must be recorded periodically. If Regional Manufacturing has a March 31 year end, an adjusting entry is required to recognize interest expense and interest payable of $833 ($250,000 x 4% x 1/12): Interest Expense Instructor’s Manual
833
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Interest Payable 833 (To accrue interest payable for one month on the HSBC bank loan) At maturity, July 1, Regional Manufacturing must pay the face value of the bank loan ($250,000) plus $3,333 interest ($250,000 x 4% x 4/12), $833 of which has already been accrued. Interest Expense 2,500 Interest Payable ($250,000 x 4% x 3/12) (To accrue interest payable for Apr, May, and Jun)
2,500
Bank Loan Payable 250,000 Interest Payable 3,333 Cash 253,333 (To record payment of HSBC bank loan and interest at maturity)
Current maturities of non-current debt – Current portion of a non-current debt should be included in Current Liabilities. A journal entry is not required to recognize this classification.
Liabilities that are uncertain are those for which we may not know who we owe, when we owe, and/or how much we owe. Uncertain liabilities are known as provisions or contingent liabilities.
Provisions – are liabilities of uncertain timing or amount but there is no uncertainty about the fact that a liability should be recorded. ▪ A provision is recorded because: • their outcome is probable • the amount owed can be estimated
Contingent liabilities – are existing or possible obligations arising from past events. A liability is contingent or dependent on whether or not some uncertain future event occurs that will confirm either its existence or the amount payable or both. ▪ A contingent liability is disclosed in the notes. It is not recorded because (1) the probability of an obligation being settled is only possible, not probable and (2) even if the probability is ‘more likely than not’ it may not be possible to estimate the amount of the liability.
ASPE comparison – Under IFRS the terms provisions and contingent liabilities are used, however, under ASPE the term provisions is not used and instead the term contingent loss is used instead. A contingent loss is recorded when the two conditions are met: (1) it is likely that a future event will confirm that liability has been incurred and (2) the amount of the related loss can be estimated. If a loss is likely to occur but cannot be estimated, note disclosure of this contingent loss is made rather than recording it. If a loss was unlikely to occur, it would not be recorded or disclosed in the notes to the financial statements. Under IFRS, probable is defined as “more likely than not” which is normally interpreted to mean more than a 50% probability of occurring. Under ASPE, likely has a higher degree of probability than the term probable.
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Learning Objective 2: Account for Instalment Notes Payable
A non-current liability is an obligation that is expected to be paid after one year or longer.
A long-term (or instalment) note may be unsecured or secured. ▪ A secured note pledges title to specific assets as security for the loan. A mortgage payable is widely used by individuals to purchase homes. It is also used by many companies to acquire property, plant, and equipment. ▪ Unsecured notes are issued against the general credit of the borrower. There are no assets used as collateral.
Most long-term (or instalment) notes are normally repayable in a series of periodic payments. ▪ These periodic payments are known as instalments and are paid monthly, quarterly, semi-annually, or at another defined period.
Each instalment payment consists of: (1) interest on the unpaid balance of the loan, (2) a reduction of loan principal. ▪ Instalment payments generally take one of two forms: (1) fixed principal payments plus interest, (2) blended principal and interest payments.
Fixed principal payments plus interest – Instalment notes with fixed principal payments are repayable in equal periodic amounts, plus interest. ▪ Interest may be fixed (rate is constant over the term of the note) or floating (rate changes with fluctuating market rates, usually tied to changes in the prime rate).
Teaching suggestion – Work through an illustration. Assume that Regional Manufacturing borrows $250,000 from the bank with a 5% interest rate, for five years. The terms provide for equal monthly instalment payments of $4,167 ($250,000 ÷ 60 periods) on the first of each month, plus interest of 5% on the outstanding principal balance. Jan 1 Cash 250,000 Bank Loan Payable 250,000 (To record five-year, 5% bank loan) For the first payment date – February 1 – interest expense is $1,042 ($250,000 x 5% x 1/12). The cash payment of $5,209 is the total of the instalment payment, $4,167, which is applied against the principal, plus the interest, $1,042. Feb 1 Interest Expense 1,042 Bank Loan Payable 5,209 Cash 5,209 (To record monthly instalment payment on loan) You could prepare an instalment payment schedule for the first few months to show students the repayments including the calculation of the interest. With fixed principal payments, the interest decreases each period (as the principal decreases). The portion applied to the reduction of the loan principal stays constant, but because of the decreasing interest, the total payment decreased.
Blended Principal and Interest Payments – Instalment loans with blended principal and interest payments are repayable in equal periodic amounts, including interest. ▪ Blended principal and interest payments result in changing amounts of interest and principal applied to the loan.
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•
As with fixed principal payments, the interest decreases each period (as the principal decreases). In contrast to fixed principal payments, the portion applied to the loan principal increases each period.
Teaching suggestion – Work through a second illustration. Assume that Regional Manufacturing borrows $250,000, at an interest rate of 5% for five years. Instead of fixed principal payments, the terms provide for equal monthly instalment payments of $2,376. Jan 1
Cash
250,000
Bank Loan Payable (To record five-year, 5% bank loan)
250,000
For the first payment date – February 1 – interest expense is $1,042 ($250,000 x 5% x 1/12). The cash payment of $4,717 is the total of the instalment payment, $3,675, which is applied against the principal, plus the interest, $1,042. Feb 1
Interest Expense 1,042 Bank Loan Payable 3,675 Cash (To record monthly instalment payment on bank loan)
4,717
You can develop an instalment payment schedule for the first few months. ▪
With both types of instalment loans, as with any other non-current liability, the reduction in principal for the next year must be reported as a current liability. The remaining unpaid principal is classified as a non-current liability.
Learning Objective 3: Identify the Requirements for the Financial Statement Presentation and Analysis of Liabilities
Interest (finance) expenses are separately reported in the “other expenses and losses” section.
Current liabilities are the first category under liabilities on the statement of financial position.
Each of the primary types of current liabilities are listed separately within this category or described in the notes to the financial statements.
Current liabilities are generally listed in their order of liquidity (by their due dates), but this is not always possible because of the varying maturity dates that may exist for specific obligations such as short-term notes payable. Note that other orders are also possible (e.g., reverse-liquidity). ▪ Remember that current maturities of non-current debt should be reported as current liabilities if they are to be paid from current assets.
Non-current liabilities are reported in a separate section of the statement of financial position immediately following current liabilities or preceding current liabilities if companies use a reverse-liquidity order. Generally non-current liabilities are measured and reported at the amount due when the liability is expected to be paid. There are exceptions to this involving bonds which are reported at amortized cost.
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Summary data regarding debts may be presented on the statement of financial position, while detailed data (such as interest rates, maturity dates, assets pledged as collateral and fair value, if available) are usually shown in the notes to the financial statements along with a list showing the amount of non-current debt that is scheduled to be paid off in each of the next 5 years.
Analysis An examination of debt obligations makes it easier to assess a company’s ability to pay its current obligations. It helps to determine whether a company can obtain long-term financing in order to grow.
Liquidity ratios measure the short-term ability of a company to pay its current obligations and to meet unexpected needs for cash within the next year.
The current ratio (Current assets ÷ Current liabilities) is a commonly used measure of liquidity.
The current ratio can sometimes be misleading, as some current assets (such as inventory) are not very liquid. The current ratio should be supplemented by other ratios such as the acid test, receivables turnover and inventory turnover.
Solvency ratios measure the ability of a company to repay its long-term debt and survive over a long period of time.
Debt to total assets is calculated by dividing total liabilities by total assets. ▪ This ratio indicates the extent to which a company’s assets are financed by debt.
Times interest earned gives an indication of a company’s ability to meet interest payments as they come due. Times interest earned is calculated by dividing the sum of -net income, interest expense, and income tax expense (or net income before interest and tax) by interest expense.
Remind students that the debt to total assets and times interest earned ratios should always be interpreted together.
Teaching suggestion – Work through the calculation of various ratios. You can use data from a popular company’s annual report. Care must be taken in interpreting debt to total asset ratios between and among different companies. For example, many companies have different capital and/or financing structures. In addition, consolidated financial statements can include 100% of its subsidiaries’ debt, but the parent company may not be responsible for this debt if a subsidiary defaults.
Off-balance sheet financing – Off-balance sheet financing refers to a situation where liabilities are not recorded on the statement of financial position. ▪ One common type of off-balance sheet financing results from leasing transactions. ▪ In most lease contracts, a periodic payment is made by the lessee and is recorded as rent expense in the income statement (i.e., apartment rent, airport car rental). This is referred to as an operating lease, where the intent is temporary use of the property by the lessee with continued ownership of the property by the lessor. ▪ Some critics argue that many operating leases are actually unavoidable obligations.
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Companies are therefore required to report their operating lease obligations in a note to the financial statements.
Learning Objective 4: Account for Bonds Payable
A bond is a form of interest-bearing non-current debt. A bond is a promise to repay a specified amount of money at a fixed future date in addition to periodic interest payments throughout the term of the bond.
Bonds have a fixed interest rate. The coupon interest rate determines the amount of interest to pay to the bondholders. Usually the coupon interest rate is stated as an annual rate and bond interest is paid semi-annually.
Bond Trading ▪ They are sold in small denominations (usually $1,000 or multiples of $1,000). ▪ Bonds are often traded on stock exchanges. ▪ Bond prices are quoted as a percentage of the face value of the bonds. Thus, a $1,000 bond with a quoted price of 97 sells at a price 97% of the face value or $970. ▪ The market interest rate or the effective-interest rate is the rate investors’ demand for lending their money.
Discount or Premium on Bonds ▪ If the coupon interest rate is less than the market rate, bonds sell at a discount or at a price less than 100% of face value. ▪ If the coupon interest rate is greater than the market rate, bonds sell at a premium or at a price greater than 100% of face value.
Teaching suggestion – Ask students which they would rather have: $100,000 cash now or $100,000 bonds maturing in 20 years. When you ask why they would rather have the $100,000 cash now they are going to say that they could be earning interest on the $100,000. Explain to them that is why the cash inflow associated with the maturity value of the bond is much less than $100,000. Now ask students if they would rather have $100,000 in bonds maturing in 20 years or $100,000 in bonds maturing in 10 years. Of course they are going to opt for the 10-year bonds because they receive the cash flow earlier. In addition to the cash inflow associated with the maturity, there is the cash flow associated with the interest, which is usually paid annually or semi-annually. Ask students if they are going to be eager to purchase 6% bonds if the market interest rate is 8%. Of course not. Now ask them if they would be eager to buy the bonds if the market interest rate was 4%. The 6% coupon or stated interest rate looks very attractive considering the market rate of 4%. Bond prices have an inverse relationship with market interest rates. When the market rate of interest falls bond prices will increase.
The current market value of a bond is equal to the present value of all the future cash payments promised by the bond. The present value of the $500,000, 5%, 5-year bonds is: Present value of $500,000 received in 10 periods $500,000 × 0.78120 (n = 10, i = 2.5%)
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Present value of $12,500 received for each of 10 periods $12,500 × 8.75206 (n = 10, i = 2.5%) Present value (issue price) of bonds
109,400 $500,000
Teaching suggestion – Discuss with students the rounding differences that can arise if a financial calculator or spreadsheet is used to determine the present value rather than present value tables. Ask how many have a financial calculator capable of making these types of calculations.
The present value (issue price) will always equal the face value when the two rates are the same, as was assumed in this case. However, market interest rates are influenced by the type of bond issued, the state of the economy, current industry conditions, and the company’s individual performance. As a result, the coupon and market interest rate often differ resulting in bonds selling above or below their face value.
Accounting for Bond Interest Expense ▪ The amortization of bonds payable is calculated using the effective-interest method. The effective-interest method is an amortization method used to allocate a bond discount or bond premium to interest expense over the life of the bond. This method results in a periodic interest expense that equals a constant percentage (the market or effectiveinterest rate) of the carrying amount of the bond. ▪ The following steps are used to calculate amortization under the effective-interest method: (1) Calculate the bond interest expense by multiplying the carrying amount of the bonds at the beginning of the interest period by the market (effective) interest rate. (2) Calculate bond interest paid by multiplying the face value of the bonds by the coupon interest rate for the semi-annual (or appropriate) period. (3) The difference between steps (1) and (2) is the amortization amount.
ASPE comparison – Under IFRS, the effective-interest method is used to amortize the bond premium or discount. Under ASPE, the effective-interest method is normally used but companies are permitted to use alternative methods (e.g., straight-line) if the results do not differ materially from the effective-interest method. ▪ ▪
Issuing bonds at face value – Assume that Regional Manufacturing issued $500,000 of 5-year, 5% bonds dated January 1, 2018 at 100 (100% of face value, also called “par value”). Interest on bonds is payable semi-annually on January 1 and July 31. The entry to record the sale is: Jan 1 Cash 500,000 Bonds Payable 500,000 (To record sale of bonds at face value) The bonds are reported in the non-current liabilities section of the statement of financial position because the maturity date is more than 1 year away. Interest is payable semi-annually on January 1 and July 1. Interest expense and interest paid are calculated by multiplying $500,000 x 5% x 6/12. The entry to record the semiannual interest on July 1 is: Jul 1 Interest Expense 12,500 Cash 12,500 (To record the payment of bond interest)
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▪ ▪
On December 31 the following adjusting entry is required to record the $12,500 of interest accrued since July 1: Dec 31 Interest Expense 12,500 Bond Interest Payable 12,500 (To accrue bond interest) Bond interest payable is classified as a current liability as it will be paid next year on January 1, 2019. Issuing bonds at a discount – To illustrate bonds sold at a discount, assume that on January 1, 2018, Regional Manufacturing., sells $500,000, 5-year, 5% bonds at a market (effective) interest rate of 6%, with interest payable on July 1 and January 1. Using present value techniques, we calculate that the bond will sell for $478,673.
Present value of $500,000 received in 10 periods $500,000 × 0.74409 (n = 10, i = 3%) Present value of $25,000 received for each of 10 periods $12,500 × 8.53020 (n = 10, i = 3%) Present value (issue price) of bonds
$372,045 106,628 $478,673
Teaching suggestion – Review the key inputs (e.g., future value [face value], market interest rate, interest payment, number of periods, interest rate, etc.) with the students needed to determine the present value, regardless of whether present value tables, a financial calculator, or a spreadsheet program is used. The journal entry to record the bond issue: Jan 1 Cash Bonds Payable (To record sale of bonds at a discount) ▪ ▪ ▪ ▪
▪ ▪ ▪
▪
478,673 478,673
The issue price of $478,673 results in a bond discount of $21,327 ($500,000 – $478,673). The $478,673 represents carrying amount of the bonds. Note that the discount is netted with the Bonds Payable account rather than recorded separately, although that is also an option for recording, but not for reporting, purposes. The issue of selling bonds below face value causes the total cost of borrowing to be higher than the bond interest paid. The difference between the issue price and the face value of the bonds—the discount—represents an additional cost of borrowing and should be allocated to bond interest expense over the life of the bond. This is referred to as amortizing the discount. At the same time, the issuing corporation will have to pay bondholders $500000 at maturity and will want the bonds to show a carrying amount of $500,000 at maturity date. Amortizing a bond discount – Using the Regional Manufacturing example above, the interest expense for the first period would be $478,673 x 6% x 6/12 or $14,360 The discount amortization would be the difference between interest expense and the interest paid ($14,360 – $12,500). The entry to record the payment of bond interest and the amortization of bond discount on the first interest date is: Jul 1 Interest Expense ($981,417 x 6% x 6/12) 14,360 Bonds Payable 1,860 Cash ($500,000 x 5% x 6/12) 12,500 (To record payment of bond interest and amortization of bond discount) The carrying amount of the bonds is now $480,533 ($478,673 + $1,860). The carrying amount will continue to increase by the amount of the discount amortization until, at maturity, the carrying amount of the bonds equals their face value.
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At December 31, the adjusting entry is: Dec 31 Interest Expense ($480,533 x 6% x 6/12) 14,416 Bonds Payable 1,916 Bond Interest Payable 12,500 (To record accrued bond interest and amortization of bond discount) Teaching suggestion – Discuss with students the issue of risk and how that affects bond ratings. Expand your discussion with these questions: Does a bond sold at a discount imply that the bonds are inferior? Do bonds that are sold at a premium imply the bonds are superior to the bonds that are sold at a discount? ▪
Issuing bonds at a premium – To illustrate bonds sold at a premium, assume the Regional Manufacturing bonds described before are sold at a market (effective) interest rate of 4%.
Using time value of money techniques, we determine that the bonds will sell for $522,457 (104.4914% of face value). Present value of $500,000 received in 10 periods $500,000 × 0.82035 (n = 10, i = 2) Present value of $12,500 received for each of 10 periods $12,500 × 8.98259 (n = 10, i = 2) Present value (issue price) of bonds
$ 410,175 112,282 $522,457
Teaching suggestion – Review the key inputs (e.g., future value [face value], market interest rate, interest payment, number of periods, interest rate, etc.) with the students needed to determine the present value, regardless of whether present value tables, a financial calculator, or a spreadsheet program is used. Help students understand how and why the inputs have changed from the previous example (issuing bonds at a discount). The entry to record the sale is: Jan 1 Cash 522,457 Bonds Payable 522,457 (To record sale of bonds at a premium) ▪ The issue price of $522,457 results in a bond premium of $22,457 ($522,457 – $500,000). ▪ Note that the premium is included in the Bonds Payable account rather than recorded separately, although that is also an option for recording, but not for reporting, purposes. ▪ The sale of bonds above face value causes the total cost of borrowing to be less than the bond interest paid because the borrower is not required to pay the bond premium at the maturity date of the bonds. The amortization of the premium will be allocated to interest expense, reducing bond interest expense over the life of the bonds. ▪ Amortizing a bond premium – Continuing with our Regional Manufacturing example, recall that Regional Manufacturing issued $500,000 of five-year, 5% bonds. Interest is payable semi-annually on July 1 and January 1. The bonds are issued to yield a market (effective) interest rate of 4%. The bonds sold for $522,457, the premium being $22,457. ▪ The entry to record the first payment of interest is: Jul 1 Bond Interest Expense 10,449 ($522,457 x 4% x 6/12) Instructor’s Manual
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▪
Bonds Payable 2,050 Cash ($500,000x 5% x 6/12) 12,500 (To record payment of bond interest and amortization of bond premium) The carrying amount of the bonds is now $520,407 ($522,457 – $2,050). The carrying amount will continue to decrease until, at maturity, the carrying amount of the bonds equals their face value. At December 31, the adjusting entry is: Dec 31 Interest Expense 10,408 ($520,407 x 4% x 6/12) Bonds Payable 2,092 Bond Interest Payable 12,500 (To record accrued bond interest and amortization of bond premium)
Teaching suggestion – Point out to the students that bonds that sell at a discount do not necessary imply the bonds are inferior. Also, bonds that are sold at a premium do not necessary imply the bonds are superior to the bonds that are sold at a discount. Accounting for Bond Retirements Bonds may be retired at maturity or before maturity.
Bonds that can be retired by the company at a stated dollar amount before they mature are known as redeemable or callable bonds. ▪ Redeeming bonds at maturity • Regardless of the issue price of bonds, the carrying amount of the bonds at maturity will equal their face value. • Assuming that the interest for the last interest period is paid and recorded separately, the entry to record the redemption of the Regional Manufacturing bonds at maturity is: Bonds Payable 500,000 Cash 500,000 (To record redemption of bonds at maturity)
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
A bank has offered you two loan repayment options: fixed principal payments or blended principal and interest payments. The blended payments have a higher amount of total payments over the life of the loan. Why would the blended payments loan have a higher total cash outlay?
A bank has offered you two loan options: fixed principal payments or blended principal and interest payments. Which loan might you prefer and why?
If hiring an accountant or lawyer does not result in additional payroll costs why would a company want to hire an accountant or lawyer on staff full-time?
If hiring contract workers does not result in extra payroll costs, why would a business employ workers as opposed to hiring contract workers?
If you had extra money to invest, would you prefer to buy shares, buy bonds, or purchase a guaranteed investment? Explain.
If you were going to the bank for a loan, what types of information would you need to provide the banker with?
If a company is being sued, why would they want to provide disclosure of the possible liability if the criteria (more likely than not and estimable) have not been met? How would this requirement impact the company?
Since companies are required to disclose loan details in the notes to the financial statements, why is it also required that the current portion of the loan be reclassified on the statement of financial position? Isn’t enough information already presented related to the amounts that would be coming due within the next year?
If you were taking out a loan from the bank, would you select a secured loan that had a lower interest rate or an unsecured loan with a higher interest rate? Why does the collateral impact the loan interest rate?
Why do bonds sell at a premium or a discount? Shouldn’t companies establish their coupon rates as equal to the market interest rate?
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Chapter 10 – Reporting and Analyzing Liabilities
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CHAPTER 10 REPORTING AND ANALYZING LIABILITIES 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
A corporation issues $1,000,000 of 4%, 5-year bonds. The 4% rate of interest is called the ______ rate. Answer: coupon interest
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
VOCABULARY QUIZ 1.
Type of payment for an instalment note that is repayable in equal periodic amounts including interest.
2.
Events with uncertain outcomes, such as a potential liability that may become an actual liability sometime in the future.
3.
The value today of an amount to be received at some date in the future after taking into account current interest rates.
4.
The amount of principal due at the maturity date of the bond.
5.
The rate potential investors, or bondholders, demand for loaning funds to the corporation.
6.
The difference between the selling price and the face value of a bond when a bond is sold for more than its face value.
7.
An arrangement with the bank to borrow money up to a specified limit to help manage temporary shortfalls of cash.
8.
An obligation in the form of a written promissory note.
9.
A measure of a company’s solvency, calculated by dividing net income before interest expense and income tax expense by interest expense.
10.
Rate used to determine the amount of interest a bond issuer pays and a bond investor receives.
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO VOCABULARY QUIZ 1.
Blended principal and interest payment
2.
Contingent Liabilities
3.
Present value
4.
Face value
5.
Market interest rate
6.
Premium (on a bond)
7.
Operating line of credit (credit facility)
8.
Notes payable
9.
Times interest earned ratio
10.
Coupon interest rate
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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MULTIPLE CHOICE QUIZ 1.
Liabilities are a. creditors’ claims on total assets. b. existing debts and obligations. c. obligations that must be settled or paid at some time in the future by the transfer of assets or services. d. all of the above
2.
Notes payable provide the lender with a. written documentation of the obligation. b. interest income. c. both a. and b d. none of the above
3.
Computer Services Inc. records sales on account of $850,000. Computer Services is subject to 13% HST. Which of the following would be the amount of HST payable? a. $42,500 b. $110,500 c. $850,000 d. $960,500
4.
When the coupon rate of interest exceeds the market rate of interest, the bond sells at a. face value. b. a discount. c. a premium. d. some amount other than those listed above.
5.
In North America, current liabilities are normally listed a. alphabetically. b. in order of liquidity. c. in order of magnitude. d. in order of maturity. e. none of the above
6.
The series of periodic payments made to repay non-current loans are referred to as a. instalments. b. principal payments. c. maturity payments. d. obligation payments.
7.
Secured notes a. have specific assets of the issuer pledged as collateral. b. are issued against the general credit of the borrower. c. can be converted into common shares at the debt holder’s option.
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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d. mature in instalments.
8.
A bond issued at a premium a. is issued by a corporation with an excellent credit rating. b. has a coupon rate of interest that exceeds the market rate. c. sells at a price in excess of the face amount of the bond. d. both b. and c. above e. both a. and c. above
9.
A $50,000, 4-month, 8% bank loan was signed on October 1, 2018. What is the amount of accrued interest on December 31, 2018, the company’s year-end, if interest is due at maturity? a. $333 b. $1,000 c. $1,333 d. $4,000
10.
Under IFRS, contingent liabilities must be accrued as liabilities if a. the company can determine a reasonable estimate of the debt. b. the amount is over $10,000. c. it is more likely than not that the company will suffer a loss. d. both a. and c. above
11.
Which of the following is indicative of the best solvency situation? a. a high asset turnover and return on assets b. a low debt to total assets and high times interest earned c. a low debt to total assets and high operating lease commitment d. a high times interest earned and an unused operating line of credit
12.
Which of the following statements is false? a. A floating interest rate changes as market rates change. b. Collateral is often required to protect banks from the company defaulting. c. Bank indebtedness is a non-current liability. d. An operating line of credit helps manage temporary cash shortfalls. e. none of the above
13.
Which of the following statements is false? a. Bond prices are quoted as a percentage of the face value of the bonds. b. Bonds can be converted into current liabilities. c. When the market interest rate is higher than the coupon rate, the bond sells at a discount. d. The effective-interest method allocates the bond premium to the interest expense over the life of the bond. e. none of the above
14.
On January 1, 2018, Hilton Inc. received a $100,000, 5%, 10-year bank loan. Payments are fixed principal payments plus interest, due on a semi-annual basis. What is the amount of the principal reduction?
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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a. $2,500 each semi-annual period b. $5,000 each semi-annual period c. $7,500 each semi-annual period d. $4,812 in 2018
15.
Which of the following statements is false? a. Non-current liabilities are usually reported separately. b. Non-current liabilities are reported following the current liabilities. c. Non-current liabilities are listed in the order of liquidity. d. Non-current liabilities are usually measured and reported at amortized cost. e. none of the above
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
d
2.
c
3.
b
4.
c
5.
b
6.
a
7.
a
8.
d
9.
b
10.
d
11.
b
12.
c
13.
b
14.
b
15.
c
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
An adjusted trial balance is prepared from the financial statements.
True
False
2.
Accrued revenues have been received but not yet earned.
True
False
3.
Payments of expenses that will benefit more than one accounting period are referred to as prepaid expenses.
True
False
4.
To close the Income Summary account when a company has a loss, debit the Income Summary account and credit the Retained Earnings account.
True
False
5.
The adjusting entry for unearned revenues results in a debit to an asset account and a credit to a revenue account.
True
False
6.
When the accrual basis of accounting is applied, adjusting entries are not necessary.
True
False
7.
Examples of accrued expenses are interest, rent, salaries, property taxes, and income taxes.
True
False
8.
Under IFRS, companies must prepare quarterly financial statements which means they must prepare adjusting entries quarterly.
True
False
9.
The adjusted trial balance shows the balances of all accounts at the end of the accounting period.
True
False
10.
After the closing entries have been posted, the balance in the shareholders’ equity account should equal the ending balance of the shareholders’ equity account as reported on the statement of financial position.
True
False
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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Multiple Choice 11.
The recording of salaries earned but not yet paid is an example of an adjustment that a. recognizes an accrued expense. b. recognizes an unrecorded revenue. c. allocates revenues between two or more periods. d. allocates estimated costs between two or more periods. e. none of the above
12.
A list of the accounts and their balances after all adjustments have been made is known as a(n) a. trial balance. b. adjusted trial balance. c. general ledger. d. statement of financial position. e. none of the above
13.
Prior to recording adjusting entries, revenues exceed expenses by $60,000. Adjusting entries for accrued salaries of $5,000 and depreciation expense of $5,000 were made. Net income for the year would be a. $60,000. b. $55,000. c. $50,000. d. $70,000. e. none of the above
14.
Revenue is not recorded in the accounting period when a. there is an increase in assets or a decrease in liabilities. b. the service has been performed or the goods have been sold and delivered. c. the revenue can be reliably measured and collection is reasonably certain. d. there is a decrease in assets or an increase in liabilities. e. none of the above
15.
A post-closing trial balance will a. be prepared before closing entries are posted to the ledger. b. contain both income statement and statement of financial position accounts. c. contain only statement of financial position accounts. d. contain only income statement accounts. e. none of the above
Quizzes
Chapter 10 – Reporting and Analyzing Liabilities
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ANSWERS TO 20-MINUTE QUIZ #1
True/False 1.
False
2.
False
3.
True
4.
False
5.
False
6.
False
7.
True
8.
True
9.
False
10. True
Multiple Choice 11.
a.
12.
b.
13.
c.
14.
d.
15.
c.
Quizzes
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20-MINUTE QUIZ #2 1. HR Plumbing Services Ltd. was hired by a customer in late December to provide plumbing services. The work was performed in January. The bill was sent to the customer in February. Payment in full was received from the customer in March. (a) In which month should the revenue be recognized by HR? (b) In which month should the expense be recognized by HR?
2.
Fill in the blanks in the following sentences using either before or after where appropriate: a. When unearned revenue exists, it is because the cash inflow occurs ______ the revenue is recognized. b. When accrued revenue exists, it is because the cash inflow occurs ______ the revenue is recognized. c. When a prepaid expense exists, it is because the cash outflow occurs ______ the expense is incurred. d. When an accrued expense exists, it is because the cash outflow occurs ______ the expense is incurred.
3.
Prepare year-end adjusting entries for each of the following: a. The Supplies account has a balance of $900. A physical count indicates that $350 of supplies are still on hand. Dec. 31
b. A $30,000 6-month 5% bank loan payable was signed November 1. Interest is payable at maturity. Record the interest that has accrued by December 31. Dec. 31
c. $12,000 was paid on August 1 for a one year insurance policy. The premium was charged to Prepaid Insurance on August 1. Record Insurance Expense for the year. Dec. 31
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Chapter 10 – Reporting and Analyzing Liabilities
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ANSWERS TO 20-MINUTE QUIZ #2 1. HR Plumbing Services Ltd. was hired by a customer in late December to provide plumbing services. The work was performed in January. The bill was sent to the customer in February. Payment in full was received from the customer in March. (a) In which month should the revenue be recognized by HR? (b) In which month should the expense be recognized by HR? (a) January (b) January
2.
Fill in the blanks in the following sentences using either before or after where appropriate: a. When unearned revenue exists, it is because the cash flow occurs before the revenue is recognized. b. When accrued revenue exists, it is because the cash flow occurs after the revenue is recognized. c. When a prepaid expense exists, it is because the cash flow occurs before the expense is incurred. d. When an accrued expense exists, it is because the cash flow occurs after the expense is incurred.
3.
Prepare year-end adjusting entries for each of the following: a. The Supplies account has a balance of $900. A physical count indicates that $350 of supplies are still on hand. Dec 31
Supplies Expense Supplies $900 – $350 = $550
550 550
b. A $30,000 6-month 5% bank loan payable was issued November 1. Interest is payable at maturity. Record the interest that has accrued by December 31. Dec 31
Interest Expense Interest Payable $30,000 x 5% x 2/12 = $250
250 250
c. $12,000 was paid on August 1 for a one year insurance policy. The premium was charged to Prepaid Insurance on August 1. Record Insurance Expense for the year. Dec. 31
Quizzes
Insurance Expense Prepaid Insurance $12,000 x 5/12 = $5,000
Chapter 10 – Reporting and Analyzing Liabilities
5,000 5,000
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CHAPTER 11 REPORTING AND ANALYZING SHAREHOLDERS’ EQUITY LEARNING OBJECTIVES 1.
Identify and discuss the major characteristics of a corporation.
2.
Record share transactions.
3.
Prepare the entries for cash dividends, stock dividends, and stock splits, and understand their financial impact.
4.
Indicate how shareholders’ equity is presented in the financial statements.
5.
Evaluate dividend and earnings performance.
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Chapter 11 – Reporting and Analyzing Shareholders’ Equity
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CHAPTER OUTLINE Learning Objective 1 – Identify and Discuss the Major Characteristics of a Corporation
Corporation ▪ legal entity ▪ created by law ▪ most of the rights and privileges of a person ▪ Ownership—publicly held or privately held • Public corporation—shares traded on organized stock exchange and may have thousands of shareholders. • Private corporation—shares not traded on organized stock exchange and may have only a few shareholders.
Teaching suggestion – discuss with students the fact that almost every person covered by an employee pension plan or holding mutual funds, has an indirect ownership in large corporations, such as Sears Canada and BCE. Teaching suggestion – Ask students to identify corporations operated for a profit (i.e. McDonald’s, Sears, Ford, etc.) Then ask them to identify corporations with objectives other than profit (i.e. Red Cross, United Way, Salvation Army, American Heart Association, etc.) If profit is not the purpose of these other corporations, then what is their goal?
Characteristics distinguishing corporations from proprietorships and partnerships: ▪ Separate legal existence • An entity separate and distinct from owners. • Acts under its own name rather than in the name of shareholders. • May buy, own, and sell property; borrow money; and enter into legally binding contracts; may sue or be sued; and pays its own income tax. • Owners (shareholders) cannot bind corporation unless owners are agents of the corporation. ▪ Limited liability of shareholders • Creditors have recourse only to corporate assets to satisfy claims. • Liability of shareholders limited to investment in corporation. • Creditors have no legal claim on personal assets of owners. • Creditors may demand a personal guarantee from a controlling shareholder, which enables the creditor to satisfy their claim with the shareholder’s assets. ▪ Transferable ownership rights • Ownership is evidenced by shares, which are transferable units. • In a public corporation, the transfer of shares is entirely up to the shareholder as no approval is needed, whereas private corporations may impose limitations on the sale or transfer of shares by shareholders. • Transfer of ownership rights between shareholders has no effect on a corporation’s financial position or on a corporation’s assets, liabilities, or shareholders’ equity. • The corporation does not participate in the transfer of ownership rights after the original sale of share capital.
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▪
▪
▪
▪
▪
Ability to acquire capital • Limited liability of shareholders coupled with transferable ownership rights make it easy for corporations to raise capital. • Only small amounts of money need be invested making shares attractive to many individuals. • Small private corporations can have difficult acquiring capital similar to proprietorships or partnerships. Continuous life • Corporations have an unlimited life. • A corporation is a separate legal entity, thus its continuance is not affected by withdrawal, death, or incapacity of a shareholder, employee, or officer. Corporation management • Shareholders manage a corporation indirectly through a board of directors, which they elect. • Board of directors formulates broad strategic objectives and selects officers to execute policy and to perform daily management functions. Government regulations • Canadian companies may be incorporated federally, under the terms of the Canada Business Corporations Act, or provincially under the terms of a provincial business corporations act. • Federal and provincial laws usually prescribe the requirements for issuing shares and reacquiring shares and distributing dividends. • Provincial securities regulations govern the sale of public company shares. • Complying with securities regulations increases the cost and complexity of reporting and disclosure requirements for the corporate form of organization. Income tax • With proprietorships and partnerships, the owner’s share of net income is reported on his or her personal income tax return. • Corporations, as separate legal entities, must pay federal and provincial income tax.
Teaching suggestion – Ask students to consider starting a business. Ask them what type organization—sole proprietorship, partnership, or corporation—they will choose for their hypothetical business. Why did they choose the type organization they chose? Prompt a discussion of the advantages and disadvantages of the corporate form of organization.
Share Issue Considerations ▪ The shares of a company are divided into different classes such as Class A and Class B. ▪ The rights and privileges for each class of shares are stated in the articles of incorporation. ▪ The classes are usually identified by the generic terms common shares and preferred shares.
Authorized Share Capital ▪ The number of authorized shares a corporation is authorized to sell is indicated in its articles of incorporation. It may be specified as an unlimited amount or a specific number. ▪ Most Canadian public companies have an unlimited number of authorized shares.
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▪
The authorization of share capital does not result in a journal entry because the event has no effect on either corporate assets or shareholders’ equity. The issue of the shares by the corporation results in a transaction that must be journalized and not the authorization of shares.
Issue of Shares ▪ The first time a corporation’s shares are offered to the public, the offer is called an initial public offering (IPO). The company receives the cash (less any financing or issue fees) from the sale of IPO shares. ▪ Once these shares have been initially issued, they continue trading on the secondary market. Investors buy and sell shares from each other, rather than from the company.
Teaching suggestion – Help students understand why a company’s shares traded on the secondary market do not have a direct impact on the company’s financial position.
Fair Value of Shares ▪ After the initial issue of new shares, the subsequent market price per share is established by the interaction between buyers and sellers. ▪ Generally, the price follows the trend of a company’s net income and dividends. ▪ For each listed security, the financial press reports: • the highest and lowest prices for the year, • the annual dividend rate, • the high and low prices for the day, • the net change over the previous day. ▪ The total volume of shares traded on a particular day, the dividend yield, and the priceearnings ratio are also reported. ▪ A commonly reported measure of fair value of a company’s total equity is its market capitalization. The market capitalization of a company is calculated by multiplying the number of shares issued by the share price at any given date.
Legal Capital ▪ Retained earnings can be distributed to the shareholders as dividends or retained in the company for operating needs. ▪ Share capital is legal capital that cannot be distributed to the shareholders. ▪ No par value shares are shares that have not been assigned a predetermined value, and all of the proceeds received upon issue of the shares are considered to be legal capital that must remain invested in the company for the protection of corporate ▪ creditors.
Learning Objective 2 – Record Share Transactions
Contributed Capital ▪ Contributed capital is the amount contributed to the corporation by shareholders in exchange for shares of ownership. ▪ Share capital can consist of both common shares and preferred shares. ▪ Contributed capital can also include other sources of capital as a result of share transactions known as contributed surplus.
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Common Shares ▪ When the issue of common shares for cash is recorded, all of the proceeds received upon issue are considered to be legal capital and this amount is credited to Common Shares. ▪ Assume Hydro-Slide, Inc., issues 1,000 common shares for cash at $5 per share. The entry to record the transaction is: Cash ...................................................... 5,000 Common Shares........................... 5,000 (To record issue of 1,000 common shares) ▪ ▪
Common shares are commonly issued for cash, but may also be issued for other considerations (for example, services or noncash assets such as land, building, or equipment). When shares are issued for a noncash consideration, they should be recorded at the fair value of the consideration received. If the fair value of the consideration received cannot be reliably determined, the fair value of the consideration given up is used.
ASPE comparison – Under IFRS, when shares are issues for noncash consideration, they are recorded at the fair value of the consideration received. If the fair value of consideration received cannot be reliably measured, then the fair value of the consideration given up would be used instead. Under ASPE, when shares are issued for noncash consideration, they should be recorded at the more reliable of the two values – the fair value of the consideration received or the fair value of the consideration given up. Note that it is often difficult to establish the fair value of the shares given up in a private company.
Reacquisition of Shares ▪ Companies can purchase their own shares on the open (secondary) market. A corporation may acquire its own shares to: • increase trading of company’s shares in the securities market in the hope of enhancing the company’s market value; • reduce the number of shares issued and thereby increase basic earnings per share and return on equity; • have additional shares available to reissue to officers and employees under stock compensation plans; • eliminate hostile shareholders by buying them out. ▪ ▪ ▪
The reacquisition of shares is often called normal course issuer bid where a company is allowed to repurchase up to a certain percentage of its shares subject to regulatory approval. When a federally incorporated company reacquires its own shares, the repurchased shares must be retired and cancelled. If the shares are not retired and cancelled they are considered treasury shares. Treasury shares are rare in Canada.
Preferred Shares ▪ Preferred shares may also be issued in addition to common shares. ▪ They may be issued for cash or for noncash consideration and the entries for these transactions are similar to the entries for common shares. ▪ Dividend preference is a contractual preference that gives preferred shareholders the right to share in the distribution of dividends before common shareholders do.
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▪ ▪ ▪ ▪
This preference does not guarantee dividends. A cumulative dividend feature means the preferred shareholders must be paid both the current-year dividend and all unpaid prior-year dividends before the common shareholders receive dividends. Any dividend that is not declared on noncumulative preferred shares in any given year is lost forever. When preferred shares are cumulative, preferred dividends that are not declared in a period are called dividends in arrears. They are not considered a liability. • To illustrate dividends in arrears, assume that Scientific Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding. The annual dividend is $35,000 (5,000 shares x $100 per share X 7%). If dividends are two years in arrears, preferred stockholders are entitled to receive dividends of $105,000 shown below before any distribution may be made to common stockholders. Dividends in arrears ($35,000 x 2 years) ................ $ 70,000 Current-year dividends ........................................... 35,000 Total preferred dividends ........................................ $105,000
▪ ▪ ▪ ▪
A liquidity preference gives preferred shareholders priority over common shareholders in the distribution of corporate assets if the corporation fails or liquidates. Convertible preferred shares allow the exchange of preferred shares for common shares at a specified ratio. Redeemable (or callable) preferred shares give the issuing corporation the right to purchase the shares from the shareholders at specified dates and prices. Retractable preferred shares are similar to redeemable shares, except that it is at the shareholder’s option.
Learning Objective 3 – Prepare the Entries for Cash Dividends, Stock Dividends, and Stock Splits, and Understand Their Financial Impact
A dividend is a distribution of retained earnings by a corporation to its shareholders on a pro rata basis.
Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend.
Cash dividends are the most common in practice, but stock splits also occur frequently.
Cash dividends are the distribution of cash to shareholders. For a corporation to pay a cash dividend, it must meet a two-part solvency test and be declared by the board of directors: ▪ Sufficient cash resources. It must have sufficient cash or other resources to be able to pay its liabilities as they come due after the dividend is declared and paid. ▪ Asset value. The net realizable value of its assets must exceed the total of its liabilities and share capital.
The board of directors approves the dividend to be paid
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Entries for cash dividends – Three dates are important in connection with dividends: ▪ The declaration date • The declaration date is the date the board of directors formally authorizes the dividend and announces it to shareholders. • The declaration of a cash dividend commits the corporation to a binding legal obligation that cannot be rescinded. • An entry is required to recognize the increase in Dividends Declared (which results in a decrease in Retained Earnings) and the increase in the liability Dividends Payable. • Assume that on December 15, 2018, the directors of IBR Inc. declare a $0.75 per share cash dividend on 50,000 common shares. The dividend is $37,500 (50,000 x $0.75), and the entry to record the declaration is: Dec 15 Dividends Declared 37,500 Dividends Payable 37,500 (To record declaration of cash dividend) ▪
The record date • The record date marks the time when ownership of the shares is determined for dividend purposes. • The purpose of the record date is to identify the persons or entities that will receive the dividend, not to determine the amount of the dividend liability. • No entry is required on the record date.
▪
The payment date • On the payment date, dividend are paid to the shareholders and the payment of the dividend is recorded. • The entry on the January 30 payment date is: Jan 30 Dividends Payable .................................. 37,500 Cash .............................................. 37,500 (To record payment of cash dividend)
A stock dividend is a distribution of the corporation’s own shares to shareholders. A stock dividend is distributed in shares.
A stock dividend results in a decrease in retained earnings and an increase in share capital.
A stock dividend does not change assets, liabilities, or total shareholders’ equity. ▪ To illustrate a stock dividend, assume that you have a 2% ownership interest in Cetus Inc., owning 20 of its 1,000 shares of common stock. In a 10% stock dividend, 100 shares (1,000 x 10%) of stock would be issued. You would receive two shares (2% x 100), but your ownership interest would remain at 2% (22/1,100). You now own more shares of stock, but your ownership interest has not changed.
Stock dividends are generally issued ▪ to satisfy shareholders’ dividend expectations while conserving cash. ▪ to increase the marketability of shares. ▪ to emphasize that a portion of shareholders’ equity has been permanently reinvested in the legal capital of the business and is unavailable for dividends.
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Stock dividends are recorded using the market (fair) value per share at the declaration date because this is what the corporation would have paid if the shares had been issued for cash rather than a stock dividend.
To illustrate a stock dividend, assume that on December 15, the directors of IBR Inc. declares a 10% stock dividend on its 50,000 common shares, to be distributed on January 20 (instead of the cash dividend). On December 15, the market value of its shares is $10 per share. The number of shares issued is 5,000 (50,000 x 10%) and the amount debited to Dividends Declared is $50,000 (5,000 x $10), and the entry to record the declaration of the stock dividend is: Dec 15 Dividends Declared.......................................... 50,000 Stock Dividends Distributable ................. 50,000 (To record declaration of 10% share dividend)
Teaching suggestion – Remind students that it is the market value at the declaration date that is used to determine the value of the stock dividend and not at the record or distribution date.
Stock Dividends Distributable is a shareholders’ equity account; it is not a liability account because assets will not be used to pay the dividend.
If a statement of financial position is prepared before the dividend shares are issued, the distributable account is reported in the share capital category in the shareholders’ equity section of the statement of financial position.
When the dividend shares are issued on January 20, Stock Dividends Distributable is decreased and Common Shares is increased as follows: Jan 20 Stock Dividends Distributable .......................... 50,000 Common Shares..................................... 50,000 (To record issue of 5,000 common shares in a 10% stock dividend)
Although total shareholders’ equity remains the same, a share dividend changes the composition of shareholders’ equity because a portion of retained earnings is transferred to share capital.
Assume that IBR has common shares of $250,000 and retained earnings of $150,000 before the stock dividend. The effects of IBR’s share dividend are shown as follows: Before After Stock Dividend Stock Dividend Shareholders’ equity Common shares $250,000 $300,000 Retained earnings 150,000 100,000 Total shareholders’ equity $400,000 $400,000 Number of shares
50,000
55,000
Stock Splits ▪ A stock split is very much like a stock dividend in that it involves the issue of additional shares to shareholders according to their percentage ownership. ▪ However, a stock split is usually much larger than a stock dividend.
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Chapter 11 – Reporting and Analyzing Shareholders’ Equity
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▪ ▪ ▪
The purpose of a stock split is to increase the marketability of the shares by lowering the share price. In a stock split, the share price is generally inversely proportional to the size of the split (that is, in a 2-for-1 split, the number of shares will double and the share price will halve). A stock split does not have any effect on total share capital, retained earnings, and total shareholders’ equity. However, the number of shares increases.
Assume that instead of issuing a 10% share dividend, IBR splits its 50,000 common shares on a 2-for-1 basis. The effects of IBR’s stock split are shown as follows: Before After Share Split Share Split Shareholders’ equity Common shares $250,000 $250,000 Retained earnings 150,000 150,000 Total shareholders’ equity $400,000 $400,000 Number of shares
50,000
100,000
Because a stock split does not affect the balances in shareholders’ equity accounts, it is not necessary to journalize a stock split.
Teaching suggestion – Discuss the differences between cash dividends, stock dividends and stock splits for a corporation and for an individual by reviewing Illustration 11-2.
Learning Objective 4 – Indicate how Shareholders’ Equity Is Presented in the Financial Statements
Statement of Financial Position Presentation ▪ In the shareholders’ equity section of the statement of financial position, contributed capital, retained earnings, and accumulated other comprehensive income are reported.
Within contributed capital, two classifications are recognized: ▪ Share Capital – consists of preferred and common shares. • Preferred shares are shown before common shares because of their additional rights. • Information about the legal capital, number of shares authorized, number of shares issued and amount received for them, and any particular share preferences is reported for each class of shares. • Any stock dividends distributable that exist at year end are also reported under share capital. ▪ Contributed Surplus includes excess received from reacquiring and retiring shares at an amount less than they were originally issued at..
Retained Earnings in the statement of financial position are derived from the statement of retained earnings. ▪ Retained earnings are the cumulative net income (or net losses) since incorporation
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▪ ▪ ▪ ▪
that have been retained in the company. Any dividends declared are deducted from opening retained earnings. The normal balance is a credit, but if a deficit (debit balance) exists it is reported as a deduction from shareholders’ equity. A retained earnings restriction makes a portion of the balance in the retained earnings account unavailable for dividends. No journal entry is needed to record a retained earnings restriction. The notes to the financial statements are required to explain any restricted retained earnings.
Accumulated Other Comprehensive Income (IFRS) includes the gains and losses that bypass net income but affect shareholders’ equity. ▪ Comprehensive income includes the revenues, expenses, gains, and losses included in net income and gains and losses that are reported in OCI. ▪ Accumulated other comprehensive income (AOCI) starts with the balance at the beginning of the period and is increased by other comprehensive income and decreased by other comprehensive losses during the period, to arrive at the ending balance. ▪ Only companies using IFRS have to report other comprehensive income. Not all companies will have examples of other comprehensive income. However, if they do, they must report comprehensive income in a statement of comprehensive income, and accumulated other comprehensive income in the statement of changes in equity and the shareholders’ equity section of the statement of financial position.
ASPE comparison – Under IFRS, companies must present accumulated other comprehensive income in the statement of financial position and detail changes in other comprehensive income in the statement of changes in equity. Under ASPE, comprehensive income is not required nor reported. Teaching suggestion – Go through each section of the shareholders’ equity section on Leon’s partial statement of financial position in Illustration 11-4.
Statement of Changes in Equity (IFRS) ▪ This statement discloses changes in total shareholders’ equity for the period, as well as changes in each individual shareholders’ equity account, including share capital, contributed surplus, retained earnings, and accumulated other comprehensive income.
ASPE comparison – Under IFRS, changes in shareholders’ equity accounts are presented in a statement of changes in equity. Under ASPE, changes in retained earnings are presented in a statement of retained earnings. Changes in share capital and other accounts are presented in the notes to the financial statements. Help students understand why this distinction exists. Teaching suggestion – Go through each section of the statement of changes in equity for Leon’s in Illustration 11-5.
Statement of Retained Earnings (ASPE) ▪ This statement can be prepared as a separate statement or combined with the income statement. ▪ This statement shows the amounts and causes of changes in retained earnings during
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Chapter 11 – Reporting and Analyzing Shareholders’ Equity
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▪ ▪
the period. Prepared after the income statement is prepared, as net income is a key component of retained earnings. In contrast to the statement of changes in equity, which shows the amounts and causes of changes in each of the shareholders’ equity accounts, the statement of retained earnings shows only the changes in the Retained Earnings account.
Teaching suggestion – Go through the statement of retained earnings for Graber Inc. in Illustration 11-6. Ask students to discuss the key differences between the statement of retained earnings for Graber Inc. and the statement of equity for Leon’s.
Learning Objective 5 – Evaluate Dividend and Earnings Performance
Dividend Record ▪ One way that companies reward share investors for their investment is to pay them dividends. ▪ The payout ratio measures the percentage of net income distributed in the form of cash dividends to common shareholders. It is calculated by dividing total cash dividends declared to common shareholders by net income. PAYOUT RATIO = CASH DIVIDENDS DECLARED NET INCOME ▪ ▪
Another ratio that interests investors is the dividend yield. The dividend yield is calculated by dividing dividends declared per share by the market price per share. DIVIDEND YIELD = __DIVIDEND DECLARED PER SHARE__ MARKET PRICE PER SHARE
Earnings Performance ▪ Basic earnings per share BASIC EARNINGS PER SHARE = INCOME AVAILABLE TO COMMON SHAREHOLDERS* WEIGHTED AVERAGE NUMBER OF COMMON SHARES *INCOME AVAILABLE TO COMMON SHAREHOLDERS = NET INCOME – PREFERRED SHARE DIVIDENDS ▪
▪
Income available to common shareholders is calculated by subtracting any preferred dividends from profit because preferred shareholders have preferential rights to receive these dividends before the common shareholders can share in any remaining amounts. The weighted average number of common shares considers the impact of shares issued at different times throughout the year. The weighted average number of common shares is calculated by multiplying the number of shares issued by the
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Chapter 11 – Reporting and Analyzing Shareholders’ Equity
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▪
fraction of the year that they have been issued. When a corporation has securities that may be converted into common shares, it has a complex capital structure. Companies with a complex capital structure must report basic earnings per share and diluted earnings per share.
ASPE comparison – Under IFRS, basic earnings per share (EPS) is required to be presented in the financial statements, however ASPE does not require EPS to be included in the financial statements. Help students understand why this is the case. ▪ ▪ ▪
The return on common shareholders’ equity is a widely used ratio that measures profitability from the common shareholders’ viewpoint. It is calculated by dividing income available to common shareholders by average common shareholders’ equity. Income available to the common shareholders is net income less any preferred dividends. RETURN ON COMMON SHAREHOLDERS’ EQUITY** = INCOME AVAILABLE TO COMMON SHAREHOLDERS AVERAGE COMMON SHAREHOLDERS’ EQUITY **RETURN ON COMMON SHAREHOLDERS EQUITY = NET INCOME – PREFERRED SHARE DIVIDENDS
▪ ▪ ▪ ▪ ▪ ▪
When a company has liabilities and is using these to finance a portion of newly acquired assets, it is using leverage. Due to leverage, interest expense will rise. If the newly acquired assets improved profitability despite the higher interest expense, then the increased net income will cause a larger increase in the return on common shareholders’ equity than the increase in the return on assets. As long as the return on assets exceeds the interest rate paid on debt, a company can increase its return on shareholders’ equity by using leverage. Advantage of debt financing: • The ownership interests remain the same. There is no dilution by new equity. • Interest is tax deductible. Dividends paid are not. Disadvantage of debt financing: • Interest payments are legally binding. Dividends are discretionary. • Principal portions must be paid back. Share proceeds do not need to be returned until the company is liquidated.
Instructor’s Manual
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Why can the separation of ownership and management be viewed as both an advantage and a weakness?
Should dividends in arrears be recorded as an obligation since the company technically needs to pay this amount to preferred shareholders? If not, wouldn’t this be inconsistent with other forms of liabilities?
A friend wants to acquire equipment for her private business but she is unsure whether she should buy the equipment directly with proceeds from the issue of shares or whether she should issue shares in exchange for the equipment. You have been asked to explain to her the difference between the transactions and recommend the most appropriate course of action.
A friend is thinking of starting up a new business near the university campus. She plans on opening up a full service copying and printing outlet that offers competitive rates to the students. She is a recent graduate and knows that the university has been overcharging students. She feels that her business will be very profitable in the near future. What advice would you provide related to what type of structure should be used for the business?
If you owned shares, would you rather have a cash or stock dividend issued and why?
What factors influence share prices? Why do some shares continually fluctuate in value?
If you were buying shares would you want to quickly sell them if the value improved or would you hold onto the shares for a long period of time? Why?
If you owned a company, under what conditions would you want the company to buy back its own shares?
If you needed to raise money for your business would you try to get a loan from the bank or would you issue shares? What are the challenges you may encounter from each option?
Instructor’s Manual
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 13
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 11 REPORTING AND ANALYZING SHAREHOLDERS’ EQUITY 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
Entries for cash dividends are required on the a. declaration date and payment date. b. declaration date and record date. c. declaration date, record date, and payment date. d. record date and payment date. Answer: a
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 1
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
VOCABULARY QUIZ 1.
Net income retained in the business.
2.
The amount per share that must be retained in the business for the protection of corporate creditors.
3.
A type of share capital that has contractual preferences over common shares in certain areas.
4.
A corporation that may have thousands of shareholders and whose shares are regularly traded on a securities exchange market.
5.
The amount of share capital that a corporation is authorized to sell.
6.
Dividends that were not declared on cumulative preferred shares during a period.
7.
Gains and losses that bypass net income but affect shareholders’ equity.
8.
The issue of additional shares to shareholders accompanied by a reduction in the legal capital per share.
9.
The date when ownership of shares is determined for dividend purposes.
10.
A statement that summarizes the changes in each shareholders’ equity account during the period.
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 2
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO VOCABULARY QUIZ 1.
Retained earnings
2.
Legal capital
3.
Preferred shares
4.
Public corporation
5.
Authorized shares
6.
Dividends in arrears
7.
Accumulated other comprehensive income
8.
Stock split
9.
Record date
10. Statement of changes in equity
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 3
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
MULTIPLE CHOICE QUIZ 1.
All the following are true about a corporation except that it a. must abide by the laws. b. is a legal entity. c. has the right to vote. d. must pay income tax. e. none of the above
2.
Which of the following is considered a disadvantage of the corporate form of business organization? a. limited liability of shareholders b. federal and provincial government regulation c. continuous life d. separate legal existence e. b and c above f. b, c, and d above
3.
All of the following classifications are reported in a statement of changes in equity except a. number of shares. b. common shares. c. accumulated other comprehensive income. d. financing activities. e. none of the above
4.
In order to pay a dividend a. the corporation must have adequate cash resources. b. the board of directors must declare a dividend. c. the net realizable value of the corporation’s assets must exceed its liabilities and share capital. d. all of the above e. none of the above
5.
Dividends can take the following forms a. cash. b. stock. c. stock split. d. both a and b e. a, b, and c above
6.
The board of directors commits the corporation to a binding legal obligation that cannot be rescinded on a. the declaration date.
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 4
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
b. the date of record. c. the date of payment. d. none of the above
7.
A stock dividend results in a. a decrease in retained earnings. b. an increase in share capital. c. a decrease in shareholder’s equity and total assets. d. both a and b above e. a, b, and c above
8.
Upon receiving a stock dividend a. you own more shares. b. your ownership interest has increased. c. your ownership interest has not changed. d. both a and c above e. both a and b above
9.
Corporations issue stock dividends a. to satisfy shareholders’ dividend expectations without spending cash. b. to increase the marketability of its shares by increasing the number of shares and thereby decreasing the market price per share. c. to emphasize that a portion of shareholders’ equity has been permanently reinvested in the business and therefore is unavailable for cash dividends. d. all of the above e. both a and c above
10.
When a company repurchases some of its own shares on the open market, it could accomplish all of the following objectives except a. increase trading of the company’s shares in the hopes of enhancing its market value. b. making additional shares available to reissue to employees under bonus and share compensation plans. c. eliminates potentially hostile shareholders by buying them out. d. lowering earnings per share. e. a and d above f. a and c above
11.
Which of the following statements is incorrect? a. Preferred shares have contractual provisions that give them preference over common shares. b. Preferred shares can be issued for cash or noncash considerations. c. Preferred shares have the right to share in the distribution of dividends before common shareholders. d. Cash dividends on preferred shares are a legal obligation for the company whether it has sufficient cash or not.
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 5
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
e.
none of the above
12.
The payout ratio is calculated by a. dividing cash dividends declared by net income. b. dividing dividend per share by the market price per share. c. dividing income available to common shareholders by the weighted average number of common shares. d. dividing income available to common shareholders by average common shareholders’ equity. e. none of the above
13.
Which of the following statements is incorrect related to basic earnings per share? a. Basic earnings per share are not required for companies utilizing ASPE. b. Basic earnings per share are presented in the income statement by publiclytraded companies. c. Basic earnings per share is calculated by dividing income available to common shareholders by the weighted average number of common shares. d. A lower basic earnings per share measure suggests improved performance. e. both a and d above f both b and c above
14.
Which of the following statements is incorrect? a. The statement of changes in equity discloses changes in total shareholders’ equity for the period. b. The statement of changes in equity is a required statement under IFRS. c. Net income increases retained earnings. d. The statement of retained earnings is not required under ASPE. e. both a and b above f. both b and d above
15.
Which of the following statements is incorrect? a. Dividends in arrears are not recorded but rather are reported in the notes to the financial statements. b. Investors wishing to earn income prefer a low dividend yield and payout ratio. c. The distinction between debt and equity is not clear with retractable preferred shares. d. Preferred shareholders have liquidation preferences. e. b and c above f. a and d above
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 6
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO MULTIPLE CHOICE QUIZ 1.
c
2.
b
3.
d
4.
d
5.
d
6.
a
7.
d
8.
d
9.
d
10.
d
11.
d
12.
a
13.
d
14.
d
15.
b
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 7
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1. Limited liability is a disadvantage of the corporate form of organization.
True
False
2.
Stock dividends declared reduce retained earnings and shareholders’ equity in total.
True
False
3.
Stock splits are not recorded in a journal entry.
True
False
4.
When calculating basic earnings per share, the current year’s dividend declared on preferred shares is subtracted from net income.
True
False
5.
Proprietorships, partnerships, and corporations do not pay income tax as separate entities.
True
False
6.
The payout ratio is calculated by dividing total cash Dividends declared by net income.
True
False
7.
Common shares have contractual provisions that give them preference, or priority, over preferred shares in certain areas.
True
False
8.
The statement of changes in equity shows the changes in total shareholders’ equity during the year as well as each shareholders’ equity account, such as accumulated other comprehensive income.
True
False
9.
Companies following ASPE need to prepare a statement of comprehensive income.
True
False
10.
Under IFRS when shares are issued for noncash consideration, they should be recorded at the fair value of the consideration received.
True
False
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 8
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
Multiple Choice 11.
A company had 50,000 common shares. During the period, a 10% stock dividend was declared and distributed. The market value was $25 a share. As a result of this stock dividend, retained earnings should increase (decrease) by a. $50,000. b. $(50,000). c. $125,000. d. $(125,000). e. $5,000. f $(5,000).
12.
Dawson Corporation reported net income of $120,000. Dawson paid $20,000 in dividends to the preferred shareholders and $40,000 in dividends to the common shareholders. Dawson had 15,000 preferred shares and 50,000 common shares issued all year. Basic earnings per share is a. $1.20. b. $2.00. c. $1.85. d. $2.40. e. none of the above
13.
Preferred shares are least likely to have which characteristic? a. the right of the holder to vote at shareholders’ meetings b. the right of the corporation to redeem or retire the shares c. preference as to assets upon liquidation of the corporation d. preference as to dividends e. both a and c f. both b and d
14.
All of the following items are characteristics of a corporation except a. separate legal existence. b. transferable ownership rights. c. limited life. d. ability to acquire capital. e. none of the above
15.
A statement of changes in equity a. must be prepared for companies following ASPE. b. includes the changes to contributed surplus, retained earnings, and accumulated other comprehensive income. c. is optional under IFRS. d. replaces the statement of comprehensive income. e. a and d above f. b and c above
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 9
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
False
2.
False
3.
True
4.
True
5.
False
6. True 7. False 8. True 9. False 10. True
Multiple Choice 11.
d (50,000 x 10% x $25)
12.
b ({$120,000 – $20,000} ÷ 50,000)
13.
a
14.
c
15.
b
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Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 10
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #2 1.
What are 2 reasons that a corporation may reacquire its own shares?
2.
On June 1, Baker Corporation issued 1,000 of its preferred shares in exchange for land valued at $50,000. Baker’s shares are not widely held or regularly traded. Four years ago, 500 preferred shares were issued for $35 a share. Prepare the journal entry.
3.
On April 12, Hobson Corporation declared a quarterly dividend of $0.05 per share on its 200,000 common shares. The dividend will be paid on Apr 29, to the shareholders of record on April 19. Prepare the journal entry necessary for each date.
4.
On July 1, when there were 220,000 shares issued, Marvo Corporation declared a 5% stock dividend on its common shares. The dividend will be distributed on July 31 to the shareholders of record on July 15. Marvo shares were trading at $18.00 on July 1, $17.50 on July 15, and $17.20 on July 31. Prepare the journal entry necessary for each date.
Quizzes
Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 11
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #2 1.
A public corporation may acquire its own shares for any of the following reasons: a. To increase trading of the company’s shares in the securities market in the hope of increasing the company’s fair value. b. To reduce the number of shares issued, which will increase earnings per share. c. To eliminate hostile shareholders by buying them out. d. To have additional shares available so that they can be reissued to officers and employees through bonus and stock compensation plans, or can be used to acquire other companies.
2. Jun 1
Land ...................................................................................... Preferred Shares............................................................. To record 1,000 preferred shares in exchange for land
50,000 50,000
3. Apr 12 Dividends Declared ................................................................ Dividends Payable .......................................................... 200,000 x $0.05 To record declaration of cash divided
10,000 10,000
Apr 19 No entry required. Apr 29 Dividends Payable ................................................................. Cash ............................................................................... To record payment of cash dividend 4. Jul 1
Dividends Declared ................................................................ Stock Dividends Distributable.......................................... 220,000 x 5% x $18 (fair value on declaration date) To record declaration of 5% share dividend
10,000 10,000
198,000 198,000
Jul 15
No entry required.
Jul 31
Stock Dividends Distributable ................................................ 198,000 Common Shares ............................................................. 198,000 To record issue of 11,000 common shares in a 5% stock dividend
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Chapter 11 – Reporting and Analyzing Shareholders’ Equity
11 - 12
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 12 REPORTING AND ANALYZING INVESTMENTS LEARNING OBJECTIVES 1.
Identify reasons to invest, and classify investments.
2.
Account for non-strategic investments.
3.
Account for strategic investments.
4.
Explain how investments are reported in the financial statements.
5.
Compare the accounting for a bond investment and a bond payable (Appendix 12A).
Instructor’s Manual
Chapter 12 – Reporting and Analyzing Investments
12 - 1
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER OUTLINE Learning Objective 1 – Identify Reasons to Invest, and Classify Investments Corporations generally purchase debt or equity investments. Debt investments are made by purchasing low-risk guaranteed investment certificates or term deposits, as well as investments in bonds, commercial paper, and a large variety of other debt securities available for purchase. Equity investments are investments made by buying common or preferred shares of another corporation in the expectation of generating revenue from dividends or earning a gain on future sale.
Investments may be made for two reasons: ▪ A non-strategic investment as a way of generating investment income such as interest, dividends, or gains upon sale of the investment. ▪ A strategic investment to influence or control the operations of another company.
Non-strategic investments There are several reasons that a company purchases debt or equity securities as a non-strategic investment, which includes: First, a corporation may have excess cash which it does not need immediately. Excess cash is often invested to earn, through interest and dividends, a greater return that would be earned from holding funds in the company’s chequing account. ▪ Companies experiencing seasonal fluctuations in sales often have excess cash at the end of an operating cycle. ▪ When investing excess cash for short periods, companies generally invest in debt securities, which have low risk and high liquidity.
Second, some companies generate earnings from investment income. ▪ Companies buy preferred shares of other companies that have stable dividends in order to generate dividends. ▪ They can also invest in debt and equity securities hoping the investment will increase in value resulting in a gain when sold. ▪ Non-strategic investments that are held for the purpose of earning capital gains are called held-for-trading investments.
Non-strategic investments can be classified as short-term investments or long-term investments depending on how liquid the investment is and how long management wants to hold the investment.
Strategic investments
While debt or equity securities can be purchased as non-strategic investments, only equity securities can be purchased as strategic investments.
Instructor’s Manual
Chapter 12 – Reporting and Analyzing Investments
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Equity securities (normally common shares) can be purchased for the strategic purpose of influencing relationships between companies.
Strategic investments are always classified as non-current assets as management has no intention of selling them.
Learning Objective 2 – Account for Non-Strategic Investments
At acquisition, debt and equity investments are recorded at their purchase cost.
There are four major models that are used for valuing investments. ▪ Fair value through profit or loss model requires that the investment be adjusted upwards or downwards to reflect its fair value at the end of the accounting period. The difference between carrying amount and fair value is called an unrealized gain or loss. It is recorded in the income statement along with any interest or dividend revenue. When the investment is sold, any resulting gain or loss is known as a realized gain or loss and is also shown in the income statement. ▪ Fair value through other comprehensive income (OCI) model requires that the investment be adjusted upwards or downwards to reflect its fair value at the end of the accounting period but instead of the difference between carrying amount and fair value being recorded in the income statement, it is recorded in other comprehensive income. This model can be used for both debt and equity investments. Realized gains and losses for debt investments are recorded in the income statement, but for equity investments, they are recorded in other comprehensive income. ▪ Amortized cost model requires that the carrying amount of the investment not be adjusted to reflect fair value unless it is impaired. No unrealized gains and losses are recorded. “Amortized” is used if the investment was purchased at a discount or a premium as is often the case when purchasing bond investments. The discount or premium would be amortized over the period of time until the bond matures. This model only applies to debt investments. ▪ Cost model (cost method) is similar to the amortized cost model except that it is used for equity investments. The concept of amortization does not apply to this model. Investment revenue from dividends along with realized gains and losses are reported in the income statement.
Fair Value Model Through Profit or Loss ▪ Investments are valued at their fair value. ▪ An unrealized gain is recorded rather than a realized gain because the investment has not actually been sold and the gain “realized.” ▪ Assume that on December 31, 2018, ACE Corporation has the following cost and fair values:
Held-for-Trading Investments
Cost
Fair Value
ABC shares XYZ bonds Total
$ 250,000 100,000 $350,000
$ 225,000 140,000 $365,000
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Chapter 12 – Reporting and Analyzing Investments
Unrealized Gain (Loss) ($25,000) 40,000 $15,000
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▪
ACE has an unrealized gain of $15,000 because the total fair value ($365,000) is $15,000 greater that the total cost ($350,000). The year end adjusting entry for Plano is: Dec 31 Held-for-Trading Investments........................... 15,000 Unrealized Gain on Held-for-Trading Investments 15,000 (To record unrealized gain of $15,000 on XYZ bonds and unrealized loss on ABC shares)
▪
This journal entry combines the ABC and XYZ bonds into a single Held-for-Trading Investments account but a subsidiary ledger containing the details of the individual investments would be maintained. If in January ACE sells its ABC shares for $225,000, the following journal entry would be recorded: Jan 15 Cash ................................................................ 225,000 Held-for-Trading Investments ................. 225,000 (To record sale of ABC shares)
▪
▪ ▪ ▪
The ABC shares originally cost $250,000, but they were written down to their fair value of $225,000 on December 31; the new carrying amount is $225,000. Consequently, the investment account is credited for that amount and no realized gain or loss is recorded. Although it could be argued that the $25,000 unrealized gain recorded in the prior year has now been realized, for simplicity we do not reclassify an unrealized gain from one period into a realized gain in another period as there is no impact on the net income. Instead, if in January ACE sells its ABC shares for $200,000 instead of the $225000, the following journal entry would be recorded: Jan 5 Cash ................................................................ 200,000 Realized Loss on Held-for-Trading Investments 25,000 Held-for-Trading Investments ................. 225,000 (To record a realized loss on ABC shares)
Fair Value through Other Comprehensive Income ▪ Unrealized gains and losses are not recorded in the income statement but are instead recorded in other comprehensive income. ▪ If management does not place a great deal of importance on measuring gains and losses because they are not intending to trade the investments frequently or use them to evaluate management, it may not make much sense to record these gains and losses in the income statement. In this case, they are recorded in other comprehensive income. When the investment is sold, any realized gain or loss arising from the sale is also recorded in comprehensive income. If the investment sold is a debt investment, the realized gain or loss is recorded in the income statement not in other comprehensive income. ▪ Companies are allowed to make an election to use fair value through OCI model on an investment-by-investment basis. Once an investment is accounted for under this approach, it cannot be changed.
Learning Objective 3 – Account for Strategic Investments
An investor is the company that purchases (owns) securities.
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Chapter 12 – Reporting and Analyzing Investments
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An investee is the company that issues (sells) the securities.
An investor that owns common shares has the potential to strategically influence the investee. The accounting for equity investments in common shares is based on how much influence the investor has over the investee’s operating, investing, and financial affairs.
The accounting for equity investments in common shares are as follows: ▪ Holdings of less than 20% • In accounting for equity investments of less than 20%, one of the fair value methods are used (fair value through profit or loss or fair value through OCI). The influence on the investee is presumed to be insignificant. ▪ Holding of 20% to 50% • In accounting for equity investments of 20% or more but does not have control, the equity method is used. The influence on the investee is presumed to be significant. • When an investee can be significantly influenced it is known as an associate. ▪ Holding of more than 50% • In accounting for equity investments of more than 50%, consolidation is used. The investor is presumed to control the investee. • The investee is a subsidiary company. • The investor is referred to the parent company. • The financial statements of all entities within the group are combined together resulting in consolidated financial statements.
Among the questions that should be considered in determining an investor’s influence are whether: (1) the investor has representation on the investee’s board of directors, (2) the investor participates in the investee’s policy-making process, (3) there are material transactions between the investor and the investee, (4) the investor and investee are exchanging managerial personnel, and (5) the investor is providing key technical information to the investee.
Equity Method ▪ Under the equity method, the investment is initially recorded at cost in the “Investments in Associates” account. ▪ The investment account is adjusted annually to show how the investor’s equity in the associate has changed. ▪ Each year, the investor: • (1) increases (debits) the investment account and increases (credits) revenue for its share of the associate’s net income and • (2) decreases (credits) the investment account and increases (debits) cash for the amount of dividends received. ▪ The investment account is reduced for dividends received because the net assets of the associate are decreased when a dividend is paid.
Recording Acquisitions of Shares ▪ Assume Miller Corporation (the investor) acquires 25% of the common shares of ACE Company (the investee) for $250,000 on January 1, 2018. The entry to record this transaction is:
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Jan 1
Investment in Associates ................................. Cash ....................................................... (To record purchase of ACE common shares)
250,000 250,000
Recording Income from Associates ▪ For the year ending December 31, 2018, ACE reports net income of $80,000 and declares and pays a $20,000 cash dividend. Miller is required to record (1) its share of ACE’s net income, $20,000 (80,000 x 25%), and (2) the reduction in the investment account for the dividends received, $12,000 ($20,000 x 25%). The following entries are required: Dec 31 Investment in Associates ................................. 20,000 Income from Associates ......................... 20,000 (To record 25% equity in ACE’s net income) Dec 31 Cash ................................................................ Investment in Associates ........................ (To record dividends received from ACE) ▪ ▪
5,000 5,000
During the year the investment account has increased by $15,000 ($20,000 - $5,000). The difference between reported net income under the fair value method through profit or loss and reported net income under the equity method can be significant. For example, Miller would report only $5,000 of dividend revenue ($20,000 x 25%) if the fair value method were used.
Teaching suggestion – Use Illustration 12-4 to show students a comparison of the journal entries used to record investment transactions using both the Fair Value through Profit or Loss and Equity method.
Cost Method ▪ Under the cost model, the equity investment is recorded initially at cost and is not subsequently adjusted until sold. ▪ When the investee declares a dividend, the investor will record dividend revenue. ▪ Recording Acquisitions • At acquisition, the cost of the investment is the price to acquire the equity securities. • Assume that on January 1, 2018, Miller Corporation (the investor) acquires 10,000 shares (10% ownership) of ACE Company (the investee) common shares at $25 per share. The entry for the purchase is: Jan 1 Long-Term Investments .............................. 250,000 Cash .................................................. 250,000 (To record purchase of 10,000 common shares of ACE) ▪
Recording Dividend Revenue • The following entry is required to record a $2 per share dividend received by Miller Corporation on October 1: Oct 1 Cash (10,000 x $2)...................................... 20,000 Dividend Revenue .............................. 20,000 (To record receipt of cash dividend)
▪
Recording Sales of Shares • When shares are sold, the difference between the net proceeds and the cost of the
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•
shares is recognized as a realized gain or realized loss. On December 10, Miller Corporation receives proceeds of $15,000, resulting in a realized loss of $5,000. The entry is: Dec 10 Cash ......................................................... 15,000 Realized Loss on Long-Term Investments 5,000 Long-Term Investments ................... 20,000 (To record the sale of ACE common shares)
Learning Objective 4 – Explain how Investments are Reported in the Financial Statements
Income Statement ▪ All gains and losses along with dividend and interest revenue and income from associates are shown in the “other revenues and expenses” section of the income statement. There are two exceptions to this treatment: • Dividend revenue under the equity method is shown as a reduction in the investment rather than in the income statement. • When using the fair value through OCI realized and unrealized gains and losses are recorded in other comprehensive income. This is covered in more advanced courses.
Statement of Comprehensive Income ▪ Other sources of comprehensive income include revaluation of property, plant, and equipment under the revaluation model. ▪ Realized and unrealized gains and losses from available-for-sale securities are recorded as other comprehensive income. ▪ Companies can present the items included in other comprehensive income in a separate statement or at the bottom of the income statement in a combined statement of comprehensive income.
Statement of Changes in Equity ▪ The statement of changes in equity presents the changes of each component of shareholders’ equity including changes to share capital, retained earnings, accumulated other comprehensive income (loss), and any other equity items that a company might report. ▪ Net income increases retained earnings; other comprehensive income (loss) increases (decreases) accumulated other comprehensive income.
Closing Entries for Other Comprehensive Income ▪ Other comprehensive income must be closed out into the Accumulated Other Comprehensive Income account at the end of the year.
Statement of Financial Position ▪ Accounting for Investments under IFRS: • If the business model is not based on held-for-trading investments and the investment is held to earn contractual cash flows relating to principal and interest payments, the investment is accounted for using the amortized cost model, although an option to use fair value is allowed.
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•
▪
▪
If the investment is a held-for-trading investment and not held to earn contractual cash flows, then it is accounted for using fair value through profit or loss model). • If the investment is held to earn principal and interest payments and for the purpose of selling it later to earn a gain, then the investment which would be a debt investment would be accounted for using the fair value through other comprehensive income model. • For strategic investments, IFRS requires the preparation of consolidated financial statements if there is control over the investee. If significant influence but no control exists, then the investment is accounted for using the equity method. Accounting for Investments under ASPE: • Non-strategic investments with a quoted market price are recorded using the fair value through profit or loss model. For all other non-strategic investments, the amortized cost (for debt) or cost model (for equity investments) would be used. Debt with a quoted price in an active market has the option to use the fair value through profit or loss. • Strategic investments with control can have consolidated financial statements prepared or choose instead to use the fair value through profit or loss model or the equity method. The cost model can be used if there is no quoted price in an active market. If significant influence but no control exists, then the investment is accounted for using the equity method or the fair value through profit or loss model. The cost model can be used if a quoted value of the associates’ shares cannot be obtained. Classifying Investments on the Statement of Financial Position: • Highly liquid investments that have insignificant risk and that are near maturity (usually less than 3 months) are viewed as cash equivalents. Other short-term investments rank next in the order of liquidity. • Held-for-trading investments are always classified as current assets. • Non-strategic investments that are not held for trading may be either current or noncurrent, depending on when management intends to sell it. Regardless of their classification, these types of investments are carried at fair value if this can be determined. • No distinction is usually made between debt and equity securities on the face of the statement of financial position. The securities are combined and reported as one portfolio amount on the statement of financial position with additional details provided in the notes. • Long-term investments include debt securities held to earn interest revenue until they mature and consequently they are reported at amortized cost. Any portion that is expected to mature within the year is classified as a current asset. • Long-term investments would include equity securities that are purchased to have significant influence or control. • If an investment is not sufficiently large enough to exercise either significant influence or control, but is still being held for long-term purposes, it will typically be accounted for using the fair value through profit or loss model unless the option to use the fair value through other comprehensive income model is taken. Investments recorded using the latter approach, are currently called available-forsale securities.
Accumulated Other Comprehensive Income (Loss) ▪ Accumulated other comprehensive income (or loss) is presented in the shareholders’ equity section of the statement of financial position.
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Teaching suggestion – Direct students’ attention to Illustration 12-13 and review the relationship between the income statement, the statement of comprehensive income, the statement of changes in equity, and statement of financial position.
Learning Objective 5 – Compare the Accounting for a Bond Investment and Bond Payable (Appendix 12A)
The issuer of the bonds is known as the investee.
The purchaser of the bonds, or the bondholder, is known as the investor.
For the investor, short-term investments in bonds that are not held for the purposes of earning interest until the bond matures are accounted for using the fair value through profit or loss model.
Long-term investments in bonds are typically accounted for using the amortized cost model.
Premiums or discounts on long-term bonds payable must be amortized using the effectiveinterest method of amortization. Similarly, premiums or discounts on bond investments must be amortized using the effective-interest method.
ASPE comparison – Under ASPE a company can use either the effective-interest method to amortize any bond premium or discount or use a straight-line basis over the period to maturity if the results do not differ materially from the effective-interest method. Whereas under IFRS, companies must use the effective-interest method to amortize any bond premium or discount.
When bonds are expected to be held-for-trading purposes, there is no requirement to amortize any premium or discount. Any misstatement of interest that might result would not be significant.
While the amortization for bonds payable is recorded in an Interest Expense account, the amortization of discounts and premiums on a bond investment is recorded in an Interest Revenue account.
If there is a bond premium on a long-term bond investment, the Interest Revenue account and carrying amount of the investment is reduced by the amortization amount. If there is a bond discount, the Interest Revenue account and carrying amount of the investment is increased by the amortization.
Teaching suggestion – Follow through the recording of the bond investment from the textbook. Teaching suggestion – Explain to students the differences between recording a bond payable and a bond investment by using Illustration 12A-1. Recording an investment in bonds for an investor differs from recording a bonds payable for an investee in the following ways: (1) Any premium or discount is not amortized by the investor as it is for the investee if the bonds Instructor’s Manual
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are held-for-trading purposes and accounted for under the fair value through profit or loss model. (2) Assuming the investor sold the bonds on the open market, the issuer, is not affected.
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
Shouldn’t companies focus on their own operations as opposed to investing in debt and equity?
Should a company invest in debt or equity or use the money internally for their company?
If you have money to invest, what would you do with it? Do you think you are a risk adverse investor or are you willing to take some risk to generate a higher return?
Why should a company try to purchase either significant influence or control of another company?
Why are there so many different models to account for investments? Shouldn’t a consistent model be used for all investments?
Why should a company record unrealized gains or losses? Wouldn’t only realized transactions be considered?
Should a company spend millions of dollars to acquire another company?
Are consolidated financial statements useful for evaluating the results of the individual companies? Should companies be required to provide consolidated financial statements and individual financial statements?
Why should a private company be allowed to use either the cost or equity method when they own a significantly influenced company? Shouldn’t there be greater consistency between the accounting standards for private and public companies?
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CHAPTER 12 REPORTING AND ANALYZING INVESTMENTS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
A type of investment that is purchased mainly to generate investment income is known as a Answer: non-strategic investment
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Chapter 12 – Reporting and Analyzing Investments
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
VOCABULARY QUIZ 1.
A company in which its common shares are controlled by another company.
2.
Non-strategic investments that are held for the purpose of earning capital gains.
3.
Investments that are bought to generate investment income.
4.
A company that controls the common shares of another company.
5.
The difference between fair value and carrying amount of an investment held by the investor.
6.
An equity investment that is purchased to influence or control another company.
7.
A financial statement that presents net income (loss) and other comprehensive income (loss) for a specific period of time.
8.
Financial statements that present the assets and liabilities controlled by the parent company and the total net income of the combined companies.
9.
An accounting method in which the investment in common shares is initially recorded at cost, and the investment account is then adjusted annually to show the investor’s equity in the investee.
10.
The ability of an investor to influence decisions made by an investee which is assumed to exist when more than 20% but less than 50% of an investee’s shares are owned.
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Chapter 12 – Reporting and Analyzing Investments
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ANSWERS TO VOCABULARY QUIZ 1.
Subsidiary (affiliated) company
2.
Held for trading investments
3.
Non-strategic investment
4.
Parent company
5.
Unrealized gain or loss
6.
Strategic investment
7.
Statement of comprehensive income
8.
Consolidated financial statements
9.
Equity method
10.
Significant influence
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Chapter 12 – Reporting and Analyzing Investments
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MULTIPLE CHOICE QUIZ 1.
Corporations purchase investments in debt or equity securities because they a. have excess cash. b. generate a significant amount of their net income from investments. c. want to, for strategic reasons. d. all of the above e. none of the above
2.
Which of the following is true? a. Non-strategic investments are classified as short-term. b. Both debt and equity can be strategic investments. c. The degree of influence determines how strategic investments are classified. d. Only equity can be a non-strategic investment. e. both a and b
3.
Non-strategic investments that are held for the purpose of earning capital gains are called a. held for trading investments. b. long-term investments. c. equity investments. d. fair value investments. e. debt investments.
4.
Which of the following is not a model used for non-strategic investments? a. fair value through profit or loss model b. amortized cost model c. cost model d. equity model e. both c and d
5.
Under the equity method, the investor records a. its share of net income of the investee in the year in which it is received as a dividend. b. its share of net income of the investee in the year in which it is earned. c. either a or b d. neither a nor b
6.
Under the equity method, the investment in common shares is initially recorded at cost, and the investment account is adjusted to show the investor’s equity in the investee. How often is the adjustment made? a. daily b. weekly c. monthly d. annually e. upon sale
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Chapter 12 – Reporting and Analyzing Investments
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7.
Mack Corporation owns 40% of the common shares of Cepollina Corporation. When Mack receives $5,000 in cash dividends from Cepollina, the journal entry on Mack’s books is a. Cash.................................................................... 5,000 Dividend Revenue ........................................ 5,000 b. Cash.................................................................... 5,000 Income from Investment in Associates .................................................... 5,000 c. Cash.................................................................... 5,000 Investment in Associates .............................. 5,000 d. Dividend Revenue ............................................... 5,000 Cash ............................................................. 5,000 e. none of the above
8.
Which of the following would not be reported under “other revenue and expense” on the income statement? a. unrealized gains (losses) from held for trading investments b. dividend revenue c. interest revenue d. both b and c e. a, b, and c
9.
A portfolio of held for trading investments that is intended to be sold in two years is reported in the a. shareholders’ equity section of the statement of financial position. b. current assets section of the statement of financial position. c. non-current assets section of the statement of financial position. d. statement of comprehensive income. e. investing section of the statement of cash flows.
10.
The consolidated financial statement a. is prepared by the parent company. b. combines the assets and liabilities of the parent and subsidiary. c. combines the assets of the parent and subsidiary. d. both a and b e. neither a and b
11.
Which of the following is true? a. Under both ASPE and IFRS premiums and discounts on bonds are amortized using the effective interest rate method. b. Under both ASPE and IFRS premiums and discounts on bonds are amortized using the straightline method. c. Under ASPE premiums and discounts on bonds are amortized either using the effective interest rate method or the straight-line method. d. Under IFRS premiums and discounts on bonds are amortized either using the effective interest rate method or the straight-line method. e. Under both ASPE and IFRS premiums and discounts on bonds are amortized using the equity method.
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Chapter 12 – Reporting and Analyzing Investments
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12.
Littletown Ltd. has purchased 30% of the common shares of Bigtown Ltd. for $45,500. At the end of year, Bigtown reported net income $250,000 and paid cash dividends of $35,000. The common shares are worth $50,000 at the end of the year. What is the value of the investment account at the end of the year? a. $45,500 b. $50,000 c. $56,000 d. $110,000
13.
Which of the following is false related to bonds? a. Premiums or discounts are not amortized for held for trading investments. b. Amortization related to bonds payable is recorded as Interest revenue. c. A bond discount reduces interest revenue account. d. A bond discount decreases the carrying amount of the investment. e. both a and d
14.
Pujol acquired 100, five-year, 7%, $1,000 bonds issued by Smec on January 1, 2015, for $95,948. The bond price is based on a market interest rate of 8%. The bonds pay interest on July 1 and January 1. Assume that Pujol intends to hold these bonds until maturity. Pujol’s journal entry to record the investment on January 1 is a. Long-Term Investments....................................... 95,948 Cash ............................................................. 95,948 b. Long-Term Investments....................................... 95,948 Unrealized Loss................................................... 4,052 Cash ............................................................. 100,000 c. Cash.................................................................... 95,948 Bonds Payable ............................................. 95,948 d. Long-Term Investments....................................... 100,000 Cash ............................................................. 100,000 e. none of the above
15.
Which of the following is true related to accounting for significantly influenced investments? a. Under IFRS and ASPE a company can select to use the equity or cost method. b. Under ASPE, a company can select to use the equity or cost method. c. Under IFRS only the cost method can be used. d. none of the above e. all of the above
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Chapter 12 – Reporting and Analyzing Investments
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
a
2.
c
3.
a
4.
d
5.
b
6.
d
7.
c
8.
d
9.
b
10.
d
11.
c
12.
d
13.
d
14.
a
15.
b
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
Non-strategic investments generate investment income from interest, dividends, or gains upon the sale of the investment.
True
False
2.
In the fair value through profit or loss model the unrealized gains and losses are recorded in comprehensive income.
True
False
3.
If Dockers Ltd. purchased as a long-term investment, $50,000 face value of Acme bonds at a price of 102.5, the journal entry to record the purchase would include a debit to Premium on Bonds.
True
False
4.
Under the cost method, the investment is initially recorded at cost and is not subsequently adjusted until sold.
True
False
5.
When an investor owns 20% or more of the common shares of another company, the investor has control.
True
False
6.
The purpose of a strategic investment is to maintain a long-term operating relationship with another company and an investment in common shares provides the investor the opportunity to influence or control the investee.
True
False
7.
Gains and losses along with dividend and interest revenue and revenue from investment in associates are shown in other revenues and expenses of the income statement.
True
False
8.
The statement of changes in equity includes changes in share capital, retained earnings, accumulated other comprehensive income, and any other equity items that a company might report.
True
False
9.
Under the equity method of accounting, the investment account is debited for dividends received from the investee.
True
False
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10.
When an investor owns more than 50% of common shares of a corporation, it has control and consolidated financial statements are prepared.
True
False
Multiple Choice 11.
Alvira Corporation purchased 500 shares of Frenette common shares for $60 per share as a held for trading investment. The shares are accounted for by the fair value through profit or loss method. The fair value at year-end was $62 per share. The shares were sold subsequent to the year-end for $65 per share. The gain or loss recognized at year end is a. $2,500 gain. b. $2,500 loss. c. $1,500 gain. d. $1,000 gain. e. $1,000 loss.
12.
A company pays $500,000 for 30% of the common shares of MSG, Inc. as a long-term equity investment. In the first year, MSG, Inc. reports net income of $80,000 and pays a cash dividend of $30,000. The investment account balance at year end under the equity method is a. $485,000. b. $500,000. c. $509,000. d. $515,000. e. $524,000.
13.
The equity method is used when the investor a. makes long-term investments in bonds. b. makes a short-term investment in common shares. c. has no significant influence over the associate. d. has significant influence over the associate. e. both a and c
Use the following information to answer questions 14 and 15. Smec utilizes the fair value through profit or loss method. At the end of its first year, the held for trading investment portfolio consisted of the following securities: Carrying Amount Fair Value Magnum Corp. $18,600 $20,000 Paddey Inc. 24,000 21,500 $42,600 $41,500
14.
The gain or loss on fair value adjustment to be recognized is a. There is no unrealized gain or loss. b. $2,500 loss. c. $1,100 loss.
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Chapter 12 – Reporting and Analyzing Investments
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d. $1,400 gain. e. $1,100 gain.
15.
The following year, the Paddey Inc. shares were sold for $20,000. The loss to be recognized is a. $4,000. b. $2,900. c. $1,500. d. $ 400. e. no loss would be recorded
Quizzes
Chapter 12 – Reporting and Analyzing Investments
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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
True
2.
False
3.
False
4.
True
5.
False
6. 7. 8. 9. 10.
True True True False True
Multiple Choice 11.
d
12.
d
13.
d
14.
c
15.
c
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Chapter 12 – Reporting and Analyzing Investments
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20-MINUTE QUIZ #2 1.
Prepare journal entries to record the following transactions for Cartier Corp. Show your calculations. a. On March 1, Cartier had excess cash and decided to purchase 500 shares of Wilson Corporation as held for trading investments, for $20 per share. The investment is recorded using the fair value through profit or loss method. b. On August 15, Wilson paid a dividend of $0.50 per share. c. On September 12, Cartier sold the Wilson shares for $23 per share.
2.
Baker Inc. owns 30% of the common shares of Naddy Corp., and exercises significant influence over Naddy. The January 1 balance of the investment account is $350,000. During the current year, Naddy reported net income of $500,000 and paid a total of $60,000 in dividends on the common shares. a. Calculate the amount that would appear on Baker’s income statement for the current year. Show your work. b. Calculate the December 31 balance in the investment account. Show your work.
3.
At Thompson Inc.’s year-end, the fair value of its held for trading investments was $37,500. The cost of the shares was $40,000. Thompson Inc. utilizes the fair value through profit or loss method. Prepare the December 31 year-end entry that is required.
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ANSWERS TO 20-MINUTE QUIZ #2 1. a.
b.
c.
Mar 1
Aug 15
Sep 12
Held for trading Investments Cash (500 x $20) Cash (500 x $0.50) Dividend Revenue Cash (500 x $23) Held for trading Investments Gain on Sale of Held for trading Investments
2. a.
$500,000 x 30% = $150,000
b.
$350,000 + ($500,000 x 30%) – ($60,000 x 30%) = $482,000
10,000 10,000 250 250 11,500 10,000 1,500
3. Dec. 31
Quizzes
Unrealized Loss on Held for trading Investments Held for trading Investments $40,000 – $37,500 = $2,500
Chapter 12 – Reporting and Analyzing Investments
2,500 2,500
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CHAPTER 13 STATEMENT OF CASH FLOWS LEARNING OBJECTIVES 1.
Describe the content and format of the statement of cash flows.
2.
Prepare operating activities section of a statement of cash flows using the indirect method.
3.
Prepare the investing and financing activities sections and complete the statement of cash flows.
4.
Use the statement of cash flows to evaluate a company.
5.
Prepare operating activities section of a statement of cash flows using the direct method (Appendix 13A).
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CHAPTER OUTLINE Learning Objective 1 – Describe the Content and Format of the Statement of Cash Flows The main purpose of the statement of cash flows is to provide information that enables its users to assess the company’s ability to generate cash from its operating activities, and to assess to what extent other cash flows regarding investing and financing activities were generated or used. ▪ The statement of cash flows helps users evaluate a company’s ability to generate future cash flows. Teaching suggestion – Ask students why they believe the Statement of Cash Flows is so important.
The statement of cash flows is often prepared using cash and cash equivalents as its basis rather than just cash. ▪ Cash equivalents are short-term, highly liquid held for trading investments that are insignificant risk and are readily convertible to cash within a very short period of time (usually 3 months or less). ▪ Bank overdrafts that are repayable on demand are included in (deducted from) cash and cash equivalents.
The statement of cash flows classifies cash receipts and cash payments into three types of activities: (1) operating, (2) investing, and (3) financing. Transactions within each activity are as follows: ▪ Operating activities include the cash effects of transactions that create revenues and expenses. ▪ Investing activities include (a) purchasing and disposing of long-lived assets and investments not held for trading and (b) lending money and collecting the loans. They generally affect non-current asset accounts. ▪ Financing activities include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from shareholders and paying them dividends. They generally affect non-current liability and shareholders’ equity accounts.
The following points show typical cash receipts and cash payments within each of the three activities—operating, investing, and financing:
Types of Operating Activity ▪ Cash receipts: • From the sale of goods or services • From returns on debt investments (interest) and on equity investments (dividends) • From proceeds received from the sale of held for trading investments ▪ Cash payments: • To suppliers for inventory • To others for expenses • To employees for services • To lenders for interest • To others for held for trading investments
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•
To government for taxes
Investing activities ▪ Cash receipts: • From the disposal of property, plant, and equipment and intangible assets • From the sale of long-term debt or equity investments • From the collection of principal on loans to other companies ▪ Cash payments: • To purchase property, plant, and equipment and intangible assets • To purchase long-term debt or equity investments • To make loans to other companies
Financing activities ▪ Cash receipts: • From the sale of preferred and common shares • From issue of debt (notes and bonds) ▪ Cash payments: • To shareholders as dividends • To redeem long-term debt or reacquire shares
Teaching suggestion – Use Illustration 13-1 to show students the typical cash receipts and cash payments within each of the three activities. Point out that receipts of investment revenue (interest and dividends) and payments of interest to lenders are classified as operating activities because these items are reported in the income statement, where results of operating activities are shown. ASPE comparison – Under IFRS, interest and dividends received can be classified as operating or investing activities while under ASPE the interest and dividends received are classified as operating activities. Under IFRS, interest and dividends paid are also classified as either operating or financing activities while under ASPE interest paid is an operating activity and dividends paid is a financing activity. Once the choice is made under IFRS, the treatment must be applied consistently. Teaching suggestion – Use Illustration 13-16 to show students the general format of the statement of cash flows and discuss the makeup of the three sections.
Significant noncash activities include: ▪ Issue of shares to purchase assets or to reduce liabilities ▪ Conversion of debt into equity ▪ Exchanges of property, plant, and equipment
Significant investing and financing activities that do not affect cash are not reported in the body of the statement of cash flows. However these activities are reported in a note to the financial statements.
The statement of cash flows covers the same period of time as the income statement,
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statement of comprehensive income, and statement of changes in equity.
The section that reports cash flows from operating activities usually appears first, followed by the investing activities section and financing activities section. ▪ ▪ ▪
▪
There are two ways to prepare the operating activity section of the statement of cash flows. One way is to use the indirect method, which converts net income from an accrual basis to a cash basis. When the indirect method is used, net income is the starting point with the removal of any revenues and expenses that do not generate operating cash flows. The direct method, rather than starting with net income, simply makes the operating section look like a cash basis income statement. The individual revenue and expense items from the income statement are reported separately as receipts and uses of cash on the statement of cash flows. Both the indirect and direct methods are acceptable choices, however, the direct method is preferred by standard setters as it is more informative for users and is easier to compare with other financial statements. Most companies use the indirect method because it is easier to prepare and reveals less company information to competitors.
There are no specific accounts in the general ledger for the types of operating activities, investing activities, or financing activities. This is because the statement of cash flows is prepared differently from the other financial statements in that it is not prepared from an adjusted trial balance. The statement of cash flows requires detailed information about the changes in account balances that occurred between two periods of time. An adjusted trial balance will not provide the necessary data.
The information to prepare this statement usually comes from three sources: ▪ Comparative statement of financial position – Information in this statement indicates the amount of the changes in assets, liabilities, and shareholders’ equity from the beginning of the period to its end. ▪ Income statement and the related noncash current asset and current liability accounts from the statement of financial position– Information in this statement helps the reader determine the amount of cash provided or used by operating activities during the period. ▪ Additional information – Additional information includes transaction data that are needed to determine how cash was provided or used during the period. Selected information from the statement of changes in equity and other sources are used to complete the statement of cash flows and the notes to the financial statements.
Learning Objective 2 – Prepare the Operating Activities Section of a Statement Cash Flows Using the Indirect Method
Step 1 – Prepare Operating Activities Section – Indirect Method ▪ The indirect method starts with net income and adjusts for items that do not affect cash. • Add back noncash expenses, such as depreciation and losses. • Add losses and deduct gains. • Add decreases in current asset accounts and increases in current liabilities accounts.
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•
Deduct increases current asset accounts and decreases current liability accounts.
Teaching suggestion – Use Illustration 13-5 to show students the connection between the accrual basis of accounting and the cash basis of accounting.
Follow through the preparation of Computer Services statement of cash flows, starting with the information provided in Illustration 13-4.
Noncash Expenses and Revenues ▪ The income statement includes expenses that do not use cash, such as depreciation and amortization expense. ▪ Depreciation expense reduces net income but does not reduce cash, so depreciation expense is added back to net income. ▪ Amortization expense for intangible assets is also added to net income to arrive at net cash provided (used) by operating activities. ▪ Another example of a noncash expense is the amortization of bond discounts and premiums. ▪ Noncash revenues might include income from associates. Just as noncash expenses are added back to net income, noncash revenues are deducted from net income.
Teaching suggestion – Help students understand that adding depreciation expense in the operating activities section is not a source of cash but rather the cancellation of an expense in the income statement because it does not use cash.
Losses and Gains ▪ Cash received from the disposal of long-lived assets should be reported in the investing activities section of the statement of cash flows. As a result, all gains and losses from investing activities must be eliminated from net income to arrive at cash from operating activities. ▪ If we did not eliminate these gains and losses, they would be counted twice, once in net income and again in the investing activities section (as part of the proceeds from the disposal of the asset). It is also important to understand that the gain or loss on disposal is not the same as the actual cash proceeds received. ▪ If a gain on disposal occurs, then the amount would be deducted from net income. ▪ The actual amount of cash received from the sale is reported as a source of cash in the investing activities section. ▪ Other examples include unrealized gains and losses on investments that are recorded when the carrying amount of an investment is adjusted to fair value but it is not sold. Other examples include realized gains and losses on investments and the early settlement of debt. Again, these gains and losses which would have been recorded on the income statement, would cause net income to be adjusted on the statement of cash flows.
Teaching suggestion – Show students the journal entry to reflect the equipment sale. This is helpful in showing students the reduction in net income but no reduction in cash.
Changes in Current Asset and Current Liability Accounts ▪ Another type of adjustment in converting net income to net cash provided (used) by operating activities involves examining the changes (increases or decreases) in noncash
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▪
▪
▪
current asset and current liability accounts. Not all noncash working capital accounts affect operating activities. Short-term loans or notes receivable are examples of a current liability that does not relate to operating activities. The issue and repayment of notes or loans that have been issued for lending purposes rather than trade are shown instead in the investing section of the statement of cash flows. The receipt and repayment of short-term loans or notes payable that have been incurred for lending purposes rather than trade are shown instead in the financing section of the statement of cash flows. The following are the adjustments to net income required by changes in noncash current items: increases in current asset accounts are deducted from net income, and decreases in current asset accounts are added to net income, to arrive at net cash provided (used) by operating activities. Accounts Receivable • When the accounts receivable balance increases during the year, revenues on an accrual basis are higher than cash receipts. Therefore, the amount of the increase in accounts receivable is deducted from net income to arrive at the cash provided (used) by operating activities.
Teaching suggestion – Students should understand why a decrease in accounts receivable increases cash. Remember that students are going to want to memorize this. Ask the students to assume that they are the accountant for a small retail business that grants credit. At the beginning of the year, the Accounts Receivable account balance is $10,000. At the end of the year, they have not made any sales, but have collected the balance in Accounts Receivable of $10,000. How much cash must they have received, and what would they have recorded for the sale of merchandise? ▪
▪
Inventory • When inventory increases during the year, the cost of goods purchased is greater than the cost of goods sold expense recorded in the income statement. • Any increase (decrease) in the inventory account must be deducted from (added to) net income to arrive at net cash provided (used) by operating activities. Prepaid Expenses • When prepaid expenses increase during the year, it means that these prepayments have reduced cash flows. It also means that expenses reported on the accrualbased income statement are lower than what expenses would be on a cash basis. • The increase (decrease) in prepaid expenses is deducted from (added to) net income to arrive at net cash provided (used) by operating activities.
Changes in Current Liabilities ▪ Accounts Payable ▪ Accounts payable is increased by the purchase of merchandise and decreased by payments to suppliers. ▪ An increase (decrease) in accounts payable means that less (more) cash was paid for purchases than was deducted in the accrual-based expenses.
Teaching suggestion – Again have students assume they own a small retail business. At the beginning of the period the balance in Accounts Payable was zero. At the end of the period, the balance in the account was $2,000. What does this mean? Assuming you purchased $10,000 worth of merchandise for resale, you have paid cash for only $8,000 of that merchandise. The Instructor’s Manual
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other $2,000 should be added to net income to get back to cash basis income and cash provided from operations. ▪
Income Tax Payable • The change in the Income tax payable account reflects the difference between income tax incurred and income tax actually paid. • If the amount of income tax payable had increased during the year, the increase would be added to net income to reflect the fact that income tax expense deducted on the accrual-based income statement was higher than the cash paid during the period. • A decrease (increase) in income tax payable would result in a decrease (increase) to cash provided (used) by operating activities since the amount paid was greater than (less than) the tax incurred.
Teaching suggestion – Walk through the Statement of Cash Flows—Indirect Method for the year ended December 31, 2018 that is shown in Illustration 13-6 in the text.
Learning Objective 3 – Prepare the Investing and Financing Sections and Complete the Statement of Cash Flows
Step 2 – Prepare Investing Activities Section
Investing activities measure cash flows relating to non-current asset accounts, such as longterm investments, property, plant and equipment, and intangible assets. ▪ Land • An increase in land financed by issuing common shares has no effect on cash, but because it is a significant noncash investing activity, it would be reported in the notes to the statement of cash flows. ▪ Accumulated Depreciation • An increase due to depreciation expense, a noncash charge does not affect the statement of cash flows. • Equipment Each transaction (purchase and sale) should be reported separately on the statement of cash flows.
Teaching suggestion – Show students the journal entries to reflect the (1) equipment purchase and (2) equipment sale. The journal entries help to show the inflow and outflow of cash. ▪
▪
Accumulated Depreciation—Equipment • The disposal of the equipment affected a number of accounts: one account on the income statement (Loss on Disposal) and three accounts on the statement of financial position (Cash, Equipment, and Accumulated Depreciation). In the statement of cash flows, it is important to combine the effects of this disposal in one place: the investing activities section. The overall result, then, is that the loss on the disposal of the equipment is removed from the operating activities section of the statement of cash flows and the cash proceeds received from the disposal of the equipment are shown in their entirety in the investing activities section. Investments
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•
It is important to remove any noncash transactions when analyzing changes in any long-term investment accounts and investment-related accounts.
Teaching suggestion – Help students understand why short-term (held for trading) investments are classified as operating activities and long-term investments as investing activities. Relate the transactions in short-term (held for trading) investments to revenue producing activities such as transactions in inventory. Teaching suggestion – Walk through the partial cash flow statement (investing activities) that is shown in Illustration 13-7 in the text.
Step 3—Prepare Financing Activities Section
The third step in preparing a statement of cash flows is to analyze the changes in non-current liability and equity accounts. In addition, changes involving current liability accounts such as dividends payable and short-term loans or notes payable should also be reported in the financing activities section if they have been incurred for lending purposes rather than for trade.
The individual inflows and outflows from financing activities are reported separately. If a company did not report inflows and outflows separately, some of the investing and financing activities would be hidden. This would make it more difficult for the user to assess future cash flows. ▪ Other comprehensive income does not have any cash flow effect. ▪ Movements in the Bonds Payable account are treated in a similar manner to bank loans, with cash received from issuing the bonds and cash paid to redeem them shown as receipts and payments in the financing section. ▪ Retained Earnings The net income is dealt with in the operating activities section, and the dividend is a cash outflow in the financing section. ▪ If accumulated other comprehensive income does not affect the statement of cash flows as there are no cash effects in any of the sources of other comprehensive income.
Teaching suggestion—Show the T account for Retained Earnings to describe changes that occurred during the year. Teaching suggestion – Walk through the partial Statement of Cash Flows (financing activities) that is shown in Illustration 13-8 in the text.
Step 4—Complete The Statement of Cash Flows.
The Statement of Cash Flows is completed by combining the three sections, beginning with operating, followed by investing and then financing activities. ▪ Note that the net cash provided or used by each activity is totalled to show the net increase (decrease) in cash for the period. The net increase (decrease) in cash for the period is then added or subtracted from the beginning-of-period cash balance to obtain the end-of-period cash balance. The end-of-period cash balance should agree with the cash balance reported on the statement of financial position. ▪ Additional disclosures are required to complete the statement of cash flows. In addition
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to significant noncash investing and financing activities, if a company has combined cash equivalents with its cash, it must disclose the components of its cash equivalents with a reconciliation of the amounts reported on the statement of cash flows with those reported on the statement of financial position. Teaching suggestion – Walk through the Statement of Cash Flows that is shown in Illustration 139 in the text. Teaching suggestion – Help students understand how the format of the Computer Services Corporation statement would differ if it was prepared using the indirect method, rather than the direct method as shown.
Learning Objective 4 – Use the Statement of Cash Flows to Evaluate a Company Learning Objective 5 – Prepare the Operating Activities Section of a Statement of Cash Flows Using the Direct Method (Appendix 13A)
Prepare the Operating Activities Section of the Statement of Cash Flows Using the Direct Method
Step 1 – Prepare Operating Activities Section – Direct Method
Under the direct method, net cash provided (or used) by operating activities is calculated by adjusting the income statement from the accrual basis to the cash basis.
An efficient way to apply the direct method is to analyze the items reported in the income statement in the order in which they are listed. The cash receipts and cash payments related to these revenues and expenses are determined by adjusting for changes (increases or decreases) in the related current asset and current liability accounts.
Follow through the preparation of Computer Services statement of cash flows, starting with the information provided in Illustration 13-4.
Cash Receipts ▪ Cash receipts from customers • When cash receipts decrease (increase) during the year, revenues on an accrual basis are lower (higher) than revenues on a cash basis, and the following adjustment is required:
Cash receipts From =
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Revenue
+ Decrease in accounts receivable or
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– Increase in accounts receivable
customers
▪
Cash Receipts from Interest and Dividends • If the income statement details other revenue such as interest revenue, these amounts must be adjusted for the change in receivable amounts to determine the actual cash receipts. • Increases (decreases) in accrued receivables would be deducted from (added to) accrual-based revenues.
Cash Payments ▪ Cash Payments to Suppliers • To determine cash payments to suppliers it is necessary to find cost of goods purchased during the year. To find cost of goods purchased, cost of goods sold is adjusted for the change in inventory. • When inventory increases during the year, the cost of goods purchased exceeds the cost of goods sold. The increase in inventory is added to the cost of goods sold. When inventory decreases, the decrease would be deducted from the cost of goods sold. • • • •
After the cost of goods purchased are adjusted, cash payments to suppliers are determined by adjusting cost of goods purchased for the change in accounts payable. An increase in accounts payable means that purchases on account are greater than cash payments to suppliers; therefore, an increase in accounts payable is deducted from the cost of goods purchased to arrive at cash payments to suppliers. A decrease in accounts payable is added to the cost of goods purchased. The relationship between cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable can be expressed as follows: – Cash payments = to suppliers
▪
Cost of
+ Increase in inventory or
goods sold – Decrease in inventory
Increase payable
in
accounts
or + Decrease in accounts payable
Cash payments for operating expenses • To determine the cash payments for operating expenses, we need to adjust this amount for any changes in prepaid expenses and accrued liabilities. • If prepaid expenses increase during the year, cash paid for operating expenses will be higher than the operating expenses reported on the income statement. To adjust operating expenses to cash payments for services, any increase in prepaid expenses must be added to operating expenses. • Any decrease in prepaid expenses must be deducted from operating expenses. • Any changes in accrued expenses payable that are related to operating expenses must also be adjusted. • When accrued expenses payable increase during the year, the increase must be
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•
deducted from operating expenses. Any decrease is added to operating expenses because the cash payments exceed the operating expenses. The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable can be expressed as follows:
Cash payments for operating = expenses
▪
▪
Operating expenses
+ Increase in prepaid expenses or - Decrease in prepaid expenses
+ Decrease in accrued expenses payable – Increase in accrued expenses payable
Cash payments to employees • If payments to employees were reported separately, salaries expense would be adjusted for any change to salaries payable. • Cash payments to employees would equal the salary expense plus any decrease (or less any increase) during the period in the amount of salaries payable. Cash payments for interest • The relationship among cash payments for interest, interest expense, and changes in interest payable (if any) can be expressed as follows:
+ Decrease in interest payable Cash payments for interest =
Interest expense
or – Increase in interest payable
▪
Cash payments for income tax • To determine cash payments for income tax, income tax expense must be adjusted for any changes in income tax payable during the year. • The relationship among cash payments for income tax, income tax expense and changes in income tax payable can be expressed as follows:
Cash payments for income tax =
Income tax expense
+ Decrease in income tax payable or – Increase in income tax payable
Teaching suggestion – Walk through the Statement of Cash Flows that is shown in Illustration 13A-6 in the text. Teaching suggestion – Walk through the comparison of indirect and direct methods by reviewing Illustration 13A-7 in the text with students.
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SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
If public companies have the option to include interest and dividends as either operating or financing activities then shouldn’t private companies have the same option?
How is it possible for a business to be generating net income but not increasing cash?
Why should there be two different ways to prepare the operating section? Shouldn’t companies use a consistent method so that the statement of cash flows can be compared between companies?
Is there a need for a separate financial statement when the cash flow information is readily available from the other information provided?
Why do companies enter into noncash transactions? How does the company know whether they are getting their money’s worth?
Should cash and cash equivalents be classified together on the statement of cash flows? If the cash equivalents were really considered cash then shouldn’t this be reflected on the statement of financial position?
Since there are so many ratios that investors can use, how do they determine which ratios to consider and which to disregard?
Why is comprehensive income not considered when preparing the statement of cash flows?
Discuss how a company’s cash flows from operating, investing, and financing activities might change over its life cycle—for example, as it grows, matures, and declines.
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CHAPTER 13 STATEMENT OF CASH FLOWS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
Which section of a statement of cash flows indicates the cash spent on land during the past accounting period? Answer: Investing Activities
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Chapter 13 – Statement of Cash Flows
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VOCABULARY QUIZ 1.
A basic financial statement that provides information about the cash receipts and cash payments of a company during a period, classified as operating, investing, and financing activities, in a format that reconciles the beginning and ending cash balances.
2.
A cash-based measure used to evaluate solvency measured by deducting net capital expenditures and cash dividends from net cash provided (used) by operating activities.
3.
Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income.
4.
The phase of the corporate life cycle where a company is able to generate positive cash from operating activities which is used to cover investing activities.
5.
Cash flow activities from the acquisition and disposal of non-current assets.
6.
A method of determining net cash provided (used) by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis.
7.
A method of determining net cash provided (used) by operating activities in which net income is adjusted for items that do not affect cash.
8.
The cycle that consists of four phases: introductory, growth, maturity, and decline which assists in understanding what to expect from a company’s cash flow activities.
9.
A significant activity, such as the issue of debt to purchase equipment that does not involve cash.
10.
Cash flow activities that result in changes in the size and composition of the equity and borrowings of a company.
Quizzes
Chapter 13 – Statement of Cash Flows
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ANSWERS TO VOCABULARY QUIZ 1.
Statement of cash flows
2.
Free cash flow
3.
Operating activities
4.
Maturity
5.
Investing activities
6.
Direct method
7.
Indirect method
8.
Corporate life cycle
9.
Noncash activity
10.
Financing activities
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MULTIPLE CHOICE QUIZ 1.
The statement of cash flows classifies cash receipts and cash payments into which of the following activities? a. investing activities b. financing activities c. operating activities d. all of the above e. none of the above
2.
Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income are referred to as a. investing activities. b. financing activities. c. operating activities. d. all of the above e. none of the above
3.
Which of the following is the usual order of the sections on a statement of cash flows? a. investing, operating, financing b. operating, financing, investing c. operating, investing, financing d. financing, investing, operating e. financing, operating, investing
4.
Cash outflows to purchase property, plant and equipment, to purchase debt or equity securities of other companies for the long-term, and to make loans to other companies are examples of a. investing activities. b. financing activities. c. operating activities. d. all of the above e. none of the above
5.
Significant noncash activities include a. conversion of bonds into common shares. b. payment of bank loan. c. issue of debt to purchase assets. d. both a and c e. both b and c
6.
If the indirect method is used for preparation of the statement of cash flows, then a decrease in accounts receivable is accounted for as a(n) a. cash inflow in the investing activities section.
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b. cash inflow in the financing activities section. c. addition to net income in the operating activities section. d. deduction from net income in the operating activities section. e. none of the above
7.
The information in a statement of cash flows should help investors, creditors, and others evaluate all of the following aspects of the firm’s financial position except the a. company’s ability to generate future cash flows. b. reasons for the differences between net income and net cash provided (used) by operating activities. c. reasons for the differences between net income and net cash provided (used) by noncash activities. d. cash investing and financing transactions during the period. e. all of the above
8.
All of the following are used in preparing a statement of cash flows except a. a trial balance. b. comparative statement of financial position. c. current income statement. d. additional information. e. all of the above are required in preparing the statement of cash flows.
9.
Which of the following is not correct concerning the indirect method of preparing the statement of cash flows? a. It is easier to prepare. b. It is required by the standard setters. c. It focuses on the differences between net income and net cash flow provided (used) by operating activities. d. It tends to reveal less company information to competitors. e. None of the above are correct related to the indirect method.
10.
What phase in the corporate life cycle you would not expect to see a company generate positive cash from its operating activities? a. introductory b. growth c. decline d. both a and b e. both a and c
11.
Which of the following activities would not usually be considered an investing activity? a. purchase of a new building b. purchase of a long-term investment c. funds received on loans to another company d. sale of a held for trading investment e. all of the above would be considered an investing activity
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Chapter 13 – Statement of Cash Flows
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12.
What phase in the corporate life cycle you would not expect to see a company generate cash through financing activities? a. introductory b. growth c. decline d. both a and b e. both b and c
13.
Which of the following activities would not be considered a financing activity? a. payment of a cash dividend b. issue of common shares c. payments on a loan d. purchase of a held for trading investment e. all of the above would be considered financing activities
14.
Under ASPE, interest and dividends received are classified as a. operating activities. b. financing activities. c. investing activities. d. either operating or financing activities. e. either investing or financing activities.
15.
Under IFRS, interest and dividends paid are classified as a. operating activities. b. financing activities. c. investing activities. d. either operating or financing activities. e. either investing or financing activities.
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ANSWERS TO MULTIPLE CHOICE QUIZ 1.
d
2.
c
3.
c
4.
a
5.
d
6.
c
7.
c
8.
a
9.
b
10.
d
11.
d
12.
d
13.
d
14.
a
15.
d
Quizzes
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20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
Cash receipts and payments from investing and financing activities should be reported separately on the cash flow statement.
True
False
2.
Information for the cash flow statement is taken from the adjusted trial balance.
True
False
3.
Free cash flow is calculated by addingthe net cash provided (used) by operating activities with net capital expenditures and deducting dividends paid.
True
False
4.
An increase in dividends payable increases net cash provided by operating activities.
True
False
5.
When accounts receivable increases during the year, revenues on a cash basis are higher than revenues on an accrual basis.
True
False
6.
The correct order of the corporate life cycle is introductory, growth, maturity and decline.
True
False
7.
A cash flow statement starts with net income and adds (or deducts) items on the income statement that did not affect cash to arrive at cash provided by operating activities if the indirect method is used.
True
False
8.
The issue of bonds to acquire land would be shown in the financing section.
True
False
9.
If equipment was sold for $15,000 and a loss of $10,000 was recognized, investing activities would show a cash receipt of $15,000.
True
False
10.
Net cash provided (used) by operating activities
True
False
Quizzes
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is determined by converting net income from an accrual basis to a cash basis.
Multiple Choice 11.
A company has credit sales of $150,000 and cash sales of $90,000 during the same year that the Accounts Receivable account decreased by $20,000. What was the total cash received from customers? a. $260,000 b. $220,000 c. $170,000 d. $130,000 e. $90,000
12.
Cash receipts from investing activities include a. sale of common shares. b. purchase of equipment. c. sale of land. d. issue of long-term debt. e. both b and c
13.
Which cash flow activity would be positive for a company in the introductory phase? a. operating b. financing c. investing d. both a and c e. both b and c
14.
Which of the following would decrease net cash provided by operating activities? a. increase in accounts payable b. depreciation expense c. increase in inventory d. loss on sale of equipment e. both a and c
15.
Noncash investing and financing activities a. may represent significant investing and financing activities. b. do not involve cash receipts or cash payments. c. are disclosed in a separate note to the statements. d. all of the above e. none of the above
Quizzes
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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
True
2.
False
3.
False
4.
False
5.
False
6.
True
7.
True
8.
False
9.
True
10.
True
Multiple Choice 11.
a ($150,000 + $90,000 + $20,000)
12.
c
13.
b
14.
c
15.
d
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20-MINUTE QUIZ #2 1. Indirect Method Assuming the indirect method is used for operating activities, complete the following table by indicating the section of the cash flow statement where each item would appear. Use R if the item would be a cash receipt and P if the item would be a cash payment. If the item would not appear, place an X in the last column. Item Increase in accounts receivable Loss on disposal of equipment Depreciation expense Dividends declared but not paid Issued bonds
Operating
Investing
Financing
Not shown
2. Direct Method Assuming the direct method is used for operating activities, complete the following table by indicating the section of the cash flow statement where each item would appear. Use R if the item would be a cash receipt and P if the item would be a cash payment. If the item would not appear, place an X in the last column. Item Cash paid for interest Loss on disposal of equipment Purchased land Dividends paid Repaid notes payable
Operating
Investing
Financing
Not shown
3. Given the following information, prepare the operating activities section of the statement of cash flows using the (a) direct method, and (b) indirect method. Sales Cost of goods sold Gross profit Depreciation expense Wages expense Operating expenses Interest expense Income tax expense Net income
$500,000 300,000 200,000 20,000 50,000 30,000 10,000 27,000 $ 63,000
Increase in accounts receivable Decrease in inventory Decrease in prepaid expenses Decrease in accounts payable Increase in interest payable
$15,000 20,000 5,000 8,000 2,000
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ANSWERS TO 20-MINUTE QUIZ #2 1. Indirect Method Assuming the indirect method is used for operating activities, complete the following table by indicating the section of the cash flow statement where each item would appear. Use R if the item would be a cash receipt and P if the item would be a cash payment. If the item would not appear, place an X in the last column. Item Increase in accounts receivable Loss on disposal of equipment Depreciation expense Dividends declared but not paid Issued bonds
Operating P R R
Investing
Financing
Not shown
X R
2. Direct Method Assuming the direct method is used for operating activities, complete the following table by indicating the section of the cash flow statement where each item would appear. Use R if the item would be a cash receipt and P if the item would be a cash payment. If the item would not appear, place an X in the last column. Item Cash paid for interest Loss on disposal of equipment Purchased land Dividends paid Repaid a note payable
Quizzes
Operating P
Investing
Financing
Not shown X
P
Chapter 13 – Statement of Cash Flows
P P
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3. (a) Direct Method Operating activities Cash received from customers Cash payments To suppliers To employees For operating expenses For interest For taxes Net cash provided by operating activities
$485,000 $288,000 50,000 25,000 8,000 27,000
398,000 87,000
Sales + A/R increase = $500,000 + ($15,000) = $485,000 COGS + inventory decrease + A/P decrease = ($300,000) + $20,000 + ($8,000) = (288,000) Wages expense = (50,000) Operating expense + prepaid decrease = ($30,000) + $5,000 = (25,000) Interest expense + interest pay increase = ($10,000) + $2,000 = (8,000) Income tax expense = (27,000) (b) Indirect Method Operating activities Net income Adjustments to reconcile net income to net cash Depreciation expense Increase in accounts receivable Decrease in inventory Decrease in prepaid expenses Decrease in accounts payable Increase in interest payable Net cash provided by operating activities
Quizzes
$63,000 $20,000 (15,000) 20,000 5,000 (8,000) 2,000
Chapter 13 – Statement of Cash Flows
24,000 87,000
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CHAPTER 14 PERFORMANCE MEASUREMENT LEARNING OBJECTIVES 1.
Explain and apply comparative analysis.
2.
Calculate and interpret ratios that are used to analyze liquidity.
3.
Calculate and interpret ratios that are used to analyze solvency.
4.
Calculate and interpret ratios that are used to analyze profitability.
5.
Understand the limitations of financial analysis.
Instructor’s Manual
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CHAPTER OUTLINE Learning Objective 1 – Explain and Apply Comparative Analysis
Comparative Analysis ▪ In assessing financial performance, investors, lenders, and other creditors are interested in making comparisons in order to evaluate a company’s past and current financial performance and position in order to better determine future expectations about the company.
Horizontal analysis, also known as trend analysis, is a technique to determine the change (in or decrease) over time that has taken place in a series of financial statement data.
Teaching suggestion – Horizontal analysis is just that—horizontal. One looks across the page. ▪
To illustrate horizontal analysis, the most recent net sales figures (in thousands) of Chicago Cereal Company are given: 2017 $11,776
2016 $10,907
2015 $10,177
2014 $9,614
2013 $8,812
Teaching suggestion – Review illustration 14-1 for Hudson’s Bay Company. ▪
Horizontal percentage of a base-period amount: If we assume that the oldest year is the base year, we can measure all percentage increases or decreases from this baseperiod amount with the following formula: ANALYSIS PERIOD AMOUNT BASE-PERIOD AMOUNT
▪
▪
Current-period sales expressed as a percentage of the base period for each of the five years, assuming 2013 as the base period is: 2017 $11,776
2016 $10,907
2015 $10,177
2014 $9,614
2013 $8,812
133.64%
123.77%
115.49%
109.10%
100%
Horizontal percentage change for period: Horizontal analysis can also be used to measure the percentage change for any one specific period. This can be calculated with the following formula: ANALYSIS-PERIOD AMOUNT – PRIOR-PERIOD AMOUNT PRIOR-PERIOD AMOUNT
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▪
If we assume that 2013 is the base year for Chicago Cereal Company, we can measure all percentage increases or decreases from this base-period amount with the following formula: Change Since Base Period =
▪
Current-Year Amount – Base-Year Amount Base-Year Amount
For example, we can determine that net sales for Chicago Cereal Company increased approximately 9.1% [($9,614 - $8,812) / $8,812] from 2013 to 2014.
Teaching suggestion – Help students understand the difference between calculating a percentage of the base-period amount and the percentage change for each period. Teaching suggestion – Use the financial statements (Illustration 14-4) of Hudson’s Bay Company to further illustrate horizontal analysis (percentage change between two periods). The financial statements of Chicago Cereal Company are used to further illustrate horizontal analysis: CHICAGO CEREAL COMPANY, INC. Condensed Balance Sheets December 31 (In thousands)
Assets Current assets Plant assets (net) Other assets Total assets
2017 $ 2,717 2,990 5,690 $11,397
Liabilities and Stockholders’ Equity Current liabilities $ 4,044 Long-term liabilities 4,827 Total liabilities 8,871 Stockholders’ equity Common stock 493 Retained earnings 3,390 Treasury stock (cost) (1,357) Total stockholders’ equity 2,526 Total liabilities and stockholders’ equity $11,397 ▪ ▪ ▪ ▪
2016 $ 2,427 2,816 5,471 $10,714
Increase (Decrease) during 2017 Amount Percent $290 11.9 174 6.2 219 4.0 $683 6.4
$ 4,020 4,625 8,645
$ 24 202 226
0.6 4.4 2.6
397 2,584 (912) 2,069
96 806 (445) 457
24.2 31.2 48.8 22.1
$10,714
$683
6.4
The comparative balance sheet shows a number of changes from 2016 to 2017. Current assets increased $290,000 or 11.9% ($290/$2,427). Property assets (net) increased $174,000 or 6.2%. Other assets increased $219,000 or 4.0%.
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▪ ▪
Current liabilities increased $24,000 or 0.6% while long-term liabilities increased $202,000, or 4.4%. Retained earnings increased $806,000 or 31.2%.
Teaching suggestion – Impress upon students the importance of the percentage figures. Discuss how the percentages allow us to see the relative size of any increase or decrease. It should be noted that accounts with large changes are not the only ones worthy of further analysis; certain accounts, such as cash, should always be evaluated. Also discuss with students situations when meaningful percentages cannot be calculated. Teaching suggestion – Use Illustration 14-5 to walk through the horizontal analysis of the income statement. ▪
A 2-year comparative income statement of Chicago Cereal Company for 2017 and 2016 is given in condensed format: CHICAGO CEREAL COMPANY, INC. Condensed Income Statement For the Years Ended December 31 (In thousands)
Net sales Cost of goods sold Gross profit Selling and administrative expenses Income from operations Interest expense Other income (expense), net Income before income taxes Income tax expense Net income ▪
▪
2017 $11,776 6,597 5,179
2016 $10,907 6,082 4,825
3,311 1,868 319 (2) 1,547 444 $ 1,103
3,059 1,766 307 13 1,472 468 $ 1,004
Increase (Decrease) during 2017 Amount Percent $869 8.0 515 8.5 354 7.3 252 102 12 (15) 75 (24) $ 99
8.2 5.8 3.9 (115.4) 5.1 (5.1) 9.9
Horizontal analysis of the income statements shows these changes: • Net sales increased $869,000 or 8.0% ($869 ÷ $10,907). • Cost of goods sold increased $515,000 or 8.5% ($515 ÷ $6,082). • Selling and administrative expenses increased $252,000, or 8.2% ($252 ÷ $3,059). • Overall, gross profit increased by 7.3% and net income increased by 9.9%. • The increase in net income can be attributed to the increase in net sales and a decrease in Income tax expense. Percentage changes are fairly straightforward to understand and can be quite useful. However, the calculations can be affected by complications. For example, if an item has a small value in a base year and a large value in the next year, the percentage change may not be meaningful. If an item has no value in a base year and a value in the next year, no percentage change can be determined. If a negative amount appears in the base year and a positive amount in the following year, or vice versa, no
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▪
percentage change can be calculated. Horizontal analysis is not as useful for the statement of comprehensive income, statement of changes in equity, and statement of cash flows. The amounts presented in these statements already give details of the changes between two periods.
Vertical analysis, also called common size analysis, is a technique for that expresses each item in a financial statement as a percent of a total (base) amount within the same financial statement.
Horizontal analysis compares data across more than one year, vertical analysis compares data within the same year. ▪ On the statement of financial position, we might say that current assets are 43.8% of total assets (total assets being the base amount). ▪ On the income statement, we say that cost of goods sold is 61.0% of net sales (net sales being the base amount).
Presented below is the comparative balance sheet of Chicago Cereal for 2017 and 2016, analyzed vertically. CHICAGO CEREAL COMPANY, INC. Condensed Balance Sheets December 31 (In thousands)
Assets Current assets Property assets (net) Other assets Total assets
2017/2016 Amount $ 2,717 2,990 5,690 $11,397
Liabilities and Stockholders’ Equity Current liabilities $4,044 Long-term liabilities 4,827 Total liabilities 8,871 Stockholders’ equity Common stock 493 Retained earnings 3,390 Treasury stock (cost) (1,357) Total stockholders’ equity 2,526 Total liabilities and shareholders’ equity $11,397
Percent* 23.8 26.2 50.0 100.0
Amount $ 2,427 2,816 5,471 $10,714
Percent* 22.6 26.3 51.1 100.0
35.5 42.4 77.9
$ 4,020 4,625 8,645
37.5 43.2 80.7
4.3 29.7 (11.9) 22.1
397 2,584 (912) 2,069
3.7 24.1 (8.5) 19.3
100.0
$10,714
100.0
*Numbers have been rounded to total 100%. ▪ ▪ ▪
In addition to showing the relative size of each category on the balance sheet, vertical analysis may show the percentage change in the individual asset, liability, and shareholders’ equity items. Chicago Cereal’s current assets increased $290,000 from 2016 to 2017 and they increased from 22.6% to 23.8% of total assets. Property assets (net) decreased from 26.3% to 26.2% of total assets.
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▪ ▪
▪
Other assets decreased from 51.1% to 50.0% of total assets. Retained earnings increased by $806,000 from 2016 to 2017, and total shareholders’ equity increased from 19.3% to 22.1% of total liabilities and shareholders’ equity. This switch to a higher percentage of equity financing has two causes: First, while total liabilities increased by $226,000 the percentage of liabilities declined from 80.7% to 77.9% of total liabilities and shareholders’ equity. Second, retained earnings increased by $806,000. Thus, the company shifted toward a heavier reliance on equity financing both by using less debt and by increasing the amount of retained earnings. Vertical analysis of the comparative income statements of Chicago Cereal, shown below reveals that: • Cost of goods sold as a percentage of net sales increased from 55.8% to 56.0%. • Selling and administrative expenses increased from 28.0% to 28.1%. • Net income as a percentage of net sales increased from 9.1% to 9.4%. • The decline in net income as a percentage of sales is due primarily to the decrease in interest expense and income tax expense as a percentage of sales. CHICAGO CEREAL COMPANY, INC. Condensed Income Statement For the Years Ended December 31 (In thousands) 2017 Amount Percent*
Net sales $11,776 Cost of goods sold 6,597 Goss profit 5,179 Selling and admin. expenses 3,311 Income from operations 1,868 Interest expense 319 Other income (expense), net (2) Income before income taxes 1,547 Income tax expense 444 Net income $ 1,103 *Numbers have been rounded to total 100%.
100.0 56.0 44.0 28.1 15.9 2.7 0 13.2 3.8 9.4
2016 Amount
Percent*
$10,907 6,082 4,825 3,059 1,766 307 13 1,472 468 $ 1,004
100.0 55.8 44.2 28.0 16.2 2.8 0 13.4 4.3 9.1
Teaching suggestion – Discuss the associated benefit of vertical analysis that enables one to compare companies of different sizes. Use Illustration 14-9 to illustrate this point. Vertical analysis is useful in comparing companies of different sizes as it reduces each financial statement item to a percentage that can be compared more easily than large differences in dollar amounts.
Learning Objective 2 – Calculate and Interpret Ratios That Are Used to Analyze Liquidity
Ratios can be assessed in three categories of comparisons: intracompany, intercompany, and industry.
Liquidity ratios measure the short-term ability of the company to pay its maturing
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obligations and to meet unexpected needs for cash. ▪ Short-term lenders and other creditors such as bankers and suppliers are particularly interested in assessing liquidity. ▪ Working capital • Difference between current assets and current liabilities. • Positive working capital indicates the likelihood for paying current liabilities is favourable. ▪ Current ratio • Calculated by dividing current assets by current liabilities. • More useful indicator of liquidity than working capital. ▪ Receivables turnover • The ratio measures the number of times, on average, that receivables are collected during the period. • Calculated by dividing net credit sales (sales on account less sales returns and allowances and discounts) by the average gross accounts receivable (before the allowance for doubtful accounts is deducted) during the year. • The turnover ratio is converted into an average collection period in terms of days. This is calculated by dividing the receivables turnover into 365 days. Teaching suggestion – Ask students to try not to memorize the information in this chapter. Ask them to think about the information that is available and about what they are trying to compute. The receivables turnover ratio tells us how many times receivables are turning over a year. Therefore, if we divide the receivables turnover ratio into the number of days in a year, we will find the number of days, on average, accounts receivable are outstanding. ▪
Inventory turnover • The ratio measures the number of times, on average, that inventory is sold during the period. • Calculated by dividing cost of goods sold by average inventory. It measures the number of times the inventory turns over during the period. • Days in inventory is calculated by dividing 365 days by the inventory turnover ratio, indicates the average age of the inventory.
Teaching suggestion – Review with students whether higher or lower for each ratio indicates an improvement or a deterioration of financial position or performance.
Learning Objective 3 – Calculate and Interpret Ratios That Are Used to Analyze Solvency
Solvency ratios measure the ability of the company to pay total liabilities. ▪ Debt to total assets ratio • Measures the percentage of total assets that have been financed by creditors. • This ratio indicates the extent to which a company’s assets are financed with debt. • When the ratio is high, the company has a high level of debt and there is a greater risk that it will be unable to pay its maturing obligations. • Calculated by dividing total liabilities (both current and non-current) by total assets. ▪ Times interest earned
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• • • •
Also called interest coverage. An indication of a company’s ability to meet interest payments as they come due. Calculated by dividing income (earnings) before interest expense and income tax (EBIT) by interest expense. The higher the ratio, the more EBIT there is available to cover interest.
Teaching suggestion – Emphasize that income before interest expense and income tax expense is the amount used in the formula because that is the amount available for paying interest payments. Again, stress to students to think about what they are trying to compute rather than trying to memorize the formulas. ▪
Free cash flow • Measured as the amount of cash left over from operating cash flows after investing some of this to maintain its current productive capacity and after paying current dividends. • Calculated by dividing net cash provided (used) by operating activities less net capital by expenditures less dividends paid.
Learning Objective 4 – Calculate and Analyze Ratios That Are Used to Analyze Profitability
Profitability ratios measure the company’s operating success for a specific period of time. To be successful, assets must be used efficiently and generate enough sales at an appropriate price to cover all of the company’s expenses.
Profitability ratios focus mainly on the relationship between income statement items and statement of financial position items.
The return on common shareholders’ equity ratio is affected by the return on assets and debt to total assets ratios. ▪ If a company wants to increase its return on common shareholders’ equity, it can either increase its return on assets or increase its reliance on debt financing. ▪ As long as the return on assets is higher than the interest rate paid on debt, the return on common shareholders’ equity will always be increased by the use of debt.
The return on assets ratio is affected by the profit margin and asset turnover. If a company wants to increase its return on assets, it can do this by either increasing its return (profit margin), or trying to increase its asset utilization (asset turnover).
The profit margin is affected by the gross profit margin and the amount, or percentage, of operating expenses. ▪ If a company wants to increase its profit margin, it can increase its gross profit margin by either raising selling prices or reducing its cost of goods sold, or reduce its operating expenses, interest expense, or income tax expense. ▪ Gross Profit margin • A measure of the company’s ability to maintain an adequate selling price above its cost of goods sold.
Instructor’s Manual
Chapter 14 – Performance Measurement
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
▪
▪ ▪
▪
▪
• Calculated by dividing gross profit (net sales less cost of goods sold) by net sales. Profit margin • A measure of how much the selling price covers all expenses (including cost of goods sold). • Calculated by dividing net income by net sales. • Indicates how effective the company is at controlling operating expenses and how interest expense and income tax expense have affected net income. Asset turnover • Indicates how efficiently a company uses its assets to generate sales. • Calculated by dividing net sales by average total assets. Return on assets • An overall measure of profitability of assets in terms of how much is earned on each dollar invested in the assets. • Calculated by dividing net income by average total assets. Return on common shareholders’ equity • Widely used ratio that measures profitability from the common shareholders’ viewpoint. • Calculated by dividing net income available to common shareholders by average common shareholders’ equity. • Net income available to the common shareholders are net income less any preferred dividends declared. Basic earnings per share • Measures the net income earned on each common share. • Calculated by the net income available to the common shareholders by the weighted average number of common shares issued during the year. • Provides a useful perspective for determining investment return.
ASPE comparison – Under IFRS, earnings per share must be reported on the face of the income statement or statement of comprehensive income whereas under ASPE earnings per share is not required to be reported. ▪
▪
▪
Price-earnings (P-E) ratio • Measures the ratio of the market price of each common share to its basic earnings per share. • Calculated by dividing the market price per share by the basic earnings per share. • Commonly known as a market measure because it uses a company’s share price, which reflects the stock market’s (investors’) expectations for the company. Payout ratio • Measures the percentage of net income distributed as cash dividends. • Calculated by dividing cash dividends by net income. • Companies with high growth rates usually have low payout ratios because they reinvest most of their income back into the company, spending funds to purchase more assets rather than paying out dividends to shareholders. Dividend yield • Reports a rate of return a shareholder earned from dividends during the year as a percentage of the share price. • Calculated by dividing dividends per share by the market price per share. • Ratio is also known as a market measure, because of the use of the share price in its calculation.
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
Teaching suggestion – Review the profitability ratios illustrated in 14-13 with students and emphasize that for profitability ratios the desired result is a higher ratio.
Learning Objective 5 – Understand the Limitations of Financial Analysis
Some of the factors that can limit the usefulness of your analysis include the degree to which a company is diversified, the use of different accounting policies and estimates, the exclusion of events reported in other comprehensive income (loss), gains or losses arising from discontinued operations, and the effects of nonrecurring items. ▪ Diversification. Diversification in Canadian industry can limit the usefulness of financial analysis. Many companies are so diversified that they cannot be classified by industry. • Deciding what industry a company is in can actually be one of the main challenges to an effective evaluation of its results. • Companies may appear to be comparable but are not. • When companies have significant operations in different lines of business, they are required to report additional disclosures in a segmented information note to their financial statements. There are specific revenue, income, and asset tests to determine if a company is required to report segmented information or not. • If a company has reportable segments, it must disclose relevant information about revenues, operating income, and/or identifiable assets by products and services, by geographic area, and by major customer.
ASPE comparison – Under IFRS, there are specific revenue, profit, and asset tests to determine if information must be reported in the notes to the financial statements for segments. While under ASPE, there are no disclosure requirements for reporting segment information. ▪
▪
Alternative accounting policies and estimates. Variations among companies in their use of alternative accounting policies can lessen the comparability of their statements. • Companies may choose from a large number of acceptable accounting policies, such as different inventory cost formulas (FIFO or average) or depreciation methods (straight-line, diminishing-balance, or units-of-production). Different choices result in differing financial positions and net incomes, which again affect how easily their results can be compared. • Although different accounting policies may be detectable from reading the notes to the financial statements, adjusting the data to compensate for differences is difficult, if not impossible. Comprehensive income. Most financial ratios exclude total comprehensive income, or other comprehensive income, from the analysis. • There are no standard ratio formulas incorporating comprehensive income.
ASPE comparison – Under IFRS, if other comprehensive income is significant, selected profitability ratios should be recalculated using total comprehensive income rather than profit. Under ASPE, comprehensive income is not reported. ▪
Discontinued operations. The effects of discontinued business operations are excluded when performing financial analysis and calculating ratios.
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
•
▪
A discontinued operation are any components of an entity that have been disposed of or are available for sale. • A component of an entity represents a separate major line of business or major geographical area of operations that has been disposed of or is held for sale. • The component must be clearly distinguishable operationally and financially from the rest of the company. • Items relating to discontinued operations are segregated from continuing operations. • Discontinued operations are shown near the bottom of the income statement immediately following the income (loss) from continuing operations. • Any income tax expense relating to discontinued operations is segregated from the income tax expense relating to continuing operations and shown within the discontinued operations section of the income statement. • The discontinued operations item consists of two parts: (1) the income (loss) from the discontinued operations during the period, net of an income tax expense or savings, and (2) the gain (loss) on the disposal of the component, net of any income tax expense or saving. • If the component has not been disposed of and is being held for sale, only the first part (the income (loss) from the discontinued operations) will be reported on the income statement until the actual disposal occurs. • Assets and liabilities pertaining to discontinued businesses are segregated on the statement of financial position and are usually shown as current items. This is because the assets are available for sale and are expected to be sold within a year and the liabilities will be settled as soon as the sale of assets occurs. To illustrate, review Illustration 14-14 from the textbook. Hudson’s Bay Company’s discontinuation of a component.
Teaching suggestion – Point out to the students the use of the terms “profit from continuing operations” and the section “discontinued operations”. Within the discontinued operations section, the loss (or gain) from operations and the loss (or gain) from disposal are reported separately and net of income tax. Also point out to students that earnings per share figures are reported separately for continuing operations and discontinued operations so that investors can clearly see the impact of the decision on the company, although this is not presented in the exhibit. ▪
Nonrecurring items. A nonrecurring item is typically recorded in the income statement but is not expected to occur again. • Gains and losses from discontinued operations are considered to be a nonrecurring item. The determination of whether an item is nonrecurring requires the use of professional judgement. • Unpredictable economic events such as steep declines in oil prices or changes in interest rates may or may not result in nonrecurring events. To the extent that these estimates are inaccurate or biased, ratios and percentages that are based on such information will also be inaccurate or biased. • When management feels that accounting standards define key measures of performance such as net income too rigidly, they will disclose non-GAAP measures, which are management-defined measures of financial performance that are not included in accounting standards.
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.
If you were an investor, which ratio would you use to evaluate a potential investment?
Is it necessary to consider all of the ratios or it is acceptable to consider some of the ratios?
Where does industry data come from? Is it representative of the company that I plan on comparing to?
What other non-financial factors should be considered when evaluating a company?
Should companies be allowed to change accounting policies?
Does a change in accounting policy impact comparability and consistency?
How many years should be used within a horizontal analysis?
What are the drawbacks to using ratio analysis when evaluating a company?
If you owned a business, would you want to use another company’s financial statements to compare your operating results to?
Should comprehensive income be considered in a financial analysis?
How can you obtain comparison information for private companies?
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Chapter 14 – Performance Measurement
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
CHAPTER 14 PERFORMANCE MEASUREMENT 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. The question may be given at the beginning of the class and count for ½ to 1 mark.
Which technique is used to evaluate a series of data over a period of time to determine the increase or decrease that has taken place, expressed either as an amount or as a percentage? Answer: horizontal analysis
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
VOCABULARY QUIZ 1.
An overall measure of profitability, calculated as net income divided by average total assets.
2.
The disposal of a component of an entity.
3.
A technique for evaluating a series of financial statement data over a period of time to determine the increase (decrease) that has taken place expressed as either an amount or a percentage.
4.
Measures of the ability of the company to survive over a long period of time.
5.
A technique that expresses each item in a financial statement as a percentage of a total (base) amount within the same financial statement.
6.
Measures the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.
7.
Measures the relationship of the market price of each common share to the basic earnings per share.
8.
Measures the success of a company for a given period of time.
9.
A measure that expresses the relationship of current assets to current liabilities calculated as current assets divided by current liabilities.
10.
The amount of cash left over from operating cash flows after investing some of this to maintain current productive capacity and after paying current dividends.
Quizzes
Chapter 14 – Performance Measurement
14 - 2
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO VOCABULARY QUIZ 1.
Return on assets
2.
Discontinued operations
3.
Horizontal analysis
4.
Solvency ratios
5.
Vertical analysis
6.
Liquidity ratios
7.
Price-earnings (P-E) ratio
8.
Profitability ratios
9.
Current ratio
10.
Free cash flow
Quizzes
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14 - 3
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
MULTIPLE CHOICE QUIZ 1.
Which of the following is considered a liquidity ratio? a. price-earnings ratio b. times interest earned c. average collection period d. free cash flow e. debt to total assets ratio
2.
The income (loss) from discontinued operations consists of the a. income (loss) from continuing operations. b. the gain (loss) on the disposed operations. c. income (loss) from the disposed operations. d. both b and c e. both a and c
3.
Discontinued operations refer to a. the disposal of a component of an entity. b. the availability for sale of a component of an entity. c. the elimination of a product line. d. both a and b e. both b and c
4.
Vertical analysis is rarely performed on which of the following statements? a. income statement b. statement of cash flows c. statement of financial position d. All of the above statements have vertical analysis performed on them. e. b and c
5.
Which of the following is considered a profitability ratio? a. price-earnings ratio b. times interest earned c. average collection period d. free cash flow e. debt to total assets ratio
6.
Comparisons with a competitor company to provide insight into a company’s competitive position is an a. intracompany basis comparison. b. intercompany basis comparison. c. industry comparison. d. both a and c e. none of the above
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
7.
A technique for evaluating a series of financial statement data over a period of time is called a. horizontal analysis. b. vertical analysis. c. ratio analysis. d. none of the above e. both a and b
8.
A technique for evaluating financial statement data that expresses each item within a financial statement as a percentage of a base amount is called a. horizontal analysis. b. vertical analysis. c. ratio analysis. d. none of the above e. both a and b
9.
Vertical analysis of comparative income statements would show cost of goods sold as a percentage of a. total assets. b. inventory. c. net sales. d. net income. e. total liabilities.
10.
A measure of the ability of a company to pay total liabilities is a a. liquidity ratio. b. solvency ratio. c. current ratio. d. profitability ratio. e. working capital ratio.
Use the following data to answer questions 11–13. Current assets ................................................ Total assets .................................................... Current liabilities ............................................. Total liabilities ................................................. Net sales ........................................................ Net credit sales................................................ Cost of goods sold ........................................... Gross profit ..................................................... Net income ...................................................... Average gross receivables ............................. Average inventory ...........................................
Quizzes
$150,000 500,000 125,000 200,000 550,000 300,000 200,000 350,000 100,000 50,000 40,000
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11.
What is the receivables turnover? a. 1 times b. 6 times c. 11 times d. 17 times e. none of the above
12.
What is the debt to total assets? a. 25% b. 40% c. 83% d. 133% e. none of the above
13.
What is the profit margin? a. 18% b. 36% c. 64% d. 82% e. none of the above
14.
Which of the following is a true statement? a. Under both ASPE and IFRS, basic earnings per share must be reported on the income statement. b. Under ASPE, basic earnings per share must be reported on the income statement. c. Under IFRS, basic earnings per share must be reported in the income statement. d. Neither ASPE nor IFRS require that the basic earnings per share be reported on the income statement. e. Only when discontinued operations are presented must basic earnings per share be reported on the income statement.
15.
Which of the following is a factor that would limit the usefulness of your financial analysis? a. alternative accounting policies b. comprehensive income c. nonrecurring items d. diversification e. all of the above
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO MULTIPLE CHOICE QUIZ 1.
c
2.
d
3.
d
4.
b
5.
a
6.
b
7.
a
8.
b
9.
c
10.
b
11.
b
12.
b
13.
a
14.
c
15.
e
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #1 Circle the correct answer.
True/False 1.
Intercompany comparison refers to comparison with other companies.
True
False
2.
Vertical analysis expresses all income statement items as a percentage of net income.
True
False
3.
A base year is selected when performing horizontal analysis.
True
False
4.
Liquidity ratios measure the ability of a company to survive over a long period of time.
True
False
5.
Current ratio, receivables turnover, and inventory turnover, are measures of solvency.
True
False
6.
Gross profit margin, asset turnover, and return on common shareholders’ equity are profitability ratios.
True
False
7.
The payout ratio is a reflection of investor’s assessments of a company’s future net income.
True
False
8.
The debt to total assets ratio measures the percentage of total assets provided by long-term creditors.
True
False
9.
The formula for calculating the times interest earned ratio is net income before interest expense and income tax divided by interest expense.
True
False
10.
Basic earnings per share is reported for both common and preferred shares.
True
False
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
Multiple Choice 11.
Sales (in millions) for a three-year period are: Year 1 $4.0, Year 2 $4.6, and Year 3 $5.0. Using Year 1 as the base year, sales in Years 2 and 3 expressed as a percentage of the base year sales are, respectively, a. 115% and 125%. b. 115% and 109%. c. 15% and 25%. d. 87% and 80%. e. none of the above
12.
All of the formulas are correct except a. Receivables Turnover = Net Credit Sales ÷ Average Gross Accounts Receivable. b. Asset turnover = Net Sales ÷ Average Total Assets. c. Current Ratio = Current Liabilities ÷ Current Assets. d. Payout Ratio = Cash Dividends ÷ Net income. e. both b and d
13.
Net credit sales are $4,000,000 and average gross receivables are $250,000. The average collection period is a. 16 times. b. 6.25 percent. c. 16 days. d. 22.8 days. e. 58.4 days.
14.
Comparisons of financial data made within a company are called a. intracompany comparisons. b. interior comparisons. c. intercompany comparisons. d. intramural comparisons. e. industry comparisons.
15.
Basic earnings per share a. is calculated by dividing net income by the number of common share issued in the year. b. is a measure of the net income realized on each common share. c. is not presented on the income statement for publicly traded companies. d. is a measure of net income realized on each preferred share. e. both a and b
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #1 True/False 1.
True
2.
False
3.
True
4.
False
5.
False
6.
True
7. 8. 9.
False False True
10.
False
Multiple Choice 11.
a ($4.6 ÷ $4.0; $5.0 ÷ $4.0)
12.
c
13.
d
14.
a
15.
b
Quizzes
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
20-MINUTE QUIZ #2
1.
State the effect of the following transactions on a current ratio of 1.5 to 1 (increase, decrease, or no effect). a. Collection of an account receivable . b. Declaration of a cash dividend . c. Sale of additional shares for cash . d. Payment of an account payable . e. Purchase of equipment for cash . f. Purchase of inventory for cash . g. Purchase of short-term held-for-trading investments for cash .
2.
The following selected solvency ratios are available for two companies, Olama Corporation and Yomanda Corporation, and their industry, for a recent fiscal year: Ratio Debt to total assets Times interest earned
Olama 45.5% 3.7 times
Yomanda 37.2% 7.6 times
Industry 45.3% 7.2 times
Which company is more solvent? Explain.
3.
Here is selected information for Phillips Inc. Use this information to answer the questions below. Round each answer to one decimal place.
Net sales (all credit) Cost of goods sold Ending inventory Ending accounts receivable Total current assets Total current liabilities
2018 5,400 4,400
2017 5,200 4,200
2016 5,000 4,000
460
430
400
300
280
250
1,200 950
1,150 900
1,100 850
a. Calculate the gross profit margin for 2017 Calculate the gross profit margin for 2018 Comment on the change b. Calculate the inventory turnover for 2017 c. Calculate the collection period for 2018 d. Calculate the current ratio for 2018
Quizzes
______________________ ______________________ ______________________ ______________________ ______________________ ______________________
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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian Edition
ANSWERS TO 20-MINUTE QUIZ #2 1. a.
no effect (no effect on current assets: cash increases and accounts receivable decreases)
b.
decrease (current liabilities increase: retained earnings decreases and dividend payable increases)
c.
increase (current assets increase: cash increases and share capital increases)
d.
increase (current liabilities decrease and current assets decrease by the same amount but the proportionate impact is likely higher on the denominator: accounts payable decreases and cash decreases. Assume current assets were $150 and current liabilities $100 before payment of the account payable, and $125 and $75 after payment of the account payable. The current ratio increases from1.5:1 to 1.7:1.)
e.
decrease (current assets decrease: equipment increases and cash decreases)
f.
no effect (no effect on current assets: inventory increases and cash decreases)
g.
no effect (no effect on current assets: short-term investments increase and cash decreases)
2. Yomanda appears to be more solvent than Olama. Yomanda has a lower debt to total assets ratio, indicating that a lower percentage of its total assets is financed by creditors. As well, Yomanda has higher times interest earned, indicating that it has a better ability to meet interest payments as they come due. When looking at debt to total assets, Olama appears to be on par with the industry average. However, when assessing Olama’s ability to meet interest payments as they come due (as indicated by times interest earned), Olama is not as solvent as the average firm in its industry.
3. a.
2017: (5200 – 4200) ÷ 5200 = 19.2% 2018: (5400 – 4400) ÷ 5400 = 18.5% There has been a decrease in gross profit margin from the previous year indicating an unfavourable trend in profitability. However, other profitability ratios need to be consulted as well.
b.
10.1 times ( $4,200 ÷ [($430 + $400) ÷2] = 10.1)
c.
19.6 days ($5,400 ÷ [($300 + $280) ÷ 2] = 18.6; 365 ÷ 18.6 = 19.6)
d.
1.26 ($1,200 ÷ $950 = 1.26)
Quizzes
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