SOLUTIONS MANUAL For Financial Accounting Tools for Business Decision-Making 6th Canadian Edition 6e by StudyGuide

Part 1 CHAPTER 1 The Purpose and Use of Financial Statements ASSIGNMENT CLASSIFICATION TABLE Questions

Brief Exercises

Exercises

A Problems

B Problems

BYP

1. Identify the uses and users of accounting.

1, 2, 3, 4

3, 5, 7

2. Describe the primary forms of business organization.

5, 6, 7, 8

3, 7

3. Explain the three main types of business activity.

9, 10, 11, 12

3, 4

4. Describe the purpose and content of each of the financial statements.

13, 14, 15, 16, 17, 18, 19, 20

5, 6, 7, 8, 9, 10

5, 6, 7, 8, 9, 10, 11, 12, 13

4A, 5A, 6A, 7A, 8A, 9A, 10A

4B, 5B, 6B, 7B, 8B, 9B, 10B

1, 2, 4, 6

Study Objectives

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Chapter 1

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number 1A

Description Identify uses of accounting information.

Difficulty Level Moderate

Time Allotted (min.) 30-40

Determine forms of business organization and accounting standards.

Moderate

20-30

Identify business activities.

Simple

25-30

Classify accounts.

Simple

20-30

Prepare accounting equation.

Simple

20-30

Determine missing amounts; answer questions.

Complex

30-40

Prepare financial statements.

Moderate

35-45

Prepare statement of cash flows; comment on adequacy of cash.

Moderate

25-35

Calculate missing amounts; explain statement interrelationships.

Moderate

40-50

10A

Prepare corrected statement of financial position; identify financial statements for ASPE.

Complex

35-45

Identify users of accounting information.

Moderate

30-40

Determine forms of business organization and accounting standards.

Moderate

20-30

Identify business activities.

Simple

25-30

Classify accounts.

Simple

20-30

Prepare accounting equation.

Simple

20-30

Determine missing amounts; answer questions.

Complex

30-40

Prepare financial statements.

Moderate

35-45

Prepare statement of cash flows; comment on adequacy of cash.

Moderate

25-35

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Chapter 1

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Calculate missing amounts; explain statement interrelationships.

Moderate

40-50

10B

Prepare corrected statement of financial position; identify financial statements for ASPE.

Complex

35-45

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Chapter 1

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Financial Accounting, Sixth Canadian Edition

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.

Internal users of accounting information work for the company and include finance directors, marketing managers, human resource personnel, production supervisors, and company officers. External users of accounting information 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.

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 profits? • 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?

Ethics are important because, without the expectation of ethical behaviour, the information presented in the financial statements would have no credibility for the accounting profession. Without credibility, financial statement information would be useless to financial statement users.

(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 profits. Depending on the circumstances, this may be an advantage or disadvantage. Disadvantages of a proprietorship includes 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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 5. (Continued) (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 profits. 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. (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 and 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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 6.

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.

(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.

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 Shoppers Drug Mart, 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.

(a) (b) (c)

(d) (e)

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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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 10.

Operating activities are the activities that the organization undertakes to earn a profit. They include the day-to-day activities which generate revenues and cause expenses to be incurred. In order to earn profits, a company must first purchase resources they need to operate. The purchase of these resources (assets) are considered to be investing activities. 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.

11.

(a)

Two examples of operating activities are revenue generated from providing auto repair services and the expenses related to paying employee salaries.

(b)

Two examples of investing activities are the purchase of property, plant, and equipment, such as a building, and the sale of a long-term investment.

(c)

Two examples of financing activities for a corporation are borrowing money (debt) and selling shares (equity).

12.

Local companies providing services and therefore generate service revenue would include doctors, dentists, 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.

13.

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.

14.

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.

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Chapter 1

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 15.

Assets = Liabilities + Shareholders’ Equity $7,473,721 = $3,150,394 + $4,323,327 (amounts are in thousands of dollars)

16.

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 profit (increases retained earnings). Examples of items that decrease the components are repurchases of shares (decreases share capital) and payment of dividends (decrease retained earnings).

17.

(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.

18.

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.

19.

(a)

The income statement reports profit for the period. The profit 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 the opening balance of 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.

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Chapter 1

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 20.

(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, statement of financial position, and a statement of cash flows.

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Chapter 1

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1

Investor Marketing manager Creditor Chief financial officer Canada Revenue Agency Labour union

(a) Type of Evaluation

(b) Type of User

5 4 3 6 1 2

External Internal External Internal External External

BRIEF EXERCISE 1-2 (a) (b) (c) (d) (e)

1 4 3 2 4

Proprietorship Private corporation Public corporation Partnership Private corporation

BRIEF EXERCISE 1-3 (a) (b) (c) (d) (e) (f)

O F* F F I O

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.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 1-4

1. 2. 3. 4. 5. 6.

(a)

(b)

O F O O O I

NE + + -

BRIEF EXERCISE 1-5 (a)

Total assets

= = =

Total liabilities + Shareholders’ equity $55,000 + $120,000 $175,000

(b)

Total assets

Total liabilities + Shareholders’ equity (share capital + retained earnings) $170,000 + ($100,000 + $90,000) $360,000

= = (c)

(d)

Total liabilities

Shareholders’ equity

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= =

Total assets – Shareholders’ equity (share capital + retained earnings) $150,000 – ($50,000 + $25,000) $75,000

= = =

Total assets – Total liabilities $500,000 – ($500,000 ÷ 2) $250,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 1-6 Beginning of Year: Assets = Liabilities + Shareholders’ equity Beginning of Year: $800,000 = $500,000 + Shareholders’ equity Beginning of Year: Shareholders’ equity = $300,000 (a)

($800,000 + $150,000) = ($500,000 – $80,000) + Shareholders’ equity Shareholders’ equity = $530,000

(b)

Assets = ($500,000 – $50,000) + ($300,000 + $50,000 + $75,000) Assets = $875,000

(c)

($800,000 – $80,000) = Liabilities + ($300,000 + $110,000) Liabilities = $310,000

BRIEF EXERCISE 1-7 (a) (b) (c) (d) (e) (f) (g) (h)

IS SFP SCE SCF SFP SCF IS SCE

BRIEF EXERCISE 1-8 (a) (b) (c) (d) (e) (f) (g) (h)

A L A A SE L SE A

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 1-9

(a) (b) (c) (d) (e) (f)

Profit Issue of common shares Dividends paid to shareholders Cash Loss Issue of long-term debt

Share Capital

Retained Earnings

Total Shareholders' Equity

NE + NE NE NE NE

+ NE NE NE

+ + NE NE

BRIEF EXERCISE 1-10 (a)

Beginning balance Issue additional shares Profit Dividends paid Ending balance (b)

Beginning balance Issue additional shares Loss Dividends paid Ending balance

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(1)

(2)

Common Shares $100,000 25,000

Retained Earnings $350,000

$125,000

75,000 (5,000) $420,000

(1)

(2)

Common Shares $100,000 25,000

Retained Earnings $350,000

$125,000

(75,000) (5,000) $270,000

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(3) Total Shareholders' Equity $450,000 25,000 75,000 (5,000) $545,000 (3) Total Shareholders' Equity $450,000 25,000 (75,000) (5,000) $395,000

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 1-1 (a)

Chief Financial Officer – Does Facebook generate enough cash to expand its product line? 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.

EXERCISE 1-2 Public Private Proprietorship Partnership Corporation Corporation 1. 2. 3.

No personal liability Owner(s) pay(s) personal income tax on company profits Generally easiest form of organization to raise capital

Ownership indicated by shares

Required to issue quarterly financial statements

Owned by one person

Limited life

8. 9.

Usually easiest form of organization to set up Requires the use of IFRS as its accounting standards

10. Shares are closely held

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Financial Accounting, Sixth 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

EXERCISE 1-4

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

(a)

(b)

O I F I O F I F F O

+ + + + -

EXERCISE 1-5 1. 2. 3. 4. 5. 6. 7. 8.

SFP IS, SCE IS SCE, SFP IS SCE SFP IS

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9. 10. 11. 12. 13. 14. 15.

SFP IS SCF SCF SFP SFP SCE, SFP

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-6 (a)

Assets – Liabilities = Shareholders’ equity 2014: $440,000 – $290,000 = $150,000 2015: $520,000 – $350,000 = $170,000

(b)

Change in shareholders’ equity $170,000 – $150,000 = $20,000 increase

(c)

1. Profit is $20,000 = the increase in shareholders’ equity 2. Profit is $25,000 = the increase in shareholders’ equity + dividends paid of $5,000 3. Loss of $5,000 = the increase in shareholders’ equity – common shares issued of $25,000 4. Profit is $15,000 = the increase in shareholders’ equity + dividends paid of $5,000 – common shares issued of $10,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-7 [1]

Total revenues – Profit = 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 profit given above

[4]

Beginning balance of retained earnings plus profit less dividends = Ending balance of retained earnings. $0 + $150,000 – Dividends = $100,000 Dividends = $50,000

[5]

Beginning balance in shareholders' equity + Issue of shares + Profit – Dividends = Ending balance in shareholders’ equity $0 + $100,000 + $150,000 – $50,000 = $200,000

[6]

Total Assets – Total liabilities = Shareholders’ equity $1,050,000 – $850,000 = $200,000 or [5] above

[7]

Total revenues – Total expenses = Profit 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 profit given above

[10]

Common shares, end of year + Retained Earnings, end of year $20,000 + $40,000 = $60,000

[11]

Liabilities + 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

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-8 ($ in thousands) (a)

Assets – Liabilities = Shareholders’ equity 2012: $3,243,696 – $2,285,697 = $957,999 2011: $2,940,459 – $2,010,346 = $930,113

(b)

Assets = Liabilities + Shareholders’ equity 2012: $3,243,696 = $2,285,697 + $957,999 Assets = Liabilities + Shareholders’ equity 2011: $2,940,459 = $2,010,346 + $930,113

(c)

Change in shareholders’ equity $957,999 – $930,113 = $27,886 increase

(d)

Shareholders’ equity, Dec. 31, 2011 Add: Profit Deduct: Dividends Other shareholders’ equity items Shareholders’ equity, December 31, 2012

$930,113 ? 22,229 65,181 $957,999

Solving for profit: $957,999 + $65,181 + $22,229 − $930,113 = $115,296

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-9 (a) L A L A A SE A

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

(b) 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, 2015 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

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$ 26,200 6,000 34,000 97,500 163,700 20,000 48,500 68,500 $232,200

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-10 (a) E E NR E R E E R

(b)

Administrative expenses Cost of goods sold Dividends Finance expenses Finance income Income tax expense Selling and distribution expenses Sales

REITMANS (Canada) Limited Income Statement Year Ended February 2, 2013 (in millions) Revenues Sales Finance income Total revenues Expenses Selling and distribution expenses Cost of goods sold Administrative expenses Finance expenses Total expenses Profit before income tax Income tax expense Profit

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$1,000.5 5.6 1,006.1 $550.2 372.1 47.4 1.3 971.0 35.1 8.5 $ 26.6

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-11 KON INC. Income Statement Year Ended December 31, 2015 Revenues Service revenue Expenses Salaries expense Rent expense Utilities expense Office expense Total expenses Profit before income tax Income tax expense Profit

$61,000 $30,000 12,400 2,400 1,600 46,400 14,600 3,000 $11,600 KON INC. Statement of Changes in Equity Year Ended December 31, 2015

Balance, January 1 Issued common shares Profit Dividends Balance, December 31

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Common Shares $20,000 10,000

Retained Earnings $58,000 11,600 (5,000) $64,600

$30,000

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Total Equity $78,000 10,000 11,600 (5,000) $94,600

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-12 (a)

Camping revenue Expenses Operating expenses Income tax expense Profit

(b)

$168,000 $130,000 10,000

140,000 $ 28,000

SEA SURF CAMPGROUND, INC. Statement of Changes in Equity Year Ended December 31, 2015

Balance, January 1 Issued common shares Profit Dividends Balance, December 31

Common Shares $30,000 10,000

Retained Earnings $18,000

Total Equity $48,000 10,000 28,000 (12,000) $74,000

28,000 (12,000) $34,000

$40,000

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. SEA SURF CAMPGROUND, INC. Statement of Financial Position December 31, 2015 Assets Cash Supplies Equipment Total assets

7,500 2,500 119,000 $129,000

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

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5,000 50,000 55,000

40,000 34,000 74,000 $129,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 1-13 1.

Yu Corporation is distributing nearly all of this year's profit as dividends. This suggests that Yu is not pursuing rapid growth. Companies that are pursuing opportunities for growth normally retain their profit and pay low, or no, dividends.

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.

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.

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.

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 1-1A (a)

1. The South Face Inc. is an external user of accounting information in assessing the credit-worthiness 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, the Caisse d’Économie Base Montréal is an external user. 4. As an employee of Tech Toy Limited, the CEO 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 profit. 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 CEO 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-2A (a)

(b)

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.

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.

Robert and Tom should form a public corporation 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.

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.

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

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Financial Accounting, Sixth 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 long-lived 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-4A

Accounts payable Accounts receivable Bank loan payable Cash Common shares Equipment Income tax expense Income tax payable Interest expense Office expense Prepaid insurance Rent expense Repairs and maintenance expense Salaries payable Service revenue Vehicles

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(a)

(b)

L A L A SE A E L E E A E E L R A

SFP SFP SFP SFP SFP, SCE SFP IS SFP IS IS SFP IS IS SFP IS SFP

Chapter 1

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 1-5A (a) and (b) Assets Accounts payable Accounts receivable Bank loan payable Cash Common shares Equipment Income tax payable Interest payable Prepaid insurance Retained earnings Salaries payable Supplies Unearned revenue

$6,400 10,800 9,000 1,250 1,000 19,400 2,000 100 600 12,250 1,000 1,200 1,500

(a) L A L A SE A L L A SE L A L

(b) Liabilities

Shareholders’ Equity

$ 6,400 $10,800 9,000 1,250 $ 1,000 19,400 2,000 100 600 12,250 1,000 1,200 ______ $33,250

Totals

1,500 ______ $20,000

______ $13,250

Assets = Liabilities + Shareholders’ equity $33,250 = $20,000 + $13,250 (c)

Beginning balance in Retained Earnings + Revenues – Expenses – Dividends = Ending balance in Retained Earnings $2,250 + $72,000 – $50,000 – $12,000 = $12,250

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-6A

(a)

(All amounts are in millions of dollars)

Sears [1]

Total assets = Total liabilities + Total shareholders’ equity Total assets = $1,638.7 + $1,092.0 Total assets = $2,730.7

[2]

Total liabilities = Total assets – Total shareholders’ equity Total liabilities = $2,479.1 – $1,076.4 Total liabilities = $1,402.7

[3]

Shareholders’ equity, beginning of year – Repurchase of shares – Dividends + Total revenues – Total expenses – Other decreases in shareholders’ equity = Shareholders’ equity, end of year $1,092.0 − $0.1 − $101.9 + $4,511.1 – [3] − $14.8 = $1,076.4 [3] Total expenses = $4,409.9

Canadian Tire [4]

Total liabilities = Total assets – Total shareholders’ equity Total liabilities = $12,338.8 – $4,409.0 Total liabilities = $7,929.8

[5]

Total assets = Total liabilities + Total shareholders’ equity Total assets = $8,417.8 + $4,574.6 [6] Total assets = $12,992.4

[6]

Shareholders’ equity, beginning of year – Repurchase of shares – Dividends + Total revenues – Total expenses – Other decreases in shareholders’ equity = Shareholders’ equity, end of year $4,409.0 − $225.0 – $97.7 + $11,451.0 – $10,951.8 − $10.9 = $4,574.6

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-6A (Continued) (b)

At the end of the most recent fiscal year, Canadian Tire has a higher proportion of debt financing and Sears has a higher proportion of equity financing. Canadian Tire financed 35.2% ($4,574.6 million ÷ $12,992.4 million) of its assets with equity and 64.8% of its assets with debt ($8,417.8 million ÷ $12,992.4 million). For the same period, 43.4% ($1,076.4 million ÷ $2,479.1 million) of Sears’s assets were financed by equity and 56.6% ($1,402.7 million ÷ $2,479.1 million) by debt. Canadian Tire is slightly more risky 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).

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-7A (a) ONE PLANET COSMETICS CORP. Income Statement Month Ended June 30, 2015 Revenues Service revenue Expenses Salaries expense Office expense Utilities expense Supplies expense Interest expense Total expenses Profit before income tax Income tax expense Profit

$12,000 $3,400 1,500 1,300 1,200 800 8,200 3,800 700 $ 3,100

ONE PLANET COSMETICS CORP. Statement of Changes in Equity Month Ended June 30, 2015

Balance, June 1 Issued common shares Profit Dividends paid Balance, June 30

Solutions Manual .

Common Shares $ 0 25,000

$25,000

1-31

Retained Earnings $ 0 3,100 (1,000) $ 2,100

Total Equity $ 0 25,000 3,100 (1,000) $27,100

Chapter 1

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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, 2015 Assets Cash Accounts receivable Supplies Equipment Total assets

$ 6,000 4,000 1,400 32,000 $43,400 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

(b)

$ 2,300 14,000 16,300

25,000 2,100 27,100 $43,400

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 profit 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.

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Financial Accounting, Sixth 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, 2015 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)

(35,000)

Net increase in cash Cash, January 1 Cash, December 31 (c)

$20,000

30,000 15,000 12,000 $27,000

The company is generating less cash from operating activities (+$20,000) than it is using in total for its investing activities (–$35,000) and the payment of dividends (– $10,000). The company, however, is making up 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-9A (a) [1]

Operating expenses = Revenue – Profit before income tax Operating expenses = $90,000 – $30,000 Operating expenses = $60,000

[2]

Profit = Profit before income tax – Income tax expense Profit = $30,000 – $6,000 Profit = $24,000

[3]

Profit (from [2]) = $24,000

[4]

Ending retained earnings = Beginning retained earnings + Profit – Dividends Ending retained earnings = $0 + $24,000 (from [2]) – $10,000 Ending retained earnings = $14,000

[5]

Total issued common shares = $12,000

[6]

Total profit = $24,000 (from [3])

[7]

Total equity = Beginning balance + Issued common shares + Profit – Dividends Total equity = $0 + $12,000 (from [5]) + $24,000 (from [6]) – $10,000 Total equity = $26,000

[8]

Land = Total assets (from [9]) – Cash – Accounts receivable – Building – Equipment Land = $110,000 – $5,000 – $10,000 – $60,000 – $25,000 Land = $10,000

[9]

Total assets = Total liabilities + Shareholders' equity Total Assets = $110,000

[10]

Accounts payable = Total liabilities – Bank loan payable Accounts payable = $84,000 – $50,000 Accounts payable = $34,000

[11]

Common shares = $12,000 (from the Statement of Changes in Equity)

[12]

Retained earnings = $14,000 (from [4])

[13]

Shareholders’ equity = Total liabilities and shareholders' equity – Total liabilities Total shareholders' equity = $110,000 – $84,000 Total shareholders' equity = $26,000

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Financial Accounting, Sixth 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)

Solutions Manual .

The reason the statements must be prepared in a certain order as indicated above, is that each statement depends on information in the previously prepared statement. For example, the profit 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.

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Chapter 1

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Financial Accounting, Sixth 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 Remove boat asset Remove bank loan Net adjustment to common shares

$10,000 24,000 (40,000) $ 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, 2015 Assets

Cash Accounts receivable ($50,000 − $10,000) Merchandise inventory Total assets

$20,000 40,000 36,000 $96,000

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 (c)

$34,000 34,000

56,000 6,000 62,000 $96,000

As a private company, GG Corporation should also prepare an income statement, a statement of retained earnings, and a statement of cash flows.

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Chapter 1

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Financial Accounting, Sixth 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 profit. 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 CEO 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). 4. In deciding whether to extend a loan, the 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.

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Chapter 1

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Financial Accounting, Sixth 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 the shareholders. 4. Abdur 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 Abdur 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

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Chapter 1

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Financial Accounting, Sixth 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 store

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 long-lived 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.

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Chapter 1

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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 Interest expense Land Merchandise inventory Mortgage payable Office expense Prepaid insurance Salaries payable Sales

Solutions Manual .

(a)

(b)

L A L A A SE E A E L E A A L E A L R

SFP SFP SFP SFP SFP SFP, SCE IS SFP IS SFP IS SFP SFP SFP IS SFP SFP IS

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Chapter 1

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 1-5B (a) and (b)

Assets Accounts payable Accounts receivable Bank loan payable Cash Common shares Income tax payable Interest payable Prepaid insurance Retained earnings Salaries payable Supplies Unearned revenue Vehicles

$10,800 16,400 40,000 11,250 5,000 2,000 400 700 42,250 2,050 1,250 2,500 75,400

(a) L A L A SE L L A SE L A L A

(b) Liabilities

Shareholders’ Equity

$10,800 $ 16,400 40,000 11,250 $ 5,000 2,000 400 700 42,250 2,050 1,250 2,500 75,400 _______ $105,000

Totals

______ $57,750

______ $47,250

Assets = Liabilities + Shareholders’ equity $105,000 = $57,750 + $47,250 (c)

Beginning balance in Retained Earnings + Revenues – Expenses – Dividends = Ending balance in Retained Earnings $22,250 + $172,000 – $140,000 – $12,000 = $42,250

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Chapter 1

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-6B (a)

(All amounts are in millions of dollars) Tim Hortons [1]

Total liabilities = Total assets – Total shareholders’ equity Total liabilities = $2,204.0 – $1,154.4 Total liabilities = $1,049.6

[2]

Total shareholders' equity = Total assets – Total liabilities Total shareholders' equity = $2,284.2 – $1,094.1 Total shareholders' equity = $1,190.1

[3]

Shareholders’ equity, beginning of year – Repurchase of shares – Dividends + Total revenues – Total expenses – Other decreases in shareholders’ equity = Shareholders’ equity, end of year $1,154.4 − $18.7 − $[3] + $3,123.8 – $2,716.0 − $222.9 = $1,190.1 [3] Dividends = $130.5

Starbucks [4]

Total assets = Total liabilities + Total shareholders’ equity Total assets = $2,973.1 + $4,387.3 Total assets = $7,360.4

[5]

Total assets = Total liabilities + Total shareholders’ equity Total assets = $3,104.7 + $5,114.5 (from [6]) Total assets = $8,219.2

[6]

Shareholders’ equity, beginning of year – Repurchase of shares – Dividends + Total revenues – Total expenses – Other decreases in shareholders’ equity = Shareholders’ equity, end of year $4,387.3 − $1.1 − $543.7 + $13,604.6 – $12,219.9 − $112.7 = $5,114.5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-6B (Continued) (b)

At the end of the most recent fiscal year, Tim Hortons has a higher proportion of debt financing and Starbucks has a higher proportion of equity financing. Starbucks financed 62.2% (U.S. $5,114.5 million ÷ U.S. $8,219.2 million) of its assets with equity and 37.8% of its assets with debt (U.S. $3,104.7 million ÷ U.S. $8,219.2 million). For the same period, 52.1% ($1,190.1 million ÷ $2,284.2 million) of Tim Hortons’ assets were financed by equity and 47.9% ($1,094.1 million ÷ $2,284.2 million) by debt. Tim Hortons is slightly more risky 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. If there are significant currency fluctuations between U.S. and Canadian dollars, it will not be possible to compare absolute amounts unless they are converted to the same currency. However, if the amounts were converted into percentages, such as was done in (b) above, percentages can be compared despite different currencies or sizes of the two companies.

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Chapter 1

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-7B (a)

AERO FLYING SCHOOL LTD. Income Statement Month Ended May 31, 2015

Revenues Service revenue Expenses Fuel expense Rent expense Office expense Salaries expense Repair and maintenance expense Interest expense Profit before income tax Income tax expense Profit

$12,600 $3,300 2,200 2,300 1,000 700 100

9,600 3,000 600 $ 2,400

AERO FLYING SCHOOL LTD. Statement of Changes in Equity Month Ended May 31, 2015

Balance, May 1 Issued common shares Profit Dividends Balance, May 31

Solutions Manual .

Common Shares $ 0 50,000

$50,000

1-44

Retained Earnings $ 0 2,400 (800) $1,600

Total Equity $ 0 50,000 2,400 (800) $51,600

Chapter 1

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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, 2015 Assets Cash Accounts receivable Equipment Total assets

$ 5,300 10,200 60,300 $75,800 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

(b)

$ 2,200 22,000 24,200 50,000 1,600 51,600 $75,800

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 profit 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.

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Chapter 1

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Financial Accounting, Sixth 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, 2015 Operating activities Cash received from customers Cash paid to suppliers 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)

(40,000)

(28,000)

Decrease in cash Cash, July 1, 2014 Cash, June 30, 2015

(c)

$49,000

(19,000) 40,000 $21,000

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.

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(b) (a)

Financial Accounting, Sixth Canadian Edition

PROBLEM 1-9B [1]

Operating expenses = Service revenue – Profit before income tax Operating expenses = $85,000 – $35,000 Operating expenses = $50,000

[2]

Profit = Profit before income tax – Income tax expense Profit = $35,000 – $9,000 Profit = $26,000

[3]

Profit = $26,000 (same as [2])

[4]

Dividends = Beginning retained earnings + Profit – Ending retained earnings Dividends = $20,000 + $26,000 – $31,000 Dividends = $15,000

[5]

Beginning total equity = Beginning common shares + Beginning retained earnings Beginning total equity = $25,000 + $20,000 Beginning total equity = $45,000

[6]

Total common shares issued = $10,000

[7]

Profit = $26,000 (same as [3])

[8]

Dividends = $15,000 (same as [4])

[9]

Ending total equity = Ending common shares + Ending retained earnings Ending total equity = $35,000 + $31,000 Ending total equity = $66,000

[10]

Cash = Total assets – (Accounts receivable + Land + Buildings + Equipment) Cash = $85,000 (from [11]) – ($15,000 + $20,000 + $40,000 + $5,000) Cash = $5,000

[11]

Total assets = Total liabilities and shareholders’ equity Total assets = $85,000

[12]

Common shares = Total liabilities and shareholders’ equity – (Liabilities + Retained earnings) Common shares = $85,000 – ($19,000 + $31,000) Common shares = $35,000

[13]

Retained earnings = $31,000 (as per statement of changes in equity)

Solutions Manual .

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Chapter 1

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Financial Accounting, Sixth 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 a certain order as indicated above, is that each statement depends on information in the previously prepared statement. For example, the profit 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 1-10B (a) 1.

Remove the $3,000 of service revenue that has not yet occurred.

Remove the $12,000 rent expense. This is not an actual transaction and cannot be listed on the company’s income statement.

Remove the $4,000 vacation expense. This is not a business expense but rather a personal expense of the business owner.

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.

(b)

INDEPENDENT BOOK SHOP LTD. Income Statement Year Ended March 31, 2015

Revenues Service revenue ($41,000 – $3,000) Expenses Office expense Profit before income tax Income tax expense Profit

(c)

$38,000 5,000 33,000 5,000 $28,000

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.

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Financial Accounting, Sixth Canadian Edition

BYP 1-1 FINANCIAL REPORTING (a)

Shoppers presents the following five 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, while Shoppers’ sales increased in 2012, its profit decreased. ($ in thousands) Sales Profit (net earnings)

2012

2011

Change

$10,781,848 608,481

$10,458,652 613,934

$323,196 (5,453)

Profit is affected by revenue and expenses incurred by Shoppers during the year. An increase in sales does not always translate into an increase in profit. For Shoppers, an increase in operating and administrative expenses in 2012 offset the increase in sales and contributed to an overall decrease in profit (net earnings).

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(1) December 29, 2012

(2) December 31, 2011

$7,473,721 3,150,394 4,323,327

$7,300,310 3,032,480 4,267,830

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BYP1-1 (Continued) (d)

($ in thousands) Share capital Retained earnings

December 29, 2012 $1,431,315 2,916,348

December 31, 2011 $1,486,455 2,806,078

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 Shoppers’ 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)

December 29, 2012

Share capital $1,431,315 Retained earnings 2,916,348 Sub-total 4,347,663 Other shareholders’ equity accounts (24,336) Total shareholders’ equity $4,323,327

(e)

($ in thousands) Cash

December 29, 2012 $104,529

December 31, 2011 $1,486,455 2,806,078 4,292,533 (24,703) $4,267,830

December 31, 2011 $118,566

This information can be obtained on the balance sheet (statement of financial position) or on the statement of cash flows.

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Financial Accounting, Sixth Canadian Edition

BYP 1-2 COMPARATIVE ANALYSIS (a) and (b)

[Shoppers ($ in thousands)]

1. Assets Liabilities Shareholders’ equity

2012 $7,473,721 3,150,394 4,323,327

2011 $7,300,310 3,032,480 4,267,830

% change 2.4% 3.9% 1.3%

2. Sales Profit

2012 $10,781,848 608,481

2011 $10,458,652 613,934

% change 3.1% (0.9)%

1. Assets Liabilities Shareholders’ equity

2013 $1,392.7 281.9 1,110.8

2012 $1,072.8 423.6 649.2

% change 29.8% (33.5)% 71.1%

2. Net sales revenue Profit

2013 $2,468.0 558.4

2012 $2,463.2 230.0

% change 0.2% 142.8%

Jean Coutu ($ in millions)

(c)

Shoppers experienced growth in assets, liabilities, and shareholders’ equity, however its liabilities grew faster than its assets which is not always a positive sign. In addition, despite a 3.1% increase in sales, there was a slight decrease in profit as a result of increased operating and administrative expenses. Jean Coutu experienced a much larger growth rate than Shoppers. Not only did its assets increase by 29.8% but its liabilities declined by 33.5% in the same period. While there was only a small increase in sales revenue, its profit increased by 142.8%. However, it is important to note that the majority of this increase was the result of a one-time gain on the sale of Rite Aid (a drugstore chain in the U.S. formerly owned by Jean Coutu) and is not expected to recur.

(d)

In 2013, Jean Coutu’s fiscal year (March 2012 through February 2013) covers the majority of the same period as Shoppers’ fiscal year (January 2012 through December 2012). The same is true for Jean Coutu’s 2012 fiscal year and Shoppers 2011 fiscal year. Consequently, unless there was a significant economic impact that affected the drugstores in the non-overlapping period of two months (January and February), I would have no concerns about the comparisons made in (c) as they both cover a oneyear period..

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Financial Accounting, Sixth Canadian Edition

BYP 1-3 COMPARING IFRS AND ASPE (a)

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 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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BYP1-3 (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 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.

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BYP 1-4 CRITICAL THINKING ACTIVITY 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. (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?

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BYP 1-5 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.

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Financial Accounting, Sixth Canadian Edition

BYP 1-6 “ALL ABOUT YOU” ACTIVITY Note to instructors: Answers will vary by student. (a)

You may want to be working as • An accountant working towards an accounting designation • A financial analyst • A financial advisor • A manager The steps needed to get there will vary depending on the work destination identified.

(b)

The basic elements of a resume include: • An objective (your goals) • A summary of your qualifications/accomplishments • Experience highlights • Employment history • Education and training • Other matters such as continuous education, languages, awards, memberships, affiliations and community involvement, as applicable

(c)

You can provide references which can substantiate the information on your resume and evidence of education (diplomas and transcripts).

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BYP 1-7 (a)

Financial Accounting, Sixth Canadian Edition

SERIAL CASE

Cookie Creations is a proprietorship. A proprietorship has a lower administrative burden than a corporation—fewer regulations and procedures to adhere to. She 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 profits of the business belong to Natalie. However, she also has personal and unlimited liability for the debts of the business. She may also have difficulty in raising capital to grow the business. Koebel’s Family Bakery Ltd. is a private corporation. It would have limited liability for the shareholders’ investments in the business compared to a proprietorship. However, this feature may be negated by a demand from creditors (such as the bank) for a personal guarantee by the shareholders. Profits would be shared with the other shareholders by way of dividends. More regulations and paperwork would be required as a corporation compared to that of a proprietorship, however, more opportunities would also exist to share the administrative burdens and to grow the business.

(b)

Cookie Creations may use a simple form of accounting, possibly even the cash basis of accounting. Given its current size, it likely has no requirements to produce financial statements to external creditors. It could also choose to follow Accounting Standards for Private Enterprises (ASPE) if it was required to produce financial statements for external users. Koebel’s Family Bakery Ltd. would most likely use Accounting Standards for Private Enterprises (ASPE).

(c)

Natalie will need information on the revenues and cost of the cupcake services and supplies so she can determine if the new contract is profitable. She will need this information more often initially (for example, on a weekly basis) so she can monitor the results of the contract and its impact on the operations of the bakery. She will also need forecasts of cupcake orders to plan the work, determine staffing and delivery schedules, and purchases of supplies. If the cupcake contract requires a loan to expand to meet demand, she will need financial statements so lenders can assess the financial health of the business. Natalie would also find financial statements useful to better understand her business and identify financial issues as early as possible. Monthly financial statements would be best because they are more timely.

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BYP 1-7 (Continued) (d)

The users of Koebel’s Family Bakery would include the existing shareholders (Natalie’s parents), potential shareholders such as Natalie, creditors such as the bank, taxing authorities, such as CRA, and major customers such as the national coffee shop. Natalie’s parents are internal users and they need information to plan, organize and run the company and determine if they can obtain the financing to meet the increase demand. Natalie needs information to determine if her parents’ business is a sound investment for her and what her responsibilities as administrator would be. The national coffee shop needs information to determine if Koebel’s Family Bakery is able to deliver the quantities of cupcakes needed, The users would need all four financial statements—income statement, statement of retained earnings (since it is assumed that Koebel's Family bakery follows ASPE, however, if it follows IFRS then it would be required to prepare a statement of changes in equity), statement of financial position, and statement of cash flows—to assess the financial health of the company.

(e)

The following are examples of activities that Koebel’s Family Bakery is likely to be engaged in: Operating activities would include revenue generated from the sale of cookies or from providing cookie-making lessons, paying for ingredients and supplies to make cupcakes, the payment of utilities for the bakery and interest on bank loans. Investing activities may include the purchase of equipment for the bakery. Financing activities may include borrowing money from the bank (debt) and paying dividends to shareholders (equity).

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Financial Accounting, Sixth Canadian Edition

CHAPTER 2 A Further Look at Financial Statements ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

B Problems

BYP

Study Objectives

Questions

1. Identify the sections of a classified statement of financial position.

1, 2, 3, 4, 5, 6, 7

1, 2, 3, 4

1, 2, 3, 4, 5

1, 2, 3, 4

1, 4, 6

2. Identify and calculate ratios for analyzing a company's liquidity, solvency and profitability.

8, 9, 10, 11, 12, 13, 14, 15

5, 6, 7

6, 7, 8

5, 6, 7, 8

2, 4, 7

3. Describe the framework for the preparation and presentation of financial statements.

16, 17, 18, 19, 20, 21, 22, 23, 24, 25

8, 9, 10

9, 10

3, 5, 7

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A Problems

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Classify accounts.

Moderate

15-25

Prepare assets section.

Simple

15-25

Prepare liabilities and equity sections.

Moderate

15-25

Prepare financial statements; discuss relationships.

Moderate

15-25

Calculate ratios and comment on liquidity, solvency, and profitability.

Simple

10-20

Calculate ratios and comment on liquidity, solvency, and profitability.

Moderate

20-30

Calculate ratios and comment on liquidity, solvency, and profitability.

Simple

10-20

Comment on liquidity, solvency, and profitability.

Moderate

15-20

Discuss financial reporting objective, qualitative characteristics, and elements.

Moderate

15-20

10A

Discuss bases of measurement.

Moderate

20-30

Classify accounts.

Moderate

15-25

Prepare assets section.

Simple

15-25

Prepare liabilities and equity sections.

Moderate

15-25

Prepare financial statements; discuss relationships.

Moderate

15-25

Calculate ratios and comment on liquidity, solvency, and profitability.

Simple

10-20

Calculate ratios and comment on liquidity, solvency, and profitability.

Moderate

20-30

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Calculate ratios and comment on liquidity, solvency, and profitability.

Simple

10-20

Comment on liquidity, solvency, and profitability.

Moderate

15-20

Discuss financial reporting objective, qualitative characteristics, and elements.

Moderate

15-20

Moderate

20-30

10B Identify bases of measurement. ASSIGNMENT CHARACTERISTICS TABLE

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ANSWERS TO QUESTIONS 1.

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, 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.

(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. Non-current 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.

(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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 5.

(a)

(b)

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 Mortgages, notes, loans, operating cycle and other bonds, and other nonshort-term debts current liabilities

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 of the company’s financial statement date. The remaining principal balance is classified as a non-current liability.

The two components of shareholders' equity and the purpose of each are: (1) Share capital is used to record investments of assets, ie. 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 paid, retained in the business.

Statements, using the common practice among North American companies, are prepared by classifying the items on the statement of financial position in order of liquidity, ranking the items with the most liquidity first. The statement of financial position prepared using a reverse-liquidity order shows assets first, followed by shareholders’ equity and liabilities. The assets section starts with non-current assets followed by current assets. Non-current assets include goodwill and intangible assets; property, plant, and equipment; and long-term investments, which are normally grouped under a non-current heading. This differs from the separate disclosure of non-current assets without a heading that is more usual in North America. Within the current assets section, items are listed in reverse order of liquidity; that is, cash is normally shown last. Items within the property, plant, and equipment section are normally listed in order of permanency. Shareholders’ equity is shown next, followed by liabilities. The liabilities section presents non-current liabilities before current liabilities, and current liabilities are listed in reverse order of liquidity similar to current assets.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 8.

(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 ratio.

(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: Earnings per share and priceearnings ratio.

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 the amount of current assets compared to current liabilities and is therefore appropriate as a tool to compare the liquidity of different size businesses.

10.

Current assets include accounts receivable and inventory. These may have increasing balances because of uncollectible receivables or slow-moving 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 convertible into cash. Consequently, the current ratio alone does not provide a complete assessment of liquidity.

11.

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.

12.

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.

13.

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 earnings per share. On the other hand, since the price-earnings ratio uses earnings per share relative to the market price of the common shares, the ratio can be compared among companies.

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Answers to Questions (Continued) 14.

Investors appear to favour TD Bank. Its higher price-earnings ratio indicates that investors are willing to pay more for the company's shares and have more favourable expectations of future growth.

15.

Increases in the earnings per share, price-earnings ratio, and the current ratio are considered to be signs of improvement because: •

An increase in the earnings per share means that the amount of profit 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 earnings per share, which implies the market believes future profit 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. 16.

(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.

17.

(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.

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Answers to Questions (Continued) 18.

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.

19.

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 exits or has happened. The information must be complete, neutral, and free from material error.

20.

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 or amount 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.

21.

The four enhancing qualitative characteristics are (1) comparability, (2) verifiability, (3) timeliness, and (4) understandability. There is no prescribed order in applying these characteristics.

22.

The cost constraint means that information will be presented only when the benefit associated with it exceeds the cost of 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.

23.

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 (including gains), and expenses (including losses). The grouping is selected in accordance with the economic characteristics of the transactions.

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Answers to Questions (Continued) 24.

The two bases are historical cost and fair value. The fair value basis of accounting is applied to those assets which are intended to be sold and whose fair value is readily available. Securities traded on the stock exchanges would be a good example of assets reported at their fair 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 fair value of the asset is not as relevant as its cost.

25.

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 fair 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 cost of the assets is the better measurement for reporting the financial statement element. For example, inventory will become cost of goods sold when sold. It is relevant to compare the actual cost of the inventory to the amount of the revenue generated from its sale. Using the cost basis of accounting gives a faithful representation of the transaction that has occurred from the sale of inventory.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2-1 (a) (b) (c) (d) (e) (f) (g) (h)

5 1 3 3 1 4 8 5

Accounts payable Accounts receivable Accumulated depreciation Buildings Cash Patents Dividends Income tax payable

(i) (j) (k) (l) (m) (n) (o) (p) (q)

2 3 1 7 1 6 5 1 5

Long-term Investments Land Merchandise inventory Common shares Supplies Mortgage payable, due in 20 years Current portion of mortgage payable Prepaid insurance Unearned revenue

BRIEF EXERCISE 2-2 SWANN LIMITED Statement of Financial Position (Partial) Assets Current assets Cash Accounts receivable Merchandise inventory Supplies Prepaid insurance Total current assets

$16,400 14,500 9,000 4,200 3,900 $48,000

BRIEF EXERCISE 2-3 SHUM CORPORATION Statement of Financial Position (Partial) Property, plant, and equipment Land Buildings Less: Accumulated depreciation—buildings Equipment Less: Accumulated depreciation—equipment Total property, plant, and equipment

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$ 65,000 $110,000 33,000 $70,000 25,000

77,000 45,000 $187,000

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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

BRIEF EXERCISE 2-5 (a)

(b)

($ in thousands) 2012

2011

Working capital:

$453,629 – $229,503 = $224,126

$336,980 – $235,365 = $101,615

Current ratio:

$453,629 = 2.0:1 $229,503

$336,980 = 1.4:1 $235,365

The working capital more than doubled in 2012 and the current ratio increased substantially when compared to 2011. Indigo's liquidity has improved in 2012 compared with 2011.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 2-6 (a)

(in USD millions) 2012

2011

Debt to total assets ratio:

($1,566.8 + $711.8) = 51.2% ($1,337.4 + $3,115.8) (b)

($977.4 + $969.4) = 49.6% ($1,242.2 + $2,684.0)

The company’s solvency was weaker in 2012 compared with 2011 because total debt has increased as a proportion of total assets.

BRIEF EXERCISE 2-7 (a)

($ in thousands) 2012

(b)

2011

Earnings per share:

$46,782 = $0.67 per share 70,033

$56,666 = $0.81 per share 69,969

Price-earnings ratio:

$12.99 = 19.4 times $ 0.67

$12.40 = 15.3 times $ 0.81

The decrease in profit and in the earnings per share during the year would indicate that profitability has deteriorated in 2012. In spite of the decline in profit, investors appear to have more confidence in Leon’s future profit as indicated by the increase in the price-earnings ratio in 2012.

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BRIEF EXERCISE 2-8 (a) (b) (c) (d) (e) (f)

Faithful representation Verifiability Understandability Cost Going concern Fair value

BRIEF EXERCISE 2-9 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m)

10 5 1 2 4 13 8 12 9 3 11 6 7

BRIEF EXERCISE 2-10 (a)

Sosa Ltd. has purchased the land for sale and not for use. The current fair 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 fair 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.

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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

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Accounts payable and accrued liabilities Accounts receivable Accumulated depreciation Buildings and leasehold improvements Common shares Current maturities of long-term debt Dividends payable Goodwill Income and other taxes payable Income and other taxes receivable Inventories Land Long-term debt Prepaid expenses

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EXERCISE 2-2 BIG ROCK BREWERY INC. Statement of Financial Position (partial) December 31, 2012 (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 Less: Accumulated depreciation Total property, plant, and equipment Intangible assets Total assets

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$4,281 2,358 3,892 364 $10,895 $ 2,516 $11,070 827 $20,800 6,480 $645 149 $310 140

10,243 14,320 496 170 27,745 128 $38,768

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EXERCISE 2-3 SAPUTO INC. Statement of Financial Position (partial) March 31, 2012 (in thousands) 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

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$571,814 163,996 166,631 $ 902,441 $379,875 156,632 54,486 590,993 1,493,434 $ 629,606 1,467,108 2,096,714 $3,590,148

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EXERCISE 2-4 (a)

Profit

= Revenues – Expenses = $73,040 – $5,000 – $4,750 – $48,680 = $14,610

Retained earnings = Beginning retained earnings + Profit – Dividends = $66,520 + $14,610 – $0 = $81,130 (b)

SUMMIT LTD. Statement of Financial Position December 31, 2015 Assets

Current assets Cash Accounts receivable Supplies 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

$ 15,040 13,780 740 390 29,950 30,000 $54,000 $128,800 45,600 $62,400 17,770

83,200 44,630 181,830 $241,780

Liabilities and Shareholders' Equity Current liabilities Accounts payable Interest payable Current portion of mortgage payable Total current liabilities Mortgage payable ($95,000 – $13,600) Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity

Solutions Manual .

$14,050 1,600 13,600 $ 29,250 81,400 110,650 $50,000 81,130 131,130 $241,780

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EXERCISE 2-5 BATRA CORPORATION Income Statement Year Ended July 31, 2015 Revenues Service revenue Rent revenue Total revenues Expenses Salaries expense Rent expense Depreciation expense Utilities expense Interest expense Supplies expense Total expenses Profit before income tax Income tax expense Profit

$81,100 18,500 99,600 $44,700 10,800 3,000 2,600 2,000 900 64,000 35,600 5,000 $30,600 BATRA CORPORATION Statement of Changes in Equity Year Ended July 31, 2015

Balance, August 1, 2014 Issued common shares Profit Dividends Balance, July 31, 2015

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Common Shares

Retained Earnings

$ 6,000 4,000

$17,940

000 000 $10,000

2-18

30,600 (12,000) $36,540

Total Equity $23,940 4,000 30,600 (12,000) $46,540

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EXERCISE 2-5 (Continued) BATRA CORPORATION Statement of Financial Position July 31, 2015 Assets Current assets Cash 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 $35,900 6,000 29,900 $73,560

Liabilities and Shareholders' Equity Current liabilities Accounts payable Interest payable Bank loan payable Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity

Solutions Manual .

$ 4,220 1,000 21,800 $27,020 $10,000 36,540 46,540 $73,560

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EXERCISE 2-6 (a)

Current ratio: $60,000 $40,000

(b)

= 1.5:1

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 which 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.

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EXERCISE 2-7 (a)

(in millions)

2012

2011

Working capital: $103.5 – $30.8 = $72.7

Working capital: $77.3 – $78.0 = $(0.7)

Current ratio: $103.5 $30.8

= 3.4:1

$77.3 $78.0

= 1.0:1

Debt to total assets ratio: ($30.8 + $114.8) = 45.3% ($103.5 + 217.8)

(b)

($78.0 + $218.2) ($77.3 + $422.5)

= 59.3%

Huntingdon’s liquidity and solvency improved dramatically in 2012 when compared to 2011.

Working capital (in millions) Current ratio Debt to total assets ratio

Huntingdon $72.7 3.4:1 45.3%

Plazacorp $(48.6) 0.1:1 58.6%

First Capital $12.8 1.0:1 55.4%

Industry n/a 0.9:1 65.0%

First Capital $(276.6) 0.5:1 58.7%

Industry n/a 2.0:1 71.0%

2011

Working capital (in millions) Current ratio Debt to total assets ratio

Solutions Manual .

Huntingdon $(0.7) 1.0:1 59.3%

2-21

Plazacorp $(8.9) 0.7:1 63.9%

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EXERCISE 2-7 (Continued) (c) (Continued) Based on working capital and the current ratio, Huntingdon’s liquidity is the best (highest) of the three companies, as the current ratio far exceeds the ratios for Plazacorp and First Capital as well as the industry average. Compared to 2011, all companies improved working capital and the current ratio except Plazacorp which has the worst (lowest), with insufficient current assets to cover its current liabilities and with a negative working capital position. Based on the debt to total assets ratio, which improved for all three companies and for the industry as a whole, Huntingdon’s solvency is the best of the three companies, exceeding the industry average by a large margin. Plazacorp’s solvency is the worst of the three companies, as is its liquidity.

EXERCISE 2-8 (a)

(in thousands)

2012

2011

Earnings per share:

$264,583 = $0.67 per share 395,234

$449,844 394,662

Price-earnings ratio:

$19.59 $0.67

(b)

= 29.2 times

$18.41 $1.14

= $1.14 per share

= 16.1 times

The decrease in the earnings per share during the year would indicate that profitability has deteriorated dramatically in 2012. However, investors appear to have more confidence in Cameco's future profitability as indicated by the increase in the priceearnings ratio in 2012 and by the increase in the share price in 2012.

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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

EXERCISE 2-10 1.

(a) The cost basis of accounting is involved in this situation. (b) The cost basis of accounting has been violated. The land was reported at its fair value when it should have remained at its historical cost.

(a) The fair value basis of accounting is involved in this situation. (b) The principle has not been violated since the parcel of land is being held for resale and not for use.

(a) The assumption involved in this situation is the going concern assumption. (b) The going concern assumption has been violated. The elements on the statement of financial position should have been classified between current and non-current.

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SOLUTIONS TO PROBLEMS PROBLEM 2-1A Statement of Financial Position Category

Item Accumulated depreciation

Cash

Contra asset to plant, equipment, and vehicles in the property, plant, and equipment section Current assets

Common (ordinary) shares Current income tax payable Current income tax recoverable Interest-bearing loans and borrowings (current) Interest-bearing loans and borrowings (non-current) Inventories Investments Plant, equipment, and vehicles Trade and other payables

Share capital Current liabilities Current assets Current liabilities Non-current liabilities Current assets Non-current assets Property, plant, and equipment Current liabilities

Trade and other receivables Trademarks

Current assets Intangible assets

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PROBLEM 2-2A (a) Statement of Financial Position Category

Item Accounts receivable Accumulated depreciation—aircraft Accumulated depreciation—buildings

Current assets Property, plant, and equipment (contra account) Property, plant, and equipment (contra account)

Accumulated depreciation—ground property and equipment Accumulated depreciation—leasehold Improvements Accumulated depreciation—spare engines and parts Aircraft Buildings Cash Ground property and equipment Inventory

Property, plant, and equipment (contra account)

Intangible assets Leasehold improvements Other assets Prepaid expenses, deposits, and other Spare engines and parts

Intangible assets Property, plant, and equipment Other assets Current assets Property, plant, and equipment

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Property, plant, and equipment (contra account) Property, plant, and equipment (contra account) Property, plant, and equipment Property, plant, and equipment Current assets Property, plant, and equipment Current assets

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PROBLEM 2-2A (Continued) (b) WESTJET AIRLINES LTD. Statement of Financial Position (partial) December 31, 2012 (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 property and equipment Less: Accumulated depreciation Spare engines and parts Less: Accumulated depreciation Buildings Less: Accumulated depreciation Leasehold improvements Less: Accumulated depreciation Total property, plant, and equipment Intangible assets Other assets Total assets

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$1,459,822 37,576 35,595 101,802 $1,634,795 $2,605,277 1,127,889 $136,167 79,052 $146,422 44,713 $135,924 20,025 $16,538 5,536

$1,477,388 57,115 101,709 115,899 11,002 1,763,113 50,808 297,899 $3,746,615

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PROBLEM 2-3A (a)

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

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)

WESTJET AIRLINES LTD. Statement of Financial Position (partial) Liabilities and Shareholders' Equity December 31, 2012 (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

$460,003 480,947 47,859 199,044 $1,187,853 $574,139 155,570 356,748 1,086,457 2,274,310 $614,899 793,296 64,110 1,472,305 $3,746,615

(c) Yes, these two amounts agree. Assets of $3,746,615 thousand equal total liabilities plus shareholders’ equity of the same amount.

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PROBLEM 2-4A (a) MBONG CORPORATION Income Statement Year Ended December 31, 2015 Revenues Service revenue Interest revenue Total revenues Expenses Salaries expense Depreciation expense Repair and maintenance expense Insurance expense Utilities expense Interest expense Supplies expense Total expenses Profit before income tax Income tax expense Profit

$81,700 500 $82,200 $37,000 6,200 2,800 2,200 2,000 1,500 1,000 52,700 29,500 6,000 $23,500

MBONG CORPORATION Statement of Changes in Equity Year Ended December 31, 2015

Balance, January 1 Issued common shares Profit Dividends Balance, December 31

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Common Shares

Retained Earnings

$30,000 4,200

$105,000

_ _____ $34,200

2-28

23,500 (5,000) $123,500

Total Equity $135,000 4,200 23,500 (5,000) $157,700

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PROBLEM 2-4A (Continued) (a) (Continued) MBONG CORPORATION Statement of Financial Position December 31, 2015 Assets Current assets Cash Trading investments Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment Land Building Less: Accumulated depreciation—building Equipment Less: Accumulated depreciation—equipment Total property, plant, and equipment Total assets

$ 5,200 20,000 14,200 200 2,000 $ 41,600 $40,000 $72,000 18,000 $66,000 17,600

54,000 48,400 142,400 $184,000

Liabilities and Shareholders' Equity Current liabilities Accounts payable Salaries payable Current portion of bank loan payable Total current liabilities Non-current liabilities Bank loan payable ($15,000 - $1,500) Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity (b)

$8,300 3,000 1,500 $ 12,800 13,500 26,300 $ 34,200 123,500 157,700 $184,000

The income statement reports the profit or loss for the period. This figure is then used in the statement of changes in equity, along with dividends 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.

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PROBLEM 2-5A (a) 1.

Working capital

Current assets – Current liabilities $ 446,900 – $142,500 = $304,400

Current ratio

Current assets Current liabilities $446,900

3.1 :1

$142,500

Debt to total assets

Total liabilities Total assets $452,500

= 42.2%

$1,072,200 Profit available to common shareholders 4.

Earnings per share

Price-earnings ratio

Weighted average number of common shares $160,000 = $4.00 40,000

Market price per share Earnings per share $35.00 = 8.8 times $4.00

(b)

Johanssen’s liquidity has improved dramatically as the working capital is greater in 2015 and the current ratio is almost double that of 2014. On the other hand, the solvency has deteriorated as the debt to total assets ratio is higher in 2015. Johanssen’s profitability has improved as the earnings per share ratio has increased in 2015, as has investors’ expectations for future profitability as indicated by the increasing price-earnings ratio.

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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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PROBLEM 2-6A (Continued) (c) Sales revenue Cost of goods sold Operating expenses Interest expense Income tax expense Total expenses

Chen $1,800,000 1,175,000 283,000 10,000 85,000 1,553,000

Caissie $620,000 340,000 98,000 4,000 35,400 477,400

Profit

$ 247,000

$142,600

Profit available to common shareholders

Earnings per share =

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 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 difficult to compare earnings per share because Caissie has more common shares issued than Chen, as well as having a different debt structure.

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PROBLEM 2-7A (a)

(in thousands) Le Château

Reitmans

Working capital

$132,223 – $47,382 = $84,841

Current ratio

$132,223 = 2.8:1 $47,382

$301,374 $86,914

= 3.5:1

Debt to total assets

$80,412 = 36.5% $220,210

$139,537 $594,555

= 23.5%

Earnings per share

$(8,717) 25,659

= $(0.34)

$26,619 65,188

= $0.41

Price-earnings ratio

= N/A

$12.39 $0.41

= 30.2 times

(b)

$301,374 – $86,914 = $214,460

Liquidity With a current ratio of 2.8:1, Le Château is less liquid than Reitmans and both have stronger ratios than the industry average of 2.0:1. Solvency Reitmans is more solvent than Le Château as evidenced by its lower debt to total assets ratio, which is almost identical to the industry average of 24%. Profitability Although the earnings per share ratio does not provide a basis for comparison investors appear to have more confidence in the future profit of Reitmans as evidenced by its price-earnings ratio, which is also much higher than that of the industry. Le Château does not have a price-earnings ratio because it has negative earnings.

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PROBLEM 2-8A (a)

The higher the amount of working capital, the better a company’ liquidity. From 2013 to 2014 Pitka Corporation’s working capital significantly deteriorated. It then went on to deteriorate even further from 2014 to 2015, decreasing by $15,000. A higher current ratio is evidence of better liquidity for a company (assuming the components of the current assets are also liquid). The current ratio for Pitka has been steady from 2013 to 2014, but deteriorated slightly from 2014 to 2015. A smaller (lower) debt to total assets ratio shows evidence of better solvency. The percentage of total liabilities to total assets increased from 2013 to 2014, showing deterioration in the solvency for Pitka. On the other hand, the ratio improved substantially from 2014 to 2015. The higher the earnings per share, the better the profitability. Profitability decreased from 2013 to 2014, but improved from 2014 to 2015. The investors appeared to have less confidence in the future profit of Pitka as evidenced by Pitka's price-earnings ratio, which declined from 2013 to 2014. This view changed as demonstrated by the climb in the price-earnings ratio from 2014 to 2015.

(b)

Liquidity Pitka’s current ratio, although steady in 2013 and 2014, declined slightly in 2015. 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 2013. Profitability Pitka’s profitability declined and then recovered as is demonstrated by the earnings per share ratio. The price-earnings ratio indicates expectations of improving profitability in 2015.

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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 team and the financial position at December 31, 2015. 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, 2015 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 team at December 31, 2015. 2. Unless the company uses the revaluation model for all of its long-lived assets, the suggestion of increasing the value of building to its fair value would violate the cost basis of accounting. It is likely far more relevant to the financial statement user of this type of company to see the original purchase price of the building rather than its fair value as it is unlikely to be resold soon. Consequently, assets and revenue (from the recording of an unrealized gain from the increase in the value of the asset) would be overstated if the Bucky’s instructions were followed. 3. The signing bonus paid to Wayne Crosby does not represent an asset at December 31, 2015. 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.

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PROBLEM 2-10A (a)

The advantage of the fair value basis of accounting is that it represents a more up-todate measurement of the value of the asset reported. Consequently, the amounts reported are more relevant to the financial statement users. The disadvantage of the fair 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 fair 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 of these assets. It is inherent in the nature of real estate that the land will increase in value over time. Creditors will find the fair 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 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 fair 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 fair value for real estate for the company using the cost basis of accounting. In fact, this information is required to be disclosed for real estate companies even if they adopted the cost basis of accounting to improve comparability and disclosure. Otherwise, trying to compare businesses that use different bases of accounting would be very difficult.

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PROBLEM 2-1B Item

Statement of Financial Position Category

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 Investments Land Non-current borrowings and debts Patents and trademarks Prepaid expenses Trade accounts payable Trade accounts receivable

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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 Non-current assets Property, plant, and equipment Non-current liabilities Intangible assets Current assets Current liabilities Current assets

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PROBLEM 2-2B (a) Item

Statement of Financial Position Category

Accounts receivable Accumulated amortization—patents Accumulated depreciation—buildings Accumulated depreciation—equipment Buildings Cash Equipment Goodwill Patent Land Trading investments Merchandise inventory Prepaid expenses

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Current assets Intangible assets (contra account) 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) Intangible assets Property, plant, and equipment Current assets Current assets Current assets

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PROBLEM 2-2B (Continued) (b) DEVON LIMITED Statement of Financial Position (partial) December 31, 2015 (in thousands) Assets Current assets Cash Trading investments Accounts receivable Merchandise inventory Prepaid expenses Total current assets Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Total property, plant, and equipment Intangible assets Patents Less: Accumulated amortization Goodwill Total assets

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$97,625 71,630 4,145 93,320 25,950 $292,670 $ 5,860 $53,150 22,470 $166,750 85,900

30,680 80,850 117,390 $29,415 10,190

19,225 42,425 $471,710

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PROBLEM 2-3B (a) Item

Category

Accounts payable Current portion of mortgage payable Mortgage payable Retained earnings Common shares Unearned revenue

Current liabilities Current liabilities Non-current liabilities Shareholders’ equity Shareholders’ equity Current liabilities

(b) DEVON LIMITED Statement of Financial Position (partial) December 31, 2015 (in thousands) 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)

$ 2,900 16,295 3,570 $ 22,765 71,430 94,195 $ 39,225 338,290 377,515 $471,710

Yes, the total assets of $471,710 agree to total liabilities and shareholders’ equity of the same amount.

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PROBLEM 2-4B (a) BEAULIEU LIMITED Income Statement Year Ended December 31, 2015 Revenues Service revenue Interest revenue Total revenues Expenses Salaries expense Interest expense Depreciation expense Utilities expense Insurance expense Total expenses Profit before income tax Income tax expense Profit

$80,500 500 $81,000 $33,000 8,000 5,400 3,700 2,400 52,500 28,500 5,000 $23,500

BEAULIEU LIMITED Statement of Changes in Equity Year Ended December 31, 2015

Balance, January 1 Issued common shares Profit Dividends Balance, December 31

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Common Shares

Retained Earnings

$15,000 5,000

$34,000

_ _____ $20,000

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23,500 (3,500) $54,000

Total Equity $49,000 5,000 23,500 (3,500) $74,000

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PROBLEM 2-4B (Continued) (a) (Continued) BEAULIEU LIMITED Statement of Financial Position December 31, 2015 Assets Current assets Cash Accounts receivable Prepaid insurance Total current assets Investments Property, plant, and equipment Land Buildings Less: Accumulated depreciation—buildings Equipment Less: Accumulated depreciation—equipment Total property, plant, and equipment Total assets

$8,000 7,500 250 $ 15,750 20,000 $50,000 $80,000 12,000 $32,000 19,200

Liabilities and Shareholders' Equity Current liabilities Accounts payable Salaries payable Current portion of mortgage payable Total current liabilities Non-current liabilities Mortgage payable ($80,000 - $10,000) Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity (b)

68,000 12,800 130,800 $166,550

$ 9,550 3,000 10,000 $ 22,550 70,000 92,550 $20,000 54,000 74,000 $166,550

The income statement reports the profit or loss for the period. This figure is then used in the statement of changes in equity, along with dividends 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.

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PROBLEM 2-5B (a) 1.

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

Debt to total assets

Total liabilities Total assets $288,550 $719,150 Profit available to common shareholders

Earnings per share

Weighted average number of common shares $96,600

$2.42

40,000

Price-earnings ratio

Market price per share Earnings per share $30.00 = 12.4 $2.42

(b)

times

Fast’s liquidity has improved as the working capital is larger in 2015 and the current ratio is greater than that of 2014. The solvency has improved as the debt to total assets ratio is a smaller percentage in 2015 than in 2014. Fast’s profitability has improved dramatically as the earnings per share ratio has increased by a large amount in 2015, as has the price-earnings ratio, suggesting that investors are excited about the company’s future prospects.

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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) Sales revenue Cost of goods sold Operating expenses Interest expense Income tax expense

Belliveau $450,000 260,000 130,000 6,000 10,000

Shields $890,000 620,000 59,000 10,000 65,000

Total expenses

406,000

754,000

Profit

$ 44,000

$136,000

Profit available to common shareholders

Earnings per share =

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 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 difficult to compare the earnings per share even though both companies have the same number of shares because of the different financing avenues each company has used (for example, Shields has a lot more debt).

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PROBLEM 2-7B (a)

(in USD millions) Walmart $59,940 – $71,818 = $(11,878)

Target $16,388 – $14,031 = $2,357

Working capital

Current ratio

$59,940 $71,818

= 0.8:1

$16,388 $14,031

= 1.2:1

Debt to total assets

$121,367 $203,105

= 59.8%

$31,605 $48,163

= 65.6%

Earnings per share

$16,999 3,374

= $5.04

$2,999 657

= $4.56

Price-earnings ratio

$69.95 $5.04

= 13.9 times

$61.15 $4.56

= 13.4 times

(b)

Liquidity With a current ratio of 1.2:1, Target is more liquid than Walmart. Both Walmart and Target have current ratios that are lower (worse) than the industry average. Solvency Walmart is more solvent than Target as evidenced by its lower debt to total assets ratio. However, since both companies have a debt to total assets ratio that is much higher than the industry average, they are less solvent than the average company in the industry. Profitability Although the earnings per share ratio does not provide a basis for comparison, investors appear to have slightly more confidence in the future profit of Walmart as evidenced by Walmart's price-earnings ratio. Both Target and Walmart have lower price-earnings ratio than the industry.

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PROBLEM 2-8B

(a)

The higher the amount of working capital, the better a business’ liquidity. From 2013 to 2014, Giasson Corporation’s working capital improved. It then deteriorated from 2014 to 2015, decreasing by $6,000. 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 2013 to 2015. A smaller debt to total assets ratio shows evidence of better solvency. The percentage of total liabilities to total assets increased from 2013 to 2014, showing deterioration in the solvency for Giasson. On the other hand the ratio remained somewhat stable from 2014 to 2015, declining (improving) slightly. The higher the earnings per share, the better evidence of an improved profitability. Profitability increased from 2013 to 2014 but declined significantly from 2014 to 2015 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 2013 to 2015.

(b)

Liquidity Giasson’s current ratio, although declining over the last two years, demonstrates adequate liquidity. There are $1.50 of current assets available to cover each $1 of current liabilities. Solvency Giasson’s debt to total assets ratio, although deteriorating 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 earnings per share ratio and the price-earnings ratio.

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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. 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 the 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.

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PROBLEM 2-10B (a)

The advantage of the fair value basis of accounting it that it represents a more up-todate measurement of the value of the asset reported. Consequently, the amounts reported are more relevant to the financial statement users. The disadvantage of the fair 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 cost basis of accounting because of its intended use. The objective of owning the asset is to use it and not to resell it. 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 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 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 cost basis of accounting should be used. On the other hand, if the purchase is for resale, the fair 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 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 fair value basis of accounting used for investments, assuming the fair value is readily available.

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BYP 2-1 FINANCIAL REPORTING

(a)

Total current assets were $2,764,997,000 at December 29, 2012, and $2,695,647,000 at December 31, 2011. Total assets were $7,473,721,000 at December 29, 2012, and $7,300,310,000 at December 31, 2011.

(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 $2,334,917,000 at December 29, 2012 and $1,776,238,000 at December 31, 2011. The total liabilities at December 29, 2012 and December 31, 2011 were in the amount of $3,150,394,000 and $3,032,480,000, respectively.

(d)

The current liabilities are listed in order of due date from those due first to those due last, with bank indebtedness and commercial paper 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 non-current liabilities.

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BYP 2-2 COMPARATIVE ANALYSIS (a) Jean Coutu (in millions, except per share information) 1. Working capital

$421.9 – $265.3 = $156.6

Shoppers Drug Mart (in thousands, except per share information) $2,764,997 – $2,334,917

= $430,080

2. Current ratio

$421.9 $265.3

= 1.6:1

$2,764,997 $2,334,917

= 1.2:1

3. Debt to total assets

$281.9 $1,392.7

= 20.2%

$3,150,394 $7,473,721

= 42.2%

4. Earnings per share

$2.57

5. Price-earnings ratio

$15.78 $2.57

(b)

$2.92

= 6.1 times

$42.80 $2.92

= 14.7 times

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 Jean Coutu is significantly more liquid than Shoppers and well ahead of the industry average. 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. Jean Coutu’s debt to total assets is very low at 20.2%, which means that it is primarily financed by equity. Shoppers’ debt to total assets ratio of 42.2% is higher (worse) than that of Jean Coutu and the industry average of 30.6%. Profitability: The earnings per share between two companies are not comparable. However, based on the price-earnings ratio, Shoppers is favoured by investors. Jean Coutu’s price-earnings ratio falls far below that of Shoppers, but both are well below the industry average of 42.0 times.

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BYP 2-3 COMPARING IFRS AND ASPE (a)

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 statements to other global 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 has a requirement for 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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BYP 2-3 (Continued) (c)

Examples of why private companies may adopt IFRS: ▪ Private companies that plan to be public sometime in the near future or who have foreign private investors, may choose to adopt IFRS. ▪ Private companies that have global shareholders or lenders (who are more familiar with IFRS). They may also want to provide financial statements to customers.

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BYP 2-4 CRITICAL THINKING 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, 2014. Sheila’s mother paid $10,000 for 1,000 common shares (or $10.00 per share) in early 2015. 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, 2015.

(b)

By December 31, 2014, Uncle Harry wanted $8,000 of the loan paid off in 2015. This amount is classified as the current portion of the loan due at December 31, 2014. The actual amount of principal paid in 2015 was $30,000. This amount paid can be determined by calculating the total decrease in the loan payable from December 31, 2014 to December 31, 2015: [($52,000 + $8,000) less ($26,000 + $4,000)]. During 2014 Uncle Harry received interest only in the amount of $3,600 as indicated in the statement of income for interest expense. In 2015, Uncle Harry received $32,700. This amount is equal to the principal repayment of $30,000 and the interest of $2,700.

2015 $46,000 $33,580

= 1.4:1

2014 $31,000 $22,490

= 1.4:1

Although the current ratio is unchanged, we need to examine further, the account balances that make up the ratio components. There has been deterioration in liquidity due to the declining cash balance and the 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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BYP 2-4 (Continued) (d) Debt to total assets

2015 $59,580 $106,000

= 56.2%

2014 $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) Earnings per share

2015 $7,910 11,000

= $0.72

2014 $3,510 10,000

= $0.35

The earnings per share more than doubled because profit 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). 2015 2014 Price-earnings $10.00 = 13.9 times $2.50 = 7.1 times ratio $0.72 $0.35 The service revenue increased 20% from 2014 to 2015 [($120,000 – $100,000) ÷ $100,000]. The profit increased by 125% from 2014 to 2015 [($7,910 – $3,510) ÷ $3,510]. Sheila’s salary increased by 25% from 2014 to 2015 [($74,000 – $59,000) ÷ $59,000]. The value of 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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BYP 2-4 (Continued) (g)

The likely reason for the sale in shares in 2015 was to obtain $10,000, which was used to repay the debt to Uncle Harry earlier than originally scheduled.

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BYP 2-5 ETHICS CASE

(a)

The stakeholders in this case are: Kathy Onishi, controller Redondo’s vice-president 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 who is focusing on the effect of the implementation on the profit 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.

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BYP 2-6 “ALL ABOUT YOU” ACTIVITY (a) NAME Personal Statement of Financial Position Date Assets Current assets Cash Total current assets Property, plant, and equipment Vehicle Laptop and accessories Clothes and furniture Total property, plant and equipment Total assets

$1,500 1,500 $3,000 750 4,500 8,250 $9,750

Liabilities and Personal Equity (Deficit) Current liabilities Student fees Credit cards Total current liabilities Non-current liabilities Student loan Due to parents Total liabilities Personal deficit Total liabilities and personal equity (deficit)

$2,300 900 $ 3,200 $20,500 2,400

22,900 26,100 (16,350) $ 9,750

Note: Technically, this person is insolvent because they have such a large personal deficit— not an infrequent occurrence for students in this age group. Debt to total assets

$26,100

267.7%

$9,750 (b)

Answers will vary with each student.

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BYP 2-7

(a)

Financial Accounting, Sixth Canadian Edition

SERIAL CASE

Biscuits’ financial statements likely include the statement of financial position, income statement, statement of changes in equity, and statement of cash flows. It may or may not also include a statement of comprehensive income combined with, or separate from, the income statement (not covered as yet in the text). It will also include the notes to the financial statements. The statement of financial position reports the assets, liabilities, and shareholders’ equity of a company at a specific date. The income statement presents the revenues and expenses and resulting profit or loss of a company 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 for a specific period of time.

(b)

Because Biscuits is public company, it is required to have its financial statements audited by an independent licensed public accountant. The date appearing on the auditor’s report which appears immediately before the financial statements is the date when the audit was completed and the financial statements were made available to the public.

(c)

By looking at the statement of financial position and determining the composition of Biscuits’ current assets and current liabilities, we can assess its ability to pay its shortterm 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 Biscuits will be able to pay your invoices in the future but will provide some assurance with respect to how they have performed in the past. The statement of cash flows will also provide information to determine if Biscuits generates positive cash flows from its operations.

(d)

By looking at the types of revenues and expenses reported in the income statement, we can determine if Biscuits is profitable. If revenues earned by Biscuits exceed expenses incurred, then Biscuits is profitable. As well, profitability ratios can be determined which measure a company’s ability to generate profit over a period of time. These profitability ratios include earnings per share and price-earnings ratio. The latter measures investors’ expectations about Biscuits’ future profitability.

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Financial Accounting, Sixth Canadian Edition

BYP 2-7 (Continued) (e)

By looking at the statement of financial position, we can determine if Biscuits has any non-current debt. We can also calculate solvency ratios, such as the debt to total assets ratio, to determine whether Biscuits has the ability to repay its non-current 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 will help in determining whether Biscuits 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 non-current obligations.

(f)

Be aware that the financial statements of Biscuits 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 Biscuits’ product may also change. As well, consider this business opportunity from your perspective. Ask yourself if the price obtained for the cookies is reasonable considering some of the risks involved. There is a risk that by taking on this obligation, additional opportunities cannot be pursued. Does Koebel’s Family Bakery have the ability to meet the demands of Biscuits? Is it able to produce 1,500 dozen cookies a week? Does it have enough staff to enable the company to do so? Does it have a large enough oven and other equipment required to do so? Does it have enough cash to pay for the staff that will be required, for supplies, for utilities, etc., and wait 30 days from the time in which the invoice is received by Biscuits until it is paid?

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Financial Accounting, Sixth Canadian Edition

CHAPTER 3 The Accounting Information System ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

A Problems

B Problems

BYP

1. Analyze the effects of transactions on the accounting equation.

1, 2, 3, 4, 5 1, 3

1, 2, 4, 8

1A, 2A, 4A 1B, 2B, 4B

1, 3, 4, 6

2. Define debits and credits and explain how they are used to record transactions.

6, 7, 8, 9, 10

2, 3, 4

3, 4, 8

3A, 4A

2, 4

3. Journalize transactions.

11, 12, 13, 14, 15

5, 6, 7

5, 6, 8

4A, 5A, 4B, 5B, 6A, 7A, 8A 6B, 7B, 8B

3, 4, 6, 7

4. Post transactions.

14, 15, 16, 17, 18

8, 9, 10

7, 8, 9,

6A, 7A, 8A 6B, 7B, 8B

3, 4, 7

5. Prepare a trial balance.

19, 20, 21, 22, 23

11, 12, 13

9, 10, 11, 12

7A, 8A, 9A, 10A, 11A

4, 5, 7

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3B, 4B

7B, 8B, 9B, 10B, 11B

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Analyze effects of transactions.

Moderate

25-30

Analyze transactions and prepare financial statements.

Moderate

40-50

Identify normal balance and statement classification.

Simple

20-30

Analyze and record transactions.

Moderate

30-40

Record transactions.

Moderate

30-40

Record and post transactions.

Moderate

40-50

Record and post transactions; prepare trial balance.

Moderate

40-50

Record and post transactions; prepare trial balance.

Moderate

40-50

Prepare trial balance.

Moderate

20-30

10A

Prepare financial statements.

Moderate

20-30

11A

Prepare corrected trial balance.

Complex

40-50

Analyze effects of transactions.

Moderate

25-30

Analyze transactions and prepare financial statements.

Moderate

40-50

Identify normal balance and statement classification.

Simple

20-30

Analyze and record transactions.

Moderate

30-40

Record transactions.

Moderate

30-40

Record and post transactions.

Moderate

40-50

Record and post transactions; prepare trial balance.

Moderate

40-50

Record and post transactions: prepare trial balance.

Moderate

40-50

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number 9B

Prepare trial balance.

Difficulty Level Moderate

Time Allotted (min.) 20-30

10B

Preparefinancial statements.

Moderate

20-30

11B

Prepare corrected trial balance.

Complex

40-50

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Description

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Financial Accounting, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1.

An accounting information system is a system of collecting and processing transaction data and communicating financial information to decision-makers. Some factors that shape these systems are the type of business and its transactions, the size of the company, the amount of data, and the information that management and other users need.

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.

Accounting transactions are the economic events of the company recorded by accountants because they affect the accounting equation assets = liabilities + shareholders’ equity. (a) (b)

(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. 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 like accounts payable have been affected.

Yes, a business can enter into a transaction in which only the left 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).

(a) (b) (c) (d) (e)

Decrease assets and decrease shareholders' equity (an expense has been increased). Increase assets and increase liabilities. Increase assets and increase shareholders' equity (common shares has increased). Decrease shareholders' equity (an expense has been increased) and decrease assets. Increase one asset (cash) and decrease another asset (accounts receivable).

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 6.

Natalie is incorrect. A debit balance only means that debit amounts or transactions affecting an account exceed the credit amounts or transactions in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Thus, a debit or credit balance is neither favourable nor unfavourable.

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 which are then added to opening retained earnings. Revenues are increased by credits while expenses and dividends are increased by debits.

Account

(a) Normal Balance

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Accounts Receivable Accounts Payable Equipment Dividends Supplies Service Revenue Unearned Revenue Income Tax Expense Prepaid Rent Bank Loan Payable

(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Debit Supplies and credit Accounts Payable Debit Accounts Payable and credit Cash Debit Cash and credit Bank Loan Payable Debit Salaries Expense and credit Cash Debit Cash and credit Unearned Revenue Debit Prepaid Expense and credit Cash Debit Accounts Receivable and credit Revenue Debit Cash and credit Accounts Receivable Debit Dividends and credit Cash Debit Income Tax Expense and credit Cash

10. (a) (b) (c) (d) (e) (f) (g)

Cash Accounts Receivable Dividends Accounts Payable Service Revenue Salaries Expense Unearned Revenue

Solutions Manual .

Debit balance Credit balance Debit balance Debit balance Debit balance Credit balance Credit balance Debit balance Debit balance Credit balance

(b) Statement Classification Statement of financial position (Asset) Statement of financial position (Liability) Statement of financial position (Asset) Statement of changes in equity Statement of financial position (Asset) Income statement (Revenue) Statement of financial position (Liability) Income statement (Expense) Statement of financial position (Asset) Statement of financial position (Liability)

Both debit and credit entries Both debit and credit entries Debit entries only Both debit and credit entries Credit entries only Debit entries only Both debit and

3-5

credit

entries

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 11. (a) (b)

12. (a)

(b) (c)

(d)

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. Including a date in a journal entry is important because it is necessary to identify which accounting period is affected by a transaction. Other transactions may follow which are based on the date of the journal entry. For example, the date a sales invoice is recorded may determine when the date of payment for the invoice is due. Recording debit entries first is important because it visually separates the accounts involved in the left side of the transaction. Indenting credit entries is important because the indentation differentiates debits from credits and decreases the chance of switching the debit and credit amounts by mistake. Including a brief explanation to the journal entry is important because it provides the background information that might be necessary to interpret the transaction recorded.

13. 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 that can be owned and used by the business. Ambiguous or multiple account titles with similar names can lead to incorrect financial reporting. Unless the business is intending on purchasing more than one type of truck the name of the account that should be used is Trucks or Vehicles. 14. 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. Furthermore, if there is a large volume of transactions, a company will not post individual transactions to the general ledger; instead totals of transactions are posted. For example, if 1,000 sales transactions occurred in a month, only one amount (the total of sales for the month) would be posted to the sales account in the general ledger (there would still be 1,000 journal entries in the general journal, however). 15. Posting should be done on a timely basis, at least monthly, so that account balances can be monitored and reconciled.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 16. (a)

(b)

17. (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 share capital, retained earnings, dividend, 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, dividend, revenue, and expense accounts. 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 ledger. Numbering the accounts helps identify and sort the accounts.

18. Cash, supplies, prepaid insurance, unearned revenue, common shares, dividends, service revenue, and income tax expense. 19. (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. The trial balance is prepared using the account balances from the general ledger.

20. 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 share capital, retained earnings, dividend, revenue, and expense accounts). This makes it easier to compare the trial balance accounts to the general ledger accounts, as well as later to prepare the financial statements from the trial balance. 21. The retained earnings account in the trial balance shows the beginning balance of the period as it has not yet been updated for the effect that the revenues, expenses, and dividends have on retained earnings for the current accounting period. (Note to instructors: This chapter only includes references to a pre-closing trial balance; the post-closing trial balance is not introduced until Chapter 4.)

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 22. (a)

(b) (c)

The trial balance will not balance because two debits were posted instead of a debit to Supplies and a credit to Accounts Payable. Total debits will exceed total credits by an amount that is equal to twice the value of the entry that was not posted correctly. The trial balance will still balance as a debit and a credit have been recorded for the same amount. Total debits will equal total credits. No, the trial balance will not balance as the amount posted as a debit is greater than the amount posted as a credit. The total debits will be higher by the difference in the two amounts posted.

23. The first four steps in the accounting cycle are: (1) (2) (3) (4)

Analyze the business transactions and determine their effects on the accounting equation and also determine when and how to record the transactions. Journalize the transactions in the general journal to record the effects of the transactions on the accounts involved in the transactions. Post to the general ledger accounts to provide an accumulation of the effect of several journalized transactions in the individual accounts. Prepare a trial balance to prove that the sum of the debit account balances equals the sum of the credit account balances after posting.

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3-1 Assets Transaction 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Total

Cash

Accounts Receivable

Supplies +$250

Prepaid Insurance

Liabilities

= Accounts Payable +$250

Unearned Revenue

Common + Shares

+$500 –$300 +5,000 –400 +500 −250 –100 +300

Shareholders’ Equity Retained Earnings + – – Revenues Expenses Dividends +$500 −$300

+$5,000 −$400 −500 −250 +$100

$4,750

+ $0

+$250

+ $100 =

3-9 .

+ $5,000

+300 + $800

– $300

TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $5,100

TOTAL ASSETS = $5,100

Solutions Manual

+$300 −300 + $0

Chapter 3

– $400

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-2 Debit Effect

(a) Credit Effect

(b) Normal Balance

1. Accounts payable

Decrease

Increase

Credit

2. Advertising expense

Increase

Decrease

Debit

Statement of financial position Income statement

3. Service revenue

Decrease

Increase

Credit

Income statement

4. Accounts receivable

Increase

Decrease

Debit

5. Unearned revenue

Decrease

Increase

Credit

6. Cash

Increase

Decrease

Debit

7. Dividends

Increase

Decrease

Debit

8. Common shares

Decrease

Increase

Credit

9. Prepaid insurance

Increase

Decrease

Debit

10. Equipment

Increase

Decrease

Debit

11. Retained earnings

Decrease

Increase

Credit

12. Income tax expense

Increase

Decrease

Debit

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 Statement of financial position Statement of financial position Statement of changes in equity/Statement of financial position Income statement

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-3 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

Debits increase assets: debit Cash $2,500. Credits increase share capital (shareholders’ equity): credit Common Shares $2,500.

Transaction 2

June 2: 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

Supplies +$250 (c) Debit−Credit Analysis

Solutions Manual .

Liabilities

Shareholders’ Equity

Accounts Payable +$250

Debits increase assets: debit Supplies $250. Credits increase liabilities: credit Accounts Payable $250.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-3 (Continued) Transaction 3

June 12: 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

Debits increase assets; debit Accounts Receivable $300. Credits increase revenues; credit Service Revenue $300.

Transaction 4

June 22: Received cash from J. Kronsnoble for work billed on June 12.

(a) Basic Analysis

The asset account Cash is increased by $300; the Asset account Accounts Receivable is decreased by $300.

(b) Equation Analysis

Assets

Liabilities

Shareholders’ Equity

Cash +$300 Accounts Receivable -$300

Solutions Manual .

Debits increase assets: debit Cash $300. Credits decrease assets: credit Accounts Receivable $300.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-3 (Continued) Transaction 5

June 25: Hired an employee to start work on July 2.

(a) Basic Analysis

An accounting transaction has not occurred. There is only an agreement of employment to start on July 2.

Transaction 6

June 28: Received cash of $200 from K. Jones 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

Shareholders’ Equity

Unearned Revenue +$200

Cash +$200 (c) Debit−Credit Analysis

Debits increase assets: debit Cash $200. Credits increase liabilities: credit Unearned Revenue $200.

Transaction 7

June 29: Paid for supplies purchased on June 2.

(a) Basic Analysis

The asset account Cash is decreased by $250; the liability account Accounts Payable is decreased by $250.

(b) Equation Analysis

Assets

Cash -$250 (c) Debit−Credit Analysis

Solutions Manual .

Liabilities

Shareholders’ Equity

Accounts Payable -$250

Debits decrease liabilities: debit Accounts Payable $250. Credits decrease assets: credit Cash $250.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-3 (Continued) Transaction 8

June 30: Paid $100 for income tax.

(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

Solutions Manual .

Shareholders’ Equity Income Tax Expense -$100

Debits increase expenses: debit Income Tax Expense $100. Credits decrease assets: credit Cash $100.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-4 (a) Transaction

Account Debited (b)

Basic Type

Specific Account

(c)

(a)

Account Credited (b)

Effect

Basic Type

Specific Account

Asset

Cash

Increase

Shareholders’ Equity

Common Shares

Increase

Asset

Prepaid Rent

Increase

Asset

Cash

Decrease

Shareholders’ Salaries Equity Expense

Decrease

Asset

Cash

Decrease

Asset

Accounts Receivable

Increase

Shareholders’ Equity

Revenue

Increase

Asset

Cash

Increase

Asset

Accounts Receivable

Decrease

Asset

Supplies

Increase

Liability

Accounts Payable

Increase

Liability

Accounts Payable

Decrease

Asset

Cash

Decrease

Asset

Cash

Increase

Liability

Bank Loan Payable

Increase

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-5 1.

10.

Solutions Manual .

Supplies ....................................................... Accounts Payable .................................

250

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

500

Salaries Expense ......................................... Cash ......................................................

300

Cash ............................................................ Common Shares ...................................

5,000

Dividends ..................................................... Cash ......................................................

400

Cash ............................................................ Accounts Receivable .............................

500

Accounts Payable ........................................ Cash ......................................................

250

Prepaid Insurance ........................................ Cash ......................................................

100

Cash ............................................................ Unearned Revenue ...............................

300

Unearned Revenue ...................................... Service Revenue ...................................

300

3-16

250

500

300

5,000

400

500

250

100

300

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-6 June

Cash ....................................................... Common Shares..........................

2,500

Supplies ................................................. Accounts Payable ........................

250

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

300

Cash ....................................................... Accounts Receivable ...................

300

2,500

250

300

No transaction – no asset, liability or equity account affected

Cash....................................................... Unearned Revenue ........................

200

Accounts Payable .................................. Cash ............................................

250

Income Tax Expense.............................. Cash ............................................

100

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200

250

100

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-7 1.

Solutions Manual .

Cash ....................................................... Common Shares..........................

5,000

Prepaid Rent .......................................... Cash ............................................

2,100

Salaries Expense ................................... Cash ............................................

500

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

1,200

Cash ....................................................... Service Revenue .........................

900

Supplies ................................................. Accounts Payable ........................

500

Accounts Payable .................................. Cash ............................................

500

Cash ....................................................... Bank Loan Payable .....................

1,000

3-18

5,000

2,100

500

1,200

900

500

1,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-8 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

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Sales 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

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-9 Cash June 1 June 22 June 28 Bal.

2,500 300 200 2,650

June 29 June 30

250 100

Accounts Receivable June 12 Bal.

300 0

June 22

300

Supplies June 2

250 Accounts Payable

June 29 Bal.

250 0

June 2

250

Unearned Revenue June 28

200

Common Shares June 1

2,500

Service Revenue June 12

300

Income Tax Expense June 30

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100

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-10 (a) May 5 May 12 May 15 May 20 May 25 May 28 May 30

Billed clients $3,200 for services provided on account Collected $1,900 from customer on account Purchased supplies on account $200 Received $2,000 from client for services provided Paid salaries of $2,500 Paid supplier $200 on account Paid income tax of $750

(b) Cash 1,900 May 25 2,000 May 28 May 30 450

2,500 200 750

May 5 Bal.

Accounts Receivable 3,200 May 12 1,300

1,900

May 15

Supplies 200

May 12 May 20 Bal.

May 28

Accounts Payable 200 May 15 Bal.

200 0

Service Revenue May 5 May 20 Bal.

3,200 2,000 5,200

May 30

Income Tax Expense 750

May 25

Salaries Expense 2,500

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-11 CARLAND INC. Trial Balance June 30, 2015 Debit Cash Accounts receivable Trading investments Equipment Accumulated depreciation—equipment Accounts payable Unearned revenue Common shares Retained earnings Dividends 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

BRIEF EXERCISE 3-12

Error 1. 2. 3. 4. 5. 6.

Solutions Manual .

(a) In Balance No No Yes Yes Yes No

(b) Difference $ 900 1,000 N/A N/A N/A 1,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 3-13 (a)

No, the trial balance is not correct, because some accounts with debit balances are listed in the credit column and vice versa.

(b) BOURQUE LIMITED Trial Balance December 31, 2015 Debit Cash Accounts receivable Supplies Accounts payable Unearned revenue Common shares Retained earnings Dividends Service revenue Salaries expense Office expense Supplies expense Rent expense Income tax expense Totals

Solutions Manual .

Credit

$10,000 6,500 3,500 $ 1,500 2,200 5,000 13,000 4,500 20,000 9,100 4,400 1,200 2,000 500 $41,700

3-23

_ $41,700

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 3-1

Assets TransAccounts action Cash Receivable Supplies 1. +$5,000 2. +$250 3. +$2,500 4. −100 5. +1,800 −1,800 6. −500 7. +1,200 8. −250 9. −750 10. −600 Total $5,800 + $700 +$250

Liabilities Bank Prepaid = Accounts Loan Insurance Equipment Payable Payable

Shareholders’ Equity Retained Earnings Common + – – Shares Revenues Expenses Dividends +$5,000

+$250 +$2,500 −$100 +$3,500

+$3,000 +1,200 −250 −$750

+$600 + $600

+ $3,500 =

+ $0

+$3,000

+ $5,000

+ $3,700

– $750

TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $10,850

TOTAL ASSETS = $10,850

Solutions Manual .

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Chapter 3

– $100

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-2 (a) Assets

Trans. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Total

Cash

Accounts Receivable

Prepaid Insurance

Liabilities

= Computer Equipment +$8,000

Accounts Payable +$8,000

Common Shares

−$1,600

-$1,600 +$3,800

−300 +20,000 −8,000 −500 +3,000 −500 −250 $11,850

+$3,800 −300 +$20,000 −8,000 +$500

−3,000 −$500 + $800

+ $500

+ $8,000 =

+ $0

+ $20,000

(b) Revenues Less: Expenses Profit

+ $3,800

−250 – $2,150

TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $21,150

TOTAL ASSETS = $21,150

Solutions Manual .

Shareholders’ Equity Retained Earnings + – – Revenues Expenses Dividends

$3,800 2,150 $1,650

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Chapter 3

– $500

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-3

Account Accounts payable and accrued liabilities

(a) Type of account Liability

(b) Normal Balance Credit Credit

Bank loan payable

Liability

Cash

Asset

Debit

Dividends

Dividend

Debit

Dividends payable

Liability

Credit

Asset

Debit

Expense

Debit

Asset

Debit

Income tax expense

Expense

Debit

Income taxes payable

Liability

Credit

Interest expense

Expense

Inventories

Asset

Debit

Prepaid expenses

Asset

Debit

Receivables

Asset

Debit

Revenues

Revenue

Credit

Trademarks

Asset

Debit

Furniture, machinery, and equipment General and administrative expenses Goodwill

Solutions Manual .

Debit

3-26

(c) Financial Statement Statement of Financial Position Statement of Financial Position Statement of Financial Position Statement of Changes in Equity Statement of Financial Position Statement of Financial Position Income Statement Statement of Financial Position Income Statement Statement of Financial Position Income Statement Statement of Financial Position Statement of Financial Position Statement of Financial Position Income Statement Statement of Financial Position

Chapter 3

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Financial Accounting, Sixth 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

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 Cash -$1,000

Liabilities

Shareholders’ Equity

Account Payable +$9,000

Vehicles +$10,000

Solutions Manual .

Debits increase assets: debit Vehicles $10,000. Credits increase liabilities: credit Accounts Payable $9,000. Credit decrease assets: credit Cash $1,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-4 (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

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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-4 (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

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.

(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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-4 (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: Paid dividends of $500 to shareholders.

(a) Basic Analysis

The asset account Cash is decreased by $500; the Dividends account is increased by $500.

(b) Equation Analysis

Assets

Liabilities

Cash -$500 (c) Debit−Credit Analysis

Solutions Manual .

Shareholders’ Equity Dividends -$500

Debits increase dividends: debit Dividends $500. Credits decrease assets: credit Cash $500.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-5 1.

10.

Solutions Manual .

Computers .............................. Accounts Payable ..............

8,000

Rent Expense ......................... Cash ................................

1,600

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

3,800

Utilities Expense ..................... Cash ................................

300

Cash ....................................... Common Shares ..............

20,000

Accounts Payable ................... Cash ................................

8,000

Prepaid Insurance................... Cash ................................

500

Cash ....................................... Accounts Receivable .......

3,000

Dividends ................................ Cash ................................

500

Income Tax Expense .............. Cash ................................

250

3-31

8,000

1,600

3,800

300

20,000

8,000

500

3,000

500

250

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-6 Mar. 2

Solutions Manual .

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 ................................. Cash .................................

500

3-32

11,000

1,000 9,000

2,300

225

1,000

9,000

700

500

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-7 Cash Mar.

Mar.

11,000 Mar.

1,000

225

700

9,000

500

1,000

31 Bal.

1,975 Accounts Receivable

Mar.

2,300 Mar.

Mar.

31 Bal.

1,300 Vehicles

Mar.

10,000 Accounts Payable

Mar.

9,000 Mar. 4

9,000

Mar. 31 Bal.

Unearned Revenue Mar.

700

Common Shares Mar.

11,000

Dividends Mar. 31

500 Service Revenue Mar.

2,300

Advertising Expense Mar. 13

Solutions Manual .

225

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-8 (a), (b), and (c) 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

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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-8 (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

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 supplies on account for $500.

(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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-8 (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 amount owing for supplies purchased Sept. 10.

(a) Basic Analysis

The liability account Accounts Payable is decreased by $500; the asset account Cash is decreased by $500.

(b) Equation Analysis

Assets

Cash -$500 (c) Debit−Credit Analysis

Solutions Manual .

Liabilities

Shareholders’ Equity

Accounts Payable -$500

Debits decrease liabilities: debit Accounts Payable $500. Credits decrease assets: credit Cash $500.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-8 (Continued) (a), (b), and (c) (Continued) Transaction 7

Sept. 30: Collected $5,000 on account owing from a customer.

(a) Basic Analysis

The asset account Cash is increased by $5,000; the Asset account Accounts Receivable is decreased by $5,000.

Assets

(b) Equation Analysis

Liabilities

Shareholders’ Equity

Cash +$5,000 Accounts Receivable -$5,000

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 ...........................................

500

Cash................................................... Accounts Receivable ..................

5,000

Sept. 1

Solutions Manual .

3-37

20,000

9,000

5,000 7,000

500

4,500

500

5,000 Chapter 3

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-8 (Continued) (e)

Sept. 1 Sept. 25 Sept. 30 Bal.

Cash 20,000 Sept. 4 4,500 Sept. 30 5,000 24,000

Sept. 2 Bal.

Accounts Receivable 9,000 Sept. 30 4,000

Sept. 10 Bal.

Supplies 500 500

Sept. 4 Bal.

Equipment 12,000 12,000

Sept. 30

Solutions Manual .

5,000 500

5,000

Accounts Payable 500 Sept. 10 Bal.

500 0

Bank Loan Payable Sept. 4 Bal.

7,000 7,000

Unearned Revenue Sept. 25 Bal.

4,500 4,500

Common Shares Sept. 1 Bal.

20,000 20,000

Service Revenue Sept. 2 Bal.

9,000 9,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-9 (a) Aug. 1 Aug. 7 Aug. 11 Aug. 14 Aug. 16 Aug. 28 Aug. 30 Aug. 31

Solutions Manual .

Issued shares in exchange for cash 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 on account Paid salaries Paid dividends

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-9 (Continued) (b) Cash Aug. 1 7 16 28

3,000 1,800 900 700

Bal.

2,400

Aug. 11 30 31

Common Shares 1,500 2,000 500

Aug. 1

3,000

Dividends Accounts Receivable Aug. 14 Bal.

1,450

Aug. 28

Aug. 31

500

700

750

Service Revenue

Equipment Aug. 11

4,000

1,800 1,450

Bal.

3,250

Salaries Expense

Unearned Revenue Aug. 16

Aug. 7 14

Aug. 30

900

2,000

Bank Loan Payable Aug. 11

Solutions Manual .

2,500

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-9 (Continued) (c) KANG, INC. Trial Balance August 31, 2015 Debit Cash Accounts receivable Equipment Unearned revenue Bank loan payable Common shares Dividends Service revenue Salaries expense Totals

Solutions Manual .

Credit

$2,400 750 4,000 $ 900 2,500 3,000 500 2,000 $9,650

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3,250 _ $9,650

Chapter 3

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-10 (a) Oct. 1 Oct. 2 Oct. 5 Oct. 6 Oct. 9 Oct. 12 Oct. 15 Oct. 16 Oct. 20 Oct. 20 Oct. 28 Oct. 30 Oct. 30 Oct. 31

Issued shares in exchange for cash Purchased equipment on account Purchased supplies for cash Performed services on account Provided services and was paid cash Made a partial payment on account Borrowed cash using a bank loan Paid dividends Received a collection on account Performed services on account Purchased advertising on account Paid rent for the month of October Paid salaries Recorded income tax owing

(b) HOLLY CORP. Trial Balance October 31, 2015 Debit Cash Accounts receivable Supplies Equipment Accounts payable Income tax payable Bank loan payable Common shares Dividends Service revenue Salaries expense Advertising expense Rent expense Income tax expense Totals

Solutions Manual .

Credit

$ 4,200 2,240 400 2,000 $

900 180 5,000 2,000

300 3,390 500 400 1,250 180 $11,470

3-42

0 $11,470

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-11 (a) SPEEDY DELIVERY SERVICE, INC. Trial Balance July 31, 2015 Debit Cash Trading investments Accounts receivable Prepaid insurance Equipment Accumulated depreciation—equipment Accounts payable Salaries payable Bank loan payable, due 2017 Common shares Retained earnings, Aug. 1, 2014 Dividends Service revenue Salaries expense Depreciation expense Rent expense Repairs and maintenance expense Vehicles expense Interest expense Insurance expense Income tax expense Totals

Solutions Manual .

3-43

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 5,700 4,750 3,600 1,800 3,000 $204,550

0 $204,550

Chapter 3

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-11 (Continued) (b) SPEEDY DELIVERY SERVICE, INC. Income Statement Year Ended July 31, 2015 Revenues Service revenue Expenses Salaries expense Depreciation expense Rent expense Repair and maintenance expense Vehicles expense Interest expense Insurance expense Total expenses Profit before income tax Income tax expense Profit

$75,000 $25,000 9,700 9,000 5,700 4,750 3,600 1,800 59,550 15,450 3,000 $12,450

SPEEDY DELIVERY SERVICE, INC. Statement of Changes in Equity Year Ended July 31, 2015

Balance, August 1, 2014 Issued common shares Profit Dividends Balance, July 31, 2015

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

3-44

12,450 (800) $32,500

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-11 (Continued) (b) (Continued) SPEEDY DELIVERY SERVICE, INC. Statement of Financial Position July 31, 2015 Assets Current assets Cash 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 2017 Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity

(c)

$9,500 800 $ 10,300 39,000 49,300 $38,000 32,500 70,500 $119,800

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 from a balanced statement of financial position.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

EXERCISE 3-12

Solutions Manual .

Error

(a) In Balance

(b) Difference

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

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Financial Accounting, Sixth 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. Total

(b)

Cash +$24,000 +7,000 –11,000 –1,200 –1,450

Accounts Receivable

Supplies

Equipment

Liabilities Bank = Accounts Loan Payable Payable

Common Shares +$24,000

+$7,000 +$11,000 –$1,200 +$1,450 –600

+$600 +2,000 –400 –2,000 –600 –40 –6,400 +12,000 –1,500 $20,410

+$16,000

+$18,000 –$400 –2,000 –600 –40 –6,400

–12,000 + $4,000

+$1,450

+ $11,000 =

$0 + $7,000

+ $24,000

TOTAL ASSETS = $36,860 TOTAL LIABILITIES + SHAREHOLDERS’ EQUITY = $7,000 + $29,860 = $36,860 PROFIT = $18,000 – $11,740 = $6,260

Solutions Manual .

Shareholders’ Equity Retained Earnings + – – Revenues Expenses Dividends

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Chapter 3

+ $18,000

–1,500 –$11,740

–$400

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 3-2A (a) Assets

Liabilities

Accounts Bank Loan Accounts Common Cash + Receivable +Supplies+Equipment= Payable + Payable + Shares + July 31 $4,000 Aug. 3 +1,200 5 +1,300 6 −2,700 7 +3,000 12 –400 14 –4,675

18 +3,500 20 –500 24 26 +2,000 28 31 –500 $6,225+

$1,500 –1,200

$500

$5,000

$4,100

Shareholders’ Equity Retained Earnings Opening Retained Earnings +Revenues – Expenses–Dividends

$3,500

$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

$1,300 $1,300+

0 0 $500+

00 00 $6,200=

700 000 $2,000+

+275 00 000 $2,475+

00 000 $4,800 +

00 000 $3,400 +

00 000 $7,500 –

–275 −500 $5,450 –

00 0 $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.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-2A (Continued) (b) HILLS LEGAL SERVICES INC. Income Statement Month Ended August 31, 2015 Revenues Service revenue Expenses Salaries expense Rent expense Advertising expense Utilities expense Total expenses Profit before income tax Income tax expense Profit

$7,500 $3,500 900 275 275 4,950 2,550 500 $2,050

HILLS LEGAL SERVICES INC. Statement of Changes in Equity Month Ended August 31, 2015

Balance, August 1 Issued common shares Profit Dividends Balance, August 31

Solutions Manual .

Common Shares

Retained Earnings

$3,500 1,300

$3,400

00 $4,800

3-49

2,050 (500) $4,950

Total Equity $6,900 1,300 2,050 (500) $9,750

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-2A (Continued) (b) (Continued)

HILLS LEGAL SERVICES INC. Statement of Financial Position August 31, 2015 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

Solutions Manual .

3-50

$2,475 2,000 $ 4,475 $4,800 4,950 9,750 $14,225

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-3A (a)

Solutions Manual .

Account

(1) Increases with

(2) Normal Balance

Accounts payable and accrued liabilities Accounts receivable Buildings Cash Common shares, beginning of year Cost of sales Furniture and equipment Income tax expense Income tax payable Interest expense Inventories Land Prepaid expenses Retained earnings, beginning of year Sales Selling, general, and administrative expenses

Credit Debit Debit Debit Credit Debit Debit Debit Credit Debit Debit Debit Debit Credit Credit Debit

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-3A (Continued) (b)

Account Accounts payable and accrued liabilities Accounts receivable Buildings Cash Common shares, beginning of year Cost of sales Furniture and equipment Income tax expense Income tax payable Interest expense Inventories Land

(1) Classification Current liabilities

Statement of Financial Position

Current assets Non-current assets (property, plant, and equipment) Current assets Share capital

Statement of Financial Position Statement of Financial Position

Expenses Non-current assets (property, plant, and equipment) Expenses Current liabilities Expenses Current assets Non-current assets (property, plant, and equipment) Current assets N/A

Income Statement Statement of Financial Position

Prepaid expenses Retained earnings, beginning of year Sales Revenues Selling, general, and Expenses administrative expenses

Solutions Manual .

(2) Financial Statement

Statement of Financial Position 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 Income Statement

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PROBLEM 3-4A (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 Equipment +$10,000

(3) Debit−Credit Analysis

Solutions Manual .

Liabilities

Shareholders’ Equity

Bank Loan Payable +$10,000

Debits increase assets: debit Equipment $10,000. Credits increase liabilities: credit Bank Loan Payable $10,000.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-4A (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: Paid dividends of $500 to shareholders.

(1) Basic Analysis

The asset account Cash is decreased by $500; the Dividends account is increased by $500.

(2) Equation Analysis

Assets

Liabilities

Cash -$500 (3) Debit−Credit Analysis

Solutions Manual .

Shareholders’ Equity Dividends -$500

Debits increase dividends: debit Dividends $500. Credits decrease assets: credit Cash $500.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-4A (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, Sixth Canadian Edition

PROBLEM 3-4A (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, Sixth Canadian Edition

PROBLEM 3-4A (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 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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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-4A (Continued) (b) Feb. 2 Supplies ........................................................... Accounts Payable .....................................

600

3 Equipment ....................................................... Bank Loan Payable .................................

10,000

6 Cash ................................................................ Accounts Receivable ...................................... Service Revenue ......................................

30,000 20,000

13 Dividends ......................................................... 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 .........................................................

Solutions Manual .

3-58

600

10,000

0 50,000

500

2,000

600

20,000

22,000

14,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-5A 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......................................................... Cash .........................................................

1,000

22 Cash ................................................................ Unearned Revenue ..................................

1,200

29 Accounts Payable............................................ Cash .........................................................

9,000

30 Interest Expense ............................................. Cash .........................................................

800

30 Salaries Expense ............................................ Cash .........................................................

3,400

Solutions Manual .

3-59

120,000

100,000 170,000

1,500

800

9,000

8,800

1,000

1,200

9,000

800

3,400

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-6A (a) Apr. 1 Cash ................................................................ Equipment ....................................................... Common Shares ......................................

10,000 6,000 16,000

1 No entry. Not a transaction 2 Rent Expense .................................................. Cash .........................................................

950

3 Supplies .......................................................... Accounts Payable ....................................

1,900

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

900

13 Cash ................................................................ Unearned Revenue ..................................

800

20 Cash ................................................................ Service Revenue ......................................

1,500

21 Cash ................................................................ Accounts Receivable ................................

500

23 Office Expense ................................................ Accounts Payable ....................................

135

Solutions Manual .

950

1,900

900

800

1,500

500

135

Salaries Expense ............................................ Cash .........................................................

1,900

Accounts Payable............................................ Cash .........................................................

950

Dividends ........................................................ Cash .........................................................

500

3-60

1,900

950

500

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-6A (Continued) (b) Cash Apr. 1 Apr. 13 Apr. 20 Apr. 21

10,000 800 1,500 500

Bal.

8,500

Apr. 2 Apr. 30 Apr. 30 Apr. 30

Common Shares 950 1,900 950 500

Apr. 1

16,000

Bal. 16,000 Dividends Apr. 30

500

Bal.

500

Accounts Receivable Apr. 10

900

Bal.

400

Apr. 21

500 Service Revenue

Supplies Apr. 3

1,900

Bal.

1,900

Apr. 10 Apr. 20

900 1,500

Bal.

2,400

Salaries Expense Equipment Apr. 1

6,000

Bal.

6,000

Apr. 30

1,900

Bal.

1,900

Rent Expense

Accounts Payable Apr. 30

950

Apr. 3 Apr. 23

1,900 135

Bal.

1,085

Solutions Manual .

800

Bal.

800

950

Bal.

950 Office Expense

Unearned Revenue Apr. 13

Apr. 2

3-61

Apr.23

135

Bal.

135

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-6A (Continued) (c)

This suggestion is not a good idea. Journals are used to record transactions. Ledgers are 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.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-7A (a) and (c) Cash Feb. 28 Bal. 15,000 Mar. 9 16,300 Mar. 20 16,600 Mar. 25 18,400 Mar. 30 1,245

Bal.

Mar. 2 Mar. 12 Mar. 13 Mar. 19 Mar. 23 Mar. 27 Mar. 30 Mar. 30

Accounts Payable

10,000 17,000 12,000 950 3,000 4,200 2,000 3,000

Mar. 12 Mar. 13

17,000 Feb. 28 Bal. 12,000 Mar. 2 Bal.

12,000 17,000 0

Mortgage Payable

15,395

Mar. 30 1,250

Feb. 28Bal. Bal.

118,000 116,750

Accounts Receivable Mar. 30 Bal.

1,245 1,245

Common Shares Feb. 28 Bal. Bal.

Land Feb. 28 Bal. 85,000 Bal. 85,000

40,000 40,000

Retained Earnings Feb. 28 Bal. Bal.

27,000 27,000

Buildings Fees Earned

Feb. 28 Bal. 77,000 Bal. 77,000

Equipment

Mar. 9 Mar. 20 Mar. 25

16,300 16,600 18,400

Bal.

51,300

Feb. 28 Bal. 20,000 Bal. 20,000

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-7A (Continued) (a) and (c) (Continued) Concession Revenue Mar. 30 Bal.

2,490 2,490

Rent Expense Mar. 2 Mar. 23 Bal.

27,000 3,000 30,000

Salaries Expense Mar. 27 Bal.

4,200 4,200

Advertising Expense Mar. 19 Bal.

950 950

Interest Expense Mar. 30 Bal.

750 750

Income Tax Expense Mar. 30 Bal.

Solutions Manual .

3,000 3,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-7A (Continued) (b) Mar. 2

27,000 17,000 10,000

No entry.

Cash ................................................................ Fees Earned .............................................

16,300

Accounts Payable ........................................... Cash .........................................................

17,000

Accounts Payable ........................................... Cash .........................................................

12,000

Advertising Expense ........................................ Cash .........................................................

950

Cash ................................................................ Fees Earned .............................................

16,600

0 16,600

Rent Expense .................................................. Cash .........................................................

3,000

0 3,000

Cash ................................................................ Fees Earned .............................................

18,400

0 18,400

Salaries Expense ............................................. Cash .........................................................

4,200

Cash ................................................................ Accounts Receivable (2,490 × 50%) ................ Concession Revenue ................................

1,245 1,245

Mortgage Payable ............................................ Interest Expense .............................................. Cash .........................................................

1,250 750

Income Tax Expense ....................................... Cash .........................................................

3,000

Solutions Manual .

Rent Expense .................................................. Accounts Payable ..................................... Cash .........................................................

3-65

16,300

17,000

12,000

950

4,200

2,490

2,000

3,000

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-7A (Continued) (d) THE STAR THEATRE, INC. Trial Balance March 31, 2015 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

Solutions Manual .

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

3-66

00 $237,540

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-8A (a) and (c)

Apr. 30 May 7 8 15 22 29

Bal.

Cash 5,000 1,500 May 1 1,200 4 800 14 1,000 21 1,700 25 31 31 31 5,100

Apr. 30 Bal.

Supplies 500 500

Apr. 30

Equipment 24,000

Bal.

24,000

May 4 21

Accounts Payable Apr. 30 1,100 May 22 1,000 25 Bal. Bank Loan Payable Apr 30 Bal.

May 15 29

Solutions Manual .

Unearned Revenue Apr. 30 700 May 7 600 Bal.

Common Shares Apr. 30

1,000 1,100 1,200 1,000 400 50 1,200 150

Bal. Retained Earnings Apr. 30 Bal. Service Revenue May 8 15 15 22 29 29 Bal.

5,000 5,000

11,400 11,400

1,200 800 700 1,000 1,700 600 6,000

Salaries Expense May 14 1,200 31 1,200 Bal. 2,400

2,100 700 500 1,200

10,000

May 1 Bal.

Rent Expense 1,000 1,000

May 22 Bal.

Supplies Expense 700 700

May 25 Bal.

Advertising Expense 500 500

10,000

1,000 1,500 1,200

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Financial Accounting, Sixth Canadian Edition

Bal.

PROBLEM 3-8A (Continued) (a) (Continued)

May 25 Bal.

Utilities Expense 400 400

May 31

Interest Expense 50

May 31 Bal.

Income Tax Expense 150 150

(b) May 1

Rent Expense .................................................. Cash .........................................................

1,000

Accounts Payable ............................................ Cash .........................................................

1,100

Cash ................................................................ Unearned Revenue ..................................

1,500

Cash ................................................................ Service Revenue ......................................

1,200

Salaries Expense ............................................. Cash .........................................................

1,200

Cash ................................................................ Service Revenue ......................................

800

Unearned Revenue ......................................... Service Revenue ......................................

700

Accounts Payable ............................................ Cash .........................................................

1,000

Cash ................................................................ Service Revenue ......................................

1,000

Supplies Expense ............................................ Accounts Payable .....................................

700

Solutions Manual .

3-68

1,000

1,100

1,500

1,200

800

700 0 1,000

1,000

700

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-8A (Continued) (b) (Continued) May 25

Solutions Manual .

Advertising Expense ........................................ Accounts Payable .......................................

500

Utilities Expense .............................................. Cash ...........................................................

400

Cash ................................................................ Service Revenue ......................................

1,700

Unearned Revenue .......................................... Service Revenue ......................................

600

Interest Expense .............................................. Cash .........................................................

Salaries Expense ............................................. Cash .........................................................

1,200

Income Tax Expense ....................................... Cash .........................................................

150

3-69

500

400

1,700

600

1,200

150

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-8A (Continued) (d) PAMPER ME SALON INC. Trial Balance May 31, 2015 Debit Cash Supplies Equipment Accounts payable Bank loan payable Unearned revenue Common shares Retained earnings Service revenue Salaries expense Rent expense Supplies expense Advertising expense Utilities expense Interest expense Income tax expense Totals

Solutions Manual .

Credit

$ 5,100 500 24,000 $ 1,200 10,000 1,200 5,000 11,400 6,000 2,400 1,000 700 500 400 50 150 $34,800

3-70

$34,800

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-9A (a) TAGGAR ENTERPRISES INC. Trial Balance June 30, 2015 Debit $ 1,800 3,000 5,100 900 7,400 15,000

Cash Accounts receivable Merchandise inventory Prepaid insurance Land Buildings Accumulated depreciation—buildings Equipment Accumulated depreciation—equipment Long-term investments Accounts payable Income tax payable Mortgage payable, due 2021 Common shares Retained earnings, July 1, 2014 Sales Cost of goods sold Office expense Interest expense Income tax expense Totals (b)

Credit

$ 4,000 3,000 1,000 3,550 1,500 100 15,000 5,000 6,250 25,000 13,700 3,300 100 1,000 $57,850

$57,850

When debits equal credits in a trial balance, there is some assurance that certain types of errors may have been caught. However, there is no guarantee that errors do not exist because entries may have been omitted completely, duplicated or recorded to incorrect accounts.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-10A

TAGGAR ENTERPRISES INC. Income Statement Year Ended June 30, 2015 Sales Expenses Cost of goods sold Office expense Interest expense Total expenses Profit before income tax Income tax expense Profit

$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, 2015 Common Shares

Retained Earnings

$3,000 2,000 00 000 $5,000

$ 6,250

Balance, July 1, 2014 Issued common shares Profit Balance, June 30, 2015

Solutions Manual .

3-72

6,900 $13,150

Total Equity $ 9,250 2,000 6,900 $18,150

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-10A (Continued) TAGGAR ENTERPRISES INC. Statement of Financial Position June 30, 2015 Assets Current assets Cash Accounts receivable Merchandise inventory Prepaid insurance Total current assets Long-term investments Property, plant, and equipment Land Buildings $15,000 Less: Accumulated depreciation 4,000 Equipment $3,000 Less: Accumulated depreciation 1,000 Total property, plant, and equipment Total assets

$1,800 3,000 5,100 900 $10,800 3,550 $ 7,400 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

Solutions Manual .

$1,500 100 1,250 $ 2,850 13,750 16,600 $ 5,000 13,150 18,150 $34,750

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-11A CANTPOST LTD. Trial Balance June 30, 2015 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 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. The retained earnings balance given in the problem is the ending retained earnings balance, which was included in the trial balance in error.

Solutions Manual .

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PROBLEM 3-1B (a) Assets

Liabilities

Accounts Accounts Supplies Equipment = Receivable Payable

Bank Loan Payable

Trans.

Cash

Unearned + Revenue

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Total

+$28,000 –1,280 –4,000

(b)

TOTAL ASSETS = $43,840 TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY = $12,700 + $31,140 = $43,840

Common Shares +$28,000

–$1,280 +$16,000 +$700

+$12,000 +$700

+4,200 –700 –200

+$4,200 –700 –200 +$3,600

–2,000 +700 +1,600 –500 –80 –600 $25,140

Shareholders’ Equity Retained Earnings + – – Revenues Expenses Dividends

+3,600 –2,000

, –1,600

+$700 –$500

+ $2,000

+ $700

+ $16,000 =

+ $12,000

+ $700 +

$28,000

PROFIT = $7,800 – $4,160 = $3,640

Solutions Manual

3-75 .

Chapter 3

+ $7,800

–80 –600 –$4,160

–$500

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 3-2B (a) Assets

Liabilities

Bank Accounts Accounts Common Cash + +Supplies+Equipment= Loan + + + Receivable Payable Shares Payable Aug. 31 Sept. 1 1 3 5 8 14 15 25 28 29 30 30 30

$4,500 –3,200 –1,200 +1,450 +2,300 –700

$1,800

$350

$6,500

$3,200 –3,200

Shareholders’ Equity Retained Earnings Opening Retained +Revenues–Expenses– Dividends Earnings

$2,500

$7,450 –$1,200

–1,450 +2,300 +2,050

+1,350

+500 –300 +2,500 +3,000 –750

+$500 –300 +$2,500

+1,500

+4,500 –750 –175

+175 –500 –350 $6,750+

0 $2,350 +

0 $350+

0 $8,550=

0 $2,500+

0 $1,525+

0 $4,800+

0 $7,450+

0 $5,000–

–350 $2,775–

–$500 0 $500

TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY = $18,000

TOTAL ASSETS = $18,000

Note: The transactions on September 4th (hired a part-time office assistant) and 25th (sent a statement) do not affect the accounting equation and are therefore not recorded in the accounting records .

Solutions Manual

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-2B (Continued) (b) CORSO CARE CORP. Income Statement Month Ended September 30, 2015 Revenues Service revenue Expenses Rent expense Salaries expense Advertising expense Utilities expense Total expenses Profit before income tax Income tax expense Profit

$5,000 $1,200 750 300 175 0

2,425 2,575 350 $2,225

CORSO CARE CORP. Statement of Changes in Equity Month Ended September 30, 2015

Balance, September 1 Issued common shares Profit Dividends Balance, September 30

Solutions Manual .

Common Shares

Retained Earnings

$2,500 2,300

$7,450

0 $4,800

3-77

2,225 (500) $9,175

Total Equity $ 9,950 2,300 2,225 (500) $13,975

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-2B (Continued) (b) (Continued) CORSO CARE CORP. Statement of Financial Position September 30, 2015 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

Solutions Manual .

3-78

$1,525 2,500 $ 4,025 $4,800 9,175 13,975 $18,000

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-3B (a)

Account Administrative expenses Buildings Cost of goods sold Dividends Finance income Fixtures and equipment Goodwill Income tax expense Income tax payable Inventories Mortgage payable Prepaid expenses Retained earnings, beginning of year Sales Trade and other receivables Trade payables

Solutions Manual .

3-79

(1) Increases with

(2) Normal Balance

Debit Debit Debit Debit Credit Debit Debit Debit Credit Debit Credit Debit Credit Credit Debit Credit

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-3B (Continued) (b) (1) Classification

Account Administrative expenses Buildings Cost of goods sold Dividends Finance income Furniture and equipment Goodwill Income tax expense Income tax payable Inventories Mortgage payable Prepaid expenses Retained earnings, beginning of year Sales Trade and other receivables Trade payables

Solutions Manual .

(2) Financial Statement

Expenses

Income Statement

Non-current assets (property, plant, and equipment) Expenses Dividends Revenues Non-current assets (property, plant, and equipment) Non-current assets Expenses Current liabilities Current assets Non-current liability Current assets N/A

Statement of Financial Position

Revenues Current assets

Income Statement Statement of Financial Position

Current liabilities

Statement of Financial Position

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Income Statement Statement of Changes in Equity Income Statement Statement of Financial Position Statement of Financial Position Income Statement Statement of Financial Position Statement of Financial Position Statement of Financial Position Statement of Financial Position Statement of Changes in Equity

Chapter 3

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-4B (a) Transaction 1

Jan. 2: Issued $10,000 of common shares for cash.

(1) Basic Analysis

The asset account Cash is increased by $10,000; the shareholders’ equity account Common Shares account is increased by $10,000.

(2) Equation Analysis

Assets

Liabilities

Cash +$10,000

Shareholders’ Equity Common Shares +$10,000

(3) Debit−Credit Analysis

Debits increase assets: debit Cash $10,000. Credits increase share capital: credit Common Shares $10,000.

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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PROBLEM 3-4B (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 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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PROBLEM 3-4B (Continued) (a) (Continued) Transaction 5

Jan. 9: Received cash of $5,000 from a customer as a deposit 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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PROBLEM 3-4B (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 to 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, Sixth Canadian Edition

PROBLEM 3-4B (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 Feb. 26.

(1) Basic Analysis

The expense account Utilities Expense is increased by $125; the liability account Accounts Payable 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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PROBLEM 3-4B (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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PROBLEM 3-4B (Continued) (a) (Continued) Transaction 13

Jan 31: Paid interest of $300 on the bank loan from the Jan. 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 3-4B (Continued) (b) Jan. 2 Cash ................................................................ Common Shares ......................................

10,000

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

Solutions Manual .

3-88

10,000

2,500

30,000

40,000

5,000

20,000

500

1,500

5,000

125

1,500

4,000

300

3,600

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-5B Apr. 1 Cash ...................................................................... Common Shares ............................................

Common 100,000 Shares 100,000 100,000

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

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.............................................................. 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

Solutions Manual .

3-89

5,500

600

10,600

1,800

2,000

800

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Financial Accounting, Sixth Canadian Edition

PROBLEM 3-6B (a)

May 1 Cash ........................................................................... 20,000 Common Shares ..................................................

20,000

1 Rent Expense ............................................................. Cash ....................................................................

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 Office Expense ................................................... Accounts Payable ........................................

275

29 Salaries Expense ................................................ Cash ............................................................

2,000

29 Income Tax Expense .......................................... Cash ............................................................

300

29 Dividends ............................................................ Cash ............................................................

250

3-90

750

2,725

3,500

2,350

1,725 , 250

275

2,000

300

250

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PROBLEM 3-6B (Continued) (b) Cash May 1 12 15 20

20,000 May 1 3,500 22 2,350 29 1,725 29 29 23,825

Bal.

950 250 2,000 300 250

Accounts Receivable May 11 Bal.

2,725 May 20 1,000

1,725

Supplies May 4 Bal.

750 750

Accounts Payable May 22

250 May

4 25

Bal.

750 275 775

Unearned Revenue May 12 Bal.

3,500 3,500

Common Shares May 1 Bal.

Solutions Manual .

20,000 20,000

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PROBLEM 3-6B (Continued) Dividends May 29 Bal.

250 250 Service Revenue May 11 15 Bal.

2,725 2,350 5,075

Salaries Expense May 29 Bal.

2,000 2,000 Rent Expense

May 1 Bal.

950 950 Office Expense

May 25 Bal.

275 275 Income Tax Expense

May 29 Bal.

Solutions Manual .

300 300

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PROBLEM 3-6B (Continued) (c)

Solutions Manual .

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PROBLEM 3-7B (a) and (c) Cash Mar. 31 Bal. 6,000 Apr. 11 1,950 Apr. 2 Apr. 25 7,300 Apr. 3 Apr. 30 560 Apr. 16 Apr. 17 Apr. 26 Apr. 27 Apr. 30 Bal. 5,140

Apr. 30 Bal.

Accounts Receivable 560 560

Apr. 27 Bal.

Prepaid Rent 700 700

Bal. 123,000 Common Shares Mar. 31 Bal. 50,000 Bal. 50,000

800 620 2,850 2,800 1,900 700 1,000

1,950 7,300 9,250

Concession Revenue Apr. 30 Bal.

1,120 1,120

Apr. 2 Apr. 20 Bal.

Rent Expense 800 750 1,550

Apr. 3 Bal.

Advertising Expense 620 620

5,000 750 2,950

Apr. 16 Bal.

Interest Expense 850 850

Mortgage Payable Mar. 31 Bal. 125,000 2,000

Apr. 30 Bal.

Income Tax Expense 1,000 1,000

Equipment Mar. 31 Bal. 25,000 Bal. 25,000

Solutions Manual .

Fees Earned Apr. 11 Apr. 25 Bal.

Apr. 26 Bal.

Buildings Mar. 31 Bal. 80,000 Bal. 80,000

Apr. 16

31,000 31,000

Salaries Expense 1,900 1,900

Land Mar. 31 Bal. 100,000 Bal. 100,000

Apr. 17

Retained Earnings Mar. 31 Bal. Bal.

Accounts Payable Mar. 31 Bal. 2,800 Apr. 20 Bal.

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PROBLEM 3-7B (Continued) (b) Apr. 2 Rent Expense.............................................................. Cash ....................................................................

800

3 Advertising Expense ................................................... Cash ....................................................................

620

800

620

3 No entry, not a transaction. 6 No entry, not a transaction. 11 Cash............................................................................ Fees Earned ........................................................

1,950

16 Mortgage Payable ....................................................... Interest Expense ......................................................... Cash ....................................................................

2,000 850

17 Accounts Payable ....................................................... Cash ....................................................................

2,800

20 Rent Expense.............................................................. Accounts Payable ................................................

750

25 Cash............................................................................ Fees Earned ........................................................

7,300

26 Salaries Expense ........................................................ Cash ....................................................................

1,900

27 Prepaid Rent ............................................................... Cash ....................................................................

700

30 Cash............................................................................ Accounts Receivable................................................... Concession Revenue (20% × $5,600) .................

560 560

30 Income Tax Expense .................................................. Cash ....................................................................

1,000

Solutions Manual .

3-95

1,950

2,850

2,800

750

7,300

1,900

700

1,120

1,000

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PROBLEM 3-7B (Continued) (d)

LAKE THEATRE, INC. Trial Balance April 30, 2015 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

Solutions Manual .

Credit

5,140 560 700 100,000 80,000 25,000 $ 2,950 123,000 50,000 31,000 9,250 1,120

1,900 1,550 620 850 1,000 $217,320

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0000 000 $217,320

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PROBLEM 3-8B (a) and (c)

Cash Apr. 30 Bal. 23,000 May 29 2,200 May 4 May 9 May 11 May 15 May 18 May 29 May 29 May 29 May 31 Bal. 6,200

Apr. 30 Bal. Bal.

Equipment 2,000 2,000

6,000 6,000

Fees Earned May 29 Bal.

17,500 17,500

May 4 May 18 Bal.

Rent Expense 7,200 7,200 14,400

May 15 May 29 Bal.

Salaries Expense 1,000 1,000 2,000

May 11 29 Bal.

Advertising Expense 500 300 800

Accounts Payable Apr 30 Bal. 500 May 21 Bal.

500 100 100

Unearned Revenue Apr 30 Bal. 17,500 May 29 Bal.

17,500 2,200 2,200

May 29 Bal.

Supplies Expense 200 200

Common Shares Apr. 30 Bal. Bal.

1,000 1,000

May 21 Bal.

Office Expense 100 100

May 31 Bal.

Income Tax Expense 1,100 1,100

May 9

May 29

7,200 500 500 1,000 7,200 200 300 1,000 1,100

Retained Earnings Apr. 30 Bal. Bal.

Solutions Manual .

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PROBLEM 3-8B (Continued) (b) May

4 Rent Expense .............................................................. 7,200 Cash ..................................................................... 9 Accounts Payable ........................................................ Cash .....................................................................

7,200

500 500

11 No entry. Not a transaction. 11 Advertising Expense .................................................... Cash .....................................................................

500 500

15 Salaries Expense......................................................... 1,000 Cash .....................................................................

1,000

18 Rent Expense .............................................................. 7,200 Cash .....................................................................

7,200

21 Office Expense ............................................................ Accounts Payable.................................................

100 100

29 Unearned Revenue ..................................................... 17,500 Fees Earned ......................................................... 29 Supplies Expense ........................................................ Cash .....................................................................

200 200

29 Cash ............................................................................ 2,200 Unearned Revenue .............................................. 29 Advertising Expense .................................................... Cash .....................................................................

Solutions Manual .

17,500

2,200

300 300

29 Salaries Expense......................................................... 1,000 Cash .....................................................................

1,000

31 Income Tax Expense ................................................... 1,100 Cash .....................................................................

1,100

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PROBLEM 3-8B (Continued) (d)

KG SPRING SKATING SCHOOL INC. Trial Balance May 31, 2015 Debit Cash Equipment Accounts payable Unearned revenue Common shares Retained earnings Fees earned Rent expense Salaries expense Advertising expense Supplies expense Office expense Income tax expense Totals

Solutions Manual .

Credit

$ 6,200 2,000 $

100 2,200 1,000 6,000 17,500

14,400 2,000 800 200 100 1,100 $26,800

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_ $26,800

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PROBLEM 3-9B (a) ASIAN IMPORTERS LIMITED Trial Balance January 31, 2015 (thousands) Debit Cash Accounts receivable Merchandise inventory Prepaid insurance Land Buildings Accumulated depreciation—buildings Equipment Accumulated depreciation—equipment Goodwill Accounts payable Other current liabilities Bank loan payable (due 2018) Mortgage payable Common shares Retained earnings, February 1, 2014 Dividends Sales Cost of goods sold Office expense Interest expense Income tax expense Totals

(b)

Credit

$ 6,000 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 14,000 $544,850

00000 0 $544,850

Solutions Manual .

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PROBLEM 3-10B

ASIAN IMPORTERS LIMITED Income Statement Year Ended January 31, 2015 (thousands) Revenues Sales Expenses Cost of goods sold Office expense Interest expense Total expenses Profit before income tax Income tax expense Profit

$370,000 $244,200 67,750 2,150 314,100 55,900 14,000 $ 41,900

ASIAN IMPORTERS LIMITED Statement of Changes in Equity Year Ended January 31, 2015 Common Shares Balance, February 1, 2014 Issued common shares Profit

$20,000 12,900

Dividends Balance, January 31, 2015

000 000 $32,900

Solutions Manual .

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Retained Earnings $37,050

Total Equity

41,900

$ 57,050 12,900 41,900

(1,850) $77,100

(1,850) $110,000

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PROBLEM 3-10B (Continued) ASIAN IMPORTERS LIMITED Statement of Financial Position January 31, 2015 (thousands) Assets Current assets Cash Accounts receivable Merchandise inventory Prepaid expenses Total current assets Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Goodwill Total assets

$ 6,000 30,200 74,250 3,950 $114,400 $42,500 $39,500 13,000 $10,900 3,600

26,500 _7,300

76,300 7,600 $198,300

Liabilities and Shareholders' Equity Liabilities Current liabilities Accounts payable 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

Solutions Manual .

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$ 46,300 6,300 12,200 64,800 $13,450 10,050 23,500 88,300 $32,900 77,100 110,000 $198,300

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PROBLEM 3-11B MESSED UP LTD. Trial Balance May 31, 2015 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 (+$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

Solutions Manual .

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BYP 3-1 FINANCIAL REPORTING (a) and (b)

Account Accounts payable and accrued liabilities Accounts receivable Cash Dividends Income tax expense Inventory Land Sales

(a) Type of account Liability Asset Asset Shareholder’s Equity (dividend) Shareholders’ Equity (expense) Asset Asset Shareholders’ Equity (revenue)

Increase with Credit

(b) Decrease with Debit

Normal Balance Credit

Debit Debit

Credit Credit

Debit Debit

Debit

Credit

Debit

Credit

Debit

Debit Debit Credit

Credit Credit Debit

Debit Debit Credit

Dividends are increased (debited) and Cash is decreased (credited) Income Tax Expense is increased (debited) or Income Tax Payable decreased (credited) and Cash is decreased (credited) Inventory is increased(debited) and Accounts Payable is increased (credited) Land is increased (debited) and Bank Loan Payable is increased (credited) Accounts Receivable is increased (debited) and Sales is increased (credited)

(d) Account Accounts payable and accrued liabilities Accounts receivable Cash Dividends Income tax expense Inventory Land Sales

Solutions Manual .

Financial Statement Balance Sheet Balance Sheet Balance Sheet Statement of Changes in Shareholders’ Equity Statement of Earnings Balance Sheet Balance Sheet Statement of Earnings

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BYP 3-2 COMPARATIVE ANALYSIS (a) Shoppers Drug Mart ($ in thousands) Total Assets =

Total Liabilities +

$7,473,721 =

$3,150,394 +

Shareholder's Equity $1,431,315 Share Capital 10,856 Contributed Surplus (35,192) Accumulated Other Comprehensive Loss 2,916,348 Retained Earnings $4,323,327

(b) Jean Coutu ($ in millions) Total Assets =

Total Liabilities +

$1,392.7 =

$281.9

Solutions Manual .

Shareholder's Equity $ 537.1 Capital Stock (2.2) Treasury Stock 1.7 Contributed Surplus Change in fair value of the investment in 40.8 Rite Aid 533.4 Retained Earnings $1,110.8

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BYP 3-3 COMPARING IFRS AND ASPE (a)

CREIT (Canadian Real Estate Investment Trust) is a public company which trades its shares on a public exchange and therefore it is required to prepare its financial statements in accordance with IFRS. First Pro Shopping Centres (First Pro) is a privately held company and therefore it has the option to prepare its financial statements in accordance with either IFRS or ASPE.

(b)

The users of CREIT (Canadian Real Estate Investment Trust) financial statements would include the shareholders of the company, potential investors, management, lenders, customers, competitors, and tax authorities. The users of First Pro’s financial statements would be similar to those of CREIT. However, since it is a privately held company there would be fewer shareholders and they would likely be more actively involved in the day to day management of First Pro. Because of this, First Pro would not be required to disclose its financial results publicly and users such as competitors and customers would not have access to the financial results. Different users will have different information needs and this will influence the type of accounting standards used by the company. For example, at First Pro the shareholder’s will have an intimate knowledge of the operations and would not need the additional disclosures required by IFRS. At CREIT, the shareholders are not actively involved in the business and would need the additional disclosures in order to make the financial information more transparent and to allow users to properly assess the performance of the business. Consequently, there is much more disclosed in the notes to the financial statements when a company is complying with IFRS.

(c)

CREIT would likely have more a sophisticated reporting system for the following reasons: -

(d)

Its operations are in Canada and in the U.S., and therefore it would need to collect information in a variety of currencies. It must comply with IFRS and therefore it would need to collect and report additional information that would not be required under ASPE. It is required to disclose its financial statements to the public within specific timing deadlines and therefore must collect information in a very efficient manner.

No, it would be very difficult to collect the necessary information without a journal or ledger. Companies of almost any size will use a journal and ledger as the foundation of their accounting records.

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Financial Accounting, Sixth Canadian Edition

BYP 3-4 CRITICAL THINKING CASE (a)

Total assets = $42,000

(b)

Total liabilities and shareholders’ equity = $42,000

A spreadsheet can help, in a small business like Uncle 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 be limiting in terms of growth in the number of accounts and transactions.

(c) UNCLE BOB'S REPAIRS LTD. Income Statement Year Ended August 31, 2015 Service revenue Expenses Salaries expense Rent expense Office expense Profit before income tax Income tax expense Profit

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$229,400 $120,000 42,000 36,400

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198,400 31,000 6,200 $ 24,800

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BYP 3-4 (Continued) (c) (Continued) UNCLE BOB'S REPAIRS LTD. Statement of Changes in Equity Year Ended August 31, 2015

Balance, September 1 Issued common shares Profit Dividends Balance, August 31

Common Shares $ 0 10,000 00 0000 $10,000

Retained Earnings $ 0 24,800 (1,000) $23,800

Total Equity $ 0 10,000 24,800 (1,000) $33,800

UNCLE BOB'S REPAIRS LTD. Statement of Financial Position August 31, 2015 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

Solutions Manual .

$ 4,000 6,200 2,000 $12,200 $10,000 23,800 33,800 $46,000

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BYP 3-4 (Continued) (d)

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 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. (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.

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Financial Accounting, Sixth Canadian Edition

BYP 3-5 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 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 (b) By adding $810 to the General and Administrative Expense account, the account total is intentionally misstated. By not locating the error causing the imbalance, some other account or accounts may also be misstated by a net amount of $810. Although the assignment will not affect external users of a real financial report, it is intended to resemble a real life situation and Ron’s reaction, had it been in a real life situation, is unethical. Ron did not advise his fellow team members of the action he has taken to avoid detection. They will be affected by his actions and had no means of agreeing to the strategy taken to address the problem. The adding of the $810 to the General and Administrative Expense account is not by itself unethical but his failure to inform other group members that he was changing amounts that they had prepared is wrong. Although 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. (c) 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.

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BYP 3-5 (Continued) (d) 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 is wrong on the financial statements. The consequences are more far reaching and so the behaviour is more serious. Deception for personal benefit is clearly viewed as unethical.

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Financial Accounting, Sixth Canadian Edition

BYP 3-6 “ALL ABOUT YOU” ACTIVITY (a) It is important to keep your personal and financial documents, such as passports, bank account information, credit cards, insurance policies, and income tax information, up to date so that they are current and accessible if you wish to travel, apply for a job, loan, or bank account, pay bills on time, prepare your income tax return, and so on. (b) A system can be organized in different ways. The system can make use of computers, filing cabinets, and/or a safety deposit box. Many individuals use a combination of all three of these systems. (c) You must report the lost documentation to cancel and replace it. Cancelling the lost information is critical to help avoid identify theft. Steps to take include: • Contact your bank for lost credit card information • Contact the local police to report the lost wallet • Contact the appropriate retailer to report other lost store credit cards • Contact the appropriate ministry of transportation office for a replacement drivers license • Contact the appropriate ministry for a replacement birth certificate • Contact Citizenship and Immigration Canada for details in replacing a citizenship certificate • Contact the appropriate department responsible for health to replace your health card • Contact Passport Canada to replace a passport • Apply for a replacement social insurance number and card.

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Financial Accounting, Sixth Canadian Edition

BYP 3-7 SERIAL CASE (b) June 2 Prepaid Insurance ........................................................ Cash ........................................................................

15,360

5 Supplies ........................................................................ Accounts Payable ....................................................

2,500

16 Equipment .................................................................... Cash ........................................................................

2,520

18 Cash ............................................................................. Unearned Revenue..................................................

500

19 Cash ............................................................................. Unearned Revenue ...................................................... Sales........................................................................

300 100

15,360

2,500

2,520

500

400

20 No entry. Not an accounting transaction. 23 Accounts Receivable .................................................... Sales........................................................................

2,040

27 Utilities Expense ........................................................... Accounts Payable ....................................................

100

30 Salaries Expense.......................................................... Cash ........................................................................

3,250

30 Accounts Receivable .................................................... Sales........................................................................

2,550

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2,040

100

3,250

2,550

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Financial Accounting, Sixth Canadian Edition

BYP 3-7 (Continued) (a) and (c) Cash June Bal. 18 19 Bal.

39,004 500 June 2 300 16 30 18,674

June Bal. 16 Bal.

15,360 2,520 3,250

Equipment 42,000 2,520 44,520

Accumulated Depreciation—Equipment June Bal. 14,000

Accounts Receivable June Bal. 5,900 23 2,040 30 2,550 Bal. 10,490

June Bal.

Vehicles 52,500 Accounts Payable June Bal. 5 27 Bal.

3,540 2,500 100 6,140

Unearned Revenue 100 June Bal. 18 Bal.

100 500 500

Bank Loan Payable June Bal.

22,500

Mortgage Payable June Bal.

53,200

Land June Bal. 100,000

Common Shares June Bal.

300

Buildings June Bal. 165,000

Retained Earnings June Bal.

66,788

Merchandise Inventory June Bal. 16,250

June Bal. 5 Bal.

Supplies 1,875 2,500 4,375

June Bal. 2 Bal.

Prepaid Insurance 12,000 15,360 27,360

June 19

Accumulated Depreciation—Buildings June Bal. 137,500

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Dividends 30,000

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Financial Accounting, Sixth Canadian Edition

BYP 3-7 (Continued) (a) and (c) (Continued) Rent Revenue June Bal.

6,000

Sales June Bal. 19 23 30 Bal.

638,768 400 2,040 2,550 643,758

Sales Returns and Allowances June Bal. 5,000

June Bal.

Cost of Goods Sold 102,386

June Bal. 30 Bal.

Salaries Expense 287,532 3,250 290,782

June Bal.

Freight Out 18,000

June Bal. 27 Bal.

Utilities Expense 12,000 100 12,100

Advertising Expense June Bal. 9,000

June Bal.

Property Tax Expense 5,950

June Bal.

Interest Expense 5,299

June Bal.

Income Tax Expense 33,000

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BYP 3-7 (Continued) (c) KOEBEL’S FAMILY BAKERY LTD. Trial Balance June 30, 2014 Cash Accounts receivable Merchandise 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 Rent revenue Sales Sales returns and allowances Cost of goods sold Salaries expense Freight out Utilities expense Advertising expense Property tax expense Interest expense Income tax expense Total

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Debit $18,674 10,490 16,250 4,375 27,360 100,000 165,000

Credit

$137,500 44,520 14,000 52,500 6,140 500 22,500 53,200 300 66,788 30,000 6,000 643,758 5,000 102,386 290,782 18,000 12,100 9,000 5,950 5,299 33,000 $950,686

00 $950,686

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 3 (a) Date

Account Titles

Ref.

Debit

Credit

Jan. 2 Cash ....................................................................................................................... 1000 15,000 Common Shares (1,000 × $15) ...................................................................... 4000 15,000 3 Cash ....................................................................................................................... 1000 50,000 Bank Loan Payable ........................................................................................ 3100 50,000 4 Rent Expense ......................................................................................................... 7400 3,000 Cash............................................................................................................... 1000 3,000 5 Equipment .............................................................................................................. 2000 40,000 Cash............................................................................................................... 1000 20,000 Accounts Payable .......................................................................................... 3000 20,000 10 Advertising Expense ............................................................................................... 7000 500 Cash.......................................................................................................... 1000 500 t 11 Supplies .................................................................................................................. 1200 1,000 Accounts Payable .......................................................................................... 3000 1,000 13 Advertising Expense ............................................................................................... 7000 3,000 Cash.......................................................................................................... 1000 3,000 t 15 Salaries Expense .................................................................................................... 7100 7,500 Cash............................................................................................................... 1000 7,500 17 Accounts Receivable ............................................................................................. 1100 15,000 Service Revenue ....................................................................................... 5000 15,000 t 20 Office Expense ...................................................................................................... 7300 1,000 Cash .......................................................................................................... 1000 1,000 t 24 Cash ...................................................................................................................... 1000 10,000 Accounts Receivable ................................................................................. 1100 10,000 t 30 Prepaid Insurance .................................................................................................. 1300 6,000 Cash ................................................... 1000 6,000

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COMPREHENSIVE CASE: CHAPTERS 1 – 3 (Continued) (a) (Continued) Date

Account Titles

Ref.

Debit

Credit

Jan. 30 Accounts Receivable .............................................................................................. 1100 18,000 Service Revenue ....................................................................................... 5000 18,000 t 31 Salaries Expense .................................................................................................... 7100 7,500 Cash ............................................................................................................... 1000 7,500 31 Interest Expense ..................................................................................................... 7200 300 Bank Loan Payable ................................................................................................. 3100 700 Cash ............................................................................................................... 1000 1,000 31 Income Tax Expense .............................................................................................. 9000 1,200 Cash ............................................................................................................... 1000 1,200

(b) Cash Jan.

Jan.

#1000

15,000 Jan.

3,000

50,000

20,000

10,000

500

3,000

7,500

1,000

6,000

7,500

1,000

1,200

31 Bal.

24,300

Accounts Receivable Jan. Jan.

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15,000 Jan.

18,000

31 Bal.

23,000

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#1100 24

10,000

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 3 (Continued) (b) (Continued) Supplies Jan.

1,000

Jan.

31 Bal.

1,000 Prepaid Insurance

Jan.

6,000

Jan.

31 Bal.

6,000

Equipment Jan.

40,000

Jan.

31 Bal.

40,000

Jan.

700 Jan. Jan.

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#3000

20,000

1,000

31 Bal.

21,000

Bank Loan Payable Jan.

#1300

#2000

Accounts Payable Jan.

#1200

#3100

50,000

31 Bal.

49,300

Common Shares

#4000

Jan.

15,000

Jan.

31 Bal.

15,000

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COMPREHENSIVE CASE: CHAPTERS 1 – 3 (Continued) (b) (Continued) Service Revenue Jan. Jan. Advertising Expense Jan. Jan.

500

3,000

31 Bal.

3,500 Salaries Expense

Jan. Jan.

7,500

31 Bal.

15,000 Interest Expense

Jan.

300

Jan.

31 Bal.

300 Office Expense

Jan.

1,000

Jan.

31 Bal.

1,000 Rent Expense

Jan.

3,000

Jan.

31 Bal.

3,000 Income Tax Expense

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Jan.

1,200

Jan.

31 Bal.

1,200

3-120

#5000 17

15,000

18,000

31 Bal.

33,000 #7000

#7100

#7200

#7300

#7400

#9000

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 3 (Continued) (c)

1000 1100 1200 1300 2000 3000 3100 4000 5000 7000 7100 7200 7300 7400 9000

SOFTWARE ADVISORS LIMITED Trial Balance January 31, 2015 Debit Cash $ 24,300 Accounts receivable 23,000 Supplies 1,000 Prepaid insurance 6,000 Equipment 40,000 Accounts payable Bank loan payable Common shares Service revenue Advertising expense 3,500 Salaries expense 15,000 Interest expense 300 Office expense 1,000 Rent expense 3,000 Income tax expense 1,200 $118,300

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Credit

$ 21,000 49,300 15,000 33,000

0 $118,300

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COMPREHENSIVE CASE: CHAPTERS 1 – 3 (Continued) (d) (1) SOFTWARE ADVISORS LIMITED Income Statement Month Ended January 31, 2015 Revenues Service revenue Expenses Salaries expense Advertising expense Rent expense Office expense Interest expense Total expenses Profit before income tax Income tax expense Profit

$33,000 $15,000 3,500 3,000 1,000 300 22,800 10,200 1,200 $ 9,000

(2) SOFTWARE ADVISORS LIMITED Statement of Changes in Equity Month Ended January 31, 2015 Common Shares Balance, January 1 Issued common shares Profit Balance, January 31

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$ 0 15,000 0 $15,000

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Retained Earnings $

9,000 $9,000

Total Equity $

0 15,000 9,000 $24,000

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COMPREHENSIVE CASE: CHAPTERS 1 – 3 (Continued) (d) (Continued) (3) SOFTWARE ADVISORS LIMITED Statement of Financial Position January 31, 2015 Assets Current assets Cash Accounts receivable Supplies Prepaid insurance Property, plant, and equipment Equipment Total assets

$24,300 23,000 1,000 6,000

$54,300 40,000 $94,300

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

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$21,000 49,300 70,300 $15,000 9,000

24,000 $94,300

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CHAPTER 4 Accrual Accounting Concepts ASSIGNMENT CLASSIFICATION TABLE Questions

Brief Exercises

Exercises

*1. Explain when revenue and expenses are recognized and how this forms the basis of accrual accounting.

1, 2, 3, 4

1, 2

1A, 6A

1B, 6B

5, 6

*2. Describe the types of adjusting entries and prepare adjusting entries for prepayments.

5, 6, 7, 8, 9, 10, 11, 12, 16

3, 4, 5

3, 4, 6, 7, 8

2A, 4A, 5A, 6A, 7A, 8A, 11A

2B, 4B, 5B, 6B, 7B, 8B, 11B

1, 2, 3, 4, 5, 7

*3. Prepare adjusting entries for accruals.

10, 11, 12, 13, 14, 16

5, 6, 7, 8, 9

5, 6, 7, 8

3A, 4A, 5A, 6A, 7A, 8A, 11A

3B, 4B, 5B, 6B, 7B, 8B, 11B

1, 2, 3, 4, 5, 7

*4. Prepare an adjusted trial balance.

15, 17, 18

10, 11

8, 9, 10

6A, 7A, 8A, 10A, 11A,

6B, 7B, 8B, 10B, 11B

3, 7

*5. Prepare closing entries and a postclosing trial balance.

16, 17, 18, 19, 20, 21, 22

12, 13, 14

9A, 10A, 12A

9B, 10B, 12B

1, 3

Study Objectives

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A Problems

B Problems

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Calculate profit on cash and accrual bases.

Moderate

25-35

Prepare transaction and adjusting entries for prepayments.

Simple

20-30

Prepare adjusting and subsequent entries for accruals.

Simple

20-30

Prepare transaction and adjusting entries.

Simple

20-30

Prepare adjusting entries.

Simple

20-30

Convert cash to accrual basis; prepare financial statements.

Complex

40-50

Prepare and post adjusting entries; prepare adjusted trial balance.

Moderate

30-40

Complete accounting cycle through to preparation of financial statements.

Moderate

Prepare and post closing entries; prepare postclosing trial balance.

Simple

25-35

10A

Prepare adjusted trial balance, closing entries and post-closing trial balance.

Moderate

40-50

11A

Prepare and post adjusting entries; prepare adjusted trial balance and financial statements; assess financial performance.

Moderate

40-50

12A

Prepare and post closing entries; prepare postclosing trial balance.

Simple

25-35

Calculate profit on cash and accrual bases.

Moderate

25-35

Prepare transaction and adjusting entries for prepayments.

Simple

20-30

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare adjusting and subsequent entries for accruals.

Simple

20-30

Prepare transaction and adjusting entries.

Simple

20-30

Prepare adjusting entries.

Simple

20-30

Convert cash to accrual basis; prepare financial statements.

Complex

40-50

Prepare and post adjusting entries; prepare adjusted trial balance.

Moderate

30-40

Complete accounting cycle through to preparation of financial statements.

Moderate

Prepare and post closing entries; prepare postclosing trial balance.

Simple

25-35

10B

Prepare adjusted trial balance, closing entries and post-closing trial balance.

Moderate

40-50

11B

Prepare and post adjusting entries; prepare adjusted trial balance and financial statements; assess financial performance.

Moderate

40-50

12B

Prepare and post closing entries; prepare postclosing trial balance.

Simple

25-35

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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, due to ordinary activities, an increase in future economic benefits arising from an increase in an asset or a decrease in a liability has occurred. In general, revenue recognition occurs when the sales or performance effort is substantially complete, the amount is determinable (measurable), and collection is reasonably assured. 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 income statement when, due to an ordinary activity, there is a decrease in future economic benefits related to a decrease in an asset or an increase in a liability and this change can be measured reliably.

The law firm should recognize the revenue in April because that is when it was earned; the work was performed during that month.

Expenses of $4,500 should be deducted from the revenues in April because that is when the expenses were incurred and the revenues earned.

Under the cash basis of accounting, events are only recognized in the period that cash is paid or received. Under the accrual basis, revenue is recognized when the goods or services are delivered or performed and expenses are recognized when incurred. Information presented on an accrual basis is more useful because it records events when they actually occurred and the timing of their recognition cannot be manipulated by delaying or speeding up the time at which the related cash flow occurs. Because of this, accrual basis information is better at predicting future performance.

(a) Prepaid expenses are assets because they have a future benefit since they were paid for before they are used or consumed. (b) 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.

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Answers to Questions (Continued) 6.

(a) 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. (b) Unearned revenues must be adjusted at the end of an accounting period to reflect any revenues that have been earned.

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 fair value.

(a) 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 to the statement of financial position date. (b) Cost is the original cost of the asset when purchased. The carrying amount (also known as net book value) 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.

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 discloses both the original cost of the asset and the total estimated cost which has expired or been used up to date. This information is useful to the financial statement user.

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 is always affected whether a simple adjusting entry or a compound adjusting entry is made.

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Answers to Questions (Continued) 11.

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, respectively. 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.

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. On the other hand, in the case of an accrual, there is no cash payment to look up in the accounts. Consequently no original entry can be examined in the process of preparing an adjusting entry related to an accrual.

13.

Before the recording of adjusting entries to accrued revenues in the amount of $780 and accrued expenses in the amount of $510, the profit would be understated by the net of the amount of unrecorded revenue of $780, less unrecorded expense of $510 or $270.

14.

Reactor should recognize the expense in the period that it was incurred—December— and set up the corresponding liability to the utility company. On December 31, Utility Expense should be debited and an accrued liability account such as Accounts Payable should be credited.

15.

Financial statements are 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.

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Answers to Questions (Continued) 16.

Adjusting entries are only recorded at the end of the accounting period, prior to the preparation of the financial statements. Transaction entries are made throughout the accounting period when transactions arise. 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). Closing entries are required to reset the revenue and expense (income statement) and dividend accounts to zero and to update the balance in Retained Earnings to the closing balance per the statement of changes in equity. Unlike adjusting entries, which are prepared before the financial statements and could be prepared more than once per year, closing entries are only prepared and posted after the year-end financial statements have been completed.

17.

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 postclosing 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) 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 post-closing trial balance is prepared only at the end of the year.

18.

The retained earnings balance on the unadjusted and adjusted trial balances are often 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 profit or loss and dividends. Consequently, the retained earnings balance on the post-closing trial balance will be different from the balance shown on the adjusted trial balance.

19.

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. 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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 20.

The Dividends account is not closed 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 represent a distribution of retained earnings and are reported on the statement of changes in equity. The Dividends account is also a temporary account and therefore requires a closing entry.

21.

(a) (1) (2) (3) (4)

Profit: (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

(b) (1) (2) (3) (4)

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

Note that it is only step 3 that differs between the two situations. 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 company’s year-end include: 8) Journalizing and posting closing entries 9) Preparing a post-closing trial balance

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Financial Accounting, Sixth 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

Profit $ 0 –75 +1,000 0 0 –1,000 0 –50 0 +200 –250

BRIEF EXERCISE 4-2 (a) Accrual Basis

(b) Cash Basis

$200

2. Collected $500 cash from customers for services provided in September.

500

3. Billed customers $600 for services provided in September.

600

4. Provided $100 services to customers who paid in advance in August.

100

0 $1,200

100 $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

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-3 (a) May 1

Supplies ......................................................................... Accounts Payable ..................................................

4,800 4,800

(b) Supplies Used = $1,500 + $4,800 – $2,300 = $4,000

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

4,000 4,000

(d)

Open. bal May 1 Dec. 31 Bal.

Solutions Manual .

Supplies 1,500 4,800 Dec. 31 Adj. 2,300

Dec. 31 Adj.

Supplies Expense 4,000

4,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-4 (a) (b)

Jan. 2

Vehicles ....................................................................... Cash .......................................................................

50,000 50,000

The journal entry for the years 2015 and 2016 will be the same: Dec. 31

Depreciation Expense ................................................. Accumulated Depreciation—Vehicles .................... ($50,000 ÷ 5 = $10,000 per year)

10,000 10,000

Property, plant, and equipment Vehicles Less: Accumulated depreciation Carrying amount

Solutions Manual .

4-11

2016

2015

$50,000 20,000 $30,000

$50,000 10,000 $40,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-5 (a) (1) Bere Ltd. June

Prepaid Insurance ........................................................... Cash ......................................................................

6,000 6,000

(2) Marla Insurance Corp. June

(b)

Cash ............................................................................... Unearned Revenue ................................................

6,000 6,000

Expired in 2015 = $6,000 × 7/12 = $3,500 Unexpired at December 31, 2015 = $6,000 × 5/12 = $2,500

Insurance Expense ......................................................... Prepaid Insurance ..................................................

3,500 3,500

(2) Marla Insurance Corp. Dec. 31

Unearned Revenue ......................................................... Insurance Revenue ................................................

3,500 3,500

(d) Bere Ltd. Prepaid Insurance June 1 6,000 Dec. 31 Adj. 3,500 Dec. 31 Bal. 2,500

Insurance Expense Dec. 31 Adj. 3,500

Marla Insurance Corp. Unearned Revenue June 1 Dec. 31 Adj. 3,500 Dec. 31 Bal.

Solutions Manual .

Insurance Revenue Dec. 31 Adj.

6,000

3,500

2,500

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-6 (a)

(b)

(c)

Nov. 28

Nov. 30

Dec. 5

Salaries Expense ................................................... Cash .............................................................

5,000

Salaries Expense ................................................... Salaries Payable ........................................... (Accrual for 3 days of salary Nov. 28 to Nov. 30)

3,000

Salaries Expense ................................................... Salaries Payable .................................................... Cash ............................................................. (The expense pertains to salary for Dec.1 to 2)

2,000 3,000

5,000

3,000

5,000

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

BRIEF EXERCISE 4-8 (a)

(b)

(c)

2015 July

Dec. 31

2016 Jan.

Solutions Manual .

Vehicles ................................................................. Bank Loan Payable ....................................... Cash .............................................................

40,000

Interest Expense ($30,000 × 6% × 6/12) ............... Interest Payable ............................................

900

Bank Loan Payable ................................................ Interest Payable ..................................................... Cash ..............................................................

30,000 900

4-13

30,000 10,000

900

30,900

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-9 (a)

$400 = $2,600 – $2,200

(b)

$3,500 = $400 (2013 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 (2014 payable balance) + $700 (2015 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.

BRIEF EXERCISE 4-10 OROMOCTO CORPORATION Adjusted Trial Balance February 28, 2015

Cash .................................................................................. Accounts receivable ........................................................... Supplies ............................................................................ Prepaid insurance .............................................................. Equipment .......................................................................... Accumulated depreciation—equipment ............................. Accounts payable............................................................... Salaries payable ................................................................ Income tax payable ............................................................ Common shares................................................................. Retained earnings .............................................................. Dividends ........................................................................... Fees earned ....................................................................... Salaries expense ............................................................... Rent expense ..................................................................... Depreciation expense ........................................................ Supplies expense............................................................... Insurance expense............................................................. Utilities expense ................................................................. Income tax expense .......................................................... Totals.................................................................................

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Debit $ 8,000 28,000 1,000 2,500 23,450

Credit

$ 5,400 13,000 3,000 50 20,000 21,000 2,000 39,500 16,400 common shares 6,000 4,400 4,000 3,500 2,400 0 300 0000 000 $101,950 $101,950

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-11 (a) OROMOCTO CORPORATION Income Statement Year Ended February 28, 2015

Revenues Fees earned ......................................................................... Expenses Salaries expense .................................................................. Rent expense ....................................................................... Depreciation expense .......................................................... Supplies expense ................................................................. Insurance expense ............................................................... Utilities expense ................................................................... Total expenses ............................................................ Profit before income tax ................................................................ Income tax expense ...................................................................... Profit .............................................................................................

$39,500

$16,400 6,000 4,400 4,000 3,500 2,400 36,700 2,800 300 $ 2,500

(b) OROMOCTO CORPORATION Statement of Changes in Equity Year Ended February 28, 2015

Common Shares

Retained Earnings

Total Equity

$15,000 Balance, March 1, 2014 ................................................................. Issued common shares .................................................................. 5,000 Profit .............................................................................................. Dividends ....................................................................................... 000000 $20,000 Balance, February 28, 2015 ...........................................................

$21,000

$36,000 5,000 2,500 (2,000) $41,500

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4-15

2,500 (2,000) $21,500

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-11 (Continued) (c) OROMOCTO CORPORATION Statement of Financial Position February 28, 2015

Assets Current Assets Cash ..................................................................................... Accounts receivable ............................................................. Supplies................................................................................ Prepaid insurance ................................................................ Total current assets ..................................................... Property, plant, and equipment Equipment ............................................................................ Less: Accumulated depreciation—equipment ..................... Total assets ...................................................................................

$ 8,000 28,000 1,000 2,500 39,500 $23,450 5,400

18,050 $57,550

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$13,000 3,000 50 16,050

41,500 $57,550

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-12 2015 Feb. 28 Fees Earned .................................................. Income Summary ....................................

39,500 39,500

28 Income Summary .......................................... Salaries Expense .................................... Rent Expense ......................................... Depreciation Expense ............................. Supplies Expense ................................... Insurance Expense ................................. Utilities Expense ..................................... Income Tax Expense ..............................

37,000

28 Income Summary .......................................... Retained Earnings ..................................

2,500

28 Retained Earnings ......................................... Dividends ................................................

2,000

Solutions Manual .

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16,400 6,000 4,400 4,000 3,500 2,400 300

2,500

2,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-13 (a)

Service revenue............................................. Expenses Salaries expense .................................... $90,000 Repairs and maintenance expense......... 15,000 Income tax expense ................................ 4,200 Profit ..............................................................

$126,000

109,200 $ 16,800

(b) Nov. 30 Service Revenue ........................................... 126,000 Income Summary ....................................

126,000

30 Income Summary .......................................... 109,200 Salaries Expense .................................... Repairs and Maintenance Expense ........ Income Tax Expense ..............................

90,000 15,000 4,200

30 Income Summary .......................................... Retained Earnings ..................................

16,800 16,800

30 Retained Earnings ......................................... Dividends ................................................

5,000

Solutions Manual .

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5,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 4-13 (Continued) (c) CE means closing entry. Service Revenue Nov 30 Bal. 126,000 Nov 30 CE1 126,000 Nov 30 Bal. 0

Nov 30 Bal

Dividends 5,000 Nov 30 CE4 Nov 30 Bal.

5,000 0

Salaries Expense Nov 30 Bal. 90,000 Nov 30 CE2 90,000 Nov 30 Bal. 0

Income Summary Nov 30 CE2 109,200 Nov 30 CE1 126,000 Nov 30 CE3 16,800 Nov 30 Bal. 0

Repairs and Maintenance Expense Nov 30 Bal. 15,000 Nov 30 CE2 15,000 Nov 30 Bal. 0

Retained Earnings Nov 1 50,000 Nov 30 CE4 5,000 Nov 30 CE3 16,800 Nov 30 Bal. 61,800

Income Tax Expense Nov 30 Bal. 4,200 Nov 30 CE2 Nov 30 Bal. 0

4,200

BRIEF EXERCISE 4-14 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Yes No Yes No No Yes No Yes Yes No

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 4-1 (a)

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.

(b)

Revenue should be recognized as each magazine is delivered.

(c)

Revenue should be recognized on a per game basis over the season from April to October, since that is when the products (games) are provided to the fans.

(d)

Interest revenue should be accrued and recognized by RBC Financial Group evenly over the term of the loan.

(e)

Revenue should be recognized when the sweater is shipped to the customer in September, provided there is reasonable assurance of collectability.

EXERCISE 4-2

Service revenue Expenses Operating expenses Insurance expense

Profit before income tax Income tax expense Profit

(c)

(a) Accrual Basis $52,000

(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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-3 (a)

2015 June

Aug.

Sept.

Nov.

Dec.

(b)

2015 Dec.

Solutions Manual .

Prepaid Insurance .......................................................... Cash .....................................................................

1,800

Prepaid Rent .................................................................. Cash .....................................................................

6,500

Cash ............................................................................. Unearned Revenue ..............................................

3,600

Prepaid Cleaning ........................................................... 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 Cleaning ..................................................

1,000

Unearned Revenue ........................................................ Sponsorship Revenue .......................................... ($1,500 – $475 not played = $1,025 played)

1,025

4-21

1,800

6,500

3,600

2,000

1,500

1,050

5,200

1,600

1,000

1,025

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-3 (Continued) (c)

June 1

Dec. 31 Bal.

Prepaid Insurance 1,800 Dec. 31 Adj.

Insurance Expense 1,050

Dec. 31 Adj.

750 Prepaid Rent

Aug. 31

Rent Expense

6,500

Dec. 31 Adj. Dec. 31 Adj.

Dec. 31 Bal.

5,200

1,300 Unearned Revenue

Dec. 31 Adj. Dec. 31 Adj.

1,050

1,600 Sept. 4 1,025 Dec. 5 Dec. 31 Bal.

Sponsorship Revenue 3,600 1,500

Dec. 31 Adj. Dec. 31 Adj.

1,600 1,025

2,475

Dec. 31 Bal.

2,625

Prepaid Cleaning Nov . 30

2,000 Dec. 31 Adj.

Dec. 31 Bal.

1,000

Repairs and Maintenance Expense 1,000

Dec. 31 Adj.

1,000

Note: The Cash account has not been included in this solution, as per the instructions.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-4 (a)

2015 Dec. 31

Depreciation Expense .................................................... Accumulated Depreciation—Vehicles ...................... ($28,000 ÷ 7 = $4,000 per year)

4,000 4,000

Depreciation Expense .................................................... Accumulated Depreciation—Equipment .................. ($12,000 ÷ 3 = $4,000 per year)

4,000 4,000

Depreciation Expense .................................................... Accumulated Depreciation—Furniture ..................... ($10,000 ÷ 5 = $2,000 per year)

2,000 2,000

(b) Vehicles Cost Accumulated depreciation Carrying amount

Solutions Manual .

Equipment

$28,000 $28,000  7×4

16,000

Furniture

$12,000 $12,000  3 × 2½

$12,000

10,000 $ 2,000

4-23

$10,000 $10,000  5×1

2,000 $ 8,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-5 (a)

2015 Dec.

(b)

2016 Jan.

Solutions Manual .

Utilities Expense ......................................................... Accounts Payable ..............................................

425

Salaries Expense ........................................................ Salaries Payable ................................................ ($3,500 × 4/7 days = $2,000)

2,000

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 ..................................................................

2,000 1,500

Interest Payable .......................................................... Cash ..................................................................

188

Cash. .......................................................................... Accounts Receivable.........................................

300

Cash. .......................................................................... Accounts Receivable.........................................

6,000

4-24

425

2,000

188

300

6,000

425

3,500

188

300

6,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-6 (a)

July

(b)

July

Solutions Manual .

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 ÷ 10 x 1/12)

125

Interest Expense ....................................................... Interest Payable ............................................... . ($1,000 × 5% × 1/12 months)

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

2,500

Unearned Revenue ................................................... Service Revenue .............................................. .

2,000

4-25

1,500

200

3,275

1,000

1,500

800

750

900

125

2,500

2,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-7 1.

Mar. 031

Solutions Manual .

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

4-26

1,350

6,400

100

1,950

3,600

3,200

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-8 (a)

December entry: Cash 1,600 Unearned Revenue 1,600 January entry:

Unearned Revenue Service Revenue

Adj.

1,600 1,600

Unearned Revenue Jan. 1 Bal. 1,600 Jan. 31 Bal.

2,350 750

The balance in Unearned Revenue on January 1, 2015 was $2,350 ($750 + $1,600).

(b)

Journal entry to record depreciation: Depreciation Expense Accumulated Depreciation 1 month = $60; Annual depreciation = $720 ($60 × 12) Number of months depreciated = accumulated depreciation ($3,660)  monthly depreciation ($60) = 61 months or 5 years, 1 month Therefore the equipment is 5 years, 1 month old. It would have been purchased on January 1, 2010.

(c)

Journal entry to adjust insurance: Insurance Expense Prepaid Insurance Since the prepaid insurance is $1,600, we can assume that 4 months ($1,600 ÷ $400 = 4) of the policy remain. Consequently, if it expires at $400 per month, then the policy is $3,200 ÷ $400 = 8 months old and it was purchased on June 1, 2014. Prepaid Insurance June 1, 2014 4,800 June 30 to Dec. 31 Adj. Dec. 31, 2014 Bal. 2,000 Jan. 31 Adj. Jan. 31, 2015 Bal. 1,600

2,800 400

The original insurance policy premium was $4,800 ($400 × 12). The monthly adjustments made June 30 through December 31 totalled $2,800 ($400 × 7).

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-8 (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

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.

Income Tax Payable Jan. 1 Bal. Payment 100 Adj. Jan. 31 Bal.

100 100

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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-9 FRASER VALLEY SERVICES LTD. Adjusted Trial Balance August 31, 2015 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 September 1, 2018 ............................................ Common shares ....................................................................................... Retained earnings .................................................................................... Dividends .................................................................................................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 Total $105,530

Solutions Manual .

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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

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-10 (a) FRASER VALLEY SERVICES LTD Income Statement Year Ended August 31, 2015

Revenues Service revenue.................................................................... Expenses Salaries expense .................................................................. Rent expense ....................................................................... Depreciation expense ........................................................... Supplies expense ................................................................. Interest expense ................................................................... Insurance expense ............................................................... Total expenses ............................................................ Profit before income tax................................................................. Income tax expense ...................................................................... Profit .............................................................................................

$54,275

$19,200 15,000 2,275 1,750 1,500 1,100 40,825 13,450 2,000 $11,450

(b) FRASER VALLEY SERVICES LTD. Statement of Changes in Equity Year Ended August 31, 2015

Balance, September 1, 2014 ........................ Issued common shares ................................. Profit ............................................................. Dividends ...................................................... Balance, August 31, 2015 .............................

Solutions Manual .

4-30

Common Shares $4,000 1,000 00000 $5,000

Retained Earnings $ 5,400 11,450 (600) $16,250

Total Equity $ 9,400 1,000 11,450 (600) $21,250

Chapter 4

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-10 (Continued) (c) FRASER VALLEY SERVICES LTD. Statement of Financial Position August 31, 2015

Assets Current assets Cash ..................................................................................... Accounts receivable ............................................................. Supplies................................................................................ Prepaid insurance................................................................. Total current assets ..................................................... Property, plant, and equipment Equipment ............................................................................ Less: Accumulated depreciation—equipment ..................... Total assets ...................................................................................

$11,430 18,225 3,400 3,450 36,505 $25,600 5,905

19,695 $56,200

$ 2,800 2,200 1,500 1,250 1,500 700 9,950

Non-current liabilities Bank loan payable ....................................................................................... 25,000 Total liabilities ..................................................................................... 34,950 Shareholders’ equity Common shares .......................................................................................... 5,000 Retained earnings ....................................................................................... 16,250 Total shareholders’ equity .................................................................. 21,250 Total liabilities and shareholders’ equity ............................................................... $56,200

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Chapter 4

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Financial Accounting, Sixth Canadian Edition

EXERCISE 4-11 (a) 2015 Aug. 31

031

Service Revenue ............................................................ Income Summary...................................................

54,275

Income Summary ........................................................... Salaries Expense ................................................... Rent Expense ........................................................ Depreciation Expense............................................ Supplies Expense .................................................. Interest Expense .................................................... Insurance Expense ................................................ Income Tax Expense .............................................

42,825

Income Summary ........................................................... Retained Earnings .................................................

11,450

Retained Earnings .......................................................... Dividends ...............................................................

600

54,275

19,200 15,000 2,275 1,750 1,500 1,100 2,000

11,450

600

(b) FRASER VALLEY SERVICES LTD. Post-Closing Trial Balance August 31, 2015

Debit 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 ............................................................................

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4-32

Credit

$11,430 18,225 3,400 3,450 25,600 $ 5,905 2,800 2,200 1,500 1,250 1,500 700 common 25,000 shares 5,000 00000 0 16,250 $62,105 $62,105

Chapter 4

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 4-1A Students may find this to be a fairly challenging problem, so here are a few points that should help: • • • •

Under the CASH BASIS, revenues are recorded when they are collected (received in cash), even if they were earned (the sale was made) earlier or later; Under the ACCRUAL BASIS of accounting, revenues are recorded when they are earned (the sale is made) even if the cash is not collected until later, or is received prior to the revenue being earned. Under the CASH BASIS, expenses are recorded when the cash is paid out; and Under the ACCRUAL BASIS of accounting, expenses are recorded when they are incurred which is when their cost has “expired”, “used up” (lost its future benefit), which is not always in the same time period as when the cash is paid out.

For example, • Under the CASH BASIS, insurance is recorded as an expense as soon as it is paid for even if a portion relates to future periods; • Under the ACCRUAL BASIS of accounting, insurance expense is not recorded until the coverage has expired through the passage of time. While the prepaid insurance has not expired, it is recorded as an asset because it still has a future benefit. (a) Cash basis profit $187,800 109,400 $ 78,400

Solutions Manual .

Cash collected from customers Cash paid for operating costs Cash basis profit

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Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-1A (Continued) (b) Accrual basis profit $78,400 –3,000 +8,400 –24,600 –15,800 +3,000 –2,800 00 0000 $43,600

(a) Cash basis profit Accounts payable owing at the end of the year should be accrued; the related expense was incurred in year and thus, reduces profit. Accounts receivable arise from sales that have been made during the year, and thus, revenue must be recognized and recorded in the year. Depreciation expense is a non-cash expense which reduces profit for the year. Income tax owing at the end of the year should be accrued; the expense related to the current year. Prepaid insurance at the end of the year is an asset rather than an expense. Amount has been deducted from cash and must be added back for accrual basis profit. Unearned revenue that was received in cash during the current year has not been earned and thus, must reduce the cash basis profit. Accrual basis profit

Notice how the difference between a cash basis and an accrual basis revenue or expense is always the change in the related balance sheet account. For example, if accounts receivable goes up during the year, that change is the difference between cash and accrual revenue. An alternate calculation: Cash collected = Less: Increase in unearned revenue Add: Increase in accounts receivable Total revenue – accrual method

$187,800 (2,800) 8,400 $193,400

Cash paid = Add: Increase in accumulated depreciation Increase in income tax payable Increase in accounts payable Deduct: Increase in prepaid insurance Total expenses – accrual method

$109,400 24,600 15,800 3,000 (3,000) $149,800

Therefore, on an accrual basis the profit is: Revenues Less: Expenses Profit Solutions Manual .

$193,400 149,800 $ 43,600 4-34

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-1A (Continued) (c)

I recommend that Southlake use the accrual basis of accounting. The cash basis does not correctly show when the revenue was earned or when the expenses were incurred and therefore does not measure performance effectively. Because of this, the accrual basis is a better indicator of future performance. The cash basis of accounting is not in accordance with generally accepted accounting principles for these reasons.

Solutions Manual .

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Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-2A 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.

1 Prepaid Insurance ....................................................... Cash ......................................................................

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.

4,100

3,400

5,000 40,000

6,750

3,600

1,500

1,600

800

1 Prepaid Rent ............................................................... Cash ......................................................................

2,400

Dec. 31 Rent Expense .............................................................. Prepaid Rent..........................................................

1,200

Solutions Manual .

4-36

2,400

1,200

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-3A 1. (a)

(b)

2. (a)

(b)

3. (a)

(b)

4. (a)

(b)

5. (a)

(b)

Mar. 31 Interest Expense ......................................................... Interest Payable ..................................................... ($12,000 × 8% × 1/12 months)

Apr. 1 Interest Payable .......................................................... Cash .......................................................................

Mar. 31 Interest Receivable...................................................... Interest Revenue ....................................................

250

Apr. 1 Cash ............................................................................ Interest Receivable .................................................

250

Mar. 31 Salaries Expense ........................................................ Salaries Payable (5 × $200 × 2 days) .....................

2,000

Apr. 3 Salaries Payable ......................................................... Salaries Expense ....................................................... Cash .......................................................................

2,000 3,000

Mar. 31 Utilities Expense .......................................................... Office Expense ............................................................ Accounts Payable ..................................................

550 200

Apr. 10 Accounts Payable ....................................................... Cash .......................................................................

750

Mar. 31 Accounts Receivable ................................................... Service Revenue.....................................................

3,000

250

2,000

5,000

750

3,000

Apr. 4 No entry required Apr. 30 Cash ............................................................................ Accounts Receivable ..............................................

Solutions Manual .

4-37

2,000 2,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-4A 1. (a) June 1, 2014

(b) Nov. 30, 2015

2. (a) Oct. 1, 2015

(b) Nov. 30, 2015

3. (a) Feb. 17, 2015

(b) Nov. 30, 2015

4. (a) June 1, 2015

(b) Nov. 30, 2015

5. (a) Nov. 2, 2015

(b) Nov. 30, 2015

Solutions Manual .

Vehicles .............................................................. Cash...........................................................

80,000

Depreciation Expense ........................................ Accumulated Depreciation—Vehicles ........ ($80,000 ÷ 5 years × 6/12)

8,000

80,000

8,000

Cash (400 × $320).............................................. 128,000 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

32,000

2,100

2,600

Cash ................................................................... 100,000 Bank Loan Payable .................................... 100,000 Interest Expense................................................. Interest Payable ......................................... ($100,000 × 6% × 1/12 months)

500

Interest Payable ................................................. Cash...........................................................

500

Cash ................................................................... Rent Revenue ............................................

200

Accounts Receivable .......................................... Rent Revenue ............................................

200

Cash ................................................................... Accounts Receivable ................................. Rent Revenue ............................................

600

4-38

500

200

200 400

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-4A (Continued) 6. (b) Nov. 30, 2015 (c) Dec. 7, 2015

7. (b) Nov. 30, 2015

Solutions Manual .

Salaries Expense................................................ Salaries Payable ($7,000 × 1/7 days) ........

1,000

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

1,000 6,000

Income Tax Expense .......................................... Income Tax Payable ..................................

1,250

Income Tax Payable ........................................... Cash...........................................................

1,250

4-39

1,000

7,000

1,250

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-5A (a) 1. Prepaid Insurance The unadjusted Prepaid Insurance account balance is $11,700 because no adjustment has yet been made for the expiry of any portion of this asset for the fiscal year ending on July 31, 2015. Policy B4564 cost $10,800 and covers a 24-month period so insurance expense relating to this policy is $450 per month ($10,800 ÷ 24). Because this policy was taken out on December 1, 2013, when the company made adjusting entries at the end of the prior fiscal year on July 31, 2014 insurance expense for the period December 1, 2013 to July 31, 2014 which covers 8 months would have been recorded for $450 × 8 = $3,600. This would have reduced the prepaid insurance relating to this policy to $7,200 ($10,800 – $3,600). During this past fiscal year ending July 31, 2015, this balance would have remained unchanged. Policy A2958 cost $4,500 and was purchased during the current fiscal year. When purchased, the Prepaid Insurance account would have been debited for this amount. The total amount of prepaid insurance on the unadjusted trial balance would therefore be $7,200 relating to the first policy plus $4,500 for a total of $11,700. 2. Unearned Revenue Unearned revenue has a balance of $51,000 because all amounts received during the year for subscription contracts were recorded into this account as follows:

Month

Number of Subscriptions Sold

Cost per Subscription

Unearned Revenue

Nov. 1, 2014 Feb. 1, 2015

220 310

$50 50

$11,000 15,500

May 1, 2015

490

24,500

Unearned revenue before adjustment =

Solutions Manual .

4-40

$51,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-5A (Continued) (b) 1.

2015 July 31

Insurance Expense...................................................... Prepaid Insurance .............................................. ($11,700 from (a) above – $4,800 see below)

6,900 6,900

Policy Number

Original Cost (1)

Period of Coverage (2)

(3) Monthly Cost (1) ÷ (2)

Remaining Months of Policy at July 31, 2015 (4)

B4564

$10,800

24 months (Dec. 1, 2013 to Nov. 30, 2015)

$450

4 months

$1,800

A2958

$4,500

18 months (Feb. 1, 2015 to July 31, 2016)

$250

12 months

3,000

Prepaid Insurance (3) × (4)

Prepaid Insurance after adjustment, July 31, 2015 = 2.

July 31

July

Solutions Manual .

$4,800

Depreciation Expense ................................................. Accumulated Depreciation—Buildings ............... ($252,000 ÷ 30 years) = $ 8,400 ($192,000 ÷ 40 years) = 4,800 $13,200

13,200

Unearned Revenue ..................................................... Subscription Revenue ........................................ Nov.1 220 × $50 × 9/12 = $ 8,250 Feb.1 310 × $50 × 6/12 = 7,750 May 1 490 × $50 × 3/12 = 6,125 $22,125

22,125

Salaries Expense ........................................................ Salaries Payable ................................................ 6 × $625 × 5/6 = $3,125 [3 × $750 × 5/6 = 1,875 $5,000

5,000

4-41

13,200

22,125

5,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-6A (a)

Cash Balance, December 31, 2015 = $177,600 cash receipts – $150,440 cash payments = $27,160.

(b) (1) CREATIVE DESIGNS LTD. Income Statement Year Ended December 31, 2015

Revenues Fees earned ($157,600 + $2,400) ................................. Expenses Salaries expense ($59,800 + $3,050) ............................ Rent expense ($20,000 – $2,000) ................................. Supplies expense ($6,800 – $1,260) ............................. Advertising expense ...................................................... Depreciation expense ($35,400 ÷ 6) .............................. Insurance expense ($3,840 × 11/12) ............................ Office expense............................................................... Total expenses ..................................................... Profit before income tax .......................................................... Income tax expense ............................................................... Profit ......................................................................................

$160,000 $62,850 18,000 5,540 6,800 5,900 3,520 1,800 104,410 55,590 13,000 $ 42,590

(2) CREATIVE DESIGNS LTD. Statement of Changes in Equity Year Ended December 31, 2015 Common Shares Balance, January 1 ........................................................................ $ 0 Issued common shares .................................................................. 20,000 Profit .................................................................. Dividends ....................................................................................... 000 000 Balance, December 31 .................................................................. $20,000

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4-42

Retained Earnings $

42,590 (10,000) $ 32,590

Total Equity $ 0 20,000 42,590 (10,000) $52,590

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-6A (Continued) (b) (Continued) (3) CREATIVE DESIGNS LTD. Statement of Financial Position December 31, 2015

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 ........................................................................ Liabilities and Shareholders’ Equity Current liabilities Salaries payable .......................................................... Income tax payable ($13,000 – $6,000) ........................ Total current liabilities ........................................... Shareholders’ equity Common shares ............................................................ Retained earnings ......................................................... Total shareholders’ equity ..................................... Total liabilities and shareholders’ equity .................................

Solutions Manual .

4-43

$27,160 2,400 1,260 2,000 320 33,140 $35,400 5,900

29,500 $62,640

$ 3,050 7,000 10,050 $20,000 32,590 52,590 $62,640

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-7A (a) and (b)

Nov. 30 Bal.

Cash 1,800

Boats Nov. 30 Bal. 140,400

Accounts Receivable Nov. 30 Bal. 2,640 Nov. 30 Adj. 1,250 Nov. 30 Bal. 3,890

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

Accumulated Depreciation—Boats Nov. 30 Bal. 46,800 Nov. 30 Adj. 11,700 Nov. 30 Bal. 58,500

Accounts Payable Nov. 30 Bal. Nov. 30 Adj. Nov. 30 Bal.

665

Bank Loan Payable Nov. 30 Bal. 54,000

1,200

Interest Payable Nov. 30 Adj.

315

Salaries Payable Nov. 30 Adj.

500

Income Tax Payable Nov. 30 Adj.

300

4,880

Equipment Nov. 30 Bal. 13,440 Accumulated Depreciation – Equipment Nov. 30 Bal. 3,360 Nov. 30 Adj. 1,680 Nov. 30 Bal. 5,040

Solutions Manual .

1,925 260 2,185

Unearned Revenue Nov. 30 Bal. 14,000 Nov. 30 Adj. 14,000 Nov. 30 Bal. 0

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-7A (Continued) (a) and (b) (Continued) Common Shares Nov. 30 Bal. 10,000

Interest Expense Nov. 30 Bal 3,465 Nov. 30 Adj. 315 Nov. 30 Bal 3,780

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. 110,575 Nov. 30 Adj. 14,000 Nov. 30 Adj. 1,250 Nov. 30 Bal. 125,825

Depreciation Expense Nov. 30 Adj. 13,380

Salaries Expense Nov. 30 Bal. 69,560 Nov. 30 Adj. 500 Nov. 30 Bal. 70,060

Supplies Expense Nov. 30 Adj. 665

Repairs and Maintenance Expense Nov. 30 Bal. 11,170

Insurance Expense Nov. 30 Adj. 4,880

Rent Expense Nov. 30 Bal 13,200 Nov. 30 Adj. 1,200 Nov. 30 Bal 14,400

Income Tax Expense Nov. 30 Bal 700 Nov. 30 Adj. 300 Nov. 30 Bal. 1,000

Solutions Manual .

4-45

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-7A (Continued) (b)

2015 Nov. 30

10.

Solutions Manual .

Insurance Expense ................................................. Prepaid Insurance ($7,320 ÷ 12 × 8) ..............................................

4,880

Depreciation Expense ............................................. Accumulated Depreciation—Equipment ($13,440 ÷ 8 yrs). ......................................... Accumulated Depreciation—Boats ($140,400 ÷ 12 yrs) ......................................

13,380

Supplies Expense ($965 – $300). ........................... Supplies. ........................................................

665

Interest Expense ($54,000 × 7% × 1/12 months) ................................ Interest Payable .............................................

315

4,880

1,680 11,700

665

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

4-46

14,000

500

1,250

260

1,200

300

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-7A (Continued) (c) RIVER TOURS LIMITED Adjusted Trial Balance November 30, 2015

Debit Cash ........................................................................................ $ 1,800 Accounts receivable ................................................................. 3,890 Supplies ................................................................................... 300 Prepaid rent ............................................................................. 1,200 Prepaid insurance .................................................................... 2,440 Equipment................................................................................13,440 Accumulated depreciation—equipment ................................... Boats ....................................................................................... 140,400 Accumulated depreciation—boats ........................................... Accounts payable .................................................................... Salaries payable ...................................................................... Interest payable ....................................................................... Income tax payable .................................................................. Bank loan payable ................................................................... Common shares ...................................................................... Retained earnings.................................................................... Fees earned............................................................................. Salaries expense .....................................................................70,060 Depreciation expense ..............................................................13,380 Insurance expense .................................................................. 4,880 Supplies expense .................................................................... 665 Repairs and maintenance expense .........................................11,170 Rent expense...........................................................................14,400 Interest expense ...................................................................... 3,780 Advertising expense ................................................................ 1,085 Income tax expense ................................................................. 1,000 Totals ................................................................................ $283,890

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4-47

Credit

$ 5,040 58,500 2,185 500 315 300 54,000 10,000 27,225 125,825

$283,890

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8A (a), (b), and (d) Cash Nov. 1 Bal. 15,580 Nov. 12 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.

Supplies 4,000 600 4,600 Nov. 30 Adj. 1,000

Nov. 21 2,200 4,600 600 2,400 500 Nov. 9

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

12,400 Income Tax Payable Nov. 30 Adj. Nov. 30 Bal.

Unearned Revenue Nov. 1 Bal. Nov. 30 Nov. 30 Bal. Nov. 30 Adj. 800 Nov. 30 Bal.

3,600

Equipment Nov. 1 Bal. 18,000 Nov. 30 Bal. 18,000

1,100 1,100

1,000 1,100 2,100 1,300

Common Shares Nov. 1 Bal. 10,000 Nov. 12 5,000 Nov. 30 Bal. 15,000

Accumulated Depreciation— Equipment Nov. 1 Bal. 3,600 Nov. 30 Adj. 300 Nov. 30 Bal. 3,900

Solutions Manual .

Accounts Payable Nov. 1 Bal. 4,600 Nov. 20 Nov. 30 Bal.

Retained Earnings Nov. 1 Bal. 33,200 Nov. 30 Bal. 33,200

4-48

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Financial Accounting, Sixth Canadian Edition

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

PROBLEM 4-8A (Continued) (a), (b) and (d) (Continued)

Nov. 28 Nov. 30 Bal.

Dividends 500 500

Supplies Expense Nov. 30 Adj. 3,600 Nov. 30 Bal. 3,600

Service Revenue Nov. 19 11,400 Nov. 27 3,800 Nov. 30 Bal. 15,200 Nov. 30 Adj. 800 Nov. 30 Bal. 16,000

Depreciation Expense Nov. 30 Adj. 300 Nov. 30 Bal. 300

Rent Expense Nov. 23 600 Nov. 30 Bal. 600

Income Tax Expense Nov. 30 Adj. 1,100 Nov. 30 Bal. 1,100

Solutions Manual .

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Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8A (Continued) (b) 2015 Nov. 9

Solutions Manual .

General Journal 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 ..................................................................... Cash ...................................................................

500

Cash ............................................................................ Unearned Revenue .............................................

1,100

4-50

2,200

5,000

12,400

11,400

600

4,600

600

2,400

3,800

500

1,100

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8A (Continued) (c) and (e) ALOU EQUIPMENT REPAIR CORP. Trial Balance November 30, 2015

Before Adjustment Dr. Cr. Cash ..................................................... Accounts receivable ............................. Supplies ................................................ Equipment ............................................ Accumulated depreciation —equipment ......................................... Accounts payable ................................. Salaries payable ................................... Income tax payable .............................. Unearned revenue ................................ Common shares ................................... Retained earnings ................................ Dividends .............................................. Service revenue .................................... Salaries expense .................................. Rent expense ....................................... Supplies expense ................................. Income tax expense ............................. Depreciation expense ........................... Totals ................................................

Solutions Manual .

$35,180 7,220 4,600 18,000

After Adjustment Dr. Cr. $35,180 7,220 1,000 18,000

$ 3,600 600 0 0 2,100 15,000 33,200 500

$ 3,900 600 1,000 1,100 1,300 15,000 33,200 500

15,200 3,600 600 0 0 0 $69,700

4-51

0000 00 $69,700

16,000 4,600 600 3,600 1,100 0 00300 $72,100

0,0 0 $72,100

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8A (Continued) (d) 2015 1. Nov. 30

Solutions Manual .

Supplies Expense ......................................................... Supplies ($4,600 – $1,000) ..................................

3,600

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

1,000

Depreciation Expense ................................................... Accumulated Depreciation—Equipment............... ($18,000 ÷ 5 years ÷ 12 months)

300

Unearned Revenue ....................................................... Service Revenue ..................................................

800

Income Tax Expense .................................................... Income Tax Payable ............................................

1,100

4-52

3,600

1,000

300

800

1,100

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8A (Continued) (f) (1) ALOU EQUIPMENT REPAIR CORP. Income Statement Month Ended November 30, 2015

Revenues Service revenue............................................................. Expenses Salaries expense ........................................................... Supplies expense .......................................................... Rent expense ................................................................ Depreciation expense .................................................... Total expenses ..................................................... Profit before income tax .......................................................... Income tax expense ............................................................... Profit ......................................................................................

$16,000 $4,600 3,600 600 300 9,100 6,900 1,100 $ 5,800

(2) ALOU EQUIPMENT REPAIR CORP. Statement of Changes in Equity Month Ended November 30, 2015

Common Shares

Retained Earnings

Balance, November 1 .................................................................... $10,000 $33,200 5,000 Issued common shares .................................................................. Profit .......................................................... ................................... 5,800 Dividends ....................................................................................... 000000 (500) Balance, November 30 .................................................................. $15,000 $38,500

Solutions Manual .

4-53

Total Equity $43,200 5,000 5,800 (500) $53,500

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8A (Continued) (f)

(Continued) (3) ALOU EQUIPMENT REPAIR CORP. Statement of Financial Position November 30, 2015

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 ......................................................

Solutions Manual .

4-54

600 1,000 1,100 1,300 4,000

53,500 $57,500

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-9A (a) 2015 Nov. 30

Solutions Manual .

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 .........................................................

500

4-55

16,000

4,600 3,600 600 300 1,100

5,800

500

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-9A (Continued) (b) CE – Means closing entry Cash Nov. 1 Bal. 15,580 Nov. 12 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.

Supplies 4,000 600 4,600 Nov. 30 Adj. 1,000

2,200 4,600 600 2,400 500

Salaries Payable Nov. 1 Bal. 1,000 Nov. 30 Bal. Nov. 30 Adj. Nov. 30 Bal.

Nov. 9

Income Tax Payable Nov. 30 Adj. Nov. 30 Bal. Unearned Revenue Nov. 1 Bal. Nov. 30 Nov. 30 Bal. Nov. 30 Adj. 800 Nov. 30 Bal.

Solutions Manual .

1,100 1,100

1,000 1,100 2,100 1,300

3,600 Common Shares Nov. 1 Bal. 10,000 Nov. 12 5,000 Nov. 30 Bal. 15,000 Retained Earnings Nov. 1 Bal. 33,200 Nov. 30 CE4 500 Nov. 30 CE3 5,800 Nov. 30 Bal. 38,500

Accumulated Depreciation— Equipment Nov. 1 Bal. 3,600 Nov. 30 Bal. 3,600 Nov. 30 Adj. 300 Nov. 30 Bal. 3,900

Nov. 21

0 1,000 1,000

12,400

Equipment Nov. 1 Bal. 18,000 Nov. 30 Bal. 18,000

Accounts Payable Nov. 1 Bal. 4,600 Nov. 20 Nov. 30 Bal.

1,000

Nov. 28 Nov. 30 Bal. Nov. 30 Bal.

4,600 600 600

4-56

Dividends 500 500 Nov. 30 CE4 0

500

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-9A (CONTINUED) (a), (b) and (d) (Continued)

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

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 Bal. 600 Nov. 30 CE2 Nov. 30 Bal. 0

Income Tax Expense Nov. 30 Adj. 1,100 Nov. 30 Bal. 1,100 Nov. 30 CE2 Nov. 30 Bal. 0

Supplies Expense Nov. 30 Adj. 3,600 Nov. 30 Bal. 3,600 Nov. 30 CE2 Nov. 30 Bal. 0

600

Depreciation Expense Nov. 30 Adj. 300 Nov. 30 Bal. 300 Nov. 30 CE2 Nov. 30 Bal. 0

1,100

4,600

3,600

300

Income Summary Nov. 30 CE2 10,200 Nov. 30 CE1 16,000 Nov. 30 CE3 5,800 Nov. 30 Bal. 0

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-9A (Continued) (c) ALOU EQUIPMENT REPAIR CORP. Post-Closing Trial Balance November 30, 2015

Dr. Cash ..................................................... Accounts receivable ............................. Supplies ............................................... Equipment ............................................ Accumulated depreciation—equipment Accounts payable ................................. Salaries payable ................................... Income tax payable .............................. Unearned revenue................................ Common shares ................................... Retained earnings ................................ Totals ..............................................

Solutions Manual .

4-58

Cr.

$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

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-10A (a) OZAKI CORP. Adjusted Trial Balance September 30, 2015

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 ................................................................................... 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

Solutions Manual .

4-59

Credit

750 4,460 840 105 200 550 7,800 7,000 2,600

22,485

$46,790

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-10A (Continued) (b)

Closing Entries:

2015 Sept. 30

Solutions Manual .

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 ...............................................................

700

4-60

22,485

13,840 1,500 820 750 485 105 600

4,385

700

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-10A (Continued) (c) OZAKI CORP. Post-Closing Trial Balance September 30, 2015

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 ............................................................................

Solutions Manual .

4-61

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

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11A (a) and (b)

May 31 Bal.

Cash 6,400

Accumulated Depreciation—Furniture May 31 Bal. 13,440 May 31 Adj. 560 May 31 Bal. 14,000

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

Accounts Payable May 31 Bal. May 31 Adj. May 31 Bal.

8,140 2,240 10,380

Salaries Payable May 31 Adj. May 31 Bal.

1,590 1,590

Interest Payable May 31 Adj. May 31 Bal.

840 840

Income Tax Payable May 31 Adj. May 31 Bal.

1,000 1,000

Unearned Revenue May 31 Bal. May 31 Adj. 2,500 May 31 Adj. May 31 Bal.

17,500 2,800 17,800

3,540

910

Land May 31 Bal. 106,370

Buildings May 31 Bal. 168,000

Accumulated Depreciation—Buildings May 31 Bal. 16,800 May 31 Adj. 700 May 31 Bal. 17,500

Mortgage Payable May 31 Bal. 126,000

Furniture May 31 Bal. 33,600

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11A (Continued) (a) and (b) (Continued)

May 31 Bal.

May 31 Adj.

Common Shares May 31 Bal.

60,000

Retained Earnings May 31 Bal.

41,580

Interest Expense May 31 Bal. 9,240 May 31Adj. 840 May 31 Bal. 10,080

Insurance Expense May 31 Bal. 6,370 May 31 Adj. 910 May 31 Bal. 7,280

Dividends 2,000

Advertising Expense May 31 Bal. 1,000

Rent Revenue May 31 Bal. 200,320 2,800 May 31 Adj. 2,500 May 31 Adj. 1,780 May 31 Bal. 201,800

Supplies Expense May 31 Adj. 3,540

Salaries Expense May 31 Bal. 98,700 May 31 Adj. 1,590 May 31 Bal. 100,290

Depreciation Expense May 31 Adj. 700 May 31 Adj. 560 May 31 Bal. 1,260

Utilities Expense May 31 Bal. 23,870 May 31 Adj. 2,240 May 31 Bal. 26,110

Solutions Manual .

Income Tax Expense May 31 Bal. 7,000 May 31 Adj. 1,000 May 31 Bal. 8,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11A (Continued) (b) 1.

2015 May 31

10.

11.

Solutions Manual .

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........................................... [($126,000 × 8%) × 1/12 months]

840

Utilities Expense ................................................... Accounts Payable ........................................

2,240

Income Tax Expense ............................................ Income Tax Payable ....................................

1,000

4-64

910

3,540

700

560

2,500

2,800

1,780

1,590

840

2,240

1,000

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11A (Continued) (c) RAINBOW LODGE LTD. Adjusted Trial Balance May 31, 2015

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 .............................................................. Common shares ................................................................ Retained earnings.............................................................. Dividends ........................................................................... 2,000 Rent revenue ..................................................................... Salaries expense ............................................................... 100,290 Utilities expense................................................................. 26,110 Interest expense ................................................................ 10,080 Insurance expense ............................................................ 7,280 Advertising expense .......................................................... 1,000 Supplies expense .............................................................. 3,540 Depreciation expense ........................................................ 1,260 Income tax expense........................................................... 8,000 Totals ............................................................................ $492,490

Solutions Manual .

4-65

Credit

$ 17,500 14,000 10,380 1,590 840 1,000 17,800 126,000 60,000 41,580 201,800

000000 0 $492,490

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11A (Continued) (d) (1) RAINBOW LODGE LTD. Income Statement Year Ended May 31, 2015

Revenues Rent revenue ................................................................. Expenses Salaries expense ........................................................... Utilities expense ............................................................ Interest expense ............................................................ Insurance expense ........................................................ Supplies expense .......................................................... Depreciation expense .................................................... Advertising expense ...................................................... Total expenses ..................................................... Profit before income tax .......................................................... Income tax expense ............................................................... Profit ......................................................................................

$201,800 $100,290 26,110 10,080 7,280 3,540 1,260 1,000 149,560 52,240 8,000 $ 44,240

(2) RAINBOW LODGE LTD. Statement of Changes in Equity Year Ended May 31, 2015

Common Shares Balance, June 1, 2014 ................................................................... $56,000 Issued common shares .................................................................. 4,000 Profit ................................................................. 00 0000 Dividends ....................................................................................... Balance, May 31, 2015 .................................................................. $60,000

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4-66

Retained Earnings

Total Equity

$41,580

$97,580 4,000 44,240 (2,000) $143,820

44,240 (2,000) $83,820

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11A (Continued) (d) (Continued) (3) RAINBOW LODGE LTD. Statement of Financial Position May 31, 2015 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 17,500 $33,600 14,000

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 ................

Solutions Manual .

4-67

150,500 19,600 276,470 $301,430

$10,380 1,590 840 1,000 17,800 $ 31,610 126,000 157,610 $60,000 83,820 143,820 $301,430

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11A (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 appear 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 ÷ $31,610). This seems to indicate initially 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. Of the total current liabilities, 56% ($17,800 ÷ $31,610) is made up of unearned revenue, which will not require the payment of cash. On the other hand, there are current assets that are not going to turn into cash such as supplies and prepaid insurance. Excluding supplies, prepaid insurance and unearned revenue, the revised current ratio is 1.4:1 [($24,960 – $1,340 – $3,640) ÷ ($31,610 – $17,800)]. Profitability According to the income statement, Rainbow Lodge was profitable in 2015 with after tax profit of over $44,000. The lodge also has a positive balance in retained earnings, which indicates it has been profitable in the past. The company also paid out 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. Shareholders’ equity is smaller, but by not a large margin, than total liabilities. Overall, Rainbow Lodge appears to have a healthy financial position. However, a more complete analysis could be performed if your friend had access to prior years’ financial statements or some industry information. We would then be able to perform some comparative analysis to better evaluate Rainbow’s financial health.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-12A (a)

Closing entries:

May

Solutions Manual .

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 .............................................

157,560

Income Summary ........................................................... Retained Earnings .................................................

44,240

Retained Earnings .......................................................... Dividends ...............................................................

2,000

4-69

201,800

100,290 26,110 10,080 7,280 3,540 1,260 1,000 8,000

44,240

2,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-12A (Continued) Accumulated Depreciation—Furniture May 31 Bal. 13,440 May 31 Adj. 560 May 31 Bal. 14,000

(b) CE means closing entry

May 31 Bal.

Cash 6,400

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

Accounts Payable May 31 Bal. May 31 Adj. May 31 Bal.

8,140 2,240 10,380

Salaries Payable May 31 Adj. May 31 Bal.

1,590 1,590

Interest Payable May 31 Adj. May 31 Bal.

840 840

Income Tax Payable May 31 Adj. May 31 Bal.

1,000 1,000

Unearned Revenue May 31 Bal. May 31 Adj. 2,500 May 31 Adj. May 31 Bal.

17,500 2,800 17,800

3,540

May 31 Bal.

910

Land May 31 Bal. 106,370

Buildings May 31 Bal. 168,000

Mortgage Payable May 31 Bal. 126,000

Accumulated Depreciation—Buildings May 31 Bal. 16,800 May 31 Adj. 700 May 31 Bal. 17,500

Common Shares May 31 Bal.

Furniture May 31 Bal. 33,600

Solutions Manual .

60,000

Retained Earnings May 31 Bal. 41,580 May 31 CE4 2,000 May 31 CE3 44,240 May 31 Bal. 83,820

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-12A (Continued) (b) (Continued)

May 31 Bal. May 31 Bal.

Dividends 2,000 May 31CE4 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. May 31 Adj. 2,800 200,320 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 3,540 3,540 May 31 CE2 May 31 Bal. 0

1,000

May 31 Adj. May 31 Bal

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

Depreciation Expense May 31 Adj. 700 May 31 Adj. 560 May 31 Bal. 1,260 May 31 CE2 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

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

Interest Expense May 31 Bal. 9,240 May 31 Adj. 840 May 31 Bal 10,080 May 31 CE2 10,080 May 31 Bal. 0

Solutions Manual .

7,280

3,540

1,260

8,000

Income Summary May 31 CE2 157,560 May31 CE1 201,800 May 31 CE3 44,240 May 31 Bal. 0

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-12A (Continued) (c) RAINBOW LODGE LTD. Post-Closing Trial Balance May 31, 2015

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

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4-72

Credit

$ 17,500 33,600 14,000 10,380 1,590 840 1,000 17,800 126,000 60,000 83,820 $332,930

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-1B Students may find this to be a fairly challenging problem, so here are a few points that should help: • • • •

Under the CASH BASIS, revenues are recorded when they are collected (received in cash), even if they were earned (the sale was made) earlier; Under the ACCRUAL BASIS of accounting, revenues are recorded when they are earned (the sale is made) even if the cash is not collected until later, or is received prior to the revenue being earned. Under the CASH BASIS, expenses are recorded when the cash is paid out; and Under the ACCRUAL BASIS of accounting, expenses are recorded when they are incurred which is when their cost has “expired”, “used up” (lost its future benefit), which is not always in the same time period as when the cash is paid out.

Solutions Manual .

Cash collected from customers Cash paid for operating costs Cash basis profit

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-1B (Continued) (b) Accrual basis profit $24,200 –905 +1,450 –8,625 –4,600 +810

–700 $11,630

(a) Cash basis profit ($78,100 – $53,900) Accounts payable owing at the end of the year should be accrued; the related expense was incurred in the year and thus, reduces profit. Accounts receivable arise from sales that have been made during the year, and thus, revenue must be recognized and recorded in the year. Depreciation expense is a non-cash expense which reduces profit for the year. Income tax owing at the end of the year should be accrued; the expense related to the current year. Prepaid insurance at end of the year is an asset rather than an expense. Amount has been deducted from cash and must be added back for accrual basis profit. Unearned revenue that was received in cash during the current year but has not been earned and thus, must reduce the cash basis profit. Accrual basis profit

Notice how the difference between a cash basis and an accrual basis revenue or expense is always the change in the related balance sheet account. For example, if accounts receivable goes up during the year, that change is the difference between cash and accrual revenue. An alternative calculation: Cash collected = Add: Increase in accounts receivable Deduct: Increase in unearned revenues Total revenue – accrual method

$78,100 1,450 (700) $78,850

Cash paid = Add: Increase in accumulated depreciation Increase in accounts payable Increase in income tax payable Deduct: Increase in prepaid insurance Total expenses – accrual method

$53,900 8,625 905 4,600 (810) $67,220

Therefore, on an accrual basis the profit is: Revenues Less: Expenses Profit

Solutions Manual .

$78,850 67,220 $11,630

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-1B (Continued) (c)

I recommend that Northland use the accrual basis of accounting. The cash basis does not correctly show when the revenue was earned or when the expenses were incurred and therefore does not measure performance effectively. Because of this, the accrual basis is a better indicator of future performance. The cash basis of accounting is not in accordance with generally accepted accounting principles for these reasons.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-2B 1. (a) Jan.

2 Supplies ........................................................................ Cash .......................................................................

2,100

(b) Dec. 31 Supplies Expense ($2,100 – $550) ............................... Supplies ..................................................................

1,550

2. (a) Mar.

2,100

1,550

1 Equipment ..................................................................... Cash .......................................................................

20,000

(b) Dec. 31 Depreciation Expense ................................................... Accumulated Depreciation—Equipment ................. ($20,000 ÷ 5 years × 10/12 months)

3,333

3. (a) June

20,000

3,333

1 Prepaid Insurance ......................................................... Cash .......................................................................

5,040

(b) Dec. 31 Insurance Expense ($5,040 × 7/12 months) ................. Prepaid Insurance ...................................................

2,940

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

5,040

2,940

1,275

850

2,500

(b) Dec. 31 No entry required

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-3B 1. (a) (b)

2. (a)

(b)

3. (a) (b)

Nov. 30 Dec.

Nov. 30

Dec.

Nov. 30 Dec.

Dec. 21

4. (a) (b)

5. (a) (b)

Nov. 30 Dec.

Nov. 30 Dec. 18

Solutions Manual .

Salaries Expense ................................................. Salaries Payable ($6,000 × 6/10 days) ...........

3,600

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

3,600 2,400

Interest Expense .................................................. Interest Payable .............................................. ($20,000 × 7% × 1/12 months)

117

Interest Payable ................................................... Cash ...............................................................

117

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

1,000

3,600

6,000

117

1,000

No entry required Cash ..................................................................... Accounts Receivable ......................................

1,000

Interest Receivable .............................................. Interest Revenue ...........................................

Cash ..................................................................... Interest Receivable .........................................

Income Tax Expense ........................................... Income Tax Payable ......................................

1,000

Income Tax Payable ............................................ Cash ...............................................................

1,000

4-77

1,000

10 10

1,000 1,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-4B 1. (a)

(b)

2. (a)

(b)

3. (a)

(b)

4. (a)

(b)

(c)

5. (b)

(c)

Mar. 1, 2015

Dec. 31, 2015

Jan. 2, 2015

Dec. 31, 2015

Aug. 21, 2015

Dec. 31, 2015

June 1, 2015

Dec. 31, 2015

Jan. 1, 2016

Dec. 31, 2015

Jan. 4, 2016

Solutions Manual .

Supplies ........................................................... Cash .......................................................... Supplies Expense ($1,500 + $5,250 – $1,000) .............................. Supplies.....................................................

5,250 5,250

5,750 5,750

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

4-78

120,000

30,000

216,000

96,000

30,000

150

4,500

9,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-4B (Continued) 6. (b)

(c)

7. (b)

(c)

Dec. 31, 2015

Jan. 6, 2016

Dec. 31, 2015

Jan. 12, 2016

Solutions Manual .

Accounts Receivable........................................ Rent Revenue ...........................................

600

Cash ................................................................. Accounts Receivable ................................. Unearned Rent Revenue ...........................

1,200

Office Expense ................................................. Accounts Payable ......................................

1,125

Accounts Payable ............................................ Cash ..........................................................

1,125

4-79

600

600 600

1,125

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-5B (a) 1. Prepaid Advertising Contract A650 Contract B974

$520 × 12 months = $ 6,240 $495 × 16 months = 7,920 $14,160

The unadjusted Prepaid Advertising account balance is $14,160 because no adjustment has yet been made for the expiry of any portion of this asset for the fiscal year ending on October 31, 2015. Contract A650 covers a 12-month period starting March 1, 2015 for $520 per month and cost $6,240 ($520 × 12). Contract B974 covers a 16-month period starting July 1, 2015 for $495 per month and cost $7,920 ($495 × 16). When purchased, the Prepaid Advertising account would have been debited for these amounts. The total amount of prepaid advertising on the unadjusted trial balance would therefore be $6,240 relating to the first contract plus $7,920 for a total of $14,160.

2. Unearned Revenue Unearned revenue has a balance of $303,000 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, 2015 Oct. 1, 2015

6 6

$4,500 $7,000

5 4

$135,000 168,000

Unearned revenue before adjustment =

Solutions Manual .

4-80

$303,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-5B (Continued) (b) 1.

2015 Oct. 31

)

Oct.

Solutions Manual .

Advertising Expense .............................................. Prepaid Advertising ............................... A650 – $520 × 8 months = $4,160 B974 – $495 × 4 months = 1,980 $6,140

6,140

Unearned Revenue ................................................ Rent Revenue ....................................... 5 × $4,500 × 2 = $45,000) (4 × $7,000 × 1 = 28,000) Total rent earned $73,000

73,000

Interest Expense .................................................... Interest Payable .................................... ($90,000 × 8% × 7/12)

4,200

Depreciation Expense ............................................ Accumulated Depreciation—Vehicles ... ($39,000  5)

7,800

4-81

6,140

73,000

4,200

7,800

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-6B (a)

Cash Balance, April 30, 2015 = $86,500 cash receipts – $70,370 cash payments = $16,130.

(b) (1)

THE RADICAL EDGE LTD. Income Statement Six Months Ended April 30, 2015

Revenues Service revenue ($66,500 + $1,440) ............................. Expenses Salaries expense ($7,200 + $4,240) .............................. Rent expense ($4,550 – $650) ...................................... Depreciation expense ($47,040 ÷ 8 × 6/12)................... Utilities expense ............................................................ Insurance expense ($2,760 × 6/12) ............................... Advertising expense ...................................................... Total expenses ..................................................... Profit before income tax.......................................................... Income tax expense ($6,000 + $800) ..................................... Profit .....................................................................................

$67,940 $11,440 3,900 2,940 1,900 1,380 920 22,480 45,460 6,800 $38,660

(2) THE RADICAL EDGE LTD. Statement of Changes in Equity Six Months Ended April 30, 2015

Common Shares Balance, November 1, 2014 .......................................................... $ 0 Issued common shares .................................................................. 20,000 0000 00 Profit .................................................................... $20,000 Balance, April 30, 2015 ..................................................................

Solutions Manual .

4-82

Retained Earnings

Total Equity

$ 0 20,000 38,660 $58,660

38,660 $38,660

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-6B (Continued) (b) (Continued) (3) THE RADICAL EDGE LTD. Statement of Financial Position April 30, 2015

Assets Current assets Cash ......................................................................... Accounts receivable ................................................ Prepaid insurance ($2,760 – $1,380) ....................... Rent deposit ............................................................. Total current assets ......................................... Property, plant, and equipment Equipment ................................................................ Less: Accumulated depreciation .............................. Total assets.......................................................................

$16,130 1,440 1,380 650 19,600 $47,040 2,940

44,100 $63,700

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 ............................

Solutions Manual .

4-83

$ 4,240 800 5,040 $20,000 38,660 58,660 $63,700

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-7B (a) and (b)

Dec. 31 Bal.

Cash 4,600

Accumulated Depreciation— Furniture Dec. 31 Bal. 4,000 Dec. 31 Adj. 1,600 Dec. 31 Bal. 5,600

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

690 690

Interest Payable Dec. 31 Adj. Dec. 31 Bal.

481 481

Income Tax Payable Dec. 31 Adj. Dec. 31 Bal.

850 850

Unearned Revenue Dec. 31 Bal. Dec. 31 Adj. 1,200 Dec. 31 Bal.

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

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

Dividends Dec. 31 Bal. 3,800

Furniture Dec. 31 Bal. 16,000

Solutions Manual .

Salaries Payable Dec. 31 Adj. Dec. 31 Bal.

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PROBLEM 4-7B (Continued) (a) and (b) (Continued) Service Revenue Dec. 31 Bal.115,600 Dec. 31 Adj. 1,750 Dec. 31 Adj. 1,200 Dec. 31 Bal.118,550

Salaries Expense Dec. 31 Bal. 57,000 Dec. 31 Adj. 690 Dec. 31 Bal. 57,690

Interest Expense 2,415 481 2,896

Dec. 31 Adj. Dec. 31 Bal.

Supplies Expense 1,930 1,930

Depreciation Expense Dec. 31 Adj. 14,500 Dec. 31 Adj. 1,600 Dec. 31 Bal. 16,100

Rent Expense Dec. 31 Bal. 12,650 Dec. 31 Adj. 1,150 Dec. 31 Bal. 13,800

Insurance Expense Dec. 31 Adj. 3,000 Dec. 31 Bal. 3,000

Repairs and Maintenance Expense Dec. 31 Bal. 4,690

Solutions Manual .

Dec. 31 Bal. Dec. 31 Adj. Dec. 31 Bal.

Income Tax Expense Dec. 31 Bal. 2,000 Dec. 31 Adj. 850 Dec. 31 Bal. 2,850

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-7B (Continued) (b) 1.

2015 Dec. 31

10.

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—Automobile ........ ($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 × $230) .................................. Salaries Payable ...........................................

690

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

1,150

Income Tax Expense ............................................ Income Tax Payable ($2,850 – $2,000)

850

4-86

3,000

1,930

14,500

1,600

1,750

481

1,200

690

1,150

850

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-7B (Continued) (c) ORTEGA LIMO SERVICE LTD. Adjusted Trial Balance December 31, 2015 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, 2019 ............................ Common shares....................................................................... Retained earnings .................................................................... Dividends ................................................................................. 3,800 Service revenue ....................................................................... Salaries expense ..................................................................... 57,690 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 .................................................................................$197,646

Solutions Manual .

4-87

Credit

$ 29,000 5,600 690 481 850 2,400 27,475 5,000 7,600 118,550

$197,646

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8B (a), (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

Accumulated Depreciation - Equipment Sept. 1 Bal. 3,000 Sept. 30 Bal. 3,000 Sept. 30 Adj. 250 Sept. 30 Bal. 3,250

2,200 7,000 2,000 2,200 500 600

Sept. 21 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

Accounts Payable Sept. 1 Bal. 7,000 Sept. 17 Sept. 30 Bal.

6,200 2,000 1,200

5,400 Unearned Revenue Sept. 1 Bal. Sept. 27 Sept. 30 Bal. Sept. 30 Adj. 800 Sept. 30 Bal.

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. 4

Prepaid Rent Sept. 24 1,000 Sept. 30 Bal. 1,000

Salaries Payable Sept. 1 Bal. 1,400 Sept.30 Bal. Sept. 30 Adj. Sept. 30 Bal.

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

Equipment Sept. 1 Bal. 30,000 Sept. 30 Bal. 30,000

Retained Earnings Sept. 1 Bal. 17,400 Sept. 30 Bal. 17,400 Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8B (Continued) (a), (b), and (d) (Continued)

Sept. 28 Sept.30 Bal.

Dividends 500 500 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

Depreciation Expense Sept. 30 Adj. 250 Sept. 30 Bal. 250 Supplies Expense Sept. 30 Adj. 2,800 Sept. 30 Bal. 2,800 Salaries Expense Sept. 4 800 Sept. 25 2,200 Sept. 30 Bal. 3,000 Sept. 30 Adj. 1,600 Sept. 30 Bal. 4,600

Rent Expense Sept. 24 1,000 Sept. 30 Bal. 1,000

Income Tax Expense Sept. 28 600 Sept. 30 Bal. 600 Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8B (Continued) (b) 2015 Sept. 4

Solutions Manual .

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 .................................................................... Cash ....................................................................

500

Income Tax Expense .................................................. Cash ....................................................................

600

4-90

8,800

5,000

2,000

7,000

2,000

2,200

1,600

1,300

500

600

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8B (Continued) (c) and (e) RIJO EQUIPMENT REPAIR CORP. Trial Balance September 30, 2015

Before Adjustment Dr. Cr. $15,760 3,640 3,600 1,000 30,000 $ 3,000 1,200 2,100 0 25,000 17,400 500 10,400 3,000 0 1,000 0 600 000 000 $59,100 $59,100

Cash ..................................................... Accounts receivable ............................. Supplies ................................................ Prepaid rent .......................................... Equipment ............................................ Accumulated depreciation—equipment Accounts payable ................................. Unearned revenue ................................ Salaries payable ................................... Common shares ................................... Retained earnings ................................ Dividends .............................................. Service revenue.................................... Salaries expense .................................. Supplies expense ................................. Rent expense ....................................... Depreciation expense ........................... Income tax expense ............................. Totals

Solutions Manual .

4-91

After Adjustment Dr. Cr. $15,760 4,240 800 1,000 30,000 $ 3,250 1,200 1,300 1,600 25,000 17,400 500 11,800 4,600 2,800 1,000 250 600 000 000 $61,550 $61,550

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8B (Continued) (d) 1.

2015 Sept. 30

Supplies Expense ................................................. Supplies ($3,600 – $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

2,800

1,600

600

250

800

(f) (1) RIJO EQUIPMENT REPAIR CORP. Income Statement Month Ended September 30, 2015

Service revenue.......................................................................... Expenses Salaries expense ............................................................... Supplies expense .............................................................. Rent expense .................................................................... Depreciation expense ........................................................ Total expenses ......................................................... Profit before income tax .............................................................. Income tax expense ................................................................... Profit ..........................................................................................

Solutions Manual .

4-92

$11,800 $4,600 2,800 1,000 250 8,650 3,150 600 $ 2,550

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8B (Continued) (f)

(Continued) (2) RIJO EQUIPMENT REPAIR CORP. Statement of Changes in Equity Month Ended September 30, 2015

Common Shares $20,000 Balance, September 1 ................................................................... Issued common shares .................................................................. 5,000 Profit .............................................................................................. Dividends ....................................................................................... 00 0000 $25,000 Balance, September 30 .................................................................

Solutions Manual .

4-93

Retained Earnings $17,400 2,550 (500) $19,450

Total Equity $37,400 5,000 2,550 (500) $44,450

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-8B (Continued) (f)

(Continued) (3) RIJO EQUIPMENT REPAIR CORP. Statement of Financial Position September 30, 2015

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 ......................................................

Solutions Manual .

4-94

$ 1,200 1,600 1,300 4,100

44,450 $48,550

Chapter 4

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-9B (a)

2015 Sept.

Solutions Manual .

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 ...........................................................

500

4-95

11,800

4,600 2,800 1,000 250 600

2,550

500

Chapter 4

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 4-9B (Continued) (a)

CE means closing entry

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

2,200 7,000 2,000 2,200 500 600

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.

6,200 2,000 1,200

800 1,300 2,100 1,300

5,400

Sept. 4

Supplies Sept. 1 Bal. 1,600 Sept. 17 2,000 Sept. 30 Bal. 3,600 Sept. 30 Adj. 2,800 Sept. 30 Bal. 800

Salaries Payable Sept. 1 Bal. 1,400 Sept.30 Bal. Sept. 30 Adj. Sept. 30 Bal.

1,400 0 1,600 1,600

Common Shares Sept. 1 Bal. 20,000 Sept. 12 5,000 Sept. 30 Bal. 25,000

Prepaid Rent Sept. 24 1,000 Sept. 30 Bal. 1,000

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

Equipment Sept. 1 Bal. 30,000 Sept. 30 Bal. 30,000 Accumulated Depreciation - Equipment Sept. 1 Bal. 3,000 Sept. 30 Bal. 3,000 Sept. 30 Adj. 250 Sept. 30 Bal. 3,250

Solutions Manual .

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PROBLEM 4-9B (Continued)

Supplies Expense Sept. 30 Adj. 2,800 Sept. 30 Bal. 2,800 Sept. 30 CE2 2,800 Sept. 30 Bal. 0

(b) (Continued)

Sept. 28 Sept.30 Bal. Sept. 30 Bal.

Dividends 500 500 Sept. 30 CE4 0

Income Tax Expense Sept. 28 600 Sept. 30 Adj. 600 Sept. 30 CE2 Sept. 30 Bal. 0

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 Sept. 30 CE1 11,800 Sept. 30 Bal. 0

Depreciation Expense Sept. 30 Adj. 250 Sept. 30 250 Sept. 30 CE2 Sept. 30 Bal. 0

Solutions Manual .

600

Rent Expense Sept. 24 1,000 Sept. 30 Bal. 1,000 Sept. 30 CE2 1,000 Sept. 30 Bal. 0 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

250 Income Summary Sept. 30 CE2 9,250 Sept. 30 CE1 11,800 Sept. 30 CE3 2,550 Sept. 30 Bal. 0

4-97

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PROBLEM 4-9B (Continued) (c) RIJO EQUIPMENT REPAIR CORP. Post-Closing Trial Balance September 30, 2015

Debit $15,760 4,240 800 1,000 30,000

Credit

$ 3,250 1,200 1,300 1,600 25,000 19,450

Totals ............................................................................ $51,800 $51,800

Solutions Manual .

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PROBLEM 4-10B (a) GRANT ADVERTISING AGENCY LIMITED Adjusted Trial Balance December 31, 2015 Debit Cash ........................................................................................... $ 11,000 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 ...................................................................... Bank loan payable ...................................................................... Income tax payable .................................................................... Common shares ......................................................................... Retained earnings ....................................................................... Dividends .................................................................................... 2,000 Fees earned ................................................................................ Salaries expense ........................................................................ 13,625 Depreciation expense ................................................................. 13,200 Rent expense ............................................................................. 7,200 Supplies expense ....................................................................... 5,935 Insurance expense...................................................................... 1,600 Interest expense ......................................................................... 700 Income tax expense .................................................................... 7,000 Totals ................................................................................... $160,925

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Credit

$ 39,600 4,800 1,625 700 6,200 10,000 7,000 20,000 10,400 60,600

$160,925

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-10B (Continued) (b)

Closing Entries:

2015 Dec. 31

031

Solutions Manual .

Fees Earned ................................................................... Income Summary...................................................

60,600

Income Summary ........................................................... Salaries Expense ................................................... Depreciation Expense............................................ Rent Expense ........................................................ Supplies Expense .................................................. Insurance Expense ................................................ Interest Expense .................................................... Income Tax Expense .............................................

49,260

Income Summary ........................................................... Retained Earnings .................................................

11,340

Retained Earnings .......................................................... Dividends ...............................................................

2,000

4-100

60,600

13,625 13,200 7,200 5,935 1,600 700 7,000

11,340

2,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-10B (Continued) (c) GRANT ADVERTISING AGENCY LIMITED Post-Closing Trial Balance December 31, 2015

Debit Cash .................................................................................. Trading investments .......................................................... Accounts receivable........................................................... Supplies ............................................................................. Prepaid insurance .............................................................. Equipment ......................................................................... Accumulated depreciation—equipment ............................. Accounts payable .............................................................. Salaries payable ................................................................ Interest payable ................................................................. Unearned revenue ............................................................. Bank loan payable ............................................................. Income tax payable............................................................ Common shares ................................................................ Retained earnings.............................................................. Totals ............................................................................

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Credit

$ 11,000 10,850 19,750 1,265 800 66,000

00 000 0 $109,665

$ 39,600 4,800 1,625 700 6,200 10,000 7,000 20,000 19,740 $109,665

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11B (a) and (b) Accounts Payable Aug. 31 Bal. 13,000 Aug. 31 Adj. 3,120 Aug. 31 Bal. 16,120

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 Buildings Aug.31 Bal. 290,000 Accumulated Depreciation— Buildings Aug. 31Bal. 87,000 Aug. 31 Adj. 5,800 Aug. 31 Bal. 92,800

1,680 1,680

Interest Payable Aug. 31 Adj. Aug. 31 Bal.

700 700

Income Tax Payable Aug. 31 Adj. Aug. 31 Bal.

2,000 2,000

Mortgage Payable Aug. 31 Bal. 120,000 Common Shares Aug. 31 Bal. 40,000

Furniture Aug. 31 Bal. 57,200 Accumulated Depreciation— Furniture Aug. 31Bal. 22,880 Aug. 31 Adj. 5,720 Aug. 31 Bal. 28,600

Solutions Manual .

Salaries Payable Aug. 31 Adj. Aug. 31 Bal.

Retained Earnings Aug. 31 Bal. 72,000

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PROBLEM 4-11B (Continued) (a) and (b) (Continued)

Dividends Aug. 31 Bal. 10,000 Aug. 31 Bal. 10,000

Insurance Expense Aug. 31 Adj. 3,180 Aug. 31 Bal. 3,180

Rent Revenue Aug. 31 Adj. 6,000 Aug.31 Bal. 497,000 Aug. 31 Adj. 62,000 Aug. 31 Bal. 553,000

Supplies Expense Aug. 31 Adj. 5,610 Aug. 31 Bal. 5,610

Depreciation Expense Aug. 31 Adj. 5,800 Aug. 31 Adj. 5,720 Aug. 31 Bal. 11,520

Salaries Expense Aug. 31 Bal. 306,000 Aug. 31 Adj. 1,680 Aug. 31 Bal. 307,680

Interest Expense

Utilities Expense Aug. 31 Bal. 75,200 Aug. 31 Adj. 3,120 Aug. 31 Bal. 78,320

Aug. 31 Bal. Aug. 31 Adj. Aug. 31 Bal.

Income Tax Expense Aug. 31 Bal. 20,000 Aug. 31 Adj.0 2,000 Aug. 31 Bal. 22,000

Repairs and Maintenance Expense Aug. 31 Bal. 28,250

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7,700 700 8,400

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PROBLEM 4-11B (Continued) (b) 1.

2015 Aug. 31

10.

Solutions Manual .

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.......................................... [($120,000 × 7%) × 1/12]. .......................

700

Income Tax Expense ........................................... Income Tax Payable ...................................

2,000

4-104

3,180

5,610

5,800

5,720

62,000

1,680

3,120

6,000

700

2,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11B (Continued) (c) ROCKY MOUNTAIN RESORT INC. Adjusted Trial Balance August 31, 2015

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 2019 ............................................. Common shares ................................................................ Retained earnings.............................................................. Dividends ........................................................................... Rent revenue ..................................................................... Salaries expense ............................................................... Utilities expense................................................................. Repairs and maintenance expense ................................... Depreciation expense ........................................................ Interest expense ................................................................ Supplies expense .............................................................. Insurance expense ............................................................ Income tax expense........................................................... Totals ........................................................................

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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

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11B (Continued) (d) (1) ROCKY MOUNTAIN RESORT INC. Income Statement Year Ended August 31, 2015

Revenues Rent revenue ............................................................... Expenses Salaries expense ......................................................... Utilities expense .......................................................... Repairs and maintenance expense ............................. Depreciation expense .................................................. Interest expense .......................................................... Supplies expense ........................................................ Insurance expense ...................................................... Total expenses ................................................... Profit before income tax ........................................................ Income tax expense ............................................................. Profit ....................................................................................

$553,000 $307,680 78,320 28,250 11,520 8,400 5,610 3,180 442,960 110,040 22,000 $ 88,040

(2) ROCKY MOUNTAIN RESORT INC. Statement of Changes in Equity Year Ended August 31, 2015 Common Shares Balance, September 1, 2014.......................................................... $35,000 Issued common shares .................................................................. 5,000 Profit ................................................................. 0000 00 Dividends ....................................................................................... Balance, August 31, 2015 .............................................................. $40,000

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Retained Earnings $ 72,000 88,040 (10,000) $150,040

Total Equity $107,000 5,000 88,040 (10,000) $190,040

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11B (Continued) (d)

(Continued)

(3) ROCKY MOUNTAIN RESORT INC. Statement of Financial Position August 31, 2015

Assets Current assets Cash .......................................................... 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 ........................................................

$ 38,820 1,380 9,540 49,740 $ 70,000 $290,000 92,800 $57,200 28,600

Liabilities and Shareholders’ Equity Current liabilities Accounts payable ...................................... Salaries payable ........................................ Interest payable ......................................... Income tax payable ................................... Unearned rent 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 .............

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197,200 28,600 295,800 $345,540

$16,120 1,680 700 2,000 15,000 $ 35,500 120,000 155,500 $ 40,000 150,040 190,040 $345,540

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-11B (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. Profitability According to the income statement, Rocky Mountain Resort was profitable in 2015 with after tax profit of over $88,000. The resort also has a positive balance in retained earnings, which indicates it has been profitable in the past. The company also paid out dividends of $10,000 in the past year, which may be of interest to your friend if your friend is considering an equity 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. Shareholders’ equity is greater than total liabilities so the level of debt held by the company is not too high which mitigates the risk of not being able to make interest payments. This, combined with strong liquidity and positive profits, 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 could be performed if your friend had access to prior years’ financial statements or some industry information. We would then be able to perform some comparative analysis to better evaluate Rocky’s financial health.

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PROBLEM 4-12B (a)

Closing Entries:

2015 Aug. 31

031

Solutions Manual .

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 ...............................................................

10,000

4-109

553,000

307,680 78,320 28,250 11,520 8,400 5,610 3,180 22,000

88,040

10,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 4-12B (Continued) (b) CE means closing entry. 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

Accounts Payable Aug. 31 Bal. 13,000 Aug. 31 Adj. 3,120 Aug. 31 Bal. 16,120

5,610

Unearned Revenue Aug. 31 Bal. 71,000 Aug. 31 Adj. 62,000 Aug. 31 Adj. 6,000 Aug. 31 Bal. 15,000

3,180

Land Aug. 31 Bal. 70,000

Buildings Aug. 31 Bal.290,000

Accumulated Depreciation— Buildings Aug. 31 Bal. 87,000 Aug. 31 Adj. 5,800 Aug. 31 Bal. 92,800

1,680 1,680

Interest Payable Aug. 31 Adj. Aug. 31 Bal.

700 700

Income Tax Payable Aug. 31 Adj. Aug. 31 Bal.

2,000 2,000

Mortgage Payable Aug. 31 Bal. 120,000

Furniture Aug. 31 Bal. 57,200

Common Shares Aug. 31 Bal. 40,000

Accumulated Depreciation— Furniture Aug. 31 Bal. 22,880 Aug. 31 Adj. 5,720 Aug. 31 Bal. 28,600

Solutions Manual .

Salaries Payable Aug. 31 Adj. Aug. 31 Bal.

Retained Earnings Aug. 31 Bal. 72,000 Aug. 31 CE4 10,000 Aug. 31 CE3 88,040 Aug. 31 Bal. 150,040

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PROBLEM 4-12B (Continued) (b)

CE means closing entry

Dividends Aug. 31 Bal. 10,000 Aug. 31 CE4 10,000 Aug. 31 Bal. 0

Supplies Expense Aug. 31 Adj. 5,610 Aug. 31 Bal. 5,610 Aug. 31 CE2 Aug. 31 Bal. 0

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

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 Interest Expense

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

7,700 700 8,400

Aug. 31 Bal.

8,400

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

Repairs and Maintenance Expense Aug. 31 Bal. 28,250 Aug. 31 CE2 28,250 Aug. 31 Bal. 0

Solutions Manual .

Aug. 31 Bal. Aug. 31 Adj. Aug. 31 Bal.

Aug. 31 CE2

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

Insurance Expense Aug. 31 Adj. 3,180 Aug. 31 Bal. 3,180 Aug. 31 CE2 Aug. 31 Bal. 0

5,610

Aug.31 CE2 464,960 Aug.31 CE1 553,000 Aug. 31Bal. 88,040 Aug.31 CE3 88,040 Aug. 31 Bal. 0

3,180

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PROBLEM 4-12B (Continued) (c) ROCKY MOUNTAIN RESORT INC. Post-Closing Trial Balance August 31, 2015

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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

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Financial Accounting, Sixth Canadian Edition

BYP 4-1 FINANCIAL REPORTING (a)

1. Accounts appearing on Shoppers’ balance sheet which may have been used in an adjusting entry for prepayments include: • • •

Prepaid expenses and deposits Property and equipment Intangible assets

The related statement of earnings account which most likely include adjusting entries at the end of the year for prepayments include: • •

Depreciation expense included in operating and administrative expenses Insurance expense included in operating and administrative expenses

2. Accounts appearing on Shoppers’ balance sheet which may have been used in an adjusting entry for accruals include: • •

Accounts payable and accrued liabilities Income tax payable

The related statement of earnings account which most likely include adjusting entries at the end of the year for accruals include: • •

Salaries expense included in operating and administrative expenses Interest expense included in finance expenses

(b) (in thousands of Canadian dollars) 2012 Dec. 29 Sales ............................................................................ 10,781,848 Income Summary ................................................

10,781,848

Income Summary ......................................................... 10,173,367 Cost of Goods Sold.............................................. Operating and Administrative Expenses .............. Finance Expenses ............................................... Income Tax Expense ...........................................

6,609,229 3,291,698 57,595 214,845

Income Summary ......................................................... 608,481 Retained Earnings ...............................................

608,481

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BYP 4-2 COMPARATIVE ANALYSIS

(a)

Shopper’s Prepaid Expenses and Deposits and Jean Coutu’s Prepaid Expenses accounts likely represent payments required by these businesses such as insurance and rent which must be made to suppliers ahead of being consumed. The types of adjustments at the end of the year would be an adjusting entry for prepayments. The related income statement accounts would be Insurance Expense and Rent Expense.

(b)

For Shoppers and Jean Coutu, the current liability Income Taxes Payable likely represents amounts due by these businesses to the Federal and Provincial governments resulting from taxes payable on corporate income. The types of adjustments at the end of the year would be an adjusting entry for accruals. The related income statement accounts would be Income Tax Expense.

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BYP 4-3 COMPARING IFRS AND ASPE

(a)

Since First Capital Realty is required to release financial statements quarterly, it would need to post adjusting entries at least quarterly. Since First Pro Shopping Centres 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 First Pro 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)

First Pro would not be required to prepare a statement of changes in equity, but rather would prepare a statement of retained earnings. First Pro would also not report any other comprehensive income in the shareholders’ equity section of its statement of financial position and it would not prepare a statement of comprehensive income. 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.

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BYP 4-4 CRITICAL THINKING 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) To record the additional depreciation, the following would be recorded: Depreciation Expense 300,000 Accumulated Depreciation—Furniture and Fixtures 300,000 To accrue the additional salary expense, the following would be recorded: Salaries Expense Salaries Payable

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

To reclassify the bonus as salary, the following entry would be made: Salary Expense Bonus Expense (b)

200,000 200,000

Profit before income tax as originally determined Additional depreciation expense Additional salaries expense Additional office expense Profit before income tax revised

$2,800,000 (300,000) (400,000) (80,000) $2,020,000

Note that the reclassification of bonus to salary has no effect on total profit. (c) Anna suggested that the useful lives of furniture and fixture be lowered to increase the amount of depreciation recorded in each year. This would lower profit 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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BYP 4-4 (Continued) (e) It appears that the office expense accrual was adjusted upward without any adequate support or justification. This seems like an attempt to lower the profit of the company prior to negotiations with the union. (f) In prior years, the management bonus was recorded separately from salary expense so that users of the financial statements could understand the difference between these two forms of compensation. A bonus is discretionary in nature while recurring salary expenses are not. By reclassifying the bonus into salary expense, management may be intending to mislead users into thinking that a bonus did not occur this year, or that the bonuses have become “regular” and there is no intention of reducing them in order to meet the demands of the union.

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BYP 4-5 ETHICS CASE (a)

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, the profit 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. Sundream Travel Agency’s liquidity improves by the changes suggested by the CEO. The current ratio should be 1.9:1 ($400,000 ÷ $210,000) but it changes 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 conditions.

(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 he should be dissuaded from his request, as his suggestions will be challenged by his controller.

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BYP 4-6 “ALL ABOUT YOU” ACTIVITY (a)

The shoe store records revenue at the point of sale when the sale is complete. At that point, the customer has paid for the shoes that have been purchased and the customer has taken the shoes from the store. Each condition of revenue recognition has been met as follows: • • •

The sale or performance effort is substantially complete: In this particular case, the effort is complete. The customer takes ownership of the shoes and leaves the store; The revenue amount is determinable (measurable): The selling price of the shoes has been preprogrammed into the cash register; and The collection of the revenue is reasonably assured: In this case, the collection has occurred. The customer has paid using cash, a debit card, or a credit card and the bank has authorized the transaction.

(b)

Your incentive to overstate revenues would be to improve the commission you would earn on shoes sold.

(c)

The store has preprogrammed the selling price of the shoes in the register. It is assumed that you cannot change the price of shoes to be sold. A sale cannot be processed unless the transaction has been approved–it is likely that the cash register will not process a sale until the bank has approved the debit or credit card transaction. You will only receive a commission if you make a sale and the sale is recorded.

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BYP 4-7

Financial Accounting, Sixth Canadian Edition

SERIAL CASE

(b) 1.

June 30 Advertising Expense .......................................... Supplies ....................................................

600

30 Depreciation Expense ....................................... Accumulated Depreciation—Buildings ($165,000 ÷ 30 years)

5,500

30 Depreciation Expense ....................................... Accumulated Depreciation—Equipment. ... ($42,000 ÷ 6 years) + ($2,520 ÷ 6 years × 1/12)

7,035

30 Depreciation Expense ....................................... Accumulated Depreciation—Vehicles ($52,500 ÷ 5 years × 6/12)

5,250

30 Interest Expense ............................................... Interest Payable .........................................

30 Insurance Expense ............................................ Prepaid Insurance ($15,360 × 1/12 months)............................

1,280

30 Insurance Expense ............................................ Prepaid Insurance ($12,000 × 6/12 months)............................

6,000

30 Utilities Expense ................................................ Accounts Payable .....................................

1,025

30 Accounts Receivable ......................................... Sales..........................................................

1,600

30 Salaries Expense .............................................. Salaries Payable ........................................ (2 × 8 × $13)

208

10.

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600

5,500

7,035

5,250

1,280

6,000

1,025

1,600

208

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Financial Accounting, Sixth Canadian Edition

BYP 4-7 (Continued) (a) and (c) Note: June balances were taken from the answer to BYP 3-7

June Bal.

Cash 18,674

Accumulated Depreciation-Equipment June Bal. 14,000 30 Adj. 7,035 June Bal. 21,035

Accounts Receivable June Bal. 10,490 30 Adj. 1,600 June Bal. 12,090

June Bal.

Merchandise Inventory June Bal. 16,250

June Bal. June Bal.

June Bal.

Supplies 4,375 June 30 Adj. 3,775

Vehicles 52,500

Accumulated Depreciation-Vehicles June 30 Adj. 5,250 Accounts Payable June Bal. 6,140 30 Adj. 1,025 June Bal. 7,165

600

Prepaid Insurance 27,360 June 30 Adj. 1,280 30 Adj. 6,000 20,080

Land June Bal. 100,000

Unearned Revenue June Bal.

500

Salaries Payable June 30 Adj.

208

Interest Payable June 30 Adj.

Buildings June Bal. 165,000 Accumulated Depreciation-Buildings June Bal. 137,500 30 Adj. 5,500 June Bal. 143,000

June Bal.

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Equipment 44,520

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BYP 4-7 (Continued) (a) and (c) (Continued) June Bal.

Bank Loan Payable June Bal.

22,500

Mortgage Payable June Bal.

53,200

Common Shares June Bal.

300

Retained Earnings June Bal.

66,788

Utilities Expense June Bal. 12,100 30 Adj. 1,025 June Bal. 13,125 Advertising Expense June Bal. 9,000 30 Adj. 600 June Bal. 9,600 Insurance Expense June 30 Adj. 1,280 30 Adj. 6,000 June Bal. 7,280

Dividends 30,000

June Bal.

Rent Revenue June Bal.

6,000

Property Tax Expense June Bal. 5,950

Sales June Bal. 643,758 30 Adj. 1,600 June Bal. 645,358

Interest Expense June Bal. 5,299 30 Adj. 55 June Bal. 5,354

Sales Returns and Allowances June Bal. 5,000 June Bal.

Cost of Goods Sold 102,386

June Bal. 30 Adj. June Bal.

Salaries Expense 290,782 208 290,990

Freight Out 18,000

June Bal.

Income Tax Expense 33,000

Depreciation Expense June 30 Adj. 5,500 30 Adj. 7,035 30 Adj. 5,250 June Bal. 17,785

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Financial Accounting, Sixth Canadian Edition

BYP 4-7 (Continued) (d) KOEBEL’S FAMILY BAKERY LTD. Adjusted Trial Balance June 30, 2014 Debit Cash Accounts receivable Merchandise 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 Bank loan payable Mortgage payable Common shares Retained earnings Dividends Rent revenue Sales Sales returns and allowances Cost of goods sold Salaries expense Depreciation expense Freight out Utilities expense Advertising expense Insurance expense Property tax expense Interest expense Income tax expense Total

Solutions Manual .

Credit

$ 18,674 12,090 16,250 3,775 20,080 100,000 165,000 $143,000 44,520 21,035 52,500 5,250 7,165 500 208 55 22,500 53,200 300 66,788 30,000 6,000 645,358 5,000 102,386 290,990 17,785 18,000 13,125 9,600 7,280 5,950 5,354 33,000 $971,359

4-123

0000000 $971,359

Chapter 4

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (a) Date July

Debit

Account Titles Cash ........................................................................ Common Shares ..............................................

50,000

Prepaid Insurance ..................................................... Cash ................................................................

3,600

Prepaid Rent ............................................................. Cash ................................................................

8,000

Supplies .................................................................... Cash ................................................................

3,800

Equipment ................................................................. Cash ................................................................ Bank Loan Payable ..........................................

24,000

50,000

3,600

8,000

3,800

4,000 20,000

No entry required (consulting agreement)

Cash ......................................................................... Accounts Receivable .......................................

1,200

Unearned Revenue ................................................... Fees Earned ....................................................

1,120

Accounts Payable ..................................................... Cash ................................................................

400

Cash ......................................................................... Unearned Revenue ..........................................

12,000

Salaries Expense ...................................................... Cash ................................................................

11,000

Accounts Receivable ............................................... Fees Earned ....................................................

28,000

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Credit

1,200

1,120

400

12,000

11,000

28,000

Chapter 4

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (a) (Continued) Date July 20 23 27

31 31

31 31 31

Solutions Manual .

Debit

Account Titles Professional Fees Expense ...................................... Accounts Payable ............................................

2,200

Unearned Revenue ................................................... Fees Earned ....................................................

10,000

Cash ......................................................................... Accounts Receivable .......................................

15,000

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

Income Tax Expense ................................................ Income Tax Payable ........................................

1,200

4-125

Credit

2,200 10,000 15,000

300

4,000 1,250

500

100

11,000 800 1,200

Chapter 4

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (b) Cash July

July

1 Bal.

5,230 July

3,600

50,000

8,000

1,200

3,800

12,000

4,000

15,000

400

11,000

31 Bal.

52,630 Accounts Receivable

July July

1 Bal.

1,200

28,000

31 Bal.

13,000

July

1,200

15,000

Prepaid Insurance July

3,600

July

31 Bal.

3,300

July

Adj.

300

Adj.

1,250

Adj.

4,000

Supplies July July

1 Bal.

690

3,800

31 Bal.

3,240

July

Prepaid Rent July

8,000

July

31 Bal.

4,000

Solutions Manual .

July

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (b) (Continued) Equipment July

24,000

July

31 Bal.

24,000 Accumulated Depreciation—Equipment July 31 Adj.

500

July 31 Bal

500

Accounts Payable July 14

400 July 1 Bal. 20

2,200

31 Adj. July

400

31 Bal.

800 3,000

Interest Payable July 31 Adj.

100

July 31 Bal.

100

Salaries Payable July 31 Adj.

11,000

July 31 Bal.

11,000

Income Tax Payable

Solutions Manual .

4-127

July 31 Adj.

1,200

July 31 Bal.

1,200

Chapter 4

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (b) (Continued) Unearned Revenue July 13

1,120

July 1 Bal.

1,120

10,000

12,000

July 31 Bal.

2,000

Bank Loan Payable July 7

20,000

July 31 Bal.

20,000

Common Shares July 1 Bal.

3,600

50,000

July 31 Bal.

53,600

Retained Earnings July 1 Bal.

2,000

July 31 Bal.

2,000

July 31 CE3

6,770

July 31 Bal.

8,770

Fees Earned

July 31 CE1

July 13

1,120

28,000

10,000

July 31 Bal.

39,120

July 31 Bal.

39,120

Note: CE means closing entry

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (b) (Continued) Salaries Expense July 18

11,000

July 31 Adj.

11,000

July 31 Bal.

22,000 July 31 CE2

July 31 Bal.

22,000

Rent Expense July

31 Adj.

4,000

July 31 Bal.

4,000 July 31 CE2

July 31 Bal.

4,000

0 Professional Fees Expense

July 20

2,200

July 31 Bal.

2,200 July 31 CE2

July 31 Bal.

2,200

0 Supplies Expense

July 31 Adj.

1,250

July 31 Bal.

1,250 July 31 CE2

July 31 Bal.

Solutions Manual .

1,250

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTER S 1 – 4 (Continued) (b) (Continued) Utilities Expense July 31 Adj.

800

July 31 Bal.

800 July 31 CE2

July 31 Bal.

800

0 Depreciation Expense

July

31 Adj.

500

July

31 Bal.

500 July 31 CE2

July

31 Bal.

500

0 Insurance Expense

July

31 Adj.

300

July

31 Bal.

300 July 31 CE2

July

31 Bal.

300

0 Interest Expense

July

31 Adj.

100

July

31 Bal.

100 July 31 CE2

July

31 Bal.

100

0 Income Tax Expense

July 31 Adj.

1,200

July 31 Bal.

1,200 July 31

July 31 Bal.

Solutions Manual .

CE2

1,200

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (c) RED RIVER COMPUTER CONSULTANTS LTD. Adjusted Trial Balance July 31, 2015 Cash ............................................................... Accounts receivable ....................................... Prepaid insurance .......................................... Supplies ......................................................... Prepaid rent .................................................... Equipment ...................................................... Accumulated depreciation—equipment ........... Accounts payable ........................................... Interest payable .............................................. Salaries payable ............................................. Income tax payable ........................................ Unearned revenue .......................................... Bank loan payable ........................................... Common shares ............................................. Retained earnings .......................................... Fees earned ................................................... Salaries expense ............................................ Rent expense ................................................. Professional fees expense ............................. Supplies expense ........................................... Utilities expense ............................................. Depreciation expense ..................................... Insurance expense ......................................... Interest expense ............................................. Income tax expense .......................................

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Debit $ 52,630 13,000 3,300 3,240 4,000 24,000

Credit

22,000 4,000 2,200 1,250 800 500 300 100 1,200 $132,520

500 3,000 100 11,000 1,200 2,000 20,000 53,600 2,000 39,120

$132,520

Chapter 4

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (d) (1) RED RIVER COMPUTER CONSULTANTS LTD. Income Statement Month Ended July 31, 2015

Revenues Service revenue.............................................. Expenses Salaries expense ............................................ Rent expense ................................................. Professional fees expense.............................. Supplies expense ........................................... Utilities expense ............................................. Depreciation expense ..................................... Insurance expense ......................................... Interest expense ............................................. Total expenses ...................................... Profit before income tax ........................................... Income tax expense ................................................ Profit .......................................................................

$39,120 $22,000 4,000 2,200 1,250 800 500 300 100 31,150 7,970 1,200 $ 6,770

(2) RED RIVER COMPUTER CONSULTANTS LTD. Statement of Changes in Equity Month Ended July 31, 2015 Common Retained Shares Earnings Balance, July 1 .............................................................................. $ 3,600 $2,000 50,000 Issued common shares .................................................................. 00 0000 6,770 Profit .............................................................................................. Balance, July 31 ............................................................................ $53,600 $8,770

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Total Equity $ 5,600 50,000 6,770 $62,370

Chapter 4

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (d)

(Continued)

(3) RED RIVER COMPUTER CONSULTANTS LTD. Statement of Financial Position July 31, 2015 Assets Current assets Cash .......................................................... Accounts receivable .................................. Prepaid rent ............................................... Prepaid insurance ...................................... Supplies ..................................................... Total current assets .......................... Property, plant, and equipment Equipment ................................................. Less: Accumulated depreciation ................ Total assets ........................................................

$52,630 13,000 4,000 3,300 3,240 76,170 $24,000 500

Liabilities and Shareholders’ Equity Current liabilities Accounts payable ...................................... $ 3,000 Salaries payable ........................................ 11,000 Interest payable ......................................... 100 Income tax payable ................................... 1,200 Unearned revenue ..................................... 2,000 Total current liabilities ........................... Non-current liabilities Bank loan payable ..................................... Total liabilities ................................... Shareholders’ equity Common shares ........................................ $53,600 Retained earnings ..................................... 8,770 Total shareholders’ equity................. Total liabilities and shareholders’ equity .............

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23,500 $99,670

$17,300 20,000 37,300

62,370 $99,670

Chapter 4

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1 – 4 (Continued) (e) Date July 31 31

(f)

Debit

Account Titles Service Revenue....................................................... 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

Credit

39,120 22,000 4,000 2,200 1,250 800 500 300 100 1,200 6,770

Current ratio $76,170 $17,300

4.4:1

Red River has exceeded the benchmark of 2.5:1 for its current ratio.

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Chapter 4

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Financial Accounting, Sixth Canadian Edition

CHAPTER 5 Merchandising Operations ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

1. Identify the differences between service and merchandising companies.

1, 2, 3, 4

1, 2

1A, 2A,*11A

1B, 2B, *11B

2. Prepare entries for purchases under a perpetual inventory system.

5, 6, 7, 8, 9, 10

3, 4, 5

2, 3, 4, 6, *13

2A, 3A, 4A, 5A

2B, 3B, 4B, 5B

4, 5

3. Prepare entries for sales under a perpetual inventory system.

7, 8, 9, 10, 11, 12

4, 6

2, 3, 5, 6, *13

2A, 3A, 4A, 5A

2B, 3B, 4B, 5B

4. Prepare a single-step and a multiple-step income statement.

13, 14, 15, 16, 17

7, 8, 9

7, 8, 9, 10

5A, 6A, 7A, 9A

5B, 6B, 7B, 9B

1, 3, 7

5. Calculate the gross profit 18, 19, 20, margin and profit margin.

10, 11

6, 9, 10, 11

8A, 9A, 10A, *14A

8B, 9B, 10B, *14B

1, 2, 3, 4, 6, 7

6. Prepare entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A).

*12, *13, *14, *15, *16

*12, *13, *14, *15

*11A, *12A, *13A, *14A, *15A

*11B, *12B, *13B, *14B, *15B

Solutions Manual .

*21, *22, *23

5-1

Exercises

A Problems

B Problems

BYP

Chapter 5

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Identify appropriate inventory system.

Moderate

15-20

Record purchase and sales transactions.

Moderate

20-30

Record purchase and sales transactions.

Moderate

20-30

Record and post purchase and sales transactions; prepare trial balance.

Simple

30-40

Record and post transactions and prepare partial financial statements.

Simple

30-40

Prepare single- and multiple-step income statements.

Moderate

20-30

Record and post adjusting entries; prepare adjusted trial balance and financial statements.

Moderate

35-45

Calculate profitability ratios and comment.

Moderate

15-20

Calculate amounts and assess profitability.

Complex

30-40

10A

Calculate ratios and comment.

Simple

20-30

*11A

Record purchase and sales transactions; discuss inventory systems.

Moderate

20-30

*12A

Record purchase and sales transactions.

Moderate

20-30

*13A

Record and post purchase and sales transactions; prepare trial balance.

Simple

30-40

*14A

Prepare partial income statement; calculate gross profit.

Simple

20-30

*15A

Prepare financial statements.

Moderate

40-50

Identify appropriate inventory system.

Moderate

15-20

Solutions Manual .

5-2

Chapter 5

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number 2B

Description Record purchase and sales transactions.

Difficulty Level Moderate

Time Allotted (min.) 20-30

Record purchase and sales transactions.

Moderate

20-30

Record and post purchase and sales transactions; prepare trial balance.

Simple

30-40

Record and post transactions and prepare partial financial statements.

Simple

30-40

Prepare single- and multiple-step income statements.

Moderate

20-30

Record and post adjusting entries; prepare adjusted trial balance and financial statements.

Moderate

35-45

Calculate profitability ratios and comment.

Moderate

15-20

Calculate amounts and assess profitability.

Complex

30-40

10B

Calculate ratios and comment.

Simple

20-30

*11B

Record purchase and sales transactions; discuss inventory systems.

Moderate

20-30

*12B

Record purchase and sales transactions.

Moderate

20-30

*13B

Record and post purchase and sales transactions; prepare trial balance.

Simple

30-40

*14B

Prepare partial income statement; calculate gross profit.

Simple

20-30

*15B

Prepare financial statements.

Moderate

40-50

Solutions Manual .

5-3

Chapter 5

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Financial Accounting, Sixth Canadian Edition

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.

(a) The income measurement process of a merchandising company is the same as the service company in that profit 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).

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.

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.

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.

Solutions Manual .

5-4

Chapter 5

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 6.

(a) The value of the purchase discount to Butler Roofing is $100.00 ($10,000 × 1%). (b) Failing to take advantage of the discount terms, is like paying the supplier an extra $100 in order to settle a $9,900 invoice 20 days later. This works out to 1.01% [$100 ÷ $9,900] every 20 days. On an annual basis this amounts to 18.4% [($100 ÷ $9,900 × (365 ÷ 20)].

The company should record the sale as revenue in June, when it is sold to a customer. The merchandise purchased should be recorded as an asset, merchandise inventory, in April. 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.

(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 Merchandise 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.

In a perpetual inventory system, purchase returns are credited to the Merchandise 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.

10. (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 Merchandise 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. When collected within the discount period, the seller records the discount as a debit to the Sales Discounts account, which is a contra revenue account to Sales. Buyers record purchase discounts when taken as a credit to Merchandise Inventory under the perpetual system or Purchase Discounts when using the periodic system.

Solutions Manual .

5-5

Chapter 5

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 11.

If the inventory 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 inventory is resaleable, it still has value to the company. In this case, the inventory is debited to inventory again and the cost of goods sold is credited.

12.

By shipping more product than was ordered, customers will be annoyed with Agnew Inc. and there will be damage done to customer relationships. Goods that are returned will cost additional freight charges. Annoyed customers could possibly refuse the whole order which will result in a lost sale. It is not an ethical tactic to implement this procedure as the objective is obviously to manipulate sales results and boost profit in the current year.

13.

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 profit before income tax. A multiple-step income statement requires several steps to determine profit before income tax. First, cost of goods sold is deducted from sales to determine gross profit. Operating expenses are then deducted to calculate profit from operations. Finally, other revenues and expenses are added or deducted to determine profit before income tax. The deduction of income tax to calculate profit (loss) is the same under both formats. In addition, both formats produce the same profit amount for the period.

14.

Shoppers Drug Mart uses a multiple-step income statement.

15. (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. 16.

Because the Katz Group 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. Shoppers, which follows IFRS must classify its expenses by their nature or their function.

17.

Interest expense is a non-operating expense because it relates to how a company’s operations are financed. This is not always within the company’s control and is usually not a decision of the general manager but of the chief financial officer.

Solutions Manual .

5-6

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 18.

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).

19.

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 dues 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.

20.

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

*21. (a) Added/Deducted Deducted Deducted Added

Accounts Purchase Returns and Allowances Purchase Discounts Freight In *22.

(b) Normal Balance Credit Credit Debit

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 as well as cost of goods sold for the period, is calculated at the end of 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 Merchandise Inventory account.

Solutions Manual .

5-7

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) *23.

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.

Solutions Manual .

5-8

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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.

BRIEF EXERCISE 5-2 (a)

[1] Profit before tax = $100 – $65 = $35 [2] Profit = $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.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 5-3

Beginning Balance Purchases

Freight in Ending Balance

Purchases

Merchandise Inventory 25,000 100,000 12,000 Purchase returns 4,400 Purchase discounts 2,400 93,000 Cost of goods sold 18,000

Merchandise Inventory............................................. 100,000 Accounts Payable ...............................................

100,000

Purchase Returns

Accounts Payable .................................................... Merchandise Inventory .......................................

12,000 12,000

Purchase Discounts

Accounts Payable ($100,000 – $12,000) ................. Merchandise Inventory ($88,000 × 5%) .............. Cash ...................................................................

88,000

Freight In

Merchandise Inventory............................................. Accounts Payable ...............................................

2,400

Cost of Goods Sold .................................................. Merchandise Inventory .......................................

93,000

Cost of Sales

4,400 83,600

2,400

93,000

BRIEF EXERCISE 5-4 Pocras Corporation (Buyer): Aug. 24

Merchandise Inventory............................................. Accounts Payable ...............................................

900 900

Wydell Inc. (Seller): Aug. 24

Solutions Manual .

Accounts Receivable ............................................... Sales ..................................................................

900

Cost of Goods Sold .................................................. Merchandise Inventory .......................................

590

5-10

900

590

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 5-5 Jan.

Merchandise Inventory............................................. Accounts Payable ...............................................

15,000 15,000

No entry necessary – Freight costs paid by Fundy Corp.

Accounts Payable .................................................... Merchandise Inventory .......................................

2,000

Accounts Payable .................................................... Merchandise Inventory ($13,000 × 2%) .............. Cash ...................................................................

13,000

2,000

260 12,740

BRIEF EXERCISE 5-6 Jan.

Solutions Manual .

Accounts Receivable ............................................... Sales ..................................................................

15,000

Cost of Goods Sold .................................................. Merchandise Inventory .......................................

11,250

Freight Out ............................................................... Cash ...................................................................

300

Sales Returns and Allowances ................................ Accounts Receivable ..........................................

2,000

Merchandise Inventory............................................. Cost of Goods Sold ............................................

1,500

Cash ........................................................................ Sales Discounts ($13,000 × 2%).............................. Accounts Receivable ..........................................

12,740 260

5-11

15,000

11,250

300

2,000

1,500

13,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 5-7 (a)

Sales.................................................................................. Less: Sales returns and allowances ................................. $25,000 Sales discounts ....................................................... 55,000 Net sales............................................................................

$650,000

(b)

Net sales............................................................................ Less: Cost of goods sold .................................................. Gross profit ........................................................................

$570,000 320,000 $250,000

(c)

Gross profit ........................................................................ Less: Administrative expenses ......................................... $100,000 Selling expenses ..................................................... 25,000 Profit from operations ........................................................

$250,000

Profit from operations ........................................................ Add: Other revenues ....................................................... $20,000 Less: Other expenses....................................................... (30,000) Profit before income tax .....................................................

$125,000

Profit before income tax ..................................................... Less: Income tax expense ................................................ Profit ..................................................................................

$115,000 25,000 $ 90,000

(d)

(e)

80,000 $570,000

125,000 $125,000

(10,000) $115,000

BRIEF EXERCISE 5-8 As the name suggests, numerous steps are required in determining profit in a multiple-step 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

Solutions Manual .

Expenses Expenses Expenses Income tax expense Expenses Revenues Revenues Expenses Revenues Revenues Revenues

5-12

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

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Financial Accounting, Sixth 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).

BRIEF EXERCISE 5-10 (a) 2015 Gross profit margin

Profit margin

(b)

$250,000 – $137,500 $250,000

2014 = 45.0%

$250,000 – $137,500 – = 17.0% $50,000 – $20,000 $250,000

$200,000 – $114,000 $200,000

43.0%

$200,000 – $114,000 – $40,000 + $10,000 – $15,000 $200,000

20.5%

The Modder Corporation’s gross profit margin increased significantly in 2015 indicating an increase in the percentage mark-up, or a reduction in the cost of goods sold, or both. On the other hand, in 2015, the company’s profit margin had dropped significantly. The decrease in profit margin indicates that in spite of an increase in gross profit, the increase operating expenses overtook this increase in gross profit, leaving a decline in profit margin.

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Chapter 5

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 5-11 (a) ($ in millions) Gross profit margin

Profit margin

(b)

2012

2011

$11,427.2 – $7,929.3 $11,427.2

30.6%

$10,387.1 – $7,326.4 $10,387.1

= 29.5%

$499.2 $11,427.2

4.4%

$467.0 $10,387.1

= 4.5%

The Canadian Tire Corporation’s gross profit margin increased marginally in 2012 indicating a slight increase in the percentage mark-up it has been able to command, or a lowering of the costs of goods sold, or both. On the other hand, the profit margin decreased slightly in 2012. This decrease is due to operating expenses or interest or income tax expense increasing at a greater pace than the increase in gross profit.

*BRIEF EXERCISE 5-12 Jan.

Purchases ................................................................ Accounts Payable ...............................................

15,000 15,000

No entry necessary - Freight costs paid by Fundy Corp.

Accounts Payable .................................................... Purchase Returns and Allowances .....................

2,000

Accounts Payable .................................................... Purchase Discounts ($13,000 × 2%) .................. Cash ..................................................................

13,000

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5-14

2,000

260 12,740

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Financial Accounting, Sixth Canadian Edition

*BRIEF EXERCISE 5-13 Jan.

Accounts Receivable ............................................... Sales ..................................................................

15,000

Freight Out ............................................................... Cash ...................................................................

300

Sales Returns and Allowances ................................ Accounts Receivable ..........................................

2,000

Cash ........................................................................ Sales Discounts ....................................................... Accounts Receivable ..........................................

12,740 260

15,000

300

2,000

13,000

*BRIEF EXERCISE 5-14 (a)

Sales.................................................................................. Less: Sales returns and allowances ................................. $75,000 Sales discounts ....................................................... 25,000 Net Sales ...........................................................................

$750,000

Purchases.......................................................................... Less: Purchase returns and allowances ........................... $11,000 Purchase discounts................................................. 9,000 Net purchases ...................................................................

$425,000

(c)

Net purchases ................................................................... Add: Freight in ................................................................. Cost of goods purchased ...................................................

$405,000 10,000 $415,000

(d)

Beginning merchandise inventory...................................... Add: Cost of goods purchased ........................................ Cost of goods available for sale ......................................... Less: Ending merchandise inventory ................................ Cost of goods sold .............................................................

$ 60,000 415,000 475,000 100,000 $375,000

(e)

Net sales............................................................................ Less: Cost of goods sold ................................................... Gross profit ........................................................................

$650,000 375,000 $275,000

(b)

Solutions Manual .

5-15

100,000 $650,000

20,000 $405,000

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Financial Accounting, Sixth Canadian Edition

*BRIEF EXERCISE 5-15 (a)

(b)

Cost of goods sold Beginning merchandise 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 merchandise 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.

*BRIEF EXERCISE 5-16 Dec. 31

Merchandise Inventory (ending) .............................. 24,000 Cost of Goods Sold .................................................. 271,000* Purchase Discounts ................................................. 4,000 Merchandise Inventory (beginning) .................... Purchases........................................................... Freight In ............................................................

30,000 262,000 7,000

* Cost of goods sold = Beginning inventory + Purchases − Purchase discounts − Purchase returns and allowances + Freight in – Ending inventory Cost of goods sold = $30,000 + $262,000 − $4,000 + $7,000 – $24,000 = $271,000

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 5-1 (a)

Toys’ R Us, Inc. is a retailer, Fasken Martineau Dumoulin LLP is a service firm, and Atlantic Grocery Distributors Ltd. is a 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 law firm that does not sell inventory. The third company, the distributing wholesaler, will have an operating cycle between that of the retailer and the service firm because its inventory is more likely to sell faster.

EXERCISE 5-2 Item (a) 1. Asset 2. Asset 3. Asset 4. Liability 5. Liability

6. Asset

Account Debited (b) Merchandise Inventory Merchandise Inventory Merchandise Inventory Accounts Payable Accounts Payable Accounts Receivable

Expense Cost of Goods Sold 7. Expense Freight Out 8. Contra Sales Returns Sales and Allowances Asset 9. Contra Sales

Merchandise Inventory Sales Returns and Allowances

10. Asset

Cash

Solutions Manual .

+$4,000 Asset +$600 Asset +$1,000 Asset

+$400 Expense +$750 Asset

+$6,000 Asset

5-17

Account Credited (b) (c) Cash –$3,500 Accounts Payable Cash

+$4,000 –$400

Merchandise –$750 Inventory Cash –$3,430 Merchandise Inventory –$70 Sales +$10,000

Merchandise Inventory Cash Accounts Receivable

–$4,000

Cost of Goods Sold Cash

–$400

Accounts Receivable

–$6,000

–$600 –$1,000

–$750

Chapter 5

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-3 (a) Sept.

2 Merchandise Inventory (75 × $20) .............................. Accounts Payable .................................................

1,500

10 Accounts Payable ....................................................... Merchandise Inventory ..........................................

11 Accounts Receivable (26 × $30) ................................. Sales .....................................................................

780

Cost of Goods Sold (26 × $20) ................................... Merchandise Inventory ..........................................

520

14 Sales Returns and Allowances ................................... Accounts Receivable .............................................

Merchandise Inventory ............................................... Cost of Goods Sold ...............................................

21 Accounts Receivable (30 × $30) ................................. Sales .....................................................................

900

Cost of Goods Sold (30 × $20) ................................... Merchandise Inventory ..........................................

600

29 Accounts Payable ($1,500 – $40)............................... Cash ......................................................................

1,460

30 Cash ($900 – $9) ........................................................ Sales Discounts ($900 × 1%) ..................................... Accounts Receivable .............................................

891 9

Solutions Manual .

5-18

1,500

780

520

900

600

1,460

900

Chapter 5

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-3 (Continued) (b) Sept. 1 2 14 Sept. 30

Merchandise Inventory Bal. 200 Sept.10 1,500 11 20 21 Bal. 560

Cost of Goods Sold Sept. 11 520 Sept. 14 21 600 Sept. 30 Bal. 1,100

40 520 600

(c) Number of calculators at September 30: 10 + 75 – 2 – 26 + 1 – 30 = 28 Cost of calculators at September 30: 28 × $20 = $560

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-4 (a)

April

(b)

April

Solutions Manual .

Merchandise Inventory .................................. Accounts Payable ....................................

28,000

Merchandise Inventory .................................. Cash ........................................................

700

Supplies ........................................................ Accounts Payable ....................................

5,000

Accounts Payable ......................................... Merchandise Inventory.............................

3,500

Accounts Payable ($28,000 – $3,500) .......... Cash .......................................................

24,500

Accounts Payable ($28,000 – $3,500) .......... Cash ($24,500 – $245) ............................ Merchandise Inventory ($24,500 × 1%) ...

24,500

5-20

28,000

700

5,000

3,500

24,500

24,255 245

Chapter 5

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-5 (a)

April

Solutions Manual .

28,000

Cost of Goods Sold ....................................... Merchandise Inventory.............................

19,000

28,000

19,000

No entry necessary - Freight costs paid by Olaf.

No entry necessary.

Sales Returns and Allowances...................... Accounts Receivable ...............................

3,500

Merchandise 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

(b)

Accounts Receivable ..................................... Sales ........................................................

5-21

3,500

2,300

24,500

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-6 (a)

Dec.

3 Accounts Receivable .......................................... Sales .............................................................

18,000

3 Cost of Goods Sold ............................................ Merchandise Inventory ..................................

10,000

18,000

10,000

7 No entry necessary.

(b)

(c)

Dec.

8 Sales Returns and Allowances ........................... Accounts Receivable .....................................

1,200

Merchandise Inventory ....................................... Cost of Goods Sold .......................................

650

11 Cash ($16,800 – $336) ....................................... Sales Discounts [($18,000 – $1,200) × 2%] ....... Accounts Receivable ($18,000 – $1,200) .....

16,464 336

3 Merchandise Inventory ....................................... Accounts Payable .........................................

18,000

7 Merchandise Inventory ....................................... Cash ..............................................................

450

8 Accounts Payable ............................................... Merchandise Inventory ..................................

1,200

11 Accounts Payable ($18,000 – $1,200)................ Merchandise Inventory [($18,000 – $1,200) × 2%]......................... Cash ($16,800 – $336) .................................

16,800

Sales................................................................................... Less: Sales returns and allowances .................................. Sales discounts ........................................................ Net sales............................................................................. Cost of goods sold ($10,000 – $650).................................. Gross profit .........................................................................

Solutions Manual .

5-22

1,200

650

16,800

18,000

450

1,200

336 16,464 $18,000 $1,200 336

1,536 16,464 9,350 $7,114

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-7 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 Land Statement of financial position Property, plant, and equipment Merchandise inventory Statement of financial position Current assets 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

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-8 (a) BLUE DOOR CORPORATION Income Statement (Single-Step) Year Ended December 31, 2015 Revenues Sales ................................................................................ $2,400,000 Less: Sales returns and allowances .................. $41,000 Sales discounts ........................................ 8,500 49,500 Net sales .......................................................................... 2,350,500 Interest revenue .............................................................. 30,000 Rent revenue .................................................................. 24,000 Expenses Cost of goods sold ........................................................... $1,085,000 Salaries expense ............................................................. 675,000 Depreciation expense ...................................................... 125,000 Interest expense .............................................................. 70,000 Advertising expense ......................................................... 55,000 Freight out ........................................................................ 25,000 Insurance expense ........................................................... 15,000 Profit before income tax ............................................................................... Income tax expense ..................................................................................... Profit .............................................................................................................

Solutions Manual .

5-24

$2,404,500

2,050,000 354,500 70,000 $ 284,500

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-8 (Continued) (b) BLUE DOOR CORPORATION Income Statement (Multiple-Step) Year Ended December 31, 2015 Sales ........................................................................................................ $2,400,000 Less: Sales returns and allowances ................................. $41,000 Sales discounts ...................................................... 8,500 49,500 Net sales .................................................................................................. 2,350,500 Cost of goods sold.................................................................................... 1,085,000 Gross profit ............................................................................................... 1,265,500 Operating expenses Salaries expense ......................................................... $675,000 Depreciation expense .................................................. 125,000 Advertising expense ..................................................... 55,000 Freight out .................................................................... 25,000 Insurance expense ....................................................... 15,000 Total operating expenses .............................................................. 895,000 Profit from operations ............................................................................... 370,500 Other revenues and expenses Interest revenue .......................................................... $30,000 Rent revenue ............................................................... 24,000 Interest expense .......................................................... (70,000) (16,000) Profit before income tax ........................................................................... 354,500 Income tax expense ................................................................................. 70,000 Profit ......................................................................................................... $ 284,500

(c)

The Blue Door Corporation is classifying its expenses by function, which is a method of 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 although if listed by nature, cost of goods sold would typically be shown in two parts: goods purchased and changes in inventory.

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Chapter 5

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-9 (a)

Young Ltd. Sales ............................................................................................ *Less: Sales returns and allowances [1].................................. Net sales ......................................................................................

$99,000 10,000 $89,000

Net sales ...................................................................................... Less: Cost of goods sold .............................................................. *Gross profit [2]..........................................................................

$89,000 58,750 $30,250

Gross profit .................................................................................. Less: Operating expenses ........................................................... *Profit from operations [3] ........................................................

$30,250 19,500 $10,750

Profit from operations................................................................... Add: Other revenues .................................................................... *Profit before income tax [4] .....................................................

$10,750 750 $11,500

Profit before income tax ............................................................... Less: Income tax expense ........................................................... *Profit [5] .....................................................................................

$11,500 2,300 $ 9,200

Rioux Lteé *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 .................................................................................. *Less: Operating expenses [8].................................................. Profit from operations...................................................................

$40,000 22,000 $18,000

Profit from operations................................................................... Less: Other expenses .................................................................. *Profit before income tax [9] .....................................................

$18,000 2,000 $16,000

Profit before income tax ............................................................... *Less: Income tax expense [10] ................................................ Profit ............................................................................................

$16,000 3,200 $12,800

* Indicates missing amount

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Chapter 5

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-9 (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%

EXERCISE 5-10 (a) MONTMORENCY LTÉE Income Statement (Multiple-step) Year Ended August 31, 2015 Net sales .................................................................................................. Cost of goods sold.................................................................................... Gross profit ............................................................................................... Operating expenses Administrative expenses .............................................. $670,000 Selling expenses .......................................................... 260,000 Total operating expenses .............................................................. Profit from operations ............................................................................... Other revenues and expenses Other expenses................................................................................... Profit before income tax ........................................................................... Income tax expense ................................................................................. Profit .........................................................................................................

$7,090,000 4,030,000 3,060,000

930,000 2,130,000 270,000 1,860,000 560,000 $1,300,000

(b)

Expenses are classified by function (cost of goods sold, administrative, selling) and not by nature.

(c)

Gross profit margin

$3,060,000 ÷ $7,090,000 = 43.2%

Profit margin

$1,300,000 ÷ $7,090,000 = 18.3%

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Chapter 5

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Financial Accounting, Sixth Canadian Edition

EXERCISE 5-11 (in USD millions) (a)

Gross profit margin 2012: ($50,705 – $38,132) ÷ $50,705 = 24.8% 2011: ($49,747 – $37,197) ÷ $49,747 = 25.2% 2010: ($49,694 – $37,534) ÷ $49,694 = 24.5% Profit margin (using profit) 2012: $(1,231) ÷ $50,705 = –2.4% 2011: $1,003 ÷ $49,747 = 2.0% 2010: $1,317 ÷ $49,694 = 2.7%

(b)

While the gross profit margin has been holding steady, with a slight deterioration from in 2012, the profit margin deteriorated slightly in 2011 and then deteriorated significantly and turned negative in 2012.

(c)

Profit margin (using profit from operations) 2012: $1,085 ÷ $50,705 = 2.1% 2011: $2,374 ÷ $49,747 = 4.8% 2010: $2,235 ÷ $49,694 = 4.5% The profit margin using profit from operations has followed the same trend in 2010 and 2012 when compared to profit margin using profit from operations. On the other hand, profit margin using profit decreased in 2011 while profit margin using profit from operations increased in 2011. The major element that is in the profit margin ratio but is not in the gross profit margin is operating expenses. In 2011, the increased profit margin is likely due to lower operating expenses relative to sales but in 2012, because the profit margin deteriorated so much, it is likely due to increased operating expenses relative to sales.

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 5-12 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

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5-29

28,000

3,500

24,500

Chapter 5

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 5-13 (a)

Duvall Ltd. (Seller) (1) Perpetual Inventory System June 10 Accounts Receivable ......................................... Sales ............................................................

5,000

Cost of Goods Sold ........................................... Merchandise Inventory .................................

3,000

5,000

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

500

4,500

(2) Periodic Inventory System June 10 Accounts Receivable ......................................... Sales ............................................................

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

5-30

500

4,500

Chapter 5

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 5-13 (Continued) (b)

Pele Ltd. (Buyer) (1) Perpetual Inventory System June 10 Merchandise Inventory ....................................... Accounts Payable .........................................

5,000

11 Merchandise Inventory (freight) .......................... Cash ..............................................................

250

12 Accounts Payable ............................................... Merchandise Inventory (returns) ...................

500

19 Accounts Payable ($5,000 – $500)..................... Merchandise Inventory ($4,500 × 1%) .......... Cash ($4,500 – $45) .....................................

4,500

5,000

250

500

45 4,455

(2) Periodic Inventory System June 10 Purchases.......................................................... Accounts Payable ........................................

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

Solutions Manual .

5-31

5,000

250

500 45 4,455

Chapter 5

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 5-14 [1] [2] [3] [4] [5] [6] [7] [8] [9]

$1,420 = $1,550 = $1,750 = $270 = $270 = $1,950 = $230 = $2,030 = $1,950 =

Solutions Manual .

($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 =

5-32

($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)

Chapter 5

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 5-15 (a)

LIVELY LIMITED Income Statement Year Ended February 28, 2015 Sales revenue Sales Less: Sales discounts Sales returns and allowances Net sales Cost of goods sold Merchandise 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: Merchandise inventory, ending Cost of goods sold Gross profit Operating expenses Administrative expenses Selling expenses Total operating expenses Profit from operations Other revenues and expenses Interest expense Profit before income tax Income tax expense Profit

$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

(b) Feb. 28

Solutions Manual .

Merchandise Inventory (ending) .............................. 79,300 Cost of Goods Sold .................................................. 196,950 Purchase Returns and Allowances .......................... 20,800 Purchase Discounts ................................................. 39,000 Merchandise Inventory (beginning) .................... Purchases........................................................... Freight In ............................................................

5-33

54,600 273,000 8,450

Chapter 5

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Financial Accounting, Sixth 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 two month 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 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 to have more cash on hand when needed.

(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. Since the salon staff and customers are resisting the process of scanning products at the time of sale, there might be a tendency for staff not to scan the product, leading to errors in the perpetual inventory record. Enforcing the scanning procedure will strengthen internal control over cash receipts as well. 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, explaining the past’s poor gross profit performance of the salon.

Solutions Manual .

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Chapter 5

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Financial Accounting, Sixth 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.

Solutions Manual .

Merchandise Inventory (140 × $18) ............................. Accounts Payable .............................................

2,520

Accounts Receivable (150 × $22) ................................ Sales .................................................................

3,300

Cost of Goods Sold (150 × $18) .................................. Merchandise Inventory ......................................

2,700

Accounts Payable ........................................................ Merchandise Inventory (10 × $18).....................

180

Accounts Receivable (80 × $25) .................................. Sales .................................................................

2,000

Cost of Goods Sold (80 × $18) .................................... Merchandise Inventory ......................................

1,440

Sales Returns and Allowances .................................... Accounts Receivable .........................................

300

Merchandise Inventory (130 × $15) ............................. Accounts Payable .............................................

1,950

Cash ($3,300 – $66) .................................................... Sales Discounts ($3,300 × 2%).................................... Accounts Receivable ........................................

3,234 66

Cash ($1,700 – $34) .................................................... Sales Discounts ($1,700 × 2%).................................... Accounts Receivable ($2,000 – $300) .............

1,666 34

Accounts Receivable (125 × $25) ................................ Sales .................................................................

3,125

Cost of Goods Sold (125 × $15) .................................. Merchandise Inventory ......................................

1,875

5-35

2,520

3,300

2,700

180

2,000

1,440

300

1,950

3,300

1,700

3,125

1,875

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-2A (Continued) (b) (Continued) June

Sales Returns and Allowances .................................... Accounts Receivable .........................................

375

Merchandise Inventory (15 × $15) ............................... Cost of Goods Sold ...........................................

225

Accounts Payable ($2,520 – $180) .............................. Cash ..................................................................

2,340

375

225

2,340

31 1 11 25 June 30 Bal.

Merchandise Inventory 3,150 June 3 2,520 5 1,950 8 225 22 1,650

2,700 7 720 180 1,440 1,875

(d) Books on hand at June 30 = 175 + 140 – 150 –10 – 80 + 130 – 125 + 15 = 95

Average cost per book = $1,650  95 = $17.37

Solutions Manual .

5-36

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-3A (a) Sept.

Equipment ....................................................................... Accounts Payable ................................................

25,000 25,000

No entry necessary.

Merchandise Inventory.................................................... Accounts Payable ................................................

65,000

Supplies .......................................................................... Cash .....................................................................

4,000

Merchandise Inventory.................................................... Cash .....................................................................

1,600

Accounts Payable ........................................................... Merchandise Inventory .........................................

5,000

Accounts Receivable ...................................................... Sales ....................................................................

20,000

Cost of Goods Sold ......................................................... Merchandise 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) ........................................ Merchandise Inventory ($60,000 × 1%) ...............

60,000

Merchandise Inventory.................................................... Cash .....................................................................

6,000

Accounts Receivable ...................................................... Sales ....................................................................

27,000

Cost of Goods Sold ......................................................... Merchandise Inventory .........................................

20,000

Solutions Manual .

5-37

65,000

4,000

1,600

5,000

20,000

15,000

375

20,000

59,400 600

6,000

27,000 20,000

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-3A (Continued) (a) (Continued) Sept.

No entry necessary.

Sales Returns and Allowances ....................................... Accounts Receivable ............................................

10,000

Merchandise Inventory.................................................... Cost of Goods Sold ..............................................

7,500

Accounts Payable ($65,000 – $5,000) ............................ Cash ....................................................................

60,000

10,000

7,500

(b) Oct.

60,000

The cost of missing this purchase discount is the amount recorded as a reduction to the Merchandise Inventory account when the payment was made within the discount period of September 18 ($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.

Solutions Manual .

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Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-4A (b) April

Solutions Manual .

Merchandise Inventory ............................................ Accounts Payable ...........................................

4,600

Merchandise Inventory ............................................ Cash ...............................................................

120

Accounts Payable .................................................... Merchandise Inventory ...................................

200

Accounts Receivable ............................................... Sales ..............................................................

5,020

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

2,010

Accounts Payable ($4,600 – $200) ......................... Merchandise Inventory ($4,400 × 1%) ............ Cash ($4,400 – $44) .......................................

4,400

Cash ....................................................................... Accounts Receivable ......................................

2,125

Merchandise Inventory ............................................ Accounts Payable ...........................................

1,300

Accounts Payable .................................................... Merchandise Inventory ...................................

100

Accounts Receivable ............................................... Sales ..............................................................

3,200

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

1,285

5-39

4,600

120

200

5,020

2,010

44 4,356

2,125

1,300

100

3,200

1,285

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-4A (Continued) (b) (Continued) April

Accounts Payable ($1,300 – $100) ......................... Merchandise Inventory ($1,200 × 2%)............ Cash ($1,200 – $24) .......................................

1,200

Sales Returns and Allowances ................................ Accounts Receivable ......................................

24 1,176

(a) and (b) Apr. 1 Bal. Apr. 14 Apr. 30 Bal.

Cash 6,000 Apr. 6 2,125 Apr. 12 Apr. 24 2,473

120 4,356 1,176

Accounts Receivable Apr. 10 5,020 Apr. 14 Apr. 20 3,200 Apr. 27 Apr. 30 Bal. 6,010

2,125 85

Merchandise Inventory Apr. 1 Bal. 2,500 Apr. 9 Apr. 3 4,600 Apr. 10 Apr. 6 120 Apr. 12 Apr. 16 1,300 Apr. 17 Apr. 20 Apr. 24 Apr. 30 Bal. 4,857

200 2,010 44 100 1,285 24

Common Shares Apr. 1 Bal. Apr. 30 Bal.

Solutions Manual .

Apr. 9 Apr. 12 Apr. 17 Apr. 24

Accounts Payable 200 Apr. 3 4,400 Apr. 16 100 1,200 Apr. 30 Bal.

4,600 1,300

Sales Apr. 10 Apr. 20 Apr. 30 Bal.

5,020 3,200 8,220

Sales Returns and Allowances Apr. 27 85 Apr. 30 Bal. 85

Apr. 10 Apr. 20 Apr. 30 Bal.

5,100 5,100

Cost of Goods Sold 2,010 1,285 3,295 Retained Earnings Apr. 1 Bal. Apr. 30 Bal.

5-40

3,400 3,400

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-4A (Continued) (c) PINES GOLF SHOP Trial Balance April 30, 2015 Debit Cash .................................................................................. $ 2,473 Accounts receivable .......................................................... 6,010 Merchandise inventory....................................................... 4,857 Common shares ................................................................ Retained earnings ............................................................. Sales.................................................................................. Sales returns and allowances ............................................ 85 Cost of goods sold ............................................................. 3,295 $16,720

Solutions Manual .

5-41

Credit

$ 5,100 3,400 8,220 00 0 00 $16,720

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5A (b) May

Merchandise Inventory ............................................ Accounts Payable ...........................................

5,800

Merchandise Inventory ............................................ Cash ...............................................................

145

Accounts Receivable ............................................... Sales ..............................................................

3,500

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

2,100

Freight Out .............................................................. Cash ...............................................................

Accounts Payable .................................................... Merchandise Inventory ...................................

200

Accounts Payable ($5,800 – $200) ......................... Merchandise 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

Merchandise Inventory ............................................ Accounts Payable ...........................................

2,000

5,800

145

3,500

2,100

200

56 5,544

400

3,500

1,000

2,000

No entry required (freight paid by Harlow)

Cash ....................................................................... Sales ..............................................................

6,500

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

3,900

Solutions Manual .

5-42

6,500

3,900

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5A (Continued) (b) (Continued) May

Sales Returns and Allowances ................................ Cash ...............................................................

100

Merchandise Inventory ............................................ Cost of Goods Sold ........................................

Cost of Goods Sold ................................................. Merchandise Inventory ................................... ($5,249* – $5,100 = $149 shortage)

149

100

149

* Unadjusted balance in Merchandise Inventory account: $3,500 + $5,800 + $145 – $2,100 – $200 – $56 + $2,000 – $3,900 + $60 = $5,249

Solutions Manual .

5-43

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5A (Continued) (a) and (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

Merchandise Inventory May 1 3,500 May 4 May 1 5,800 May 8 May 3 145 May 9 May 18 2,000 May 22 May 29 60 May 31 May 31 Bal. 5,100

2,100 200 56 3,900 149

May 11 May 31 Bal.

May 8 May 9

5,800 2,000 2,000

Sales May 4 May 22 May 31 Bal.

3,500 6,500 10,000

Sales Returns and Allowances May 29 100 May 31 Bal. 100 Sales Discounts May 14 70 May 31 Bal. 70

May 7 May 31 Bal.

Supplies 400 400 Common Shares May 1 Bal. May 31 Bal.

Accounts Payable 200 May 1 5,600 May 18 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

8,000 8,000

Retained Earnings May 1 Bal. May 31 Bal.

Solutions Manual .

5-44

4,000 4,000

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5A (Continued) (c) EAGLE HARDWARE STORE LTD. Income Statement (Partial) Month Ended May 31, 2015 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, 2015 Assets Current assets Cash ......................................................................... Accounts receivable .................................................. Merchandise inventory .............................................. Supplies .................................................................... Total current assets ........................................

Solutions Manual .

5-45

$11,651 500 5,100 400 $17,651

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-6A (a) CLUB CANADA WHOLESALE INC. Income Statement (Single-step) Year Ended December 31, 2015 Revenues Sales ......................................................................................... Less: Sales returns and allowances ...................... $17,745 Sales discounts ............................................ 4,615 Net sales ................................................................................. Interest revenue ...................................................................... Expenses Cost of goods sold .................................................................. Administrative expenses ......................................................... Interest expense ..................................................................... Selling expenses..................................................................... Profit before income tax ............................................................. Income tax expense ................................................................... Profit ...........................................................................................

Solutions Manual .

5-46

$922,360 22,360 900,000 2,400 $692,100 116,115 8,830 5,900

$902,400

822,945 79,455 15,500 $ 63,955

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-6A (Continued) (b) CLUB CANADA WHOLESALE INC. Income Statement (Multiple-step) Year Ended December 31, 2015 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 ....................................... Profit from operations ............................................................. Other revenues and expenses Interest revenue ............................................................... Interest expense ............................................................... Profit before income tax ......................................................... Income tax expense ............................................................... Profit .......................................................................................

$922,360 $17,745 4,615

22,360 900,000 692,100 207,900

$116,115 5,900 0 122,015 85,885 ($2,400) 8,830

6,430 79,455 15,500 $ 63,955

(c)

Both income statements result in the same amount of profit. 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 profit 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).

Solutions Manual .

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Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7A (b) Dec. 31

Solutions Manual .

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 ................................................................ Merchandise Inventory .................................................

2,000

Income Tax Expense .............................................................. Income Tax Payable .....................................................

500

Cost of Goods Sold ................................................................ Merchandise Inventory ................................................. ($28,750 – $2,000 = $26,750 – $23,800 = $2,950 shortage)

2,950

5-48

2,750

2,190

6,000 4,500

750

735

3,025

2,000

500

2,950

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7A (Continued) (a) and (b)

Dec. 31 Dec.31 Bal.

Cash 17,000 17,000

Dec. 31 Dec.31 Bal.

Accounts Receivable Dec. 31 31,700 Dec.31 Bal. 31,700 Merchandise Inventory Dec.31 28,750 Dec. 31 Dec. 31 Dec. 31 Bal. 23,800

Dec. 31 Dec. 31 Bal.

Supplies 2,940 Dec. 31 750

Prepaid Insurance Dec. 31 3,000 Dec. 31 Dec. 31 Bal. 250

Dec. 31 Dec.31 Bal.

Land 30,000 30,000

Dec. 31 Dec.31 Bal.

Buildings 150,000 150,000

Accumulated Depreciation— Equipment Dec. 31 18,000 Dec. 31 4,500 Dec. 31 Bal. 22,500 2,000 2,950

2,190 Dec. 31

2,750

Accumulated Depreciation— Buildings Dec. 31 24,000 Dec. 31 6,000 Dec. 31 Bal. 30,000

Solutions Manual .

Equipment 45,000 45,000

5-49

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.

500 500

Mortgage Payable Dec. 31 Dec.31 Bal.

147,100 147,100

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7A (Continued) (a) and (b) (Continued)

Dec. 31 Dec. 31 Bal.

Common Shares Dec. 31 Dec.31 Bal.

13,000 13,000

Salaries Expense Dec. 31 30,950 Dec. 31 750 Dec. 31 Bal. 31,700

Retained Earnings Dec. 31 Dec.31 Bal.

31,425 31,425

Depreciation Expense Dec. 31 10,500 Dec. 31 Bal. 10,500

Dividends 2,000 2,000 Sales Dec. 31 Dec. 31 Dec.31Bal.

Utilities Expense Dec. 31 5,100 Dec. 31 Bal. 5,100 Insurance Expense Dec. 31 2,750 Dec. 31 Bal. 2,750

265,770 3,025 268,795

Supplies Expense 2,190 2,190

Sales Returns and Allowances Dec. 31 2,500 Dec. 31 Bal. 2,500

Dec. 31 Dec. 31 Bal.

Sales Discounts Dec. 31 3,275 Dec. 31 Bal. 3,275

Interest Expense Dec. 31 8,090 Dec. 31 735 Dec. 31Bal. 8,825

Dec. 31 Dec. 31 Dec. 31 Dec.31Bal.

Solutions Manual .

Cost of Goods Sold 171,225 2,000 2,950 176,175

Income Tax Expense Dec.31 5,500 Dec. 31 500 Dec.31 Bal. 6,000

5-50

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7A (Continued) (c) MESA INC. Adjusted Trial Balance December 31, 2015 Debit Cash ........................................................................... $ 17,000 Accounts receivable.................................................... 31,700 Merchandise inventory................................................ 23,800 Supplies ...................................................................... 750 Prepaid insurance ....................................................... 250 Land............................................................................ 30,000 Buildings ..................................................................... 150,000 Accumulated depreciation—buildings ......................... Equipment .................................................................. 45,000 Accumulated depreciation—equipment ...................... Accounts payable ....................................................... Unearned revenue ...................................................... Salaries payable ......................................................... Interest payable .......................................................... Income tax payable..................................................... Mortgage payable ....................................................... Common shares ......................................................... Retained earnings....................................................... Dividends .................................................................... 2,000 Sales........................................................................... Sales returns and allowances ..................................... 2,500 Sales discounts........................................................... 3,275 Cost of goods sold ...................................................... 176,175 Salaries expense ........................................................ 31,700 Depreciation expense ................................................. 10,500 Utilities expense.......................................................... 5,100 Insurance expense ..................................................... 2,750 Supplies expense ....................................................... 2,190 Interest expense ......................................................... 8,825 Income tax expense.................................................... 6,000 Totals ..................................................................... $549,515

Solutions Manual .

5-51

Credit

$ 30,000 22,500 33,735 975 750 735 500 147,100 13,000 31,425 268,795

0000 000 $549,515

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7A (Continued) (d) MESA INC. Income Statement Year Ended December 31, 2015

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 ................................... Profit from operations ................................................. Other revenues and expenses Interest expense ................................................ Profit before income tax.............................................. Income tax expense ................................................... Profit ...........................................................................

Solutions Manual .

5-52

$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

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7A (Continued) (d) (Continued) MESA INC. Statement of Changes in Equity Year Ended December 31, 2015

Balance, January 1 Issued common shares Profit Dividends 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

MESA INC. Statement of Financial Position December 31, 2015

Assets Current assets Cash .............................................................................................................. Accounts receivable ..................................................................................... Merchandise inventory .................................................................................. Supplies......................................................................................................... Prepaid insurance ......................................................................................... Total current assets .............................................................................. 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 ......... Total assets...................................................................................................

Solutions Manual .

5-53

$ 17,000 31,700 23,800 750 250 73,500

172,500 $246,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7A (Continued) (d) (Continued) Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................................................... Unearned revenue ......................................................................................... Salaries payable ............................................................................................ Interest payable ............................................................................................. Income tax payable ....................................................................................... Current portion of mortgage payable ............................................................. Total current liabilities .......................................................................... Non-current liabilities Mortgage 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 ........................................................

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5-54

$ 33,735 975 750 735 500 9,800 46,495 137,300 183,795

62,205 $246,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-8A (a)

Gross profit margin

$207,900 ÷ $900,000 = 23.1%

Profit margin

$63,955 ÷ $900,000 = 7.1%

(b) Net Sales

Gross Profit

Profit

Existing balances Increase sales ($900,000 × 15%) Increase in gross profit Increase in operating expenses Increase in income tax expense

$ 900,000 135,000

$207,900

$63,955

27,000

27,000 (13,500) (2,700)

Revised amounts

$1,035,000

$234,900

$74,755

$234,900 ÷ $1,035,000 = 22.7%

Revised profit margin

$74,755 ÷ $1,035,000 = 7.2%

While the gross profit margin decreases, the profit margin increases slightly from 7.1% to 7.2%. The plan therefore has marginal merit.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-9A (a) [1] [8]

Sales Accounts receivable

= $540,000 (given) = Sales × 30% = $540,000 × 30% = $162,000

(b) [2] [9]

Cost of goods sold Merchandise 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] [4] [5]

= Sales – Cost of goods sold = $540,000 – $270,000 = $270,000 Operating expenses = $120,000 (given) Profit before income taxes = Gross profit – Operating expenses = $270,000 – $120,000 = $150,000 Gross profit

(d) [6]

Income tax expense

[7]

Profit

[11] Income tax payable

= Profit before income taxes × 30% = $150,000 × 30% = $45,000 = Profit before income taxes – Income tax expense = $150,000 – $45,000 = $105,000 = given as equal to income tax expense = $45,000

(e) Gross profit margin Profit margin

= $270,000 ÷ $540,000 = 50.0% = $105,000 ÷ $540,000 = 19.4%

(e)

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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-10A (a)

($ in thousands) 2012

Current ratio

$60,965 $11,748

Gross profit margin

($148,219 – $71,513) $148,219

Profit margin

$4,003 $148,219

2011 5.2:1

= 51.8%

= 2.7%

$58,948 $12,838

($157,621 – $71,352) $157,621

$7,568 $157,621

2010 =

4.6:1

= 54.7%

= 4.8%

$54,836 $17,958

($164,217 – $77,438) $164,217

$7,219 $164,217

3.1:1

= 52.8%

= 4.4%

The company’s current ratio keeps climbing higher and higher each year from 2010 to 2012. The ratio itself is extremely strong, covering current liabilities 5.2 times. Danier Leather’s gross profit margin improved in 2011 but declined in 2012. This trend is repeated in the profit margin. After improving slightly in 2011, the profit fell further in 2012. (b) Current ratio Gross profit margin Profit margin

2012 Industry Average 2.0:1 37.4% 6.1%

2012 Danier Leather Inc. 5.2:1 51.8% 2.7%

Danier’s current ratio and gross profit margins are substantially higher than the industry averages but its profit margin is much lower than the industry average. This indicates that Danier’s operating expenses are much higher than the industry’s.

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*PROBLEM 5-11A (a) June

Solutions Manual .

Purchases (140 × $18) ............................................ Accounts Payable ...........................................

2,520

Accounts Receivable (150 × $22) ............................ Sales ...............................................................

3,300

Accounts Payable .................................................... Purchase Returns and Allowances .................

180

Accounts Receivable (80 × $25) .............................. Sales ...............................................................

2,000

Sales Returns and Allowances ................................ Accounts Receivable ......................................

300

Purchases (130 × $15) ............................................ Accounts Payable ...........................................

1,950

Cash ($3,300 – $66) ............................................. Sales Discounts ($3,300 × 2%) .............................. Accounts Receivable ..................................

3,234 66

Cash ($1,700 – $34) ........................................... Sales Discounts ($1,700 × 2%) .............................. Accounts Receivable ($2,000 – $300) ........

1,666 34

Accounts Receivable (125 × $25) .......................... Sales ...........................................................

3,125

Sales Returns and Allowances .............................. Accounts Receivable ...................................

375

Accounts Payable ($2,520 − $180) ........................ Cash ............................................................

2,340

5-58

2,520

3,300

180

2,000

300

1,950

3,300

1,700

3,125

375

2,340

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-11A (Continued) (b)

The advantages of the periodic inventory system are that it is simpler and cheaper compared to a perpetual inventory system. There are fewer accounting entries and cash registers need not 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 reduction in inventory levels can be quickly identified and restocking done 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. 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.

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-12A (a) Sept.

Equipment ....................................................................... Accounts Payable ..................................................

25,000 25,000

No entry necessary.

Purchases ....................................................................... Accounts Payable ..................................................

65,000

Supplies .......................................................................... Cash.......................................................................

4,000

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

No entry necessary.

Sales Returns and Allowances ....................................... Accounts Receivable..............................................

Solutions Manual .

5-60

65,000

4,000

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, Sixth Canadian Edition

*PROBLEM 5-12A (Continued) (a) (Continued) (b) Oct.

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 of September 18 ($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.

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*PROBLEM 5-13A (b) Apr.

Solutions Manual .

Purchases ..................................................................................... 4,600 Accounts Payable ................................................................

4,600

Freight In ......................................................................................120 Cash ....................................................................................

120

Accounts Payable .........................................................................200 Purchase Returns and Allowances ......................................

200

Accounts Receivable .................................................................... 5,020 Sales ....................................................................................

5,020

Accounts Payable ($4,600 – $200) ............................................... 4,400 Purchase Discounts ($4,400 × 1%) ..................................... Cash ($4,400 – $44) ............................................................

44 4,356

Cash ............................................................................................ 2,125 Accounts Receivable ...........................................................

2,125

Purchases ..................................................................................... 1,300 Accounts Payable ................................................................

1,300

Accounts Payable .........................................................................100 Purchase Returns and Allowances ......................................

100

Accounts Receivable .................................................................... 3,200 Sales ....................................................................................

3,200

Accounts Payable ($1,300 – $100) ............................................... 1,200 Purchase Discounts ($1,200 × 2%) ..................................... Cash ($1,200 – $24) ............................................................

24 1,176

Sales Returns and Allowances ..................................................... 85 Accounts Receivable ...........................................................

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*PROBLEM 5-13A (Continued) (a) and (b)

120 4,356 1,176

Apr. 30 Bal.

Cash 6,000 Apr. 6 2,125 Apr. 12 Apr. 24 2,473

Apr. 10 Apr. 20 Apr. 30 Bal.

Accounts Receivable 5,020 Apr. 14 3,200 Apr. 27 6,010

2,125 85

Apr. 1 Bal. Apr. 14

Sales Apr. 10 Apr. 20 Apr. 30 Bal.

Sales Returns and Allowances Apr. 27 85 Apr. 30 85

Merchandise Inventory Apr. 1 Bal. 2,500 Apr. 30 Bal. 2,500

Apr. 9 Apr. 12 Apr. 17 Apr. 24

Accounts Payable 200 Apr. 3 4,400 Apr. 16 100 1,200 Apr. 30 Bal.

Apr. 3 Apr. 15 Apr. 30 Bal.

Purchases 4,600 1,300 5,900

Purchase Returns and Allowances Apr. 9 200 Apr. 17 100 Apr. 30 Bal. 300

4,600 1,300

0 Purchase Discounts Apr. 12 Apr. 21 Apr. 30 Bal.

Common Shares Apr. 1 Bal. 5,100 Apr. 30 Bal. 5,100

Retained Earnings Apr. 1 Bal. 3,400 Apr. 30 Bal. 3,400

Solutions Manual .

5,020 3,200 8,220

Apr. 6 Apr. 30 Bal.

5-63

44 24 68

Freight In 120 120

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-13A (Continued) (c) PINES GOLF SHOP Trial Balance April 30

Cash ...................................................................................... Accounts receivable ............................................................... Merchandise inventory ........................................................... Common shares ..................................................................... Retained earnings .................................................................. Sales ...................................................................................... Sales returns and allowances ................................................ Purchases .............................................................................. Freight in ................................................................................ Purchase returns and allowances .......................................... Purchase discounts ................................................................

Debit $ 2,473 6,010 2,500

Credit

$ 5,100 3,400 8,220 85 5,900 120 00 000 $17,088

300 68 $17,088

(d)

Apr. 30

Merchandise Inventory (ending) .............................. Cost of Goods Sold .................................................. Purchase Returns and Allowances .......................... Purchase Discounts ................................................. Merchandise Inventory (beginning) .................... Purchases........................................................... Freight In ............................................................

4,857 3,295* 300 68 2,500 5,900 120

*Cost of goods sold = Beginning inventory + Purchases − Purchase discounts − Purchase returns and allowances + Freight in – Ending inventory Cost of goods sold = $2,500 + $5,900 – $68 – $300 + $120 – $4,857 = $3,295

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-14A (a) FEISTY LTD. Income Statement (Partial) Year Ended April 30, 2015 Sales revenue Sales.................................................................................. Less: Sales returns and allowances. ................................ Net sales............................................................................ Cost of goods sold Merchandise inventory, May 1, 2014 ................................. 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 ......................................... Merchandise inventory, April 30, 2015............................... Cost of goods sold .................................................... Gross profit ............................................................................ (b) Apr. 30

Merchandise Inventory (ending) .............................. Cost of Goods Sold .................................................. Purchase Discounts ................................................. Merchandise Inventory (beginning) .................... Purchases........................................................... Freight In ............................................................

$9,300,000 250,000 9,050,000 $ 600,000

5,980,000 6,580,000 700,000 5,880,000 $3,170,000

700,000 5,880,000 40,000 600,000 5,900,000 120,000

= 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.

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*PROBLEM 5-15A ANDREA’S ATHLETIC WEAR INC. Income Statement Year Ended December 31, 2015

Sales revenue Sales ......................................................................................... Less: Sales discounts .............................................................. Sales returns and allowances ......................................... Net sales ................................................................................... Cost of goods sold Merchandise 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: Merchandise inventory, December 31 ............................. Cost of goods sold .............................................................. Gross profit ...................................................................................... Operating expenses Administrative expenses ............................................................ Selling expenses ....................................................................... Total operating expenses ................................................... Profit from operations ....................................................................... Other revenues and expenses Interest expense ...................................................................... Profit before income tax ................................................................... Income tax expense ......................................................................... Profit ................................................................................................

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5-66

$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

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-15A (Continued) ANDREA’S ATHLETIC WEAR INC. Statement of Changes in Equity Year Ended December 31, 2015 Common Shares Balance, January 1 Issued common shares Profit Dividends Balance, December 31

$ 75,000 37,500 000 0000 $112,500

Retained Earnings $102,900 79,500 (12,000) $170,400

Total Equity $177,900 37,500 79,500 (12,000) $282,900

ANDREA’S ATHLETIC WEAR INC. Statement of Financial Position December 31, 2015

Assets Current assets Cash .............................................................................................................. Accounts receivable ..................................................................................... Merchandise 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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5-67

$ 25,500 66,300 108,900 3,600 204,300

420,450 $624,750

Chapter 5

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Financial Accounting, Sixth 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 .......................................................

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5-68

$ 129,450 5,250 7,200 12,450 18,750 173,100 168,750 341,850

282,900 $624,750

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Financial Accounting, Sixth Canadian Edition

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 outof-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.

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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

Solutions Manual .

Merchandise Inventory (55 × $45) .................... Accounts Payable ..................................

2,475

Accounts Payable ............................................. Merchandise Inventory (5 × $45) ...........

225

Accounts Receivable (50 × $80) ....................... Sales ......................................................

4,000

Cost of Goods Sold (50 × $45) ......................... Merchandise Inventory ...........................

2,250

Sales Returns and Allowances ......................... Accounts Receivable ..............................

400

Merchandise Inventory...................................... Cost of goods Sold (5 × $45) .................

225

Accounts Receivable (5 × $90) ......................... Sales ......................................................

450

Cost of Goods Sold (5 × $45) ........................... Merchandise Inventory ...........................

225

Accounts Payable ($2,475 – $225) ................... Merchandise Inventory ($2,250 × 2%) ... Cash ($2,250 – $45) ..............................

2,250

Accounts Receivable (25 × $80) ....................... Sales ......................................................

2,000

Cost of Goods Sold (25 × $45) ......................... Merchandise Inventory ...........................

1,125

Merchandise Inventory...................................... Accounts Payable ..................................

3,500

5-70

2,475

225

4,000

2,250

400

225

450

225

45 2,205

2,000

1,125

3,500

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-2B (Continued) (b) (Continued) July

Sales Returns and Allowances ......................... Accounts Receivable ..............................

800

Cash ($4,050 – $81) ....................................... Sales Discounts ($4,050 × 2%)......................... Accounts Receivable ($4,000 – $400 + $450) ..........................

3,969 81

Cash ($1,200 – $24) ......................................... Sales Discounts ($1,200 × 2%)......................... Accounts Receivable ($2,000 – $800) ...

1,176 24

800

4,050

1,200

(c)

(d)

July

1 2 7 16

July

Bal.

Merchandise Inventory 1,350 July 3 2,475 6 225 9 3,500 11 13 3,680

225 2,250 225 45 1,125

Number of suitcases on hand at July 31 = 30 + 55 – 5 – 50 + 5 – 5 – 25 + 70 = 75 $3,680  75 = $49.07

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PROBLEM 5-3B (a) Oct.

Solutions Manual .

Merchandise Inventory...................................................... Accounts Payable ..................................................

65,000

Merchandise Inventory...................................................... Cash .......................................................................

1,600

Accounts Payable ............................................................. Merchandise Inventory ...........................................

7,000

Accounts Receivable ........................................................ Sales ......................................................................

100,000

Cost of Goods Sold ........................................................... Merchandise Inventory ...........................................

59,600

Freight Out ........................................................................ Cash .......................................................................

2,300

Sales Returns and Allowances ......................................... Accounts Receivable ..............................................

4,000

Supplies ............................................................................ Cash .......................................................................

5,000

Merchandise Inventory...................................................... Cash .......................................................................

7,500

Cash ($96,000 – $1,920) .................................................. Sales Discounts [($100,000 – $4,000) × 2%] .................... Accounts Receivable ($100,000 – $4,000).............

94,080 1,920

5-72

65,000

1,600

7,000

100,000

59,600

2,300

4,000

5,000

7,500

96,000

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-3B (Continued) (a) (Continued) Oct.

Equipment ......................................................................... Accounts Payable ..................................................

45,000

Accounts Receivable ........................................................ Sales ......................................................................

30,000

Cost of Goods Sold ........................................................... Merchandise Inventory ...........................................

18,000

45,000

30,000

18,000

No entry necessary.

Accounts Payable ($65,000 – $7,000) .............................. Cash .......................................................................

58,000

Sales Returns and Allowances ......................................... Accounts Receivable ..............................................

5,000

Merchandise Inventory...................................................... Cost of Goods Sold ................................................

3,000

Accounts Payable ($65,000 – $7,000) ............................ Merchandise Inventory ($58,000 × 1%) ............... Cash ($58,000 – $580) ........................................

58,000

5,000

3,000

(b) Oct.

580 57,420

The cost of missing this purchase discount is the amount recorded as a reduction to the Merchandise Inventory account when the payment was made within the discount period of October 14 ($580). Expressing this in terms of an annual interest rate, it would be the equivalent of paying 24.6% ($580 ÷ $57,420 × 365/15) for the use of the money for 15 days.

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PROBLEM 5-4B (b) April

Solutions Manual .

Merchandise Inventory ............................................ Accounts Payable ...........................................

4,900

Merchandise Inventory ............................................ Cash ...............................................................

120

Accounts Payable .................................................... Merchandise Inventory ...................................

100

Accounts Payable ($4,900 – $100) ........................ Merchandise Inventory ($4,800 × 2%) ............. Cash ($4,800 – $96) .......................................

4,800

Merchandise Inventory ............................................ Cash ...............................................................

920

Merchandise Inventory ............................................ Cash ...............................................................

Supplies................................................................... Cash ...............................................................

1,300

Cash ....................................................................... Merchandise Inventory ...................................

110

Accounts Receivable ............................................... Sales ..............................................................

6,800

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

4,080

Sales Returns and Allowances ................................ Accounts Receivable ......................................

1,000

Merchandise Inventory ............................................ Cost of Goods Sold .......................................

600

5-74

4,900

120

100

96 4,704

920

1,300

110

6,800

4,080 1,000

600

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-4B (Continued) (b) (Continued) April

Solutions Manual .

Accounts Receivable ............................................... Sales ..............................................................

5,600

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

3,360

Cash ....................................................................... Accounts Receivable ......................................

8,000

Sales Returns and Allowances ............................... Accounts Receivable ......................................

150

Equipment ............................................................... Accounts Payable ...........................................

3,600

5-75

5,600

3,360

8,000

150

3,600

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-4B (Continued) (a) and (b)

Apr. 1 Bal. Apr. 18 Apr. 25

Apr. 30 Bal.

Cash 8,000 Apr. 3 110 Apr. 11 8,000 Apr. 13 Apr. 16 Apr. 17 9,051

Accounts Receivable Apr. 20 6,800 Apr. 21 Apr. 23 5,600 Apr. 25 Apr. 28 Apr. 30 Bal. 3,250

Merchandise Inventory Apr. 1 Bal. 5,400 Apr. 7 Apr. 2 4,900 Apr. 11 Apr. 3 120 Apr. 18 Apr. 13 920 Apr. 20 Apr. 16 15 Apr. 23 Apr. 21 600 Apr. 30 Bal. 4,209

Apr. 14 Apr. 30 Bal.

Apr. 30 Apr. 30 Bal.

Solutions Manual .

120 4,704 920 15 1,300

Apr. 7 Apr. 11

1,000 8,000 150

100 96 110 4,080 3,360

Accounts Payable 100 Apr. 2 4,800 Apr. 30 Apr. 30 Bal.

4,900 3,600 3,600

Common Shares Apr. 1 Bal. Apr. 30 Bal.

6,000 6,000

Retained Earnings Apr. 1 Bal. Apr. 30 Bal.

7,400 7,400

Sales Apr. 20 Apr. 23 Apr. 30 Bal.

6,800 5,600 12,400

Sales Returns and Allowances Apr. 21 1,000 Apr. 28 150 Apr. 30 Bal. 1,150

Supplies 1,300 1,300

Cost of Goods Sold Apr. 20 4,080 Apr. 21 Apr. 23 3,360 Apr. 30 Bal. 6,840

Equipment 3,600 3,600

5-76

600

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-4B (Continued) (c) GRAND SLAM TENNIS SHOP Trial Balance April 30, 2015

Solutions Manual .

5-77

Debit $ 9,051 3,250 4,209 1,300 3,600

Credit

$ 3,600 6,000 7,400 12,400 1,150 6,840 $29,400

0 0000 $29,400

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5B (b) Apr.

Merchandise Inventory ............................................ Accounts Payable ...........................................

8,900

Merchandise Inventory ............................................ Cash ...............................................................

225

8,900

225

Accounts Receivable ............................................... 11,600 Sales ..............................................................

11,600

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

7,540 7,540

Freight Out .............................................................. Cash ...............................................................

290

Sales Returns and Allowances ................................ Accounts Receivable ......................................

1,600

Merchandise Inventory ............................................ Cost of Goods Sold ........................................

1,030

Merchandise Inventory ............................................ Accounts Payable ...........................................

4,200

290

1,600

1,030

4,200

No entry necessary

Accounts Payable .................................................... Merchandise Inventory ...................................

300

Cash ($10,000 – $200) ............................................ Sales Discounts ($10,000 × 2%) ............................. Accounts Receivable ($11,600 – $1,600) ..........

9,800 200

Accounts Payable .................................................... Merchandise Inventory ($8,900 × 1%) ............ Cash ...............................................................

8,900

Accounts Payable ($4,200 – $300)………… Merchandise Inventory ($3,900 × 1%) ............ Cash ($3,900 – $39) .......................................

3,900

Solutions Manual .

5-78

300

10,000 89 8,811

39 3,861

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5B (Continued) (b)

(Continued)

Apr.

Solutions Manual .

Cash ........................................................................ Sales ..............................................................

6,400

Cost of Goods Sold ................................................. Merchandise Inventory ...................................

5,200

Sales Returns and Allowances ................................ Cash ...............................................................

400

Merchandise Inventory ............................................ Cash ...............................................................

6,100

Cash ........................................................................ Merchandise Inventory ...................................

500

5-79

6,400

5,200

400

6,100

500

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5B (Continued) (a) and (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. 6 11,600 Apr. 14 Apr. 30 Bal. 3,500

1,600 10,000

Merchandise Inventory Apr. 1 Bal. 2,500 Apr. 6 Apr. 2 8,900 Apr. 13 Apr. 3 225 Apr. 17 Apr. 10 1,030 Apr. 20 Apr. 11 4,200 Apr. 23 Apr. 27 6,100 Apr. 30 Apr. 30 Bal. 9,287

7,540 300 89 39 5,200 500

Common Shares Apr. 1 Bal. Apr. 30 Bal.

Apr. 13 Apr. 17 Apr. 20

Accounts Payable 300 Apr. 2 8,900 Apr. 11 3,900 Apr. 30 Bal. Sales Apr. 6 Apr. 23 Apr. 30 Bal.

11,600 6,400 18,000

Sales Returns and Allowances Apr. 10 1,600 Apr. 24 400 Apr. 30 Bal. 2,000

5,000 5,000

Apr. 14 Apr. 30 Bal.

Sales Discounts 200 200

Apr. 6 Apr. 30 Bal.

Freight Out 290 290

Cost of Goods Sold Apr. 6 7,540 Apr. 10 Apr. 23 5,200 Apr. 30 Bal. 11,710 Retained Earnings Apr. 1 Bal. Apr. 30 Bal.

Solutions Manual .

8,900 4,200

5-80

1,030

5,000 5,000

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 5-5B (Continued) (c) NISSON DISTRIBUTING LTD. Income Statement Month Ended April 30, 2015 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

NISSON DISTRIBUTING LTD. Statement of Financial Position (Partial) April 30, 2015 Assets Current assets Cash ........................................................................................... Accounts receivable .................................................................... Merchandise inventory ................................................................ Total current assets ..............................................................

Solutions Manual .

5-81

$ 1,013 3,500 9,287 $13,800

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-6B (a) BRIGUS WHOLESALE LTD. Income Statement (Single-step) Year Ended November 30, 2015 Revenues Sales ......................................................................................... Less: Sales returns and allowances ...................... $8,400 Sales discounts ............................................ 7,500 Net sales ................................................................................. Interest revenue ...................................................................... Expenses Cost of goods sold .................................................................. Administrative expenses ......................................................... Selling expenses..................................................................... Interest expense ..................................................................... Profit before income tax ............................................................. Income tax expense ................................................................... Profit ...........................................................................................

Solutions Manual .

5-82

$1,700,600 15,900 1,684,700 3,240 $1,095,000 341,340 86,200 7,400

$1,687,940

1,529,940 158,000 31,000 $ 127,000

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 5-6B (Continued) (b) BRIGUS WHOLESALE LTD. Income Statement (Multiple-step) Year Ended November 30, 2015 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 ....................................... Profit from operations ............................................................. Other revenues and expenses Interest revenue ............................................................... Interest expense ............................................................... Profit before income tax ......................................................... Income tax expense ............................................................... Profit .......................................................................................

$1,700,600 $8,400 7,500

15,900 1,684,700 1,095,000 589,700

$341,340 86,200 427,540 162,160 ($3,240) 7,400

4,160 158,000 31,000 $ 127,000

(c)

(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).

Solutions Manual .

5-83

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7B (b) Nov. 30

30 30

Solutions Manual .

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 Revenue ..........................................................

2,400

Cost of Goods Sold ............................................................ Merchandise Inventory ..............................................

1,560

Income Tax Expense ......................................................... Income Tax Payable ..................................................

1,100

Cost of Goods Sold ............................................................. Merchandise Inventory .............................................. ($27,500 – $1,560 = $25,940 – $25,000 = $940 shortage)

940

5-84

600

700

5,360 1,210

175

2,400

1,560

1,100

940

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7B (Continued) (a) and (b) Cash 22,000 22,000

Accounts Payable Nov. 30 Nov.30 Bal.

34,400 34,400

Accounts Receivable 30,600 30,600

Salaries Payable Nov. 30 Nov. 30 Bal.

1,210 1,210

Merchandise Inventory Nov. 30 27,500 Nov. 30 Nov. 30 Nov. 30 Bal. 25,000

1,560 940

Interest Payable Nov. 30 Nov. 30 Bal.

175 175

700

Income Tax Payable Nov.30 Nov. 30 Bal.

1,100 1,100

Unearned Revenue 2,400 Nov. 30 Nov. 30 Bal.

3,000 600

Bank Loan Payable Nov. 30 Nov.30 Bal.

35,000 35,000

Nov. 30 Nov.30Bal.

Nov.30 Nov.30Bal.

Nov. 30 Nov. 30 Bal.

Supplies 1,650 Nov. 30 950

Prepaid Insurance Nov. 30 1,800 Nov. 30 Nov. 30 Bal. 1,200

Nov. 30 600

Long-term Investments Nov.30 37,000 Nov.30 Bal. 37,000

Nov.30 Nov.30Bal.

Equipment 26,800 26,800

Accumulated Depreciation— Equipment Nov. 30 10,720 Nov. 30 5,360 Nov. 30 Bal. 16,080

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7B (Continued) (a) and (b) (Continued) Common Shares Nov. 30 Nov.30 Bal. Retained Earnings Nov. 30 Nov.30 Bal.

Nov.30 Nov.30 Bal.

16,400 16,400

Depreciation Expense Nov. 30 5,360 Nov.30 Bal. 5,360

30,000 30,000

Rent Expense Nov. 30 13,850 Nov. 30 Bal. 13,850

Dividends 10,000 10,000 Sales Nov. 30 Nov. 30 Nov.30Bal.

Advertising Expense Nov. 30 2,100 Nov. 30 Bal. 2,100

248,500 2,400 250,900

Nov. 30 Nov. 30 Bal.

Insurance Expense Nov. 30 600 Nov. 30 Bal. 600

Sales Returns and Allowances Nov. 30 4,600 Nov. 30 Bal. 4,600

Nov. 30 Nov. 30 Bal.

Supplies Expense 700 700

Interest Expense Nov. 30 4,000 Nov. 30 175 Nov. 30 Bal. 4,175

Sales Discounts 4,520 4,520

Cost of Goods Sold Nov. 30 157,000 Nov. 30 1,560 Nov. 30 940 Nov.30Bal. 159,500

Income Tax Expense Nov. 30 2,000 Nov. 30 1,100 Nov. 30 Bal. 3,100

Salaries Expense Nov. 30 32,600 Nov. 30 1,210 Nov. 30 Bal. 33,810

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7B (Continued) (c) FASHION CENTRE LTD. Adjusted Trial Balance November 30, 2015 Debit Cash ..................................................................................... $ 22,000 Accounts receivable ............................................................. 30,600 Merchandise inventory ......................................................... 25,000 Supplies ................................................................................ 950 Prepaid insurance................................................................. 1,200 Long-term investments ......................................................... 37,000 Equipment ............................................................................ 26,800 Accumulated depreciation—equipment ................................ Accounts payable ................................................................. Salaries payable ................................................................... Interest payable .................................................................... Income tax payable .............................................................. Unearned revenue ................................................................ Bank loan payable ................................................................ Common shares ................................................................... Retained earnings ................................................................ Dividends .............................................................................. 10,000 Sales .................................................................................... Sales discounts .................................................................... 4,520 Sales returns and allowances ............................................... 4,600 Cost of goods sold ................................................................ 159,500 Salaries expense .................................................................. 33,810 Rent expense ....................................................................... 13,850 Depreciation expense ........................................................... 5,360 Supplies expense ................................................................. 700 Insurance expense ............................................................... 600 Interest expense ................................................................... 4,175 Advertising expense ............................................................. 2,100 Income tax expense ............................................................. 3,100 Totals ............................................................................. $385,865

Solutions Manual .

5-87

Credit

$ 16,080 34,400 1,210 175 1,100 600 35,000 16,400 30,000 250,900

0000 000 $385,865

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7B (Continued) (d) FASHION CENTRE LTD. Income Statement Year Ended November 30, 2015

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 .................................................... Profit from operations ........................................................................... Other revenues and expenses Interest expense .......................................................................... Profit before income tax ....................................................................... Income tax expense ............................................................................. Profit ....................................................................................................

Solutions Manual .

5-88

$250,900 9,120 241,780 159,500 82,280

56,420 25,860 4,175 21,685 3,100 $ 18,585

Chapter 5

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-7B (Continued) (d) (Continued) FASHION CENTRE LTD. Statement of Changes in Equity Year Ended November 30, 2015 Common Shares Balance, December 1, 2014 Issued common shares Profit Dividends Balance, November 30, 2015

Retained Earnings

$ 11,400 5,000 _______ $ 16,400

$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, 2015

Assets Current assets Cash ........................................................................................ $22,000 Accounts receivable ................................................................ 30,600 Merchandise 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...................................................................................................

Solutions Manual .

5-89

$ 79,750 37,000

10,720 $127,470

Chapter 5

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Financial Accounting, Sixth 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)

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-8B (a)

Gross profit margin

$589,700 ÷ $1,684,700 = 35.0%

Profit margin

$127,000 ÷ $1,684,700 = 7.5%

(b)

Existing balances Increase sales ($1,684,700 × 10%) Increase in gross profit Increase in operating expenses Increase in income tax expense Revised amounts

Net

Gross

Sales

Profit

$1,684,700

$589,700

$127,000

60,000

60,000 (32,000) (4,000)

$649,700

$151,000

168,470

$1,853,170

$649,700 ÷ $1,853,170 = 35.1%

Revised profit margin

$151,000 ÷ $1,853,170 = 8.1%

While the gross profit margin increases slightly, the profit margin increases by from 7.5% to 8.1%. The plan therefore has merit.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-9B (a) [1] [8]

Sales Accounts receivable

= $400,000 (given) = Sales × 20% = $400,000 × 20% = $80,000

(b) [2] [9]

Cost of goods sold Merchandise 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] [4] [5]

= Sales – Cost of goods sold = $400,000 – $160,000 = $240,000 Operating expenses = $140,000 (given) Profit before income taxes = Gross profit – Operating expenses = $240,000 – $140,000 = $100,000 Gross profit

(d) [6]

Income tax expense

[7]

Profit

[11] Income tax payable

= Profit before income taxes × 30% = $100,000 × 30% = $30,000 = Profit before income taxes – Income tax expense = $100,000 – $30,000 = $70,000 = given as equal to income tax expense = $30,000

(e) Gross profit margin Profit margin

= $240,000 ÷ $400,000 = 60.0% = $70,000 ÷ $400,000 = 17.5%

(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 which 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.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 5-10B (a)

(in SEK millions) 2012

Current ratio

Gross profit margin Profit margin

2011

2010

152,751 ÷ 131,105

172,659 ÷ 143,679

147,139 ÷ 124,059

= 1.2:1

(303,647 – 235,085) 303,647

(310,367 – 236,685) 310,367

(264,749 – 201,797) 264,749

= 22.6%

= 23.7%

= 23.8%

11,258 ÷ 303,647

18,115 ÷ 310,367

11,212 ÷ 264,749

= 3.7%

= 5.8%

= 4.2%

The company’s current ratio remained consistent at 1.2:1 over the three year period. Volvo’s gross profit margin decreased slightly in 2011 and experienced a more substantial decline in 2012. On the other hand, the company’s profit margin improved substantially in 2011 but then declined dramatically in 2012. (b)

Current ratio Gross profit margin Profit margin

2012 Industry Average 0.9:1 13.5% (3.8)%

2012 AB Volvo 1.2:1 22.6% 3.7%

The 2012 gross profit margin and profit margin are well above the industry averages, indicating that the company is performing better than the average company in the industry. Its 2012 current ratio is also substantially stronger than the average company in the industry, indicating the company’s liquidity is stronger than most companies in the industry.

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-11B (a) July

Solutions Manual .

Purchases (55 × $45) ............................................. Accounts Payable ..........................................

2,475

Accounts Payable ................................................... Purchase Returns and Allowances .................

225

Accounts Receivable (50 × $80) ............................. Sales..............................................................

4,000

Sales Returns and Allowances ............................... Accounts Receivable .....................................

400

Accounts Receivable (5 × $90) ............................... Sales..............................................................

450

Accounts Payable ($2,475 – $225) ......................... Purchase Discounts ($2,250 × 2%) .............. Cash ($2,250 – $45) ....................................

2,250

Accounts Receivable (25 × $80) ............................. Sales ............................................................

2,000

Purchases ............................................................... Accounts Payable ........................................

3,500

Sales Returns and Allowances ................................ Accounts Receivable ....................................

800

Cash ($4,050 – $81) ............................................. Sales Discounts ($4,050 × 2%) ............................... Accounts Receivable ($4,000 – $400 + $450) ................................

3,969 81

Cash ($1,200 – $24) ............................................... Sales Discounts ($1,200 × 2%) ............................... Accounts Receivable ($2,000 – $800) .........

1,176 24

5-94

2,475

225

4,000

400

450

45 2,205

2,000

3,500

800

4,050

1,200

Chapter 5

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-11B (Continued) (b)

Solutions Manual .

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*PROBLEM 5-12B (a) Oct.

Purchases ............................................................................ Accounts Payable ........................................................

65,000

Freight In .............................................................................. Cash ............................................................................

1,600

Accounts Payable ................................................................. Purchase Returns and Allowances ..............................

7,000

Accounts Receivable ............................................................ Sales ...........................................................................

100,000

Freight Out ........................................................................... Cash ............................................................................

2,300

Sales Returns and Allowances ............................................. Accounts Receivable ...................................................

4,000

Supplies................................................................................ Cash ............................................................................

5,000

Purchases ............................................................................ Cash ............................................................................

7,500

Cash ($96,000 – $1,920) ...................................................... Sales Discounts [($100,000 – $4,000) × 2%] ....................... Accounts Receivable ($100,000 – $4,000) .................

94,080 1,920

Equipment ............................................................................ Accounts Payable ........................................................

45,000

Accounts Receivable ............................................................ Sales ...........................................................................

30,000

65,000

1,600

7,000

100,000

2,300

4,000

5,000

7,500

96,000

45,000

30,000

No entry necessary.

Accounts Payable ($65,000 – $7,000) ................................. Cash ...........................................................................

58,000

Sales Returns and Allowances ............................................. Accounts Receivable ..................................................

5,000

Solutions Manual .

5-96

58,000

5,000

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-12B (Continued) (b) Oct.

Accounts Payable ($65,000 – $7,000) ............................ Purchase Discounts ($58,000 × 1%) .................... Cash ($58,000 – $580) ........................................

58,000 580 57,420

The cost of missing this purchase discount is the amount recorded as a purchase discount when the payment was made within the discount period of October 14 ($580). Expressing this in terms of an annual interest rate, it would be the equivalent of paying 24.6% ($580 ÷ $57,420 × 365/15) for the use of the money for 15 days.

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*PROBLEM 5-13B (b) Apr.

Solutions Manual .

Purchases ............................................................................ Accounts Payable........................................................

4,900

Freight In .............................................................................. Cash ............................................................................

120

Accounts Payable ................................................................ Purchase Returns and Allowances..............................

100

Accounts Payable ($4,900 – $100) ...................................... Purchase Discounts ($4,800 × 2%) ............................. Cash ($4,800 – $96)....................................................

4,800

Purchases ............................................................................ Cash ............................................................................

920

Freight In .............................................................................. Cash ............................................................................

Supplies ............................................................................... Cash ............................................................................

1,300

Cash .................................................................................... Purchase Returns and Allowances..............................

110

Accounts Receivable ............................................................ Sales ...........................................................................

6,800

4,900

120

100

96 4,704

920

1,300

110

6,800

Sales Returns and Allowances ............................................. 1,000 Accounts Receivable ...................................................

1,000

Accounts Receivable ............................................................ 5,600 Sales ...........................................................................

5,600

Cash .................................................................................... 8,000 Accounts Receivable ...................................................

8,000

Sales Returns and Allowances ............................................. Accounts Receivable ...........................................

5-98

150 150

Chapter 5

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 5-13B (Continued) (b) (Continued) 30

Equipment .................................................................... 3,600 Accounts Payable ........................................................

3,600

(a) and (b)

Apr. 1 Bal. Apr. 18 Apr. 25

Apr. 30 Bal.

Cash 8,000 Apr. 3 110 Apr. 11 8,000 Apr. 13 Apr. 16 Apr. 17 9,051

Accounts Receivable Apr. 20 6,800 Apr. 21 Apr. 23 5,600 Apr. 25 Apr. 28 Apr.30 Bal. 3,250

120 4,704 920 15 1,300

1,000 8,000 150

Common Shares Apr. 1 Bal. Apr. 30 Bal.

6,000 6,000

Retained Earnings Apr. 1 Bal. Apr. 30 Bal.

7,400 7,400

Sales Apr. 20 6,800 Apr. 23 5,600 Apr. 30 Bal. 12,400

Merchandise Inventory Apr. 1 Bal. 5,400 Apr. 30 Bal. 5,400

Apr. 14 Apr. 30 Bal.

Supplies 1,300 1,300

Apr. 27 Apr. 30 Bal.

Equipment 3,600 3,600

Apr. 7 Apr. 11

Solutions Manual .

Accounts Payable 100 Apr. 2 4,800 Apr. 27 Apr. 30 Bal.

4,900 3,600 3,600

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*PROBLEM 5-13B (Continued) (a) and (b) (Continued) Sales Returns and Allowances Apr. 21 1,000 Apr. 28 150 Apr. 30 Bal. 1,150

Apr. 2 Apr. 13 Apr. 30 Bal.

Purchases 4,900 920 5,820

Purchase Returns and Allowances Apr. 7 100 Apr. 18 110 Apr. 30 Bal. 210

Purchase Discounts Apr. 11 Apr. 30 Bal.

Apr. 3 Apr. 16 Apr. 30 Bal.

Solutions Manual .

96 96

Freight In 120 15 135

5-100

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*PROBLEM 5-13B (Continued) (c) GRAND SLAM TENNIS SHOP Trial Balance April 30, 2015

Cash ....................................................................................... Accounts receivable ............................................................... Merchandise inventory ........................................................... Supplies .................................................................................. Equipment .............................................................................. Accounts payable ................................................................... Common shares ..................................................................... Retained earnings .................................................................. Sales ...................................................................................... Sales returns and allowances ................................................. Purchases............................................................................... Purchase returns and allowances........................................... Purchase discounts ................................................................ Freight in ................................................................................

Debit $ 9,051 3,250 5,400 1,300 3,600

Credit

$ 3,600 6,000 7,400 12,400 1,150 5,820 210 96 00 000 $29,706

135 $29,706

(d) Apr. 30

Merchandise Inventory (ending) .............................. Cost of Goods Sold .................................................. Purchase Returns and Allowances .......................... Purchase Discounts ................................................. Merchandise Inventory (beginning) .................... Purchases .......................................................... Freight In ............................................................

4,209 6,840* 210 96 5,400 5,820 135

*Cost of goods sold = Beginning inventory + Purchases – Purchase discounts – Purchase returns and allowances + Freight in – Ending inventory Cost of goods sold = $5,400 + $5,820 – $96 – $210 + $135 – $4,209 = $6,840

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*PROBLEM 5-14B (a) SEVERN LIMITED Income Statement (Partial) Year Ended June 30, 2015 Sales revenue Sales ..................................................................................... $7,800,000 Less: Sales discounts ........................................................... 100,000 Net sales................................................................................ 7,700,000 Cost of goods sold Merchandise inventory, July 1, 2014 ..................................... $ 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 Merchandise inventory, June 30, 2015 ................................. 600,000 Cost of goods sold ........................................................ 6,040,000 Gross profit ................................................................................ $1,660,000 (b) June 30

Merchandise Inventory (ending) .............................. Cost of Goods Sold .................................................. Purchase Returns and Allowances .......................... Merchandise Inventory (beginning) .................... Purchases .......................................................... Freight In ............................................................

600,000 6,040,000 240,000 520,000 6,280,000 80,000

= 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.

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*PROBLEM 5-15B THE GOODY SHOP LTD. Income Statement Year Ended November 30, 2015

Sales revenue Sales ......................................................................................... Less: Sales discounts .............................................................. Sales returns and allowances......................................... Net sales ................................................................................... Cost of goods sold Merchandise inventory, December 1, 2014 .............................. 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 ................................................ Merchandise inventory, November 30, 2015 ............................ Cost of goods sold .............................................................. Gross profit...................................................................................... Operating expenses Administrative expenses............................................................ Selling expenses ...................................................................... Total operating expenses .................................................. Profit from operations ...................................................................... Other revenues and expenses Interest expense ...................................................................... Profit before income tax ................................................................. Income tax expense ....................................................................... Profit ..............................................................................................

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$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

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*PROBLEM 5-15B (Continued) THE GOODY SHOP LTD. Statement of Changes in Equity Year Ended November 30, 2015 Common Shares Balance, December 1, 2014 Issued common shares Profit Dividends Balance, November 30, 2015

$ 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

THE GOODY SHOP LTD. Statement of Financial Position November 30, 2015

Assets Current assets Cash ...................................................................................................... Accounts receivable ............................................................................. Merchandise 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 ..........................................

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$ 32,310 3,000 8,500 3,500 6,000 5,300 58,610 100,700 159,310

140,730 $300,040

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BYP 5-1 FINANCIAL REPORTING (in USD millions) (a)

Shoppers Drug Mart is a merchandising company because it buys products and resells them to the public.

(b)

Shoppers Drug Mart classifies its operating expenses by function since captions include titles like “operating and administrative” expenses. Furthermore, cost of goods sold is shown rather than being split into purchases and change in inventory.

(c)

Other non-operating revenues or expenses reported include finance expenses totalling $57,595,000.

(d) and (e) ($ in thousands)

(f)

2012

2011

Gross profit margin

$4,172,619 $10,781,848

= 38.7%

$4,042,444 $10,458,652

38.7%

Profit margin

$608,481 $10,781,848

= 5.6%

$613,934 $10,458,652

5.9%

The company’s profitability deteriorated in 2012. In spite of achieving the same gross profit margin, Shoppers’ profit margin decreased from 5.9% to 5.6% of sales. This was due to higher operating expenses.

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BYP 5-2 COMPARATIVE ANALYSIS

(a)

1 Percentage 1. . change in sales

1Percentage 2. .change in operating income

(b)

Gross profit margin

Profit margin

Jean Coutu (in millions)

Shoppers Drug Mart (in millions)

($2,468.0 – $2,463.2) $2,463.2

($10,782 – $10,459) $10,459

= 0.2%

= 3.1%

($291.3 – $280.8) $280.8

($881 – $911) $911

= 3.7%

= (3.3%)

($2,468.0 – $2,169.0) $2,468.0

$4,173 $10,782

= 12.1%

= 38.7%

$558.4 $2,468.0

$608 $10,782

= 22.6%

= 5.6%

Although Jean Coutu appears to be profitable based on its profit margin, that ratio needs to be adjusted to exclude the unrealized gain related to the investment in Rite Aid, in order to measure a normalized profit margin. This revised profit margin would have the net profit of $558.4 reduced by $265.2. When divided by sales of $2,468.0 the calculation yields a revised profit margin of 11.9%. Even at the revised profit margin of 11.9%, the profit margin for Jean Coutu is more than double that of Shoppers Drug Mart. On the other hand, the gross profit margin for Shoppers is more than three times that of Jean Coutu. Shoppers’ sales are increasing at a greater pace than Jean Coutu. However, the operating profit of Shoppers is declining.

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BYP 5-3 COMPARING IFRS AND ASPE (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 which 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 only two categories—cost of goods sold and general administrative expenses. In some other cases, for example, depreciation expense may have to be allocated to store operating expenses and general and office expense.

(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 definition of gross profit and profit and therefore the related amounts do not change when preparing the income statement 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.

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BYP 5-4 CRITICAL THINKING 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:

Net sales Cost of goods sold Gross profit Operating expenses Profit from operations Income tax expense Profit Gross profit margin: $51,000 ÷ $113,000 Gross profit margin: $40,000 ÷ $100,000

2015 Draft Adjustments 2015 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 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 and because of this, the CEO will not obtain a bonus. (b)

The profit margin in 2015 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.

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BYP 5-4 (Continued) (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 due 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 Retailers Ltd. 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.

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BYP 5-5 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 his unethical behaviour) 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.

Comply with Jamie’s directions and continue the unethical practice of taking unearned cash discounts.

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.

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BYP 5-6 “ALL ABOUT YOU” ACTIVITY (a)

The gross profit margin would remain the same for both alternatives. Costs of purchasing merchandise would remain the same. Cost to have the merchandise shipped from the supplier to your place of business would likely not change (assuming that the location will remain the same).

(b)

The profit margin may change depending upon the alternative that is chosen. If another store is opened then additional costs incurred would include rent for premises, utilities for the premises, depreciation on the capital costs incurred to purchase additional equipment, as well as the hiring of additional staff members. If a website is the alternative chosen then additional costs may include the hiring of staff to fill orders, costs of having orders shipped, costs to maintain the website up to date, depreciation on the capital costs to set up the website, costs of renting additional premises if the current premises are not large enough to hold the additional inventory required.

(c)

Other issues that must be considered include availability of inventory (can I buy more inventory from my suppliers?), customer demand, customer loyalty, type of customer (do they own a computer?), cash flow (how are you going to finance one of these alternatives?), availability of staff in your neighbourhood, availability of space and location.

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BYP 5-7

Financial Accounting, Sixth Canadian Edition

SERIAL CASE

For (a) and (b) Note to instructors: June balances were taken from the answer to BYP 4-7. (a) June

Merchandise Inventory.......................................... 1,750 Cost of Goods Sold ...................................... 1,750 ($18,000 physical count – $16,250 perpetual record = $1,750 overage)

Income Tax Expense ............................................ Income Tax Payable ....................................

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BYP 5-7 (Continued) (b)

June Bal.

Cash 18,674 (Ch. 4)

June Bal.

Vehicles 52,500 (Ch. 4)

Accounts Receivable June Bal. 12,090 (Ch. 4)

Accumulated Depreciation—Vehicles (Ch. 4) June Bal. 5,250

Merchandise Inventory June Bal. 16,250 (Ch. 4) 30 AJE 1,750 June Bal. 18,000

(Ch. 4)

Accounts Payable June Bal.

7,165

(Ch. 4)

Unearned Revenue June Bal.

500

(Ch. 4)

Salaries Payable June Bal.

208

(Ch. 4)

Interest Payable June Bal.

Income Tax Payable June 30 AJE

937

June Bal.

Supplies 3,775 (Ch. 4)

Prepaid Insurance 20,080 (Ch. 4)

Land June Bal. 100,000 (Ch. 4)

Buildings June Bal. 165,000 (Ch. 4) (Ch. 4)

Bank Loan Payable June Bal.

22,500

(Ch. 4)

Mortgage Payable June Bal.

53,200

(Ch. 4)

Common Shares June Bal.

300

Accumulated Depreciation—Buildings (Ch. 4) June Bal. 143,000

June Bal.

Equipment 44,520 (Ch. 4)

Accumulated Depreciation—Equipment (Ch. 4) Bal. 21,035

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BYP 5-7 (Continued) (b) (Continued)

(Ch. 4)

Retained Earnings June Bal.

June Bal.

Dividends 30,000 (Ch. 4)

(Ch. 4)

Rent Revenue June Bal.

6,000

(Ch. 4)

Sales June Bal.

645,358

66,788

Sales Returns and Allowances June Bal. 5,000 (Ch. 4)

Cost of Goods Sold June Bal. 102,386 (Ch. 4) June 30 AJE 1,750 June Bal. 100,636

June Bal.

Depreciation Expense 17,785 (Ch. 4)

June Bal.

Freight Out 18,000 (Ch. 4)

June Bal.

Utilities Expense 13,125 (Ch. 4)

June Bal.

Advertising Expense 9,600 (Ch. 4)

June Bal.

Insurance Expense 7,280 (Ch. 4)

June Bal.

Property Tax Expense 5,950 (Ch. 4)

June Bal.

Interest Expense 5,354 (Ch. 4)

Salaries Expense 290,990 (Ch. 4) Income Tax Expense June Bal. 33,000 (Ch. 4) 30 AJE 937 June Bal. 33,937

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BYP 5-7 (Continued) (c) KOEBEL’S FAMILY BAKERY LTD. Adjusted Trial Balance June 30, 2014 Debit Cash Accounts receivable Merchandise 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 Rent revenue Sales Sales returns and allowances Cost of goods sold Salaries expense Depreciation expense Freight out Utilities expense Advertising expense Insurance expense Property tax expense Interest expense Income tax expense Total

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Credit

$ 18,674 12,090 18,000 3,775 20,080 100,000 165,000 $143,000 44,520 21,035 52,500 5,250 7,165 500 208 55 937 22,500 53,200 300 66,788 30,000 6,000 645,358 5,000 100,636 290,990 17,785 18,000 13,125 9,600 7,280 5,950 5,354 33,937 $972,296

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BYP 5-7 (Continued) (d) KOEBEL’S FAMILY BAKERY LTD. Income Statement Year Ended June 30, 2014 Sales revenue Sales ........................................................................................... Less: Sales returns and allowances........................................... Net sales ..................................................................................... Cost of goods sold .............................................................................. Gross profit .......................................................................................... Operating expenses Salaries expense ..................................................... $290,990 Depreciation expense ............................................... 17,785 Freight out ............................................................... 18,000 Utilities expense ....................................................... 13,125 Advertising expense ................................................. 9,600 Insurance expense ................................................... 7,280 Property tax expense ............................................... 5,950 Total operating expenses .................................................... Profit from operations........................................................................... Other revenues and expenses Rent revenue ............................................................ $6,000 Interest expense ...................................................... 5,354 Profit before income tax ....................................................................... Income tax expense ............................................................................. Profit ....................................................................................................

$645,358 5,000 640,358 100,636 539,722

362,730 176,992

646 177,638 33,937 $143,701

(e) Retained Earnings: Beginning balance ............................................................................... Add: Profit ........................................................................................... Less: Dividends ................................................................................... Ending balance ....................................................................................

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$ 66,788 143,701 (30,000) $180,489

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BYP 5-7 (Continued) (f) KOEBEL’S FAMILY BAKERY LTD. Statement of Financial Position June 30, 2014 Assets Current assets Cash ............................................................................................................. Accounts receivable ..................................................................................... Merchandise inventory .................................................................................. Supplies ........................................................................................................ Prepaid insurance ......................................................................................... Total current assets ............................................................................. Property, plant, and equipment Land ..................................................................... $100,000 Buildings .............................................................. $165,000 Less: Accumulated depreciation .......................... 143,000 22,000 Equipment ............................................................ $44,520 Less: Accumulated depreciation .......................... 21,035 23,485 Vehicles ............................................................... $52,500 Less: Accumulated depreciation .......................... 5,250 47,250 Total property, plant, and equipment.......... Total assets ..................................................................................................

$ 18,674 12,090 18,000 3,775 20,080 72,619

192,735 $265,354

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 ......................................................................... Non-current liabilities Bank loan payable ($22,500 – $7,500).......................................................... Mortgage payable ($53,200 – $5,000) .......................................................... Total liabilities ...................................................................................... Shareholders’ equity Common shares........................................................................ $ 300 Retained earnings ..................................................................... 180,489 Total shareholders’ equity .................................................................... Total liabilities and shareholders’ equity .......................................................

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7,165 500 208 55 937 7,500 5,000 21,365 15,000 48,200 84,565

180,789 $265,354

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BYP 5-7 (Continued) (g) Koebel

Competitor

$72,619 = 3.4:1 $21,365

2:1

Gross profit Margin

$539,722 = 84.3% $640,358

75%

Profit margin

$143,701 = 22.4% $640,358

15%

Current ratio

Koebel’s Family Bakery’s ratios are better in every respect. Koebel has better liquidity and profitability than its competitor. Of course, you must recall that Koebel’s 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 their financial results.

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COMPREHENSIVE CASE: CHAPTERS 1 – 5 (b) Date

Account Titles

March 1

Debit

Credit

Cash .................................................................................... 125,000 Accounts Receivable...................................................

125,000

Accounts Payable ................................................................ 200,000 Merchandise Inventory ($200,000 × 2%) ................................................. Cash ($200,000 – $4,000) ..........................................

4,000 196,000

Merchandise Inventory......................................................... 300,000 Accounts Payable .......................................................

300,000

Cash .................................................................................... 285,000 Sales ...........................................................................

285,000

Cost of Goods Sold .............................................................. 200,000 Merchandise Inventory ................................................

200,000

25,000 Accounts Payable ................................................................ Merchandise Inventory ................................................

25,000

No entry necessary

Accounts Receivable ........................................................... 200,000 Sales ...........................................................................

200,000

Cost of Goods Sold .............................................................. 140,000 Merchandise Inventory ................................................

140,000

Freight Out ........................................................................... 5,000 Cash ...........................................................................

5,000

12,500 Cash .................................................................................... Unearned Revenue .....................................................

12,500

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (b) (Continued) Date

Account Titles

March 13

Solutions Manual .

Debit

Credit

Sales Returns and Allowances ............................................ 20,000 Accounts Receivable...................................................

20,000

14,000 Merchandise Inventory ......................................................... Cost of Goods Sold .....................................................

14,000

Accounts Payable ($300,000 – $25,000) ............................. 275,000 Merchandise Inventory ($275,000 × 2%) ................................................... Cash ($300,000 – $25,000 – $5,500)

5,500 269,500

45,000 Salaries Expense ................................................................. Cash............................................................................

45,000

Cash ($200,000 – $20,000 – $3,600) .................................. 176,400 Sales Discounts ($180,000 × 2%)........................................ 3,600 Accounts Receivable ($200,000 – $20,000) ............................................

180,000

255,000 Cash ................................................................................... Sales ...........................................................................

255,000

Cost of Goods Sold .............................................................. 179,000 Merchandise Inventory ................................................

179,000

Salaries Expense ................................................................. 50,000 Cash ............................................................................

50,000

Rent Expense ...................................................................... 5,000 Cash ...........................................................................

5,000

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (d) Date

Account Titles

March 31

Solutions Manual .

Debit

Credit

Utilities Expense .................................................................. 10,000 Accounts Payable .......................................................

10,000

Salaries Expense ................................................................. 10,000 Salaries Payable .........................................................

10,000

Interest Expense .................................................................. 9,000 Interest Payable ..........................................................

9,000

Depreciation Expense .......................................................... 14,500 Accumulated Depreciation—Equipment ...................... ($145,000 ÷ 10 years = $14,500)

14,500

Income Tax Expense ........................................................... 50,000 Income Tax Payable ...................................................

50,000

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (a), (b), (d) and (g) Cash

Supplies

Feb. 28 Bal.

65,000

Feb. 28 Bal.

7,500

Mar.

125,000 Mar.

196,000

Mar. 31 Bal.

7,500

285,000

5,000

12,500

269,500

176,400

45,000

Feb. 28

Bal.

5,000

255,000

50,000

Mar. 31

Bal.

5,000

Prepaid Rent

Mar. 31 Bal. 348,400

Equipment

Accounts Receivable Feb. 28 Bal. 350,000 Mar.

200,000 Mar.

125,000

20,000

180,000

Feb. 28 Bal.

145,000

Mar. 31 Bal.

145,000

Accumulated Depreciation —Equipment

Mar. 31 Bal. 225,000 Merchandise Inventory 5 13

300,000 Mar. 14,000

28 Bal.

29,000

Mar.

14,500

Mar.

31 Bal.

43,500

Accounts Payable

Feb. 28 Bal. 2,750,000 Mar.

Feb.

4,000

200,000

25,000

140,000

5,500

179,000

Feb. Mar.

28 Bal. 1,550,000

200,000 Mar.

300,000

25,000

10,000

275,000 Mar.

31 Bal. 1,360,000

Mar. 31 Bal. 2,510,500

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (a), (b), (d) and (g) (Continued)

Salaries Payable Mar.

Mar.

10,000 Bal.

10,000

Interest Payable Mar.

Mar.

9,000 Bal.

9,000

Bal.

35,000

Unearned Revenue Feb.

Mar.

12,500 Bal.

47,500

Bank Loan Payable – Non-Current Feb.

Bal. 450,000

Mar.

Bal. 450,000

Income Tax Payable Mar.

50,000

Mar.

Bal. 50,000

Common Shares Feb.

Bal.

200,000

Mar.

Bal.

200,000

Feb.

28 Bal.

550,500

50,000 Mar.

31 CE

570,900

Retained Earnings Mar. 31

Mar.

Solutions Manual .

31 Bal. 1,071,400

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (a), (b), (d) and (g) (Continued) Dividends Feb. 28 Bal.

50,000

Mar. 31 Bal.

50,000 Mar. 31 CE

Mar. 31 Bal.

50,000

0 Sales Feb. 28 Bal. 5,479,400 Mar.

285,000

200,000

255,000

Mar. 31 Bal. 6,219,400 Mar. 31 CE

6,219,400 Mar. 31 Bal.

Sales Returns and Allowances Feb. 28 Bal. 107,000 Mar. 13

20,000

Mar. 31 Bal. 127,000 Mar. 31 Mar. 31 Bal.

CE 127,000

0 Sales Discounts

Feb. 28 Bal.

65,000

Mar. 19

3,600

Mar. 31 Bal.

68,600 Mar. 31 CE

Mar. 31

Bal.

Solutions Manual .

68,600

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (a), (b), (d) and (g) (Continued)

Advertising Expense Feb. 28 Bal.

75,000

Mar. 31 Bal.

75,000 Mar. 31 CE

Mar. 31

Bal.

75,000

Cost of Goods Sold Feb. 28 Bal. 3,843,900 Mar.

200,000 Mar.

140,000

179,000

14,000

Mar. 31 Bal. 4,348,900 Mar. 31 CE 4,348,900 Mar. 31

Bal.

0 Freight Out

Feb. 28 Bal. 180,000 Mar.

5,000

Mar. 31 Bal. 185,000 Mar. 31 CE Mar. 31

Bal.

185,000

Depreciation Expense Feb. 28 Bal.

Mar. 31

14,500

Mar. 31 Bal.

14,500 Mar. 31 CE

Mar. 31

Bal.

Solutions Manual .

14,500

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (a), (b), (d) and (g) (Continued) Interest Expense Feb. 28 Bal.

27,000

Mar. 31

9,000

Mar. 31 Bal.

36,000 Mar. 31 CE 36,000

Mar. 31

Bal.

0 Office Expense

Feb. 28 Bal.

26,000

Mar. 31 Bal.

26,000 Mar. 31 CE 26,000

Mar. 31

Bal.

0 Rent Expense

Feb. 28 Bal.

55,000

Mar. 30

5,000

Mar. 31 Bal.

60,000 Mar. 31 CE 60,000

Mar. 31

Bal.

Salaries Expense Feb. 28

Bal. 360,000

Mar. 16

45,000

50,000

10,000

Mar. 31

Bal. 465,000 Mar. 31 CE 465,000

Mar. 31

Bal.

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (a), (b), (d) and (g) (Continued) Travel Expense Feb. 28

Bal.

12,500

Mar. 31

Bal.

12,500 Mar. 31 CE

Mar. 31

Bal.

12,500

0 Utilities Expense

Feb. 28

Bal.

Mar. 31 Mar. 31

20,000 10,000

Bal.

30,000 Mar. 31 CE

Mar. 31

Bal.

30,000

Income Tax Expense Feb. 28

Bal.

150,000

Mar. 31

50,000

Mar. 31 Bal.

200,000 Mar. 31 CE

Mar. 31

Bal.

200,000

0 Income Summary

Mar. 31 CE 5,648,500 Mar. 31 CE 6,219,400 CE Bal.

Solutions Manual .

570,900 0

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (c) HERITAGE FURNITURE LIMITED Trial Balance March 31, 2015 Debit $ 348,400 225,000 2,510,500 7,500 5,000 145,000

Cash Accounts receivable Merchandise inventory Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Unearned revenue Bank loan payable—non-current Common shares Retained earnings Dividends Sales Sales returns and allowances Sales discounts Advertising expense Cost of goods sold Freight out Interest expense Office expense Rent expense Salaries expense Travel expense Utilities expense Income tax expense

Solutions Manual .

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 27,000 26,000 60,000 455,000 12,500 20,000 150,000 $8,846,400

5-129

000000v 0 $8,846,400

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (e) HERITAGE FURNITURE LIMITED Adjusted Trial Balance March 31, 2015 Debit $ 348,400 225,000 2,510,500 7,500 5,000 145,000

Cash Accounts receivable Merchandise inventory Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Salaries payable Interest payable Unearned revenue Bank loan payable—non-current Income tax payable Common shares Retained earnings Dividends Sales Sales returns and allowances Sales discounts Cost of goods sold Advertising expense Freight out Depreciation expense Interest expense Office expense Rent expense Salaries expense Travel expense Utilities expense Income tax expense

Solutions Manual .

Credit

$ 43,500 1,360,000 10,000 9,000 47,500 450,000 50,000 200,000 550,500 50,000 6,219,400 127,000 68,600 4,348,900 75,000 185,000 14,500 36,000 26,000 60,000 465,000 12,500 30,000 200,000 $8,939,900

5-130

000000v 0 $8,939,900

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (f) HERITAGE FURNITURE LIMITED Income Statement Year Ended March 31, 2015 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 Profit from operations Other revenues and expenses Interest expense Profit before income tax Income tax expense Profit

Solutions Manual .

5-131

$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

Chapter 5

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (f) HERITAGE FURNITURE LIMITED Statement of Changes in Equity Year Ended March 31, 2015 Common Shares Balance, April 1, 2014 Issued common shares Profit Dividends Balance, March 31, 2015

Solutions Manual .

$199,000 1,000 00 00000 $200,000

5-132

Retained Earnings

Total Equity

$ 550,500

$ 749,500 1,000 570,900 (50,000) $1,271,400

570,900 (50,000) $1,071,400

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (f) (Continued) HERITAGE FURNITURE LIMITED Statement of Financial Position March 31, 2015 Assets Current assets Cash Accounts receivable Merchandise 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

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 $ 200,000 Retained earnings 1,071,400 Total liabilities and shareholders’ equity

Solutions Manual .

5-133

$3,096,400

101,500 $3,197,900

$1,360,000 10,000 9,000 47,500 50,000 45,000 1,521,500 405,000 1,926,500

1,271,400 $3,197,900

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (g) Date

Account Titles

March 31

Credit

6,219,400 Sales .................................................................................... Income Summary .........................................................

6,219,400

31 Income Summary ................................................................. 5,648,500 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 ...................................................

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

31 Income Summary ................................................................. 570,900 Retained Earnings ......................................................

570,900

31 Retained Earnings ............................................................... 50,000 Dividends .....................................................................

50,000

Solutions Manual .

Debit

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COMPREHENSIVE CASE: CHAPTERS 1─5 (Continued) (h) HERITAGE FURNITURE LIMITED Post-Closing Trial Balance March 31, 2015 Debit $ 348,400 225,000 2,510,500 7,500 5,000 145,000

Solutions Manual .

000000000 $3,241,400

5-135

Credit

$ 43,500 1,360,000 10,000 9,000 47,500 450,000 50,000 200,000 1,071,400 $3,241,400

Chapter 5

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

CHAPTER 6 Reporting and Analyzing Inventory ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

A Problems

B Problems

BYP

1. Describe the steps in determining inventory quantities.

1, 2, 3, 4

1, 2

3, 6

2. Apply the methods of cost determination using specific identification, FIFO, and average under a perpetual inventory system.

5, 6, 7, *18, *20, *21

3, 4, 5, 6, *14, *15

3, 4, 5, 6, 2A, 3A, 7, *15, *16 4A, 5A, 6A, *15A, *16A

2B, 3B, 4B, 5B, 6B, *15B, *16B

3, 5, 6, 7

3. Explain the effects on financial statement of choosing each of the inventory cost determination methods.

8, 9, 10

3, 6, 7, 12

3A, 5A

3B, 5B

1, 3, 5, 7

4. Identify the effects of inventory errors on the financial statements

11, 12, 13

8, 9

4A, 7A, 8A 4B, 7B, 8B 4

5. Demonstrate the presentation and analysis of inventory.

14, 15, 16, 17

10, 11, 12

6A, 7A, 8A, 9A, 10A, 11A, 12A, *14A

*6. Apply the FIFO and average cost inventory cost determination methods under a periodic inventory system (Appendix 6A).

*18, *19, *20, *21

*13, *14, *15

*13, *14, *15, *16

*13A, *13B, *14A, *14B, *15A, *16A *15B, *16B

6B, 7B, 8B, 9B, 10B, 11B, 12B, *14B

1, 2, 4

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendices to each chapter.

Solutions Manual .

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Identify items in inventory.

Simple

30-40

Apply specific identification.

Moderate

30-40

Apply perpetual FIFO and answer questions about effects.

Moderate

30-40

Apply perpetual average cost and discuss errors.

Moderate

30-40

Apply perpetual FIFO and average cost; compare effects.

Moderate

35-45

Record transactions using perpetual average cost; apply LCNRV.

Moderate

30-40

Determine effects of inventory error for two years.

Moderate

20-25

Determine effects of inventory errors for multiple years.

Moderate

25-30

Determine and record LCNRV.

Moderate

15-25

10A

Record and present LCNRV valuation for multiple periods.

Moderate

15-25

11A

Calculate ratios and comment on liquidity.

Moderate

25-30

12A

Compare ratios; comment on liquidity and profitability. Moderate

25-30

*13A

Apply periodic FIFO and average cost.

Moderate

25-35

*14A

Prepare partial financial statements and assess effects.

Moderate

20-30

*15A

Apply perpetual and periodic FIFO.

Moderate

25-35

*16A

Apply perpetual and periodic average cost.

Moderate

25-35

Identify items in inventory.

Simple

30-40

Solutions Manual .

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number 2B

Description Apply specific identification.

Difficulty Level Moderate

Time Allotted (min.) 25-35

Apply perpetual FIFO and answer questions about effects.

Moderate

30-40

Apply perpetual average cost and discuss errors.

Moderate

30-40

Apply perpetual FIFO and average cost; compare effects.

Moderate

30-40

Record transactions using perpetual FIFO; apply LCNRV.

Moderate

30-40

Determine effects of inventory error for two years.

Moderate

25-35

Determine effects of inventory errors for multiple years.

Moderate

25-35

Determine and record LCNRV.

Moderate

15-25

10B

Record and present LCNRV valuation for multiple periods.

Moderate

15-25

11B

Calculate ratios and comment on liquidity.

Moderate

25-30

12B

Compare ratios; comment on liquidity and profitability. Moderate

25-30

*13B

Apply periodic FIFO and average cost.

Moderate

25-35

*14B

Prepare partial financial statements and assess effects.

Moderate

20-30

*15B

Apply perpetual and periodic FIFO.

Moderate

25-35

*16B

Apply perpetual and periodic average cost.

Moderate

25-35

Solutions Manual .

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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. 2.

Internal control consists of all the related methods and measures adopted within an organization to help it achieve reliable financial reporting, effective and efficient operations, and compliance with relevant laws and regulations. The use of internal control procedures will result in a more accurate and reliable inventory count. For example, the counting should be done by employees who do not have responsibility for the custody or record-keeping for the inventory. Each counter should verify the validity of each inventory item by checking that the items actually exist, how many there are and what condition they are in. To ensure accuracy, counting should be completed in teams of two and all inventory counts should be rechecked. Finally pre-numbered inventory tags should be used to ensure that all inventory is counted and none is counted twice. The pre-numbering of the tags will assist in the retracing of the count back to the physical inventory on hand and will also assist in establishing to the completeness of the count, when the inventory is compiled from the tags.

(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.

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 4.

(a) Include: the inventory items belong to Kingsway. (b) Include: the inventory items belong to Kingsway. (c) Exclude: the customer has purchased the inventory item and legal ownership has passed to the customer.

5. The specific identification method tracks the physical flow of individual inventory items, matching the cost of the actual item sold against the revenue from that item. 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 serial numbers. The FIFO inventory cost method assumes the first inventory purchased is the first inventory sold. The most recent purchases are assumed to remain in ending inventory. Inventory such as groceries could be accounted for using the FIFO cost method since older items should be sold first. The average cost method assumes that all goods available for sale are indistinguishable or homogeneous. Inventory such as hardware could be accounted for using an average cost method. 6. Average assumes that the goods available for sale are identical. FIFO assumes that the first goods purchased are the first to be sold. Specific identification matches the actual physical flow of merchandise. 7. 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. 8. A company should consider: • Whether the goods are interchangeable or not, or whether they are produced or segregated for specific projects; • Whether the method corresponds most closely to the physical flow of goods; • Whether the method reports inventory on the statement of financial position that is close to the inventory’s most recent cost; and • Whether the method is used for other inventories with a similar nature and usage. 9. Average 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. Solutions Manual .

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 10. (a) No effect – cash is not affected by the choice of inventory cost methods. (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 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 method. (d) Because of the effect on the cost of goods sold as outlined in (c), profit will be lower under FIFO and higher under average. (e) The impact on retained earnings will be the same as the impact on profit and ending inventory—lower in a period of declining prices using FIFO and higher using average cost. 11. 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. 12. (a) Mila Ltd.’s 2014 profit will be understated by $5,000. 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 profit will be understated. (b) 2014 retained earnings will be understated by $5,000 because profit is understated (see (a) above). (c) 2014 total shareholders’ equity will be understated by $5,000 because the retained earnings balance is understated (see (b) above). (d) 2015 profit will be overstated $5,000. This is because beginning inventory is understated by $5,000, which will result in an understatement of cost of goods sold (recognizing that 2014 ending inventory is 2015 beginning inventory). If cost of goods sold is understated, then profit will be overstated. (e) 2015 retained earnings will be correct because the understatement in profit in 2014 and overstatement in 2015 will cancel each other. (f) 2015 total shareholders’ equity will be correct because the retained earnings balance is correct.

Solutions Manual .

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 13. (a) At the end of the fiscal year, before the inventory is adjusted to the inventory count, Shediac’s assets (Merchandise 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 profit 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). 14. (a) Cost refers to the original cost of inventory as determined by using specific identification, or the FIFO or average cost methods. (b) Net realizable value is the selling price less any costs required to make the goods ready for sale. (c) The lower of cost and net realizable value rule should be applied at the end of the accounting period, before financial statements are prepared. 15. Cost of Goods Sold is debited when recording a decline in inventory value under the lower of cost and net realizable value rule because a decline in the value of inventory is considered to be a cost of buying and selling merchandise. 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. 16. 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.

Solutions Manual .

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 17. (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. *18. 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 a Merchandise 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. *19. 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. *20. In both systems, the first costs in are the costs assigned to the goods sold so no matter what system is used, the cost of goods sold will always consist of the oldest units and these would are assumed to be on hand when using either method. *21. In a perpetual system, the average cost per item is recalculated every time a purchase transaction takes place. In a periodic system, the average 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.

Solutions Manual .

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Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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 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. (d) 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. (e) 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. (f) 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.

BRIEF EXERCISE 6-2 $66,000 (6,000) (1,000) 4,000 $63,000

Solutions Manual .

Count Held on consignment Sold August 28 shipment plus freight, FOB shipping point ($3,750 + $250) Correct inventory cost

6-9

Chapter 6

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 6-3 Cost of Goods Available for Sale 3 electric pianos @ $600 = 2 electric pianos @ $475 =

$1,800 950 $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 profit, it could have sold two pianos from the last shipment that had a lower cost. If it wished lower profit, it could have sold the first two pianos purchased.

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

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BRIEF EXERCISE 6-5 [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13]

$15 ($450  30) 45 (15 + 30) $720 ($270 + $450) $16 ($720 (from [3]) ÷ 45 (from [2])) $16 (from [4]) 25 x $16 = $400 45 (from [2]) – 25 sold = 20 $720 (from [3]) – $400 (from [6]) = $320 $320 (from [8])  20 (from [7]) = $16. Notice how the average does not change after a sale. $144  $12 = 12 20 (from [7]) + 12 (from [10]) = 32 $320 (from [8]) + $144 = $464 $464 (from [12])  32 (from [11]) = $14.50

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BRIEF EXERCISE 6-6 (a)

FIFO cost method

Date Description

Purchases

Cost of Goods Sold

Aug. 2 Purchase

250

$ 1,750

3 Purchase

500

5,000

10 Sale 15 Purchase

900

1,650

$17,550

250 250 500

$7 7 10

$ 1,750 1,750 5,000

10 10 12 10 12

4,500 4,500 10,800 1,250 10,800

250 50

$7 10

$2,250

325

3,250

450 450 900 125 900

$5,500

1,025

10,800

25 Sale

Ending Inventory

625

$12,050

Check: $5,500 + $12,050 = $17,550 (b) Average cost method Date Description

Purchases

Aug. 2 Purchase

250 $ 7.00 $ 1,750.00

250

500

750

9.00

450

9.00 04,050.00

1,350

11.00 514,850.00

3,575.00 1,025

11.00 11,275.00

3 Purchase

10.00

5,000.00

10 Sale 15 Purchase

Cost of Goods Sold

300 $9.00 $2,700.00 900

12.00

10,800.00

25 Sale

325 11.00 1,650

$17,550.00 625

$5,500.00

Ending Inventory

375

$ 7.00 $ 1,750.00 6,750.00

$11,275.00

Check: $5,500 + $11,275 = $17,550

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BRIEF EXERCISE 6-7 (a)

Average. The ending inventory is valued at the average of the cost of the product, including earlier costs. Since this method yields a higher ending inventory than average cost when prices are falling, the result will not be closer to replacement cost. This result is achieved with the FIFO cost method.

(b)

FIFO. The cost of goods is valued using the earlier, higher costs. Since the revenue reflects current lower prices, the FIFO cost method does not match current costs against revenue when prices are falling. This result is better achieved by the average cost method.

(c)

One of the guidelines that management should consider is choosing an inventory cost method that corresponds as closely to the physical flow of goods as possible. A cost method that provides an ending inventory cost close to the inventory’s recent cost is also preferable.

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.

BRIEF EXERCISE 6-9 When items are not counted, an adjustment would be made to lower the balance in the Merchandise 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 Merchandise Inventory. The offsetting debit would be to Cost of Goods Sold, thereby overstating this account and reducing profit. In the following year, assuming that these goods are sold, their cost is zero so cost of goods sold would be understated and profit overstated. Assuming that there are no errors when counting inventory at the end of next year, this profit overstatement when combined with the previous year profit 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

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Current Year Understated $7,000 No impact Understated $7,000

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Next Year No impact No impact No impact

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BRIEF EXERCISE 6-10 (a) Inventory Categories Camcorders Cameras DVD players Total valuation

Cost $11,000 9,000 14,000 $34,000

NRV $10,200 9,500 12,800 $32,500

LCNRV $10,200 9,000 12,800 $32,000

The lower of cost and net realizable value is $32,000. (b) Cost of Goods Sold ......................................................................... Merchandise Inventory......................................................... $34,000 – $32,000 = $2,000

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2,000 2,000

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BRIEF EXERCISE 6-11 (a) Cost of Goods Sold ................................................................... Merchandise Inventory......................................................... $54,700 – $52,500 = $2,200

2,200 2,200

(b) $54,700

BRIEF EXERCISE 6-12 (a)

(b)

Inventory Turnover (2012)

$7,929 = 5.4 times ($1,503 + $1,449) ÷ 2

Days in Inventory (2012)

365 = 68 days 5.4

Inventory Turnover (2011)

$7,326 = 6.2 times ($1,449 + $933) ÷ 2

Days in Inventory (2011)

365 = 59 days 6.2

The inventory management deteriorated in 2012 as evidenced by the increase in number of days in inventory from 59 days in 2011 to 68 days in 2012. This was corroborated by the declining inventory turnover. This deterioration signifies that the inventory was sold more slowly.

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*BRIEF EXERCISE 6-13 Beginning inventory Purchases (370 @ $9) + (700 @ $12) + (800 @ $11) Goods available for sale Ending inventory Goods sold

Units 0

Dollars $ 0

1,870 1,870 (600) 1,270

20,530 $20,530

(a) 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 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 = $ 6,578.17 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

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*BRIEF EXERCISE 6-14 (a) Ending Inventory: (13 × $4.50) + (2 × $5.00) = $68.50 Cost of goods sold = Goods available for sale – ending inventory $216.00 – $68.50 = $147.50 Proof: Cost of goods sold = (15 × $4.50) + (16 × $5.00) = $147.50 (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. (c) Cost of Goods Sold .................................................................... Merchandise Inventory......................................................... 5 × $5.00 = $25

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*BRIEF EXERCISE 6-15 (a) Jan.

FIFO Perpetual 3

Accounts Receivable ............................................ Sales (500 × $6) ..........................................

3,000

Cost of Goods Sold (500 × $4) ............................. Merchandise Inventory .................................

2,000

Merchandise Inventory (1,000 × $4) ..................... Accounts Payable ........................................

4,000

Cash ..................................................................... Sales (800 x $8) ...........................................

6,400

Cost of Goods Sold [(200 × $4) + (600 × $4)] ...... Merchandise Inventory .................................

3,200

3,000

2,000

4,000

6,400

3,200

(b) FIFO Periodic Jan.

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Accounts Receivable ............................................. Sales ............................................................

3,000

Purchases ............................................................. Accounts Payable .........................................

4,000

Cash ...................................................................... Sales .............................................................

6,400

6-18

3,000

4,000

6,400

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SOLUTIONS TO EXERCISES EXERCISE 6-1 1. Do not include – Shippers Ltd. does not own items held on consignment. 2. Include in inventory – Shippers Ltd. still owns the items as they were only shipped on consignment. 3. Include in inventory – Shipping terms FOB destination means that Shippers Ltd. owns the items until they reach the customer. 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 shipping point so ownership has transferred to the customer. Shippers Ltd. should record this as a sale on the income statement. 6.

Do not include in inventory. The shipping terms are FOB destination so Shippers Ltd. does not own the goods until they arrive at Shippers Ltd.’s premises.

7. 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.

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EXERCISE 6-2 (a) Ending inventory⎯physical 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

(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.

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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 profit selectively. If it wished to minimize profit it would choose to sell the units purchased at higher costs–in which case the cost of goods sold would be $1,540 ($800 + $740) and gross profit would be $1,060 ($2,600 – $1,540). If it wished to maximize profit it would choose to sell the units purchased at lower costs; in which case the cost of goods sold would be $1,420 ($740 + $680) and gross profit would be $1,180 ($2,600 – $1,420). (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 should consider the use of either the FIFO or average cost flow methods.

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EXERCISE 6-4 (a) Date

Description

Purchases

Cost of Goods Sold

Apr. 1 Beg. inventory

Ending 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 75 175

17 Sale 24 Purchase

300

290

225 275

87,000 25 175

30 Sale 30 Balance

500

65,000

275 290

$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

250

400

100,000

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 method 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 method. Under FIFO, ending inventory is higher, cost of goods sold is lower and gross profit is higher.

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EXERCISE 6-5 (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. Date

Description

Purchases

Cost of Goods Sold

June 1 Beginning 6 Purchase

500 $125.00 $ 62,500.00 1,200 $127.00 $152,400.00

10 Sale 14 Purchase

Ending Inventory

1,000 1,800

128.00

1,600 1,000

30 Balance

4,000

129.00

$126,411.76

‘230,400.00

16 Sale 26 Purchase

$126.41

127.56

204,088.47

129,000.00 $511,800.00

2,600

$330,500.23

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

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 method because the cost of the product being purchased is rising.

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EXERCISE 6-6 (a) (1) FIFO Date Purchases Cost of Goods Sold Balance June 1 Beginning inventory 150 @ $5 = $ 750 12 230 @ $6 = $1,380 150 @ $5 230 @ $6 = 2,130 15 150 @ $5 100 @ $6 = $1,350 130 @ $6 = 780 16 450 @ $7 = 3,150 130 @ $6 450 @ $7 = 3,930 23 150 @ $8 = 1,200 130 @ $6 450 @ $7 150 @ $8 = 5,130 27 130 @ $6 10 @ $7 440 @ $7 = 3,860 150 @ $8 = 1,270 Total $5,730 $5,210 $1,270 Check: $5,210 + $1,270 = $6,480 ($750 + $5,730) (a) (2) Average 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 230 @ $6 = $1,380.00

Cost of Goods Sold 250 @ $5.61 = $1,401.32

450 @ $7 150 @ $8

= 3,150.00 = 1,200.00 $5,730.00

570 @ $6.96 = 3,965.54 $5,366.86

Balance 150 @ $5.00 = $ 750.00 380 @ $5.61 = 2,130.00 130 @ $5.61 = 728.68 580 @ $6.69 = 3,878.68 730 @ $6.96 = 5,078.68 160 @ $6.96 = 1,113.14 $1,113.14

Check: $5,366.86 + $1,113.14 = $6,480 ($750 + $5,730) (b) The average cost method results in a higher cost of goods sold because the cost of inventory is rising. (c) The FIFO cost method results in a higher profit because it produces the lower cost of goods sold when prices are rising.

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EXERCISE 6-6 (Continued) (d) The FIFO cost method results in a higher ending inventory because the cost of inventory is rising. (e) Both cost methods result in the same pre-tax cash flow. The cost methods do not change the pre-tax cash flows of a company.

EXERCISE 6-7 (a)

FIFO cost method

Date Oct. 2 15

Units 9,000 15,000

Purchases Cost Total $12 $108,000 14 210,000

(b) Date Oct. 2 15 29

Cost of Goods Sold Units Cost Total

9,000 13,000

$12 14

$290,000

Units 9,000 9,000 15,000 2,000

Balance Cost Total $12 $108,000 12 14 318,000 14

28,000

Average cost method 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 Profit before income tax Income tax expense (30%) Profit

Solutions Manual .

FIFO $525,000 290,000 235,000 200,000 35,000 10,500 $ 24,500

6-25

Average $525,000 291,500 233,500 200,000 33,500 10,050 $ 23,450

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EXERCISE 6-7 (Continued) (d)

(1) Currently, as shown in (a) above, FIFO results in a higher profit than the average cost method. This is anticipated when costs are rising, as is the case above. If instead costs fall, the use of the FIFO cost method will result in a lower profit compared to the average cost method. The cost of goods sold will then be composed of higher costs than the average cost method and this will generate lower profits. (2) If costs remain stable, the two cost methods will produce the same profits.

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EXERCISE 6-8 (a) Corrected merchandise inventory 2014 = $30,000 + $4,000 = $34,000 2015 = $37,000 – $2,000 = $35,000 Corrected cost of goods sold 2014 = $154,000 – $4,000 = $150,000 2015 = $168,000 + $2,000 + $4,000 = $174,000 (b) (1) and (2) Cost of goods sold and profit before income tax: The inventory error for 2014 will cause the cost of goods sold to be overstated by $4,000, which will cause profit and retained earnings to be understated by the same amount. When the error reverses in 2015, cost of goods sold will be understated and profit will be overstated. Over the two years the error will reverse and therefore the retained earnings balance will be correct at the end of 2015. The $2,000 overstatement of inventory in 2015 will cause the cost of goods sold to be understated and the profit and retained earnings to be overstated by $2,000. (3) The inventory error for 2014 will cause the merchandise inventory—an asset account—to be understated by $4,000. The inventory error for 2015 will cause the merchandise inventory (asset) account to be overstated by $2,000. (4) The errors will not affect liabilities. (5) Shareholders’ equity is also understated by $4,000 in 2014 (see retained earnings explanation in previous section). Shareholders’ equity will also be overstated by $2,000 in 2015 (see retained earnings explanation in previous section). (c) 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 profit.

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EXERCISE 6-9 (a) Sales ........................................................................................... Cost of goods sold (see 1 and 2) ................................................ Gross profit .................................................................................

2015 $265,000 213,000 $ 52,000

2014 $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

$56,000 + $60,000 = $64,000 + $52,000 =

$116,000 116,000 $ 0

2015

2014

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%

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EXERCISE 6-10 Units Cost/Unit Cameras: Sony Canon Light Meters: Gossen Seconic Total (b) Dec. 31

Solutions Manual .

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) ............................... Merchandise Inventory ...............................................

110

Cost of Goods Sold (2  150) ............................................. Merchandise Inventory ...............................................

300

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110

300

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EXERCISE 6-11 (a) Inventory Turnover (2012):

$1,552,128 = 2.8 times ($553,068 + $568,311)÷2

Days in Inventory (2012):

365 = 130 days 2.8

Gross Profit Margin (2012):

($1,948,253 - $1,552,128) = 20.3% $1,948,253

Inventory Turnover (2011):

$1,288,106 = 2.9 times ($568,311 + $332,542)÷2

Days in Inventory (2011):

365 = 126 days 2.9

Gross Profit Margin (2011):

($1,725,712 - $1,288,106) = 25.4% $1,725,712

(b)

In 2012, Gildan Activewear experienced a deterioration in liquidity and profitability. The liquidity has been deteriorated due to the increase in time required to turn over its inventory, from 126 days to 130 days. The company has experienced deteriorated profitability due to a significant drop in its gross profit margin from 25.4% to 20.3%.

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EXERCISE 6-12 (a) Inventory turnover (FIFO)

$750,000 = 3.4 times $222,500

Inventory turnover (Average)

$735,000 = 3.2 times $227,500

(b) Current ratio (FIFO)

($450,000 + $222,500) = 1.9 times $350,000

Current ratio (Average)

($450,000 + $227,500) = 1.9 times $350,000

(c) The FIFO cost method appears to show a slightly better turnover ratio because it has a lower ending inventory. The current ratios are the same. The two cost methods 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 method will be the same since the methods involve allocating the same costs. In reality, there is no economic difference between the two methods and any differences in ratios are artificial ones caused solely by the different cost methods. Consequently, there is no real difference in liquidity.

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*EXERCISE 6-13 (a) FIFO Beginning inventory (30 × $10) ............................................... Purchases May 12 (50 × $12)........................................................ May 14 (20 × $15)........................................................ Cost of goods available for sale (100 units) ............................ Less: Ending inventory (15 × $15) ......................................... Cost of goods sold (85 units) ..................................................

$ 300 $600 300

900 1,200 225 $ 975

(b) Average Beginning inventory (30 × $10) ............................................... Purchases May 12 (50 × $12)........................................................ May 14 (20 × $15)........................................................ Cost of goods available for sale (100 units) ............................ Less: Ending inventory (15 × $12*)......................................... Cost of goods sold (85 units) ..................................................

$ 300 $600 300

900 1,200 180 $1,020

*$1,200 ÷ 100 units = $12/unit

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*EXERCISE 6-14

(a) (1) FIFO Beginning inventory (150 × $5) ........................................................ Purchases June 12 (230 × $6)....................................................................... June 16 (450 × $7)....................................................................... June 23 (150 × $8)....................................................................... Cost of goods available for sale (980 units) ..................................... Less: Ending inventory [(150 × $8) + (75 × $7)] ............................... Cost of goods sold ...........................................................................

$ 750 $1,380 3,150 1,200

5,730 6,480 1,725 $4,755

(2) Average 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 $6,480



Total Units Available for Sale 980

Weighted Average Unit Cost $6.61

Ending inventory = 225 × $6.61 = $1,487.76 Cost of goods sold = $6,480.00 – $1,487.76 = $4,992.24 Proof: 755 × ($6,480 ÷ 980) = $4,992.24 (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 – 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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*EXERCISE 6-15 (a) (1) FIFO Date

Purchases

Nov. 1

Sales

Beginning inventory

(30 @ $295) = $8,850

5 25 @ $300 = $7,500

(30 @ $295) + (25 @ $300) = $16,350 (30 @ $295) + (12 @ $300) = $12,450

19 40 @ $305 = $12,200

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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*EXERCISE 6-15 (Continued) (a) (2) Average 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 of goods available for sale (125 units) ....................................... Less: Ending inventory (33 × $302.801)............................................. Cost of goods sold .............................................................................

$ 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

1 $37,850 ÷ 125 = $302.80

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*EXERCISE 6-16 (a) Nov. 5 Merchandise Inventory Accounts Payable 12 Cash Sales 12 Cost of Goods Sold Merchandise Inventory 19 Merchandise Inventory Accounts Payable 22 Cash Sales 22 Cost of Goods Sold Merchandise Inventory 25 Merchandise 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 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

Nov. 5 Purchases Accounts Payable 12 Cash Sales 19 Purchases Accounts Payable 22 Cash Sales 25 Purchases Accounts Payable

(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 Dr. Cr. 7,500 7,500 19,320 19,320 12,200 12,200 23,500 23,500 9,300 9,300

(b)

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SOLUTIONS TO PROBLEMS PROBLEM 6-1A (a)

(b)

The unsold consignment inventory should be included in Kananaskis’ inventory. Include $900 ($1,800 – $900) in inventory.

Exclude the items from Kananaskis’ inventory. Craft Producers Ltd. still owns the inventory.

The inventory has been sold to the customer so the customer has ownership. Exclude.

The sale will be recorded on February 23. The goods (cost, $560) should be excluded from Kananaskis’ inventory at the end of February.

Kananaskis owns the goods once they are shipped on February 26. Include inventory of $830 ($750 + $80).

Title of the goods does not transfer to Kananaskis until March 4. Exclude this amount from the February 28 inventory.

Title to the goods does not transfer to the customer until March 7. Include the $1,900 in ending inventory.

Include $1,260 in inventory.

The revised ending inventory is: Unadjusted inventory Adjustments 1. February 1 5. February 24 7. February 27 8. March 5 Adjusted inventory

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$150,000 $ 900 830 1,900 1,260

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PROBLEM 6-2A (a) Cost of Goods Sold Cost/ Unit $

Ending Inventory Sales price/ Unit $

Model

Serial #

Apr.

8 Focus Mustang 18 Mustang Flex F-150 Escape

C81362 G62313 G71891 X3892 F1921 E21202

(b)

Gross profit

= $177,500 – $158,000 = $19,500

(c)

The specific identification method is likely the most appropriate method for Dean’s Sales Ltd. because the vehicles are large dollar value items that are specifically identifiable by serial number.

Solutions Manual .

22,000 24,000 27,000 30,000 26,000 31,000 29,000 32,000 27,000 30,500 27,000 30,000 158,000 177,500

6-38

Apr.

Model

Serial #

1 F-150 12 Mustang Flex Flex 23 Focus Escape

F1883 G71811 X4212 X4214 C81528 E28268

Cost/ Unit $ 23,000 28,000 28,000 29,000 25,000 28,000 161,000

Chapter 6

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PROBLEM 6-3A (a) Date

Description

Purchases

Cost of Goods Sold

Apr. 1 Beg. inventory 6 Purchase

$45 $ 675 30 5

9 Sale 14 Purchase

20 Sale 20

30 Total

$1,725

800 10 15

28 Purchase

50 45

45 40

1,050

700 $2,175

$2,775

Ending Inventory 30 30 15

$50 50 45

$1,500

10 10 20

45 45 40

450

5 5 20

40 40 35

200

$ 900

2,175

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 method 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 method would be lower.

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PROBLEM 6-4A (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.

Date

Description

Purchases

Cost of Goods Sold

Apr. 1 Beg. inventory 6 Purchase

30 $50.00 $1,500.00 15 $45 $ 675.00

9 Sale 14 Purchase

Ending Inventory

35 $48.33 $1,691.67 20

800.00

20 Sale

28 Purchase

31 Balance

42.78 1,069.44

700.00 $2,175.00

$2,761.11

48.33 2,175.00

48.33

42.78 1,283.33

42.78

213.89

36.56

913.89

483.33

$ 913.89

Check: $2,761.11 + $913.89 = $3,675.00 ($1,500.00 + $2,175.00) (b) Cost of Goods Sold .......................................................... Merchandise Inventory (1 × $36.56)...................... (c)

36.56 36.56

Three accounts would be affected—Merchandise Inventory, Cost of Goods Sold, and Retained Earnings. The Merchandise 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 profit being overstated by $36.56. The Retained Earnings account would also be overstated by $36.56.

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PROBLEM 6-5A (a)

(1) FIFO Date

Description

May 1 Purchase

Purchases 12

Cost of Goods Sold

$100 $1,200

3 Sale 8 Purchase

110

115

$100

4 4

100 110

$ 800

1,100

13 Sale 15 Purchase

840

690

Ending Inventory 12

$100

$1,200

04 4 10

100 100 110

400

6 6 6

110 110 115

1,350

1,500 660

20 Sale

110

660

115

690

27 Sale

115

460

115

230

$2,760

31 Balance

$2,990 26

$ 230

Check: $2,760 + $230 = $2,990

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PROBLEM 6-5A (Continued) (a) (Continued) (2) Average 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

July 1 Purchase

12 $100.00 $1,200.00

3 Sale 8 Purchase

Ending Inventory 12 $100.00 $1,200.00

8 $100.00 $ 800.00 4 10 110.00 1,100.00

13 Sale 15 Purchase

Cost of Goods Sold

14 8 107.14

6 115.00

690.00

857.14 6 12

100.00

400.00

107.14 1,500.00 107.14

642.86

111.07 1,332.86

20 Sale

6 111.07

666.43 6

111.07

666.43

27 Sale

4 111.07

444.28 2

111.07

222.15

31 Balance

$2,990.00 26

$2,767.85 2

$ 222.15

Check: $2,767.85 + $222.15 = $2,990.00 (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 method produces a higher gross profit and profit as its cost of goods sold are 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 method is used.

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PROBLEM 6-6A (a) April

No entry

Merchandise Inventory (110 × $9) ......................... Cash .............................................................

990.00

Cash (140 × $12)................................................... Sales .............................................................

1,680.00

Cost of Goods Sold (140 × $8.69*)........................ Merchandise Inventory ..................................

1,216.25

Merchandise Inventory (120 × $7) ........................ Cash .............................................................

840.00

Cash (110 × $10)................................................... Sales .............................................................

1,100.00

Cost of Goods Sold (110 × $7.24*)........................ Merchandise Inventory ..................................

796.52

Merchandise Inventory (20 × $6) ........................... Cash .............................................................

120.00

990.00

1,680.00

1,216.25

840.00

1,100.00

796.52 120.00

* 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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PROBLEM 6-6A (Continued) (b)

Purchases

Cost of Goods Sold

May 1 Beginning 6 Purchase

110

$9 $ 990

8 Sale 15 Purchase

140 120

840

20 Sale

110

27 Purchase

31 Balance

250

$8.69 $1,216.25

7.24

796.52

120 $1,950 250

$2,012.77

Ending Inventory 50

$8.00

$ 400.00

160

8.69

1,390.00

8.69

173.75

140

7.24

1,013.75

7.24

217.23

6.74

337.23

$ 337.23

Check: $2,012.77 + $337.23 = $2,350 ($400 + $1,950)

(c)

Ending inventory should be valued at $250 (50 x $5) which is the lower of cost and net realizable value. Cost = $337.23 NRV = $250.00 (50 units @ $5)

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PROBLEM 6-7A

(a) (b) (c) (d) (e) (f) (g)

2015 Cash No effect Cost of goods sold Overstated Profit Understated Retained earnings No effect Ending inventory No effect Gross profit margin ratio Understated Inventory turnover ratio Understated*

2014 No effect Understated Overstated Overstated Overstated Overstated Understated

*Although the cost of goods sold is overstated in 2015, 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 2015.

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PROBLEM 6-8A (a)

(INCORRECT) KMETA INC. Income Statement Year Ended July 31

Sales Cost of goods sold Gross profit Operating expenses Profit before income tax

2015 $340,000 233,000 107,000 68,000 $ 39,000

2014 $320,000 220,000 100,000 64,000 $ 36,000

2013 $300,000 209,000 91,000 64,000 $ 27,000

Statement of financial position: Merchandise inventory

$40,000

$24,000

(CORRECT) KMETA INC. Income Statement Year Ended July 31

Sales Cost of goods sold Gross profit Operating expenses Profit before income tax

2015 $340,000 218,0003 122,000 68,000 $ 54,000

2014 $320,000 244,0002 76,000 64,000 $ 12,000

2013 $300,000 200,0001 100,000 64,000 $ 36,000

Statement of financial position: Merchandise inventory

$40,000

$25,0005

$33,0004

1 $209,000 – $9,000 = $200,000 2 $220,000 + $9,000 + $15,000 = $244,000 3 $233,000 – $15,000 = $218,000 4 $24,000 + $9,000 = $33,000 5 $40,000 – $15,000 = $25,000

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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 + $12,000 + $54,000 = $102,000 The retained earnings balance at the end of 2015 is unaffected and remains at $102,000 because by that time all errors have been corrected.

$233,000 = 5.8 times ($40,000 + $40,000) ÷ 2

Inventory turnover (2014)

$220,000 = 6.9 times ($40,000 + $24,000) ÷ 2

(CORRECT) Inventory turnover (2015)

$218,000 = 6.7 times ($40,000 + $25,000) ÷ 2

Inventory turnover (2014)

$244,000 = 8.4 times ($25,000 + $33,000) ÷ 2

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PROBLEM 6-9A (a)

Quantity

Unit Cost

Total Cost

NRV

Total NRV

LCNRV

Coffea arabica

13,000 bags

$5.60

$72,800

$5.55

$72,150

Coffea robusta

5,000 bags

3.40

17,000 $89,800

3.50

17,500 $89,650

17,000 $89,150

Type of Bean

(b)

(c)

Dec. 31

Cost of Goods Sold ($89,800 – $89,150)........... Merchandise Inventory ...............................

650 650

If the same inventory has recovered its decline in value, the write down should be reversed. A reversal is justified when the economic circumstances that previously caused the inventory to be written down below cost no longer exist or there is clear evidence that net realizable value now exceeds cost. The inventory would be restated at its unit cost. The inventory cannot be valued at an amount greater than its original cost.

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PROBLEM 6-10A (a)

(1) (2) (3)

(b)

June 30 July 31 August 31

Total NRV $5,100,000 5,460,500 4,345,000

LCNRV $4,740,000 5,460,500 4,345,000

(1) June 30

No entry

(2) July 31

Cost of Goods Sold .......................................... Merchandise Inventory ...................... ($5,695,000 – $ 5,460,000 = $234,500)

234,500

Cost of Goods Sold ........................................ Merchandise Inventory ...................... ($4,482,500 – $4,345,000 = $137,500)

137,500

(3) Aug. 31

(c)

Total Cost $4,740,000 5,695,000 4,482,500

234,500

137,500

There are no significant differences in recording LCNRV under ASPE rather than IFRS.

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PROBLEM 6-11A (a) (in USD millions) Inventory Turnover

Days In Inventory

Current Ratio

2012

$19,053 = 6.0 times ($3,264 + $3,092)÷2

365 = 61 days 6.0 times

$30,328 = 1.1 : 1 $27,821

2011

$18,216 = 6.3 times ($3,092 + $2,650)÷2

365 = 58 days 6.3 times

$25,497 = 1.1 : 1 $24,282

Coca-Cola’s current ratio remained constant in 2012 and is slightly below the industry average of 1.2:1. 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 deteriorated and 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. Tim Hortons has a higher current ratio and higher inventory turnover ratio and therefore greater liquidity than Starbucks. Both companies have significantly 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)

Starbucks’ gross profit margin significantly exceeds the industry average, likely because of its high sales price strategy, but its profit margin only matches the industry average. Tim Hortons’ gross profit margin is below industry average but its profit margin is much larger than both Starbucks and its industry counterparts. This indicates that Tim Hortons likely has lower operating expenses relative to sales, since it has leveraged a lower gross profit margin into a higher profit margin.

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*PROBLEM 6-13A

(a)

Cost Of Goods Available For Sale Date Jan. 1 Mar. 15 July 20 Sept. 4 Dec. 2

(b)

Explanation Beginning inventory Purchase Purchase Purchase Purchase Total

Units 25 70 50 45 10 200

Unit Cost $160 150 145 135 125

Total Cost $ 4,000 10,500 7,250 6,075 1,250 $29,075

FIFO Step 1: Ending Inventory Date Units Unit Cost Sept. 4 10 $135 Dec. 2 10 125 20

Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold

Total Cost $1,350 1,250 $2,600

$29,075 2,600 $26,475

Proof: Cost of Goods Sold Unit Total Units Cost Cost 25 $160 $ 4,000 70 150 10,500 50 145 7,250 35 135 4,725 180 $26,475

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*PROBLEM 6-13A (Continued) (b) (Continued) Average Step 1: Ending Inventory Weighted Average Units Unit Cost 20 $145.38* =

Total Cost $2,907.50

*$29,075  200 = $145.38 (rounded) Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold

$29,075.00 2,907.50 $26,167.50

Proof: Cost of goods sold 180 × ($29,075 ÷ 200) = $26,167.50

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*PROBLEM 6-14A (a) KANE LTD. Partial Income Statements

Sales (180 × $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

$36,000

4,000 25,075 29,075 2,600 26,475 9,525

4,000 25,075 29,075 2,908 26,167 9,833

(b) KANE LTD. Partial Statement of Financial Position

Assets Current assets Merchandise inventory ...............................

FIFO

Average

$2,600

$2,908

(c) 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 and lower profit because FIFO values the cost of goods sold at the oldest higher prices.

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*PROBLEM PROBLEM6-15A 6-5A (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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*PROBLEM 6-15A (Continued) (a) (Continued) (2) Perpetual Inventory System Date Description

Purchases

Cost of Goods Sold

June1 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

30 Balance

290

$90 92 $14,620

92 94

9,260

3,800 $26,940 125

$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

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.

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*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 $21 $10,500

11 Sale 16 Purchase

450 750

$20.83 $ 9,375.00

16,500

20 Sale

800

27 Purchase

600

30 Balance

1,850

21.81

17,444.44

13,800 $40,800 1,250

$26,819.44

Ending Inventory

100 $20.00

$ 2,000.00

600 20.83

12,500.00

150 20.83

3,125.00

900 21.81

19,625.00

100 21.81

2,180.56

700 22.83

15,980.56

700

$15,980.56

Check: $26,819.44 + $15,980.56 = $42,800 ($2,000 + $40,800)

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*PROBLEM 6-16A (Continued) (a) (Continued) (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 $20 21 22 23

Total Cost $ 2,000 10,500 16,500 13,800 $42,800

Average cost per unit = $42,800  1,950 = $21.95 Units Sold = 450 + 800 = 1,250 Units in Ending inventory = 1,950 – 1,250 = 700 Step 1: Ending Inventory 700 units @ $21.95 = $15,364.10 Step 2: Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold

$42,800.00 15,364.10 $27,435.90

Proof: Cost of Goods Sold 1,250 × ($42,800 ÷ 1,950) = $27,435.90

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*PROBLEM 6-16A (Continued) (b) Average Periodic

Perpetual

Cost of goods sold

$27,435.90

$26,819.44

Ending inventory Cost of goods available for sale

15,364.10 $42,800.00

15,980.56 $42,800.00

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.

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PROBLEM 6-1B (a)

(b)

The goods on consignment belong to Kananaskis and should not be included in Banff’s ending inventory.

Include $600 ($1,200 ÷ 2) in inventory as Banff has title to this inventory.

$1,650 ($1,500 + $150) should be included in inventory as the goods were shipped FOB shipping point on February 25th.

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.

The amount should not be included in inventory as they were shipped FOB destination and not received until March 2. The seller still owns the inventory. No entry is recorded.

The sale will be recorded on March 3. The goods should be included in inventory at the end of February at their cost of $800. The freight is a selling expense.

Include $1,300 in inventory as it has not been sold.

Inventory should be decreased by $800 to record these goods at lower of cost and net realizable value, which is zero.

The revised ending inventory is: Unadjusted inventory Adjustments 2. February 5 3. February 20 6. February 25 7. February 27 8. February 28 Adjusted inventory

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$112,000 $ 600 1,650 800 1,300 (800)

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PROBLEM 6-2B (a) Cost of Goods Sold

Supplier

Serial #

Aug. 10 Suzuki Kawai 18 Yamaha Steinway 26 Suzuki Yamaha Yamaha

SZ5828 KG1520 YH4418 ST0944 SZ6132 YH6318 YH5632

Ending Inventory

Cost/ Unit $

Sales price/ Unit $

1,600 600 1,300 2,200 1,800 1,500 1,600 10,600

2,700 1,000 2,100 3,700 2,900 2,500 2,600 17,500

Aug.

Supplier

Serial #

1 Suzuki Kawai Steinway 22 Suzuki

SZ5716 KG1268 ST8411 SZ6148

Cost/ Unit $ 1,100 1,500 2,600 1,600 6,800

(b)

Gross profit = $17,500 – $10,600 = $6,900

(c)

The specific identification method is likely the most appropriate method for the Piano Studio Ltd. because the pianos are large dollar value items that are specifically identifiable by serial number.

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PROBLEM 6-3B (a) 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

245

9,800 30 20

20 Sale 28 Purchase

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 $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 method 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, ending inventory includes some lower cost goods purchased earlier. I would expect cost of goods sold to be higher under average since the average would include the cost of more recently purchased goods. Notice that average will give higher cost of goods sold while having ending inventory that is lower than under FIFO.

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PROBLEM 6-4B (a)

Date

Description

Purchases

Cost of Goods Sold

Ending Inventory

April 1 Beg. inventory 6 Purchase

50 $230.00 $11,500.00 35 $240 $ 8,400

9 Sale 14 Purchase

55 $234.12 $12,876.47 40

245

9,800

20 Sale

28 Purchase

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

$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 ........................................... Merchandise Inventory ...........................

246.13 246.13

Three accounts would be affected—Merchandise Inventory, Cost of Goods Sold, and Retained Earnings. The Merchandise 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 profit being overstated by $246.13. The Retained Earnings account would also be overstated by $246.13.

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PROBLEM 6-5B (a) (1) FIFO Date

Description

Purchases

Cost of Goods Sold

May 1 Purchase

110

$19 $2,090

6 Purchase

140

22 3,080 110 90

11 Sale 14 Purchase

23 1,840 50 50

21 Sale 27 Purchase

31 Balance

380

$19 22 $4,070

22 23

2,250

25 1,250 $8,260 300

$6,320

Ending Inventory 110 110 140

$19 19 22

$2,090

50 50 80

22 22 23

1,100

30 30 50

23 23 25

690

5,170

2,940

1,940 $1,940

Check: $6,320 + $1,940 = $8,260

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PROBLEM 6-5B (Continued) (a) (Continued) (2) Average 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

May 1 Purchase 6 Purchase

Purchases

Ending Inventory

110 $19 $2,090

110 $19.00

$2,090.00

140

250

20.68

5,170.00

20.68

1,034.00

130

22.11

2,874.00

22.11

663.23

23.92

1,913.23

3,080

11 Sale 14 Purchase

Cost of Goods Sold

200 $20.68 $4,136.00 80

1,840

21 Sale

100 22.11

27 Purchase

31 Balance

380

2,210.77

1,250 $8,260 300

$6,346.77

$1,913.23

Check: $6,346.77 + $1,913.23 = $8,260 (b)

Family Appliance Mart should consider whether the goods are ordinarily interchangeable. If so, it should consider • The method that corresponds most closely to the physical flow of goods • The method that 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 profit.

(d)

Because the ending inventory is determined using the most recent prices, the FIFO cost method produces the higher ending inventory.

(e)

Pre-tax cash flow will be the same under both cost methods.

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PROBLEM 6-6B (a) Oct.

No entry required

Merchandise Inventory (100 × $13) ....................... Accounts Payable ........................................

1,300

Accounts Receivable ............................................. Sales (130 × $20)..........................................

2,600

Cost of Goods Sold ............................................... Merchandise Inventory [(60 × $14) + (70 × $13)] ...............................

1,750

Merchandise Inventory (35 × $12) ......................... Accounts Payable .........................................

420

Accounts Receivable ............................................. Sales (50 × $16) ...........................................

800

Cost of Goods Sold ............................................... Merchandise Inventory [(30 × $13) + (20 × $12)]

630

Merchandise Inventory (15 × $11) ......................... Accounts Payable ........................................

165

(b) Date Oct. 31

Ending Inventory Unit Units Cost 30* 15 @ $12 15 @ $11

1,300

2,600

1,750

420

800

630

165

Total Cost $345

*60 + 100 – 130 + 35 – 50 + 15 = 30

(c) The inventory should be valued at $300. This is the lower of cost and net realizable value. Cost = $345 NRV = $300 (30 @ $10)

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PROBLEM 6-7B

(a) (b) (c) (d) (e) (f) (g)

Cash Cost of goods sold Profit Retained earnings Ending inventory Gross profit margin ratio Inventory turnover ratio

2015 No effect Understated Overstated No effect No effect Overstated Overstated*

2014 No effect Overstated Understated Understated Understated Understated Overstated

* Although the cost of goods sold is understated in 2015, 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 2015.

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PROBLEM 6-8B (a)

(INCORRECT) PELLETIER INC. Income Statement Year Ended July 31

Sales Cost of goods sold Gross profit Operating expenses Profit before income tax

2015 $320,000 187,000 133,000 52,000 $ 81,000

2014 $312,000 203,000 109,000 52,000 $ 57,000

2013 $300,000 170,000 130,000 50,000 $ 80,000

Statement of financial position: Merchandise inventory

$37,000

$24,000

$37,000

Sales Cost of goods sold Gross profit Operating expenses Profit before income tax

2015 $320,000 182,000 3 138,000 52,000 $ 86,000

2014 $312,000 198,0002 114,000 52,000 $ 62,000

2013 $300,000 180,0001 120,000 50,000 $ 70,000

Statement of financial position: Merchandise inventory

$37,000

$19,0005

$27,0004

(CORRECT) PELLETIER INC. Income Statement Year Ended July 31

1 $170,000 + $10,000 = $180,000 2 $203,000 – $10,000 + $5,000 = $198,000 3 $187,000 – $5,000 = $182,000 4 $37,000 – $10,000 = $27,000 5 $24,000 – $5,000 = $19,000

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PROBLEM 6-8B (Continued) (b)

Before correction = $80,000 + $57,000 + $81,000 = $218,000 After correction = $86,000 + $62,000 + $70,000 = $218,000

(c)

Inventory turnover

(INCORRECT) Inventory turnover (2015)

$187,000 = 6.1 times ($37,000 + $24,000)÷2

Inventory turnover (2014)

$203,000 = 6.7 times ($24,000 + $37,000)÷2

(CORRECT) Inventory turnover (2015)

$182,000 = 6.5 times ($37,000 + $19,000)÷2

Inventory turnover (2014)

$198,000 = 8.6 times ($19,000 + $27,000)÷2

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PROBLEM 6-9B (a)

Product A B C

(b)

(c)

Quantity 25 30 60

Unit Cost $7 6 11

Total Cost $ 175 180 660 $1,015

Net Realizable Value $7 8 10

Total NRV $ 175 240 600 $1,015

March 31 Cost of Goods Sold ................................................... Merchandise Inventory ................................

Lower of Cost and NRV $175 180 600 $955

60 60

Product C has recovered its decline in value, so the write down should be reversed. A reversal is justified when the economic circumstances that previously caused the inventory to be written down below cost no longer exist or there is clear evidence that net realizable value now exceeds cost. The inventory would be restated at its unit cost of $11. The inventory cannot be valued at an amount greater than its original cost.

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PROBLEM 6-10B (a) Tonnes

Total Cost $2,175,000 1,787,500 2,030,000

Total NRV

(1) (2) (3)

March 31 April 30 May 31

3,000 2,500 2,800

$2,220,000 1,775,000 2,030,000

(1)

March 31

No entry

(2)

April 30

Cost of Goods Sold ...................................... Merchandise Inventory ........................... ($1,787,500 – $1,775,000 = $12,500)

LCNRV $2,175,000 1,775,000 2,030,000

(b)

(3)

(c)

May 31

12,500 12,500

No entry

There are no significant differences in recording LCNRV under ASPE rather than IFRS.

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PROBLEM 6-11B (a) (in USD millions) Inventory Turnover

Days In Inventory

Current Ratio

2012

$31,291 = 8.4 times ($3,581 + $3,827)÷2

365 = 43 days 8.4 times

$18,720 = 1.1 : 1 $17,089

2011

$31,593 = 8.8 times ($3,827 + $3,372)÷2

365 = 42 days 8.8 times

$17,441 = 1.0 : 1 $18,154

PepsiCo’s current ratio improved slightly in 2012 but is below the industry average of 1.2:1. This ratio indicates that the company less current assets to cover its current liabilities than 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 deteriorated slightly but remains above the industry average. This ratio has also experienced the same trend as the industry. (b)

PepsiCo has different types of inventory that likely have different physical flows. For example, drinks with “best before dates” likely flow first-in, first-out, which make the FIFO inventory cost method an appropriate choice. Other components of inventory, including raw materials such as sugar may be accounted for on an average basis.

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PROBLEM 6-12B (a)

Magna’s inventory turnover outpaces its industry counterparts by a large margin while Dana falls short in this respect. On the other hand Dana has a much stronger current ratio compared to its industry counterparts while Magna falls short for this measure of liquidity.

(b)

Both Magna and Dana have gross profit margins and profit margins that are substantially lower than industry average. This could be due in part to the product mix for each company compared to its industry peers.

(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. 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 is kept on hand, the greater the current assets and the current ratio.

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*PROBLEM 6-13B (a)

Cost Of Goods Available For Sale Date Jan. Feb. May Aug. Dec.

(b)

1 20 5 12 8

Explanation Beginning inventory Purchase Purchase Purchase Purchase Total

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

(1) FIFO Step 1: Ending Inventory Date Units Unit Cost Dec. 8 400 22

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

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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) (Continued) (2) Average 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

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*PROBLEM 6-14B (a) STEWARD INC. Partial Income Statements

Sales (1,900 × $20) ......................................... 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

$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

FIFO

Average

$8,800

$8,018

Assets Current assets Merchandise inventory ............................

(c) 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 profit because FIFO values the cost of goods sold at the earliest and lowest prices.

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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

31 Balance

130,000

2.45

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)

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*PROBLEM 6-15B (Continued) (a) (Continued) (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 (b) 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 method because the most recently purchased goods remain in inventory.

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*PROBLEM 6-16B (a)

Date

Description

Purchases

Cost of Goods Sold

Oct. 1 Beg. inventory 9 Purchase

50 $24.00 $1,200.00 125 $26 $3,250

15 Sale 20 Purchase

175

25.43 4,450.00

25.43

26.59 2,525.71

1,462.25

26.59 1,063.46

$5,276.54

$1,063.46

150 $25.43 $3,814.29 70 27

29 Sale 30 Balance

Ending Inventory

1,890 55

195

$5,140 205

26.59

635.71

Check: $5,276.54 + $1,063.46 = $6,340 ($1,200 + $5,140)

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*PROBLEM 6-16B (Continued) (a) (Continued) (2) Average – Periodic Cost of Goods Available for Sale Date Oct.

Explanation Beginning inventory Purchase Purchase

1 9 22

Units 50 125 70 245

Total Ending Inventory Date Oct. 31

Units 40

Unit Total Cost Cost $25.88* $1,035.10

Unit Cost $24 26 27

Total Cost $1,200 3,250 1,890 $6,340

Cost of Goods Sold Cost of goods available for sale $6,340.00 Less: Ending inventory 1,035.10 Cost of goods sold $5,304.90

*$6,340  245 = $25.88

Proof: Cost of Goods Sold 205 × ($6,340  245) = $5,304.90 (b) Average Perpetual Periodic Cost of goods sold

$5,276.54

$5,304.90

Ending inventory Cost of goods available for sale

1,063.46 $6,340.00

1,035.10 $6,340.00

The results for the average cost method 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.

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BYP 6-1 FINANCIAL REPORTING

(Note: All amounts are in thousands) (a)

Inventories were $2,148,484 in 2012 and $2,042,302 in 2011.

(b) 2012

2011

Increase

As a Percentage

Inventory

$2,148,484

$2,042,302

$106,182

5.2%

Current assets

2,764,997

2,695,647

77.7%

75.8%

Inventory as a % of current assets

Inventory has increased at a modest pace from 2011 to 2012. There was also a modest increase in inventory as a percentage of current assets. (c)

When choosing the cost method of FIFO, Shoppers, whose product is interchangeable, considered the flowing guidelines: 1. Choose a method 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 method 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 have a high turnover, Shoppers has attempted to fulfill the guidelines above and has chosen FIFO.

(d)

Shoppers wrote down its inventory to net realizable value in both the 2011 and 2012 fiscal years. The journal entry for 2012 in thousands of dollars was as follows: Cost of Goods Sold ................................................................. Merchandise Inventory .................................................

44,334 44,334

The amount of the write down in 2011 of $39,943 thousand was slightly lower than in 2012.

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BYP 6-2 COMPARATIVE ANALYSIS (a)

Current ratio

Shoppers (in thousands)

Jean Coutu (in millions)

$2,764,997 = 1.2 : 1 2,334,917

$421.9 = 1.6 : 1 $265.3

(b) Shoppers (in millions)

Inventory turnover

Days in inventory

(c)

Jean Coutu (in millions)

$6,609.2 ($2,148.5 + $2,042.3) ÷ 2

$2,169.0 ($190.1 + $166.2) ÷ 2

= 3.2 times

= 12.2 times

365 = 114 days 3.2 times

365 = 30 days 12.2 times

Jean Coutu has the better ratios of the two companies and its ratios are better than that of the industry, while Shoppers is worse than the industry. While the ratios might be affected by the product mix of the inventory of both companies, Shoppers’ liquidity is poor as demonstrated by its current ratio and the movement of inventory is more three times slower than that of Jean Coutu.

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BYP 6-3 COMPARING IFRS AND ASPE

(a)

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 method, used by Global Lumber, will not result in any financial differences between a periodic and perpetual inventory system. The use of the average cost method, 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 methods 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 method and therefore its inventory is valued at the most current price. Gibson uses the average cost method and therefore its inventory is valued at the average cost of all inventory purchased 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.

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BYP 6-4 CRITICAL THINKING CASE (a) 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

Doors

Cost

Total

2,600 800 600 4,000

310 240 190

$ 806,000 192,000 114,000 $1,112,000

(b) 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 Merchandise Inventory account will have to be adjusted along with a corresponding adjustment to Cost of Goods Sold. The error can be calculated as follows: Merchandise Inventory balance per Kevin 900 × $310 Merchandise Inventory correct balance (see above) Difference

$279,000 222,400 $ 56,600

As this will directly affect operating profit for the month of December, Kevin’s bonus should be reduced by $5,660 (10% of $56,600). (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 amount that the bank will now allow the loan balance to be. 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.

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BYP 6-4 (Continued) (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 method 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 as calculated in (b) above would be above this amount at $278 each. 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).

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BYP 6-5 ETHICS CASE

(a)

Specific Identification

Sales ........................................................... Cost of goods sold ...................................... Gross profit ................................................. 1

(1) Maximize Gross Profit

(2) Minimize Gross Profit

$561,0001 366,1002 $194,900

“$561,0001 366,8003 “$194,200

Sales = ( 170  $800) + (500  $850) = $561,000 Goods Available for Sale Date Units Cost Mar. 1 140 “$500 3 200 540 10 340 570

Total $ 70,000 108,000 193,800 $371,800

Specific Identification–Maximize gross profit (minimize cost of sales by deciding to sell the diamonds 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 $366,100 2

Ending Inventory Date Units Mar. 25 10

Cost $570

Total $5,700

Specific Identification–Minimize gross profit (maximize cost of sales by selling the diamonds purchased at the highest cost) Cost of Goods Sold Date Units Mar. 5 170 25 340 30 130

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Cost ,,$540 570 540 500

Total $ 91,800 193,800 16,200 65,000 $366,800 3

6-86

Ending Inventory Date Units Mar. 1 10

Cost $500

Total $5,000

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BYP 6-5 (Continued) (b)

The stakeholders are the shareholders, customers, and staff of Swag Diamonds. There is not really anything unethical in selecting which diamonds to sell, unless it is done solely on a desire to manipulate profits.

(c)

Average Sales ................................................................... Cost of goods sold .............................................. Gross profit..........................................................

March 1 Beginning inventory 3 Purchase 5 Sale 10 Purchase 25 Sale 31 Balance

140 200 340 (170) 170 340 510 (500) 10

$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

4 Cost of Goods Sold = (170 × $523.53) + (500 × $554.51) = $366,255

(d)

Swag Diamonds should select the average cost method given that the inventory is homogeneous and not individually distinguishable. The specific identification method is not a permissible choice for the company given the type and physical flow of inventory it carried. The average cost method also has the advantage of not being subject to manipulation.

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BYP 6-6 “ALL ABOUT YOU” ACTIVITY (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 merchandise in locked display cases that can be accessed only by staff.

(b)

The inventory should be counted more frequently than once a year, particularly for highend product. 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 Merchandise 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)

If the cameras and photographic equipment are unique and identifiable, I would recommend the specific identification method of costing inventory. Using this method will better track the items on an individual basis, helping narrow down errors in recording or pinpointing the pilferage of specific inventory items. This method 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 picture frames, FIFO or average would be a better choice as there are no need to have as stringent control over these items, due to their minimal value.

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BYP 6-7 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) Mixer Inventory - FIFO 2014 Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total July 4 3 $550 $1,650 3 $550 $1,650 14 1 $550 $ 550 2 550 1,100 Aug. 1 1 568 568 2 550 1 568 1,668 27 2 550 1,100 1 568 568 Sept. 4 3 564 1,692 1 568 3 564 2,260 12 1 568 2 564 1,696 1 564 564 Oct. 3 3 574 1,722 1 564 3 574 2,286 27 1 564 564 3 574 1,722 Total 10 $5,632 7 $3,910 3 $1,722 (b) July

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Merchandise Inventory (3 × $550) ......................... Accounts Payable .........................................

1,650

Cash ...................................................................... Sales .............................................................

995

Cost of Goods Sold ............................................... Merchandise Inventory ..................................

550

Accounts Payable .................................................. Cash .............................................................

1,650

6-89

1,650

995

550

1,650

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BYP 6-7 (Continued) (b) (Continued) Aug.

Sept.

Oct.

Solutions Manual .

Merchandise Inventory ......................................... Accounts Payable .........................................

568

Cash ...................................................................... Sales .............................................................

1,990

Cost of Goods Sold (2 × $550) .............................. Merchandise Inventory ..................................

1,100

Accounts Payable .................................................. Cash ............................................................

568

Merchandise Inventory (3 × $564) ........................ Accounts Payable .........................................

1,692

Accounts Receivable ............................................. Sales .............................................................

2,985

Cost of Goods Sold [(1 × $568) + (2 × $564)] ....... Merchandise Inventory ..................................

1,696

Accounts Payable .................................................. Cash .............................................................

1,692

Merchandise Inventory ......................................... Accounts Payable .........................................

1,722

Cash ...................................................................... Sales .............................................................

995

Cost of Goods Sold (1 × $564) .............................. Merchandise Inventory ..................................

564

6-90

568

1,990

1,100

568

1,692

2,985

1, 696

1,692

1,722

995

564

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BYP 6-7 (Continued) (c)

2011 Date July 4 14 Aug. 1 27 Sept. 4 12 Oct. 3 27 Total

Mixer Inventory - Average Purchases Cost of Goods Sold Balance Units Cost Total Units Cost Total Units Cost Total 3 $550 $1,650 3 $550 $1,650 1 $550 $ 550 2 550 1,100 1 568 568 3 556 1,668 2 556 1,112 1 556 556 3 564 1,692 4 562 2,248 3 562 1,686 1 562 562 3 574 1,722 4 571 2,284 1 571 571 3 571 1,713 10 $5,632 7 $3,919 3 $1,713

(d) July

Aug.

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Merchandise Inventory (3 × $550) ......................... Accounts Payable .........................................

1,650

Cash ...................................................................... Sales .............................................................

995

Cost of Goods Sold ............................................... Merchandise Inventory ..................................

550

Accounts Payable .................................................. Cash .............................................................

1,650

Merchandise Inventory ......................................... Accounts Payable .........................................

568

Cash ...................................................................... Sales .............................................................

1,990

Cost of Goods Sold (2 × $556) .............................. Merchandise Inventory ..................................

1,112

Accounts Payable .................................................. Cash .............................................................

568

6-91

1,650

995

550

1,650

568

1,990

1,112

568

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BYP 6-7 (Continued) (d) (Continued) Sept.

Oct.

Merchandise Inventory (3 × $564) ........................ Accounts Payable .........................................

1,692

Accounts Receivable ............................................. Sales .............................................................

2,985

Cost of Goods Sold (3 × $562) .............................. Merchandise Inventory ..................................

1,686

Accounts Payable .................................................. Cash .............................................................

1,692

Merchandise Inventory ......................................... Accounts Payable .........................................

1,722

Cash ...................................................................... Sales .............................................................

995

Cost of Goods Sold ............................................... Merchandise Inventory ..................................

571

1,692

2,985

1, 686

1,692

1,722

995

571

(e) Sales Cost of goods sold Gross profit

FIFO $6,965 3,910 3,055

Gross profit margin

43.9%

(1)

Average $6,965 3,919 3,046 43.7%

(1) Sales = $995 + $1,990 + $2,985 + $995 = $6,965

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BYP 6-7 (Continued) (f) Natalie should consider: • Whether the goods are interchangeable or not, or whether they are produced or segregated for specific projects; • Whether the method corresponds most closely to the physical flow of goods; • Whether the method reports inventory on the statement of financial position that is close to the inventory’s most recent cost; and • Whether the method is used for other inventories with a similar nature and usage. For Natalie, the inventory of mixers consists of goods that are interchangeable. The nature of the items is not subject to a particular flow of goods so older mixers do not need to be sold first. Under the FIFO cost method, the cost of the ending inventory is determined using the most recent costs and is closer to replacement cost. This may not necessarily be the case for the mixers because they are subject to currency fluctuations. The ending inventory cost may not match the replacement cost. Because of the currency fluctuations, it is also not possible to know if the cost will increase or decrease over time and what the impact of using FIFO will be on cost of goods sold. Under the average cost method, the cost of the mixers will be averaged out and will smooth out the impact of the currency fluctuations. Since the mixers are identical and there is no issue of obsolescence, the average cost method may better suit the type of inventory.

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CHAPTER 7 Internal Control and Cash ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

A Problems

B Problems

BPY

1, 2, 3, 4, 5, 6

1, 2, 3, 4

1A, 2A, 3A, 4A

1B, 2B, 3B, 4B

1, 3, 4, 7

2. Apply key control activities to cash receipts and payments.

7, 8, 9, 10, 11, 12, 13

3, 4

1A, 2A, 3A, 4A

1B, 2B, 3B, 4B

4, 7

3. Prepare a bank reconciliation.

12, 13, 14, 15, 16, 17

5, 6, 7, 8, 9, 10, 11

5, 6, 7, 8

5A, 6A, 7A 5B, 6B, 7B

4. Explain the reporting and management of cash.

18, 19, 20, 21, 22

12, 13

9, 10

8A, 9A, 10A

2, 6

Study Objectives

Questions

1. Describe the primary components of an internal control system.

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8B, 9B, 10B

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Time Allotted (min.)

Identify control activities over cash receipts.

Simple

20-30

Identify control weaknesses over cash payments.

Simple

20-30

Identify control weaknesses.

Moderate

30-40

Identify control weaknesses over cash receipts and payments.

Complex

40-50

Prepare bank reconciliation and adjusting entries.

Moderate

30-40

Prepare bank reconciliation and adjusting entries.

Moderate

40-50

Prepare bank reconciliation and adjusting entries.

Moderate

40-50

Calculate cash.

Moderate

15-20

Discuss reporting of cash.

Simple

15-20

10A

Recommend cash management improvements.

Moderate

20-30

Identify control activities over cash payments.

Simple

20-30

Identify control weaknesses over cash receipts.

Simple

20-30

Identify control weakness.

Moderate

30-40

Identify control weaknesses over cash receipts and payments.

Complex

40-50

Prepare bank reconciliation and adjusting entries.

Moderate

30-40

Prepare bank reconciliation and adjusting entries.

Moderate

40-50

Prepare bank reconciliation and adjusting entries.

Moderate

40-50

Calculate cash.

Moderate

15-20

Discuss reporting of cash.

Simple

15-20

11B

Recommend cash management improvements.

Moderate

20-30

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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.

The six control activities that apply to most companies are authorization of transactions and activities, segregation of duties, documentation, physical controls, independent checks of performance, and human resource controls.

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.

Independent review 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. A performance review still needs to be done. In such a review, the accounting records are compared with existing assets or with external sources of information. The review helps ensure accuracy.

Retail stores that do not conduct criminal checks when hiring employees are missing the human resource control activity. These stores are accepting increased risk of employee theft and fraud.

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.

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Answers to Questions (Continued) 7.

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.

This is a violation of authorization of transactions. 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 bills for making change) in the register. If a discrepancy arises, the employee responsible for that register can be held responsible.

Cash registers are visible to the customer. Thus, they prevent the sales clerk from ringing up a lower amount and pocketing the difference. In addition, the customer receives an itemized receipt, and the cash register tape is locked into the register for further verification. Having scanners reduces the chance of error in entering the price of an item.

10. This statement is true if the alternative to a cheque payment is one done with cash. 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. 11. 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. 12. An employee who has no other responsibilities that relate to cash should 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. 13. 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. 14. The lack of agreement between the cash balances may be due to either: (1) Time lags—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.

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Answers to Questions (Continued) 15. (a)

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. (b) An NSF cheque makes the bank balance lower than the book balance and requires the book balance to be adjusted. Consequently, it is deducted from the balance per books. (c) An NSF cheque results in an adjusting 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.

16. 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. 17. 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 does 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. 18. Cash includes cash on hand and cash in bank accounts, including any debit and bank credit card slips. Cash equivalents include short-term, highly liquid 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. 19. 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.

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Answers to Questions (Continued) 20. 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 statement the terms of the line of credit facility 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 take advantage of investment opportunities. 21. 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. 22. 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.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 Control Activity

Example

Authorization of transactions and activities

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.

Independent checks of performance

If a customer is overcharged, they will complain. Review to make sure parking gate is not being raised prior to payment being received.

Human resource controls

Employees working the cash register are bonded. This allows for insurance to be purchased covering theft or robbery.

BRIEF EXERCISE 7-2 (a) (b) (c) (d) (e) (f)

3 4 6 5 1 2

All transactions should include original, detailed receipts. Undeposited cash should be stored in the company safe. Employees must take their full vacation allotment each year. 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

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BRIEF EXERCISE 7-3 1. 2. 3. 4. 5. 6.

Documentation and physical controls Human resource controls Independent checks of performance Segregation of duties Authorization of transactions and activities Physical controls

BRIEF EXERCISE 7-4 1. 2. 3. 4. 5. 6.

Documentation Independent checks of performance Physical controls Authorization of transactions and activities Segregation of duties Physical controls

BRIEF EXERCISE 7-5 1. 2. 3. 4. 5. 6.

Book – Book + Bank – Bank – NA Bank +

7. 8. 9. 10. 11. 12.

Book + Book – Book – Bank + Book – Bank –

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 .................................................................

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$1,000 5,600 4,600 $2,000

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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 12,600 11,100 $ 1,500

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............................................................

$1,500 9,500 9,900 $1,100

BRIEF EXERCISE 7-8 (a)

Kashechewan should correct its books for the error in recording the cheque by reducing cash by $18 ($86 – $68). The cheque mistakenly deducted by the bank should be added back to the bank balance since it is the bank’s error.

(b)

Accounts Payable ..................................................................... Cash ...........................................................................

18 18

No entry is necessary for the cheque mistakenly deducted by the bank, although the bank should be notified of this error.

BRIEF EXERCISE 7-9 June 30, adjusted cash balance per bank reconciliation ................. Add: Cash receipts in July ............................................................... Less: Cash disbursements in July ................................................... July 31, unadjusted cash balance....................................................

Solutions Manual .

7-9

$18,920 21,700 24,300 $16,320

Chapter 7

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 7-10 Cash balance per bank Add: Deposits in transit

$15,840 4,300 20,140 2,300 $17,840

Less: Outstanding cheques Adjusted cash balance per bank Cash balance per books (as per BE7-9) Add: EFT collections on account

$16,320 1,960 18,280

Less: Bank service charge NSF cheque and fee ($290 + $80)

$ 70 370 440 $17,840

Adjusted cash balance per books

BRIEF EXERCISE 7-11 July 31

Cash ......................................................................... Accounts Receivable.........................................

1,960

Bank Charges Expense ............................................ Cash..................................................................

Accounts Receivable ................................................ Cash..................................................................

370

1,960

370

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 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.

BRIEF EXERCISE 7-13 Cash and cash equivalents should be reported at $45,100 ($12,000 + $1,700 + $24,000 + $5,000 + $2,400). Note that all of these items are actually cash. The company has no cash equivalents. The other items are receivables. The income tax refund due from CRA is a receivable until collected. Postdated cheques are also receivables until they can be cashed.

Solutions Manual .

7-10

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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 performed independently – weakness

Cash counts should be performed by a supervisor at the end of the shift and the totals compared to the cash register reading.

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.

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

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

Solutions Manual .

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.

7-11

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 7-2 1.

(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)

(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 day prior to the schedule 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 appointments be written in ink.

(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.

Solutions Manual .

7-12

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 7-3 (a) Weakness 1.

Cashiers are not bonded.

Human resource controls

All cashiers should be bonded.

Inability to fix responsibility for cash to a specific clerk.

Authorization of transactions and activities

There should be separate cash drawers and register codes for each clerk.

Cash is not adequately protected from theft.

Physical controls

Cash should be stored in a locked safe until it is deposited in the bank.

Cash is not independently counted.

Independent checks of performance

A cashier office supervisor should count cash and reconcile the amount of cash received to the cash register reading.

The accountant should not handle cash and record cash transactions.

Segregation of duties

The cashier’s department should make the deposits.

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.

Solutions Manual .

Control Activity

(b) Recommended Improvement

7-13

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 7-4 (a) Weakness 1.

Cheques are not stored in a secure area.

Physical controls

Cheques should be stored in a safe or locked file drawer.

The approval of and payment to suppliers is done by the wrong employee.

Authorization 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 signing cheques.

Blank cheques are signed.

Authorization of transactions and activities

Establish a second signing authority with the bank.

Cheques are not prenumbered.

Documentation

Cheques should be prenumbered and their serial continuity subsequently tested for completeness.

The bank reconciliation is not independently prepared.

Independent checks of performance

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.

Solutions Manual .

Control Activity

(b) Recommended Improvement

7-14

Chapter 7

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Financial Accounting, Sixth Canadian Edition

EXERCISE 7-5 (a) August 31 adjusted cash balance per bank reconciliation ............................ Add: (4) Cash deposits in September ......................................................... Less: (1) Cheques issued .................................................... $127,492 (2) Salaries deposited to employees accounts ........... 49,900 (3) Monthly EFT payment for insurance ..................... 1,500 September, unadjusted cash balance .......................................................... (b)

$ 54,700 128,658

178,892 $ 4,466

None of the above items would be included in the bank reconciliation as they are included in the starting (unadjusted) cash balance and already have been recorded by the company.

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 end of April 4. Outstanding cheques at the beginning of April that cleared the bank in April 5. Cheque written for $250 recorded in error as $520 on the books 6. Deposit of $400 made in error by the bank to the company’s account 7. Bank service charges 8. EFT, collection on account not previously recorded by company 9. NSF cheque received from customer 10. Interest earned on bank account

Solutions Manual .

Bank Add Deduct (Credit) (Debit)  NA

Books Add Deduct (Debit) (Credit)

 NA

No No



Yes



No 

Yes Yes



Yes



7-15

Adjusting Entry No

Yes

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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

Solutions Manual .

7-16

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 7-8 (a) NEOPOLITAN LTD. Bank Reconciliation July 31

Cash balance per bank statement Add: Deposits in transit Cheque No. 373 error ($762 – $672)

$ 8,833 $1,575 90 1,665 10,498 2,449 $ 8,049

Less: Outstanding cheques Adjusted cash balance per bank

Cash balance per books Add: EFT deposits

$7,190 883 8,073 24 $8,049

Less: Bank service charges Adjusted cash balance per books

(b)

July 31

Solutions Manual .

Cash ................................................................. Accounts Receivable ...................................

883

Bank Charges Expense .................................... Cash ............................................................

7-17

883

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 7-9 (a) Items that are considered cash but not cash equivalents would include: 1. 3. 5. 6. 9. 10.

Currency and coin April cheques Royal Bank chequing account Royal Bank savings account Cash register floats Over-the-counter receipts ($550 + $185 + $685 + $755) Total cash

The $10,000 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.

(b)

Cash and cash equivalents = $9,387 [from (a)] + $10,000 = $19,387

(c)

4. 7. 8.

87 300 2,575 4,000 250 2,175 $9,387

Post-dated cheque—Accounts Receivable; Statement of Financial Position Prepaid postage in postage meter—Supplies; Statement of Financial Position IOU from company receptionist—Advances to Employees; Statement of Financial Position

EXERCISE 7-10 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 which 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.

Solutions Manual .

7-18

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 7-1A (a)

(b)

Control Activities

Application to Cash Receipts

Authorization of transactions and activities

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.

Independent checks of performance

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.

Human resource controls

Cashiers are bonded.

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.

Solutions Manual .

7-19

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-2A (a)Control Weaknesses

(b) Improvements

Fred or Asmaa can order goods (authorization) and approve invoices for payment (up to $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.

John or Rehana should be authorizing the purchase of goods.

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 adjusting 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.

Solutions Manual .

7-20

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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 sales person 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.

Solutions Manual .

7-21

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-4A (a) Control Weaknesses

(b) Improvements

The tickets were unnumbered so there is no way of knowing if duplicates were made and sold.

Tickets should be prenumbered so that the students could be held more 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 Al. Without a receipt, there is no way to 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.

A receipt should have been obtained from Obnoxious Al.

Inadequate control over the cash box.

Only Roger should have had access to the key and dispersed 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.

Solutions Manual .

7-22

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-4A (Continued) (a) and (b) (Continued) (a) Control Weaknesses

(b) Improvements

Students taking money for decorations were not required to have a receipt and had unrestricted access to the cash box to pay for their purchases.

Roger should reimburse each student when a receipt is provided

Sara Wu was collecting tickets and receiving cash for additional tickets sold.

There should have been one 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 were less than anticipated.

A final reconciliation should have been performed between cash on hand, ticket sales and purchase receipts.

Solutions Manual .

7-23

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-5A (a)

BEAUPRÉLTD. Bank Reconciliation July 31

Cash balance per bank statement .............................................. Less: Outstanding cheques ($1,844 – $1,378) .......................... Deposit incorrectly posted by bank .................................. Adjusted cash balance per bank .................................................

$21,062 $ 466 1,800

Cash balance per books ............................................................. Add: EFT collections .................................................................

2,266 $18,796 $14,786 4,110 18,896 100 $18,796

Less: Bank service charges ....................................................... Adjusted cash balance per books ...............................................

The salaries are not a reconciling item because they were recorded by both the bank and the company. (b)

July

Solutions Manual .

Cash ....................................................................... Accounts Receivable .....................................

4,110

Bank Charges Expense .......................................... Cash ..............................................................

100

7-24

4,110

100

Chapter 7

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-6A (a) February 28, adjusted cash balance per bank reconciliation ... Add: Cash receipts in March ................................................... Less: Cash disbursements in March........................................ March 31, unadjusted cash balance ........................................ (b)

Deposits in transit: $1,025 (dated March 31)

(c)

Outstanding cheques: #3473 for $487(dated March 29)

$13,103 4,813 3,375 $14,541

(d) YAP LTD. Bank Reconciliation March 31 Balance per bank statement ................................................. Add: Deposits in transit [from (b)] ..................................... Error in recording cheque #3472 ($1,641 – $1,461) ................................................

$12,287 $1,025 180

Less: Outstanding cheques No. 3473 [from (c)]................................................... Adjusted cash balance per bank ...........................................

487 $13,005

Balance per books [from (a)] ................................................ Add: EFT collection—Boudreault ..................................... Less:

Service charges ($49 + $65) ................................... NSF cheque and fee—Aubut ($550 + $40) ............. EFT loan payment ................................................... Adjusted cash balance..........................................................

Solutions Manual .

7-25

1,205 13,492

$14,541 230 14,771 $ 114 590 1,062

1,766 $13,005

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-6A (Continued) (e)

Mar.

Solutions Manual .

Cash .................................................................. Accounts Receivable .................................

230

Bank Charges Expense ..................................... Cash ..........................................................

114

Accounts Receivable ......................................... Cash ..........................................................

590

Bank Loan Payable ........................................... Interest Expense ............................................... Cash ..........................................................

1,000 62

7-26

230

114

590

1,062

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-7A (a) October 31, adjusted cash balance per bank reconciliation................... Add: Cash receipts in November ........................................................... Less: Cash disbursements in November ............................................... November 30, unadjusted cash balance................................................ (b)

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 .......................................................... Adjusted 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) ......... Adjusted cash balance per books ...................................

Solutions Manual .

$23,812 21,438 30,968 $14,282

7-27

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

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-7A (Continued) (c)

Nov. 30

Solutions Manual .

Cash ........................................................................... Notes Receivable ............................................... Interest Revenue ................................................

5,008

Bank Charges Expense .............................................. Cash ...................................................................

Accounts Receivable (Giasson Developments) .......... Cash ...................................................................

580

Accounts Payable ........................................................ Cash ....................................................................

900

Accounts Receivable.................................................... Cash ....................................................................

7-28

4,400 608

580

900

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-8A

(a) and (b) Cash and cash equivalents (reported in Current Assets section) Cash: 1. Cash on hand ............................................................... 2. Commercial bank savings account............................... Commercial bank chequing account ............................ US bank account (Canadian equivalent) ...................... Total cash ............................................................................... Cash equivalents: 5. Government of Canada Bond ...................................... Total cash and cash equivalents............................................. (c)

5,000 100,000 25,000 45,000 175,000

75,000 $250,000

Restricted cash would be reported as a current or non-current asset, depending on the timing of the equipment replacement.

Amounts due from employees (travel advances) would be classified as other receivables account called Advances to Employees.

Trading investments would be listed separately in the current assets section of the statement of financial position and would include the term deposit which matures in 120 days (to be a cash equivalent it would have to mature in 90 days or less) and the shares of Shoppers Drug Mart. The classification of the shares could also be non-current depending on management’s intentions for holding the shares.

Unused postage stamps would be included in Supplies.

NSF cheques would be included in Accounts Receivable, assuming the company expects collection. If collection is doubtful, they might be provided for as part of Bad Debts Expense or written off as uncollectable.

This amount would be reported as restricted cash in the non-current assets section of the statement of financial position.

Solutions Manual .

7-29

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-9A (a)

Cash includes cash on hand, including any debit and bank credit card slips, 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.

(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 of management’s intent in the use of the cash. Since the cash cannot be used for regular operations and has been set aside for a specific purpose, it is not available to settle liabilities whenever these are due. 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.

Solutions Manual .

7-30

Chapter 7

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-10A 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 collection 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

Solutions Manual .

7-31

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 7-1B Control Activities

Application to Cash Payments

Authorization of transactions and activities

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.

Independent checks of performance

The cheque signer compares the cheque with the approved invoice prior to issue. A staff accountant reconciles bank and book balances monthly.

Human resource controls

None identified.

Solutions Manual .

7-32

Chapter 7

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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 other than the financial secretary will know if the cash placed in the safe was ever deposited. The financial secretary counts 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 secretary is not bonded. 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.

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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. • The financial secretary should be bonded. • At the end of each month, a member of the finance committee should prepare the bank reconciliation. • Annual audits should be performed.

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Financial Accounting, Sixth 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 provides 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 submits the money collected (cash or cheque) for the product being replaced.

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Financial Accounting, Sixth 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.

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Financial Accounting, Sixth 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. In some cases, bonding of volunteers may be an option. 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.

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Financial Accounting, Sixth 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) ............ Adjusted cash balance per bank ................................................... Cash balance per books ............................................................... Add: EFT collections..................................................................

(b)

$1,430 80

May

Cash .................................................................... Accounts Receivable ...................................

4,188

Accounts Receivable ........................................... Cash ............................................................

1,430

Bank Charges Expense ....................................... Cash ............................................................

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$13,126 4,188 17,314

Less: NSF cheque and service charge ($1,350 + $80)............... Bank service charge ...................................................................... Adjusted cash balance per books .................................................

7-38

3,126 18,356 2,552 $15,804

1,510 $15,804

4,188

1,430

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-6B (a) April 30, adjusted cash balance per bank reconciliation .................... Add: Cash receipts in May ................................................................. Less: Cash disbursements in May ..................................................... May 31, unadjusted cash balance ..................................................... (b)

Deposits in transit, May 31, $1,286 (dated May 31).

(c)

Outstanding cheques #545 for $950

$ 9,213 4,307 5,199 $ 8,321

(d) RIVER ADVENTURES LTD. Bank Reconciliation May 31 Balance per bank statement ............................................. Add: Deposits in transit [from (b)] ................................... Less: Outstanding cheques No. 545 [from (c)]................................................. Bank error cheque #543 ($1,650 – $1,560) ......... Adjusted cash balance per bank .......................................

$7,567 1,286 8,853 $950 90

Balance per books [from (a)] ............................................ Add: EFT collection ...................................................... Less:

Service charges ($75 + $25) ............................... EFT insurance payment ...................................... NSF cheque and fee ($440 + $40) ...................... Adjusted cash balance......................................................

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1,040 $7,813 $8,321 650 8,971

$100 578 480

1,158 $7,813

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-6B (Continued) (e)

Cash ................................................................................. Accounts Receivable................................................

650

Accounts Receivable ........................................................ Cash.........................................................................

480

Bank Charges Expense .................................................... Cash.........................................................................

100

Prepaid Insurance ............................................................ Cash.........................................................................

578

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7-40

650

480

100

578

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-7B (a) November 30, adjusted cash balance per bank reconciliation .......... Add: Cash receipts in December ...................................................... Less: Cash disbursements in December .......................................... December 31, unadjusted 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 ....................................................... Adjusted cash balance per bank ..................................

$10,395 1,197 11,592 $1,050 538 1,390

Cash balance per books [from (a)] .............................. Add: EFT collection .................................................... Less:

NSF cheque and fee ($987 + $40) ................. Bank service charges ..................................... Error in Dec. 17 deposit ($2,954 – $2,945)..... Adjusted cash balance per books ................................

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$12,743 8,955 15,148 $ 6,550

7-41

2,978 $ 8,614 $6,550 3,145 9,695

$1,027 45 9

1,081 $8,614

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-7B (Continued) (c)

Dec. 31

Solutions Manual .

Cash ................................................................ Accounts Receivable ...............................

3,145

Accounts Receivable........................................ Cash ........................................................

1,027

Bank Charges Expense ................................... Cash ........................................................

Accounts Receivable........................................ Cash ........................................................

7-42

3,145

1,027

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-8B (a) and (b)

(c)

Cash: 1. Cash on hand ........................................................................ 2. Debit card slips ...................................................................... 3. MasterCard credit card slips .................................................. 4. Bank chequing account ......................................................... 7. US dollar account (Canadian equivalent) .............................. Total cash balance ...........................................................

$ 1,600 500 975 7,460 2,241 12,776

Cash equivalents: 5. Government of Ontario bond ................................................ Cash and cash equivalents ...........................................................

5,000 $17,776

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 merchandise inventory (current asset), sales (revenue), and cost of goods sold (expense).

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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-9B (a)

The security deposits were not included in cash and cash equivalents as these amounts cannot be spent freely by the company to pay off current liabilities. They are held in trust for the tenants and are therefore a form of restricted cash. They are therefore segregated on the statement of financial position.

(b)

Segregated tenant’s security deposits would most likely be classified in the noncurrent assets section of the statement of financial position. Depending on the length of the apartment leases to which the security deposits relate and the operating cycle of the business, the timing of when the repayment of these deposits are not likely to be in the current accounting cycle.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 7-10B 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

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Financial Accounting, Sixth Canadian Edition

BYP 7-1 FINANCIAL REPORTING (a)

The second paragraph of the Management’s Responsibility for Financial Statements clearly states that management is responsible for establishing and maintaining a proper system of internal control. This statement is followed by a description of the limitations of internal control, a general description of the purpose of internal control, and mention that the internal auditors of the company perform a review and evaluation of internal controls on management’s behalf. 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.

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Financial Accounting, Sixth Canadian Edition

BYP 7-2 COMPARATIVE ANALYSIS (a)

Jean Coutu reports a negative balance of cash and cash equivalents of $(1.6) million at March 2, 2013.

(b)

At March 2, 2013, Jean Coutu reports a temporary investment of $20 million in the current assets section of its statement of financial position and a bank overdraft balance of $21.6 million in the current liabilities section. These two amounts net to the $(1.6) million ($20 – $21.6) reported on its statement of cash flows.

(c)

Shoppers Drug Mart reports a positive cash balance of $104,529 thousand, compared to Jean Coutu’s negative cash and cash equivalents balance of $1.6 million. Shoppers has the better cash position in the most recent year.

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Financial Accounting, Sixth Canadian Edition

BYP 7-3 COMPARING IFRS AND ASPE (a)

Generally, which accounting standards a company follows should not have a significant impact on its internal controls. However, since IFRS is more principlesbased 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 and approval.

(b)

Strong internal controls are essential to 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.

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Financial Accounting, Sixth Canadian Edition

BYP 7-4 CRITICAL THINKING CASE

(a)

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.

(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.

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BYP 7-4 (Continued) (c) (Continued) 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 for the reasonableness of the amount of revenues reported from bar sales should be made 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.

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Financial Accounting, Sixth Canadian Edition

BYP 7-5 ETHICS CASE (a)

The stakeholders are the customers affected by the policy, the shareholders of the banks who want to see higher profits 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 nonsufficient 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, all of the cheques will clear processing except for the largest cheque which is cheque #3158 for $1,510. By processing the cheques in this way, only one cheque will bounce and this means that the bank will earn a processing fee of only $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.

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Financial Accounting, Sixth Canadian Edition

BYP 7-6 “ALL ABOUT YOU” ACTIVITY Note to instructors: Answers will vary based on individual student experiences. (a) Here is the information that the website will generate assuming a student is attending the University of Calgary and studying business. Calculate your school tuition cost Select the province where you will attend school:

Alberta

Select a school:

University of Calgary

Select a degree:

Business, Mgt and Public Administration

Alberta

University of Cal

Select degree length:

Business, Mgt a

Year 1 ($)

48005000

7697

years

Year 2 ($)

Year 3 ($)

Year 4 ($)

Tuition

7697

Books

1,500

Room/rent

5,394

Food

3,347

Entertainment

1,600

Transportation

880

20418

Other Total

Adapted from Statistics Canada Survey of Tuition and Living Accommodation Costs for Full-time Students at Canadian Degree-granting Institutions (TLAC), 2012 � 2013

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BYP7-6 (Continued) (b) Here is an example of where the funding for a student’s education may come from using the tool provided. How will you pay for school? Enter any additional money that you will use to pay for your education. Fields on this tab allow you to enter annual amounts, which are then multiplied by the number of years in your program. If you have a one-time funding source (such as a bursary or scholarship), you should divide the total amount of funding by the number of years in your program to avoid overstating your funding. For example, if you get a first-year entrance scholarship of $1,000 for your 4-year program, and you do not expect to receive the same amount every year, enter $250 for this scholarship ($1,000/4 years).

Scholarships & bursaries:

5,000

per year

Gifts and $ family's contributions:

1,000

per year

Earnings from your job (after tax):

per year

Education $ savings plan:

2,500

per year

Personal savings:

5,000

per year

Other:

per year

Total cost of university According to the above current plan, total education costs of $81,672 ($20,418 × 4 years) will be offset by $54,000 ($13,500 × 4 years) in funding.

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Financial Accounting, Sixth Canadian Edition

BYP 7-7 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)

The strengths in Koebel’s system of internal control and related control activity are as follows: Control Activity

Strength 1. Password access to the cash register Cash register calculates the pricing of the goods and prints receipt

Documentation

2. Cash is deposited daily

Physical controls

Owners are involved in the reconciliation of cash with totals from the cash register 3. Inventory is counted daily

Independent checks of performance Independent checks of performance Documentation

4. Invoices are prepared when the shipment of cupcakes is complete 5. The monthly payroll schedule is reconciled to actual salaries paid 6. Janet or Brian authorize the purchase of inventory

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Independent checks of performance Authorization of transactions

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Financial Accounting, Sixth Canadian Edition

BYP 7-7 (Continued) (b)

The weaknesses in Koebel’s system of internal control and the control activities violated are as follows: Control Activity

Weaknesses 1. Employees share one cash register and management currently is unable to affix responsibility for cash to a specific employee Cashier is handling cash and inventory

Segregation of duties

Entering transactions can be performed by incorrect cashier, due to no logging off No mention if employees are bonded

Physical controls

No mention of supervision of employees entering sales and handling inventory No mention of procedures for voided transactions or pricing adjustments on sales

Segregation of duties

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Authorization of transactions and activities

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Human resource controls

Authorization of transactions and activities

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Financial Accounting, Sixth Canadian Edition

BYP 7-7 (Continued) (b) (Continued) Control Activity

Weaknesses 2. Reconciliation of sales is not done daily and so one cannot establish who has made an error on a sale 3. Inventory is counted daily to determine what product is needed for the next day, but should also be used to determine unrecorded sales 4. Documentation of authorized overtime is not obtained 5. Invoices are not prenumbered Invoices are not issued in duplicate photocopies have to be made and if staff forget to make a photocopy, sales could go unrecorded Invoices are manually prepared, leading to possible pricing or calculation errors 6. No system in place to avoid duplication of purchases

Independent checks of performance Independent checks of performance Documentation Documentation Documentation

Independent checks of performance Independent checks of performance

In order to address the weaknesses, improvements that Koebel’s Family Bakery should consider include: 1. Program the cash register such that a new transaction cannot be entered without the operator logging off from the previous transaction. 2. Reconcile the sales to the deposit daily and establish the responsibility of errors to the particular employee causing the error. 3. Consider bonding the employees handling cash. 4. Provide supervision of employees or install cameras to ensure that all sales are recorded. 5. Design procedures involving owners for the voiding or altering the pricing for transactions entered. 6. Compare and reconcile the reduction of inventory to the sales recorded daily. 7. Implement the use of pre-numbered invoices that are printed induplicate carbon copies which cannot be altered. 8. Account for the numerical sequence of invoices. 9. Consider automating the production of invoices. 10. Install a log of purchase orders made to avoid duplication of orders.

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Financial Accounting, Sixth Canadian Edition

CHAPTER 8 Reporting and Analyzing Receivables ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Questions

Brief Exercises Exercises

A Problems

B Problems

BYP

Identify the types of receivables and record accounts receivable transactions.

1, 2, 3, 4, 5, 11, 12

1, 2, 3, 4, 1, 2 10

1A, 2A, 6A

1B, 2B, 6B

1, 5, 6

Account for bad debts.

6, 7, 8, 9, 10

5, 6, 7, 8

1A, 2A, 3A, 4A, 5A, 8A

1B, 2B, 3B, 4B, 5B, 8B

3, 4

Account for notes 11, 12, receivable. 13, 14, 15, 16

Explain the statement presentation of receivables.

17, 18, 19 14

Apply the principles of sound accounts receivable management.

20, 21, 22, 23

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3, 4, 5, 6

9, 10, 11, 7, 8, 9 12, 13

8-1

6A, 7A, 8A 6B, 7B, 8B

10, 11

1A, 2A, 8A, 9A

1B, 2B, 8B, 9B

12, 13

10A, 11A

10B, 11B

1, 2, 4, 6, 7

Chapter 8

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record receivables and bad debts transactions; show statement presentation.

Moderate

25-35

Record receivables and bad debts; show statement presentation.

Moderate

25-35

Determine missing amounts.

Complex

15-20

Prepare aging schedule and record bad debts.

Moderate

20-30

Prepare aging schedule; record bad debts for two years.

Moderate

25-35

Record receivables transactions.

Moderate

20-30

Record notes receivable and payable transactions.

Moderate

20-30

Record notes receivable transactions; show statement presentation.

Moderate

30-35

Prepare assets section.

Moderate

20-30

10A

Calculate and evaluate ratios.

Moderate

15-20

11A

Evaluate liquidity.

Moderate

15-20

Record receivables and bad debts; show statement presentation.

Moderate

25-35

Record receivables and bad debts; show statement presentation.

Moderate

25-35

Determine missing amounts.

Complex

15-20

Prepare aging schedule and record bad debts.

Moderate

20-30

Prepare aging schedule, record bad debts for two years.

Moderate

25-35

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record receivables transactions.

Moderate

20-30

Record notes receivable and payable transactions.

Moderate

20-30

Record notes receivable transactions; show statement presentation.

Moderate

30-35

Prepare assets section.

Moderate

20-30

10B

Calculate and evaluate ratios.

Moderate

15-20

11B

Evaluate liquidity.

Moderate

15-20

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ANSWERS TO QUESTIONS 1. Three types of receivables along with examples follows: (1)

(a) Type Accounts receivable

(b) Examples Accounts receivable from trade customers

(2)

Notes receivable

Notes receivables 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

2. Trade receivables are the result of sales transactions while nontrade receivables are the result of transactions other than sales transactions of the business, such as interest receivable, income tax receivable, and similar types of receivables. 3.

(a) For a service company, a receivable is recorded when service is provided on account as required by the revenue recognition criteria. For a merchandising company, a receivable is recorded at the point of sale of merchandise on account as required by the revenue recognition criteria. (b) Revenue should be recognized when the performance or sales effort is substantially complete. This normally occurs when the service is performed, or when goods are delivered at the point of sale, but not necessarily when cash is received. In addition, collection must be reasonably assured.

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Answers to Questions (Continued) 4.

(a) Nonbank credit cards: From its own company credit card, Canadian Tire realizes interest revenue from customers who do not pay the balance due within a specified grace period. Bank credit cards: Bank credit cards offer the following advantages: (1) The credit card issuer makes the credit card investigation of the customer. (2) The issuer maintains individual customer accounts. (3) The issuer undertakes the collection process and absorbs any losses from uncollectible accounts. (4) The retailer receives cash more quickly from the credit card issuer than it would from individual customers. 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 using its own credit cards, bank credit cards and debit cards, Canadian Tire provides more options to its customers, increases its revenue, and reduces its risk.

4. (b)

Nonbank credit cards: To record a company credit card transaction, the seller records a debit to Accounts Receivable and a credit to Sales. 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 a credit to Sales. Bank charges expense for debit card and bank credit card fees must also be recorded, usually as part of the bank reconciliation process.

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.

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Answers to Questions (Continued) 6. (a)

An aging schedule shows the receivables in various stages outstanding 0–30 days, 31–60 days, 61–90 days, and so on as long as required.

(b) The aging schedule is used to apply percentages to outstanding receivables in each age category to determine the total estimated uncollectible accounts. 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. 8. 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. 9. The write off of an uncollectible account reduces both Accounts Receivable and the Allowance for Doubtful Accounts by the same amount. Thus, net realizable value (which is the difference between accounts receivable and allowance for doubtful accounts) does not change. Net realizable value 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. 10. 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.

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Answers to Questions (Continued) 11. (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 net realizable value. (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 an entire period.

12. (a) (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. 12. (b) (1) Accounts Receivable is normally debited for interest 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 interest revenue is accrued, 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. 13. 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. 14. 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.

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Answers to Questions (Continued) 15. 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. 16. These notes should be recorded at their net realizable value. 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. 17. 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. It is usual to report the receivables on the statement of financial position at their net realizable value and to provide additional information about the allowance in the notes to the statements. 18. Current assets Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable Notes receivable (due in three months) Less: Allowance for doubtful notes Net realizable value of short-term notes Sales tax recoverable Income tax receivable Non-current assets Notes receivable (due in two years) 19.

$xxx xxx $xxx $xxx xxx xxx xxx xxx

$xxx

(a) Account (1) Sales or Service Revenue (2) Bad Debt Expense (3) Interest Revenue

(b) Classification Revenues Operating expenses Other revenues and expenses

20. The steps involved in receivables management are: (1) Determine who to extend credit to. (2) Establish a payment period. (3) Monitor collections. (4) Evaluate the liquidity of receivables.

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Answers to Questions (Continued) 21. To help in determining whether Canam Group’s receivables management has improved or worsened the average collection period should be determined.

Average collection period

2012 365 = 118 days 3.1

2011 365 = 111 days 3.3

Canam’s receivable management has worsened. The receivables turnover has decreased from 3.3 times to 3.1 times, indicating a slower collection of receivables. The average collection period shows this more clearly; the average time it takes to collect a receivable has risen from 111 days to 118 days. 22. (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.

23. 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.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 (a) (b) (c) (d) (e) (f) (g)

Other receivables Other receivables Notes receivable Accounts receivable Accounts receivable Other receivables Notes receivable

BRIEF EXERCISE 8-2 (a)

(b)

(c)

(d)

July 1

July 8

July 9

Accounts Receivable ................................................. Sales ....................................................................

42,000

Cost of Goods Sold ................................................... Merchandise Inventory.........................................

30,000

Sales Returns and Allowances .................................. Accounts Receivable ...........................................

7,200

Merchandise Inventory .............................................. Cost of Goods Sold ..............................................

4,320

Cash ($34,800 – $696).............................................. Sales Discounts ($34,800 × 2%) ............................... Accounts Receivable ($42,000 – $7,200) ............

34,104 696

Aug. 31 Accounts Receivable ................................................. Interest Revenue [($42,000 – $7,200) × 24% × 1/12]

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42,000

30,000

7,200

4,320

34,800 696 696

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BRIEF EXERCISE 8-3 (a) Visa card Cash ........................................................................................ Sales ...............................................................................

100 100

Bank Charges Expense ............................................................ Cash ................................................................................ (b) Nonbank credit card Accounts Receivable ................................................................ Sales ...............................................................................

2 2

100 100

Because VISA is sponsored by a bank, it is appropriate to record a debit to cash in the first entry. In the second entry, because a nonbank credit card is used, the company bears the entire risk of collecting the amount, so it is recorded in accounts receivable. In addition, there are normally no bank charges incurred with respect to the use of a company credit card.

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

Elbaz Inc. Jan. 15 6,000 Jan. 24 Jan. 31 Bal. 4,000

2,000

General Ledger Control Account Accounts Receivable Jan. 31 11,500 Jan. 31 Jan. 31Bal. 5,100

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6,400

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BRIEF EXERCISE 8-5 (a)

(b)

Bad Debts Expense ................................................................. Allowance for Doubtful Accounts .................................... [($600,000 × 4%) – $3,600]

20,400 20,400

The amount to be reported as bad debts expense would be [($600,000 × 4%) + $4,000] = $28,000 Bad Debts Expense ................................................................. Allowance for Doubtful Accounts ....................................

28,000 28,000

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

Accounts Receivable $368,000 120,000 72,000 40,000 $600,000

Estimated % Uncollectible 1% 4% 10% 20%

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 20,080

BRIEF EXERCISE 8-7 (a)

Jan. 24

Allowance for Doubtful Accounts........................... Accounts Receivable.....................................

(b)

(1) Accounts receivable Allowance for doubtful accounts Net realizable value

Before Write Off $600,000 36,000 $564,000

8,000 8,000 (2)

After Write Off $592,000 28,000 $564,000

BRIEF EXERCISE 8-8 Mar. 4

Accounts Receivable ....................................................... Allowance for Doubtful Accounts...........................

8,000

Cash ................................................................................ Accounts Receivable .............................................

8,000

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8,000

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BRIEF EXERCISE 8-9 (a) Interest Revenue 2014

(b) Interest Revenue 2015

Note #1

$81,000

(1)

$54,000

(2)

$135,000

Note #2

4,200

(3)

2,100

(4)

6,300

Note #3

002,800

(5)

14,000

(6)

16,800

Totals

$88,000

(1) (2) (3) (4) (5) (6)

$70,100

$158,100

$1,800,000 × 6% × 9/12 (April 1 to Dec. 31) = $81,000 $1,800,000 × 6% × 6/12 (Jan. 1 to June 30) = $54,000 $168,000 × 5% × 6/12 (July 2 to Dec. 31) = $4,200 $168,000 × 5% × 3/12 (Jan. 1 to maturity) = $2,100 $420,000 × 4% × 2/12 (Nov. 1 to Dec. 31) = $2,800 $420,000 × 4% × 10/12 (Jan. 1 to Oct. 30) = $14,000

BRIEF EXERCISE 8-10 Jan.

Feb.

April 30

July

Solutions Manual .

Accounts Receivable ...................................................... Sales ......................................................................

48,000

Cost of Goods Sold ........................................................ Merchandise 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

8-13

48,000

32,000

48,000

840

840 48,000 560

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BRIEF EXERCISE 8-11 2014 April 1

Dec. 31

2015 Mar 31

Notes Receivable ........................................................... Sales ......................................................................

10,000

Cost of Goods Sold ........................................................ Merchandise Inventory ...........................................

6,000

Interest Receivable ($10,000 × 9% × 9/12) .................... Interest Revenue ....................................................

675

10,900

10,000

6,000

675

675 10,000 225

BRIEF EXERCISE 8-12 2014 Apr.

Sept 30 2015 Mar. 31

Solutions Manual .

Merchandise Inventory................................................. Notes Payable.....................................................

10,000

Interest Expense ($10,000 × 9% × 6/12) ..................... Interest Payable ..................................................

450

Interest Expense ($10,000 × 9% × 6/12) .................... Interest Payable ........................................................... Notes Payable.............................................................. Cash ...................................................................

450 450 10,000

8-14

10,000 450

10,900

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BRIEF EXERCISE 8-13 (a) Apr. 1 Notes Receivable ......................................................... Accounts Receivable ..........................................

40,000

July 1 Cash ............................................................................ Notes Receivable ................................................ Interest Revenue ($40,000 × 6% × 3/12) ............

40,600

Apr. 1 Notes Receivable ......................................................... Accounts Receivable ..........................................

40,000

July 1 Accounts Receivable ................................................... Notes Receivable ................................................ Interest Revenue ($40,000 × 6% × 3/12) ............

40,600

Apr. 1 Notes Receivable ......................................................... Accounts Receivable ..........................................

40,000

July 1 Allowance for Doubtful Notes ....................................... Notes Receivable ................................................

40,000

40,000 40,000 600

(b) 40,000 40,000 600

Note that no interest revenue is recorded in (c) because it is unlikely that it will be collected.

BRIEF EXERCISE 8-14 NIAS CORPORATION Statement of Financial Position (Partial) February 28, 2015 Assets Current assets Cash ........................................................................ Trading investments................................................. Accounts receivable ................................................. Less: Allowance for doubtful accounts ..................... Notes receivable (due Nov. 1, 2015)........................ Sales tax recoverable .............................................. Merchandise inventory ............................................. Prepaid rent ............................................................. Total current assets .................................................

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$ 150,000 330,000 $470,000 30,000

440,000 300,000 38,000 380,000 8,000 $1,646,000

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BRIEF EXERCISE 8-15 (a) ($ in thousands) Receivables turnover Average collection period

2012 $4,864,779 70.8 = times $55,954 + $81,477 2 365 = 5 days 70.8

2011 $4,893,624 = $81,477 + $65,084 2 365 = 66.8

66.8 times

5 days

(b) The receivables turnover is better in 2012 and the average collection period is generally unchanged in 2012 (when rounded to the nearest day).

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SOLUTIONS TO EXERCISES EXERCISE 8-1 (a)

Compton Limited

Jan.

Accounts Receivable. ..................................................... Sales ......................................................................

24,000

Cost of Goods Sold ........................................................ Merchandise Inventory ...........................................

16,000

Cash ($24,000 – $480) ................................................... Sales Discounts (2% × $24,000) .................................... Accounts Receivable. .............................................

23,520 480

(b)

Singh Inc.

Jan.

24,000

16,000

24,000

Merchandise Inventory ................................................... Accounts Payable ...................................................

24,000

Accounts Payable ........................................................... Merchandise Inventory ........................................... Cash .......................................................................

24,000

480 23,520

EXERCISE 8-2 (a) Feb.

2 4 5 8 10

Solutions Manual .

Accounts Receivable (Andrew Noren) ............................ Sales ......................................................................

1,140

Sales Returns and Allowances ....................................... Accounts Receivable (Andrew Noren) ....................

140

Accounts Receivable (Dong Corporation) ...................... Sales ......................................................................

760

Cash ............................................................................... Sales ......................................................................

842

Accounts Receivable (Discovery Sports) ........................ Sales ......................................................................

920

8-17

1,140 140 760 842 920

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EXERCISE 8-2 (Continued) (a) (Continued) Feb.

17 22 28 (b)

Cash ($760 – $15) ................................................ Sales Discount ($760 × 2%) ................................. Accounts Receivable (Dong Corporation) ....

745 15

Accounts Receivable (Andrew Noren) ................. Sales ............................................................

696

Accounts Receivable (Batstone Corporation) ....... Sales ............................................................

1,738

Cash ..................................................................... Accounts Receivable (Andrew Noren) .........

1,000

760 696 1,738 1,000

Accounts Receivable Subsidiary Ledger

Andrew Noren Feb. 2 1,140 Feb. 4 17 696 28 Feb. 28 Bal. 696

140 1,000

Batstone Corporation Feb. 22 1,738 Feb. 28 Bal. 1,738

Dong Corporation Feb. 5 760 Feb. 14 Feb. 28 Bal. 0

760

Discovery Sports (Company Credit Card) Feb. 10 920 Feb. 28 Bal. 920

General Ledger Control Account Accounts Receivable Feb. 2 1,140 Feb. 4 5 760 14 10 920 28 17 696 22 1,738 Feb. 28 Bal. 3,354 (c)

140 760 1,000

Subledger listing Andrew Noren ............................................................................... Dong Corporation .......................................................................... Batstone Corporation .................................................................... Discovery Sports (Company credit card) ....................................... Total ..............................................................................................

$ 696 0 1,738 920 $3,354

Balance per general ledger control account ..................................

$3,354

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EXERCISE 8-3 (a)

(b)

(c)

Dec. 31

Bad Debts Expense ($36,000 – $4,400) .............. Allowance for Doubtful Accounts .................

31,600

Bad Debts Expense ($360,000 × 9% – $4,400) ................................. Allowance for Doubtful Accounts .................

28,000

Bad Debts Expense ($36,000 + $2,400) .............. Allowance for Doubtful Accounts .................

31,600

28,000 38,400 38,400

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 net realizable value of the accounts receivable at March 31 is as follows: Accounts receivable ............................................................... Less: Allowance for doubtful accounts ................................... Net realizable value ................................................................

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$370,000 33,240 $336,760

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EXERCISE 8-5 (a) 2014 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

2015 May 11

Nov. 12

1,900

(b)

Accounts receivable Less: Allowance for doubtful accounts Net realizable value

Solutions Manual .

Dec. 31 2014

May 11 2015

Nov.12 2015

$300,000 16,800 $283,200

$298,100 14,900 $283,200

$298,100 16,800 $281,300

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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 ..........................

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2,500 2,500

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EXERCISE 8-7 Nov.

Dec.

Feb.

Notes Receivable ........................................................... Cash .......................................................................

48,000

Notes Receivable ........................................................... Sales ......................................................................

8,400

Cost of Goods Sold ........................................................ Merchandise Inventory ...........................................

5,000

Notes Receivable ........................................................... Accounts Receivable ..............................................

16,000

Cash ............................................................................... Notes Receivable ................................................... Interest Revenue ($8,400 × 6% × 2/12) ..................

8,484

Interest Receivable ......................................................... Interest Revenue ....................................................

1,513

Calculation of interest revenue on February 28: Bouchard note: $48,000 × 8% × 4/12 Aqualina note: $16,000 × 7% × 2.5/12 Total accrued interest

48,000

8,400

5,000

16,000

8,400 84

1,513

= $1,280 =. 233 $1,513

Bad Debt Expense.......................................................... Allowance for Doubtful Notes .................................

16,000 16,000

EXERCISE 8-8 Dec.

Feb.

Solutions Manual .

Merchandise Inventory ................................................... Notes Payable ........................................................

8,400

Interest Expense ($8,400 × 6% × 1/12) .......................... Interest Payable......................................................

Notes Payable ................................................................ Interest Payable ............................................................. Interest Expense............................................................. Cash .......................................................................

8,400 42 42

8-22

8,400

8,484

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EXERCISE 8-9 May

June 30

July

Aug. 31

Sept. 30

Oct.

Nov.

Solutions Manual .

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)................

Cash ............................................................................... Interest Revenue ....................................................

10,058

Allowance for Doubtful Accounts .................................... Note Receivable ..................................................... Interest Receivable .................................................

12,100

8-23

12,000

100

10,000

10,000 58

12,000 100

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Financial Accounting, Sixth Canadian Edition

EXERCISE 8-10 DEERE & COMPANY Statement of Financial Position (partial) October 31, 2012 (in U.S. millions) Assets Current assets Receivables Trade accounts and notes receivable............................. $3,799.1 Less: Allowance for doubtful trade and notes receivables 66.0 Financing receivables .................................................... $22,159.1 Less: Allowance for doubtful financing receivables ........ 177.0 Other receivables .............................................................................. Total receivables ...............................................................................

Solutions Manual .

8-24

$ 3,733.1 21,982.1 1,790.9 $27,506.1

Chapter 8

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Financial Accounting, Sixth Canadian Edition

EXERCISE 8-11

Accounts payable Accounts receivable Advances to employees Allowance for doubtful accounts Allowance for doubtful notes (current) Bad debts expense Cash Interest expense Interest revenue Merchandise 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, 2015 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 ........................................................................... Merchandise inventory ......................................................................... Prepaid insurance ................................................................................ Total current assets ...................................................................

Solutions Manual .

8-25

$ 7,500 16,900 20,000 2,900 3,150 26,400 1,500 $78,350

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Financial Accounting, Sixth Canadian Edition

EXERCISE 8-12 (a)

($ in millions)

2012 Current ratio =

$1,869 $2,203

= 0.8 : 1

Receivables turnover =

$9,920 ($841 + $836) ÷ 2

Average collection period =

365 days 11.8 times

= 31 days

$1,848 $1,715

= 1.1 : 1

2011 Current ratio =

Receivables turnover =

$9,028 ($836 + $796) ÷ 2

Average collection period =

365 days 11.1 times

(b)

= 11.8 times

= 11.1 times

= 33 days

In 2012, accounts receivable increased 0.6% [($841 − $836) ÷ $836] while revenues increased 9.9% [($9,920 − $9,028) ÷ $9,028]. CN is doing a better job of collecting its accounts receivable. The receivables turnover ratio and the average collection period indicate that the company’s management of receivables has improved. The turnover has improved from 11.1 times in 2011 to 11.8 times in 2012. The average collection period has decreased from 33 days in 2011 to 31 days in 2012 so cash is being collected sooner. The current ratio has declined from 1.1:1 in 2011 to 0.8:1 in 2012. However, this decrease is not due to slow-collection of receivables (or slow moving inventory). This decrease can be attributed to the 28% [($2,203 – $1,715)  $1,715] increase in current liabilities compared to the modest increase in current assets of 1% [($1,869 – $1,848)  $1,848].

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Chapter 8

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Financial Accounting, Sixth 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 2015. 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 result of 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. Establishment of credit policies and credit limits for certain customers. 2. Initiate the use of a cash discount to encourage early payment of receivables. 3. Aggressively monitor collections to encourage customers to pay on time. These measures could include the following for inventory: 1. Monitor its inventory levels carefully and only reorder when inventory is selling and additional supplies are required. 2. Limit the amount of inventory by improving its purchasing relationships with suppliers. 3. If possible, move to a just-in-time system where inventory is only purchased as needed.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 8-1A

(a)

Accounts Receivable .................................................... Sales .....................................................................

5,200,000

Sales Returns and Allowances ...................................... Accounts Receivable .............................................

80,000

Cash .............................................................................. Accounts Receivable .............................................

5,400,000

Accounts Receivable ..................................................... Interest Revenue ...................................................

400,000

Allowance for Doubtful Accounts ................................... Accounts Receivable .............................................

150,000

Accounts Receivable ..................................................... Allowance for Doubtful Accounts ...........................

60,000

Cash .............................................................................. Accounts Receivable .............................................

60,000

Bad Debts Expense ....................................................... Allowance for Doubtful Accounts ................................ $100,000 – ($124,000 – $150,000 + $60,000) = $66,000

66,000

5,200,000

80,000

5,400,000

400,000

150,000

60,000

66,000

(b)

Bal. (1) (4) (6) Bal

Accounts Receivable 1,990,000 5,200,000 (2) 80,000 400,000 (3) 5,400,000 60,000 (5) 150,000 (6) 60,000 1,960,000

Solutions Manual .

(5)

Allowance for Doubtful Accounts Bal. 124,000 150,000 (6) 60,000 (7) 66,000

Bal.

8-28

100,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-1A (Continued) (c)

January 1, 2015 Accounts receivable ............................................................... Less: Allowance for doubtful accounts ................................... Net realizable value ................................................................

$1,990,000 124,000 $1,866,000

December 31, 2015 Accounts receivable ............................................................... Less: Allowance for doubtful accounts ................................... Net realizable value ................................................................

$1,960,000 100,000 $1,860,000

(d) UNDERWOOD IMPORTS INC. Statement of Financial Position (partial) December 31, 2015 Assets Current assets Accounts receivable .................................................... Less: Allowance for doubtful accounts ........................

$1,960,000 100,000

$1,860,000

(e) UNDERWOOD IMPORTS INC. Income Statement (partial) Year Ended December 31, 2015 Sales ...................................................................................... $5,200,000 Less: Sales returns and allowances ....................................... 80,000 Net sales .......................................................................................................... Operating expenses Bad debts expense ................................................................................ Other revenues and expenses Interest revenue.....................................................................................

Solutions Manual .

8-29

$5,120,000 66,000 400,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-2A (a)

(b)

(c)

(d)

Accounts Receivable ..................................................... Sales .........................................................................

3,800,000

Cash .............................................................................. Accounts Receivable .................................................

4,084,000

Allowance for Doubtful Accounts ................................... Accounts Receivable .................................................

116,000

Accounts Receivable ..................................................... Allowance for Doubtful Accounts ...............................

8,000

Cash .............................................................................. Accounts Receivable .................................................

8,000

Bad Debts Expense [see (e)] ......................................... Allowance for Doubtful Accounts ...............................

92,000

3,800,000

4,084,000

116,000

8,000

92,000

(e) Accounts Receivable Beg. Bal. 1,600,000 Sales 3,800,000 Collections Recovery 8,000 Write off Collections End Bal. 1,200,000

4,084,000 116,000 8,000

Allowance for Doubtful Accounts Beg. Bal 88,000 Write off 116,000 Recovery 8,000 Bad debts 92,000 End Bal 72,000

Before bad debts expense was recorded, the Allowance account had a debit balance of $20,000 ($88,000 – $116,000 + $8,000). To adjust this to $72,000 requires a credit to this account of $92,000 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 .................................... Net realizable value ................................................................

Solutions Manual .

8-30

$1,200,000 72,000 1,128,000

Chapter 8

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-3A

Beg. bal.

Accounts Receivable 18,000

End. bal.

(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)]

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Financial Accounting, Sixth 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 $240,000 120,000 100,000 60,000 $520,000

Estimated Estimated Percentage Uncollectible Uncollectible Accounts 1% $ 2,400 5% 6,000 10% 10,000 25% 5,000 $33,400

(1) Bad Debts Expense ................................................................ Allowance for Doubtful Accounts ....................................... [$33,400 – $20,000]

13,400 13,400

(2) If the allowance for doubtful accounts had an unadjusted debit balance of $20,000, the bad debts expense in the entry above would be $53,400 ($33,400 + $20,000) (c)

(d)

(e)

Allowance for Doubtful Accounts .............................................. Accounts Receivable .........................................................

4,000

Accounts Receivable ................................................................ Allowance for Doubtful Accounts .......................................

1,700

Cash ......................................................................................... Accounts Receivable .........................................................

1,700

4,000

1,700

Part (a):

The total estimated allowance for doubtful accounts = $520,000 × 6% = $31,200.

Part (b):

(1) The journal entry would record bad debts expense of $11,200 ($31,200 – $20,000) (2) If the allowance for doubtful accounts had an unadjusted debit balance of $20,000, the bad debts expense in the entry above would be $51,200 ($31,200 + $20,000)

Parts (c) and (d): no change

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-4A (Continued) (f)

Aging the individual accounts should produce a more accurate estimate of the net realizable value of the receivables. As the receivables get older, a higher percentage is applied to them when calculating the amount of uncollectible accounts. This is more accurate because older receivables have a greater probability of not being collected .

Solutions Manual .

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Chapter 8

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-5A (a) Total estimated allowance balance at Dec. 31, 2014:

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 Estimated Percentage Uncollectible Uncollectible Accounts 3% $ 9,600 6% 6,840 12% 9,120 24% 12,000 $37,560

Total estimated allowance balance at Dec. 31, 2015:

Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total

Estimated Estimated Accounts Percentage Uncollectible Receivable Uncollectible Accounts $300,000 3% $ 9,000 64,000 6% 3,840 86,000 12% 10,320 130,000 24% 31,200 $580,000 $54,360

Total accounts receivable increased slightly from 2014 to 2015. However, 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

Solutions Manual .

8-34

28,560

42,000

3,000

Chapter 8

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Financial Accounting, Sixth 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 ..................................... Net realizable value ..................................................................

Solutions Manual .

8-35

55,800 55,800

2015 $580,000 54,360 $525,640

2014 $560,000 37,560 $522,440

Chapter 8

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-6A Feb.

Mar.

Apr.

May

Solutions Manual .

Accounts Receivable ...................................................... Sales .................................................................

6,000

Cost of Goods Sold ......................................................... Merchandise Inventory............................................

4,000

Notes Receivable ............................................................ Sales .......................................................................

13,400

Cost of Goods Sold ......................................................... Merchandise Inventory............................................

8,800

Accounts Receivable ...................................................... Sales .......................................................................

8,000

Cost of Goods Sold ......................................................... Merchandise Inventory............................................

5,400

Cash ............................................................................... Sales .......................................................................

4,000

Cost of Goods Sold ......................................................... Merchandise Inventory............................................

3,000

Bank Charges Expense .................................................. Cash .......................................................................

120

Notes Receivable ............................................................ Accounts Receivable ..............................................

8,000

Cash ($13,400 + $134) ................................................... Notes Receivable .................................................... Interest Revenue ($13,400 × 6% × 2/12) ................

13,534

Accounts Receivable ($8,000 + $93) ............................. Notes Receivable .................................................... Interest Revenue ($8,000 × 7% × 2/12) ..................

8,093

Accounts Receivable ($6,000 × 24% × 4/12) .................. Interest Revenue ....................................................

480

8-36

6,000

4,000

13,400

8,800

8,000

5,400

4,000

3,000

120

8,000

13,400 134

8,000 93

480

Chapter 8

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-7A (a)

Nov.

Dec.

Jan.

Feb.

(b)

Nov.

Dec.

Jan.

Feb.

(2)

Feb.

Solutions Manual .

Notes Receivable ...................................... Accounts Receivable ........................

40,000

Cash ......................................................... Interest Revenue .............................. ($40,000 × 6% × 1/12)

200

Interest Receivable ($40,000 × 6% × 1/12) Interest Revenue ..............................

200

Cash ......................................................... Interest Receivable ...........................

200

40,000

200

Cash ......................................................... Interest Revenue ($40,000 × 6% × 1/12) Notes Receivable ..............................

40,200

Accounts Payable ..................................... Notes Payable ..................................

40,000

Interest Expense ....................................... Cash ($40,000 × 6% × 1/12) .............

200

Interest Expense ($40,000 × 6% × 1/12) .. Interest Payable ................................

200

Interest Payable ........................................ Cash .................................................

200

Notes Payable .......................................... Interest Expense ($40,000 × 6% × 1/12) .. Cash .................................................

40,000 200

Accounts Receivable ................................ Interest Revenue .............................. Notes Receivable ..............................

40,200

Allowance for Doubtful Notes.................... Notes Receivable ..............................

40,000

8-37

200 40,000

40,000

200

40,200

200 40,000

40,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-8A a (a)

Notes receivable total $61,000 and interest receivable $603 at September 30, 2015: RES Inc. Ihara Ltd. Dragon Limited MGH Corp. Total

(b)

Oct.

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 ...........................

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 Debt Expense .................................... Allowance for Doubtful Notes............

17,500

8-38

6,000 35 35

17,000 510 85

143

17,500

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-8A (Continued) (c)

Bal. see (a) Oct. 31 Bal.

Bal.

Interest Receivable 603 Oct. 1 143 31 31 143

Notes Receivable Bal. see (a) 61,000 Oct. 31 31

58 35 510

Bal.

6,000 17,000

38,000

Allowance for Doubtful Notes 0 Oct. 31 17,500 Bal. 17,500

(d) TARDIF CORPORATION Balance Sheet (partial) October 31, 2015 _________________________________________________________________________ Assets Current assets Notes receivable .......................................................... Less: Allowance for doubtful notes .............................. Interest receivable .......................................................

Solutions Manual .

8-39

$38,000 17,500

$20,500 143

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-9A CANADIANA CORPORATION Statement of Financial Position (Partial) December 31, 2015 (in thousands) Assets Current assets Cash Trading investments Accounts receivable Less: Allowance for doubtful accounts Notes receivable Income tax receivable Merchandise 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

Solutions Manual .

8-40

$ $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

Chapter 8

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-10A

(a) Nike (in US $ millions)

Receivables turnover

$24,128 ($3,212+$3,330) [ ] 2 =7.4 times

Average collection period

365 = 49 days 7.4

(b)

Adidas (in euro millions) €13,344 (€1,794+€1,858) [ ] 2 =7.3 times 365 = 50 days 7.3

Both companies’ collection experiences are very close to each other and to the industry. Nike’s receivables turnover ratio and collection period are practically identical to the industry average, whereas Adidas’ is slightly below that of Nike and the industry. Adidas’ collection experience is marginally but not notably weaker (meaning that it collects its receivables slower).

Solutions Manual .

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Chapter 8

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-11A (a)

2015

Average collection period Days in inventory

365 = 45 days 8.2

2014

2013

365 = 49 days 7.4

365 = 54 days 6.7

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 last 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, Sixth Canadian Edition

PROBLEM 8-11A (Continued) (e)

There are several steps that Pampered Pets could consider to improve its receivables and inventory turnover: Receivables o The company could establish credit policies and credit limits for certain customers, if it doesn’t already have them. o The company could initiate the use of a cash discount to encourage early payment of receivables o The company could more aggressively monitor collections to encourage customers to pay on time. Inventory o Pampered Pets should monitor its inventory levels carefully and only reorder when inventory is selling and additional supplies 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. o 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.

o Further to the above point, 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 stockouts (which means shortages) occur.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-1B (a)

Accounts Receivable ................................................ Sales ...............................................................

1,600,000

Sales Returns and Allowances ................................. Accounts Receivable .......................................

250,000

Cash ........................................................................ Accounts Receivable .......................................

1,500,000

Accounts Receivable ................................................ Interest Revenue .............................................

125,000

Allowance for Doubtful Accounts .............................. Accounts Receivable .......................................

45,000

Accounts Receivable ................................................ Allowance for Doubtful Accounts .....................

10,500

Cash ........................................................................ Accounts Receivable .......................................

10,500

Bad Debts Expense .................................................. Allowance for Doubtful Accounts............ $25,000 – ($35,000 – $45,000 + $10,500) = $24,500

24,500

1,600,000

250,000

1,500,000

125,000

45,000

10,500

24,500

(b)

Bal. (1) (4) (6) Bal.

Accounts Receivable 480,000 1,600,000 (2) 250,000 125,000 (3) 1,500,000 10,500 (5) 45,000 (6) 10,500 410,000

Solutions Manual .

(5)

Allowance for Doubtful Accounts Bal. 35,000 45,000 (6) 10,500 (7) 24,500

Bal.

8-44

25,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-1B (Continued) (c)

January 1, 2015 Accounts receivable ...................................................................... Less: Allowance for doubtful accounts .......................................... Net realizable value .......................................................................

$480,000 35,000 $445,000

December 31, 2015 Accounts receivable ...................................................................... Less: Allowance for doubtful accounts .......................................... Net realizable value .......................................................................

$410,000 25,000 $385,000

(d) BORDEAUX INC. Statement of Financial Position (partial) December 31, 2015 Assets Current assets Accounts receivable .................................................. Less: Allowance for doubtful accounts ......................

$410,000 25,000

$385,000

(e) BORDEAUX INC. Income Statement (partial) Year Ended December 31, 2015 Sales .................................................................................. $1,600,000 Less: Sales returns and allowances ..................................... 250,000 Net sales .................................................................................................. Operating expenses Bad debts expense ........................................................................ Other revenues and expenses Interest revenue.............................................................................

Solutions Manual .

8-45

$1,350,000 24,500 125,000

Chapter 8

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Financial Accounting, Sixth Canadian Edition

PROBLEM 8-2B (a)

(b)

(c)

(d)

Accounts Receivable ..................................................... Sales .........................................................................

800,000

Cash .............................................................................. Accounts Receivable .................................................

723,000

Allowance for Doubtful Accounts ................................... Accounts Receivable .................................................

21,000

Accounts Receivable ..................................................... Allowance for Doubtful Accounts ...............................

3,500

Cash .............................................................................. Accounts Receivable .................................................

3,500

Bad Debts Expense (see (e) below) .............................. Allowance for Doubtful Accounts ...............................

19,500

800,000

723,000

21,000

3,500

19,500

(e)

Beg. Bal. Sales Recovery End Bal.

Accounts Receivable 200,000 800,000 Collections 3,500 Write off Collections 256,000

723,000 21,000 3,500

Allowance for Doubtful Accounts Beg. Bal. 14,000 Write off 21,000 Recovery 3,500 Bad Debts 19,500 End Bal. 16,000 Before bad debts expense was recorded, the balance in the Allowance account was a debit $3,500 ($14,000 – $21,000 + $3,500). To move this balance to a credit of $16,000 requires a credit to the Allowance of $19,500 with an offsetting debit to Bad Debts Expense.

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PROBLEM 8-2B (Continued) (f) HUANG LTD. Statement of Financial Position (partial) Assets Current assets Accounts receivable .............................................................. Less: Allowance for doubtful accounts ................................... Net realizable value ................................................................

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$256,000 16,000 240,000

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Financial Accounting, Sixth 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))

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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)

(c)

(d)

Accounts Receivable $110,000 50,000 20,000 12,500 $192,500

Estimated Estimated Percentage Uncollectible Uncollectible Accounts 1% $1,100 5% 2,500 10% 2,000 20% 2,500 $8,100

(1) Bad Debts Expense .................................................................. 13,100 Allowance for Doubtful Accounts ....................................... ($8,100 + $5,000 = $13,100) (2) If the allowance for doubtful accounts had an unadjusted credit balance of $5,000, the bad debts expense in the entry above would be $3,100 ($8,100 – $5,000) Allowance for Doubtful Accounts .............................................. Accounts Receivable .........................................................

3,000

Accounts Receivable ................................................................ Allowance for Doubtful Accounts .......................................

1,500

Cash ......................................................................................... Accounts Receivable .........................................................

1,500

13,100

3,000

1,500

(e)

If Imagine used 4% of total accounts receivable rather than aging the individual accounts to determine the allowance at year end, the bad debts expense adjustment would be $12,700 [$7,700 ($192,500 × 4%) + $5,000]. If the allowance for doubtful accounts had an unadjusted credit balance of $5,000, the bad debts expense in the entry above would be $2,700. The answers to (c) – (d) would not change.

(f)

Aging the individual accounts should produce a more accurate estimate of the net realizable value of the accounts receivable. As the receivables get older, a higher percentage is applied to them when calculating the uncollectable accounts. This is more accurate because older receivables have a greater probability of not being collected.

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PROBLEM 8-5B (a) Total estimated allowance balance at Dec. 31, 2014:

Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total

Estimated Estimated Accounts Percentage Uncollectible Receivable Uncollectible Accounts $220,000 3% $ 6,600 86,000 6% 5,160 52,000 12% 6,240 22,000 20% 4,400 $380,000 $22,400

Total estimated allowance balance at Dec. 31, 2015:

Number of Days Outstanding 0-30 days 31-60 days 61-90 days Over 90 days Total

Estimated Estimated Accounts Percentage Uncollectible Receivable Uncollectible Accounts $240,000 3% $ 7,200 104,000 6% 6,240 62,000 12% 7,440 34,000 20% 6,800 $440,000 $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)

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

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19,400

28,000

3,000

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PROBLEM 8-5B (Continued) (e)

Bad Debts Expense .................................................................. 30,280 Allowance for Doubtful Accounts ....................................... 30,280 $27,680 – balance in allowance before adjustment ($22,400 – $28,000 + $3,000)

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2015 $440,000 27,680 $412,320

2014 $380,000 22,400 $357,600

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PROBLEM 8-6B Jan.

Feb.

Mar.

May

25 Aug.

Sept. 30

Solutions Manual .

Notes Receivable ............................................................ Cash .......................................................................

6,000

Accounts Receivable ...................................................... Sales .......................................................................

8,000

Cost of Goods Sold ......................................................... Merchandise Inventory............................................

4,800

Notes Receivable ............................................................ Accounts Receivable ..............................................

8,000

Cash ............................................................................... Interest Revenue ($8,000 × 9% × 1/12) ..................

Cash ($8,000 + $60) ....................................................... Notes Receivable .................................................... Interest Revenue ($8,000 × 9% × 1/12) ..................

8,060

Cash ............................................................................... Note Receivable ..................................................... Interest Revenue ($6,000 × 8% × 4/12) ..................

6,160

Notes Receivable ............................................................ Accounts Receivable ..............................................

3,000

Accounts Receivable ...................................................... Sales .................................................................

6,000

Cost of Goods Sold ......................................................... Merchandise Inventory............................................

4,000

Allowance for Doubtful Notes .......................................... Notes Receivable .............................................

3,000

Accounts Receivable ($6,000 × 24% × 2/12) .................. Interest Revenue ....................................................

240

8-52

6,000

8,000

4,800

8,000

8,000 60

6,000 160

3,000 6,000

4,000

3,000

240

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PROBLEM 8-7B (a)

Aug.

Sept.

Oct.

(b)

Aug.

Sept.

Oct.

(2)

Oct.

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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 ....................................... Cash ($30,000 × 4% × 1/12) .............

30,000 100

Accounts Receivable................................. Notes Receivable .............................. Interest Revenue ............................... ($30,000 × 4% × 1/12)

30,100

Allowance for Doubtful Notes .................... Notes Receivable ..............................

30,000

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30,000

100

30,000 100

30,000

100

30,100

30,000 100

30,000

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PROBLEM 8-8B (a)

Total notes receivable are $58,000 and total interest receivable $918 at November 30, 2015: Kootenay Inc. Cassiar Ltd. Namu Limited Siska Corp. Total

(b)

Dec.

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$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

133

Bad Debt Expense .................................... Allowance for Doubtful Notes............

20,000

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133

6,000 105

17,000 680 85

133

20,000

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PROBLEM 8-8B (Continued) (c) Interest Receivable Bal. See (a) 918 Dec. 1 Dec. 31 133 31 31 Bal. 133

Bal.

Notes Receivable Bal. See (a) 58,000 Dec. 31 31

133 105 680

Bal.

6,000 17,000

35,000

Allowance for Doubtful Notes 0 Dec. 31 20,000 Bal. 20,000

(d) KITIMAT CORPORATION Balance Sheet (partial) December 31, 2015 _________________________________________________________________________ Assets Current assets Notes receivable .......................................................... Less: Allowance for doubtful notes .............................. Interest receivable .......................................................

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$35,000 20,000

$15,000 133

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PROBLEM 8-9B OUTAOUAIS INC. Statement of Financial Position (Partial) January 31, 2015 (in thousands) Assets Current assets Accounts receivable Less: Allowance for doubtful accounts Notes receivable Income tax receivable Merchandise inventory Supplies Total current assets Non-current assets Notes receivable Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Goodwill Total assets

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$2,468 268

$2,200 50 20 3,000 50 5,320

300 $200 $1,000 250 $750 375

750 375

1,325 100 $7,045

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PROBLEM 8-10B

(a) Rogers (in millions)

Shaw (in millions)

Receivables turnover

$12,486 ($1,693 + $1,665) [ ] 2 = 7.4 times

$4,998 ($472 + $461) [ ] 2 = 10.7 times

Average collection period

365 = 49 days 7.4

365 = 34 days 10.7

(b)

Shaw’s receivables turnover was considerably better than that of Rogers’, which means Shaw was more efficient than Rogers in collecting its receivables. While Rogers is collecting their accounts receivable at a similar pace as that of the industry, it remains considerably slower than Shaw’s.

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PROBLEM 8-11B (a)

2015

Average collection period Days in inventory

365 = 46 days 8

2014

2013

365 = 52 days 7

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)

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PROBLEM 8-11B (Continued) (e)

There are several steps that Tianjin might have taken to improve its receivables and inventory turnover: Receivables o The company could establish credit policies and credit limits for certain customers, if it doesn’t already have them. o The company could initiate the use of a cash discount to encourage early payment of receivables. o The company could more aggressively monitor collections to encourage customers to pay on time. Inventory o Tianjin should monitor its inventory levels carefully and only reorder when inventory is selling and additional supplies 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. o 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. o 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 (which means shortages) occur.

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BYP 8-1 FINANCIAL REPORTING (a)

Shoppers Drug Mart reports accounts receivable on its 2012 balance sheet.

(b) ($ in thousands) Receivables turnover

Average collection period

(c)

2012 $10,781,848 $469,683 + $493,338 2 365 22.4

2011

22.4 times

$10,458,652 $493,338 + $470,935 2

16 days

365 21.7

21.7 times

17 days

Shoppers Drug Mart has exhibited relatively consistent performance in the collection of its accounts receivable. It showed a slight improvement in its receivables management in 2012. 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.

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BYP 8-2 COMPARATIVE ANALYSIS (a) ($ in thousands) Current ratio

Shoppers Drug Mart $2,764,997 $2,334,917

Receivables turnover

$10,781,848 $469,683 + $493,338 2

Average collection period

365 22.4

Jean Coutu

1.2:1

22.4 = times

16 days

$421,900 $265,300

$2,468,000 $199,600 + $206,500 2 365 12.2

1.6:1

12.2 times

30 days

(b) Ratio Current ratio Receivables turnover Average collection period

Shoppers 1.2:1 22.4 times 16 days

Jean Coutu 1.6:1 12.2 times 30 days

Industry 1.6:1 22.4 times 16 days

Shoppers Drug Mart demonstrates superior management of accounts receivable as shown by its receivables turnover and average collection period ratios, which are better than those of Jean Coutu and identical to the industry average. It should be noted that Jean Coutu’s collection period is still a reasonable one at 30 days, assuming its terms of sale are 30 days. On the other hand, Shoppers Drug Mart’s current ratio is below that of Jean Coutu as well as that of the industry average. Still it is above 1:1 so given that and its receivables position, its overall liquidity appears to be better than that of Jean Coutu. Further investigation as to why Shoppers Drug Mart’s current ratio is lower than that of Jean Coutu and the industry is warranted (for example, is their inventory turnover slower?) before concluding on its liquidity.

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BYP 8-3 COMPARING IFRS AND ASPE (a)

Both Lava and Flow provide the information on the net realizable value of the trade receivable, 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 receivables, 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 2015.

(b)

Since Lava follows IFRS, it is required 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 are: • • • •

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.

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BYP 8-4 CRITICAL THINKING 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 2015: 1.6:1 ($10,600,000 ÷ $6,800,000) 2014: 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. 2014 2015 write offs 100,000 Bal. 2015

500,000 400,000

Notes Receivable Bal. 2014 2,000,000 2015 New notes 1,500,000 2015 Collections 800,000 Bal. 2015 2,700,000 (c)

It is difficult to say whether the Allowance for Doubtful Accounts is adequate or not. It is noteworthy that in 2014 the allowance was 10% of the royalties receivable ($500,000 ÷ $5,000,000). In 2015, 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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BYP 8-4 (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 2015 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 Debt Expense 1,200,000 Allowance for Doubtful Notes 1,200,000 One could possibly argue that the outstanding notes that were issued in 2015 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) 2015: 10.0 times ($60,000,000 ÷ $6,000,000) 2014: 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 2015 while current liabilities are higher. While the accounts (royalties) receivables turnover is unchanged in 2015, 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.

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BYP 8-5 ETHICS CASE (a)

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 a product of 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”.

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BYP 8-6 “ALL ABOUT YOU” ACTIVITY

(a)

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BYP 8-6 (Continued) (b)

Answers will vary by student.

(c)

Money obtained from your credit cards is not “free” money. Your friend will be responsible for making minimum monthly payments and ultimately paying for the TV. Interest will accumulate at a possible average rate of 20% yearly on the monthly balance that is outstanding on his credit card. If those minimum monthly payments are not met, then there is a strong likelihood that your friend’s credit score will be impacted.

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BYP 8-7 SERIAL CASE CONTINU

(a) Advantages to Koebel’s of reducing credit from 30 to 15 days: •

If in fact Coffee Beans can meet these credit terms, 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 wages will be alleviated.

•

Will provide Koebel’s a consistent credit policy that they are able to use. When negotiating with Biscuits, for example, they will be able to say that they have a credit policy of 15 days which is the same as what is being offered to their current customers.

Disadvantages to Koebel’s of reducing credit from 30 to 15 days: •

30 days may be a consistent policy in this industry and Coffee Beans may chose to go elsewhere to purchase their cupcake requirements (as may other customers such as Biscuits). Not only would Koebel’s lose their current contractual commitment but the additional sales they are expecting to earn in the future.

•

Coffee Beans may in fact negotiate a 15 day settlement and still take 45 days to pay. The 45 days it is taking Coffee Beans to pay could be a result of their cash flow requirements.

(b) Implications of the doubling of cupcake requirements on a weekly basis and credit terms remaining at 30 days Natalie, Brian and Janet must carefully consider their cash flow requirements on a weekly basis. Inventory requirements to prepare cupcakes will increase. There may be a need to hire additional staff (bakers for example) as a result of the planned increase in sales. If so, this amount will also have to be considered when determining cash flows. Utility costs, such as electricity will also increase and expenditures for more equipment may also be necessary. Finally, invoices are now being prepared on a weekly basis. Time will have to be spent on ensuring that invoices are appropriately prepared, checked, sent and followed up if they are not paid for on a timely basis.

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BYP 8-7 (Continued) (c) Alternatives: •

Consider not extending credit. Perhaps Coffee Beans would consider payment by using a credit card. Some businesses do use credit cards to pay for goods purchased. Although this is a valid alternative it may not be one that Coffee Beans would consider. Many organizations want a consistent alternative when paying for product purchased. Coffee Beans may not want to implement this strategy. Koebel’s would also have to consider the costs of accepting payment by credit card. The issuing credit card company or bank may charge a processing fee. This may be more costly than allowing Coffee Beans to pay in 45 days.

•

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 Koebel’s as the fees charged by a factor can be significant.

•

Consider providing Coffee Beans an incentive or discount to paying quickly, for example a 2% discount. Again, a valid alternative but a costly one to Koebel’s. This cost should be compared to the cost of credit card fees.

•

No change. Consider discussions with Frank to encourage the 30 days payment period instead of 45. Perhaps, arrangements could be made to have the funds transferred from Coffee Beans bank account to Koebel’s bank account. This way funds could be transferred on a timely basis.

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CHAPTER 9 Reporting and Analyzing Long-Lived Assets ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Determine the cost of property, plant, and equipment.

1, 2, 3, 4

1, 2, 3

1, 2

1A, 2A, 3A

1B, 2B, 3B

4, 6, 7

Explain and calculate depreciation.

5, 6, 7, 8, 9, 13

4, 5, 6, 7, 8, 9

2, 3, 4, 5, 6, 2A, 3A, 4A, 8 5A, 6A, 7A, 8A

2B, 3B, 4B 5B, 6B, 7B, 8B

1, 3, 4, 5, 7

Account for the derecognition of property, plant, and equipment.

10, 11, 12

10, 11

5, 6, 7

6A, 7A, 8A

6B, 7B, 8B

Identify the basic accounting issues for intangible assets and goodwill.

13, 14, 15, 16, 17

12, 13

8, 9, 10

9A, 10A, 11A

9B, 10B, 11B

1, 4

Illustrate how long18, 19, 20 lived assets are reported in the financial statements.

12, 14, 15

10, 11

8A, 10A,

8B, 10B

Describe the 21, 22, 23 methods for evaluating the use of assets.

16, 17

12, 13

11A, 12A,

11B, 12B

2, 3, 4, 5

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Exercises

A Problems

B Problems

BYP

Chapter 9

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Classify expenditures.

Moderate

15-20

Determine cost; record property transactions.

Simple

20-30

Determine cost; calculate depreciation under different methods.

Moderate

30-40

Calculate and compare depreciation under different methods.

Moderate

40-50

Calculate depreciation; discuss revision of estimate.

Moderate

15-20

Record acquisition, depreciation, and disposal of equipment.

Simple

15-20

Record and determine effect of depreciation method over life of asset.

Moderate

35-45

Record property, plant and equipment transactions; prepare partial statement of financial position.

Moderate

10-15

Identify intangible assets and goodwill.

Moderate

20-30

10A

Record intangible asset transactions; prepare partial statement of financial position.

Moderate

30-40

11A

Calculate and evaluate ratios.

Moderate

30-40

12A

Calculate and evaluate ratios.

Moderate

30-40

Classify expenditures.

Moderate

15-20

Determine cost; record property transactions.

Simple

20-30

Determine cost; calculate depreciation under different methods.

Moderate

35-45

Calculate and compare depreciation under different methods.

Moderate

40-50

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Calculate depreciation; discuss revision of estimate.

Moderate

15-20

Record acquisition, depreciation, and disposal of equipment.

Simple

15-20

Record and determine effect of depreciation method over life of asset.

Moderate

35-45

Record property, plant and equipment transactions; prepare partial statement of financial position.

Moderate

10-15

Identify intangible assets and goodwill.

Moderate

20-30

10B

Record intangible asset transactions; prepare partial statement of financial position.

Moderate

30-40

11B

Calculate and evaluate ratios.

Moderate

30-40

12B

Calculate and evaluate ratios.

Moderate

30-40

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Financial Accounting, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1.

(a)

The cost principle requires that property, plant, and equipment be recorded 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.

(b)

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.

Two examples of operating expenditures include routine maintenance and painting of equipment. 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. Two examples of capital expenditures include the shipping cost of equipment to its location of use and testing it to ensure it is ready for its intended use. 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).

Land improvements are structural additions made to the land such as parking lots and fences. 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.

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 Assets under Finance Leases and the related liability account would be Finance Lease Liability.

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Chapter 9

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 5. (1) Depreciation Expense

(2) Profit

(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 profit

Increases at a constant amount each year

Units-ofproduction

Varies with number of units produced

Impact on profit 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 profit 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 All three result in the same total in the same total depreciation impact on profit expense

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

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 its 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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 7.

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-of-production 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 a result for that six month period (the company could not have produced units before it purchased the asset) and therefore does not need to be adjusted for the half year ownership period.

(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.

(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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 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.

11.

In a sale of property, plant, and equipment, the carrying amount of the asset is compared to the proceeds received from the sale. If the proceeds of the sale 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.

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.

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.

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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 15. (a)

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. Extending the amortization period beyond the useful life would result in a misallocation of the cost of the intangible asset to accounting periods beyond those when the asset was in use and contributed to producing revenue.

(b)

If the 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.

16.

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.

17.

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.

18. (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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 19.

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.

20.

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.

21.

(a)

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.

(b)

Railway companies normally have a low asset turnover because they are so capital intensive. To compensate for this, companies such as these need to have a high profit margin which is typical in an industry that is hard to enter due to high capital barriers.

22.

The return on assets ratio measures the return being generated by each dollar invested in the business (profit ÷ 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 profit 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 profit 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).

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 23. ($ in millions)

2012

2011

Return on assets $403 = 18.0% $2,244

$383 = 16.3% $2,343

Asset turnover $2,226 = 1.0 times $2,244

$2,012 = 0.9 times $2,343

Tim Hortons’ return on assets and asset turnover ratios improved in 2012 compared to 2011.

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Chapter 9

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Financial Accounting, Sixth 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 $61,000 (cash price of $50,000 + legal fees of $2,500 + removal of old building $5,000 + cleaning and grading costs of $3,500). The fence would be included in the cost of land improvements.

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.

BRIEF EXERCISE 9-3 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

O C C C C O O C C O

BRIEF EXERCISE 9-4 (a)

The depreciable amount is $80,000 ($86,000 – $6,000). With a 4-year useful life, annual depreciation is $20,000 ($80,000 ÷ 4). Under the straight-line method, depreciation expense is the same each year.

(b)

Total depreciation over the truck’s life will be $20,000 per year × 4 years = $80,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 9-5 Depreciation expense for 2015 = $20,000 × 8/12 = $13,333 Depreciation expense for 2016 = $20,000

BRIEF EXERCISE 9-6 (a) Depreciation rate = 1 ÷ 4 = 25% January 1 Carrying amount 2015 2016 2017 2018

$86,000 64,500 48,375 36,281

Depreciation expense

Rate

25% 25% 25% to residual value

$21,500 16,125 12,094 30,281 $80,000

December 31 Carrying amount $64,500 48,375 36,281 6,000

Calculations: 2015 Depreciation expense = $86,000 × 25% = $21,500 2016 Depreciation expense = ($86,000 – $21,500) × 25% = $16,125 2017 Depreciation expense = ($86,000 – $21,500 – $16,125) × 25% = $12,094 2018 Depreciation expense = ($86,000 – $21,500 – $16,125 – $12,094) × 25% = $9,070 (amount calculated of $9,070 is adjusted to $30,281 so that the carrying amount will equal the residual value) (b)

Total depreciation expense = $21,500 + $16,125 + $12,094 + $30,281 = $80,000

BRIEF EXERCISE 9-7 (A) Carrying amount 2015 $86,000 2016 ($86,000 – $14,333) = $71,667

Solutions Manual .

(B) (1 ÷ 4) Rate

25% 25%

8 12

9-12

[(A) × (B) × (C)] ÷12 Depreciation expense $14,333 17,917

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Financial Accounting, Sixth Canadian Edition

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 2014 2015

125,000 km × $0.10 = $12,500 depreciation expense 105,000 km × $0.10 = $10,500 depreciation expense

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

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

9-13

144,000 $ 42,000

$144,000 77,000*

* Depreciation Jan. 1, 2013 – Dec. 31, 2014 ($144,000 – $4,000) ÷ 5 = $28,000 × 2 years Depreciation Jan. 1, 2015 – Sept. 30, 2015 $28,000 × 9/12 Accumulated depreciation

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21,000

67,000 $(25,000)

$56,000 21,000 $77,000

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Financial Accounting, Sixth Canadian Edition

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 $

$42,000 40,000 2,000 $(2,000)

BRIEF EXERCISE 9-12 (a) (1) Apr. 2 Patents ................................................................ Cash ............................................................ (2) Dec. 31 Amortization Expense ($180,000  5 = $36,000 × 9/12) ......................... Accumulated Amortization—Patents ........... (b)

180,000 180,000 27,000 27,000

SURKIS CORPORATION Statement of Financial Position (Partial) December 31, 2015 Assets

Intangible assets Patents Less: Accumulated amortization Carrying amount

$180,000 27,000 153,000

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.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 9-14 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) (p)

I PPE PPE PPE I NA (current asset) NA (shareholders’ equity) NA (expense) PPE PPE PPE I NA (expense) I NA (expense) I

BRIEF EXERCISE 9-15 CANADIAN TIRE CORPORATION, LIMITED Statement of Financial Position (Partial) December 29, 2012 (in millions) Property, plant, and equipment Land ........................................................................................ Buildings .............................................................. $2,683.7 Less: Accumulated depreciation .......................... 1,102.9 Fixtures and equipment ........................................ $880.4 Less: Accumulated depreciation .......................... 591.4 Other property and equipment ............................. $1,153.7 Less: Accumulated depreciation ........................ 424.2 Total property, plant, and equipment .................................... Intangible assets Finite-life intangible assets ................................... $932.6 Less: Accumulated amortization ...................... 604.6 Indefinite-life intangible assets ................................................ Total intangible assets .......................................................... Goodwill ...................................................................................... Total long-lived assets ....................................................

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$ 744.2 1,580.8 289.0 729.5 $3,343.5

$328.0 385.0 713.0 376.9 $4,433.4

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 9-16 (a)

(1) (2)

Coke has a better return on assets ratio. Pepsi has a better asset turnover ratio.

(b)

Based on the two ratios given, I would expect Coke to have a better profit margin. Profit margin × Asset turnover = Return on assets Coke: Profit margin × 0.6 = 10.9%; Solving for profit margin = 18.2% Pepsi: Profit margin × 0.9 = 8.4%; Solving for profit margin = 9.3%

BRIEF EXERCISE 9-17 (a) ($ in U.S. millions)

(b)

2012

2011

(1) Asset turnover

$1,948 $1,896 + $1,858 ( ) 2 = 1.0 times

$1,726 $1,858 + $1,335 ( ) 2 = 1.1 times

(2) Profit margin

$148 = 7.6 % $1,948

$234 = 13.6 % $1,726

(3) Return on assets

$148 $1,896 + $1,858 ( ) 2 = 7.9%

$234 $1,858 + $1,335 ( ) 2 = 14.7%

The return on assets changed primarily due to a change in profit margin.

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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

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, 2015 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 machinery’s useful life.

(d)

Depreciation expense in 2015 would be $5,888 ($78,500 ÷ 10 × 9/12).

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EXERCISE 9-3 (a) (1)

Straight-line method ($172,000 – $16,000) Depreciation = 4

$39,000

2012 expense = $39,000 × 9/12 =

$29,250

2013, 2014, 2015 expense =

$39,000 each year

2016 expense = $39,000 × 3/12 =

$9,750

(2)

Diminishing balance rate = 1 ÷ 4 = 25% × 2 = 50% January 1 Carrying amount

2012 2013 2014 2015 2016

$172,000 107,500 53,750 26,875 16,000

Depreciation expense

Rate

50% $86,000 × 9/12= $64,500 50% 53,750 50% 26,875 to residual value 10,875 0

December 31 Carrying amount $107,500 53,750 26,875 16,000 16,000

Depreciation ceases in 2015 as the carrying amount cannot fall below residual value. (3)

Units of production: Depreciation expense per unit = ($172,000 – $16,000) 10,000 hours

2012 2013 2014 2015 2016

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

(b) All three methods result in the same amount depreciation expense over the life of the asset and so the same profit will be experienced as well. The choice of depreciation method will have no impact on cash flow.

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EXERCISE 9-4 (a) Cost Less: Residual value Depreciable cost Useful life in years

(b)

(c)

Machine 1 $800,000 40,000 $760,000

Cost Less: Residual value Depreciable cost

Machine 2 $120,000 5,000 $115,000

Annual depreciation $760,000 ÷ 20 = $38,000

$115,000 ÷ 5 = $23,000

Accumulated depreciation, December 31, 2014 Machine 1 ($38,000 × 10 years) Machine 2 ($23,000 × 2 years)

$380,000 46,000

Carrying amount, December 31, 2014 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 2015 depreciation expense for Machine 1 will be lower and the depreciation expense for Machine 2 will be higher than for 2014. 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.

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EXERCISE 9-5 (a)

The amount paid for the equipment is $1,100.

Jan.

(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

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Impairment Loss ............................................................ Accumulated Depreciation—Equipment ................

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EXERCISE 9-6 (a) (1)

Straight-line method

$5,000 − $500 = $1,125 each year 4

(2)

Double diminishing-balance (DDB) method

DDB Rate: 1 ÷ 4 = 25% × 2 = 50% Year 1: $5,000 × 50% = $2,500 Year 2: ($5,000 – $2,500) × 50% = $2,500 × 50% = $1,250 Year 3: ($5,000 – $2,500 – $1,250) × 50% = $1,250 × 50% = $625

Year 1 Year 2 Year 3 Total

(b)

(1)

Straight-Line Depreciation Carrying Expense Amount $1,125 $3,875 1,125 2,750 1,125 1,625 $3,375

Double Diminishing-Balance Depreciation Carrying Expense Amount $2,500 $2,500 1,250 1,250 625 625 $4,375

Straight-line method

Proceeds – carrying amount = Gain (loss) $1,225 – $1,625 = ($400) (2)

Double diminishing-balance method

Proceeds – carrying amount = Gain (loss) $1,225 – $625 = $600 (c)

(1)

Straight-line method Depreciation expense: $3,375 + Loss: $400 = $3,775

(2)

Double-diminishing balance method Depreciation expense: $4,375 – Gain: $600 = $3,775

Note: There is no difference in the total expense over the life of the asset.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 9-7 Jan.

Sept

Dec. 30

Solutions Manual .

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 ................ Accumulated Depreciation—Equipment [($150,000 ÷ 10) × 10] ................................................... Equipment .............................................................

9-22

42,000 2,000 62,000

2,440

9,760 720 10,980 15,000 15,000

150,000 150,000

Chapter 9

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Financial Accounting, Sixth 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. Therefore it would be incorrect for the student to depreciate the land.

Goodwill is an intangible asset with an indefinite life. According to generally accepted accounting principles, goodwill is not amortized but reviewed annually for impairment. If a decline in value has occurred, goodwill is written down and an impairment loss is recorded on the income statement. Therefore, the amortization entry should be reversed and no decline in value recorded unless an impairment in value occurs.

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 not appropriate, especially since depreciation is being calculated. 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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 9-9 (a) Jan.

Mar.

Sept. 1

1 (b) Dec. 31

Patents ........................................................................... Cash .......................................................................

120,000

Franchises ...................................................................... Cash ....................................................................... Bank Loan Payable ................................................

540,000

Trademarks .................................................................... Cash .......................................................................

75,000

Trademarks .................................................................... Cash .......................................................................

35,000

Amortization Expense ..................................................... Accumulated Amortization—Patents ...................... ($120,000 ÷ 6 = $20,000)

20,000

Amortization Expense ..................................................... Accumulated Amortization—Franchises ................. [($540,000 ÷ 6) × 10/12 = $75,000]

75,000

40,000

40,000 500,000

75,000

35,000

20,000

75,000

No amortization recorded on the trademark purchased Sept. 1

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Financial Accounting, Sixth Canadian Edition

EXERCISE 9-10 (a) Jan.

April

July

Sept.

Dec. 31

Patents ........................................................................... Cash .......................................................................

40,000

Goodwill .......................................................................... Cash .......................................................................

300,000

Franchises ...................................................................... Cash .......................................................................

250,000

Research Expenses ....................................................... Cash .......................................................................

150,000

Development Costs ........................................................ Cash .......................................................................

50,000

Amortization Expense ..................................................... Accumulated Amortization—Patents ...................... ($40,000 ÷ 5 = $8,000)

8,000

40,000

300,000

250,000

150,000

50,000

8,000

Given that recoverable amount exceeded carrying amount for intangible assets, no impairment loss is recognized.

Impairment Loss ............................................................. Goodwill ..................................................................

30,000 30,000

(b) COLLINS LTD. Statement of Financial Position (Partial) December 31, 2015 Intangible assets Patents ................................................................. Less: Accumulated amortization .......................... Franchise ............................................................. Development costs ............................................... Total intangible assets................................................. Goodwill ......................................................................

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$40,000 8,000

$ 32,000 250,000 50,000 332,000 270,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 9-11 (a) Account

Financial Statement

Section

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

Accumulated depreciation— Software

Statement of Financial Position

Intangible assets

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

Land

Statement of Financial Position

Property, plant, and equipment

Impairment loss

Income Statement

Operating expenses

Leasehold improvements

Statement of Financial Position

Property, plant, an equipment

Operating leases

Income Statement

Operating expenses

Reversal of impairment loss

Income Statement

Operating expenses

Software

Statement of Financial Position

Intangible assets

Trademarks

Statement of Financial Position

Intangible assets

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Financial Accounting, Sixth Canadian Edition

EXERCISE 9-11 (Continued) (b) REITMANS (CANADA) LIMITED Statement of Financial Position (Partial) February 3, 2013 (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 ..................................................... Goodwill ............................................................................................

$ 5,860 $53,149 22,467 $166,756 85,936 $189,730 101,961

$28,916 10,191

30,682 80,820 87,769 205,131

18,725 499 19,224 42,426

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.

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Financial Accounting, Sixth 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 [(profit ÷ net sales) × (net sales ÷ average total assets)] = profit ÷ 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 industry.

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 9-1A Account Debited

Explanation

Equipment

Makes the equipment more productive or efficient.

Land improvements

Non-permanent land expenditure.

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).

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.

Equipment

Cost to prepare the equipment for use.

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.

Repair and maintenance Does not extend the life of the truck or make it more expense productive or efficient.

Repair and maintenance Does not extend the life of the factory or make it more expense productive or efficient. Painting is a recurring expense over time.

Vehicles

The future operating costs will be substantially reduced.

10. Repair and maintenance Light bulbs are expected to be replaced frequently. expense

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-2A (a) Feb.

Land ............................................................................. 550,000 Cash .................................................................... 150,000 Mortgage Payable ................................................ 400,000 Note: There is no intention of using the old building so the purchase price really relates to only the land.

Land ............................................................................. Cash ....................................................................

11,000

Land ............................................................................. Cash ....................................................................

30,000

Cash ............................................................................ Land .....................................................................

8,000

Land ............................................................................. Cash ....................................................................

2,000

Buildings ...................................................................... Cash ....................................................................

36,000

Mar.

July

Aug. 29

Solutions Manual .

11,000

30,000

8,000

2,000

36,000

Buildings ...................................................................... 1,300,000 Cash .................................................................... Bank Loan Payable .............................................. Prepaid Insurance ........................................................ Cash ....................................................................

5,000

Land Improvements ..................................................... Cash ....................................................................

24,000

9-30

340,000 960,000

5,000

24,000

Chapter 9

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-2A (Continued) (b) Date

Land

Feb. 7 9 15 17 28 Mar. 2 July 2 Aug. 29

$550,000 11,000 30,000 (8,000) 2,000

Land Improvements

Buildings

$24,000 $24,000

$ 36,000 1,300,000 000000000 $1,336,000

$585,000 (c)

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.

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Financial Accounting, Sixth Canadian Edition

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

2015 2016 2017 2018 2019 2020

$290,0001 0,290,000 0, 290,000 290,000 290,000 290,000

End of Year

Depreciation Rate 2 20% × 8/12 20% 20% 20% 20% 20% × 4/12

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

1 $370,000 – $80,000 = $290,000 2 1 ÷ 5 years = 20%

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PROBLEM 9-3A (Continued) (b) (Continued) (2) DOUBLE DIMINISHING–BALANCE DEPRECIATION Calculation

Year

Opening Carrying Amount

2015 2016 2017 2018 2019 2020

$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 2018 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. Profit is lower in the earlier years of the machine’s useful life if the double diminishingbalance method is used. (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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PROBLEM 9-4A (a) (1) STRAIGHT-LINE DEPRECIATION Calculation Year

Depreciable Cost

2015 2016 2017 2018 2019

$120,0002 ,,120,000 ,,120,000 ,,120,000 ,,120,000

End of Year

Depreciation Rate1

Depreciation Expense

Accumulated Depreciation

Carrying Amount

25% × 9/12 25% 25% 25% 25% × 3/12

$22,500 30,000 30,000 30,000 7,500

$ 22,500 52,500 82,500 112,500 120,000

$122,000 99,500 69,500 39,500 9,500 2,000

1 1 ÷ 4 years = 25% 2 $122,000 – $2,000 = $120,000

(2) DOUBLE DIMINISHING–BALANCE DEPRECIATION Calculation

Year

2015 2016 2017 2018 2019

Opening Carrying Amount

$122,000 ,, 76,250 ,, 38,125 ,, 19,063 9,531

End of Year

Depreciation Rate1

50% × 9/12 50% 50% 50% 50% × 3/122

Depreciation Expense

$45,750 38,125 19,062 9,532 7,5312

Accumulated Depreciation

Carrying Amount

$ 45,750 83,875 102,937 112,469 120,000

$122,000 76,250 38,125 19,063 9,531 2,000

1 ÷ 4 years = 25% × 2 = 50%

Adjusted so that carrying amount would equal residual value of $2,000 ($9,531 × 50% × 3/12 = $1,191; $9,531 – $2,000 = $7,531) at the end of the useful life.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-4A (Continued) (a) (Continued) (3) UNITS-OF-PRODUCTION DEPRECIATION Calculation Year

Units-ofProduction

2015 2016 2017 2018 2019

7,400 10,200 9,900 10,000 2,500

End of Year

Depreciation Cost/Unit 1

$3 3 3 3 3

Depreciation Expense

Accumulated Depreciation

Carrying Amount

$22,200 30,600 29,700 30,000 7,500

$ 22,200 52,800 82,500 112,500 120,000

$122,000 99,800 69,200 39,500 9,500 2,000

1 Depreciable cost per unit = ($122,000 – $2,000) ÷ 40,000 units = $3 per unit

(b)

Total depreciation expense Accumulated depreciation

StraightLine

Units-ofProduction

DoubleDiminishing Balance

$120,000 120,000

(c)

Depreciation is a non-cash expense so the cash flows are not affected.

(d)

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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-5A (a)

Equipment $65,000 3,000 62,000 ÷ 8 $ 7,750

Cost, January 1, 2013 Less: Residual value Depreciable cost Useful life in years Annual depreciation ($62,000 ÷ 8)

The equipment’s accumulated depreciation on January 1, 2015 will be $15,500 ($7,750 × 2 years) and the carrying amount will be $49,500 ($65,000 – $15,500). (b)

You would expect the depreciation expense to increase in 2015 after the change in useful life because the undepreciated cost will be expensed over a shorter period of time.

(c)

The change in the useful life should only affect current and future periods. The rationale is that the original estimate was based on information known at the time the asset was purchased and the revision is based on new information and should only affect future periods. In addition, if prior periods were regularly restated, users would have less confidence in the financial statements.

(d)

If the company had not revised the remaining useful life, the total depreciation expense over the equipment’s life would be the depreciable cost of $62,000. The accumulated depreciation at the end of the equipment’s useful life would be $62,000 and the carrying amount would be $3,000.

(e)

The total depreciation expense would not change after the useful life has been revised. There would be no changes to the accumulated depreciation or the carrying amount at the end of the equipment’s useful life. The undepreciated cost of the equipment has not changed; only the length of time over which it will be depreciated has been revised.

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PROBLEM 9-6A (a)

2013 Mar.

Equipment............................................................ Cash ............................................................

(b)

130,000 130,000

DIMINISHING–BALANCE DEPRECIATION Calculation

Year

Opening Carrying Amount

2013 2014 2015 Sep./15

$130,000 117,000 93,600 74,880

End of Year

Depreciation Rate 1

Depreciation Expense

20% × 6/12 20% 20% 20% × 1/12

$13,000 23,400 18,720 1,248

Accumulated Depreciation

Carrying Amount

$13,000 36,400 55,120 56,368

$117,000 93,600 74,880 73,632

1 1 ÷ 5 years = 20%

2013 Aug.

2014 Aug.

2015 Aug.

Solutions Manual .

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

13,000

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

23,400

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

18,720

9-37

13,000

23,400

18,720

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Financial Accounting, Sixth Canadian Edition

(1) Sept. 30

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

1,248

Cash ................................................................... Accumulated Depreciation—Equipment .............. Loss on Disposal ................................................. Equipment ..................................................

60,000 56,368 13,632

Cash proceeds .............................................. Carrying amount ............................................ Loss on disposal............................................ (2) Sept. 30

(3) Sept. 30

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80,000 56,368 6,368 130,000

$80,000 73,632 $ 6,368

Accumulated Depreciation—Equipment .............. Loss on Disposal ................................................. Equipment ..................................................

Cash proceeds .............................................. Carrying amount ............................................ Loss on disposal............................................

130,000

$ 60,000 73,632 $(13,632)

Cash ................................................................... Accumulated Depreciation—Equipment .............. Gain on Disposal ........................................ Equipment ..................................................

Cash proceeds .............................................. Carrying amount ........................................... Gain on disposal............................................

1,248

56,368 73,632 130,000

0 73,632 $(73,632)

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-7A (a) (1)

Straight-line Depreciation Expense = ($70,000 – $10,000) 3

2015 Mar. 1

Dec. 31

2016 Nov. 30

(2)

$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.................................................................

70,000

Single diminishing-balance Depreciation Rate = 1 ÷ 3 years = 33% (note textbook convention to round rates to two decimal spots 0.33 or 33%)

2015 Mar. 1

Dec. 31

Solutions Manual .

Equipment ........................................................................... Cash .........................................................................

70,000

Depreciation Expense ......................................................... Accumulated Depreciation—Equipment ................... ($70,000 × 33% × 10/12 = $19,250)

19,250

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70,000

19,250

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-7A (Continued) (a) (Continued) 2016 Nov. 30

Depreciation Expense ......................................................... Accumulated Depreciation—Equipment ................... [($70,000 – $19,250) × 33% × 11/12 = $15,352]

Nov. 30

15,352 15,352

Cash .................................................................................... 18,000 Accumulated Depreciation—Equipment ($19,250 + $15,352) 34,602 Loss on Disposal ................................................................. 17,398 Equipment.................................................................

70,000

(3) Units-of-Production Depreciable cost per unit = ($70,000 – $10,000) 12,000 2016 Mar. 1

Dec. 31

2016 Nov. 30

Solutions Manual .

$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

Cash .................................................................................... 18,000 Accumulated Depreciation—Equipment ($24,500 + $28,000) 52,500 Gain on Disposal ...................................................... Equipment.................................................................

9-40

28,000

500 70,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-7A (Continued) (b)

Depreciation expense 2015 2016 Total depreciation for two years + Loss (or – gain) on disposal = Net expense for two years

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Straight -Line

Diminishing -Balance

Units-ofProduction

$16,667 18,333

$19,250 15,352

$24,500 28,000

35,000 17,000

34,602 17,398

52,500 (500)

$52,000

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PROBLEM 9-8A (a)

April

May

June

July

Dec. 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

1,100,000 3,300,000

93,333

2,800,000

2,333,333 466,667 300,000 $ (166,667)

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

1,400,000 2,200,000

2,200,000

100,000

Impairment Loss ($23,000,000* – $20,000,000) 3,000,000 Land ........................................................

1,000,000

3,000,000

*Carrying amount = $20,000,000 + $4,400,000 – $1,400,000 = $23,000,000

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PROBLEM 9-8A (Continued) (b)

Dec.

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

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, 2015 Property, plant, and equipment1 Land .................................................................. Buildings............................................................ Less: Accumulated depreciation ....................... Equipment ......................................................... Less: Accumulated depreciation ....................... Total property, plant, and equipment ..........

$ 20,000,000 $97,400,000 64,635,000 $148,400,000 65,590,000

32,765,000 82,810,000 $135,575,000

1 See T accounts on the following page.

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PROBLEM 9-8A (Continued) (c) (Continued) Land Jan. 1, 2015 April 1, 2015

20,000,000 4,400,000

Dec. 31, 2015

Bal. 20,000,000

June 1, 2015 Dec. 31, 2015

1,400,000 3,000,000

Buildings Jan. 1, 2015 Dec. 31, 2015

97,400,000 Bal. 97,400,000

Equipment Jan. 1, 2015 July 1, 2015 Dec. 31, 2015

150,000,000 2,200,000

May 1, 2015 Dec. 31, 2015

2,800,000 1,000,000

Bal. 148,400,000

Accumulated Depreciation—Buildings Jan. 1, 2015 Dec. 31, 2015

62,200,000 2,435,000

Dec. 31, 2015

Bal. 64,635,000

Accumulated Depreciation—Equipment May 1, 2015 Dec. 31, 2015

Solutions Manual .

2,333,333 1,000,000

9-44

Jan. 1, 2015 May 1, 2015 Dec. 31, 2015 Dec. 31, 2015

54,000,000 93,333 100,000 14,730,000

Dec. 31, 2015

Bal. 65,590,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-9A (a)

(b)

yes

Goodwill

not amortized N/A

N/A

Assets under Finance Leases, Statement of Financial Position, Property, plant and equipment

yes

Franchises

amortized

N/A

yes

Patents

amortized

N/A

yes

Patents

amortized

N/A

Not recorded or reported

N/A

Rent (Lease) Expense, Income Statement, Operating expenses

yes

Trademarks

not amortized N/A

N/A

Professional Fees Expense, Income Statement, Operating expenses

10.

N/A

Research Expenses, Income Statement, Operating expenses

Solutions Manual .

(c)

(d)

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-10A (a)

Jan.

July

Sept.

Oct.

Dec. 31

(b)

Dec. 31

Solutions Manual .

Trademarks............................................................. Cash .................................................................

7,000

Research Expenses ................................................ Cash .................................................................

210,000

Development Costs................................................. Cash .................................................................

50,000

Advertising Expense ............................................... Cash .................................................................

60,000

Copyrights............................................................... Cash .................................................................

180,000

Impairment Loss ($90,000 – $125,000) .................. Goodwill ...........................................................

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

Amortization Expense ............................................. Accumulated Amortization—Development Costs ($50,000 ÷ 20 × 6/12 = $1,250)

1,250

9-46

7,000

210,000

50,000

60,000

180,000

35,000

9,000

11,250

1,250

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-10A (Continued) (c) GHANI CORPORATION Statement of Financial Position (Partial) December 31, 2015 Intangible Assets 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 .................................................... 1

Copyrights: $36,000 + $180,000 = $216,000

Accumulated amortization Copyright (#1): $18,000 + $9,000 Copyright (#2)

177,750 61,0003 90,0004 $377,500

$27,000 11,250 $38,250

Trademarks: $54,000 + $7,000 = $61,000

Goodwill: $125,000 – $35,000 = $90,000

Solutions Manual .

$ 48,750

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PROBLEM 9-11A (a)

Second Cup (4 ................................ Starbucks (in CAD $ millions) ......................... (in U.S. $ millions) $(9.4) = (35.7)% $26.3

$1,383.8 = 10.4 % $13,299.5

$26.3 $88.7 + $105.6 ( ) 2 = 0.3 times

$13,299.5 $8,219.2 + $7,360.4 ( ) 2 = 1.7 times

(3) Return on assets

$(9.4) $88.7 + $105.6 ( ) 2 = (9.7)%

$1,383.8 $8,219.2 + $7,360.4 ( ) 2 = 17.8%

(1) Profit margin

$5.9 = 22.4% $26.3

(1) Profit margin

(2) Asset turnover

(b)

(2) Asset turnover

(3) Return on assets

Solutions Manual .

$26.3 $104.0 + $105.6 ( ) 2 = 0.3 times (unchanged)

$5.9 $104.0 + $105.6 ( ) 2 = 5.6%

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-11A (Continued) (c)

The ratios, as restated for Second Cup, of part (b) should be used to make a proper comparison between the two companies. Due to the nature and size of the impairment loss recorded for the goodwill and trademarks, it would not be fair to attempt to make a comparison without taking the impairment loss into consideration. The impairment loss is unusual as is unlikely to recur in the immediate future. In spite of the use of revised ratios, Second Cup has a low asset turnover and poor return on assets, when compared to Starbucks whose ratios exceed industry averages. On the other hand, with the exclusion of the impairment loss, Second Cup shows a much stronger profit margin compared to Starbucks and compared to the industry average.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-12A (a) (in thousands)

Delicious ................................... Scrumptious

(1) Profit margin 2015

$350 = 11.3% $3,100

$180 = 9.5% $1,900

Profit margin 2014

$150 = 10.0% $1,500

$200 = 11.8% $1,700

(2) Asset turnover 2015

$3,100 $2,000 + $1,100 ( ) 2 = 2.0 times

$1,900 $800 + $900 ( ) 2 = 2.2 times

Asset turnover 2014

$1,500 $1,100 + $1,000 ( ) 2 = 1.4 times

$1,700 $900 + $1,000 ( ) 2 = 1.8 times

(3) Return on assets 2015

$350 $2,000 + $1,100 ( ) 2 = 22.6%

$180 $800 + $900 ( ) 2 = 21.2%

Return on assets 2014

$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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-1B Account Debited

Explanation

Equipment

Capital expenditure, which makes the equipment more productive and/or extends its useful life.

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.

Equipment

Repair and Maintenance Operating expenditure that does not make the equipment Expense more productive nor extend its useful life.

Training Expense

Repair and Maintenance Operating expenditure that does not make the equipment Expense more productive nor extend its useful life. Painting is a recurring expense.

Prepaid Insurance

Operating expenditure as it benefits the current period only.

Operating Expenses

Reorganization of the warehouse is an ongoing activity so should be expensed even though efficiency should increase.

Equipment

Capital expenditure: a one time cost which 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-2B (a) Jan.

Land ............................................................................... 440,000 Cash .................................................................... 110,000 Mortgage Payable ................................................ 330,000 Note: There is no intention of using the old building so the purchase price really relates to only the land.

Land ............................................................................... Cash ....................................................................

9,000

Land ............................................................................... Cash ....................................................................

50,000

Land ............................................................................... Cash ....................................................................

16,000

28 Cash ............................................................................... Land .....................................................................

15,000

Buildings ......................................................................... Cash ....................................................................

68,000

Buildings ......................................................................... Cash ....................................................................

34,000

Buildings ......................................................................... Cash .................................................................... Bank Loan Payable ..............................................

600,000

Land Improvements ........................................................ Cash ....................................................................

84,000

Feb. 13

Mar.

Apr.

June 15

Sept. 29

Oct.

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9-52

9,000

50,000

16,000

15,000

68,000

34,000

150,000 450,000

200,000 400,000

84,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-2B (Continued) (b)

(c)

Date

Land

Jan. 22 24 31 Feb. 13 28 Mar. 14 Apr. 22 June 15 Sept. 29 Oct. 1

$440,000 9,000 50,000 16,000 (15,000)

Land Improvements

Buildings

0000 000 $500,000

$84,000 $84,000

68,000 34,000 600,000 600,000 000000000 $1,302,000

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, Sixth 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

2015 2016 2017 2018 2019

$196,0001 0,196,000 0, 196,000 196,000 196,000

End of Year

Depreciation Rate 2

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

1 $196,000 cost – $0 residual value = $196,000 2 1 ÷ 4 years = 25%

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PROBLEM 9-3B (Continued) (b) (Continued) DOUBLE DIMINISHING–BALANCE DEPRECIATION Calculation

Year

Opening Carrying Amount

2015 2016 2017 2018 2019

$196,000 171,500 85,750 42,875 21,437

End of Year

Depreciation Rate1

Depreciation Expense

50% × 3/12 50% 50% 50% 50% × 9/12

Accumulated Depreciation

Carrying Amount

$ 24,500 110,250 153,125 174,563 196,000

$196,000 171,500 85,750 42,875 21,437 0

$ 24,500 85,750 42,875 21,438 21,4372

1 Double diminishing-balance depreciation rate = 1 ÷ 4 = 25% × 2 = 50%

expense in 2019 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 2019 nil, or equal to the residual value.

2 Depreciation

UNITS-OF-PRODUCTION DEPRECIATION Calculation Year

2015 2016 2017 2018 2019

Units-ofProduction

2,500 10,300 9,900 8,800 8,500

End of Year

Depreciation Rate 1

$4.90 ……4.90 ,,,,,,,,4.90 ,,,,,,,,4.90 4.90

Depreciation Expense

$12,250 50,470 48,510 43,120 41,650

Accumulated Depreciation

Carrying Amount

$ 12,250 62,720 111,230 154,350 196,000

$196,000 183,750 133,280 84,770 41,650 0

1 Depreciation rate (per unit):

$196,000 40,000

$4.90

The double diminishing-balance depreciation causes profit to be lower in the early years of the asset’s life because the depreciation expense is higher in 2016 and 2017 than under the other two methods.

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Financial Accounting, Sixth 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.

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PROBLEM 9-4B (a)

(1) STRAIGHT-LINE DEPRECIATION

Year

Depreciable Cost

2015 2016 2017 2018 2019

$300,0001 300,000 300,000 300,000 300,000

Calculation Depreciation # of Rate 2 Mos. 25% 25% 25% 25% 25%

Depreciation Expense

1/12 12/12 12/12 12/12 11/12

End of Year Accumulated Carrying Depreciation Amount

$ 6,250 75,000 75,000 75,000 68,750

$ 6,250 81,250 156,250 231,250 300,000

$323,750 248,750 173,750 98,750 30,000

1 $330,000 – $30,000 = $300,000 2 1 ÷ 4 years = 25%

(2) DOUBLE DIMINISHING-BALANCE DEPRECIATION Calculation

Year

Carrying Amount Beg. of Yr

2015 2016 2017 2018 2019

$330,000 316,250 158,125 79,062 39,531

End of Year

Depreciation Rate 1

# of mos

Depr. Expense

Acc. Depre.

Carrying Amount

50% 50% 50% 50% 50%

1/12 12/12 12/12 12/12 11/12

$ 13,750 158,125 79,063 39,531 9,5312

$ 13,750 171,875 250,938 290,469 300,000

$316,250 158,125 79,062 39,531 30,000

1 1 ÷ 4 years × 2 = 25% × 2 = 50% 2 Adjusted so that the carrying amount at the end of the useful life equals $30,000 ($39,531 ×

50% × 11/12 = $18,118 was not used as it would make carrying amount lower than residual value; $39,531 – $30,000 = $9,531).

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PROBLEM 9-4B (Continued) (a) (Continued) (3) UNITS-OF-PRODUCTION DEPRECIATION Calculation Year

Units-ofProduction

2015 2016 2017 2018 2019

15,000 200,000 125,000 190,000 70,000

(b)

Depreciable Cost/Unit 1

End of Year =

$0.50 0.50 0.50 0.50 0.50

Depreciation Expense

Accumulated Depreciation

Carrying Amount

$ 7,500 107,500 170,000 265,000 300,000

$322,500 222,500 160,000 65,000 30,000

$ 7,500 100,000 62,500 95,000 35,000

Depreciable cost per unit = ($330,000 – $30,000) ÷ 600,000 km = $0.50 per kilometre Total depreciation:

Depreciation expense Accumulated depreciation

Straight -Line $300,000 300,000

Diminishing Balance $300,000 300,000

Units-ofProduction $300,000 300,000

(c)

Depreciation is a non-cash expense so the cash flows are not affected over the threeyear period.

(d)

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.

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PROBLEM 9-5B (a)

Equipment $60,000 4,500 55,500 ÷ 5 $11,100

Cost, January 1, 2013 Less: Residual value Depreciable cost Useful life in years Annual depreciation ($55,500 ÷ 5)

The equipment’s accumulated depreciation on January 1, 2015 will be $22,200 ($11,100 × 2 years) and the carrying amount will be $37,800 ($60,000 – $22,200). (b)

I would expect the depreciation expense to decrease in 2015 after the change in useful life because the depreciable cost will be expensed over a longer period of time.

(c)

The change in the useful life should only affect current and future periods. This is because the original estimate was based on information known at the time the asset was purchased. The revision is based on new information and should only affect future periods. In addition, if prior periods where regularly restated, users would have less confidence in the financial statements.

(d)

If they had not revised the remaining useful life, the total depreciation expense over the equipment’s life would be the depreciable cost of $55,500. The accumulated depreciation at the end of the equipment’s useful life would be $55,500 and the carrying amount would be $4,500.

(e)

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PROBLEM 9-6B (a)

2013 Jan. 1

Equipment............................................................ Accounts Payable ........................................

(b)

170,000 170,000

DIMINISHING–BALANCE DEPRECIATION Calculation

Year

Opening Carrying Amount

2013 2014 June/15

$170,000 , 144,500 115,600

Depreciation Rate 1

Depreciation Expense

20% × 9/12 20% 20% × 8/12

$ 25,500 28,900 15,413

End of Year

Accumulated Depreciation

Carrying Amount

$25,500 54,400 69,813

$144,500 115,600 100,187

1 1 ÷ 5 years = 20%

2013 Sept. 30

2014 Sept. 30

(c)

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

25,500

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

28,900

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

15,413

Cash ................................................................... Accumulated Depreciation—Equipment ............. Equipment .................................................. Gain on Disposal ........................................

105,000 69,813

25,500

28,900

2015 (1, 2, 3) June 1

(1)

June 1

Cash proceeds ................................................... Carrying amount ................................................. Gain on disposal.................................................

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9-60

15,413

170,000 4,813

$105,000 100,187 $ 4,813

Chapter 9

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-6B (Continued) (c) (Continued) (2)

June 1

Cash proceeds ................................................... Carrying amount ................................................. Loss on disposal.................................................

(3)

June 1

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170,000

$ 80,000 100,187 $(20,187)

Accumulated Depreciation—Equipment .............. Loss on Disposal ................................................. Equipment ..................................................

Cash proceeds ................................................... Carrying amount ................................................. Loss on disposal.................................................

80,000 69,813 20,187

69,813 100,187 170,000

0 100,187 $(100,187)

Chapter 9

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-7B (a) (1)

Straight-line Depreciation Expense = ($50,000 – $10,000) 3

2015 Feb. 1

Dec. 31

2016 Oct. 31

$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

50,000

12,222

11,111

23,333 14,667 50,000

(2) Single diminishing-balance Depreciation rate = 1/3 × 1 = 33% (note textbook convention to round rates to two decimal spots 0.33 or 33%) 2015 Feb. 1

Dec. 31

Solutions Manual .

Equipment............................................................... Cash .................................................................

50,000

Depreciation Expense ............................................. Accumulated Depreciation—Equipment ........... ($50,000 × 33% × 11/12 = $15,125)

15,125

9-62

50,000

15,125

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-7B (Continued) (a) (Continued) 2016 Oct. 31

Depreciation Expense ............................................. Accumulated Depreciation—Equipment ........... [($50,000 – $15,125) × 33% × 10/12 = $9,591]

9,591

Cash ..................................................................... Accumulated Depreciation—Equipment ($15,125 + $9,591) ................................................. Loss on Disposal .................................................... Equipment ........................................................

12,000

9,591

24,716 13,284 50,000

(3) Units-of-Production Depreciable cost per unit = ($50,000 – $10,000) 10,000 2015 Feb. 1

Dec. 31

2016 Oct. 31

Solutions Manual .

$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

9-63

50,000

16,000

20,000

36,000 2,000 50,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-7B (Continued) (b)

Depreciation expense 2015 2016 Total depreciation for two years + Loss (or – gain) on disposal = Net expense for two years

Solutions Manual .

Straight -Line

Diminishing -Balance

Units-ofProduction

$12,222 11,111

$15,125 9,591

$16,000 20,000

23,333 14,667

24,716 13,284

36,000 2,000

$38,000

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PROBLEM 9-8B (a)

April

May

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.

Dec. 31

Solutions Manual .

950,000 2,850,000

50,000

1,500,000 $ 700,000

$1,500,000 650,000 850,000 $(150,000)

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

Impairment Loss ............................................. Land ........................................................ ($11,200,000 – $11,000,000 = $200,000)

200,000

9-65

600,000 1,800,000

2,000,000

94,000

940,000

200,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 9-8B (Continued) (b)

Dec.

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

1,425,000

9,456,000 $9,356,000 100,000 $9,456,000

*$96,000,000 – $1,500,000 – $940,000 = $93,560,000 31

(c)

Interest Expense ............................................... Interest Payable ........................................ ($2,850,000 × 6% × 9/12 = $64,125)

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, 2015 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, 2015 April 1, 2015

8,000,000 3,800,000

Dec. 31, 2015

Bal. 11,000,000

June 1, 2015 Dec. 31, 2015

600,000 200,000

Buildings Jan. 1, 2015 Dec. 31, 2015

57,000,000 Bal. 57,000,000

Equipment Jan. 1, 2015 July 1, 2015 Dec. 31, 2015

96,000,000 2,000,000

May 1, 2015 Dec. 31, 2015

1,500,000 940,000

Bal. 95,560,000

Accumulated Depreciation—Buildings Jan. 1, 2015 Dec. 31, 2015

24,200,000 1,425,000

Dec. 31, 2015

Bal. 25,625,000

Accumulated Depreciation—Equipment May 1, 2015 Dec. 31, 2015

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650,000 940,000

9-67

Jan. 1, 2015 May 1, 2015 Dec. 31, 2015 Dec. 31, 2015

30,000,000 50,000 94,000 9,456,000

Dec. 31, 2015

Bal. 38,010,000

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PROBLEM 9-9B (a)

(b)

yes

Goodwill

not amortized N/A

N/A

Assets under Finance Leases, Statement of Financial Position, Property, plant and equipment

yes

Software

amortized

N/A

yes

Patents

amortized

N/A

Professional Fees Expense, Income Statement, Operating expenses

N/A

Not recorded or reported

N/A

Rent Expense, Income Statement, Operating expenses

yes

Trademarks

not amortized N/A

yes

Trademarks

not amortized N/A

10.

N/A

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(c)

(d)

Research Expenses, Income Statement, Operating expenses

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PROBLEM 9-10B (a)

Jan.

July

Sept.

Oct.

Dec. 31

(b)

Dec. 31

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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

9-69

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, 2015 Intangible assets Finite life intangible assets Patents ................................................................ Less: Accumulated amortization .......................... Copyrights ........................................................... Less: Accumulated amortization .......................... Development costs .............................................. Less: Accumulated amortization .......................... Goodwill ....................................................................... Total intangible assets .........................................

$92,5001 23,8122 $64,0003 34,4004 $60,000 1,500

Patents: $70,000 + $22,500 = $92,500

Accumulated amortization: $14,000 + $9,812 = $23,812

Copyrights: $48,000 + $16,000 = $64,000

Accumulated amortization Copyright (original): $28,800 + $4,800 = Copyright (additional):

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$ 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)

(b)

Le Château ................................. Reitmans

Profit margin

$(2.4) = (0.8)% $302.7

$47.5 = 4.7% $1,019.4

Asset turnover

$ 302.7 $233.8 + $246.1 ( ) 2 = 1.3 times

$ 1,019.4 $633.9 + $659.4 ( ) 2 = 1.6 times

Return on assets

$(2.4) $233.8 + $246.1 ( ) 2 = (1.0)%

$47.5 $633.9 + $659.4 ( ) 2 = 7.3%

Based on the profit margin we can see that Reitmans is more profitable than Le Château. Both companies have profit margins that are lower than the average company in the industry (6.0%). 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. Reitmans’ asset turnover ratio is higher than Le Château’s and yet both are lower than the average company in the industry (2 times). The return on assets ratio indicates that Reitmans is generating a higher return than Le Château based on the amount of assets invested in the business. Based on the industry average of 12.0%, both companies are performing worse than the industry average.

(c)

Some additional information about long-lived assets which would assist in the comparisons would 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 finally, details concerning the costs and accumulated depreciation or amortization recorded to date. The latter information would provide a give an idea of the age of the long-lived assets.

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PROBLEM 9-12B (a) (in thousands)

NAL ...........................................BRI

Profit margin 2015

$220 = 8.8% $2,500

$250 = 13.9% $1,800

Profit margin 2014

$150 = 10.0% $1,500

Asset turnover 2015

$2,500 $2,500 + $1,100 ( ) 2 = 1.4 times

$1,800 $1,100 + $1,050 ( ) 2 = 1.7 times

Asset turnover 2014

$1,500 $1,100 + $1,000 ( ) 2 = 1.4 times

$1,500 $1,050 + $1,000 ( ) 2 = 1.5 times

Return on assets 2015

$220 $2,500 + $1,100 ( ) 2 = 12.2%

$250 $1,100 + $1,050 ( ) 2 = 23.3%

Return on assets 2014

$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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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 volume 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 2014 to 2015 the profit 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.

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BYP 9-1 FINANCIAL REPORTING ($ in thousands) (a)

From note 3 (l) (iii) to the financial statements, we find that Shoppers Drug Mart uses a straight-line method of depreciating its property and equipment.

(b) (1)

(2) (3) Accumulated Impairment Depreciation Losses

Cost December 29, 2012 Properties under Development Land Buildings Equipment, Fixtures and Computer Equipment Leasehold Improvements Assets under Finance Leases

December 31, 2011 Properties under Development Land Buildings Equipment, Fixtures and Computer Equipment Leasehold Improvements Assets under Finance Leases

60,894 69,605 233,535

1,319,002 1,355,590 134,705 $3,173,331

71,342 65,478 214,043

(4) Carrying Amount $

32,742

872,160 504,057 23,179 $1,432,138

$12,310 10,890 00 0000 $23,200

434,532 840,643 111,526 $1,717,993

$ $

24,325

60,894 69,605 200,793

71,342 65,478 189,718

1,283,062 1,291,445

776,387 436,016

$16,257 15,465

490,418 839,964

127,034 $3,052,404

16,411 $1,253,139

00 0000 $31,722

__110,623 $1,767,543

(c)

Net change in accumulated depreciation $178,999 Depreciation recorded in 2012 (note 13 & 15) 263,134 Difference for disposals, transfers and retirements (note 15) $ 84,135

(d)

Shoppers has a balance of Goodwill at December 29, 2012 of $2,572,707,000.

(e)

Shoppers’ intangible assets include: prescription files, customer relationships, computer software and computer software under development. There were no impairments recorded in the year ending December 29, 2012 for intangible assets.

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BYP 9-2 COMPARATIVE ANALYSIS (a) Ratios

Shoppers ($ in thousands)

Jean Coutu ($ in millions)

1. Profit margin

$608,481 $10,781,848

2. Return on assets

$608,481 ($7,473,721 + $7,300,310) 2

3. Asset turnover

$10,781,848 = 1.5 ($7,473,721 + $7,300,310) times 2

$558.4 $2,468.0

= 5.6%

8.2%

$558.4 ($1,392.7 + $1,072.8) 2 $2,468.0 ($1,392.7 + $1,072.8) 2

= 22.6%

= 45.3%

= 2.0 times

(b) Ratio Profit margin Return on assets Asset turnover

Shoppers 5.6% 8.2% 1.5 times

Jean Coutu 22.6% 45.3% 2.0 times

Industry 2.6% 5.4% 2.1 times

Based on profit margin we can see that Jean Coutu is more profitable than Shoppers. Jean Coutu’s profit margin is significantly above the industry average of 2.6%, which indicates that it is much more profitable than the average company in the industry. The return on assets ratio indicates that Shoppers is generating a much lower return than Jean Coutu based on the amount of assets invested in the business. However, again, based on the industry average of 5.4% both Shoppers and Jean Coutu are generating a significantly better return on their assets than most other companies in the industry. 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. Jean Coutu’s asset turnover was higher than Shoppers and is slightly lower than the industry average.

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BYP 9-3 COMPARING IFRS AND ASPE (a)

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: Rosewood (without impairment reversal)

Blaze Mountain (without impairment reversal)

1. Profit Margin

$180,000 ÷ $2,250,000 = 8.0%

$200,000 ÷ $2,500,000 = 8.0%

2. Asset Turnover 3. Return on Assets

$2,250,000 ÷ $9,000,000 = 0.2 times

$2,500,000 ÷ $10,000,000 = 0.2 times

$180,000 ÷ $9,000,000 = 2.0%

$200,000 ÷ $10,000,000 = 2.0%

If we take into consideration the adjustment Rosewood made above to reverse the impairment loss, profit would now go up by $800,000 to $980,000 while average assets would go up 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)

Blaze Mountain (without impairment reversal)

1. Profit Margin

$980,000 ÷ $2,250,000 = 43.6%

$200,000 ÷ $2,500,000 = 8.0%

2. Asset Turnover 3. Return on Assets

$2,250,000 ÷ $9,400,000 = 0.2 times

$2,500,000 ÷ $10,000,000 = 0.2 times

$980,000 ÷ $9,400,000 = 10.4%

$200,000 ÷ $10,000,000 = 2.0%

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BYP 9-3 (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.

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BYP 9-4 CRITICAL THINKING 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 of time when the rigs are being used the most and lower in periods of time when the rigs are not used as much. Furniture – as usage of these assets is uniform over useful life, the straight-line method would be the most appropriate method for furniture.

(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 or 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 sales contract with the drill bit manufacturer.

(c)

If the company is planning to have its shares trade on a public stock exchange, it must prepare its financial statements under IFRS.

(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 in order to prevent the possibility of seizure by the bank if the company defaulted on its loan payments. 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 value on resale.

(e)

If a 15 year lease was entered into, it would be considered a finance lease rather than an operating lease because a significant portion of the asset’s benefits would be controlled by the company due to the long term nature of the lease. Because of this, the leased rig would meet the definition of an asset and would be recorded as such by the company. An offsetting liability (lease obligation) would also be recorded. This would be similar to buying a rig on credit.

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BYP 9-4 (Continued) (f)

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 while the numerator remains constant. 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.

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BYP 9-5 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)

Profit before income tax in 2015 (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 profit for 2014.

(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 overstatement of 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 for whatever the reason and would represent an attempt at profit manipulation. There is nothing unethical about changing the estimate either of the life of an asset or of an asset’s residual value if the change is an attempt to better reflect the pattern of consumption of economic benefits. In this case, it appears from the controller’s reaction that the revisions in the life and residual value are intended only to improve profit, which would be unethical.

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BYP 9-6 “ALL ABOUT YOU” ACTIVITY (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.

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BYP 9-7 SERIAL CASE (a)

The following costs should be capitalized: Purchase price of 2 ovens $30,000 Purchase price of new refrigerator 8,500 Plumbing upgrade 1,750 Electrical upgrade 2,450 Shipping ($500 × 3) 1,500 Total costs to be capitalized $44,200

The additional insurance and painting of the walls should be expensed during the year. (b)

Sep.

Depreciation Expense ..................................... Accumulated Depreciation—Equipment. ($5,000 ÷ 5 × 2/12 = $167)

167

Accumulated Depreciation—Equipment. ........ Loss on Disposal ............................................ Equipment...............................................

3,667 1,333

167

5,000

Accumulated depreciation—equipment: [($5,000 ÷ 5) × 3.5] + $167 = $3,667

(c)

Sept. 1

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Equipment....................................................... Prepaid Insurance ........................................... Repair and Maintenance Expense .................. Cash .......................................................

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44,200 1,200 3,850 49,250

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COMPREHENSIVE CASE: CHAPTERS 3 – 9 (a) Date Aug. 1

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Account Titles

Debit

Office Expense ............................................................... Rent Expense ................................................................. Cash ....................................................................

20,000 3,600

Notes Receivable ........................................................... Accounts Receivable ...........................................

100,000

Accounts Receivable ...................................................... Sales ....................................................................

500,000

Cost of Goods Sold ........................................................ Merchandise Inventory.........................................

270,000

Allowance for Doubtful Accounts .................................... Accounts Receivable ...........................................

70,000

Cash ............................................................................... Sales Discounts ($300,000 × 2%) .................................. Accounts Receivable ...........................................

294,000 6,000

Cash ............................................................................... Accumulated Depreciation—Equipment ......................... Loss on Disposal ............................................................ Equipment............................................................

6,000 36,169 1,831

Income Tax Expense ...................................................... Cash ....................................................................

10,000

Patents ........................................................................... Cash ....................................................................

24,000

Cash ............................................................................... Sales ....................................................................

75,000

Cost of Goods Sold ........................................................ Merchandise Inventory.........................................

35,000

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Credit

23,600

100,000

500,000

270,000

70,000

300,000

44,000

10,000

24,000

75,000

35,000

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COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (a) (Continued) Date

Aug. 31

31 31 31

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Debit

Account Titles

Interest Expense ............................................................. Bank Charges Expense .................................................. Cash ....................................................................

1,500 1,130

Bad Debts 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 × 8% × 1/12) ...........

667

Amortization Expense ..................................................... Accumulated Amortization—Patents.................... ($24,000 ÷ 5 × 1/12 = $400)

400

9-84

Credit

2,630

90,000

3,125

100,000 667 400

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COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (b) Cash July 31, 2015

170,000 Aug.

23,600

Aug.

294,000

10,000

6,000

24,000

75,000

2,630

100,000

Aug. 31 Bal.

384,770 Accounts Receivable

July 31, 2015 Aug.

Aug. 31 Bal.

2,700,000 Aug. 2 500,000

100,000

70,000

300,000

2,730,000 Allowance for Doubtful Accounts

Aug. 8

70,000 July 31, 2015

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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COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (b) (Continued) Merchandise Inventory July 31, 2015

270,000

35,000

July 31, 2015

194,000 Aug. 10

44,000

Aug. 31 Bal.

150,000

Aug. 31 Bal.

500,000 Aug. 195,000 Equipment

Accumulated Depreciation—Equipment Aug. 10

36,169 July

31, 2015

73,669

3,125

Aug. 31 Bal.

40,625

Patents Aug. 21, 2015

24,000

Aug. 31 Bal.

24,000

Accumulated Amortization—Patents

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Aug. 31

400

Aug. 31 Bal.

400

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COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (b) (Continued) Accounts Payable July

31, 2015

Aug. 31 Bal. July 31, 2012

1,009,000 1,009,000

260,000 Bank Loan Payable July

31, 2015

Aug. 31 Bal.

350,000 350,000

Common Shares July

31, 2015

Aug. 31 Bal.

300,000 300,000

Retained Earnings July

31, 2015

Aug. 31 Bal.

1,531,331 1,531,331

Sales

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Aug. 3

500,000

75,000

Aug. 31 Bal.

575,000

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COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (b) (Continued) Sales Discounts Aug.

Aug. 31 Bal.

6,000 6,000 Interest Revenue Aug. 31

667

Aug. 31 Bal.

667

Cost of Goods Sold Aug.

270,000

Aug. 31

35,000

Aug. 31 Bal.

305,000 Depreciation Expense

Aug. 31

3,125

Aug. 31 Bal.

3,125 Amortization Expense

Aug. 10

400

Aug. 31 Bal.

400 Salaries Expense

Aug. 31

100,000

Aug. 31 Bal.

100,000

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (b) (Continued) Bad Debts Expense Aug.

90,000

Aug.

31 Bal.

90,000 Office Expense

Aug.

20,000

Aug.

31 Bal.

20,000 Rent Expense

Aug.

3,600

Aug.

31 Bal.

3,600 Bank Charges Expense

Aug.

1,130

Aug.

31 Bal.

1,130 Interest Expense

Aug.

1,500

Aug.

31 Bal.

1,500 Loss on Disposal

Aug.

1,831

Aug.

31 Bal.

1,831 Income Tax Expense

Aug.

10,000

Aug.

31 Bal.

10,000

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (c) CLEAR IMAGES LTD. Trial Balance August 31, 2015 Debit $ 384,770 2,730,000

Cash Accounts receivable Allowance for doubtful accounts Notes receivable Interest receivable Merchandise 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 6,000 667 305,000 3,125 400 100,000 90,000 20,000 3,600 1,130 1,500 1,831 10,000 $4,127,023

9-90

000000000 $4,127,023

Chapter 9

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (d) (1) CLEAR IMAGES LTD. Income Statement Month Ended August 31, 2015 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 Profit from operations Other revenues and expenses Interest revenue Interest expense Total other revenues and expenses Profit before income tax Income tax expense Profit

Solutions Manual .

$575,000 6,000

$569,000 305,000 264,000

$100,000 90,000 20,000 3,600 1,130 3,125 400 1,831 220,086 43,914 $

667 (1,500) (833) 43,081 10,000 $ 33,081

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 3–9 (Continued) (d) (2) (Continued) CLEAR IMAGES LTD. Statement of Changes in Equity Month Ended August 31, 2015

Balance, August 1 Profit Balance, August 31

Common Shares $300,000 0000 000 $300,000

Retained Earnings $1,531,331 33,081 $1,564,412

Total Equity $1,831,331 33,081 $1,864,412

(3) CLEAR IMAGES LTD. Statement of Financial Position August 31, 2015 Assets Current assets Cash Accounts receivable Less: Allowance for doubtful accounts Interest receivable Notes receivable Merchandise inventory Total current assets Property, plant and equipment Equipment Less: Accumulated depreciation Intangible assets Patents Less: Accumulated amortization Total assets

$ 384,770 $2,730,000 320,000

$150,000 40,625 $24,000 400

2,410,000 667 100,000 195,000 3,090,437

109,375

23,600 $3,223,412

Solutions Manual .

$1,009,000 350,000 $1,359,000 $ 300,000 1,564,412 1,864,412 $3,223,412

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Financial Accounting, Sixth Canadian Edition

CHAPTER 10 Reporting and Analyzing Liabilities ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

1. Account for current liabilities.

1, 2, 3, 4, 5, 6, 7, 8

1, 2, 3, 4, 5

1, 2, 3, 4

1A, 2A, 6A

1B, 2B, 6B

2. Account for instalment notes payable.

8, 9, 10, 11, 12, 13

6, 7, 8, 9

5, 6, 7

3A, 4A, 5A

3B, 4B, 5B

1, 6, 7

3. Identify the requirements for the financial statement presentation and analysis of liabilities.

14, 15, 16, 17, 18

10, 11, 12, 8, 9, 10

1A, 2A, 4A, 5A, 6A, 7A, 8A, 10A

1B, 2B, 4B, 1, 2, 3, 5B, 6B, 7B, 4, 5, 7 8B, 10B

4. Account for bonds payable.

*19, *20, *21

*13, *14, *15

*9A, *10A

*9B, *10B

Solutions Manual .

10-1

Exercises

A Problems

B Problems

*11, *12, *13, *14

BYP

Chapter 10

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record and present current liabilities.

Moderate

25-30

Record and present short-term notes.

Moderate

30-40

Record instalment note.

Moderate

30-40

Prepare instalment payment schedule; record and present instalment note.

Moderate

30-40

Prepare instalment payment schedule; record and present instalment note.

Moderate

30-40

Classify liabilities.

Moderate

20-30

Analyze liquidity and solvency.

Moderate

30-40

Analyze liquidity and solvency.

Moderate

30-40

*9A

Record bond transactions.

Moderate

30-40

*10A

Calculate present value; prepare amortization schedule; record and present bond transactions.

Moderate

30-40

Record and present current liabilities.

Moderate

25-30

Record and present short-term notes.

Moderate

30-40

Record instalment note.

Moderate

30-40

Prepare instalment payment schedule; record and present instalment note.

Moderate

30-40

Prepare instalment payment schedule; record and present instalment note.

Moderate

30-40

Classify liabilities.

Moderate

20-30

Solutions Manual .

10-2

Chapter 10

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Analyze liquidity and solvency.

Moderate

30-40

Analyze liquidity and solvency.

Moderate

30-40

*9B

Record bond transactions.

Moderate

30-40

*10B

Calculate present value; prepare amortization schedule; record and present bond transactions.

Moderate

30-40

Solutions Manual .

10-3

Chapter 10

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Financial Accounting, Sixth 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 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.

An operating line of credit, or credit facility, is used by a business to overcome shortterm 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. Bank loans on the other hand are structured in such a way to deal with more short-term or long-term cash needs of the business. Longer type loans are used to finance the purchase of property, plant, and equipment and short-term bank loans would be used to finance inventory. Bank loans are for specific amounts that have structured terms for the repayment of the principal.

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.

A difference exists in the timing of the incurrence of the expense for property tax and the timing of the payment of the property tax bills. Due to this difference, at any reporting period, the balance can shift from a liability when the property tax bill is received, to a prepayment when it is paid. In addition, an expense must be recorded as the property tax prepayment is used up.

The difference between (a) gross pay (the total amount an employee earned in salary or wages) and net pay stems from the payroll deductions deducted from the gross pay of an employee. Some of the deductions are mandatory, such as income tax, and some are optional such as donations to charities. In turn, the difference between (b) deductions withheld from an employee (i.e., deducted from an employee’s pay), and employee benefits, is the employee benefits are paid by the employer only. They are not part of the employee’s gross earnings. These employer paid benefits include required payments for CPP and EI, for example.

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10-4

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 6.

When determining whether a contingent 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 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 contingent liability will be disclosed in the notes to the financial statements. On the other hand, if the company is reporting under ASPE, the probability needs to be “likely.” This is a higher level of probability that the standard used in IFRS.

Shoppers must report details of any outstanding claims or possible claims even though the amount of any claim cannot be reasonably determined. This disclosure helps the readers of the financial statements assess any future possible consequences that might come about concerning these potential claims. Since they cannot be measured, the amounts cannot be recorded as provisions. Unrecorded claims or possible claims are contingent liabilities.

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.

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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 10.

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.

11.

It is a blended payment pattern. Instalment notes with blended principal and interest payments are repayable in equal periodic amounts, including interest. Instalment notes payable with fixed principal payments are repayable in equal principal periodic amounts, plus interest.

12.

(a) A student choosing the 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 loan. Since the loan 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 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.

13.

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.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 14.

(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.

15.

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. 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.

16.

An operating line of credit, or credit facility, is used by a business to overcome shortterm 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. As a consequence, the business does not incur the constant charge for interest on a long-term debt loan and can save on interest costs. The liquidity issues of a business can therefore be effectively dealt with using an operating line of credit.

17.

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 profits. Alternatively, a company with a low debt to total assets may find itself in financial difficulty if it does not have sufficient profit to cover required interest payments. Therefore, it is important to interpret these two ratios in conjunction with one another.

18.

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.

Solutions Manual .

10-7

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 19. (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 the stock exchange, 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 on the stock exchange. 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.

20.

Investors paid more than the face value of the bond; therefore, the market interest rate must have been less than the coupon interest rate. Investors are willing to pay more for a bond that offers a coupon rate of return greater than the rate offered in the market. The demand for this bond then causes the price to increase above its face value.

21. (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 buy 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 interest paid.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) (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 and a portion relating to the amortization of the premium thereby marking it lower than the interest paid.

Solutions Manual .

10-9

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 (a) Oct.

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.

6,000 899

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

Solutions Manual .

10-10

16,500

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 10-3 (a)

(b)

(c)

Aug.

Sept.

Salaries Expense ...................................................... Income Tax Payable ......................................... CPP Payable .................................................... EI Payable ........................................................ Cash ($15,000 – $6,258 – $743 – $267) ..........

15,000

Employee Benefits Expense ..................................... CPP Payable .................................................... EI Payable ........................................................

1,117

Income Tax Payable ................................................. CPP Payable ($743 + $743) ..................................... EI Payable ($267 + $374) ......................................... Cash ($6,258 + $1,486 + $641) ........................

6,258 1,486 641

6,258 743 267 7,732 743 374

8,385

BRIEF EXERCISE 10-4 (a)

July

(b) (1) Aug. 1

(2) Aug. 31

(3) Sept. 1

(4) Oct.

(c)

Oct.

Solutions Manual .

Cash ...................................................................... Bank Loan Payable .......................................

60,000

Interest Expense ($60,000 × 5% × 1/12)................ Cash ..............................................................

250

Interest Expense .................................................... Interest Payable ............................................

250

Interest Payable ..................................................... Cash ..............................................................

250

Interest Expense .................................................... Cash ..............................................................

250

Bank Loan Payable ................................................ Cash .............................................................

60,000

10-11

60,000

250

60,000

Chapter 10

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 10-5 IFRS a) Record and disclose (likely is a higher level of probability than more likely than not) b) Not recorded, disclose only c) Not recorded nor disclosed d) Not recorded, disclose only

ASPE Record and disclose Not recorded, disclose only Not recorded nor disclosed Not recorded, disclose only

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.

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Chapter 10

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 10-7 (a)

[1] [2] [3] [4] [5] [6] [7] [8] [9] [10]

$50,000 × 7% = $3,500 $13,500 – $3,500 = $10,000 $12,800 – $2,800 = $10,000 or same as [2] as fixed principal reduction $40,000 – $10,000 = $30,000 (or $2,100 ÷ 7% = $30,000) $10,000 fixed principal reduction [6] + $2,100 = $12,100 $10,000 fixed principal reduction $30,000 [4] – $10,000 [6] = $20,000 $11,400 – $1,400 = $10,000 fixed principal reduction or $20,000 [7] – $10,000 $10,700 – $700 = $10,000 fixed principal reduction $10,000 – $10,000 = $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 $10,000. This leaves $10,000 ($20,000 less current portion of $10,000) as the non-current portion of the debt.

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 non-current portion of the debt.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 10-9 (a)

Fixed principal payment

Monthly Interest Period Nov. 30, 2014 Dec. 31, 2014 Jan. 31, 2015

2014 Nov. 30 Dec.

2015 Jan. 31

Solutions Manual .

(A) Cash Payment (B) + (C)

(B) Interest Expense (D) × 7% ÷ 12 mos.

$4,250 04,235

$1,750 01,735

$2,500 02,500

(D) Principal Balance (D) – (C) $300,000 297,500 295,000 2,000

Cash ......................................................................... Mortgage Payable............................................

300,000

Interest Expense ....................................................... Mortgage Payable .................................................... Cash ................................................................

1,750 2,500

1,735 2,500

10-14

300,000

4,250

4,235

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 10-9 (Continued) (b)

Blended principal and interest payment

Monthly Interest Period Nov. 30, 2014 Dec. 31, 2014 Jan. 31, 2015 2014 Nov. 30 Dec.

2015 Jan. 31

(A) Cash Payment $3,483 3,483

(B) Interest Expense (D) × 7% ÷ 12 mos. $1,750 1,740

Cash .................................................................. Mortgage Payable.....................................

300,000

Interest Expense ................................................ Mortgage Payable ............................................. Cash .........................................................

1,750 1,733

Interest Expense ................................................ Mortgage Payable ............................................. Cash .........................................................

1,740 1,743

(D) Principal Balance (D) – (C) $300,000 298,267 296,524 22,000

300,000

3,483

BRIEF EXERCISE 10-10 a. b. c. d. e. f. g. h. i. j.

Non-current liability Current liability Current liability Neither – 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 Current asset Current liability for the $5,000 due next year. The remaining $70,000 balance is a noncurrent liability.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 10-11 (in USD millions) (a)

Current ratio $1,748.0 = $2,598.7

(b) Debt to total assets (c)

0.7:1

$8,220.6 $16,212.2

Times interest earned =

50.7%

$443.0 + $154.5 + $185.0 = $185.0

4.2 times

BRIEF EXERCISE 10-12 (a)

Debt to total assets Times interest earned

(b)

Although Fromage’s debt to total assets ratio improved in 2015, 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 profit before income tax and interest relative to its interest expense than it did in the prior year.

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Improvement Deterioration

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*BRIEF EXERCISE 10-13 (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:

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 a spreadsheet program is used to determine the present value.

Solutions Manual .

10-17

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

*BRIEF EXERCISE 10-14 (a)

CARVEL CORP. Bond Premium Amortization

Semiannual Interest Periods

Jan. 1/15 July 1/15 Jan. 1/16

(A) Interest Payment (6% × 6/12 = 3%)

$15,000 15,000

(b)

(B) Interest Expense (5% × 6/12 = 2.5%)

$13,047 12,998

(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. 1/15 July 1/15 Jan. 1/16

Interest Payment (6% × 6/12 = 3%)

$15,000 15,000

(c)

Semiannual Interest Periods Jan. 1/15 July 1/15 Jan. 1/16

Solutions Manual .

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%)

(B) Interest Expense (7% × 6/12 = 3.5%)

$15,000 15,000

$16,772 16,834

$1,772 1,834

10-18

(D) Unamortized Discount (D) – (C)

(E) Bond Carrying Amount ($500,000 – D)

$20,791 19,019 17,185

$479,209 480,981 482,815

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

*BRIEF EXERCISE 10-15 (a) Jan.

July

Dec. 31

Cash ........................................................... Bonds Payable ...................................

521,881

Interest Expense ......................................... Bonds Payable ............................................ Cash ...................................................

13,047 1,953

Interest Expense ......................................... Bond 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 ......................................... Bond Payable ..................................... Interest Payable .................................

16,834

521,881

15,000

(b) Jan.

July

Dec. 31

500,000

15,000

July

Dec. 31

Solutions Manual .

10-19

479,209

1,772 15,000

1,834 15,000

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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.

Solutions Manual .

Shareholders’ Equity NE NE NE + NE +

10-20

Revenues

Expenses

Profit

NE NE NE NE + NE NE NE NE +

NE NE + NE NE + + + NE NE

NE NE NE + NE +

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 10-2 (a) Mar. 17

May

July

Aug. 15

Oct.

Nov. 1

Dec. 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 .............................................................. Income Tax Payable ............................................... Pension Payable..................................................... Cash .......................................................................

81,000

Employee Benefits Expense ........................................... CPP Payable .......................................................... EI Payable ..............................................................

6,029

Cash ............................................................................... Bank Loan Payable ................................................

100,000

Interest Expense ($100,000 × 4% × 1/12) ...................... Cash .....................................................................

333

Interest Expense ($100,000 × 4% × 1/12) ...................... Cash .....................................................................

333

Property Tax Expense .................................................... Prepaid Property Tax..............................................

26,400

Interest Expense ($100,000 × 4% × 1/12) ...................... Interest Payable......................................................

333

50,000 6,000

17,600

52,800

4,010 1,442 16,020 6,400 53,128

4,010 2,019

100,000

333

(b) Dec. 31

Solutions Manual .

10-21

26,400

333

Chapter 10

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Financial Accounting, Sixth Canadian Edition

EXERCISE 10-3 (a)

Dougald Construction

(1)

Oct. 1, 2014

(2)

(3)

Cash ..................................................................... Bank Loan Payable ........................................

250,000

Dec. 31, 2014 Interest Expense ................................................... Interest Payable ............................................. ($250,000 × 5% × 3/12)

3,125

July 1, 2015

Interest Expense ($250,000 × 5% × 6/12) ............ Interest Payable .............................................

6,250

Bank Loan Payable .............................................. Interest Payable ($3,125 + $6,250) ...................... Cash ...............................................................

250,000 9,375

Notes Receivable ................................................. Cash ...............................................................

250,000

Dec. 31, 2014 Interest Receivable ............................................... Interest Revenue ............................................ ($250,000 × 5% × 3/12)

3,125

July 1, 2015

Interest Receivable ($250,000 × 5% × 6/12) ........ Interest Revenue ...........................................

6,250

Cash ..................................................................... Interest Receivable ($3,125 + $6,250) ........... Notes Receivable ...........................................

259,375

(b)

TD Bank

(1)

Oct. 1, 2014

(2)

(3)

250,000 3,125

6,250

259,375

250,000 3,125

6,250 9,375 250,000

EXERCISE 10-4 (a) It would be appropriate for Walmart to accrue a liability as a provision, rather than only disclose the item as a contingent liability when a reasonable estimate can be made of the amount of the claim and when a payment to the claimant in the lawsuit is “more likely than not” to occur. (b) If Walmart were reporting under ASPE, the probability of the contingent liability becoming a liability needs to be “likely” before it is accrued as a provision. The probability level required is higher than that used under IFRS, which is “more likely than not.”

Solutions Manual .

10-22

Chapter 10

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Financial Accounting, Sixth Canadian Edition

EXERCISE 10-5 (a) and (b) (1)

Fixed principal payment (A) Cash Payment (B) + (C)

Semi-annual Interest Period Dec. 31, 2014 June 30, 2015 Dec. 31, 2015

$11,250 11,063 01

(B) Interest Expense (D) × 5% × 6/12

(D) Principal Balance (D) – (C)

$3,750 3,3,,5$3,563

$7,500 7,500 01476.73

$150,000 142,500 135,000 22,000

Issue of Mortgage 2014

Dec.

Cash ............................................................... Mortgage Payable ..................................

150,000 150,000

First Instalment Payment 2015

June

Interest Expense ($150,000 × 5% × 6/12) ..... Mortgage Payable ........................................... Cash ......................................................

3,750 7,500 11,250

Second Instalment Payment Dec.

Solutions Manual .

Interest Expense [($150,000 – $7,500) × 5% × 6/12] ............. Mortgage Payable ........................................... Cash.......................................................

10-23

3,563 7,500 11,063

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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, 2014 June 30, 2015 Dec. 31, 2015

2014

Dec.

(B) Interest Expense (D) × 5% × 6/12

$9,622 9,622 01 31

$3,750 3,603 0 Issue of Mortgage

(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 2015

June

Interest Expense ($150,000 × 5% × 6/12) .............................. Mortgage Payable ........................................... Cash ......................................................

3,750 5,872 9,622

Second Instalment Payment Dec.

(c)

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 ending June 30, 2015 is in 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 changes 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.

Solutions Manual .

10-24

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 10-6 (a) Annual Interest Period July 1, 2014 June 30, 2015 June 30, 2016 (b) (1) (2) (3)

(c)

2014 July 1 Dec. 31 2015 June 30

(A) Cash Payment $4,909 4,909

(B) Interest Expense (D) × 6%

$540 278

(D) Principal Balance (D) – (C) $9,000 4,631 0

$4,369 4,631

Cash ....................................................................... Notes Payable ...............................................

9,000

Interest Expense ($540 × 6/12) .............................. Interest Payable .............................................

270

Interest Expense .................................................... Interest Payable ..................................................... Notes Payable ........................................................ Cash ..............................................................

270 270 4,369

9,000 270

4,909

On December 31, 2015 another accrual for interest expense would be made as follows: Dec. 31

Interest Expense ($278 × 6/12) .............................. Interest Payable .............................................

139 139

After making the above entry the company would have two current liabilities relating to the note as follows: Current liability Interest payable Note payable

Solutions Manual .

$139 4,631

10-25

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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

EXERCISE 10-8 (a)

Current liabilities would likely include: Accounts payable and accrued liabilities Current portion of long-term debt Income taxes payable Provisions Unearned revenue Non-current liabilities would likely include: Deferred income taxes Long-term debt Pension liabilities Depending on when the liability will become due, some items listed above under noncurrent could instead be current. As well, some items listed above as current could be non-current or portions of the balances could be non-current; examples include: Provisions and Unearned Revenue.

Solutions Manual .

10-26

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 10-8 (Continued) (b) SHAW COMMUNICATIONS INC. Statement of Financial Position (partial) August 31, 2012 (in thousands) Current liabilities Accounts payable and accrued liabilities ................................ Provisions ............................................................................... Income taxes payable............................................................. Unearned revenue .................................................................. Current portion of long-term debt ........................................... Total current liabilities ................................................. Non-current liabilities Long-term debt ....................................................................... Deferred income taxes ........................................................... Pension liability ....................................................................... Total liabilities ..................................................................................

Solutions Manual .

10-27

$ 811 27 156 157 451 1,602 4,812 1,085 401 $7,900

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 10-9 ($ in thousands) (a)

Current ratio 2015:

(b)

$6,244 $4,503

= 1.4:1

2014:

$3,798 $2,619

= 1.5:1

(1)

Based only on the current ratio, the Fruition’s liquidity appears to be relatively stable and strong as there are enough 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 merchandise 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 2015: Before: $6,244 $4,503

= 1.4:1

After: $6,244 - $1,000 = 1.5:1 $4,503 - $1,000 Paying off the $1 million improves Fruition’s current ratio from 1.4:1 to 1.5:1. 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. (c)

Having access to an operating line of credit means that cash is available on a shortterm 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. $6,244 + $4,000 $4,503 + $4,000

Solutions Manual .

= 1.2:1

10-28

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 10-10 ($ in thousands) (a) 2011 Debt to total assets =

$97,171 $241,733

Times interest earned =

$11,917 + $3,623 + $3,004 = $3,004

Debt to total assets =

$89,830 $250,755

Times interest earned =

$16,363 + $3,278 + $3,507 = $3,507

40.2%

6.2 times

2012 =

35.8%

6.6 times

Buhler Industries Inc.’s debt to total assets ratio improved in 2012, with a decline from 40.2% to 35.8%. The company’s times interest earned ratio increased from 6.2 times in 2011 to 6.6 times in 2012. This reveals an improvement in solvency. (b) Having access to an operating line of credit means that cash is available on a shortterm basis. Of the total line of credit available in the amount of $60 million, $13 million has been drawn down by the end of the 2012 fiscal year and is therefore included in the total liabilities of $89.83 million. The amount drawn down of $13 million would be shown as bank loan payable in the current liability section of the statement of financial position. It is not shown as non-current liability because it does not have a fixed payment date beyond one year from the end of the current year.

Solutions Manual .

10-29

Chapter 10

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 10-11 (a)

The BC Provincial bonds were issued at a discount.

(b)

The Bank of Montreal bonds were issued at a premium.

(c)

One reason the prices of the two bonds differed is because a bond price is based on the market rate of interest not the coupon rate of interest. Although the market rate of interest is very close in amount for two bonds, the coupon rate of interest for the Bank of Montreal bond is almost double that of BC Provincial. This difference in cash flow from the coupon or contractual interest rate would explain a large portion of the premium recorded on the issuance of the Bank of Montreal bond. Also, investors probably believed there is a different credit risk level for each issuer of the bonds and this could have an effect on the selling prices of the bonds. The lower the amount of risk, the higher will be the premium paid by the investor.

(d)

Cash (0.999 × $100,000) ................................................. Bonds Payable ........................................................

99,900

Cash (1.0897 × $100,000) ............................................... Bonds Payable ........................................................

108,970

99,900

108,970

*EXERCISE 10-12 (a)

2015 1. Oct.

2. Dec. 31

2016 3. Apr.

Cash ............................................................ Bonds Payable ...................................

800,000

Interest Expense ($800,000 × 5% × 3/12) ... Interest Payable .................................

10,000

Interest Expense ($800,000 × 5% × 3/12) ... Interest Payable .......................................... Cash ($800,000 × 5% × 6/12) ............

10,000 10,000

800,000

10,000

20,000

(b) December 31, 2015 Current liabilities Interest payable ....................................................

$ 10,000

Non-current liabilities Bonds payable, due 2025 .....................................

800,000

Solutions Manual .

10-30

Chapter 10

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Financial Accounting, Sixth 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 face value of the bond $1,000,000 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 = 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.

Solutions Manual .

10-31

Chapter 10

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 10-14 (a)

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) = 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

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)

(c)

(d)

Jan. 1

July

Dec. 31

Solutions Manual .

Cash ......................................................................... Bonds Payable .................................................

925,617

Interest Expense ($925,617× 6% × 6/12) ................. Bonds Payable ($27,769 – $25,000) ................ Cash ($1,000,000 × 5% × 6/12) .......................

27,769

Interest Expense [($925,617 + $2,769) × 6% × 6/12] Bonds Payable ($27,852 – $25,000) ................ Interest Payable ($1,000,000 × 5% × 6/12) ......

27,852

10-32

925,617

2,769 25,000

2,852 25,000

Chapter 10

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 10-1A (a)

Mar. 2

10,000

Cash .................................................................... Sales ............................................................ Sales Tax Payable ($40,000 × 13%) ...........

45,200

Cost of Goods Sold .............................................. Merchandise Inventory.................................

24,000

10,000

40,000 5,200

24,000

Property Tax Expense ($18,000 × 3/12) .............. 4,500 Property Tax Payable .................................. 4,500 As we are now in the third month, expense 3 months of property taxes.

Unearned Revenue .............................................. Service Revenue ......................................... Sales Tax Payable ($11,300 ÷ 1.13 × 13%)

11,300

Sales Tax Payable ............................................... Cash ............................................................

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

Salaries Expense.................................................. CPP Payable ............................................... EI Payable ................................................... Income Tax Payable .................................... Cash ............................................................

16,000

Employee Benefits Expense ................................ CPP Payable ............................................... EI Payable ...................................................

1,191

Solutions Manual .

Accounts Payable ................................................ Notes Payable .............................................

10-33

10,000 1,300

5,800

9,318

30,000

792 285 5,870 9,053 792 399

Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-1A (Continued) (b)

Mar. 31

Interest Expense .................................................. Interest Payable .............................................. ($10,000 × 6% × 1/12)

50 50

(c) MOLEGA LTD. Statement of Financial Position (partial) March 31, 2015 Current liabilities Accounts payable ($42,500 – $10,000 – $30,000) ............ Notes payable.................................................................... Unearned revenue ($15,000 – $7,500).............................. Income tax payable ($5,515 – $5,515 + $5,870) ............... Property tax payable .......................................................... Sales tax payable ($5,800 + $5,200 - $5,800) ................... CPP payable ($2,680 – $2,680 + $792 + $792) ................ EI payable ($1,123 – $1,123 + $285 + $399) .................... Interest payable ................................................................. Total current liabilities ................................................

Solutions Manual .

10-34

$ 2,500 10,000 7,500 5,870 4,500 5,200 1,584 684 50 $37,888

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 10-2A (a)

Sept.

Oct.

Nov.

Dec.

Solutions Manual .

Merchandise Inventory ......................................... Accounts Payable ........................................

15,000

Bank Loan Payable............................................... Interest Expense ($12,000 × 6% × 3/12) .............. Cash ............................................................

12,000 180

Accounts Payable ................................................. Notes Payable .............................................

15,000

Buildings ............................................................... Bank Loan Payable......................................

25,000

Interest Expense ($15,000 × 7% × 1/12) .............. Cash ............................................................

Interest Expense ($25,000 × 8% × 1/12) .............. Cash ............................................................

167

Interest Expense ($15,000 × 7% × 1/12) .............. Cash ............................................................

Interest Expense ($25,000 × 8% × 1/12) .............. Cash ............................................................

167

Vehicles ................................................................ Bank Loan Payable ...................................... Cash ............................................................

28,000

Interest Expense ($88* + $167** + $117***) ......... Interest Payable ........................................... * $15,000 × 7% × 1/12 = $88 ** $25,000 × 8% × 1/12 = $167 *** $20,000 × 7% × 1/12 = $117

372

10-35

15,000

12,180

15,000

25,000

167

20,000 8,000

372

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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.

Sept. 30

Interest Expense 0 180 88 167 88 167 372 1,062 Interest Payable Sept. 1 Bal. Dec. 31 Dec. 31Bal.

0 372 372

Notes Payable Sept. 1 Bal. Sept. 30 Dec. 31Bal.

0 15,000 15,000

Bank Loan Payable Sept. 1 Bal. 12,000 Oct. 2 Dec. 2 Dec. 31Bal.

12,000 25,000 20,000 45,000

(c) CLING-ON LTD. Income Statement (partial) Year Ended December 31, 2015 Other revenues and expenses Interest expense .........................................................................$1,062 (d) CLING-ON LTD. Statement of Financial Position (partial) December 31, 2015 Current liabilities Bank loan payable ................................................................................ Notes payable ...................................................................................... Interest payable ....................................................................................

Solutions Manual .

10-36

$45,000 15,000 372

Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-3A (a)

Table not required but source for detailed calculations

Quarterly Interest Period

Cash Payment

Interest Expense 8% × 3/12

Reduction of Principal

Sept. 30, 2014

(c)

$1,000,000

Dec. 31, 2014

$103,333

$20,000

$83,333

916,667

Mar. 31, 2015

101,666

18,333

83,333

833,334

June 30, 2015

100,000

16,667

83,333

750,001

2014 Sept. 30

(b)

Principal Balance

2014 Nov. 30

2014 Dec. 31

2015 Mar. 31

Solutions Manual .

Equipment............................................................... Cash .............................................................. Bank Loan Payable ........................................

1,100,000

Interest Expense ($20,000 × 2/3)............................ Interest payable .............................................

13,333

Interest Payable ...................................................... Interest Expense ..................................................... Bank Loan Payable ................................................. Cash ..............................................................

13,333 6,667 83,333

Interest Expense ..................................................... Bank Loan Payable ................................................. Cash ..............................................................

18,333 83,333

10-37

100,000 1,000,000

13,333

103,333

101,666

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 10-3A (Continued) (d)

Table not required but source for detailed calculations

Quarterly Interest Period

Cash Payment

Interest Expense 8% × 3/12

Reduction of Principal

Sept. 30, 2014

Principal Balance $1,000,000

Dec. 31, 2014

$94,560

$20,000

$74,560

925,440

Mar. 31, 2015

94,560

18,509

76,051

849,389

June 30, 2015

94,560

16,988

77,572

771,817

2014 Nov. 30

Dec. 31

2015 Mar. 31

Solutions Manual .

Interest Expense ..................................................... Interest Payable .............................................

13,333

Interest Expense ..................................................... Interest Payable ...................................................... Bank Loan Payable ................................................. Cash ..............................................................

6,667 13,333 74,560

18,509 76,051

10-38

13,333

94,560

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 10-4A (a)

(b)

(c)

Semi-annual Interest Period

Cash Payment

Interest Expense 6.5% × 6/12

June 30, 2014 Dec. 31, 2014 June 30, 2015 Dec. 31, 2015 June 30, 2016

$48,145 48,145 48,145 48,145

$22,750 021,925 021,073 020,193

2014 June 30 2014 Dec. 31

2015 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

021,925 26,220

700,000

48,145

(d) STARLIGHT GRAPHICS LTD. Statement of Financial Position (Partial) June 30, 2015 Current liabilities Current portion of mortgage payable ...............................

$ 55,024*

Non-current liabilities Mortgage payable ............................................................

0593,361

*($27,072 + $27,952) = $55,024

Solutions Manual .

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Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 10-5A (a)

Period

(A)

(B)

(C)

Cash

Interest

Principal

(D)

Payment

Expense

Reduction

Balance

(B) + (C)

(D) × 12% × 3/12

$100,000 ÷ 12

(D) – (C)

Apr. 30, 2015

$100,000

July 31, 2015

$11,333

$3,000

$8,333

91,667

Oct. 31, 2015

11,083

2,750

8,333

83,334

Jan. 31, 2016

10,833

2,500

8,333

75,001

Apr. 30, 2016

10,583

2,250

8,333

66,668

July 31, 2016

10,333

2,000

8,333

58,335

Oct. 31, 2016

10,083

1,750

8,333

50,002

Jan. 31, 2017

9,833

1,500

8,333

41,669

Apr. 30, 2017

9,583

1,250

8,333

33,336

July 31, 2017

9,333

1,000

8,333

25,003

Oct. 31, 2017

9,083

750

8,333

16,670

Jan. 31, 2018

8,833

500

8,333

8,337

Apr. 30, 2018

8,583

250

8,333

$19,500

$100,000

Total (b) 2015 Apr.

Cash .......................................................... Notes Payable ...................................

100,000

Notes Payable ........................................... Interest Expense........................................ Cash ..................................................

8,333 3,000

Notes Payable ........................................... Interest Expense........................................ Cash ..................................................

8,333 2,750

100,000

Oct.

Solutions Manual .

10-40

11,333

11,083

Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-5A (Continued) (d) FURLONG SAILING SCHOOL Statement of Financial Position (Partial) October 31, 2015 Current liabilities Current portion of 12% notes payable ..................

$33,332*

Non-current liabilities Notes payable, 12%, due in 2018 ($83,334 – $33,332) ................................... Total liabilities

50,002 $83,334

*$8,333 × 4 = $33,332

Solutions Manual .

10-41

Chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 10-5A (Continued) (e)

Had the repayment of the note been 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) × 12% × 3/12

(A) – (B)

(D) – (C)

Apr. 30, 2015

$100,000

July 31, 2015

$10,046

$ 3,000

$7,046

92,954

Oct. 31, 2015

10,046

2,789

7,257

85,697

Jan. 31, 2016

10,046

2,571

7,475

78,222

Apr. 30, 2016

10,046

2,347

7,699

70,523

July 31, 2016

10,046

2,116

7,930

62,593

Oct. 31, 2016

10,046

1,878

8,168

54,425

Jan. 31, 2017

10,046

1,633

8,413

46,012

Apr. 30, 2017

10,046

1,380

8,666

37,346

July 31, 2017

10,046

1,120

8,926

28,420

Oct. 31, 2017

10,046

853

9,193

19,227

Jan. 31, 2018

10,046

577

9,469

9,758

Apr. 30, 2018

10,046

288 *

9,758

$20,552

$100,000

Total * Adjusted for rounding of $5

Interest expense would only be the same on October 31, 2015. After the first payment, the principal reduction would be lower under the blended payment method for both the July 31 and October 31 payments. Correspondingly, the total interest expense over the term of the note will be higher by $1,052 ($20,552 – $19,500) 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.

Solutions Manual .

10-42

Chapter 10

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Financial Accounting, Sixth 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 [($6,000 × 3/5 days) – $297 – $107 – $1,300] CPP payable ($297 + employer share $297) EI payable ($107 + employer share $150 (1.4 × $107) Income tax payable

1,896

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)

594 257 1,300 0 5,000

30,000 220,000

10. Not on the financial statements as not drawn on

Solutions Manual .

10-43

Chapter 10

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Financial Accounting, Sixth 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.

Solutions Manual .

10-44

Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-7A (a)

(in USD millions) 1. Current ratio

2012 $9,135 = 1.4:1 $6,684

2. Receivables turnover

$30,837 $4,774 + $4,398 2

3. Inventory turnover

$27,010 $2,512 + $2,045 2

4. Debt to total assets

2011

= 6.7 times

= 11.9 times

$7,651 = 44.7% $17,109

5. Times Interest earned $1,433+$16+$324 = 111 times $16

Solutions Manual .

10-45

$8,146 = 1.4:1 $5,724

$28,748 $4,398 + $3,543 2

$25,434 $2,045 + $1,822 2

= 7.2 times

= 13.2 times

$6,477 = 44.1% $14,679

$1,018+$0+$202 $0

= NA

Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-7A (Continued) (b)

Magna’s current ratio has remained the same at 1.4:1. The receivables turnover ratio deteriorated from 7.2 times in 2011 to 6.7 times in 2012. The inventory turnover deteriorated as well from 13.2 times in 2011 to 11.9 times in 2012. This means that Magna is collecting its receivables and moving its inventory more slowly in 2012 than in 2011. Despite the deterioration in these liquidity ratios, the current ratio remained the same because the company offset the declining receivables and inventory turnover with an increase in cash. Magna’s 2012 liquidity ratios are slightly worse than the industry averages, but still quite healthy. During 2012, Magna’s debt to total assets ratio deteriorated slightly from 44.1% in 2011 to 44.7% in 2012. The company’s times interest earned ratio deteriorated because it had no interest expense in 2011 but had a modest amount of interest expense in 2012. In comparison to the industry average, Magna is carrying more debt compared to total assets, but its times interest earned ratio is significantly higher. This indicates that even though the company is using more debt than the average firm in the industry the company appears to be earning more than enough profit 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 Magna’s solvency in 2012.

(c)

Magna has secured a line of credit which helps it through short-term liquidity problems during its operating cycle. The fact that it has not used any of the $2.25 billion line of credit as of the end of 2012 demonstrates that it is not in great need of cash to meet its obligations. Magna is ready to take advantage of opportunities that may come up in the future that would require significant amounts of cash. As for the decline in the currencies from Brazil and China against the U.S. dollar, these changes provide an advantage to Magna as it will take fewer U.S. dollars to satisfy the debt owing in the future. Balances for any foreign debt would be reported at exchange rates as of the date on the statement of financial position.

(d)

When assessing Magna’s liquidity and solvency it is necessary to look at operating lease commitments which 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 a company’s liquidity and solvency.

Solutions Manual .

10-46

Chapter 10

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Financial Accounting, Sixth 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 PetroZoom 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 Petro-Zoom’s debt to total assets ratio is marginally higher (worse) than Sun-Oil’s ratio, indicating that PetroZoom has a higher percent of its assets financed by debt. Sun-Oil also appears to be in a better position to repay 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 leaves little doubt that 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 profit to cover interest payments so I would not be significantly concerned about the solvency of either company.

Solutions Manual .

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Chapter 10

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 10-9A (a) Able Limited – issued at par or 100 with coupon rate 6%: 2015 Jan. 1 Cash .................................................................... Bonds Payable ............................................ (b) Dec. 31 Interest Expense ($100,000 × 6%) ....................... Cash ............................................................ (a) Beta Corp. – issued at a discount price 94 with coupon rate 4%: 2015 Jan. 1 Cash ($100,000 × .94) ......................................... Bonds Payable ............................................ (b) Dec. 31 Interest Expense ($94,000 × 6%) ......................... Bonds Payable ($5,640 – $4,000) ............... Cash ($100,000 × 4%) ................................

100,000 100,000 6,000 6,000

94,000 94,000 5,640

(a) Charles Inc. – issued at a premium price 105 with coupon rate 7%: 2015 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%) ................................ (c)

1,640 4,000

105,000

7,000

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 amount that will be paid at the maturity of the bond of $100,000 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 what Charles received which is $105,000 and the amount that will be paid at the maturity of the bond of $100,000 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.

Solutions Manual .

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Chapter 10

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 10-9A (Continued) (d)

Balance in Bonds Payable account December 31, 2015: Able Limited: Bond issue January 1, 2015 No premium or discount Dec. 31, 2015

$100,000 $100,000

Beta Corp: Bond issue January 1, 2015 Plus amortization of bond discount Balance Dec. 31, 2015

$94,000 1,640 $95,640

Charles Inc.: Bond issue January 1, 2015 Less amortization of bond premium Balance Dec. 31, 2015

$107,000 700 $106,300

Solutions Manual .

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Chapter 10

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 10-10A (a)

Key inputs:

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 is used to determine the present value. When using a calculator, students will likely determine the first amount above to be $1,611,581. (b)

GLOBAL SATELLITES CORPORATION Bond Premium Amortization

Semiannual Interest Periods

July 1/14 Jan. 1/15 July 1/15 Jan. 1/16 July 1/16

Solutions Manual .

(A) Interest to Be Paid (7% × 6/12 = 3.5%)

$52,500 52,500 52,500 52,500

(B) Interest Expense to Be Recorded (6% × 6/12 = 3%)

$48,348 48,223 48,095 47,963

(D) Unamortized Premium (D) – (C)

(E) Bond Carrying Amount ($1,500,000 + D)

$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

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Chapter 10

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 10-10A (Continued)

(c)

July

2014 Cash ........................................................... Bonds Payable ...................................

1,611,587 1,611,587

Note: Interest would also be recorded January 1, 2015 and July 1, 2015 (not illustrated here)

(d)

Dec. 31

2015 Interest Expense ....................................... Bonds Payable .......................................... Interest Payable ...............................

48,095 4,405 52,500

(e) GLOBAL SATELLITES CORPORATION Statement of Financial Position (Partial) December 31, 2015 Current liabilities Interest payable

Non-current liabilities Bonds payable, due 2024

(f)

Jan.

Solutions Manual .

52,500

1,598,753

2016 Interest Payable ........................................ Cash .................................................

10-51

52,500 52,500

Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-1B (a)

Jan.

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 ..............................................................

7,500

Sales Tax Payable.................................................. Cash ..............................................................

10,500

CPP Payable ($1,905 + $1,905) ............................. EI Payable ($666 + $932) ....................................... Income Tax Payable ............................................... Cash ..............................................................

3,810 1,598 7,700

Cash ...................................................................... Bank Loan Payable ......................................

18,000

20,000 2,400

14,000

7,500

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 ..............................................................

32,000

Property Tax Expense ($4,200 ÷ 12) ...................... Property Tax Payable ....................................

350

Salaries Expense.................................................... CPP Payable ................................................. EI Payable ..................................................... Income Tax Payable ...................................... Cash ..............................................................

40,000

Employee Benefits Expense ................................... CPP Payable ................................................. EI Payable .....................................................

2,977

10-52

10,000 1,200

32,000

350

1,980 712 9,474 27,834

1,980 997

Chapter 10

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Financial Accounting, Sixth 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, 2015 Liabilities Current liabilities Accounts payable ($52,000 – $32,000) .................................................. Bank loan payable .................................................................................. Unearned revenue ($16,000 – $7,000) ................................................... 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 + $712 + $997) .......................................... Sales tax payable ($18,000 – $7,500 – $10,500 + $2,400)..................... Property tax payable ............................................................................... Interest payable ...................................................................................... Total current liabilities ........................................................................

Solutions Manual .

10-53

$20,000 18,000 9,000 9,474 3,960 1,709 2,400 350 45 $64,938

Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-2B (a)

Mar.

Apr.

May

June

Solutions Manual .

Equipment ............................................................ Bank Loan Payable......................................

16,000

Notes Payable ...................................................... Interest Expense ($30,000 × 7% × 6/12) .............. Cash ............................................................

30,000 1,050

Land ..................................................................... Notes Payable .............................................

50,000

Interest Expense ($50,000 × 6% × 1/12) .............. Cash ............................................................

250

Cash ..................................................................... Bank Loan Payable......................................

36,000

Interest Expense ($50,000 × 6% × 1/12) .............. Cash ............................................................

250

Bank Loan Payable............................................... Interest Expense ($16,000 × 8% × 3/12) .............. Cash ............................................................

16,000 320

Equipment ............................................................ Cash ............................................................ Bank Loan Payable......................................

10,000

Interest Expense ($250 + $420*) .......................... Interest Payable ........................................... (*$36,000 × 7% × 2/12 = $420)

670

10-54

16,000

31,050

50,000

250

36,000

250

16,320

1,000 9,000

670

Chapter 10

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Financial Accounting, Sixth 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 1,050 250 250 320 670 2,540 Interest Payable Mar. 1 Bal. June 30 June 30 Bal.

0 670 670

Notes Payable Mar. 31 30,000 Mar. 1 Bal. April 1 June 30 Bal.

30,000 50,000 50,000

Bank Loan Payable Mar. 1 Bal. Mar. 2 May 1 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, 2015 Other revenues and expenses Interest expense ...................................................................................

$2,540

(d) SPARKY’S MOUNTAIN BIKES LTD. Statement of Financial Position (partial) June 30, 2015 Current liabilities Bank loan payable ................................................................................ Notes payable ...................................................................................... Interest payable .................................................................................... Solutions Manual .

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$45,000 50,000 670 Chapter 10

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-3B (a) July

(b)

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. 31/15 Sept. 30/15 Oct. 31/15 Nov. 30/15 Dec. 31/15 Jan. 31/16 Feb. 29/16 Mar. 31/16 Apr. 30/16 May 31/16 June 30/16 July 31/16 Aug. 31/16 Sept. 30/16

Aug. 31

Sept. 30

Solutions Manual .

(A) Cash Payment

(B) Interest Expense (D) × 6% × 1/12

$16,440 16,440 16,440 16,440 16,440 16,440 16,440 16,440 16,440 16,440 16,440 16,440 16,440 16,440

$3,500 3,435 3,370 3,305 3,239 3,173 3,107 3,040 2,973 2,906 2,838 2,770 2,702 2,633

$12,940 13,005 13,070 13,135 13,201 13,267 13,333 13,400 13,467 13,534 13,602 13,670 13,738 13,807

Interest Expense ($700,000 × 6% × 1/12) ......... Bank Loan Payable ($16,440 – $3,500) ............ Cash ......................................................... Interest Expense [($700,000 – $12,940) × 6% × 1/12] .................. Bank Loan Payable ($16,440 – $3,435) ............ Cash .........................................................

10-56

(D) Principal Balance (D) – (C) $700,000 687,060 674,055 660,985 647,850 634,649 621,382 608,049 594,649 581,182 567,648 554,046 540,376 526,638 512,831

3,500 12,940 16,440

3,435 13,005 16,440

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Financial Accounting, Sixth 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. 31/15 Sept. 30/15 Oct. 31/15 Nov. 30/15 Dec. 31/15 Jan. 31/16 Feb. 29/16 Mar. 31/16 Apr. 30/16 May 31/16 June 30/16 July 31/16 Aug. 31/16 Sept. 30/16

Aug.

Sept.

Solutions Manual .

(A) Cash Payment (B) + (C)

(B) Interest Expense (D) × 6% × 1/12

$18,083 18,010 17,937 17,864 17,791 17,718 17,646 17,573 17,500 17,427 17,354 17,281 17,208 17,135

$3,500 3,427 3,354 3,281 3,208 3,135 3,063 2,990 2,917 2,844 2,771 2,698 2,625 2,552

$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 × 6% × 1/12) ............ Bank Loan Payable .............................................. Cash ($3,500 + $14,583) .......................... Interest Expense [($700,000 – $14,583) × 6% × 1/12] ..................... Bank Loan Payable .............................................. Cash .........................................................

10-57

(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

3,500 14,583 18,083

3,427 14,583 18,010

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-4B (a)

Semi-annual Interest Period Dec. 31, 2014 June 30, 2015 Dec. 31, 2015 June 30, 2016 Dec. 31, 2016

(b)

(c)

2014 Dec. 31

2015 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

40,000 50,000

38,000 50,000

1,000,000

90,000

088,000

BEAUMONT BUILDING SUPPLIES LIMITED Statement of Financial Position (Partial) December 31, 2015

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, 2016 balance.

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PROBLEM 10-5B

Period

(B)

(C)

(A)

Interest

Principal

(D)

Cash

Expense

Reduction

Balance

Payment

(D) × 13%

(A) – (B)

(D) – (C)

April 1, 2013

$100,000

March 31, 2014

$ 33,619

$13,000

$ 20,619

79,381

March 31, 2015

33,619

10,320

23,299

56,082

March 31, 2016

33,619

7,291

26,328

29,754

March 31, 2017

33,619

*3,865

29,754

Total $134,476 * adjusted for rounding error

$34,476

$100,000

(b) April 1/13

Cash ................................................... Loan Payable ..............................

100,000

Loan Payable ...................................... Interest Expense.................................. Cash ............................................

20,619 13,000

Loan Payable ...................................... Interest Expense.................................. Cash ............................................

23,299 10,320

100,000

March 31/15

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-5B (Continued) (d)

SKI HILL Statement of Financial Position (Partial) March 31, 2015

Liabilities

(e)

Current liabilities Current portion of 13% loan payable

$26,328

Non-current liabilities Loan payable, 13%, due in 2017 ($56,082 – $26,328)

29,754

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) × 13%

($100,000 ÷ 4)

(D) – (C)

April 1, 2013

$100,000

March 31, 2014

$ 38,000

$13,000

$ 25,000

75,000

March 31, 2015

34,750

9,750

25,000

50,000

March 31, 2016

31,500

6,500

25,000

March 31, 2017

28,250

3,250

25,000

$132,500

$32,500

$100,000

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.

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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 [($10,000 × 4/5 days) – $495 – $178 – $3,710] CPP payable ($495 + employer share $495) EI payable [$178 + employer share $249 (1.4 × $178)] Income tax payable

3,617

990 427 3,710

7. Contingent liability

Not on statement of financial position

8. Current liabilities

Income tax payable ($80,000 − $55,000)

25,000

9. Current liabilities Non-current liabilities

Debt due within one year Non-current debt ($150,000 – $15,000)

15,000 135,000

10. Not a liability as line has not been drawn on

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PROBLEM 10-6B (Continued) (b)

The notes should disclose information on the bank loan payable, including the interest rate and repayment term. 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.

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PROBLEM 10-7B

(a)

(in USD millions)

2012

2011

1. Current ratio

$5,863 $4,415

2. Receivables turnover

$14,547 $449 + $426 2

3. Inventory turnover

$7,654 $2,695 + $2,498 2

4. Debt to total assets

$22,774 $47,282

= 48.2%

$23,330 $48,884

5. Times interest earned

$(677)+$(236)+$177 $177

= N/A

$4,537+$2,287+$199 $199

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= 1.3:1

= 33.3 times

= 2.9 times

10-63

$6,545 $2,911

$14,236 $426 + $370 2

$6,240 $2,498 + $1,798 2

= 2.2:1

= 35.8 times

= 2.9 times

= 47.7%

= 35.3 times

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Financial Accounting, Sixth Canadian Edition

PROBLEM 10-7B (Continued) (b)

During the year Barrick’s liquidity has deteriorated. It has a lower current ratio (1.3:1 in 2012 compared to 2.2:1 in 2011). The company’s receivables are being collected more slowly as evidenced by the receivables turnover ratio which decreased from 35.8 times in 2011 to 33.3 times in 2012, but inventory turnover remains the same each year. When compared to the industry average, Barrick has a much lower current ratio and inventory turnover ratio, but its receivables turnover ratio is significantly ahead of the industry average. In 2012, the company’s solvency deteriorated because the company was not profitable that year. The debt to total assets ratio worsened from 47.7% in 2011 to 48.2% in 2012. This ratio remains significantly higher (worse) than other companies in the industry as the industry average is only 20.6%. Barrick showed a strong times interest earned ratio of 35.3 times in 2011 which was almost double that of its industry peers for that year, but one year later the company was unable to cover its interest due to a loss that year.

(c)

In providing disclosure of the extent of any contingent liabilities stemming from pending litigation, Barrick is providing additional information which is otherwise not available from the numeric portion of the financial statements. Notes describing the potential for losses that could be incurred in the future through the settlement of outstanding litigation give the users of the financial statements insight into the potential for cash outflows in the future. These potential outflows could negatively affect profits and the cash position of the business and, as a result, have a negative impact on Barrick’s solvency. Although it is not unusual for a public company to have several legal cases pending at any one time, due to the potentially adverse effect of settlements, this information is worthy of scrutiny by the users of the financial statements.

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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.

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PROBLEM 10-5B *PROBLEM 10-9B (a) Delta Limited – issued at par or 100 with coupon rate 5%: 2015 Jan. 1 Cash .................................................................... Bonds Payable ............................................ (b) Dec. 31 Interest Expense ($200,000 × 5%) ....................... Cash ............................................................

200,000 200,000 10,000 10,000

(a) Founders Corp. – issued at a discount price 94 with coupon rate 3%: 2015 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%) ................................

188,000

(a) Grand Inc. – issued at a premium price 108 with coupon rate 7%: 2015 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%) ................................

216,000

(c)

3,400 6,000

14,000

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 amount that will be paid at the maturity of the bond of $200,000 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 what Grand received which is $216,000 and the amount that will be paid at the maturity of the bond of $200,000 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.

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*PROBLEM 10-9B (Continued) (d)

Balance in Bonds Payable account December 31, 2015: Delta Limited: Bond issue January 1, 2015 No premium or discount Dec. 31, 2015

$200,000 $200,000

Founders Corp: Bond issue January 1, 2015 Plus amortization of bond discount Balance Dec. 31, 2015

$188,000 3,400 $191,400

Grand Inc.: Bond issue January 1, 2015 Less amortization of bond premium Balance Dec. 31, 2015

$216,000 3,200 $212,800

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PROBLEM 10-5B *PROBLEM 10-10B (a)

Key inputs:

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

(b)

Semiannual Interest Periods July 1/14 Jan.1/15 July 1/15 Jan.1/16

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PONASIS CORPORATION Bond Discount Amortization

(A) Interest to Be Paid (6% × 6/12 = 3%)

(B) Interest Expense (7% × 6/12 = 3.5%)

$30,000 30,000 30,000

$32,513 32,601 32,692

$2,513 2,601 2,692

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(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

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 10-10B (Continued) (c) July

2014 Cash ........................................................... Bonds Payable ...................................

928,942 928,942

Note: Interest would also be recorded January 1, 2014 and July 1, 2014 (not illustrated here)

(d)

Dec. 31

2015 Interest Expense ....................................... Bonds Payable ................................. Interest Payable ...............................

32,692 2,692 30,000

(e) PONASIS CORPORATION Statement of Financial Position (Partial) December 31, 2015 Liabilities

(f)

Current Liabilities Interest payable ...........................................................................

$ 30,000

Non-current liabilities Bonds payable, due 2024 ........................................................... Total liabilities .....................................................................

936,748 $966,748

2016 Interest Payable ........................................ Cash .................................................

30,000

Jan.

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Financial Accounting, Sixth Canadian Edition

BYP 10-1 FINANCIAL REPORTING (a)

Shoppers Drug Mart shows the following current and non-current liabilities on its consolidated balance sheet at December 29, 2012: Current liabilities: Bank indebtedness Commercial paper Accounts payable and accrued liabilities Income taxes payable Dividends payable Current portion of long-term debt Provisions Associate interest Non-current liabilities Long-term debt Other long-term liabilities Provisions Deferred tax liabilities

(b)

The bank indebtedness that appears on Shopper’s balance sheet does not necessarily represent a bank account with a negative balance that can be offset or paid off with a bank account balance with a positive balance at the same financial institution. The bank indebtedness in this case consists primarily of lines of credit drawn on by various stores. Although the cash balance appearing on the balance sheet seems available immediately for paying off the bank indebtedness, it is very likely that immediate cash demands require that a substantial balance of cash be in place to make quick payments, for example to take advantage of a purchase discount.

(c)

Commercial paper is a very liquid means of obtaining financing for Shoppers when cash is needed. The use of this type of debt is very flexible and for very short periods of time (90 days) allowing Shoppers to find more permanent sources of financing if it is deemed necessary and appropriate. Because the interest rate on commercial paper is floating, the risk to Shoppers is reduced as it is not committed to any particular interest rate for a long period of time.

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BYP 10-2 COMPARATIVE ANALYSIS (a) in millions 1. Current ratio

2. Receivables turnover

3. Inventory turnover

4. Debt to total assets

5. Times interest earned

Shoppers $2,765.0 $2,334.9

Jean Coutu

= 1.2:1

$421.9 $265.3

= 22.4 times $10,781.8 $469.7 + $493.3 2

$2,468.0 $199.6 + $206.5 2

$6,609.2 = 3.2 times $2,148.5 + 2,042.3 2

$2,169.0 $190.1 + $166.2 2

$3,150.4 $7,473.7

= 42.2%

$608.5 + $214.8 + $57.6 = 15.3 times $57.6

$281.9 $1,392.7

= 1.6:1

= 12.2 times

= 20.2%

$558.4 + $78.9 + $2.0 = 320 times $2.0

(b) Liquidity: Comparing the ratios related to liquidity, Jean Coutu on an overall basis is more liquid than Shoppers and their industry with the exception of receivables turnover. Its current ratio is excellent. While its receivables turnover ratio is not as strong as either that of Shoppers or the industry, its inventory turnover ratio is far superior, at 12.2 times (30 days).

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BYP10-2 (Continued) (b)

(Continued) 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. Shoppers’ debt to total assets ratio of 42.2% is higher (worse) than that of the industry average of 30.6% and more than double that of Jean Coutu. However, it is well able to handle this level of debt, as evidenced by its high times interest earned ratio of 15.3 which is well in excess of the industry average of 6.5 times. The times interest earned ratio provides an indication of a company’s ability to meet interest payments. Jean Coutu’s debt to total assets is low at 20.2% which means that it is primarily financed by equity. Its times interest earned ratio is consequently extremely high.

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BYP 10-3 COMPARING IFRS AND ASPE (a)

Two key ratios that Matthew could use to assess Fly Fast’s solvency in comparison to that of East Jet are the debt to total asset ratios and the times interest earned ratio. The following is a summary of the results of these two ratios for each of the two companies. ($ in thousands) Total debt to assets

Times interest earned

East Jet ($832,172 + $1,222,993) ÷ ($1,268,710 + $ 2,294,134) = 57.7%

Fly Fast ($120,000 + $270,000) ÷ ($317,178 + $573,533) = 43.8%

($136,720 + $59,947 + $60,164) ÷ $60,164 = 4.3 times

($34,180 + $14,986 + $9,876) ÷ $9,876 = 6.0 times

Fly Fast appears to be less burdened with debt as compared to East Jet. Only 43.8% of its assets are leveraged compared to 57.7% for East Jet. The times interest earned ratio is also better, at 6.0 times compared to 4.3 for East Jet. This implies that Fly Fast is the more solvent of the two companies and in a better position to pay its interest payments. (b)

The main difference between IFRS and ASPE is that with IFRS there is increased likelihood that a liability will be recognized on the statement of financial position. The requirement for recognition of a provision is “more likely than not” for IFRS rather than “likely” under ASPE. Specifically, ASPE indicates that a contingent liability should be recognized when the chance of occurrence is higher than under IFRS, where a provision should be recognized when the chance of occurrence is greater than 50%. This difference could cause East Jet to recognize liabilities that Fast Fly did not recognize. Matthew could also review the notes to the financial statements to identify any contingencies that did not meet recognition criteria but only the disclosure criteria under ASPE.

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BYP 10-4 CRITICAL THINKING 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. Current Assets: Cash Accounts receivable Merchandise inventory

2015 2,000 20,000 30,000 52,000

2014 $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)

Profit before taxes and interest (1) $100,000 – $50,000 – $26,000 (2) $50,000 – $20,000 – $10,000

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Average $6,000 12,500 18,750 37,250

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BYP10-4 (Continued) Please note that when calculating turnover ratios, amounts from the current and prior year statement of financial position are averaged. However, if the prior year amount is not available, we use the current year amount only. 2015

in thousands

2014

1. Current ratio

$52,000 $30,930

2. Receivables turnover

$100,000 $12,500

3. Inventory turnover

$50,000 $18,750

= 2.7 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

= 1.7:1

= 8.0 times

= 10.0 times

$22,500 $16,550

$50,000 $5,000

$20,000 $1,500

= 1.4:1

= 10.0 times

= 13.3 times

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 2015 but this was due to the high levels of accounts receivable and inventory. The receivable turnover has deteriorated substantially from 10 times in 2014 to only 8 times in 2015. Fortunately, the inventory turnover has remained unchanged at 2.7 times for both years. Atlas needs to improve its collection of receivables. Furthermore, Jim needs to keep in mind that some cash has been retained by negotiating an interest only loan that will end in 2017. 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 2014 to 10 times in 2015 indicating less 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.

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BYP10-4 (Continued) 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 2015 compared to 40% of sales in 2014. 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 which have decreased profitability will concern the banker. A final area of concern from the point of view of 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.

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BYP 10-5 ETHICS CASE (a)

The stakeholders in this situation include: Shareholders Lenders 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)

While management does have a choice of structuring a lease agreement as an operating or finance lease, it is unethical on the part of management to deliberately structure a transaction for the sole purpose of keeping debt off the financial statements. This 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.

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BYP 10-6 “ALL ABOUT YOU” ACTIVITY (a)

Most student loan programs require repayment and begin charging interest as soon as the student has finished school. The options offered by the Canada Student Loan Program are: • Start making interest payments as soon as the student finishes school • Add the amount of interest for the first six month grace period to the loan principal and make regular loan payments • Pay six months of interest as a lump sum before making regular loan payments The length of time to repay the loan can vary up to 114 months (if you take advantage of the grace period) or up to 120 months if you don’t. You can also choose a shorter repayment period. One can also request an extension to 174 months (with grace period) or 180 months (without grace period).

(b)

The answer will depend on the prime rate. This solution uses a prime rate of 3%. With a fixed rate the monthly loan payments are:

Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum (c)

Monthly Payment $303.32

# of Months 120

Note

$326.33

114

$313.78

114

Interest of $1,000 added to loan Lump sum of $1,000 to be paid

The answer will depend on the prime rate. This solution uses a prime rate of 3%. With a floating rate the monthly loan payments are:

Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum

Solutions Manual .

Monthly Payment $271.32

# of Months 120

Note

$289.80

114

$282.05

114

Interest of $687.50 added to loan Lump sum of $687.50 to be paid

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BYP10-6 (Continued) (d)

For a loan to be repaid in five years (60 months) the monthly repayment options are:

(1) Fixed Rate: Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum

Monthly Payment $506.91

# of Months 60

Note

$574.92

$552.81

Interest of $1,000 added to loan Lump sum of $1,000 to be paid

(2) Floating Rate: Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum

Monthly Payment $477.53

# of Months 60

Note

$538.07

$523.67

Interest of $687.50 added to loan Lump sum of $687.50 to be paid

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BYP 10-7 SERIAL CASE

(a)

The balance of the mortgage payable at November 25, 2015 is $46,718 as calculated below.

Monthly Interest Period June July Aug. Sept. Oct. Nov.

(b)

25, 2015 25, 2015 25, 2015 25, 2015 25, 2015 25, 2015

(A)

(B) Interest Expense

Cash Payment

(D) × 5% × 1/12

Balance $667 667 667 667 667

$204 202 201 199 197

(D) Principal Balance (D) – (C)

$463 465 466 468 470

$49,050 48,587 48,122 47,656 47,188 46,718

The balance of the mortgage payable at November 25, 2015 of $46,718 will increase by $25,000 to a total of $71,718 after the mortgage is renegotiated. Nov. 26, 2015

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Bank Indebtedness ...................................... Mortgage Payable................................

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25,000 25,000

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BYP10-7 (Continued) (c)

Monthly Interest Period

(A)

(B) Interest Expense

Cash Payment

(D) × 4% × 1/12

(D) Principal Balance (D) – (C)

Nov. Dec. Jan. Feb. Mar. Apr. May June July

25, 2015 25, 2015 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016

Balance $1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320

$239 235 232 228 225 221 217 214

$1,081 1,085 1,088 1,092 1,095 1,099 1,103 1,106

$71,718 70,637 69,552 68,464 67,372 66,277 65,178 64,075 62,969

Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.

25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2017 25, 2017 25, 2017 25, 2017

1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320

210 206 202 199 195 191 188 184 180

1,110 1,114 1,118 1,121 1,125 1,129 1,132 1,136 1,140

61,859 60,745 59,627 58,506 57,381 56,252 55,120 53,984 52,844

May June

25, 2017 25, 2017

1,320 1,320

176 172

1,144 1,148

51,700 50,552

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BYP10-7 (Continued) (d) First Instalment Payment 2015

Dec. 25

Interest Expense ............................................. Mortgage Payable ........................................... Cash ......................................................

239 1,081 1,320

Second Instalment Payment 2016

Jan. 25

Interest Expense ............................................. Mortgage Payable ........................................... Cash.......................................................

235 1,085 1,320

(e) KOEBEL’S FAMILY BAKERY Statement of Financial Position (Partial) June 30, 2016

Liabilities Current liabilities Current portion of 4% mortgage payable ($64,075 – $50,552) Non-current liabilities Mortgage payable, 4%, due in 2020

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CHAPTER 11 Reporting and Analyzing Shareholders’ Equity ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

A Problems

B Problems

BYP

1. Identify and discuss the major characteristics of a corporation.

1, 2, 3, 4, 5 1

2. Record share transactions.

6, 7, 8, 9, 10

2, 3, 4

2, 3, 4, 5, 7 1A, 2A, 3A, 1B, 2B, 1, 3, 4, 4A, 5A 3B, 4B, 5B 7

3. Prepare the entries for cash dividends, stock dividends, and stock splits, and understand their financial impact.

11, 12, 13, 14, 15

5, 6, 7, 8

5, 6, 7

1A, 2A, 3A, 1B, 2B, 1, 5, 7 4A, 5A, 6A, 3B, 4B, 7A 5B, 6B, 7B

4. Indicate how shareholders’ equity is presented in the financial statements.

16, 17, 18, 19, 20

9, 10, 11

7, 8, 9, 10, 11

1A, 2A, 3A, 1B, 2B, 4A, 5A, 7A 3B, 4B, 5B, 7B

1, 7

5. Evaluate dividend and earnings performance.

21, 22, 23, 24, 25

12, 13, 14, 15, 16, 17

12, 13, 14, 15

8A, 9A, 10A, 11A

2, 3, 4, 6

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8B, 9B, 10B, 11B

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Show impact of transactions on accounts.

Moderate

40-50

Record and post equity transactions; prepare shareholders’ equity section.

Simple

30-40

Record and post equity transactions; prepare statements.

Moderate

40-50

Record and post equity transactions; prepare statements under ASPE.

Complex

30-40

Reproduce equity accounts; prepare shareholders’ equity section.

Moderate

30-40

Compare impact of cash dividend, stock dividend, and stock split.

Moderate

30-40

Record and post dividend transactions, prepare statements.

Moderate

40-50

Calculate earnings per share.

Moderate

20-30

Evaluate ratios.

Moderate

20-30

10A

Calculate and evaluate ratios.

Complex

20-30

11A

Evaluate profitability ratios.

Complex

20-30

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Show impact of transactions on accounts.

Moderate

40-50

Record and post equity transactions; prepare shareholders’ equity section.

Simple

30-40

Record and post equity transactions; prepare statements.

Moderate

40-50

Record and post equity transactions; prepare statements under ASPE.

Complex

30-40

Reproduce equity accounts; prepare shareholders’ equity section.

Moderate

30-40

Compare impact of cash dividend, stock dividend, and stock split.

Moderate

30-40

Record and post dividend transactions, prepare statements.

Moderate

40-50

Calculate earnings per share.

Moderate

20-30

Evaluate ratios.

Moderate

30-40

10B

Calculate and evaluate ratios.

Complex

20-30

11B

Evaluate profitability ratios.

Complex

20-30

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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-to-day activities. This is normally seen to be an advantage to the corporate form of organization.

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Answers to Questions (Continued) 1.

(a) (Continued) (7) Government regulations. Corporations in Canada may incorporate federally or provincially. Government regulations usually provide guidelines for issuing shares, distributing profit, 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 taxation. 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 profit 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 is the case for public companies.

(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.

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.

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Answers to Questions (Continued) 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. The market capitalization for Plazacorp Retail Properties Limited has increased in 2012. There are two primary reasons for an increase in the market capitalization of a company which may happen separately or in combination. First, the number of shares may have increased. If this is the case, assets (Cash) and shareholders’ equity (Common Shares) would increase as a result of the issue of new shares. Liabilities would be unaffected. Second, the market price of the shares could have increased. Increases in the market price of the shares can result for a number of reasons but are most likely due to the market’s perception of the future ability of the corporation to earn profit. As a result, investors bid up 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.

Legal capital is the portion of a company’s share capital which cannot be distributed to shareholders. Legal capital is created largely for the protection of creditors. It 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. The proceeds received from a company’s share issue are considered to be legal capital.

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.

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.

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Answers to Questions (Continued) 8.

(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 earnings per share and return on equity ratio, (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.

Assad should expect to receive a dividend in the amount of $281.25 (1,000 shares × $1.125 ÷ 4) each quarter.

10. Preferred shares are cumulative or noncumulative with respect to their dividend provisions. Cumulative preferred shares entitle the shareholder to any previous years’ dividends, which have not yet been paid, as well as their current dividend, before common shareholders can get any dividends. Noncumulative preferred shares do not entitle the shareholder to any unpaid dividends. 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. 11. 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. In addition, a formal dividend declaration by the board of directors is required.

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Answers to Questions (Continued) 12. 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

(b) Record date

No effect Increase No effect Decrease Decrease No effect

No effect No effect No effect No effect No effect No effect

Decrease Decrease No effect No effect No effect No effect

(a) Cash dividend

(b) Stock dividend

Decrease No effect No effect Decrease Decrease No effect

No effect No effect Increase Decrease No effect Increase

No effect No effect No effect No effect No effect Increase

13.

(1) (2) (3) (4) (5) (6)

Assets Liabilities Share capital Retained earnings Total shareholders' equity Number of shares

14. (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).

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Answers to Questions (Continued) 15. 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, Cash Dividends are increased, which in turn decreases retained earnings. Cash is also reduced with a cash dividend. In the case of a stock dividend, Stock Dividends are increased, which in turn decreases retained earnings. Common Shares are increased in the case of a stock dividend. 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 changes, typically by a multiple (for example, 2 for 1). 16. (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 sub-heading of share capital in the shareholders’ equity section of the statement of financial position. The remaining accounts would be reported separately in the same shareholders’ equity section of the statement of financial position.

17. 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. 18. Comprehensive income is the sum of profit 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. 19. (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 by companies following IFRS.

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Answers to Questions (Continued) 19. (b)

The statement of retained earnings shows the changes in determining 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 in determining 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.

20. (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 and 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.

21. (a) (b) (c) (d)

Unfavourable Favourable Unfavourable Favourable

22. 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. Doing so would result in a market price of approximately $67 ($1.00 ÷ 1.5%) and $72 ($2.15 ÷ 3.0%) per share for CocaCola and Pepsi, respectively.

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Answers to Questions (Continued) 23. 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 profit 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 earnings per share. 24. Companies must use the profit available to common shareholders (profit – preferred dividends) in the calculation of their earnings per share figures because preferred shareholders are subject to 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 (profit – preferred dividends) and denominator (total shareholders’ equity – preferred shares) in the calculation of return on common shareholders’ equity. Consequently, both ratios use profit available to common shareholders in their numerators. 25. Company B pays out the highest proportion of its profits in dividends and these dividends give shareholders the highest dividend yield, when compared to Company A. Therefore Company B is the better choice for an investor interested in a steady dividend income.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 (a)

At Hudson’s Bay Company’s initial public offering, the shares issued were purchased from the corporation. The $17 per share received goes directly to Hudson’s Bay and increases assets (cash) and shareholders’ equity (share capital).

(b)

At the January 2013 date, the market price of $16.81 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 Hudson’s Bay. Therefore, there is no impact on Hudson’s Bay Company’s financial position as a result of the trading occurring on the stock market subsequent to the IPO.

BRIEF EXERCISE 11-2 (a) May

June 15 Nov.

Dec. 15

Cash ................................................................................. Common Shares (1,000 × $15) ................................

15,000

Cash ................................................................................. Common Shares (500 × $17) ...................................

8,500

Cash ................................................................................. Preferred Shares (100 × $30) ...................................

3,000

Cash ................................................................................. Preferred Shares (100 × $35) ...................................

3,500

15,000

8,500 3,000

3,500

(b) Number of shares authorized

Number of shares issued

(1) Preferred shares

100,000

200

(2) Common shares

Unlimited

1,500

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BRIEF EXERCISE 11-3 (a) Mar. 8

April 20

(b)

Cash ...................................................................................... Preferred Shares (5,000 × $30) ....................................

150,000

Land ..................................................................................... Preferred Shares (3,000 shares)...................................

110,000

150,000

110,000

If the fair 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

Land ..................................................................................... Preferred Shares (3,000 × $35) ....................................

105,000 105,000

BRIEF EXERCISE 11-4 (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.

BRIEF EXERCISE 11-5 Nov. 15

Dec. 10 31

Cash Dividends (30,000 × $2 ÷ 4) .................................... Dividends Payable ....................................................

15,000 15,000

No entry required Dividends Payable ............................................................ Cash .........................................................................

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BRIEF EXERCISE 11-6 Dec.

Jan.

Stock Dividends (100,000 × 5% × $15) ......................... Stock Dividends Distributable ...............................

No entry required

Stock Dividends Distributable........................................ Common Shares ...................................................

75,000 75,000

BRIEF EXERCISE 11-7 (a) (b) (c)

Before the stock split: 129,000,000 shares After the stock split: 129,000,000 × 3 = 387,000,000 shares Likely stock price after the stock split: $117 ÷ 3 = $39 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.

BRIEF EXERCISE 11-8 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 + +

BRIEF EXERCISE 11-9 [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) $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

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BRIEF EXERCISE 11-10 LUXAT CORPORATION Statement of Financial Position (Partial) December 31, 2015

Shareholders' equity Contributed capital Common shares, unlimited number of shares authorized, 550,000 issued ............................................ Additional contributed capital ................................................ 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

BRIEF EXERCISE 11-11 (a) STIRLING FARMS LIMITED Statement of Retained Earnings Year Ended December 31, 2015

Retained earnings, January 1 ...................................................................... Add: Profit .................................................................................................. Less: Cash dividends .................................................................................. Retained earnings, December 31 ................................................................. (b)

$490,000 150,000 640,000 90,000 $550,000

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.

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BRIEF EXERCISE 11-12 $60,000 $600,000

(a)

Payout ratio − last year

(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).

= 10%

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 profit fluctuates will result in variable dividend amounts being paid to shareholders, which may not be wise from a cash flow or growth perspective.

BRIEF EXERCISE 11-13 Canadian National Railway

(a) Dividend yield

(b)

$1.50 $93.72 = 1.6%

Canadian Pacific Railway $1.40 $108.55 = 1.3%

Investors would likely prefer Canadian National Railway because of its higher dividend yield if they wish to purchase shares for the purpose of dividend income.

BRIEF EXERCISE 11-14 Weighted average number of shares: January 1 August 31 November 30

34,000 × 12/12 = 9,000 × 4/12 = 6,000 × 1/12 = 49,000

34,000 3,000 500 37,500

(a)

The number of common shares issued at December 31, 2015 is 49,000.

(b)

The weighted average number of common shares for 2015 is 37,500.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 11-15 Earnings per share

$370,000 – $20,000* 37,500

= $9.33

*10,000 × $2 = $20,000

BRIEF EXERCISE 11-16 (a) Earnings per share

$500,000 – $50,000* 200,000

= $2.25

*25,000 × $2 = $50,000 (b)

Same amount as in (a) $2.25

$500,000 200,000

= $2.50

BRIEF EXERCISE 11-17 (a)

Return on common shareholders’ equity:

$14,000 = 12.4% ($104,000 + $122,000)  2 (b)

Had Salliq issued preferred shares and paid dividends to the preferred shareholders, the amount of the profit available to common shareholders would be reduced by the amount of the preferred dividend, reducing the return on common shareholders’ equity ratio.

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SOLUTIONS TO EXERCISES EXERCISE 11-1 (a)

High $4.93 Low $2.97

(b)

$0.10 per share

(c)

1,000 × $4.02 = $4,020

(d)

$4.02 + $0.08 = $4.10

(e)

12,260 × 1,000 = 12,260,000

EXERCISE 11-2 (a)

June 12

July 11

Oct.

Nov. 15

(b)

Cash (50,000 × $6) ............................................ Common Shares........................................

300,000

Cash (1,000 × $25) ............................................ Preferred Shares .......................................

25,000

Land ................................................................... Common Shares (10,000 shares)..............

75,000

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

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Financial Accounting, Sixth Canadian Edition

EXERCISE 11-3 (a)

Jan.

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 (10,000 shares) .........

15,000

300,000

87,500

250,000

15,000

(b) Date January 6 January 12 January 18 January 31 Total (c)

Total Number of Common Shares Issued 200,000 50,000 10,000 260,000

Total Number of Preferred Shares Issued

10,000 000 00 10,000

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 fair value of the consideration received cannot be reliably determined, then the fair value of the consideration given up (shares in this case) can be used. In this case the value of the services was given and so the journal entry would not be any different under IFRS.

EXERCISE 11-4 (a)

Total annual preferred dividend should be 400,000 × $1 per share or $400,000.

(b)

Dividends in arrears at the end of Year 1 are $100,000 ($400,000 annual dividend less dividends declared of $300,000). By the end of Year 2, the dividends paid of $400,000 are first allocated to the dividends in arrears of Year 1 of $100,000 and the remaining $300,000. Consequently by the end of Year 2, dividends in arrears at the end of Year 2 remain at $100,000.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 11-4 (Continued) (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)

If the preferred shares were noncumulative, the corporation would have no obligation to pay any dividends. This is the same as if the preferred shares were cumulative. 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.

EXERCISE 11-5 (a)

Apr.

June 15

July 10

Aug. 21

Sept. 20

Nov.

Dec. 20

Solutions Manual .

Cash .............................................................. Common Shares (5,000 × $20) .............

100,000

Cash Dividends (85,000 × $0.25) .................. Dividends Payable ................................

21,250

Dividends Payable ......................................... Cash ......................................................

21,250

Stock Dividends ............................................. Stock Dividends Distributable ................ (80,000 + 5,000 = 85,000 × 5% = 4,250 × $22)

93,500

Stock Dividends Distributable ........................ Common Shares ...................................

93,500

Cash .............................................................. Common Shares (3,000 × $25) .............

75,000

100,000

21,250

93,500

Cash Dividends.............................................. 27,675 Dividends Payable ................................. (80,000 + 5,000 + 4,250 + 3,000 = 92,250 × $0.30)

11-20

75,000

27,675

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EXERCISE 11-5 (Continued) (b) Common Shares Jan. 1 Bal. April 1 Sept. 20 Nov. 1 Dec. 31 Bal.

600,000 100,000 93,500 75,000 868,500

June 15 Dec. 20 Dec. 31 Bal.

Cash Dividends 21,250 27,675 48,925

Aug. 21 Dec. 31 Bal.

Stock Dividends 93,500 79, ........................ 51,000 93,500

Sept. 20

Stock Dividends Distributable 93,500 Aug. 21 79, ........................ 93,500 51,000 Dec. 31 Bal. 0 Retained Earnings Jan. 1 Bal. Dec. 31 Bal.

1,000,000 1,000,000*

* Note: This balance is before closing entries adding profit or deducting loss and dividends.

(c)

Number of common shares at the end of the year: 80,000 + 5,000 + 4,250 + 3,000 = 92,250

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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

Total liabilities

$ 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

Number of common shares

100,000

105,000

200,000

* $600,000 + (100,000 shares × 5% × $14) = $670,000

EXERCISE 11-7

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Assets + NE + + NE NE NE NE +

Solutions Manual .

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 + +

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EXERCISE 11-8 Statement of Changes in Equity Accumulated Other CompreOther hensive Financial Income Statement NE Statement of financial position NE NE

Share Capital NE

Retained Earnings NE

2. Common shares 3. Revaluation gain from revaluing property, plant, and equipment to fair value 4. Long-term investments

Common shares NE

NE NE

Other comprehensi ve income: Revaluation gain

Non-current assets

5. Preferred shares 6. Retained earnings 7. Gain on disposal

Preferred shares NE

Statement of financial position NE

Retained earnings NE

Income statement

8. Cash dividends

Retained earnings

Operating expenses (reduction of) NE

9. Stock split 10. Stock dividends distributable

NE Common shares*

NE NE

Account 1. Cash

Classification Current assets NE

* Note to instructors: Preferred shares is also an acceptable answer here although common shares are more often issued as stock dividends.

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EXERCISE 11-9 OZABAL INC. Statement of Financial Position (Partial) December 31, 2015 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 ................................... Additional contributed capital ....................................... 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.

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EXERCISE 11-10 (a) THE BLUE CANOE LIMITED Statement of Changes in Equity Year Ended December 31, 2015

Balance Jan. 1 Issued common shares Profit Cash dividends Other comprehensive income Balance Dec. 31

Common Shares $800,000 180,000

Additional Contributed Capital $540,000

Retained Earnings $1,500,000

Accumulated Other Comprehensive Income $90,000

400,000 (70,000)

$980,000

$540,000

$1,830,000

(25,000) $65,000

Total $2,930,000 180,000 400,000 (70,000) (25,000) $3,415,000

(b) THE BLUE CANOE LIMITED Statement of Financial Position (Partial) December 31, 2015 Shareholders’ equity Contributed capital Common shares ............................................................. Additional contributed capital ......................................... Total contributed capital ...................................................... Retained earnings ............................................................... Accumulated other comprehensive income ........................ Total shareholders’ equity ...........................................................

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11-25

$980,000 540,000 $1,520,000 1,830,000 65,000 $3,415,000

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EXERCISE 11-11 (a) SOBEYS INC. Statement of Retained Earnings Year Ended May 5, 2012 (in millions)

Retained earnings, May 7, 2011 .................................................................. Add: Profit .................................................................................................. Less: Cash dividends ...................................................................... $70.5 Other deductions .................................................................. 47.5 Retained earnings, May 5, 2012 .................................................................. (b)

$1,362.8 322.5 1,685.3 118.0 $1,567.3

If Sobeys were a publicly traded corporation, a statement of changes in equity would be required instead of a statement of retained earnings. A statement of changes in equity would explain the changes in each component of shareholders’ equity; not just retained earnings.

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EXERCISE 11-12 (a) (1) Payout ratio (2) Dividend yield (b)

Nike (in millions of USD) $619 ÷ $2,223 = 27.8% $1.565 ÷ $53.68 = 2.9%

Adidas (in millions of euros) €282 ÷ €791 = 35.7% €1.35 ÷ €67.33 = 2.0%

Investors would likely prefer Nike for dividend income purposes because of its higher dividend yield. Adidas pays out more of its profits in dividends, yet its dividend yield of 2% is not as high as Nike’s at 2.9%.

EXERCISE 11-13 (a)

Profit available to common shareholders = Profit – Preferred share dividends = $351,250 – (20,000 × $1 × ¼) = $346,250

(b)

Weighted average number of shares Dec. 1 60,000 × 12/12 = 60,000 Feb. 28 15,000 × 9/12 = 11,250 Nov. 1 6,000 × 1/12 = 500 71,750

(c)

Earnings per share = Profit available to common shareholders ÷ Weighted average number of common shares = $346,250 ÷ 71,750 = $4.83

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EXERCISE 11-14 ($ in millions) (1) Payout ratio

2012 $1,470 = $3,173

2011 46.3%

$1,391 = $2,690

51.7%

(2) Dividend yield

$3.64 = 4.6% $78.56

$3.51 = 4.7% $73.96

Earnings per share

$3,173 = $7.85 404

$2,690 = $6.79 396

Return on common (4) = 22.1% $3,173 shareholders' ($15,332 + $13,335) ÷ 2 equity

= 21.5% $2,690 ($13,335 + $11,643) ÷ 2

(3)

The dividends paid by CIBC in 2012 increased in absolute amount. However, when dividends are expressed as a percentage of the profit, the result—the payout ratio— decreased from 51.7% to 46.3%. This is because profit increased at a higher rate than did dividends. Similarly, even though the dividends per share increased in 2012, because the increase in the market price was proportionately greater than the increase in the amount of dividends paid, the dividend yield reduced marginally from 4.7% in 2011 to 4.6% in 2012. CIBC’s profit improved in 2012 both in total amount and on a per share basis. Its return on common shareholders’ equity also improved slightly from 21.5% to 22.1%. With improved profitability, the bank’s shareholders were willing to pay a higher market price for the common shares in 2012 ($78.56) compared to 2011 ($73.96).

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EXERCISE 11-15 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 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 priceearnings ratio) or the amount of dividends paid per share (for example, the dividend payout ratio). A higher earnings per share ratio does not necessarily mean a more profitable company or a better investment. 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.

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SOLUTIONS TO PROBLEMS PROBLEM 11-1A

Shareholders’ Equity

1. 2. 3. 4. 5. 1 2

Assets +$140,000 +70,0001 +100,000 -42,0002 -5,000

Preferred Liabilities Shares NE NE NE NE NE +$100,000 NE NE NE NE

Common Shares +$140,000 +70,000 NE NE NE

Retained Earnings NE NE NE -$42,000 NE

Accumulated Other Comprehensive Income NE NE NE NE -$5,000

5,000 × $14 = $70,000 (6,000 + 1,000) × $6 = $42,000

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PROBLEM 11-2A (a)

Transaction entries: Jan.

Mar.

May

July

Sept.

Nov.

Dec. 15

Cash (500,000 × $2) ............................................ Common Shares .........................................

1,000,000

Cash (10,000 × $50) ............................................ Preferred Shares .........................................

500,000

Cash (50,000 × $3) .............................................. Common Shares .........................................

150,000

Cash .................................................................... Equipment ........................................................... Common Shares (16,800 shares) ...............

60,000 8,000

Cash (5,000 × $5) ................................................ Common Shares .........................................

25,000

Cash (2,000 × $50) .............................................. Preferred Shares .........................................

100,000

Cash Dividends.................................................... Dividends Payable ......................................

36,000

1,000,000

500,000

150,000

68,000

25,000

100,000

36,000

Closing entries: Dec. 31

Solutions Manual .

Retained Earnings ............................................... Cash Dividends............................................

36,000

Income Summary ................................................. Retained Earnings .......................................

650,000

11-31

36,000

650,000

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PROBLEM 11-2A (Continued) (b)

Dec. 15 Dec. 31 Bal.

Dec. 31 CE

Preferred Shares Mar. 1 Nov. 1 Dec. 31 Bal.

500,000 100,000 600,000

Common Shares Jan. 10 May 1 July 24 Sept. 1 Dec. 31 Bal.

1,000,000 150,000 68,000 25,000 1,243,000

Cash Dividends 36,000 Dec. 31 CE 0

36,000

Retained Earnings 36,000 Dec. 31 CE Dec. 31 Bal.

650,000 614,000

CE: Closing entry (c)

Number of preferred shares: 10,000 + 2,000 = 12,000 Number of common shares: 500,000 + 50,000 + 16,800 + 5,000 = 571,800 REMMERS CORPORATION Statement of Financial Position (Partial) December 31, 2015 Shareholders’ equity Share capital $3 Preferred shares, noncumulative, unlimited number authorized, 12,000 shares issued .......................... Common shares, unlimited number authorized, 571,800 shares issued .............................................................. Total share capital........................................................................... Retained earnings ........................................................................... Total shareholders’ equity ....................................................................

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11-32

$ 600,000 1,243,000 1,843,000 614,000 $2,457,000

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PROBLEM 11-3A (a)

Transaction entries: Feb.

April

May

Cash .............................................................. Preferred Shares (10,000 shares) .........

600,000

Cash .............................................................. Common Shares (20,000 shares) ..........

560,000

Cash Dividends.............................................. Dividends Payable [(8,000 + 10,000) × $4 × 6/12] ...............

36,000

600,000

560,000

36,000

June 12

No entry required

July

Dividends Payable ......................................... Cash ......................................................

36,000

Buildings ........................................................ Common Shares (5,000 shares) ............

165,000

Aug.

36,000

165,000

Closing entries: Dec.

Solutions Manual .

Income Summary ........................................... Retained Earnings .................................

582,000

Retained Earnings ......................................... Cash Dividends......................................

36,000

11-33

582,000

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

Common Shares Jan.1 Bal. 1,050,000 April 6 560,000 Aug. 22 165,000 Dec. 31 Bal. 1,775,000

Additional Contributed Capital Jan. 1 Bal. 25,000 Dec. 31 Bal. 25,000

Cash Dividends May 29 36,000 Dec. 31 CE Dec. 31 Bal. 0

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 (d) LARGENT CORPORATION Statement of Financial Position (Partial) December 31, 2015 Shareholders’ equity Share capital $4 Preferred shares, cumulative, 200,000 shares authorized, 18,000 issued ............................. Common shares, unlimited number of shares authorized, 95,000 issued ........................................................ Additional contributed capital ..................................................... Total share capital........................................................................... Retained earnings ........................................................................... Accumulated other comprehensive income .................................... Total shareholders’ equity ....................................................................

$1,040,000 1,775,000 25,000 2,840,000 1,346,000 10,000 $4,196,000

Note: Dividends of $36,000 (18,000 × $4 × 6/12) are in arrears on the cumulative preferred shares.

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PROBLEM 11-3A (Continued) (c) LARGENT CORPORATION Statement of Changes in Equity Year Ended December 31, 2015

Share Capital Preferred Common Shares Shares Balance Jan. 1 Issued preferred shares Issued common shares Cash dividends Profit Balance Dec. 31

$ 440,000 600,000

$1,050,000

Additional Contributed Capital

Retained Earnings

Accumulated Other Comprehensive Income

$25,000

$ 800,000

$10,000

$25,000

(36,000) 582,000 $1,346,000

$10,000

725,000

$1,040,000

$1,775,000

Number of preferred shares: 8,000 + 10,000 = 18,000 Number of common shares: 70,000 + 20,000 + 5,000 = 95,000

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Chapter 11

Total $2,325,000 600,000 725,000 (36,000) 582,000 $4,196,000

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 11-4A (a)

Transaction entries: Jan.

Feb.

Mar.

April

July

Sept.

Oct.

Dec.

Solutions Manual .

10,000,000

Land ......................................................... Common Shares (50,000 shares) .....

105,000

Cash Dividends (100,000 × $5 × 3/12) ..... Dividends Payable ............................

125,000

10,000,000

105,000

125,000

No entry required

Dividends Payable .................................... Cash .................................................

125,000

Cash (200,000 × $3) ................................. Common Shares ...............................

600,000

Cash Dividends (100,000 × $5 × 3/12) ..... Dividends Payable ............................

125,000

June

Cash ......................................................... Preferred Shares (100,000 × $100) ..

125,000

600,000

125,000

No entry required

Dividends Payable .................................... Cash .................................................

125,000

Cash Dividends (100,000 × $5 × 3/12) ..... Dividends Payable ............................

125,000

No entry required

Dividends Payable .................................... Cash .................................................

125,000

Cash Dividends (100,000 × $5 × 3/12) ..... Dividends Payable ............................

125,000

Cash Dividends (1,750,000* × $0.50) ....... 875,000 Dividends Payable ............................ *1,500,000 + 50,000 + 200,000 = 1,750,000 shares

875,000

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PROBLEM 11-4A (Continued) (a)

(Continued) Closing entries: Dec.

Income Summary ...................................... Retained Earnings ............................

1,000,000

Retained Earnings .................................... Cash Dividends .................................

1,375,000

1,000,000

1,375,000

(b) Preferred Shares Jan. 1 Bal. 0 Jan. 2 10,000,000 Dec. 31 Bal. 10,000,000

Retained Earnings Jan. 1 Bal. 1,900,000 Dec. 31CE 1,375,000 Dec. 31 CE 1,000,000 Dec. 31 Bal. 1,525,000

Common Shares Jan. 1 Bal. 1,500,000 Feb. 8 105,000 April 18 600,000 Dec. 31 Bal. 2,205,000 Cash Dividends Jan. 1 Bal. 0 Dec. 31 CE Mar. 5 125,000 June 5 125,000 Sept. 5 125,000 Dec. 5 125,000 Dec. 14 875,000 Dec. 31 Bal. 0

1,375,000

CE: Closing entry

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PROBLEM 11-4A (Continued) (c) CONWAY LTD, Statement of Retained Earnings Year Ended December 31, 2015

Retained earnings, January 1 ................................................................ Add: Profit ............................................................................................ Less: Cash dividends ............................................................................ Retained earnings, December 31 ..........................................................

$1,900,000 1,000,000 2,900,000 1,375,000 $1,525,000

(d) CONWAY LTD. Statement of Financial Position (Partial) December 31, 2015 Shareholders’ equity Share capital $5 Preferred shares, noncumulative, unlimited number authorized, 100,000 shares issued......................... Common shares, unlimited number authorized, 1,750,000 shares issued ................................................... Total share capital......................................................................... Retained earnings ......................................................................... Total shareholders’ equity .....................................................................

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$10,000,000 2,205,000 12,205,000 1,525,000 $13,730,000

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PROBLEM 11-4A (Continued) (e)

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 fair value of the land of $105,000 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, 2015 Share Capital Preferred Common Shares Shares

Balance Jan, 1 Issued preferred shares Issued common shares Cash dividends Profit Balance Dec. 31

Solutions Manual .

$1,500,000

Retained Earnings $1,900,000

$10,000,000 705,000

$10,000,000

$2,205,000

11-39

(1,375,000) 1,000,000 $1,525,000

Total $3,400,000 10,000,000 705,000 (1,375,000) 1,000,000 $13,730,000

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PROBLEM 11-5A (a)

Jan. 1 Balance Dec. 31 Declaration** Dec. 31 Balance

Preferred Shares Jan. 1 Jan. 1 Dec. 31

Balance Issue Balance

500,000 500,000 1,000,000

Common Shares Jan. 1 Oct. 1 Dec. 31

Balance Issue Balance

2,700,000 1,000,000 3,700,000

Stock Dividends 0 407,000 Dec. 31 CE 0

407,000

Stock Dividends Distributable Dec. 31 Declaration**

Retained Earnings During year CE Cash dividend* 100,000 Jan. 1 Dec. 31 CE Stock dividend** 407,000 Dec. 31 Dec. 31 * **

Balance CE Profit Balance

407,000

2,980,000 872,000 3,345,000

20,000 × $5 = $100,000 370,000 × 5% × $22 = $407,000

Solutions Manual .

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Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-5A (Continued) (b)

ROBICHAUD CORPORATION Statement of Financial Position (Partial) December 31, 2015

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 (See 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

Note A: On December 31, 2015 the Board of Directors authorized a $500,000 restriction of retained earnings for a plant expansion.

Solutions Manual .

11-41

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-6A (a)

(1)

Assets

(2)

Liabilities

(3)

Common shares

(4)

Retained earnings

(5)

(6)

a b c

Cash Dividend $16,000,000 – $600,000a = $15,400,000 No effect $6,000,000 No effect $2,000,000

$8,000,000 – $600,000 = $7,400,000 Total $10,000,000 – shareholders’ $600,000 = equity $9,400,000

Number of shares

No effect 400,000

Stock Dividend No effect $16,000,000

Stock Split 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)

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% = 20,000 × $30 = $600,000 400,000 ÷ 2 = 200,000 × 3 = 600,000 after the 3-for-2 stock split

Solutions Manual .

11-42

Chapter 11

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Financial Accounting, Sixth Canadian Edition

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

Solutions Manual .

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

•Retains cash •Share price reduces significantly making shares more affordable to a broader number of investors •Share price generally starts increasing after split

•Reduces earnings per share •More shares on which to pay future cash dividends

11-43

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-7A (a)

Transaction entries: Jan.

Feb.

Apr.

May

Oct.

Cash Dividends (110,000 × $1) ..................... Dividends Payable.................................

110,000 110,000

No entry required

Dividends Payable ......................................... Cash ......................................................

110,000

Stock Dividends (11,000* × $15) ................... Stock Dividends Distributable ................ * 110,000 × 10% = 11,000

165,000

No entry required

Stock Dividends Distributable ........................ Common Shares ...................................

110,000

165,000

165,000 165,000

No journal entry (memorandum entry only: 121,000 common shares × 2 = 242,000 common shares)

Closing entries: Dec.

Solutions Manual .

Income Summary........................................... Retained Earnings .................................

350,000

Retained Earnings ......................................... Cash Dividends ..................................... Stock Dividends.....................................

275,000

11-44

350,000

110,000 165,000

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-7A (Continued) (b) CE: Closing entry

Common Shares Jan. 1 Bal. 1,100,000 May 15 165,000 Dec. 31 Bal.1,265,000

Cash Dividends Jan. 15 110,000 Dec. 31 CE Dec. 31 Bal. 0

Retained Earnings Jan. 1 Bal. Dec. 31 CE 275,000 Dec. 31 CE Dec. 31 Bal.

110,000

Stock Dividends Distributable May 15 165,000 Apr. 15 165,000 Dec. 31 Bal. 0

Solutions Manual .

Stock Dividends Apr. 15 165,000 Dec. 31 CE Dec. 31 Bal. 0

540,000 350,000 615,000

165,000

Accumulated Other Comprehensive Income Jan. 1 60,000

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Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-7A (Continued) (c) WIRTH CORPORATION Statement of Changes in Equity Year Ended December 31, 2015

Balance Jan, 1 Cash dividends Stock dividends Profit Balance Dec. 31

Solutions Manual .

Common Shares

Retained Earnings

$1,100,000

$540,000 (110,000) (165,000) 350,000 $615,000

165,000 $1,265,000

11-46

Accumulated Other Comprehensive Income $60,000

$60,000

Total $1,700,000 (110,000) 0 350,000 $1,940,000

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-7A (Continued) (d)

Number of common shares: 110,000 + 11,000 + 121,000 = 242,000

WIRTH CORPORATION Statement of Financial Position (Partial) December 31, 2015 Shareholders’ equity Common shares, unlimited number of shares authorized, 242,000 issued ................................................. Retained earnings ............................................................... Accumulated other comprehensive income ......................... Total shareholders’ equity ...........................................

Solutions Manual .

11-47

$1,265,000 615,000 60,000 $1,940,000

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-8A (a)

Weighted Average Number of Shares Aug. 1 Dec. 1 Feb. 1

(b)

350,000 × 12/12 = 60,000 × 8/12 = 10,000 × 6/12 = 420,000

350,000 40,000 5,000 395,000

Earnings per Share = Profit available to common shareholders ÷ Weighted average number of common shares = ($1,280,000 – $125,000*) ÷ 395,000 = $2.92 *Preferred dividend: $5 × 25,000 = $125,000

(c)

A weighted average number of shares is used in the 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 profit can be earned. Using the number of shares at a point in time such as year-end to calculate earnings-per-share does not take into account the year’s economic activity and other factors, which 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 profit available to common shareholders. The earnings per share would be as follows: = Profit available to common shareholders ÷ Weighted average number of common shares = $1,280,000 ÷ 395,000 = $3.24

Solutions Manual .

11-48

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-9A 8A (a)

Although profits were low in 2008, as demonstrated by the earnings per share ratio, it is likely that the dollar amount of dividends remained unchanged from previous years resulting in a higher than normal payout ratio in that year. Once Barrick experienced a more normal level of profit in 2010 the payout ratio decreased to a level that is also more normal for its operations. With the improved profit, likely came a share price increase, resulting in a slight decrease in the dividend yield.

(b)

If the dividend per share remained unchanged or even increased marginally, the increase in the dividend yield most likely resulted from a decline in share price. With the decline from a profit in 2011 to a loss in 2012, the market price of Barrick shares likely declined significantly.

(c)

Because of the nature of the business, creditors should not be overly concerned with the company’s continued payment of dividends, particularly since past experience would have given them the reassurance that the company would return to profitability. Due to the volatility of gold prices, creditors would carefully scrutinize the source of the losses of 2009 and 2012 and reassess their risk in holding debt due from Barrick. Although creditors are generally more concerned with cash flow than profit, Barrick’s poor profit performance of 2009 and 2012 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 Barrick’s ability to repay its debt.

Solutions Manual .

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Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-10A (a)

(in millions, except per share information) 2012

Ratio

2011

1. Payout ratio

$485 $1,518

= 31.9%

$437 $1,137

= 38.4%

2. Dividend yield

$3.08 $77.18

= 4.0%

$2.74 $69.61

= 3.9%

3. Earnings per share

$1,518 161.4

= $9.41

$1,137 162.4

= $7.00

4. Return on common shareholders' equity

$1,518 $6,089

(b)

= 24.9%

$1,137 $5,535

= 20.5%

For the year 2012, National Bank’s dividend yield, earnings per share, and return on common shareholders’ equity ratios all improved over 2011. Its payout ratio declined, most likely due to the increase in profits (profitability). Compared to its industry, National Bank payout, dividend yield, and return on common shareholders’ equity ratios are in line with its peers.

Solutions Manual .

11-50

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-11A (a)

World Oil is the more profitable of the two companies in spite of having a lower profit margin than Petro-Boost. Petro-Boost’s profit margin of 10% is higher than World Oil’s 8.4% and in line with the average company in the industry, which has a profit margin of 10.9%. Despite this, World Oil’s return on common shareholders’ equity, return on assets, and asset turnover ratios are much higher than those of Petro-Boost and the average company in the industry.

(b)

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.

(c)

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.

Solutions Manual .

11-51

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-1B Shareholders’ Equity

1. 2. 3. 4. 5. 1 2

Assets +$300,000 +50,0001 +29,000 -71,0002 +5,000

Preferred Common Liabilities Shares Shares NE NE +$300,000 NE +$50,000 NE NE NE +29,000 NE NE NE NE NE NE

Retained Earnings NE NE NE -$71,000 NE

Accumulated Other Comprehensive Income NE NE NE NE +$5,000

500 × $100 = $50,000 (35,000 + 500) × $2 = $71,000

Solutions Manual .

11-52

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-2B (a)

Transaction entries: June

Aug.

Sept. 15

Nov.

Mar.

April

May

Cash (80,000 × $4) ........................................ Common Shares ...................................

320,000

Cash (5,000 × $100) ...................................... Preferred Shares ...................................

500,000

Land .............................................................. Common Shares ...................................

95,000

Cash (78,000 × $4.50) ................................... Common Shares ...................................

351,000

Cash (10,000 × $5) ........................................ Common Shares ...................................

50,000

Cash (2,000 × $100) ...................................... Preferred Shares ...................................

200,000

Cash Dividends (7,000 × $4) ......................... Dividends Payable ................................

28,000

320,000

500,000

95,000

351,000

50,000

200,000

28,000

Closing entries: May

Solutions Manual .

Retained Earnings .......................................... Cash Dividends.....................................

28,000

Income Summary ............................................ Retained Earnings ..................................

250,000

11-53

28,000

250,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-2B (Continued) (b) Preferred Shares Aug. 21 500,000 Apr. 16 200,000 May 31 Bal. 700,000

Common Shares June 5 320,000 Sept. 15 95,000 Nov. 20 351,000 Mar. 9 50,000 May 31 Bal. 816,000

May 15 May 31 Bal.

May 31 CE

Cash Dividends 28,000 May 31 CE 0

28,000

Retained Earnings 28,000 May 31 CE 250,000 May 31 Bal. 222,000

CE: Closing entry

(c)

Number of preferred shares: 5,000 + 2,000 = 7,000 Number of common shares: 80,000 + 22,000 + 78,000 + 10,000 = 190,000

WETLAND CORPORATION Statement of Financial Position (Partial) May 31, 2015 Shareholders’ equity Share capital $4 Preferred shares, cumulative, unlimited number authorized, 7,000 shares issued ................................... Common shares, unlimited number authorized 190,000 shares issued ........................................................... Total share capital........................................................................... Retained earnings ........................................................................... 9 Total shareholders' equity ......................................................................

Solutions Manual .

11-54

$ 700,000 816,000 1,516,000 222,000 $1,738,000

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-3B (a)

Transaction entries: Feb.

April

May

Dec.

Jan.

Cash ......................................................... Preferred Shares (1,500 shares) ......

150,000

Cash ......................................................... Common Shares (100,000 shares) ...

3,500,000

Land .......................................................... Common Shares (2,500 shares) .......

85,000

Cash Dividends......................................... Dividends Payable ............................ (44,000 + 1,500) × $2.50 = $113,750

113,750

150,000

3,500,000

85,000

113,750

No entry required

Closing entries: Jan.

Solutions Manual .

Retained Earnings .................................... Cash Dividends.................................

113,750

Retained Earnings .................................... Income Summary..............................

5,000

11-55

113,750

5,000

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-3B (Continued) (b)

CE: Closing entry Preferred Shares Feb. 1 Bal. Feb. 28 Jan. 31 Bal.

440,000 150,000 590,000

Common Shares Feb.1 Bal. 1,050,000 April 12 3,500,000 May 25 85,000 Jan. 31 Bal. 4,635,000

Additional Contributed Capital Feb. 1 Bal. Jan. 31 Bal

Jan. 31 CE Jan. 31 CE

75,000 75,000

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 29 Jan 31 Bal.

Solutions Manual .

Cash Dividends 113,750 Jan 31 CE 0

113,750

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-3B (Continued) (c) UJJAL CORPORATION Statement of Changes in Equity Year Ended January 31, 2016

Share Capital Preferred Common Shares Shares Balance Feb. 1, 2015 Issued preferred shares Issued common shares Cash dividends Loss Balance Jan. 31, 2016

Solutions Manual

$440,000 150,000

$1,050,000

Retained Earnings

Accumulated Other Comprehensive Income

$75,000

$1,000,000

$65,000

$75,000

(113,750) (5,000) $881,250

$65,000

3,585,000

$590,000

$4,635,000

11-57 .

Additional Contributed Capital

Chapter 11

Total $2,630,000 150,000 3,585,000 (113,750) (5,000) $6,246,250

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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 = 172,500

UJJAL CORPORATION Statement of Financial Position (Partial) January 31, 2016 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, 172,500 issued ........................................ 4,635,000 Additional contributed capital ............................................................... Total contributed capital ....................................................................... Retained earnings ................................................................................ Accumulated other comprehensive income ......................................... Total shareholders’ equity ...........................................................................

Solutions Manual .

11-58

$5,225,000 75,000 5,300,000 881,250 65,000 $6,246,250

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-4B (a)

Transaction entries: Jan.

Mar.

April

June

July

Aug.

Sept.

Oct.

Cash ......................................................... Preferred Shares (10,000 × $50) ......

500,000

Cash Dividends (10,000 × $2 × 3/12) ....... Dividends Payable ............................

5,000

500,000

5,000

No entry required

Dividends Payable .................................... Cash .................................................

5,000

Cash Dividends (10,000 × $2 × 3/12) ....... Dividends Payable ............................

5,000

No entry required

Dividends Payable .................................... Cash .................................................

5,000

Cash ......................................................... Common Shares (10,000 × $7.30) ...

73,000

Cash Dividends (10,000 × $2 × 3/12) ....... Dividends Payable ............................

5,000

73,000

5,000

No entry required

Dividends Payable .................................... Cash .................................................

5,000

Equipment................................................. Common Shares (2,000 shares) .......

15,000

5,000

15,000

Closing entries: Dec.

Solutions Manual .

Retained Earnings .................................... Income Summary..............................

50,000

Retained Earnings .................................... Cash Dividends.................................

15,000

11-59

50,000

15,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-4B (Continued) (b) Preferred Shares Jan. 2

Retained Earnings Jan. 1 Bal. Dec. 31 CE 15,000 Dec. 31 CE 50,000 Dec. 31 Bal.

Common Shares Jan. 1 Bal. Aug. 12 Oct. 15 Dec. 31 Bal.

500,000

580,000

515,000

Jan. 1 Bal. Mar. 10 June 10 Sept. 1 Dec. 31 Bal.

150,000 73,000 15,000 238,000

Cash Dividends 0 Dec. 31 CE 5,000 5,000 5,000 0

CE: Closing entry

Retained earnings, January 1 .................................................................... Less: Loss ................................................................................................ Less: Cash dividends............................................................................... Retained earnings, December 31 ..............................................................

Solutions Manual .

11-60

$580,000 50,000 530,000 15,000 $515,000

Chapter 11

15,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-4B (Continued) (d) SCHIPPER LTD. Statement of Financial Position (Partial) December 31, 2015 Shareholders’ equity Share capital $2 Preferred shares, noncumulative, unlimited number authorized, 10,000 issued ............................................................. Common shares, unlimited number authorized, 112,000* issued .......................................................... Total share capital ............................................................................ Retained earnings ............................................................................. Total shareholders’ equity .................................................................

$ 500,000 238,000 738,000 515,000 $1,253,000

*Number of common shares: 100,000 + 10,000 + 2,000 = 112,000 (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 fair 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, 2015

Balance Jan, 1 Issued preferred shares Issued common shares Cash dividends Loss Balance Dec. 31

Solutions Manual .

Share Capital Preferred Common Shares Shares

Retained Earnings

$150,000

$580,000

$500,000 88,000

$500,000

$238,000

11-61

(15,000) (50,000) $515,000

Total $730,000 500,000 88,000 (15,000) (50,000) $1,253,000

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-5B (a) Preferred Shares Jan. 1 Dec. 31

Balance Balance

Common Shares Jan. 1 March 1 Sept. 25 Dec. 31

Balance Issue Stock dividend Balance

750,000 750,000

3,210,000 350,0001 297,000 3,857,000

Stock Dividends 297,0002 Dec. 31 CE 0

Aug. 18 Dec. 31

Declaration Balance

Sept. 25

Issue

Jan.-Dec. Dec. 31

CE Cash dividend CE Stock dividend

297,000

Stock Dividends Distributable 297,000 Aug. 18 Declaration Dec. 31 Balance

Retained Earnings 60,0003 Jan. 1 297,000 Dec. 31 Dec. 31

Balance CE Profit Balance

297,0002 0

980,000 750,000 1,373,000

1 Common Shares: 20,000 × $17.50 = $350,000 2 Common Shares: (255,000 + 20,000) × 6% = 16,500 × $18 = $297,000. Note that the

stock dividend was declared on August 18 (thus the debit to Stock Dividends) and distributed on September 25 (thus the credit to Common Shares). 3 Preferred Shares:15,000 × $4 = $60,000

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-5B (Continued) (b) MAGGIO CORPORATION Statement of Financial Position (Partial) December 31, 2015 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

Note X: $200,000 of retained earnings are restricted by a debt covenant.

Solutions Manual .

11-63

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-6B (a) Cash Dividend

Stock Dividend

Stock Split

(1)

Assets

$9,000,000 – $500,000a = $8,500,000

No effect = $9,000,000

(2)

Liabilities

No effect = $2,500,000

(3)

Common shares

No effect = $3,000,000

$3,000,000 + $375,000b = $3,375,000

No effect = $3,000,000

(4)

Retained earnings

$3,500,000 – $500,000 = $3,000,000

$3,500,000 – $375,000 = $3,125,000

No effect = $3,500,000

(5)

Total shareholders’ equity

$6,500,000 – $500,000 = $6,000,000

No effect ($6,500,000 + $375,000 – $375,000 = $6,500,000)

No effect = $6,500,000

(6)

Number of shares

No effect = 500,000

25,000 increase (25,000 + 500,000 = 525,000)

500,000 increase (500,000 × 2 = 1,000,000)

a 500,000 × $1.00 = $500,000 b 500,000 × 5% × $15 = $375,000

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

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

Solutions Manual .

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

•Retains cash •Share price reduces significantly making shares more affordable to a broader number of investors •Share price generally starts increasing after split

•Reduces earnings per share •More shares on which to pay future cash dividends

11-65

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-7B

(a)

Transaction entries: Feb.

Mar.

Cash Dividends (75,000 × $1) ....................... Dividends Payable.................................

No entry required

Dividends Payable ......................................... Cash ......................................................

Apr.

No journal entry required (memorandum entry only)

July

Stock Dividends (11,250* × $14) ................... Stock Dividends Distributable ............... *75,000 shares × 3 = 225,000 × 5% = 11,250

No entry required

Stock Dividends Distributable ........................ Common Shares ...................................

75,000 75,000

157,500 157,500

Closing entries: Dec.

Solutions Manual .

Income Summary........................................... Retained Earnings .................................

400,000

Retained Earnings ......................................... Stock Dividends..................................... Cash Dividends .....................................

232,500

11-66

400,000

157,500 75,000

Chapter 11

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Financial Accounting, Sixth Canadian Edition

PROBLEM 11-7B (Continued) (b) Common Shares Jan. 1 Bal. 1,700,000 July 31 157,500 Dec. 31 Bal.1,857,500

July 31

Stock Dividends Distributable 157,500 July 1 157,500 Dec. 31 Bal. 0

Cash Dividends Feb. 1 75,000 Dec. 31 CE Dec. 31 Bal. 0

75,000

Retained Earnings Jan. 1 Bal. 900,000 Dec. 31 CE 232,500 Dec. 31 CE 400,000 Dec. 31 Bal. 1,067,500

Accumulated Other Comprehensive Loss Jan. 1 125,000

Stock Dividends July 1 157,500 Dec. 31 CE Dec. 31 Bal. 0

157,500

Balance Jan, 1 Cash dividends Stock dividends Profit Balance Dec. 31

Solutions Manual .

Common Shares

Retained Earnings

$1,700,000

$ 900,000 (75,000) (157,500) 400,000 $1,067,500

157,500 $1,857,500

11-67

Accumulated Other Comprehensive Loss $(125,000)

$(125,000)

Total $2,475,000 (75,000) 0 400,000 $2,800,000

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PROBLEM 11-7B (Continued) (d) Number of common shares: 75,000 × 3 = 225,000 + 11,250 = 236,250

STENGEL CORPORATION Statement of Financial Position (Partial) December 31, 2015 Shareholders’ equity Common shares, unlimited number of shares authorized, 236,500 issued .............................................. Retained earnings .................................................................... Accumulated other comprehensive loss ................................... Total shareholders’ equity .................................................................

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$1,857,500 1,067,500 (125,000) $2,800,000

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PROBLEM 11-8B

(a)

Weighted Average Number of Shares April 1 June 1 July 1

(b)

500,000 × 12/12 = 2,000 × 10/12 = 50,000 × 9/12 = 552,000

500,000 1,667 37,500 539,167

Earnings per Share = ($1,016,750 – $100,000*) ÷ 539,167 = $1.70 *Preferred dividend: 20,000 × $5 = $100,000

(c)

It is important to use the profit 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 earnings per share if the dividend had not been declared to the preferred shareholders during the year.

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PROBLEM 11-9B (a)

The increase in the payout ratio in 2009 compared to 2008 is related to the decline in profit, as indicated by the earnings per share ratio. The earnings per share amount is the denominator in the calculation of the payout ratio (when dividend per share is used as the numerator). When the denominator declines, the ratio result increases. The dollar amount of the dividend likely did not change.

(b)

In 2012, TransAlta’s experienced a large loss as is demonstrated by the earnings per share. Because of the nature of the business, creditors are not likely overly concerned with the company’s continued payment of dividends, particularly since past experience would have given them the reassurance that the company would return to profitability. Investors would view a suspension of dividends as a very negative signal.

(c)

If the dividend per share remained unchanged or even increased marginally, the increase in the dividend yield most likely resulted from a decline in share price. With the decline in profit in 2011 to a loss in 2012, the market price of TransAlta’s shares likely declined significantly.

(d)

Investors seeking dividend income would be happy with the corporation’s dividend policy. A higher dividend payout ratio means that a greater portion of the company’s profit is distributed to investors in the form of dividends. Since dividend yield is often compared to fixed income interest rates, a dividend yield in 2012 of 7.7% is much higher than the rate of interest that could have been earned by an investor on debt investments.

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PROBLEM 11-10B (a)

(in millions, except for per share information) Ratio

2012

2011

1. Payout ratio

$2,493 $6,023

= 41.4%

$2,200 $4,965

= 44.3%

2. Dividend yield

$2.19 $54.25

= 4.0%

$2.05 $52.53

= 3.9%

3. Earnings per share

$6,023 1,133

= $5.32

$4,965 1,072

= $4.63

4. Return on common shareholders' equity

$6,023 $30,804

(b)

= 19.6%

$4,965 $24,042

= 20.7%

During 2012, Scotiabank’s payout ratio decreased primarily because the bank’s profit rose proportionately more than the amount of cash dividends paid to the common shareholders. Its dividend yield slightly increased, primarily because of an increase in share prices. Its return on common shareholders’ equity declined in 2012. Despite an increase in profit, its shareholders’ equity increased more proportionately. The Scotiabank’s payout and dividend yield ratios are in line with those of its industry peers. Its return on common shareholders’ equity, although higher than the industry in 2011, is quite a bit lower than the industry in 2012.

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PROBLEM 11-11B (a)

Overall, Bargain Hunters is the more profitable of the two companies. Its profit margin, return on common shareholders’ equity, and return on assets ratios are higher than both Discount Paradise and the average company in the industry. In addition, Bargain Hunters has a lower asset turnover ratio than its competitors. This may mean that the company is not using its assets as productively as its competitors.

(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 profit 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 profits 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. Consequently, Discount Paradise can be expected to have a faster and higher growth in its share price.

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BYP 11-1 FINANCIAL REPORTING

(a)

1. Shoppers Drug Mart’s reported basic earnings per share for the year ended December 29, 2012 was $2.92 and for the year ended December 31, 2011 was $2.84. 2. Shoppers reported a weighted average number of common shares of 208.4 million in 2012, lower than the 216.4 million reported in 2011.

(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

2012 unlimited unlimited 204,451.8 nil

2011 unlimited unlimited 212,475.6 nil

The number of common shares issued does not correspond to the weighted average number of common shares because the number of shares is the actual number of shares issued as of the end of the fiscal year while the weighted average amount of shares weights shares issued and repurchased during each fiscal year for the proportion of the year they have been outstanding. 3. 7,949,400 common shares were repurchased during the 2012 fiscal year using a normal course issuer bid at an average cost of $41.53 per share ($330,128,000 ÷ 7,949,400). (c)

1. Shoppers reported other comprehensive loss in the amount of $4,978,000 for the 2012 fiscal year and a loss in the amount of $21,571,000 for the 2011 fiscal year. 2. Shoppers declared quarterly dividends to common shareholders in the amount of $0.265 per share during the 2012 fiscal year for a total of $1.06 per share. This amount compares to $0.25 per share in the 2011 fiscal year for a total of $1.00 per share.

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BYP 11-2 COMPARATIVE ANALYSIS (a) Ratio

Shoppers Drug Mart

Jean Coutu

Earnings per share (basic)

$2.92

$2.57

Diluted earnings per share

$2.92

$2.57

Both Shoppers and Jean Coutu report the same amount for both basic and diluted earnings per share. (b) Ratio

Jean Coutu ($ in millions)

Payout ratio

$215,671 $608,481

= 35.4%

$60.8 $558.4

Dividend yield

$1.08 $42.80

= 2.5%

$0.28 = 1.8% $15.78

$42.80 $2.92

= 14.7 times

$15.78 = 6.1 times $2.57

Price-earnings ratio

(c)

Shoppers Drug Mart ($ in thousands)

= 10.9%

Investors who are interested in dividend income would favour Shoppers over Jean Coutu based on its higher payout and dividend yield ratios. The earnings per share calculated in (a) is not comparable between companies because of differing capital structures.

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BYP 11-3 COMPARING IFRS AND ASPE (a)

Companies choose different types of ownership structures for a variety of reasons. One of the most common reasons companies choose to go public it is to access the funds available through the capital market. 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 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 in what 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 fair value of the consideration given up, given the lack of a readily available share price.

(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, earnings per share (EPS), is not usually considered to be relevant to the shareholders. 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).

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BYP 11-4 CRITICAL THINKING 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 All equity

Option 2 All debt

Option 3 Debt & equity

$1,000,000 1,000,000

$1,000,000 999,999 1

$2,000,000 1,000,000 1,000,000

Option 1 All equity

Option 2 All debt

Option 3 Debt & 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) Profit from operations Interest expense (6% of liabilities) Profit before income tax Income tax expense (25% of profit before income tax) Profit

(b) The return on common shareholders’ equity for each option is calculated below. Please note that because the profit 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.

Profit for the year Common shareholder's equity, beg. of year Common shareholder's equity, end of year Average shareholder's equity for the year Return on common shareholders’ equity

Solutions Manual .

Option 1 Option 2 All equity All debt $ 112,500 $67,500 1,000,000 1 1,000,000 1 1,000,000 1 11.3% 6,750,000.0%

11-76

Option 3 Debt & equity $ 180,000 1,000,000 1,000,000 1,000,000 18.0%

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BYP 11-4 (Continued) (b) (Continued) 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.

Dividends received by Depinder Interest received by Depinder

Option 1 All equity $112,500

Option 2 All debt $ 67,500 60,000 $127,500

Option 3 Debt & equity $180,000

(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 profit would rise. The preferred dividends would be reported on the statement of changes in equity and not on the income statement. The profit for the large restaurant would be exactly double what is currently reported on the income statement for the Option 1, the purchase of the small restaurant. (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 in the income statement rather than as dividends in 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 be shown. This is because the profit of the business is paid at the personal level as the business is not a separate legal entity.

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BYP 11-5 ETHICS CASE (a)

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 shareholder in the same position. A stock dividend is a “paper” dividend—the company issues a certificate, not a cheque (cash).

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BYP 11-6 “ALL ABOUT YOU” ACTIVITY 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%

Earnings per share

$21,600 ÷ 500 = $43.20

$24,000 ÷ 1,000 = $24.00

($24,000 - $3,000) ÷ 500 = $42.00

(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 earnings per share.

(d)

If I were a shareholder, I would choose Alternative 1. This alternative would generate a smaller amount of profit because of the amount of after tax interest expense paid on the loan; however, the return on common shareholder’s equity and earnings per share would increase because the distribution of profit is limited to current shareholders.

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BYP 11-7 SERIAL CASE (a)

June 15 Cash Dividends .................................................... Dividends Payable ........................................

75,000

June 30 Dividends Payable ................................................ Cash .............................................................

75,000

Since the date of record on the declaration of the dividend is June 20, 2015, only shareholders on that date are eligible to receive dividends. Natalie, Janet, and Brian each receive ⅓ of the dividend and will each receive $25,000. (b)

June 30 Vehicles ................................................................ Cash ..................................................................... Common Shares (100 × $1,075) ..................

45,000 62,500 107,500

Retained earnings, July 1, 2014 ................................................................... Add: Profit .................................................................................................. Less: Cash dividends .................................................................................. Retained earnings, June 30, 2015 ...............................................................

$182,601 216,069 398,670 75,000 $323,670

If Koebel’s 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) KOEBEL’S FAMILY BAKERY LTD. Statement of Financial Position (Partial) June 30, 2015 Shareholders’ equity Common shares, unlimited number authorized, 400 issued .......... Retained earnings .......................................................................... Total shareholders’ equity ......................................................................

$107,800 323,670 $431.470

($300 + $107,500 = $107,800)

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COMPREHENSIVE CASE: CHAPTERS 3 – 11 (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 ............................................................... Merchandise Inventory.....................................................

250,000

Cash ...................................................................................... Accounts Receivable .......................................................

296,000

Supplies ................................................................................ Accounts Payable ............................................................

35,100

Merchandise Inventory .......................................................... Accounts Payable ............................................................

330,000

Accounts Payable ................................................................. Merchandise 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. Cash Dividends ($1,400 + $4,200) ........................................ Dividends Payable ...........................................................

5,600

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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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COMPREHENSIVE CASE: CHAPTERS 3–11(Continued) (a) (Continued) Adjusting Journal Entries: 1. Dec.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) Cash Jan. 1

Bal.

24,000

Summary

50,000 Summary

315,560

Summary

30,000 Summary

88,200

Summary

100,000 Summary

6,000

Summary

296,000 Adj.

3,000

Dec. 31

Bal.

87,240 Accounts Receivable

Jan. 1

Bal.

Summary Dec. 31

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Bal.

45,500 Summary

296,000

320,000 Summary

1,700

67,800

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COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (b) (Continued)

Allowance for Doubtful Accounts Summary

1,700 Jan.

Bal.

1,500

Dec.

31 Adj.

3,700

Dec.

31 Bal.

3,500

Merchandise Inventory Jan.

1 Bal.

Summary Dec.

31 Bal.

70,000 Summary

250,000

330,000 Summary

6,440

143,560 Supplies

Jan.

1 Bal.

Summary Dec.

4,400 Dec.

Adj.

33,600

35,100 31 Bal.

5,900

Land Jan.

1 Bal.

40,000

Buildings Jan.

1 Bal.

142,000 Accumulated Depreciation—Buildings

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Jan.

Bal.

22,000

Dec.

Adj.

4,400

Dec.

Bal.

26,400

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COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (b) (Continued)

Accounts Payable Jan. Summary

1 Bal.

55,600

322,000 Summary

35,100

Summary

330,000

Dec.

31 Bal.

98,700

31 Adj.

350

Interest Payable Dec. Dividends Payable Summary

5,600

Income Tax Payable Dec.

31 Adj.

6,000

Jan.

1 Bal.

80,000

Dec.

31 Bal.

78,000

Mortgage Payable Summary

2,000

Preferred Shares Summary

50,000

Common Shares Jan.

Summary Dec.

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30,000 30,000

31 Bal.

60,000

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COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (b) (Continued) and (e) CE – Means closing entry Retained Earnings Dec. 31 CE

Jan.

1 Bal.

127,400

5,600 Dec.

31 CE

26,750

Dec.

31 Bal.

148,550

Accumulated Other Comprehensive Income Jan. 1 Bal.

9,400

Cash Dividends Summary

5,600

Dec. 31 Bal.

Dec. 31 CE

5,600

0 Sales

Dec. 31 CE

420,000 Summary Dec.

31 Bal.

420,000 0

Cost of Goods Sold Summary

250,000

Dec. 31 Bal.

Dec. 31 CE

250,000

0 Salaries Expense

Summary Dec.

88,200 31 Bal.

Dec. 31 CE

88,200

0 Supplies Expense

Dec. 31 Adj. Dec.

31 Bal.

33,600

Dec. 31 CE

33,600

0 Depreciation Expense

Dec. 31 Adj. Dec. Solutions Manual .

31 Bal.

4,400

Dec. 31 CE

4,400

0 11-85

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COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (b) and (e) (Continued) Bad Debts Expense Dec. 31 Adj. Dec.

31 Bal.

3,700

Dec. 31

3,700

0 Bank Charges Expense

Dec. 31 Adj. Dec.

31 Bal.

3,000

Dec. 31

3,000

4,350

0 Interest Expense

Summary

4,000

Dec. 31 Adj. Dec.

31 Bal.

350

Dec. 31

0 Income Tax Expense

Dec. 31

Adj.

Dec.

31 Bal.

6,000

Dec. 31 CE

6,000

0 Income Summary

Dec. 31

393,250

Dec. 31

26,750

Dec.

31 Bal.

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Dec. 31 CE

420,000

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COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (c)

HAMPTON CORPORATION Adjusted Trial Balance December 31, 2015

Debit Cash Accounts receivable Allowance for doubtful accounts Merchandise 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 Cash dividends 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

$885,350

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COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (d) (1) HAMPTON CORPORATION Income Statement Year Ended December 31, 2015

Sales ........................................................................ Cost of goods sold.................................................... Gross profit Operating expenses Salaries expense ............................................. Supplies expense ............................................ Depreciation expense ...................................... Bad debts expense .......................................... Bank charges expense .................................... Total operating expenses ....................... Profit from operations ............................................... Other revenues and expenses Interest expense .............................................. Profit before income tax ........................................... Income tax expense ................................................. Profit ........................................................................

$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

(2) HAMPTON CORPORATION Statement of Changes in Equity Year Ended December 31, 2015

Balance Jan. 1 Issued preferred shares Issued common shares Cash dividends Profit Balance Dec. 31

Solutions Manual .

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

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Total $166,800 50,000 30,000 (5,600) 26,750 $267,950

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (d) (Continued) (3) HAMPTON CORPORATION Statement of Financial Position December 31, 2015

Assets Current assets Cash........................................................... Accounts receivable ................................... Less: Allowance for doubtful accounts ...... Merchandise inventory ............................... Supplies ..................................................... Total current assets ............................. Property, plant and equipment Land ........................................................... Buildings .................................................... Less: Accumulated depreciation ............... Total property, plant, and equipment... Total assets.........................................................

$ 87,240 $67,800 3,500

64,300 143,560 5,900 301,000

$ 40,000 $142,000 26,400

115,600 155,600 $456,600

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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$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

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 3–11 (Continued) (e)

Closing Entries:

2015 Dec. 31

031

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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 ..............................................................

5,600

11-90

420,000

250,000 88,200 33,600 4,400 3,700 3,000 4,350 6,000

26,750

5,600

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Financial Accounting, Sixth Canadian Edition

CHAPTER 12 Reporting and Analyzing Investments ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Brief Questions Exercises

Exercises

A Problems

B Problems

BYP

Identify reasons to invest, and classify investments.

1, 2, 3

1, 2

Account for nonstrategic investments.

4, 5, 6, 7, 8, 18

2, 3, 4, 5, 8

3, 4, 5, 6, 8

1, 2, 3, 4, 5, 6, 7, 8

2, 4, 5

Account for strategic 9, 10, 11, 6, 7, 8 investments. 16

6, 7, 8

5, 6, 7, 8

2, 3, 4, 5, 7

Indicate how 3, 4, 12, 8, 9, 10, investments are 13, 14, 15, 11, 12 reported in the 16 financial statements.

2, 5, 8, 9

1, 2, 3, 4, 5, 6, 7, 8

1, 2, 3, 4, 5, 7

9, 10

*5. Compare the 17, 18, 19 13 accounting for a bond investment and a bond payable (Appendix 12A).

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record trading investments; show statement presentation.

Moderate

30-40

Record trading investments; show statement presentation.

Moderate

30-40

Record trading investments; show statement presentation.

Moderate

30-40

Determine valuation of investments; indicate statement presentation.

Moderate

30-40

Identify impact of investment transactions.

Moderate

20-30

Record strategic investment.

Moderate

30-40

Record investments; indicate statement presentation.

Moderate

30-40

Analyze strategic investment.

Moderate

30-40

*9A

Record bond investment; show statement presentation.

Complex

30-40

*10A

Record bonds for investor and investee.

Complex

30-40

Record trading investments; show statement presentation.

Moderate

30-40

Record trading investments; show statement presentation.

Moderate

30-40

Record trading investments; show statement presentation.

Moderate

30-40

Determine valuation of investments; indicate statement presentation.

Complex

30-40

Identify impact of investment transactions.

Moderate

20-30

Record strategic equity investment.

Moderate

30-40

Record investment; indicate statement presentation.

Moderate

30-40

Analyze strategic investment.

Moderate

30-40

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Description *9B Record bond investment; show statement presentation. *10B

Record bonds for investor and investee.

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Difficulty Level Complex

Time Allotted (min.) 30-40

Complex

30-40

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Financial Accounting, Sixth 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.

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.

(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.

(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.

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.

(a)

The $10 million difference between the carrying amount of $245 million and the fair value of $255 million 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.

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Answers to Questions (Continued) 7.

(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 other revenue and expenses section of the statement of income.

The carrying amount of the investment ($130,000) would be compared to the proceeds ($125,000). The $5,000 difference is a realized loss. The realized loss would be reported on the 2015 income statement in other revenues and expenses. The journal entries to record these transactions (not required) follow: Dec. 31, 2014

2015

Trading Investments Unrealized Gain on Trading Investments

15,000

Cash Realized Loss on Trading Investments Trading Investments

125,000 5,000

15,000

130,000

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. However, companies are required to use judgement rather than to blindly follow the 20% guideline. For example, 25% ownership in a company that is 75% controlled by another company would not necessarily indicate significant influence.

10. Under the cost model, the carrying amount of the company’s investment is recorded at cost. The investment account is not affected by the earnings of the entity into which the investment is made. The investing company records any dividends received as investment revenue, leaving the carrying amount (usually cost) of the investment intact. Under the equity method, the investment is also recorded at cost on the day the investment is made. However, the investment account is increased or decreased by the investor’s share of the investee company’s profit 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.

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Answers to Questions (Continued) 11. (a)

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.

(b)

The equity method is used when the investor exercises significant influence over the investee. Consequently, the investor has played a role in the determination of any profit or loss experienced by the investee. As the investee earns profit, 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 profit (or loss) and does not wait for the distribution of profit by way of dividends. The investment is reduced by the amount of dividends received rather than the dividends being recorded as revenue as is the case with the cost model.

12. (a)

Trading investments are classified as a 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 long-term investments 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 a current asset.

13. Account

Financial Statement

Classification

(a)

Unrealized Gain on Trading Investments

Income Statement

Other revenues and expenses

(b)

Realized Loss on Trading Investments

Income Statement

Other revenues and expenses

(c)

Revenue from Investment in Associates

Income Statement

Other revenues and expenses

(d)

Investment in Associate

Statement of Financial Position

Non-current assets

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Answers to Questions (Continued) 14.

Comprehensive income includes all changes to shareholders’ equity during a period except changes resulting from investments by shareholders and dividends declared. Profit 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. Profit 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 profit 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.

15.

Profit reported on the income statement is a component of comprehensive income. Profit along with other comprehensive income is reported in the statement of comprehensive income (if the company chooses to report both under a single statement). Profit (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).

16. (a)

Since George Weston Ltd. owns 63% of the common shares of Loblaw Compaines Ltd., it must use the equity method to account for its investment. Furthermore, George Weston must consolidate its results with those of Loblaw by preparing consolidated financial statements.

(b)

George Weston is the parent since it owns 63% of the voting shares of Loblaw. Therefore, Loblaw is a subsidiary of George Weston.

(c)

Consolidated financial statements should be prepared. When consolidated financial statements are prepared, George Weston will eliminate its investment account from its own records and replace this with the specific assets and liabilities of Loblaw. The consolidated financial statements would include all of

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George Weston’s assets and liabilities at their carrying amount in addition to the assets and liabilities of Loblaw.

Answers to Questions (Continued) *17. The accounting treatment for an investment in bonds is essentially the inverse of the recording required for a bond liability. In both cases, the investment 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 revalued 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). *18. 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. *19. 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 as 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.

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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

A few common shares of a small oil company purchased with a temporary surplus of cash 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 100% of the common shares of a company purchased to amalgamate 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.

4. 5.

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(c) Reason for Making the Investment? Interest revenue for 120 days. Share price appreciation (capital gain) and dividend revenue.

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BRIEF EXERCISE 12-2 (a) Jan. (b) July (c) Dec.

Dec.

Trading Investments ............................................... Cash ..............................................................

200,000

Cash ....................................................................... Interest Revenue ($200,000 × 10% × 6/12) ...

10,000

Interest Receivable ................................................. Interest Revenue ($200,000 × 10% × 6/12) ..

10,000

Unrealized Loss on Trading Investments ................ Trading Investments ..................................... ($200,000 – [$200,000 × 97%])

6,000

200,000

10,000

6,000

BRIEF EXERCISE 12-3 2016 Jan.

Cash ....................................................................... 194,000 Trading Investments ...................................... 194,000 The investment is already carried at fair value so no gain or loss will result on this sale.

BRIEF EXERCISE 12-4 (a) Aug. (b) Dec.

Trading Investments. .............................................. Cash ..............................................................

45,000

Trading Investments ............................................... Unrealized Gain on Trading Investments .......

4,000

45,000

4,000

BRIEF EXERCISE 12-5 Feb.

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Cash ........................................................................... Realized Loss on Trading Investments ………... ........ Trading Investments ..........................................

12-10

47,000 2,000 49,000

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BRIEF EXERCISE 12-6 Jan.

Dec.

Investment in Associates .............................................. Cash.....................................................................

400,000

Cash (25% × $32,000) ................................................. Investment in Associates .....................................

8,000

Investment in Associates (25% × $800,000) ................ Revenue from Investment in Associates ............

200,000

400,000

8,000

200,000

Rook would report $200,000 of revenue from its investment in Hook for the year.

BRIEF EXERCISE 12-7 Jan.

Dec.

Investment in Associates .............................................. Cash.....................................................................

400,000

Cash (25% × $32,000) ................................................. Dividend Revenue ................................................

8,000

400,000

8,000

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 $8,000 (25% × $32,000). This is different from the equity method which records a pro-rata share of profit from Hook and records receipt of dividends as a reduction of the investment account on the statement of financial position.

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 profit (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

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investments.

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BRIEF EXERCISE 12-9 Financial Statement

Classification

A bond investment that will mature next year

Statement of financial position

Current assets

Dividend revenue from a trading investment

Income statement

Other revenues and expenses

Investment in associate

Statement of financial position

Long-term investments

Investment of a few hundred common shares in a large publicly traded company that is held for trading purposes

Statement of financial position

Current assets

A bond investment that management intends to hold for 10 years

Statement of financial position

Long-term investments

Realized gain on a trading investment

Income statement

Other revenues and expenses

Unrealized gain on a 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

Interest earned on a trading investment

Income statement

Other revenues and expenses

BRIEF EXERCISE 12-10 Include in profit or OCI?

Item Realized gain on long-term investments Unrealized loss on trading investments Revenue from investment in associates

Profit Profit Profit

For investments that are non-strategic and not held for trading, the company can elect to report unrealized gains and losses in other comprehensive income.

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BRIEF EXERCISE 12-11 SABRE CORPORATION Statement of Financial Position (Partial) December 31, 2015 Assets Current assets Trading investments……………… ............................................

$ 29,000

Long-term investments Long-term investments .............................................................. Investment in associates ...........................................................

435,000 * 116,800 **

* **

$435,000 = $275,000 (equity investment in Epee at fair value) + $160,000 (bond investment held to maturity at amortized cost) $116,800 = $110,000 + ($25,000 × 40%) – ($8,000 × 40%)

BRIEF EXERCISE 12-12 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 long-term investments as an investment in associates. Brookfield’s share of profit from associates would be reported on their 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 in 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 in the statement of financial position in long-term investments.

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*BRIEF EXERCISE 12-13 (a)

Investor

June

Dec.

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

Dec.

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138,960

8,338

Cash ....................................................................... Bonds Payable ...............................................

138,960

Interest Expense ($138,960 × 12% × 6/12) ............ Cash .............................................................. Bonds Payable ...............................................

8,338

12-15

138,960 7,500 838

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SOLUTIONS TO EXERCISES EXERCISE 12-1

1. 2. 3. 4. 5.

(a) Debt or Equity Investment? Equity Debt Equity Debt Equity

(b) Non-Strategic or Strategic Investment? Strategic Non-Strategic Strategic Non-Strategic Non-Strategic

EXERCISE 12-2 (a) 1.

10-year BCE bonds

10-year GE bonds

5-year Government of Canada bonds 180-day treasury bill

4. 5.

Bank of Montreal preferred shares*

TMX common shares

NonStrategic NonStrategic NonStrategic NonStrategic NonStrategic

NonStrategic

(b) Held until maturity Trading

Trading

Current

Trading

Current

Neither trading or held to maturity Trading

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 profit or loss model.

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EXERCISE 12-3 (a) July (b) Dec.

Trading Investments ($700,000 × 106.5%) ............. Cash ..............................................................

745,500

Interest Receivable ................................................. Interest Revenue ($700,000 × 10% × 6/12) ...

35,000

Adjustment to fair value: Dec. 31 Trading Investments ............................................... Unrealized Gain on Trading Investments ....... ($700,000 × 107%) – $745,500

745,500

35,000

3,500 3,500

EXERCISE 12-4 Jan. 01 Trading Investments .................................................... Cash....................................................................... Apr.

July

Oct.

210,000 210,000

1 Cash (2,000 × $5 ÷ 4) .................................................. Dividend Revenue ..................................................

2,500

1 Cash (2,000 × $5 ÷ 4) .................................................. Dividend Revenue ..................................................

2,500

02 Cash ............................................................................ Realized Gain on Trading Investments ................. Trading Investments.............................................. [($210,000 ÷ 2,000) × 500]

57,000

1 Cash (1,500 × $5 ÷ 4) .................................................. Dividend Revenue ..................................................

1,875

(b) Dec. 31 Dividends Receivable .................................................. Dividend Revenue .................................................. 31 Trading Investments .................................................... Unrealized Gain on Trading Investments ............... (1,500 × $115) – ($210,000 – $52,500) (c) Feb. 15 Cash (500 × $117)....................................................... Realized Gain on Trading Investments .................. Trading Investments............................................... (Carrying amount = $115 × 500)

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2,500

4,500 52,500

1,875 1,875 1,875 15,000 15,000

58,500 1,000 57,500

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EXERCISE 12-5 (a) Dec.

31 Trading Investments ........................................... Unrealized Gain on Trading Investments ...... ($54,000 – $52,000)

2,000 2,000

(b) YANIK INC. Statement of Financial Position (Partial) December 31, 2015

Current assets Trading investments ............................................................... $54,000

YANIK INC. Income Statement (Partial) Year Ended December 31, 2015

Other revenues and expenses Unrealized gain on trading investments .................................. (c) Mar.

22 Cash ................................................................... Realized Gain on Trading Investments.......... Trading Investments ......................................

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$2,000

22,000 1,000 21,000

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EXERCISE 12-6 Jan.

Mar.

June

Dec.

1 Investment in Associates .................................... 192,000 Cash (30,000 × 40% × $16) .........................

192,000

18 Long-Term Investments ....................................... 840,000 Cash (200,000 × 15% × $28) ........................

840,000

15 Cash ($70,000 × 40%) ......................................... Investment in Associates .............................

28,000 28,000

30 Cash ($150,000 × 15%) ....................................... Dividend Revenue .........................................

22,500

31 Investment in Associates .................................... Revenue from Investment in Associates ...... ($150,000 × 40%)

60,000

31 Unrealized Loss on Long-Term Investments [($840,000 – (30,000 × $26)] ............................... Long-Term Investments ................................

22,500

60,000

60,000 60,000

When the equity method is used to account for investment in associates, the investment account is not adjusted to fair value.

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EXERCISE 12-7 (a) Oct.

Dec. 29

(b) Oct.

Dec. 29

Investment in Associates .................................. Cash (200,000 × $2.50) ...............................

500,000

Cash ($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

Cash ($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

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EXERCISE 12-8

(a)Account Balance, beginning of year Purchases of investments during the year Carrying amount of investments sold during the year

Trading Investments

Investment in Associates

$100,000

$300,000

30,000

40,000

(43,000)*

(42,000)**

Dividends received

(8,000)

Share of associates’ profit Fair value adjustment derived($94,000−$100,000 + $30,000 −$43,000)

43,000

7,000

Balance, end of year * $55,000 less gain of $12,000 ** $32,000 plus loss of $10,000 (b)

$94,000

$333,000

Trading Investments Trading Investments ............................................... Cash ..............................................................

30,000

Cash ....................................................................... Realized Gain on Trading Investments .......... Trading Investments ......................................

55,000

Cash ....................................................................... Dividend Revenue.........................................

3,000

Trading Investments ............................................... Unrealized Gain on Trading Investments ......

7,000

30,000

12,000 43,000

3,000

7,000

Investment in Associates

Solutions Manual .

Investment in Associates ........................................ Cash .............................................................

40,000

Cash ....................................................................... Realized Loss on Investment in Associates ............ Investment in Associates ...............................

32,000 10,000

Cash ....................................................................... Investment in Associates ..............................

8,000

12-21

40,000

42,000

8,000 Chapter 12

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Financial Accounting, Sixth Canadian Edition

EXERCISE 12-8 (Continued) (b) Continued Investment in Associates ........................................ Revenue from Investment in Associates .......

43,000 43,000

Investment in Associates

$94,000 $333,000

Income Statement: Realized gain on trading investments Unrealized gain on trading investments Dividend revenue

$12,000 7,000 3,000

Revenue from investment in associates Realized loss from investment in associates

$43,000 10,000

EXERCISE 12-9 (a)

100% Cameco Europe – equity method but then investment is eliminated when the subsidiary accounts are consolidated together with those of the parent company 23.3% UEX – equity method 24% GE-Hitachi Global – equity method All 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.

(b)

Cameco Europe should be consolidated with Cameco’s operations because Cameco is the parent company of a fully owned subsidiary, Cameco Europe.

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 12-10 (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

2015 June 30

Dec.

2016 June

Solutions Manual .

Long-Term Investments .......................................... Cash ..............................................................

462,808

Cash ($500,000 × 5% × 6/12) ................................. Long-Term Investments .......................................... Interest Revenue ($462,808 × 6% × 6/12) .....

12,500 1,384

462,808

Cash ($500,000 × 5% × 6/12) ................................. 12,500 Long-Term Investments .......................................... 1,426 Interest Revenue (($462,808 + $1,384) × 6% × 6/12)

12-23

13,884

13,926

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Financial Accounting, Sixth Canadian Edition

*EXERCISE 12-10 (Continued) (c)

Investee

2016 June 30

Dec.

2016 June 30

Cash ....................................................................... Bonds Payable ...............................................

462,808

Interest Expense ($462,808 × 6% × 6/12) .............. Cash .............................................................. Bonds Payable ...............................................

13,884

Interest Expense (($462,808 + $1,384) × 6% × 6/12) Cash .............................................................. Bonds Payable ...............................................

13,926

462,808

12,500 1,384

12,500 1,426

(d) The response to (a) would differ in that the bond purchase would be recorded in a trading investment account. The discount would not be amortized; the $12,500 cash receipt of interest would be recorded as interest revenue. The bonds carrying amount would be adjusted to the fair value of $465,000 ($500,000 × 93%) at December 31, 2015. 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.

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 12-1A (a)

Feb.

Aug.

Dec. 31

Trading Investments ...................................... Cash ($100,000 × 1.04) .........................

104,000

Cash ($100,000 × 9% × 6/12) ........................ Interest Revenue ...................................

4,500

Cash ($40,000 × 1.02) ................................... Realized Loss on Trading Investments .......... Trading Investments ($104,000 × 40%).

40,800 800

104,000

4,500

41,600

Interest Receivable ($60,000 × 9% × 5/12) ................................... Interest Revenue ...................................

2,250

Unrealized Loss on Trading Investments ($104,000 – $41,600) – $60,000 .................... Trading Investments ..............................

2,400

2,250

2,400

(b) GIVARZ CORPORATION Statement of Financial Position (Partial) December 31, 2015 Current assets Interest receivable ............................................................................ Trading investments .........................................................................

$ 2,250 60,000

(c) GIVARZ CORPORATION Income Statement (Partial) Year Ended December 31, 2015 Other revenues and expenses Interest revenue ($4,500 + $2,250) .................................................. Unrealized loss on trading investments ................................. $2,400 Realized loss on trading investments ...................................... 800

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$6,750 3,200 $3,550 Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-2A

(a)

Feb. 1

Mar. 1

Apr.

July

Aug. 1

Sept. 1

Oct.

Solutions Manual .

Trading Investments ................................................. Cash ...............................................................

36,000

Trading Investments ................................................. Cash ................................................................

24,000

Trading Investments ................................................. Cash ...............................................................

60,000

Cash ($3 × 600) ....................................................... Dividend Revenue ...........................................

1,800

Cash ($58 × 200) .................................................... Realized Loss on Trading Investments .................... Trading Investments ........................................ [($36,000 ÷ 600) × 200]

11,600 400

Cash ($1.50 × 800) .................................................. Dividend Revenue ...........................................

1,200

Cash ($60,000 × 7% × 6/12) .................................... Interest Revenue .............................................

2,100

Cash ......................................................................... Realized Gain on Trading Investments ($62,000 – $60,000) ........................................ Trading Investments ........................................

62,000

12-26

36,000

24,000

60,000

1,800

12,000

1,200

2,100

2,000 60,000

Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-2A (Continued) (a) (Continued) Dec. 31

Unrealized Loss on Trading Investments (see below $48,000 – $46,800).......................... Trading Investments ..................................

Security CBF common RSD common

Cost $24,000* 24,000 $48,000

Fair Value $22,000 24,800 $46,800

1,200 1,200

(400 × $55) (800 × $31)

*$36,000 − $12,000 = $24,000

(b)

KAKISA FINANCIAL CORPORATION Statement of Financial Position (Partial) December 31, 2015 Current assets Trading investments ....................................................................

(c)

$46,800

KAKISA FINANCIAL CORPORATION Income Statement (Partial) Year Ended December 31, 2015 Other revenues and expenses Dividend revenue ($1,800 + $1,200) ................................................ Interest revenue ............................................................................... Realized gain on trading investments ............................................... Unrealized loss on trading investments ................................. $1,200 Realized loss on trading investments ...................................... 400

$3,000 2,100 2,000 7,100 1,600 $5,500

Please note that it would not be wrong to combine realized gains and losses for a specific category of investments for presentation purposes.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-3A (a) Mar.

June

Sept.

Oct.

Dec.

Cash ......................................................................... Realized Gain on Trading Investments ............ Trading Investments ........................................

23,600

Trading Investments ................................................. Cash ................................................................

28,000

Cash ($1.50 × 800) .................................................. Dividend Revenue ...........................................

1,200

Cash ........................................................................ Realized Gain on Trading Investments ............ Trading Investments (400 × $31) .....................

12,500

Unrealized Loss on Trading Investments ................. Trading Investments ($40,400 – $35,200) .......

5,200

Security

Carrying Amount

Fair Value

$12,400* 28,000 $40,400

$13,200 22,000 $35,200

RSD common KEF common

1,600 22,000

28,000

1,200

100 12,400

5,200

(400 × $33) (2,000 × $11)

*$24,800 – $12,400 = $12,400

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-3A (Continued)

(b)

KAKISA FINANCIAL CORPORATION Statement of Financial Position (Partial) December 31, 2016 Current assets Trading investments ....................................................................

(c)

$35,200

KAKISA FINANCIAL CORPORATION Income Statement (Partial) Year Ended December 31, 2016 Other revenue Realized gain on trading investments ($1,600 + $100) .................... Dividend revenue ........................................................................... Other expense Unrealized loss on trading investments ............................................

Solutions Manual .

12-29

$1,700 1,200 2,900 5,200

Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-4A

(a)

Debt Securities

Quantity

Dominion bonds Government of Canada bonds Sub-total

2,000

Cost Unit Total $100 $200,000

1,000

100

Equity Securities Bank of Calgary Matco Inc. Argenta Corp. Sub-total Total

Quantity 2,000 5,000 5,000

100,000 300,000

Cost Unit Total $55 $110,000 29 145,000 36 180,000 435,000 $735,000

Fair Value Unit Total $ 97 $194,000 135

135,000 329,000

Fair Value Unit Total $61 $122,000 32 160,000 40 200,000 482,000 $811,000

(b)

If Val d’Or’s entire portfolio is comprised of trading investments, they would be carried at their fair value of $811,000. An unrealized gain of $76,000 ($811,000 – $735,000) would appear under other revenues and expenses on the company’s income statement.

(c)

If Val d’Or’s 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 $300,000. The portfolio of debt securities would be classified as a long-term investment. No unrealized gains or losses would be recognized for the debt portfolio on the income statement. The equity securities would be carried at fair value of $482,000. The portfolio of equity securities would be classified as a current asset. An unrealized gain of $47,000 ($482,000 – $435,000) would appear under other revenues and expenses on the company’s income statement.

(d)

If Val d’Or 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-5A (a)

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. (b)

Statement of Financial Position Shareholders’ Assets Liabilities Equity 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 Shareholders’ Assets Liabilities Equity 10. + NE +

(c)

Income Statement Revenues Expenses and Gains and Losses Profit

Income Statement Revenues Expenses and Gains and Losses Profit + NE +

Under ASPE, using the cost model to account for 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 Shareholders’ Assets Liabilities Equity 7. NE NE NE 8. + NE +

Solutions Manual .

Income Statement Revenues Expenses and Gains and Losses NE NE + NE

12-31

Profit NE +

Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-6A (a)

No significant influence

Jan.

Mar.

June 15

Sept. 15

Dec. 15

Long-Term Investments ....................................... Cash ...............................................................

1,800,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

Unrealized Loss on Long-Term Investments [$1,800,000 – (100,000 × $17)] ............................ Long-Term Investments ..................................

(b)

Significant influence

Jan.

Mar.

June 15

Sept. 15

Dec. 15

Solutions Manual .

1,800,000

50,000

100,000 100,000

Investment in Associates ..................................... Cash ...............................................................

1,800,000

Cash (100,000 × $0.50) ....................................... Investment in Associates ................................

50,000

Cash (100,000 × $0.50) ....................................... Investment in Associates ................................

50,000

Cash (100,000 × $0.50) ....................................... Investment in Associates ................................

50,000

Cash (100,000 × $0.50) ....................................... Investment in Associates ................................

50,000

Investment in Associates ..................................... Revenue from Investment in Associates ($1,100,000 × 25%) .....................................

275,000

12-32

1,800,000

50,000

275,000

Chapter 12

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Financial Accounting, Sixth 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.

Mar.

June 15

Sept. 15

Dec. 15

Solutions Manual .

Long-Term Investments ....................................... Cash ...............................................................

1,800,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

Cash (100,000 × $0.50) ....................................... Dividend Revenue ..........................................

50,000

12-33

1,800,000

50,000

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Financial Accounting, Sixth 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 and the information provided by the equity method may not relevant.

(f)

Statement of Financial Position: Long-term investments: Purchase price Receipt of dividends ($50,000 × 4) Investee’s profit Fair value adjustment Carrying amount Income Statement: Dividend revenue Revenue from Investment in Associates Unrealized loss on longterm investments

Solutions Manual .

No Significant Influence

Significant Influence

Cost Model

$1,800,000

0 0 (100,000) $1,700,000

(200,000) 275,000 0 $1,875,000

0 0 0 $1,800,000

$200,000

275,000

(100,000)

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-7A (a)

2014 Oct.

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)

2015 Sept. 30

Long-Term Investments .................................... Cash (25,000 × $50) ....................................

1,250,000

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 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 (b)

2014 Oct.

$ 0 1,250,000 75,000 $1,325,000 $ 6,250 75,000

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)

2015 Sept. 30

Solutions Manual .

Investment in Associates .................................. Cash (70,000 × $50) ....................................

3,500,000

Cash ($0.25 × 70,000) ...................................... Investment in Associates .............................

17,500

Investment in Associates .................................. Revenue from Investment in Associates ($575,000 × 35%) ........................................

201,250

12-35

3,500,000

17,500

201,250

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-7A (Continued) (b) Continued Statement of Financial Position: Investments in Associates: Beginning balance Purchase price Receipt of dividends Investee’s profit Carrying amount end of year Income Statement: Dividend revenue Revenue from investment in associates Unrealized gain on long-term investments

Situation 2

$ 0 3,500,000 (17,500) 201,250 $3,683,750 $ 0 201,250 0

(c)

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.

(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 would be used rather than the cost model.

(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.

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Financial Accounting, Sixth 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 the 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 profits 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

$1,200,000 (90,000) 1,110,000

Plus: 25% of Sandhu Travel Agency’s earnings for the year that the investment was owned - derived ( 1,400,000 – 1,110,000) Balance of investment, December 31, 2015

290,000 $1,400,000

If $290,000 is 25% of Sandhu’s income for the year, then the 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 profits as follows: KANG INC. Income Statement (Partial) Year Ended December 31, 2015 Other revenues and expenses Revenue from investment in associates ....................................

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$290,000

Chapter 12

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Financial Accounting, Sixth 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, 2015 Other revenues and expenses Dividend revenue.......................................................................

Solutions Manual .

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$90,000

Chapter 12

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 12-9A (a) Jan.

(b)

Long-Term Investments .................................... Cash ............................................................

1,658,157 1,658,157

Bond Amortization Schedule Interest Received 3.5%

Interest Revenue 3.25%

Premium Amortization

$56,000 56,000 56,000 56,000 56,000 56,000 56,000

$53,890 53,822 53,751 53,678 53,602 53,524 53,444

$2,110 2,178 2,249 2,322 2,398 2,476 2,556

Amortized Cost $1,658,157 1,656,047 1,653,869 1,651,620 1,649,298 1,646,900 1,644,424 1,641,868

8 9 10 11 12 13 14 15 16 17

56,000 56,000 56,000 56,000 56,000 56,000 56,000 56,000 56,000 56,000

53,361 53,275 53,186 53,095 53,001 52,903 52,802 52,698 52,591 52,480

2,639 2,725 2,814 2,905 2,999 3,097 3,198 3,302 3,409 3,520

1,639,229 1,636,504 1,633,690 1,630,785 1,627,786 1,624,689 1,621,491 1,618,189 1,614,780 1,611,260

18 19 20

56,000 56,000 56,000

52,366 52,248 52,126

3,634 3,752 3,874

1,607,626 1,603,874 1,600,000

Semi-Annual Interest Period Issue Date 1 2 3 4 5 6 7

* Note: Rounding adjustments have been made as required in the above schedule.

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 12-9A (Continued) (c) July

(d) Sept. 30

(e) 2025 Jan. 1

Cash ................................................................. Long-Term Investments ............................... Interest Revenue ........................................

56,000

Interest Receivable ($56,000 × 3/6) .................. Long-Term Investments ............................... Interest Revenue ($53,822 × 3/6) ...............

28,000

Cash.................................................................. Long-Term Investments ...............................

1,600,000

2,110 53,890

1,089 26,911

1,600,000

(f) JACKSON CORP. Statement of Financial Position (Partial) September 30, 2015 Current assets Interest receivable ........................................................

Long term investments .......................................................... ($1,658,157– $2,110 – $1,089)

Solutions Manual .

12-40

$ 28,000

1,654,958

Chapter 12

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 12-10A (a)

Feb.

Aug.

(b)

Feb.

Aug.

(c)

Feb.

Aug.

1 Long-Term Investments ............................... Cash ($3,000,000 × 98%) ......................

2,940,000

1 Cash ($3,000,000 × 8% × 6/12) ................... Long-Term Investments ............................... Interest Revenue ($2,940,000 × 8.5% × 6/12) ....................

120,000 4,950

1 Cash ($3,000,000 × 99%) ............................ Long-Term Investments ($2,940,000 + $4,950) ........................... Realized Gain on Long-Term Investments .........................................

2,970,000

1 Trading Investments .................................... Cash ($3,000,000 × 98%) ......................

2,940,000

1 Cash ($3,000,000 × 8% × 6/12) ................... Interest Revenue ....................................

120,000

1 Cash ($3,000,000 × 99%) ............................ Long-Term Investments.......................... Realized Gain on Trading Investments .........................................

2,970,000

1 Cash ............................................................ Bonds Payable ($10,000,000 × 98%) .....

9,800,000

1 Interest Expense ($9,800,000 × 8.5% × 6/12) ......................... Bonds Payable ....................................... Cash ($10,000,000 × 8% × 6/12) ...........

2,940,000

124,950

2,944,950 25,050

2,940,000

120,000

2,940,000 30,000

9,800,000

416,500 16,500 400,000

1 Bonds Payable* ........................................... 2,944,950 Loss on Redemption of Bonds ..................... 25,050 Cash ($3,000,000 × 99%) ...................... 2,970,000 * $2,944,950 = ($9,800,000 + $16,500) × ($3,000,000 / $10,000,000)

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 12-10A (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 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 carrying 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-1B (a)

Jan.

July

Dec. 31

Trading Investments ............................................ Cash ($100,000 × .96) .................................

96,000

Cash ($100,000 × 8% × 6/12) .............................. Interest Revenue .........................................

4,000

Cash .................................................................... Trading Investments ($96,000 ÷ 4) .............. Realized Gain on Trading Investments ........

25,000

Interest Receivable ($75,000 × 8% × 6/12) .......... Interest Revenue .........................................

3,000

Trading Investments ([$75,000 × 1.01] – $72,000*) .............................. Unrealized Gain on Trading Investments .... *$96,000 – $24,000 = $72,000

96,000

4,000

24,000 1,000

3,000

3,750 3,750

(b) LIU CORPORATION Statement of Financial Position (Partial) December 31, 2015 Current assets Interest receivable ............................................................ Trading investments ........................................................

$ 3,000 75,750

LIU CORPORATION Income Statement (Partial) Year Ended December 31, 2015 Other revenues and expenses Interest revenue ($4,000 + $3,000) ................................... Realized gain on trading investments ................................ Unrealized gain on trading investments ............................. Solutions Manual .

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$7,000 1,000 3,750 Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-2B (a)

Feb. 1

Mar. 1

Apr.

July

Aug. 1

Sept. 1

Oct.

Solutions Manual .

Trading Investments ................................................. Cash ................................................................

30,000

Trading Investments ................................................. Cash ................................................................

29,000

Trading Investments ................................................. Cash ...............................................................

90,000

Cash ($2 × 1,000) .................................................... Dividend Revenue ...........................................

2,000

Cash (350 × $33) ..................................................... Realized Gain on Trading Investments ............ 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 Trading Investments .................... Trading Investments ........................................

86,000 4,000

12-44

30,000

29,000

90,000

2,000

1,050 10,500

750

2,700

90,000

Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-2B (Continued) Dec. 31

Trading Investments................................................. Unrealized Gain on Trading Investments ......... ($49,200 – $48,500) .........................................

Security IBF Common RST Common

Cost $19,500* 29,000 $48,500

Fair Value $18,200 31,000 $49,200

700 700

(650 × $28) (500 × $62)

*$30,000 – $10,500 = $19,500 (b)

CHEQUE MART LTD. Statement of Financial Position (Partial) December 31, 2015 Current assets Trading investments ....................................................................

(c)

$49,200

CHEQUE MART LTD. Income Statement (Partial) Year Ended December 31, 2015 Other revenue Dividend revenue ($2,000 + $750) ................................................... Interest revenue ............................................................................... Realized gain on trading investments ............................................... Unrealized gain on trading investments ............................................

Other expense Realized loss on trading investments ...............................................

$2,750 2,700 1,050 700 7,200

4,000

Please note that it would not be wrong to combine realized gains and losses for a specific category of investments for presentation purposes.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-3B (a) Mar.

June

Sept.

Oct.

Dec.

Security RST Common DEF Common

Cash ......................................................................... Realized Gain on Trading Investments ............ Trading Investments ........................................

22,100

Trading Investments ................................................. Cash ................................................................

18,000

Cash ($1.50 × 500) .................................................. Dividend Revenue ...........................................

750

Cash ........................................................................ Realized Loss on Trading Investments .................... Trading Investments ........................................ (250 × $62)

14,250 1,250

Trading Investments ................................................. Unrealized Gain on Trading Investments ......... (See below: $38,000 – $33,500)

4,500

Carrying Amount $15,500* 18,000 $33,500

Fair Value $14,000 24,000 $38,000

3,900 18,200

18,000

750

15,500

4,500

(250 × $56) (2,000 × $12)

*$31,000 – $15,500 = $15,500 which is the same as 250 × $62

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-3B (Continued) (b)

CHEQUE MART LTD. Statement of Financial Position (Partial) December 31, 2016 Current assets Trading investments ....................................................................

(c)

$38,000

CHEQUE MART LTD. Income Statement (Partial) Year Ended December 31, 2016 Other revenue Unrealized gain on trading investments ............................................ Realized gain on trading investments ............................................... Dividend revenue ...........................................................................

Other expense Realized loss on trading investments ...............................................

$4,500 3,900 750 9,150

1,250

Please note that it would not be wrong to combine realized gains and losses for a specific category of investments for presentation purposes.

Solutions Manual .

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-4B (a) Security Ajax Ltd. shares Beta Corp. shares Citrus Inc. bonds

Quantity

Cost

4,700 2,500 300

$ 50,2001 18,0002 30,0003 $98,200

1 (1,500 × $12) + (1,200 × $11) + (1,000 × $9) + (1,000 × $10) = $50,200 2 (2,000 × $7) + (500 × $8) = $18,000 3 (300 × $100) = $30,000

Security Ajax Ltd. shares Beta Corp. shares Citrus Inc. bonds

Quantity 4,700 2,500 300

Fair Value $28,2001 22,5002 32,1003 $82,800

1 4,700 × $6 = $28,200 2 2,500 × $9 = $22,500 3 300 × $100 × 1.07 = $32,100

(b)

If Sturge’s entire portfolio is comprised of trading investments, they would be carried at their fair value of $82,800. An unrealized loss of $15,400 ($98,200 – $82,800) would be reported under other revenues and expenses on the company’s income statement.

(c)

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 $30,000. The portfolio of debt securities would be classified as a long-term investment. 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 of $17,500 [($50,200 + $18,000) – ($28,200 + $22,500)] under other revenues and expenses on the income statement. The equity securities would be carried at fair value of $50,700 ($82,800 – $32,100) or ($28,200 + $22,500) 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-5B (a)

Statement of Financial Position

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. (b)

Income Statement

Shareholders’ Assets Liabilities Equity NE NE NE (+/-) + NE + NE NE NE (+/-) + NE + + NE + (+/-) NE NE NE (+/-) + NE + NE NE NE (+/-) + NE + NE NE NE

Expenses and Losses Profit

+ 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 Shareholders’ Assets Liabilities Equity 10. NE -

(c)

Revenues and Gains

Income Statement Revenues Expenses and Gains and Losses Profit NE + -

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 Shareholders’ Assets Liabilities Equity 7. NE NE NE

Solutions Manual .

Income Statement Revenues Expenses and Gains and Losses NE NE

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Profit NE

Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-6B (a)

No significant influence Jan. 1 Long-Term Investments ................................. Cash ...................................................... June

Dec.

(b)

Dec.

Solutions Manual .

3,000,000

Cash (100,000 × $0.50) ................................. Dividend Revenue .................................

50,000

Cash (100,000 × $0.50) ................................. Dividend Revenue .................................

50,000

Long-Term Investments ($31 × 100,000) – $3,000,000 ........................ Unrealized Gain on Long-Term Investments .......................................

Significant influence Jan. 1 Investment in Associates ............................... Cash ...................................................... June

3,000,000

50,000

100,000 100,000

3,000,000 3,000,000

Cash (100,000 × $0.50) ................................. Investment in Associates .......................

50,000

Cash (100,000 × $0.50) ................................. Investment in Associates .......................

50,000

Investment in Associates ............................... Revenue from Investment in Associates ($1,680,000 × 20%) ...............................

336,000

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50,000

336,000

Chapter 12

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-6B (Continued) (c)

(d)

Cost model Jan.

June

Dec.

(e)

Long-Term Investments ................................. Cash ......................................................

3,000,000

Cash (100,000 × $0.50) ................................. Dividend Revenue .................................

50,000

Cash (100,000 × $0.50) ................................. Dividend Revenue .................................

50,000

3,000,000

50,000

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 and the information provided by the equity method may not relevant.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-6B (Continued) (f)

Statement of Financial Position: Long-term investments: Purchase price Receipt of dividends ($50,000 × 2) Investee’s profit Fair value adjustment Carrying amount Income Statement: Dividend revenue Revenue from investment in associates Unrealized gain on longterm investments

Solutions Manual .

No Significant Influence

Significant Influence

Cost Model

$3,000,000

0 0 100,000 $3,100,000

(100,000) 336,000 0 $3,236,000

0 0 0 $3,000,000

$100,000

336,000

100,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 12-7B (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) 2015 Jan.

Dec.

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 Situation 1

$ 0 600,000 120,000 $720,000 $ 30,000 120,000

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) 2015 Jan.

Dec.

Solutions Manual .

2 Investment in Associates ............................. Cash (125,000 × $10) .......................

1,250,000

31 Cash (125,000 × $0.50) ............................... Investment in Associates ..................

62,500

31 Investment in Associates ............................. Revenue from Investment in Associates ($350,000 × 25%) ......

87,500

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1,250,000

62,500

87,500

Chapter 12

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 12-7B (Continued) (b) Continued Statement of Financial Position: Investments in Associates: Beginning balance Purchase price Receipt of dividends Investee’s profit Carrying amount end of year Income Statement: Dividend revenue Revenue from investment in associates Unrealized gain on long-term investments

Situation 2

$ 0 1,250,000 (62,500) 87,500 $1,275,000 $ 0 87,500 0

(c)

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.

(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 would be used rather than the cost model.

(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.

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Financial Accounting, Sixth 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 earnings 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 Part (b) above

(d)

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 to the above, 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.

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Financial Accounting, Sixth 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, 2015 Investments Long-term investments ...............................................................

$950,000

HADLEY INC. Income Statement (Partial) Year Ended December 31, 2015 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.

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 12-9B (a) Jan.

(b)

Long-Term Investments .................................... Cash ............................................................

770,921 770,921

Bond Amortization Schedule

Semi-Annual Interest Period

Interest Received 3%

Interest Revenue 3.25%

Discount Amortization

Amortized Cost

Issue Date 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

$24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000

$25,055 25,089 25,125 25,161 25,199 25,238 25,278 25,320 25,363 25,407 25,453 25,500 25,549 25,599 25,651 25,705

$1,055 1,089 1,125 1,161 1,199 1,238 1,278 1,320 1,363 1,407 1,453 1,500 1,549 1,599 1,651 1,705

$770,921 771,976 773,065 774,190 775,351 776,550 777,788 779,066 780,386 781,749 783,156 784,609 786,109 787,658 789,257 790,908 792,613

17 18 19 20

24,000 24,000 24,000 24,000

25,760 25,817 25,876 25,934

1,760 1,817 1,876 1,934

794,373 796,190 798,066 800,000

* Note: Rounding adjustments have been made as required in the above schedule.

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 12-9B (Continued) (c) July

(d) Oct. 31

(e) 2025 Jan. 1

Cash ................................................................. Long-Term Investments .................................... Interest Revenue ........................................

24,000 1,055

Interest Receivable ($24,000 × 4/6) .................. Long-Term Investments ($1,089 × 4/6) ............. Interest Revenue ........................................

16,000 726

Cash.................................................................. Long-Term Investments ...............................

800,000

25,055

16,726

800,000

(f) MORRISETTE INC. Statement of Financial Position (Partial) October 31, 2015 Current assets Interest receivable ............................................................ $ 16,000

Long-term investments ............................................................ 772,702 ($770,921 + $1,055 + $726)

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*PROBLEM 12-10B (a)

Densmore Consulting — Trading Jan.

June

July

(b)

Trading Investments .................................... Cash ($200,000 × 1.02)..........................

204,000

Cash ($200,000 × 8% × 6/12) ...................... Interest Revenue ...................................

8,000

Cash ($200,000 × 1.03) ............................... Realized Gain on Trading Investments .. Trading Investments ...............................

206,000 2,000

204,000

8,000

204,000

Densmore Consulting — Hold to Maturity Jan.

June

July

Solutions Manual .

Long-Term Investments ............................... Cash .......................................................

204,000

Cash ($200,000 × 8% × 6/12) ...................... Long-Term Investments.......................... Interest Revenue .................................... ($204,000 × 7.7% × 6/12)

8,000

Cash ($200,000 × 1.03) ............................... Long-Term Investments ($204,000 – $146) ................................. Realized Gain on Long-Term Investments .........................................

206,000

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204,000

146 7,854

203,854 2,146

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Financial Accounting, Sixth Canadian Edition

*PROBLEM 12-10B (Continued) (c)

CASB Jan.

June

Dec.

(d)

Cash ($1,000,000 × 1.02) ............................ Bonds Payable .......................................

1,020,000 1,020,000

Interest Expense ($1,020,000 × 7.7% × 6/12) ......................... Bonds Payable............................................. Cash ($1,000,000 × 8% × 6/12) .............

39,270 730

Interest Expense .......................................... ([$1,020,000 – $730] × 7.7% × 6/12) ...... Bonds Payable............................................. Cash ($1,000,000 × 8% × 6/12) .............

39,242 758

40,000

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 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 carrying 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.

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Financial Accounting, Sixth Canadian Edition

BYP 12-1 FINANCIAL REPORTING

(a)

Shoppers does not have trading securities but does have investment property classified as non-current assets.

(b)

Shoppers does not report any income from investments on its income statement or on its statement of comprehensive income.

(c)

The companies mentioned in note 29 are subsidiaries of Shoppers Drug Mart. 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”.

(d)

The investing activities in the statement of cash flows would report purchases and sales of investments. Shoppers used cash in 2012 to purchase the assets of Paragon Pharmacies.

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BYP 12-2 COMPARATIVE ANALYSIS (a)

Shoppers has investments in subsidiaries, as does Jean Coutu. These investments are eliminated upon consolidating the financial statements. Shoppers does not have trading securities but Jean Coutu does and calls them temporary investments. As well Jean Coutu has a large investment in Rite Aid, and a small amount of investment in associates and a joint venture. Because of the large investment in Rite Aid, Jean Coutu’s statement of financial position indicates a larger amount of investments than Shoppers. However, we have to remember that Shoppers has a number of subsidiaries that are consolidated and when this happens, the investment account relating to those subsidiaries is eliminated and replaced with specific assets and liabilities of those subsidiaries. The most common type of investment appearing on the statement of financial position is an investment in associates, over which the investor has significant influence.

(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. Jean Coutu, on the other hand, does not consolidate its investment in Rite Aid and therefore shows separate amounts for this investment, which included a substantial unrealized gain that doubled its income. Jean Coutu also had realized gains arising from a partial sale of its investment in Rite Aid.

(c)

As with all of its subsidiaries, Loblaw Companies Ltd. will consolidate the financial statement of Shoppers Drug Mart, once the shares are acquired.

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BYP 12-3 COMPARING IFRS AND ASPE (a) 1. 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 profit. Robert would prefer the cost model to keep profit higher by $10,000 for 2015 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.

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BYP 12-4 (a)

Financial Accounting, Sixth Canadian Edition

CRITICAL THINKING

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 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 bond will normally be accounted for using 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, 2015 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 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 and 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 trading investments in the amount of $5,000 is therefore recognized as other revenue on the income statement. 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 common shares and exercises significant influence over CH Resources. Bering will recognize revenue from investment in associates and an in increase in its investment in this associate in the amount of its share of the profits reported by CH Resources Inc. 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 in the amount of $103,200 ($100,000 + $4,000 – $800).

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BYP12-4 (Continued) (a) (Continued) If it can be demonstrated that Bering does not have significant influence over CH Resources Ltd. then the investment should be reported at fair value. An unrealized gain of $11,000 would be recorded as an unrealized gain 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 facts of 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 Inc. using the equity method. Based on the above, the financial statements will show the following: BERING LIMITED Statement of Financial Position (Partial) December 31, 2015 Current assets Trading investments ....................................................................

$105,000

Non-current assets Long-term investments................................................................ Investment in associates .............................................................

100,000 103,200

BERING LIMITED Income Statement (Partial) Year Ended December 31, 2015 Other revenue Revenue from investment in associates ........................................... Interest revenue ............................................................................... Unrealized gain on 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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BYP12-4 (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 — for 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 the recording of an unrealized loss. 2.Non-strategic trading investments purchased with the expectation of active trading of the security — for the Atlas Inc. common shares will be reported using the fair value through profit and loss because the shares market value is available (as under IFRS), but Bering cannot report their investments using the fair value through other comprehensive income model. 3.Strategic investment in an associate where Bering exercises significant influence over the investee — for the CH Resources Inc. common shares is 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.

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BYP 12-5

Financial Accounting, Sixth 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 trading investments that had risen in value just prior to year end, Kreiter Financial Services would report realized gains on its income statement. The 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 profit because investments are reported at fair value.

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.

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BYP 12-6 “ALL ABOUT YOU” ACTIVITY The following solution provides information from the ING website in September 2013. Rates and other information are obviously subject to change. (a)

Rates at Ing Direct: Tax-Free Investment Savings account: 1.4% 2 year GIC: 1.75%

(b)

Using the Ing Direct Investment Savings Calculator $5,000 at 1.4% for 2 years = $5,141.89 Using the Ing Direct GIC Calculator $5,000 at 1.75% for 2 years = $5,177.97

(c)

Using http://www.ingdirect.ca/en/tools/calcs/TFSA_ISA_Calculator.html

A contribution of $416.67 monthly for 40 years at the TFSA rate of 1.4 % will yield $268,420.38 and with GIC rates of 1.75% will yield $290,004.11. In order to reach a goal of $1,000,000 with contributions of $416.67 per month for 40 years, the annual yield rate would need to be 6.68% Using a financial calculator: PV

I/Y

480

PMT FV

Yields .5566% per month or 6.68% annually

$ (416.67) $1,000,000.00

Type 0 Excel formula =RATE(nper,pmt,pv,fv,type)

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BYP 12-7 SERIAL CASE (a)

If Biscuits succeeds in purchasing all of the shares of Koebel’s Family Bakery, Biscuits would record the investment in its accounting records using the equity method. However, there would be a requirement to consolidate the Bakery’s accounts into Biscuits financial statements using consolidation techniques that would remove the investment account and replace it with the assets and liabilities of the Koebel’s Family Bakery. Koebel’s would be a subsidiary company and Biscuits would be the parent company. The purchase of the shares would not necessarily require a change in Koebel’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 Koebel’s fiscal year end match that of its’ parent.

(b)

If Coffee Beans succeeds in purchasing 50% of the shares of Koebel’s Family Bakery, but control is retained by Natalie and Daniel, Coffee Beans would account for the investment using the equity method. This reflects Coffee Beans’ significant influence over the operations of Koebel’s Family Bakery. The purchase of the shares would likely not require a change in Koebel’s accounting records since the relationship between Coffee Beans and Koebel’s is one of significant influence and not control.

(c)

Offer from Biscuits: The offer from Biscuits may result in reduced hours of work for Natalie 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 which, if invested wisely, could yield benefits for many years. The transition of Natalie and Daniel from shareholders to employees would also result in some disadvantages, such as loss of control. Biscuits will exercise control over Koebel’s operations and will not likely be willing to let Natalie and Daniel participate in the decision making process. Their employment contract is also limited to 2 years, leaving uncertainty about their relationship with Biscuits at the end of the employment period. The nature of the income received would also change. Natalie and Daniel currently can receive dividends as well as a salary as shareholders and management of Koebel’s. 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 profits of the business.

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BYP12-7 (Continued) (c) (Continued) Offer from Coffee Beans: The offer from Coffee Beans will keep Natalie and Daniel in control of the operations of Koebel’s. It will also allow them to participate in their share of the profits 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 Coffee Beans, as well as taking advantage of the expertise of the Coffee Beans management team. The offer would not result in reduced hours of work for Natalie and Daniel, as they would be responsible for running the bakery. In addition, they would be subject to the significant influence of Coffee Beans rather than dealing with Janet and Brian. They would also not receive a large cash payment for the sale of their shares as would Janet and Brian. Finally, if the business relationship with Coffee Beans did not work out, it may be difficult to find another investor to purchase the shares held by Natalie and Daniel.

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CHAPTER 13 Statement of Cash Flows ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Questions

1. Describe the purpose and content of the statement of cash flows.

1, 2, 3, 4, 5

2. Prepare the operating activities section of a statement of cash flows using one of two approaches:

6, 7, 8, 14, 16, 17

Brief Exercises

Exercises

A Problems

B Problems

BYP

1, 2, 3

1, 2

1, 3, 5

3, 13

11A

11B

1, 7

(a) the indirect method or 9, 10, 11

3, 4, 5

4, 5, 8, 9, 12

2A, 3A, 2B, 3B, 6A, 7A, 8A 6B, 7B, 8B

(b) the direct method.

12, 13, 15

6, 7, 8, 9, 10

6, 7, 10, 12

2A, 3A, 6A, 7A

2B, 3B, 6B, 7B

3. Prepare the investing activities section of a statement of cash flows.

14, 15, 17

11, 12

8, 9, 11, 12, 13

4A, 6A, 7A, 8A, 11A

4B, 6B, 7B, 8B, 11B

1, 7

4. Prepare the financing activities section of a statement of cash flows.

15, 16, 17

13, 14

8, 9, 11, 12, 13

5A, 6A, 7A, 8A, 11A

5B, 6B, 7B, 8B, 11B

1, 7

5. Complete the statement of cash flows.

8, 9, 12

6A, 7A, 8A, 11A

6B, 7B, 8B, 11B

1, 6, 7

6. Use the statement of cash flows to evaluate a company’s liquidity and solvency.

19, 20, 21, 22, 23

8, 9, 13, 14

9A, 10A

9B, 10B

2, 3, 4, 7

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Classify activities.

Simple

20-30

Prepare operating activities section—indirect and direct methods.

Moderate

30-40

Prepare operating activities section—indirect and direct methods—and discuss methods.

Moderate

30-40

Calculate and classify cash flows for property, plant, and equipment.

Moderate

20-30

Calculate and classify cash flows for shareholders’ equity.

Moderate

20-30

Prepare statement of cash flows—indirect and direct methods.

Moderate

30-40

Prepare statement of cash flows—indirect and direct methods.

Moderate

50-60

Prepare statement of cash flows (indirect method) and answer questions.

Complex

40-50

Calculate and evaluate liquidity and solvency.

Moderate

20-30

10A

Evaluate liquidity and solvency.

Moderate

20-30

11A

Compare cash flows for three companies.

Moderate

20-30

Classify activities.

Simple

20-30

Prepare operating activities section—indirect and direct methods.

Moderate

40-50

Prepare operating activities section—indirect and direct methods—and discuss methods.

Moderate

50-60

Calculate and classify cash flows for property, plant, and equipment.

Moderate

20-30

Calculate and classify cash flows for shareholders’ equity.

Moderate

30-40

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ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare statement of cash flows—indirect and direct methods.

Moderate

30-40

Prepare statement of cash flows—indirect and direct methods.

Moderate

50-60

Prepare statement of cash flows (indirect method) and answer questions.

Complex

40-50

Calculate and evaluate liquidity and solvency.

Moderate

20-30

10B

Evaluate liquidity and solvency.

Moderate

20-30

11B

Compare cash flows for three companies.

Moderate

20-30

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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 because it helps investors, lenders and other creditors, as well as other users, assess the following aspects of a company’s financial position: • the reasons for the difference between profit and cash provided (used) by operating activities. • the cash investing and financing transactions during a period. • the company’s ability to generate future cash flows.

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 (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.

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.

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 profit. 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.

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.

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Answers to Questions (Continued) 6. (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 short-term 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. 7.

Although the approaches and format are different, both the direct and indirect methods will produce the same net cash provided by operating activities.

A number of factors could have caused net cash provided by operating activities to exceed profit. These include (1) a high amount of collections of unearned revenue; (2) large amounts of depreciation or amortization; and (3) accounting losses. These are non-cash items deducted in arriving at profit so they are now added back to profit when determining net cash flow provided by operating activities thereby making it higher than profit.

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Answers to Questions (Continued) 9.

The indirect method involves converting accrual-based profit to net cash provided by operating activities. This is done by starting with accrual-based profit from the income statement and adding or subtracting noncash items included in profit. Examples of adjustments include adding back noncash expenses, such as depreciation, and removing any noncash gains or losses from profit. Then changes in the balances of noncash current asset and current liability accounts from one period to the next are added or subtracted.

10.

Under the indirect method, depreciation and amortization expense is added back to profit to reconcile profit to net cash provided by operating activities because depreciation and amortization are expenses that have reduced profit, but do not result in the use of cash. Adding them back cancels the expenses reported in the income statement, as accrual profit is the starting point under the indirect method. Example:

Profit before depreciation $5,000 Less: Depreciation expense (1,000) Profit 4,000 Add: Depreciation expense 1,000 Cash provided by operating activities $5,000

11.

Under the indirect method, a gain on disposal of equipment is deducted from profit to reconcile profit 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 profit, must be deducted from profit on the statement of cash flows to convert profit to net cash provided by operating activities. The total cash proceeds received when the asset is disposed would be reported in the statement of cash flows as an investing activity.

12.

Net cash provided by operating activities under the direct method is the difference between cash revenues and cash expenses. The direct method adjusts the accrualbased revenues and expenses directly to reflect the cash-based revenues and expenses, which combine to equal "net cash provided by operating activities."

13.

Depreciation and amortization expenses are not listed in the direct method operating activities section 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 profit as its starting point and must add back depreciation and amortization as noncash items included in the determination of profit.

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Answers to Questions (Continued) 14.

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 similar to inventory acquired for resale. These types of investments are reported as operating activities.

15.

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.

16.

Short-term loans payable issued for trade purposes (e.g., instead of an accounts payable) are classified as operating activities. However, short-term loans payable that are issued for borrowing purposes rather than for trade do not relate to operating activities. The issue or repayment of such short-term loans payable are consequently classified as financing activities.

17.

A growing company would report low or negative cash flows from operating activities if it just commenced its operations. Later, as its sales grow, 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 and to cover the shortfall from operating activities.

18.

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.

19.

(a) The cash current debt coverage ratio is a cash-based ratio that measures liquidity. Liquidity can also be measured using the current ratio (accrual-based). (b) Solvency can be measured by the cash total debt coverage ratio (cash-based). Solvency can also be measured using the debt to total assets ratio (accrualbased). Free cash flow is also a cash-based solvency measure, but there is not accrual-based counterpart to this measure.

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Answers to Questions (Continued) 20.

Leon’s cash current debt coverage was probably lower than its current ratio because its net cash flows provided by operating activities was significantly lower than its current assets and/or because the company’s average current liabilities for the year were higher than its current liabilities on the statement of financial position date. Cash flows from operating activities could have been lower than current assets because of receivables, inventory, or prepaids which are included in current assets but do not increase cash.

21.

It is difficult to draw conclusions about the relative solvency of these companies, given the limited information provided. For instance, one would want to know the composition of the cash provided by operating activities and the debt of each of the companies. In addition to this, the times interest earned ratio for each company would prove helpful. Based on the information provided, Rogers reports a higher debt to total assets ratio than Shaw, which indicates a worse solvency. However, Rogers also shows a higher debt coverage ratio than Shaw and this ratio indicates a better solvency as Rogers seems more able to pay its interest. Consequently, Rogers would be considered more solvent.

22.

Creditors may be concerned about the company’s ability to repay its obligations over the long-term. The company’s declining cash total debt coverage ratio indicates either a decline in cash from operating activities, an increasing dependence on borrowed funds, or both. Creditors may be reluctant to grant loans to the company if these trends persist. 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.

23. If net capital expenditures and dividends paid exceed cash provided by operating activities, then free cash flow will be negative.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 (a) (b) (c) (d) (e)

– – NE + –

(f) (g) (h) (i) (j)

+ NE – – NE

BRIEF EXERCISE 13-2 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

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

BRIEF EXERCISE 13-3 (a) 1. 2. 3. 4. 5. 6.

F O I F F O

(b) Mega Brands uses the indirect method as indicated by the changes in noncash operating working capital items and the depreciation expense.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 13-4 (a) (b) (c) (d) (e) (f) (g) (h) (i)

+ – + + – – + – +

BRIEF EXERCISE 13-5 DUPIGNE CORPORATION Statement of Cash Flows (Partial)—Indirect Method Year Ended March 31, 2015 Operating activities Profit ............................................................................. Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense ........................................... Loss on disposal of land ....................................... Accounts receivable increase ............................... Merchandise inventory increase ........................... Prepaid expenses increase .................................. Accounts payable decrease ................................. Interest payable decrease .................................... Income tax payable increase ................................ Net cash provided by operating activities ...............................

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$275,000

$60,000 15,000 (20,000) (5,000) (2,000) (5,000) (2,500) 5,000

45,500 $320,500

Chapter 13

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 13-6

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)].

BRIEF EXERCISE 13-7 (in USD millions) Cash payments to = Cost of goods suppliers

+ Increase in inventory

+ Decrease in accounts payable

– Decrease in inventory

– Increase in accounts payable

Thus, the cash payments to suppliers must have equalled = $958,028 ($953,169 - $1,874 + $6,733).

BRIEF EXERCISE 13-8

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 = $92,000 ($100,000 – $15,000 – $2,500 + $500 + $6,600 + $2,400).

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 13-9 (a) Income tax expense Less: Increase in income tax payable Cash payments for income tax

$90,000 (2,000) $88,000

(b) Income tax expense Add: Decrease in income tax payable Cash payments for income tax

$90,000 2,000 $92,000

BRIEF EXERCISE 13-10 Operating activities Cash receipts from customers ................................................. Cash payments To suppliers ........................................................................... For operating expenses ......................................................... For interest ............................................................................ For income tax....................................................................... Net cash provided by operating activities .......................................

$830,0001 $474,0002 212,0003 51,0004 10,0005

747,000* $ 83,000*

$850,000 – $20,000 = $830,000 $475,000 – $6,000 + $5,000 = $474,000 3 $230,000 – $20,000 + $2,000 = $212,000 4 $50,000 + $1,000 = $51,000 5 $15,000 – $5,000 = $10,000 1 2

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 13-11 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 .........................................................

(a)

Cash provided by disposal of equipment = $13,000

(b)

Investing activities

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13-13

13,000 5,500 1,500 20,000

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 13-12 ($ 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)

BRIEF EXERCISE 13-13 ($ in millions) Beginning balance, retained earnings .......................... Add: Profit .................................................................. Less: Ending balance, retained earnings ..................... Dividends paid ..............................................................

$3,686.4 499.2 (4,074.4) $ 111.2

Retained Earnings 3,686.4 499.2 111.2 4,074.4 The answer would change if the Dividends Payable account increased during the year. In this case, the $111.2 decrease in Retained Earnings would be reduced by the increase in Dividends Payable to arrive at the amount of dividends paid.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 13-14 ($ 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: Profit............................................................ 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

Beginning balance, bank loan ($200 + $300) ...... Additional borrowings ..........................................

$500 300 800 (600) $200

Ending balance, bank loan ($200 + $400) ........... Loan payments made ..........................................

BRIEF EXERCISE 13-15 (a)

Cash current debt coverage

$325,000 $215,000

1.5 times

(b)

Cash total debt coverage

$325,000 $360,000

0.9 times

(c)

Free cash flow = $325,000 – $200,000 – $25,000 = $100,000

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13-15

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 13-16 Both ratios are indicators of liquidity. An increase in the two ratios indicates improving liquidity and an improvement in the company’s ability to pay current liabilities in the short-term. A number of factors could have contributed to Big Rock Brewery’s improving liquidity. A decrease in current liabilities during the year would cause both ratios to increase. Alternatively, an increase in sales would cause an increase in cash flows from operating activities and cause an increase in current assets due to higher accounts receivable.

BRIEF EXERCISE 13-17 A decrease in the debt to total asset ratio shows an improvement in solvency as more of the assets on hand have been financed by equity rather than by debt compared to the prior year. The slight increase in the cash total debt coverage also indicates an improvement in solvency as more cash is available to pay off total debts.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO EXERCISES

EXERCISE 13-1

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. *

(a) Cash Effect

(b) Classification

+ $50,000 – $5,000 + $16,000 – $25,000 + $18,000 + $1,000 – $18,000 – $100,000 NE + $1,000

F I / NC* O F I O O O ** O

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 merchandise inventory offset by increase in accounts payable.

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13-17

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth 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 profit to reverse this loss in the operating activities section prepared using the indirect method.)

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 profit to reverse this expense in the operating activities section prepared using the indirect method.)

The recording of the fair value adjustment through profit or loss for an unrealized gain on a trading investment does not involve cash, but increases profit 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 profit in the operating activities section prepared using the indirect method.)

The purchase of a new vehicle by signing a bank loan payable does not involve 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 vehicle) and financing (issue of the bank loan payable) activity and would be disclosed in the notes to the financial statements.

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, but would be reported in the statement of changes in equity.

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 or in the accompanying notes, but would be reported in the statement of changes in equity.

The conversion occurs as a result of non-payment of the outstanding receivable and does not involve cash. This would not be reported on the statement of cash flows or in the accompanying notes.

The equipment was purchased by paying with 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.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-3 Profit

Cash Provided (Used) by Operating Activities

Collected cash in advance from a customer for a service to be provided in the future.

Purchased merchandise 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.

–

10.

Collected an amount owing from a customer.

1. 2.

Transaction Sold merchandise inventory for cash at a higher price than cost.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-4

Transaction Purchased merchandise inventory for cash.

Operating Activities

Investing Activities

Financing Activities

Noncash Activities

–

Sold merchandise inventory on account.

(+/–) 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.

–

10.

Purchased land by issuing common shares.

+/–

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Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-5

JUNO LTD. Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2015 Operating activities Profit ..................................................................................... Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense ................................................... Loss on disposal of equipment ..................................... Decrease in accounts receivable .................................. Increase in merchandise 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.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-6 (a) Add to (+) or Deduct from (–) Income Statement Account

Income Statement Account

Change in Current Asset / Current Liability Account

1. Sales revenue

Increase in accounts receivable

–

Cash receipts from customers

2. Dividend revenue

Decrease in dividends receivable

Cash receipts from dividends

3. Interest revenue

Increase in interest receivable

–

Cash receipts from interest

4. Rent revenue

Increase in unearned rent

Cash receipts from customers

5. Cost of goods sold

Increase in merchandise inventory

Cash payments to suppliers

6. Cost of goods sold

Increase in accounts payable

–

Cash payments to suppliers

7. Insurance expense

Increase in prepaid insurance

Cash payments for operating expenses

8. Salaries expense

Increase in salaries payable

–

Cash payments to employees

9. Interest expense

Decrease in interest payable

Cash payments for interest

10. Income tax expense

Increase in income tax payable

–

Cash payments for income tax

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13-22

(b) Related Cash Receipt or Payment

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-7 (a)

Sales revenue Add: Decrease in accounts receivable Cash receipts from customers

$160,000 2,000 $162,000

(b)

Cost of goods sold Add: Increase in inventory Add: Decrease in accounts payable Cash payments to suppliers

$96,000 1,700 800 $98,500

(c)

Salaries expense Less: Increase in salaries payable Cash payments to employees

$35,000 (175) $34,825

(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

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-8 CHARMAINE RETAILERS LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015 Operating activities Profit ............................................................................ Adjustments to reconcile profit 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 .....................................

$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

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 however, why the inventory rose as much as it did because it did lower cash from operating activities.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-9 DAGENAIS RETAILERS LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015 Operating activities Profit ............................................................................ Adjustments to reconcile profit to net cash provided (used) by operating activities Gain on disposal of furniture ................................ $ (2,000) Depreciation expense .......................................... 19,000 Increase in accounts receivable ($76,000 – $50,000) ......................................... (26,000) Increase in inventory ($219,000 – $168,000) ...... (51,000) Increase in accounts payable ($58,000 – $45,000) 13,000 Net cash used by operating activities .................................... Investing activities Disposal of furniture (see calculations below) .............. Net cash provided by investing activities ............................... Financing activities Payment of cash dividends ($173,000 + $32,000 – $146,000) ............................. Repayment of bank loan ($103,000 – $100,000) ......... Net cash used by financing activities ..................................... Net decrease in cash ............................................................. Cash, January 1 .................................................................... Cash, December 31 ..............................................................

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13-25

$32,000

(47,000) (15,000)

$6,000 6,000

$(5,000) (3,000) (8,000) (17,000) 18,000) $ 1,000)

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-9 (Continued) Calculations: Transactions involving Furniture: Furniture Dec. 31, 2014

163,000

Dec. 31, 2015

130,000

Disposal

33,000

Accumulated Depreciation—Furniture Disposal (derived)

29,000

Dec. 31, 2014 Depreciation Dec. 31, 2015

45,000 19,000 35,000

Cost of equipment sold (derived)...................................... Accumulated depreciation ................................................ 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 2,000 33,000

In 2015, Degenais suffered a significant decline in cash. This decline was principally caused by the mismanagement of current assets including accounts receivable and merchandise inventories. 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 should have postponed the payment of dividends. This year the negative cash from operations may have lead 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.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-10 JUNO LTD. Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2015 Operating activities Cash receipts from customers ................................................. Cash payments To suppliers ........................................................................... For operating expenses ......................................................... For interest ............................................................................ For income tax....................................................................... Net cash provided by operating activities .......................................

$195,000 1 $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

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13-27

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-11 DUPRÉ CORP. Statement of Cash Flows (Partial) Year Ended December 31 Investing activities 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....................................................

*Cost of equipment sold ........................................................ *Accumulated depreciation .................................................... *Carrying amount .................................................................. *Loss on disposal of equipment............................................. *Cash proceeds ..................................................................... Cash ................................................................................. Accumulated Depreciation—Equipment ........................... Loss on Disposal .............................................................. Equipment ....................................................................

(4,000)

$39,000 30,000 9,000 3,000) $ 6,000)

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.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-12 (a) PUFFY LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015 Operating activities Profit ............................................................................ Adjustments to reconcile profit to net cash provided (used) by operating activities Gain on disposal of land ...................................... $ (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 Disposal of land ............................................................ 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 .....................................

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13-29

21,000 136,000

$35,000* (65,000) (30,000)

$(50,000) (50,000) 25,000 (75,000)

Net increase in cash .............................................................. Cash, January 1 .................................................................... Cash, December 31 .............................................................. * Cash proceeds received from disposal of land: Cash ....................................................................... 35,000 Land ($100,000 – $70,000) ............................ Gain on Disposal ............................................

$115,000

31,000) 22,000) $ 53,000)

30,000 5,000

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-12 (Continued) (b) PUFFY LTD. Statement of Cash Flows—Direct Method Year Ended December 31, 2015 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 Disposal of land*** ........................................................ 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 ..................................... Net increase in cash .............................................................. Cash, January 1 .................................................................... Cash, December 31 ..............................................................

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13-30

$974,000

838,000 136,000

$35,000 (65,000) (30,000)

$(50,000) (50,000) 25,000 (75,000) 31,000) 22,000 $ 53,000)

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-12 (Continued) (b) (Continued) Calculations: * Cash receipts = sales – increase in accounts receivable $978,000 – $4,000 = $974,000 ** Cash payments to suppliers = cost of goods sold – decrease in inventories + decrease in accounts payable $751,000 – $4,000 + $8,000 = $755,000 *** Cash proceeds received from disposal of land: Cash ....................................................................... 35,000 Land ($100,000 – $70,000) ............................ Gain on Disposal ...........................................

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13-31

30,000 5,000

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

EXERCISE 13-13 Company A is clearly in a better financial condition than company B and C. Company C had a loss for the year. While all three companies experienced exactly the same increases in cash for the year, it should be noted that Company A’s cash flow comes from its operations, while company B’s cash was acquired through financing, as evidenced by the large amount of cash generated through financing activities. Company C appears to be in the weakest financial position since not only did it have a loss for the year, it also depended on the sale of investments or property, plant and equipment to generate cash. By contrast, Company A appears to be able to buy investments or property, plant, and equipment and is also paying down debt, as its cash flow from financing activities is negative. Essentially, Company A appears to be more self-sustaining compared to Company B and C.

EXERCISE 13-14 (a)

Ria Corporation

Les Corporation $200,000

Cash current debt coverage

$200,000 $50,000 = 4.0 times

Cash total debt coverage

$200,000 $200,000 = 1.0 times

$200,000 = 1.0 times

$200,000 – $20,000 – $24,000 = $156,000

$200,000 – $35,000 – $18,000 = $147,000

Free cash flow (b)

$150,000 = 1.3 times $200,000

Ria’s liquidity is better than Les’s. In particular, Ria’s cash current debt coverage ratio is three times as high as that of Les’s. This ratio indicates that Ria is substantially more liquid than Les. Ria’s solvency, as measured by the cash total debt coverage ratio, is the same as Les’s. However, Ria has a slightly higher free cash flow than Les, which would better enable the company to invest in new opportunities without having to obtain outside financing. So, Ria has better overall liquidity and solvency than Les.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 13-1A

Transaction 1. Paid salaries to employees.

Classification O

(b) Cash Receipt or Payment –

2. Sold land for cash, at a gain.

(a)

3. Purchased a building by making a down payment in cash and signing a mortgage payable for the balance.

–

(for the cash downpayment)

NC (for the exchange) 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 merchandise 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.

–

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-1A (Continued) (d)

Because of the accrual basis of accounting, it is not surprising that transactions can impact cash and profit differently. For example, in transaction #6 above, cash was received from the issue of common shares without profit being affected in any way. In transaction #9 above, revenue and profit were affected by the sale of merchandise inventory but because it was sold on account, cash was not affected.

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Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 13-2A (a) (1)

WHISTLER LTD. Statement of Cash Flows (Partial)—Indirect Method Year Ended November 30, 2015

Operating activities Profit ....................................................................... Adjustments to reconcile profit 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 .........................

(2)

$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

WHISTLER LTD. Statement of Cash Flows (Partial)—Direct Method Year Ended November 30, 2015

Operating activities Cash receipts from customers ................................. Cash payments To suppliers .................................................... For operating expenses .................................. For interest ..................................................... For income tax ................................................ Net cash provided by operating activities .........................

$7,793,000 (1) $(5,130,000) (2) (1,955,000) (3) (110,000) (4) (280,000) (5)

(7,475,000 ) $ 318,000

Note: Calculations on following page.

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Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 13-2A (Continued) (a) (2) (Continued) (1)

(2)

(3)

(4)

(5)

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 inventories 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 expenses payable Cash payments for operating expenses

$2,000,000 (75,000) (100,000) 1,825,000 $40,000 90,000

130,000 $1,955,000

Cash payments for interest Interest expense Add: Decrease in interest payable Cash payments for income tax

$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

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 13-2A (Continued) (b) The answer would remain the same if Whistler were a private company. As a publicly traded company following IFRS, Whistler has the choice to disclose interest expense as part of financing activities rather than in operating activities. We have chosen to report this in the operating activities section above, which is the usual practice for a publiclytraded company and also the practice that would be followed by a private company.

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Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 13-3A (a) (1)

TREMBLANT LIMITED Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2015

Operating activities Profit ............................................................................... Adjustments to reconcile profit 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 ..................................

(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, 2015

Operating activities Cash receipts from customers .......................................... Cash payments For operating expenses ........................................... To employees .......................................................... For interest .............................................................. For income tax ......................................................... Net cash provided by operating activities ..................................

$918,000 (1) $(112,000) (2) (500,500) (3) (73,750) (4) (42,500) (5)

(728,750) $189,250

Note: Calculations on following page.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-3A (Continued) (a) (2) (Continued) (1)

(2)

(3)

(4)

(5)

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

(b) 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 customer 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 approach because it is easier to prepare and their accounting system may not be adapted to capture the transaction data required in the direct method.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-4A (a) Cash receipts and payments related to property, plant, and equipment in 2015: 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 exercise. Equipment .............................................................................................. Bank Loan Payable ........................................................................ Cash ...............................................................................................

75,000

40,000

Cash ....................................................................................................... Accumulated Depreciation—Equipment ................................................. Gain on Disposal ............................................................................ Equipment ......................................................................................

8,000 12,000

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65,000 10,000

40,000

5,000 15,000

Chapter 13

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 13-4A (Continued) (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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-5A (a)

Cash receipts:

Issue of common shares $600,000 – $400,000 = $200,000 Issuance of preferred shares $325,000 – $275,000 = $50,000

Cash payments:

Payment of dividends =

$11,876

Note to instructor: Students may find summary journal entries helpful in understanding this problem. Cash .................................................................................... Common Shares ($600,000 – $400,000) ....................

200,000

Cash Dividends ................................................................... Dividends Payable ($3,438 – $2,812).................................. Cash ............................................................................

11,250 626

200,000

11,876

(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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-6A (a) (1) E-PERFORM, INC. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015 Operating activities Profit ..................................................................................... Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense ................................................... Loss on disposal of equipment ..................................... Unrealized gain on trading investments........................ Increase in accounts receivable ................................... Increase in inventories.................................................. Decrease in prepaid expenses ..................................... Increase in accounts payable ....................................... Increase in accrued liabilities ........................................ Net cash provided by operating activities ....................................... Investing activities 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.............................................. Net increase in cash ....................................................................... Cash, January 1 ............................................................................. Cash, December 31 .......................................................................

$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) 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-6A (Continued) (a) (2) (Continued) E-PERFORM, INC. Statement of Cash Flows—Direct Method Year Ended December 31, 2015

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 on following page.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-6A (Continued) (a) (2) (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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-7A (a) (1)

RESOLUTE INC. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015

Operating activities Profit ............................................................................... Adjustments to reconcile profit to net cash provided by operating activities Depreciation expense ............................................. Impairment loss on goodwill ................................... Increase in accounts receivable ............................. Increase in merchandise inventory ......................... Increase in accounts payable ................................. Decrease in salaries payable.................................. Decrease in income tax payable............................. Net cash provided by operating activities .................................

$27,750

$ 9,500 11,000 (14,000) (7,000) 2,000 (200) (3,000)

Investing activities Purchase of equipment (Note X) ..................................... Disposal of equipment ..................................................... Net cash provided by investing activities ..................................

$(4,000) 8,500

Financing activities Issue of common shares ................................................. Repayment of bank loan payable .................................... Net cash used by financing activities ........................................

$ 4,000 (26,550)*

(1,700) 26,050

4,500

(22,550) 8,000 5,000 $13,000

Note X to the Statement of Cash Flows: During the year, the company purchased equipment costing $14,000 by paying $4,000 cash and issuing a $10,000 bank loan payable. * $50,650 + $10,000 – $34,100 = $26,550

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-7A (Continued)

(a) (2)

RESOLUTE INC. Statement of Cash Flows —Direct Method Year Ended December 31, 2015

Operating activities Cash receipts from customers .............................. Cash payments To suppliers ................................................. For operating expenses ............................... For interest .................................................. For income tax ............................................. Net cash provided by operating activities ......................

$242,000 (1) $(145,000) (2) (57,950) (3) (4,000) (9,000) (4)

Investing activities Purchase of equipment (Note X) .......................... Disposal of equipment .......................................... Net cash provided by investing activities .......................

$(4,000 ) 8,500

Financing activities Issue of common shares ........................................ Repayment of bank loan payable ........................... Net cash used by financing activities ...............................

$ 4,000 (26,550)

Net increase in cash ........................................................ Cash, January 1 .............................................................. Cash, December 31 ........................................................

(215,950) 26,050

4,500

(22,550) 8,000 5,000 $13,000

Note X to the Statement of Cash Flows: During the year, the company purchased equipment costing $14,000 by paying $4,000 cash and issuing a $10,000 bank loan payable. (See calculations on following page.)

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-7A (Continued) (a)

(2) (Continued)

Calculations (1)

(2)

(3)

Cash receipts from customers Revenues ................................................................................... Deduct: Increase in accounts receivable ................................... Cash receipts from customers ....................................................

$256,000 (14,000) $242,000

Cash payments to suppliers Cost of goods sold ...................................................................... Add: Increase in inventories ...................................................... Cost of purchases....................................................................... Deduct: Increase in accounts payable ....................................... Cash payments to suppliers .......................................................

$140,000 7,000 147,000 (2,000) $145,000

Cash payments for operating expenses Operating expenses .................................................................. Add: Decrease in salaries payable ............................................ Deduct: Depreciation expense ................................................. Impairment loss on goodwill ....................................... Cash payments for operating expenses .....................................

$78,250 200 (9,500) (11,000) $57,950

Alternatively we could isolate the portion of the cash payments relating to salaries and show them as a separate item. Salaries paid is equal to salaries expense of $50,000 plus the decrease in salaries payable of $200 ($2,100 − $1,900) = $50,200. Cash payments for other operating expenses would then be $57,950 − $50,200 = $7,750. (4)

Cash payments for income tax Income tax expense .................................................................. Add: Decrease in income tax payable ....................................... Cash payments for income tax ...................................................

$6,000 3,000 $9,000

(b) Resolute’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 $26,050. In addition, the disposal of equipment resulted in a net increase (after the purchase of equipment) of $4,500 from investing activities. Some of this cash was used to repay its bank loans, but sufficient cash remained at the end of the year to increase its cash position by $8,000.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-8A (a)

SYLVESTER LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015 Operating activities Profit ............................................................................... Adjustments to reconcile profit to net cash provided 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 merchandise 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 5,000 21,000 11,000 (1,000) 1,000

70,000 127,000

Investing activities Purchase of building (1)................................................... $(364,000) Purchase of equipment (2) .............................................. (65,000) Disposal of land ($110,000 – $100,000 + $7,000 gain) ... 17,000 Disposal of equipment (2)................................................ 5,000 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 ................................................ Dividends paid (4)............................................................ Net cash provided by financing activities ..................................

247,000

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$110,000 210,000 (36,000) (37,000)

17,000 6,000 $ 23,000

Chapter 13

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-8A (Continued) Calculations: (1) Transactions involving Buildings: Buildings Dec. 31, 2014 Purchases Dec. 31, 2015

263,000 364,000 527,000

Disposal

100,000

Accumulated Depreciation—Buildings Disposal (derived)

88,000

Dec. 31, 2014 Depreciation Dec. 31, 2015

100,000 55,000 67,000

Cost of equipment sold (derived)...................................... Accumulated depreciation ................................................ Net carrying amount (derived) .......................................... Add: Gain on disposal of buildings .................................. 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 38,000 100,000

(2) Transactions involving Equipment: Equipment Dec. 31, 2014 Purchases Dec. 31, 2015

40,000 65,000 85,000

Disposal

20,000

Accumulated Depreciation—Equipment Disposal

11,000

Dec. 31, 2014 Depreciation Dec. 31, 2015

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

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Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

PROBLEM 13-8A (Continued) (3) Total depreciation recorded during the year: For buildings ................................................................ For equipment .............................................................. Total depreciation expense for the year: ......................

$55,000 19,000 $74,000

(4) Transactions involving Retained Earnings: Retained Earnings Dividends (derived)

37,000

Dec. 31, 2014 Profit Dec. 31, 2015

30,000 57,000 50,000

(5) Transactions involving Bank Loan Payable: Bank loan balance Dec. 31, 2014: Current portion ............................................................ $ 20,000 Non-current portion ..................................................... 212,000 Total ............................................................................ $232,000 Bank loan balance Dec. 31, 2015: 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 merchandise 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. Profit is modest and is made up of a one-time gain realized on the disposal of the old building. The profit 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-9A (a) ($ in thousands)

Reitmans

Le Château

Cash current debt coverage

$51,797 $95,474 = 0.5 times

$6,602 $44,871 = 0.1 times

Cash total debt coverage

$51,797 $147,724 = 0.4 times

$6,602 $85,550 = 0.1 times

Free cash flow

(b)

$51,797 – $84,433 – $52,068 = $(84,704)

$6,602 – $8,723 – $0 = $(2,121)

Reitmans is more liquid than Le Château. As evidenced by its cash current debt coverage ratio, Reitmans is able to generate more cash to meet all of its currently maturing liabilities than Le Château. In terms of solvency, we again see that Reitmans has a higher cash total debt coverage ratio than Le Château, which indicates that Reitmans is the more solvent of the two retailers. There is negative free cash flow for both companies, but in the case of Reitmans it is far larger than that of Le Château because of the substantial dividends paid. Unlike Le Château, Reitmans can afford to pay a higher level of dividends because of its greater liquidity and solvency.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-10A (a)

Grenville appears to be the more liquid of the two companies. The company has more assets to repay its currently maturing liabilities as evidenced by its higher current and cash current debt coverage ratios. Grenville is moving its inventory faster than Portage, as indicated by the company’s higher inventory turnover ratio, which again indicates that the company is more liquid. Moreover, Grenville’s superior cash current debt coverage ratio indicates that the company is generating more cash from operating activities that can be used to repay current obligations. One area of concern would be Grenville’s receivable turnover ratio, which is half of Portage’s. Grenville is turning its receivables into cash every 37 days (365 ÷ 10 times), which is slower than Portage who is currently taking only 18 days (365 ÷ 20) on the average to collect its receivables. This could also partially explain Grenville’s higher current ratio, although it would not explain all of it. In addition to this, 37 days may not be a bad collection period, depending on Grenville’s credit policies. However, investors may want to compare the credit terms offered by the two companies to see why there is such a discrepancy.

(b)

Grenville has a much higher percentage of debt to total assets than Portage, which would indicate that the company is the less solvent of the two. Portage also has a much higher times interest earned ratio than Grenville, indicating that Portage is better able to meet its interest obligations out of current earnings. However, Grenville seems to be generating slightly more cash that can be used toward the repayment of long-term debt as indicated by the company’s higher cash total debt coverage ratio. Given Portage’s significantly lower debt to total assets and higher times interest earned ratio, the company appears to be more solvent than Grenville.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-11A (a)

Tim Hortons provided cash from operating activities that almost equalled the cash used in investing and financing activities. The amount of cash generated from operating activities was 37% [($559.3 – $407.8) ÷ $407.8] larger than the amount of the profit for the year. Although Second Cup had a loss from the year, it managed to generate positive cash flows from operating activities that were sufficient enough to offset the negative investing activities and most of the financing activities. By the end of the year it had reduced its cash balance by a large margin. Starbucks provided cash from operating activities that nearly equalled the amount of cash consumed by investing and financing activities. The company generated 26% more cash from operating activities than profit [($1,750.3 – $1,383.8) ÷ $1,383.8]. Cash increased modestly by the end of the year.

(b)

Starbucks appears to be in the strongest cash position. It was the only company of the three that managed to increase its cash.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-1B (a) Classification O

(b) Cash Flow +

– (loss decreases profit) +

–

6. Paid dividends to preferred shareholders.

–

7. Recorded depreciation expense. 8. Issued preferred shares for cash.

–

9. Purchased inventory for cash. The company uses a perpetual inventory system. 10. Provided services on account.

–

Transaction 1. Collected an account receivable. 2. Sold equipment for cash, at a loss. 3. Recorded an unrealized gain on a 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-2B (a) (1) GUM SAN LTD. Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2015

Operating activities Profit ............................................................................. Adjustments to reconcile profit 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 expenses payable ............... Increase in interest payable .................................. Increase in unearned revenue .............................. Decrease in income tax payable .......................... Net cash provided by operating activities ...............................

$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

(2) GUM SAN LTD. Statement of Cash Flows (Partial)—Direct Method Year Ended December 31, 2015 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

Note: Calculations on following page.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-2B (Continued) Calculations (1) Cash receipts from customers Sales ...................................................................................... Add: Increase in unearned revenue........................................ Deduct: Increase in accounts receivable ................................ Cash receipts from customers ................................................ (2)

(3)

(4)

(5)

(b)

$4,500,000 8,000 (500,000) $4,008,000

Cash payments to suppliers Cost of goods sold .................................................................. Deduct: Decrease in inventories ............................................ 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 expenses payable ....................... 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

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

The answer would remain the same if Gum San were a private company. As a publicly traded company following IFRS, Gum San has the choice to disclose interest expense as part of investing activities rather than in operating activities. We have chosen to report this in the operating activities section above, which is the usual practice for a publicly-traded company and also the practice that would be followed by a private company.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-3B (a) (1) HANALEI INTERNATIONAL INC. Statement of Cash Flows (Partial)—Indirect Method Year Ended December 31, 2015 Operating activities Profit ................................................................................ Adjustments to reconcile profit 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, 2015

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 on following page.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-3B (Continued) Calculations (1)

(2)

(3)

(4)

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

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-4B (a)

Cash receipts and payments related to property, plant, and equipment 2015: 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

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80,000

20,000 30,000

60,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-4B (Continued)

(b)

Equipment purchase Land purchase Proceeds from equipment disposal

Investing activities (use) Investing activities (use) Investing activities (source)

$(80,000) $(20,000) $24,000

Also note to the financial statements: 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-5B (a)

Cash receipts: Issue preferred shares $25,000 Cash payments: Payment of cash dividends, $7,500

Journal entry for stock dividend: Stock Dividends (1,000 × $40) ........................................... Common Shares..........................................................

40,000 40,000

The T-account for Retained Earnings is provided to illustrate that all transactions have been considered:

Cash dividends Stock dividends

Retained Earnings 250,000 Beg. balance 7,500 40,000 37,500 Profit 240,000 End. balance

(b)

Both of the above activities (issuance of preferred shares and payment of dividends) would be classified as financing activities on the statement of cash flows.

(c)

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-6B (a) (1) NACKAWIC INC. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015 Operating activities Profit ..................................................................................... Adjustments to reconcile profit 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 inventories.................................................. Increase in accounts payable ....................................... Decrease in accrued liabilities ...................................... Net cash provided by operating activities ....................................... Investing activities Sale of long-term investments ............................................... Disposal of property, plant, and equipment ........................... Purchase of property, plant, and equipment .......................... Net cash used by investing activities ..............................................

$87,810

$58,700 7,500 (8,750) (43,800) (29,250) 14,420 (6,730)

$ 5,000 15,550 (71,000)

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 ........................................ Net increase in cash ....................................................................... Cash, January 1 ............................................................................. Cash, December 31 .......................................................................

(7,910) 79,900

(50,450)

6,000 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-6B (Continued) (a) (2) NACKAWIC INC. Statement of Cash Flows—Direct Method Year Ended December 31, 2015 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 property, plant, and equipment ........................... Purchase of property, plant, and equipment .......................... Net cash used by investing activities ..............................................

(193,800) 79,900

$ 5,000 15,550 (71,000)

$273,700

(50,450)

6,000 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 on following page.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-6B (Continued) (a)

(Continued)

Calculations (1)

(2)

(3)

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 inventories .................................................. 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

(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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-7B (a) (1)

WETASKIWIN LIMITED Statement of Cash Flows—Indirect Method Year Ended December 31, 2015

Operating activities Profit ............................................................................... Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense (given) ................................. Unrealized loss on trading investments .................. Loss on disposal ..................................................... Increase in accounts receivable ............................. Increase in merchandise inventory ......................... Decrease in accounts payable................................ Decrease in income tax payable............................. Net cash provided by operating activities .................................

$36,000

$11,000 9,000 2,000 (14,000) (4,000) (26,000) (8,000)

Investing activities Disposal of equipment ..................................................... Purchase of equipment (Note X) ..................................... Net cash provided by investing activities ..................................

$8,000 (5,000)

Financing activities Repayment of bank loan payable .................................... Net cash used in financing activities......................................

$(10,000)*

Net decrease in cash Cash, January 1 Cash, December 31

.......................................................... .......................................................... ..........................................................

(30,000) 6,000

3,000

(10,000) (1,000) 10,000 $ 9,000

* $20,000 + $5,000 – $15,000 = $10,000 Note X to the Statement of Cash Flows: Equipment of $10,000 was purchased for $5,000 cash and issue of a $5,000 bank loan payable.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-7B (Continued)

(a) (2)

WETASKIWIN LIMITED Statement of Cash Flows—Direct Method Year Ended December 31, 2015

Operating activities Cash receipts from customers (1) ...................................... Cash payments To suppliers (2) ............................................................ For operating expenses (3) .......................................... For interest ................................................................... For income tax (4) ........................................................ Net cash provided by operating activities ...........................

$272,000 $(184,000) (61,000) (3,000) (18,000)

Investing activities Disposal of equipment .................................................. Purchase of equipment (Note X) .................................. Net cash provided by investing activities ...............................

$8,000 (5,000 )

Financing activities Repayment of bank loan payable .................................... Net cash used in financing activities ......................................

$(10,000)*

Net decrease in cash ............................................................. Cash, January 1 .................................................................... Cash, December 31 ..............................................................

(266,000) 6,000

3,000

(10,000) (1,000) 10,000 $ 9,000

*$20,000 + $5,000 – $15,000 = $10,000 Note X to the Statement of Cash Flows: Equipment of $10,000 was purchased for $5,000 cash and issue of a $5,000 bank loan payable. (See calculations on following page.)

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-7B (Continued) (a) (2) (Continued) Calculations (1)

(2)

(3)

$286,000 (14,000) $272,000

Cash payments to suppliers Cost of goods sold ...................................................................... Add: Increase in inventories ...................................................... Cost of purchases....................................................................... Add: Decrease in accounts payable .......................................... Cash payments to suppliers .......................................................

$154,000 4,000 158,000 26,000 $184,000

Cash payments for operating expenses Operating expenses .................................................................. Deduct: Depreciation expense ................................................. Loss on disposal ......................................................... Cash payments for operating expenses .....................................

$74,000 (11,000) (2,000) $61,000

Alternatively we could isolate the portion of the cash payments relating to salaries and show them as a separate item. Salaries paid are equal to salaries expense of $49,000 plus the decrease in salaries payable or minus the increase in salaries payable. There are no salaries payable so the salaries paid are equal to salaries expense. Cash payments for other operating expenses would then be $61,000 − $49,000 = $11,000.

(4)

$10,000 8,000 $18,000

(b) Wetaskiwin’s cash position has decreased primarily because a relatively small amount of cash, $6,000, was generated by its operating activities. Despite also generating cash from the disposal of equipment in investing activities, this amount of cash was not sufficient to cover the bank loan repayments of $10,000 and triggered a net decrease of cash of $1,000 for the year.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-8B (a)

ANDERSON LTD. Statement of Cash Flows—Indirect Method Year Ended December 31, 2015 Operating activities Profit ............................................................................... Adjustments to reconcile profit to net cash provided 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 merchandise 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 (15,000) (14,000) (21,000) (1,000) 1,000

(13,000) 40,000

Investing activities Purchase of building (1)................................................... $(304,000) Purchase of equipment (2) .............................................. (125,000) Disposal of land ($110,000 – $95,000 + $14,000 gain) ... 29,000 Disposal of equipment (2) ................................................ 4,000 Disposal of building (1) .................................................... 40,000 Net cash used by investing activities ........................................

(356,000)

Financing activities Issue of common shares ($90,000 – $88,000) ................ Additions to bank loan ..................................................... Repayments of bank loan ................................................ Dividends paid (4)............................................................ Net cash provided by financing activities ..................................

283,000

Net decrease in cash ................................................................ Cash, January 1 ....................................................................... Cash, December 31 .................................................................

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$ 2,000 350,000 (36,000) (33,000)

(33,000) 36,000 $ 3,000

Chapter 13

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-8B (Continued) Calculations: (1) Transactions involving Buildings: Buildings Dec. 31, 2014 Purchases Dec. 31, 2015

263,000 304,000 477,000

Disposal

90,000

Accumulated Depreciation—Buildings Disposal (derived)

78,000

Dec. 31, 2014 Depreciation Dec. 31, 2015

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

40,000 78,000 28,000 90,000

(2) Transactions involving Equipment: Equipment Dec. 31, 2014 Purchases Dec. 31, 2015

40,000 125,000 135,000

Disposal

30,000

Accumulated Depreciation—Equipment Disposal

21,000

Dec. 31, 2014 Depreciation Dec. 31, 2015

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

4,000 21,000 5,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-8B (Continued) (3) Total depreciation recorded during the year: For buildings: ............................................................... For equipment: ............................................................. Total depreciation expense for the year: ......................

$45,000 29,000 $74,000

(4) Transactions involving Retained Earnings: Retained Earnings Dividends (derived)

33,000

Dec. 31, 2014 Profit Dec. 31, 2015

30,000 53,000 50,000

(5) Transactions involving Bank Loan Payable: Bank loan balance Dec. 31, 2014: Current portion ............................................................ $ 20,000 Non-current portion ..................................................... 212,000 Total ............................................................................ $232,000 Bank loan balance Dec. 31, 2015: 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 (b)

Anderson Ltd. did not manage its noncash working capital efficiently. It increased its accounts receivable and merchandise 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 $36,000 and this may rise in the future because of the additional debt incurred this year. To pay for this, the company has only generated $40,000 from operating activities. The bank will be concerned about this. Furthermore, the bank will notice that dividends paid were over 80% of the cash from operating activities and the bank may ask for dividends to be reduced.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-9B (a) (USD millions)

Google

Yahoo!

Cash current debt coverage

$16,619 ÷ $11,625 = 1.4 times

$(281.6) ÷ $1,248.8 = N/A as negative

Cash total debt coverage

$16,619 ÷ $18,256 = 0.9 times

$(281.6) ÷ $2,349.5 = N/A as negative

Free cash flow

$16,619 – $3,273 – $0 = $13,346

$(281.6) – $505.5 – $0 = $(787.1)

(b)

Google is significantly more liquid than Yahoo! as evidenced by its cash current debt coverage ratio. Google is able to generate significantly more cash to meet all of its currently maturing liabilities. Google is also more solvent than Yahoo! Google has a higher cash total debt coverage ratio than Yahoo!, which indicates that Google is the more solvent of the two companies. Only Google has positive free cash flows. Google is both more liquid and more solvent than Yahoo!.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-10B (a)

Barrington is definitely the more liquid of the two companies. The company has more current assets to repay its currently maturing liabilities as evidenced by its higher current ratio. Also, Barrington is turning its receivables into cash every 60 days (365 ÷ 6 times), which is quicker than Ste-Croix who is currently taking over 90 days on the average to collect its receivables. As well, Barrington is moving its inventory faster than Ste-Croix, which again, indicates Barrington is more liquid. Finally, Barrington’s cash current debt coverage is higher than Ste-Croix’s. This indicates that Barrington is generating more cash from operating activities that can be used to repay current obligations.

(b)

Barrington has a much higher percentage of debt to total assets than Ste-Croix, which would indicate that the company is the less solvent of the two. However, Barrington is generating more cash to use for the repayment of long-term debt as can be seen by examining the cash total debt coverage ratios of the two companies. Finally, the times interest earned ratio indicates that Barrington’s profit when compared to its required interest payments (the company’s times interest earned ratio is 6 times) is higher than the same ratio for Ste-Croix. Therefore, although Barrington carries more debt relative to total assets than Ste-Croix, Barrington seems to be in a better position than SteCroix to meet its obligations regarding repayment of principal and interest.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 13-11B (a)

All three companies generated cash from operating activities and used cash in investing and financing activities, with the exception that Burger King which generated cash from investing activities. All three companies produced more cash from operating activities than profit with Wendy’s showing the largest proportion of cash from operating activities to profit. McDonald’s showed no increase in cash and cash equivalents while Burger King showed a 19.1% increase in cash and cash equivalents, whereas Wendy’s showed a net decrease in cash and cash equivalents. ($ in USD millions) Profit Net cash provided by operating activities Net cash provided by operating activities in excess of profit Net cash provided by operating activities as a % of profit % increase in cash from prior year

(b)

McDonald’s $5,464.8 $6,966.1

Burger King $117.7 $224.4

Wendy’s $9.5 $190.4

$1,501.3

$106.7

$180.9

127.5%

190.7%

2,004.2%

19.1%

(4.6)%

Burger King is in the strongest position. It shows the highest percentage increase in cash during the year. Because we need to ignore the comparisons to profit for Wendy’s due to the extremely small profit, Burger King has the highest proportion of net cash provided by operating activities to profit. Despite McDonald’s far larger profit and cash amounts, proportionately, Burger King appears to be the stronger of the two from a “cash generated by operating activities” perspective. More information in terms of past trends would be helpful to properly compare the two.

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Financial Accounting, Sixth Canadian Edition

BYP 13-1 FINANCIAL REPORTING (a)

Shoppers Drug Mart uses the indirect method of calculating operating activities.

(b)

Shoppers generated cash from operating activities in the amount of $916,816,000 in 2012 and $973,838,000 in 2011.

(c)

The most significant investing activity for Shoppers is cash used in the acquisition and development of property and equipment in the amount of $254,259,000. For financing activities, Shoppers did a refinancing of debt by issuing one quarter of a billion dollars of commercial paper and repaying long-term debt of the same amount.

(d)

Cash decreased in 2012 by $14,037,000 and increased in 2011 in the amount of $54,212,000.

(e)

Shoppers grew from acquiring property and equipment, and from developing property with a cost that was approximately one quarter of a billion dollars in total. It also spent considerable amounts of cash buying other businesses.

(f)

Shoppers used the cash generated from operating activities to repurchase its own shares and to pay dividends. These payments were also made in similar amounts in 2011.

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Financial Accounting, Sixth Canadian Edition

BYP 13-2 COMPARATIVE ANALYSIS (a)

Ratio

Shoppers (in thousands $)

Jean Coutu (in millions $)

Cash current 1. debt coverage

$916,816 = 0.4 times ($2,334,917 + $1,776,238) ÷ 2

$223.8 = 0.7 times ($265.2 + $408.7) ÷ 2

Current

$2,764,997 = 1.2 :1 $2,334,917

$421.9 = 1.6 :1 $265.2

Cash total

$916,816 = 0.3 times ($3,150,394 + $3,032,480) ÷ 2

$223.8 = 0.6 times ($281.9 + $423.6) ÷ 2

$3,150,394 = 42.2% $7,473,721

$281.9 = 20.2% $1,392.7

2. ratio 3. debt

coverage Debt to 4. total assets Times 5. interest earned Free cash

6. flow

$608,481 + $57,595 + $214,845 $558.4 + $2.0 + $78.9 = 15.3 times = 319.7 times $57,595 $2.0 $916,816 – $395,074 – $218,732 = $303,010

$223.8 – $66.0 – $60.8 = $97.0

(b)

From all measures arrived at in part (a), we can conclude that Jean Coutu enjoys far better liquidity and solvency than Shoppers. While Shoppers demonstrates good ratios, for debt to total assets and times interest earned, the corresponding ratios are far superior with Jean Coutu.

(c)

In order to conclude which company is more committed to growth, we would look at the investing activities of the statement of cash flows. While Jean Coutu has a net cash position in investing activities from selling Rite Aid, Shoppers incurred a large cash outflow from purchasing investments in businesses and developing properties for new store locations. Shoppers is, therefore, the company most committed to growth. In order to conclude which company is more committed to paying down debt, we would look at the financing activities the statement of cash flows. Shoppers’ financing activities consisted primarily of cash payments to buy back common shares and pay dividends. On the other hand, Jean Coutu appears to have used the proceeds from the sale of Rite Aid to pay down its revolving credit facility. This explains in part why the debt to total asset and times interest earned ratios are more favourable with Jean Coutu. Jean Coutu is more committed to paying down debt. Looking at the proportion of cash obtained from operating activities paid out in dividends, Shoppers percentage payout is slightly lower than that of Jean Coutu. Shoppers’ is 23.9% ($218,732 ÷ $916,816) while Jean Coutu’s is 27.1% ($60.8 ÷ $223.8).

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Financial Accounting, Sixth Canadian Edition

BYP 13-3 COMPARING IFRS AND ASPE

(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 profit. 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 cause Discount Ltd. to have a higher (better) cash debt coverage and higher (better) cash total debt coverage since, in both ratios, the numerator will be larger. The choice will also provide for a larger (better) free cash flow ratio as the amount of cash flow from operating activities will be larger, leaving more cash remaining after covering capital expenditures and dividend payments.

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Financial Accounting, Sixth Canadian Edition

BYP 13-4 CRITICAL THINKING 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 2014, 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 2015, 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 less 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 2014 made by C Limited were financed with debt, even though C Limited was able to pay down some of this debt in 2015 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)

Because A Limited financed expansion in 2015 using mostly equity, and it grew its operations in that year through expansion, it generated the most cash from operations. The cash total debt coverage is determined by taking cash from operating activities and dividing it by average total liabilities. Even though A Limited has the highest cash flow from operations, B Limited has very little debt and because of this, is likely the company that would have the highest cash to total debt ratio.

(c)

C Limited is the only company that had a decrease in the net cash from its operating activities in 2015. This happened because too much cash was tied up in accounts receivable and inventory. The increases in these current assets, particularly during 2015, caused a large reduction of cash that could have been used instead to reduce the high levels of debt.

(d)

C Limited likely did not have a choice to pay down its bank loans in 2015. 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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Financial Accounting, Sixth Canadian Edition

BYP 13-4 (Continued) (e)

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 2015 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.

(f)

A Limited is the company most committed to growth as demonstrated by the large investment in property, plant and equipment that continued into 2015. 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.

(g)

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 (h)

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 2014 to buy non-current assets, and then sold some of them in 2015 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 2015. If it occurred early in the year, one would expect, given the larger asset base of this company, that profit would be higher. On the other hand if the expansion occurred very late in 2015, the extra asset base could trigger much higher amounts of profit next year compared to 2015. 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 2015 expansion before buying their shares. On the other hand, B Limited is probably the safest company to lend money to, given its low level of debt and its reasonably high operating cash flows.

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Financial Accounting, Sixth Canadian Edition

BYP 13-5 ETHICS CASE (a)

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: • 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 longterm goals, such as property, plant, and equipment purchases, expansion, debt repayment, etc.

(b)

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 just like the dividend payment discussed above, 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.

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Financial Accounting, Sixth Canadian Edition

BYP 13-6 “ALL ABOUT YOU” ACTIVITY

(a)

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 ......................

$(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)

Net increase in cash ........................................................ Cash, beginning of year................................................... Cash, end of year ............................................................ (b)

$45,000

(28,800 ) 16,200

(25,900)

10,200 500 500 $ 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.

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BYP 13-7 SERIAL CASE (a) Biscuits ($ in thousands)

Koebel’s Family Bakery

Coffee Beans ($ in thousands)

Cash current debt coverage ratio

$235,279 $31,121 = 7.6 times

$6,821 $16,233 = 0.4 times

$1,594 $3,759 = 0.4 times

Cash total debt coverage ratio

$235,279 $81,551 = 2.9 times

$6,821 $27,758.5 = 0.2 times

$1,594 $8,879 = 0.2 times

Free cash flow

$235,279 – $144,000 – $120,000 = $(28,721)

$6,821 – $3,414 – $580 = $2,827

$1,594 – $1,448 – $0 = $146

(b)

Koebel is able to generate a significant amount of cash from its operating activities—in excess of its profit. It uses cash for both its investing activities and financing activities. The use of cash in investing activities indicates that Koebel is investing in its plant and equipment, which is a good sign for future growth. Its use of cash in financing activities indicates that they are either repaying more debt than they are raising (through debt or equity) or are using cash for dividends. From the additional information, we can determine that a $120,000 dividend was paid, which exceeded the amount that Daniel contributed in equity ($107,500). See Chapter 11. Biscuits is also generating a significant amount of cash from its operating activities—far in excess of its profit. It is also using cash in both its investing and financing activities. From this, it appears to be at the maturity stage of its corporate life cycle. Coffee Beans’ 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 profit, 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.

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BYP 13-7 (Continued) (c)

As we saw above, Koebel is generating positive cash from its operating activities. While its free cash flow is negative (because of its investment in capital expenditures and relatively large dividend), it has little debt and is able to pay a generous dividend from its operating activities. Its cash current debt coverage and cash total debt coverage ratios indicate that the cash provided from its operating activities is more than sufficient to pay the current and total liabilities. Overall, the company appears to report strong profit and cash flow, which are likely two of the financial reasons Biscuits and Coffee Beans are interested in acquiring Koebel, in addition to strategic reasons discussed in the past.

(d)

The Koebels will likely favour Biscuits over Coffee Beans. Biscuits appears to have a stronger financial position than Coffee Beans. It has more cash available to pay for its investment in Koebel’s Family Bakery. Coffee Beans, on the other hand, does not pay a dividend and has decreased its overall cash position during 2016. Even though its cash current debt coverage and cash total debt coverage ratios are similar to those of Biscuits, its free cash flow is significantly less. Other issues the Koebels should consider before finalizing their decision could include: • • • •

Determining what percentage of ownership Natalie and Daniel will have going forward. How will Natalie 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?

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Financial Accounting, Sixth Canadian Edition

CHAPTER 14 Performance Measurement ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

A Problems

B Problems

1. Understand the 1, 2, 3, 18 concept of sustainable income and indicate how discontinued items are presented.

1, 2

1, 4

2B, 4B

2. Explain and apply horizontal analysis.

4, 5, 6, 7, 10,

3, 4, 5, 6

2, 4

1A, 3A

1B, 3B

1, 5

3. Explain and apply vertical analysis.

5, 6, 7, 8, 9, 10,

5, 6, 7, 8

3, 4

2A, 3A

2B, 3B

1, 4

4. Identify and calculate ratios that are used to analyze liquidity.

10, 11, 12, 15

9, 10

5, 6, 7, 13 5A, 6A, 7A, 8A, 9A

5B, 6B, 7B, 2, 3, 4, 8B, 9B 5, 7

5. Identify and calculate ratios that are used to analyze solvency.

13, 14, 15

5, 8, 9, 13 5A, 6A, 7A, 8A, 9A

5B, 6B, 7B, 2, 3, 4, 8B, 9B 5, 7

6. Identify and calculate ratios that are used to analyze profitability.

15, 16, 17, 18, 19, 20

12, 13, 14

5, 10, 11, 12, 13

4A, 5A, 6A, 7A, 8A, 9A

4B, 5B, 6B, 2, 3, 4, 7B, 8B, 9B 5, 6, 7

7. Understand the limitations of financial analysis.

20, 21, 22, 23

Study Objectives

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Questions

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BYP

Chapter 14

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Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare horizontal analysis.

Moderate

30-40

Prepare vertical analysis.

Moderate

25-35

Interpret horizontal and vertical analysis.

Moderate

20-30

Calculate and evaluate profitability ratios with discontinued operations.

Moderate

30-40

Calculate and evaluate ratios.

Moderate

40-50

Calculate and evaluate ratios.

Moderate

50-60

Evaluate ratios.

Moderate

50-60

Evaluate liquidity, solvency, and profitability.

Moderate

40-50

Discuss impact of accounting policies on financial analysis.

Moderate

30-40

Prepare horizontal analysis

Moderate

30-40

Prepare vertical analysis, with discontinued operations.

Moderate

25-35

Interpret horizontal and vertical analysis.

Moderate

20-30

Calculate and evaluate profitability ratios with discontinued operations.

Moderate

30-40

Calculate and evaluate ratios.

Moderate

40-50

Calculate and evaluate ratios.

Moderate

50-60

Evaluate ratios.

Moderate

50-60

Evaluate liquidity, solvency, and profitability.

Moderate

40-50

Discuss impact of accounting policies on financial analysis.

Moderate

30-40

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Financial Accounting, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1.

Sustainable income is the level of income that is most likely to be maintained in the future. It differs from profit by the amount of irregular or non-typical items (e.g., from non-recurring or unusual revenues, expenses, gains, or losses) included. In other words, it is the amount of profit that a company can expect to earn from its normal, recurring operations.

(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.

(a) Statement of financial position: If discontinued operations are being held for sale, the assets held for sale are reported separately on the statement of financial position, and they are valued and reported at the lower of their carrying amount and fair value, less costs to sell. Any liabilities relating to the discontinued operations are also shown separately as current liabilities. (b) Income statement: The results from a company’s discontinued operations and the gain (loss) on disposal are shown separately on the income statement after profit from continuing operations. Note that the results from discontinued operations usually contains two parts; the first being the operating results attributable to the discontinued component and the second being the gain or loss (if any) on disposal of the component. The amounts for the discontinued component are presented net of any income tax expense or savings. In addition, earnings per share must be reported separately for continuing operations and for discontinued operations.

(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.

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).

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 6.

(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 profit of $200,000 and $220,000 for 2014 and 2015 respectively. If 2014 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 a period would be 10% (110% – 100%). (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 2012. The percent of base amount is calculated as follows: $200,000 ÷ $5,000,000 = 4%, and expressed as a percentage.

Trend analysis is made difficult when a limited amount of information is available to the general public concerning a business. In the case of Facebook, the first fiscal period is less than a full year. Horizontal analysis of 2012 and 2013 would not be useful since apples would be compared to oranges. Vertical analysis may be less problematic.

(a) The base amount assigned a 100% value in a vertical analysis of a statement of financial position is total assets. (b) The base amount assigned a 100% value in a vertical analysis of an income statement is net sales.

Yes. Companies competing in the same industry that are different sizes and in different countries with different exchange rates 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.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 10.

(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. (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.

11.

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.

12.

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.

13.

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.

14.

Tim Hortons’ has a lower debt to total assets ratio than the industry average. Even though its times interest earned is lower than average, it is quite acceptable. As a result, Tim Hortons’ solvency is probably better than other businesses in the same the industry.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 15.

(a) (b) (c) (d) (e)

Asset turnover Inventory turnover, days in inventory Return on common shareholders’ equity Times interest earned Current ratio, cash current debt coverage

16.

The difference between CIBC’s return on assets of 0.8% and the return on common shareholders’ equity of 21.8% means that the company must be using a substantial amount of debt to finance their assets. 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.

17.

The profit margin and the asset turnover ratio combine mathematically 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. 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 profits.

18.

Lai’s profit margin has improved. When comparing the company’s profit margin before considering irregular items, we see that the profit margin has improved from 5% to 6.5%. Discontinued operations are a nonrecurring item and should be excluded for analysis purposes.

19.

(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 the receiving dividends from the company. Investors would focus on the payout ratio to determine the extent to which the company pays dividends from the profits earned and consider the dividend yield to measure the rate of return that a dividend gives the investor relative to the share’s price.

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Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 20.

(a) Yum Brands’ profitability has improved as its profit margin excluding other comprehensive income increased from 10.6% to 11.8%. (b) It is common practice to calculate profitability ratios using profit 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 profit 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.

21.

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.

22.

Management must use professional judgement to choose the most appropriate accounting policy and in preparing estimates. This can impact the financial statements through bias (since management is often under pressure to meet company objectives) and inaccuracies in the estimates.

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.

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Chapter 14

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 Profit from continuing operations before income tax ................................. $1,040,000 Less: Interest expense .......................................................... $125,000 Income tax expense ..................................................... 260,000 385,000 Sustainable income ................................................................................... $ 655,000

BRIEF EXERCISE 14-2 (a) 3 (b) 1 (c) 2 (d) 1 (e) 3 (f) 4 (g) 3 (h) 1 (i) 4

A realized gain on the sale of trading investments Sales revenue Salaries expense Cost of goods sold Dividend revenue A loss from operations of a discontinued wholesale business Interest expense A write-down of obsolete inventory A gain on the sale of assets of a discontinued wholesale business

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-3 (a) Horizontal percentage of a base-year amount

Cash Accounts receivable Inventory Property, plant, and equipment Intangible assets

Solutions Manual .

2015

2014

2013

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%

—

$175,000 = 233.3% $75,000

$150,000 = 200.0% $75,000

$400,000 = 88.9% $450,000

$600,000 = 133.3% $450,000

$600,000 = 85.7% $700,000

$780,000 = 111.4% $700,000

$2,800,000 = 98.2% $2,850,000

$3,130,000 = 109.8% $2,850,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-3 (Continued) (b) Horizontal percentage change for each year

Cash Accounts receivable Inventory Property, plant, and equipment Intangible assets

2015

2014

(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 —

2013 0% 0% 0% 0% —

($175,000 – $75,000) = 133.3% $75,000

($600,000 – $400,000) = 50.0% $400,000

($400,000 – $450,000) = (11.1)% $450,000

($780,000 – $600,000) = 30.0% $600,000

($600,000 – $700,000) = (14.3)% $700,000

($3,130,000 – $2,800,000) = 11.8% $2,800,000

($2,800,000 – $2,850,000) = (1.8)% $2,850,000

($90,000 – $100,000) = (10.0)% $100,000

($150,000 – $175,000) = (14.3)% $175,000

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-4 Comparing the percentages presented results in the following conclusions: The profit for Coastal decreased in 2014 over 2013. Cost of goods sold and operating expenses increased faster than net sales. In addition, income tax expense declined indicating that profit from operations also declined, assuming no change in the income tax rate. Profit in 2015 increased over 2014. Sales increased faster than did cost of goods sold and operating expenses, which actually declined. Income tax expense increased indicating that profit from operations also increased, assuming no change in the income tax rate.

BRIEF EXERCISE 14-5 (a) (b) (c) (d)

Basis of Comparison Intracompany Intercompany Intercompany Intracompany

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Tool of Analysis Horizontal Vertical Vertical Horizontal

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-6 (a) 2015 125%

2014 96%

2013 100%

Property, plant, and equipment

110%

98%

100%

Goodwill

117%

100%

Current assets

Total assets

We did not calculate the change in goodwill as is it too large in 2014 and goodwill is not a significant asset. (b) 2015 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

2014 Current assets

Amount $ 1,175,000

Percentage 28.8%

2,800,000

68.7%

100,000 $ 4,075,000

2.5% 100.0%

Property, plant, and equipment Goodwill Total assets

2013 Current assets

Amount $ 1,225,000

Percentage 30.1%

2,850,000

69.9%

0.0%

$ 4,075,000

100.0%

Property, plant, and equipment Goodwill Total assets

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-7

Net sales Cost of goods sold Gross profit Operating expenses Profit before income tax Income tax expense Profit

2015 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%

2014 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%

BRIEF EXERCISE 14-8 Profit as a percentage of sales for Waubon decreased in 2014 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. Profit as a percentage of sales increased in 2015 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 profit as a percentage of sales is: 2013 = 16% (100% – 60% – 20% – 4%) 2014 = 15.3% (100% – 60.5% – 20.4% – 3.8%) 2015 = 16.8% (100% – 59.4% – 19.6% – 4.2%).

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Chapter 14

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-9 (a) Current ratio Receivables turnover Inventory turnover

2015 2.1 : 1 8.0 times 4.5 times

1 3 5

2014 1.8 : 1 8.9 times 5.0 times

2 4 6

$2,100,000 = 2.1 :1 $1,000,000

$6,240,000 = 8.9 times ($750,000 + $650,000) ÷ 2

$2,000,000 = 1.8 :1 $1,100,000

$4,540,000 = 4.5 times ($1,020,000 + $980,000) ÷ 2

$6,420,000 = 8.0 times ($850,000 + $750,000) ÷ 2

$4,550,000 = 5.0 times ($980,000 + $840,000) ÷ 2

(b) The company’s current ratio has improved from 2014 to 2015. 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 of the turnover of receivables and inventory leads to an increase in these assets and increases the current ratio.

BRIEF EXERCISE 14-10 Holysh’s liquidity is probably deteriorating. The increase in the current ratio is likely caused by the deteriorating turnover of receivables and inventory. This 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.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-11 Manulife’s solvency appears to have deteriorated slightly. The company’s reliance on debt did not change in 2012 as evidenced by the very high but identical debt to total assets ratio. There has been deterioration in the times interest earned ratio but offsetting this trend has been a small increase in its free cash flow. Cash total debt coverage also stayed the same. These changes are marginal however. The decrease in Manulife’s times interest earned ratio was more significant, moving from a 1.0 times in 2011 to 0.8 times in 2012. The overall conclusion is that Manulife’s solvency has deteriorated slightly.

BRIEF EXERCISE 14-12 (a)

The Wolastoq’s profitability is deteriorating.

(b)

Its return on common shareholders’ equity, return on assets and profit margin have all deteriorated, whereas the debt to total assets, and asset turnover have remained the same. Return on common shareholders’ equity is affected by return on assets and debt to total assets. Since the return on assets has deteriorated while the debt to total asset ratio has remained stable, the return on assets has driven the decline in return on common shareholders’ equity. Return on assets, in turn, is driven by profit margin and asset turnover. The decline in profit margin has decreased the return on assets and consequently the decrease in the return on common shareholders’ equity.

BRIEF EXERCISE 14-13 For growth, I would purchase the shares of Loblaws as the price-earnings ratio is higher, suggesting investors are willing to pay more for the shares because the company has higher prospects for growth and profits 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 profit 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.

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Financial Accounting, Sixth Canadian Edition

BRIEF EXERCISE 14-14 (a) (in U.S. $ millions) With OCI: Profit margin

$1,868 = 14.1% $13,278

$(1,690) = (12.2%) $13,807

$816 = 6.2% $13,070

Without OCI: Profit margin

$2,123 = 16.0% $13,278

$(1,392) = (10.1%) $13,807

$933 = 7.1% $13,070

2012

2011

2010

(b) 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 profit and other comprehensive income. In addition, there are no standard ratio formulas incorporating comprehensive income. Consequently, the profit margin without other comprehensive loss should be used in reliable financial analysis.

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 14-1 (a)

(b) Statement

Classification

Realized gain on the sale of longterm investments

Sustainable

Income Statement

Other revenue

A loss caused by a labour strike

Sustainable

Income Statement

Other expenses

Current assets of Irregular a discontinued component of an entity being held for immediate and probable sale

Statement of Financial Position

Current assets

An operating loss from a discontinued component of an entity, held for immediate and probable sale

Irregular

Income Statement

Discontinued operations

An impairment loss on goodwill

Sustainable

Income Statement

Operating expenses

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-2 (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

Solutions Manual .

2015

2014

2013

120.0 133.3 107.7 110.0 150.0 158.8

80.0 116.7 138.5 70.0 115.0 141.2

100.0 100.0 100.0 100.0 100.0 100.0

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-2 (Continued) (b) DRESSAIRE INC. Horizontal Analysis of Statement of Financial Position (% change between periods) 2015

Increase (Decrease) Amount

2014

Increase (Decrease) Amount

2013

Assets Current assets

$12

$ 40,000

50.0%

$ 80,000

$(20,000))

(20.0)%

$100,

Non-current assets

50,000

14.3%

350,000

50,000)

16.7 %

Total assets

$90,000

20.9%

$430,000

$ 30,000)

7.5 %

300,000

$400,000

4 0 0, 0 0 0 $520,000

14-19 Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-2 (Continued) (b) (Continued) Liabilities and Shareholders’ Equity Liabilities Current liabilities

$ 70,000

$(20,000)

(22.2)%

$ 90,000

$ 25,000

38.5%

$ 65,000

Non-current liabilities

165,000

60,000

57.1%

105,000

(45,000)

(30.0%)

150,000

Total liabilities

235,000

40,000

20.5%

195,000

(20,000)

(9.3%)

215,000

150,

35,000

30.4%

115,000

15,000

15.0%

15,000

12.5%

120,000

35,000

41.2%

50,000

21.3%

235,000

50,000

27.0%

0,0

Shareholders’ equity Common shares Retained earnings Total shareholders’ equity

0 Total liabilities and shareholders’ equity

135,000

00 $90,000

20.9%

$430,000

($30,000)

7.5%

85,000

285,000

185,000

$520,000

$400,000

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-3

FLEETWOOD CORPORATION Vertical Analysis of Income Statement 2015

2014

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

250,000 175,000

31.3% 21.9%

225,000 125,000

37.5% 20.8%

Profit before income tax Income tax expense

75,000 15,000

9.4% 1.9%

100,000 20,000

16.7% 3.3%

Profit

$60,000

7.5%

$80,000

13.3%

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-4 (a)

POSTMEDIA NETWORK CANADA CORP. Horizontal Analysis of Income Statement (% of base-year amount) Year Ended August 31 2012

2011

2010

Revenues

681.3

736.2

100.0

Operating expenses

593.1

613.5

100.0

Other expenses

231.5

275.6

100.0

Loss from continuing operations before income tax

83.5

27.2

100.0

83.5

27.2

100.0

52.0

21.5

100.0

Income tax expense Loss from continuing operations Income from discontinued operations, net of income tax Loss

Because there was no income from discontinued operations in 2010, no percentage change is calculated for 2011 and 2012 even though in those years, income from discontinued operations was recorded.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-4 (Continued) (b) POSTMEDIA NETWORK CANADA CORP. Vertical Analysis of Income Statement 2010 Revenues Operating expenses Other expenses Loss from continuing operations before income tax Income tax expense Loss from continuing operations Income from discontinued operations, net of income tax Loss

Amount $122,094 133,650 33,062 (44,618) 0 (44,618) 0 $(44,618)

Percent 100.0% 109.5% 27.1% (36.5%) 0.0% (36.5%) 0.0% (36.5%)

2011 Revenues Operating expenses Other expenses Loss from continuing operations before income tax Income tax expense Loss from continuing operations Income from discontinued operations, net of income tax Loss

Amount $898,888 819,921 91,121 (12,154) 0 (12,154) 2,565 $(9,589)

Percent 100.0% 91.2% 10.1% (1.4%) 0.0% (1.4%) 0.3% (1.1%)

2012 Revenues Operating expenses Other expenses Loss from continuing operations before income tax Income tax expense Loss from continuing operations Income from discontinued operations, net of income tax Loss

Amount $831,877 792,619 76,533 (37,275) 0 (37,275) 14,053 $(23,222)

Percent 100.0% 95.3% 9.2% (4.5%) 0.0% (4.5%) 1.7% (2.8%)

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-4 (Continued) (c)

Comparing 2011 to 2010, we can use the horizontal analysis of part (a) which demonstrates to us how extensive the increase in revenues was in 2011 over 2010. The increase was more than 7 times the level of revenue of 2010. With the increase in revenue came corresponding increases in expenses, with operating expenses coming in at 6 times the level of 2010, and other expenses increasing to a lesser extent. Other expenses also rose in 2011 but not by as much as revenues. We can see this effect when we look at the vertical analysis for 2011 versus 2010. Notice how the operating expenses and other expenses as a percentage of revenues fell in 2011. Because the expenses did not rise as much as the revenues,the loss from continuing operations fell a great deal in 2011 and represented only 1.4% of revenues in 2011 compared to 36.5% in 2010. In 2011, unlike 2010, there was income from discontinued operations that lowered the overall loss for that year. In 2012, both revenues and operating expenses fell but revenues fell by a greater extent as evidenced by the fact that operating expenses in 2012 were 95.3% of revenues compared to 91.2% in 2011 as we can see in the vertical analysis. Other expenses fell in 2012 and represented only 9.2% of sales in that year compared to 10.1% in the prior year. Despite this however, the loss from continuing operations in 2012 rose to 4.5% of revenues compared to only 1.4% of revenues in 2011. Fortunately, in 2012, income from discontinued operations grew but not by enough to prevent the overall loss for the year from being more than twice the amount in 2011.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-5

Asset turnover Average collection period Cash current debt coverage Cash total debt coverage Current ratio Days in inventory Debt to total assets Dividend yield Earnings per share 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

Solutions Manual .

(a) P L L S L L S P P S P L P P P L P P S L

14-25

(b) B W B B B W W B B B B B B B B B B B B B

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EXERCISE 14-6 ($ in millions) (a) 2015 Working capital = $1,430 – $890 = $540

= $1,314 – $825 = $489

Current ratio = 1.61:1 ($1,430  $890)

= 1.59:1 ($1,314  $825)

Acid-test ratio = 0.86:1 [($30 + $55 + $676)  $890]

= 0.89:1 [($91 + $60 + $586)  $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 Acid-test ratio Receivables turnover Collection period Inventory turnover Days sales in inventory

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2014

Better Better Worse Worse Worse Better Better

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-7 (a)

The company’s collection of its accounts receivable has deteriorated over the past several years 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.

EXERCISE 14-8 (a) 2015 Debt to total assets

Free cash flow Interest coverage

$2,175 $3,890

55.9%

$850 – $400

$450

($405 + $15 + $175) $15

39.7

times

2014 Debt to total assets

Free cash flow Interest coverage (b)

$1,960 $3,700

53.0%

$580 – $300

$280

($375 + $25 + $150) $25

22.0

Debt to total assets Free cash flow Interest coverage

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times

Worse Better Better

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-9 (a)

The debt to total assets ratio has deteriorated over the last 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 last three years. This means that the company’s profit before interest and taxes has risen more than the increase in interest expense.

(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 and cash total debt coverage ratios are improving, so the company appears to be able to handle this increasing level of debt. Because of the impact of these latter two ratios, solvency has not deteriorated.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-10 (a) ($ in thousands) 2015 ($500 $375)

Gross profit margin

(b)

2014

= 25.0%

$500

($400 - $290)

= 27.5%

$400

Profit margin

$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 ($275 + $350) 2

Return on equity

$33.5 ($133.5 + $100) 2

Gross profit margin Profit margin Asset turnover Return on assets Return on equity

= 10.7%

$30.0 ($275 + $274) 2

= 10.9%

$30.0 = 28.7%

= 40.0% ($100 + $50) 2

Worse Worse Better Worse Worse

EXERCISE 14-11 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.

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Financial Accounting, Sixth Canadian Edition

EXERCISE 14-12 (a)

Return on assets is influenced by the profit margin and asset turnover. The main driver of the company’s return on assets is its profit margin. This is because the profit margin has decreased, whereas the asset turnover has remained constant.

(b)

Return on common shareholders’ equity is influenced by return on assets and debt to total assts. The return on assets ratio, more specifically the profit margin, was the primary driver of the deterioration in the return on common shareholders’ equity ratio. The profit margin has shown an increase from 2010 to 2011 and a substantial decrease from 2011 to 2012. This same pattern is reflected in the return on common shareholders’ equity. The debt to total assets ratio rose in 2011 and then remained constant from 2011 to 2012 so it is less of an influence on return on common shareholders’ equity.

EXERCISE 14-13 (a)

Nyarboro is the more liquid of the two despite Rogers’s 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 concluding, 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.

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 14-1A (a) CLUBLINK ENTERPRISES LIMITED Horizontal Analysis of Statement of Financial Position (% of base-year amount) December 31

2012

2011

2010

Current assets Non-current assets Total assets

81.2 107.2 106.7

118.4 108.1 108.3

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

105.3 103.0 103.2 117.0

126.4 101.0 103.7 121.7

100.0 100.0 100.0 100.0

106.7

108.3

100.0

Assets

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PROBLEM 14-1A (Continued) (a) (Continued) CLUBLINK ENTERPRISES LIMITED Horizontal Analysis of Income Statement (% of base-year amount) Year Ended December 31

Revenue Operating expenses Profit from operations Interest expense Other Profit before income tax Income tax expense Profit

2012

2011

2010

104.9 104.3 107.5 95.8 NA 118.7 106.0 122.9

105.4 107.0 98.4 98.2 1,970.1 139.4 142.6 138.4

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

The percentage change for other revenues and expenses in 2012 is not calculated because the amount changed from a large expense to a small revenue amount. (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 decline in current assets in 2012 and the increase in current liabilities and shareholders’ equity in 2011. The latter arose due the large increase in retained earnings arising from other revenues in 2011. 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 the decrease in revenue in 2012 likely due to the decline in the number of members as revealed in the footnote to the income statement. The increase in operating expenses increased by more than the increase in revenues in 2011, resulting in decreased profit from operations. The large source of other revenues in 2011 was the main reason for the increase in profits for 2011. The income tax expense decreased relative to profit before income tax in 2012, possibly due to a decrease in tax rates.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-2A (a) BIG ROCK BREWERY Vertical Analysis of Statement of Financial Position December 31 (in thousands) 2012

2011

2010

10,895 35,409 46,300

23.5 76.5 100.0

8,089 37,081 45,170

17.9 82.1 100.0

7,426 27,035 34,461

21.5 78.5 100.0

Liabilities and Shareholders’ Equity Liabilities Current liabilities 6,318 Non-current liabilities 7,911 Total liabilities 14,229 Shareholders’ equity 32,071 Total liabilities and shareholders’ equity 46,300

13.6 17.1 30.7 69.3

5,575 7,146 12,721 32,449

12.3 15.8 28.2 71.8

4,322 4,786 9,108 25,353

12.5 13.9 26.4 73.6

100.0

45,170

100.0

34,461

100.0

Assets Current assets Non-current assets Total assets

BIG ROCK BREWERY Vertical Analysis of Income Statement Year Ended December 31 (in thousands) 2012 Net sales Cost of sales Gross profit Operating expenses Profit from operations Interest expense Other income Profit before income tax Income tax expense (recovery) Profit

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$ 46,057 21,149 24,908 19,290 5,618 93 (204) 5,729 1,594 4,135

2011 % 100.0 45.9 54.1 41.9 12.2 0.2 (0.4) 12.4 3.5 9.0

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$ 45,183 21,385 23,798 20,455 3,343 141 (288) 3,490 957 2,533

2010 % 100.0 47.3 52.7 45.3 7.4 0.3 (0.6) 7.7 2.1 5.6

$ 45,130 19,418 25,712 20,054 5,658 147 (327) 5,838 (279) 6,117

% 100.0 43.0 57.0 44.4 12.5 0.3 (0.7) 12.9 (0.6) 13.6

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PROBLEM 14-2A (Continued) Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place. (b)

The most significant change in Big Rock’s statement of financial position has been a expansion of the business, which occurred in 2011 giving rise to non-current assets that increased by over $10 million. This increase was financed partially from debt as seen in the increase in non-current liabilities of $2.4 million and by a more substantial increase in equity of $6.9 million. There probably was a large issuance of shares as the increase in shareholders’ equity can only partially be explained by an increase in retained earnings arising profit of $2.5 million. Consequently, most of the increase in shareholders’ equity likely arose from share issuances that were used to finance the purchase of the noncurrent assets. The company’s gross profit decreased significantly in 2011 compared to 2010 but this improved somewhat in the following year. The decrease in gross profit percentage was counterbalanced somewhat in 2012 with a decline in operating expenses so that overall there was an improvement in the profit margin percentage in 2012 compared to 2011.

(c)

Big Rock has primarily financed its assets through equity, but as indicated by the gradually increasing debt to total assets ratio of 26.4% in 2010, 28.2% in 2011, and 30.7% in 2012, the company is relying less on equity financing than it has in the past.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-3A (a)

Although the operating expenses have been increasing over the last 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 2015 than in 2012, demonstrating that the company has a good control over the operating expenses.

(b)

The change in profit before income tax, income tax expense and profit 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 profit 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 profit.

(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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-4A ($ in millions) (a) Before Discontinued Operations Ratio Profit margin

2012 $333 $6,430 = 5.2%

2011 $395 $6,169 = 6.4%

2010 $572 $5,411 = 10.6%

2009 $512 $4,203 = 12.2%

2008 $1,602 $6,576 =24.4%

Return on assets

$333 $20,302 = 1.6%

$395 $19,493 = 2.0%

$572 $22,030 = 2.6%

$512 $22,528 = 2.3%

$1,602 $20,115 = 8.0%

Return on common shareholders’ equity

$333 $8,589 = 3.9%

$395 $8,094 = 4.9%

$572 $8,218 = 7.0%

$512 $7,418 = 6.9%

$1,602 $6,374 = 25.1%

After Discontinued Operations Ratio Profit margin

2012 $333 $6,430 = 5.2%

2011 $697 $6,169 = 11.3%

2010 $1,197 $5,411 = 22.1%

2009 $536 $4,203 = 12.8%

2008 $1,715 $6,576 = 26.1%

Return on assets

$333 $20,302 = 1.6%

$697 $19,858 = 3.5%

$1,197 $22,404 = 5.3%

$536 $22,528 = 2.4%

$1,715 $20,115 = 8.5%

Return on common shareholders’ equity

$333 $8,589 = 3.9%

$697 $8,094 = 8.6%

$1,197 $8,218 = 14.6%

$536 $7,418 = 7.2%

$1,715 $6,374 = 26.9%

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-4A (Continued) (b)

Nexen’s revenues declined sharply in 2009 but steadily arose afterwards. However, despite this, profit margin before discontinued operations deteriorated gradually over the five year period. Return on assets and return on equity improved slightly in 2010, but showed significant declines in 2011 and 2012. If we analyze profitability using profit after continuing operations, the pattern is similar – a sharp decline in 2009, significant improvements in 2010, followed by declines in 2011 and 2012. All 3 ratios for 2010 and 2011 are much higher than those calculated without the discontinued operations because the discontinued operations gave rise to higher profit due to the disposal of the assets held by these operations.

(c)

An analysis on profitability before discontinued operations is more relevant to investors as it provides a better indication as to how the company will perform in future periods.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-5A (a) 2015

2014

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

3. Inventory turnover

$450,000 = 4.9 times $100,000 + $85,000 ( ) 2

$300,000 = 4.0 times $85,000 + $64,000 ( ) 2

4. Debt to total assets

$240,000 = 32.7% $735,000

$165,000 = 28.0% $590,000

5. Times interest earned

$100,000 = 10.0 times $10,000

$66,000 = 16.5 times $4,000

$102,000 6. Cash total = 0.5 times debt coverage ($240,000 + $165,000) 2

$119,600 = 1.1 times $165,000 + $50,000 ( ) 2

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

* 2. Receivables turnover—Gross accounts receivable: 2015: $55,000 + $5,000 2014: $45,000 + $4,500 2013: $48,000 + $4,800

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-5A (Continued) (a) (Continued) 2015

2014

9. Asset turnover

$700,000 = 1.1 times $735,000 + $590,000 ( ) 2

$450,000 = 0.9 times $590,000 + $433,000 ( ) 2

10.Return on assets

$72,000 = 10.9% $735,000 + $590,000 ( ) 2

$49,600 = 9.7% $590,000 + $433,000 ( ) 2

(b)

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Current ratio Receivables turnover Inventory turnover Debt to total assets Times interest earned Cash total debt coverage Gross profit margin Profit margin Asset turnover Return on assets

(c)

Overall: (1) Liquidity improved in 2014. The current ratio, the accounts receivable turnover and inventory turnovers ratio were all favourable. (2) Solvency deteriorated because the debt to total assets ratio, the times interest earned ratio and cash total debt coverage trends were all unfavourable. (3) Profitability improved because the gross profit margin ratio trend was favourable, as were the asset turnover and return on assets ratios. On the other hand, the profit margin ratio trend was unfavourable. Overall, the profitability improved as the profit increased by a substantial amount in 2015.

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Favourable Favourable Favourable Unfavourable Unfavourable Unfavourable Favourable Unfavourable Favourable Favourable

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PROBLEM 14-6A (a) Liquidity 2015

2014

Working capital 

$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

$96,000 Cash current = 0.5 times $185,000 + $182,000 1 debt coverage ( ) 2

$85,000 = 0.5 times $182,000 + $180,000 ( ) 2

Receivables turnover

$900,000 × 75% ($95,000 + $5,000 + $90,000 + $4,000) [ ] 2 = 7.0 times

$840,000 × 75% ($90,000 + $4,000 + $88,000 + $3,000) [ ] 2 = 6.8 times

Average collection period

365 = 52 days 7.0

365 = 54 days 6.8

Inventory turnover

$600,000 = 4.7 times $130,000 + $125,000 ( ) 2

$575,000 = 4.8 times $125,000 + $115,000 ( ) 2

Days in inventory

365 = 78 days 4.7

365 = 76 days 4.8

 Current assets, 2015 = $70,000 + $95,000 + $130,000 + $24,000 = $319,000

Current assets, 2014 = $65,000 + $90,000 + $125,000 + $23,000 = $303,000 Current liabilities, 2015 = $45,000 + $30,000 + $110,000 = $185,000 Current liabilities, 2014 = $42,000 + $40,000 + $100,000 = $182,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-6A (Continued) (a) (Continued) Solvency 2015

2014

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

Cash total debt coverage

$96,000 $385,000 + $332,000 ( ) 2 = 0.3 times

$85,000 $332,000 + $371,000 ( ) 2 = 0.2 times

Free cash flow

$96,000 – $125,000 – $8,000 = $(37,000)

$85,000 – $50,000 – $8,000 = $27,000

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-6A (Continued) (a) (Continued) Profitability 2015

2014

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

$64,000 = 7.1 % $900,000

$65,000 = 7.7 % $840,000

Asset turnover

$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

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

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-6A (Continued) (b)

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18.

Working capital Favourable Current ratio Unchanged Cash current debt coverage Unchanged Receivables turnover Favourable Average collection period Favourable Inventory turnover Unfavourable Days in inventory Unfavourable Debt to total assets Favourable Times interest earned Unfavourable Cash total debt coverage Favourable Free cash flow Unfavourable Return on common shareholders’ equity Unfavourable Return on assets Unfavourable Profit margin Unfavourable Asset turnover Unchanged Gross profit margin Favourable Earnings per share Unfavourable Payout Favourable

(c)

(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 and the cash total debt coverage ratios have improved slightly, the times interest earnings and free cash flow ratios have deteriorated. (3) Clack’s profitability has declined as indicated by the decrease in the return on common shareholders’ equity, return on assets, profit margin, and earnings per share ratios. The asset turnover has remained constant. The gross profit margin and the payout ratio have increased slightly.

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Financial Accounting, Sixth 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 faster.

(c)

Supplies Unlimited has a higher current ratio than Bureau Nouveau and this would normally indicate a greater level of liquidity but in this case it probably does not as 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. Furthermore, Bureau Nouveau’s cash current debt ratio is higher than that of Supplies Unlimited and this indicates greater liquidity.

(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 the fact that operating expenses, other expenses and/or income tax expense are larger relative to sales for this company and this has caused the profit margin to fall.

(f)

Recall that 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-7A (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 14.3% while the return on common shareholders’ equity is 26.1%. The difference which is slightly smaller than 14.3% arose because of that company’s use of debt. Therefore, the return on assets is a larger contributing factor to the return on common shareholders’ equity than the use of debt.

(h)

Bureau Nouveau may have a lower payout ratio than Supplies Unlimited because Bureau Nouveau’s management has likely decided to retain profits in the business to finance future growth.

(i)

Market price per share = Price-earnings ratio × 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 profits.

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Financial Accounting, Sixth 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 compared to King’s or the industry average because of its lower receivables and inventory turnovers. Each companies’ 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 profit 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 industry average while King’s is below 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.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-9A (a) and (b) (a) Higher

(b) Higher

(1) Current ratio

Company A

no impact

(2) Debt to total assets

Company B

Company A

(3) Profit margin

Company A

Company B

(c)

Yes. The impact the different accounting policies and estimates will have on each company’s profit and ratios must be considered so that the comparison is meaningful.

(d)

An analyst must also consider professional judgement and diversification. Professional judgement impacts estimates made by management as it prepares the financial statements. The more diversified a company is, the harder it is to compare as it is involved in many industries.

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-1B (a) LULULEMON ATHLETICA INC. Horizontal Analysis of Statement of Financial Position (% of base-year amount) January 31 2013

2012

2011

Assets Current assets Non-current assets Total assets

202.2 240.0 210.5

135.4 188.6 147.1

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

156.2 154.9 156.0 225.0

121.2 127.3 122.3 153.7

100.0 100.0 100.0 100.0

210.5

147.1

100.0

LULULEMON ATHLETICA INC. Horizontal Analysis of Income Statement (% of base-year amount) Year Ended January 31 2013 Net revenue Cost of goods sold Gross profit Operating expenses Profit from operations Other income Profit before income tax Income tax expense Profit

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192.5 191.8 193.1 180.1 208.7 161.0 208.0 180.0 222.0

14-48

2012 140.6 136.2 144.2 131.6 159.1 63.1 157.7 171.1 151.1

2011 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-1B (Continued) (b)

The primary driver of the company’s profit appears to be the increase in revenues. In 2012, cost of goods sold increased at a slower rate than did revenues, which resulted in an increase in gross profit. The other income which fell in 2012, increased in 2013 and also contributed to higher profit in that year. In the statement of financial position, total assets increased at a faster rate than did total liabilities. This increase in assets was financed primarily by an increase in shareholders’ equity. Shareholders’ equity increased both from profit and what must have been an increase in shares not counting the amount of dividends that must have been paid out because shareholders’ equity increased more than by profit for 2012 and 2013. 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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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-2B (a)

YELLOW MEDIA INC. Vertical Analysis of Statement of Financial Position December 31 (in thousands) 2012

2011

2010

369,361 27,414 1,312,148 47,553 1,756,476

21.0 1.6 74.7 2.7 100.0

350,559 46,496 1,658,051 2,967,847 25,979 5,048,932

6.9 0.9 32.8 58.8 0.5 100.0

443,370 112,445 2,123,776 6,508,984 111,673 9,300,248

4.8 1.2 22.8 70.0 1.2 100.0

Liabilities and Shareholders’ Equity Liabilities Current liabilities 326,923 Non-current liabilities 1,143,393 Total liabilities 1,470,316 Shareholders’ equity 286,160 Total liabilities and shareholders’ equity 1,756,476

18.6 65.1 83.7 16.3

634,613 2,329,292 2,963,905 2,085,027

12.6 46.1 58.7 41.3

478,562 2,871,617 3,350,179 5,950,069

5.1 30.9 36.0 64.0

100.0

5,048,932

100.0

9,300,248

100.0

Assets Current assets Fixed assets Intangible assets Goodwill Other assets Total assets

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PROBLEM 14-2B (Continued) (a) (Continued) YELLOW MEDIA INC. Vertical Analysis of Income Statement Year Ended December 31 (in thousands) 2012 $ 1,107,715 686,331 3,267,847 (2,846,463)

Revenues Operating expenses Goodwill impairment Profit (loss) from operations Other revenues and expenses Interest expense (146,265) Other 962,788 Profit (loss) before income (2,029,940) tax Income tax expense (recovery) (75,935) Profit (loss) from continuing operations (1,954,005) Discontinued business loss Profit (loss) (1,954,005)

2011

% 100.0 62.0 295.0 (257.0)

$ 1,328,866 843,950 2,900,000 (2,415,084)

(13.2) 86.9 (183.3)

2010

100.0 63.5 218.2 (181.7)

$ 1,679,860 1,164,104 515,756

100.0 69.3 30.7

(130,582) (75,307) (2,620,973)

(9.8) (5.7) (197.2)

(144,796) (36,398) 334,562

(8.6) (2.2) 19.9

(6.9)

87,149

6.6

60,527

3.6

(176.4) (176.4)

(2,708,122) 120,877 (2,828,999)

(203.8) 9.1 (212.9)

274,035 274,035

16.3 16.3

(b)

Yellow Media performance and financial position are overshadowed by the devastating effect of taking an impairment charge on goodwill of $2.9 billion in 2011 followed by a complete balance write-off in 2012 of $3.3 billion. This charge coupled with declining revenues caused devastating losses for 2011 and 2012 and consequently declining shareholders’ equity to $0.3 billion by the end of 2012. Because goodwill represented 70% of the total assets at the end of 2010, the impairment of this asset caused this company to shrink to a fraction of its former self. The only positive sign in 2012 is the large other revenue of slightly under $1 billion. By the end of 2012 due to the dwindling equity position, debt to total asset climbed to 83.7%. This is a level that will cause concerns to shareholders and to creditors.

(c)

As mentioned in part (b) above, Yellow Media had previously financed its assets primarily through equity with an equity to total assets ratio of 64% but by the end of 2012, this ratio had reduced to 16.3%.

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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 2013 and 2014 but went somewhat out of control in 2015, when costs of goods sold increased by 2.4% of revenue.

(b)

Although the profit before income tax has remained constant as a percentage of each year’s revenue over the last 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 profit before income tax is increasing at about the same pace as the percentage increase in revenue.

(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. 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 that 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 profit.

(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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Financial Accounting, Sixth Canadian Edition

PROBLEM 14-4B (in USD millions) (a) Before Discontinued Operations Ratio Return on common shareholders’ equity Return on assets

Profit margin

2013

2012

2011

2010

2009

$4,535 $17,837 = 25.4%

$3,883 $18,394 = 21.1%

$3,338 $19,141 = 17.4%

$2,620 $18,585 = 14.1%

$2,312 $17,746 = 13.0%

$4,535 $40,801 = 11.1%

$3,883 $40,321 = 9.6%

$3,338 $40,501 = 8.2%

$2,620 $41,020 = 6.4%

$2,312 $42,744 = 5.4%

$4,535 $74,754 = 6.1%

$3,883 $70,395 = 5.5%

$3,338 $67,997 = 4.9%

$2,620 $66,176 = 4.0%

$2,312 $71,288 = 3.2%

2013

2012

2011

2010

2009

$4,535 $17,837 = 25.4%

$3,883 $18,394 = 21.1%

$3,338 $19,141 = 17.4%

$2,661 $18,585 = 14.3%

$2,260 $17,746 = 12.7%

$4,535 $40,801 = 11.1%

$3,883 $40,321 = 9.6%

$3,338 $40,501 = 8.2%

$2,661 $41,020 = 6.5%

$2,260 $42,744 = 5.3%

$4,535 $74,754 = 6.1%

$3,883 $70,395 = 5.5%

$3,338 $67,997 = 4.9%

$2,661 $66,176 = 4.0%

$2,260 $71,288 = 3.2%

After Discontinued Operations Ratio Return on common shareholders’ equity Return on assets

Profit margin

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PROBLEM 14-4B (Continued) (b)

Home Depot’s profitability before and net of discontinued operations is very similar and is gradually improving over the five year period. This is demonstrated in all three ratios. Net sales have been increasing since 2010 and profits have been rising at a faster rate, having doubled from 2009 to 2013. Consequently, all profitability ratios show significant improvement because profits are rising at a faster rate than net sales. Cost control explains this result. Average shareholders’ equity is actually declining in 2012 and 2013, yielding a larger increase in the return on common shareholders’ equity than the other two ratios. Similarly average total assets declined over the five year period, which helped provide for a stronger increase in the return on assets.

(c)

An analysis on profitability before discontinued operations is more relevant to investors as it provides a better indication as to how the company will perform in future periods.

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PROBLEM 14-5B (a) 2015

2014

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

3. Inventory turnover

$490,000 = 7.5 times $85,000 + $45,000 ( ) 2

$450,000 = 9.5 times $45,000 + $50,000 ( ) 2

4. Debt to total assets

$308,500 = 32.1% $960,000

$116,000 = 18.9% $615,000

5. Times interest earned

$134,000 = 4.8 times $27,750

$90,000 = 10.3 times $8,750

$107,500 6. Cash total = 0.5 times debt coverage ($308,500 + $116,000) 2 7. Gross profit margin

$400,000 = 44.9% $890,000

$91,000 = 0.7 times $116,000 + $135,000 ( ) 2 $350,000 = 43.8% $800,000

1. Current ratio: 1 Current assets 2015 = $30,000 + $80,000 + $85,000 + $70,000 = $265,000 2 Current assets 2014 = $24,000 + $50,000 + $45,000 + $75,000 = $194,000 2. Receivables turnover—Gross accounts receivable: * 2015: $80,000 + $3,650 = $83,650 * 2014: $50,000 + $2,750 = $52,750 * 2013: $53,000 + $2,400 = $55,400

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PROBLEM 14-5B (Continued) (a) (Continued)

2015

2014

8. Profit margin

$85,000 = 9.6% $890,000

$65,000 = 8.1% $800,000

9. Asset turnover

$890,000 = 1.1 times $960,000 + $615,000 ( ) 2

$800,000 = 1.4 times $615,000 + $540,000 ( ) 2

10.Return on assets

$85,000 = 10.8% $960,000 + $615,000 ( ) 2

$65,000 = 11.3% $615,000 + $540,000 ( ) 2

(b)

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Current ratio Receivables turnover Inventory turnover Debt to total assets Times interest earned Cash total debt coverage Gross profit margin Profit margin Asset turnover Return on assets

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Favourable Unfavourable Unfavourable Unfavourable Unfavourable Unfavourable Favourable Favourable Unfavourable Unfavourable

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PROBLEM 14-6B (a) Liquidity 2015

2014

Working capital 

$575,000 – $443,750 = $131,250

$460,000 – $265,000 = $195,000

Current ratio

$575,000 = 1.3 :1 $443,750

$460,000 = 1.7 :1 $265,000

$223,000 Cash current = 0.6 times $443,750 + $265,000 1 debt coverage ( ) 2

$135,500 = 0.5 times $265,000 + $250,000 ( ) 2

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

Inventory turnover

$650,000 = 1.9 times $400,000 + $300,000 ( ) 2

$635,000 = 2.0 times $300,000 + $320,000 ( ) 2

Days in inventory

365 = 192 days 1.9

365 = 183 days 2.0

 Current assets, 2015 = $50,000 + $100,000 + $400,000 + $25,000 = $575,000

Current assets, 2014 = $42,000 + $87,000 + $300,000 + $31,000 = $460,000 Current liabilities, 2015 = $150,000 + $245,000 + $48,750 = $443,750 Current liabilities, 2014 = $50,000 + $190,000 + $25,000 = $265,000

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PROBLEM 14-6B (Continued) (a) (Continued) Solvency 2015

2014

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

Cash total debt coverage

$223,000 $643,750 + $390,000 ( ) 2 = 0.4 times

$135,500 $390,000 + $543,500 ( ) 2 = 0.3 times

Free cash flow

$223,000 – $92,000 – $4,000 = $127,000

$135,500 – $50,000 – $4,000 = $81,500

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PROBLEM 14-6B (Continued) (a) (Continued) Profitability 2015

2014

Return on common shareholders’ equity

$101,250 $696,250 + $595,000 ( ) 2 = 15.7%

$67,500 $595,000 + $531,500 ( ) 2 = 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

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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PROBLEM 14-6B (Continued) (b)

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18.

Working capital Current ratio Cash current debt coverage Receivables turnover Average collection period Inventory turnover Days in inventory Debt to total assets Times interest earned Cash total debt coverage Free cash flow Return on common shareholders’ equity Return on assets Profit margin Asset turnover Gross profit margin Earnings per share Payout

Unfavourable Unfavourable Favourable Unchanged Unchanged Unfavourable Unfavourable Unfavourable Unfavourable Favourable Favourable Favourable Favourable Favourable Unchanged Favourable Favourable Unfavourable

(c)

(1) Track’s overall liquidity has declined in 2015. Its working capital and current ratio have declined and it is taking longer to turnover its inventory. The receivables turnover and average collection period have stayed the same. The cash current debt coverage is the only liquidity ratio that has shown an improvement. (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. The cash total debt coverage and free cash flow have improved. (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 earnings per share. The decrease in payout ratio is due to Track’s increased profit. The asset turnover ratio has remained constant.

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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 32 days (365 ÷ 10.4) days. This is excellent 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 has a higher current ratio than Flavour likely because it is 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 and a higher cash total debt coverage indicating it has a better ability to pay its debts.

(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 expenses or 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 seems to be attributable to Flavour’s higher profit margin.

(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 much larger than 10.2% and arose because of that company’s use of debt. Therefore, the use of debt is a greater contributing factor to the return on common shareholders’ equity than the return on assets.

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PROBLEM 14-7B (Continued) (h)

Refresh may have a lower payout ratio than Flavour because Refresh’s management may have decided to retain profits in the business to finance future growth.

(i)

Market price per share Refresh = Price-earnings ratio × Earnings per share = 14.3 × $0.98 = $14.01 Flavour = Price-earnings ratio × 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 profit in future.

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PROBLEM 14-8B

(a)

Best Tools appears to be more liquid. Although Snappy Tool’s 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 Tool 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 Tool 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 Tool is the more profitable company.

(d)

Investors seem to favour Snappy Tools as it has the higher price-earnings 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.

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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 profit and ratios must be considered. Otherwise, the comparison would not be as meaningful.

(d)

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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BYP 14-1 FINANCIAL REPORTING (a) SHOPPERS DRUG MART Horizontal Analysis of Income Statement (% of base-year amount) Year Ended December 31 (in U.S. thousands)

Income statement Sales Cost of goods sold Gross profit Operating expenses Profit from operations Interest expense Income tax expense Profit

Statement of financial position Current assets Non-current assets Current liabilities Non-current liabilities Shareholders’ equity

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2012

2011

2010

105.8 105.2 106.7 109.3 98.2 95.0 87.7 102.8

102.6 102.1 103.4 104.0 101.5 106.1 95.1 103.7

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

2012

2011

2010

108.7 104.6 152.9 57.7 105.4

106.0 102.3 116.3 88.8 104.0

100.0 100.0 100.0 100.0 100.0

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BYP 14-1 (Continued) (b) (1)

SHOPPERS DRUG MART Vertical Analysis of Income Statement Year Ended December (thousands) 2012 Sales Cost of goods sold Gross profit Operating expenses Profit from operations Interest expense Income tax expense Profit

$ 10,781,848 6,609,229 4,172,619 3,291,698 880,921 57,595 214,845 608,481

2011 % 100.0 61.3 38.7 30.5 8.2 0.5 2.0 5.6

$ 10,458,652 6,416,208 4,042,444 3,131,539 910,905 64,038 232,933 613,934

2010 % 100.0 61.3 38.7 29.9 8.7 0.6 2.2 5.9

$ 10,192,714 6,283,634 3,909,080 3,011,758 897,322 60,633 244,838 591,851

% 100.0 61.6 38.4 29.5 8.8 0.6 2.4 5.8

(2)

SHOPPERS DRUG MART Vertical Analysis of Statement of Financial Position (thousands)

Current assets Non-current assets Total Assets Current liabilities Non-current liabilities Shareholders’ equity Total Liab. & Equity

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2012 $ 2,764,997 4,708,724 7,473,721 2,334,917 815,477 4,323,327 7,473,721

2011 $ 2,695,647 4,604,663 7,300,310 1,776,238 1,256,242 4,267,830 7,300,310

% 37.0 63.0 100.0 31.2 10.9 57.8 100.0

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% 36.9 63.1 100.0 24.3 17.2 58.5 100.0

2010 $ 2,542,820 4,501,377 7,044,197 1,527,567 1,413,995 4,102,635 7,044,197

% 36.1 63.9 100.0 21.7 20.1 58.2 100.0

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BYP 14-1 (Continued) (c)

The horizontal analysis of part (a) highlights disproportionate increases in operating expense in 2012 and of current liabilities by the end of 2012. To some extent the vertical analysis of part (b) echoes the highlights of part (a). Whereas gross profit ratio is essentially holding to a constant, the profit margin is declining due to the increase of operating expenses. Similarly, the increase in current liabilities to 31.2% of total assets is demonstrated in the vertical analysis. In spite of this increase, Shoppers is enjoying strong solvency with debt to equity proportions remaining close to a 40:60 split. On the other hand, liquidity is being hurt by the increase in current liabilities.

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BYP 14-2 COMPARATIVE ANALYSIS (a) Liquidity ratios Shoppers Drug Mart (millions)

Jean Coutu (millions)

Current ratio

$2,765.0 = 1.2 :1 $2,335.9

$421.9 = 1.6 :1 $265.3

Receivables turnover

$10,781.8 = 22.4 times ($469.7 + $493.3) [ ] 2

$2,468.0 = 12.2 times ($199.6 + $206.5) [ ] 2

Average collection period

365 = 16 days 22.4

365 = 30 days 12.2

Inventory turnover

$6,609.2 = 3.2 times $2,148.5 + $2,042.3 ( ) 2

$2,169.0 = 12.2 times $190.1 + $166.2 ( ) 2

Days in inventory

365 = 114 days 3.2

365 = 30 days 12.2

$916.8 Cash current = 0.4 times $2,334.9 + $1,776.2 debt coverage ( ) 2

$223.8 = 0.7 times $265.3 + $408.7 ( ) 2

Liquidity: Comparing the ratios related to liquidity, Jean Coutu is more liquid than Shoppers with the exception of receivables turnover. Its current ratio is excellent. While its receivables turnover ratio is not as strong as Shoppers, its inventory turnover ratio is far superior, at 12.2 times (30 days).

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BYP 14-2 (Continued) (b) Solvency Shoppers Drug Mart (millions)

Jean Coutu (millions)

Debt to total assets

$3,150.4 = 42.2 % $7,473.7

$281.9 = 20.2 % $1,392.7

Free cash flow

$916.8 – $254.2 – $54.4 – $218.7 $223.8 – $20.9 – $16.1 – $60.8 = $389.5 = $126.0

Times interest earned

$608.5 + $214.8 + $57.6 $57.6 = 15.3 times

$558.4 + $78.9 + $2.0 $2.0 = 319.7 times

Cash total debt coverage

$916.8 $3,150.4 + $3,032.5 ( ) 2 = 0.3 times

$223.8 $281.9 + $423.6 ( ) 2 = 0.6 times

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. Shoppers’ debt to total assets ratio of 42.2% is more than double that of Jean Coutu. However, it has sufficient profit before income tax and interest expense to service this debt, as evidenced by its high times interest earned ratio of 15.3. Jean Coutu’s debt to total assets is extremely low at 20.2% which means that it is primarily financed by equity. Its times interest earned ratio is consequently extremely high. Although Shoppers has a larger free cash flow amount, this is an absolute amount and not a ratio and so it is dependent on the size of the business. Jean Coutu’s cash total debt coverage is twice that of Shoppers.

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BYP 14-2 (Continued) (c) Profitability ratios Shoppers Drug Mart (millions)

Jean Coutu (millions)

Gross profit margin

$4,172.6 = 38.7 % $10,781.8

$2,468.0 – $2,169.0 = 12.1% $2,468.0

Profit margin

$608.5 = 5.6 % $10,781.8

$558.4 = 22.6 % $2,468.0

Asset turnover

$10,781.8 $7,473.7 + $7,300.3 ( ) 2 = 1.5 times

$2,468.0 $1,392.7 + $1,072.8 ( ) 2 = 2.0 times

Return on assets

$608.5 $7,473.7 + $7,300.3 ( ) 2 = 8.2%

$558.4 $1,392.7 + $1,072.8 ( ) 2 = 45.3%

Return on common shareholders’ equity

$608.5 $4,323.3 + $4,267.8 ( ) 2 = 14.2%

$558.4 $1,110.8 + $649.2 ( ) 2 = 63.5%

Profitability: Although Shoppers has a much stronger gross profit margin compared to Jean Coutu based on their respective profit margins, we can see that Jean Coutu is more profitable than Shoppers. The large difference in gross profit margin may be due to the product mix of each company or the allocation of costs between cost of goods sold and operating expenses. Nonetheless, Jean Coutu appears to control its operating expenses better. This has allowed the company to have a much healthier profit margin compared to Shoppers. The return on assets ratio indicates that Shoppers is generating a much lower return than Jean Coutu based on the amount of assets invested in the business. The asset turnover measures how efficiently a company uses its assets to generate sales. Jean Coutu’s asset turnover was higher than Shoppers.

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BYP 14-2 (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 indicate the reasons behind some of the changes in the financial ratios.

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BYP 14-3 COMPARING IFRS AND ASPE (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 term used only under IFRS. Since DLL has recorded none of these items allowed under IFRS, it is logical to assume that it 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 methods 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 asset ratio because the equipment value has been increased to fair value, and because of 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 profit. Asset turnover: FLL will have higher total assets as explained in the debt to total assets ratio above. Consequently its asset turnover ratio will be lower than DLL.

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BYP 14-4 CRITICAL THINKING 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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BYP 14-4 (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

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BYP 14-5 ETHICS CASE (a)

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 action is unethical.

(c)

As controller you should at least inform Anne Saint-Onge, the vice-president 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 of the about-to-be-released information.

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BYP 14-6 “ALL ABOUT YOU” ACTIVITY (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 profits and cash flows and are not in the same growth phase that a newly public company would be in. 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 profits (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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BYP 14-6 (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 profit 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’s 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.

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BYP 14-7 SERIAL CASE (a)

Biscuits is more liquid than Cookies Are for Us. Biscuits’ current ratio is higher and matches the industry ratio. Its receivables turnover and inventory turnover are both higher than those of Cookies Are for Us and the industry average. This indicates that the Biscuits’ current ratio is strong, and that it is collecting its accounts receivable and turning over its inventory more quickly than its competitor.

(b)

It appears that Biscuits is the more solvent of the two companies. The two ratios provide conflicting results. Cookies Are for Us has a lower debt to total assets ratio, which is indicative of greater solvency. However, despite having a higher debt to total assets ratio, Biscuits also has a higher times interest earned ratio. Biscuits’ times interest earned ratio exceeds the industry average, which is also indicative of greater solvency. Biscuits higher times interest earned ratio indicates that it can service its higher debt load.

(c)

Biscuits is clearly the more profitable of the two, as all of its profitability ratios are superior to those of Cookies Are for Us. Biscuits’ return on common shareholders’ equity and gross profit margin ratios also exceed the industry average. However, its profit margin and return on assets ratios are lower than the industry average.

(d)

Investors favour Biscuits as indicated by their higher price-earnings ratio. Their P-E ratio is also higher industry average. This could mean that Natalie and Daniel may have to pay more to purchases shares of Biscuits.

(e)

Natalie 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 are different from those applied by companies using ASPE. 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 will be subject to additional volatility and how they will interpret the change in the trends for the ratios affected.

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Financial Accounting, Sixth Canadian Edition

BYP 14-7 (Continued) (f)

Natalie and Daniel should consider some of the following factors related to making an investment in Biscuits: - 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 longterm growth). - is this the right time to be purchasing the shares (are they currently overvalued by other investors)? - are they looking for dividend income or capital growth? In addition, before concluding their analysis, Natalie 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 Koebel’s Family Bakery.

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Chapter 14

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 13 – 14 (a) MANUTECH LTD. Vertical Analysis of Income Statement Year Ended December 31 2015 Amount Percent

2014 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

24.6%

Profit from operations

421,500

28.7%

175,000

15.9%

Interest expense

61,500

4.2%

53,600

4.9%

Profit before income tax Income tax expense

360,000 90,000

24.5% 6.1%

121,400 30,350

11.0% 2.7%

$ 270,000

18.4%

91,050

8.3%

Net sales

Profit

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 sales of the past. 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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Chapter 14

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 13 - 14(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

Days in inventory

365 = 50 days 7.3

40 days

Compared to the industry average, Manutech has a low 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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Chapter 14

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 13-14 (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%

$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%

$1,470,000 Profit margin

Compared to the industry averages, Manutech is stronger on all profitability ratios.

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Chapter 14

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Financial Accounting, Sixth Canadian Edition

COMPREHENSIVE CASE: CHAPTERS 13-14 (Continued) (e) MANUTECH LTD. Statement of Cash Flows—Partial Year Ended December 31, 2015

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) (49,500) 79,500 $ 30,000

Net decrease in cash Cash, January 1 Cash, December 31

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 profit. These two factors are the main reasons why the cash position did not improve at the same pace as profit.

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Chapter 14

Part 2 CHAPTER 1 The Purpose and Use of Financial Statements 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 a balance sheet.

True

False

20-Minute Quiz

Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth Canadian Edition

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

Multiple Choice 11. Which one of the following groups uses accounting information to determine whether the company’s profit will result in a share price increase? a. investors b. auditors c. creditors d. production managers 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.

14. Which of the following accounts would be found on an income statement? a. Sales, salary expense, and dividends b. Service revenue and salary expense c. Sales, salary expense, and cash d. Salary expense, dividends, and cash 15. The financial statement that reports the assets, liabilities, and shareholders’ equity at a specific date is the 20-Minute Quiz

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Financial Accounting, Sixth Canadian Edition

a. income statement. b. statement of changes in equity. c. statement of financial position. d. statement of cash flows.

20-Minute Quiz

Chapter 1 – The Purpose and Use of Financial Statements

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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

20-Minute Quiz

Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth Canadian Edition

20-MINUTE QUIZ #2

1. Identify the different forms of business organization.

2. Identify 2 internal users and 2 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.

20-Minute Quiz

Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth 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 • Employees External users could include: • Investors • Lenders • Creditors • Canada Revenue Agency (CRA) • Government • Union • Potential employees

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.

20-Minute Quiz

Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth Canadian Edition

CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS STUDY OBJECTIVES 1. Identify the uses and users of accounting.

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.

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Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth Canadian Edition

CHAPTER OUTLINE Study Objective 1 – Identify the Uses and Users of Accounting 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 plan, organize, and run companies.



External users – users who are outside the organization.  Investors  Lenders  Other creditors  Others (i.e., Canada Revenue Agency, security commissions and other regulatory agencies, labour unions, 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 make a profit, 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.

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Study 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 profits  Disadvantages proprietor personally liable financing may be difficult 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

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Chapter 1 – The Purpose and Use of Financial Statements

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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, Bombardier, Loblaw, Manulife Financial, Royal Bank, and Suncor—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 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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Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth Canadian Edition

Study 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 in the corporation to shareholders



Investing activities – obtaining resources or assets needed to operate the business (such as equipment, land, etc.) and investing idle cash (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? 

Operating activities – comprise the primary activities for which the organization is in business.  Revenue is generated from sales or services (and other activities like trading investments)  Expenses are incurred in earning revenue

Teaching suggestion – Stress the fact that just because a business is making money 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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Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth Canadian Edition

Study 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 profit. If expenses exceed revenues, the result is a loss. Also commonly known as the statement of earnings or statement of profit and loss. Profit is also known as net income (especially for companies reporting under ASPE) or net earnings. Must be prepared first as profit 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 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).

Statement of Cash Flows

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    

Financial Accounting, Sixth Canadian Edition

Reports the cash effects (receipts and payments) of a company’s activities for a period of time. Shows cash increases and decreases from 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 Shoppers Drug Mart and/or the CSU Corporation 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 (profit to statement of changes in equity). 2. Statement of changes in equity (profit 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).

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Chapter 1 – The Purpose and Use of Financial Statements

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CHAPTER 1 – 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. Suggested Solution: External users: Investors, lenders, other creditors, regulators, customers, labour unions, and the like.

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Chapter 1 – The Purpose and Use of Financial Statements

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CHAPTER 1 VOCABULARY QUIZ

Instructor’s Manual

The amount by which expenses exceed revenues.

An association of two or more persons to carry on as co-owners of a business for profit.

A financial statement that reports the assets, liabilities, and shareholders’ equity at a specific date.

A business owned by one person.

Users of financial information that use the information to determine whether or not to lend money.

Assets = Liabilities + Shareholders’ equity.

Debts and obligations of a business.

A report prepared by management that presents financial and nonfinancial information about the company.

The amount of accumulated profit from the prior and current periods kept in the company for future use and not distributed to shareholders as dividends.

10.

The cost of assets consumed or services used in ongoing operations to generate revenues.

Chapter 1 – The Purpose and Use of Financial Statements

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SOLUTIONS TO CHAPTER 1 VOCABULARY QUIZ

1. 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

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Chapter 1 – The Purpose and Use of Financial Statements

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Financial Accounting, Sixth Canadian Edition

CHAPTER 1 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.

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.

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.

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. Instructor’s Manual

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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. b. statement of changes in equity. c. statement of financial position. d. statement of cash flows.

8. Profit 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 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 Instructor’s Manual

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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 c. Assets - Shareholders’ Equity = Liabilities d. Assets - Shareholders’ Equity - Liabilities = 0

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.

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SOLUTIONS TO CHAPTER 1 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

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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 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?

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CHAPTER 2 A Further Look at Financial Statements 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 creditors 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 replacement 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

True

False

20-Minute Quiz

Chapter 2 – A Further Look at Financial Statements

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Financial Accounting, Sixth Canadian Edition

a company will liquidate in the near future

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 12. Which of the following is not an enhancing qualitative characteristic of useful information? a. comparability b. completeness c. verifiability d. timeliness 13. Profit 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. 14. Which ratio measures the percentage of assets financed by creditors rather than by shareholders? a. Current ratio b. Earnings per share ratio c. Debt to total assets ratio d. Price-earnings ratio 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.

20-Minute Quiz

Chapter 2 – A Further Look at Financial Statements

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Financial Accounting, Sixth Canadian Edition

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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20-MINUTE QUIZ #2

1. Selected components of the conceptual framework are shown below: 1. Going concern 2. Predictive value 3. Neutrality 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. Information has this quality if different knowledgeable and independent users can reach consensus that the information is faithfully represented. b. Accounting information cannot be biased toward one set of users over another. c. Information that is presented must portray what really exists or happened. d. Information has this quality if it is classified, characterized, and presented clearly and concisely. e. Relevant information helps users make predictions about future events. f. Accounting information must be available to decision makers before it loses its ability to influence their decisions. g. The company will remain in operation for the foreseeable future. h. Information has this quality if users can identify and understand similarities in, and differences among, items. i. Information has this quality if it provides users with feedback regarding their previous predictions or expectations. j. The value of the information provided in financial reporting information should justify the cost of providing it. k. 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. 20-Minute Quiz

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2. Consider the following data from Meadows Corporation:

Current assets Total assets Current liabilities Total liabilities Net sales Profit available to common shareholders Market price per common share Weighted average number of common shares

2015 $ 61,000 108,000 47,000 80,000 200,000 30,000 $9.00 30,000

2014 $ 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 2015 and 2014 b. Current ratio for 2015 and 2014 c. Debt to total assets for 2015 and 2014 d. Earnings per share for 2015 and 2014 e. Price-earnings ratio for 2015 and 2014

3. The following presents December 31, 2015, 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.

20-Minute Quiz

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ANSWERS TO 20-MINUTE QUIZ #2 1. a. 5 b. 3 c. 7 d. 4 e. 2 f.

g. 1 h. 8 i.

k. 11 2. a. Working Capital = Current Assets – Current Liabilities 2015: $61,000 – $47,000 = $14,000 2014: $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 2015: $61,000 ÷ $47,000 = 1.30:1 2014: $50,000 ÷ $39,000 = 1.28:1 The current ratio is another measure of liquidity. In 2015, the company had $1.30 of current assets for every dollar of current liabilities. In 2014, 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 2015: $80,000 ÷ $108,000 = 74% 2014: $62,000 ÷ $85,000 = 73% This ratio measures the percentage of assets that is financed by creditors rather than by

20-Minute Quiz

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shareholders. In 2015, $0.74 of every dollar invested in assets was provided by creditors. In 2014, $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. d. Earnings per Share = Profit Available to Common Shareholders ÷ Weighted Average Number of Common Shares 2015: $30,000 ÷ 30,000 = $1.00 2014: $20,000 ÷ 25,000 = $0.80 This ratio is a measure of profitability. It measures the profit earned for each common share, and provides a useful perspective of shareholder investment return. e. Price-Earnings Ratio = Market Price per Share ÷ Earnings per Share 2015: $9.00 ÷ $1.00 = 9 times 2014: $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 profit level will persist or increase in the future.

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3. VARIETY CORPORATION Statement of Financial Position December 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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

20-Minute Quiz

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CHAPTER 2 A FURTHER LOOK AT FINANCIAL STATEMENTS STUDY 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.

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CHAPTER OUTLINE Study Objective 1 – Identify the Sections of a Classified Statement of Financial Position In a classified statement of financial position, 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 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, trading investments, receivables, merchandise inventories, 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 reverseliquidity. 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? Non-Current Assets  Assets that are not expected to be converted into cash, sold, or used by the business within one year of the financial statement date or its operating cycle. Long-Term Investments  Assets that can be converted into cash, but whose conversion is not generally expected within one year.  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 for investment purposes or for strategic reasons.  Examples are investments in shares and bonds of other corporations. Teaching suggestion – Explain to students that in large companies there are individuals who do nothing but take care of long-term investments.

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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, and furniture.  Sometimes known as tangible assets, 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 over the life of the asset. It is possible to revalue the assets to fair value using the revaluation model. The revaluation method will be discussed in Chapter 9. 

Intangible Assets and Goodwill Non-current assets. Assets which have no physical substance but represent a privilege or right granted. Examples are patents, copyrights, franchises, trademarks, trade names, and licences. Goodwill is also an intangible asset but 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 Research in Motion are companies that spend a great deal of money on patents. ASPE comparison – Under IFRS, depreciation refers to the allocation of the cost of depreciating tangible assets 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. Liabilities are obligations that result from past transactions. 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, bank loans or notes payable and current maturities of long-term debt. 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. Non-Current Liabilities  Obligations expected to be paid or settled after one year.  Liabilities in this category include notes payable including bank loans payable, Instructor’s Manual

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bonds payable, mortgages payable, lease obligations, pension and benefit obligations, and deferred income tax liabilities. Sometimes known as long-term debt.

w Shareholders’ Equity  Share capital – investments in the business by the shareholders.  Retained earnings – cumulative profits retained for use in the business.  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 2-9. 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 reverse-liquidity. Ask them if it makes a difference how accounts are ordered?

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Study Objective 2 – Identify and Calculate Ratios for Analyzing a Company’s Liquidity, Solvency, and Profitability An analysis of the relationship between a company’s assets and liabilities can provide users with information about the firm’s liquidity and solvency. Liquidity – The ability to pay obligations as they become due. 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. 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 debt. 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 – The ability of the company to survive over a long period of time through paying interest as it comes due and repaying the face value of debt at maturity. 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. 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 long-term liabilities) by total assets.

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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.  Earnings per Share Measures the profit earned on each common share. Calculated by dividing the profit 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. 

Price-Earnings Ratio Measures the ratio of the market price of each common share to its earnings per share. Calculated by dividing the market price per share by the earnings per share.

Teaching suggestion – Walk through the calculation of the price-earnings ratio for Plazacorp and compare it to the industry average. Provide an explanation of what this ratio reveals – a general guideline in gauging share values.

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Study Objective 3 – Describe the Framework for the Preparation and Presentation of Financial 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. In order to be useful, financial information should possess the following fundamental qualitative characteristics:  Relevance – if information has the ability to make a difference in a decision scenario, it is relevant. Accounting information is also relevant to business decisions because it confirms or corrects prior expectations, thereby providing confirmatory value. Financial statements help predict future events thereby providing predictive value. Materiality is an important concept in 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. 

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 – all information that is needed to faithfully represent the economic reality must be included.  Neutral – cannot be selected, prepared, or presented to favour one set of users over another.  Free from material error.

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 Instructor’s Manual

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information:  Comparability Comparability – users can identify and understand similarities in, and differences among, items. Comparability can refer to inter- or intracompany. Consistency – when a company uses the same accounting principles and methods from year to year. Consistency aids comparability. 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 the same conclusion that the information is faithfully represented. In order to be relevant accounting information must have timeliness; therefore, it must 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 reasonably informed users can interpret the information and comprehend its meaning.

Teaching suggestion - Identify the various levels of understanding that might exist amongst users of financial information. Cost constraint - the value of the information 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 business will continue in operation for the foreseeable future. Teaching suggestion – Ask students what would happen to a business 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. The elements of financial statements are key definitions in accounting, such as assets, liabilities, equity, income, and expenses. 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. Instructor’s Manual

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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. Cost basis of accounting requires assets and liabilities to be recorded at original cost, as cost is a faithful representation. Cost is objective, easily verifiable and is neutral. 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? Fair value basis of accounting states that certain assets and liabilities should be recorded and reported at fair value. 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 – 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. Suggested solution: d

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CHAPTER 2 VOCABULARY QUIZ

Instructor’s Manual

Tangible assets that are being used in the business and are not intended for resale.

The quality of information that indicates the information makes a difference in a decision.

A measure used to evaluate a company’s liquidity and shortterm debt-paying ability, calculated by dividing current assets by current liabilities.

The basis of accounting that states assets should be recorded at their cost.

If information is important enough to influence the decision of an investor or creditor then the information is said to be this.

Assets not expected to be converted into cash, sold, or consumed in operations within the next year or operating cycle.

Obligations reasonably expected to be paid from existing current assets within the next year or operating cycle.

The excess of current assets over current liabilities.

Measures the ratio of the market price of each common share to its 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.

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SOLUTIONS TO CHAPTER 2 VOCABULARY QUIZ 1. Property, plant, and equipment 2. Relevance 3. Current ratio 4. 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 MULTIPLE CHOICE QUIZ

1. All of the following are current assets except a. accounts receivable. b. cash. c. patents. d. short-term investments.

2. Current liabilities include a. obligations to be paid within the year or operating cycle. b. accounts payable. c. salaries payable. d. all of the above. 3. Shareholders’ equity includes a. share capital. b. long-term investments. c. advances from shareholders. d. goodwill.

4. Current assets may be listed in the order of a. liquidity. b. reverse liquidity. c. permanency. d. both a and b.

5. Working capital is a. current assets less current liabilities. b. current assets divided by current liabilities. c. profit divided by average assets. d. profit divided by net sales.

6. The current ratio is a a. solvency ratio. b. profitability ratio. c. liquidity ratio. d. none of the above.

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. Instructor’s Manual

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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.

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%.

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.

10. 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.

11. Materiality in accounting implies a. that everything is important. 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. Instructor’s Manual

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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.

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.

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 material error

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.

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SOLUTIONS TO CHAPTER 2 MULTIPLE CHOICE QUIZ 1. c 2. d 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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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

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.

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.

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

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 profit reported by The Sun and Snow Shop Ltd. for the year is a. $20,000. b. $35,000. c. $45,000. d. $90,000. 6. Which financial statement reports the cash effects of the company’s operating, investing and financing activities for a period of time? Instructor’s Manual

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a. b. c. d.

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Income statement Statement of changes in equity Statement of financial position Statement of cash flows

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.

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 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

10. Borrowing money from a bank is considered to be a(n) a. merchandising activity. b. financing activity. c. operating activity. d. investing activity.

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.

12. Relevant information is considered a. timely. b. predictive and material. c. predictive, confirmatory, and material. d. confirmatory and timely. Instructor’s Manual

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13. Faithful representation is considered a. complete and neutral. b. complete and free from material errors. c. neutral and free from material errors. d. complete, neutral, and free from material errors.

14. The earnings per share ratio is a a. solvency ratio. b. profitability ratio. c. liquidity ratio. d. None of the above.

15. Selected financial information from ACE Corporation has been provided: Common shares Profit Market price per share Weighted average number of common shares

$10,000 $80,000 $25 100,000

ACE Corporation’s earnings per share is a. $0.80. b. $8.00. c. $10.00. d. $25.00.

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SOLUTIONS 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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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 fair value on an annual basis? If the students owned a business, would they want to use the fair value basis of accounting or the 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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Financial Accounting, Sixth Canadian Edition

CHAPTER 3 The Accounting Information System 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 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

True

False

20-Minute Quiz

Chapter 3 – The Accounting Information System

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Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

not journalized

Multiple Choice 11. Transactions are initially recorded in the a. general ledger. b. general journal. c. trial balance. d. statement of financial position.

12. The right side of an account is referred to as the a. negative side. b. positive side. c. debit side. d. credit side.

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.

20-Minute Quiz

Chapter 3 – The Accounting Information System

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Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

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

20-Minute Quiz

Chapter 3 – The Accounting Information System

3-3

Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

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.

20-Minute Quiz

Chapter 3 – The Accounting Information System

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Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

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:

Jul 5

Jul 10

Jul 15

Jul 18

Jul 20

Jul 22

20-Minute Quiz

Accounts Receivable Service Revenue Invoiced customer for architect drawings.

1,500 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

300

800

900

600

800

Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

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.

20-Minute Quiz

Chapter 3 – The Accounting Information System

3-6

Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM STUDY OBJECTIVES 1. Analyze the effects of transactions on the accounting equation.

2. Define debits and credits and explain how they are used to record transactions.

3. Journalize transactions.

4. Post transactions.

5. Prepare a trial balance.

Instructor’s Manual

Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

CHAPTER OUTLINE Study Objective 1 – Analyze the Effects 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. Transactions – accounting transactions occur when assets, liabilities, or shareholders’ equity items change 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. 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. These are the transactions that led to the financial statements shown earlier in Chapter 1. 1.

On October 1, Sierra Corporation issued $10,000 of common shares. Both Cash and Common Shares would increase by $10,000.

On October 1, Sierra borrowed $5,000 from Scotiabank to purchase equipment. Sierra agreed to repay the bank loan plus 6 percent interest in 3 months. Both Equipment and Bank Loan Payable would increase by $5,000.

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Financial Accounting, Sixth Canadian Edition

On October 2, Sierra paid its office rent for the month of October in cash, $900. Cash is decreased by $900 while Rent Expense would increase. Expenses decrease shareholders’ equity (through the Retained Earnings account).

On October 5, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30. Cash would decrease and another asset, Prepaid Insurance would increase.

On October 7, Sierra hired four new employees. This is not a business transaction.

On October 9, Sierra purchased advertising materials on account from Aero Supply for $2,500. Both Supplies and Accounts Payable would increase by $2,500.

On October 13, Sierra performs $20,000 of advertising services for Copa Ltd. A bill is sent to Copa for these services. Accounts Receivable is increased indicating an increase in the amount owed by Copa to Sierra. Service Revenue is increased (increasing Retained Earnings and consequently Shareholders’ Equity).

On October 19, Sierra received a $1,200 cash advance from R. Knox, a client, for advertising services that are not expected to be completed until November. Both Cash and Unearned Revenue, a liability, would increase by $1,200.

On October 22, Sierra makes a partial payment of $1,000 owing to Aero Supply (see transaction 6). Both Cash and Accounts Payable, would decrease by $1,000.

10.

Employees have worked two weeks, earning $4,000 in salary, which was paid on October 23. Cash would decrease and Salaries Expense would increase (decreasing Retained Earnings).

11.

On October 26, Sierra paid a $500 cash dividend. Cash would decrease and Dividends would increase (decreasing Retained Earnings).

12.

On October 30, Copa pays Sierra $5,000 of the amount owing (see transaction 7). This increases Cash and decreases Accounts Receivable by $5,000.

13.

On October 30, Sierra paid a monthly income tax instalment of $1,800. Cash is decreased by $1,800 while the Income Tax Expense is increased by $1,800 which decreases Retained Earnings and Shareholders’ Equity by $1,800.

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Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

Study Objective 2 – Define Debits and Credits and Explain How They are used to Record Transactions Account – an individual accounting record of increases and decreases in a specific asset, liability, or shareholders’ equity item.  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 events. 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.  When the totals of the two sides are compared, an account will 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, for every debit there must be an equal credit. The accounting equation must also be kept in balance.  Debits increase assets, dividends, and expenses while they decrease liabilities, common shares, and revenues.  Credits decrease assets, dividends, and expenses. Conversely, they increase liabilities, common shares, and revenues.  The normal balance of an account is always on its increase side. Teaching suggestion – Show students how to record transactions in the account using the information for Sierra. On October 1, $10,000 was invested in Sierra Corporation common shares. Both Cash and Common Shares would increase by $10,000. Cash 10,000

Common Shares 10,000

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. Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

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. 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, decrease shareholders’ equity. Therefore Expenses and Dividends are increased by debit entries and decreased by credit entries.

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Chapter 3 – The Accounting Information System

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Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

Study Objective 3 – Journalize Transactions 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. 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.

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Chapter 3 – The Accounting Information System

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Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

Teaching suggestion – Show the students examples of journal entries. Return to the example of Sierra. On October 1, $10,000 of cash was invested in the business, in exchange for Sierra Corporation common shares. Both Cash and Common Shares would increase by $10,000. This transaction would be recorded in the following manner:

Date Oct. 1

Instructor’s Manual

Account Titles and Explanation Cash Common Shares (Issued common shares)

Debit

Credit

10,000

Chapter 3 – The Accounting Information System

10,000

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Financial Accounting, Sixth Canadian Edition

Study Objective 4 – Post Transactions 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 revenue and expense accounts. Information in the ledger provides management with the balances (or subtotals) in various accounts. Accounts in the general ledger are listed in the chart of accounts. Remind students that a comprehensive chart of accounts is included in the Study Tool section of the textbook website and the Student Resources section of WileyPlus. Posting Posting is the process of transferring journal entries to the 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. 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?

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Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

Study 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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Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

CHAPTER 3 – 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. Suggested solution: b

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Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

CHAPTER 3 VOCABULARY QUIZ

Instructor’s Manual

The entire group of accounts maintained by a company.

A list of accounts and the account numbers which identify their location in the general ledger.

The procedure of entering transaction data in the journal.

Events that require recording in the financial statements because they involve an exchange affecting assets, liabilities, or shareholders’ equity.

Shows the debit and credit effects on specific accounts.

An individual accounting record of increases and decreases in a specific asset, liability, and shareholders’ equity items.

A system that records the dual effect of each transaction in appropriate accounts.

The procedure of transferring journal entries to the general ledger accounts.

The left side of an account.

10.

A list of accounts and their balances at a given time.

Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO CHAPTER 3 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

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Chapter 3 – The Accounting Information System

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Financial Accounting, Sixth Canadian Edition

CHAPTER 3 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.

2. A cash payment by a corporation to its shareholders by way of a distribution of profit is a. recorded as an advance to shareholders. b. recorded as salaries expense. c. recorded as an investment. d. recorded as dividends.

3. Dividends 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 profits 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 Instructor’s Manual

Chapter 3 – The Accounting Information System

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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 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.

9. All of the following accounts would have normal credit balances, except a. Accounts Payable. b. Bank Loan Payable. c. Unearned Revenue. d. Dividends.

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.

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.

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. Instructor’s Manual

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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

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

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.

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Financial Accounting, Sixth Canadian Edition

SOLUTIONS TO CHAPTER 3 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

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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 4 Accrual Accounting Concepts 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 when a company has a loss, you 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

20-Minute Quiz

Chapter 4 – Accrual Accounting Concepts

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Financial Accounting, Sixth Canadian Edition

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

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.

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.

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. Profit for the year would be a. $60,000. b. $55,000. c. $50,000. d. 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. 20-Minute Quiz

Chapter 4 – Accrual Accounting Concepts

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Financial Accounting, Sixth Canadian Edition

d. there is a decrease in assets or an increase in liabilities.

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.

20-Minute Quiz

Chapter 4 – Accrual Accounting Concepts

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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.

20-Minute Quiz

Chapter 4 – Accrual Accounting Concepts

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Financial Accounting, Sixth Canadian Edition

20-MINUTE QUIZ #2 1. Plumbing work was done for a customer in January. The bill was sent to the customer in February. Payment in full was received from the customer in March. In which month should the revenue be recognized? _____________________

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

20-Minute Quiz

Chapter 4 – Accrual Accounting Concepts

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ANSWERS TO 20-MINUTE QUIZ #2 1. Plumbing work was done for a customer in January. The bill was sent to the customer in February. Payment in full was received from the customer in March. In which month should the revenue be recognized? 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

20-Minute Quiz

Insurance Expense Prepaid Insurance $12,000 x 5/12 = $5,000

5,000 5,000

Chapter 4 – Accrual Accounting Concepts

4-6

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CHAPTER 4 ACCRUAL ACCOUNTING CONCEPTS STUDY OBJECTIVES 1. Explain when revenues and expenses are recognized and how this forms the basis for accrual accounting. 2. Describe the types of adjusting entries and prepare adjusting entries for prepayments. 3. Prepare adjusting entries for accruals. 4. Prepare the adjusted trial balance. 5. Prepare closing entries and a post-closing trial balance.

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CHAPTER OUTLINE Study Objective 1 - Explain when Revenues and Expenses Are Recognized and How This Forms the Basis for Accrual Accounting Accounting divides the economic life of a business into artificial 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. Revenue is recognized (recorded) when goods or services are exchanged for cash or claims to cash (such as accounts receivable) which results in an increase in future economic. Revenues arise in the course of “ordinary’ activities but can also arise from other activities. Revenue recognition occurs when the sales or performance effort is substantially complete, the amount is determinable (measurable), and collection is reasonably assured. Teaching suggestion - Retail stores recognize revenue when the sale is made, although many customers may not yet have paid for their merchandise (for example, because the customer purchased it on account). The cash has not been received; however, the goods have been delivered. Therefore, revenue should be recognized. 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 service has not been provided. The revenue will be recognized on June 15 when the ticket holder takes the flight. Expenses are the costs of assets that are consumed or services used in a company’s ordinary business activities. Expenses are tied to 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. 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.

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Teaching suggestion - Returning to the retail store example, suppose sales personnel are paid every two weeks. 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 the revenue recognition principle. With cash basis accounting, revenue is recorded when cash is received. Expenses are recorded only when cash is paid. Cash basis accounting does not satisfy the requirements of generally accepted accounting principles (ASPE and IFRS), whereas accrual basis accounting does. Teaching suggestion - Return to the illustration of the retail store and the airlines. If the retail store used cash basis accounting, revenue would be recognized only when cash was received. Air Canada would recognize revenue on May 1 when the ticket was purchased. All expenses of both the retail store and Air Canada would be recorded when cash was paid.

Study Objective 2 – Describe the Types of Adjusting Entries and Prepare Adjusting Entries for Prepayments 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. Adjusting entries are required every time financial statements are prepared, and often are prepared more frequently. 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. Chapter 4

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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 on an annual basis so adjusting entries may only be completed at year end, although many companies will record adjusting entries more frequently. 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). Depreciation is the process of allocating the cost of a long-lived asset to expense over its useful life. Unearned revenues - cash received in advanced and recorded as liabilities before the revenues are earned.   

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. 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.

Study Objective 3 - Prepare Adjusting Entries for Accruals Accruals fall into two categories—accrued revenues and accrued expenses.  Accrued revenues - revenues earned but not yet received in cash or recorded at the statement date. An adjusting entry for accrued revenue will result in a debit or an increase Chapter 4

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in an asset account and an increase or a credit to a revenue account. 

Accrued expenses - expenses incurred but not yet paid in cash or recorded at the statement date. 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. 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 and accrued salaries.

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.

Study Objective 4 - Prepare the Adjusted Trial Balance 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. 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.

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Study Objective 5 - Prepare Closing Entries and a Post-Closing Trial Balance Permanent accounts are asset, liability and shareholders’ equity accounts. Temporary accounts are all expense and revenue accounts and the dividends account. Closing entries     

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 profit, 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 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, etc.) Ending October 31, 2015." 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. 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 post-closing trial balance as all temporary accounts should have balances of zero.

Summary of the Accounting Cycle (Steps 1-9) Analyze business transactions. Journalize the transactions. Post to general ledger accounts.

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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 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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Chapter 4 - 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. Suggested solution: 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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CHAPTER 4 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 revenue was earned and recorded as liabilities. 5. Revenue, expense, and dividend 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 in the accounting period in which it is earned. 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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SOLUTIONS TO CHAPTER 4 VOCABULARY QUIZ

Prepaid expenses

Closing entries

Depreciation

Unearned revenues

Temporary accounts

Accrual basis of accounting

Revenue recognition

Adjusting entries

Contra asset account

10.

Cash basis of accounting

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CHAPTER 4 MULTIPLE CHOICE QUIZ

Which of the following is not a permanent account? a. Accumulated depreciation b. Unearned revenue c. Common shares d. Dividends

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 received. c. It records expenses in the period they were incurred. d. It records expenses when cash is paid.

In order for revenues to be recorded in the period in which they are earned and for expenses to be recognized in the period in which they are incurred: a. adjusting entries are made. b. the cash basis of accounting is used. c. closing entries are made. d. None of the above.

Unearned revenues are: a. prepayments. b. liability accounts. c. temporary accounts. d. revenue accounts.

All of the following are examples of prepaid expenses, except a. prepaid rent. b. prepaid insurance. c. supplies. d. unearned revenue.

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.

Accumulated depreciation is a(n): a. contra asset account. b. contra revenue account. c. unearned revenue account. d. expense account.

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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

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 under GAAP. d. both a and b above.

10.

Which of the following is not a temporary account? a. Prepaid insurance. b. Rent expense. c. Dividends. d. Sales returns and allowances.

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 are closed to the Income Summary account along with expenses.

12.

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.

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.

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?

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a. b. c. d. 15.

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$42. $83. $125. $500.

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.

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SOLUTIONS TO CHAPTER 4 MULTIPLE CHOICE QUIZ Chapter 4

10.

11.

12.

13.

14.

15.

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Multiple Choice Quiz Chapters 3 and 4

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.

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 debts 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.

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.

All of the following are examples of permanent accounts, except: a. an asset account. b. a liability account. c. a shareholders' equity account. d. the Dividends account.

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.

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.

Cash received and recorded as a liability before revenue is earned is called: a. accrued revenue. b. unearned revenue. c. unrecorded revenue. d. None of the above.

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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.

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

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.

13.

A closing entry for the dividends accounts will require a. a debit to Income Summary. b. a debit to the Retained Earnings account. c. a debit to the Dividends 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? 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.

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d. 15.

Financial Accounting, Sixth Canadian Edition

The $12,000 is a prepaid expense under the accrual basis.

Which of the following statements related to revenue recognition is incorrect? a. For a merchandising company, revenue is generally considered earned when merchandise is sold. b. Recognizing revenue too early overstates current period revenues. c. Revenue should be recorded when earned. d. Revenue is recognized when there is a decline in future economic benefits.

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Solutions to Multiple Choice Quiz Chapters 3 and 4

10.

11.

12.

13.

14.

15.

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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 their 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 rarely impact the Cash account?

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Chapter 4 Quiz Spot Out Cleaning Services Ltd. was incorporated July 1, 2015. 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 Cleaning revenue

$ 4,500 1,500 36,000 -020,000 4,500 1,600

Additional information is as follows: 1. 2. 3. 4. 5. 6. 7.

The company purchased a one-year insurance policy for $4,500, effective July 1. The Supplies account shows a balance of $1,500 but a physical count shows only $300 of supplies remaining. The equipment costing $36,000 is estimated to have a 10-year useful life. The bank loan payable was signed July 1. It is a six-month, 6% loan. Interest is payable on the first of each month. Spot Out had performed services for a client totalling $500 but has not yet billed the client or recorded the transaction. 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. 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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Solution to Chapter 4 Quiz

SPOT OUT CLEANING SERVICES LTD. General Journal 2015 July 31

Chapter 4

Account Titles and Explanations Insurance Expense Prepaid Insurance (To record insurance expired: $4,500 x 1/12 = $375 per month)

Debit 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 Cleaning Revenue (To accrue revenue earned but not yet billed or collected)

500

Unearned Revenue Cleaning 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

Credit 375

1,200

300

100

500

750

150

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CHAPTER 5 Merchandising Operations 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 profit.

True

False

9. In a single-step income statement, gross profit and profit 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

True

False

20-Minute Quiz

Chapter 5 – Merchandising Operations

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according to the accounting records includes an adjustment of cost of goods sold.

Multiple Choice 11. Sales Returns and Allowances a. is a contra revenue account. b. has a normal debit balance. c. appears on the income statement. d. is all of the above. 12. Profit 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%. 13. Which of the following is a non-operating expense? a. finance expense b. rent expense c. delivery expense d. office 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. 15. When a company uses the perpetual inventory system, the a. Merchandise Inventory account balance does not change until the end of the year. b. Merchandise 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.

20-Minute Quiz

Chapter 5 – Merchandising Operations

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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. d 12. c

$15,000 + $3,000 + $20,000 = $38,000 of gross profit $38,000 ÷ $75,000 = 51% (rounded)

13. a 14. d 15. b

20-Minute Quiz

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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. Profit from Operations _________________ d. Profit _________________ Cost of goods sold Sales returns and allowances Non-operating expenses

20-Minute Quiz

$500 $ 30 $150

Sales Operating expenses Merchandise 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. Merchandise Inventory ................................................... Accounts Payable .................................................... (Purchased 10 stoves)

3,000

b. Accounts Payable ........................................................... Merchandise Inventory ............................................. (Returned 2 defective stoves) .........................................

600

c. Cash ............................................................................... Sales ........................................................................

650

Cost of Goods Sold ........................................................ Merchandise Inventory ............................................. (Sold a stove)

300

d. Accounts Payable ........................................................... Cash ......................................................................... (Paid the manufacturer)

2,400

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. Profit from operations $310 ($420 – $110) d. Profit $160 ($310 – $150) Cost of goods sold Sales returns and allowances Non-operating expenses

20-Minute Quiz

$500 $30 $150

Sales Operating expenses Merchandise inventory

Chapter 5 – Merchandising Operations

$950 $110 $60

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CHAPTER 5 MERCHANDISING OPERATIONS STUDY 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. Prepare entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A).

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CHAPTER OUTLINE Study Objective 1 – Identify the Differences between Service and Merchandising Companies In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales. 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. 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 profit (or loss) before income taxes. 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 inventory purchase and sale 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 provide timely information to management.  Periodic Detailed records are not kept throughout the period. Cost of goods sold determined only at the end of the accounting period, when a physical inventory count is taken.

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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.

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Study Objective 2 – Prepare Entries for Purchases under a Perpetual Inventory System The purchase of merchandise for resale is normally recorded by the buyer when the goods are transferred from the seller. Every purchase should be supported by a record that provides written evidence of the transaction.  Every cash purchase should be supported by a cash register or similar receipt, indicating the items purchased and the amounts paid.  Each credit purchase should be supported by a purchase invoice, which indicates the total purchase price and other relevant information such as shipping and credit terms. Cash purchases are recorded by an increase in Merchandise Inventory and a decrease in Cash. Credit purchases are recorded by an increase in Merchandise Inventory and an increase in Accounts Payable. Note: Sales taxes are amounts collected by most merchandising and service organizations at the time of payment. 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. If the freight costs are to be paid by the buyer, the costs are considered part of the cost of purchasing inventory. In this instance, Merchandise Inventory is increased and Cash is decreased.  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. 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. 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 Merchandise 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 Instructor’s Manual

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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 Merchandise Inventory account. The entry to record a payment would require the purchaser to decrease Accounts Payable, Decrease Cash, and decrease Merchandise 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 Merchandise 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 Merchandise Inventory. Ask students to recall examples of merchandising companies discussed earlier. What types of merchandise would these companies consider Merchandise Inventory? Sauk Stereo was able to take a purchase discount of $70. If Sauk Stereo had passed up the discount, it would be paying 2% for the use of $3,500 for 20 days. This equals an annual interest rate of 36.5%. Discuss the importance of companies taking discounts using this example.

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Study Objective 3 – Prepare Entries for Sales under a Perpetual Inventory System Sales revenues are recorded when goods are transferred from the seller to the buyer. This practice is in accordance with the revenue recognition principle. Sales may be made on credit or for cash. Each sales transaction should be supported by a record, which provides written evidence of the sale.  Cash register tapes provide evidence of cash sales.  A sales invoice provides written evidence of a credit sale. 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 asset 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 or Delivery Expense. 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 Merchandise 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 Instructor’s Manual

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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 company 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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Study 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 profits before income tax—subtract total expenses from total revenues.  Revenues – include both operating revenues and non-operating revenues and gains.  Expenses – include cost of goods sold, operating expenses, as well as nonoperating expenses 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 advertising, freight, salaries, and depreciation. 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, selling expenses, and administrative 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 profit.  Distinguishes between operating and non-operating activities.  This statement includes the following 5 main steps: Net sales (gross sales – sales discounts – sales returns and allowances) Gross profit (net sales – cost of goods sold) Profit from operations (gross profit – operating expenses) Non-operating revenues and expenses Profit (profit before income tax – income tax expense) Sales revenues – the income statement for a merchandising concern 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.

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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 profit; operating expenses must still be deducted. 



Profit from Operations – Operating expenses is deducted from gross profit to determine profit from operations. Reporting profit from operations as a separate number from overall profit 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 multiple-step income statement if they were a manager or a potential investor. Why? If trying to predict future profits, is profit or profit from operations the more relevant figure?

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Study 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 profit by net sales and measures the percentage of each dollar of sales that results in profit. 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).

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Study Objective 6 – Prepare Entries for Purchases and Sales under a Periodic Inventory System and Calculate Cost of Goods Sold (Appendix 5A) Revenues from the sale of merchandise are recorded when sales are made. 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 Merchandise Inventory account during the period. An adjusting entry is needed at the end of each period to update the amounts in the Merchandise Inventory and Cost of Goods Sold account.  Merchandise 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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CHAPTER 5 – 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? Suggested solution: Perpetual system and Periodic system

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CHAPTER 5 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 profit. 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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SOLUTIONS TO CHAPTER 5 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

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CHAPTER 5 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

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. Merchandise Inventory. d. Finished Goods.

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.

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 Merchandise Inventory. c. a debit to Loss on Merchandise Inventory. d. No entry would be made for a physical inventory count in a perpetual inventory system.

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.

6. Freight costs incurred by the seller on outgoing merchandise are considered a. operating expenses to the seller. b. part of merchandise inventory. c. part of purchases. d. part of cost of goods sold. Instructor’s Manual

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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. cannot be determined from the information given.

8. Revenue recognition guidelines require 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.

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 profits. d. sales revenue, cost of goods sold, and gross profit.

11. Profit margin is calculated by a. subtracting cost of goods sold from net sales. b. dividing profit by net sales. c. dividing gross profit by net sales. d. subtracting 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 c. insurance expense d. utilities expense

13. Which of the following inventory accounts would a manufacturing company not likely have? a. Merchandise Inventory Instructor’s Manual

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b. Raw Materials c. Finished Goods d. Work in Process 14. Burn’s Heating Inc. has provided the following information for 2015: Sales revenues $100,000 Sales returns and allowances 5,000 Sales discounts 5,000 Cost of goods sold 40,000 Rent expense 15,000 Salaries expense 10,000 What is Burn’s Heating Inc.’s gross profit margin? a. 27.8% b. 44.4% c. 55.6% d. 60.0%

*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 Merchandise Inventory $200. d. Debit Accounts Payable $10,000, credit Cash $9,800, and credit Purchase Allowances $200.

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SOLUTIONS TO CHAPTER 5 MULTIPLE CHOICE QUIZ 1.

10. d 11. b 12. b 13. a 14. c *15. a

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Discuss some of the different types of merchandise 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 6 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 profit 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. The specific identification method 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 profit and lower ending inventory than the average cost method.

True

False

8. The specific identification method 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

20-Minute Quiz ..

Chapter 6 –Reporting and Analyzing Inventory

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Multiple Choice 1. If the ending inventory is overstated: a. profit will be understated. b. profit will be overstated. c. profit will be correct. d. gross profit will be understated. 2. A company that uses a perpetual inventory system must still take a physical inventory count at year end, for the following reasons: 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. 3. In a period of rising prices, a. Cost of Goods sold is higher using the average cost method, compared with FIFO. b. Compared with the average cost method, FIFO results in lower gross profit. c. Compared with the average cost method, FIFO has lower ending inventory. d. Compared with FIFO, the average cost method has higher shareholders’ equity. 4. Which of the following statements is not true? a. Specific identification exactly matches costs and revenues. b. Average cost method 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. 5. 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

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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1. 2. 3. 4. 5.

True False True True True

6. 7. 8. 9. 10.

False False False True False

Multiple Choice 1. 2. 3. 4. 5.

b. b. a. c. d.

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20-MINUTE QUIZ #2 1.

Acme has the following information about its inventory. Beginning inventory- May 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 method b. FIFO

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

Effect

Year 1 cost of goods sold Year 1 gross profit Year 1 ending shareholders’ equity Year 2 cost of goods sold Year 2 profit 3.

Given the following information for Delta Company, calculate the Inventory turnover ratio: Cost of Goods Sold

$945,230

Opening Inventory

$278,560

Ending Inventory

$303,457

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(* Appendix 6A) 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 inventory- May 1 Purchase- May 2

Balance

120 @ $3.00 $360 280 @ $2.80 $784

Sold units – May 15 Purchase – May 20

Cost of Goods Sold

$360 (120 @ $3.00) $1,144 (400@$2.86) $286 (100 @ $2.86) $1,276 (550@$2.32)

$858 (300@ $2.86) 450 @ $2.20 $990

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 inventory- May 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 @ $3.00 280 @ $2.80 120 @ $3.00 = $360 180 @ $2.80 =$504

450 @ $2.20 $990

$360 $784 $1,144 100 @ $2.80 $280

100 @ $2.80 450 @ $2.20

$280 $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

Effect

Year 1 cost of goods sold

Year 1 gross profit

Year 1 ending shareholders’ equity

Year 2 cost of goods sold

Year 2 profit

3. Given the following information for Delta Company, calculate the Inventory turnover ratio: Cost of Goods Sold

$945,230

Opening Inventory

$278,560

Ending Inventory

$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 6 REPORTING AND ANALYZING INVENTORY STUDY OBJECTIVES 1. Describe the steps in determining inventory quantities.

2. Apply the methods of cost determination using specific identification, FIFO, and average cost under a perpetual inventory system.

3. Explain the financial statement effects of choosing each of the inventory cost determination methods.

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 determination methods under a periodic inventory system (Appendix 6A).

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Chapter 6 – Reporting and Analyzing Inventory

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CHAPTER OUTLINE Study Objective 1 – Describe the Steps in Determining Inventory Quantities Determining inventory quantities involves two steps: 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 listed on inventory summary sheets where unit costs will be applied to the quantities to determine total cost of the inventory.  Internal controls for counting inventory include: The count should be performed by employees who do not have responsibility for the custody or record-keeping of the inventory. The validity of inventory is established by checking that the item exists, determining the quantity of each item on hand, and noting the condition of the goods. A second count should be performed by another employee or auditor. 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.  Goods on approval should be added to the inventory count because they still belong to the seller.  If goods are held for alteration or until the customer picks up the goods, these goods should not be included in the physical count because legal title to ownership has passed to the customer. 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. Instructor’s Manual

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Study Objective 2 – Apply the Methods of Cost Determination 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 methods of cost determination that can be used: Specific identification should be used when goods are not ordinarily interchangeable, and 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 method 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 determinations may be used:  First-in, first-out (FIFO)  Average Cost The first-in, first-out (FIFO) cost method assumes that the earliest goods purchased are the first to be sold and recognized as cost of goods sold. The cost determination 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 University Soccer Shirt. Beginning inventory Purchases Apr 15 Aug 24 Nov 27 Cost of goods available

100 200 300 400 1,000

@ $10 @ 11 @ 12 @ 13

= = = =

1,000 2,200 3,600 5,200 $12,000

150 units were sold on May 1 and 400 units were sold on Sep 1; ending inventory is 450 units Instructor’s Manual

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Teaching suggestion – Use the University Soccer Shirt example to illustrate FIFO under a perpetual system. Cost of Ending Date Purchases Goods Sold Inventory Beginning inventory

(100 @ $10) $1,000

$ 1,000

Apr 15

(200 @ $11) 2,200

3,200

May 1

(100 @ $10) $1,000 (50 @ $11) 550 1,550

Aug 24

(300 @ 12) 3,600

Sep 10

Nov 27

(150 @ $11) $1,650 (250 @ $12) 3,000 4,650 (400 @ 13) 5,200

Total cost of goods sold

1,650 5,250

600 5,800

$6,200

The average cost method 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 method, 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.

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Chapter 6 – Reporting and Analyzing Inventory

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Teaching suggestion – Use the University Soccer Shirt example to illustrate the average cost method under a perpetual system. Cost of Ending Date Purchases Goods Sold Inventory Beginning inventory

(100 @ $10) $1,000

(100 @ $10) $ 1,000

Apr 15

(200 @ $11) 2,200

(300 @ $10.67) 3,200

May 1

Aug 24

(150 @ $10.67) $1,600 (300 @ $12) 3,600

Sep 10

Nov 27

(450 @ $11.56) 5,200 (400 @ $11.56) $4,622.22

(400 @ $13) 5,200

Total cost of goods sold

(150 @ $10.67) 1,600

(50 @ $11.56) 577.78

(450 @ $12.84) 5,777.78 $6,222.22

Teaching suggestion – Explain to students how rounding discrepancies can change the results in the average cost method. 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.

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Study Objective 3 – Explain the Financial Statement Effects of Choosing Each of the Inventory Cost Determination Methods If a company’s goods are not ordinarily interchangeable, or have been produced and segregated for specific projects, then the company should 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 method 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 profits and average results in the lowest profits. In periods of decreasing prices, the opposite is true, FIFO will report the lowest profits and average will report the highest profits.  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 profit on the income statement. However, the specific identification method 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.

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Chapter 6 – Reporting and Analyzing Inventory

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Study 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,  purchase of inventory recorded incorrectly. Inventory errors cause misstatements in cost of goods sold, gross profit, profit, 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 profits of the next period. The effect on the statement of financial position is balanced. The over or understatement in the Merchandise Inventory account equals the over or understatement error in the Retained Earnings account. Errors made when recording the purchase of inventory will cause the Merchandise Inventory and Accounts Payable accounts to be misstated. Teaching suggestion – Use Illustration 6-9 to show students that inventory errors offset each other and that the combined total profits for a two year period are correct.

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Chapter 6 – Reporting and Analyzing Inventory

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Study 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 Merchandise Inventory account being directly credited (reduced) when 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 2015 model SUV may decline below its cost in 2016 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,  method of cost determination (specific identification, fifo, or average cost),  amount of any writedown to net realizable value or reversals of previous writedowns, including the reason why the writedown was reversed. Analysis 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 Instructor’s Manual

Chapter 6 – Reporting and Analyzing Inventory

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Financial Accounting, Sixth Canadian Edition

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?

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Chapter 6 – Reporting and Analyzing Inventory

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Financial Accounting, Sixth Canadian Edition

Study Objective 6 – Apply the Inventory Cost Determination Methods of FIFO and Average Cost Under a Periodic Inventory System (Appendix 6A) Each of the inventory cost determination methods described in Chapter 6 for a perpetual inventory system may be used in a periodic inventory system. The first-in, first-out (FIFO) cost method 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 University Soccer Shirt example to illustrate FIFO and the methods for determining ending inventory and cost of goods sold: Beginning inventory Purchases Apr 15 Aug 24 Nov 27 Cost of goods available

100 200 300 400 1,000

@ $10 @ 11 @ 12 @ 13

= = = =

1,000 2,200 3,600 5,200 $12,000

A physical inventory count determines that ending inventory is 450 units. The value of ending inventory is calculated by starting with the last purchase: 400 @ $13 = $5,200 50 @ 12 = 600 Ending Inventory 450 $5,800 Cost of goods sold is then calculated: Instructor’s Manual

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Cost of goods available Less: Ending inventory Cost of goods sold This can be verified: Beginning inventory Purchases

$12,000 5,800 $ 6,200

100 200 250

@ $10 @ 11 @ 12

= = =

Cost of goods sold

$ 1,000 2,200 3,000 $ 6,200

The average cost method assumes that the goods available for sale are homogeneous or non-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 University Soccer Shirt example to illustrate the average cost method. Beginning inventory Purchases Apr. 15 Aug. 24 Nov. 27 Cost of goods available

100 200 300 400 1,000

@ $10 @ 11 @ 12 @ 13

= = = =

$ 1,000 2,200 3,600 5,200 $12,000

Average cost 12,000 ÷ 1,000 = $12 per unit Ending Inventory $12 x 450 = $5,400 Cost of goods available for sale Less: Ending inventory Cost of goods sold

$12,000 5,400 $ 6,600

We can check our work multiplying the units sold by the weighted average unit cost: 550 x $12 = $6,600. 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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Chapter 6 – Reporting and Analyzing Inventory

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CHAPTER 6 – 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 determinations often parallels the physical flow of goods? Suggested solution: Specific identification parallels the actual physical flow of goods. However, it is not a “cost determination”. Of the two cost methods, FIFO and average, FIFO often parallels the actual physical flow of merchandise because it generally is good business practice to sell the oldest units first.

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Chapter 6 – Reporting and Analyzing Inventory

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CHAPTER 6 VOCABULARY QUIZ 1. An inventory cost method 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 costing method used when goods are distinguishable and not ordinarily interchangeable.

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SOLUTIONS TO CHAPTER 6 VOCABULARY QUIZ 1. First-in, first-out (FIFO) cost method 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 method

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Chapter 6 – Reporting and Analyzing Inventory

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CHAPTER 6 MULTIPLE CHOICE QUIZ

1. In order to be classified as Merchandise 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.

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. merchandise 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. Instructor’s Manual

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d. none of the above.

7. The two cost determinations are a. specific identification and FIFO. b. FIFO and average cost. c. Perpetual and periodic. d. 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.

In a period of increasing prices, the inventory cost determination method that will yield the highest profit is a. periodic. b. FIFO. c. average. d. perpetual.

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 Merchandise Inventory. b. Debit Merchandise Inventory and credit Purchases. c. Debit Cost of Goods Sold and credit Merchandise Inventory. d. Debit Loss on Write-Down of Merchandise Inventory and credit Merchandise Inventory.

11. When deciding between the FIFO and average cost methods, 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 method for similar inventory. d. all of the above.

12. Which of the following statements is not true? a. During periods of rising prices, FIFO results in the highest profits. b. During periods of rising prices, the average cost method results in the highest cost of goods sold. c. During periods of rising prices, FIFO has the highest retained earnings. Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

d. During periods of rising prices, the average cost method has the highest ending inventory.

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.

14. Used Cars Inc. has the following inventory of vehicles: Cost NRV Vehicle A $ 25,000 $ 25,500 Vehicle B 50,000 40,000 Vehicle C 16,000 18,000 Vehicle D 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.

*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 Explanation Units Unit Cost Total Cost Jan. 1 Beginning inventory 200 $10 $2,000 Jan. 12 Purchase 50 12 600 Jan. 14 Sale 150 Jan. 15 Purchase 150 14 2,100 Jan. 20 Purchase 200 15 3,000 Assuming the use of the average cost method, what is the cost of the ending inventory? a. $1,500 b. $1,925 c. $5,775 d. $6,200

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SOLUTIONS TO CHAPTER 6 MULTIPLE CHOICE QUIZ 1.

10. c 11. d 12. d 13. d 14. c *15. c

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Do you think that a grocery store uses the FIFO cost method 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 determination methods? 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 method 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 7 Internal Control and Cash 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 trading investments, net of bank overdrafts.

True

False

6. Journal 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

20-Minute Quiz

Chapter 7 – Internal Control and Cash

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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. independent checks of performance.

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. b. added to the balance per bank. c. deducted from the balance per books. d. added to the balance per books.

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 Post-dated cheques 4,000 Chequing account balance 9,000 Debit card slips 1,000 Which amount should be reported as cash in the statement of financial position? a. $ 9,000 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.

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. 20-Minute Quiz

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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.

20-Minute Quiz

Chapter 7 – Internal Control and Cash

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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 Balance

Book Balance

Bank service charge Deposits in transit Cheques outstanding Interest earned Debit and credit card fees 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. 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.

20-Minute Quiz

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ANSWERS TO 20-MINUTE QUIZ #2 1. Provide five examples of control activities that apply to most companies. • authorization of transactions and activities • segregation of duties • documentation • physical controls • independent checks of performance • human resource controls. 2. Item

Bank Balance

Book Balance

–

Bank service charge

+ –

Deposits in transit Cheques outstanding

+ – –

Interest earned Debit and credit card fees 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. a. There is no rotation of employees, which means that Basil is more susceptible to employee fraud. Rotating employees’ duties is a human resource control, which is a key control activity. 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. b. 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 20-Minute Quiz

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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. c. 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 pay their accounts through EFT, as this would limit the amount of cash on hand. d. 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.

20-Minute Quiz

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CHAPTER 7 INTERNAL CONTROL AND CASH STUDY OBJECTIVES 1. Describe the primary components of an internal control system.

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 OUTLINE Study Objective 1 – Describe the Primary Components of an Internal Control System 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 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: Companies 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 fraud, 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: 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 Authorization of transactions and activities – Control is most effective when only one person is authorized to perform a specific task. 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 errors increases.  The following activities should be separated from one another: o Authorization of transactions and activities o Recording of transactions o Custody of assets 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. Instructor’s Manual

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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? Documentation – Documents provide evidence that transactions and events have occurred.  Documents should be 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. 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. Discuss the importance of internal controls over cash transactions. Independent Checks of Performance – the four control activities: authorization of transactions and activities, 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 Instructor’s Manual

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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? Human Resource Controls  Conduct thorough background checks to ensure that honest employees are hired as this inexpensive measure will reduce employee theft and fraud.  Bonding of employees who handle cash.  Rotating employees’ duties and requiring employees to take vacations. 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. Limitations of Internal Control  Internal control is designed to provide reasonable assurance that assets are properly safeguarded and that the accounting records are reliable. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit.  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 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 human element 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. 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?

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Chapter 7 – Internal Control and Cash

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Study Objective 2 – Apply the Key Control Activities to Cash Receipts and Payments Cash includes: Coins, currency, cheques, money orders, and money on hand or on deposit in a bank or similar depository. Cash does not generally include: post-dated, stale-dated or returned cheques, postage stamps, and employee IOUs. Debit card transactions and bank credit card transactions are considered cash but nonbank company credit card transactions (such as use of the Sears card) are not. 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 receipts may result from cash sales; cheques received either at the time of sale or at a later date by mail; the receipt of interest, rents, and dividends; investments by shareholders; bank loans; and proceeds from the sale of assets. 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 account 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:  Authorization—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.  Independent checks of performance—Supervisors count cash receipts daily; an accountant compares total receipts to bank deposits daily. Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

Human resource controls—Conduct background checks; bond personnel who handle cash; require vacations.

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. 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:  Authorization of transactions and activities—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.  Independent checks of performance—Compare cheques to invoices; reconcile bank statements monthly.  Human resource controls— Conduct background checks; bond personnel who handle cash; require vacations.

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Study 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: Time lags that prevent one of the parties from recording the transaction in the same period.  Days elapse between the time a company mails a supplier a cheque and the date the supplier presents the cheque to the bank for payment.  A time lag may occur when a company uses the bank’s night depository to make its deposits. There will be a difference of one day or more between the time the receipts are recorded by the company and the time they are recorded by the bank. Errors by either party in recording transactions. Reconciliation Procedure To obtain maximum 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 adjusted (correct) cash balance. The reconciliation is divided into two sections—balance per bank and balance per Instructor’s Manual

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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 depositor are reconciling items in determining the adjusted cash balance per books. In contrast, all errors made by the bank are reconciling items in determining the adjusted 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, the collection of a note receivable.  Any unrecorded other payments should be deducted from the balance per books, for example, NSF cheques or service charges.  Note any errors made by the depositor that have been discovered in the previous steps. Make sure to include errors made by the company as reconciling items in determining the adjusted cash balance per books. 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 Instructor’s Manual

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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: Balance per bank June 30 Add: Deposits in transit Deduct: Outstanding cheques # 502 503 Adjusted balance June 30 Balance per books June 30 Add: Electronic accounts receivable Less: Bank service charge NSF cheque—E. Collins Adjusted balance June 30

$ 8,450 1,890 $ 50 215

265 $10,075 $ 9,670 650

$ 15 230

245 $10,075

Entries from Bank Reconciliation Each reconciling item which arises from determining the adjusted cash balance per books should be recorded by the depositor. If these items are not journalized and posted, the Cash account will not show the correct balance. Any errors on the 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 adjusting 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)

650

Accounts Receivable 230 Cash 230 (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 adjusted cash balance in the bank reconciliation after the above entries have been posted. Instructor’s Manual

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Study 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 sources and uses of cash during a period of time. Teaching suggestion – Which statement, the statement of financial position or the statement of cash flows, provides the user with more information about cash? 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 trading investments that that are subject to an insignificant risk of changes in value, net of any bank overdrafts. 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. 6. Prepare a cash budget. Teaching suggestion – Ask students what they would do to increase the speed of collection on receivables.

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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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CHAPTER 7 – 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? Suggested solution: Statement of financial position and statement of cash flows

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CHAPTER 7 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, money orders, and money on hand or on deposit in a bank or similar depository. 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 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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SOLUTIONS TO CHAPTER 7 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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CHAPTER 7 MULTIPLE CHOICE QUIZ

1. Control activities consist of all of the following except a. authorization of transactions and activities. b. segregation of duties. c. generally accepted accounting principles. d. documentation.

2. The following measure is recommended to obtain maximum benefit from independent checks of performance. a. Independent checks of performance should be made periodically on a surprise basis. b. Independent checks 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.

4. Cash consists of a. coin, currency, and postage stamps. b. coins, currency, cheques, money orders, money on hand or on deposit in a bank or similar depository. c. coins, currency, postage stamps, money on deposit in a bank. 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. 6. The bank would debit the customer’s bank account for all of the following items, Instructor’s Manual

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except a. cheques drawn on the account. b. monthly service charge. c. electronic deposit. d. NSF cheque deposited by customer.

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.

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 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 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.

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 Instructor’s Manual

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the cash sales recorded by the system.

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.

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.

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.

15. When reconciling the balance per the books, the following adjustments are made to the Cash balance per the general ledger: 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.

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SOLUTIONS TO CHAPTER 7 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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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? Instructor’s Manual

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CHAPTER 8 Reporting and Analyzing Receivables 20-MINUTE QUIZ #1 Circle the correct answer.

True/False Receivables are classified as accounts receivable and notes receivable. 2. The net realizable value of the receivables is calculated by subtracting the Allowance for Doubtful Accounts from the Accounts Receivable. 3. As part of extending credit, companies need to establish a payment period.

True

False

True

False

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. 5. The percentage of receivables basis is the most common method used by companies in estimating uncollectible accounts

True

False

True

False

6. Credit card sales made using a nonbank (company) credit card are recorded by debiting Cash and crediting Sales.

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.

True

False

20-Minute Quiz

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The note is dated January 1, 2015 and is due January 1, 2018. The interest revenue to be recognized on December 31, 2015, the company’s year-end, is $105,000.

9. Short-term receivables are reported in the statement of financial position immediately following cash and trading investments.

True

False

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 realizable value of accounts receivable decreases b. Total net current assets will decrease c. The cash account will decrease d. The realizable value of accounts receivable will not change

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.

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: 20-Minute Quiz

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a. b. c. d.

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a debit to Allowance for Doubtful Accounts. only a credit to Notes Receivable. a credit to Notes Receivable and Interest Revenue. a credit to Notes Receivable and Interest Receivable.

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. 36 days. d. 73 days.

20-Minute Quiz

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Financial Accounting, Sixth 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. c

20-Minute Quiz

Chapter 8 – Reporting and Analyzing Receivables

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Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

20-MINUTE QUIZ #2

1. A company’s partial statement of financial position, as at December 31, appears as follows: 2015 Current Assets Cash Trading investments Accounts receivable Less: Allowance for doubtful accts Notes receivable Other current assets Total current assets

2014 $ 50,000 40,000

$90,000 15,000

75,000 80,000 90,000 $335,000

$ 60,000 30,000 $80,000 10,000

70,000 75,000 95,000 $330,000

Calculate the receivables turnover and the average collection period for 2015, assuming net credit sales for 2015 are $501,500.

2. Before adjustments, Amie Corporation had the following balances on December 31, 2015: Accounts Receivable ............................................................ $ 65,000 Allowance for Doubtful Accounts .......................................... 3,000 credit Net Credit Sales .................................................................... 550,000 a. Prepare the journal entry to record the estimated uncollectible accounts assuming Amie uses the percentage of receivables approach. An aging of the accounts receivable estimated the collectible amount of the receivables at December 31, 2015 at $57,800. b. On March 5, 2016 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, 2016 Amie receives a payment of $500 from Baker for the amount that had been previously written off on March 5, 2015. Prepare the required journal entries.

3. On November 1, 2015, 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 2015? c. How much interest would Amie earn in 2016?

20-Minute Quiz

Chapter 8 – Reporting and Analyzing Receivables

8-5

Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

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.

Dec 31 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

Mar 5 Allowance for Doubtful Accounts Accounts Receivable Wrote off Baker’s account.

500

Jul 1 Accounts Receivable Allowance for Doubtful Accounts To reverse the above write off.

500

Jul 1 Cash Accounts Receivable To record collection from Baker.

500

3. a.

Nov 1 Notes Receivable Accounts Receivable 6-month, 5% note.

b. Interest in 2015

= $6,000 x 5% x 2/12 = $50

c. Interest in 2016

= $6,000 x 5% x 4/12 =$100

20-Minute Quiz

Chapter 8 – Reporting and Analyzing Receivables

6,000 6,000

8-6

Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

CHAPTER 8 REPORTING AND ANALYZING RECEIVABLES STUDY OBJECTIVES 1. Identify 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.

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Financial Accounting, Sixth Canadian Edition

CHAPTER OUTLINE Study Objective 1 – Identify 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 or other entities. 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 Usually the most significant type of claim held by a company 

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 Notes and accounts 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, and recoverable sales taxes and income taxes

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? Nonbank Credit Card Receivables Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

When customers use a bank credit card to make a purchase, the transaction is recorded as a sale because the banks honour the credit card receipt as cash. In contrast, when a company like Canadian Tire sponsors its own credit card, the sale is considered a credit sale. Receipts from nonbank credit card sales are sent to a credit card company for reimbursement rather than deposited at a bank. Accounts Receivable Subsidiary Ledger A subsidiary ledger is a group of accounts with a common characteristic. Individual customer balances are organized and tracked. All transactions are posted twice, once to the general ledger and once to the subsidiary ledger. Transactions are usually posted daily to the accounts receivable subsidiary ledger. In computerized systems, the entries to the two ledgers—subsidiary and general— are simultaneous. Interest Revenue If the customer does not pay 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.

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Financial Accounting, Sixth Canadian Edition

Study 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. 1. Measuring and Recording Estimated Uncollectible Accounts  While there are several acceptable methods, most companies use a percentage of receivables basis to determine the balance of Allowance for Doubtful Accounts.  Under the percentage of receivables, management estimates the percentage of outstanding receivables that will result in losses from uncollectible accounts.  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 the accounts receivable classifies the outstanding accounts by age and applies percentages to these categories based on past experience. Using the Abrams Furniture Ltd. example from the text, a company has total accounts receivable of $200,000. Bad debt expense is estimated at $10,000. The required adjusting entry is: Dec. 31

  

Bad Debts Expense ................................... 10,000 Allowance for Doubtful Accounts ...... (To record estimate of uncollectible accounts)

10,000

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. Using a contra account helps separate estimates (Allowance for Doubtful Accounts) from actual amounts (Accounts Receivable).

The balance in Allowance for Doubtful Accounts is deducted from Accounts Receivable in the current assets section of the statement of financial position. Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Using the allowance method ensures that receivables are stated at their net realizable value. Net realizable value is the net amount expected to be received in cash; it excludes amounts that the company estimates it will not collect. Assuming an opening balance of $1,000 in Allowance for Doubtful Accounts, the ending balance of $11,000 would be reported as Accounts Receivable ......................................... Less Allowance for Doubtful Accounts ............... Net realizable value ...........................................

$200,000 11,000 $189,000

The $189,000 represents the expected Net Realizable Value of the Accounts Receivable. Teaching suggestion – Refer the students to the aging schedule for Abrams Furniture Ltd. in Illustration 8-2. Note the increasing uncollectible percentages from 2% to 50% over the different categories. The aging schedule estimates the balance in Allowance for Doubtful Accounts at $11,000. Assuming Allowance for Doubtful Accounts has an existing credit balance of $1,000, the required adjusting entry is: Dec. 31

Bad Debts Expense ................................... Allowance for Doubtful Accounts ......

10,000 10,000

Occasionally the allowance account will have a debit balance before the adjustment. If the Allowance for Doubtful Accounts had a debit balance of $1,000, then the adjusting entry would have been for $12,000 to arrive at the credit balance of $11,000. 2. Writing off Uncollectible Accounts  Write-offs should be formally approved in writing by authorized management personnel. To adhere to the appropriate internal control activity, authorization to write off accounts 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.

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Continuing with the Abrams Furniture Ltd. example, assume the vice-president of finance authorizes a write-off of a $2,500 balance owed by T. Ebbet. The required entry is: Allowance for Doubtful Accounts ............... Accounts Receivable ........................

2,500 2,500

Note that this entry does not change the net receivables balance, as both Accounts Receivable and Allowance for Doubtful Accounts have been decreased by the same amount. 3. 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 collection is recorded in the usual manner. Assuming Ebbet later pays the $2,500 balance that has been written off, the resulting entries are: Accounts Receivable ................................. Allowance for Doubtful Accounts ...... (To reverse write-off of T. Ebbet account)

2,500

Cash .......................................................... Accounts Receivable ........................ (To record collection from T. Ebbet)

2,500

2500

2,500

Summary of the Allowance Method Allowance method has three essential features:  The amount of uncollectible accounts receivable is estimated by ensuring that the balance in the Allowance for Doubtful Accounts is equal to the estimate of uncollectible accounts.  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 writeoff is reversed and the collection is recorded.

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Kimmel, Weygandt, Kieso, Trenholm, and Irvine

Financial Accounting, Sixth Canadian Edition

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. 1. Measuring and recording estimated uncollectible accounts: Dec 31

Bad Debts Expense ................................... 10,000 Allowance for Doubtful Accounts ...... 10,000 (To record estimate of uncollectible accounts ($11,000 – $1,000))

At year-end, the current assets section of Abrams Furniture’s statement of financial position would report receivables as follows: Accounts receivable ........................................... Less: Allowance for doubtful accounts ............... Net realizable value ...........................................

$200,000 11,000 $189,000

2. Recording the write off an uncollectible account: Mar 1

Allowance for Doubtful Accounts ............... Accounts Receivable ....................... (Write-off of T. Ebbet account)

2,500 2,500

On March 1, the current assets section of Abrams Furniture’s statement of financial position would report receivables as follows before and after this write-off: Before Write-off Accounts receivable ................................... $227,500 Allowance for doubtful accounts ................ 11,000 Net realizable value ................................... $216,500

After Write-off $225,000 8,500 $216,500

3. Recording the recovery of an uncollectible account: Jul 1

Accounts Receivable ................................. Allowance for Doubtful Accounts ...... (To reverse write-off of T. Ebbet account)

2,500

Cash .......................................................... Accounts Receivable ........................ (To record collection from T. Ebbet)

2,500

Instructor’s Manual

2,500

Chapter 8 – Reporting and Analyzing Receivables

2,500

8-7

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Financial Accounting, Sixth Canadian Edition

Study 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 definite time. 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 or face value with no interest added. Notes that are exchanged for accounts receivable are considered trade receivables whereas notes that are exchanged for a loan of cash would not be a trade receivable. A note receivable is essentially the same as a note payable except that one note is an asset while the other note is a liability. Using the example from the text, on May 1, Tabusintac Ltd. accepts a note receivable in exchange for an account receivable from Raja Ltd. The note is for $10,000 with 6% interest due in four months. The entry to record this transaction is: May 1

Notes Receivable ....................................... 10,000 Accounts Receivable ......................... (To record acceptance of Raja four-month, 6% note)

10,000

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 over the duration of the note.

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Financial Accounting, Sixth Canadian Edition

In the Raja example, the interest is calculated for the 4 months of the note as: $10,000 x 6% x 4/12 = $200 If Tabusintac’s year end is May 31, the following adjusting entry would accrue one month’s interest: May 31

Interest Receivable .................................... Interest Revenue ............................... (To accrue interest on Raja note receivable $10,000 x 6% x 1/12 = $50)

50 50

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. Notes that have a maturity date beyond one year from the statement of financial position would be classified as non-current. Non-current or long-term notes are generally repaid in instalments rather than at maturity. Short-term notes can also be repaid in instalments rather than at maturity. The interest calculation for instalment notes uses a method to determine interest revenue called the effective-interest method. Valuing Notes Receivable Notes receivable are reported at their net realizable value. 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, usually at maturity. The entry to record the receipt of the $10,000 principal and $200 interest would be:

Instructor’s Manual

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Sep 1

Financial Accounting, Sixth Canadian Edition

Cash .......................................................... 10,200 Notes Receivable .............................. Interest Receivable ............................ Interest Revenue ............................... (To record collection of Raja note and interest)

10,000 50 150

If a note is not paid in full at maturity, it is called a dishonoured note. The entry to record the dishonoured note would be: Sep 1

Accounts Receivable ................................. 10,200 Notes Receivable .............................. 10,000 Interest Receivable ............................ 50 Interest Revenue ............................... 150 (To record dishonoured Raja note; eventual collection expected)

If there is no hope of collection, the principal and any accrued interest should be written off. No interest revenue would be recorded, because collection will not occur. Sep 1

Allowance for Doubtful Notes ..................... Notes Receivable .............................. Interest Receivable ............................

Instructor’s Manual

10,050

Chapter 8 – Reporting and Analyzing Receivables

10,000 50

8-10

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Financial Accounting, Sixth Canadian Edition

Study 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 short-term investments. 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. 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.

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Financial Accounting, Sixth Canadian Edition

Study Objective 5 – Apply the Principles of Sound Accounts Receivable Management There are 4 steps to Managing Receivables 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 sales.  A credit policy that is too loose may increase bad debts beyond an acceptable level.  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. 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. Monitor collections.  Prepare accounts receivable aging schedule at least monthly.  Pursue problem accounts with phone calls, letters, and legal action if necessary.  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. 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.

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Teaching suggestion – Show the students how Canadian Tire’s receivables turnover ratio for 2012 and 2011 were calculated from Illustration 8-5:

 

2012 Net Credit Sales Average Receivables

2011 Net Credit Sales__ Average Receivables

$10,005.8 = 12.7 times ($757.2 + $813.1) ÷ 2

$8,997.6 = 12.0 times ($813.1 + $681.6) ÷ 2

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 – Canadian Tire’s average collection period for 2012 and 2011 would be calculated as follows: 2012 365 ÷ 12.7 = 29 days

Instructor’s Manual

2011 365 ÷ 12.0 = 30 days

Chapter 8 – Reporting and Analyzing Receivables

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Financial Accounting, Sixth Canadian Edition

CHAPTER 8 - 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? Suggested solution: Bad Debts Expense

Instructor’s Manual

Chapter 8 – Reporting and Analyzing Receivables

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Financial Accounting, Sixth Canadian Edition

CHAPTER 8 VOCABULARY QUIZ 1. A note that is not paid in full at maturity. 2. Amounts owed by customers on account. __________

__________

Notes and accounts receivable that result from the sale of transactions.

A group of accounts that provide details of a control account in the general ledger.

A measure of the liquidity of receivables, calculated by dividing net credit sales by average gross accounts receivable.

The average amount of time that a receivable is outstanding, calculated by dividing 365 days by the receivables turnover.

A written promise to pay a specified amount of money on demand or at a definitive time.

A method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period.

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.

Instructor’s Manual

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SOLUTIONS TO CHAPTER 8 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. Net realizable value 10. Aging the accounts receivable

Instructor’s Manual

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CHAPTER 8 MULTIPLE CHOICE QUIZ

1. To ensure receivables are not overstated on the statement of financial position, they are reported a. at gross realizable value. b. at their net realizable value. c. less interest revenue, if any. d. plus bank charges expense, if any.

2. Which of the following is the most liquid asset listed? a. unearned revenue b. equipment c. accounts receivable d. goodwill

3. Receivables are often classified as a. accounts, notes, long-lived. b. accounts, notes, other. c. accounts, notes, inventory. d. none of the above

4. All of the following are "other receivables," except a. trade receivables. b. interest receivable. c. recoverable income taxes. d. advances to employees.

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

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 category, depending on the number of days outstanding. Instructor’s Manual

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d. none of the 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. 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.

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.

10. Where would accounts receivable be recorded on the statement of financial position? a. before cash b. after trading investments c. before trading investments d. after inventory

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

12. Rayan Ltd. accepts an 8-month, $10,000 note with interest at 10% on June 1. Rayan 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 Instructor’s Manual

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c. $10,417 d. $10,667

13. The receivables turnover ratio is used to analyze a. creditworthiness. b. profitability. c. solvency. d. liquidity. Use the following information for questions 14–15. The balance of accounts receivable is $655,000. The company uses the percentage of receivables basis to estimate uncollectible accounts. A partial aging of accounts receivable is presented below: Days Outstanding 0-30 days 31-60 days 61-90 days 91-120 days Over 120 days

Amount $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.

Instructor’s Manual

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SOLUTIONS TO CHAPTER 8 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

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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.

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CHAPTER 9 Reporting and Analyzing Long-Lived Assets 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

20-Minute Quiz

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10. Asset turnover is calculated by dividing average total assets by net sales.

True

False

Multiple Choice 11. 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.

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

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.

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.

15. The exclusive right to publish and sell artistic or published work is called a a. patent. b. trademark. c. license. d. copyright. 20-Minute Quiz

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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

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20-MINUTE QUIZ #2

1. Name three advantages of leasing an asset.

2. On October 1, 2015, 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 2015. Calculate a) depreciation for 2015 using the straight-line method. b) depreciation for 2015 using the double-diminishing balance method. c) depreciation for 2016 using the double-diminishing balance method. d) depreciation for 2015 using the units-of-production method.

3. On April 30, 2016, Wilson Limited sold a used piece of manufacturing equipment for $6,500. The equipment had been purchased on January 1, 2013 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, 2015. b) Record the depreciation for 2016. c) Calculate the gain or loss on disposal. d) Record the sale of the equipment on Apr 30, 2016.

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ANSWERS TO 20-MINUTE QUIZ #2 1. Advantages of leasing an asset include: • reduced risk of obsolescence, • 100% financing, • income tax advantages, • off-balance sheet financing. 2. a) Depreciation for 2015 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 2015 using the double-diminishing balance method: 100% ÷ 5 x 2 = 40% $45,000 x 40% x 3/12 = $4,500 c) Depreciation for 2016 using the double-diminishing balance method: ($45,000 – $4,500) x 40% = $16,200 d) Depreciation for 2015 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, 2015: $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 2016. Apr 30 Depreciation Expense .................................................... Accumulated Depreciation ....................................... Four months depreciation. ($12,000 x 4/12)

4,000 4,000

c) Gain or loss on disposal: $3,500 loss Carrying amount on April 30 ($14,000 – $4,000) $10,000 Proceeds ......................................................... 6,500 Loss on disposal .............................................. $ 3,500

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d) Record the sale of the equipment on Apr 30, 2016. Apr 30 Cash ............................................................................... Accumulated Depreciation ($36,000 + $4,000) .............. Loss on Disposal ............................................................ Equipment ................................................................ Sold used equipment

20-Minute Quiz

6,500 40,000 3,500

Chapter 9 – Reporting and Analyzing Long-Lived Assets

50,000

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CHAPTER 9 REPORTING AND ANALYZING LONG-LIVED ASSETS STUDY OBJECTIVES 1. Determine the cost of property, plant, and equipment.

2. Explain and calculate depreciation.

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.

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CHAPTER OUTLINE Study 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. Property, plant, and equipment are originally recorded at 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 acquire the asset 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 longlived asset. 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

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used. 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. 

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

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excavation costs. Interest costs incurred to finance a construction project can be included in the cost of the asset, and is limited to the construction period. Equipment – The “equipment” classification is a broad one that can include: delivery equipment, office equipment, machinery, vehicles, furniture and fixtures and other similar 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. o 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 is allowing its 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 (4) “off-balance sheet” financing for operating leases.  An operating lease is viewed as a rental transaction. The lessee accounts for the transaction as a rental and therefore does not record an asset or liability on the company’s books.  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 long-lived assets.  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. Instructor’s Manual

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Study Objective 2 – Explain and Calculate Depreciation 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 a long-lived asset 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 a longlived asset may be very different from its fair (market) value. Depreciation neither uses or nor provides cash to replace the asset. Teaching suggestion – Remind students of the journal 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 from an asset. Useful life is an estimate based on such factors Instructor’s Manual

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as the intended use of the asset, repair and maintenance policies, 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 if the asset were sold as it will be and in the condition it is expected to be in 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 example in the book of the delivery truck purchased by Perfect Pizzas Ltd. on January 1, 2015: Cost .................................................... Expected residual value ...................... Estimated useful life (in years) ............ Estimated useful life (in kms) ..............

$ 33,000 3,000 5 100,000

Calculation of straight-line depreciation: $33,000 – $3,000 5 years = $6,000 per year

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Depreciation Schedule Assuming Straight-Line Depreciation Year Depreciation Expense 1 2 3 4 5

$6,000 6,000 6,000 6,000 6,000 $30,000

Accumulated Depreciation $ 6,000 12,000 18,000 24,000 30,000

Carrying Amount $33,000 27,000 21,000 15,000 9,000 3,000

Show students that the depreciation was the same for each year. The total depreciation taken on the delivery truck was $30,000, which is the depreciable amount of the truck ($33,000 – $3,000). Also point out that the delivery truck has a remaining carrying amount of $3,000 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 in the book of the delivery truck purchased by Perfect Pizzas on January 1, 2015, work through the depreciation, this time using the double diminishing-balance method. Remember, when calculating depreciation using the diminishing-balance 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 Perfect Pizzas delivery truck was 1 ÷ 5 years = 20%. The diminishing-balance 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%. Instructor’s Manual

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The depreciation schedule assuming double-diminishing-balance depreciation is presented for comparison purposes. Year Depreciation Expense 1 2 3 4 5

$13,200 7,920 4,752 2,851 1,277* $30,000

Accumulated Depreciation $13,200 21,120 25,872 28,723 30,000

Carrying Amount $33,000 19,800 11,880 7,128 4,277 3,000

*The asset cannot be depreciated below its residual value of $3,000. 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, 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 Perfect Pizza’s delivery truck, the units-of-production depreciable amount per unit would be calculated as follows: the estimated residual value of $3,000 would be subtracted from the amortizable cost of $33,000, and then divided by the estimated useful life of 100,000 kilometres. The depreciable amount per unit is $0.30. If the delivery truck is driven 15,000 kilometres in the first year, then depreciation expense is $4,500 (15,000 km x $0.30). The units-of-production schedule, assuming units-of-production depreciation, is presented below for comparison purposes.

Year

Activity

Depreciation Expense

Accumulated Depreciation

1 2 3 4 5

15,000 30,000 20,000 25,000 10,000 100,000

$4,500 9,000 6,000 7,500 3,000 $30,000

$4,500 13,500 19,500 27,000 30,000

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Carrying Amount $33,000 28,500 19,500 13,500 6,000 3,000

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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. Comparison of Depreciation Expense and Profits Straight-Line Year Method Profit 1 $ 6,000 $ 39,000 2 6,000 39,000 3 6,000 39,000 4 6,000 39,000 5 6,000 39,000 $30,000 $195,000

Double-DiminishingUnits-of-Production Balance Method Profit Method Profit $ 13,200 $ 31,800 $ 4,500 $ 40,500 7,920 37,080 9,000 36,000 4,752 40,248 6,000 39,000 2,851 42,149 7,500 37,500 1,277 43,723 3,000 42,000 $30,000 $195,000 $30,000 $195,000

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 profit in the early years and higher profit 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. 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 Instructor’s Manual

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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 profit. Impairment 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 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. If this is the case, 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. Instructor’s Manual

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Revaluation Model  Under the revaluation model, the carrying amount of property, plant, and equipment is adjusted to reflect its fair value. 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 fair 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. 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 correction 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.

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Study 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 disposal. 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 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.

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Teaching suggestion – Review the Keystone Ltd. example of the sale of an asset. Equipment purchased at a cost of $60,000 has accumulated depreciation of $33,000 to December 31, 2014. Annual depreciation is $11,000, and the asset is sold July 1, 2015 for $25,000 cash. The first step is to update the depreciation ($11,000 x 6/12 = $5,500) with the following entry: Depreciation Expense .......................................... Accumulated Depreciation—Equipment ......

5,500 5,500

After the Accumulated Depreciation is updated, the entry to record the sale of the Equipment is: Cash .................................................................... Accumulated Depreciation—Equipment* ............. Equipment ................................................... Gain on Disposal** ......................................

25,000 38,500 60,000 3,500

* $ 33,000 + $5,500 = $38,500 ** $ 60,000 – $38,500 = $21,500, $ 25,000 – $21,500 = $3,500 gain. Now assume instead of receiving $25,000 in cash, Keystone only receives $20,000. After the Accumulated Depreciation is updated, the entry to record the sale of the Equipment is: Cash .................................................................... Accumulated Depreciation—Equipment* ............. Loss on Disposal** ............................................... Equipment ...................................................

20,000 38,500 1,500 60,000

* $ 33,000 + $5,500 = $38,500 ** $ 60,000 – $38,500 = $21,500, $ 20,000 – $21,500 = $1,500 loss.

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Study Objective 4 – Identify the Basic Accounting Issues for Intangible Assets and Goodwill Intangible assets do not have physical substance. The future economic benefits flowing from an intangible asset may include revenue from the sale of products or services, and/or cost savings resulting from the use of the asset by the company. Intangible assets involve rights, privileges, and/or competitive advantages. Well known intangibles are Coca-Cola’s patents, the franchises of Tim Hortons, Apple’s trade name, and Google’s trademarks. 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.  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 Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

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 cash 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. Teaching suggestion – Discuss the illegal downloading of music or movies from the internet and point out that it is a copyright issue. 

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 has a desire to complete development. The company is able to complete development. A market exists for the product.

Intangible assets with indefinite lives:  Trademarks, trade names and brands—a trademark or trade name is a word, Instructor’s Manual

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phrase, jingle, or symbol that distinguishes or identifies a particular enterprise 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 of Industry Canada. 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—represents the value of all favourable attributes that relate to a company, including exceptional management, a desirable location, good customer relations, skilled employees, 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 finite-life 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. Instructor’s Manual

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Study 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 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.

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Study 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 profit by average total assets. The return on assets ratio indicates the amount of profit 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 profit by net sales. It tells how effectively a company is in turning its sales into profit.  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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CHAPTER 9 – 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 Suggested solution: c

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CHAPTER 9 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.

The systematic allocation of the cost of equipment over its useful life.

A loss incurred when the carrying amount of an asset exceeds its recoverable amount.

The value of all favourable attributes that relate to a company.

A method in which periodic depreciation is the same for each year of the asset's useful life.

A word, phrase, jingle, or symbol that distinguishes or identifies a particular company or product.

Rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance.

The cost of property, plant, and equipment less its residual value.

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.

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SOLUTIONS TO CHAPTER 9 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

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CHAPTER 9 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.

2. An exclusive right issued by the Canadian Intellectual Property Office of Industry Canada 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.

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, 2015. 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.

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. Instructor’s Manual

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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

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.

9. All of the following are intangible assets, except a. franchises. b. trademarks. c. land improvements. d. patents.

10. An exclusive right to reproduce and sell artistic or published work is a a. patent. b. copyright. c. license. d. franchise.

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

12.

Which of the following is false? a. Tax depreciation is called capital cost allowance. b. Significant components should be depreciated separately. c. Impairment losses can always be reversed.

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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 diminishingbalance method results in a higher pre-tax cash flow in the early years of the asset’s life.

15. The ratio which indicates the amount of profit generated by each dollar invested in assets is a. return on assets. b. asset turnover. c. profit margin. d. none of the above.

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SOLUTIONS TO CHAPTER 9 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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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, diminishingbalance, 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 10 Reporting and Analyzing Liabilities 20-MINUTE QUIZ #1 Circle the correct answer.

True/False 1. Bond prices are quoted as a percentage of the face value of the bonds.

True

False

2. The amount that must be invested today at current interest rates in order to receive a specified sum of money at a specified date is the present value.

True

False

3. One example of a financial liability is unearned revenue.

True

False

4. Bonds with a higher coupon interest rate than the market rate for similar bonds will probably sell at a discount.

True

False

5. Current maturities of non-current debt are identified on the statement of financial position as current liabilities.

True

False

6. Under ASPE, a contingent loss is recorded if it is likely and the amount can be reasonably estimated.

True

False

7. Property tax is an example of a contingent liability.

True

False

8. For a blended principal and interest instalment loan, the interest expense increases each period.

True

False

9. Instalment loans with fixed principal payments are

True

False

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repayable in equal periodic amounts. 10. The principal portion of the instalment loan is reported as a non-current liability.

True

False

Multiple Choice 11. When a company is overdrawn at the bank as a result of using its line of credit, the amount would be shown on the statement of financial position as a. a current asset with a debit balance. b. a current asset with a credit balance. c. a contra account to Accounts Receivable. d. a current liability.

12. The total cost of borrowing on a 10 year, 4%, $1,000 bond that is sold for $970 is a. $370. b. $400. c. $430. d. $970.

13. Payroll costs create expenses to the employer for all of the following except a. Income Tax. b. Employment Insurance. c. Canada Pension Plan. d. Workers’ Compensation Plan.

14. If bonds payable are issued at a discount, the coupon interest rate is a. higher than the market rate of interest. b. lower than the market rate of interest. c. equal to the market rate of interest. d. changed to reflect the market rate of interest.

15. Castaway Corporation borrows $300,000 and signs a 6%, 5 year note. Monthly payments will include a fixed amount of principal, plus interest on the unpaid balance. The first payment will be a. $5,000. b. $6,500. c. $18,000. d. $23,000.

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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1. True 2. True 3. False 4. False 5. True 6. True 7. False 8. False 9. True 10. False

Multiple Choice 11. d. 12. c. [($1,000 x 4% x 10 years) + ($1,000 – $970)] 13. a. 14. b. 15. b. [($300,000 ÷ 60 months) + ($300,000 x 6% x 1/12)]

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20-MINUTE QUIZ #2

face value interest expense market interest rate

a premium present value plus

a discount coupon interest rate minus

1. Select the appropriate word or phrase from the table above to complete the following statements correctly: a. When the market rate exceeds the coupon interest rate, bonds will sell at _________________________________. b. Cash paid to bondholders each period is calculated by multiplying the _________________________ by the __________________________. c. When bonds are issued at a discount, the total cost of borrowing will equal the sum of the periodic interest payments _______________ the discount. d. The carrying value of the bond moves towards the _____________________.

2. On Jan 1, 2015, Dawson Corporation borrows $300,000 and signs a 5-year, 6% note payable. Blended monthly payments of $5,800 are required, beginning Feb 1, 2015. a. Record the journal entry for Dawson on January 1. b. Record the journal entry for Dawson on February 1.

3. Jays Corporation issues a $500,000, five-year, 5% bond on January 1, 2015, with interest payable each July 1 and January 1 when the market (effective) interest rate is 6%. a. State whether the bond was sold at a discount or a premium. b. Calculate the issue price of the bond. c. Prepare the journal entry to record the bond issuance on January 1, 2015.

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ANSWERS TO 20-MINUTE QUIZ #2 1. a. a discount b. face value, coupon interest rate c.

plus

d. face value

2. a. Jan 1

Cash Notes Payable Five-year note, 6% interest

300,000 300,000

b. Feb 1

Interest Expense* Notes Payable Cash *$300,000 x 6% x 1/12

1,500 4,300 5,800

3. a. The bond was sold at a discount. b. Present value of $500,000 received in 10 periods $500,000 x 0.74409 (n =10, i =3) .............................................. $372,045 Present value of $12,500 received for each of 10 periods ($500,000 x 5% x 6/12) = $12,500 x 8.53020 (n =10, i = 3) ...... 106,628 Issue price of bonds .................................................................. $478,673 c. Jan 1

20-Minute Quiz

Cash Bonds Payable To record issue of bonds

478,673

Chapter 10 – Reporting and Analyzing Liabilities

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CHAPTER 10 REPORTING AND ANALYZING LIABILITIES STUDY 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).

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CHAPTER OUTLINE Study 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 services. 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 noncurrent or long-term liabilities. The different types of current liabilities include bank indebtedness, accounts payable, accrued liabilities such as taxes, salaries, and interest, unearned revenue, notes or loans payable, 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 – 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. Instructor’s Manual

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Teaching suggestion – Show an alternate form of the entry made by Islander Corporation for the March 25 cash register reading showing sales of $10,000 and HST of $1,300. Mar 25

Cash Sales Sales Tax Payable ($10,000 x 13%)

11,300 10,000 1,300

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 the illustration in the text, which assumes that Tantramar Management Ltd. owns land and a building in the city of Regina. Tantramar’s year end is December 31 and it makes annual adjusting entries. Tantramar receives its property tax bill of $6,000 on March 1, and it is due to be paid on May 31. In March, when Tantramar receives the property tax bill the entry is: Mar 1

Property Tax Expense ($6,000 x 2/12) 1,000 Property Tax Payable (To record property tax expense for Jan and Feb)

1,000

In May, when Tantramar pays the property tax bill, the entry also records the expense incurred from March to May. May 31 Property Tax Payable 1,000 Property Tax Expense ($6,000 x 3/12) 1,500 Prepaid Property Tax ($6,000 x 7/12) 3,500 Cash 6,000 (To record payment of property tax for Jan through Dec) At the December 31 year end, Tantramar will adjust the prepaid property tax with the entry: Dec 31 Property Tax Expense 3,500 Prepaid Property Tax (To record property tax expense for Jun through Dec)

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Financial Accounting, Sixth Canadian Edition

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 contributions.  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 the Pepitone example in the book concerning the entry for the accrual and payment of a $100,000 payroll on which a corporation withholds taxes from its employees’ wages and salaries: Mar 7 Salaries Expense 100,000 CPP Payable 4,950 EI Payable 1,780 Income Tax Payable 20,427 United Way Payable 2,395 Union Dues Payable 1,037 Salaries Payable 69,411 (To record payroll and employee deductions for week ending Mar 7) Instructor’s Manual

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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: Mar 7

Employee Benefits Expense 11,947 CPP Payable EI Payable Worker’s Compensation Payable Health Insurance Benefits Payable (To record employer’s payroll costs on Mar 7 payroll)

4,950 2,492 1,575 2,930

The following entry is made to pay Pepitone’s employees: Mar 7

Salaries Payable Cash (To record payment of the Mar 7 payroll)

69,411 69,411

Pepitone 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.  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 – 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. Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

Teaching suggestion – Walk through the illustration in the text, which assumes HSBC Bank agrees to lend $100,000 on March 1, if Williams Ltd. signs a $100,000, 6%, fourmonth bank loan maturing on July 1 (interest payable at maturity). The entry made by Williams upon receipt of cash and after note is signed: Mar 1

Cash

100,000 Bank Loan Payable 100,000 (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 Williams has a March 31 year end, an adjusting entry is required to recognize interest expense and interest payable of $500 ($100,000 x 6% x 1/12): Interest Expense 500 Interest Payable 500 (To accrue interest payable for one month on the HSBC bank loan) At maturity, July 1, Williams Ltd. must pay the face value of the bank loan ($100,000) plus $2,000 interest ($100,000 x 6% x 4/12), $500 of which has already been accrued. Interest Expense 1,500 Interest Payable ($100,000 x 6% x 3/12) (To accrue interest payable for Apr, May, and Jun)

1,500

Bank Loan Payable 100,000 Interest Payable 2,000 Cash 102,000 (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 the charge will result.  A provision has 3 characteristics: A present obligation that exists as a result of a past event A probable outflow of resources to settle the obligation An ability to estimate the amount of this obligation  Provisions are recorded using reliable estimates based on past experience and future expectations.



Contingent liabilities – are existing or possible obligations arising from past events.

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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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Study 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. One type of financial instrument is a financial liability. These liabilities have contractual obligations to pay cash in the future. 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 the illustration in the chapter concerning Belanger Ltée. who borrows $120,000 from the bank with a 7% interest rate, for five years. The terms provide for equal monthly instalment payments of $2,000 ($120,000 ÷ 60 periods) on the first of each month, plus interest of 7% on the outstanding principal balance. Jan 1 Cash 120,000 Bank Loan Payable 120,000 (To record five-year, 7% bank loan) For the first payment date – February 1 – interest expense is $700 ($120,000 x 7% x 1/12). The cash payment of $2,700 is the total of the instalment payment, $2,000, which is applied against the principal, plus the interest, $700. Feb 1 Interest Expense 700 Bank Loan Payable 2,000 Cash 2,700 (To record monthly instalment payment on loan) Instructor’s Manual

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Illustration 10-2 shows the instalment payment schedule for the first few months. 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. 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 the second illustration in the chapter concerning Belanger Ltée. who borrows $120,000, at an interest rate of 7% for five years. Instead of fixed principal payments, the terms provide for equal monthly instalment payments of $2,376. Jan 1

Cash

120,000

Bank Loan Payable (To record five-year, 7% bank loan)

120,000

For the first payment date – February 1 – interest expense is $700 ($120,000 x 7% x 1/12). The cash payment of $2,376 is the total of the instalment payment, $1,676, which is applied against the principal, plus the interest, $700. Feb 1

Interest Expense 700 Bank Loan Payable 1,676 Cash 2,376 (To record monthly instalment payment on bank loan)

Illustration 10-3 shows the 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.

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Study 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. There is no generally prescribed order within the non-current liability classification. 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 longterm 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 Instructor’s Manual

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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 profit, interest expense, and income tax expense (or profit 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 the debt to total assets ratio and the times interest earned ratio for Canada Post which is presented in your text. 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. Companies are therefore required to report their operating lease obligations in a note to the financial statements.

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Study Objective 4 – Account for Bonds Payable A bond is a form of interest-bearing non-current debt. 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. Bonds have many different types of features. Commonly issued bonds include:  Secured bonds which have specific assets of the issuer pledged as collateral for the bond.  Unsecured bonds, called debentures, are issued against the general credit of the borrower and are used extensively by large corporations with good credit ratings. Bond Trading  A bond certificate is issued to investors to provide evidence of an investor’s credit claim against the company.  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. Determining the Issue Price of Bonds 

The present value of a bond is the amount at which it sells in the marketplace. The issue price (present value) is a function of three factors:  Dollar amounts to be received There are two cash inflows associated with bonds: the amount received at maturity and the amount received in interest payments.  Length of time until the amounts are received The longer the period of time until maturity, the lower the present value of the cash inflow associated with the maturity.  Market interest rate The market interest rate is the rate investors demand for loaning funds to the corporation. The market interest rate is also known as the effective interest rate, which equates market price at a particular date to the sum of the present value of the principal and interest at that same date. The process of finding the present value is referred to as discounting the future cash flows.

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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 $1,000,000, 5%, Candlestick Inc. bonds is: Present value of $1,000,000 received in 4 periods $1,000,000 × 0.90595 (n = 4, i = 2.5%) Present value of $25,000 received for each of 4 periods $25,000 × 3.76197 (n = 4, i = 2.5%) Present value (issue price) of bonds

$ 905,950 94,050 $1,000,000

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. 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. Instructor’s Manual

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Teaching suggestion – Use Illustration 10A-1 to explain to students the relationship between the coupon rate and whether the bond was issued at a discount or a premium. Accounting for Bond Issues  Bonds may be issued at face value, below face value (at a discount) or above face value (at a premium).  The carrying amount of a bond is its face value plus any unamortized premium, or less any unamortized discount. At the date of issue, the carrying amount equals the bond’s issue price. 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 effective interest rate) of the carrying amount of the bond.  The following steps are used to calculate amortization under the effectiveinterest 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 Candlestick Inc. issued $1 million of 2-year, 5% bonds dated January 1, 2015 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 1,000,000 Bonds Payable 1,000,000 (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 $1,000,000 x 5% x 6/12. The entry to record the semi-annual interest on July 1 is: Jul 1 Interest Expense 25,000

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Cash (To record the payment of bond interest)

25,000

On December 31 the following adjusting entry is required to record the $25,000 of interest accrued since July 1: Dec 31 Interest Expense 25,000 Bond Interest Payable 25,000 (To accrue bond interest) 

Bond interest payable is classified as a current liability as it will be paid next year on January 1, 2016.



Issuing bonds at a discount – To illustrate bonds sold at a discount, assume that on January 1, 2015, Candlestick Inc., sells $1 million, 2-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 $957,345.

Present value of $1,000,000 received in 10 periods $1,000,000 × 0.88849 (n = 4, i = 3%) Present value of $25,000 received for each of 10 periods $25,000 × 3.71710 (n = 4, i = 3%) Present value (issue price) of bonds

$888,490 92,927 $981,417

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)    

981,417 981,417

The issue price of $981,417 results in a bond discount of $18,583 ($1,000,000 – $981,417) The $981,417 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 $1,000,000 at maturity and will want the bonds to show a carrying amount of $1,000,000 at maturity date.

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  



Financial Accounting, Sixth Canadian Edition

Amortizing a bond discount – Using the Candlestick example above, the interest expense for the first period would be $981,417 x 6% x 6/12 or $29,443. The discount amortization would be the difference between interest expense and the interest paid ($29,443 – $25,000). 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) 29,443 Bonds Payable 4,443 Cash ($1,000,000 x 5% x 6/12) 25,000 (To record payment of bond interest and amortization of bond discount) The carrying amount of the bonds is now $985,860 ($981,417 + $4,443). 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. At December 31, the adjusting entry is: Dec 31 Interest Expense ($985,860 x 6% x 6/12) 29,576 Bonds Payable 4,576 Bond Interest Payable 25,000 (To record accrued bond interest and amortization of bond discount)



Issuing bonds at a premium – To illustrate bonds sold at a premium, assume the Candlestick Inc. 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 $1,019,043 (101.9043% of face value). Present value of $1,000,000 received in 4 periods $1,000,000 × 0.92385 (n = 4, i = 2) Present value of $25,000 received for each of 10 periods $25,000 × 3.80773 (n = 4, i = 2) Present value (issue price) of bonds

$ 923,850 95,193 $1,019,043

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 1,019,043 Bonds Payable 1,019,043 (To record sale of bonds at a premium) Instructor’s Manual

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  



Financial Accounting, Sixth Canadian Edition

The issue price of $1,019,043 results in a bond premium of $19,043 ($1,019,043 – $1,000,000) 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 Candlestick example, recall that Candlestick issued $1,000,000 of two-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 $1,019,043, the premium being $19,043. The entry to record the first payment of interest is: Jul 1 Bond Interest Expense 20,381 ($1,019,043 x 4% x 6/12) Bonds Payable 4,619 Cash ($1,000,000 x 5% x 6/12) 25,000 (To record payment of bond interest and amortization of bond premium) The carrying amount of the bonds is now $1,014,424 ($1,019,043 – $4,619). 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 20,288 ($1,014,424 x 4% x 6/12) Bonds Payable 4,712 Bond Interest Payable 25,000 (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 Instructor’s Manual

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separately, the entry to record the redemption of the Candlestick bonds at maturity is: Bonds Payable 1,000,000 Cash 1,000,000 (To record redemption of bonds at maturity)

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CHAPTER 10 – 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 5%, 5-year bonds. The 5% rate of interest is called the ___________ rate. Suggested solution: coupon interest

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CHAPTER 10 VOCABULARY QUIZ

Type of payment for an instalment note that is repayable in equal periodic amounts including interest.

Events with uncertain outcomes, such as a potential liability that may become an actual liability sometime in the future.

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 profits 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.

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SOLUTION TO CHAPTER 10 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

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CHAPTER 10 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.

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. Instructor’s Manual

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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. 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.

9. A $50,000, 4-month, 8% bank loan was signed on October 1, 2015. What is the amount of accrued interest on December 31, 2015, 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.

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. Instructor’s Manual

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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.

14. On January 1, 2015, 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? 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 2015

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.

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SOLUTION TO CHAPTER 10 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

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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 11 Reporting and Analyzing Shareholders’ Equity 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 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 earnings per share, the current year’s dividend declared on preferred shares is subtracted from profit.

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 by profit.

True

False

7. Common shares have contractual provisions that give them preference, or priority, over preferred shares in certain areas. 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

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

True

False

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value of the consideration received.

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).

12. Dawson Corporation reported a profit 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. Earnings per share is a. $1.20. b. $2.00. c. $1.85. d. $2.40.

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

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.

15. A statement of changes in equity a. must be prepared for companies following ASPE. b. includes the changes to contributed capital, retained earnings, and accumulated other comprehensive income. c. is optional under IFRS. d. replaces the statement of comprehensive income.

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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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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.

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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 Cash Dividends .............................................................. 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

Stock Dividends .............................................................. 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 ...................................................... To record issue of 11,000 common shares in a 5% stock dividend

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CHAPTER 11 REPORTING AND ANALYZING SHAREHOLDERS’ EQUITY STUDY 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 OUTLINE Study 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 Publicly held corporation—shares traded on organized stock exchange and may have thousands of shareholders. Privately held 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. 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 corporations may impose limitations on the sale or transfer of shares by shareholders. Transfer of ownership rights among 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.  Ability to acquire capital Limited liability of shareholders coupled with transferable ownership rights Instructor’s Manual

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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 operating policies and selects officers to execute policy and to perform daily management functions. The corporation hires professional managers to run the business, so the owners are not required to have managerial expertise. 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 the distributions of profits permitted to shareholders. Provincial securities regulations govern the sale of share capital to the general public, and corporations listed in foreign security markets must also respect their requirements. 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 profits is reported on his or her personal income tax return. Corporations, as separate legal entities, must pay federal and provincial income tax.

Share Issue Considerations  When a corporation decides to issue shares it must answer the following questions: How many shares should be authorized for sale? At what price should the shares be issued? What value should be assigned to the shares?  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 Instructor’s Manual

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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. 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 profits and dividends.  For each listed security, the financial press reports: the high and low 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 price-earnings 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.

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Study 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 additional contributed capital. 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 $2 per share. The entry to record the transaction is: Cash 2,000 Common Shares 2,000 (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). 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 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 earnings per share and return on equity; have additional shares available to reissue to officers and employees under stock compensation plans; have additional shares available for use in acquiring other companies; eliminate hostile shareholders by buying them out. Instructor’s Manual

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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.  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.  A liquidity preference gives preferred shareholders priority over common shareholders in the distribution of assets in the case of bankruptcy.  Convertible preferred shares allow the exchange of preferred shares for common shares at the shareholders option, and 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.

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Study 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 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 Cash Dividends (which results in a decrease in Retained Earnings) and the increase in the liability Dividends Payable. Assume that on December 1, 2015, the directors of IBR Inc. declare a $0.50 per share cash dividend on 100,000 common shares. The dividend is $50,000 (100,000 x $0.50), and the entry to record the declaration is: Dec 1 Cash Dividends 50,000 Dividends Payable 50,000 (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.

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The payment date On the payment date, dividend cheques are mailed to the shareholders and the payment of the dividend is recorded. The entry on the January 20 payment date is: Jan 20 Dividends Payable 50,000 Cash 50,000 (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 decrease total shareholders’ equity or total assets. Stock dividends are generally issued:  by companies that do not have adequate cash to issue a cash dividend.  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 cash dividends. Stock dividends are valued using the fair value per share at the declaration date because this is what the corporation would have received if the shares had been issued for cash rather than a stock dividend. To illustrate a stock dividend, assume that on June 30, CIS Inc. declares a 10% stock dividend on its 50,000 common shares, to be distributed on August 5. On June 30, the market value of its shares is $15 per share. The number of shares issued is 5,000 (50,000 x 10%) and the amount debited to stock dividends is $75,000 (5,000 x $15), and the entry to record the declaration of the stock dividend is: Jun 30 Stock Dividends 75,000 Stock Dividends Distributable 75,000 (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 amount is reported in the share capital category in the Instructor’s Manual

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shareholder equity section of the statement of financial position. When the dividend shares are issued on August 5, Stock Dividends Distributable is decreased and Common Shares is increased as follows: Aug 5 Stock Dividends Distributable 75,000 Common Shares 75,000 (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. The effects of CIS’ share dividend are shown as follows: Before After Stock Dividend Stock Dividend Shareholders’ equity Common shares $500,000 $575,000 Retained earnings 300,000 225,000 Total shareholders’ equity $800,000 $800,000 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 results in a reduction in the legal capital per share and is usually much larger than a stock dividend.  The purpose of a stock split is to increase the marketability of the shares by lowering the share price, making it easier for the corporation to issue additional shares and also to increase investor interest.  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, CIS 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 $500,000 $500,000 Retained earnings 300,000 300,000 Total shareholders’ equity $800,000 $800,000 Number of shares Instructor’s Manual

50,000

100,000

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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.

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Study 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.  Additional Contributed Capital includes amounts contributed from reacquiring and retiring shares, or from other shareholder transactions. Retained Earnings in the statement of financial position are derived from the statement of retained earnings.  Retained earnings are the cumulative profits (or losses) since incorporation that have been retained in the company.  Any dividends declared are deducted from opening retained earnings.  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.  The normal balance is a credit, but if a deficit (debit balance) exists it is reported as a deduction from shareholders’ equity. Accumulated Other Comprehensive Income (IFRS) includes the gains and losses that bypass profits but affect shareholders’ equity.  Total comprehensive income includes both profit (the revenues, expenses, gains, and losses included in income) and gains and losses that bypass profit but affect shareholders’ equity.  Accumulated other comprehensive income is the cumulative change in shareholders’ equity that results from the gains and losses that bypasses profits but affect shareholders’ equity.  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 financial position. Instructor’s Manual

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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 Tim Hortons’ partial balance sheet (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, additional contributed capital, 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 Tim Hortons 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 the period.  Prepared after the income statement is prepared, as profit 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 Tim Hortons Inc.

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Study 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 profits distributed in the form of cash dividends to common shareholders. It is calculated by dividing total cash dividends to common shareholders by profits.  The payout ratios for Tim Hortons in 2012 and 2011 are as follows: PAYOUT RATIO = CASH DIVIDENDS PROFIT ($ in thousands except for per share data) Payout Ratio

Industry Average   

2012 $130,509 $402,885

= 32.4%

31.0%

2011 $110,187 $382,812

= 28.8%

32.3%

Another ratio that interests investors is the dividend yield. The dividend yield is calculated by dividing dividends per share by the market price per share. The dividend yields for Tim Hortons in 2012 and 2011 are as follows:

DIVIDEND YIELD = __DIVIDEND PER SHARE____ MARKET PRICE PER SHARE 2012 Dividend Yield

_ $0.84 $48.83

Industry Average

1.2%

2011 = 1.7%

$0.68 $49.36

= 1.4%

1.6%

Earnings Performance  Earnings per share EARNINGS PER SHARE = PROFIT – PREFERRED SHARE DIVIDENDS________ WEIGHTED AVERAGE NUMBER OF COMMON SHARES 



Profit 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

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number of common shares is calculated by multiplying the number of shares issued by the 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. An example of a convertible security is convertible preferred shares. When the preferred shares are converted into common shares, the additional common shares will result in a reduced, or diluted, earnings per share figure. Companies with a complex capital structure must report basic earnings per share and diluted earnings per share.

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.    

The return on common shareholders’ equity is a widely used ratio that measures profitability from the common shareholders’ viewpoint. It is calculated by dividing profits available to common shareholders by average common shareholders’ equity. Profits available to the common shareholders is profits less any preferred dividends. The return on common shareholders’ equity ratios for Tim Hortons for 2012 and 2011 are:

RETURN ON COMMON = SHAREHOLDERS’ EQUITY

PROFIT – PREFERRED SHARE DIVIDENDS____ AVERAGE COMMON SHAREHOLDERS’ EQUITY 2012

Return on common shareholders’ equity

Industry average

Instructor’s Manual

$ 402,885 – $0 ($1,190,091+ $1,154,433)÷2

2011 $382,812 – $0__ ($1,154,433 + $1,442,442)÷2

= 34.4%

= 29.5%

17.3%

9.4%

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CHAPTER 11 – 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. Suggested solution: a

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CHAPTER 11 VOCABULARY QUIZ

Instructor’s Manual

Profits retained in the business.

The amount per share that must be retained in the business for the protection of corporate creditors.

A type of share capital that has contractual preferences over common shares in certain areas.

A corporation that may have thousands of shareholders and whose shares are regularly traded on a securities exchange market.

The amount of share capital that a corporation is authorized to sell.

Dividends that were not declared on cumulative preferred shares during a period.

The cumulative change in shareholders’ equity that result from the gains and losses that bypass profits but affect shareholders’ equity.

The issue of additional shares to shareholders accompanied by a reduction in the legal capital per share.

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.

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SOLUTIONS TO CHAPTER 11 VOCABULARY QUIZ

1. Retained earnings 2. Legal capital 3. Preferred shares 4. Publicly held 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

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CHAPTER 11 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.

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

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.

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.

5. Dividends can take the following forms a. cash. b. stock. c. stock split. d. both a and b.

6. The board of directors commits the corporation to a binding legal obligation that cannot be rescinded on a. the declaration date. b. the date of record. c. the date of payment. d. none of the above. Instructor’s Manual

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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.

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.

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.

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.

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.

12. The payout ratio is calculated by a. dividing cash dividends by profit. b. dividing dividend per share by the market price per share. c. dividing profit available to common shareholders by the weighted average Instructor’s Manual

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number of common shares. d. dividing profit available to common shareholders by average common shareholders’ equity.

13. Which of the following statements is incorrect related to earnings per share? a. Earnings per share are not required for companies utilizing ASPE. b. Earnings per share are presented in the income statement by publicly-traded companies. c. Earnings per share is calculated by dividing profit available to common shareholders by the weighted average number of common shares. d. A lower earnings per share measure suggests improved performance.

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. Profits increase retained earnings. d. The statement of retained earnings is not required under ASPE.

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.

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SOLUTIONS TO CHAPTER 11 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

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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 the 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?

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CHAPTER 12 Reporting and Analyzing Investments 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 and loss model the unrealized gains and losses are recorded in comprehensive income. 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

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. 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. 8. The statement of changes in equity includes changes in share capital, retained earnings, accumulated other comprehensive income, and any other equity

True

False

True

False

True

False

20-Minute Quiz

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items that a company might report. 9. Under the equity method of accounting, the investment account is debited for dividends received from the investee.

True

False

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 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.

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 profit 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. $509,000. c. $515,000. d. $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.

20-Minute Quiz

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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 trading investment portfolio consisted of the following securities: Carrying Value 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. d. $1,400 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.

20-Minute Quiz

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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. True

Multiple Choice 11. d 12. c 13. d 14. c 15. c

20-Minute Quiz

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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 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 a profit 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 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.

Mar 1

Aug 15

Sep 12

Trading Investments Cash (500 x $20)

10,000

Cash (500 x $0.50) Dividend Revenue

250

Cash (500 x $23) Trading Investments Gain on Sale of Trading Investments

10,000

250 11,500 10,000 1,500

2. a. $500,000 x 30% = $150,000 b. $350,000 + ($500,000 x 30%) – ($60,000 x 30%) = $482,000

3. Dec. 31

20-Minute Quiz

Unrealized Loss on Trading Investments Trading Investments $40,000 – $37,500 = $2,500

Chapter 12 – Reporting and Analyzing Investments

2,500 2,500

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CHAPTER 12 REPORTING AND ANALYZING INVESTMENTS STUDY 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).

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CHAPTER OUTLINE Study 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 dividend income or 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 corporation. Non-Strategic Investments There are several reasons that a company purchases debt or equity securities as a nonstrategic 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 bank.  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 dividend revenue.  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 trading investments. Non-strategic investments can be classified as short-term investments or longterm investments depending on how liquid the investment is and how long management wants to hold the investment. Strategic Investments Instructor’s Manual

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While debt or equity securities can be purchased as non-strategic investments, only equity securities can be purchased as strategic investments. Equity securities (normally common shares) can be purchased for the strategic purpose of influencing relationships between companies.

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Study Objective 2 – Account for Non-Strategic Investments At acquisition, debt and equity investments are recorded at their purchase cost. There are 4 major models that are used for valuing investments.  Fair value through profit of loss model requires that the investment be adjusted upwards or downwards to reflect its fair value at year end. The difference between cost 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 year end but instead of the difference between cost and fair value being recorded in the income statement, it is recorded in other comprehensive income. This model is only used for equity investments (not debt investments).  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.  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, 2015, Plano Corporation has the following cost and fair values: Trading Investments BCE shares Norbord bonds Total 

Cost

Fair Value

$ 50,000 90,000 $140,000

$ 48,000 95,000 $143,000

Unrealized Gain (Loss) ($2,000) 5,000 $3,000

Plano has an unrealized gain of $3,000 because the total fair value ($143,000) is $3,000 greater that the total cost ($140,000). The year end adjusting entry for Plano is: Dec 31 Trading Investments 3,000 Unrealized Gain on Trading Investments 3,000 (To record unrealized gain of $5,000 on Norbord bonds and unrealized loss on BCE shares)

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

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This journal entry combines the BCE and Norbord bonds into a single Trading Investments account but a subsidiary ledger containing the details of the individual investments would be maintained. If in January Plano sells its BCE shares for $48,000, the following journal entry would be recorded: Jan 5 Cash 48,000 Trading Investments 48,000 (To record sale of BCE shares) The BCE shares originally cost $50,000, but they were written down to their fair value of $48,000 on December 31; the new carrying amount is $48,000. Consequently, the investment account is credited for that amount and no realized gain or loss is recorded. Although it could be argued that the $2,000 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 profit. Instead, if in January Plano sells its BCE shares for $47,000 instead of the $48,000, the following journal entry would be recorded: Jan 5 Cash 47,000 Realized Loss on Trading Investments 1,000 Trading Investments 48,000 (To record a realized loss on BCE 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.  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. This model can only be used for equity investments.

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Study Objective 3 – Account for Strategic Investments An investor is the company that purchases (owns) securities. 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 profit and (2) decreases (credits) the investment account and increases (debits) cash Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

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 Milar Corporation (the investor) acquires 30% of the common shares of Beck Company (the investee) for $120,000 on January 1, 2015. The entry to record this transaction is: Jan 1 Investment in Associates 120,000 Cash 120,000 (To record purchase of Beck common shares) Recording Investment Revenue  For the year ending December 31, 2015, Beck reports profit of $100,000 and declares and pays a $40,000 cash dividend. Milar is required to record (1) its share of Beck’s profits, $30,000 (100,000 x 30%), and (2) the reduction in the investment account for the dividends received, $12,000 ($40,000 x 30%). The following entries are required: Dec 31 Investment in Associates 30,000 Revenue from Investment in Associates 30,000 (To record 30% equity in Beck’s profits) Dec 31

 

Cash 12,000 Investment in Associates (To record dividends received from Beck)

12,000

During the year the investment account has increased by $18,000 ($30,000 $12,000). The difference between reported profits under the fair value method through profit or loss and reported profits under the equity method can be significant. For example, Milar would report only $12,000 of dividend revenue ($40,000 x 30%) 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 July 1, 2015, Passera Corporation (the investor) acquires 1,000 shares (10% ownership) of Beal Corporation (the investee) common shares at $40 per share. The entry for the purchase is: Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

Long-Term Investments 40,000 Cash 40,000 (To record purchase of 1,000 common shares of Beal)



Recording Dividend Revenue The following entry is required to record a $2 per share dividend received by Passera Corporation on October 1: Oct 1 Cash (1,000 x $2) 2,000 Dividend Revenue 2,000 (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 shares is recognized as a realized gain or realized loss. On December 10, Passera Corporation receives proceeds of $39,000, resulting in a realized loss of $1,000. The entry is: Dec 10 Cash 39,000 Realized Loss on Long-Term Investments 1,000 Long-Term Investments 40,000 (To record the sale of Beal common shares)

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Study Objective 4 – Explain how Investments are Reported in the Financial Statements Income Statement  All gains and losses along with dividend and interest revenue and revenue from investment in associates are shown in the “other revenues and expenses” section of the income statement. There are 2 exceptions to this treatment: When using the fair value through OCI realized and unrealized gains and losses are recorded in other comprehensive income. Dividend revenue under the equity method is shown as a reduction in the investment rather than in the income statement. Statement of Comprehensive Income  Realized and unrealized gains and losses from available-for-sale securities are recorded as other comprehensive income.  Other sources of comprehensive income include revaluation of property, plant, and equipment under the revaluation model.  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.  Profits increase 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 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. If the investment is a trading investment and not held to earn contractual cash flows, then it is accounted for using fair value (fair value through profit or loss or fair value through OCI models). 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: Instructor’s Manual

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Financial Accounting, Sixth Canadian Edition

Non-strategic investments with a quoted market price are recorded using the fair value through profit or loss model. For all other non-strategy investments, the amortized cost (for debt) or cost model (for equities) 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 are very near maturity (usually less than 3 months) are viewed as cash equivalents. Other short-term investments rank next in the order of liquidity. Trading investments are always classified as current assets. Non-strategic investments that are not held for trading may be either current or non-current, depending on whether the investment is capable of reasonably prompt liquidation and 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 be typically be accounted for using the fair value 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-for-sale 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. 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.

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Consolidated Financial Statements  An additional set of financial statements called consolidated financial statements must be prepared when one company (the parent) controls another company (the subsidiary). Consolidated financial statements present the combined assets and liabilities of both the part and subsidiary companies. Teaching suggestion – Direct students’ attention to companies that prepare consolidated statements which are shown in the text (Accounting Matters). See if the students can name other companies that would be required to prepare consolidated financial statements.

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Study 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 effective-interest 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. However, under ASPE, companies have the choice of amortizing premiums and discounts on a straight-line basis over the period to maturity if the results do not differ materially from the effective-interest method. 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.

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Teaching suggestion – Follow through the recording of the bond investment from the textbook. Kuhl Corporation acquires $50,000 face value 10-year, 6%, bonds on January 1, 2015, for $49,000. This means that the bonds sold at a discount of $1,000 and the market rate of interest was approximately 6.272%. The bonds receive interest semiannually on July 1 and January 1. Assuming that Kuhl does not intend to hold the bonds for trading purposes, then the entry to record the transaction is: Jan 1

Long-Term Investments Cash (To record purchase of Doan bonds)

49,000 49,000

The entry to record interest and the amortization of the bond discount on July 1 is: Jul 1

Cash ($50,000 x 6% x 6/12) 1,500 Long-Term Investments 37 Interest Revenue ($49,000x 6.272% x 6/12) (To record interest on Doan bonds)

1,537

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 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.

Instructor’s Manual

Chapter 12 – Reporting and Analyzing Investments

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CHAPTER 12 – 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 Suggested solution: non-strategic investment

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CHAPTER 12 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 cost 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 profit (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 profitability 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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SOLUTIONS TO CHAPTER 12 VOCABULARY QUIZ 1. Subsidiary (affiliated) company 2. 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 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 profits from investments. c. want to, for strategic reasons. d. all 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.

3. Non-strategic investments that are held for the purpose of earning capital gains are called a. trading investments. b. long-term investments. c. equity investments. d. fair value 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

5. Under the equity method, the investor records a. its share of profits of the investee in the year in which it is received as a dividend. b. its share of profits 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 Instructor’s Manual

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d. annually

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 Revenue from Investment in Associates ............................................... 5,000 c. Cash .............................................................. 5,000 Investment in Associates......................... 5,000 d. Dividend Revenue ......................................... 5,000 Cash ........................................................ 5,000 8. Which of the following would not be reported under “other revenue and expense” on the income statement? a. unrealized gains (losses) from trading investments b. dividend revenue c. interest revenue d. all of the above

A portfolio of 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.

10. The consolidated financial statement a. is prepared by the parent company. b. combines the assets and liabilities of the parent and subsidiary. c. both a and b. d. 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 straight-line 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 of the straight-line method. Instructor’s Manual

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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 profits $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 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.

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

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.

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SOLUTIONS TO CHAPTER 12 MULTIPLE CHOICE QUIZ 1. a 2. c 3. a 4. d 5. b 6. d 7. c 8. d 9. b 10. c 11. c 12. d 13. d 14. a 15. b

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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 13 Statement of Cash Flows 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

Information for the cash flow statement is taken from the adjusted trial balance.

True

False

Cash total debt coverage ratio is calculated by dividing the net cash provided (used) by operating activities by the average current liabilities.

True

False

An increase in dividends payable increases net cash provided by operating activities. When accounts receivable increases during the year, revenues on a cash basis are higher than revenues on an accrual basis. Solvency is the ability of a company to survive over the long term by having enough assets to settle its liabilities as they fall due.

True

False

True

False

True

False

A cash flow statement starts with profit 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

The issue of bonds to acquire land would be shown in the financing section.

True

False

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

20-Minute Quiz

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10. Net cash provided (used) by operating activities is determined by converting profit from an accrual basis to a cash basis.

True

False

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

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.

13. Which of the following ratios is a measure of liquidity? a. cash total debt coverage b. cash current debt coverage c. free cash flow d. debt to total assets

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

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

20-Minute Quiz

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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

20-Minute Quiz

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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

20-Minute Quiz

Operating

Investing Financing

Chapter 13 – Statement of Cash Flows

Not shown

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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 Profit

$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

20-Minute Quiz

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Financial Accounting, Sixth Canadian Edition

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

20-Minute Quiz

Operating P

Investing Financing

Not shown X

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 incr = $500,000 + ($15,000) = $485,000 COGS + inventory decr + A/P decr = ($300,000) + $20,000 + ($8,000) = (288,000) Wages exp = (50,000) Operating exp + prepaid decr = ($30,000) + $5,000 = (25,000) Interest exp + interest pay incr = ($10,000) + $2,000 = (8,000) Income tax expense = (27,000)

(b) Indirect Method Operating activities Profit Adjustments 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

20-Minute Quiz

$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 13 STATEMENT OF CASH FLOWS STUDY OBJECTIVES 1. Describe the purpose and content of the statement of cash flows.

2. Prepare operating activities section of a statement of cash flows using one of two approaches: (a) the indirect method or (b) the direct method.

3. Prepare the investing activities section of a statement of cash flows.

4. Prepare the financing activities section of a statement of cash flows.

5. Complete the statement of cash flows. 6. Use the statement of cash flows to evaluate a company’s liquidity and solvency.

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Chapter 13 – Statement of Cash Flows

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CHAPTER OUTLINE Study Objective 1 – Describe the Purpose and Content 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, and to assess what the company did with the cash.  The information in a statement of cash flows provides information about a company’s investing and financial activities that will enable users to evaluate the changes in the company’s assets and liabilities and in its financial structure.  provides information about historical events that is useful in assessing a company’s ability to generate future cash flows.  enhances the comparability of different companies because it eliminates the accrual-based effects of using different accounting treatments for similar transactions and events. 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 investments that 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 investments not held for trading and long-lived assets 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 illustration shows 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 interest received from debt investments and dividends received from equity investments From proceeds received from the sale of trading investments  Cash payments: Instructor’s Manual

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To suppliers for inventory To employees for services To government for taxes To lenders for interest To others for expenses 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 share capital 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.

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Significant noncash activities include:  Issue of debt to purchase assets  Issue of shares to purchase assets  Conversion of debt into equity  Exchange 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.

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Study Objective 2 – Prepare the Operating Activities Section of a Statement Cash Flows Using One of Two Approaches: (a) the Indirect Method or (b) the Direct Method The statement of cash flows covers the same period of time as the income statement, 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 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 – 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 are used to complete the statement of cash flows and the notes to the financial statements. Step 1 – Operating Activities  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 the profit from an accrual basis to a cash basis.  Profit must be converted because earned revenues may include credit sales that have not been collected in cash and expenses incurred that may not have been paid in cash.  Under accrual basis of accounting, profit does not indicate the net cash provided (used) by operating activities: therefore, under the indirect method, accrual-based profit must be adjusted to convert certain items to the cash basis.  When the indirect method is used, profit is the starting point that is adjusted for depreciation, gains and losses, and changes in noncash current assets and current liabilities.  The direct method, rather than starting with profit, simply makes the operating section look like a cash basis income statement.  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. Instructor’s Manual

Chapter 13 – Statement of Cash Flows

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Prepare the Operating section of the Statement of Cash Flows Using the Indirect Method  The indirect method starts with profit and converts it to net cash provided (used) by operating activities. Add back noncash expenses, such as depreciation and losses. Subtract noncash revenues and gains. Add decreases in noncash current asset accounts and increases in most noncash current liabilities accounts. Subtract increases in noncash current asset accounts and decreases in most noncash 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 profits but does not reduce cash, so depreciation expense is added back to profits. For Computer Services this amount would be $9,000.  Amortization expense for intangible assets is also added to profits 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 the amortization of a bond discount by a bond investor. Just as noncash expenses are added back to profit, noncash revenues are deducted from profit. 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 sale 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 profits to arrive at cash from operating activities.  If we did not eliminate these gains and losses, they would be counted twice, once in profits and again in the investing activities section (as part of the proceeds from the sale of the asset).  For Computer Services, the $3,000 loss on the sale of equipment must be added back to profit.  If a gain on sale occurs, then the amount would be deducted from profit. Instructor’s Manual

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 

Financial Accounting, Sixth Canadian Edition

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 profit 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 profit but no reduction in cash. Cash Accumulated Depreciation Loss on Disposal Equipment

4,000 1,000 3,000 8,000

Changes in Current Asset and Current Liability Accounts  Another type of adjustment in converting profit to net cash provided (used) by operating activities involves examining the changes (increases or decreases) in noncash current asset and current liability accounts.  Not all noncash working capital accounts affect operating activities. Short-term notes or loans receivable are an example 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 profit required by changes in noncash current items.  Decrease in Accounts Receivable: Revenues on an accrual basis would be lower than revenues on a cash basis. Computer Services’ accounts receivable decreased by $10,000, so cash receipts were $10,000 higher than revenues. Consequently, $10,000 must be added to profit to convert them to net cash provided (used) by operating activities. 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 profit to arrive at the cash provided (used) by operating activities.

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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? 



Increase in Merchandise Inventory: When merchandise 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 merchandise inventory account must be deducted from (added to) profit to arrive at net cash provided (used) by operating activities. Computer Services’ inventory increased by $5,000; it must have purchased more merchandise inventory than it sold. Consequently, the $5,000 increase must be deducted from profit. Increase in 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 accrual-based income statement are lower than what expenses would be on a cash basis. The increase (decrease) in prepaid expenses is deducted from (added to) profit to arrive at net cash provided (used) by operating activities. The $4,000 increase in prepaid expenses must be deducted from profit to determine cash paid for expenses.

Changes in Current Liabilities  Increase in 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.  To convert profit to net cash, the $16,000 increase in accounts payable must be added to profit.  Decrease in 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 profit 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.  The decrease of $2,000 to Income Tax Payable will result in the amount being deducted from profit. The Operating Activities section of the statement of cash flows for Computer Instructor’s Manual

Chapter 13 – Statement of Cash Flows

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Services is reproduced below from Illustration 13-6. COMPUTER SERVICES CORPORATION Statement of Cash Flows —Indirect Method (partial) Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Profit ................................................................................... $145,000 Adjustments to reconcile profit to net cash provided (used) by operating activities: Depreciation expense ................................................... $ 9,000 Loss on disposal of equipment ..................................... 3,000 Decrease in accounts receivable .................................. 10,000 Increase in merchandise inventory ............................... (5,000) Increase in prepaid expense......................................... (4,000) Increase in accounts payable .................................... 16,000 Decrease in income tax payable ................................... (2,000) 27,000 Net cash used by operating activities ........................................ $172,000 Prepare the Operating Activities Section of the Statement of Cash Flows Using the Direct Method Step 1 – Operating Activities 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 Computer Services’ sales of $507,000 must be adjusted by the change in accounts receivable during the year to determine 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:

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Cash receipts from = customers

Revenue

Financial Accounting, Sixth Canadian Edition

+ Decrease in accounts receivable or – Increase in accounts receivable

For Computer Services, cash receipts from customers were: $517,000 = $507,000 + $10,000 Cash receipts from customers can also be determined from an analysis of the Accounts Receivable account as follows:

Accounts Receivable _______ Jan 1 Balance 30,000| Sales on account 507,000| Receipts from customers 517,000 Dec 31 Balance 20,000|



Cash Receipts from Interest and Dividends Computer Services does not have cash receipts for any source other than customers. 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 merchandise inventory. When merchandise inventory increases during the year, the cost of goods purchased exceeds the cost of goods sold. The increase in merchandise inventory is added to the cost of goods sold. When merchandise inventory decreases, the decrease would be deducted from the cost of goods sold. In 2015, Computer Services cost of goods purchased is: Cost of goods sold Add: Increase in merchandise inventory Cost of goods purchased

$150,000 5,000 $155,000

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 Instructor’s Manual

Chapter 13 – Statement of Cash Flows

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Financial Accounting, Sixth Canadian Edition

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. For Computer Services, cash payments to suppliers were $139,000. Cost of goods purchased Deduct: Increase in accounts payable Cash payments to suppliers

$155,000 16,000 $139,000

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 Cost of payments = to goods sold suppliers



+ Increase in inventory or – Decrease in inventory

– Increase in accounts payable 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 deducted from operating expenses. Any decrease is added to operating expenses because the cash payments exceed the operating expenses. Computer Services does not have any accrued expenses payable related to its operating expenses. Computer Services’ cash payments for operating expenses were $145,000 calculated as follows: Operating expenses Add: Increase in prepaid expenses Deduct: Increase in accrued expenses payable Cash payments for operating expenses

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Chapter 13 – Statement of Cash Flows

$141,000 4,000 -0$145,000

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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 Computer Services reports $12,000 of interest expense on its income statement. This amount equals the cash paid, since the comparative statement of financial position indicated no interest payable at the beginning or end of the year. 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. Computer Services’ Income Tax Payable account decreased by $2,000. This means that $47,000 of income tax expense reported on the income statement was $2,000 less than the $49,000 of taxes paid during the period. The relationship among cash payments for income tax, income tax expense and changes in income tax payable can be expressed as follows:

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Cash payments for income tax

Income tax expense

Financial Accounting, Sixth Canadian Edition

+ Decrease in income tax payable or – Increase in income tax payable

The Operating Activities section of Computer Services’ statement of cash flows is reproduced below from Illustration 13-12: COMPUTER SERVICES CORPORATION Statement of Cash Flows – Direct Method (partial) Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers .......................................... $ 517,000 Cash payments To suppliers ................................................................ ($139,000) For operating expenses .............................................. (145,000) For interest ................................................................. (12,000) For income tax ............................................................ (49,000) (345,000) Net cash provided by operating activities ................................ $172,000

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Study Objective 3 – Prepare the Investing Section of the Statement of Cash Flows Step 2 – Investing Activities Regardless of whether the indirect or direct method is used to calculate operating activities, investing and financing activities are measured and reported in the same way. Investing activities generally affect non-current asset accounts, such as long-term investments, property, plant and equipment, and intangible assets. Computer Services has three long-term asset accounts that must be analyzed: Land, Building, and Equipment.  Increase in Land An increase in land financed by obtaining a mortgage 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.  Increase in Building With no additional information, it is assumed that the building was acquired for $120,000 cash.  Increase in Accumulated Depreciation—Building The accumulated depreciation increase of $6,000 was due to the depreciation expense, a noncash charge. Noncash items do not affect the statement of cash flows.  Increase in Equipment The increase in equipment of $17,000 is due to a purchase of equipment for $25,000 and the sale of equipment costing $8,000 for $4,000 cash.  Each transaction 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. (1) Equipment Cash

25,000

(2) Cash Accumulated Depreciation Loss on Disposal Equipment

4,000 1,000 3,000



25,000

8,000

Increase in Accumulated Depreciation—Equipment The accumulated depreciation for the equipment increased by $2,000, due to the depreciation expense of $3,000, and $1,000 decrease due to the disposal of equipment. The disposal of the equipment affected a number of accounts: one account on Computer Services’ income statement (Loss on Disposal) and three accounts on its 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

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

Financial Accounting, Sixth Canadian Edition

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 – Computer Services’ has no investment accounts; however, 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 (trading) investments are classified as operating activities and long-term investments as investing activities. Relate the transactions in short-term (trading) investments to revenue producing activities such as transactions in merchandise inventory. The Investing Activities section of Computer Services’ statement of cash flows is reproduced below from Illustration 13-14: COMPUTER SERVICES CORPORATION Statement of Cash Flows (partial) Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Investing activities Purchase of building ................................................. $(120,000) Purchase of equipment ............................................. (25,000) Disposal of equipment .............................................. 4,000 Net cash used by investing activities .................. $(141,000) Note x: Significant noncash investing and financing activities Mortgage received to purchase land .........................

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Chapter 13 – Statement of Cash Flows

$110,000

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Study Objective 4 – Prepare the Financing Section of the Statement of Cash Flows Step 3—Financing Activities The third step in preparing a statement of cash flows is to analyze the changes in noncurrent liability and equity accounts. In addition, changes involving short-term loans (including notes) payable should also be reported in the financing activities section if they have been incurred for lending purposes rather than for trade. Regardless of whether the indirect or direct method is used to calculate operating activities, financing activities are measured and reported in the same way. 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.  Computer Services has one non-current liability account (Mortgage Payable) and two shareholders’ equity accounts (Common Shares and Retained Earnings) that are affected.  Note that Accumulated Other Comprehensive Income showed no change for the period. Even if it did, other comprehensive income does not have any cash flow effect.  Increase in Mortgage Payable The increase in mortgage payable of $110,000 in order to acquire land is a noncash transaction, and is reported as a note to the statement of cash flows.  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.  Increase in Share Capital In the absence of additional information, the $20,000 increase in the common shares is assumed to have been for cash.  Increase in Retained Earnings The net change in retained earnings of $116,000 is increased by profit of $145,000 and decreased by a cash dividend of $29,000. The profit is dealt with in the operating activities section, and the dividend is a cash outflow in the financing section.  If accumulated other comprehensive income had increased or decreased in the current year, it would 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. Retained Earnings Jan.1 Balance 48,000 Cash Dividend 29,000 Profit 145,000 Dec 31 Balance 164,000

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The Financing Activities section of Computer Services’ statement of cash flows is reproduced below from Illustration 13-15: COMPUTER SERVICES CORPORATION Statement of Cash Flows (partial) Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Financing activities Issue of common shares ............................................... $20,000 Payment of cash dividend ............................................. (29,000) Net cash used by financing activities ...................... $(9,000) Note x: Significant noncash investing and financing activities Mortgage received to purchase land .............................

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Chapter 13 – Statement of Cash Flows

$110,000

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Study Objective 5 – Complete the Statement of Cash Flows Step 4—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. Computer Services’ statement of cash flows, reproduced from Illustration 13-16, is shown below: COMPUTER SERVICES CORPORATION Statement of Cash Flows Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers .................................. $517,000 Cash payments To suppliers ........................................................ $(139,000) For operating expenses ...................................... (145,000) For interest ......................................................... (12,000) For income tax .................................................... (49,000) (345,000) Net cash provided by operating activities ........... 172,000 Investing activities Purchase of building ................................................. $(120,000) Purchase of equipment ............................................. (25,000) Disposal of equipment .............................................. 4,000 Net cash used by investing activities .................. (141,000) Financing activities Issue of common shares ........................................... $20,000 Payment of cash dividend ......................................... (29,000) Net cash used by financing activities .................. (9,000) Net increase in cash ........................................................ 22,000 Cash, January 1 .............................................................. 33,000 Cash, December 31 ........................................................ $ 55,000 Note x: Significant noncash investing and financing activities Mortgage received to purchase land ......................... 



$110,000

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 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.

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Teaching suggestion – Help students understand how the format of the above statement would differ if it was prepared using the indirect method, rather than the direct method as shown.

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Study Objective 6 – Use the Statement of Cash Flows to Evaluate a Company’s Liquidity and Solvency Traditionally, the ratios most commonly used by investors and creditors have been based on accrual accounting. Ratios calculated on accrual-based numbers are subject to managerial discretion. For this reason, analysts like to supplement accrual-based analysis with measures that use information from the statement of cash flows. Liquidity  Liquidity is the ability of a company to pay obligations expected to become due within the next year.  One measure of liquidity is the current ratio. One disadvantage of the current ratio is that it uses year-end balances of current asset and current liability accounts. These year-end balances may not be representative of the company’s position during most of the year. Another disadvantage is that current assets and current liabilities include accrual-based numbers so they may change in value without any impact on cash flow.  A ratio that partially corrects this problem is the cash current debt coverage ratio. Though the numerator uses cash-based numbers, the denominator, current liabilities, does not.

Cash Current Debt Coverage  

Net Cash Provided (Used) by Operating Activities Average Current Liabilities

The higher the cash current debt coverage ratio is, the better the company’s liquidity. Additional ratios such as the receivables turnover and inventory turnover must also be calculated in order to properly assess a company’s liquidity.

Solvency  Solvency is the ability of a company to survive over the long term by having enough assets to settle its liabilities as they fall due.  The cash total debt coverage ratio indicates the company’s ability to repay its liabilities from cash generated from operating activities without having to liquidate productive assets such as property, plant, and equipment. Cash Total Debt Coverage   

Net Cash Provided (Used) by Operating Activities Average Total Liabilities

The higher the cash total debt coverage ratio is, the more solvent a company is. A low cash total debt coverage ratio could signal a long-term solvency problem if the company is not able to generate enough cash internally to repay its debt. Free cash flow describes the cash remaining from operating activities after

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adjusting for capital expenditures and dividends. Free Cash Flow = Net Cash Provided (Used) by Operating Activities – Net Capital Expenditures – Dividends Paid 

The higher the free cash flow, the more solvent a company is.

Teaching suggestion – Help students find net capital expenditures and dividend payments on the statement of cash flows.

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CHAPTER 13 – 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? Suggested solution: Investing Activities

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CHAPTER 13 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 profit. 4. A cash-basis ratio used to evaluate solvency, calculated as net cash provided (used) by operating activities divided by average total liabilities. 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 profit is adjusted for items that do not affect cash. 8. A cash-basis ratio used to evaluate liquidity, calculated as net cash provided (used) by operating activities divided by average current liabilities. 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.

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SOLUTIONS TO CHAPTER 13 VOCABULARY QUIZ 1. Statement of cash flows 2. Free cash flow 3. Operating activities 4. Cash total debt coverage ratio 5. Investing activities 6. Direct method 7. Indirect method 8. Cash current debt coverage ratio 9. Noncash activity 10. Financing activities

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CHAPTER 13 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

2. Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of profit are referred to as a. investing activities. b. financing activities. c. operating activities. d. all 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

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

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.

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. b. cash inflow in the financing activities section. c. addition to profit in the operating activities section. Instructor’s Manual

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d. deduction from profit in the operating activities section.

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 profit and net cash provided (used) by operating activities. c. reasons for the differences between profit and net cash provided (used) by noncash activities. d. cash investing and financing transactions during the period.

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.

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 profit and net cash flow provided (used) by operating activities. d. It tends to reveal less company information to competitors.

10. A cash-basis ratio used to evaluate liquidity and calculated as net cash provided (used) by operating activities divided by average current liabilities is the a. current ratio. b. free cash flow. c. cash total debt coverage ratio. d. cash current debt coverage ratio.

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 trading investment

12. Which of the following statements best represents the meaning of liquidity? a. the ability to pay obligations due within a year b. the ability to survive over the long term c. the amount the company can generate from operating activities to use to expand d. a ratio to determine whether the company has sufficient cash flows to meet total Instructor’s Manual

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obligations

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 trading investment

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.

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.

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SOLUTIONS TO CHAPTER 13 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. a 13. d 14. a 15. d

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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 profits 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 14 Performance Measurement 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 profit.

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 profits.

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 profit before interest expense and income tax divided by interest expense.

True

False

10. Earnings per share is reported for both common and preferred shares.

True

False

20-Minute Quiz

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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%.

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 ÷ Profit.

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.

14. Comparisons of financial data made within a company are called a. intracompany comparisons. b. interior comparisons. c. intercompany comparisons. d. intramural comparisons.

15. Earnings per share a. is calculated by dividing profit by the number of common share issued in the year. b. is a measure of the profit realized on each common share. c. is not presented on the income statement for publicly traded companies. d. is a measure of profit realized on each preferred share.

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ANSWERS TO 20-MINUTE QUIZ #1 True/False 1. True 2. False 3. True 4. False 5. False 6. True 7. False 8. False 9. True 10. False

Multiple Choice 11. a ($4.6 ÷ $4.0; $5.0 ÷ $4.0) 12. c 13. d 14. a 15. b

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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) b) c) d) e) f) g)

Collection of an account receivable Declaration of a cash dividend Sale of additional shares for cash Payment of an account payable Purchase of equipment for cash Purchase of inventory for cash Purchase of short-term 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

2017 5,400 4,400

2016 5,200 4,200

2015 5,000 4,000

Ending inventory Ending accounts receivable

460 300

430 280

400 250

Total current assets Total current liabilities

1,200 950

1,150 900

1,100 850

20-Minute Quiz

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a. Calculate the gross profit margin for 2016 ______________________ Calculate the gross profit margin for 2017 ______________________ Comment on the change ______________________________________ b. Calculate the inventory turnover for 2016

______________________

Calculate the collection period for 2017

d. Calculate the current ratio for 2017

20-Minute Quiz

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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. 2016: (5200 – 4200) ÷ 5200 = 19.2% 2017: (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)

20-Minute Quiz

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CHAPTER 14 PERFORMANCE MEASUREMENT STUDY OBJECTIVES 1. Understand the concept of sustainable income and indicate how discontinued items are presented.

2. Explain and apply horizontal analysis.

3. Explain and apply vertical analysis.

4. Identify and calculate ratios that are used to analyze liquidity.

5. Identify and calculate ratios that are used to analyze solvency.

Identify and calculate ratios that are used to analyze profitability.

7. Understand the limitations of financial analysis.

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CHAPTER OUTLINE Study Objective 1 – Understand the Concept of Sustainable Income and Indicate How Discontinued Items are Presented Sustainable income is the level of profit that is most likely to be obtained in the future. Sustainable income differs from actual profit by the amount of irregular (out of the ordinary) revenues, expenses, gains, and losses that are included in profit.  Users are interested in sustainable income because the amount helps them estimate future income without the “noise” of irregular items. One type of irregular item reported is discontinued operations. A discontinued operation refers to the disposal, or availability for sale, of a component of an entity.  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.  Statement of financial position Assets and liabilities of a discontinued operation that are held for sale as discontinued operations are valued and reported on the statement of financial position at the lower of their carrying amount and fair value (less any anticipated costs of selling) as current or non-current assets or liabilities. Once the asset or liability is disposed of, it is no longer reported on the statement of financial position.  Income statement Items relating to discontinued operations are segregated from continuing operations. Discontinued operations are shown near the bottom of the income statement immediately following the profit or 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 profit (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 profit (loss) from the discontinued operations) will be reported on the income statement until the actual disposal occurs.  To illustrate, review Illustration 14-2 from the textbook. Hudson’s Bay Company’s discontinuation of a component. Instructor’s Manual

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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.

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Study Objective 2 – Explain and Apply Horizontal Analysis Comparative Analysis  In assessing financial performance, investors, lenders, and other creditors are interested in the sustainable income of a company. They are also interested in making comparisons in order to evaluate a company’s past and current financial performance and position, and help determine future expectations. Horizontal analysis, also known as trend analysis, is a technique for evaluating a series of financial statement data over a period of time.  The purpose of horizontal analysis is to determine whether an increase or decrease has taken place, expressed as either an amount or a percentage. Teaching suggestion – Horizontal analysis is just that—horizontal. One looks across the page. 

To illustrate horizontal analysis, net sales for the past four years of Hudson’s Bay are shown below:

Net sales % of base-period amount % change per year 

2012 $4,077.0 112.6% 5.9%

2011 $3,849.6 106.4% 3.5%

2010 $3,718.2 102.7% 2.7%

2009 $3,619.7 100.0% -

Horizontal percentage of a base-period amount: If we assume that 2009 is the base year, we can measure all percentage increases or decreases from this base-period amount with the following formula: ANALYSIS PERIOD AMOUNT BASE-PERIOD AMOUNT

  

We can determine that net sales in 2012 are 112.6% of net sales in 2009 ($4,077.0 ÷ $3,619.7). In other words, net sales in 2012 are 12.6% greater than sales four years earlier. 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 Hudson’s Bay’s sales increased by $227.4 million ($4,077.0 2 – $3,849.6) between 2011 and 2012. This increase can then be expressed as a percentage by dividing the amount of the change between the two years of $227.4 million

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by the amount in the prior year, the 2011 net sales of $3,849.6 million. Thus, in 2012, sales increased by 5.9% compared with 2011. Teaching suggestion – Help students understand the difference between calculating a percentage of the base-period amount and the percentage change for each period.  

The financial statements of Hudson’s Bay Company are used to further illustrate horizontal analysis (percentage change between two periods). The condensed Statement of Financial Position (balance sheet) for 2012 and 2011 showing dollar and percentage changes are: HUDSON’S BAY COMPANY Balance Sheet February 2, 2013 and January 28, 2012 (In millions) Increase (Decrease) 2012 2011 Amount Percentage

Assets Current assets Cash Trade and other receivables Inventories Other current assets Assets of discontinued operations held for sale Total current assets Property, plant and equipment Intangible assets Other assets Total assets Liabilities and Shareholders’ Equity Liabilities Current liabilities Loans and borrowings Trade payables and accrued liabilities Unearned revenue Provisions and other Liabilities of discontinued operations held for sale Total current liabilities Non-current liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity

Instructor’s Manual

$ 48.3 74.3 994.3 34.2

$ 42.4 68.0 970.0 25.6

5.9 6.3 24.3 8.6

13.9% 9.3% 2.5% 33.6%

273.6 1,424.7 1,335.0 233.0 259.9 $3,252.6

1,096.1 2,202.1 1,270.5 224.6 296.3 $3,993.5

(822.5) (777.4) 64.5 8.4 (36.4) $(740.9)

(75.0)% (35.3)% 5.1% 3.7% (12.3)% (18.6)%

291.0

$ (158.9)

(54.6)%

670.1 109.9 89.9

715.5 101.4 86.3

(45.4) 8.5 3.6

(6.3)% 8.4% 4.2%

361.5 1,363.5 891.1 2,254.6 998.0

781.3 1,975.5 1,062.1 3,037.6 955.9

(419.8) (612.0) (171.0) (783.0) 42.1

(53.7)% (31.0)% (16.1)% (25.8)% 4.4%

$3,252.6

$3,993.5

$(740.9)

(18.6)%

$ 132.1

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 

  

   

 

Financial Accounting, Sixth Canadian Edition

The comparative statement of financial position (balance sheet) shows a number of changes from 2012 to 2011. Cash increased by 13.9%. It is helpful to look at the statement of cash flows to determine the cause of the key changes in cash during the year. After reviewing the statement, the increase was primarily because of cash received from the sale of the discontinued businesses and from improved cash flow from operating activities. Accounts receivable increased by 9.3%. We should determine if sales increased proportionately. Inventories increased by 2.5%. We will look at the income statement to determine if cost of goods sold changed proportionately to the inventory increase. The most significant change in current assets was caused by the decline in the assets of discontinued operations that were held for sale. These decreased by 75.0% as the assets were sold off due to the sale or closures of Zellers and Fields operations. Property, plant, and equipment increased by $64.5 million, or 5.1% as funds were spent to upgrade stores and purchase new computer hardware. Intangible assets rose by $8.4 million, or 3.7%, due to software purchases. Other assets, which consisted of several different types of assets including deferred tax assets and pension-related assets, declined by $36.4 million or 12.3% as the advantages of these assets are used up over time. Total current liabilities decreased by $612.0 million, or 31.0%, primarily because liabilities relating to Zellers and Fields were paid off with the proceeds received from the sale of the assets relating to these stores. The proceeds were also used to pay off current bank borrowings, which fell by $158.9 million or 54.6%. Furthermore, the additional cash on hand allowed the company to pay down trade payables and accrued liabilities more promptly as these fell by $45.4 million or 6.3%. The company’s non-current liabilities were reduced by $171 million or 16.1% as funds from the sale of discontinued operations and the public issue of shares were used to pay down these liabilities. The company’s total shareholders’ equity changed very little in 2012, increasing by only $42.1 million or 4.4%.

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. Also discuss with students situations when meaningful percentages cannot be calculated.

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

Financial Accounting, Sixth Canadian Edition

A horizontal analysis of Hudson’s Bay Company Statement of Earnings for 2012 and 2011 follows, calculating a percentage change between two periods: HUDSON’S BAY COMPANY Statement of earnings Years Ended February 2, 2013 and January 28, 2012 (In millions)

Net sales Cost of goods sold Gross profit Selling, general and administrative expenses Profit from operations Interest expense Profit from continuing operations before income tax Income tax recovery Profit from continuing operations Profit (loss) from discontinued operations, net of income tax Profit (loss)

Increase (Decrease) Amount Percent $227.4 5.9% 181.0 7.8% 46.4 3.0%

2012 $4,077.0 2,487.0 1,590.0

2011 $3,849.6 2,306.0 1,543.6

1,469.2 120.8 97.3

1,347.2 196.4 142.9

122.0 (75.6) (45.6)

9.1% (38.5)% (31.9)%

23.5 8.0

53.5 3.8

(30.0) 4.2

56.1% 110.5%

31.5

57.3

(25.8)

(45.0)%

(76.3) (44.8)

1,391.7 $1,449.0

(1,468.0) $(1,493.8)

(105.5)% (103.1)%



Horizontal analysis of the income statement shows these changes: Net sales increased by $2227.4 million or 5.9%. Cost of goods sold increased by 7.8% which is more than the increase in net sales in percentage terms. Selling, general, and administrative expenses increased by $122.0 million or 9.1%. Interest expense was down by $45.6 million or 31.9% because of the significant amount of bank loans were paid down in mid to late fiscal 2011.



Percentages are fairly straightforward and 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 percentage change can be calculated. Horizontal analysis is not as useful for the statement of comprehensive income,



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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.

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Study Objective 3 – Explain and Apply Vertical Analysis Vertical analysis, also called common size analysis, is a technique for evaluating financial statement data that expresses each item in a financial statement as a percent of a total (base) amount in 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 a vertical analysis of the comparative statement of financial position (Balance Sheet) for Hudson’s Bay Company for 2012 and 2011. The base for the asset items is total assets and the base for the liabilities and shareholders’ equity is total liabilities and shareholders’ equity. Hudson’s Bay Company Balance Sheet February 2, 2013 and January 28, 2012 (in millions)

Assets Current assets Cash Trade and other receivables Inventories Other current assets Assets of discontinued operations held for sale Total current assets Property plant, and equipment Intangible assets Other assets Total assets Liabilities and Shareholders’ Equity Liabilities Current liabilities Loans and borrowings Trade payables and accrued liabilities Unearned revenue Provisions and other Instructor’s Manual

2012 Amount Percent

Amount

2011 Percent

48.3 74.3 994.3 34.2

1.5% 2.3% 30.6% 1.0%

42.4 68.0 970.0 25.6

1.1% 1.7% 24.3% 0.6%

273.6 1,424.7 1,335.0 233.0 259.9 $ 3,252.6

8.4% 43.8% 41.0% 7.2% 8.0% 100.0%

1,096.1 2,202.1 1,270.5 224.6 296.3 $3,993.5

27.4% 55.1% 31.8% 5.6% 7.4% 100.0%

$ 132.1

4.1%

291.0

7.3%

670.1 109.9 89.9

20.6% 3.4% 2.8%

715.5 101.4 86.3

17.9% 2.5% 2.2%

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Liabilities of discontinued operations held for sale Total current liabilities Non-current liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ Equity  



Financial Accounting, Sixth Canadian Edition

361.5 1,363.5 891.1 2,254.6 998.0

11.1% 41.9% 27.4% 69.3% 30.7%

781.3 1,975.5 1,062.1 3,037.6 955.9

19.6% 49.5% 26.6% 76.1% 23.9%

$3,252.6

100.0%

$3,993.5

100.0%

Vertical analysis shows the relative size of each category in the statement of financial position. Vertical analysis of the statement of financial position shows these changes: The most significant change in current assets was a drop in the assets of the discontinued operations for sale which fell from 27.5% to 8.4%. Liabilities relating to discontinued operations, which represented 19.6% of total liabilities and shareholders’ equity in fiscal 2011, fell to 11.1% by 2012. Loans and borrowings were also reduced causing the percentage to fall from 7.3% to 4.1% of total liabilities and shareholders’ equity. Even though non-current liabilities decreased in absolute dollar terms, the percentage they represent of total liabilities and shareholders’ equity actually rose slightly from 26.6% to 27.4%. Shareholders’ equity at the end of the fiscal 2012 year had risen to 30.7% from 23.9% in 2011 of total liabilities and shareholders’ equity. This was caused not by an increase in shareholders’ equity but a decrease in liabilities, which was part of the company’s strategy to create a stronger statement of financial position with lower liabilities before going public in late 2012. A vertical analysis of Hudson’s Bay Company comparative statement of earnings is: HUDSON’S BAY COMPANY Statement of Earnings Year Ended February 2, 2013, and January 28, 2012 (in millions)

2012 Amount Percent $4,077.0 100.0% 2,487.0 61.0% 1,590.0 39.0%

2011 Amount Percent $3,849.6 100.0% 2,306.0 59.9% 1,543.6 40.1%

1,469.2 120.8 97.3

36.0% 3.0% 2.4%

1347.2 196.4 142.9

35.0% 5.1% 3.7%

23.5

0.6%

53.5

1.4%

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Income tax recovery Profit from continuing operations Profit (loss) from discontinued operations, net of income tax Profit (loss)  



Financial Accounting, Sixth Canadian Edition

8.0

0.2%

3.8

0.1%

31.5

0.8%

57.3

1.5%

(76.3) (44.8)

(1.9)% (1.1)%

1,391.7 $ 980.7

36.2% 37.6%

The base for this analysis is net sales. Percentage changes in horizontal analysis tend to be larger than percentage changes in vertical analysis but often reflect the same events. As we saw in our horizontal analysis, both net sales and cost of sales rose in 2012 by 5.9% and 7.8%, respectively, and since net sales growth was lower, gross profit fell by 3.0%. Vertical analysis is rarely performed on the statement of comprehensive income, statement of changes in equity, and the statement of cash flows.

Teaching suggestion – Discuss the associated benefit of vertical analysis that enables one to compare companies of different sizes. Use Illustration 14-11 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.

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Study Objective 4 – Identify and Calculate 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 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 dependable indicator of liquidity than working capital.  Cash current debt coverage Calculated by dividing net cash provided (or used) by operating activities by average current liabilities. Better indicator of liquidity because it uses cash provided (or used) by operating activities that covers a period of time, rather than current assets that represent a balance at a point in time.  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.  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.

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Study Objective 5 – Identify and Calculate 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 provided by creditors. This ratio indicates the company’s reliance on debt as it measures the proportion of total assets relative to total liabilities. The higher the percentage of debt financing, the riskier the company and the lower a company’s solvency. Calculated by dividing total liabilities (both current and non-current) by total assets.  Times interest earned Also called interest coverage. An indication of a company’s ability to meet interest payments as they come due. Calculated by dividing the sum of profit, interest expense, and income tax expense by interest expense. The higher the ratio, the more EBIT there is available to cover interest.  Cash total debt coverage Indicates the company’s ability to repay its liabilities from cash generated from operating activities (without having to liquidate assets used in its operations). The higher the cash total debt coverage ratio is, the more solvent a company is. Calculated by dividing net cash provided (used) by operating activities by average total liabilities.  Free cash flow Describes the cash remaining from operating activities after spending 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.

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Study Objective 6 – Identify and Calculate 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.  Gross Profit margin A measure of the company’s ability to maintain an adequate selling price above its cost of goods sold. 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). Calculated by dividing profit by net sales. Indicates how effective the company is at controlling operating expenses and how interest expense and income tax expense have affected profit.  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 profit by average total assets. Instructor’s Manual

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 Return on common shareholders’ equity Widely used ratio that measures profitability from the common shareholders’ viewpoint. Calculated by dividing profits available to common shareholders by average common shareholders’ equity. Profits available to the common shareholders are profits less any preferred dividends.  Earnings per share Measures the profit earned on each common share. Calculated by the profit 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 ratio Measures the ratio of the market price of each common share to its earnings per share. Calculated by dividing the market price per share by the 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 profits distributed as cash dividends. Calculated by dividing total cash dividends by profits. Companies with high growth rates usually have low payout ratios because they reinvest most of their profit back into the company, spending funds on new assets rather than paying out dividends to shareholders.  Dividend yield Reports a rate of return a shareholder earned from dividends during the year. 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 stock market price in its calculation. Teaching suggestion – Review the profitability ratios illustrated in 14-15 with students and emphasize that for profitability ratios the desired result is a higher ratio.

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Study Objective 7 – Understand the Limitations of Financial Analysis Some of the factors that can limit the usefulness of your analysis include alternative accounting policies, professional judgement, comprehensive income, diversification, inflation, and economic factors.  Alternative accounting policies. Variations among companies in the application of GAAP may 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-ofproduction). Different choices result in differing financial positions, 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.  Professional judgement. Management must use professional judgement in choosing the most appropriate accounting principle for the circumstance. Management’s choices may be biased in favour of a presentation that furthers certain company objectives. Many estimates are required in preparing financial information. Estimates are used in determining the allowance for uncollectible receivables, estimated useful lives and residual values for depreciation, and the fair values of certain investment securities and properties. 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. To help reduce the bias and inaccuracy and ensure that the quality of information is as high as possible, the chief executive officer and chief financial officer of publicly traded companies are required to certify that the reported financial information is presented fairly and does not misrepresent in all material respects the company’s financial condition, financial performance, and cash flows. Audit committees are also held responsible for quizzing management on the degree of aggressiveness or conservatism that has been applied and on the quality of underlying accounting policies, estimates, and judgements.  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. 

Diversification. Diversification in Canadian industry can limit the usefulness of

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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, profit, 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. 



Inflation. Our accounting information system does not adjust data for pricelevel changes. Comparisons are still relevant because data from neither company analyzed is being adjusted for inflation. In Canada, inflation is not very significant. Economic factors. Cannot interpret a financial analysis without considering the economic circumstances in which a company operates. Economic measures such as the rate of interest, unemployment, and changes in demand and supply can have a significant impact on a company’s performance. One must use this information, along with non-financial information, to try to assess what changes related to the economic situation and what changes related to factors that management can, or should be able to, control.

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CHAPTER 14 – 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? Suggested solution: horizontal analysis

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CHAPTER 14 VOCABULARY QUIZ 1. An overall measure of profitability, calculated as profit 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. The most likely level of profit to be obtained in the future, determined by adjusting profit for irregular items. 8. Measures the profits or operating 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 excess cash from operating activities available for paying dividends or expanding operations after spending enough cash to maintain operations at their current level.

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SOLUTIONS TO CHAPTER 14 VOCABULARY QUIZ 1. Return on assets 2. Discontinued operations 3. Horizontal analysis 4. Solvency ratios 5. Vertical analysis 6. Liquidity ratios 7. Sustainable income 8. Profitability ratios 9. Current ratio 10. Free cash flow

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CHAPTER 14 MULTIPLE CHOICE QUIZ

1. The most likely level of profits to be obtained in the future is(are) a. sustainable income. b. profits. c. profits adjusted for irregular items. d. both a and c.

2. The profit (loss) from discontinued operations consists of the a. profit (loss) from continuing operations. b. the gain (loss) on the disposed operations. c. profit (loss) from the disposed operations. d. both b 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.

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.

5. Which of the following is considered a profitability ratio? a. price-earnings ratio b. times interest earned c. average collection period d. cash current debt coverage

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. none of the above.

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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.

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.

9. Vertical analysis of comparative income statements would show cost of goods sold as a percentage of a. total assets. b. merchandise inventory. c. net sales. d. profit.

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.

Use the following data to answer questions 11–13. Current assets .......................................... $150,000 Total assets .............................................. 500,000 Current liabilities ....................................... 125,000 Total liabilities ........................................... 200,000 Net sales .................................................. 550,000 Net credit sales ......................................... 300,000 Cost of goods sold..................................... 200,000 Gross profit ............................................... 350,000 Profit .......................................................... 100,000 Average gross receivables ....................... 50,000 Average inventory .................................... 40,000

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11. What is the receivables turnover? a. 1 times b. 6 times c. 11 times d. 17 times

12. What is the debt to total assets? a. 25% b. 40% c. 83% d. 133%

13. What is the profit margin? a. 18% b. 36% c. 64% d. 82%

14. Which of the following is a true statement? a. Under both ASPE and IFRS, earnings per share must be reported on the income statement. b. Under ASPE, earnings per share must be reported on the income statement. c. Under IFRS, earnings per share must be reported in the income statement. d. Neither ASPE nor IFRS require that the 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. economic factors d. all of the above

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SOLUTIONS TO CHAPTER 14 MULTIPLE CHOICE QUIZ 1. d 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. d

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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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