SOLUTIONS MANUAL for Intermediate Accounting, Volume 2, 13th Canadian Edition by Donald Kieso, Jerry by StudyGuide

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

CHAPTER 13 NON-FINANCIAL AND CURRENT LIABILITIES Learning Objectives 1. Understand the importance of non-financial and current liabilities from a business perspective. 2. Define liabilities, distinguish financial liabilities from other liabilities, and identify how they are measured. 3. Define current liabilities and identify and account for common types of current liabilities. 4. Identify and account for the major types of employee-related liabilities. 5. Explain the recognition, measurement, and disclosure requirements for decommissioning and restoration obligations. 6. Explain the issues and account for product guarantees, other customer program obligations, and unearned revenue. 7. Explain and account for contingencies and uncertain commitments, and identify the accounting and reporting requirements for guarantees and commitments. 8. Indicate how non-financial and current liabilities are presented and analyzed. 9. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

BT Item LO

1. 2. 3. 4. 5. 6. 7.

1 3 3 3 3 2,3 3

C AP AP AP AP AP AP

1. 2,9 2. 3 3. 3 4. 3,9 5. 3 6. 3,9 7. 3,4,6,7,9

C AP AP AP AP AP C

1. 2,3,5,9 AP 2. 2,3 AP 3. 2,3,4,6,9 AP 4. 2,3,5,6 AP 1.

6,9

1. 2.

5,6,7 3,7,8

AP AP

BT Item LO BT Item LO BT Item LO BT Brief Exercises 8. 3 AP 15. 4 AP 22. 5,9 AP 29. 6,9 AP 9. 3 AP 16. 4 AP 23. 6 AP 30. 7,9 AP 10. 3 AP 17. 4 AP 24. 6 AP 31. 7 AP 11. 3 AP 18. 4 AP 25. 6 AP 32. 8 AN 12. 3 AP 19. 4 AP 26. 6 AP 33. 8 AN 13. 3,9 C 20. 2,5 AP 27. 6 AP 34. 8 AN 14. 3,9 C 21. 5,9 AP 28. 6 AP 34. 8 AN Exercises 8. 3,8,9 AP 15. 5,9 AP 22. 6,9 AP 29. 7,9 C 9. 3,8,9 AP 16. 5,9 AP 23. 6,9 AP 30. 8 AN 10. 4 AP 17. 6 AP 24. 6,9 AP 31. 8 AN 11. 4 AP 18. 3,4,6 AP 25. 6 AP 32. 8 AN 12. 4 AP 19. 6,9 AP 26. 6,9 AP 13. 4 AP 20. 6,8,9 AP 27. 6 AP 14. 4,9 AN 21. 6,9 AP 28. 6 AP Problems 5. 4 AP 9. 6,7,9 AP 13. 6,9 AP 17. 7,8,9 AP 6. 4 AP 10. 6,7,10 AP 14. 6,8,9 AP 7. 4,9 AN 11. 6,8 AP 15. 6,9 AP 8. 5,7 AP 12. 6,7,9 AP 16. 7,8 AP Cases 2. 3. Integrated Cases 2. 7 AP 3. 7 AP Research and Analysis 3. 6,7,8 AP 5. 6,7 AP 6. 4,8 AP 7. 2,6,7 AN 4. 3,5,6,8 AP

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Learning objective Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to complete in minutes Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Tech. Technology Diversity Diversity Reflec. Thinking Reflective Thinking CPA Canada Competency Map Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation DAIS Data Analytics and Information Systems

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

Problems

1& Concept of liabilities; 2. definition, measurement, and classification.

1, 6, 20

1, 2, 3, 4, 7

3. Current liabilities including accounts and notes payable, dividends payable, sales and income tax payable, refund liabilities, and short-term obligations expected to be refinanced.

2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14

2, 3, 4, 5, 6, 7, 8, 9,18

1, 2, 3, 4

4. Employee-related liabilities.

15, 16, 17, 18, 19

7, 9, 10, 11, 12, 13, 14, 18

3, 5, 6, 7

5. Asset retirement obligations.

20, 21, 22

15, 16

1, 4, 8

6. Unearned revenue.

23, 24

7, 17, 18

8, 9, 16

6. Product guarantees, warranties, and other customer programs.

25, 26, 27, 28, 29

7, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28

3, 4, 10, 11, 12, 13, 14, 15

7. Contingencies, guarantees, and uncertain commitments.

30, 31

7, 29

8, 9, 12, 16, 17

8. Presentation and analysis.

32, 33, 34, 35

8, 9, 20, 30, 31, 32

3, 8, 9, 11, 16, 17

9. IFRS and ASPE compared.

13,14, 21, 22, 29, 30, 31

1, 4, 6, 7, 8, 9, 14, 15, 16, 19, 20, 21, 22, 24, 29

1, 3, 7, 9, 12, 13, 14, 15, 17

Topics

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Item

Description

E13.1

Balance sheet classification of various liabilities Accounts and notes payable Notes payable and reversing entry Liability for returnable containers Entries for sales taxes Income tax Financial statement impact of liability transactions Refinancing of short-term debt Refinancing of short-term debt Payroll tax entries Compensated absences–vacation and sick pay Compensated absences–vacation and sick pay Compensated absences–parental benefits Bonus calculation and income statement preparation Asset retirement obligation Asset retirement obligation Unearned revenue HST and payroll Warranties–assurance-type and cash basis Warranties–assurance-type Warranties–assurance-type and service-type Warranties–assurance-type and service-type Customer loyalty programs Premium entries Premiums Premiums Coupons and rebates Customer returns Contingencies and commitments Ratio calculations and discussion Ratio calculations and analysis Ratio calculations and effect of transactions

E13.2 E13.3 E13.4 E13.5 E13.6 E13.7 E13.8 E13.9 E13.10 E13.11 E13.12 E13.13 E13.14 E13.15 E13.16 E13.17 E13.18 E13.19 E13.20 E13.21 E13.22 E13.23 E13.24 E13.25 E13.26 E13.27 E13.28 E13.29 E13.30 E13.31 E13.32

Level of Difficulty

Time (minutes)

Simple

10-15

Simple Moderate Moderate Moderate Moderate Moderate

10-15 15-20 15-20 25-35 15-20 30-35

Moderate Simple Moderate Moderate

20-25 10-15 15-20 40-45

Moderate

25-30

Moderate

20-25

Complex

15-20

Moderate Moderate Simple Moderate Simple

40-45 40-50 10-15 15-20 10-15

Moderate Moderate

15-20 20-25

Moderate

25-30

Moderate Moderate Moderate Simple Moderate Simple Moderate Simple Simple Moderate

15-20 15-20 20-30 10-15 15-20 10-15 20-30 15-20 20-25 15-25

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Item

Description

P13.1 P13.2 P13.3 P13.4

Current liability entries and adjustments Instalment notes Current liabilities: various Asset retirement obligation and warranties Payroll tax entries Payroll tax entries Bonus calculation Loss contingencies: entries and essay. Advances, self-insurance, loss contingencies, guarantees, and commitments Assurance-type warranties and cash basis Assurance-type and service-type warranties Warranty calculations Premium entries Premium entries and financial statement presentation Warranties and premiums Guarantees and contingencies Loss contingencies: entries and essays

P13.5 P13.6 P13.7 P13.8 P13.9

P13.10 P13.11 P13.12 P13.13 P13.14 P13.15 P13.16 P13.17

Level of Difficulty

Time (minutes)

Simple Moderate Complex Moderate

40-50 40-45 45-55 25-35

Moderate Moderate Moderate Moderate Moderate

25-35 35-45 35-40 45-50 35-40

Simple

25-30

Moderate

20-30

Moderate Moderate Moderate

30-35 30-45 30-45

Simple Complex Moderate

35-40 35-45 45-50

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13.1 (a)

Working capital is the excess of total current assets over total current liabilities. It represents the liquid buffer that is available to meet the financial demands of the company’s operating cycle. Current liabilities place a demand on the company’s current assets. Management of the due dates of current liabilities and management of current assets to generate cash on a timely basis are important for effective management of business operations. Effective management of working capital to achieve high liquidity may also contribute to positive cash from operating activities, as seen on the statement of cash flows.

(b)

Wellson can improve its management of working capital by focusing on the management of current liabilities as well as current assets. For example, if Wellson has a cash flow shortage, it can take advantage of the full credit period extended by its suppliers. As another example, Wellson may also time the due dates of short-term notes payable to coincide with expected periods of positive cash flow.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.2 07/01 Purchases ................................................. Accounts Payable ........................... To record purchase on account

60,000

Freight in ................................................... Cash ................................................. To record freight on purchase

1,200

07/03 Accounts Payable .................................... Purchase Returns and Allowances

6,000

07/10 Accounts Payable .................................... Cash ($54,000 X 98%)...................... Purchase Discounts ........................

54,000

60,000

1,200

6,000

52,920 1,080

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.3

07/01 Inventory ................................................... Accounts Payable ........................... To record purchase on account

60,000

Inventory ................................................... Cash ................................................. To record freight on purchase

1,200

07/03 Accounts Payable .................................... Inventory ..........................................

6,000

07/10 Accounts Payable .................................... Cash ($54,000 X 98%)...................... Inventory ..........................................

54,000

60,000

1,200

6,000

52,920 1,080

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.4 11/01/23 Cash .................................................... Notes Payable ............................

40,000

12/31/23 Interest Expense1................................ Interest Payable ......................... 1 ($40,000 X 9% X 2/12)

600

02/01/24 Notes Payable ..................................... Interest Payable .................................. Interest Expense2................................ Cash ........................................... 2 ($40,000 X 9% X 1/12)

40,000 600 300

40,000

600

40,900

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.5 01/01/24 Interest Payable .................................. Interest Expense ........................

600

02/01/24 Notes Payable ..................................... Interest Expense1................................ Cash ........................................... 1 ($40,000 X 9% X 3/12)

40,000 900

600

40,900

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.6 (a) Using a financial calculator: PV $ 60,000 I ? % Yields .744 % per month or 8.9% per year N 3 PMT 0 FV $ (61,350) Type 0 Excel formula =RATE(nper,pmt,pv,fv,type)

Result: .0074444

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.6 (Continued) (b) 11/01/23 Cash .................................................... Notes Payable ............................

60,000 60,000

12/31/23 Interest Expense1................................ 897 Notes Payable ............................ 1 ($60,000 x .007444) = $447 ($60,447 x .007444) = $450 ($447 + $450) = $897 (alternately could record $1,350 X 2/3 = $900) 02/01/23 Interest Expense2................................ Notes Payable ............................ 2 ($1,350 – $897) To accrue interest expense

453

Notes Payable ..................................... Cash ........................................... To record note repayment

61,350

897

453

61,350

LO 2,3 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.7 (a)

(b)

Cash .................................................... 13,000 Sales ............................................ Refund Liability ...........................

8,000 5,000

Refund Liability ($5,000 x 60%) ......... Container Sales Revenue ...........

3,000

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.8 Accounts Receivable .................................... Sales Revenue ..................................... HST Payable ($37,500 X 13%) ............. To record sales on account

42,375.00

Furniture ....................................................... HST Receivable ($2,860 X 13%) ................... Cash ...................................................... To record cash purchase of furniture

2,860.00 371.80

37,500.00 4,875.00

3,231.80

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.9 Accounts Receivable .................................. 37,500.00 Sales Revenue ($37,500 ÷ 1.13) ........ 33,185.84 HST Payable ($37,500 ÷ 1.13 X .13) ... 4,314.16 To record sales on account Furniture ($2,860 ÷ 1.13) .............................. 2,530.97 HST Receivable ($2,860 ÷ 1.13 X .13) ......... 329.03 Cash .................................................... To record cash purchase of furniture

2,860.00

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.10 (a) Purchases.................................................. GST Receivable ($29,400 X 5%) ............... Accounts Payable ...............................

29,400 1,470

(b) Accounts Receivable................................ Sales Revenue ..................................... GST Payable ........................................

47,250

(c) GST Payable .............................................. Cash .................................................... GST Receivable ..................................

2,250

30,870 45,000 2,250

780 1,470

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.11 (a)

Income Tax Expense ............................... Cash ($3,200 X 4) .............................. To record income tax payments

12,800

Income Tax Expense ($20,000–$12,800) Income Tax Payable ......................... To accrue income tax expense

7,200

12,800

7,200

(b) At year end, the company would report Income Tax Payable of $7,200 in current liabilities. LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.12 (a)

Income Tax Receivable ............................ Income Tax Expense1 .......................... 1 ($12,800 – $10,200)

2,600 2,600

(b) At year end, the company would report Income Tax Receivable of $2,600 in current assets. LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.13 (a)

Under IFRS, the $700,000 debt is reclassified as current because the long-term debt agreement is violated and the liability becomes payable on demand. It should be noted that under IFRS, the debt is reclassified as current, even if the lender agrees between the date of the SFP and the date the financial statements are released that it will not demand repayment because of the violation.

(b)

Under ASPE, the $700,000 debt is reclassified as current unless the creditor waives, in writing, the covenant (agreement) requirements, or the violation has been corrected within the grace period that is usually given in these agreements and it is likely that the company will not violate the covenant requirements within a year from the balance sheet date.

LO 3,9 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.14 (a)

Under IFRS, since the debt is due within 12 months from the reporting date, it is classified as a current liability. This classification holds even if long-term refinancing has been completed before the financial statements are released. The only exception for continuing long-term classification is if, at the balance sheet date, the entity expects to refinance it or roll it over under an existing agreement for at least 12 months and the decision is solely at its discretion.

(b)

Under IFRS, the whole $500,000 of maturing debt would still be classified as a current obligation at December 31, 2023. The international standard has a stringent requirement that the agreement must be firm at the date of the SFP in order to qualify for classification as long-term. (This assumes Burr had not entered into a long-term agreement prior to the SFP date of Dec. 31, 2023.)

(c)

For part (a), under ASPE, the debt would be classified as a long-term liability. If there is irrefutable evidence by the time the financial statements are completed and released that the debt has been or will be converted into a long-term obligation, ASPE allows currently maturing debt to be classified as longterm on the balance sheet. In this case, the debt was refinanced before the financial statements were completed and released. For part (b), under ASPE, the debt would be classified as a current liability since there is not irrefutable evidence by the time the financial statements were completed that the debt has been or will be converted into a long-term obligation. (This assumes Burr had not entered into a long-term agreement prior to the release of the financial statements of Dec. 31, 2023.) In addition, since repayment occurred before funds were obtained through long-term financing, the repayment used existing current assets.

LO 3,9 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.15 Salaries and Wages Expense ............................ Employee Income Tax Deductions Payable .................................................. CPP Contributions Payable...................... EI Premiums Payable................................ Cash ...........................................................

23,000 3,426 990 420 18,164

LO 4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.16 (a) Payroll Tax Expense .......................................... EI Premiums Payable ($420 X 1.4) ........... CPP Contributions Payable......................

1,578 588 990

(b) Employee Income Tax Deductions Payable ..... CPP Contributions Payable ($990 X 2) ............. EI Premiums Payable ($420 + $588).................. Cash ...........................................................

3,426 1,980 1,008 6,414

LO 4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.17 Salaries and Wages Expense1 .......................... Vacation Wages Payable .......................... 1 (30 X 1 X $1,000)

30,000 30,000

LO 4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.18 December 1, 2023: Employee Benefit Expense1 .............................. Parental Leave Benefits Payable ............. To record expense for parental leave 1

Salary for 17 weeks ($74,000 ÷ 52 X 17) Less: employment insurance payments ($720/week X 17 weeks) Employee Benefit Expense

11,952 11,952

$24,192 (12,240) $11,952

For each of the 4 weeks in December 2023, Laurin Corporation will pay Ruzbeh Awad a top-up amount and record the payments as follows: Parental Leave Benefits Payable ...................... Cash ........................................................... ($74,000 ÷ 52 weeks) = $1,423.08; $1,423.08 – $720.00 = $703.08 To record parental leave payment

703.08 703.08

LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.19 12/31/23 Bonus Expense ................................. 350,000 Bonus Payable ......................... 350,000 2/15/24

Bonus Payable .................................. 350,000 Cash ......................................... 350,000

LO 4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.20 Drilling Platform ................................................. 500,249 Asset Retirement Obligation1 .................. 500,249 (a) Using Table A.2: ($1,000,000 X .50025) (b) Using a financial calculator: PV ? Yields $ 500,248.97 I 8% N 9 PMT 0 FV $ (1,000,000) Type 0 (c) Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $500,248.97 LO 2,5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.21 (a) IFRS Depreciation Expense1 ........................... Accumulated Depreciation – Drilling Platform ............................. 1 ($500,249 ÷ 9 years) To record depreciation expense Interest Expense2 .................................... Asset Retirement Obligation ......... 2 ($500,249 X 8%) To record interest expense (b) ASPE Depreciation Expense3 ........................... Accumulated Depreciation– Drilling Platform ............................. 3 ($500,249 ÷ 9 years) To record depreciation expense Accretion Expense4 ................................ Asset Retirement Obligation ......... 4 ($500,249 X 8%) To record accretion expense

55,583 55,583

40,020 40,020

55,583 55,583

40,020 40,020

LO 5,9 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.22 (a) IFRS Inventory.................................................. Asset Retirement Obligation .........

61,942

(b) ASPE Drilling Platform ...................................... Asset Retirement Obligation .........

61,942

LO 5,9 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.23 Aug. 1 Cash (12,000 X $18) ............................... 216,000 Unearned Revenue ....................... Dec. 31 Unearned Revenue ............................... 90,000 Sales Revenue1.......................... 1 ($216,000 X 5/12 = $90,000)

216,000

90,000

LO 6 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.24 (a)

Cash ....................................................... 104,500 Service Revenue ....................... Unearned Revenue ....................

200 @ $100 100 @ $95 300 @ $250

(b)

Cash $20,000 9,500 75,000 $104,500

Earned $20,000

45,000 59,500

Unearned

25,000 $45,000

$9,500 50,000 $59,500

The current portion of the unearned revenue will be $9,500 plus $25,000 relating to the three-year plan. The non-current portion will be $25,000 for the last year of the three-year plan.

LO 6 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.25 2023

Cash. ................................................. Sales Revenue ......................... To record cash sale

2,500,000

Warranty Expense ............................ Materials, Cash, Payables ........ To record warranty expense

68,000

12/31/23 Warranty Expense ............................ Warranty Liability ....................

420,000

2023

2,500,000

68,000

420,000

LO 6 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 13.26 2023

Cash. ............................................... Sales Revenue ....................... Unearned Revenue ................ To record cash sale

2,500,000

Warranty Expense .......................... Materials, Cash, Payables To record warranty expense

68,000

12/31/23 Unearned Revenue ......................... Warranty Revenue1 ............... 1 $600,000 X 25% To record year-end adjustment

150,000

2023

1,900,000 600,000

68,000

150,000

LO 6 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.27 (a)

(b)

(c)

Cash .................................................... Unearned Revenue1 ................... 1 (20,000 X $99)

1,980,000

Warranty Expense .............................. Materials, Cash, Payables. ........

180,000

Unearned Revenue ............................. Warranty Revenue2 .................... 2 [$1,980,000 X ($180,000/$1,080,0003)] 3 $180,000 + $900,000 = $1,080,000

330,000

1,980,000

180,000

330,000

LO 6 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.28 a.

July 10, 2023 Accounts Receivable .............................. Refund Liability (15% X $1,700,000) Sales Revenue ................................. To record sales on account

1,700,000

Cost of Goods Sold ................................ Estimated Inventory Returns1 ................. Inventory ......................................... 1 ($960,000 X 15%) To record cost of goods sold

816,000 144,000

255,000 1,445,000

960,000

October 11, 2023 Refund Liability ....................................... Cash ................................................. Sales Revenue .................................. To record returns from customers

255,000

Returned Inventory1 ................................ Cost of Goods Sold2 ............................... Estimated Inventory Returns .......... To record return of inventory 1 ($960,000 ÷ $1,700,000) X $248,000 2 $144,000 - $140,047

140,047 3,953

248,000 7,000

144,000

LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.29 (a) IFRS Inventory of Premiums1 .............................. Cash .................................................... 1 100,000 X $2.50 To record cash purchase of premiums

250,000 250,000

Cash. ............................................................ Sales Revenue ................................... Unearned Revenue2 ........................... 2 1,000,000 X $4.00 X 10% To record cash sales

4,000,000

Cash3............................................................ Premium Expense ....................................... Inventory of Premiums4 ..................... 3 240,000/3 X $1.00 4 240,000/3 X $2.50 To record redemption of codes

80,000 120,000

Unearned Revenue ..................................... Sales Revenue5 .................................. 5 240,000/(1,000,000 X 30%) X $400,000 To adjust unearned revenue

320,000

(b) ASPE Inventory of Premiums6 .............................. Cash .................................................... 6 100,000 X $2.50 To record cash purchase of premiums Cash. ............................................................ Sales Revenue ................................... To record cash sales

3,600,000 400,000

200,000

320,000

250,000 250,000

4,000,000 4,000,000

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BRIEF EXERCISE 13.29 (Continued) (b) (Continued) Cash7............................................................ Premium Expense ....................................... Inventory of Premiums8 ..................... 7 240,000/3 X $1.00 8 240,000/3 X $2.50 To record redemption of codes

80,000 120,000

Premium Expense9 ..................................... 30,000 Estimated Liability for Premiums...... 9 [(1,000,000 X 30%) – 240,000] / 3 X ($2.50 - $1.00) To record premium expense

200,000

30,000

LO 6,9 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.30 (a)

Litigation Expense ..................................... 700,000 Litigation Liability ............................

700,000

(b)

Litigation Expense ..................................... 700,000 Litigation Liability ............................. 700,000

(c)

No entry is necessary. The loss is not accrued because it is not probable that a liability has been incurred at 12/31/23.

(d)

(a) - ASPE where Litigation Liability is likely: Litigation Expense ................................... 700,000 Litigation Liability .......................... 700,000 (b) - ASPE where Litigation Liability is not likely: No entry is necessary. The loss is not accrued because it is not likely that a liability has been incurred at 12/31/23.

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.31 (a)

Under IFRS, Siddle should record a loss since it is probable that a liability has been incurred, and the amount is reliably measurable. The amount should be measured at the probability-weighted expected value of the loss. Assuming that a payout of $100,000 and a payout of $250,000 are equally probable, a loss in the amount of $175,000 is recorded. Litigation Expense ..................................... Litigation Liability .............................

175,000 175,000

(b) Under ASPE, Siddle should record a loss since it is likely that a liability has been incurred, and the amount can be reasonably estimated. The amount should be measured at the best estimate in the range of possible outcomes. If no particular estimate is better than another, the bottom of the range is recognized, and the amount of the remaining exposure to possible loss is disclosed in the notes. Assuming that a payout of $100,000 and a payout of $250,000 are equally likely, a loss in the amount of $100,000 is recorded, and the remaining exposure of $150,000 is disclosed in the notes. Litigation Expense .................................... Litigation Liability ............................

100,000 100,000

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.32 a. Ratio Current Ratio

2025 2.17

2024 2.11

2023 2.00

Quick Ratio

0.54

0.59

0.66

Days Payables Outstanding

39.54

34.98

N/A

Current Ratio = Current Assets / Current Liabilities 2025: $8,250 / $3,800 = 2.17 2024: $7,800 / $3,700 = 2.11 2023: $7,300 / $3,650 = 2.00 Quick Ratio = Quick Assets / Current Liabilities 2025: ($650 + $500 + $900) / $3,800 = 0.54 2024: ($700 + $500 + $1,000) / $3,700 = 0.59 2023: ($600 + $500 + $1,300) / $3,650 = 0.66 Days Payables Outstanding = Average Trade Accounts Payable Average Daily Cost of Goods Sold 2025: 2024:

($1,550 + $1,700) / 2 = 39.54 ($15,000 / 365) ($1,700 + $1,750) / 2 = 34.98 ($18,000 / 365)

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.32 (Continued) b.

Yuen Corporation - Ratio Analysis 2.5

Ratio

1.5

0.5

0 2023

2024

2025

Years Quick Ratio

Current Ratio

The company shows a positive trend in the current ratio. However, the quick ratio shows deterioration in the quality of the current assets. The two ratios combined show that the increasing liquidity in the current ratio is created from less liquid assets such as inventory and prepaid expenses.

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BRIEF EXERCISE 13.32 (Continued) b. (Continued) Yuan Corporation - Days Payable Outstanding 40.00

39.00 38.00 37.00 36.00 35.00 34.00 33.00 32.00 31.00

30.00 2024

2025

The days payables outstanding ratio shows the company is taking a longer amount of time to pay off its current liabilities. The ratio has increased from approximately 35 days in 2024 to almost 40 days in 2025. If the company’s creditors normally have credit terms of 30 days, this shows a disturbing trend, especially when combined with the deterioration in the quick ratio. LO 8 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005, cpa-t007 CM: Reporting, Finance and DAIS

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BRIEF EXERCISE 13.33 The following data can be used to forecast the liability: • Pre-pandemic historical number of points awarded and redeemed • Pre-pandemic average value of a point ($ value of flight / total points redeemed) • Actual amount of points set to expire → use the average value of a point to reduce liability The following adjustments should be made to the liability: Addition to the liability Current awarding of loyalty points since the pandemic → use to forecast amount of points to be awarded in the next 6 months and then multiply with average value of a point to add to the liability.

Reduction to the liability The reduction in liability will be related to 1) the use of the awards and, 2) the expiration of the awards due to 12 months passing from the date the points were earned by the customers. LO 8 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 13.34 The following information can be used to forecast the liability: • Average number of vacation days taken (total number of days / employee headcount) • Average cost of a vacation day to the company • Average number of vacation days taken during pandemic (total days / average headcount) • Determination (using market data) when travel will return back to normal (if at all, in the current year) • Average headcount for the remaining of the year The following adjustments should be made to the liability: Additions to the liability Calculate weighted average of average vacation days earned pre/post pandemic based on determination (using market data) when travel will return back to normal (if at all, in the current year) and multiply it by the average headcount. Reduction to the liability Calculate weighted average of average vacation days taken pre/post pandemic based on determination (using market data) when travel will return back to normal (if at all, in the current year) and multiply it by the average headcount. LO 8 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 13.35 (a) Refer to Step-by-Step Excel video

(b) Refer to Step-by-Step Excel video

Current Ratio

3.8 3.6 3.4 3.2

3 2.8 2.6 2.4 2.2 2

Q3 2022

2023

LO 8 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005, cpa-t007 CM: Reporting, Finance and DAIS

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Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 13.1 a.

Classifications on balance sheet prepared under ASPE: 1. Current liability; financial liability. 2. Current asset. 3. Current liability or long-term liability depending on term of warranty; not a financial liability. 4. Current liability; financial liability. A company would have an obligation to pay cash to the bank for any overdraft and this would result from the contractual agreement with the bank. 5. Current liability; not a financial liability if this refers to legislative obligations for income tax withholdings, CPP, and EI. This is a financial liability if it refers to other withholdings of a contractual nature with employees (union dues, for example). 6. Current liability; financial liability. 7. Current or noncurrent liability depending upon the time involved; not a financial liability (if deposit will be returned then it would be a financial liability). 8. Current liability; not a financial liability; this is a legislative obligation. 9. Current liability; not a financial liability. A portion could be noncurrent depending on the expiry date of the certificate. 10. Current liability; not a financial liability. 11. Current liability; financial liability. 12. Current asset. 13. Current liability; financial liability. 14. Current liability; financial liability.

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EXERCISE 13.1 (CONTINUED) a. (Continued) 15.

16. 17. 18.

19.

Note disclosure; not a financial liability. Dividends in arrears have not been declared – so it cannot be a financial liability. It becomes a financial liability only when declared by the company. The contractual arrangement between a company and its preferred shareholders is that they are entitled to a dividend every year before the common shareholders get any distributions, but they must be declared before they become a liability. Separate presentation in either current or long-term liability section; financial liability. Current liability; not a financial liability; this is a legislative obligation. Current or noncurrent liability depending upon the time involved; not a financial liability; this is a legislative or constructive obligation. Current liability; financial liability.

There would be no changes if the SFP was prepared under IFRS.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.2 a.

Sept. 1

Purchases ..................................... Accounts Payable ................ Purchase on account

50,000

Accounts Payable ......................... Notes Payable ...................... Settlement of accounts payable by issuing a note

50,000

Cash .............................................. Notes Payable ...................... Borrowed cash and issued a note

75,000

Dec. 31 Interest Expense1 .......................... Interest Payable ................... 1 ($50,000 X 8% X 3/12) To accrue interest expense on 8% note

1,000

Dec. 31 Interest Expense2 .......................... Notes Payable ...................... 2 [($81,000 – $75,000) X 3/12] To accrue interest expense on non–interest-bearing note

1,500

Oct. 1

50,000

75,000

1,000

(1)

Note payable Interest payable

$50,000 1,000 $51,000

(2)

Note payable at issuance Interest accrued Note payable balance

$75,000 1,500 $76,500

1,500

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EXERCISE 13.3 a.

Oct. 1/24 Interest Expense1 ....................... Interest Payable .......................... Notes Payable ............................. Cash ..................................... 1 ($50,000 X 8% X 9/12) To record repayment of 8% note

3,000 1,000 50,000

Oct. 1/24 Interest Expense2 ....................... Notes Payable ..................... 2 [($81,000 – $75,000) X 9/12] To accrue interest expense on non–interest-bearing note

4,500

Notes Payable ............................. Cash ..................................... To record repayment of non– interest-bearing note

81,000

b. Jan. 1

Oct. 1

Orion Note: Interest Payable .................... Interest Expense ............. Interest Expense ....................... Notes Payable ........................... Cash.................................

54,000

4,500

81,000

1,000 1,000 4,000 50,000 54,000

Bank Note: The use of reversing entries is more efficient for the interest-bearing note. In this case, the bookkeeping staff will debit interest expense for the full 12 months when the note is paid and, in combination with the reversing entry, the expense in 2024 will be correct. With the non–interest-bearing note, there is no need to reverse the interest. When the note is paid at maturity, the difference between the note’s carrying amount and the amount paid is all charged – correctly – to interest expense.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.3 (Continued) b. (continued) Jan. 1

Oct. 1

If reversing entry used: Notes Payable ............................... Interest Expense..................

1,500 1,500

Interest Expense ........................... Note Payable ....................... To accrue interest expense on non–interest-bearing note

6,000

Notes Payable ............................... Cash ..................................... To record repayment of non– interest-bearing note

81,000

If reversing entry not used: Interest Expense …………………. Note Payable ……………… To accrue interest expense on non–interest-bearing note Notes Payable ............................... Cash .................................... To record repayment of non– interest-bearing note

6,000

81,000

4,500 4,500

81,000 81,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.4 a.

Cash ........................................................... 894,000 Deposits ............................................ 894,000 To record deposit from customers Deposits ..................................................... 705,400 Cash................................................... 705,400 To record refund of deposit Deposits ..................................................... Container Sales Revenue ................. ($170,000 – $115,000) To record revenue

55,000 55,000

Deposits $650,000 894,000 2023 returns 2024 expired Deposits

$705,400 55,000

12/31/22 liability 2023 deliveries

(760,400) $783,600 12/31/23 liability

The classification of this liability as current or long-term depends upon the length of the company’s operating cycle. If the company’s operating cycle is one year or less, then the portion of the liability that is expected to be settled within one year is classified as current. The remaining deposits would be classified as long-term. If the company’s operating cycle is between one year and two years, the portion of the liability that is expected to be settled within one operating cycle is classified as current. If the company’s operating cycle is two years or more, the entire liability ($783,600) is classified as current.

There would be no changes if the SFP was prepared under ASPE.

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EXERCISE 13.5 a.

Province of Ontario

March 1 Rent Expense .................................. HST Receivable ($5,500 X 13%) ..... Cash ...........................................

5,500 715

3 Accounts Receivable—Marcus ...... Sales Revenue ........................... HST Payable ($20,000 X 13%) ... To record sales on account

22,600

Cost of Goods Sold......................... Inventory .................................... To record cost of goods sold

11,000

5 Sales Returns and Allowances ...... HST Payable ($500 X 13%).............. Accounts Receivable—Marcus

500 65

7 Inventory HST Receivable ($4,000 X 13%) ..... Accounts Payable—Tinney .......

4,000 520

12 Furniture and Fixtures ................... HST Receivable ($600 X 13%) ........ Cash ...........................................

600 78

Apr. 15 HST Payable ($2,600 – $65) ............ Cash ........................................... HST Receivable ......................... ($715 + $520 + $78)

2,535

6,215

20,000 2,600

11,000

565

4,520

678

1,222 1,313

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.5 (CONTINUED) b.

Province of Alberta

March 1 Rent Expense ................................... GST Receivable ($5,500 X 5%) ........ Cash .............................................

5,500 275

3 Accounts Receivable—Marcus ....... Sales Revenue ............................ GST Payable ($20,000 X 5%) ...... To record sales on account

21,000

Cost of Goods Sold .......................... Inventory ..................................... To record cost of goods sold

11,000

5 Sales Returns and Allowances ....... GST Payable ($500 X 5%) ................ Accounts Receivable—Marcus ..

500 25

7 Inventory ........................................... GST Receivable ($4,000 X 5%) ........ Accounts Payable—Tinney ........

4,000 200

12 Furniture and Fixtures .................... GST Receivable ($600 X 5%) ........... Cash .............................................

600 30

Apr. 15 GST Payable ($1,000 – $25) ............. Cash ............................................. GST Receivable ($275 + $200 + $30) .....................

975

5,775

20,000 1,000

11,000

525

4,200

630

470 505

LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.6 a.

Mar. 31

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

8,100

Cash .............................................. Income Tax Receivable .......

11,250

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

8,100

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

8,100

Dec. 31 Income Tax Expense .................... Cash...................................... To record income tax instalment payment

8,100

Dec. 31 Income Tax Expense .................... Income Tax Payable ............ To accrue income tax expense

5,400

June

Estimated income tax Income tax instalments paid ($8,100 X 4) Income tax payable b.

8,100

11,250

8,100

5,400

$37,800 (32,400) $ 5,400

The income tax payable will be shown as a current liability.

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EXERCISE 13.6 (c.

June

Cash .............................................. Retained Earnings ........................ Income Tax Receivable .......

2,750 8,500 11,250

The error relates to a prior period and should be treated as an adjustment to opening retained earnings on the statement of retained earnings or statement of changes in equity. No tax effect would be applicable for this correction of error. LO 3,9 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.7 a. #

Assets

Liabilities

Shareholders’ Equity

Net Income

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EXERCISE 13.7 (CONTINUED) b.

Under IFRS, addition considerations should be applied to the following items:

Item No. 12 The criteria for recording a contingent loss under ASPE must be “likely,” meaning a high probability, whereas for IFRS the threshold for recognition is lower at “probable.” 13 and 15 ASPE requires companies to apply recognition criteria separately when the selling price includes an identifiable amount for subsequent servicing. Under IFRS 15, warranties are considered either assurance-type or service-type. LO 3,4,6,7,9 BT: C Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.8 a. Hornsby Corporation Partial Balance Sheet December 31, 2023 Current liabilities: Notes payable (Note 1)

$250,000

Long-term liabilities: Notes payable refinanced in February 2024 (Note 1)

950,000

Note 1: Short-term debt refinanced As at December 31, 2023, the company had notes payable totalling $1,200,000 due on February 2, 2024. These notes were refinanced on their due date to the extent of $950,000 received from the issuance of common shares on January 21, 2024. The balance of $250,000 was liquidated using current assets. OR Current liabilities: Notes payable (Note 1) Long-term liabilities: Short-term debt expected to be refinanced (Note 1)

$250,000

950,000

(Same Note as above.)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.8 (CONTINUED) b.

Under IFRS, since the debt is due within 12 months from the reporting date, the whole amount ($1.2 million) is classified as a current liability. This classification holds even if a long-term refinancing has been completed before the financial statements are released. The only exception for continuing long-term classification is if, at the balance sheet date, the entity expects to refinance it or roll it over under an existing agreement for at least 12 months and the decision is solely at its discretion. The international standard has a stringent requirement that the agreement must be firm at the balance sheet date.

The current ratio is calculated as current assets/current liabilities. If Hornsby follows ASPE, current liabilities would include $250,000 related to the short-term notes payable. If Hornsby follows IFRS, current liabilities would include $1.2 million related to the short-term notes payable. Therefore, the current ratio would appear higher if Hornsby follows ASPE. A creditor would want to assess the company’s liquidity and solvency, and should be aware that classification of the shortterm notes payable on the balance sheet has a significant impact on key ratios, including the current ratio. The creditor should refer to all information in the financial statements, including notes to the financial statements, to determine the financial position of the company, especially when comparing the company’s performance to that of another company with financial statements prepared under a different standard.

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EXERCISE 13.9 Zimmer Corporation Partial Balance Sheet December 31, 2023 Current liabilities: Notes payable (Note 1)

$4,480,000

Long-term liabilities: Notes payable expected to be refinanced in 2024 (Note 1)

3,420,000

Note 1. Under a financing agreement with Provincial Bank, the company may borrow up to 60% of the gross amount of its accounts receivable at an interest cost of 1% above the prime rate (currently prime rate is 8%). The company has informed Provincial Bank that it wishes to refinance as much of its debt as possible and will issue notes maturing in 2025 to replace $3,420,000 of short-term, 15%, notes due periodically in 2024. Because the amount that can be borrowed may range from $3,420,0001 to $4,200,0002, only $3,420,000 of the $7,900,000 of currently maturing debt has been reclassified as long-term debt. Expected range of receivables: 1 low in May: $5,700,000 X 60% = $3,420,000 2 high in October: $7,000,000 X 60% = $4,200,000 b.

Under IFRS, since the debt is due within 12 months from the reporting date, the whole amount ($7.9 million) is classified as a current liability. This classification holds even if a long-term refinancing has been completed before the financial statements are released. The only exception accepted for continuing long-term classification is if, at the balance sheet date, the entity expects to refinance it or roll it over under an existing agreement for at least 12 months and the decision is solely at its discretion. The international standard has a stringent requirement that the agreement must be firm at the balance sheet date.

LO 3,8,9 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13-48 Chapter 13 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 13.10 a.

Salaries and Wages Expense.................... 485,000 Employee Income Tax Deductions Payable .......................................... 85,000 1 EI Premiums Payable ....................... 5,767 2 CPP Contributions Payable ............. 19,893 Union Dues Payable .......................... 8,000 Cash .................................................... 366,340 1 $365,000 X 1.58% = $5,767 2 $365,000 X 5.45% = $19,893 To record the salaries and wages paid and the employee payroll deductions Payroll Tax Expense ................................. EI Premiums Payable3 ....................... CPP Contributions Payable4 ............. 3 $365,000 X 2.212% = $8,074 4 $365,000 X 5.45% = $19,893 To record employer contributions

Employee Income Tax Deductions Payable .................................................. EI Premiums Payable ($5,767 + $8,074)... CPP Contributions Payable5 .................... Cash .................................................... 5 ($19,893 + $19,893) To record remittance Union Dues Payable ................................. Cash .................................................... To remit union dues collected

27,967 8,074 19,893

85,000 13,841 39,786 138,627

8,000 8,000

Salaries and wages for September 2023 $485,000 Payroll tax expense 27,967 Total payroll cost for September 2023 $512,967 Cost per dollar of salaries and wages = ($512,967  $485,000) = $1.058

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EXERCISE 13.10 (CONTINUED) d.

The company may have additional employee-related costs such as Workplace Safety and Insurance Board (WSIB) coverage, health taxes, life, health and disability insurance, pension benefits, compensated absences (paid vacation, maternity/paternity leave, sick pay), and indirect costs such as a human resources department.

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EXERCISE 13.11 a.

To accrue the expense and liability for vacation entitlement:

2022

Salaries and Wages Expense Vacation Wages Payable1

14,400

Salaries and Wages Expense Vacation Wages Payable2

15,120

Salaries and Wages Expense Vacation Wages Payable3 Cash4

648 12,960

2023

1 2

3 4

14,400

15,120

13,608

9 employees X $20.00/hr. X 8 hrs./day X 10 days = 9 employees X $21.00/hr. X 8 hrs./day X 10 days =

$14,400 $15,120

9 employees X $20.00/hr. X 8 hrs./day X 9 days = 9 employees X $21.00/hr. X 8 hrs./day X 9 days =

$12,960 $13,608

NOTE: Vacation days are paid at the employee’s current wage.

To accrue the expense and liability for sick days:

2022

Salaries and Wages Expense Sick Pay Wages Payable5

8,640 8,640

To record payment for compensated time when used by employees:

2023

Sick Pay Wages Payable6 Cash

5,760

Salaries and Wages Expense Sick Pay Wages Payable7

9,072

5,760

9,072

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EXERCISE 13.11 (CONTINUED) b. (continued) 2023

Salaries and Wages Expense 144 8 Sick Pay Wages Payable 7,416 9 Cash 7,560 Note: in 2020, employees would first use up remaining 2019 sick leave (2 days), and then use 2020 sick leave. The 2019 sick leave had originally been accrued at $20 per hour, but it is being paid at 2020 pay rates ($21/hr), therefore increase expense in 2020 by: 9 employees X 8hrs./day X 2 days X ($21 - $20) = $144 5

9 employees X $20.00/hr. X 8 hrs./day X 6 days = $8,640 9 employees X $20.00/hr. X 8 hrs./day X 4 days = $5,760 7 9 employees X $21.00/hr. X 8 hrs./day X 6 days = $9,072 8 9 employees X $20.00/hr. X 8 hrs./day X (6–4) days = $2,880 9 employees X $21.00/hr. X 8 hrs./day X (5–2) days = + $4,536 $7,416 9 9 employees X $21.00/hr. X 8 hrs./day X 5 days = $7,560 6

NOTE: Sick days are paid at the employee’s current wage.

Accrued liability at year-end: 2022 Vacation Sick Pay Wages Wages Payable Payable Jan. 1 balance $ 0 $ 0 + accrued 14,400 8,640 – paid ( 0) (5,760) 10 Dec. 31 balance $14,400 $2,88011 10

2023 Vacation Sick Pay Wages Wages Payable Payable $14,400 $2,880 15,120 9,072 (12,960) (7,416) 12 $16,560 $4,53613

9 emp. X $20.00/hr. X 8 hrs./day X 10 days =

$14,400

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EXERCISE 13.11 (CONTINUED) c. (continued) 11

9 emp. X $20.00/hr. X 8 hrs./day X (6–4) days =

9 emp. X $20.00/hr. X 8 hrs./day X (10–9) days = 9 emp. X $21.00/hr. X 8 hrs./day X 10 days

9 emp. X $21.00/hr. X 8 hrs./day X (6 + 6 – 4 – 5) days

$2,880*

$ 1,440 +15,120* $16,560 * Based on company policy; a more precise estimate would use the rate of pay expected at the time the sick leave will be used of $21.00/hr. (or higher if a pay raise is expected in 2022). $4,536

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.11 (CONTINUED) d.

Since the sick days entitlement does not accumulate, the company would not accrue unused sick days. Unused sick days would expire. Paid sick days taken by employees during the year would be debited to Salaries and Wages Expense as taken, at the wage rate in effect in that year. To record payment for compensated time when used by employees:

2022 Salaries and Wages Expense14 Cash

5,760

2023 Salaries and Wages Expense15 Cash

7,560

14 15

5,760

9 employees X $20.00/hr. X 8 hrs./day X 4 days = 9 employees X $21.00/hr. X 8 hrs./day X 5 days =

7,560 $5,760 $7,560

The accrued liability at year-end would be the same as part c. for vacation wages payable, but no accrual would be required for sick days. Vacation Wages Payable (2022) = $14,400 Vacation Wages Payable (2023) = $16,632 LO 4 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.12 a. 2022

To accrue the expense and liability for vacations: Salaries and Wages Expense1 14,940 Vacation Wages Payable 14,940 To record vacation time paid: No entry.

2023

To accrue the expense and liability for vacations: Salaries and Wages Expense2 15,552 Vacation Wages Payable 15,552 To record vacation time paid: Salaries and Wages Expense Vacation Wages Payable3 Cash4

1 2 3 4

To record sick time paid: Salaries and Wages Expense5 Cash

2023

13,608

9 employees X $20.75/hr. X 8 hrs./day X 10 days = $14,940 9 employees X $21.60/hr. X 8 hrs./day X 10 days = $15,552 9 employees X $20.75/hr. X 8 hrs./day X 9 days = $13,446 9 employees X $21.00/hr. X 8 hrs./day X 9 days = $13,608

b. 2022

162 13,446

To record sick time paid: Salaries and Wages Expense6 Cash

5,760 5,760

7,560 7,560

9 employees X $20.00/hr. X 8 hrs./day X 4 days = $5,760 9 employees X $21.00/hr. X 8 hrs./day X 5 days = $7,560

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.12 (CONTINUED) c.

Accrued liability at year-end (vacation pay only): 2022 2023 Jan. 1 balance $ 0 $14,940 + accrued 14,940 15,552 – paid ( 0) (13,446) 7 Dec. 31 balance $14,940 $17,0468

9 employees X $20.75/hr. X 8 hrs./day X 10 days =

$14,940

9 employees X $20.75/hr. X 8 hrs./day X 1 day = 9 employees X $21.60/hr. X 8 hrs./day X 10 days =

$ 1,494 15,552 $17,046

LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.13 a.

October 29, 2023:

Employee Benefit Expense1 .............................. Parental Leave Benefits Payable .............

36,810 36,810

The expense and liability are recognized when the event that obligates the entity occurs. For maternity and parental leave, the application for leave is the event that obligates the corporation. The notification in June is not considered an actual application for leave. 1

Salary for 12 months Less: employment insurance payments ($720/week X 52 weeks) Salary for 6 months at 75% ($54,000 X 6/12 X 75%) Employee Benefit Expense

$54,000 (37,440) 20,250 $36,810

For each of the 9 weeks from October 29, 2023 to December 31, 2023, Goldwing Corporation will pay Zeinab Jolan a top-up amount and record the payments as follows: Parental Leave Benefits Payable2 .......... Cash ................................................ 2 ($54,000 – $37,440) ÷ 52 weeks = $318 Parental Leave Benefits Payable3 ....... Cash .............................................

Top up for one year ($54,000 – $37,440) Less portion used in 2023 (9 weeks X $318) Remaining 9 weeks at 75% of full pay ($20,250 X 9/26) Benefits paid during 2024

318 318

20,708 20,708 $16,560 (2,862) 7,010 $20,708

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.13 (CONTINUED) c.

Parental Leave Benefits Payable at December 31, 2023 = $36,810 – (9 weeks X $318) = $33,948 Parental Leave Benefits Payable at December 31, 2024 = $33,948 – $20,708 = $13,240 The parental leave benefits payable balance at December 31, 2023 will have both a current and long-term portion. The amount payable within the coming year, $20,708, will be shown as a current liability, whereas the remaining $13,240, which will be payable in 2025, will be shown as a long-term liability. On the December 31, 2024 balance sheet, the remaining amount of $13,240 will be shown as a current liability.

LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.14 a. Justin Corp. Income Statement For the Year Ended December 31, 2023 Sales revenue $10,000,000 Cost of goods sold 7,000,000 Gross profit 3,000,000 Administrative and selling expenses $1,000,000 Profit-sharing bonus to employees 245,614 1,245,614 Income before income tax 1,754,386 Income tax (30%) 526,316 Net income $ 1,228,070 Calculation of bonus and tax: T = .30 ($3,000,000 – $1,000,000 – B) B = .20 ($2,000,000 – B – T) B = .20 [$2,000,000 – B – .30 ($2,000,000 – B)] B = .20 ($2,000,000 – B – $600,000 + .30B) B = .20 ($1,400,000 – .70B) B = $280,000 – .14B 1.14B = $280,000 Bonus = $245,614.04 T = .30 ($2,000,000 – $245,614.04) T = .30 ($1,754,385.96) Tax = $526,315.79

Bonus Expense ......................................... Bonus Payable .................................

245,614 245,614

The calculation of the bonus would not have changed had Justin followed IFRS.

LO 4,9 BT: AN Difficulty: C Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.15 a. Drilling Platform Cash

January 1, 2023 5,460,000

Drilling Platform1 Asset Retirement Obligation 1 $598,661.502 X 70% = $419,063

5,460,000 419,063 419,063

1. Using Table A.2 tables i=8% and n=6): ($950,000 X .63017) = $598,661.502 2. Using a financial calculator: PV ? Yields $ 598,661.15 I 8% N 6 PMT 0 FV $ (950,000) Type 0 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $598,661.15

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EXERCISE 13-15 (CONTINUED) b. December 31, 2023 3 Depreciation Expense Accumulated Depreciation – Drilling Platform 3 ($5,460,000 + $419,063) ÷ 6 To record depreciation expense

979,844 979,844

Interest Expense4 Asset Retirement Obligation 4 $419,063 X 8% To record interest expense

33,525

Inventory Asset Retirement Obligation To record production of oil inventory

32,328

c. December 31, 2024 5 Depreciation Expense Accumulated Depreciation – Drilling Platform 5 ($5,460,000 + $419,063) ÷ 6 To record depreciation expense

33,525

32,328

979,844 979,844

Interest Expense6 Asset Retirement Obligation 6 ($419,063 + $33,525 + $32,328) X 8% To record interest expense

38,793

Inventory Asset Retirement Obligation To record production of oil inventory

34,914

38,793

34,914

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.15 (CONTINUED) d. December 31, 2028 Asset Retirement Obligation Gain on Settlement of ARO Cash

e. Drilling Platform Cash

950,000 28,000 922,000

January 1, 2023 5,460,000 5,460,000

Drilling Platform Asset Retirement Obligation Same amount as in (a)

419,063 419,063

December 31, 2023 7

Depreciation Expense Accumulated Depreciation – Drilling Platform 7 ($5,460,000 + $419,063) ÷ 6 To record depreciation expense

979,844

Accretion Expense8 Asset Retirement Obligation 8 $419,063 X 8% To record accretion expense

33,525

Drilling Platform Asset Retirement Obligation To adjust asset retirement obligation

32,328

979,844

33,525

32,328

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.15 (CONTINUED) e. (continued) December 31, 2024 9

Depreciation Expense Accumulated Depreciation – Drilling Platform 9 ($5,460,000 + $419,063) ÷ 6 + $32,328 ÷ 5 To record depreciation expense

986,310

Accretion Expense10 Asset Retirement Obligation 10 ($419,063 + $33,525 + $32,328) X 8% To record accretion expense

38,793

Drilling Platform Asset Retirement Obligation To adjust asset retirement obligation

34,914

December 31, 2028 Asset Retirement Obligation Gain on Settlement of ARO Cash

986,310

38,793

34,914

950,000 28,000 922,000

LO 5,9 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.16 a. Present value of the asset retirement obligation 1. Using Table A.2 i=6% and n=10):= $75,000 X .55839 = $41,879 2. Using a financial calculator: PV ? Yields $ 41,879.61 I 6% N 10 PMT 0 FV $ (75,000) Type 0 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $41,879.61

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.16 (CONTINUED) a. (continued) July 2, 2023 Oil Tanker Depot Cash To record purchase of depot

600,000

Oil Tanker Depot Asset Retirement Obligation To record asset retirement obligation

41,879

600,000

41,879

b. December 31, 2023 1 Depreciation Expense Accumulated Depreciation – Oil Tanker Depot 1 ($600,000 + $41,879) ÷ 10 X 6/12 To record depreciation expense Accretion Expense2 Asset Retirement Obligation 2 ($41,879 X 6% X 6/12) To record accretion expense c.

Balance Sheet: Property, Plant, and Equipment: Oil Tanker Depot Less: Accumulated Depreciation Long-term Liabilities: Asset Retirement Obligation ($41,879 + $1,256) Income Statement: Operating Expenses Depreciation Expense Accretion Expense

32,094 32,094

1,256 1,256

$641,879 32,094 $609,785

43,135

32,094 1,256

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EXERCISE 13.16 (CONTINUED) d. Year June 30, 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033

Beg. Carrying Amount

Accretion Expense (6%)

Ending Carrying Amount

41,879.00 44,391.74 47,055.24 49,878.55 52,871.26 56,043.54 59,406.15 62,970.52 66,748.75 70,753.68

2,512.74 2,663.50 2,823.31 2,992.71 3,172.28 3,362.61 3,564.37 3,778.23 4,004.93 4,245.22

44,391.74 47,055.24 49,878.55 52,871.26 56,043.54 59,406.15 62,970.52 66,748.75 70,753.68 74,998.90

e. June 30, 2033 Asset Retirement Obligation Loss on Settlement of ARO Cash

75,000 5,000 80,000

f. The accretion expense is a non-cash expense. It would be omitted from cash from operations in the statement of cash flows prepared using the direct method. It would be added back to net income in the statement of cash flows prepared using the indirect method.

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EXERCISE 13.16 (CONTINUED) g.

If the company reports under IFRS, the main differences in accounting for the asset retirement costs and obligation are as follows: 1. In addition to the legal obligations recognized in part a, if there are any constructive obligations related to retiring the oil tanker depot, the related costs would be included in the asset retirement obligation (ARO). Under ASPE, only the costs associated with legal obligations are included in the ARO. 2. The costs included in the capital asset would only be those retirement obligations related to the acquisition of the asset, not those retirement obligations related to the subsequent production of goods or services. Under IFRS, retirement costs related to the subsequent production of goods or services are included as inventory or product costs as the depot is used and the retirement costs increase due to production. Under ASPE, the costs included in the capital asset are the retirement obligations resulting from both the acquisition of the asset and its subsequent use in producing inventory. 3. The interest adjustment to the liability account recorded in part b. would be recognized as a borrowing cost in the interest expense account. Under ASPE, the interest adjustment is recognized as an operating expense in the accretion expense account. As an example, assuming that Crude Oil follows IFRS and that the ARO of $75,000 at the end of the depot’s useful life relates 50% to acquisition of the depot and 50% to the subsequent production: • The July 2, 2023 entry to acquire the oil tanker depot would be the same as under ASPE. • Instead of capitalizing the full $41,879 in the Oil Tanker Depot account, only ½ X $41,879 or $20,940 would be capitalized at July 2, 2023.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.16 (CONTINUED) g. (continued) • •

•

The depreciation expense for the six months ended December 31, 2023 would be ($600,000 + $20,940) ÷ 10 X 6/12 = $31,047 Interest expense (which would be accretion expense under ASPE as discussed above) for the 6 months ended December 31, 2023 would be lower under ASPE. It would be $20,940 X 6% X 6/12 = $628. An entry would have to be made to recognize the increased ARO due to the production activities for the 6 months ended December 31, 2023, with the costs charged to Inventory. This would be measured at the present value of the incremental costs caused by this production. If $37,500 of the remediation obligation (ARO) was caused by the acquisition of the asset, then the other $37,500 of the ARO, or $1,875 every six months, would be caused by production. At the end of December 2023, $1,078 is the present value of the incremental cost caused by production (PV $1,875 using i=6% and n=9.5 periods which gives a PV factor of .57490). On June 30, 2024, an additional $1,110 would be recognized as production costs and an increase in the ARO (PV $1,875 using i=6% and n=9 periods which gives a PV factor of .59190). At June 30, 2024, additional interest expense would be recognized as well because $1,078 has been included in the ARO since December 31, 2023. However, only $1,078 is charged to Inventory and credited to the Asset Retirement Obligation at December 31, 2023. At June 30, 2033, the ARO will have accumulated to $75,000, the same as under ASPE. Therefore, the same entry would be made to recognize the $80,000 expenditure for remediation and the $5,000 loss.

Note to instructor: This may be more detail than you would like to get into with your students, but it is provided here as one way to calculate reasonable numbers for the entries. The following table sets out a “proof” that the ARO related to production activity and interest for the first year’s production will accumulate to 1/10 of the estimated retirement costs at the end of 10 years or $3,750. Solutions Manual 13-68 Chapter 13 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 13.16 (CONTINUED) g. (continued) For each period, the ARO relating to the current production is recorded at its present value at the end of the period of production, added to the same liability account for the ARO recognized for the asset acquisition, and then accreted until the obligation is eventually retired. There is no amount in the ARO account related to inventory production until December 31, 2023, so no accretion is needed in that first period.

Jul.1/23 Dec.31/23 Jul.1/24 Jul.1/25 Jul.1/26 Jul.1/27 Jul.1/28 Jul.1/29 Jul.1/30 Jul.1/31 Jul.1/32 Jul.1/33

Present value of additional costs resulting from production in first year 0 1,078 1,110 0 0 0 0 0 0 0 0 0

Accretion at 6% per year 0 0 32 133 141 150 159 168 178 189 200 212

Balance of ARO related to production activity for first year 0 1,078 2,220 2,353 2,494 2,644 2,803 2,971 3,149 3,338 3,538 3,750

LO 5,9 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.17 a.

May 1, 2023 No entry – neither party has performed on May 1, 2023.

May 15, 2023

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

3,200 3,200

May 31, 2023

Unearned Revenue .......................................... Sales Revenue ........................................ To record sales revenue

3,200

Cost of Goods Sold ......................................... Inventory ................................................. To record cost of goods sold

2,150

3,200

2,150

LO 6 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.18 Jan.

5 Cash............................................... 17,854 Sales Revenue......................... HST Payable ($15,800 × 13%) . To record cash sales plus HST 12 Unearned Revenue ....................... 7,000 HST Payable ($6,195 x 13%) ... Service Revenue1 .................... To record service revenue for cash previously received 1 ($7,000 / 1.13) = $6,195 14 HST Payable .................................. 11,390 HST Receivable ....................... Cash ......................................... Remitted HST payable 15 CPP Contributions Payable ......... EI Premiums Payable ................... Employee Income Tax Deductions Payable................... Cash ......................................... Remitted payroll deduction

15,800 2,054

805 6,195

4,260 7,130

2,152 1,019 4,563 7,734

20 Equipment2.................................... 5,600 HST Receivable ($5,600 x 13%) ... 728 Accounts Payable ................... 6,328 To record purchase of equipment on account 2 ($6,328 / 1.13) = $5,600 31 Salaries and Wages Expense ...... 25,350 CPP Contributions Payable .. EI Premiums Payable ............ Employee Income Tax Deductions Payable .......... Cash........................................ To record payment of monthly payroll

1,183 464 4,563 19,140

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.18 (CONTINUED) Jan. 31 Payroll Tax Expense ................. 1,833 CPP Contributions Payable . EI Premiums Payable 3 ......... To record employer benefits expense. 3 ($464 × 1.4)

1,183 650

LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.19 a.

Cash (150 X $4,000) .................................. Sales Revenue ................................. To record cash sales

600,000

Warranty Expense .................................... Materials, Cash, Payables. .............. To record warranty expense

17,000

Warranty Expense ($45,0001 – $17,000) .. Warranty Liability ............................ 1 (150 X $300) To accrue warranty expense

28,000

Cash .......................................................... Sales Revenue ................................. To record cash sales

600,000

Warranty Expense .................................... Materials, Cash, Payables. .............. To record warranty expense

17,000

600,000

17,000

28,000

600,000

17,000

The cash basis of accounting for warranty costs is generally not acceptable under GAAP. However, some companies may use it when the costs are very immaterial or when the warranty period is quite short. It may also be used when the amount of the liability cannot be reasonably estimated or if future costs are not likely to be incurred.

The recording of assurance-type warranties is the same under IFRS and ASPE. However, under ASPE it is based on the principle that when revenue covers a variety of deliverables (bundled sales) it should be unbundled and the revenue allocated to the various goods or services that are required to be performed.

LO 6,9 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 13.20 a.

Estimated warranty expense for 2023: On 2023 sales: $1,036,000 X .091 =

$ 93,240

(2% of sales first year + 3% of sales second year + 4% of sales third year = 9% of sales) Sales $810,000 1,070,000 1,036,000

2021 $16,200 ______ $16,200

2022 $24,300 21,400 ______ $45,700

2023 $32,400 32,100 20,720 $85,220

Estimated warranty costs: On 2021 sales $ 810,000 X .09 On 2022 sales $1,070,000 X .09 On 2023 sales $1,036,000 X .09 Total estimated costs Total warranty expenditures2 Balance of liability, 12/31/23 2

2024

2025

$42,800 31,080 $73,880

$41,440 $41,440

Total $72,900 96,300 93,240 $262,440

$ 72,900 96,300 93,240 262,440 146,700 $115,740

2021—$16,500; 2022—$47,200, and 2023—$83,000.

The liability account has a balance of $115,740 at 12/31/23 based on the difference between the estimated warranty costs (totalling $262,440) for the three years’ sales and the actual warranty expenditures (totalling $146,700) during that same period. b.

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EXERCISE 13.20 (CONTINUED) c.

The difference between actual warranty expenditures and the estimated amount would be treated as a change in accounting estimate and applied to the current and future years. The difference would be used as part of Cool Sound’s experience in setting the rate for current and future years’ transactions. If the difference is considered material, the additional warranty expenditures would be charged to the income statement in the current year.

When arriving at the estimate of likely costs to be incurred in satisfying warranty claims, Cool Sound could use information to generate predictive analytics regarding matters such as which parts are most likely to fail, and the number and severity of expected claims. Data analytics information about the parts used, customer feedback, repair technician comments, and similar data can be important tools in estimating warranty costs and highlighting quality issues that should be focused upon by management.

LO 6, 8, 9 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001, cpa-t007 CM: Reporting and DAIS

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EXERCISE 13.21 a.

Accounts Receivable .......................... Sales Revenue1 .......................... 1 (500 X $6,000) To record sales on account

3,000,000 3,000,000

Warranty Expense .............................. 30,000 Cash............................................ To record payment of warranty expense

Warranty Expense2 ............................. Warranty Liability ...................... 2 ($120,000 – $30,000) To accrue warranty expense

90,000

Accounts Receivable .......................... Sales Revenue ........................... Unearned Revenue .................... To record sales on account

3,000,000

90,000

2,840,000 160,000

Warranty Expense .............................. 30,000 Cash............................................ To record payment of warranty expense Unearned Revenue ............................. Warranty Revenue3 .................... 3 [$160,000 X ($30,000/$120,000)] To remeasure unearned revenue

30,000

40,000 40,000

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EXERCISE 13.21 (CONTINUED) c. Sales Revenue Warranty Revenue Warranty Expense Net Income

$3,000,000 0 (120,000) $2,880,000

$2,840,000 40,000 (30,000) $2,850,000

Treating the warranty as an integral part of the sale under the assurance-type (expense-based) approach for warranties will trigger a larger expense. This is because the full cost of servicing the product over the course of the warranty period must be estimated and disclosed in the period of sale. The warranty expense under a service-type (revenue-based) approach for warranties consists of only expenses incurred in the current period. The presentation of sales revenue will also differ under the two approaches. Under the assurance-type warranty, the sales proceeds from selling the product generate only one revenue source. Under the service-type warranty approach, the sale of the product generates two different revenue streams (the sale of the product and the sale of the warranty contract as service revenue) as well as two gross profit sources (sales revenue less cost of goods sold and warranty revenue net of warranty expense). The service-type warranty approach generates a lower income in the current year because a portion of the profit is deferred to future periods, when it is earned as the service is provided. d.

The recording of assurance-type and service-type warranties is the same under IFRS and ASPE. However, under ASPE, it is based on the principle that when revenue covers a variety of deliverables (bundled sales) it should be unbundled and the revenue allocated to the various goods or services that are required to be performed.

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EXERCISE 13.21 (CONTINUED) e. If the warranty costs are considered to be immaterial, the cash basis method could be used and warranty costs recognized in the year they are incurred. However, if the warranty costs are considered material to the company’s financial statements, the company may have to defer recognizing the revenue from the sale of the product until all costs can be measured and matched against the related revenues. LO 6,9 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.22 a.

Assurance-type (expense approach): Accounts Receivable .......................... Sales Revenue1 .......................... 1 (1,000 X $3,000) To record sales on account

3,000,000 3,000,000

Warranty Expense .............................. 105,000 Cash............................................ To record payment of warranty expense Warranty Expense2 ............................. Warranty Liability ...................... 2 [(1,000 X $200) – $105,000] To accrue warranty expense

105,000

95,000 95,000

December 31, 2023 financial statement amounts reported: Balance Sheet Warranty liability

$95,000

Income Statement Sales revenue Warranty expense

$3,000,000 200,000

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EXERCISE 13.22 (CONTINUED) a. (continued) Service-type (revenue approach): Accounts Receivable ........................... Sales Revenue ............................ Unearned Revenue ..................... To record sales on account

3,000,000

Warranty Expense ............................... Cash............................................. To record warranty expense

105,000

Unearned Revenue .............................. Warranty Revenue1 ..................... 1 [$350,000 X ($105,000/$200,000)] To remeasure unearned revenue

183,750

2,650,000 350,000

105,000

183,750

December 31, 2023 financial statement amounts reported:

Balance Sheet Unearned revenue

$166,250

Income Statement Sales revenue Warranty revenue Warranty expense

$2,650,000 183,750 105,000

The recording of assurance-type and service-type warranties is the same under IFRS and ASPE. However, under ASPE it is based on the principle that when revenue covers a variety of deliverables (bundled sales) it should be unbundled and the revenue allocated to the various goods or services that are required to be performed.

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EXERCISE 13.22 (CONTINUED) c.

When the assurance-type approach is used to account for warranty costs, sales revenue will be higher because it is all considered to be earned upon the sale of the product. As well, the expense on the income statement will represent the total estimated costs of servicing the warranties (i.e., the actual costs of servicing the warranty in the period, plus a year-end adjustment for expected future costs.) Therefore, the total gross profit on the warranty work is recognized in the period the equipment is sold. When the service-type approach is used, sales revenue will be lower because the total selling price is allocated between the sale of the product and the sale of the warranty service. There will be an unearned revenue liability account for the portion of the warranty that has not been taken into revenue at year end. Warranty expense will be equal to the actual costs of servicing the warranty during the year. In summary, the profit on the warranty work is recognized later under the revenue approach—in the period in which the warranty work is performed. In this situation, it makes more sense to choose the servicetype approach. In this way, income is reported as it is earned, and is a better measure of performance. In addition, as the company is considering going public in a few years, and the bifurcation of revenues to multiple deliverables is required by IFRS, the service-type approach would be consistent with what will be required after the company goes public. It would make sense to adopt this accounting policy now so that a retrospective change is not required later.

LO 6,9 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.23 a.

The performance obligation is satisfied when the points are used or the time to use them expires. Because the points provide a material right to a customer that it would not receive without entering into a loyalty program, the points are a separate performance obligation. Bélanger allocates the transaction price to the product and the points on a relative stand-alone selling price basis as follows. The stand-alone selling price: Purchased products: Estimated points to be redeemed1 Total fair value 1 9,500 points X $1 per point The allocation is as follows:

$100,000 9,500 $109,500

Products ($100,000 / $109,500) X $100,000 = $91,324 Bonus points ($9,500 / $109,500) X $100,000 = $8,676

To record sales of products subject to bonus points:

Cash ................................................................. Unearned Revenue .................................. Sales Revenue ......................................... To record cash sale

100,000

Cost of Goods Sold (1–45%) X 100,000 ......... Inventory .................................................. To record cost of goods sold

55,000

8,676 91,324

55,000

Had Bélanger been following ASPE, there would be no difference in the accounting of the customer loyalty program transactions.

LO 6,9 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.24 a. Inventory of Premiums (8,800 X $0.90) .......... Cash ........................................................ To record cash purchase of premiums

7,920 7,920

Cash (120,000 X $3.30) ................................... Sales Revenue ....................................... To record cash sales

396,000

Premium Expense1 ......................................... Inventory of Premiums .......................... 1 [(44,000  10) X $0.90] To record redemption of coupons

3,960

Premium Expense2 ......................................... Estimated Liability for Premiums ......... 2 [(120,000 X 60%) – 44,000]  10 X $0.90 To record premium expense

2,520

396,000

3,960

2,520

b. Balance Sheet: Current Assets: Inventory of premiums ($7,920 – $3,960)

$3,960

Current Liabilities: Estimated liability for premiums

2,520

Income Statement: Sales revenue Less: Premium expense ($3,960 + $2,520)

$396,000 (6,480)

Moleski followed the expense approach under ASPE. Had Moleski followed IFRS, the revenue approach would have been used.

LO 6,9 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.25 1

Liability for stamp redemptions, 12/31/22 Cost of redemptions redeemed in 2023 Cost of redemptions to be redeemed in 2024 ($5,200,000 x 80%) Liability for stamp redemptions, 12/31/23

2 a.

$13,000,000 (6,000,000) 7,000,000 4,160,000 $11,160,000

Face value of total coupons issued Redemption rate Amount to be redeemed Handling charges ($480,000 X 10%) Total cost

$800,000 60% 480,000 48,000 $528,000

Total cost Total payments to retailers Liability for unredeemed coupons

$528,000 330,000 $198,000

Premium expense

$528,000

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EXERCISE 13.25 (CONTINUED) 3 a. Boxes sold Sale price per unit related to premium Unearned revenue recorded in 2023

700,000 X $1.00 $700,000

Total coupons expected to be redeemed (700,000 x 60%) Less: coupons redeemed during 2023 Coupons still to be redeemed, 12/31/23  Total coupons expected to be redeemed % of unearned revenue to be earned after 20231 1 ($315,000 / $420,000)

420,000 105,000 315,000 420,000 75%

Unearned revenue recorded in 2023 % of unearned revenue to be earned after 2023 Unearned revenue (adjusted), 12/31/23

$700,000 X 75% $525,000

Total coupons redeemed in 2023 Cost per redemption ($6.25 – $4.75) Premium expense

c. Cash ............................................................... Sales Revenue (700,000 X $3.50) .......... Unearned Revenue (700,000 x $1.00) ... To record cash sale

105,000 X $1.50 $157,500

3,150,000 2,450,000 700,000

Cash (105,000 X $4.75) ................................... 498,750 2 Premium Expense ......................................... 157,500 Inventory of Premiums (105,000 X $5.00) Accounts Payable (105,000 X $1.25) 2 (105,000 X [$5.00 + $1.25 - $4.75]) To record redemptions of coupons

525,000 131,250

Unearned Revenue ($700,000 - $525,000) ..... Sales Revenue ....................................... To adjust unearned revenue

175,000

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EXERCISE 13.25 (CONTINUED) 3 (continued) d. An unredeemed coupon represents an obligation that arose from a past sale transaction, which may result in a transfer of assets (cash, for the freight, and inventory) upon coupon redemption. The company has little or no discretion to avoid the obligation. Therefore, the unredeemed coupons meet the definition of a liability. Their fair value should be represented as unearned revenue on the balance sheet because a coupon was offered with each box of pie mix purchased, and a portion of the sales revenue related to each box of pie mix sold was related to the promotional coupon that was included with each box. The unredeemed coupons represent unearned revenue to be settled by delivery of goods in the future, upon coupon redemption. LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.26 a. Balance Sheet: Current Liabilities: Estimated liability for premiums1

$600

Income Statement: Premium expense 1

Total estimated redemptions of stickers, at cost (25,000 X 10% ÷ 10 X $10) X 60% Stickers redeemed in current year (25,000 x 6% ÷ 10 x $10) X 60% Estimated future redemptions, at cost

b. Premium Expense ........................................... Inventory of Premiums .......................... (cost of free product given in exchange when stickers were redeemed) Premium Expense ........................................... Estimated Liability for Premiums ......... (liability for unredeemed stickers)

$1,500

$1,500 900 $ 600

900 900

600 600

Had Timo been following IFRS, the revenue approach would have been used for the premiums instead of the expense approach used under ASPE.

LO 6,9 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.27 a. 1. Coupon Estimated promotion expense to be reported on income statement: Remaining estimated redemptions of coupons (50 coupons to be used in future X 10% discount X $75 average sale) $375 Coupons already used 250 Total promotion expense $625 Balance sheet disclosure: Unredeemed coupons liability

$375

2. Sick time As it is possible that these amounts will be paid in the future, and there is little likelihood that the employees will resign, the full amount should be accrued. Balance Sheet: Sick pay wages payable: (2 employees X $200/day X 4 days X 50%)

$800

Income Statement: Increase to salaries and wages expense on the income statement: - For the sick days bonus outstanding related to the liability: (2 employees X $200/day X 4 days X 50%) $800

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EXERCISE 13.27 (CONTINUED) b.

The customer loyalty program offers future discounts of $10 for accumulating sales of $250. Under ASPE, these types of programs may be evaluated as a revenue arrangement with multiple deliverables. The fair value of the award credits would be recognized as unearned revenue, a liability, with each sale. When customers redeem their award credits, the amount would be recognized as revenue. However, not all of the awards will be redeemed, as customers may lose their card, move away, or forget to redeem their award once it is earned. Once the company has some experience, an estimation of how many award credits will be redeemed as compared to the total credits awarded to customers can be determined, and an adjustment can be made to the liability account at year end. If the program is accounted for as a revenue arrangement with multiple deliverables, a liability must be recorded as each customer earns sales “credits” towards the $250 total. The fair value of each credit given for each dollar of sales is $0.04 ($10/$250). Therefore, each sale to a customer who is a member of the customer loyalty program must be split, with 4% of the sale being recorded as unearned revenue, and the balance as a sale in the period of the transaction. When customers accumulate $250 in credits, and come in to receive their $10 discounts, this amount will be recorded as a decrease in unearned revenue and an increase in sales.

LO 6 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.28 a.

July 1, 2023

Accounts Receivable ...................................... Refund Liability ($3,000,000 X 12%) ...... Sales Revenue ........................................ To record sales on account

3,000,000

Estimated Inventory Returns1 ....................... Cost of Goods Sold ......................................... Inventory ................................................. 1 ($1,700,000 X 12%) To record cost of goods sold

204,000 1,496,000

360,000 2,640,000

1,700,000

October 3, 2023

Refund Liability .............................................. 360,000 Accounts Receivable .............................. 340,000 Sales Revenue ......................................... 20,000 To record sales return (to account for July sales returned and to adjust the original estimate of returns to reflect actual results for this year’s “special”). Cost of Goods Sold1........................................ 11,333 2 Inventory ......................................................... 192,667 Estimated Inventory Returns ................. 204,000 2 ($1,700,000 ÷ $3,000,000) X $340,000 = $192,667 1 $204,000 – $192,667 = $11,333 To record inventory returns from customers Cash ................................................................. Accounts Receivable ............................. Collection on account

2,660,000 2,660,000

LO 6 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 13.29 1.

The CPA Canada Handbook for Private Enterprises section 3290 requires that, when some amount within the range appears at the time to be a better estimate than any other amount within the range, that amount be accrued. When no amount within the range is a better estimate than any other amount, the dollar amount at the low end of the range is accrued and the dollar amount of the high end of the range is disclosed. Since the information indicates that it is likely that a liability has been incurred at December 31, 2023, and a range of possible amounts can be reasonably determined, the criteria for recording a liability are met. In this case, therefore, Sugarpost Inc. would report a liability of $900,000 at December 31, 2023.

Su Li Corp. would not be required to make any entry. The wage increase is for the coming two years and does not relate to the current or prior years.

3.a. The loss should be accrued since both criteria (it is likely that a loss is incurred and the amount of the loss can be reasonably determined) for recording the contingency are met. Given that the loss is covered by insurance, except for the $500,000 deductible, only the $500,000 should be accrued. b. Under IFRS requirements, the recognition criterion used to determine the chance of occurrence of a confirming future event is “probable,” which is interpreted to mean “more likely than not.” This is a somewhat lower hurdle than the “likely” required under ASPE. If the amount cannot be measured reliably, no liability is recognized under IFRS either; however, the standard indicates that it is only in very rare circumstances that this would be the case. If recognized, IAS 37 requires the best estimate and an “expected value” method to be used to measure the liability. As in part a. above, this would be the $500,000 deductible.

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EXERCISE 13.29 (CONTINUED) 4.

This is a gain contingency because the amount to be received will be in excess of the carrying amount of the plant. Under ASPE, gain contingencies are not recorded and are disclosed in the notes only when the probabilities are high that a gain contingency will become a reality.

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EXERCISE 13.30 a.

Current Ratio =

Current Assets Current Liabilities

$210,000 $70,000

= 3.00

Current ratio measures the short-term ability of the company to meet its currently maturing obligations with current assets. In this case, current assets include cash, net accounts receivable, and inventory. b.

Cash + Marketable Securities + Net Receivables Acid-test = ratio Current Liabilities =

$115,000 $70,000

1.64

Acid-test ratio also measures the short-term ability of the company to meet its current maturing obligations. However, it eliminates assets that might be slow moving, such as inventory and prepaid expenses. In this case there are no marketable securities, so only cash and accounts receivable are included as current assets. c.

Debt to total assets =

Total Liabilities Total Assets

$210,000 $430,000

48.84%

This ratio provides the creditors with some idea of the corporation’s ability to withstand losses without impairing the interest of creditors. Net Income Rate of return on assets = Average Total Assets =

$27,000 $430,000

6.28%

This ratio measures the return the company is earning on its average total assets and provides one indication related to the profitability of the enterprise. Solutions Manual 13-93 Chapter 13 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 13.30 (CONTINUED)

Days payables outstanding

Average Trade Accounts Payable Average Daily Cost of Total Operating Expenses $70,000 $471,0001/365

54.2 days

($420,000 + $51,000) This ratio measures the time it takes a company to pay its trade accounts payable and provides one indication related to the liquidity of the enterprise if the number of days exceeds the normal credit period for the industry, or if the ratio reveals an increasing trend. LO 8 BT: AN Difficulty: S Time: 20 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 13.31 a. 1.

Current ratio =

$773,000 $220,000 + $20,000

Acid-test ratio =

$52,000 + $198,000 + $80,000 $220,000 + $20,000

Accounts receivable turnover = $80,000 + $198,000 = 11.8 times $1,640,000  2 (or approximately every 31 days) (365  11.8)

Inventory turnover =

= 3.22 = 1.38

$360,000 + $440,000 = 2 times 2 (or approximately every 183 days) (365  2) $800,000 

Days payables outstanding = $145,000 + $220,000 2



$800,000 365

Rate of return on assets = $1,400,000 + $1,630,000 $360,000  2

= 83 days

= 23.76%

Profit margin on sales = $360,000  $1,640,000 = 21.95%

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EXERCISE 13.31 (CONTINUED) b.

Financial ratios should be evaluated in terms of industry peculiarities and prevailing business conditions. Although industry and general business conditions are unknown in this case, the company appears to have a relatively strong current position. The main concern from a short-term perspective is the apparently low inventory turnover and the high days payables outstanding. The two ratios may be linked when extended credit terms are provided by suppliers or if the inventory is slow-moving. The rate of return on assets and profit margin on sales are extremely good and indicate that the company is employing its assets advantageously.

Unearned revenue is a liability that arises from current sales but for which some services or products are owed to customers in the future. At the time of sale, customers pay not only for the delivered product, but they also pay for future products or services. In this case, the company recognizes revenue from the current product and part of the sale proceeds is recorded as a liability (unearned revenue) for the value of future products or services that are “owed” to customers. An increase in the unearned revenue liability, rather than raising a red flag, often provides a positive signal about sales and profitability. When the sales are growing, the unearned revenue account should grow. Thus, an increase in a liability may be good news about company performance. In contrast, when unearned revenue declines, the company owes less future amounts but this also means that sales of new products may have slowed.

LO 8 BT: AN Difficulty: S Time: 25 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 13.32 a.

$318,000  $87,000 = 3.66

$820,000 

$1,400,000  $95,000 = 14.74 times

365  14.74 times = 25 days

$32,000  $820,000 X 365 = 14 days

$285,000  52,000 = $5.48

$285,000  $1,400,000 = 20.4%

$285,000  $588,000 = 48.5%

No effect on current ratio.

Weaken current ratio by increasing current assets and current liabilities by the same amount.

Improve current ratio by reducing current assets and current liabilities by the same amount.

No effect on current ratio.

Weaken current ratio by increasing current liabilities with no change to current assets.

No effect on current ratio.

$200,000 + $170,000 = 4.43 times = 82 days 2

LO 8 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance Solutions Manual 13-97 Chapter 13 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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TIME AND PURPOSE OF PROBLEMS Problem 13.1 Purpose—to present the student with an opportunity to prepare journal entries for a variety of situations related to liabilities. The situations presented include purchases on account and payments on account, borrowing funds by giving a zero-interestbearing note, sales tax, deposits, and corporate income tax. The student is also required to prepare year-end adjusting entries and to calculate sales tax two ways. A comparison of any difference between the accounting treatment under IFRS and ASPE is included.

Problem 13.2 Purpose—to present the student with an instalment note with two terms of repayment (fixed principal, fixed amount of repayment) with a current and long-term portion. The student must prepare the amortization schedule for each note and the related journal entries. The balance sheet presentation is also required to emphasize the current amounts related to the note for two consecutive year ends. The comparison of interest costs for the two sets of notes and lender preferences are also discussed.

Problem 13.3 Purpose—to provide the student with experience in calculating the amounts of various liabilities and determining the portion relating to current liabilities. The student must calculate the interest payable on bonds and notes payable, warranty liability, employee withholding amounts payable, GST payable, and deal with debit balances in the trade payables and other miscellaneous payables. The student is also required to discuss why certain items were excluded from current liabilities and which items are considered financial liabilities. Journal entries are not required. The student must also discuss debt covenants and income statement presentation of revenue from gift cards. This problem is an excellent overview of the chapter content.

Problem 13.4 Purpose—to present the student a comprehensive problem in determining various liabilities and to present their findings in writing. Issues addressed relate to asset retirement obligation, warranties, and HST.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 13.5 Purpose—to present the student with an opportunity to prepare journal entries for four weekly payrolls. The student must calculate income tax to be withheld, CPP premiums, and Employment Insurance. The student must record two pay periods where employees are on vacation. In addition, the student needs to comment on the adequacy of the disclosure of grouped liabilities on the balance sheet and grouped salary-related expenses on the income statement, taking the perspective of a banker.

Problem 13.6 Purpose—to provide the student with the opportunity to prepare journal entries for a monthly payroll. The student must calculate income tax to be withheld, CPP contributions, and Employment Insurance. The student must also calculate the total payroll tax expense for the company for the month. Analysis of the amount of payroll tax expense compared to salaries and wages expense is required. Student must comment on whether payroll taxes expense is a constant for all months of the calendar year. Finally, a proposal to convert salaried employees to contractors is discussed, along with the point of view of a potential investor for the proposal.

Problem 13.7 Purpose—to provide the student with experience in calculating bonuses under a variety of compensation plans. The student must calculate a bonus before deduction of bonus and income tax, after deduction of bonus but before deduction of income tax, and before deduction of bonus but after deduction of income tax. The student must also arrive at the classification of any balances owing, and deal with the accrual of bonus expenses when quarterly financial statements are issued by the business. A proposal for the timing of payments of the bonus is made by the recipient and the student must comment on the ethical and legal aspects of the proposal, taking the perspective of the CRA.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 13.8 Purpose—to provide the student with a comprehensive problem dealing with contingent losses. The student is required to prepare journal entries for each of four independent situations. For each situation the student must also discuss the appropriate disclosure in the financial statements. The situations presented include a lawsuit, an environmental assessment, an expropriation, and a self-insurance situation. This problem challenges the student not only to apply the guidelines set forth in CPA Canada Handbook-Accounting, Part II, Section 3290, but also to develop reasoning as to how the guidelines relate to each situation. The student is also required to discuss ethical issues inherent in contingent liabilities. Finally, the student must take the perspective of a potential investor and discuss the consequences of investing in a politically volatile location. A good problem to analyze the effects of Section 3290 on a variety of situations.

Problem 13.9 Purpose—to provide a problem in determining various liabilities, including advance payments, self insurance, litigation, commitments, guarantees, and loss contingencies. The student must also discuss any required disclosures. Finally, the student must look at the inherent risk of self-insurance from the perspective of a potential investor.

Problem 13.10 Purpose—to provide the student with an opportunity to prepare journal entries and balance sheet presentations for warranty costs under the cash basis and the assurance-type approach. Entries in the sales year and one subsequent year are required. The student must deal with recording differences between the amount accrued and the amount paid. The problem highlights the differences between the two methods in the accounts and on the balance sheet.

Problem 13.11 Purpose—to provide the student with a problem covering the assurance-type and service-type approaches for warranties. The student is required to prepare journal entries in the year of sale and in subsequent years as warranty costs are incurred. Also required are balance sheet presentations for the year of sale and two subsequent years. Finally, the student takes the perspective of a potential investor dealing with the risk of product recalls.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 13.12 Purpose—to present the student with a comprehensive problem in determining the amounts of various liabilities. The student must calculate (for independent situations) the warranty liability, and an estimated liability for premium claims outstanding. Journal entries are not required. A comparison of the IFRS and ASPE accounting treatment is also required. A discussion of the financial implications of a change in policy concerning unlimited returns is included. This problem should challenge the better students.

Problem 13.13 Purpose—to provide the student with a basic problem in accounting for premium offers. The student is required to prepare journal entries relating to sales, the purchase of premium inventory, and the redemption of coupons. The student must also prepare the year-end adjusting entry reflecting the estimated liability for premium claims outstanding. The student is required to prepare the entries under two different approaches; the premium redemptions are recorded as premium expense or as a decrease of the estimated liability for premiums. Statement presentation is also required.

Problem 13.14 Purpose—to present the student with a problem related to accounting for premium offers. The problem is more complicated in that coupons redeemed are accompanied by cash payments, and in addition to the cost of the premium item, postage costs are also incurred. The student is required to prepare journal entries for various transactions including sales, purchase of the premium inventory, and redemption of coupons for two years. The second year’s entries are more complicated due to the existence of the liability for claims outstanding. Finally, the student is required to indicate the amounts related to the premium offer that would be included in the financial statements for each of two years and determine if the liability is financial. A comparison of the IFRS and ASPE accounting treatment is also required. This very realistic problem challenges the student’s ability to account for all transactions related to premium offers.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 13.15 Purpose—the student must calculate warranty expense, warranty liability, premium expense, inventory of premiums, and estimated liability for premiums. The student is also required to discuss how the accounting would be affected if the warranty were treated under the service-type warranty approach.

Problem 13.16 Purpose—to provide the student with experience in guarantees of indebtedness and contingencies. The student is required to provide journal entries related to guarantees and loss contingencies and to identify related disclosures. The situation is complicated by receivables from the guaranteed customer and revenue recognition issues related to the guarantee fee. A challenging problem.

Problem 13.17 Purpose—to present the student with the problem of determining the proper amount of, and disclosure for, two contingent losses due to lawsuits. The student is required to prepare journal entries and notes. The student is also required to discuss any liability incurred by the company due to the risk of loss from lack of insurance coverage. The student is required to take the position of the manager and describe both how the assessment of the likelihood of the outcome of each case is arrived at and the measurement of the amount of the probable judgement.

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SOLUTIONS TO PROBLEMS PROBLEM 13.1 a. February 6 Purchases ............................................................ GST Receivable ($46,000 X .05) ......................... Accounts Payable .......................................

46,000 2,300

February 20 Accounts Payable ................................................ Cash ...........................................................

48,300

April 1 Vehicles ($50,000 X 1.07) .................................... GST Receivable ($50,000 X .05) ......................... Cash ........................................................... Notes Payable ............................................ May 1 Cash ................................................................... Notes Payable ............................................

48,300

53,500 2,500 11,000 45,000 83,000 83,000

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

19,000

August 14 Dividends (or Retained Earnings) Dividends Payable ......................................

13,000

September 10 Dividends Payable ............................................... Cash ...........................................................

13,000

December 5 Cash ................................................................... Refund Liability ...........................................

750

19,000

13,000

750

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PROBLEM 13.1 (CONTINUED) a. (continued) December 10 Furniture and Fixtures ($8,000 X 1.07) ................ GST Receivable ($8,000 X .05) ........................... Accounts Payable ....................................... December 31 Cash ................................................................... Sales Revenue ........................................... Sales Tax Payable ($79,000 X .07)............. GST Payable ($79,000 X .05) ..................... To record cash sales December 31 Rent Expense ..................................................... Rent Payable .............................................. 1 ($2,500 + [3% X $79,000]) Note no GST recorded on an accrual To accrue rent expense 1

December 31 Land Improvements ............................................. Asset Retirement Obligation ....................... To record asset retirement obligation December 31 Income Tax Expense ........................................... Cash ........................................................... To record payment of income tax expense December 31 Income Tax Expense ......................................... Income Tax Payable ................................... 2 ($205,000 X 20%) – ($19,000 X 2) To accrue income tax expense 2

8,560 400 8,960

88,480 79,000 5,530 3,950

4,870 4,870

46,000 46,000

19,000 19,000

3,000 3,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.1 (CONTINUED) a. (Continued) December 31 Interest Expense ($45,000 X 8% X 9/12) ............. Interest Payable .......................................... To accrue interest expense December 31 Interest Expense ($9,000 X 8/12)......................... Notes Payable ............................................ To accrue expense on non–interest-bearing note

2,700 2,700

6,000 6,000

Current Liabilities: Accounts Payable ....................................... Notes Payable ............................................ Interest Payable .......................................... Notes Payable ............................................ Sales Tax Payable ...................................... GST Payable 3 ............................................ Rent Payable .............................................. Income Tax Payable ................................... Refund Liability ........................................... Total Current Liabilities ......................

$8,960 45,000 2,700 89,000 5,530 0 4,870 3,000 ____750 $159,810

Net GST: GST Payable Dec. 31 sales entry ................

$3,950

GST Receivable Feb. 6 inventory purchase . April 1 Truck purchase ............ Dec. 10 Furniture purchase..... Total GST Receivable ..................................

$2,300 2,500 400 $5,200

Net GST claim for refund..............................

$1,250

There is a legal right to offset the GST Payable against the GST Receivable. The net amount is reported as a current asset of $1,250 on the SFP. Solutions Manual 13-105 Chapter 13 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.1 (CONTINUED) c.

As a lender of money, the banker is interested in the priority his/her claim has on the company’s assets relative to other claims. Close examination of the liability section and the related notes discloses amounts, maturity dates, collateral, subordinations, and restrictions of existing contractual obligations, all of which are important to potential and existing creditors. The assets and earning power are likewise important to a banker considering a loan.

Current liabilities are obligations whose liquidation is reasonably expected to require the use of existing resources properly classified as current assets, or the creation of other current liabilities.

A liability is an obligation that arises from past transactions or events, which may result in a transfer of assets or provision of services. Under IFRS, for a liability to exist, the following criteria must all be satisfied: 1. the entity has an obligation (that is, a duty or responsibility to others that it has no practical ability to avoid). 2. the liability has the potential to require the transfer of an economic resource or exchange economic resources with another party on unfavourable terms. 3. the obligation is a present obligation that exists as a result of past events. Under ASPE, the thee essential characteristics of liabilities are: 1. They embody a duty or responsibility to others. 2. The entity has little or no discretion to avoid the duty. 3. The transaction or event that obliges the entity has already occurred. The potential transfer of an economic resource does not have to be certain, or even likely, under IFRS. Under IFRS, a present obligation can exist even if it cannot be enforced until some date in the future.

LO 2,3,5,9 BT: AP Difficulty: S Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.2 a.

Date Jan. 1, 2023 Jan. 1, 2024 Jan. 1, 2025 Jan. 1, 2026 Jan. 1, 2027 Total

Payment

$23,971 23,971 23,971 23,971 $95,884

Using a financial calculator: PV ? I 5% N 4 PMT $ (23,971) FV 0 Type 0 Using a financial calculator: PV $ 85,000 I ?% N 4 $ (23,971) PMT 0 FV 0 Type

Interest (5%)

$4,250 3,264 2,229 1,141 $10,884

Principal repayment

$19,721 20,707 21,742 22,830 $85,000

Carrying Amount of Note $85,000 65,279 44,572 22,830 0

Yields $ 84,999.98

Yields 5.0 %

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.2 (CONTINUED) a. (continued) Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $84,999.98 OR Excel formula =RATE(nper,pmt,pv,fv,type)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.2 (CONTINUED) b. Jan. 1 2023

Equipment ............................... Notes Payable ................

85,000

Dec. 31 2023

Interest Expense .......................... Interest Payable ....................

4,250

Jan. 1 2024

Interest Payable ........................... Notes Payable ............................. Cash .....................................

4,250 19,721

85,000

4,250

23,971

c. Bian Inc. Statement of Financial Position (partial) December 31, 2023 Current Liabilities: Interest Payable $4,250 Current portion of long-term note payable 19,721

$23,971

Long-term Liabilities Note Payable Less: current portion

85,000 (19,721)

$65,279

Bian Inc. Statement of Financial Position (partial) December 31, 2024 Current Liabilities: Interest Payable $3,264 Current portion of long-term note payable 20,707

$23,971

Long-term Liabilities Note Payable Less: current portion

$44,572

65,279 (20,707)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.2 (CONTINUED) e.

Bian Inc. Statement of Financial Position (partial) December 31, 2023 Current Liabilities: Interest Payable1 $2,125 Current portion of long-term note payable 19,721

$21,846

Long-term Liabilities Note Payable Less: current portion

$65,279

85,000 (19,721)

$4,250 X 6/12 = $2,125

The fixed principal payments for each year would have been in the amount of $21,250 ($85,000 ÷ 4).

Date Jan. 1, 2023 Jan. 1, 2024 Jan. 1, 2025 Jan. 1, 2026 Jan. 1, 2027 Total

Payment

$25,500 24,438 23,375 22,312 $95,625

Interest (5%)

$4,250 3,188 2,125 1,062 $10,625

Principal repayment

$21,250 21,250 21,250 21,250 $85,000

Carrying Amount of Note $85,000 63,750 42,500 21,250 -

The higher interest costs are incurred with the fixed payment terms in part a.

As a lender, I would prefer to negotiate a fixed payment for the terms of repayment as I would collect more interest.

LO 2,3 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.3 a. Current Liabilities: Accounts payable ($414,0001 – $23,000) Liability to affiliated company Notes payable ($150,000 + $200,000) GST payable (Schedule 6) Dividends payable Bonus payable (75% X $25,000) Unearned revenue (Schedule 1) Accrued liabilities (Schedule 2) Total current liabilities 1 Note: The debit balances in accounts payable would be classified as current assets. Schedule 1: Unearned revenue, Mar. 1, 2022 New gift card purchases Gift card redemptions 15% of Mar. 1, 2022 balance recognized as revenue (15% X $95,000) Unearned revenue, Feb. 29, 2023 Schedule 2: Interest payable (Schedule 3) Warranty liability (Schedule 4) Salaries and wages payable Employee withholdings payable (Schedule 5) Union dues payable Audit fee accrual Total accrued liabilities

$ 391,000 23,000 350,000 11,900 50,000 18,750 65,750 545,749 $1,456,149

$ 95,000 22,500 (37,500) (14,250) $65,750

$ 122,709 1,240 220,000 105,300 21,500 75,000 $545,749

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.3 (CONTINUED) a. (continued) Schedule 3: Interest on the bond ($4,000,000 X 7% X 3/12) Interest on Note due 04/01/23 ($150,000 X 8% X 11/12) Interest on Note due 01/31/24 ($200,000 X 9% X 1/12) Interest on Note due 03/15/24 ($500,000 X 7% X 11.5/12) Interest on Note due 10/30/25 ($250,000 X 8% X 4/12) Total interest payable Schedule 4: Warranty liability 02/28/22 Less warranty claims on 2021-2022 sales Remaining warranty liability Warranty liability on 2022-2023 sales for following 12 months ($154,000 X 1%) Less: warranty claims on 2022-2023 sales Current warranty liability 02/29/23

$ 70,000 11,000 1,500 33,542 6,667 $122,709

$5,700 (4,900) 800 1,540 (1,100) $1,240

Schedule 5: EI premiums payable (2.4 X $9,500) CPP contributions payable (2 X $16,900) Employee income tax deductions payable Employee withholdings payable

$ 22,800 33,800 48,700 $105,300

Schedule 6: Net GST payable, 01/31/23 ($60,000 – $34,000) Less: payment on 15th of Feb./23 GST charged on February sales GST Receivable Net GST payable, 02/29/23

$ 26,000 (26,000) 39,900 (28,000) $11,900

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.3 (CONTINUED) b.

All current liabilities listed with the exception of the unearned revenue, the warranty liability, the employee withholdings payable (employee income tax deductions payable, EI premiums payable, and CPP contributions payable), and GST payable are financial liabilities. A financial liability is any liability that is a contractual obligation to deliver cash or other financial assets to another party, or to exchange financial assets or financial liabilities with another party under conditions that are potentially unfavourable to the entity. A contractual obligation refers to an agreement between two or more parties that has clear economic consequences that the parties have little, if any, discretion to avoid, usually because the agreement is enforceable at law. Contracts, and thus financial instruments, may take a variety of forms and need not be in writing. Items such as unearned revenue and most warranty obligations are not financial liabilities because the probable outflow of economic benefits associated with them is the delivery of goods and services rather than cash or another financial asset. GST payable and employee withholdings payable are not considered financial liabilities because they are not contractual in nature. They are created as a result of statutory requirements imposed by governments.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.3 (CONTINUED) c.

Items excluded from current liabilities: 1. Bonds payable were excluded based on the assumption that the bonds will not be redeemed in the coming period or operating cycle, whichever is longer. 2. Notes payable due 03/15/24 and 10/30/25 were excluded because their due date is beyond the coming period. 3. Warranty liability for costs of 1.5% of 2022-2023 sales (1.5% X $154,000 = $2,310) would be shown as a long-term liability. The costs of honouring the warranty would occur beyond the coming period. 4. Bonus payable in March 2024 ($25,000 X 25% = $6,250).

Under ASPE, if Hrudka is not in compliance with the bank’s debt covenants, the note would be reclassified as a current liability. A breach of the covenants of long-term debt gives the creditor the right to demand short-term repayment of the debt (the liability becomes payable on demand). The note can be classified as longterm only if the creditor waives in writing the covenant (agreement) requirements, or the violation has been cured within the grace period and it is likely Hrudka will not violate the covenant requirements within a year from the balance sheet date.

Revenue from redeemed cards should be shown with other product sales and offset against cost of sales to accurately measure gross profit. Revenue from unredeemed gift cards do not have a related product cost and will distort the gross margin if they are included in product sales revenues. They should be shown as a separate source of revenue. Given the increasing popularity of gift cards, the revenue should be shown as an ongoing source of revenue in the income from operations section of the income statement and not as “other revenues.”

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.3 (CONTINUED) f.

ASPE does not separately address the issue of non-financial liabilities, and so they are measured in a variety of ways, depending on the liability. Under IFRS, non-financial liabilities are measured initially, and at each subsequent reporting date, at the best estimate of the amount the entity would rationally pay at the date of the SFP to settle the present obligation. This is usually the present value of the resources needed to fulfill the obligation, measured at the expected value or probability-weighted average of the range of possible outcomes. When assessing the adequacy of the Warranty Liability account balance at year-end under IFRS, management would scrutinize the historical data available to support the balance needed to satisfy future warranty claims. Using a probability-weighted average of the range of possible outcomes may result in a different required year-end balance in the account.

LO 2,3,4,6,9 BT: AP Difficulty: C Time: 55 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.4 a. Cost of storage tanks Asset retirement cost ($28,000 X .55839) [PV of $28,000 FV (n=10, i=6%)] Balance in asset account, Feb. 28, 2023

$110,000

Depreciation for 2023 ($125,635 ÷ 10 X 10/12):

$10,470

Presentation on Dec. 31, 2023 balance sheet: Asset cost Less: Accumulated depreciation

15,635 $125,635

$125,635 (10,470) $115,165

b. Asset retirement obligation (ARO), Feb. 28, 2023 (from above) 2023 interest expense ($15,635 X 6% X 10/12) Balance of ARO, December 31, 2023 2024 interest expense ($16,417 X 6%) Balance of ARO, December 31, 2024 2025 interest expense ($17,402 X 6%) Balance of ARO, December 31, 2025

$15,635 782 16,417 985 17,402 1,044 $18,446

c. Unearned revenue recorded in 2023 ($970 X 20) Portion unearned at December 31, 2023 Unearned revenue, December 31, 2023

$19,400 X 75% $14,550

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PROBLEM 13.4 (CONTINUED) d.

Warranty expense on the 2023 income statement will be $2,700.

e. HST collected on sales (and therefore payable to the government) (20 machines X $12,000 X 15%) HST paid on purchase of underground tanks (and therefore, receivable from government) ($110,000 X 15%)

$36,000

16,500 $19,500

Healy will send a cheque to the Receiver General for Canada of $19,500 to pay its net HST liability. f.

Healy’s warranty obligation represents a stand-ready obligation to provide parts and labour under the warranty agreement at any time throughout the two-year contract period. This argument may support straight-line recognition of warranty revenue over the twoyear contract term. On the other hand, if historical evidence indicates that warranty services are usually provided later in the two-year warranty period, a higher proportion of warranty revenue is actually earned in the later years of the contract period, and a higher proportion of warranty revenue should be recognized later in the contract. This would result in lower warranty revenue and net income in year 1, and a higher unearned revenue liability balance at the end of year 1.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.4 (CONTINUED) f. (continued) In this case, the company’s 25% estimate of warranty revenue being earned in 2023 looks realistic. The $2,700 of costs incurred in 2023 is exactly 25% of the estimate of total costs over the twoyear contract term. In addition, if the assumption is that the warranties have been outstanding, on average, for half a year in 2023, they will be outstanding also for a full year in 2024 and the remaining half year in 2025. This supports an assumption of being earned evenly over the two-year warranty period. A potential investor should be aware that accounting for warranties affects liabilities on the SFP, as well as revenue and net income on the income statement, for multiple periods. If unsupported or biased assumptions are used in accounting for warranties, the resulting financial statements may not reflect the appropriate financial position or performance of the company. LO 2,3,5,6 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.5 a. Entries for Payrolls 1 and 4 (individually) Salaries and Wages Expense1 .......................... 3,640.00 Employee Income Tax Deductions Payable (10% X $3,640) ..................... 364.00 2 EI Premiums Payable ............................ 57.51 3 CPP Contributions Payable ................... 198.38 Union Dues Payable (1% X $3,640)......... 36.40 Cash ........................................................ 2,983.71 To record payroll 1 $450 + $610 + $550 + $1,250 + $780 = $3,640 2 EI Premiums = $3,640 X 1.58% = $57.51 3 CPP Contributions = $3,640 X 5.45% = $198.38 Payroll Tax Expense ......................................... 278.89 EI Premiums Payable (1.4 X $57.51) ....... CPP Contributions Payable ..................... To record employer share for payroll tax expense

80.51 198.38

Entries for Payrolls 2 and 3 (individually) Vacation Wages Payable 4 ............................... 2,310.00 Salaries and Wages Expense ($550 + $780) .... 1,330.00 Employee Income Tax Deductions Payable (10% X $3,640) ..................... 364.00 EI Premiums Payable ............................. 57.51 CPP Contributions Payable ..................... 198.38 Union Dues Payable (1% X $3,640)......... 36.40 Cash ........................................................ 2,983.71 4 ($450 + $610 + $1,250) To record payroll Payroll Tax Expense ......................................... 278.89 EI Premiums Payable (1.4 X $57.51) ....... CPP Contributions Payable ..................... To record employer share for payroll tax expense

80.51 198.38

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.5 (CONTINUED) b. Monthly Remittance to Receiver General Employee Income Tax Deductions Payable5..... 1,456.00 EI Premiums Payable6 ...................................... 552.08 CPP Contributions Payable ($198.38 X 8) ........ 1,587.04 Cash ........................................................ 3,595.12 5 ($364.00 X 4) 6 [($57.51 X 4) + ($80.51 X 4)] c. Vacation Entitlement for August Salaries and Wages Expense ........................... 397.60 Vacation Wages Payable ........................ $3,640 X 2 weeks X 4% = $1,330 X 2 weeks X 4% =

397.60

$291.20 106.40 $397.60

As Sultanaly’s banker I do not object to the presentation adopted for salaries, wages, and related expenses, nor for the accrued liabilities. A certain level of grouping to reduce details is perfectly acceptable and likely useful. It is fairly standard to accrue vacation entitlement at the rate of 4% and the statutory deductions are well known and could easily be estimated to arrive at a gross pay amount. Should details in either groupings of accounts become necessary, I would not hesitate to request the detail from the bank’s client.

LO 4 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.6 a. Name

Earnings to Oct. 31

1st week of Nov. Earnings

L. Meloche P. Groot D. Beaux C. Regier Total

$36,120 33,540 54,180 6,000 $129,840

$ 840 780 1,260 1,000 $3,880

Income Tax Deducted

CPP

Union Dues

$ 126 117 189 150 $582

$ 45.78 42.51 68.67 54.50 $211.46

$13.27 12.32 19.91 15.80 $61.30

$8.40 7.80 12.60 10.00 $38.80

Salaries and Wages Expense ............... Employee Income Tax Deductions Payable ............... EI Premiums Payable ................. CPP Contributions Payable ......... Union Dues Payable .................... Cash ............................................ b.

3,880.00 582.00 61.30 211.46 38.80 2,986.44

Payroll Tax Expense ..................................... 297.28 EI Premiums Payable (1.4 X $61.30) ... CPP Contributions Payable ................. Employee Income Tax Deductions Payable............................................... EI Premiums Payable ($61.30 + $85.82) . CPP Contributions Payable1 .................. Cash ............................................... 1 ($211.46 + $211.46) Union Dues Payable ............................... Cash ...............................................

85.82 211.46

582.00 147.12 422.92 1,152.04

38.80 38.80

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.6 (CONTINUED) d.

Salaries and Wages Expense Payroll tax expense Total cost for first week of November 2023 Percentage of payroll tax expense to gross pay

$3,880.00 297.28 $4,177.28 7.7%

Later in the calendar year, some employees will have reached the maximum amount of contributions to the CPP and EI programs, as will soon be the case for D. Beaux above. Consequently, the payroll tax expense will be higher at the beginning of the calendar year, or at the beginning of the employment of a new employee and lower at the end of the calendar year, assuming employees earn more than $56,300 per year for EI and $61,600 for CPP calculation purposes.

As a potential investor, I would likely not be fooled by the reclassification of labour costs. I would be concerned with the shift from salaried employees to contract services provided by the same employees. My first concern would be with the Canada Revenue Agency (CRA), which keeps a close eye on employers who are mischaracterizing their relationships with employees in order to save costs on payroll expenses, including CPP and EI, or for vacation pay or parental leave entitlements and possibly also additional benefit costs for such plans as medical and dental coverage. Bayview would be responsible for any penalties and unpaid payroll tax CRA would deem should have been remitted. My second concern would be with employee loyalty. Since Bayview would not be perceived as a long-term employer and could lay off employees on short notice with few consequences, employees would be more likely to look elsewhere for employment, causing high turnover of staff at Bayview. I would also question the lack of accrual for severance packages. This is legally required and its absence could lead to lawsuits from former employees.

LO 4 BT: AP Difficulty: M Time: 45 min. AACSB: Ethics CPA: cpa-t001 cpa-e001 CM: Reporting and Ethics

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PROBLEM 13.7 a. (B = bonus; T = tax) 1.

B B T T

= = = =

0.12 ($250,000) $30,000 .30 ($250,000 – $30,000) $66,000

B B 1.12B B T T

= = = = = =

0.12 ($308,000 – B) $36,960 – .12B $36,960 $33,000 0.30 ($308,000 – $33,000) $82,500

B T B B B 0.964B B T T

= = = = = = = = =

0.12 ($350,000 – T) 0.30 ($350,000 – B) 0.12 [$350,000 – 0.30 ($350,000 – B)] 0.12 ($350,000 – $105,000 + .3B) $29,400 + .036B $29,400 $30,497.93 .30 ($350,000 – $30,497.93) $95,850.62

Any outstanding bonus payable to Ms. Shen would be classified as a current liability on the SFP for all three years since the quarterly payments are made within one year of the fiscal year end in which the bonus was earned.

Using the formulas and based on the best possible information at hand concerning the financial performance of the business, a prorated estimate would be made of the annual bonus for the first three quarters of the fiscal year and a final accrual would be made on the final results for the fourth quarter of the fiscal year.

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PROBLEM 13.7 (CONTINUED) d.

There would be no difference in the accounting treatment of Huang’s bonus to Ms. Shen had IFRS been followed.

e. 1.

From the perspective of the CRA, advances on bonuses can be treated as loans to the officer, in this case the President Ms. Shen. The proposal is acceptable. From an accounting perspective, Huang will accrue the bonus payable as described in (c) above. Any balance of the bonus liability will be reduced by advances paid to Ms. Shen. The net amount of any balances would be disclosed separately in the current assets or liability section of the SFP.

Ms. Shen’s proposal is ethical. The proposal is not to evade tax but to postpone tax and it is a reasonable approach to tax planning.

LO 4,9 BT: AN Difficulty: M Time: 40 min. AACSB: Ethics CPA: cpa-t001 cpa-e001 CM: Reporting and Ethics

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PROBLEM 13.8 a. 1.

4. b. 1.

Litigation Expense ............................... Litigation Liability .........................

225,000

Loss Due to Environmental Clean-up ... Liability for Environmental Clean-up ...................................

500,000

Loss on Expropriation1 .......................... Inventory, Accumulated Impairment Losses, (for each individual asset that has a value assessed to be impaired)............................................... 1 [$5,725,000 – (40% X $8,700,000)]

2,245,000

225,000

500,000

2,245,000

No entry required.

A loss and a liability have been recorded in the first case because (i) information is available prior to the issuance of the financial statements indicating it is likely that a liability has been incurred at the date of the financial statements and (ii) the amount is reasonably estimable. That is, the occurrence of the uninsured accidents during the year plus the outstanding injury suits and the legal counsel’s estimate of probable loss require recognition of a loss contingency. No journal entry is recorded in the case of the $60,000 injury suit since it is considered unlikely that a liability has been incurred at the date of the financial statements. If the amount were considered material, it would be desirable to disclose the existence of the lawsuit in the notes to the financial statements.

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PROBLEM 13.8 (CONTINUED) b. (continued) 2.

A loss and a liability have been recorded because information is available prior to the issuance of the financial statements that indicates it is likely that a liability has been incurred at the date of the financial statements. Under ASPE, where a range of possible amounts is determined and no one amount within the range is more likely than another, the bottom of the range is usually accrued with the amount of the remaining exposure disclosed in the notes.

An entry to record a loss and to establish reduced asset values due to threat of expropriation is necessary because the expropriation is imminent as evidenced by the foreign government’s communicated intent to expropriate, and the prior settlements for properties already expropriated. Enough evidence exists to reasonably estimate the amount of the probable loss resulting from the impairment of assets at the balance sheet date. The amount of the loss is measured by the excess of the carrying amount of the assets over the expected compensation. At the time the expropriation occurs, the related assets are written down or written off and any differences between the amount received and the reduced asset values will be adjusted to the Loss from Expropriation. In this case, it is asset values that have been impaired, not an additional liability that has been incurred. If there is significant uncertainty about which specific assets are affected, general allowance accounts (contra asset accounts) could be credited for each general category of assets.

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PROBLEM 13.8 (CONTINUED) b. (continued) 4.

Even though Sahoto’s chemical product division is uninsurable due to high risk and has sustained repeated losses in the past, as at the balance sheet date, no assets have been impaired or liabilities incurred nor is an amount reasonably estimable. Therefore, this situation does not satisfy the criteria for recognition of a loss contingency. Also, unless a casualty has occurred or there is some other evidence to indicate impairment of an asset prior to the issuance of the financial statements, there is no disclosure required relative to a loss contingency. The absence of insurance does not of itself result in the impairment of assets or the incurrence of liabilities. Expected future injuries to others or damage to the property of others, even if the amount is reasonably estimable, does not require recording a loss or a liability. The cause for loss or litigation or claim must have occurred on or prior to the balance sheet date and the amount of the loss must be reasonably estimable in order for a loss contingency to be recorded. Disclosure is required when one or both of the criteria for a loss contingency are not satisfied and there is a reasonable possibility that a liability may have been incurred or an asset impaired, or, it is probable that a claim will be asserted and there is a reasonable possibility of an unfavourable outcome.

In contingencies related to legal proceedings, the accrual for contingencies and the related disclosure can be construed as an admission of guilt and could weaken the company’s position. Company’s management has to balance the need for full disclosure with the need for careful management of the legal proceedings and protecting shareholders’ interests by avoiding costly lawsuit damages. The ethical issues also involve the interpretation of terms such as “likely” and “reasonably estimable” in determining when and how much is shown on financial statements.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.8 (CONTINUED) d.

As a potential investor, I might find the consequences of management’s past investment decisions to have been less than ideal. This would be particularly true with the benefit of hindsight. Claiming negligence on the part of the board of directors, however, is another matter. Management would have studied the potential financial consequences of locating in a politically volatile location and the past history of expropriations experienced by other firms. The decision to go ahead with the investment would have been reported and disclosed in the financial statements. The decision to absorb this risk on the basis of a cost-benefit analysis warns the financial statement user of the potential for losses in the future. As a potential investor, I would not view the choice as negligent on the part of the board of directors.

LO 5,7 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.9 a. ASPE 1.

Unearned Revenue .................................... 400,000 Sales Revenue .................................. 400,000 To record subscriptions earned during 2023 Carrying amount balance of liability account at 12/31/23 Adjusted balance ($600,000 + $500,000 + $800,000) Credit to Sales Revenue account

$2,300,000 1,900,000 $ 400,000

No entry should be made to accrue for an expense, because the absence of insurance coverage does not mean that an asset has been impaired or a liability has been incurred as at the balance sheet date. The company may, however, appropriate retained earnings for self-insurance as long as actual costs or losses are not charged to the appropriation of retained earnings and no part of the appropriation is transferred to income. Appropriation of retained earnings and/or disclosure in the notes to the financial statements are not required, but are recommended.

Litigation Expense ........................................ Litigation Liability ................................... To record estimated minimum damages on breach-of-contract litigation

300,000 300,000

Note disclosure would also be required indicating the nature of the loss contingency and the exposure to loss in excess of the amount recorded.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.9 (CONTINUED) a. (continued) 4.

No entry should be made for this loss contingency, because it is not likely that an asset has been impaired or a liability has been incurred and the loss cannot be reasonably estimated as at the balance sheet date. The company must however disclose the guarantee in the notes to its financial statements, even if the likelihood of loss is remote. The note disclosure should include the nature of the guarantee, the maximum potential amount of future payments, the nature and extent of any recourse provisions, and the carrying amount of any liability.

No entry should be made since it does not represent a liability at the balance sheet date. The company should have a note disclosure for this contractual obligation since it represents a major capital expenditure commitment.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.9 (CONTINUED) b. IFRS IAS 37 would be similar to the ASPE standard except that under IAS 37, provisions are required for situations where it is “probable” or “more likely than not” that a present obligation exists. This is a somewhat lower hurdle than the “likely” required under ASPE. If the amount cannot be measured reliably, no liability is recognized under IFRS either; however, the standard indicates that it is only in very rare circumstances that this would be the case. If recognized, IAS 37 requires that the best estimate and an “expected value” method be used to measure the liability. This approach assigns weights to the possible outcomes according to their associated probabilities when measuring the amount of the provision, if a range of possible amounts is available. c.

As a potential investor, I might find the future adverse consequences of the decision made by Ramirez to become selfinsured as negligent behaviour on the part of the board of directors. However, presumably management would have studied the potential financial consequences of self insurance and would have reported and disclosed the decision in the notes to the financial statements. Disclosing the decision to absorb this risk on the basis of a cost-benefit analysis warns the financial statement user of the potential for losses in the future. As a potential investor, I would not view the choice as negligent on the part of the board of directors if it was properly studied by management and fully disclosed.

LO 6,7,9 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.10 a.

Cash (400 X $2,500) ........................... Sales Revenue ...........................

1,000,000

Cash (400 X $2,500) ........................... Sales Revenue ........................... To record cash sales

1,000,000

Warranty Expense1 ............................. Warranty Liability ........................ 1 (400 X [$155 + $185]) To accrue warranty expense

136,000

1,000,000

136,000

No liability would be disclosed under the cash basis method, with respect to future costs due to warranties on past sales.

Current Liabilities: Warranty Liability

$68,000

Long-term Liabilities: Warranty Liability

$68,000

Warranty Expense ................................ Inventory...................................... Salaries and Wages Payable .......

61,300

Warranty Liability .................................. Inventory...................................... Salaries and Wages Payable .......

61,300

21,400 39,900

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.10 (CONTINUED) g.

The assurance-type approach results in matching of warranty costs with the revenues that generate them. The cash basis would be acceptable only where the warranty costs are immaterial or when the warranty period is relatively short. This is not the case for Brooks. Increasingly today, the asset and liability view and faithful representation drive the accounting model, resulting in the bifurcation or separation of the proceeds received into two or more revenue amounts for the various deliverables promised. This is referred to as the service-type warranty approach.

Higher than predicted warranty expenditures will cause the Warranty Liability account to have an understated balance that will not be sufficient for future warranty obligations. Management must review actual warranty claims experience against the estimated warranty liability balances in order to adjust the rate used to record warranty expense in current and future years. The discrepancy is treated as a change in an accounting estimate and is applied to current and future periods. In 2025, Brook’s management would have to record a larger warranty expense in order to more accurately measure the Warranty Liability.

LO 6,7,10 BT: AP Difficulty: S Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.11 a.

Cash .................................................... Sales Revenue (300 X $850) ....... Unearned Revenue (270 X $90) .. To record cash sales

279,300

Warranty Expense (300 X $25) ............. Warranty Liability .................... To accrue warranty expense

7,500

255,000 24,300

7,500

Current Liabilities: Warranty Liability

$ 7,500

Long-term Liabilities: Unearned Revenue

$24,300

Warranty Liability .................................. Inventory...................................... Salaries and Wages Payable ....... To record settlement of warranty claims

7,350

Warranty Liability ($7,500 - $7,350) ... Warranty Expense ....................... To adjust warranty liability balance

150

4,410 2,940

150

Current Liabilities: Unearned Revenue1

$ 8,100

Long-term Liabilities: Unearned Revenue

$16,200

The extended warranty revenues are expected to be earned evenly over the warranty period ($24,300 / 3 = $8,100).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.11 (CONTINUED) e.

Unearned Revenue.............................. Warranty Revenue ...................... To remeasure unearned revenue

8,100

Warranty Expense ............................... Inventory..................................... Salaries and Wages Payable ...... To record settlement of warranty claims

5,000

8,100

2,000 3,000

Current Liabilities: Unearned Revenue ....................

$ 8,100

Long-term Liabilities: Unearned Revenue ....................

$ 8,100

The costs incurred for product recalls are not included in the liability for warranties accounted for using the assurance-type method. Warranty claims are initiated by users for defects in products, whereas in the case of product recalls, the manufacturer initiates the offer to replace or repair all products. Product recalls occur when faults are found in products that can result in harm or injury to all users. When products are recalled, the business is required to correct or repair the faulty equipment or refund the consumer for the purchase of the recalled product. At the point of sale of the product, the event that causes the recall is considered remote. Businesses are not required to accrue for this contingency, unless, because of the nature of the product and the history of recalls in the past, the company can reasonably measure a likely amount that will need to be paid to satisfy recalls. This could be the case, for example, in the auto industry for a normal level of minor recalls, where user harm or negligence on the part of the manufacturer is not involved.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.11 (CONTINUED) g. (continued) Product recalls involve costs that are far greater than the costs involved in honouring individual warranties. Although recalls may be infrequent, they generally have a substantial impact on the financial performance of the business. If the business accepts an imperfect product design that is unlikely to affect the performance of the product and not cause any harm, it may ignore the requirement to accrue for those future events. LO 6,8 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.12 a. Calculation of the sales price of batteries expected to be returned: July – September sales X 8% return rate ($1,800,000 + $1,650,000 + $2,050,000) X 8% ...... $440,000 October – December sales X 10% return rate ($1,425,000 + $1,000,000 + $900,000) X 10% ....... 332,500 See also total in part b. $772,500 Estimated cost to replace batteries that have been returned as defective (measured as the sales price of batteries to be returned X cost of goods sold percentage): The account balance in the Warranty Expense account for the period July 1 to December 31, 2023 is calculated as follows: Estimated cost of replacing batteries related to the July – December sales: Cost to replace batteries ($772,500 X 60%) ......... Freight cost ($772,500 X 10%) ............................. Less: Salvage value ($772,500 X 14%) ................ See also total in part b. Less: adjustment for the warranty liability not needed from expense estimate for the first half of the year (unadjusted balance in Warranty Liability account Dec. 31) ...................... Warranty expense, July 1 – Dec. 31, 2023 ...............

$463,500 77,250 (108,150) 432,600

(5,000) $427,600

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.12 (CONTINUED) b.

The amount of the accrual required in the Warranty Liability account as at December 31, 2023 is calculated as follows:

Month

Sales amount for month

July August September October November December

$1,800,000 1,650,000 2,050,000 1,425,000 1,000,000 900,000

% of battery returns expected

8% 8% 8% 10% 10% 10%

Sales price of batteries expect to be returned

$ 144,000 132,000 164,000 142,500 100,000 90,000 $772,500

Cost to replace defective batteries (= 60% + 10% – 14% = 56% of returns)

$ 80,640 73,920 91,840 79,800 56,000 50,400 $432,600

% of defective batteries remaining to be returned as at December 31, 2023

10% 20% 30% 50% 80% 100%

Accrual required (= cost to replace X % remaining to be returned)

$ 8,064 14,784 27,552 39,900 44,800 50,400 $185,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.12 (CONTINUED) c.

There would be no difference in the accounting treatment under ASPE.

Because the change in the warranty policy was not in effect for the fiscal year ended December 31, 2023, there would be no basis for accruing any expenses related to the accounting treatment of future warranty claims made by existing customers. Since the policy will begin April, 1, 2024, soon after the release of the announcement, sales to April 1, 2024 will be given the warranty policy treatment in effect at the date of the sale. Within the December 31, 2023 financial statement notes, a description of the estimates used in accounting for warranty claims would be disclosed. These financial statement notes would not include the basis of future estimates under the new warranty policy effective April 1, 2024. Statements and claims made by the CEO concerning the likely effect on future sales that are expected under the new policy are not required within the financial statements and are not subject to IFRS or ASPE disclosure requirements. They may also be overly optimistic. The potential shareholder should be mindful of management’s tendency to be optimistic about potential future effects on sales and the related warranty expenses.

LO 6,7,9 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.13 a. Inventory of Premiums ................................. 60,000 Cash ................................................... To record purchase of 40,000 puppets at $1.50 each

60,000

Cash ........................................................... 1,800,000 Sales Revenue ................................... To record sales of 480,000 boxes at $3.75 each

1,800,000

Premium Expense1 ...................................... Inventory of Premiums ........................ To record redemption of 115,000 coupons 1 (115,000  5) X $1.50 = $34,500

34,500

Premium Expense2 ...................................... Estimated Liability for Premiums ......... To accrue premium expense

23,100

34,500

23,100

Calculation: Total coupons issued in 2023

480,000

192,000 115,000 77,000

Total estimated redemptions (40%) Coupons redeemed in 2023 Estimated future redemptions Cost of estimated claims outstanding (77,000  5) X $1.50 = $23,100

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.13 (CONTINUED) b. Inventory of Premiums ................................. 60,000 Cash ................................................... To record purchase of 40,000 puppets at $1.50 each

60,000

Cash ........................................................... 1,800,000 Sales Revenue ................................... To record sales of 480,000 boxes at $3.75 each

1,800,000

Premium Expense3 ...................................... Estimated Liability for Premiums ......... To accrue premium expense

57,600 57,600

Calculation: Total coupons issued in 2023 Redemption rate Total estimated redemptions Number of coupons per premium Number of premium claims Cost of premium Total premium expense for the year 2023 Estimated Liability for Premiums .................. Inventory of Premiums4 ....................... To record redemption of 115,000 coupons 4 (115,000  5) X $1.50 = $34,500

480,000 X 40% 192,000  5 38,400 X $1.50 $57,600 34,500 34,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.13 (CONTINUED) c.

The financial statement presentation would be the same for both approaches used in parts (a) and (b).

Balance Sheet: Current Assets: Inventory of Premiums ($60,000 – $34,500)

$25,500

Current Liabilities: Estimated Liability for Premiums ($57,600 – $34,500)

$23,100

Income Statement: Sales Revenue Less: Premium Expense

$1,800,000 57,600

d. Inventory of Premiums ................................. 60,000 Cash ................................................... To record purchase of 40,000 puppets at $1.50 each Cash ........................................................... Sales Revenue (480,000 X $3.55) ...... Unearned Revenue (480,000 X $0.20) To record sales and unearned revenue

60,000

1,800,000 1,704,000 96,000

Estimated number of puppets to be awarded: (480,000 X 40%) ÷ 5 = 38,400 Premium revenue per award: $96,000 ÷ 38,400 puppets = $2.50 Cost per award: $1.50 purchase cost Premium Expense5 ...................................... Inventory of Premiums ........................ 5 (115,000  5) = 23,000 puppets 23,000 puppets X $1.50 each

34,500 34,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.13 (CONTINUED) d. (continued) Unearned Revenue ...................................... Sales Revenue6 .................................. 6 23,000 puppets awarded X $2.50 = $57,500

57,500 57,500

e. Balance Sheet: Current Assets: Inventory of Premiums ($60,000 – $34,500)

$25,500

Current Liabilities: Unearned Revenue ($96,000 – $57,500)

$38,500

Income Statement: Sales revenue - cereal Sales revenue - premiums Less: premiums expense Net premiums income

$1,704,000 $57,500 34,500 23,000

Alternatively, the two Sales amounts could be reported together and the cost of the premiums could be included in Cost of Goods Sold, along with the cost of the cereal.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.13 (CONTINUED) f.

Under the expense approach in part (c), total revenue recorded in 2023 is higher than under the revenue approach in part (e). However, the expense approach triggers a larger premium expense in 2023 because the full cost of providing the premium is estimated and recorded in 2023; whereas the premium expense recorded under the revenue approach represents only expenses incurred in the current period. In 2023, net income is higher under the expense approach than under the revenue approach. Current liabilities are higher under the revenue approach than under the expense approach, due to bifurcation of the sale proceeds between the product and the premium and deferral of the revenue related to the premium, under the revenue approach. IFRS 15 suggests that the revenue approach is more appropriate in these circumstances. Increasingly today, faithful representation and the asset and liability view of the financial statements drive the accounting model in favour of the revenue approach.

LO 6,9 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.14 a.

2023

Inventory of Premiums1 .................................... Cash ....................................................... To record the purchase of mini piggy banks 1 (250,000 x $1.80)

450,000

Cash ............................................................... Sales Revenue2 ...................................... To record cash sales 2 (2,895,400 x $0.30)

868,620

Cash ($480,0003 – $120,0004) ......................... Premium Expense5 .......................................... Inventory of Premiums (240,000 x $1.80) To record the redemption of wrappers

360,000 72,000

Calculation of premium expense: 240,000 banks X $1.80 each = Postage—240,000 X $.50 =4 Less: Cash received— 240,000 X $2.003 Premium expense for banks issued

450,000

868,620

432,000

$432,000 120,000 $552,000 480,000 $ 72,000

Premium Expense6 .......................................... 17,400 Estimated Liability for Premiums ............. To accrue premium expense for premium claims outstanding at 12/31/23 6 (290,000  5) X ($1.80 + $.50 – $2.00) = $17,400

17,400

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.14 (CONTINUED) a. (continued) 2024 Inventory of Premiums7 ........................................... Cash .............................................................. To record the purchase of mini piggy banks 7 (330,000 x $1.80)

594,000 594,000

Cash ...................................................................... Sales Revenue8 ............................................. To record cash sales 8 (2,743,600 x $0.30)

823,080

Cash ($600,0009 – $150,00010)............................... Estimated Liability for Premiums ............................. Premium Expense11 ................................................ Inventory of Premiums (300,000 x $1.80) ...... To record the redemption of wrappers

450,000 17,400 72,600

Calculation of premium expense: 300,000 banks X $1.80 = Postage—300,000 X $0.50 = 10 Less: Cash received— (1,500,000  5) X $2.009 Premium expense for banks issued Less: Outstanding claims at 12/31/24 charged to 2023 but redeemed in 2024 Premium expense chargeable to 2024

Premium Expense12 ................................................ Estimated Liability for Premiums .................... 12 (350,000  5) X ($1.80 + $.50 – $2.00) = $21,000 To accrue premium expense

823,080

540,000

$540,000 150,000 690,000 600,000 90,000 17,400 $ 72,600 21,000 21,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.14 (CONTINUED) b. Account Inventory of Premiums Estimated Liability for Premiums Premium Expense 1 2 3 4

Amount 2023 2024 Classification $18,0001 $72,0002 Current asset 17,400 89,4003

21,000 Current liability 93,6004 Selling expense

$1.80 X (250,000 – 240,000) $1.80 X (10,000 + 330,000 – 300,000) $72,000 + $17,400 $72,600 + $21,000

The Estimated Liability for Premiums is not a financial liability since it is an obligation to customers to provide a mini piggy bank, not a contractual obligation to pay out cash or other financial assets. The fact that there are some cash amounts involved in its measurement does not make it a financial liability.

The additional information that would be required to record the promotional premium program transactions using the revenue approach under IFRS would include the portion of the sales price of chocolate bars representing the performance obligation relating to the mini piggy bank premium.

LO 6,8,9 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.15 a. 1.

Sales of musical instruments and sound equipment Estimated warranty rate Warranty expense for 2023

$5,400,000 .02 $ 108,000

Warranty liability —1/1/23 2023 warranty expense (Requirement 1) Subtotal Actual warranty costs during 2023 Warranty liability —12/31/23

$ 136,000 108,000 244,000 164,000 $ 80,000

Points issued (1 coupon/$1 sale) Estimated redemption rate Estimated number of points to be redeemed Exchange rate (200 points for speakers) Estimated number of speakers to be issued Net cost of speakers ($34 – $20) Premium expense for 2023

1,800,000 .60 1,080,000  200 5,400 14 $ 75,600

Inventory of premiums—1/1/23 Premium speakers purchased during 2023 (6,500 X $34) Premium speakers available Premium speakers exchanged for points during 2023 (1,200,000/200 X $34) Inventory of premiums—12/31/23

Estimated liability for premiums—1/1/23 2023 premium expense (Requirement 3) Subtotal Actual redemptions during 2023 [1,200,000/200 X ($34 – $20)] Estimated liability for premiums—12/31/23

39,950 221,000 260,950

204,000 $ 56,950

44,800 75,600 120,400 84,000 36,400

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.15 (CONTINUED) b.

Under IFRS, the warranty and premium offers are considered revenue arrangements with multiple deliverables and the servicetype warranty approach is used to account for the warranties. A portion of the sales revenue from musical instruments and sound equipment, and from recorded and sheet music will have to be deferred as unearned revenue. This revenue will be recognized as revenue over the term of the warranty period and premium offer period as points are redeemed and warranties are honoured. Management will need to determine what portion of the sales price represents revenue from warranties and premiums. When the musical instruments and sound equipment are sold, a portion of the sales price will be credited to Unearned Revenue. For the premiums, a portion of the recorded and sheet music sales will be credited to Unearned Revenue. As warranties are claimed, a portion of the Unearned Revenue will be earned and will be transferred to the income statement. Actual warranty costs will be recorded as warranty expense. As points for premiums are redeemed, a portion of the Unearned Revenue will be earned and will be transferred to the income statement. The premium expense (or cost of premium) will also be transferred to the income statement.

LO 6,9 BT: AP Difficulty: S Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.16 a. Cash ................................................................ Unearned Revenue ..................................

30,000 30,000

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

15,000

Unearned Revenue ........................................... Service Revenue1 .................................... 1 ($30,000  3)

10,000

Loss on Guarantee* .......................................... Liability for Guarantee ..............................

30,000

15,000

10,000

30,000

* This entry is based on management’s determination of the likelihood of loss in providing guarantees for Hutter. Since the collateral for the loan involves rights on unproven technology, it appears that the possibility of loss is likely. Accounts receivable was not debited since Dungannon has not yet made payment on Hutter’s debt. They do not have a balance owing from Hutter for this amount. The Service Revenue has been recognized on a straight-line basis. Company management may consider another basis more appropriate, such as an amount proportionate to the amount of debt being covered by the guarantee. Dungannon will also need to assess the collectibility of the account receivable and include it in its bad debt expense and allowance for doubtful accounts determination as part of its adjusting entries.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.16 (CONTINUED) b.

Dungannon needs to disclose the following information related to its guarantees: • The nature of the guarantee, how it arose, and circumstances that require the guarantor to perform under the guarantee; • The maximum potential amount of future payments that the guarantor could be required to make, without any reduction for receivable amounts; • The nature and extent of any recourse provisions or collateral held; • The carrying amount of the liability, if any. Disclosure in Dungannon’s notes: The company provides guarantees to certain customers whereby the company assumes their long-term debt in the event of nonpayment to their creditors. The guarantee arrangement covers a three-year period from the date of the agreement. The maximum potential amount of future payments that the Company could be required to make is $XXXXX. The Company does not have any recourse provisions or collateral against the current and potential liabilities arising from these guarantees. The Company has made payments under the guarantee of $15,000 and has accrued an additional $30,000 for the same customer. The possibility of further loss from this customer cannot be determined at this point. All other customers under guarantee have honoured their debt arrangements and the Company believes the possibility of loss under guarantees to these other customers to be unlikely.

LO 7,8 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.17 a. 1. (1) ASPE – Section 3290 It is likely a loss and liability have been incurred and a reasonable estimate can be made of the amount. The loss and liability should be recorded as follows: Litigation Expense ............................... Litigation Liability ............................

800,000 800,000

Note to the Financial Statements The company is a defendant in a personal injury suit for $4,000,000. The company is charging the year of the accident with $800,000 in estimated losses, which represents the amount the company estimates will likely be awarded. (2) IFRS IAS 37 would be similar to the ASPE standard except that under IAS 37, provisions are required for situations where it is “probable” or “more likely than not” that a present obligation exists. This is a somewhat lower hurdle than the “likely” required under ASPE. If the amount cannot be measured reliably, no liability is recognized under IFRS either; however, the standard indicates that it is only in very rare circumstances that this would be the case. If recognized, IAS 37 requires that the best estimate and an “expected value” method be used to measure the liability. This approach assigns weights to the possible outcomes according to their associated probabilities when measuring the amount of the provision, if a range of possible amounts is available.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.17 (CONTINUED) a. (continued) 2. (1) ASPE – Section 3290 Because the cause for litigation occurred before the date of the financial statements and because an unfavourable outcome is likely and reasonably estimable, Hamilton Airlines should report a loss and a liability in the December 31, 2023 financial statements. The loss and liability might be recorded as follows: Litigation expense1................................ Litigation Liability ............................. 1 ($5,000,000 X 60%)

3,000,000 3,000,000

Note to the Financial Statements Due to an accident that occurred during 2023, the company is a defendant in personal injury suits totalling $5,000,000. The company is charging the year of the casualty with management’s best estimate for the total expected losses, which represents the amount the company estimates will finally be awarded. (2) IFRS IAS 37 would be similar to the ASPE standard with the same exceptions for IAS 37 as noted in part a.(1)(2) above. b.

Hamilton Airlines need not establish a liability for the risk of loss from lack of insurance coverage itself. CPA Canada Handbook for Private Enterprises Section 3290 does not require or allow the establishment of a liability for expected future injury to others or damage to the property of others even if the amount of the losses is reasonably estimable. IAS 37 mirrors the ASPE standards in this situation. The cause for a loss must occur on or before the balance sheet date for a loss contingency to be recorded. However, the fact that Hamilton is self-insured should be disclosed in a note.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 13.17 (CONTINUED) c.

It is management’s responsibility to prepare the financial statements. Audited financial statements are preceded by a statement of management’s responsibilities in this respect, which is also reiterated in the auditor’s report. Included in management’s responsibility is the task of arriving at the proper accounting treatment for contingent losses. At the end of the fiscal year, management makes an assessment of the likelihood of occurrence concerning the outcome of any future event relating to the cases and applies a reasonable measurement of the dollar amount of the probable judgement or settlement out of court. Once management’s evaluation of each claim or case is arrived at, the company lawyer is contacted and asked to comment on the completeness, assessment, and measurement of all claims or possible claims. The lawyer’s response to this request is provided to the auditor as evidence to support the measurement and disclosure requirements concerning all outstanding contingent liabilities. Depending on the in-house expertise available to Hamilton Airlines, management will arrive at the estimates on its own. Should that expertise not be available, consultation with the litigation lawyer on the status of each matter will be required to perform the outcome assessment and measurement for financial reporting purposes.

LO 7,8,9 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

CASE See the Case Primer on the Student website, as well as the Summary of the Case Primer in the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 13.1 ABC AIRLINES Case Overview The company is in a highly competitive and risky industry. The economic environment over the past few years has caused many airlines to restructure in the face of declining sales, increased competition, and falling seat prices. ABC has maintained operations by undergoing two restructurings, the most recent of which requires increases in network profitability and cutting costs. Even so, the company is in a very precarious position with a long-term debt to equity ratio of 3.2 to 1 and a current ratio of .6 to 1. Losses for the past two years have been significant at close to $200 million each year. Users of the financial statements will be existing creditors and shareholders who are monitoring the liquidity of the company given the ratios identified above. Employees, who are also shareholders, will be watching the statements for information about financial and job stability. This is a private company and ASPE is a constraint since users will want the most useful information. Note that as a private entity, the company may elect to follow IFRS. The company is interested in understanding any differences between IFRS and ASPE. Management is concerned with full disclosure of the situation, due to the liquidity issues that are apparent in the financial statements and yet is also concerned with assuring the stakeholders that the company will remain operational.

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CA 13.1 ABC AIRLINES (CONTINUED) Analysis and Recommendations The major issue is the accounting for the free flights. As already noted, these flights are similar to the Frequent Flyer Points. One option is to treat these flights the same as the Frequent Flyer Points given that in substance they are the same. For example, the more a customer flies, the more free flights they earn. In the notes to the financial statements for Frequent Flyer Points, ABC assumes that there is a cost to providing these free flights, which must be accrued and matched with the revenues. The revenues in question would be the revenues from the paid flights that would be recorded in the current period. The cost of the free flights should be tied to the current revenues, given that the free flights are an inducement to buy tickets and are similar to advertising costs. Also, the program creates a liability for ABC to its customers. The more customers fly, the greater the duty ABC has to them. This duty cannot be avoided as the event obligating ABC is the fact that the customers have taken flights anticipating a free flight in the future. There is a measurement issue here since not all customers will complete the requirement for a free flight, and even if they do, not all customers will take the free flight. ABC does have some history with these types of programs, and this might help with estimating costs. However, this is a new and different program. This treatment would not be used under IFRS. Under IFRS the company could defer revenues until the future flights are taken. The full amount of revenues from the ticket sold includes the flight taken and a potential future flight. Although ASPE does not explicitly refer to these types of plans, IFRS deals with this in IFRS 15 – Revenue from Contracts with Customers. IFRS 15 requires accounting for the transaction as a performance obligation as part of a multiple element arrangement at the fair value of the possible free flight. This would decrease current revenue and be reallocated to the statement of financial position as a contract liability. The impact in the short-term is to increase the company’s losses.

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Intermediate Accounting, Thirteenth Canadian Edition

CA 13.1 ABC AIRLINES (CONTINUED) When the free flights are taken by customers the revenue would be earned, which would then have a positive impact on earnings. Prior to IFRS 15, some airlines only provided note disclosure of the program, given that there are minimal incremental costs for free flights and it is difficult to measure how many people will earn and actually take these free flights. This could result in costs related to missed revenue opportunities if a paying customer is bumped. Given increased competition, it is unlikely that the planes will always be full and ABC might mitigate this risk by limiting the free flight options to certain flights that might not normally be flying at capacity. However, the latest restructuring strategy is to increase network profitability, which means filling up each plane. Therefore, this could result in paying passengers being bumped in the future. Conservative accounting (deferral of revenues) in this situation, along with full disclosure, would be prudent for the company for both the frequent flyer program and the “Fly 5, Fly Free” program.

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Intermediate Accounting, Thirteenth Canadian Edition

INTEGRATED CASES IC 13.1 ENVIROCOMPANY LIMITED Case Overview This is a public entity (shares trade on a public stock exchange); therefore, the statements must follow IFRS. The shareholders may not want the environmental issues overemphasized since this would drive the share price down. Employees likely feel the same way since they could lose their jobs if the company was forced to close. Management is likely reluctant to disclose too much for the same reasons, especially until they develop an alternative course of action that would allow the plant to continue operations and maintain profitability. Furthermore, they may be concerned that negative disclosures would reflect poor stewardship. Potential investors, on the other hand, would want full disclosure in order to assess the risks before investing, and protect themselves as well as the environment. Whatever is disclosed could be used against the company by the public “at large”. Other users include government environmental agencies who might use the information against EL. The board of directors might resist disclosures that imply negligence or guilt since they do not wish to be held personally liable. The controller must ensure transparency.

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IC 13.1 ENVIROCOMPANY LIMITED (CONTINUED) Analysis and Recommendations Issue: EL’s operating activities are contributing to water and air pollution to the surrounding community with chemicals that may be carcinogenic. One individual has threatened to sue, and EL’s lawyers are privately acknowledging the potential for a class action suit. EL has insurance that would cover up to $5 million in damages. Based on a strict interpretation of GAAP, there is no liability for potential lawsuits relating to the pollutants until the company is sued. Until that time there is no basis to estimate the potential loss and to make an accrual. Likewise, until the person actually sues the company, and a court rules against the company, there is an opportunity to avoid the potential obligation (i.e., hire good lawyers, present a good defence). The event that potentially obligates the entity may be the act of polluting, the act of a neighbouring company polluting, or the act of the person getting sick and, therefore, this may have already happened. However, as noted above, the obligation has not yet been established even though the lawyers have acknowledged the potential for a class action suit. IFRS requires accrual of a potential loss if occurrence of a future event is probable (more likely than not) and measurable. In this case it does not appear that these criteria have been met. Under ASPE, the threshold to record a liability is more conservative. The accrual of a loss is recorded if the occurrence of a future confirming event is “likely,” meaning it has a high probability, and it is measurable. ASPE could be used if EL were a private company. Public knowledge of the company’s financial position would not be known, but if EL uses bank financing, the bank would be kept informed and would regularly receive company financial statements. If assets are used as security for loans, and these assets are nearing the end of their useful lives, the bank would want to know the specifics of any modernization plans for the pulp and paper mill.

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IC 13.1 ENVIROCOMPANY LIMITED (CONTINUED) Note disclosure might be prudent; however, threatened lawsuits would normally not be disclosed, given the difficulty in assessing the probability that the person or others will actually sue. What about potential investors? Should management in all good conscience make this information available? Also, if management is aware that their company is responsible for pollutants that are causing birth defects and related issues, they have an ethical obligation to fix the related problems. Given the increasing onus on boards of directors to take full responsibility for the actions of the company, should they disclose the problem in order to protect themselves? It is likely unnecessary to disclose the threatened lawsuit for the abovenoted reasons (primarily the uncertainty and the fact that the loss from a potential lawsuit is not measurable). However, given that larger issue of the harmful pollutants, it could be argued that EL should disclose. In conclusion, no disclosure is required since, at best, the threatened lawsuit is a contingent liability and it could be argued that it is unlikely that the company will suffer a material loss from it, especially since EL’s insurance will cover up to $5 million. Issue: EL’s equipment is outdated and pollutes the surrounding water and air with chemicals that have been shown to contain possible carcinogens. It is not clear if EL has an asset retirement obligation or if the assets are impaired. Little detail is given in the case regarding whether the company has an asset retirement obligation. Under IFRS, the company would have to accrue an obligation if there was a legal obligation or a constructive obligation. While there is little information given in the case, and the old assets likely have small carrying values, the company should consider whether the assets are impaired.

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IC 13.2 LANDFILL LIMITED Case Overview Landfill Limited (LL) is in the waste disposal business and as such, environmental concerns increase business risk. The company has many users of its financial statements. Nova Bank, which financed the acquisitions, will use the financial statements to assess cash flows. The government might use the financial statements to assess whether the company is in compliance with regulations with respect to closure and post-closure activities, etc. The financial statements will also be used by existing and potential customers to see if LL is stable and in compliance with environmental standards prior to entering into waste removal contracts. A final user is the purchaser’s lawyers who will use the financial statements to perhaps assess what the company is worth in terms of negotiating a potential settlement regarding the toxins that are leaking (since LL has guaranteed toxin-free land). The fact that the financial statements are being audited is an indication that many stakeholders are interested in reliable and relevant information about the company. As a private company, LL may use ASPE or IFRS. Management is interested in any differences between the two standards. As the auditor, this is a new client and so the risk is greater, especially given the number of users and the potential lawsuit. Care must be taken to ensure that LL is not overstating income or net assets.

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IC 13.2 LANDFILL LIMITED (CONTINUED) Analysis and recommendations Issue: Asset retirement obligations/impairment Since the government regulations require capping, closure, and postclosure activities, a legal obligation exists, and a liability must be recognized as soon as measurable. The obligation would be measured at the best estimate of the expenditure required to settle the present obligation. It is also prudent to ensure that the liability is accrued since LL must pay for cleanup where toxins are found subsequent to the sale of land. There is an additional risk here since the land sold by LL recently has been found to contain toxins. The amount would be added to the cost of the land. The treatment would essentially be the same under ASPE and IFRS; however, the measurement might differ. Under ASPE, if there is a range of values, the company would pick the most likely estimate within the range unless this amount was not determinable. In that case the lowest amount in the range would be accrued. Under IFRS, the amount would be measured at the probability-weighted expected value. Care should be taken to assess the existing landfill sites to ensure that the value is not impaired. The potential lawsuit represents a change in circumstances that might signal impairment.

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IC 13.2 LANDFILL LIMITED (CONTINUED) Issue: Should LL depreciate the landfill sites. Depreciate sites Do not depreciate sites - The garbage sites have a life of - The land has 20 years (finite life). historically held its - Since the sites contribute to value (as long as there revenues, the cost should be are no toxins present). allocated to the period in which Therefore, an estimate revenue is generated (matching). of salvage value might - Since varying amounts of be based on past land garbage are dumped, perhaps a values. unit of production type method - Currently, it is in the should be used. This will allow best interest of the the costs to be better matched company to deal with with the revenues generated. environmental issues - Although the land holds its value, and ensure that there it is difficult to measure salvage are no toxins given value. that existing and future - Given the potential liability for customers assess this cleanup costs, the land may be on an ongoing basis. worthless at the end of its life if The bank will also the company does not manage watch for this since the environmental issues toxins will destroy the properly. This is supported by the land value. current lawsuit. - The government will - The depreciation would also assess for compliance allow for the allocation of the with regulations. asset retirement obligation, which is part of the cost of the land, matching it to revenue for the appropriate period of use. Recommendation: It might be more prudent to depreciate the landfill values. Environmental standards change (and are increasing) and given the potential liability if toxins are subsequently found, the land could be rendered worthless.

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IC 13.2 LANDFILL LIMITED (CONTINUED) Issue: Potential liabilities related to land that has been sold. LL guarantees that the land is toxin-free and will pay for clean-up if toxins are subsequently found. LL recently received notification from the purchaser’s lawyers that high levels of toxins have been found leaking into the water table and LL must decide how to account for these costs.

Disclose Accrue - The issue of toxins being - The company must reflect the discovered must at least potential costs in the financial be disclosed since this statements and must try to could be material. estimate these costs. The - The company has discovery of toxins is very guaranteed that there are material to users (the bank, no toxins and has agreed purchaser, and potential to pay if there are. The customers). existence of the toxins is - Even though the purchaser yet to be proved. has yet to prove the existence - The question is also one of of toxins, it might be argued measurement. Given the that the company has a early stages of the constructive obligation, notification by the lawyers, particularly since it works hard it is unlikely that the to signal that it is responsible company will be able to and environmentally friendly. measure the potential cost. - IFRS requires an accrual if the - Disclosing or accruing a obligation is probable and specific amount might ASPE requires an accrual if it prejudice the company’s is likely. position in terms of how - Measurement may also differ much is owed to the under ASPE versus IFRS as purchaser. noted above. Recommendation: It would be more prudent to accrue the costs if they are measurable. The company should contact the lawyers and verify the status of this claim.

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IC 13.3 CANDELABRA LIMITED Case Overview There is currently one major user of the financial statements, the creditors related to the bond debt. Therefore, GAAP is likely a constraint. The bond debt would imply that the company is publicly accountable if the bonds are traded in a public market, and the company would be required to follow IFRS. Alternatively, if the bonds are not publicly traded, Candelabra may chose to follow ASPE or IFRS . Company revenues are steadily increasing and there may be pressure from the various stakeholders to preserve this trend. The bondholder is a key stakeholder give that the bond contains a debt covenant of 2:1. This ratio is particularly sensitive since the company is operating close to the covenant limit. The auditor will want to ensure full disclosure. Analysis and recommendations Issue: The production facility was financed by a 100-year bond that pays 5% interest annually. The bond includes a covenant that stipulates that the debt-to-equity ratio must not exceed 2:1. This is clearly a liability since there is an obligation to deliver cash in the form of interest payments and ultimately the principal repayment.

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IC 13.3 CANDELABRA LIMITED (CONTINUED) Issue: The government introduced a system to control pollution through the issue of “carbon credits.” The carbon credits allow the company to produce a certain amount of carbon dioxide as a byproduct from its production facilities. CL has been allocated a fixed number of these credits by the government at no cost. CL has also purchased several carbon credit contracts in the marketplace. Recognize the carbon credits

Do not recognize the carbon credits - The carbon credits represents an asset to the - There was no cost company since it allows the company to to the company for produce pollution without incurring a penalty. the allocated credits - Credits trade on a market and have a initially received measurable value. from the - The credits given by the government are government. essentially government grants that should be - Under the historical reflected in the financial statements. cost principle there - If recognized, is this a derivative instrument? If was no cost yes, would the credits be valued at fair value incurred. Therefore, with gains/losses booked to income (note that the credits should derivatives are discussed in chapter 16)? Note be valued at $0. that the contracts meet the definition of a - It may be difficult to derivative under IFRS, since their value measure this since changes as the supply of carbon dioxide the governmentchanges, little was paid for the credits upfront, established and they will likely be settled in future. Under marketplace is ASPE, derivative accounting would not apply informal and may since these are not exchange-traded futures; not have many therefore, they are not covered by Section 3856. transactions. Recommendation: These represent an asset to the company. Therefore, in the interest of transparency, Candelabra should recognize the carbon credits. Since the credits trade on a market and meet the definition of a derivative, they should be valued at fair value (which appears to be measurable) if IFRS is followed. Note that recognition of positive value will improve the debt-to-equity ratio. If ASPE is followed, recognize the asset as a government grant, but do not revalue it subsequently. Solutions Manual 13-166 Chapter 13 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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IC 13.3 CANDELABRA LIMITED (CONTINUED) Issue: CL is investigating diverting excess carbon dioxide to an underground cave that is situated on company-owned property. Currently, CL has spent a significant amount of money to determine if it can divert and store the extra carbon dioxide it produces. The engineers working on the project are still not convinced this type of storage is workable on a larger scale. The company has started to store some excess carbon dioxide on a test basis. Capitalize the research costs - This diversion and storage process may become valuable if it is feasible (future benefit). - The company is already storing carbon dioxide on a test basis so one could argue that it is already feasible. - There is a strong motivation for the engineers to succeed, since the company produces significant amounts of carbon dioxide and will otherwise have to pay to purchase carbon credits. Also there has been a significant amount of funds committed to this project. The company has a vested interest in its success and reaching the completion stages.

Expense the research costs - The project has not yet been deemed feasible as per the engineers. - This is clearly a matter of judgement and there is significant uncertainty. - There is no evidence that future benefits exist.

Recommendation: Candelabra should not recognize this as an asset, particularly given that the engineers, as the feasibility experts, are uncertain that this will work and are suggesting that there is significant uncertainty.

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RESEARCH AND ANALYSIS RA 13.1 EMPIRE COMPANY LIMITED a. Note 1 to Empire’s financial statements indicates that the company’s main businesses are food retailing – primarily under the Sobeys logo, and real estate related to the retail operations. b. Note 3o provides information about Empire’s intangible assets. The note mentions that the company has loyalty programs that are included in this category. The company does not explain how they account for these programs. This suggests that the amounts involved are not material. The loyalty programs are also mentioned in Note 12 – Intangibles as being grouped in Other Intangibles for an amount of $11.4 million. Note 3r provides information about Empire’s participation in the AIR MILES® customer loyalty program. This is a loyalty program used by many retailers. Under this arrangement, customers earn AIR MILES® points based on their in-store purchases, and Empire pays AIR MILES® a fee for each point earned by the customer. The cost of these points is recorded as a reduction to revenue.

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RA 13.1 EMPIRE COMPANY LIMITED (CONTINUED) c. Empire reported Provisions in current liabilities of $48.7 million and another $54.7 million in other (long-term) liabilities, for a total of $103.4 million at May 2, 2020. According to Note 3s, provisions are recognized “when there is a present legal or constructive obligation as a result of a past event, for which it is probable that a transfer of economic benefits will be required to settle the obligation, and where a reliable estimate can be made of the amount of the obligation”. Where the obligations are material and won’t be met currently, the amount of the provision is discounted using a rate that takes into account the time value of money and the specific risks associated with the obligation. Over time, the company recognizes the increase (accretion) of the liability as a finance expense in net income. Note 15 explains that Empire’s provisions relate to onerous lease contracts, where the unavoidable costs of fulfilling the obligations are higher than the future benefits expected from the contracts; to legal costs associated with outstanding claims that result from ordinary business operations; to environmental costs related to locations requiring environmental restoration; to provisions for restructuring costs related to company initiatives to improve financial performance by lowering costs. Under IAS 37, a “provision” is defined as “a liability of uncertain timing or amount.” In all the situations where Empire has recognized a provision, the company has a present legal or constructive obligation resulting from a past event requiring a probable future transfer of economic benefits (a liability), the associated amounts have required estimation and reliable measurements were made of the liability amount. In most cases, the timing of when the obligation is required to be satisfied is also uncertain. d. As indicated in (c) above, when the obligation will not be met until some future date, measurement of the provision requires discounting to take into account the time value of money. Note that the provision for legal costs has not been increased for the interest factor, likely because the entire amount is considered a current obligation. For the other categories, the longer term nature of the obligation has caused an increase in the provision.

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RA 13.2 CANADIAN TIRE CORPORATION, LIMITED. a.

Canadian Tire’s current liabilities include the following amounts:

($ millions) Deposits Trade and other payables Provisions Short-term borrowings Loans Current portion of lease liability Income taxes payable Current portion of long-term debt

January 2, 2021 Balance $ 1,228.0 2,508.3 196.7 165.4 506.6 329.9 120.4 150.5 $5,205.8

“Trade and other payables” on the consolidated balance sheet includes trade payables and accrued liabilities, derivatives, deferred revenue, insurance reserves, and other liabilities, primarily consisting of the short-term portion of share based payment transactions and sales taxes payable. The majority of the $2,508.3 million relates to trade payables and accrued financial liabilities. This amount ($1,962.4 million) most likely relates to regular trade accounts payable for inventory purchases, office supplies and utility costs, and to accrued liabilities for wages and salaries payable, dividends payable, vacation pay accruals, and interest payable. Note 17 describes deposits, a significant part of the current liabilities, which are related to the financial services (including a bank) segment of Canadian Tire’s business activities and represent the monies owed to various parties who hold investment accounts with its banking subsidiary. This is made up of broker deposits and retail deposits. Broker deposits originate when the company issues GICs (guaranteed investment certificates) to brokers instead of directly to retail customers. Retail deposits include amounts held for, and therefore owed to, retail clients in high interest savings (HIS) accounts, GICs, and tax-free savings accounts (TFSAs).

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RA 13.2 CANADIAN TIRE (CONTINUED) b.

(1)

Working capital = Current assets less current liabilities

$ In millions Current assets Current liabilities Working capital

(2)

2020 10,546.8 5,205.8 5,341.0

2019 9,555.3 5,751.4 3,803.9

Cash + short-term investments + trade and other receivables + loans receivable Current liabilities

Acid-test ratio =

2020:

1.53 times =

$1,327.2 + $643.0 + $973.6 + $5,031.8 $5,205.8

2019:

1.24 times =

$205.5 + $201.7 + $938.3 + $5,813.8 $5,751.4

(3)

Current ratio =

Current assets Current liabilities

2020:

2.03 times =

$10,546.8 $5,205.8

2019:

1.66 times =

$9,555.3 $5,751.4

(4) Four-year history:

Current assets Current liabilities Working capital Current ratio

2020 10,546.8

2019 9,555.3

2018 9,255.8

2017 8,796.1

5,205.8

5,751.4

5,258.2

4,529.7

5,341.0

3,803.9

3,997.6

4,266.4

2.03

1.66

1.76

1.94

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RA 13.2 CANADIAN TIRE (CONTINUED) b. (continued) (4) (continued) Canadian Tire Corporation’s liquidity is good in general, since it has sufficient current assets to meet current liabilities. Its sound working capital position is reflected in its current ratio. The acid-test ratios over the last two years are consistent with the current ratio performance. The company’s liquidity has been fluctuating within a fairly narrow range for the past 4 years. The current ratio has remained relatively stable from 2017 to 2020 except for a decrease in 2018 due to an increase in the level of current liabilities, and in 2020, when the current ratio increased due to an increase in the level of current assets (specifically in the amount of cash and cash equivalents). (5)

Inventory turnover =

2020:

4.33 times =

COGS* Average inventory $9,794.4 ($2,312.9 + $2,212.9)/2

* from consolidated statement of income or note 29 of financial statements. The inventory and receivables tend to be a large proportion of the current assets used in assessing liquidity using working capital and the current ratio. Calculating the turnover of both the receivables and inventory provides information useful in assessing the current ratio by indicating how long it takes to convert the company’s inventory into receivables and then into cash. The turnover ratio also provides information about the legitimacy of including inventory in the determination of the current ratio and whether the acid-test ratio would be a better indicator of liquidity. The inventory turnover provides information about the saleability of the inventory and the number of days it takes to sell on average. Canadian Tire’s turnover of 4.33 times represents an average of 84 days that the inventory is held before being sold. The company sells many different types of inventory items, and the turnover figure calculated is an average for all inventories. It is not possible to determine whether this turnover is high or low without calculating the amount over several years and comparing it to other companies in the same industry as this would provide more meaningful information. Canadian Tire’s current ratio makes it important to calculate an acid test ratio as well.

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RA 13.2 CANADIAN TIRE (CONTINUED) b. (continued) In the case of receivables, the company has several types of receivables including credit card receivables and loans from dealers (see Notes 8 and 9). Many of these receivables may not arise from sales in Canadian Tire retail outlets, since the credit card can be used with many different merchants. The loans from associates do not relate to sales. As a result, a meaningful accounts receivable turnover ratio cannot be calculated. However, the large amount of cash that will be collected from these receivables and loans aids in paying current liabilities and increases working capital and current ratios. c.

The current portion of long-term debt (all numbers are are found in Note 23) at January 2, 2021, is $150.5 million. This amount represents the portion of long-term debt that is payable by the company within the next 12 months. The amount will be paid from current assets and includes only the principal portion of the debt, not any interest payable for the coming year. In this case, the current portion amount of $150.5 million is related to a Debenture that comes due on June 1, 2021. If the company’s long-term debt does not increase, the current portion of longterm debt will be $709.0 million on the 2021 end-of-year balance sheet. This amount represents the company’s Senior ($522.8 million) and Subordinated ($36.4 million) notes, as well Debentures ($149.8 million). This was determined by reviewing the maturity dates of all the outstanding items of longterm debt for those maturing in 2022. This is a higher amount compared to 2020, but is lower than the current portion shown in 2019 ($788.2 million). Since the company’s long-term liabilities consist primarily of the maturity of specific notes, fluctuations of maturity amounts are to be expected. Based on the lower amount paid in 2020, the company should plan for an increased cash outflow. An examination of the company’s statement of cash flows also shows large amounts of cash generated from operating activities and cash outflows used to acquire assets, pay dividends and repay debt. This indicates that the company has a strong cash position and will be able to honour its current liability commitments.

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RA 13.2 CANADIAN TIRE (CONTINUED) d. Commitments and Contingencies: Commitments: As per Note 34, the company has Capital Commitments. As at January 2, 2021, the Company had capital commitments for the acquisition of property and equipment, investment property and intangible assets for an aggregate cost of approximately $263.9 million (2019 – $201.5 million). Note 34 provides information related to guarantees and commitments, most of which are in the nature of guarantees. These include: • •

• • • •

Standby letters of credit for Dealers’ loans from a third party. Indemnification to purchasers of the company’s businesses or property that it will cover costs relating to any covenants, breaches of representations and warranties resulting from its past conduct, including those related to environmental remediation. Guarantees of lease payments by sublessees of space Canadian Tire had leased and vacated before the lease terms had ended. Third-party financial guarantees of the debt of certain Dealers. Indemnification of its lenders under its credit facilities for any increased costs due to changes in laws and regulations. Other indemnification agreements to compensate various counterparties for additional costs incurred as a result of specific events.

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RA 13.2 CANADIAN TIRE (CONTINUED) d. (continued) Guarantees are required to be recorded as liabilities in the financial statements when the criteria for accrual are met. If the criteria are not met, note disclosure is required. Wherever it can be measured, Canadian Tire discloses the maximum potential liability that could result from these guarantees. The company indicates that no amounts have been accrued in the consolidated financial statements with respect to these guarantees and agreements. Management indicates that because no significant amounts have historically been paid under such guarantees, they deemed it was not necessary to accrue any amounts. Contingencies: Note 20 outlines that the company is dealing with tax assessments from 2011 to 2015 that are currently in tax court. In addition, years 2016 and 2017 have been reassessed by the CRA. The note indicates that management does not agree with the rulings. As at the financial statement date, it has been determined that it is more likely than not that the court will find in favour of the company. A provision has not been made on the financial statements. e.

Note 4 on Capital Management discloses extensive information about the company’s covenants, requirements, and objectives related to managing capital. The key financial covenant for the company is a requirement to maintain at all times a ratio of debt to capital equal to or lower than a specified maximum. The company was in compliance with all requirements as of December 31, 2020, and 2019.

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RA 13.3 DEUTSCHE LUFTHANSA AG a. The current liabilities for Lufthansa are made up of the following amounts: (in millions EUR) Other provisions Borrowings Trade payables and other financial liabilities Liabilities from unused flight documents Other contract liabilities Advance payments received, deferred income and other nonfinancial liabilities Derivative financial instruments Effective income tax obligations Liabilities in connection with assets held for sale Total

2020 € 831 3,116

2020 % of total 5.7 21.3

2019 € 794 1,634

2019 % of total 5.0 10.2

3,321

22.7

5,351

33.5

2,064 2,977

14.1 20.3

4,071 2,675

25.5 16.7

1,295

8.8

382

2.4

366

2.5

137

0.9

689

4.6

402 540

2.5 3.3

14,659

100.0

15,986

100.0

As can be seen from the table, borrowings, trade payables and other financial liabilities, and liabilities from unused flights represent the largest proportion of the current liabilities in both years. Other contract liabilities also represents a significant proportion of current liabilities in both years. The year-over-year comparisons of the percentages indicate the percentages fluctuated from 2019 to 2020. There was an 11.1 percentage point increase in borrowing, an 11.4 percentage point decrease in the liabilities from unused flight documents, and an 11.1 percentage point increase in the Borrowings. b. The notes provide further disclosure of the types of obligations included in the accounts as indicated below. Other provisions (Note 36) include obligations under partial retirement contracts, other staff costs, obligation to return emissions certificates, onerous contracts, environmental restoration, legal proceedings, restructuring/severance payments, maintenance of lease aircraft, warranties, and other provisions.

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RA 13.3 DEUTSCHE LUFTHANSA AG (CONTINUED) Trade payables and other (current) financial liabilities (Note 41) include trade payables and other liabilities to affiliated companies, trade payables and other liabilities to other equity investments, trade payables to third parties, liabilities to banks, and other financial liabilities. Advance payments received, deferred income and other non-financial liabilities (Nte 42) include advance payments received, deferred income, and other nonfinancial liabilities. Liabilities from unused flight documents, as outlined in Note 3, are flights that have been sold, but not yet used. These coupons or tickets will be recognized as traffic revenue when used. Coupons that have not been used and are unlikely to be used in future, based on previous years’ statistical data, are recognized as traffic revenue. c. According to Note 36, employee benefit obligations under partial retirement contracts, representing its underfunded benefit plan, and other staff costs are included in Other Provisions. The provision for other staff costs relate to anniversary bonuses and other current obligations that are not detailed. The environmental restoration obligations are estimated based on surveyors’ reports and the clean-up is assumed to be fully completed within 10 years. Note 42 also provides information about other accruals related to employee benefits as follows: • Outstanding holiday allowance and overtime, and • The current portion of fair value obligations under share-based remuneration agreements.

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RA 13.3 DEUTSCHE LUFTHANSA AG (CONTINUED) d. Note 36 provides a reconciliation of the Other Provisions between the opening and closing balances (although it does not split out the current and long-term portions). Reconciliation of the opening and closing balances:

As of 1.1.2020 Changes in the group of consolidated companies Currency translation differences Utilization Increase/addition Interest added back Reversal Transfers As of 31.12.2020

EUR millions 1,284 -16 -407 631 13 -105 -11 1,389

e. As per Note 3, customer loyalty plans exist. The largest bonus miles plan is the Miles & More programme. As per Note 40, there is a liability within Contract Liabilities of 2,220.0 million EUR attributed to the customer loyalty programmes. A total of 228 billion miles were used to measure this liability. f. As explained in Note 46, the company has measured the following types of contingent liabilities: guarantees, bills of exchange and cheque guarantees totalling EUR 664 million; warranty contracts of EUR 192 million (including EUR 69 million in connection with creditors of joint ventures); and provisions of collateral for third parties totalling EUR 16 million. Legal risks incurred during the normal course of business are uncertain and are therefore not accrued in the financial statements.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.3 DEUTSCHE LUFTHANSA AG (CONTINUED) g.

The balance sheet shows current borrowings of EUR 3,116 million and noncurrent borrowings of EUR 12,252 million. As per Note 37, the current portion totalling EUR 3,116 million can be broken down into the following categories (in million EUR); Bonds 200, Liabilities to banks 2,071, Leasing liabilities 454, and Other loans 391.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.4 MEMO TO CFO a. Memo prepared by: ProVizzion Controller Date: January 2024 ProVizzion Corporation December 31, 2023 Issue 1: Warranties During June of this year, the company began the manufacturing and sales of a new line of dishwasher. Sales of 100,000 dishwashers during this period amounted to $50,000,000. These dishwashers were sold with a one-year warranty, with a warranty cost estimated on average to be $25 per appliance for a total estimated cost of $2,500,000. Management indicates that similar warranties are available for sale for $75. As at the balance sheet date, ProVizzion has paid out $1,000,000 in warranty expenditures and these have been expensed in the income statement. No recognition of any further liability associated with the warranty has yet been made. There are two kinds of warranties for accounting purposes, each with its own method of recognizing the associated costs, revenues, and liabilities: the service-type and the assurance-type. Under the service-type warranty, the assumption is that the $500 price charged for each dishwasher covers two separate performance obligations on our part. That is, the sale of each dishwasher is a bundled sale that includes (1) providing the dishwasher and (2) providing the warranty service, which expires one year from the date of sale. Therefore, the $500 sale amount is bifurcated/split out into two different types of revenue. The revenue related to the warranty service of $75 per unit sold is deferred at the point of sale, the costs of making good on the warranties are recognized in expense as incurred, and the deferred revenue is recognized as revenue as the warranty work is performed. The remaining $425 per unit is recognized as revenue on delivery of the dishwasher. The entries to record the years’ events under this method are: 1.

Accounts Receivable ........................................... 50,000,000 Sales Revenue (100,000 X $425) ................ 42,500,000 Unearned Warranty Revenue (100,000 X $75) 7,500,000 (To record sale of 100,000 dishwashers and unearned warranty revenue)

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RA 13.4 MEMO TO CFO (CONTINUED) a. (continued) Issue 1 2.

Warranty Expense ............................................... 1,000,000 Materials, Cash, Payables, etc. .................. 1,000,000 (To record warranty expense as the costs are incurred)

Unearned Warranty Revenue .............................. 3,000,000 Warranty Revenue ....................................... 3,000,000 [To record estimated warranty revenue earned based on costs incurred in year relative to total estimated cost of warranties on units sold: $1,000,000/$2,500,000 = 40% of estimated revenue or 40% X $7,500,000] Under the assurance-type warranty approach, the assumption is that the warranty guarantees or assures the purchaser that the product was manufactured without defects. If this is not the case, the company will take responsibility for its repair. In this situation, 100% of the $500 we charge the customer is for the dishwasher alone and any subsequent costs incurred under the warranty should be recognized as an expense that is matched with the sales revenue. The entries would be:

Accounts Receivable ........................................... 50,000,000 Sales Revenue ............................................ 50,000,000 (To record sale of 100,000 dishwashers at $500 each)

Warranty Expense ............................................... Materials, Cash, Payables, etc. .................. (To record warranty costs incurred)

1,000,000 1,000,000

Warranty Expense ............................................... 1,500,000 Warranty Liability ......................................... 1,500,000 [To accrue estimated remaining warranty costs ($2,500,000 – $1,000,000)] As can be seen, the amounts to be reported on the income statement will be different under the two approaches: Service-type Assurance-type approach approach Sales revenue - Dishwashers $42,500,000 $50,000,000 Warranty revenue 3,000,000 Warranty expense Net impact on income

(1,000,000) $44,500,000

(2,500,000) $47,500,000

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RA 13.4 MEMO TO CFO (CONTINUED) a. (continued) Issue 1 The service-type warranty method more closely reflects the contract-based approach for revenue recognition, and more faithfully presents outstanding performance obligations as a result of the sale transactions. This approach is consistent with both IFRS and, increasingly, with current ASPE practice. The liability on the statement of financial position is reflected at the fair value of the services still to be provided, as indicated in IFRS 13 that deals with fair value measurements. It is consistent with a warranty that protects the customer from defects that arise after the point of sale of the underlying asset. The gross profit on the warranty is actually deferred until the related work is performed. The assurance-type warranty method corresponds well with a warranty that protects the customer from defects that exist when the product is transferred to the customer. All the revenue is therefore recognized when the product is sold, and the costs are matched with the revenue generated. The liability is measured under IAS 37 as a provision for the estimated costs to correct the product. While recognizing income earlier rather than later (and therefore the assurance-type method is usually preferred by management), the choice should be made based on the particular circumstances of the warranty we provide on the dishwashers. This would be consistent with both ASPE’s bifurcation model and with the requirements of IFRS 15. In this way, the accounting reports will best reflect the economic circumstances associated with our business model. Issue 2: Rental Charges of Retail Division Based on Retail Profits In reviewing the estimates used for bad debt expense and warranty costs, I noticed an increase from previous years. Burt Wilson, CEO had instructed the previous accountant to increase these estimates in order to keep the retail division’s profits at $475,000. Since a portion of the rental costs are based on retail profits in excess of $500,000, the increase in estimates results in lower rent expense as it prevents income from reaching the $500,000 threshold. If the increases in estimates seem to be justified, based on current year actual experience, and/or by changes in economic conditions, the creditworthiness of customers, past experience, or changes in product quality, I recommend continuing with the higher percentages. If not justified, I recommend reverting to estimates that can be substantiated. If a higher profit is indicated, we should recognize the additional rent expense and an increase in our rent payable liability.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.4 MEMO TO CFO (CONTINUED) a. (continued) Issue 3: Asset retirement obligation The treatment of asset retirement obligations under ASPE and IFRS are different. In both cases, the present value of the estimated future cash flows has to be determined. In the case of ASPE, the dismantling of the equipment and any added costs that result from the production process are added to the cost of the asset, and these are amortized over the life of the capital assets. Under IFRS, only the cost of dismantling the equipment is added to the capital cost. Any costs resulting from the production process are added to the cost of inventory as production costs and are expensed through cost of goods sold as the dishwashers are sold. The present value of the dismantling costs alone at June 1, 2023 is the present value of $3 million due in 120 months. This, using a 0.5% per month discount rate is $3,000,000 X 0.54963 = $1,648,890. Dismantling costs under IFRS and ASPE: the journal entry required to record the dismantling costs related to the equipment itself and the asset retirement obligation: Equipment .............................................................. Asset Retirement Obligation ................................

1,648,890 1,648,890

Accumulated cleanup costs under ASPE: the accumulated cleanup costs related to the production process and the asset retirement obligation to December 31, 2023: Estimated cash flows $600,000/120 X 7 months = $35,000 The present value of the estimated cleanup costs and the entry to record them are: Present value of $35,000 to be paid in 113 months’ time at 0.5% per month $35,000 X 0.56916 = $19,921 Equipment .............................................................. Asset Retirement Obligation ................................

19,921 19,921

Accumulated cleanup costs under IFRS: these costs will be charged to Inventory cost as they are considered a production cost: Inventory ................................................................. Asset Retirement Obligation ................................

19,921 19,921

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RA 13.4 MEMO TO CFO (CONTINUED) a. (continued) Issue 3 Depreciation expense under ASPE: the amount of the 7 months’ depreciation on the equipment at December 31, 2023 is: [($11,648,890 X 7/120) + $19,921] = $699,440 Note: While the cost of the ARO that has been capitalized for the equipment as a whole is amortized over the full 120 months, the cost of the monthly clean-up costs should be recognized in the months the clean-up costs relate to. While these costs are recognized at their present value, the obligation will have to be accreted because the obligation for these costs will not be paid for another 113 months. Depreciation Expense ............................................ Accumulated Depreciation – Equipment ..............

699,440 699,440

(Note that these costs which are charged to Depreciation Expense are production overhead costs. These will be either expensed in Cost of Goods Sold or included in ending inventory, depending on the number of dishwashers sold and still in inventory.) Depreciation expense under IFRS: because the present value of the cleanup costs was charged directly to Inventory as a production cost instead of to the Equipment account, the depreciation expense under IFRS is limited to the balance in the Equipment account of $11,648,890. Depreciation expense = $11,648,890 X 7/120 = $679,519. Depreciation Expense ............................................ Accumulated Depreciation – Equipment ..............

679,519 679,519

(Note that these costs which are charged to Depreciation Expense are production overhead costs. These will be either expensed in Cost of Goods Sold or included in ending inventory, depending on the number of dishwashers sold and still in inventory.) Interest/accretion expense under IFRS and ASPE: to record the interest/accretion expense of the asset retirement obligation assuming there is no change in the estimate of cash flows, timing, or discount rate. Present value at December 31, 2023 is:

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RA 13.4 MEMO TO CFO (CONTINUED) a. (continued) Issue 3 Present value of $3 million in 113 months at 0.5% = $3,000,000 X .56916 = $1,707,480 Accretion = $1,707,480 – $1,648,890 Interest Expense (IFRS)/Accretion Expense (ASPE) 58,590 Asset Retirement Obligation .......................................................

58,590

Note: The present value of the $35,000 clean-up costs of $19,921 is already at its Dec. 31, 2023 present value in the ARO. Therefore, the book value and PV of the ARO at Dec. 31/23 is now $1,707,480 + $19,921 = $1,727,401. At Dec. 31/24, this total will be subject to a full year’s accretion. Effect on net income ASPE and IFRS: As can be seen, the amounts to be reported on the income statement will likely be the same under the two approaches. The clean-up costs incurred for the 7 months under ASPE are recognized in depreciation expense which is a production overhead cost that is ultimately charged to Inventory, and under IFRS they are charged to production costs of Inventory. In both cases, the production/conversion costs will then be allocated between inventory and cost of goods sold.

Depreciation expense (to Inventory as a production overhead cost)* Inventory (production overhead cost)* Interest expense Accretion expense

ASPE $699,440

IFRS $679,519 19,921 58,590

58,590

*allocated between cost of goods sold and ending inventory Issue 4: Litigation Loss Contingency on Patent Infringement Litigation Under ASPE, the contingent liability is recognized if it is “likely” to occur and can be reliably measured. In this case, since the lawsuit is still pending and has been assessed as “more likely than not,” this is not quite as high as “likely” as interpreted under ASPE. There is a 45% probability that no settlement will be required. As a result, under ASPE, there would be no liability recognized, but note disclosure would be required.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.4 MEMO TO CFO (CONTINUED) a. (continued) Issue 4 Since the liability recognition criteria have not been met, it must be disclosed in the notes to the financial statements. This note should include a discussion of this pending litigation along with the lawyer’s assessment that the outcome is indeterminable. Under IFRS, the treatment is different. Since the threshold of more likely than not has been met at a 55% probability, the next step is to determine its expected value. Using the information provided by Roberta Dowski, the best estimate is calculated as follows: (20% X $5 million) + (35% X $3 million) + (45% X 0) = $2.05 million A liability of $2.05 million would be accrued as follows: Litigation Expense .................................................. 2,050,000 Litigation Liability..................................................

2,050,000

Therefore, before-tax income would be lower under IFRS by $2,050,000. b. For Issue 1, there is a fine line between what is an assurance-type and a service-type warranty. In such a situation, management may revert to looking at which has the more favourable effect on income in making the choice. Professional ethics would require me to understand the underlying objective of the accounting standards so that the accounting measurements would best represent economic reality. Although ASPE does not use the terms “assurance” and “service” warranties, it is clear that ASPE standards require a separation of the selling price into a sale and a servicing component where one exists. Issue 2 also requires an ethical perspective to be exercised with the same objective in mind as in Issue 1. In this case, however, and assuming that the higher percentages cannot be substantiated by current conditions, increasing the allowances for expected credit losses and warranties to reduce rental costs is blatantly unethical and should be corrected. The benefits of this type of behaviour are short-term in nature and will cause long-term difficulties for the company. The trend of higher estimates cannot be maintained indefinitely. The results can include losing the rental location, civil action against the company, as well as criminal action for fraudulent behaviour. In addition, the current shareholders are harmed because the lower net income reduces the current value of their holdings.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.4 MEMO TO CFO (CONTINUED) There are no ethical considerations with Issues 3 and 4. The accounting in both cases depends on whether IFRS or ASPE is chosen. The choice in Issue 3 has no resulting difference in 2023 income. While there is a current year reduction in 2023 income associated with Issue 4 if IFRS is chosen, the total of 2023 and 2024 net incomes are likely to be the same under both sets of standards as the litigation is settled.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.5 CITY GOODS LIMITED: ASPE AND IFRS 1. The customer loyalty program represents an obligation for the company at January 31, 2024. Under IFRS, each sale has multiple deliverables that include not only the goods sold, but also the value of the points awarded. The fair value of the points must be recognized as unearned revenue until they are redeemed at some future date. Based on 700,000 points being awarded during the year, the amount of unearned revenue should be $350,000 (700,000 X $0.50). The journal entry to record the sales for the year should have been: Cash / Accounts Receivable ................................ Sales Revenue ............................................ Unearned Revenue ......................................

XXXX XXX 350,000

By the end of the year, 80,000 points have been redeemed out of a total expected redemption of 630,000 points or 90% of the 700,000 issued. Consequently, the amount of the unearned revenue to take into current year revenue is: [80,000 / 630,000] X $350,000 = $44,444 The journal entry to record the amount of revenue earned for the loyalty points is: Unearned Revenue .............................................. Sales Revenue ............................................

44,444 44,444

The treatment under ASPE would be similar.

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RA 13.5 CITY GOODS LIMITED (CONTINUED) 2. The second issue is one of an onerous contract. The company is no longer gaining any benefits from the lease of this retail location since the store has been closed. However, it still has to make payments on the lease until March 1, 2025. The company has a legal obligation to continue to make the payments under the lease agreement, and these payments are unavoidable costs. The landlord is likely to accept a lump sum payment now equal to the present value of the remaining lease payments. Under IFRS, the liability must be recognized and measured at the present value of the unavoidable payments that must be made and unrecoverable loss expected to be incurred. At January 31, 2024, the company has 14 payments left from February 1, 2024 to March 1, 2025. The present value of these annuity due payments is: $2,300 each month, for 14 months at an interest rate of 0.5% per month = $31,179 (found using a financial calculator or Excel). The January 31, 2024 journal entry required is:

Loss on Lease .......................................... 31,179 Liability for Onerous Contracts .....................

31,179

Under ASPE, onerous contracts are not specifically addressed, but practice has been to recognize the liability and the loss based on the fact that the entity has an obligation to pay for something that provides no future benefit to the entity.

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RA 13.6 EMPLOYEE BENEFITS Item 1 The sick leave obligation arises as the employee provides a service to the company and therefore must be accrued at December 31, 2023. Under IFRS, the entity recognizes the expected cost of short-term employee benefits such as accumulating paid absences as the employees provide services that increase such entitlements. (IAS 19.11 and .13). In this case, the 3% increase has already been agreed to so the expected amount would include this increase and the best estimate is calculated as follows: 60 days X $250 per day X 103% = $15,450 The following journal entry would be required on December 31, 2023: Salaries and Wages Expense .............................. Sick Pay Wages Payable .............................

15,450 15,450

ASPE does not provide any specific guidance on this type of benefit except that a liability arises from past transactions and requires settlement in the future with a possible transfer of assets. Established practice would record similar amounts as under IFRS. Item 2 Parental leave is a non-accumulating benefit and only arises when an event that obligates the company takes place. In this case, the employee who has already started maternity leave on December 15 is entitled to the benefit. Conduit’s obligation for the benefit to be paid in 2024 is accrued at December 31, 2023. The amount of this obligation is: $1,000 X 11.5 months = $11,500. The journal entry is: Employee Benefit Expense .................................. Parental Leave Benefits Payable .................

11,500 11,500

For the other employee, the adoption has not yet taken place, and therefore the event obligating Conduit has not yet occurred. There will be no liability recognized in relation to this employee until the time of the adoption and the parental leave commences. IFRS and ASPE treatments are the same for these benefits.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.6 EMPLOYEE BENEFITS (CONTINUED) Item 3 This bonus is payable at December 31, 2023, since it relates to compensation that was earned during 2023. The total amount of the bonus is $2 million X 3% = $60,000. This equates to: Managers – 30% X $60,000 = $18,000 Non-managers – 70% X $60,000 = $42,000. For each non-manager, the bonus is $42,000 ÷ 40 = $1,050 However, there is a stipulation that the bonus will only be paid to employees who are still working for the company on October 31, 2024 – 10 months from now. As a result, the best estimate of the liability would take into the consideration the turnover that is expected to occur over the next 10 months. With the estimated turnover of 5%, this means that only 38 non-management employees (40 X 95%) are expected to still be employed by the company by the payout date. Therefore, the best estimate of the payment to non-managers is: 38 X $1,050 = $39,900. Therefore, the total bonus payable is: $18,000 + $39,900 = $57,900 and the December 31, 2023 journal entry required for the bonus payable is: Bonus Expense .................................................... 57,900 Bonus Payable ............................................. 57,900 Item 4 The vacation payable is an accumulating benefit that vests since the employee is entitled to this amount. However, the legal entitlement is only 2 weeks, and the additional amount of 1 week is a constructive obligation. Currently, 10 employees are still owed 2 weeks’ vacation (having taken 1 week already during 2023). Under IFRS, the entire 2 weeks would be reported as an obligation at December 31, 2023, but adjusted for the probabilities related to all employees being entitled to this full amount. Based on the information, the expected value of the obligation would be calculated as follows: [10 employees X 10 days x $250 x 103%] minus [(1 employee X 5 days X $250 X103%) X.15] = $25,750 - $193 = $25,557 The journal entry required is: Salaries and Wages Expense ............................. Vacation Wages Payable .............................

25,557 25,557

Under ASPE, this type of constructive obligation would also be recorded as it is the normal business practice.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.6 EMPLOYEE BENEFITS (CONTINUED) Item 5 This relates to a possible contingent obligation. It appears that a settlement above the $30,000 already recognized will be required, and the obligation arose from a past event. The employee is asking for $62,500 (25 years X 10 days X $250/day). Consequently, some amount above the $30,000 must be reported at December 31, 2023. Under IFRS, a probability- weighted expected value is determined. Using the estimates provided by the lawyer, this amount is estimated to be: (25% X $20,000) + (60% X $28,000) + (15% X $30,000) = $26,300. An additional provision will be accrued as follows: Litigation Expense........................................................ Litigation Liability..................................................

26,300 26,300

Reconciliations from opening balances to closing balances are required for each class of provision. The changes due to this litigation case would be aggregated with other litigation amounts, but no specific amounts would have to be disclosed about the expected outcome of this arbitration because such information would seriously prejudice Conduit’s position. Under ASPE, this contingency appears to be likely and it will require some amount of settlement based on the estimates provided by the lawyer. However, the amount to be recorded is either the best estimate within a range if it can be determined, or the lowest of the ranges of possible outcomes if no one amount is any more likely than any other. In this case, the range of settlements is $20,000 to $30,000. Assuming a most likely estimate of $28,000 based on the information provided by the lawyer, this would be used to measure the additional amount of the liability. The estimated obligation would be recorded as follows: Litigation Expense........................................................ Litigation Liability..................................................

28,000 28,000

The note disclosure required under ASPE includes the fact that a contingent loss exists at December 31, 2023 and that an exposure to loss exists in excess of the amount recognized.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 13.7 RESEARCH TOPICS Sample Solution Topic: Liability accruals on interim financial statements International accounting standards (IFRS) use the approach that an enterprise should apply the same accounting policies in its interim financial statements as are applied in its annual financial statements. Therefore, an enterprise should apply the same criteria for recognizing and measuring a liability accrual at the end of an interim period as it does at the end of its fiscal year. This means liabilities are recognized if an enterprise has a present obligation, resulting from a past event, it is probable that an outflow of economic benefits will be required to settle that obligation, and a reliable estimate of the obligation can be made. For example, if a year-end bonus is a legal obligation, or past practice makes the bonus a constructive obligation for which the enterprise has no realistic alternative but to make the payments, and a reliable estimate of the amount of the obligation can be made, the bonus is accrued for interim reporting purposes. Since this type of bonus is usually based on a contract and is short-term in nature, it is recorded in the accounting records and reported in financial statements as the amount of cash that is payable in the future. The accounting standard that is applied to this topic is International Accounting Standard 34, “Interim Financial Reporting.” IAS 34 mentions recognizing and measuring losses that require accounting estimates (e.g., inventory writedowns or restructurings). It states that if the estimates change in a subsequent interim period of that financial year, the original estimate is changed in the subsequent interim period either by accrual of an additional amount of loss or by reversal of the previously recognized amount. Several accounting issues are related to the fact that interim financial statements require many more estimates than annual financial statements, particularly for those costs and receipts that are annual in nature. These would include, for example, accruals for income taxes, bonuses, and customer and vendor rebates. While the general principles are included in IAS 34 itself, an Appendix to this standard (not considered part of IFRS) provides additional details for common issues that many companies must deal with in preparing their interim statements. Under ASPE, there is no standard covering interim financial reports. However, following the ASPE standards (Section 1100, Generally Accepted Accounting Principles), it is likely that a private company wishing to prepare interim financial statements would look to be relatively consistent with IFRS requirements in determining the recognition and measurement principles

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MMXXII vii F2

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CHAPTER 14 LONG-TERM FINANCIAL LIABILITIES Learning Objectives 1. Understand the nature of long-term debt financing arrangements. 2. Understand how long-term debt is measured and accounted for. 3. Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings. 4. Explain how long-term debt is presented, disclosed, and analyzed. 5. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.

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Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

BT Item LO

AP 25. C 26. AP 27. AN K AP

4 4 4

AN AN K

AP 29. AP 30. AP 31. AP AP AP AP

4 4 4

K K AP

AP AP AP AP

2,3 2,3 2,3 2,3

AP AP AP C

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

1 1 2 2 2 2

C C AP AP AP AP

1. 2. 3. 4. 5. 6. 7.

1 1,2 2 2 2 2 2

K AP AP AP AP AP AP

1. 1,2 2. 1,2,4 3. 2 4. 2,3

AP AP AP AP

1,4

1. 2.

1,4 1,4

AP AP

BT Item LO BT Item LO Brief Exercises 7. 2 AP 13. 2 AP 19. 3 8. 2 AP 14. 2 AP 20. 3 9. 2 AP 15. 2 AP 21. 3 10. 2 AP 16. 2 AP 22. 3 11. 2 AP 17. 2 AP 23. 4 12. 2 AP 18. 2 AP 24. 4 Exercises 8. 2 AP 15. 2 AP 22. 3 9. 2 AP 16. 2,4 AP 23. 3 10. 2 AP 17. 3 AP 24. 3,5 11. 2 AP 18. 2,4 AP 25. 3 12. 2 AP 19. 3 AP 26. 3 13. 2 AP 20. 3 AP 27. 3 14. 2 AP 21. 3 AP 28. 3 Problems 5. 2,3 AP 9. 2,4 AP 13. 2,3 6. 2,3,5 AP 10. 2,4 AP 14. 2,3 7. 2,4 AP 11. 2,3 AP 15. 2,3 8. 2 AP 12. 2,3 AP 16. 2,3 Cases 2. 3. Integrated Cases 2. 1,3 AN Research and Analysis 3. 4 AN 4. 1,4 AP 5.

17. 18. 19. 20.

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Intermediate Accounting, Thirteenth Canadian Edition

Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

Problems

1. Understand the nature of long-term debt.

1, 2

2. Understand how long-term debt is measured and accounted for.

3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 13

3. Recognition and derecognition of debt and debt restructurings.

19, 20, 21

17, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28

6, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20

4. Presentation of long-term debt.

16, 18, 29, 30

2, 8, 10

9, 10

Topics

5. Disclosure requirements. 6. Long-term debt analysis.

25, 26, 27

7. Differences between IFRS and ASPE.

NOTE: If your students are solving the end-of-chapter material using a financial calculator or Excel functions as opposed to the PV tables, please note that there will be a difference in amounts. Excel and financial calculators yield a more precise result as opposed to PV tables. The amounts used for the preparation of journal entries in solutions have been prepared from the results of calculations arrived at using the PV tables unless otherwise indicated in the question.

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ASSIGNMENT CHARACTERISTICS TABLE Item

Description

E14.1 E14.2 E14.3 E14.4

Features of long-term debt Information related to various bond issues Entries for bond transactions Entries for bond transactions—effective interest Entries for bond transactions—straightline Entries for non–interest-bearing debt Imputation of interest Purchase of land with instalment note Purchase of equipment with non–interestbearing debt Purchase of computer with non–interestbearing debt Entries for bond transactions Amortization schedule—straight-line Amortization schedule—effective interest Determination of proper amounts in account balances Interest-free government loan Entries and questions for bond transactions Entries for retirement and issuance of bonds Entries for retirement and issuance of bonds – straight line Entries for retirement and issuance of bonds – effective interest Entry for retirement of bond; costs for bond issuance Entries for retirement and issuance of bonds Impairments Settlement of debt Term modification–debtor’s entries Term modification–creditor’s entries Settlement–debtor’s entries Settlement–creditor’s entries Debtor entries for settlement of troubled debt

E14.5 E14.6 E14.7 E14.8 E14.9 E14.10 E14.11 E14.12 E14.13 E14.14 E14.15 E14.16 E14.17 E14.18 E14.19 E14.20 E14.21 E14.22 E14.23 E14.24 E14.25 E14.26 E14.27 E14.28

Level of Difficulty

Time (minutes)

Simple Moderate Simple Simple

10-15 35-45 15-20 15-20

Simple

15-20

Simple Simple Moderate Moderate

15-20 15-20 15-20 15-20

Moderate

15-20

Moderate Simple Simple Moderate

15-20 10-15 15-20 15-20

Moderate Moderate

15-20 20-30

Simple

10-15

Simple

15-20

Complex

30-35

Moderate

20-25

Simple

10-15

Moderate Moderate Complex Moderate Moderate Moderate Moderate

15-25 15-20 45-50 25-30 25-30 20-30 20-25

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Item

Description

Level of Difficulty

Time (minutes)

E14.29 E14.30 E14.31

Classification of liabilities Classification. Long-term debt disclosure.

Simple Simple Simple

15-20 15-20 10-15

P14.1

Entries for noninterest-bearing debt; payable in instalments Contrasting note terms Analysis of amortization schedule and interest entries Issuance and retirement of bonds Comprehensive bond problem Issuance of bonds between interest dates, straight-line, retirement Entries for noninterest-bearing debt Classification of accounts used in bond issuance Issuance and retirement of bonds; income statement presentation Comprehensive problem; issuance, classification, reporting Issuance of bonds, straight-line interest, retirement Issuance of bonds effective interest, retirement Bonds at discount and premium including partial redemption Loan impairment entries

Moderate

30-35

Complex Simple

50-60 15-20

Moderate Complex Complex

25-30 50-65 30-35

Simple Moderate

15-25 55-65

Simple

15-20

Moderate

20-25

Moderate

20-25

Moderate

30-35

Complex

45-50

Moderate

30-40

Debtor/creditor entries for continuation of troubled debt Restructure of note under different circumstances Debtor/creditor entries for continuation of troubled debt Entries for troubled debt restructuring Debtor/creditor entries for continuation of troubled debt with new effective interest Legal versus in-substance defeasance

Moderate

15-25

Complex

50-60

Complex

40-50

Moderate Moderate

30-35 30-35

Moderate

15-20

P14.2 P14.3 P14.4 P14.5 P14.6 P14.7 P14.8 P14.9 P14.10 P14.11 P14.12 P14.13 P14.14 P14.15 P14.16 P14.17 P14.18 P14.19 P14.20

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Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14.1 (a)

A bond’s credit rating is a reflection of credit quality. The BBB credit rating of the bond at the time of issuance reflected an assessment of the company’s ability to pay the amounts that will be due on that specific bond. With four consecutive quarters of increasing losses and deteriorating financial position in 2023, and new competition in the industry, credit analysts may downgrade the bond’s credit rating to below investment grade.

(b)

The market closely monitors a bond’s credit rating when determining the required yield and pricing of bonds at issuance and in periods after issuance. If the bond’s credit rating is downgraded, the yield required by investors will likely increase, and the price of the bonds will likely decrease in order to compensate the bondholder for the additional risk associated with that specific bond.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.2 (a)

Financing is generally obtained through three sources: borrowing, issuing shares, and/or using internally generated funds. Leverage (or using borrowed money to increase returns to shareholders) can maximize returns to shareholders, and the related interest paid is tax deductible. However, borrowed funds must be repaid and can increase liquidity and solvency risk. Issuing shares does not increase liquidity and solvency risk; however, it may result in dilution of ownership. Using internally generated funds may be appropriate if the company’s business model is generating excess funds.

(b)

Based on the information provided, borrowing is the most suitable source of financing for Jensen & Jensen. With a debt to total assets ratio of 55%, Jensen & Jensen is underleveraged compared to similar size competitors operating in the same industry. This means that Jensen & Jensen may not be maximizing returns to shareholders, and the company may be able to finance the expansion by borrowing while still maintaining an acceptable level of liquidity and solvency risk. As a telecommunications equipment manufacturer, Jensen & Jensen operates in a capital-intensive industry, and a lender may be able to structure the lending agreement in such a way as to secure the loan with the company’s underlying tangible assets. Further, issuing shares is not ideal given the owners’ desire to keep the company closely held.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.3 1. Using tables: Present value of the principal $500,000 X .37689 Present value of the interest payments $27,500 X 12.46221 Issue price

$188,445 342,711 $531,156

2. Using a financial calculator: PV I N PMT FV Type

? Yields $ 531,155.53 5% 20 $ (27,500) $ (500,000) 0

3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $531,155.53 rounded to $531,156 LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.4 (a)

(b)

Cash ........................................................ Notes Payable ................................

300,000

Interest Expense ($300,000 X 8%) ......... Cash................................................

24,000

300,000

24,000

LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 14.5 (a) 1. Using tables: Present value of the principal $200,000 X .74409 Present value of the interest payments $8,000 X 8.53020 Issue price

$148,818 68,242 $217,060

2. Using a financial calculator: PV I N PMT FV Type

? 3% 10 $ (8,000) $ (200,000) 0

Yields $ 217,060.41

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.5 (a) (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $217,060.41 rounded to $217,060 (b)

(c)

Cash ........................................................ Bonds Payable ...............................

217,060

Interest Expense ($217,060 X 6% X 6/12) Bonds Payable ($8,000 – $6,512) ........... Cash ($200,000 X 8% X 6/12) .........

6,512 1,488

Interest Expense [($217,060 – $1,488) X 6% X 6/12] ........ Bonds Payable ($8,000 – $6,467) ........... Cash ($200,000 X 8% X 6/12) .........

217,060

8,000

6,467 1,533 8,000

LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.6 (a) 1. Using a financial calculator: PV I N PMT FV Type

$52,000 Yields 15.09% ? 5 $ 0 $ (105,000) 0 2. Using Excel: =RATE(nper,pmt,pv, fv,type)

Result: 15.0898943 rounded to two decimal places 15.09 % (b)

(c)

Cash ........................................................ Notes Payable ................................

52,000.00

Interest Expense ($52,000 X 15.09%)..... Notes Payable ................................

7,846.80

52,000.00

7,846.80

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.6 (d)

Date Jan. 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 1

Schedule of Discount Amortization Effective Interest Method (15.09%) 15.09% Effective Discount Interest Amort. 2023 2023 2024 2025 2026 2027

$7,846.80 9,030.88 10,393.64 11,962.04 13,766.641 $53,000.00

$7,846.80 9,030.88 10,393.64 11,962.04 13,766.64 $53,000.00

Carrying Amount $52,000.00 59,846.80 68,877.68 79,271.32 91,233.36 105,000.00

rounded

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.7 (a) 1. Using a financial calculator: PV $ 38,912 Yields 11.00% (rounded to I ? 2 decimal places) N 5 PMT $(2,500) FV $ (50,000) Type 0 2. Using Excel: =RATE(nper,pmt,pv, fv,type)

Result: 11% rounded (b)

Equipment ............................................... Notes Payable ................................

38,912 38,912

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.7 (Continued) (c) Interest Expense1.................................. Cash2 .............................................. Notes Payable ................................ 1 ($38,912 X 11.00% = $4,280) 2 ($50,000 X 5% = $2,500)

4,280 2,500 1,780

LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.8 Cash ............................................................... Notes Payable ....................................... Unearned Revenue ...............................

200,000 176,448 23,552

The difference between the present value (using an 8% discount rate) and the proceeds is recorded as unearned revenue, since Big Country agreed to provide cattle at a reduced price over the term of the note. The amount will be brought into revenue over the term of the note, as the cattle are provided to Little Town. 1. Using a financial calculator: PV ? Yields $ 176,447.50 I 8% N 6 PMT 0 FV $ (280,000) Type 0 2. Excel formula: =PV(rate,nper,pmt,fv,type)

Result; $176,447.50 rounded to $176,448 LO 2 BT: AP Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.9 The relevant interest rate to be imputed on the instalment note is the rate Pflug would pay at its bank of 11% 1. Using tables: Using ordinary annuity tables for 11% for two periods, the factor of 1.71252 is used and divided into the present value amount of $40,000 to arrive at the amount of the equal instalment payment of $23,357.39. 2. Using a financial calculator: PV I N PMT FV Type

$ (40,000) 11% 2 ? Yields $ (23,357.35) $ 0 0

3. Using Excel: = PMT(rate,nper,pv,fv,type)

Result: $23,357.35 LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 14.17 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.10 (a)

(b)

Cash ($500,000 – $25,000) ...................... Bonds Payable ...............................

475,000

Interest Expense ($40,0001 + $2,5002).... Bonds Payable ............................... Cash1 .............................................. 1 $500,000 X 8% = $40,000 2 $25,000 issue cost X 1/10 = $2,500

42,500

475,000

2,500 40,000

(c)

When a note or bond is issued, it should be recognized at fair value adjusted by any directly attributable issue costs. However, note that where the liability will subsequently be measured at fair value (e.g., under the fair value option or because it is a derivative), the transaction costs should not be included in the initial measurement (i.e., the costs should be expensed) [CPA Canada Handbook, Part II, Section 3856.07 and IFRS 9.5.1.1].

(d)

If the bonds were trading on the market for over their face value, this would imply that the bonds were not actually issued at face value, but rather that the interest rate paid on the bonds exceeds market rate, and thus, the bonds are trading at a premium. This reflects the fair value hierarchy, whereby observable market prices for identical assets and liabilities is first on the hierarchy, and thus, if fair value was being used to record these bonds, their value would be higher than what is currently recorded.

LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.11 (a)

(b)

(c)

Cash ........................................................ Bonds Payable ...............................

300,000

Interest Expense ..................................... Cash ($300,000 X 10% X 6/12) .......

15,000

Interest Expense ..................................... Interest Payable .............................

15,000

300,000

15,000

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 14.12 (a)

(b)

(c)

Cash ($300,000 X .98) ............................. Bonds Payable ...............................

294,000

Interest Expense ..................................... Cash ($300,000 X 10% X 6/12) ....... Bonds Payable1.............................. 1 ($6,000 X 1/5 X .5 = $600)

15,600

Interest Expense ..................................... Interest Payable ............................. Bonds Payable ...............................

15,600

294,000

15,000 600

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.13 (a)

(b)

(c)

Cash ($300,000 X 1.03 = $309,000)......... Bonds Payable ...............................

309,000

Interest Expense ..................................... Bonds Payable ($9,000 X 1/5 X .5) ......... Cash ($300,000 X 10% X 6/12) .......

14,100 900

Interest Expense ..................................... Bonds Payable ........................................ Interest Payable .............................

14,100 900

309,000

15,000

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 14.14 (a)

Cash .......................................................... 615,000 Bonds Payable ................................. 600,000 1 Interest Expense ............................. 15,000 1 ($600,000 X 6% X 5/12 = $15,000)

(b)

Interest Expense2 ...................................... Cash ................................................. 2 ($600,000 X 6% X 6/12 = $18,000)

18,000

Interest Expense ....................................... Interest Payable ...............................

18,000

(c)

18,000

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.15 (a)

(b)

(c)

(d)

Cash ........................................................ Bonds Payable ...............................

559,229

Interest Expense ..................................... Cash................................................ Bonds Payable ...............................

22,369

Interest Expense ..................................... Interest Payable ............................. Bonds Payable ...............................

22,424

559,229

21,000 1,369

21,000 1,424

1. Using a financial calculator: FV = n= PMT = i= PV =

(600,000) 20 (21,000) 4.0% 559,229

Given 10 years X 2 Face X 7% X 6/12 Calculate Given

2. Using Excel: =RATE(nper,pmt,pv, fv,type)

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.15 (Continued) e. Schedule of Discount Amortization Effective Interest Method (4%)

Date Jan. 1 July 1 Jan. 1 July 1

2023 2023 2024 2024

3.5% Cash Interest

4.0% Effective Discount Interest Amortized

$21,000.00 21,000.00 21,000.00

$22,369.16 22,423.93 22,480.88

Carrying Amount $559,229.00 $1,369.16 560,598.16 1,423.93 562,022.09 1,480.88 563,502.97

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 14.16 (a)

(b)

(c)

Cash ........................................................ Bonds Payable ...............................

644,632

Interest Expense ..................................... Bonds Payable ........................................ Cash................................................

19,339 1,661

Interest Expense ..................................... Bonds Payable ........................................ Interest Payable .............................

19,289 1,711

644,632

21,000

(d) 1. Using a financial calculator: FV = n= PMT = i= PV =

(600,000) 20 (21,000) 3.0% 644,632

Given 10 years X 2 Face X 7% X 6/12 Calculate Given

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.16 (Continued) (d) (continued) 2. Using Excel: =RATE(nper,pmt,pv, fv,type)

Result: 3% rounded (e) Schedule of Premium Amortization Effective Interest Method (3%)

Date Jan. 1 July 1 Jan. 1 July 1

3.5% Cash Interest

3.0% Effective Premium Interest Amortized

2023 2023 $21,000.00 $19,338.96 2024 21,000.00 19,289.13 2024 21,000.00 19,237.80

Carrying Amount $644,632.00 $1,661.04 642,970.96 1,710.87 641,260.09 1,762.20 639,497.89

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.17 (a)

(b)

Cash .................................................... Bonds Payable ...........................

1,058,671

Interest Expense1 .................................... Bonds Payable ........................................ Cash2 .............................................. 1 ($1,058,671 x 8% x 3/12 = $21,173) 2 ($1,000,000 x 9% x 3/12 = $22,500)

1,058,671 21,173 1,327 22,500

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 14.18 (a)

Interest Expense ($1,000,000 X 7%) ........ Cash.................................................. To record payment of interest

70,000

Bonds Payable ($1,000,000 - $900,000) ... Unrealized Gain or Loss ................. To record fair value adjustment

100,000

70,000

100,000

The unrealized gain or loss is recorded in net income. (b)

Interest Expense ($1,000,000 X 7%) ........ Cash.................................................. To record payment of interest

70,000

Bonds Payable ($1,000,000 - $900,000) ... Unrealized Gain or Loss - OCI ........ To record fair value adjustment

100,000

70,000

100,000

The unrealized gain or loss is recorded in other comprehensive income. LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 14.19 Bonds Payable ($800,000 + $6,500) ............. Cash ($800,000 X .97) .......................... Gain on Redemption of Bonds ...........

806,500 776,000 30,500

LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 14.20 This is a situation where a currently maturing liability (a current liability) at year end is expected to be refinanced on a long-term basis. Under IFRS, this loan liability is required to be reported as a current liability on the December 31 financial statements because it was not refinanced by the reporting date. The only exception permitted would be if the refinancing that extends the repayment terms was done under an agreement that existed at December 31 and the decision about the refinancing is solely up to the discretion of the entity’s management. The ASPE standard, however, allows more flexibility. The maturing debt is required to be reported as a current liability unless it has been refinanced on a long-term basis or there is a non-cancellable agreement to do so before the financial statements are completed, and there is nothing that prevents completion of the refinancing. Because the entity’s financial statements would not have been completed as soon as two days after the reporting date (December 31) when the new agreement was finalized, ASPE would permit the debt to be included with long-term liabilities. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 14.21 Since the present value of the future cash flows of the new debt differs by an amount larger than 10% of the present value of the old debt, the renegotiated debt is considered a settlement. A gain/loss is recorded by Lawrence (debtor) and no interest is recorded by the debtor. This is not considered a modification of terms. The old debt is removed from the books of Lawrence with a gain/loss being recognized, and the new debt is recorded. 2023 Notes Payable ..................................... Gain on Restructuring of Debt .... Notes Payable .............................

100,000

2024 Interest Expense ($72,397 X .10) ........ Notes Payable .............................. Cash (8% X $75,000) ....................

7,240

2025 Interest Expense1 ................................ Notes Payable .............................. Cash .............................................. 1 ($72,397 + $1,240) X .10 = $7,364 To record payment of interest

7,364

2025 Notes Payable ..................................... Cash ............................................. . To record maturity of note

75,000

27,603 72,397

1,240 6,000

1,364 6,000

75,000

LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 14.22 (a)

Steinem’s liquidity has improved. As a result of this transaction, the company’s SFP will show $1 million more cash, and $1 million less accounts receivable (a less liquid asset than cash).

(b)

Steinem’s SFP will not show increased debt or equity as a result of this transaction. The cash was generated by the special purpose entity, which sold shares to its investors.

(c)

This transaction is an example of off–balance sheet financing.

(d)

From the perspective of an investor, there is a risk that the special purpose entity is being used primarily to make Steinem’s SFP and liquidity position appear better. As a general rule, special purpose entities should be consolidated with the main company when the main company is the primary beneficiary.

LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

BRIEF EXERCISE 14.23 Current liabilities Interest payable ................................................

$ 25,000

Bonds payable, due September 1, 2024 ..........

$1,200,000

LO 4 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 14.24 (a) Ambrosia Limited Partial Statement of Financial Position As at December 31, 2023 Liabilities Wages payable Accounts payable and accrued liabilities Bonus payable Bonds payable Total liabilities

$ 15,000 20,000 15,000 140,000 $190,000

(b) Ambrosia Limited Partial Statement of Financial Position As at December 31, 2023 Liabilities Current Accounts payable and accrued liabilities Wages payable Current portion of bonds payable Total current liabilities

$ 20,000 15,000 30,000 65,000

Long-term Bonus payable Bonds payable Total long-term liabilities Total liabilities

15,000 110,000 125,000 $190,000

LO 4 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 14.25 (a) Debt-paying ability (solvency) may be evaluated by calculating the debt to total assets ratio: 2023 - $500,000 / $900,000= 56% 2022 - $750,000/$ 700,000 = 107% Sports International’s debt to assets ratio improved significantly from 2022 to 2023, so their debt-paying ability and long-term solvency has improved. Short-term debt-paying ability (liquidity) may also be evaluated by calculating the current ratio: 2023 - $120,000 / $100,000 = 1.20 2022 - $140,000 / $150,000 = 0.93 Based on Sports International’s current ratio, their ability to meet short-term payment requirements in 2023 improved from 2022.

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BRIEF EXERCISE 14.25 (CONTINUED) (b) Ability to Pay Debt 1.40 1.20 1.00 0.80 0.60 0.40

0.20 2022

2023 Debt to Total Assets

Current Ratio

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BRIEF EXERCISE 14.26 (a) Year

Debt to Total Assets

2023

0.43

2024

0.52

2025

0.72

2026

0.46

2027

0.45

(b)

Debt and Total Assets

Thousands

Debt to Total Assets Ratio compared to Debt and Total Assets $2,500

80% 72%

70%

$2,000

60% 52%

$1,500

50%

46% 45%

43%

40% 30%

$1,000

20% 10%

$500

0% 2023

2024 Debt

2025 Total Assets

2026

2027

Debt to asset

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BRIEF EXERCISE 14.27 Weather bonds have interest or principal payments that are tied to changes in the weather. The incidence of unusual and extreme weather events has been increasing, along with potential losses from these often unexpected events. Many insurers are feeling the impact of this in terms of profits. Insurance companies issue these weather bonds to help manage risk. Holders of the bonds would lose their rights to some or all of the interest and/or principal payments if a “triggering event” occurred. A triggering event could be anything from an excess amount of rainfall to a hailstorm or drought. These instruments are part of a larger group of instruments sometimes called catastrophe bonds (“cat” bonds), which are used globally. The bonds are often sold in private placement offerings, meaning that they are sold to large institutional investors. Because many bonds do not repay the principal if the triggering event occurs, they are called “principal-at-risk variable-rate notes.” Institutional investors invest in these bonds to diversify since the risks associated with the potential loss events (for instance a hurricane) are not primarily dependent upon the same factors as the markets in general (for instance the economy). LO 4 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

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SOLUTIONS TO EXERCISES EXERCISE 14.1 a. 1. 2 2. 3 3. 2 4. 2 5. 1 6. 2 7. 2 8. 1 b.

A feature or characteristic that increases the riskiness of the long-term debt will cause investors to require a higher yield on the long-term debt. A higher yield on the long-term debt will give investors an acceptable return that matches the issuer’s risk characteristics.

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EXERCISE 14.2 Unsecured Bonds a.

Maturity value

Number of interest periods

$10,000,000

ZeroCoupon Bonds $2,500,000

Mortgage Bonds $15,000,000

Stated rate per period

3.25% (

13% 4

)

10%

Effective rate per period

3% (

12% 4

)

12%

Payment amount per period

$325,000 (1)

$1,500,000 (2)

Present value

$10,577,900 (3)

$804,925 (4)

$13,304,880 (5)

(1) (2)

$10,000,000 X 13% X 1/4 = $325,000 $15,000,000 X 10% = $1,500,000

1. Using factor tables (3)

Present value of an annuity of $325,000 discounted at 3% per period for 40 periods ($325,000 X 23.11477) = Present value of $10,000,000 discounted at 3% per period for 40 periods ($10,000,000 X .30656) =

$ 7,512,300

3,065,600 $10,577,900

2. Using a financial calculator: PV I N PMT FV Type

$ ? 3% 40 $ (325,000) $ (10,000,000) 0

Yields $10,577,869

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EXERCISE 14.2 (CONTINUED) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $10,577,869.30 rounded to $10,577,869 1. Using factor tables (4)

Present value of $2,500,000 discounted at 12% for 10 periods ($2,500,000 X .32197) = $804,925

2) Using a financial calculator: PV I N PMT FV Type

$ ? 12% 10 0 $ (2,500,000) 0

Yields $804,933

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EXERCISE 14.2 (CONTINUED) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $804,933.09 rounded to $804,933 1. Using factor tables (5)

Present value of an annuity of $1,500,000 discounted at 12% for 10 periods ($1,500,000 X 5.65022) = $8,475,330 Present value of $15,000,000 discounted at 12% for 10 years ($15,000,000 X .32197) 4,829,550 $13,304,880 2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields $13,304,933 12% 10 $ (1,500,000) $ (15,000,000) 0

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EXERCISE 14.2 (CONTINUED) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $13,304,933.09 rounded to $13,304,933 A more accurate result is obtained using Excel or a financial calculator as compared to using factors from tables as there are a limited number of decimal places in the tables.

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EXERCISE 14.2 (CONTINUED) g. Similarities and differences among the bond features and their impact on risk are as follows: – bond maturity (duration) – The bonds all have the same maturity date (duration), thus this risk factor is equalized among the bonds. – bond stated rate and effective interest rate – The bonds all have a different stated interest rate (ranging from a deep discount, zero-coupon bond of 0% to 13%). A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on the bonds. This occurs when the investors are not satisfied with the stated nominal interest rate because they can earn a greater rate on alternative investments of equal risk. They refuse to pay par for the bonds and cannot change the stated nominal rate. However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest. A premium on bonds payable results from the opposite conditions. That is, when investors are satisfied with a rate of interest lower than the rate stated on the bonds, they are willing to pay more than the face value of the bonds in order to acquire them, thus reducing their effective rate of interest below the stated rate. In this case, all the bonds are set to yield an effective interest rate of 12%, which adjusts the pricing of each individual bond so that they are all equally attractive to investors (purely on interest rates). – timing of cash flows – The bonds all have differing timing of cash flow to the investors. This can affect their risk, as cash flows further in the future have a higher risk factor than cash flows in the present. – bond security – Bonds security affects the risk of the bond. In the event of default, a secured bond will rank higher than an unsecured bond. Thus, unsecured bonds are generally riskier than secured bonds. Presumably the mortgage bonds have security. Solutions Manual 14.38 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 14.2 (CONTINUED) g. (continued) All the above factors have to be assessed together to determine the riskiness of each bond. The zero-coupon bonds have no cash flows over the entire 10-year term, making them riskier in that the company may not be able to pay back the $2.5 million at that time. On the other hand, the zero-coupon bonds may have more security underlying them than the 13% bonds that are listed as unsecured. The mortgage bonds are the least risky with the interest cash flows spread over the life of the bonds, and with physical property pledged as collateral if Anaconda is unable to pay the principal or interest. Further information is required, however, about the fair value of the underlying collateral. LO 1,2 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 14.3 1. a.

Divac Limited: 1/1/23 Cash ....................................... Bonds Payable ..............

300,000 300,000

Interest Expense1................... Cash .............................. 1 ($300,000 X 9% X 3/12)

6,750

12/31/23 Interest Expense .................... Interest Payable ............

6,750

7/1/23

6,750

2. a.

Verbitsky Inc.: 6/1/23 Cash ....................................... 210,000 Bonds Payable .............. 200,000 2 Interest Expense .......... 10,000 2 ($200,000 X 12% X 5/12)

7/1/23

Interest Expense3................... Cash .............................. 3 ($200,000 X 12% X 6/12)

12,000

12/31/23 Interest Expense .................... Interest Payable ............

12,000

Note to instructor: Some students may credit Interest Payable on 6/1/23. If they do so, the entry on 7/1/23 will have a debit to Interest Payable for $10,000 and a debit to Interest Expense for $2,000. LO 2 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 14.4 a. 1/1/23

b. 7/1/23

Cash ($800,000 X 102%) ............. Bonds Payable ......................

816,000

Interest Expense1 ........................ Bonds Payable ............................ Cash2 ...................................... 1 ($816,000 X 9.75% X 1/2) 2 ($800,000 X 10% X 6/12)

39,780 220

c. 12/31/23 Interest Expense3 ........................ Bonds Payable ............................ Interest Payable ..................... 3 ($815,7804 X 9.75% X 1/2) 4

816,000

40,000

39,769 231

Carrying amount of bonds at July 1, 2023: Carrying amount of bonds at January 1, 2023 Amortization of bond premium ($40,000 – $39,780) Carrying amount of bonds at July 1, 2023

40,000

$816,000 (220) $815,780

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EXERCISE 14.5 a. (1) 1/1/23

Cash ($800,000 X 102%) ....... Bonds Payable .................

816,000

Interest Expense ................... Bonds Payable1 ..................... Cash2 ................................ 1 ($16,000  40) 2 ($800,000 X 10% X 6/12)

39,600 400

(3) 12/31/23 Interest Expense ................... Bonds Payable ...................... Interest Payable ...............

39,600 400

(2) 7/1/23

816,000

40,000

Although the effective interest method is required under IFRS per IFRS 9.5.4.1, accounting standards for private enterprises do not specify that this method must be used and therefore, the straight-line method is also an option. The straight-line method is valued for its simplicity and might be used by companies reporting under ASPE.

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EXERCISE 14.6 a. 1.

January 1, 2023 Investment Property ...................... 1,500,000 Notes Payable ....................... (The $1,500,000 capitalized cost represents the present value of the note with maturity amount of $2,307,941 discounted for five years at 9%) Land ................................................ Mortgage Payable .................

1,500,000

1,743,292 1,743,292

1. Using tables: Present value of $2,000,000 due in 10 years at 9%—$2,000,000 X .42241 Present value of $140,000 ($2,000,000 X 7%) payable annually for 10 years at 9% annually—$140,000 X 6.41766 Present value of the note Discount to be amortized

$844,820

898,472 $1,743,292 $

256,708

2. Using a financial calculator: - for the principal PV I N PMT FV Type

$ ? Yields $1,743,293.69 9% 10 $(140,000) $ (2,000,000) 0

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EXERCISE 14.6 (CONTINUED) a. (continued) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $1,743,293.692 rounded to $1,743,294

A more accurate result is obtained using Excel or a financial calculator as compared to using factors from tables as there are a limited number of decimal places in the tables. This difference in most cases is immaterial. b. 1.

Interest Expense ($1,500,000 X .09) .. Notes Payable ...........................

135,000

Interest Expense ($1,743,292 X .09) .. Mortgage Payable ..................... Cash ($2,000,000 X .07).............

156,896

135,000

16,896 140,000

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EXERCISE 14.7 a. 1. Using tables Face value of the non-interest-bearing note $600,000 Discounting factor (12% for 3 periods) X .71178 Amount to be recorded for the land at January 1, 2023 $427,068 2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields 12% 3 0 $ (600,000) 0

$427,068.15

3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $427,068.1487 rounded to $427,068

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EXERCISE 14.7 (CONTINUED) a. (continued) Carrying amount of the note at January 1, 2023 Applicable interest rate (12%) Interest expense to be reported in 2023

$427,068 X .12 $ 51,248

The assessed value for the land is not as clear a measure of the value of the land compared to the present value of the future cash flows on the note. The present value represents the agreed cash flows, discounted at the market rate of interest, whereas the assessed value has been computed (generally) only for the purpose of municipal taxation. It can be used as a reasonableness check on the amount arrived for the carrying amount of the non–interest-bearing note. b. 1. Using tables $4,000,000 X .68301 = $2,732,040

2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields $2,732,054 10% 4 0 $ (4,000,000) 0

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EXERCISE 14.7 (CONTINUED) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $2,732,053.821 rounded to $2,732,054

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EXERCISE 14.8 a.

The purchase price of the land should be recorded at the present value of the future cash flows of the instalment note at the imputed interest rate of 9%. This is the fairest measure of the value of the asset obtained as it represents the present value of an agreed series of future cash flows. The listing price represents a tentative amount “asked” for the property and could be above or below the eventual agreed value.

Land will be recorded at $110,000 based on the calculations below: 1. Using tables *PV of $43,456 ordinary annuity @ 9% for 3 years: ($43,456 X 2.53130) = $110,000 2. Using a financial calculator: PV ? Yields $ 109,999.94 I 9% N 3 PMT $ (43,456) FV $0 Type 0

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EXERCISE 14.8 (CONTINUED) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $109,999.941 rounded to $110,000

Effective Interest Amortization Table Effective Interest Method – 9% Year 1/1/23 12/31/23 12/31/24 12/31/25

Note Payment

9% Interest

Reduction of Principal

$43,456 43,456 43,456

$9,900 6,880 3,588

$ 33,556 36,576 39,868

Carrying Amount $110,000 76,444 39,868 0

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EXERCISE 14.8 (CONTINUED) c.

Land .................................................... Notes Payable............................

110,000 110,000

Interest Expense ................................. 9,900 Notes Payable ..................................... 33,556 Cash ............................................ 43,456 (a) From the perspective of Safayeni Ltd., an instalment note provides for a reduced risk of collection when compared to a regular interest-bearing note. In the case of the interestbearing note, the principal amount is due at the maturity of the note. Further, the instalment note provides a regular reduction of the principal balance in every payment received annually and therefore reduces Safayeni’s investment in the receivable, freeing up the cash for other purposes. This is demonstrated in the effective interest amortization table provided above for the instalment note.

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EXERCISE 14.9 a.

Equipment ......................................... Notes Payable ..........................

316,987 316,987

1. Using tables PV of $100,000 annuity @ 10% for 4 years: ($100,000 X 3.16987) = $316,987 2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields $316,986.54 10% 4 $ (100,000) $ 0 0

3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $316,986.5446 rounded to $316,987

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EXERCISE 14.9 (Continued) b.

Interest Expense1.............................. Notes Payable ................................... Cash ......................................... 1 (10% X $316,987)

Year 1/2/23 12/31/23 12/31/24

31,699 68,301 100,000

Note Payment

10% Interest

Reduction of Principal

$100,000 100,000

$31,699 24,869

$68,301 75,131

Interest Expense ................................. Notes Payable ..................................... Cash ...........................................

Carrying Amount $316,987 248,686 173,555

24,869 75,131 100,000

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EXERCISE 14.10 a.

Equipment ...................................... Cash ...................................... Notes Payable .......................

86,349

1. Using tables PV of $75,000 @ 10% for 3 years ($75,000 X 0.75132) Down payment Capitalized value of equipment

30,000 56,349

$56,349 30,000 $86,349

2. Using a financial calculator: PV I N PMT FV Type

$? 10% 3 $0 ($ 75,000) 0

Yields $56,348.61

3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $56,348.61007 rounded to $56,349 Solutions Manual 14.53 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 14.10 (Continued)

December 31, 2024: Interest Expense (see schedule) .. Notes Payable ....................... Year 10% Interest 12/31/23 12/31/24 $5,634.90 12/31/25 6,198.39 12/31/26 6,817.711 1 rounded by $0.52

5,634.90

Balance $56,349.00 61,983.90 68,182.29 75,000.00

December 31, 2025: Interest Expense ............................ Notes Payable ....................... To record interest expense December 31, 2026: Interest Expense ............................ Notes Payable ....................... To record interest expense Notes Payable ................................ Cash ...................................... To record repayment of note c.

5,634.90

6,198.39 6,198.39

6,817.71 6,817.71

75,000.00 75,000.00

Accounting standards for private enterprises do not specify that the effective interest method must be used and therefore the straight-line method is also an option. Collins may prefer to use the straight-line method due to its simplicity. However, the effective interest method is required under IFRS per IFRS 9.5.4.1.

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EXERCISE 14.11 a. January 1, 2023 Cash ...................................................... Bonds Payable .............................

860,652 860,652

b. Schedule of Interest Expense and Bond Premium Amortization Effective Interest Method 12% Bonds Sold to Yield 10% Debit Debit Carrying Credit Interest Bond Amount of Date Cash Expense Payable Bonds 1/1/23 – – – $860,652 1/1/24 $96,000 $86,065 $ 9,935 850,717 1/1/25 96,000 85,072 10,928 839,789 1/1/26 96,000 83,979 12,021 827,768

December 31, 2023 Interest Expense ................................. Bonds Payable .................................... Interest Payable .........................

86,065 9,935

January 1, 2024 Interest Payable .................................. Cash............................................

96,000

December 31, 2025 Interest Expense ................................. Bonds Payable .................................... Interest Payable .........................

83,979 12,021

January 1, 2026 Interest Payable .................................. Cash............................................

96,000

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EXERCISE 14.11 (CONTINUED) e.

Accounting standards for private enterprises do not specify that the effective interest method must be used and therefore the straight-line method is also an option. Osborn may prefer to use the straight-line method due to its simplicity. However, the effective interest method is required under IFRS per IFRS 9.5.4.1.

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EXERCISE 14.12

Year Jan. 1, 2023 July 1, 2023 Jan. 1, 2024 July 1, 2024 Jan. 1, 2025 1

Schedule of Discount Amortization Straight-Line Method Debit Credit Credit Interest Bond Cash Expense Payable $40,000 40,000 40,000 40,000

$90,000 90,000 90,000 90,000

$50,000 50,000 50,000 50,000

Carrying Amount of Bonds $800,000 850,000 900,000 950,000 1,000,000

$50,000 = ($1,000,000 – $800,000) / 4 semi-annual periods

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EXERCISE 14.13 a. 1. Using a financial calculator: PV I N PMT FV Type

$ 2,783,713 ?% 5 $ (300,000) $ (3,000,000) 0

Yield 12%

2. Using Excel formula: = RATE(nper,pmt,pv,fv,type)

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EXERCISE 14.13 (Continued) a. (continued)

Year (1) Jan. 1, 2023 Jan. 1, 2024 Jan. 1, 2025 Jan. 1, 2026 Jan. 1, 2027 Jan. 1, 2028 1

Schedule of Discount Amortization Effective Interest Method (12%) Debit Credit Credit Interest Bond Cash Expense Payable (2) (3) (4) $300,000 300,000 300,000 300,000 300,000

$334,046 338,131 342,707 347,832 353,571

$34,046 38,131 42,707 47,832 53,571

Carrying Amount of Bonds $2,783,713 2,817,759 2,855,890 2,898,597 2,946,429 3,000,000

$334,046 = $2,783,713 X .12

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EXERCISE 14.13 (CONTINUED) b.

The straight-line method results in higher interest expense for the year ended December 31, 2023, and the effective interest method results in higher interest expense for the year ended December 31, 2027. Under the straight-line method, the amount that is amortized each year is constant. Under the effective interest method, the amount amortized each year is based on a constant percentage of the bonds’ increasing carrying amount. Users who like the company’s income statement to reflect the most faithfully representative measure of net income would prefer that the company use the effective interest method, under which interest expense correlates more closely with the actual carrying amount of the bond.

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EXERCISE 14.14 a. Printing and engraving costs of bonds Legal fees Commissions paid to underwriter Amount to be reported

$25,000 69,000 70,000 $164,000

When a note or bond is issued, it should be recognized at the fair value adjusted by any directly attributable issue costs. The costs would affect the amount of bond premium or discount amortization recorded and effectively increase the interest expense over the term of the bond. However, note that where the liabilities will subsequently be measured at fair value (e.g., under the fair value option or because they are derivatives), the transaction costs should not be included in the initial measurement (i.e., the costs should be expensed at the time of issuance) [CPA Canada Handbook, Part II, Section 3856.07 and IFRS 9.5.1.1]. b. Interest paid for each period, from January 1 to June 30, 2023 and July 1 to Dec. 31, 2023 $3,000,000 X 10% X 6/12 Less: Premium amortization for each period from January 1 to June 30, and July 1 to Dec. 31, [($3,000,000 X 1.04) – $3,000,000]  10 X 6/12 Interest expense to be recorded on each of July 1 and December 31, 2023 c. Carrying amount of bonds on June 30, 2023 Effective interest rate for the period from June 30 to October 31, 2023 (.10 X 4/12) Interest expense to be recorded on October 31, 2023

$150,000

6,000 $ 144,000

$562,613 X .033333 $ 18,754

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.14 (CONTINUED) d. Carrying amount of bonds on Dec. 31, 2023 Less: fair value of bonds on Dec. 31, 2023 Gain on bonds due to change in credit risk

$850,716.97 838,000.00 $12,716.97

Under IFRS 9 gains/losses related to changes in credit risk are booked through Other Comprehensive Income. (Note that under ASPE, where the fair value option is used, credit risk is incorporated into the measurement and resulting gains/losses are booked through net income.) e.

1. IFRS Bonds Payable .................................... Unrealized Gain or Loss—OCI .

12,717

2. ASPE Bonds Payable .................................... Unrealized Gain or Loss ...........

12,717

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.15 a.

Through the interest-free forgivable loan for Sunshine to build additional solar panels, the government is reducing the cost of the panels in addition to providing the financing. The company is avoiding the interest it would ordinarily have been charged. Sunshine is getting a double benefit. First it is getting the loan and second the company does not have to incur interest payments on the note. Since the company believes that the loan will be forgiven, the benefit should be accounted for as a government grant. The measurement of the interest at 12% is the fair rate of interest to impute on this loan.

1. Using tables: PV of $500,000 @ 12% discounted 5 years (500,000 x 0.56743 = 283,715) 2. Using a financial calculator: PV I N PMT FV Type

$ ? 12% 5 $ 0 (500,000) 0

Yields $ 283,713.43

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.15 (CONTINUED) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $283,713.4279 rounded to $283,713

Date 12/31/23 12/31/24 12/31/25 12/31/26

Schedule of Note Discount Amortization Debit, Interest Expense Carrying Amount Credit Notes Payable of Note $ 283,715 $34,046 317,761 38,131 355,892 42,707 398,599

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.15 (CONTINUED) c. Cash .................................................................. 500,000 Notes Payable ......................................... 283,715 1 Equipment .............................................. 216,285 1 ($500,000 – $283,715 = $216,285)

d. December 31, 2024 Interest Expense .............................................. Notes Payable .........................................

34,046 34,046

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.16 a. 1.

June 30, 2023 Cash ........................................................ 4,300,920 Bonds Payable ..............................

December 31, 2023 Interest Expense ................................... Bonds Payable ....................................... Cash2 ............................................. 1 ($4,300,920 X 12% X 6/12) 2 ($4,000,000 X 13% X 6/12) 1

June 30, 2024 Interest Expense ................................... Bonds Payable ....................................... Cash ............................................... 3 [($4,300,920 – $1,945) X 12% X 6/12] 3

4,300,920

258,055 1,945 260,000

257,939 2,061

December 31, 2024 Interest Expense ................................... 257,815 Bonds Payable ....................................... 2,185 Cash ............................................... 4 [($4,300,920 – $1,945 – $2,061) X 12% X 6/12]

260,000

b. Long-term Liabilities: Bonds payable, 13% (due on June 30, 2043)

$4,298,975

($4,300,920 – $1,945) = $4,298,975

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.16 (CONTINUED) c. 1.

Interest expense for the period from July 1 to December 31, 2023 from (a) 2. Amount of bond interest expense reported for 2023

$258,055 $258,055

The amount of bond interest expense reported in 2023 will be greater than the amount that would be reported if the straight-line method of amortization were used. Under the straight-line method, the amortization of bond premium is $7,523 ($300,920/20 X 6/12). Bond interest expense for 2023 would be the difference between the actual interest paid, $260,000 ($4,000,000 X 13% X 6/12) and the amortized premium, $7,523. Thus, the amount of bond interest expense would be $252,477, which is smaller than the bond interest expense under the effective interest method. Note: Although the effective interest method is required under IFRS per IFRS 9.5.4.1, accounting standards for private enterprises do not specify that this method must be used and therefore the straight-line method is also an option. The straight-line method is valued for its simplicity and might be used by companies reporting under ASPE.

Total interest to be paid for the bond ($4,000,000 X 13% X 20) Principal due in 2043 Total cash outlays for the bond Cash received at issuance of the bond Total cost of borrowing over the life of the bond

$10,400,000 4,000,000 14,400,000 (4,300,920) $10,099,080

They will be the same, although the pattern of recognition will be different.

LO 2,4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.17 Reacquisition price ($500,000 X 104%) .... Less: Net carrying amount of bonds redeemed: Face value ....................................... Unamortized discount .................... Loss on redemption................................... April 30, 2023 Bonds Payable ........................................... Loss on Redemption of Bonds ................. Cash................................................... To record redemption of bonds payable March 31, 2023 Cash ............................................................ Bonds Payable ($500,000 + $15,000 – $3,000).......... To record issuance of new bonds

$520,000

$500,000 (10,000)

490,000 $ 30,000

490,000 30,000 520,000

512,000 512,000

Note: When a note or bond is issued, it should be recognized at the fair value adjusted by any directly attributable issue costs. These costs would affect the amount of bond premium or discount amortization recorded and effectively increase the interest expense over the term of the bond through the allocation of the issuance cost to periods. However, note that where the liabilities will subsequently be measured at fair value (e.g., under the fair value option or because they are derivatives), the transaction costs should not be included in the initial measurement (i.e., the costs should be expensed at the time of issuance) [CPA Canada Handbook, Part II, Section 3856.07 and IFRS 9.5.1.1]. LO 3 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.18 a. June 30, 2023 Bonds Payable ............................................ Loss on Redemption of Bonds .................. Cash.................................................... To record redemption of bonds payable

789,600 42,400 832,000

Reacquisition price ($800,000 X 104%) ..... Carrying amount of bonds redeemed: Par value ............................................ Unamortized discount1 ...................... 1 (.02 X $800,000 X 13/20) Loss on redemption.................................... Cash ($1,000,000 X 102%) .......................... Bonds Payable ................................... To record issuance of new bonds b.

$832,000 $800,000 (10,400)

(789,600) $ 42,400

1,020,000

December 31, 2023 Interest Expense ................................. Bonds Payable2................................... Cash3 .......................................... 2 (1/40 X $20,000 = $500) 3 (.05 X $1,000,000 = $50,000)

1,020,000

49,500 500 50,000

LO 2,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.19 1. Using a financial calculator: PV I N PMT FV Type

$ 784,000 ?% 40 $ (48,000) $ (800,000) 0

Yields 6.135%

2. Using Excel: =RATE(nper,pmt,pv,fv,type)

Result: .061351945 rounded to three decimal places 6.135%

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.19 (CONTINUED) a. (continued) Schedule of Bond Discount Amortization Effective Interest Method 12% Semi-annual Bonds Sold to Yield 12.27% 6.0% 6.135% Cash Effective Discount Carrying Date Interest Interest Amortized Amount June 30 2016 $784,000.00 Dec. 31 2016 $48,000.00 $48,098.40 $98.40 784,098.40 June 30 2017 48,000.00 48,104.44 104.44 784,202.84 Dec. 31 2017 48,000.00 48,110.84 110.84 784,313.68 June 30 2018 48,000.00 48,117.64 117.64 784,431.32 Dec. 31 2018 48,000.00 48,124.86 124.86 784,556.18 June 30 2019 48,000.00 48,132.52 132.52 784,688.70 Dec. 31 2019 48,000.00 48,140.65 140.65 784,829.35 June 30 2020 48,000.00 48,149.28 149.28 784,978.63 Dec. 31 2020 48,000.00 48,158.44 158.44 785,137.07 June 30 2021 48,000.00 48,168.16 168.16 785,305.23 Dec. 31 2021 48,000.00 48,178.48 178.48 785,483.71 June 30 2022 48,000.00 48,189.43 189.43 785,673.14 Dec. 31 2022 48,000.00 48,201.05 201.05 785,874.19 June 30 2023 48,000.00 48,213.38 213.38 786,087.57 $2,087.57 Although not required, the entry at the issuance of the bonds is: 6/30/16 Cash ($800,000 X 98%) ................ Bonds Payable........................

784,000 784,000

At June 30, 2023, the carrying amount of the bonds is as indicated in the effective interest table: $786,087.57

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.19 (CONTINUED) a. (continued) June 30, 2023 Bonds Payable ......................................... Loss on Redemption of Bonds ............... Cash................................................. To record reacquisition of bonds payable

786,087.57 45,912.43 832,000.00

Reacquisition price ($800,000 X 104%) . Net carrying amount of bonds redeemed: Loss on redemption................................ Cash ($1,000,000 X 102%) ...................... Bonds Payable ............................... To record issuance of new bonds

$832,000.00 786,087.57 $45,912.43 1,020,000 1,020,000

1. Using a financial calculator: PV I N PMT FV Type

$ 1,020,000 ?% 40 $ (50,000) $ (1,000,000) 0

Yields 4.885 %

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.19 (CONTINUED) a. (continued) 2. Using Excel: =RATE(nper,pmt,pv,fv,type)

Result: 0.048852691 rounded to three decimal places 4.885%

December 31, 2023 Interest Expense ............................... Bonds Payable ................................... Cash .......................................... 1 ($1,020,000 X 4.885% = $49,827) 1

49,827 173 50,000

LO 3 BT: AP Difficulty: C Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.20 a. Reacquisition price ($850,000 X 102%) Less: Net carrying amount of bonds redeemed: Par value Unamortized discount1 Loss on redemption 1

Calculation of unamortized discount— Original amount of discount: $850,000 X 3% = $25,500 Bond issuance costs ($110,000 X $850,000/$1,500,000 =

Amount to be amortized over 10 years Amount of discount unamortized: 1 ($87,833 X 5) ÷ 10 = $43,917

$867,000 850,000 (43,917) 806,083 $ 60,917

$25,500 62,333 $87,833

January 2, 2023 Bonds Payable ................................................. 806,083 Loss on Redemption of Bonds ...................... 60,917 Cash......................................................... 867,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.20 (CONTINUED) b.

Had the costs of issuing the bond of $110,000 been expensed on the date of issue (which is the required accounting treatment for transactions costs when the debt is subsequently measured at fair value rather than amortized cost), the issue costs would have been charged to expense in 2018.

Reacquisition price ($850,000 X 102%) Less: Carrying amount of bonds on the reacquisition date = fair value at that date (see assumption) Gain/Loss on redemption

$867,000

867,000 $ -0-

Note to instructor: Since the bonds are carried at fair value, there would be no separate gain or loss on retirement. All changes in the fair value of the bonds would have already been recognized in net income in prior years. If the company had adopted IFRS 9 early in prior years, all changes in the fair value of the bonds (which relate to changes in credit risk) would have already been recognized in Other Comprehensive Income. January 2, 2023 Bonds Payable ................................................. 867,000 Cash......................................................... 867,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.20 (CONTINUED) c.

If Kowalchuk were to follow IFRS, then the effective interest method must be used to amortize any discounts or premiums. Although the effective interest method is required under IFRS per IFRS 9.5.4.1, accounting standards for private enterprises do not specify that this method must be used and therefore, the straight-line method is also an option. The straight-line method is valued for its simplicity and might be used by companies whose financial statements are not constrained by IFRS. Under IAS 39, where the fair value option is selected, credit risk is incorporated into the measurement and resulting gains/losses are booked through net income. However, under IFRS 9, gains/losses related to changes in credit risk are booked through Other Comprehensive Income. (Note that under ASPE, where the fair value option is used, credit risk is incorporated into the measurement and resulting gains/losses are booked through net income.)

LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.21 Cash ($5,000,000 X .97) ....................... Bonds Payable ............................ To record issuance of 6% bonds

4,850,000

Bonds Payable ..................................... Loss on Redemption of Bonds ........... Cash ($10,000,000 X 1.05) .......... To record retirement of 8% bonds

8,900,000 1,600,000

4,850,000

10,500,000

Reacquisition price .............................. $10,500,000 Less: Net carrying amount of bonds redeemed: Par value ..................................... $10,000,000 Unamortized bond discount ...... ( 1,100,000) 8,900,000 Loss on redemption............................. $ 1,600,000 LO 3 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.22 a.

Journal entry to record issuance of loan by Par Bank: December 31, 2022 Notes Receivable ................................ Cash ...........................................

81,241 81,241

Date 12/31/22 12/31/23

Note Amortization Schedule (Before Impairment) Cash Interest Received Income Discount (0%) (9%) Amortized $0

$7,312

Computation of the impairment loss: Carrying amount of investment (12/31/23)

Carrying Amount of Note $81,241 88,553

$88,553

1. Using tables: Less: Present value of $93,750 due in 4 years at 9% ($93,750 X .70843) Loss due to impairment

66,415 $22,138

2. Using a financial calculator: PV I N PMT FV Type

$ ? 9% 4 0 $ (93,750) 0

Yields $66,415

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.22 (CONTINUED) b. (continued) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $66,414.86354 rounded to $66,415 The entry to record the loss by Par Bank is as follows: Loss on Impairment ..................................... Allowance for Expected Credit Losses ........................................... c.

22,138 22,138

Mohr Inc., the debtor, makes no entry because it still legally owes $125,000.

LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.23 a. Transfer of property on December 31, 2023: Strickland Inc. (Debtor): Notes Payable .......................................... Interest Payable ....................................... Accumulated Depreciation—Machinery . Machinery .......................................... Gain on Disposal of Machinery1 ....... Gain on Restructuring of Debt2 ........ 1 2

200,000 18,000 221,000 390,000 11,000 38,000

$180,000 – ($390,000 – $221,000) = $11,000 ($200,000 + $18,000) – $180,000 = $38,000 Heartland Bank (Creditor): Machinery ................................................... Allowance for Expected Credit Losses3 ... Notes Receivable ............................... Interest Receivable ............................

180,000 38,000 200,000 18,000

As given in the problem, this assumes Heartland had previously recognized a loss when they determined the loan was impaired and set up an allowance for expected credit losses or had otherwise included this category of notes in allowance calculations. b.

If “Gain on Disposal of Machinery” and “Gain on Restructuring of Debt” do not occur frequently, they are still presented as part of income from continuing operations. If they are not material in amount, they are combined with the other items in the income statement. If they are material, they are disclosed separately. However, if the same types of gains/losses recur each year, then they are not really unusual and care must be taken to classify them with other gains and losses as normal transactions.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.23 (CONTINUED) c.

Granting of equity interest on December 31, 2023: Strickland Inc. (Debtor): Notes Payable ...................................... Interest Payable ................................... Common Shares .......................... Gain on Restructuring of Debt .... Heartland Bank (Creditor): FV-NI Investments ............................... Allowance for Expected Credit Losses4 ................................................ Notes Receivable ......................... Interest Receivable ......................

200,000 18,000 190,000 28,000

190,000 28,000 200,000 18,000

Assumes Heartland had previously recognized a loss when they determined the loan was impaired and set up an allowance for expected credit losses or had otherwise included this category of notes in allowance calculations. LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.24 a.

The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency and therefore the test to establish whether there is a settlement or not revolves around the cash flows. The present value of the cash flow streams of the new debt are calculated using the historical interest rate of 12% for consistency and comparability. Present value of old debt is $2,000,000. Present value of new debt is calculated as follows: 1. Using tables:

Single amount Interest annuity

$1,900,000 190,000

12% Factor 0.71178 2.40183

Present Value $1,352,382 456,348 $1,808,730

2. Using a financial calculator: PV I N PMT FV Type

$? 12% 3 $ (190,000) $ (1,900,000) 0

Yields $1,808,730

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.24 (CONTINUED) a. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $1,808,730.41 rounded to $1,808,730 Since the present value of the future cash flows of the new debt does not differ by an amount greater than 10%1 of the present value of the old debt, the renegotiated debt is not considered a substantial modification. This is considered a modification of terms. The old debt remains on the books of Troubled but a gain is recognized to reflect the new cash flows. Note disclosure is required. 1

Old debt New debt Difference As a %

$2,000,000 1,808,730 $ 191,270 9.56%

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.24 (CONTINUED) b.

Under IFRS, the note would be remeasured to reflect the new cash flows discounted at the original effective interest rate of 12% as follows.

December 31, 2023 Notes Payable ............................................ Gain on Restructuring of Debt2 ....... 2 ($2,000,000 - $1,808,730)

191,270 191,270

c. TROUBLED INC. INTEREST PAYMENT SCHEDULE AFTER DEBT RESTRUCTURING EFFECTIVE INTEREST RATE 12% Cash Effective Increase Carrying Interest Interest of Carrying Amount of Date 10% 12% Amount Note 12/31/23 $1,808,730 a b c 12/31/24 $190,000 $217,048 $27,048 1,835,778 12/31/25 190,000 220,293 30,293 1,866,071 12/31/26 190,000 223,929 33,929 1,900,000 Total $570,000 $661,270 $91,270 a

$1,900,000 X 10% = $190,000 $1,808,730 X 12% = $217,048 c $190,000 – $217,048 = $27,048 b

Interest payment entry for Troubled Inc. is: December 31, 2025 Interest Expense ................................. 220,293 Notes Payable............................. Cash ...........................................

30,293 190,000

January 1, 2027 Notes Payable ..................................... 1,900,000 Cash ...........................................

1,900,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.24 (CONTINUED) e.

The new effective rate of 7.9592% was computed by Troubled in order to record the interest expense based on the future cash flows specified by the new terms with the pre-restructuring carrying amount of the debt of $2,000,000. The rate would have been calculated as follows: 1. Using a financial calculator: PV I N PMT FV Type

$ 2,000,000 ?% 3 $ (190,000) $ (1,900,000) 0

Yields 7.9592 %

2) Using Excel: =RATE(nper,pmt,pv,fv,type)

Result: 0.079592209 rounded to 7.9592%

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.24 (CONTINUED) f. The interest payment schedule is prepared as follows: TROUBLED INC. INTEREST PAYMENT SCHEDULE AFTER DEBT RESTRUCTURING EFFECTIVE INTEREST RATE 7.9592% Cash Effective Reduction Carrying Interest Interest of Carrying Amount of Date 10% 7.9592% Amount Note 12/31/23 $2,000,000 a b c 12/31/24 $190,000 $159,184 $30,816 1,969,184 12/31/25 190,000 156,731 33,269 1,935,915 d 12/31/26 190,000 154,085 35,915 1,900,000 Total $570,000 $470,000 $100,000 a

$1,900,000 X 10% = $190,000 $2,000,000 X 7.9592% = $159,184 c $190,000 – $159,184 = $30,816 d Rounded b

Interest payment entry for Troubled Inc. is: December 31, 2025 Notes Payable ..................................... 33,269 Interest Expense ................................. 156,731 Cash ...........................................

190,000

January 1, 2027 Notes Payable ..................................... 1,900,000 Cash ...........................................

1,900,000

LO 3,5 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.25 a.

Green Bank should use the historical interest rate of 12% to calculate the loss.

b. Pre-restructuring carrying amount of note Present value of restructured cash flows (below) Loss on restructuring of debt

$2,000,000 1,808,730 $ 191,270

1. Using tables:

Single amount Interest annuity

$1,900,000 190,000

12% Factor 0.71178 2.40183

Present Value $1,352,382 456,348 $1,808,730

2. Using a financial calculator: PV I N PMT FV Type

$? 12% 3 $ (190,000) $ (1,900,000) 0

Yields $1,808,730

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.25 (CONTINUED) b. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $1,808,730.41 rounded to $1,808,730

December 31, 2023 Modification Gain or Loss ......................... Notes Receivable ..............................

191,270 191,270

Note: Any gains or losses on modification of contractual cash flows must be shown in the income statement as a modification gain or loss (IFRS 9.5.4.3). If Green Bank had previously recognized an Allowance for Expected Credit Losses related to this account, the debit account would have been the Allowance account instead of the expense account.

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EXERCISE 14.25 (CONTINUED) c.

The interest receipt schedule is prepared as follows: GREEN BANK INTEREST RECEIPT SCHEDULE AFTER DEBT RESTRUCTURING EFFECTIVE INTEREST RATE 12% Cash Effective Increase Carrying Interest Interest in Carrying Amount of Date 10% 12% Amount Note

12/31/23 12/31/24 $190,000a $217,048b 12/31/25 190,000 220,293 12/31/26 190,000 223,929 Total $570,000 $661,270 a $1,900,000 X 10% = $190,000 b $1,808,730 X 12% = $217,048 c $217,048 – $190,000 = $27,048

$27,048 30,293 33,929 $91,270

$1,808,730 1,835,778 1,866,071 1,900,000

Interest receipt entry for Green Bank is: December 31, 2025 Cash ................................................... 190,000 Notes Receivable ............................... 30,293 Interest Income .........................

220,293

The receipt entry at maturity is: January 1, 2027 Cash ................................................... 1,900,000 Notes Receivable......................

1,900,000

LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.26 a.

The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency and therefore, the test to establish whether there is a settlement or not revolves around the cash flows. The present value of the cash flow streams of the new debt are calculated using the historical interest rate of 12% for consistency and comparability. Present value of old debt is $2,000,000. Present value of new debt is calculated as follows:

1. Using tables: Single amount Interest annuity

$1,600,000 160,000

12%

Present

Factor 0.71178 2.40183

Value $1,138,848 384,293 $1,523,141

2. Using a financial calculator: PV I N PMT FV Type

$? 12% 3 $ (160,000) $ (1,600,000) 0

Yields $1,523,141

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.26 (CONTINUED) a. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $1,523,141.399 rounded to $1,523,141 Since the present value of the future cash flows of the new debt of $1,523,141 differs by an amount larger than 10% of the present value of the future cash flows of the old debt in the amount of $2,000,000, the renegotiated debt is considered a settlement and Troubled records a gain. b.

Notes Payable ................................... Gain on Restructuring of Debt Notes Payable ..........................

2,000,000 400,000 1,600,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.26 (CONTINUED) c.

The new debt would be recorded at the present value of the new cash flows at the current market rate of 10%. Therefore, Troubled should use the current market rate of 10% to calculate its interest expense in future periods. In E14.24, the renegotiated debt was not considered a settlement, and a new effective interest rate was imputed by equating the carrying amount of the original debt with the present value of the revised cash flows.

The interest payment schedule is prepared as follows: TROUBLED INC. INTEREST PAYMENT SCHEDULE AFTER DEBT RESTRUCTURING EFFECTIVE INTEREST RATE 10% Cash Effective Reduction Carrying Interest Interest of Carrying Amount of Date 10% 10% Amount Note 12/31/23 $1,600,000 a 12/31/24 $160,000 $160,000 1,600,000 12/31/25 160,000 160,000 1,600,000 12/31/26 160,000 160,000 1,600,000 Total $480,000 $480,000 a $1,600,000 X 10% = $160,000

Interest payment entries for Troubled Inc. are: December 31, 2024 through 2026 Interest Expense ................................. 160,000 Cash ...........................................

160,000

The payment entry at maturity is: January 1, 2027 Notes Payable ..................................... 1,600,000 Cash ...........................................

1,600,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.27 a.

Green Bank needs to calculate the present value of the expected cash flows discounted at the historical effective interest rate, which in this case is 12%.

b. Pre-restructuring carrying amount of note Present value of restructured cash flows (below) Loss on debt restructuring

$2,000,000 1,523,141 $ 476,859

1. Using tables:

Single amount Interest annuity

$1,600,000 160,000

12% Factor 0.71178 2.40183

Present Value $1,138,848 384,293 $1,523,141

2. Using a financial calculator: PV I N PMT FV Type

$? 12% 3 $ (160,000) $ (1,600,000) 0

Yields $1,523,141

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.27 (Continued) b. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $1,523,141.399 rounded to $1,523,141 b. December 31, 2026 Modification Gain or Loss ........................... Notes Receivable ................................

476,859 476,859

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.28 The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency and therefore, the test to establish whether there is a settlement or not revolves around the cash flows. The present value of the cash flow streams of the new debt are calculated using the historical interest rate of 12% for consistency and comparability. Present value of old debt is $270,000. Present value of new debt is calculated as follows: 1. Using tables: Single amount Interest annuity

$220,000 11,000

12% Factor 0.79719 1.69005

Present Value $175,382 18,591 $193,973

2. Using a financial calculator: PV I N PMT FV Type

$? 12% 2 $ (11,000) $ (220,000) 0

Yields $193,973

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.28 (CONTINUED) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $193,973.2143 rounded to $193,973 Since the present value of the future cash flows of the new debt differs by an amount larger than 10% of the present value of the old debt, the renegotiated debt is considered a settlement. A gain/loss is recorded by Vargo (debtor) and no interest is recorded by the debtor. This is not considered a modification of terms. The old debt is removed from the books of Vargo with a gain/loss being recognized, and the new debt is recorded.

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EXERCISE 14.28 (CONTINUED) Vargo Corp.’s entries: 2023 Notes Payable ....................................... Gain on Restructuring of Debt ..... Notes Payable ...............................

270,000 50,000 220,000

2024 Interest Expense ................................... Cash (5% X $220,000) ...................

11,000

2025 Interest Expense…………………………. Cash…………………………………..

11,000

2025 Notes Payable…………………………… Cash…………………………………..

220,000

11,000

220,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 14.29 a.

IFRS

6. 7. 8. 9. 10.

Current liability since the operating cycle of the winery is 5 years. Current liability, $2,000,000; long-term liability, $8,000,000. Current liability (amount actually held in trust). Long-term liability Interest payable is a current liability and the note payable is long-term liability. Current liability. Long-term liability. Current liability. Current asset – netted against other cash balances. Current liability.

ASPE

2. 3. 4. 5.

No differences. All the above IFRS classifications would be the same under ASPE. LO 4 BT: K Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 14.30 a.

IFRS

Interest expense (debit balance)—“Interest expense” on the income statement. Loss on restructuring of debt— If “Loss on restructuring of debt” does not occur frequently, it is still presented as part of “Income from continuing operations.” If it is not material in amount, it is combined with the other items in the income statement. If it is material, it is disclosed separately. Mortgage payable—Classify full amount as long-term liability on the statement of financial position (SFP). Debenture bonds—Classify as current liability on the SFP since the covenant was breached, making the amount immediately owing. Since the waiver was received after year end, must still be current. Promissory notes payable—Classify 1/10 of the balance as current portion of promissory notes payable, and remaining balance as long-term liability on the SFP. Income bonds payable—Classify full amount as current liability on the SFP.

3. 4.

ASPE Except for number 4, no differences. All the above IFRS classifications would be the same under ASPE. Under number 4, since the waiver was received after year end but before the financial statements were issued, ASPE would allow the debentures to still be presented as long term on the balance sheet.

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EXERCISE 14.31 At December 31, 2023, disclosures would be as follows: Long-term debt consists of the following: Notes payable, due June 30, 2026 Bonds, due September 30, 2027 Debenture

$2,200,000 4,000,000 17,500,000 $23,700,000

The debenture has annual sinking fund payments of $3,500,000 in each of the years 2025 to 2029. Maturities and sinking fund requirements on long-term debt are as follows: 2024 2025 2026 2027 2028 Thereafter

$ 0 3,500,000 5,700,000 7,500,000 3,500,000 3,500,000

($2,200,000 + $3,500,000) ($4,000,000 + $3,500,000)

Note: The company would also need to disclose interest rates for each liability, collateral if any, covenants, and any other significant details in the debt agreements. LO 4 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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TIME AND PURPOSE OF PROBLEMS Problem 14.1 Purpose—to provide the student with an opportunity to become familiar with the exchange of an instalment note, which is payable in equal instalments, for raw materials to construct equipment. This problem requires the preparation of the necessary journal entries concerning the exchange and the annual payments and interest. A schedule of note discount amortization should be constructed to support the respective entries.

Problem 14.2 Purpose—to provide the student with the opportunity to contrast the terms of a long-term note given in exchange for the purchase of land. The discussion of risk and financial statement disclosure is included as part of the required for this question. The preparation of effective interest tables for both alternatives is intended to draw the student’s attention to the differences in the treatment of principal and interest between a regular note and an instalment note payable. Journal entries and adjusting entries and the SFP disclosure must also be prepared under both alternatives. This is a comprehensive question.

Problem 14.3 Purpose—to provide the student with the opportunity to interpret a bond amortization schedule. This problem requires both an understanding of the function of such a schedule and the relevance of each of the individual numbers. The student is to prepare journal entries to reflect the information given in the bond amortization schedule.

Problem 14.4 Purpose—to provide the student with an understanding of how to make the journal entry to record the issuance of bonds. In addition, a portion of the bonds are retired and therefore a bond amortization schedule has to be prepared. Student must also deal with accounting for the costs of issuing a bond and the fair value method.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 14.5 Purpose—to provide the student with an understanding of the relevant journal entries necessary for a bond issuance. This problem involves two independent bond issuances with the assumption that one is sold at a discount and the other at a premium, both utilizing the effective interest method. This comprehensive problem requires preparing journal entries for the issuance of bonds, related interest payments and amortization (with the construction of amortization tables where applicable), and the retirement of part of the bonds.

Problem 14.6 Purpose—to provide the student with an understanding of the relevant journal entries for a bond issuance and partial bond retirement. This problem requires preparing journal entries, assuming the straight-line method, for the issuance of bonds, related interest payments and amortization, and the retirement of part of the bonds. The student must also comment on any differences that would be addressed under IFRS.

Problem 14.7 Purpose—to provide the student with an opportunity to become familiar with the exchange of notes for cash or property, goods, or services. This problem requires the preparation of the necessary journal entries concerning the exchange of a non–interest-bearing long-term note for a machine, and the necessary adjusting entries relative to amortization. The student should construct the relevant schedule of note discount amortization to support the respective entries. Finally, the effect of issuing debt on the debt to total assets ratio is calculated.

Problem 14.8 Purpose—to provide the student with an understanding of the various accounts that are generated in a non-market rate bond issue, the financing of the purchase of machinery with an instalment loan, a government loan with a near zero interest rate, and the treatment of the repurchase of bonds issued earlier in the year. Justification must be provided for the treatment of the items in the SFP related to the specifics of this case.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 14.9 Purpose—to provide the student with an understanding of the relevant journal entries necessary when there is a bond issuance and bond retirement. This problem also provides an opportunity for the student to learn the income statement treatment of a loss from retirement and the footnote disclosure required.

Problem 14.10 Purpose—to provide the student with an understanding of a number of areas related to bonds. Specifically, the classification of bonds, determination of cash received with bond issue costs and accrued interest, and disclosure requirements.

Problem 14.11 Purpose—to provide the student with a series of transactions from bond issuance, payment of bond interest, accrual of bond interest, amortization of bond discount, and bond retirement. Journal entries are required for each of these transactions.

Problem 14.12 Purpose—to provide the student the same opportunity as those given in Problem 14.11 except that the effective interest method will be used. The student will be required to calculate the effective interest rate on the bond using either a financial calculator or Excel function. The preparation of a partial effective interest table is also required.

Problem 14.13 Purpose—to provide the student with an understanding of the relevant journal entries necessary for a bond issuance. This problem involves two independent bond issuances with the assumption that one is sold at a discount and the other at a premium, both utilizing the effective interest method. This comprehensive problem requires preparing journal entries for the issuance of bonds, related interest payments and amortization (with the construction of amortization tables where applicable), and the retirement of part of the bonds.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 14.14 Purpose—to provide the student with a loan impairment situation that requires entries by both the debtor and the creditor and an analysis of the loss on impairment.

Problem 14.15 Purpose—to provide the student with a troubled debt situation that requires calculation of the creditor’s loss on restructure, entries to recognize the loss, and discussion of GAAP relating to this situation.

Problem 14.16 Purpose—to provide the student with four independent and different restructured debt situations where losses or gains must be computed and journal entries recorded on the books of the creditor and the debtor.

Problem 14.17 Purpose—to provide the student with a restructuring of a troubled debt situation requiring computation of the creditor’s loss and entries by both the debtor and creditor before and after restructuring along with an amortization schedule.

Problem 14.18 Purpose—to provide the student with a situation where troubled debt is sold to another creditor. The student must prepare entries on the books of both creditors and debtors after computing any gains or losses.

Problem 14.19 Purpose—to provide the student with a complex troubled debt situation that requires two amortization schedules, computation of loss on restructure, and entries at different times on both the creditor’s and debtor’s books.

Problem 14.20 Purpose—to provide the student with an opportunity to advise management on the legal, accounting, and reporting issues concerning derecognition of debt on the SFP. Legal defeasance and in-substance defeasance are contrasted in this case. Solutions Manual 14.104 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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SOLUTIONS TO PROBLEMS PROBLEM 14.1 a. 1. Using tables: PV of $200,000 annuity @ 9% for 5 years ($200,000 X 3.88965) Down payment Capitalized value of metals

$ 777,930 500,000 $1,277,930

2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields $777,930 9% 5 $ (200,000) $0 0

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result $777,930.2527 rounded to $777,930 Solutions Manual 14.105 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 14.1 (CONTINUED) b.

Date Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31

Instalment Note Repayment Schedule 10% 9% Cash Effective Principal Paid Interest Paid 2023 2024 2025 2026 2027 2028

$200,000 200,000 200,000 200,000 200,000

$ 70,014 58,315 45,563 31,664 16,514 $222,070

$129,986 141,685 154,437 168,336 183,486 $777,930

Carrying Amount of Note $777,930 647,944 506,259 351,822 183,486 0

c. 12/31/23 Equipment ................................... Cash ...................................... Notes Payable .......................

1,277,930

12/31/24 Notes Payable ............................. Interest Expense.......................... Cash .....................................

129,986 70,014

12/31/25 Notes Payable .............................. Interest Expense........................... Cash ....................................

141,685 58,315

12/31/26 Notes Payable .............................. Interest Expense........................... Cash ....................................

154,437 45,563

500,000 777,930

200,000

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PROBLEM 14.1 (CONTINUED) c. (continued) 12/31/27 Notes Payable .............................. Interest Expense........................... Cash ....................................

168,336 31,664

12/31/28 Notes Payable .............................. Interest Expense........................... Cash ....................................

183,486 16,514

200,000

From the perspective of the lender, an instalment note provides for a reduced risk of collection when compared to an interestbearing note. In the case of the interest-bearing note, the principal amount is due at the maturity of the note. Further, the instalment note provides a regular reduction of the principal balance in every payment received annually and therefore reduces the lender’s investment in the receivable, freeing up the cash for other purposes. This is demonstrated in the instalment note repayment schedule provided above.

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PROBLEM 14.2 a.

The value of the land should be recorded at the present value of the future cash flows of the note given in exchange for the land. The asking price for the land is higher than the real purchase price. There is some flexibility to negotiate a reduction in the asking price for the land for sale by Silverman Corporation. The relevant interest rate to impute on the note is the interest rate to MacDougall who is the borrower in this case. The relevant interest rate is therefore 10%. The interest rate called for in the note of 4% is very low in relation to a fair market rate of interest.

A mortgage note involves the registering of a charge against the property, in this case land, whereas a promissory note alone offers no reduction of risk to Silverman Corporation. Should MacDougall fail to pay the note within the terms, Silverman Corporation can obtain recourse through the court and obtain the asset, or the proceeds from the resale of the asset, as satisfaction for the outstanding principal and interest owing on the mortgage note. A promissory note alone does not offer this potential relief and would therefore be a higher credit risk to Silverman Corporation.

The land is capitalized at the present value of a single payment at the end of five years of $300,000 plus the annuity interest payments of $12,000 per year for 5 years, imputed at 10% interest. 1. Using tables: $300,000 X .62092 = $12,000 X 3.79079 = Present value *rounded up

$186,276 45,490* $231,766

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.2 (CONTINUED) c. (continued) 2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields $231,766 10% 5 $ (12,000) $ (300,000) 0

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $231,765.8382 rounded to $231,766

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PROBLEM 14.2 (CONTINUED) c. (continued) Mortgage Note Payable – interest paid at 4%

Date June 1 2023 June 1 2024 June 1 2025 June 1 2026 June 1 2027 June 1 2028 1

4% Cash Interest

10% Effective Intrerest

$12,000 12,000 12,000 12,000 12,000

$23,177 24,294 25,524 26,876 28,3631 $128,234

Discount Amortized $11,177 12,294 13,524 14,876 16,363 $68,234

Carrying Amount of Note $231,766 242,943 255,237 268,761 283,637 300,000

$1 rounding

June 1, 2023 Land ............................................... Notes Payable .......................

231,766 231,766

e. December 31, 2023 Interest Expense ............................... Notes Payable3 ........................ Interest Payable....................... 2 ($23,177 X 7/12 = $13,520) 3 ($11,177 X 7/12 =$6,520) 2

June 1, 2024 Interest Expense ............................... Interest Payable ................................. Notes Payable5 ........................ Cash ........................................ 4 ($23,177 X 5/12 = $9,657) 5 ($11,177 X 5/12 =$4,657) 4

13,520 6,520 7,000

9,657 7,000 4,657 12,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.2 (CONTINUED) f. 1. Using the alternative of the instalment note, the land is capitalized at the present value of the annuity payment at the end of each of the next five years that will correspond to the same value as that arrived at for the mortgage note, imputed at 10% interest. The present value is $231,766. 1. Using tables: $231,766  3.79079 (PVOA5, 10%) = $61,139.23 2. Using a financial calculator: PV I N PMT FV Type

$ 231,766 10% 5 $ ? $0 0

Yields $(61,139)

3. Using Excel: =PMT(rate,nper,pv,fv,type)

Result: $61,139.28693 rounded to $61,139 Solutions Manual 14.111 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 14.2 (CONTINUED) f. (continued) 2.

Date June 1 June 1 June 1 June 1 June 1 June 1

Instalment Note Payable 10% Cash Effective Discount Interest Interest Amortized 2023 2024 2025 2026 2027 2028

$61,139 61,139 61,139 61,139 61,139

$23,177 19,380 15,205 10,611 5,5566 $73,929

$37,962 41,759 45,934 50,528 55,583 $231,766

Carrying Amount of Note $231,766 193,804 152,045 106,111 55,583 0.00

$2 Rounding

3. June 1, 2023 Land .................................................. Notes Payable ..........................

231,766 231,766

4. December 31, 2023 Interest Expense ............................... Interest Payable....................... 7 ($23,177X 7/12 = $13,520) 7

June 1, 2024 Interest Expense ................................ Interest Payable ................................. Notes Payable ................................... Cash ........................................

13,520 13,520

9,657 13,520 37,962 61,139

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PROBLEM 14.2 (CONTINUED) f. (continued) 5. The classification of the Mortgage Note on the December 31, 2023 statement of financial position is: Current liabilities: Interest payable

$7,000

Non-current liabilities: Mortgage note payable, due June 1, 2028 ($231,766 + $6,520)

238,286

The classification of the Instalment Note on the December 31, 2023 statement of financial position is:

Current liabilities: Interest payable Instalment note payable, current portion

$13,520 37,962

Non-current liabilities: Instalment note payable, (due in annual payments of $61,139 ending June 1, 2028) ($231,766 – $37,962)

193,804

Silverman Corporation would insist on the instalment note in order to secure larger cash inflows during the term of the note and to reduce the risk of having to collect the principal of the note in the case of a default by MacDougall.

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PROBLEM 14.3 a.

The bonds were sold at a discount of $5,651. Evidence of the discount is the January 1, 2023 carrying amount of $94,349, which is less than the maturity value of $100,000 in 2032.

The interest allocation and bond discount amortization are based upon the effective interest method; this is evident from the increasing interest charge. Under the straight-line method the amount of interest would have been $11,565.10 [$11,000 + ($5,651  10)] for each year of the term of the bonds. Although the effective interest method is required under IFRS per IFRS 9.5.4.1, accounting standards for private enterprises do not specify that this method must be used and therefore the straight-line method is also an option. The straight-line method is valued for its simplicity and might be used by companies reporting under ASPE.

The stated rate is 11% ($11,000  $100,000). The effective rate is 12% ($11,322  $94,349).

January 1, 2023 Cash .................................................... Bonds Payable ............................

December 31, 2023 Interest Expense................................... Bonds Payable ............................ Interest Payable ..........................

94,349 94,349 11,322 322 11,000

January 1, 2031 (Interest Payment) Interest Payable.................................... 11,000 Cash ............................................

11,000

December 31, 2031 Interest Expense................................... Bonds Payable ............................ Interest Payable ..........................

797 11,000

11,797

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PROBLEM 14.4 a.

The present value of the future cash flows totals $2,061,440. 1. Using tables: Present value of the principal $2,000,000 X .38554 (PV10, 10%)

$771,080

Present value of the interest payments $210,000* X 6.14457 (PVOA10, 10%)

1,290,360

Present value (selling price of the bonds)

$2,061,440

*$2,000,000 X 10.5% = $210,000

2. Using a financial calculator: PV I N PMT FV Type

$ ? 10% 10 $ (210,000) $ (2,000,000) 0

Yields $2,061,446

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PROBLEM 14.4 (CONTINUED) a. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $2,061,445.671 rounded to $2,061,446 Cash 1 .......................................................... Bonds Payable ................................... 1 ($2,000,000 + $61,440 – $50,000)

2,011,440 2,011,440

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PROBLEM 14.4 (CONTINUED) b.

Date 1/1/23 1/1/24 1/1/25 1/1/26 1/1/27 1/1/28

Cash Interest 10.5%

Effective Interest 10.4053%

Premium Amortization

$210,000 210,000 210,000 210,000 210,000

$209,296 209,223 209,142 209,053 208,954

$704 777 858 947 1,046

Carrying Amount of Bonds $2,011,440 2,010,736 2,009,959 2,009,101 2,008,154 2,007,108

Carrying amount as of 1/1/26 Less: Amortization of bond premium ($947  2) Carrying amount as of 7/1/26

$2,009,101

Reacquisition price Carrying amount as of 7/1/26 of bond ($2,008,627  2) Loss on Redemption

$1,065,000

474 $2,008,627

(1,004,314) $ 60,686

Interest Expense ......................................... Bonds Payable ($947 X 1/2 X 1/2) ............... Cash ($210,000 X 1/2 X 1/2) .............. To record the payment of interest

52,263 237

Bonds Payable......................................... Loss on Redemption of Bonds ................. Bonds Payable2 ....................................... Cash .............................................. To record retirement of the bonds 2 Premium as of 7/1/26 to be written off ($2,008,627 – $2,000,000) X 1/2 = $4,314

1,000,000 60,686 4,314

52,500

1,065,000

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PROBLEM 14.4 (CONTINUED)

By choosing to carry the bonds at fair value and expensing the costs of issuing the bond in the amount of $50,000, the premium on bonds payable would increase at the date of issuance by the $50,000 expensed at issue. Correspondingly, the interest expense recorded each year would be lower by the amount charged to expense using the effective interest method for the amortization of the additional $50,000 (the effective interest rate would be 10% instead of the 10.4053% required due to the capitalization of the bond issue costs). In total, the periodic expense would be lower over the 10-year term of the bond by $50,000, equal to the expense recognized at issuance. The total costs would be ultimately charged to income. The only difference would be that the charge would be completely expensed in the year the bond was issued as opposed to spread over the ten-year term of the bond. Note: When a note or bond is issued, it should be recognized at the fair value adjusted by any directly attributable issue costs. However, note that where the liabilities will subsequently be measured at fair value (e.g., under the fair value option or because they are derivatives), the transaction costs should not be included in the initial measurement (i.e., the costs should be expensed) [CPA Canada Handbook, Part II, Section 3856.07 and IFRS 9.5.1.1].

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PROBLEM 14.5 1. Armstrong Inc. 3/1/23

Cash ............................................... Bonds Payable .......................

1,888,352 1,888,352

Maturity value of bonds payable

$2,000,000

1. Using tables: Present value of $2,000,000 due in 7 periods at 6% ($2,000,000 X .66506) Present value of interest payable semi-annually at 6% ($100,000 X 5.58238) Proceeds from sale of bonds Discount on bonds payable

$1,330,120 558,238 (1,888,358) $111,642

2. Using a financial calculator: PV I N PMT FV Type

? 6% 7 $ (100,000) $ (2,000,000) 0

Yields $1,888,352

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.5 (CONTINUED) 3. Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $1,888,352.371 rounded to $1,888,352 A more accurate result is obtained using Excel or a financial calculator as compared to using factors from tables as there are a limited number of decimal places in the tables.

9/1/23

1. Armstrong Inc. Interest Expense ................................ Bonds Payable ............................... Cash ...............................................

113,301 13,301 100,000

12/31/23 Interest Expense ................................. Bonds Payable ($14,099 X 4/6) ..... Interest Payable ($100,000 X 4/6) ..

76,066

3/1/24

38,033 66,667

Interest Expense ................................ Interest Payable ................................. Bonds Payable ($14,099 X 2/6) . Cash..........................................

9,399 66,667

4,700 100,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.5 (CONTINUED) 1. Armstrong Inc. (continued) 9/1/24

Interest Expense ............................... 114,945 Bonds Payable ......................... 14,495 Cash......................................... 100,000

12/31/24

Interest Expense ............................... Bonds Payable ($15,842 X 4/6) Interest Payable .......................

Date 3/1/23 9/1/23 3/1/24 9/1/24 3/1/25 9/1/25 3/1/26 9/1/26

77,228

Schedule of Bond Discount Amortization Effective Interest Method 10% Bonds Sold to Yield 12% 5% 6% Cash Effective Discount Interest Interest Amortized $100,000 100,000 100,000 100,000 100,000 100,000 100,000

$113,301 114,099 114,945 115,842 116,792 117,800 118,869*

$13,301 14,099 14,945 15,842 16,792 17,800 18,869

10,561 66,667

Carrying Amount of Bonds $1,888,352 1,901,653 1,915,752 1,930,697 1,946,539 1,963,331 1,981,131 2,000,000

* rounded

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PROBLEM 14.5 (CONTINUED) 2. Ouelette Ltd. 6/1/23

Cash ............................................ Bonds Payable ........................

6,193,896 6,193,896

1. Using tables: Maturity value of bonds payable Present value of $6,000,000 due in 8 periods at 5% ($6,000,000 X .67684) Present value of interest payable semi-annually ($330,000 X 6.46321) Proceeds from sale of bonds Premium on bonds payable

$6,000,000 $4,061,040 2,132,859 6,193,899 $ 193,899

2. Using a financial calculator: PV I N PMT FV Type

? 5% 8 $ (330,000) $ (6,000,000) 0

Yields $6,193,896

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.5 (CONTINUED) 3. Using Excel: =PV (rate, nper, pmt, fv, type)

Result: $6,193,896.383 rounded to $6,193,896

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.5 (CONTINUED) 2. Ouelette Ltd. (continued) 12/1/23

Interest Expense ................................. Bonds Payable.................................... Cash ($6,000,000 X .11 X 6/12) .....

309,695 20,305

12/31/23 Interest Expense ($308,680 X 1/6) ..... Bond Payable ($21,320 X 1/6) ............ Interest Payable ($330,000 X 1/6) ......

51,447 3,553

6/1/24

Interest Expense ($308,680 X 5/6) ..... Interest Payable .................................. Bonds Payable ($21,320 X 5/6) .......... Cash ............................................

257,233 55,000 17,767

Interest Expense1................................ Bonds Payable ($22,386 X .2 X 4/6) ... Cash ($330,000 X .2* X 4/6) .......... 1 ($307,614 X .22 X 4/6) 2 $1,200,000  $6,000,000 = .2 To record payment of interest

41,015 2,985

Bonds Payable.................................... Loss on Redemption of Bonds ............ Cash.............................................. To record reacquisition of bonds

1,227,469 128,531

10/1/24

Reacquisition price ($1,400,000 – $44,000) Net carrying amount of bonds redeemed: Par value Unamortized premium [.2 X ($193,896–$20,305–$21,320)] – $2,985 Loss on redemption

330,000

55,000

330,000

44,000

1,356,000

$1,356,000 $1,200,000 27,469

(1,227,469) $ 128,531

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.5 (CONTINUED) 2. Ouelette Ltd. (continued) 12/1/24

Interest Expense ($307,614 X .83) ......... 246,091 Bonds Payable ($22,386 X .8) ............... 17,909 Cash ($330,000 X .8) ................... 264,000 3 ($6,000,000 – $1,200,000)  $6,000,000 = .8

12/31/24 Interest Expense4 .................................. Bonds Payable ($23,506 X .8 X 1/6) ...... Interest Payable5 .......................... 4 ($306,494 X .8 X 1/6) 5 ($330,000 X .8 X 1/6)

40,866 3,134

6/1/25

Interest Expense ($306,494 X .8 X 5/6) . Interest Payable..................................... Bonds Payable ($23,506 X .8 X 5/6) ...... Cash ($330,000 X .8) ...................

204,329 44,000 15,671

Interest Expense ($305,319 X .8) .......... Bonds Payable ($24,681 X .8) ............... Cash ($330,000 X .8) ...................

244,255 19,745

12/1/25

Date 6/1/23 12/1/23 6/1/24 12/1/24 6/1/25 12/1/25 6/1/26 12/1/26 6/1/27

44,000

264,000

5.5% Cash Interest

5% Effective Interest

Premium Amortized

$330,000 330,000 330,000 330,000 330,000 330,000 330,000 330,000

$309,695 308,680 307,614 306,494 305,319 304,085 302,789 301,428

$20,305 21,320 22,386 23,506 24,681 25,915 27,211 28,572

264,000

Carrying Amount of Bonds $6,193,896 6,173,591 6,152,271 6,129,885 6,106,379 6,081,698 6,055,783 6,028,572 6,000,000

LO 2,3 BT: AP Difficulty: C Time: 65 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.6 a. May 1, 2023 Cash ......................................................... 763,000 ($700,000 X 105%) + ($700,000 X 12% X 4/12) Bonds Payable ($700,000 X 105%) ....... Interest Expense ($700,000 X 12% X 4/12) .... December 31, 2023 Interest Expense ($700,000 X 12%) .......... Interest Payable ................................ To accrue interest expense Bonds Payable........................................... Interest Expense1 ............................. 1 ($35,000 X 8/1162 = $2,414) 2 (12 X 10) – 4 = 116 To amortize bond premium January 1, 2024 Interest Payable ......................................... Cash ................................................. April 1, 2024 Bonds Payable........................................... Interest Expense3 ............................. 3 ($35,000 X 3/116 X .604) 4 $420,000 / $700,000 = .60 To amortize bond premium

735,000 28,000

84,000 84,000

2,414 2,414

84,000 84,000

543

Bonds Payable5 ......................................... 439,009 Interest Expense ($420,000 X .12 X 3/12) . 12,600 Cash ($432,600 + $12,600) .............. Gain on Redemption of Bonds 6........ To record bond redemption 5 below 6 [($420,000 + $19,009) – $420,000 X 103%)] – below

543

445,200 6,409

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.6 (CONTINUED) a. (continued) Reacquisition price (including accrued interest) ($420,000 X 103%) + ($420,000 X 12% X 3/12) .... Net carrying amount of bonds redeemed: Par value .................................................................. Unamortized premium [$35,000 X ($420,000  $700,000) X 105/116] ...... Net carrying amount of bonds redeemed5 ................. Accrued interest ($420,000 X 12% X 3/12) ............... Gain on redemption .................................................. December 31, 2024 Interest Expense ($280,000 X .12) ............ Interest Payable ................................ To accrue interest expense Bonds Payable........................................... Interest Expense7 ............................. To amortize bond premium

420,000 19,009 439,009 12,600 451,609 $ 6,409

33,600 33,600

1,448

Amortization per year on $280,000 7 ($35,000 X 12/116 X .408) 8 ($700,000 – $420,000)  $700,000 = .40 b.

$445,200

1,448

$1,448

If Pfaff were to follow IFRS, then the effective interest method must be used to amortize any discounts or premiums. Although the effective interest method is required under IFRS per IFRS 9.5.4.1, accounting standards for private enterprises do not specify that this method must be used and therefore, the straightline method is also an option. The straight-line method is valued for its simplicity and might be used by companies reporting under ASPE.

LO 2,3,5 BT: AP Difficulty: C Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.7 December 31, 2023 a. Machinery ......................................... Notes Payable .......................... Machine capitalized at the present value of the note

409,806 409,806

1. Using tables: $600,000 X .68301 2. Using a financial calculator: PV I N PMT FV Type

$ ? 10% 4 $ 0 $ (600,000) 0

Yields $409,808

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $409,808.0732 rounded to $409,808 Solutions Manual 14.128 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 14.7 (CONTINUED) b.

December 31, 2024 Depreciation Expense1 ........................ Accumulated Depreciation— Machinery ................................ 1 [($409,806 – $70,000)  5] To record depreciation expense Interest Expense.................................. Notes Payable ............................ To record interest expense

Date 12/31/23 12/31/24 12/31/25 12/31/26 12/31/27 2

67,961 67,961

40,981 40,981

Schedule of Note Discount Amortization Debit Interest Expense Carrying Amount Credit Notes Payable of Note $409,806.00 $40,980.60 450,786.60 45,078.66 495,865.26 49,586.53 545,451.79 2 54,548.21 600,000.00

$3.03 adjustment due to rounding c.

December 31, 2025 Depreciation Expense.......................... Accumulated Depreciation— Machinery ................................ To record depreciation expense Interest Expense.................................. Notes Payable ............................ To record interest expense

67,961 67,961

45,079 45,079

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PROBLEM 14.7 (CONTINUED) d.

Debt to total assets is a measure of debt-paying ability and longrun solvency. Prior to purchasing the machine, the company’s debt to total assets ratio was 48.2% ($432,000 ÷ $896,000). As a result of the purchase, the debt to total assets ratio increased to 64.5% [($432,000 + $409,806) ÷ ($896,000 + $409,806)]. The percentage of total assets provided by creditors increased, which a creditor would view as unfavourable. The creditor may also consider that while the non–interest-bearing note payable is included in debt in the debt to total assets ratio, it will not result in cash outflow until it is due in four years.

LO 2,4 BT: AP Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.8 a.

The machine is purchased as an instalment sale. In this case, this is a debt instrument exchanged for the machine. The fair value of the debt must be determined by discounting the cash flows required on the debt at the appropriate rate to reflect the credit risk of Thompson. Because this is a private company, with no credit rating, we would not be able to observe market risk assessment rates for this company. We have used unobservable data that is particular to this company only, which would be level 3 in the fair value hierarchy. We are told that the company could have borrowed funds at 7% from the bank for this same purchase. If we use the 7% rate to discount the cash flows on the debt, the present value can be determined as follows: Payment Jan. 1, 2023 $ 240,000 Present value of 4 annual payments of $240,000 at 7% $240,000 X 3.3872 812,928 Total $1,052,928

1. Using tables: Present value of 4 annual payments of $240,000 at 7% $240,000 X 3.3872 = 812,928

2. Using a financial calculator: PV I N PMT FV Type

$ ? 7% 4 ($ 240,000) $ 0 0

Yields $812,931

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.8 (CONTINUED) a. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $812,930.7016 rounded to $812,931 This fair value determination would be a “soft” value since the 7% interest rate is a proposed (versus actual) lending rate. However, we are also told that the fair value of the machine is $1,050,000. This is an observable market value for similar assets. As such, this input is a level 2 fair value hierarchy. And again, this fair value would be considered a “soft” value. The question becomes, what fair value should be used – the fair value of what is given up (the debt) or the fair value of what has been received (the machine). ASPE and IFRS recommend that the fair value of the consideration given up should be used to determine the value of the transaction unless the fair value of the item received is more reliable and more clearly evident. In this case, both of the fair values are estimates, and one is not more reliable than the other.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.8 (CONTINUED) a. (continued) As such, the value of the debt that has been given up is determined to be reliably determinable and is used to value the transaction. The treatment under ASPE and IFRS would be the same. January 1, 2023 - Record purchase of the machine as follows: Machinery ................................................... 1,052,928 Cash ................................................... 240,000 Notes Payable ..................................... 812,928 Government loan – The government loan has been given at an interest rate substantially below market. The company would normally have had to pay 6% given its credit risk, but the government is charging 1%. To record the loan, we must determine the loan discounted at 6% and compare to the loan discounted at 1%.

PV of 500,000 in 5 years PV of 5,000 annual payments for 5 years

1% $475,733

6% $373,629

24,267 $500,000

21,062 $394,691

Difference

$105,309

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.8 (CONTINUED) a. (continued) Journal entry to record the government funding December 31, 2023 Cash ........................................................... Notes Payable ..................................... Equipment ...........................................

500,000 394,691 105,309

The grant of $105,309 will be amortized to net income on the same basis as the plant technology in order to offset the depreciation. Or alternatively, the grant can be directly netted against the plant technology equipment purchased and a smaller amount of depreciation will be recorded each year. The note payable to the government will be amortized to interest expense over the five years, so that at the end of 5 years, the balance will be $500,000. Under IFRS, the effective interest rate of 6% will be used. Again, this rate is likely not observable in the market place since the company has no credit rating for comparison purposes. Consequently, this value is a level 3 in the fair value hierarchy. b. 1. Use of the asset requires a depreciation charge in each year of use. This in turn requires carrying the equipment as an asset as the risk and rewards of ownership have passed to the company, although the company does not have legal title to the asset. The company has contracted to purchase the machine and, thus, has a real liability that affects its financial condition and must be shown on the statement. As such, the fair value of the liability that the company owes must be recorded along with the fair value of the asset that has been received in return for the liability.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.8 (CONTINUED) b. (continued) There is an imputed interest rate built into the payments over the 5 years that must be recorded. Since the fair value of the machine is only $1,050,000, we cannot show a higher than fair value amount (although in this case the entry was made for $1,052,928). Effectively, the difference between the total payments being made and the fair value of the machine is the interest to be paid over the 5-year period, in the amount of $147,072 [($240,000 x 4) - $812,928]. 2. The obligation of a company is to its bondholders, not to the trustee. Until the bondholders have received payment, the company still has a liability. Note to instructor: The student may have difficulty with this statement because this type of situation was not discussed in the chapter. It therefore provides an opportunity to emphasize that payment to an agent or trustee does not constitute payment of the liability for bond interest. When the trustee dispenses the funds to bondholders, the liability should be reduced. A separate Bond Interest Fund account, similar to a “Sinking” fund is established at the time payment is made to the trustee. This fund is shown as a long-term investment in the asset section of the SFP. 3. Repurchased bonds are not an asset. A company cannot owe or own itself. Thus, these bonds are different from investments in bonds of other companies. Repurchased bonds should be reported as a deduction from bonds payable.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.8 (CONTINUED) b. (continued) 4. There are two points here. First of all, we obtained very favourable financing from the government, since we only pay 1% on the loan and not the 6% that we would have paid on borrowed funds. Consequently, this concession must be given separate treatment in our books. It is as though the government is forgiving 5% interest each year. The loan is recorded as though it was charging 6%, and therefore the payments we will make of $5,000 each year for the next 5 years and then the $500,000 repayment are part principal and part interest payments. An amount of $105,309 will be charged as interest over the 5-year period. The second point is what to do about this concession. The benefit of this will be treated as a government grant (i.e., forgiven amount of interest). As a grant, the amount is recorded either in a separate account or as a reduction against the technology purchased. In either case, the “grant” is amortized into income over the life of the asset. Consequently, we will also have a lower depreciation charged to net income as a result. Over the five years, this reduction in depreciation will be offset by the additional interest expense charged on the loan. LO 2 BT: AP Difficulty: M Time: 65 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.9 a. To record the issuance of the 8% mortgage on January 1, 2023: Cash 1 .................................................. Mortgage Payable....................... 1 ($3 million x 101% = $3,030,000)

3,030,000 3,030,000

To record retirement of the 7% debenture bonds on Jan.1, 2023: Bonds Payable..................................... Loss on Redemption of Bonds ............. Cash ($2,000,000 x 105%) .........

1,910,000 190,000 2,100,000

At January 1, 2023 the carrying amount of the retired bonds is:

Bonds payable Less unamortized discount ($300,000 X 3/10) Bond carrying amount

$2,000,000 90,000 $1,910,000

Income from operations Loss on redemption of bonds (Note 1) Income before taxes Income tax expense Net income

$1,700,000 190,000 1,510,000 286,900 $1,223,100

Earnings per share: Net income

$1.02

Note 1. Debenture Bonds Redemption: A loss of $190,000 occurred from the redemption and retirement of $2,000,000 of the corporation’s outstanding debenture bonds issue due in 2026. The debentures were redeemed at 105% as provided for in the terms of the indenture. The funds used to repurchase the debentures represent a portion of the proceeds from the sale of $3,000,000 of 8% mortgage issued January 1, 2023 and due in 2048. LO 2,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 14.10 a. Wilkie Inc. Selling price of the bonds ($4,000,000 X 103%) Accrued interest from January 1 to February 29, 2023 ($4,000,000 X 9% X 2/12) Total cash received from issuance of the bonds Less: Bond issuance costs1 Net amount of cash received

$4,120,000 60,000 4,180,000 27,000 $4,153,000

When a note or bond is issued, it should be recognized at the fair value adjusted by any directly attributable issue costs. However, note that where the liabilities will subsequently be measured at fair value (e.g., under the fair value option or because they are derivatives), the transaction costs should not be included in the initial measurement (i.e., the costs should be expensed at the time of issuance) [CPA Canada Handbook, Part II, Section 3856.07 and IFRS 9.5.1.1]. b. Langley Ltd. Carrying amount of the bonds on 1/1/23 Effective interest rate (10%) Interest expense to be reported for 2023

$469,280 X 0.10 $ 46,928

Although the effective interest method is required under IFRS per IFRS 9.5.4.1, accounting standards for private enterprises do not specify that this method must be used and therefore the straightline method is also an option. The straight-line method is valued for its simplicity and might be used by companies reporting under ASPE.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.10 (CONTINUED) c.

Chico Building Inc. Maturities and sinking fund requirements on long-term debt are as follows: 2024 2025 2026

$400,000 350,000 200,000

2027 2028 Thereafter

$200,000 350,000 300,000

Czeslaw Inc. Since three bonds reported by Czeslaw Inc. are secured by either real estate, securities of other corporations, or plant equipment, there are no debenture bonds outstanding for the company.

LO 2,4 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.11 a. 4/1/23

Cash (12,000 X $1,000 X 97%) ... Bonds Payable .......................

11,640,000 11,640,000

b. 10/1/23 Interest Expense .............................. 672,000 Cash1 ......................................... 660,000 2 Bonds Payable .......................... 12,000 1 $12,000,000 X .11 X 6/12 = $660,000 2 $360,000  180 months X 6 months = $12,000 c. 12/31/23 Interest Expense............................. Interest Payable3 ...................... Bonds Payable4......................... 3 ($660,000 X 3/6) 4 ($2,000 X 3 months) d. 3/1/24

336,000 330,000 6,000

Interest Payable ($330,000 X ¼) ...... 82,500 Interest Expense ............................... 56,000 5 Cash .......................................... 137,500 6 Bonds Payable ........................... 1,000 5 $3,000,000 X .11 X 5/12 = $137,500 6 $2,000/month X 2 months X ¼ of the bonds = $1,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.11 (CONTINUED) d. (continued) At March 1, 2024 the carrying amount of the retired bonds is: Bonds payable Less: unamortized discount7 Bond carrying amount 7

$3,000,000 84,500 $2,915,500

$2,000/month X 169 months X ¼ of the bonds = $84,500

The reacquisition price: 100,000 shares X $31 = $3,100,000. The loss on extinguishment of the bonds is: Reacquisition price Less: carrying amount Loss

$3,100,000 2,915,500 $ 184,500

The entry to record extinguishment of the bonds is: Bonds Payable ......................................... 2,915,500 Loss on Redemption of Bonds ................. 184,500 Common Shares ...............................

3,100,000

LO 2,3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.12 1. Using a financial calculator: PV I N PMT FV Type

$ 11,640,000 ?% 30 $ (660,000) $ (12,000,000) 0

Yields 5.7113 %

2. Using Excel: =RATE(nper,pmt,pv,fv,type)

Result: 0.05711256 rounded to four decimal places 5.7113%

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.12 (CONTINUED) Schedule of Bond Discount Amortization Effective Interest Method 5.5% Semi-annual Bonds Sold to Yield 5.7113%

Date April 1 ’23 Oct. 1 ’23 April 1 ’24

a. 4/1/23

5.5% Cash Interest

5.7113% Effective Interest

660,000.00 660,000.00

664,795.32 665,069.20

Discount Amortized

Carrying Amount $11,640,000.00 4,795.32 11,644,795.32 5,069.20 11,649,864.52

Cash (12,000 X $1,000 X 97%) .... 11,640,000 Bonds Payable ........................ 11,640,000

b. 10/1/23 Interest Expense .......................... 664,795.32 Cash ....................................... Bonds Payable ....................... c. 12/31/23 Interest Expense1 ...................... 332,534.60 Interest Payable2 .................. Bonds Payable3.................... 1 ($665,069.20 X 3/6) = $332,534.60 2 ($660,000 X 3/6) 3 ($5,069.20 X 3/6 = $2,534.60)

660,000.00 4,795.32

330,000.00 2,534.60

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PROBLEM 14.12 (CONTINUED) d. 3/1/24

Interest Payable ($330,000 X ¼).. 82,500.00 4 Interest Expense ......................... 55,422.43 5 Cash ..................................... 137,500.00 6 Bonds Payable ...................... 422.43 4 ($665,069.20 X 2/6 X ¼) = $55,422.43 5 $3,000,000 X .11 X 5/12 = $137,500.00 6 ($5,069.20 X 2/6 X ¼) = $422.43

At March 1, 2024 the carrying amount of the retired bonds is: Bonds payable Less: unamortized discount7 Bonds carrying amount 7

Balance of Discount Balance at issuance Amortization Oct. 1, 2023 Accrual December 31, 2023 Balance December 31, 2023 Less: March 1, 2024 for 25% Balance March 1, 2024

$3,000,000.00 87,745.09 $2,912,254.91 100% 25% $360,000.00 (4,795.32) (2,534.60) $352,670.08 X ¼ = $88,167.52 422.43 $87,745.09

The reacquisition price: 100,000 shares X $31 = $3,100,000. The loss on extinguishment of the bonds is: Reacquisition price Less: carrying amount of bonds Loss

$3,100,000.00 2,912,254.91 $ 187,745.09

The entry to record extinguishment of the bonds is: Bonds Payable ................................. 2,912,254.91 Loss on Redemption of Bonds ......... 187,745.09 Common Shares ....................... 3,100,000.00 LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.13 1. Sanford Co. Calculate cash proceeds on issuance: 1. Using tables: Present value of annuity: $25,000 x 5.58238 = $139,560 Present value of principal: $500,000 x 0.66506 = 332,530 Total $472,090 2. Using a financial calculator: PV I N PMT FV Type

$ ? 12%/2 = 6% 7 $(25,000) $(500,000) 0

Yields $472,088

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result $472,088.0928 rounded to $472,088

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.13 (CONTINUED) 1. Sanford Co. (continued) Schedule of Bond Discount Amortization Effective-Interest Method 10% Bonds Sold to Yield 12%

Date 3/1/23 9/1/23 3/1/24 9/1/24 3/1/25 9/1/25 3/1/26 9/1/26

5% Cash Interest 1

6% Effective Interest

$25,000 $28,325 25,000 28,525 25,000 28,736 25,000 28,960 25,000 29,198 25,000 29,450 25,000 29,7182 1 ($500,000 X 10% X 1/2) 2 Rounded $1

3/1/23

9/1/23

12/31/23

3/1/24

Discount Amortized

Carrying Amount of Bonds

$3,325 3,525 3,736 3,960 4,198 4,450 4,718

$472,088 475,413 478,938 482,674 486,634 490,832 495,282 500,000

Cash ......................................................... Bonds Payable ................................

472,088

Interest Expense ................................... Bonds Payable ............................. Cash.............................................

28,325

Interest Expense ................................... Bonds Payable ($3,525 X 4/6) ........................... Interest Payable ($25,000 X 4/6) ..

19,017

Interest Expense ................................... Interest Payable .................................... Bonds Payable ($3,525 X 2/6)...... Cash.............................................

9,508 16,667

472,088

3,325 25,000

2,350 16,667

1,175 25,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.13 (CONTINUED) 1. Sandford Co. (continued) 9/1/24

12/31/24

Interest Expense .............................. Bonds Payable ........................ Cash........................................

28,736

Interest Expense .............................. Bonds Payable $3,960 X 4/6) Interest Payable ......................

19,307

3,736 25,000

2,640 16,667

2. Titania Co. Calculate cash proceeds on issuance: 1. Using tables: Present value of annuity: $24,000 x 6.46321= $155,117 Present value of principal: $400,000 x 0.67684 = 270,736 Total $425,853 2. Using a financial calculator: PV I N PMT FV Type

$ ? 10%/2 = 5% 8 $ (24,000) $ (400,000) 0

Yields $425,853

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.13 (CONTINUED) 2. Titania Co. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $425,852.851 rounded to $425,853 Schedule of Bond Premium Amortization Effective-Interest Method 12% Bonds Sold to Yield 10% 6% Cash Interest

Date 6/1/23 12/1/23 6/1/24 12/1/24 6/1/25 12/1/25 6/1/26 12/1/26 6/1/27

5% Effective Interest 3

$24,000 $21,293 24,000 21,157 24,000 21,015 24,000 20,866 24,000 20,709 24,000 20,545 24,000 20,372 24,000 20,190 3 ($400,000 X 12% X 1/2)

Premium Amortized

Carrying Amount of Bonds

$2,707 2,843 2,985 3,134 3,291 3,455 3,628 3,810

$425,853 423,146 420,303 417,318 414,184 410,893 407,438 403,810 400,000

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PROBLEM 14.13 (CONTINUED) 2. Titania Co. (continued) 6/1/23

12/1/23

12/31/23

6/1/24

10/1/24

Cash .................................................... Bonds Payable ..............................

425,853

Interest Expense ................................. Bonds Payable .................................... Cash ($400,000 X .12 X 6/12) ....

21,293 2,707

Interest Expense ($21,157 X 1/6) ........ Bonds Payable ($2,843 X 1/6) Interest Payable ($24,000 X 1/6)

3,526 474

Interest Expense ($21,157 X 5/6) ............... Interest Payable ......................................... Bonds Payable ($2,843 X 5/6) ................... Cash .................................................

17,631 4,000 2,369

Interest Expense ($21,015 X .34 X 4/6) ..... Bonds Payable ($2,985 X .3 X 4/6) ............ Cash ................................................. 4 $120,000 ÷ $400,000 = .3 To record payment of interest

4,203 597

425,853

24,000

4,000

24,000

4,800

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PROBLEM 14.13 (CONTINUED) 2. Titania Co. (continued) 10/1/24

Bonds Payable ..................................... Gain on Redemption of Bonds5 Cash6 .......................................... To record redemption of bonds

$126,000 – ($120,000 X 12% X 4/12) Net carrying amount of bonds redeemed: Carrying amount of all bonds June 1, 2024 x 30 % redeemed Less amortization Oct. 1, 2024 5 Gain on redemption

125,494 4,294 121,200

12/1/24

12/31/24

6/1/25

12/1/25

$121,200 $420,303 126,091 597 (125,494) $ (4,294)

Interest Expense ($21,015 X .77) ......... Bonds Payable ($2,985 X .7) ............... Cash ($24,000 X .7) ................... 7 ($400,000 – $120,000) ÷ $400,000 = .7

14,711 2,089

Interest Expense ($20,866 X .7 X 1/6) .... Bonds Payable ($3,134 X .7 X 1/6) ..... Interest Payable8 ......................... 8 ($24,000 X .7 X 1/6)

2,434 366

Interest Expense ($20,866 X .7 X 5/6) .. Interest Payable .................................. Bonds Payable ($3,134 X .7 X 5/6) ..... Cash ($24,000 X .7) ...................

12,172 2,800 1,828

Interest Expense ($20,709 X .7) .......... Bonds Payable ($3,291 X .7) ............... Cash ($24,000 X .7) ...................

14,496 2,304

16,800

2,800

16,800

LO 2,3 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.14 a.

The entries for the issuance of the note on January 1, 2023: The present value of the note is: 1. Using tables: $1,200,000 X .68058 = $816,696 2. Using a financial calculator: PV I N PMT FV Type

$? 8% 5 $ 0 $ (1,200,000) 0

Yields $816,700

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $816,699.8364 rounded to $816,700

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.14 (CONTINUED) a. (continued) January 1, 2023

Batonica Limited (Debtor): Cash ................................................... Notes Payable ............................

816,700

Northern Savings Bank (Creditor): Notes Receivable ............................... Cash ...........................................

816,700

The amortization schedule for this note is:

SCHEDULE FOR INTEREST AND DISCOUNT AMORTIZATION— EFFECTIVE INTEREST METHOD $1,200,000 NOTE ISSUED TO YIELD 8% 8% Cash Effective Discount Carrying Date Interest Interest Amortized Amount 1/1/23 $ 816,700 12/31/23 $0 $ 65,336 $ 65,336 882,036 12/31/24 0 70,563 70,563 952,599 12/31/25 0 76,208 76,208 1,028,807 12/31/26 0 82,305 82,305 1,111,112 12/31/27 0 88,888 88,888 1,200,000 Total $0 $383,300 $383,300

In accordance with IFRS 9.5.5.3, Northern Savings Bank would measure the loss allowance on the receivable for an amount equal to the lifetime expected credit losses if credit risk has significantly increased since initial recognition.

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PROBLEM 14.14 (CONTINUED) d.

The loss is computed as follows: Carrying amount of loan (12/31/23) Less: Present value of $800,000 due in 4 years at 8% Loss due to impairment a

See amortization schedule from answer (b)

1. Using tables: $800,000 X .73503 = $588,024

$882,036a (588,024)b $294,012

2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields $588,024 8% 4 $0 $ (800,000) 0

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $588,023.8822 rounded to $588,024

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.14 (CONTINUED) d. (continued) Batonica Limited (Debtor): No entry. Northern Savings Bank (Creditor): Loss on Impairment ............................ Allowance for Expected Credit Losses ........................................

294,012 294,012

Note to Instructor: Since this note is not yet restructured, the loss is treated as an increase in the allowance. LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.15 a.

The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency, and therefore, the test to establish whether there is a settlement or not revolves around the cash flows. The present value of both of the cash flow streams of the new debt are calculated using the historical interest rate of 12% for consistency and comparability. Pre-restructure carrying amount Present value of restructured cash flows: Present value of $600,000 due in 10 years at 12%, interest payable annually; ($600,000 X .32197) Present value of $30,000 interest payable annually for 10 years at 12% ($30,000 X 5.65022) Difference

$600,000

$193,182

169,507

(362,689) $237,311

1. Using tables: Present value of $600,000 due in 10 years at 12%, interest payable annually; $600,000 x .32197 = $193,182 Present value of $30,000 interest payable annually for 10 years at 12%; $30,000 x 5.65022 = $169,507 2. Using a financial calculator: PV I N PMT FV Type

$ ? 12% 10 $ (30,000) $ (600,000) 0

Yields $362,691

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PROBLEM 14.15 (CONTINUED) a. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $362,690.6328 rounded to $362,691 As the present value of the new debt is more than 10% different from the present value of the old debt (using the original rate), this is a substantial change and the transaction is accounted for as a settlement by Perkins and new debt is recorded. The new debt is recorded at the present value of the new cash flows using the current market rate of interest.

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PROBLEM 14.15 (CONTINUED) b. 1. Perkins Inc. Notes Payable…………………………………. Gain on Restructuring of Debt…… Notes Payable………………………. 2. United Bank Modification Gain or Loss1 ............................. Notes Receivable ............................. 1

237,311 362,689

237,311 237,311

Calculation of loss:

Pre-restructure carrying amount Present value of restructured cash flows: Present value of $600,000 due in 10 years at 12%, interest payable annually; ($600,000 X .32197) Present value of $30,000 interest payable annually for 10 years at 12% ($30,000 X 5.65022) Creditor’s loss on restructure

600,000

$600,000

$193,182

169,507

(362,689) $237,311

Losses are now calculated based on the discounted present value of future cash flows; thus, this fairly approximates the economic loss to the lender. The debtor recognizes a gain, which reflects the fact that they are now paying lower interest. Care should be taken to ensure the reason for the gain is clearly noted in the statements as this is material information and the gain has been generated solely because the entity is in financial distress.

LO 2,3 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.16 a. On the books of Rocky Mountain Corporation: Notes Payable ............................................. Common Shares ................................. Gain on Restructuring of Debt ............

2,000,000 1,500,000 500,000

Fair value of equity Carrying amount of debt Gain on restructuring of debt On the books of Abbra Bank: FV-NI Investments ........................................ Allowance for Expected Credit Losses .......... Notes Receivable.................................

b. On the books of Rocky Mountain: Notes Payable .............................................. Accumulated Depreciation-Buildings............. Buildings .............................................. Gain on Disposal of Buildings .............. Gain on Restructuring of Debt .............

$1,500,000 2,000,000 $ 500,000

1,500,000 500,000 2,000,000

2,000,000 1,400,000 1,900,000 1,000,000 500,000

Fair value of building Carrying amount of building Gain on disposal of building

$1,500,000 500,000 $1,000,000

Note payable (carrying amount) Fair value of building Gain on restructuring of debt

$2,000,000 1,500,000 $ 500,000

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PROBLEM 14.16 (CONTINUED) b. (continued) On the books of Abbra Bank: Investment in Property .................................. Allowance for Expected Credit Losses .......... Notes Receivable................................. c.

1,500,000 500,000 2,000,000

The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency and therefore, the test to establish whether there is a settlement or not revolves around the cash flows. The present value of the cash flow streams of the new debt are calculated using the historical interest rate of 7% for consistency and comparability. Present value of old debt is $2,000,000. Present value of new debt is calculated as follows: Using present value tables:

Single amount

$ 2,000,000

7% Factor 0.816296

Present Value $ 1,632,592

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PROBLEM 14.16 (CONTINUED) c. (continued) Using Excel: =PV(rate,nper,pmt,fv,type)

Result $1,632,595.754 rounded to $1,632,596 Since the present value of the future cash flows of the new debt differs by an amount larger than 10% of the present value of the future cash flows of the old debt (2,000,000 x 10% = 200,000), the renegotiated debt is considered a settlement and a gain is recorded by Rocky Mountain as calculated below: The amount of the new debt is recorded at the new cash flows at the current market rate of interest, which is 9%. Using present value tables: 2,000,000 x 0.772183 = $1,544,367 (rounded by $1)

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PROBLEM 14.16 (CONTINUED) c. (continued) Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $1,544,366.96 rounded to $1,544,367 On the books of Rocky Mountain: Notes Payable ...................................... Gain on Restructuring of Debt ..... Notes Payable .............................

2,000,000 455,633 1,544,367

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PROBLEM 14.16 (CONTINUED) c. (continued) On the books of Abbra Bank: Modification Gain or Loss1 ............................ Notes Receivable................................. 1

367,408 367,408

Calculation of loss: Pre-restructure carrying amount Less: Present value of restructured cash flows: Present value of $2,000,000 due in 3 years at 7% ($2,000,000 X .816296)

1,632,592 $ (367,408)

Creditor’s loss on restructure

$2,000,000

The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency and therefore, the test to establish whether there is a settlement or not revolves around the cash flows. The present value of the cash flow streams of the new debt are calculated using the historical interest rate of 7% for consistency and comparability. Present value of old debt is $2,000,000. Present value of new debt is calculated as follows: Using present value tables:

Single amount Interest payments for third year

$1,700,000

7% Factor 0.816296

Present Value $1,387,703

68,000

0.816296

55,508 $1,443,211

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PROBLEM 14.16 (CONTINUED) d. (continued) Since the present value of the future cash flows of the new debt differs by an amount larger than 10% of the present value of the future cash flows of the old debt (2,000,000 x 10% = 200,000), the renegotiated debt is considered a settlement and a gain is recorded by Rocky Mountain as set out below: The amount of the new debt is recorded at the new cash flows at the current market rate of interest, which is 9%. Using present value tables:

Single amount Interest payments for third year

$1,700,000

9% Factor 0.77218

Present Value $1,312,706

68,000

0.77218

52,508 $1,365,214

Notes Payable ................................... 2,000,000 Gain on Restructuring of Debt .. Notes Payable ..........................

634,786 1,365,214

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PROBLEM 14.16 (CONTINUED) d. (continued) On the books of Abbra Bank: Modification Gain or Loss2 ........................... Notes Receivable................................ 2

Calculation of loss: Pre-restructure carrying amount Present value of restructured cash flows: Present value of $1,700,000 due in 3 years at 7%, ($1,700,000 X .816296) Present value of $68,000 interest payable in third year 7%, ($68,000 X .816296) Creditor’s loss on restructure

556,789 556,789

$2,000,000

$1,387,703

55,508

1,443,211 $ (556,789)

LO 2,3 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.17 The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency and therefore, the test to establish whether there is a settlement or not revolves around the cash flows. The present value of the cash flow streams of the new debt are calculated using the historical interest rate of 10% for consistency and comparability. Present value of old debt is $500,000 + accrued interest of $50,000 ($500,000 x 10%) for a total of $550,000.

Present value of new debt is calculated as follows: Using present value tables:

Single amount, 5 years Interest annuity, 5 years ($300,000 X 10%) Shares given 20,000 X $5

$ 300,000

10% Factor 0.62092

Present Value $ 186,276

30,000

3.79079

113,724 300,000 100,000 $ 400,000

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PROBLEM 14.17 (CONTINUED) Using Excel: = PV(rate,nper,pmt,fv,type)

Result: $300,000 Since the difference between the present value of the future cash flows of the new debt and the present value of the future cash flows of the old debt differs by an amount larger than 10% of the present value of the future cash flows of the old debt (10% x $550,000 = $55,000), the renegotiated debt is considered a settlement and a gain is recorded by Gaming as follows: 2023 Entries by Gaming Inc.: Interest Payable ........................................... Notes Payable .............................................. Notes Payable ..................................... Common Shares ................................. Gain on Restructuring of Debt .............

50,000 500,000 278,372 100,000 171,628

The note payable now has a balance of $278,372, which equals the present value of the future cash flows to be paid.

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PROBLEM 14.17 (CONTINUED) 1. Using tables:

Single amount, 5 years Interest annuity, 5 years ($300,000 X 10%)

$300,000

12% Factor 0.56743

Present Value $170,229

30,000

3.60478

108,143 $278,372

2. Using a financial calculator: PV I N PMT FV Type

$? 12% 5 $ (30,000) $ (300,000) 0

Yields $278,371

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $278,371.3428 rounded to $278,371 Solutions Manual 14.167 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 14.17 (CONTINUED)

Date 12/31/23 12/31/24 12/31/25 12/31/26 12/31/27 12/31/28

10% Cash Interest

12% Effective Interest

Increase in Carrying Amount

$30,000a 30,000 30,000 30,000 30,000

$ 33,405 33,813 34,271 34,783 35,356d

$ 3,405c 3,813 4,271 4,783 5,356

Carrying Amount of Note $ 278,372 281,777 285,590 289,861 294,644 300,000

$30,000 = $300,000 x 0.10 $33,405 = $278,372 X 12% c $3,405 = $33,405 – $30,000 d Adjusted due to rounding b

Dec. 31, 2024: Interest Expense ......................................... Notes Payable ................................... Cash .................................................. Dec. 31, 2025: Interest Expense ......................................... Notes Payable ................................... Cash .................................................. Dec. 31, 2026 Interest Expense ......................................... Notes Payable ................................... Cash .................................................. Dec. 31, 2027 Interest Expense ......................................... Notes Payable ................................... Cash ..................................................

33,405 3,405 30,000

33,813 3,813 30,000

34,271 4,271 30,000

34,783 4,783 30,000

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PROBLEM 14.17 (CONTINUED) Dec. 31, 2028 Interest Expense ........................................ Notes Payable ................................... Cash.................................................. To record payment of interest

35,356 34,783 5,356 4,783 30,000 30,000 300,000

Notes Payable ............................................ Cash .................................................. To record repayment of note

300,000

LO 2,3 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.18 a.

September 30, 2023 Thornton: Interest Receivable ......................................... Interest Income1..................................... To accrue interest income 1 ($300,000 X .12 X 9/12) Loss on Investments ....................................... Cash .............................................................. Interest Receivable ................................ Notes Receivable................................... To record sale of note This would not be a troubled debt restructuring.

27,000 27,000

47,000 280,000 27,000 300,000

Shutdown: No entry. Shutdown does not have a troubled debt restructuring. Orsini: Interest Income2 .............................................. Notes Receivable ............................................ Cash ......................................................

27,000 253,000 280,000

A debit to Interest Receivable is also appropriate. This would not be a troubled debt restructuring.

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PROBLEM 14.18 (CONTINUED) b.

December 31, 2023 Shutdown: Interest Expense ($300,000 X .12) ............... Interest Payable ................................... To record accrued interest expense Notes Payable .............................................. Interest Payable ............................................ Cost of Goods Sold ....................................... Inventory .............................................. Gain on Restructuring of Debt ............. Sales Revenue ....................................

36,000 36,000

300,000 36,000 240,000 240,000 21,000 315,000

This would be a troubled debt restructuring for Shutdown, since the settlement, $315,000, is less than the carrying amount of the debt, $336,000. Orsini: Interest Receivable3 .................................... Interest Income ($300,000 X .12)....... To accrue interest income

36,000 36,000

Only net of $9,000 reported as interest income because $27,000 of accrued interest was purchased in September. Inventory ..................................................... Notes Receivable............................... Interest Receivable ............................ Investment Income or Loss ................

315,000 253,000 36,000 26,000

This would not be a troubled debt restructuring. (Note to instructor: This problem indicates that symmetry may not always be achieved between the debtor and creditor and that the debtor may have a restructuring but the creditor, if changed, may not.) LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 14.19 a.

The first step is to determine the economic substance of the debt renegotiation and determine if it should be accounted for as a settlement or a modification/exchange regarding the old debt. In this case, the creditor is the same and so is the currency and therefore, the test to establish whether there is a settlement or not revolves around the cash flows. The present value of the cash flow streams of the new debt are calculated using the historical interest rate of 10% for consistency and comparability. Present value of old debt is $110,000 + $11,000 = $121,000. Present value of new debt is calculated as follows:

1. Using tables:

Single amount, 3 years Interest annuity, 3 years

$100,000 10,000

10% Factor 0.75132 2.48685

Present Value $ 75,132 24,868 $100,000

2. Using a financial calculator: PV I N PMT FV Type

$? 10% 3 $ (10,000) $ (100,000) 0

Yields $100,000

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PROBLEM 14.19 (CONTINUED) a. (continued) 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $100,000 Since the present value of the future cash flows of the new debt differs by an amount larger than 10% of the present value of the future cash flows of the old debt in the amount of $121,000, the renegotiated debt is considered a settlement. The old debt would be removed from the books, the new debt recognized, and the difference would be recorded as a gain for Mazza. The effective interest rate subsequent to restructure is the current market rate of interest.

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PROBLEM 14.19 (CONTINUED) b.

Date

Mazza Corp. SCHEDULE OF DEBT REDUCTION AND INTEREST EXPENSE AMORTIZATION Cash Effective Change in Interest Interest Carrying (Market) Amortized

12/31/23 12/31/24 $10,000a $10,000b 12/31/25 10,000 10,000 12/31/26 10,000 10,000 12/31/26 a $10,000 = $100,000 X 10% b $10,000 = $100,000 X 10%

0 0 0

c. Calculation of loss: Pre-restructure carrying amount Present value of restructured cash flows: Tsang Corp.’s loss on restructure

Date 12/31/23 12/31/24 12/31/25 12/31/26 12/31/26 a b

Cash Interest

Tsang Corp. Effective Interest (Market)

$10,000a 10,000 10,000

$10,000b 10,000 10,000 0

Carrying Amount $100,000 100,000 100,000 100,000 -0-

$121,000 100,000 $ (21,000)

Change in Carrying Amortized $

0 0 0

Carrying Amount of Note $100,000 100,000 100,000 100,000 0

$10,000 = $100,000 X 10% $10,000 = $100,000 X 10%

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PROBLEM 14.19 (CONTINUED) d.

Mazza Corp. entries: December 31, 2023 Interest Payable ..................................... Notes Payable ........................................ Notes Payable ............................... Gain on Restructuring of Debt ........

11,000 110,000

December 31, 2024, 2025 Interest Expense .................................... Cash ..............................................

10,000

100,000 21,000

10,000

Tsang Corp. entries: December 31, 2023 Modification Gain or Loss ............................ Notes Receivable ............................... Note that the debit could be booked to the Allowance account instead if the loss had already been provided for. December 31, 2024, 2025 Cash ........................................................... Interest Income...................................

21,000 21,000

10,000 10,000

LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 14.20 a.

Legal defeasance requires that the creditor agree to collect principal and interest payments from the trust rather than from LL. A legal agreement on behalf of the creditor, the trust, and the debtor would be needed to achieve legal defeasance. Under IFRS, LL would be able to derecognize the liability if they obtain legal defeasance and extinguish the debt. In-substance defeasance results when a company sets up a trust to repay the principal and interest payments for the debt without obtaining the creditor’s agreement. Without obtaining a legal agreement from the creditor, the primary obligation to repay the loan resides with LL. As a result, in-substance defeasance does not result in derecognition of the liability according to IFRS.

For both legal and in-substance defeasance there is an argument for derecognition of debt on the financial statements since LL has set up a trust with low-risk investments that will be able to cover all future interest and principal payments. Effectively, by setting up the trust, LL has prepaid the debt with low risk of default based on their investment strategy.

Regardless of the intent of the company, IFRS looks at whether there is a legal obligation. Therefore, if the agreement from the creditor has not been obtained, in-substance defeasance occurs and the debt must remain on the SFP. In order to extinguish the debt, LL needs to obtain a legal agreement from the creditor releasing them from the debt obligation and transferring that obligation to the trust. The ethical accountant must communicate this to the VP Finance and explain that, without a formal agreement with the creditor, the debt cannot be extinguished from the LL financial statements.

LO 2,3 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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CASE Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the front of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 14.1 Kitchener Mechanical Incorporated Case Overview Kitchener is a manufacturer and is looking to expand its facility. The company has cash flow issues, and currently has substantial outstanding accounts receivable from one major customer. This is creating pressure on the company’s debt-to-equity covenant with Nexis Bank. Kitchener is looking into alternative methods of financing an expansion of its facility that will not create additional pressure on its cash flows, nor breach the debt-to-equity covenant. Magmum Production has offered a solution by the way of building a facility that Kitchener could lease for 20 years with a purchase clause at the end of the lease agreement. Given this, Magmum Production will be a user of Kitchener’s financial statements. Magmum will want to assess the financial position of Kitchener to ensure that the lease payments can be made and that a portion of the lease payment based on revenues is properly remitted. Nexis Bank is also a user and will use statements to predict cash flows to ensure debts are repaid. The bank will also use the statements to assess whether the covenant is met. Kitchener’s president is concerned about adding additional debt to the statement of financial position, specifically in terms of the debt-toequity ratio. Therefore, GAAP is a constraint. Magmum would likely also want to assess Kitchener’s ability to meet the lease payments. GAAP prepared statements would provide more useful information.

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CA 14.1 Kitchener Mechanical Incorporated (CONTINUED) The controller would like to know where any differences exist between IFRS and ASPE. Analysis and recommendation Issue: How to account for the project financing arrangement between Kitchener and Magmum. Magnum has offered to build a facility for Kitchener’s exclusive use that Magnum will retain ownership of until the end of the agreement. Kitchener would agree to a 20-year lease and a facility purchase price of 1.2 times the market rate for the facility at the end of the lease period. The lease payments will be based on a flat rate plus a percentage of any additional revenues generated by Kitchener related to the new facility. Analysis: Treat the agreement as a lease

Treat the agreement as a project financing arrangement - It needs to determined whether - It needs to determined if this is or not the agreement is a a project financing capital or operating lease arrangement whereby obligation under ASPE. It may Magmum is providing be an operating lease since construction services for the the purchase price of the building—which is exclusively facility at the end of the going to be used by Kitchener. contract is 1.2 x market rate, This is then the economic which does not constitute a substance of the arrangement. bargain purchase option and - These services are being paid the lease term is short for over time (debt service compared to the likely life of component of the lease the facility. The amount of payments) instead of upfront. lease payments is not given in - Since the plant ownership the case, but this would need reverts to Kitchener at the end to be determined to see how it of the 20 year “lease” and the compares to the fair value of facility is being built on the facility. Kitchener’s land, it could be considered Kitchener’s asset. However, Kitchener does need to pay 1.2 x market value at

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- The purchase of the facility at 1.2 X market value may be a binding non-cancellable part of the arrangement and may constitute transfer of ownership. - If this is an operating lease, it is considered an executory contract, and no amount would be recorded on the statement of financial position. The lease payments are payable as each month passes. -

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the end of the term and does not own the facility until that time. - egardless of the above, Kitchener has an obligation to pay the lease payments, which are comprised of a flat fee plus a percentage of the revenue earned from the new facility. - Recognition of an obligation would worsen the debt-toequity ratio.

Either way, a note disclosure is required outlining the commitment to pay lease payments and the payment at the end of the term. The building, even though on Kitchener’s property, is owned by Magmum for the first 20 years. Kitchener does not have control over it. This does not affect debt on the statement of financial position if treated as an operating lease under ASPE. Under IFRS 16, if the contract met the definition of a lease, the company would have to estimate and recognize a liability for any amounts that were probable as well as a contractual right to use the facility. This would impact the debt-to-equity ratio (likely worsening it).

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CA 14.1 Kitchener Mechanical Incorporated (CONTINUED) Recommendation: If the lease is classified as an operating lease under ASPE, it would only be recognized as an expense over the lease term and not violate the debt-to-equity covenant. Under IFRS a lease liability and contractual right to use the facility would be recorded on the statement of financial position. The associated increase in liabilities may result in a violation of the debt-to-equity ratio. Since the company is planning to go public, it should recognize the arrangement as a lease under IFRS and apply IFRS 16.

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INTEGRATED CASES IC 14.1 Big Bath Emporium (BBE) Case Overview The bank has requested audited statements and imposed a debt covenant requiring a debt/equity ratio of no more than 1:1. Therefore, the statements must follow GAAP (may use ASPE or IFRS) and the debt and equity numbers are sensitive. There may be a bias to ensure that the debt covenant is not violated since the company needs the bank loan in order to finance its expansion into Quebec. The statements will be used to assess financial position and performance. Income tax minimization may have been an objective in the past, since BBE is a private company. As such, BBE was not legally bound by GAAP. However, an audit is now required and there will be a bias to ensure that the debt covenant is met. As auditors, we must ensure that the statements are transparent. Differences between IFRS and ASPE will be noted. Analysis and recommendations - MEMO To: Manager, Brayden LLP From: Senior Accountant, Brayden LLP Re: Accounting issues noted for Big Bath Emporium

Introduction The following report has been prepared to analyze the current policies and the transactions that took place during the year. The purpose of this report is to identify potential issues that may be encountered during the audit. BBE may choose to report using either IFRS or ASPE. ASPE has been applied given there is no need to use IFRS, as the firm has not provided any indication of an intention to go public. Differences between ASPE and IFRS will be noted for discussion with the client.

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IC 14.1 BBE (CONTINUED) Warranty Expense Issue: BBE sold 100 five-year warranties for $5,000 each on the bathtubs it sold in 2023. Typically, the warranties result in a cost of approximately $500 each / year. BBE uses the cash basis to recognize the warranty expense and revenue. In 2023, no warranty costs were incurred or recognized.

Analysis and Recommendation: The cash method of accounting for warranty costs is acceptable when the costs are not material or when the warranty period is relatively short. It may also be acceptable when the amount of the liability cannot be reasonably estimated or if future costs are not likely to be incurred. However, the current warranty expense is material and can be estimated. Therefore, the cash method is not acceptable. Given that the warranty is sold as a separate product, the revenue from the warranty should be recognized (unearned revenues). The company has sold 100 warranties at $5,000 each, for total revenue of $500,000. However, given that the performance on the warranty takes place over five years, the revenue should be recognized over time. Given that the warranty costs are incurred relatively evenly over five years, the revenue should also be recognized evenly over five years, $100,000 per year. Since no warranty costs were incurred in 2023, the company may want to examine the basis under which revenues are recognized over the warranty period. Historically, expenses averaged $500 per year per warranty over the term of the warranty. If the costs are not expected to be incurred in a straight-line pattern, then it may be preferable to recognize revenues in the same pattern as in which the costs are expected to be incurred.

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IC 14.1 BBE (CONTINUED) Since the company previously recognized revenue on the cash basis, it needs to reverse the revenue amount pertaining to future years’ service and recognize as unearned revenues ($400,000). This will have the following implication on the debt-to-equity ratio: • liabilities will increase by $400,000 in the form of deferred revenue • revenues will decrease by $400,000, decreasing retained earnings and equity (since BBE uses the cash basis to record the warranty and revenue) The treatment of the warranties would be the same under both ASPE and IFRS. Decommissioning costs Issue: At yearend, BBE was notified that every 10 years, it must perform a cleanup of its plant and surrounding area. The estimated clean costs are approximately $500,000 in 10 years.

Analysis and Recommendation: The loss should be accrued since the costs meet the definition of a liability: result of a past transaction (since the facility has already been built), probable outflow of resources (government required, thus, probable), and costs are measurable (management is able to estimate the costs). Given that the amount is due in ten years, the cost needs to be discounted. We can use the recent borrowing rate from the bank at 9% for discounting. Using present value tables: $500,000 x 0.42241 = $211,205. Since the amount is a decommissioning cost, the $211,205 increases the cost of the asset, and is also recorded as a liability. Buildings ............................................ Asset Retirement Obligation ........

211,205 211,205

Each year, the liability will be increased, with the increase being recorded as interest expense. The asset will be depreciated with the increased amount. Solutions Manual 14.183 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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IC 14.1 BBE (CONTINUED) Each year, the company would recognize the increase in the ARO due to accretion as follows: Year 0 1 2 3 4 5 6 7 8 9 10 1

Balance $211,205 211,205 + 19,008 = 230,213 230,213 + 20,719 = 250,932 250,932 + 22,584 = 273,516 273,516 + 24,616 = 298,132 298,132 + 26,832 = 324,964 324,964 + 29,247 = 354,211 354,211 + 31,879 = 386,090 386,090 + 34,748 = 420,838 420,838 + 37,875 = 458,713 458,713 + 41,287 = 500,000

Accretion (9%) $19,008 20,719 22,584 24,616 26,832 29,247 31,879 34,748 37,875 41,2871 0

Rounded

Decommissioning costs (continued) The debt-to-equity ratio is negatively affected. Debt will increase by $211,205, however, this treatment of the cleanup costs is required for GAAP compliance under ASPE. The treatment of the cleanup costs may be different under IFRS depending on how the cleanup costs arise. If the costs relate to the use of the facilities and increase over time, the costs would be included as product costs. The measurement of the asset retirement obligation would remain the same. Interest-Free Loan Issue: Inventory purchased on January 1, 2023, was financed through an interest free vendor take-back loan and a promise to pay $200,000 in 2 years. Although the inventory value was recorded as $200,000, the net realizable value at year end is $100,000. Solutions Manual 14.184 Chapter 14 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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IC 14.1 BBE (CONTINUED) Analysis and Recommendation: Long-term debt is recorded at the present value (fair value) of the stream of payments. Currently, BBE recorded the liability at the face value of $200,000, however, this represents the undiscounted amount. As a result, both assets and liabilities are overstated. The present value of the payments is calculated using the 9% interest rate on the current bank loan over two years. Present value using tables is $200,000 x 0.84168 = $168,336. Thus, the inventory and the liability should be recorded at $168,336. However, since the net realizable value of the inventory is only $100,000, and the inventory must be recorded at the lower of cost and net realizable value, the inventory needs to be written down further to $100,000, representing a loss of $68,336. The adjusting entries would be: Liability ........................................ Inventory ...............................

31,664

Loss on Inventory (or COGS) ...... Inventory (or allowance) ........

68,336

Interest Expense.......................... Liability ..................................

15,150

31,664

68,336

15,150

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IC 14.1 BBE (CONTINUED) Interest-Free Loan (continued) Liabilities decrease by $16,514, which reflects positively on the debtto-equity ratio, but income decreases by $83,486 due to the write down and interest expense, which decreases retained earnings and decreases equity. The treatment of the interest-free loan would be the same under both ASPE and IFRS. Contingent liability Issue: A wrongful dismissal suit has been launched against BBE by an employee for $150,000. BBE’s lawyers expect that BBE will need to payout between $100,000 and $120,000. The lawsuit is still in court. Analysis and Recommendation: The liability should be recognized because the criteria of likely and measurable are met. The liability is likely given that the lawyers predict a settlement. The liability is also measurable because the lawyers anticipate a settlement between $100,000 and $120,000. Under ASPE, the contingent liability should be recorded at the lower end of the range, $100,000. Under IFRS, this would need to be recognized at the mid-point of the range, $110,000. IFRS would also recognize the liability if it is “probable,” rather than likely, which is a lower threshold. Although Thomas believes that there will be no outflow, the lawyers anticipate a settlement, and thus the adjusting journal entry is as follows: Litigation Expense .............................. Contingent Liability ......................

100,000 100,000

The debt-to-equity ratio is negatively impacted by the $100,000 expense, decreasing retained earnings and equity, and increasing liabilities by $100,000.

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IC 14.1 BBE (CONTINUED) Redeemable and Retractable Shares Issue: BBE issued 10,000 redeemable and retractable preferred shares at $50 each. BBE has classified the shares as equity, however ASPE/IFRS requires the substance of the instruments to be assessed, as opposed to the legal form. Analysis and Recommendation: Elements of Equity • Dividends are to be declared on a discretionary period after the expiry of the retraction period • Dividends after the retraction period are not cumulative Elements of Debt • Mandatory dividend payment of $10 per share requires the delivery of cash for the first five years • The shares are retractable at the discretion of the holder, therefore requiring BBE to deliver cash. The likelihood of the holders retracting the shares is high given that after 5 years, the retraction period expires, and dividends are no longer mandatory or cumulative. Based on the substance of the transaction, ASPE/IFRS provides guidance on when preferred shares establish a contractual obligation to deliver cash indirectly through the terms and conditions, such as these preferred shares. These shares should be classified as a financial liability. ASPE has an exemption for redeemable and retractable shares issued in a tax planning arrangement. Under the exemption, the shares may be recognized as equity, and the dividends accounted for as ordinary dividends through retained earnings. As such, under ASPE, no revision would be needed. However, under IFRS, the shares would need to be reclassified as a liability, and the dividend of $100,000 that went through the retained earnings should go through the income statement as interest expense.

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IC 14.1 BBE (CONTINUED) Under ASPE, there would be no effect on the debt-to-equity ratio.. Under IFRS, the debt-to-equity ratio is negatively impacted since the debt is understated by the $500,000 and the income is overstated by the $100,000 dividend.

Payment of Dividend on Common Shares Issue: BBE issued 10,000 redeemable and retractable preferred shares at $50 per share in 2023. The retractable / redeemable feature expires December 31, 2028. The preferred shares pay a mandatory dividend of $10 per share per year until then. Prior to paying the dividend, Bob should look at the revised covenant to determine if it is met after all the adjustments. Analysis: Exhibit I summarizes the GAAP adjustments and the impact on the debt-to-equity ratio. After making the necessary GAAP adjustments, the debt-to-equity ratio will be 1.10:1, which is in violation of compliance with the covenants. Once the dividend is paid, equity will decrease by $800,000, and the ratio will increase to 1.96:1. Exhibit 1 - Recalculation of Debt-to-Equity Ratio Debt Preliminary 1,300,000 Debt-to-equity ratio 0.54 :1 GAAP Adjustments 1) Warranty expense 400,000 2) Decommissioning costs 211,205 3) Interest-free loan (16,514) 4) Contingent liability 100,000 5) Redeemable shares 0 Pre-dividend balances 1,994,691 Debt-to-equity ratio 1.10 :1 Dividend Adjusted balance 1,994,691 Adjusted D/E ratio 1.96 : 1

Equity 2,400,000

(400,000) 0 (83,486) (100,000) 0 1,816,514 (800,000) 1,016,514

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IC 14.1 BBE (CONTINUED) Recommendation: Bob should not pay the dividend, and the company should seek an alternative to avoid the covenant violation and classification of the long-term debt as current. Additional equity is required. Alternatively, the company should renegotiate the covenant with the bank, since, even without the dividend, the covenant is still breached.

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IC 14.2 RTL Case Overview: RTL is a private family-run business, so reporting under ASPE is an option. Since the company is not going public, IFRS is not required. The bank will use the financial statements to assess RTL as a going concern and its ability to pay interest and principal on any outstanding and future loans. Management will use the financial statements to assess RTL’s performance as it transitions to digital printing and the company’s ability to achieve its revenue targets. The auditors will be auditing the financial statements with a transparent reporting objective. There is a potential for management bias and aggressive accounting policies, especially given recent events that include: o A decline in RTL’s profits over the past 2 years with a 50% loss of its revenue. o A new agreement that RTL has entered into with the bank for the restructuring of its loan. The reporting objective as the controller is to fairly present the statements. Issue: The bank is willing to decrease the lending rate on the loan by 2% (from 10% to 8%), extend the current debt maturity by three years and reduce the principal repayment by $500,000 (from $2,000,000 to $1,500,000). How the restructured debt should be recognized must be investigated. Analysis and Recommendation: A modification of debt can be treated as a settlement if the following condition is met: if the discounted PV under the new terms (discounted at the original effective rate) is at least 10% different from the discounted PV of the remaining cash flows under the old debt, the old debt is treated as a settlement and removed from the books.

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IC 14.2 RTL (CONTINUED) Old debt: $2,000,000 (debt is due end of 2023) New debt: $1,500,000 (0.75132) + $120,000 (2.48685) = $1,425,402 10% of the value of the old debt is $200,000. The difference between the old and new debt is greater than $200,000. Therefore, this restructuring qualifies as a settlement of the old debt. The discount rates are calculated using the following: Discount rate of 0.75132 is the PV discount factor for a single sum (10%, 3 years) Discount rate of 2.48685 is the PV discount factor for an ordinary annuity (10%, 3 years) Using a financial calculator: PV $ ? Yields $1,425,394 I 10% N 3 PMT $ (120,000) FV $ (1,500,000) Type 0 Excel formula =PV(rate,nper,pmt,fv,type) On the books, the new debt is calculated using the current market discount rates using the following: Discount rate of 0.77218 is the PV discount factor for a single sum (9%, 3 years) Discount rate of 2.53130 is the PV discount factor for an ordinary annuity (9%, 3 years) Resulting present value is $1,462,026

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IC 14.2 RTL (CONTINUED) Using a financial calculator: PV $ ? I 9% N 3 PMT $ (120,000) FV $ (1,500,000) Type 0

Yields $1,462,031

Excel formula =PV(rate,nper,pmt,fv,type) The following journal entry is required (using the PV tables): Debt (old)............................................... Debt (new) ..................................... Gain on Restructuring of Debt .......

2,000,000 1,462,026 537,974

Issue: Revenue recognition of the digital contract sales. Revenue contracts for digital services include an upfront nonrefundable fee and a term of two to three years. Customers are charged for each digital print and a flat fee for concept or design changes. Therefore, each contract has a minimum value regardless of whether any work is performed.

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IC 14.2 RTL (CONTINUED) Analysis: Immediate recognition of Deferred recognition of revenues revenues - There is a nonrefundable - There is a nonrefundable and fee, so no additional minimal contract fee, therefore, service is required to be the earnings process for the performed by RTL. The sales transaction is the entire upfront fee is paid in duration of the contract. RTL advance ensuring must be available to perform collectibility and printing services on-demand, as measurability. a result the earnings process is not completed upon the signing - There is a minimum of the contract. contract fee, therefore, RTL earns a minimal - Risk remains with RTL for the contract fee at the end of duration of the contract for the the contract term (2-3 on-demand printing services. years) even if no printing - Collectibility may be an issue, services are performed. since two of RTL’s digital customers have gone bankrupt. - Customers pay a per-unit fee for each digital print RTL does not have any history job, this would be with digital customers so an recognized as earned appropriate estimate for an (covering costs). allowance for doubtful accounts may not be possible. - Another option is to recognize the nonrefundable fee and the minimal contract fee over the duration of the contract.

Recommendation: Depending on the significance of the two digital customers that have filed for bankruptcy and RTL’s limited digital sales history, collectibility may be a concern. RTL should then recognize the nonrefundable fee and minimal contract fee at the end of the contract. Assuming collectability is not a concern, RTL may also recognize revenues over time as earned.

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IC 14.2 RTL (CONTINUED) Minor Issue: Recognition of an asset retirement obligation for the digital printing equipment that was to be used for only 5 years prior to its sale to another vendor. The costs to modify the equipment and prepare it for sale are estimated at $100,000. Analysis and Recommendation: The $100,000 represents a constructive obligation. RTL is planning to sell the equipment to a vendor who will only purchase the digital printing equipment if RTL makes the necessary modifications to update the equipment and prepare it for sale. The liability should have been recorded at PV (using the discount rate in effect at that time), not at $100,000. The printing equipment asset should have increased by the PV of the obligation. Accretion expense should have been recorded for 2022 and 2023. As the accounting ledger for 2022 is now closed the correction must be recorded in the 2023 ledger. An adjustment to opening equity will be required. For 2023, the appropriate accretion expense must be recorded in the operating statement.

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RESEARCH AND ANALYSIS RA 14.1 BROOKFIELD ASSET MANAGEMENT INC. a. Debt-to-total assets ratio = (Total debt) / (Total assets) Times interest earned = (Income before income taxes + interest expense) / (Interest expense) Debt-to-equity ratio = (Total debt) / (Total equity) December 31, 2019: Debt-to-total assets ratio = $207,123 / $323,969 = 63.9% Times interest earned = $13,0761 / $7,227= 1.81 Debt-to-equity = $207,123 / 116,846 = 1.77 December 31, 2020: Debt-to-total assets ratio = $221,054 / $343,696 = 64.3% Times interest earned = $8,7572 / $3,7,213 =1.21 Debt-to-equity = $221,054 / 122,642 = 1.80 During 2020, BAM’s solvency deteriorated slightly as its ratio of debt to total assets increased and the ratio of debt to equity also increased, indicating that the company’s creditors financed an increased proportion of its investment in assets. Its times interest earned also deteriorated during 2020, indicating a decrease in BAM’s ability to cover the interest charges associated with its debt. It should be noted that BAM’s business requires heavy investment in stable long-term assets, so the debt ratios are likely not out-of-line in its industry. The times interest earned ratio may be reasonable, but a comparison to industry benchmarks would provide a better assessment. As this ratio is deteriorating, there may be a concern regarding meeting its interest obligations should interest rates rise in the future. 1 $5,354 + $495 + $7,227 = $13,076 2 $707 + $837 + $7,213= $8,757

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RA 14.1 BROOKFIELD (CONTINUED) b.

BAM has borrowed long-term through the following types of interest-bearing debt: long-term notes payable, commercial paper, bank loans, and mortgages. Details are not provided about the make-up of the subsidiary borrowings. Due dates of debt reported, December 31, 2020: Corporate Property-specific Subsidiary borrowings borrowings borrowings (Note 16) Current (2021) $ $ 20,970 $ 317 and commercial paper and bank borrowings 2 to 5 years 2,114 (2022 to 2025) 64,263 5,750 6 to 10 years (2026 to 2030) 3,962 44,428* 4,732* After 10 years (2031 on) 3,071 Deferred financing costs (70) (1,105) (31) $ 9,077 $128,556 $ 10,768 *Note 18 does not provide any further breakdowns after year 5 Note 16 (Corporate Borrowings) gives no indication of security by anything other than the reputation of the company. However, Note 6 (Fair Value of Financial Instruments) and Note 8 (Inventory) indicate that $9.7 billion of financial assets and $6.0 billion of inventory, respectively, are pledged as collateral/security. This is likely for any bank borrowings and notes payable. In addition, all the property-specific mortgages (non-recourse borrowings) are secured by the underlying property the funds were borrowed for, as indicated in Note 18. Note 11 (Investment Properties) indicates that the investment properties are pledged as collateral for the non-recourse borrowings at their respective properties, and Note 12 (Property, plant and equipment) indicated that $80.2 billion of property, plant and equipment, at cost, were pledged as collateral for the property debt at their respective properties. The subsidiary borrowings (under non-recourse borrowings) are not described as secured, but it is likely they are also secured by a mix of current and financial assets as well as underlying property held by the subsidiaries.

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RA 14.1 BROOKFIELD (CONTINUED) c. Currency US$ Canadian $ Deferred finance costs Australian $ British £ (pounds) Brazilian reals Korean won Chilean unidades de fomento European Union € (euros) Indian rupees Columbian pesos Peruvian nuevo soles Japanese yen Other Currencies Total

Corporate Borrowings $ 6,786 2,264 (70)

Property- Specific Borrowings $ 78,223 8,458

Subsidiary Borrowings $ 4,376 6,254

4,799 10,341 3,487 2,082 1,187

138

7,816 8,978 2,141 97 1,044 $ 9,077

$ 128,556

$ 10,768

Note 2(d) - Foreign Currency Translation indicates that the “U.S. dollar is the functional and presentation currency of the company.” This means that all amounts presented on the December 31, 2020 balance sheet, including the corporate borrowings, property-specific mortgages, and the subsidiary borrowings are reported at or are restated into their U.S. dollar equivalent at this reporting date. d.

The subsidiary borrowings are included in BAM’s liabilities because BAM presents consolidated financial statements. As indicated in Note 2(c), such statements include the accounts (which means all the assets and liabilities) of the company and entities that BAM exercises control over – its subsidiaries. It is BAM’s ability to control the “relevant activities, exposure or rights to variable returns from involvement with the investee, and the ability to use its power over the investee to affect the amount of its returns” which is the reason all the controlled companies’ assets, liabilities, revenues, and expenses are included with BAM’s own corporate items. In this way, BAM’s existing and potential shareholders can more fully appreciate the company’s financial position and financial performance.

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RA 14.2 LOBLAW COMPANIES LIMITED AND EMPIRE COMPANY LIMITED a.

The following are the debt to total assets and times interest earned ratios for the companies: In millions Total liabilities Total assets Debt-to-asset ratio Earnings before interest and taxes Interest expense Times interest earned

Loblaw

Empire

January 2, 2021

May 2, 2020

$24,751 35,870 0.69 2,365

$10,619.0 14,632.9 0.73 1,111.8

742 3.19

279.1 3.98

From the above analysis, it appears that Loblaw has relatively more debt than Empire in its capital structure. The two companies have relatively similar debtto-asset ratios when comparing their level of debt to total assets. Given that Loblaw generates substantially higher earnings, it can achieve a better times interest earned ratio than Empire. This shows that even with a higher level of debt, Loblaw is better able to service the debt and has more financial flexibility. b.

The following key financial condition ratios are highlighted in either or both of each company’s Management Discussion and Analysis and its note to the financial statements on Capital Management, with all terms defined in the discussion: Loblaw Empire (Note 34) ( MD&A) Net funded debt to net capital ratio 58.8% Funded debt to EBITDA EBITDA to interest expense Retail debt to adjusted EBITDA

3.3X 8.0X 2.8:1

Adjusted return on equity

14.0%

Adjusted return on capital

8.2%

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RA 14.2 LOBLAW AND EMPIRE (CONTINUED) b. (continued) As can be seen from the above table, the two companies use different ratios to monitor and present their debt financial condition, and the ratios are calculated differently. Since these are non-GAAP measures, there is detail provided as to how these ratios have been calculated in the “Non-GAAP Financial Measures” section of the MD&A, although Empire provides this information in its Capital Management note as well (along with other ratios where the formulas are provided, but not the calculation). Financial analysts may calculate their own ratios so that the two companies could be compared on the same basis. In addition, because Loblaw’s operations include PC Bank, it is subject to regulatory requirements of the Superintendent of Financial Institutions (OSFI), particularly for equity capital ratios. c.

Reviewing the long-term debt (Note 16) of Empire, the company has a relatively small amount of first mortgage loans repayable 2021 to 2033, medium term notes coming due between 2035 to 2040, credit facilities due in 2020 and 2022, finance lease obligations (details founds in Note 3(ab)), and miscellaneous other debt. According to Empire’s MD&A, the Dominion Bond Rating Service (DBRS) assessed the credit rating of Sobeys (Empire’s major food retailer and operating company) as BBB (low) with a stable trend, and Standard and Poors (S&P) rated it at a BBB- rating with a stable trend. Loblaw, in Note 21, outlines that its debt is primarily made up of debentures notes over the short, medium and long-term that mature on various dates from 2020 to 2043. It also has a committed credit facility of $1.0 billion, guaranteed investment certificates (GICs), and independent securitization and funding trust borrowings. In addition, the company has finance lease obligations. In Section 7.5 of Loblaw’s MD&A, the company reports that both DBRS and S&P assigned the company a credit rating of BBB with a stable trend. Although Empire has a similar debt-to-assets ratio as Loblaw, the lower rating for Empire could be expected since its times interest earned ratio is lower than Loblaw’s. Further financial statement and ratio analysis would need to be performed and compared on the two companies in order to properly make a determination as to why one rating is different from the other. While the ratios identified in part a) are a start, other ratios such as debt to equity, and debt service ratio, along with profitability trends should be part of the analysis as well as comparison against industry benchmarks.

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RA 14.2 LOBLAW AND EMPIRE (CONTINUED) d. Note 30 provides Empire’s capital management disclosures. The company’s objectives in managing its capital are: to ensure sufficient liquidity to pay its obligations and to carry out its operating and strategic plans, to minimize its cost of capital, to maintain an optimal capital structure to ensure financial flexibility and that financial covenants are met, and to maintain an investment grade credit rating. The company defines “capital under management” as including all interest-bearing debt (funded debt) net of cash and cash equivalents, plus shareholders’ equity net of non-controlling interests. The total capital measure at May 2, 2020 was $9,857.6 million. The key ratios monitored are (from the MD&A): net funded debt to total capital, funded debt to EBITDA, and EBITDA to interest expense. In Note 30, Empire had three financial covenants to maintain for which it was in compliance: (1) adjusted total debt to EBITDA, (2) lease adjusted debt to EBITDAR (note: the “R” refers to rent) and (3) debt service coverage ratio: EBITDA to the total of interest expense and repayments of long-term debt over the previous 52 weeks. In Note 24, Loblaw outlines its capital disclosures. It has six objectives in managing its capital: ensure sufficient liquidity to pay its obligations and to carry out its operating and strategic plans; maintain financial capacity and the ability to access capital as needs arise; minimize its cost of capital; use short term funding to manage working capital needs and long term funding to finance long term capital investments; return appropriate capital to shareholders; and target appropriate leverage and capital structure for each reportable operating segment. Management defines capital as the total of its bank indebtedness, demand deposits from customers, current debt, current and long-term portions of longterm debt, certain other liabilities, lease liabilities, and Loblaw shareholders’ equity. At January 2, 2020, capital under management amounted to $27,737 million. Loblaw monitors certain interest coverage and leverage ratios as defined by loan facility agreements. Its major subsidiary, Choice Properties, also has defined debt service and leverage financial ratios it must meet under creditor agreements. Loblaw’s MD&A states that its regulated PC Bank subsidiary is required to meet a common equity Tier 1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5%, a total capital ratio of 10.5%, as well as liquidity adequacy requirements such as a liquidity coverage ratio. Loblaw does not provide the results of its ratios except to state that it has been in compliance with all requirements throughout the year.

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RA 14.2 LOBLAW AND EMPIRE (CONTINUED) e.

Empire explains clearly in Note 3(a) that structured entities are entities controlled by the company through means other than share ownership and voting control. Instead, the company has rights through existing agreements that give it the ability to direct the other entities’ activities that significantly affect the returns to Empire. Such entities are fully consolidated with their assets and liabilities being combined with those of Empire and its subsidiaries. While these structured entities are not specifically identified, the company has franchise affiliates where control is attained through franchise agreements, guarantees, and standby letters of credit. Loblaw, in Note 2, explains its consolidated structured entities. These include independent franchisees of the company who obtained funding from a structured independent funding trust associated with Loblaw to help with their purchase of inventory and fixed assets. Also, through its banking subsidiary, PC Bank, Loblaw is party to securitization programs that provide funds to operate its credit card operations (Eagle Credit Card Trust). This involves selling some of its interests in credit card receivables to Eagle. PC Bank continues to service the credit cards and retains the rights to future cash flows after its obligations to Eagle have been met. Loblaw also has set up trusts to acquire company shares that will be needed under its executive compensation restricted share unit (RSU) and its performance share unit (PSU) stock option plans. The company provides the funds to the trust to acquire its shares and it earns a management fee from the trust. All the consolidated structured entities are fully consolidated with their assets and liabilities reported with those of Loblaw itself. Loblaw also has unconsolidated structured entities. These are made up of securitization trusts managed by major Canadian banks, and which Loblaw cannot control through share ownership or management and asset agreements.

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RA 14.3 AIR CANADA a.

Debt-to-equity ratio = (Total debt) / (Total equity) Times interest earned = (Income before income taxes + interest expense) / (Interest expense) 2020: (in $ millions) Debt-to-equity ratio = $27,198 / $1,715 = 15.86 : 1 Times interest earned = (-$4,853 + 765 – 64 + $656)/ $656 = -5.33 times 2019: (in $ thousands) Debt-to-equity ratio = $23,359 / $4,400 = 5.31 : 1 Times interest earned = ($1,775 - $22 + $25 + 515) / $515 = 4.45 times The debt-to-equity ratios indicate that Air Canada is highly leveraged, and has taken on significantly more debt in 2020 compared to 2019. This is a significant increase in risk. Its liabilities equal 15.86 times its shareholder equity in 2020 and 5.31 times in 2019. This means that as of 2020, almost all of Air Canada’s assets are funded by liabilities. The times interest earned ratio has also significantly deteriorated from 4.45 times in 2019 to -5.33 in 2020. Due to the net income loss in 2020 and operating at a deficit, Air Canada is ultimately borrowing funds to cover its interest payment obligations. The main reason for this major deterioration in performance, as highlighted throughout the notes of the financial statements, is due to the Covid-19 pandemic. The airline and travel industry experienced a significant decrease in volume and customer traffic. In 2020, Air Canada took on significantly more debt, while also moving into a deficit position in its retained earnings. In addition, Air Canada was able to raise additional share capital to generate cash and cover its fixed costs over this difficult period. While debt significantly increased, there was only a small increase in interest expense year over year. This indicates that in addition to securing additional debt, Air Canada was able to negotiate more favorable interest terms on its debt through restructuring and a deferral of interest payments.

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RA 14.3 AIR CANADA (CONTINUED) Air Canada: net debt-to-equity ratio (See Note 19) 2020 = $4,976 / $1,715 = 2.90 : 1 2019 = $2,841 / $4,400 = 0.65 : 1 Both 2020 and 2019 debt-to-equity ratios are significantly better when using net debt instead of total debt (liabilities) in the ratio calculation. The results of the revised calculations underscore the necessity of always understanding what is included in the terms used in any given ratio. It is reasonable for the companies to zero in on their long-term interest-bearing debt, but to ensure that the users of the statements are not misled by the nature of the obligations of the company and understand what is included in the values provided. Air Canada calculates net debt by only including total long-term debt and lease liabilities, and then reducing that value by cash and cash equivalents, short-term investments, and long-term investments. While this provides a focused debt-to-equity ratio, it does not consider other obligations that Air Canada has that are valid claims against the assets of the company. Examples include, current liabilities, Aeroplan and other deferred revenue, pension liabilities, and other long-term liabilities. c.

There is no mention of sustainability in the financial statements other than a minor mention in Note 17, under Risk Management – Liquidity Risk, where it indicates that the company is committed to managing liquidity through sustaining and improving cash from operations. To borrow from lenders / investors, a company needs to be able to demonstrate that its earnings, both cash flow and profitability, are sustainable into the future. Air Canada, along with many other airlines around the world, suffered major financial losses due to the Covid-19 pandemic. As a result, a variety of initiatives that included cost costing and financial restructuring were undertaken. For a lender / investor to offer and support the restructuring of debt, there must be confidence that earnings will rebound in the future. A short summary of activities that Air Canada undertook to deal with the Covid19 pandemic are provided in Note 17. Air Canada publishes a Corporate Sustainability report on its company website. This report includes a sustainability mission statement that commits to integrate economic, environmental, and social factors. This comes together under three sustainability pillars: Our Business, Our People, Our Planet. There is also a section that includes highlights of performance under this mandate.

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MMXXII vii F2

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CHAPTER 15 SHAREHOLDERS’ EQUITY Learning Objectives 1. Discuss the characteristics of the corporate form of organization, rights of shareholders, and different types of shares. 2. Explain how to account for the issuance, reacquisition, and retirement of shares, stock splits, and dividend distribution. 3. Understand how shareholders’ equity is presented, disclosed, and analyzed. 4. Identify the major differences in accounting between IFRS and ASPE, and what changes are expected in the near future. 5. Explain how to account for par value and treasury shares. 6. Explain how to account for a financial reorganization.

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Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

Item LO

AP AP AP AN AN

Brief Exercises

1. 2. 3. 4. 5.

1 1 1 2 2,3

C K C AP AP

6. 7. 8. 9. 10.

2 2,3 2,3 2 2

AP AP AP AP AP

11. 12. 13. 14. 15.

2 2 2 2 2

AP AP AP AP AP

16. 17. 18. 19. 20.

2 3 3,4 3 3

21. 22. 23. 24.

5 5 5 6

AP AP AP AP

1. 2 2. 2,3,4 3. 2 4. 2

AP AP AP AP

5. 6. 7. 8.

2,3 2 2 2

AP AP AP AP

9. 2 10. 2 11. 2 12. 2,3

AP AN AP AP

13. 14. 15. 16.

2,3 AP 17. 2,3 AP 18. 2,3 AP 19. 2,4 C 20.

3 3 6 6

AP AP AP AP

1. 1,2,3 AP 2. 1,2,3 AP 3. 2 AP

4. 5. 6.

2 2 2

AP AP AP

7. 2 AP 10. 8. 2,3 AP 11. 9. 2 AP 12. Cases

2 AP 13. 2,3 AP 2 AP 14. 3,4 AP 2,3 AP 15. 2,3 AP

1. 1, 2, 6 AP 1. 1, 2, 6 AP 1. 2.

1,3 2,3

AP AP

Integrated Cases 2. 2, 3 AN Research and Analysis 3. 1,2,3 AN 5. 1,3 AN 7. 4. 1,2,3 AP 6. 2,3 AP

2,3 AP

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

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ASSIGNMENT CLASSIFICATION TABLE Topics

Brief Exercises

Exercises

Problems

1. The corporate form; share capital; and profit distributions.

1, 2, 3

1, 2

2. Issuance of shares; reacquisition transactions; stock splits; dividend distributions.

3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16

1, 2, 3, 4, 5, 6, 7, 9, 10, 11, 12, 13, 15

3. Presentation of shareholders’ equity, disclosure requirements, and ratio analysis

17, 18,19, 20

4, 5, 12, 13, 14, 15, 17, 18

1, 2, 7, 12, 13, 14, 15

4. Differences between IFRS and ASPE.

5, 7, 8, 18

2, 16

*5. Par value and treasury shares.

21, 22, 23

*6. Financial reorganization.

19, 20

*This material is dealt with in an Appendix to the chapter.

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ASSIGNMENT CHARACTERISTICS TABLE Item

Description

E15.1

Recording issuance of common and preferred shares Subscribed shares Share issuances and repurchase Correcting entries for equity transactions Preferred dividends Preferred dividends and DAIS Participating preferred and stock dividend Dividend entries Stock split and stock dividend Reverse stock split and convertible preferred shares Entries for stock dividends and stock splits Dividends and shareholders’ equity section Statement of changes in shareholders’ equity Equity transactions and statement of changes in shareholders’ equity Shareholders’ equity section Equity items on SFP Shareholders’ equity section Comparison of alternative forms of financing and DAIS Financial reorganization Financial reorganization

E15.2 E15.3 E15.4 E15.5 E15.6 E15.7 E15.8 E15.9 E15.10 E15.11 E15.12 E15.13 E15.14 E15.15 E15.16 E15.17 E15.18 *E15.19 *E15.20 P15.1 P15.2 P15.3 P15.4 P15.5 P15.6 P15.7 P15.8 P15.9 P15.10 P15.11

Issuance, repurchase, and prepare shareholders’ equity Analysis and classification of equity transactions Various issuances Various issuances Share repurchases Subscriptions, repurchase, and lump-sum issuance Issuance, repurchase, and dividends Subscriptions, repurchase, and lump-sum issuance Preferred share dividends Preferred share dividends Dividends and SFP impact.

Level of Difficulty

Time (minutes)

Simple

10-15

Moderate Simple Moderate Simple Moderate Moderate Simple Simple Moderate

15.20 10-15 15-20 20-25 20-25 20-30 10-15 10-15 10-15

Simple Moderate Simple Moderate

10-15 30-35 15-20 35-40

Moderate Moderate Moderate Moderate

20-30 15-20 10-15 20-25

Simple Moderate

10-15 15-20

Moderate

40-45

Complex

45-55

Simple Moderate Moderate Moderate

20-30 20-30 20-30 30-40

Moderate Moderate

25-30 25-35

Moderate Moderate Simple

15-20 20-25 20-25

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ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) P15.12 P15.13

P15.14

P15.15

Analysis and classification of equity transactions. Issuances, subscriptions and defaults, issuance costs, shares issued on account, preparing shareholders’ equity section. Share transactions, statement of changes in shareholders’ equity, and equity section preparation. Dividend entries and SFP presentation

Complex

40-45

Moderate

30-40

Moderate

40-45

Complex

35-45

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 15.1 Of the three primary forms of business organization—the proprietorship, the partnership, and the corporation—the most common form of business is the corporate form. The main advantage of incorporating is that a corporation is a separate legal entity, so the entity’s owners have greater legal protection against lawsuits. An additional important advantage is that incorporation involves the issuance of shares, which gives access to capital markets for companies that choose to raise funds in this way. The transfer of ownership is made easy with the corporate structure, using the shares as units of ownership. Corporations may also receive more favourable tax treatment than other forms of business organizations. Finally, corporations have a continuous life, unlike a proprietorship or partnership. 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. Disadvantages of a corporation are increased government regulations and the fact that corporations are taxed as a separate legal entity, thus not allowing losses to be utilized by the shareholders to offset other sources of taxable income. LO 1 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 15.2 A dividend is a pro rata (equal) distribution of a portion of a corporation’s retained earnings to its shareholders. There are basically two classes of dividends: 1. Those that are a return on capital (a share of the earnings) 2. Those that are a return of capital, referred to as liquidating dividends. The various types of dividends, and a brief description, are: Cash Dividends — To pay a cash dividend, a corporation must have retained earnings, adequate cash, and dividends declared by the board of directors. While many companies pay a quarterly dividend, there are companies, called growth companies, that pay no dividends but reinvest earnings in the company to finance its growth. Dividends in Kind —Instead of distributing cash, the corporation distributes some of its other assets, such as shares of other corporations, to its shareholders in proportion to their shareholdings. Property dividends or dividends in specie (Latin for "in kind") are those paid out in the form of assets from the issuing corporation or another corporation, such as a subsidiary corporation. They are relatively rare and most frequently are securities of other companies owned by the issuer; however, they can take other forms, such as products and services.

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BRIEF EXERCISE 15.2 (CONTINUED) Stock Dividends — 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. It does not decrease total shareholders’ equity or total assets. Stock dividends are generally issued: (a) by companies that do not have adequate cash to issue a cash dividend, (b) to increase the marketability of shares, and/or (c) 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. Liquidating Dividends — A liquidating dividend is a payment of a dividend to shareholders that exceeds the company's retained earnings. Once retained earnings is depleted, capital accounts such as contributed surplus are decreased to make up for the remaining dividend to be paid to shareholders. When a liquidating dividend occurs, it is a return of investment instead of a distribution of profits. Investors generally prefer cash dividends, and they are the most common in practice. Stock dividends are taxable to the shareholders while at the same time not distributing any cash. Consequently, the shareholder may need to sell the additional shares received to pay the income tax on the stock dividend. This is the main reason why stock dividends are not popular with shareholders. A cash dividend transfers the wealth inside the corporation to the shareholder in cash, allowing the shareholder to use the cash as desired. LO 1 BT: K Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 15.3 Series A: The shares would be reported as a liability since they are “mandatorily redeemable” i.e., there is an obligation for the company to pay cash at some point in the future. When the term expires, the company is obligated to buy back the shares from the holder. Series B: The shares have the characteristics of preferred shares since they have a stated dividend and they are cumulative. As well, voting rights are not included. The shares do not have the full risks and rewards of ownership that common shares have. Class A: The shares would be considered “in-substance” common shares since they are subordinated to Series A and B shares for dividend and asset distribution and they enjoy the risks and rewards of ownership by participating in the earnings and losses of the company. As well, the shares have voting rights. LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 15.4 June 1

Dec.

Share Subscriptions Receivable ......... 91,000 Common Shares Subscribed ...... 91,000 To record sale of shares on a subscription basis Cash (45% X $91,000) .......................... 40,950 Share Subscriptions Receivable . To record collection of down payment

40,950

Cash ($91,000 – $40,950) ..................... 50,050 Share Subscriptions Receivable . Collection of share subscriptions receivable

50,050

Common Shares Subscribed .............. 91,000 Common Shares ........................... To record issuance of shares

91,000

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 15.5 (a) March 1

Cash ...................................................... 12,500 Notes Receivable ................................. 12,500 Common Shares (1,000 X $25) ....

25,000

(b)(1) When shares are issued on account, ASPE [CPA Canada Handbook, Part II – ASPE, Section 3251.10] specifically states that the receivable for the uncollected amount should be reported as a reduction in shareholders’ equity unless there is no risk of a reduction in the value of the shares. This is similar to the accounting for shares sold on a subscription basis. It is also similar to the U.S. approach, as the SEC requires companies to use this approach because the risk of collection on these types of transactions is often very high. (2) IFRS is not definitive on the issue of presentation of the receivable for shares issued on account, but the conceptual framework would support presenting the receivables as a reduction of shareholders’ equity unless there is substantial evidence that the company is not at risk for declines in the value of the shares and there is reasonable assurance that the company will collect the amount in cash. The receivable from employees should be segregated from trade accounts receivable if not treated as a reduction of shareholders’ equity. LO 2,3 BT: AP Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 15.6 Cash ($66,000 – $1,700) ........................................... 64,300 Common Shares ............................................... 64,300 LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 15.7 (a) Common Shares ($21 X 800) .................................. 16,800 Retained Earnings .................................................. 28,000 Cash ($56 X 800) ............................................. 44,800 (b) Under IFRS, no explicit guidance is given with respect to accounting for reacquisition of shares, although the accounting may end up the same as in part (a), using basic principles under IFRS. LO 2,3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 15.8 (a) Common Shares ($8 X 600) ................................... Contributed Surplus............................................... Retained Earnings .................................................. Cash ($40 X 600) ...........................................

4,800 12,500 6,700 24,000

(b) Under IFRS, no explicit guidance is given with respect to accounting for the reacquisition of shares, although the accounting may end up the same as in part (a), using basic principles under IFRS. LO 2,3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 15.9 Preferred Shares (200 X $75) ................................. Common Shares ....................................

15,000 15,000

LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 15.10 Aug. 1 Dividends1 ................................... Dividends Payable ............. 1 (1,500,000 x $.60 = $900,000)

900,000 900,000

Aug. 15 No entry. Sep. 9

Dividends Payable ...................... Cash....................................

900,000 900,000

LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 15.11 (a) The average issue price of the preferred shares is $25.00. ($62,500 ÷ 2,500) (b) The average issue price of the common shares is $100. ($400,000 ÷ 4,000) (c) Rate paid to preferred shareholders is 4% ($1 ÷ $25.00) The equivalent for common shares is 4% on $100 paid per share or $4 per share. LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 15.12 Sep. 21

FV-NI Investments1 ....................... Investment Income or Loss . 1 ($1,300,000 – $850,000) To record fair value adjustment

450,000

Dividends ...................................... Property Dividends Payable To record declaration of property dividend

1,300,000

Oct. 8

No entry.

Oct. 23

Property Dividends Payable......... FV-NI Investments ..............

450,000

1,300,000

1,300,000 1,300,000

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 15.13 Apr. 20

Dividends ........................................... 250,000 Common Shares1 ............................... 150,000 Dividends Payable .................... 400,000

June 1

Dividends Payable ............................. 400,000 Cash........................................... 400,000

Any balance in contributed surplus, if related to the same class of shares, would be debited first, had there been a balance. LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 15.14 Declaration Date: Dividends1 ................................................... Common Stock Dividends Distributable ................................... 1 (450,000 X 6% X $30 = $810,000) Distribution Date: Common Stock Dividends Distributable ... Common Shares ................................

810,000 810,000

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 15.15 (a) (b) (c) (d)

740,000 (185,000 X 4) $5.00 ($20 X 1/4) $3,700,000 (740,000 X $5) no change in amount No entry to the general ledger, but a formal record of the split is made in the directors’ minutes, shareholder register, and as necessary in the corporate records to ensure both the split and the new number of shares are properly tracked and reported.

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 15.16 (a) (b) (c) (d)

37,000 (185,000 ÷ 5) $100.00 ($20 x 5) $3,700,000 (37,000 X $100) no change in amount No entry to the general ledger, but a formal record of the split is made in the directors’ minutes, shareholder register and as necessary in the corporate records to ensure both the split and the new number of shares are properly tracked and reported.

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 15.17 LU CORPORATION Shareholders’ Equity As at December 31, 2023

Share Capital Common shares........................................................... $ 310,000 Common shares subscribed ....................... $250,000 Less: share subscriptions receivable ........ (80,000) 170,000 Total share capital .................................................... 480,000 Contributed surplus .................................................... 320,000 Total paid-in capital ..................................................... 800,000 Retained earnings ........................................................... 1,340,000 Accumulated other comprehensive income ................. 560,000 Total shareholders’ equity ....................................... $2,700,000 LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 15.18 (a) THE SAWGRASS CORPORATION Statement of Changes in Shareholders' Equity Year Ended December 31, 2023 Share Capital Number of Legal Shares Capital Bal. Jan. 1, 2023 Issued common shares Repurchase of shares Declared dividends Comprehensive income: Net income Unrealized gain-OCI Bal. Dec. 31, 2023

32,000 2,000 (1,000)

$800,000 100,000 (25,000)

Other Contributed Capital

Retained Earnings

Accumulated Other Comprehensive Income

$145,000

$1,500,000

$40,000

(17,500) (70,000) 400,000

33,000

$875,000

$127,500

$1,830,000

25,000 $65,000

Total $2,485,000 100,000 (42,500) (70,000) 400,000 25,000 $2,897,500

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 15.18 (CONTINUED) (b) THE SAWGRASS CORPORATION Statement of Financial Position (Partial) December 31, 2023

Share Capital Common shares unlimited shares authorized 33,000 shares issued ............................................ $ 875,000 Contributed surplus .................................................. 127,500 Total paid-in capital ................................................. 1,002,500 Retained earnings ......................................................... 1,830,000 Accumulated other comprehensive income ............... 65,000 Total shareholders’ equity ..................................... $2,897,500

(c) Other comprehensive income and accumulated other comprehensive income are not recorded under ASPE. Under ASPE, changes in retained earnings are usually presented in a statement of retained earnings, and details of changes in capital accounts are usually presented in the notes to financial statements. LO 3,4 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 15.19 (1) Rate of return on common shareholders’ equity: Net income – preferred dividends Average common shareholders’ equity $720,000 – $24,000 2 $2,975,500 1

= 23.39%

Average common shareholders’ equity = [($3,881,000 $600,000) + ($3,270,000 – $600,000)] ÷ 2 = $2,975,500 1

Preferred dividends = 4% X $600,000 = $24,000

(2) Payout ratio: Cash dividends to common Net income – preferred dividends $124,000 – $24,000 $720,000 – $24,000

= 14.37%

(3) Price earnings ratio: Market price of common shares Earnings per share $97.46 $8.70 3

= 11.2 times

Earnings per share = (Net income – preferred dividends)  weighted-average number of common shares = ($720,000 – $24,000)  80,000 = $8.70 3

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 15.19 (CONTINUED) (4) Book value per share: Common shareholders’ equity Number of outstanding common shares $3,281,000 4 = $41.01 80,000 4

Common shareholders’ equity = ($3,881,000 - $600,000) = $3,281,000

(5) Rate of return on total assets: Net income _____ Average total assets $720,000 ($5,136,000 + $4,525,000) / 2

= 14.91%

Since Khalid’s rate of return on shareholders’ equity exceeds the rate of return on assets, the company is trading on the equity, also known as “employing leverage” to the advantage of the company. LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

BRIEF EXERCISE 15.20

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Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 15.21 (a) Cash.................................................................. 79,000 Common Shares....................................... 79,000 (b) Cash.................................................................. 79,000 Common Shares (2,000 X $11) ................ 22,000 Contributed Surplus ................................ 57,000 LO 5 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

*BRIEF EXERCISE 15.22 Sept. 5

Treasury Shares (1,500 X $75) .......... 112,500 Cash........................................... 112,500

Nov. 20 Cash (1,000 X $80) ............................. Treasury Shares (1,000 X $75) . Contributed Surplus .................

80,000 75,000 5,000

LO 5 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

*BRIEF EXERCISE 15.23 Sept. 5

Treasury Shares (1,500 X $75) .......... 112,500 Cash........................................... 112,500

Nov. 20 Cash (1,000 X $55) ............................. Retained Earnings1 ............................ Treasury Shares (1,000 X $75) .

55,000 20,000 75,000

Any balance in contributed surplus, if related to the same class of shares, would be debited first. LO 5 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 15.24 Deficit .......................................................... Buildings ............................................ To eliminate deficit with write-down of buildings

107,000

Common Shares ......................................... Deficit 1 ............................................... 1 ($182,000 + $107,000) To eliminate deficit against contributed capital

289,000

Notes Payable ............................................. Common Shares ................................ To eliminate notes payable by issuance of common shares

1,800,000

107,000

289,000

1,800,000

LO 6 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 15.1 Jan. 10

Mar.

April 1

May

Aug. 1

Sept. 1

Nov. 1

Cash (200,000 X $23) .............. Common Shares ...............

4,600,000

Cash (17,000 X $119) .............. Preferred Shares...............

2,023,000

Land ......................................... Common Shares ...............

60,000

Cash (20,000 X $18) ................ Common Shares ...............

360,000

Legal Expense ........................ Common Shares ...............

19,000

Cash (32,500 X $16) ................ Common Shares ...............

520,000

Cash (1,500 X $125) ................ Preferred Shares...............

187,500

4,600,000

2,023,000

60,000

360,000

19,000

520,000

187,500

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.2 a. Original Subscription: Share Subscriptions Receivable1 ........................ 880,000 Common Shares Subscribed ....................... 880,000 1 (40,000 shares X $22 each)

Collection of Down Payments: Cash ($880,000 X .35) ........................................... 308,000 Share Subscriptions Receivable ................. 308,000 Collection of Balance: Cash ($880,000 – $308,000) ................................. 572,000 Share Subscriptions Receivable ................. 572,000 Issuance of Shares: Common Shares Subscribed .............................. 880,000 Common Shares ........................................... 880,000 b.

Under ASPE, whether the Share Subscriptions Receivable account should be presented as an asset or a contra equity account is a matter of professional judgement, although conceptually, it makes sense to show it as a reduction of equity. Note that Section 3251.10 of the CPA Canada Handbook, Part II requires that share purchase loans receivables must be shown as contra equity unless the borrower is fully responsible for declines in the value of the shares and there is reasonable assurance that the full amounts will be collected. In the United States, the SEC requires the Share Subscriptions Receivable account to be presented as a reduction of equity. Under IFRS, specific guidance is not given, but using first principles, the company would likely end up treating it the same as noted above.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.2 (CONTINUED) c.

If a subscriber is unable to pay all instalments and therefore defaults on the agreement, the possibilities include: (1) returning the amount already paid by the subscriber (possibly after deducting some expenses), (2) treating the amount paid as forfeited and therefore transferring it to the Contributed Surplus account, or (3) issuing fewer shares to the subscriber so that the number of shares issued is equivalent to what the subscription payments already received would have paid for fully.

LO 2,3,4 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.3 a. 1.

Cash [(6,000 X $29) – $2,000] ......................... 172,000 Common Shares...................................... 172,000 Land ................................................................ 130,000 Common Shares...................................... 130,000 Note: The appraised value of the land is used since IFRS 2 Share Based Payment assumes that the fair value of the items acquired can be measured in most cases (IFRS 2.10 and .13). In this case, the appraisal supplies evidence of the value. IFRS is a constraint since the company is a public company as noted by the fact that the shares trade on a national stock exchange.

Common Shares (500 X $30) .......................... 15,000 Contributed Surplus ............................... 1,000 Cash (500 X $28)...................................... 14,000

Share repurchases are recorded at the average issue price or carrying amount per share, or the average price at which the shares were issued for that class of shares. The original issue price of the individual shares being repurchased is not used. The original issue price of the individual shares repurchased would be considered in the total issue price for the class of shares but would be averaged with all other shares of the same class.

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.4 May 12

The entry is correct.

May 14

Cash (8,000 x $50) ................................. 400,000 Preferred Shares ............................ 400,000

The transaction involves the issue of preferred shares rather than common shares. May 15

Common Shares (1,000 X $17) .............. 17,000 Contributed Surplus ...................... 2,000 Cash (1,000 X $15) ......................... 15,000

The share account is debited for the average issue price per share in the account ($17 per share based on the May 12 transaction). The difference between the average issue price per share and the purchase price is credited to Contributed Surplus. May 31

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

9,000 9,000

No gain can be recognized on the issuance of shares. LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.5

Preferred share is non-cumulative, non-participating ($7 x 3,000 = $21,000) b. Preferred share is cumulative, nonparticipating ($21,000 x 3 = $63,000) c. Preferred share is cumulative, participating

Preferred

Common

Total

$21,000

$74,000

$95,000

$63,000

$32,000

$95,000

$69,414

$25,586

$95,000

Dividends in arrears Current dividend Pro rata share to common ($280,000 X 7%1) Balance dividend pro rata ($300,000  $580,000) X $12,4002 ($280,000  $580,000) X $12,400

Carrying amount: Preferred: $100 X 3,000 Common: $40 X 7,000 Total carrying amount

$42,000 21,000

$19,600

6,414 _______ $69,414

19,600

6,414 5,986 $25,586

5,986 $95,000

$300,000 280,000 $580,000

Dividend rate per share of $7 divided by $100 stated value for the preferred shares. 2 $95,000 – $42,000 – $21,000 – $19,600 = $12,400

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.5 (CONTINUED) d.

Current year payout ratio under (a):

Payout ratio =

Cash dividends to common__ Net income – Preferred dividends = ____$74,000____ $90,000 – $21,000 = 1.07 Current year payout ratio under (b): Payout ratio =

Cash dividends to common__ Net income – Preferred dividends = ____$32,000____ $90,000 – $63,000 = 1.19 Current year payout ratio under (c): Payout ratio =

Cash dividends to common__ Net income – Preferred dividends = ____$25,586____ $90,000 – $69,414 = 1.24

If the preferred shares are cumulative and dividends in arrears are paid in the year, and/or if the preferred shares are participating, the company’s payout ratio may appear higher than it would have been if the preferred shares were not cumulative or participating. A potential investor may be interested in earning dividend income through ownership of the company’s common shares and may require a high enough payout ratio to provide a good yield on the shares. The investor should consider that the company’s payout ratio may appear higher due to certain preferred share dividend features, and not necessarily due to excess distribution of profit to common shareholders. LO 2,3 BT: AP Difficulty: S Time: 25 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.6

One year in arrears Current year2

Participating (5.2414%3)

Preferred Common $ 37,500 37,500 $180,000 32,758 157,242 $107,758 $337,242

Total $ 37,500 217,500 255,000 190,000 $445,000

25,000 X $1.50 = $37,500 Pro rata share to common: $3,000,000 X 6%4 = $180,000 2

3  $445,000 - $255,000 

 

$3,625,000

 = 5.2414% 

5.2414% x 625,000 = 32,758 (rounded) 5.2414% x 3,000,000 = 157,242 4 Dividend rate per share for preferred shares is 6% calculated: [$1.50 ÷ ($625,000 ÷ 25,000 shares)] b.

$37,500 $407,500

$445,000

Current year Additional 4%5 to common

$37,500 $180,000 120,000

Participating (2.9655%6)

18,535 88,965 $56,035 $388,965

$217,500 120,000 337,500 107,500 $445,000

6  $445,000 - $337,500 

 

$3,625,000

 = 2.9655% 

2.9655% x 625,000 = 18,534 (rounded to 18,535) 2.9655% x 3,000,000 = 88,965 5 Dividend rate on common shares Less: matching amount ($37,500 / $625,000) Additional rate to common shares

10% (6%) 4%

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.6 (CONTINUED) d.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.6 (CONTINUED)

Proportion of $445,000 dividend allocated to Preferred and Common Shares Preferred

(a) Cumulative; fully participating

107,758

Common

337,242

(b) Non-cumulative; non-participating

37,500

407,500

56,035

388,965

LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001; cpa-t007 CM: Reporting and DAIS

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.7 a. Dividends in arrears (1) Current year dividend (2) Participating dividend (3) Total

Preferred Common Total $100,000 $100,000 50,000 $180,000 230,000 25,000 60,000 85,000 $175,000 $240,000 $415,000

(1) Dividends in arrears: 25,000 X $2 X 2 years = (2) Current year dividend: Preferred: 25,000 X $2 = Common: Number of shares issued

$100,000

$50,000 60,000 X $3 $ 180,000

(3) Participating dividend: Since the common shareholders will receive a $4 per share dividend, $1 per share is in excess of the $3 dividend per share participation threshold. Excess dividend Number of common shares outstanding Excess total dividend Common share capital Excess return Apply excess return to preferred shareholders’ capital Participating dividend to preferred shareholders

$1 X 60,000 $60,000  $1,800,000 3.3333% X $750,000 $25,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.7 (CONTINUED) b.

Dividends1 .......................................... Common Stock Dividends Distributable .......................... 1 (60,000 X 15% X $45)

405,000

Common Shares2 ............................... Contributed Surplus .......................... Retained Earnings ............................. Cash (10,500 X $45) .................. 2 ($1,800,000 / 60,000 X 10,500

315,000 150,000 7,500

405,000

472,500

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.8 a.

Dividends1 .......................................... 1,728,000 Common Stock Dividends Distributable........................... 1,728,000 1 (600,000 shares X 6% X $48 = $1,728,000) To record stock dividend declaration Common Stock Dividends Distributable.................................. 1,728,000 Common Shares ....................... 1,728,000 To record stock dividend distribution

No entry, memorandum note to indicate that shares outstanding are now 2,400,000 (600,000 X 4).

January 8, 2024 FV-NI Investments ............................. Investment Income or Loss ........ To record fair value adjustment

5,000 5,000

Dividends ........................................... 165,000 Property Dividends Payable ....... 165,000 To record declaration of property dividend January 28, 2024 Property Dividends Payable ............. FV-NI Investments .......................

165,000 165,000

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.9 a. 1.

No entry—simply a memorandum indicating the number of shares has increased to 2 million. Dividends1 .................................. Common Stock Dividends Distributable ................. 1 (1,000,000 shares X $143)

Common Stock Dividends Distributable ............................ Common Shares ...............

143,000,000 143,000,000

Large stock dividends and splits serve the same function with regard to the securities markets. Both techniques allow the board of directors to increase the quantity of shares outstanding and channel share prices into the “popular trading range”. For accounting purposes, the 20%-25% rule reasonably views large stock dividends as substantive stock splits. It is necessary to capitalize the stated value with a stock dividend because the number of shares is increased and the stated value per share remains the same. Stock dividends are sometimes referred to as “capitalization of earnings”.

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.10 a.

The market price should change from $1 to around $10.

The current shareholder will be grateful for the reverse stock split as it will ensure that the trading of the shares will remain intact and not be affected by delisting. Liquidity in trading is very important to shareholders.

The reverse stock split will not affect the $4 dividend rate per share per year of the preferred shares outstanding. It will affect the conversion ratio as follows: Original conversion ratio was 1 for 5 New conversion ratio will be 1 for 0.50 (5 / 10)

LO 2 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.11 a.

Dividends1 ......................................... Common Stock Dividends Distributable.......................... 1 (400,000 X 10% X $59) To record declaration of stock dividend Common Stock Dividends Distributable.................................. Common Shares ...................... To record distribution of stock dividend

2,360,000 2,360,000

Dividends (400,000 X $59) ................ 23,600,000 Common Stock Dividends Distributable.......................... 23,600,000 To record declaration of stock dividend Common Stock Dividends Distributable.................................. 23,600,000 Common Shares ...................... 23,600,000 To record distribution of stock dividend

No entry. The number of shares outstanding increases to 800,000.

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.12 a.

Dividends Payable (Preferred - 2,000 X $8) .................... Dividends Payable (Common - 25,000 X $3)................... Cash ............................................ Common Shares1 ................................ Contributed Surplus ........................... Cash (3,700 X $35) ..................... 1 ($600,000 / 25,000 X 3,700 = $88,800)

16,000 75,000 91,000 88,800 40,700 129,500

Cash (1,000 X $105) ............................ 105,000 Preferred Shares ........................ 105,000

Dividends............................................. Common Stock Dividends Distributable ......................... [(25,000 – 3,700) X 10% X $45]

Common Stock Dividends Distributable ................................. Common Shares ........................

95,850 95,850

95,850

Dividends............................................. 70,860 Dividends Payable (Preferred: 3,000 X $8) ............ Dividends Payable [Common: (25,000 – 3,700 + 2,130) X $2]

95,850

24,000 46,860

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.12 (CONTINUED) b. Falkon Corp. Statement of Changes in Shareholders' Equity For the Year Ended December 31, 2023 Preferred shares Number of sh. Paid-in Balance, January 1 Net income Other comprehensive income Comprehensive income Repurchase of common shares Issuance of preferred shares Issuance of common shares through stock dividend Cash dividend: – preferred – common Balance, December 31

2,000 $200,000

1,000

Common Shares Number of sh. Paid-in

Contrib. Surplus

Retained Earnings

$250,000 $75,000 $1,180,000 450,000 450,000 5,000 5,000 455,000 (129,500) 105,000

25,000

$600,000

$55,000

(3,700)

(88,800)

(40,700)

2,130

95,850

105,000

3,000 $305,000

23,430

$607,050

Acc. Other Compr. Income

(95,850)

$14,300

Total

(24,000) (24,000) (46,860) (46,860) $533,290 $80,000 $1,539,640

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.12 (CONTINUED) c.

Falkon Corp. Shareholders’ Equity—December 31, 2023 Share capital Preferred shares, $8, (10,000 shares authorized, 3,000 shares issued) $ 305,000 Common shares, unlimited authorized, 23,430 shares issued 607,050 Total share capital 912,050 Contributed surplus 14,300 Total paid-in capital 926,350 Retained earnings 533,290 Accumulated other comprehensive income 80,000 Total shareholders’ equity $1,539,640 Calculations: [refer to part (b)] Preferred shares: $200,000 + $105,000 = $305,000 Common shares: $600,000 – $88,800 + $95,850 = $607,050 Contributed surplus: $55,000 – $40,700 = $14,300 Retained earnings: $250,000 – $95,850 – $70,860 + $450,000 = $533,290 AOCI: $75,000 + ($455,000 – $450,000) = $80,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.12 (CONTINUED) d. Rate of return on common shareholders’ equity for 2023: Net income – preferred dividends Average common shareholders’ equity $450,000 – $24,000 $1,107,320 2

= 38.47%

Average common shareholders’ equity = [($1,180,000 - $200,000) + ($1,539,640 – $305,000)] ÷ 2 = $1,107,320 2

Rate of return on total assets for 2023: Net income – preferred dividends Average total assets $450,000 – $24,000 ($2,140,000 + $2,616,000) / 2

= 17.91%

Since Falkon’s rate of return on shareholders’ equity exceeds the rate of return on assets, the company is trading on the equity, also known as “employing leverage” to the advantage of the company. A common shareholder would generally favour a company that is trading on the equity, because the company is using borrowed money at preferably fixed interest rates (or issuing preferred shares with constant dividend rates) and earning a higher rate of return on the money used. LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 15.13 a. Jan. 15

Feb. 12

Sept. 2

Oct. 31

Nov. 1

Nov. 15

Cash (10,000 X $6) ............................ Common Shares ......................

60,000

Cash (2,000 X $60) ............................ Preferred Shares ......................

120,000

Land .................................................. Common Shares ......................

25,000

Dividends ........................................... Cash (2,000 X $2) .....................

4,000

Dividends ........................................... Cash (40,000 X $1.50) ..............

60,000

Preferred Shares (500 X $60)............ Retained Earnings............................. Cash (500 X $62) ......................

30,000 1,000

60,000

120,000

25,000

4,000

60,000

31,000

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EXERCISE 15.13 (CONTINUED) b. Miss M’s Dance Studios Ltd. Statement of Changes in Shareholders’ Equity Year Ended December 31, 2023 Number Number of of Common Common Preferred Preferred shares Shares Shares Shares 25,000 $100,000 – – 10,000 60,000 2,000 $120,000 5,000 25,000

Balance, January 1, 2023 Shares issued for cash Shares issued for land Dividends, common shares Dividends, preferred shares Shares purchased and retired (500) (30,000) Net income _ _ _ _ _ Balance, December 31, 2023 40,000 $185,000 1,500 $90,000 c. Dec. 31 Income Summary .............................. 232,000 Retained Earnings .................... 232,000 To close Income Summary Dec. 31 Retained Earnings ............................. 64,000 Dividends ................................. 64,000 ($4,000 + $60,000 = $64,000) To close dividends LO 2,3 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Retained Earnings $365,000

(60,000) (4,000) (1,000) 232,000 $532,000

Total Shareholders’ Equity $465,000 180,000 25,000 (60,000) (4,000) (31,000) 232,000 $807,000

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EXERCISE 15.14 a. Transaction entries for 2023: Jan.

Cash (100,000 X $100) ................... 10,000,000 Preferred Shares .................... 10,000,000

Mar.

Dividends (100,000 X $5 X 3/12) ... Dividends Payable .................

125,000

Dividends Payable......................... Cash ........................................

125,000

Cash (130,000 X $11) ..................... Common Shares .....................

1,430,000

Dividends (100,000 X $5 X 3/12) ... Dividends Payable .................

125,000

Dividends Payable......................... Cash ........................................

125,000

Dividends (100,000 X $5 X 3/12) ... Dividends Payable .................

125,000

Dividends Payable......................... Cash ........................................

125,000

Dividends (100,000 X $5 X 3/12) ... Dividends Payable .................

125,000

April 1

June 5

July

Sept. 5

Oct.

Dec.

125,000

1,430,000

125,000

Note: The December 5, 2023 dividend will be paid on January 1, 2024 and will reduce both Cash and the Dividends Payable liability by $125,000 on that date. The following closing entries would also be made: Dec. 31

Income Summary ................................. 374,000 Retained Earnings ........................ 374,000

Dec. 31

Retained Earnings ................................ 500,000 Dividends .................................... 500,000

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EXERCISE 15.14 (CONTINUED) b. Preferred Shares Jan. 1 – Jan. 2 10,000,000 Dec. 31 10,000,000

Retained Earnings Jan. 1

1,323,000

Dec. 31 500,000

Common Shares Jan. 1 5,600,000 Apr. 18 1,430,000 Dec. 31 7,030,000

Accumulated Other Comprehensive Income Jan. 1 142,000 Dec. 31 142,000

Dec. 31 374,000 Dec. 31 1,197,000

Mar. 5 Jun. 5 Sep. 5 Dec. 5

Dividends 125,000 125,000 125,000 125,000 Dec. 31 Dec. 31

500,000 0

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EXERCISE 15.14 (CONTINUED) c. COPELAND LTD. Statement of Changes in Shareholders' Equity Year Ended December 31, 2023 Preferred Shares Number of Share Shares Capital Balance Jan, 1, 2023 Issued preferred shares Issued common shares Declared dividends Net income Balance Dec. 31, 2023

Common Shares Number of Shares

Share Capital

Retained Earnings

800,000 $5,600,000 $1,323,000

Accum. Other Comprehensive Income $142,000

100,000 $10,000,000 130,000

100,000 $10,000,000

1,430,000

(500,000) 374,000 930,000 $7,030,000 $1,197,000

$142,000

Total $7,065,000 10,000,000 1,430,000 (500,000) 374,000 $18,369,000

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EXERCISE 15.14 (CONTINUED) d. COPELAND LTD. Statement of Financial Position (Partial) December 31, 2023 Shareholders’ equity Share capital $5 Preferred shares, non-cumulative, unlimited number authorized, 100,000 shares issued .............................. $ 10,000,000 Common shares, unlimited number authorized, 930,000 shares issued .......... 7,030,000 Total share capital ................................ 17,030,000 Retained earnings ............................................... 1,197,000 Accumulated other comprehensive income ..... 142,000 Total shareholders’ equity .......................... $18,369,000

e. COPELAND LTD. Cash Flow Statement (Partial) Year Ended December 31, 2023 Financing activities Proceeds from issue of preferred shares .......... Proceeds from issue of common shares .......... Payment of preferred dividends1 ....................... Cash provided by financing activities ......................

$10,000,000 1,430,000 (375,000) $11,055,000

Dividends declared on December 5 will be paid on January 1, 2024 and will appear on the statement of cash flows in that year (the year paid). LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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*EXERCISE 15.15 a.

RADFORD CORPORATION Partial Statement of Financial Position December 31, 2023

Shareholders’ equity: Share capital: Preferred shares, $100 par value, 6% cumulative and non-participating, authorized 300,000 shares, issued and outstanding 10,000 shares $1,000,000 Common shares, $11 par value, authorized 1,000,000 shares, issued and outstanding 290,000 shares1 $3,190,000 Common shares subscribed, 10,500 shares2 115,500 Total common shares issued and to be issued 3,305,500 Total share capital 4,305,500 3 Contributed surplus 817,500 Total paid-in capital 5,123,000 4 Retained earnings 150,000 Total paid-in capital and retained earnings 5,273,000 5 Less: Share subscriptions receivable 117,600 Total shareholders’ equity $5,155,400 1

Common share balance calculations: Issued 300,000 x $11 Retired 10,000 x $11 2

Subscribed 10,500 x $11

= $ 3,300,000 = (110,000) $ 3,190,000 =

115,500

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*EXERCISE 15.15 (CONTINUED) a. (continued) 3

Contributed surplus balance is composed of the following: From issue of preferred shares: $1,475,000 – (10,000 shares X $100 par value) = $475,000 From sale of common shares: $3,600,000 – (300,000 shares X $11 par value) = 300,000 From sale of common share subscription: ($16 per share – $11 par value) X 10,500 shares 52,500 From repurchase and retirement of common shares: $300,000 X (10,000 / 300,000) (10,000) $817,500

Retained earnings balance $180,000 Less repurchase and retirement of common shares: Purchase price $150,000 Less: par value of common shares ($10,000 X $11) ( 110,000 ) Less: pro-rata portion of contributed surplus ( 10,000 ) ( 30,000 ) Adjusted balance of retained earnings $150,000 5

$16 X 10,500 X (1 – 30%) = $117,600

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*EXERCISE 15.15 (CONTINUED) b.

RADFORD CORPORATION Partial Statement of Financial Position December 31, 2023

Shareholders’ equity: Share capital: Preferred shares, 6% cumulative and nonparticipating, 300,000 shares authorized, 10,000 shares issued $1,475,000 Common shares, 1,000,000 shares authorized, 290,000 shares issued6 $3,480,000 Common shares subscribed, 10,500 shares7 168,000 Total common shares issued and to be issued 3,648,000 Total share capital 5,123,000 8 Retained earnings 150,000 Total paid-in capital and retained earnings 5,273,000 9 Less: Share subscriptions receivable 117,600 Total shareholders’ equity $5,155,400 6

Common shares ($3,600,000/300,000) = $12 stated value Issued 300,000 shares $3,600,000 Retired 10,000 x $12 (120,000) $3,480,000 7 8

Subscribed 10,500 x $16 Retained earnings balance Less: repurchase of common shares: Purchase price $150,000 Less stated value of common shares ($10,000 X $12) ( 120,000 ) Adjusted balance of retained earnings $168,000 x 70%

168,000 $180,000

( 30,000 ) $150,000 117,600

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*EXERCISE 15.15 (CONTINUED) c.

The Share Subscriptions Receivable account can be shown as a contra-equity account in shareholders’ equity or as a receivable in the asset section of the SFP. Both presentations are acceptable under IFRS and ASPE although the contra-equity presentation reflects “paid-in” capital more accurately and is required in some jurisdictions. The contra-equity presentation would produce a lower book value and a higher rate of return on shareholders’ equity by reducing the amount of shareholders’ equity in the formula.

LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 15.16 a. Shareholders’ Item Assets Liabilities Equity 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

NE NE NE D D NE I NE D NE NE D NE

D I NE NE D I NE I D NE NE NE NE

I D NE D NE D I D NE NE NE D I/D

Share Capital

Cont. Surplus

Retained Earnings

I NE NE NE NE NE NE NE NE I NE D I/D

NE NE NE NE NE NE NE NE NE NE NE I NE

NE D NE D NE D NE D I D NE NE NE

I = increase; NE = no effect; D = decrease I/D = increase and decrease

Acc. Other Comprehensive Income NE NE NE NE NE NE I NE D NE NE NE NE

Net Income NE NE NE D NE D NE NE I NE NE NE NE

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EXERCISE 15.16 (CONTINUED) b.

If the company was a private entity following ASPE, then the only items that would be handled differently are items #7 and #9, the investment accounted for using FV-OCI. Under ASPE, the investment would have to be accounted for using fair value through net income (since ASPE does not have an FV-OCI option and the shares trade in an active market).

LO 2,4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

*EXERCISE 15.17 Brubacher Limited Shareholders’ Equity December 31, 2023 Share Capital: Preferred shares, $5 cumulative, $50 preference in liquidation; authorized 60,000 shares, issued and outstanding 10,000 shares $ 500,000 Common shares, authorized 600,000 shares, issued 200,000 shares, and outstanding 190,000 shares 200,000 Total share capital 700,000 Contributed surplus—common 1,460,000 Total paid-in capital 2,160,000 Retained earnings 201,000 Accumulated other comprehensive income 100,000 Total paid-in capital and retained earnings 2,461,000 Less: Treasury shares, 10,000 common shares 170,000 Total shareholders’ equity $2,291,000 LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 15.18 a.

Bennington Corp. is the more profitable in terms of return on total assets. This may be shown as follows: Bennington Corp.

$840,000 $4,200,000

= 20.00%

Kao Corp.

$756,000 $4,200,000

= 18.00%

It should be noted that these returns are based on net income related to total assets, where the ending amount of total assets is considered representative. If the rate of return on total assets uses net income before interest but after tax in the numerator, the rates of return on total assets are as shown below: Bennington Corp.

$840,000 $4,200,000

= 20.00%

$756,000 + $120,000 – $36,000* $840,000 = $4,200,000 $4,200,000 = 20.00% *Tax on $120,000 x 30% = $36,000

Kao Corp.

Kao Corp. is the more profitable in terms of return on shareholders’ equity. This may be shown as follows: Kao Corp.

$756,000 $2,700,000

= 28.00%

Bennington Corp.

$840,000 $3,600,000

= 23.33%

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EXERCISE 15.18 (CONTINUED) b. (continued) Note to instructor: To explain why the difference in rate of return on assets and rate of return on shareholders’ equity occurs, the following schedule might be provided to the student.

Fund Supplies Current liabilities Long-term debt Common shares Retained earnings

Kao Corp. Rate of Return Funds on Funds at Cost of 1 Supplied 20% Funds $ 300,000 $ 60,000 $ 0 1,200,000 240,000 84,000 2 2,000,000 400,000 0 700,000 140,000 0 $4,200,000 $840,000 $84,000

Accruing to Common Shares $ 60,000 156,000 400,000 140,000 $756,000

Determined in part (a), 20% The cost of funds is the interest of $120,000 (1,200,000 X 10%). This interest cost must be reduced by the tax savings of $36,000 (30%) related to the interest. 2

The schedule indicates that the income earned on the total assets (before interest cost) was $840,000. The interest cost (net of tax) of this income was $84,000, which indicates a net return to the common equity of $756,000.

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EXERCISE 15.18 (CONTINUED) c.

Kao Corp. earned a net income per share of $7.56 ($756,000  100,000) while the Bennington Corp. had net income per share of $5.79 ($840,000  145,000). Kao Corp. has borrowed a substantial portion of its capital at a cost of 10% and has used these assets to earn a return in excess of 10%. The excess was financed by borrowed capital, represents additional income for the shareholders, and has resulted in the higher net income per share. Due to the debt financing, Kao has less shareholder contributed capital outstanding.

Yes, from the point of view of income it is advantageous for the shareholders of Kao Corp. to have long-term debt outstanding. The assets obtained from incurrence of this debt are earning a higher return than their cost to Kao Corp., which is evidence of leverage, yet may lead to increased risk in the case of an economic downturn.

e. Price earnings ratio. Kao Corp.

$101 $7.56

Bennington Corp.

$63.50 $5.79

= 13.4 times earnings.

= 11.0 times earnings.

f. Book value per share. Kao Corp.

$2,000,000 + $700,000 = $27.00 100,000

Bennington Corp.

$2,900,000 + $700,000 = $24.83 145,000

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EXERCISE 15.18 (CONTINUED) g. Comparison of Return on Total Assets and Return on Sharheholders' Equity 30% 25% 20% 15% 10% 5% 0% Return on Total Assets Bennington Corp.

Return on Shareholders' Equity Kao Corp

Comparison of Price Earnings Ratio and Book Value Per Share 30 25 20 15 10 5 0 Price earnings ratio

Bennington Corp.

Book value per share

Kao Corp

LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001; cpa-t007 cpa-t005 CM: Reporting, Finance and DAIS

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*EXERCISE 15.19 Common Shares ............................................... Deficit ........................................................ To record the elimination of the deficit against share capital

190,000

Buildings ........................................................... Notes Payable ................................................... Common Shares ........................................ To record write-up of buildings to fair value and record the negotiated change in control

135,600 260,000

190,000

395,600

LO 6 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

*EXERCISE 15.20 Deficit............................................................. Inventory .............................................. Buildings1 ............................................. 1 $1,700,000 – ($1,290,000 + $80,000).. To record impairment of assets that existed before reorganization

450,000

Common Shares ........................................... Contributed Surplus ..................................... Deficit2 .................................................. 2 ($450,000 first entry + $620,000 deficit) To eliminate deficit

850,000 220,000

120,000 330,000

1,070,000

The balance in Retained Earnings for the year following the reorganization should include only Net Income – dividends = $190,000 – $30,000 = $160,000. LO 6 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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TIME AND PURPOSE OF PROBLEMS Problem 15.1 Purpose—to provide the student with an understanding of the necessary entries to properly account for a corporation’s share transactions. The problem involves such concepts as noncash share exchanges, sale of preferred and common shares, and the reacquisition of both preferred and common shares. The student is required to prepare the respective journal entries and the shareholders’ equity section of the SFP so as to reflect these transactions. The student must also discuss the distinction between paid-in capital and retained earnings and the different types of preferred shares repurchases.

Problem 15.2 Purpose—to provide the student a comprehensive problem involving all facets of the shareholders’ equity section. The student must prepare the shareholders’ equity section of the SFP, analyzing and classifying different transactions to come up with proper accounts and amounts. Journal entries for the transactions are also required.

Problem 15.3 Purpose—to provide the student with an understanding of the necessary entries to properly account for a corporation’s share transactions. This problem involves such events as lump-sum sales of shares, and a noncash share exchange.

Problem 15.4 Purpose—to provide the student with an understanding of various entries relating to share issuances and dividend declaration to two classes of shares. This problem involves non-monetary, lump-sum, and subscription issuances.

Problem 15.5 Purpose—to provide the student with an understanding of the proper entries to reflect the reacquisition and issuance of a corporation’s shares. The student is required to prepare the journal entries to reflect these transactions.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 15.6 Purpose—to provide the student with an opportunity to record five different journal entries. The entries involve a share subscription, collection of the receivable, and default on certain of these receivables. In addition, a repurchase of shares and a lump-sum issuance must be recorded.

Problem 15.7 Purpose—to provide the student with an opportunity to record a nonmonetary share issuance, a share repurchase, and a cash dividend payment. The calculation of the cash dividend is challenging due to cumulative, participating preferred shares.

*Problem 15.8 Purpose—to provide the student with an opportunity to analyze a set of transactions affecting shareholders’ equity and prepare the company’s shareholders’ equity section. Transactions include issuance of par value shares to buy equipment, lump-sum sale, collection of subscribed shares, and a reacquisition of shares.

Problem 15.9 Purpose—to provide the student with an understanding of the proper accounting for the declaration and payment of cash dividends on both preferred and common shares. This problem also involves a dividend arrearage on preferred shares, which will be satisfied by the issuance of common shares. The student is required to prepare the necessary journal entries for the dividend declaration and payment, assuming that they occur simultaneously.

Problem 15.10 Purpose—to provide the student with an understanding of the effect that certain preferred share provisions, such as cumulative and fully participating, have on dividend distributions to common and preferred shareholders. The student is required to allocate the dividends to each type of share under two different assumptions: (1) the preferred share possesses these two aforementioned provisions, and (2) the preferred share does not.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 15.11 Purpose—to provide the student with an understanding of the accounting effects related to the cash, property, stock dividends, and stock splits. The student is required to analyze their effect on total assets, common shares, contributed surplus, retained earnings, and total shareholders’ equity.

Problem 15.12 Purpose—to provide the student with an understanding of the respective entries for a series of transactions involving equity accounts, such as the declaration of property dividends and stock dividends, and the donation of land. The student is required to prepare the proper journal entries to reflect these transactions and to prepare a shareholders’ equity section to reflect the entries during the period.

Problem 15.13 Purpose—to provide the student with an understanding of the proper accounting for the issuance of shares, issuance costs, shares sold on a subscription basis, and defaulted subscriptions. The student is required to prepare both the necessary journal entries to record the equity transactions and to prepare the shareholders’ equity section of the SFP.

Problem 15.14 Purpose—to provide the student with an opportunity to prepare a statement of changes in shareholders’ equity and the shareholders’ equity section of the SFP, to reflect the changes from five different transactions involving share issuances, reacquisitions, stock splits, and dividend declarations. Throughout the problem the student needs to keep track of the number of shares outstanding.

Problem 15.15 Purpose—to provide the student with an understanding of the proper accounting for the declaration and payment of both a cash and stock dividend. The student is required to prepare both the necessary journal entries to record the cash and stock dividends and the shareholders’ equity section of the balance sheet. The student is also required to prepare the statement of changes in shareholders’ equity.

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SOLUTIONS TO PROBLEMS PROBLEM 15.1

-1(no entry necessary) -2Land ............................................................ Common Shares ..................................

210,000 210,000

-3Cash ............................................................ 1,672,000 Preferred Shares1 ................................ 1,672,000 1 (15,200 shares X $110) -4Preferred Shares ($110 X 3,000 shares) ..... Cash ($100 X 3,000 shares) ................ Contributed Surplus ............................. -5Dividends Payable ....................................... Cash .................................................... -6Common Shares ........................................ Retained Earnings ....................................... Cash (500 x $49).................................. 2 ($210,000 ÷ 10,000 = $21.00 per share; $21.00 X 500 shares = $10,500) 2

-7Cash (2,000 shares X $99) .......................... Preferred Shares ..................................

330,000 300,000 30,000

85,000 85,000

10,500 14,000 24,500

198,000 198,000

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PROBLEM 15.1 (CONTINUED) b.

Shareholders’ equity: Share capital Preferred shares, 150,000 shares authorized 14,200 shares issued Common shares, unlimited authorized; 9,500 shares issued Total share capital Contributed surplus Total paid-in capital Retained earnings Total shareholders’ equity

$1,540,000 199,500 1,739,500 30,000 1,769,500 1,018,000 $2,787,500

Schedule of Capital Amounts

Transaction 2 3 4 6 7 Totals

Preferred Shares

Contr. Surplus Preferred

Common Shares

Retained Earnings

Number of Shares Preferred Common

$210,000 $1,672,000 (330,000) 198,000 _$1,540,000

10,000 15,200 (3,000)

$30,000 _

$30,000

(10,500) _ _$199,500

$(14,000 )

(500) 2,000

1,032,000 $1,018,000

14,200

9,500

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PROBLEM 15.1 (CONTINUED) c.

The distinction between contributed (paid-in) capital and retained earnings is important from legal, tax, and economic points of view. Legally, dividends can be declared only out of retained earnings. Economically, management, shareholders, and others look to earnings for the continued existence and growth of the corporation, whereas paid-in capital represents amounts contributed to the corporation by shareholders over its life.

Although a corporation always has the right to repurchase outstanding shares “on the market” at the prevailing market price, preferred shares that are callable/redeemable can be repurchased by the corporation at specified future dates and specified prices, frequently by a random draw for a partial call. These prices may or may not be the same as the prevailing market price. This would affect the amount of cash paid for the shares and the timing of the repurchase. A corporation might want to reduce the amount paid out as dividends to the preferred shareholders and would invoke the right to call the preferred shares. The corporation is in control of the timing of the cash outflows required by the repurchase. This feature can make preferred shares unattractive and risky from the point of view of investors.

Retractable preferred shares are repurchased by the corporation at the option of the shareholder, usually (but not always) at the prevailing market price. This feature would affect the timing of the repurchase. Since the shareholder can trigger the repurchase, several repurchase transactions could potentially take place during the fiscal period, or the share indenture may specify only particular dates. This feature gives flexibility to the shareholders, who have control over the timing of the repurchase.

LO 1,2,3 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 15.2 a. Oregano Inc. Balance Sheet (Partial – Shareholders’ Equity section) June 30, 2023 Share Capital: Preferred shares, $2.00, cumulative and non-participating, 100,000 shares authorized, 50,000 shares Issued $2,200,000 Common shares, unlimited number authorized, 116,000 shares issued Common shares subscribed, 8,000 shares Total share capital

$3,918,340 2

368,000

381,6601 6,868,000 (368,000) $6,500,000

Retained earnings Total share capital and retained earnings Less: Share subscriptions receivable Total shareholders’ equity 1

Retained earnings, June 30, 2022 Add: Net Income Deduct: Excess of cost of reacquired shares over assigned value Preferred dividend Stock dividend, common shares

4,286,340 6,486,340

$ 690,000 40,000

$12,340 50,000 286,000

348,340 $ 381,660

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PROBLEM 15.2 (CONTINUED) a. (continued) 2

Common share transactions: Date Shares Price 07/01/20 95,000 $31.00 07/24/20 5,000 – 03/01/21 10,000 42.00 10/01/22 2,000 46.00 Subtotal 112,000 11/30/22 (2,000) 32.83 Subtotal 110,000 01/31/23 5,500d 52.00 06/20/23 500 Total 116,000

Common shares $2,945,000 220,000a 420,000 92,000b 3,677,000 c 65,660 3,611,340 286,000 21,000 $3,918,340

a. The 5,000 shares exchanged for a plot of land are recorded at $220,000 (use the current fair value of the land on July 24 to value the share issuance). b. The remaining subscriptions for 8,000 shares resulted in $368,000 of common shares subscribed. c. $3,677,000 / 112,000 = $32.83 per share. Retained Earnings is also debited for $12,340, since there is no contributed surplus, the difference between the repurchase price of $39 per share less the average stated price of $32.83 per share. d. 5% stock dividend on outstanding shares 110,000 x 5% = 5,500 at market value $52 = 286,000. b. October 1, 2022 Cash...................................................................... Common Shares ............................................ To record issuance of fully paid shares Share Subscriptions Receivable ............................ Common Shares Subscribed ......................... To record subscriptions receivable

92,000 92,000

368,000 368,000

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PROBLEM 15.2 (CONTINUED) b. (continued) November 30, 2022 Common Shares ..................................................... 65,660 Retained Earnings .................................................... 12,340 Cash (2,000 X $39)........................................... 3 $3,677,000 / 112,000 = $32.83 per share x 2,000 3

78,000

December 15, 2022 Dividends ................................................................. 336,000 Common Stock Dividends Distributable ............ 286,000 Dividends Payable ........................................... 50,000 January 2023 Dividends Payable ................................................... 50,000 Cash .................................................................

50,000

January 31, 2023 Common Stock Dividends Distributable ................... 286,000 Common Shares ............................................... 286,000 June 20, 2023 Cash......................................................................... 21,000 Common Shares ...............................................

21,000

c. A stock dividend is currently disadvantageous for common shareholders since they will have to pay taxes on the value of the stock dividend without the receipt of cash to settle the tax liability. The total book value of the shareholders’ holdings does not increase to compensate for this tax burden. The shareholders of Oregano Inc. may be willing to accept a stock dividend in the current year if the company is committed to continuing its payment of $0.30 per share as cash dividends in the future. In this case, the stock dividend would result in higher cash dividends for common shareholders because each shareholder would hold additional shares. LO 1,2,3 BT: AP Difficulty: C Time: 55 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance Solutions Manual 15.69 Chapter 15 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 15.3 -1Machinery ................................................................ 74,500 Common Shares ............................................... 74,500 (Although the value of the shares is $75,600 (4,200 X $18), the machinery cannot be recorded at a cost higher than its fair value.) -2Dividends ................................................................. 342,000 Dividends Payable ............................................ 342,000 Dividend to preferred: $6 X 40,000 shares = Dividend to common: $6 X 17,000 shares =

$240,000 102,000 $342,000

-3Cash......................................................................... 125,000 Preferred Shares .............................................. Common Shares ............................................... Fair value of common (2,500 X $13) = Fair value of preferred (1,200 X $80) = Aggregate

93,385 31,615

$ 32,500 96,000 $128,500

Using the relative fair value method (since the fair values of both shares are available):

$32,500 Allocated to common: X $125,000 = $128,500

$ 31,615

$96,000 X $125,000 = $128,500

93,385

Allocated to preferred: Total allocation

$125,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.3 (CONTINUED) -4Furniture and Fixtures .............................................. Preferred Shares .............................................. Common Shares (2,200 X $14) ........................

36,000 5,200 30,800

Using the residual value method: Fair value of furniture Less: Fair value of common shares Total value assigned to preferred shares

$36,000 30,800 $ 5,200

The company must use the residual value method to allocate the lumpsum issue since only the value of the common shares is known. The value of the preferred shares is not directly known and therefore the residual value is assigned. LO 2 BT: AP Difficulty: S Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 15.4 a. January 1, 2023 No entry. January 10, 2023 Land ...................................................................... 450,000 Common Shares ............................................ 450,000 March 10, 2023 Cash...................................................................... 400,000 Preferred Shares (4,000 X $100) ................... 400,000 April 15, 2023 Vehicles ................................................................ Common Shares (110 X $55) ........................

6,050 6,050

August 20, 2023 Cash ($600,000 x 10%) ......................................... 60,000 Share Subscriptions Receivable ............................ 540,000 Common Shares Subscribed1 ........................ 600,000 1 (40 X 250 shares X $60) October 11, 2023 Cash...................................................................... 230,000 Common Shares ............................................ 168,861 Preferred Shares ........................................... 61,139 (3,000 X $58) + (600 X $105) = $237,000; Common: $174,0002 / $237,000 X $230,000 = $168,861; Preferred: $63,0003 / $237,000 X $230,000 = $61,139 2 (3,000X $58 = $174,000) 3 (600 X $105 = $63,000)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.4 (CONTINUED) a. (continued) December 31, 2023 Dividends ............................................................... 18,400 Dividends Payable ........................................... To record dividends declared on preferred shares 4 (4,000 + 600) X $4.00 = $18,400 for preferred shares

18,400

Dividends ($26,000 - $18,400) ................................. Dividends Payable ........................................... To record dividends declared on common shares

7,600

This transaction is a non-monetary exchange with a share-based payment. IFRS 2 Share-based Payment indicates that the fair value of the asset acquired should be used to measure its acquisition cost, and it presumes that this value can be determined except in rare cases. If the asset’s fair value cannot be determined reliably, then its fair value and cost are determined by using the fair value of the shares given in exchange. In this example, the company uses the fair value of the shares given in exchange since only the fair value of the common shares is known. The asking price for the used car does not represent the car’s fair value because the asking price for the used car does not necessarily represent the exchange value of the vehicle between two arm’s length parties. Valuing the used car using the fair value of the shares given in exchange (which are publicly and actively traded) maintains the representational faithfulness and neutrality of the financial statements. Alternatively, the fair value of the used car may be determinable by direct comparison with a similar used car that was recently sold.

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.5 a.

Common Shares ($30 X 430) ........................... 12,900 Contributed Surplus .......................................... 3,440 Cash ($38 X 430) ...................................... 16,340

Common Shares ($30 X 200) ........................... Contributed Surplus .......................................... Cash ($44 X 200) ......................................

6,000 2,800 8,800

Cash (3,200 X $41)........................................... 131,200 Common Shares ....................................... 131,200

Cash (1,500 X $47)........................................... 70,500 Common Shares ....................................... 70,500

Common Shares (1,000 X $34.6441) ................ 34,644 Contributed Surplus2 ......................................... 1,760 3 Retained Earnings .......................................... 13,596 Cash (1,000 X $50) ....................................... 50,000 3 ($50,000 – $34,644 – $1,760) Common Shares Bal. $270,000 12,900 6,000 c. 131,200 d. 70,500 $452,800

a. b.

Number of Common Shares Bal. ($270,000 / $30) 9,000 a. (430) b. (200) c. 3,200 d. 1,500 Bal. 13,070

Average cost = ($452,800 / 13,070 shares) = $34.644 2

a. b.

Contributed Surplus Bal. $8,000 3,440 2,800 $1,760

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 15.74 Chapter 15 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 15.6 a. 1.

Cash (12,000 X $10)......................................... 120,000 Share Subscriptions Receivable ....................... 192,000 Common Shares Subscribed 1 .................. 312,000 1 (12,000 X $26)

Cash (10,000 X $16)......................................... 160,000 Share Subscriptions Receivable................ 160,000

Common Shares Subscribed (2,000 X $26)...... 52,000 Share Subscriptions Receivable................ 32,000 Cash (2,000 X $10) ................................... 20,000 To record refund to defaulting subscribers Common Shares Subscribed ............................ 260,000 Common Shares (10,000 X $26) ............... 260,000 To issue shares fully paid on subscriptions

Common Shares (22,000 X $4.822) .................. 106,040 Contributed Surplus .......................................... 310,000 Retained Earnings ............................................ 221,960 Cash (22,000 X $29) ................................. 638,000 2 ($270,000 + $260,000) ÷ (100,000 + 10,000) = $4.82

Cash ................................................................. 300,000 Common Shares (3,000 X $31) ................. 93,000 3 Preferred Shares ..................................... 207,000 3

Total received Assigned to common shares (3,000 X $31) Assigned to preferred shares

$300,000 (93,000 ) $207,000

The company must use the residual value method to allocate the lumpsum issue since only the value of the common shares is known. Since the value of the preferred shares is not known, the residual value is assigned. Solutions Manual 15.75 Chapter 15 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 15.6 (CONTINUED) b. The journal entries for transactions 2 to 4 are as follows: 2.

No change.

Common Shares Subscribed (2,000 X $26)...... 52,000 Share Subscriptions Receivable................ 32,000 Contributed Surplus (2,000 X $10) ............ 20,000 To record forfeit of payment from defaulting subscribers Common Shares Subscribed ............................ 260,000 Common Shares (10,000 X $26) ............... 260,000 To issue shares fully paid on subscriptions

Common Shares (22,000 X $4.824) .................. 106,040 Contributed Surplus .......................................... 310,000 Contributed Surplus5…………………………. .... 4,000 Retained Earnings ............................................ 217,960 Cash (22,000 X $29) ................................. 638,000 4

($270,000 + $260,000) ÷ (100,000 + 10,000) = $4.82 per share

Because this part of the Contributed Surplus came from a different type of transaction, ASPE requires that it be reduced on a pro rata basis: 22,000/110,000 X $20,000 = $4,000 c.

Using the market value or fair value of the common shares of a private company introduces measurement uncertainty, because a liquid market for the shares is not available to provide evidence of fair value. Stellar may have determined the fair value of its common shares based on a quoted price of the common shares of a similar size public company operating in the same industry with the same number of shares outstanding (adjusted to include Stellar’s own data), based on a discounted cash flow analysis of the company’s expected future cash flows (using as many objectively determined market inputs as possible), or based on a calculation of the fair value of the company’s net tangible assets.

LO 2 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 15.76 Chapter 15 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 15.7 a. -1Equipment ............................................................. 100,000 Common Shares (10,000 X $10) ................... 100,000 -2Common Shares (10,000 X $12.001) ..................... 120,000 Retained Earnings2 ............................................... 5,000 Cash (10,000 X $12.50) ................................. 125,000 1 2

($500,000 + $100,000) / (40,000 + 10,000) = $12.00 per share The contributed surplus balance in the December 2022 shareholders’ equity arose from preferred share repurchases and is not available for common share repurchases. -3Preferred – arrears $8 X 1,000 Preferred – current $8 X 1,000 Common – 8%5 X $480,000 4 Pro-rata ($80,000 – $38,400) Total

3 4 5 6 7

Preferred 8,000 8,000 8,667 7 $24,667

Common

38,400 41,600 6 $80,000 3

$2 per share X (40,000 + 10,000 – 10,000) = $80,000 $500,000 + $100,000 – $120,000 = $480,000 $8,000 / $100,000 = 8% (Pfd. base %) $80,000 – $38,400 = $41,600 Common excess % = $41,600/$480,000 = 8.6667% Preferred participation, therefore = 8.6667% X $100,000 = $8,667

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.7 (CONTINUED) a. (continued) Dividends ................................................................. 24,667 Cash ................................................................. 24,667 To record payment of dividend to preferred shareholders Dividends ................................................................. 80,000 Cash ................................................................. 80,000 To record payment of dividend to common shareholders b.

Payout ratio for 2023: Payout ratio =

Cash dividends to common__ Net income – Preferred dividends = ____$80,000____ $65,000 – $24,667 = 198%

Payout ratio for 2023 if the preferred share dividend was paid in 2022: Payout ratio =

Cash dividends to common__ Net income – Preferred dividends = ____$80,000____ $ 65,000 – $16,667 = 166%

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.7 (CONTINUED) c. If the preferred shares are cumulative and dividends in arrears are paid in the year, the company’s payout ratio may appear higher than it would have been if there were no dividends in arrears paid in the year. A potential investor may be interested in earning dividend income through ownership of the company’s common shares and may require a high enough payout ratio to provide a good yield on the shares. The investor should consider that the company’s payout ratio may appear higher due to payment of dividends in arrears in the year, and not necessarily due to excess distribution of profit to common shareholders. LO 2,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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*PROBLEM 15.8 LAURENTIAN MILLS LTD. Shareholders’ Equity December 31, 2023

Preferred shares, 8%, $100 par value, 10,000 shares authorized, 6,100 issued Common shares, $2 par value, 200,000 shares authorized, 90,100 issued Contributed surplus1 Total paid-in capital Retained earnings Total shareholders’ equity 1

$ 610,000 180,200 967,039 1,757,239 1,023,461 $2,780,700

$24,500 + $942,539 = $967,039 Preferred Shares Bal. $400,000 2. 10,000 3. 200,000 $ 610,000

Contributed Surplus – Pref. Bal. $20,000 2. 500 3. 4,000 $ 24,500

Common Shares Bal. $160,000 1. 200 2. 2,000 5. 20,000 2,000 $ 180,200

Contributed Surplus – Com. Bal. $940,000 1. 1,000 2. 12,000 953,000 6. 10,461 $942,539

Common Shares – Subscribed Bal. $20,000 5. 20,000 $0

Retained Earnings Bal. $780,000 2,539 7. 246,000 $ 1,023,461

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Intermediate Accounting, Thirteenth Canadian Edition

*PROBLEM 15.8 (CONTINUED) Share Subscriptions Receivable Bal. $40,000 4. 40,000 $0 1. Common shares = $2 par value X 100 shares = $200 Contributed surplus–common = ($12 – $2 par value) X 100 = $1,000 2. Common shares = $2 par value X 1,000 shares = $2,000 Contributed surplus – common = ($14 – $2 par value) X 1,000 shares = $12,000 Preferred shares = $100 par value X 100 shares = $10,000 Contributed surplus – preferred = ($24,500 – $2,000 – $12,000 – $10,000) = $500 3. Preferred shares = $100 par value X 2,000 shares = $200,000 Cont. surplus – preferred = ($102 – $100 par value) X 2,000 shares = $4,000 6. Common shares = $2 par value X 1,000 shares = $2,000 Contributed surplus – common on a pro rata basis: $953,000/91,100 shares = $10.461 per share For 1,000 shares = 1,000 X $10.461 = $10,461 Debit to Retained Earnings: ($15 X 1,000 shares) – $2,000 – $10,461 = $2,539. Number of Common Shares Bal. 80,000 1. 100 2. 1,000 5. 10,000 91,100 6. (1,000) 90,100 shares

Number of Preferred Shares Bal. 4,000 2. 100 3. 2,000 6,100 shares

LO 5 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.9 a.

For Preferred in arrears:

Dividends1.................................................... Common Shares ................................. 1

50,000 50,000

25,000  10 = 2,500 common shares issued as dividend 2,500 X $20 market value = $50,000

For $2 Preferred current: Dividends2.................................................... Cash ................................................... 2 ($2 X 25,000 shares)

50,000 50,000

For $0.70 per share Common: Dividends3.................................................... Cash ...................................................

211,750 211,750

Since all preferred dividends must be paid before the common dividend, outstanding common shares include— 3

As at Dec. 1, 2023 Preferred distribution—1 common for every 10 preferred shares Common dividend Amount of common cash dividend b.

300,000 shares 2,500 Shares 302,500 Shares X 0.70 per share $211,750

Preferred in arrears ($2 X 25,000 shares) Current preferred ($2 X 25,000 shares) Common dividend ($0.70 X 300,000) Total cash dividend

$ 50,000 50,000 210,000 $310,000

**Beginning Retained Earnings balance Net income as estimated Available to pay dividends

$327,000 56,000 $383,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.9 (CONTINUED) b. (continued) Total dividends would be $310,000, which is adequately covered by the cash balance. The retained earnings balance, after adding the 2023 net income (estimated at $56,000), is also sufficient to cover the dividends. To determine the legality of dividends, various tests of corporate solvency have been used over the years. Under the Canada Business Corporations Act (CBCA), dividends may not be declared or paid if there are reasonable grounds for believing that (1) the corporation is, or would be after the dividend, unable to pay its liabilities as they become due; or (2) the realizable value of the corporation’s assets would, as a result of the dividend, be less than the total of its liabilities and stated or legal capital for all classes of shares. There is no evidence in this case that these considerations would be violated. LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 15.10 Assumptions

Year 2020 2021 2022 2023

Paid-out $8,000 $24,000 $60,000 $126,000

a. Preferred, noncumulative, and nonparticipating Preferred Common $1.60 -0$2.00 $ .47a $2.00 $1.67b $2.00 $3.87c

b. Preferred, cumulative, and fully participating Preferred Common $ 1.60 -0d $ 2.40 $ .40e $ 2.57 f $1.57 f $ 5.39g $3.29g

For 2020: $8,000 ÷ 5,000 shares = $1.60 a

$.47 =

$24,000 – $10,0001 30,000

($10,000 = $2 X 5,000) b

$1.67 =

$60,000 – $10,000 30,000

$3.87 =

$126,000 – $10,000 30,000

$2.40 =

$2 + $0.40 (for 2020)

$.40 =

$24,000 – $12,0002 30,000

($12,000 = $2.40 X 5,000)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.10 (CONTINUED) f

Total

Total amount to be distributed Preferred dividend ($2 X 5,000) Available for common and participation Ratable dividend to common (6.667%3 X $550,000) Available for participation Preferred .0194 X $150,000 5,000 4 Common .019 X $550,000 30,000 Totals 4

(.019 =

$60,000 (10,000)

(36,669) 13,331

.35 $2.57 3

$ 1.57

$10,000 ) $150,000 Per Share Preferred Common

(6.667%=

Total

(.113 =

$1.22 0.57

$ 2.00

50,000

$13,331 ) $150,000 + $550,000

Total amount to be distributed Preferred dividend ($2 X 5,000) Available for common and participation Ratable dividend to common (6.667% X $550,000) Available for participation Preferred .1135 X $150,000 5,000 5 Common .113 X $550,000 30,000 Totals

Per Share Preferred Common

$126,000 (10,000)

$ 2.00

116,000 (36,669) 79,331

$ 1.22 3.39 2.07 $5.39

$3.29

$79,331 ) $150,000 + $550,000

LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 15.11 a. Transactions: 1.

Guoping Limited declares and pays a $.50 per share cash dividend. (1) Total assets—decrease $5,000 (10,000 x $.50) (2) Common shares—no effect (3) Retained earnings—decrease $5,000 (4) Total shareholders’ equity—decrease $5,000

Guoping declares and issues a 10% stock dividend at their fair value when the market price of the share is $12. (1) Total assets—no effect (2) Common shares—increase $12,000 (10,000 X 10%) X $12 (3) Retained earnings—decrease $12,000 ($12 X 1,000) (4) Total shareholders’ equity—no effect

Guoping declares and issues a 40% stock dividend when the market price of the share is $17. (1) Total assets—no effect (2) Common shares—increase $68,000 (10,000 X 40%) X $17 (3) Retained earnings—decrease $68,000 (4) Total shareholders’ equity—no effect

Guoping declares and distributes a property dividend (1) Total assets—increase of $10,000 and decrease of $40,000, (net $30,000) (refer to Note and journal entries) (2) Common shares—no effect (3) Retained earnings—decrease $30,000 (4) Total shareholders’ equity—decrease $30,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.11 (CONTINUED) a. (continued) Note: The journal entries made for the above transaction are: FV-NI Investments ..................................... 10,000 Investment Income or Loss ................ 10,000 [To record fair value adjustment of securities to be issued 60,000/10,000 = $6 per share recorded value. 5,0001 x ($8 - $6)] 1 10,000 common shares / 2 = 5,000 shares of Geneva. Unrealized holding gain of $2 recognized to record 5,000 Geneva shares at FV upon declaration of property dividend. Dividends2 .................................................. 40,000 FV-NI Investments .............................. 40,000 2 (To record declaration and distribution of property dividend) 5,000 x $8 = $40,000 5.

Guoping declares a 3-for-1 stock split (1) Total assets—no effect (2) Common shares—no effect (3) Retained earnings—no effect (4) Total shareholders’ equity—no effect

Cash or property dividends involve a transfer of assets to shareholders. Stock dividends cause a portion of retained earnings to be “capitalized” and transferred to paid-in capital. No assets are distributed to the shareholders. Stock dividends cause an increase to contributed capital with no corresponding increase in the assets or decrease in the liabilities of the corporation. With both types of dividends, retained earnings are decreased.

LO 2 BT: AP Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.12 (a)

1. April 1:

FV-OCI Investments ......................................... 23,281 Unrealized Gain or Loss - OCI .................. (5,0001 shares X $16) $80,000 2 Less: carrying amount 56,719 $23,281 1 50,000 shares outstanding  10 = 5,000 shares 2 ([$68,400 + $22,350]  8,000 shares) X 5,000 shares To record fair value adjustment Dividends ........................................................... Property Dividends Payable ...................... To record declaration of property dividend

23,281

80,000 80,000

Note: This transaction is a partial distribution and the entry represents revaluation of only the 5,000 shares distributed out of the total of 8,000 on hand. In addition, a portion of the Accumulated Other Comprehensive Income will be reclassified to account for the portion of the fair value increase that has been realized through the dividend. Unrealized Gain or Loss - OCI ........................... Gain on Disposal of Investments FV-OCI . To reclassify holding gain (5,000* shares X $16) Less: cost of 5,000 shares3 3

37,250 37,250 $80,000 42,750 $37,250

($68,400  8,000 shares) X 5,000 shares]

April 21: Property Dividends Payable ............................... FV-OCI Investments ................................

80,000 80,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.12 (CONTINUED) a. 2. (continued)

2. July 1: Dividends ........................................................... Common Stock Dividends Distributable ...... (50,000 X 5% X $24 = $60,000)

60,000 60,000

July 22: Common Stock Dividends Distributable ............. Common Shares .......................................

60,000

3. Land .................................................................. Contributed Surplus – Donated Land .........

42,000

60,000

42,000

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PROBLEM 15.12 (CONTINUED) b. Vos Limited Shareholders’ Equity December 31, 2023 Share Capital: Preferred shares, $6 dividend, 2,000 shares authorized, 2,000 shares Issued Common shares, unlimited number authorized, 52,5004 shares issued Total share capital Contributed surplus 5 Total paid-in capital Retained earnings 6 Accumulated other comprehensive income 7 Total shareholders’ equity

$520,000 560,000 1,080,000 145,000 1,225,000 788,000 29,850 $2,042,850

Number of common shares = 50,000 + 2,500 = 52,500 Common shares account = $500,000 + $60,000 = $560,000 5 $103,000 + $42,000 = $145,000 6 $774,000 + $154,000 – $80,000 – $60,000 = $788,000 7 8,000 shares – 5,000 shares distributed = 3,000 shares remaining Fair value = 3,000 shares X $18.50 $55,500 Cost = ($68,400 / 8,000) X 3,000 (25,650) $29,850

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PROBLEM 15.12 (CONTINUED) c.

The changes in fair value of the Waterloo Corp. shares after dividend declaration are ignored for accounting purposes. The legal liability is fixed at the time the dividend is declared and is recorded at this point based on the fair value on that date. Most shares (including common and preferred shares) may be considered equity instruments, although some preferred shares with debt-like features may be classified as financial liabilities. In this case, since the property being distributed consists of shares of another company (an equity instrument), the liability is not considered to be a financial liability. Property dividends that involve non-financial assets such as property, plant, and equipment would also not be considered financial liabilities.

LO 2,3 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.13 a. Jan. 1

No entry. Memo only.

Jan. 15

Share Subscriptions Receivable1 ......... Cash (30,000 X $50 X 10%) ................ Common Shares Subscribed ...... 1 (30,000 X $50 X 90%)

1,350,000 150,000

Cash (70,000 X $50 X 10%) ................ Share Subscriptions Receivable2 ......... Common Shares Subscribed ...... 2 (70,000 X $50 X 90%)

350,000 3,150,000

Cash ................................................... Common Shares3 ....................... 3 (50,000 X $52 X 95%)

2,470,000

Common Shares .................................. Cash ($15,000 + $2,000) ............

17,000

Cash ................................................... Common Shares (2,000 x $52) ... Preferred Shares4 ....................... 4 ($200,000 – $104,000)

200,000

Notes Receivable................................. Common Shares (500 X $52) .....

26,000

Feb. 20

Mar. 3

May 10

Sep. 23

Nov. 28

1,500,000

3,500,000

2,470,000

17,000

104,000 96,000

26,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.13 (CONTINUED) a. (continued) Dec. 31

Dec. 31

Cash5 ................................................... Share Subscriptions Receivable . 5 (10,000 x 5 x $50) x .90 To record collection of subscriptions receivable

2,250,000

Common Shares Subscribed ............... Common Shares6 ....................... 6 (5 X 10,000 X $50) To record issuance of shares for fully paid subscriptions

2,500,000

2,250,000

2,500,000

Common Shares Subscribed7 .............. 1,000,000 Share Subscriptions Receivable8 Contributed Surplus – Common Shares ....................... 7 (2 X 10,000 X $50) 8 (2 X 10,000 X $50 X 90%) To record forfeit of unpaid subscriptions receivable Dividends ............................................. Dividends Payable ...................... To record dividends declared to preferred shareholders

3,000

Dividends ............................................. Dividends Payable ..................... To record dividends declared to common shareholders

197,000

900,000 100,000

3,000

197,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 15.13 (CONTINUED)

Dividend declared ÷ number of shares issued = dividend per share. ($200,000 – ($1,000 x $3)) ÷ 102,500 = $1.92

Date Mar. 3 May 10 Sept. 23 Nov. 28 Dec. 31 Balance Dec. 31

Number of shares Value 50,000 $2,470,000 (17,000) 2,000 104,000 500 26,000 50,000 2,500,000 102,500 $5,083,000

c. Perfect Ponds Inc. Shareholders’ Equity December 31, 2023 Share Capital: Preferred shares, $3 cumulative, 50,000 authorized, 1,000 issued..................... Common shares, unlimited number authorized, 102,500 issued9 ........................... Common shares subscribed .............................. Less: Share subscriptions receivable ................ Less: Note receivable from employee for issued shares ............................................ Total share capital ............................................ Contributed surplus ................................................... Total paid-in capital ................................................... Retained earnings ..................................................... Total shareholders’ equity ..................................... 9

96,000

5,083,000 1,500,000 (1,350,000) (26,000) 5,303,000 100,000 5,403,000 600,000 $6,003,000

Refer to b.

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PROBLEM 15.13 (CONTINUED) d.

The November 28 transaction is presented in the shareholders’ equity section of the SFP as an increase in common shares issued and a deduction from share capital (for the note receivable from the employee for the issued shares). According to the conceptual framework, equity is a residual interest in the net assets of an entity. The common shares issued represent issued equity and should be shown as an increase in common shares issued. The note receivable from the employee represents an amount that may be collected within one year, however the risk of collection related to this type of receivable is often high, and there may not be reasonable assurance that the company will collect the amount in cash. ASPE specifically supports reporting the receivable as a reduction of equity. Note: IFRS is not definitive on this issue, but the conceptual framework would also support reporting the note receivable as a reduction of equity unless there is substantial evidence that the company is not at risk for declines in the value of the shares and there is reasonable assurance that the company will collect the amount in cash.

LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 15.14 a. SECORD LIMITED Statement of Changes in Shareholders' Equity Year Ended December 31, 2023 Preferred Shares Number of Share Shares Capital Balance January 1, 2023

300,000

$3,000,000

Issued preferred shares

25,000

625,000

Issued common shares

Common Shares Number of Share Shares Capital 1,000,000

$200,000

Contrib. Surplus – Common $2,000,000

Retained Earnings

Acc. Other Comprehensive Income

Total

$5,500,000

$250,000

$35,950,000 625,000

50,000

2-for-1 stock split

$25,000,000

Contrib. Surplus – Preferred

1,000,000

1,050,000

Reacquired common shares

(30,000)

(371,400)

(78,600)

(450,000)

Declared dividends – preferred

(1,950,000)

Declared dividends – common

(1,035,000)

Net income

2,100,000

Other comprehensive income Balance December 31, 2023

325,000

$3,625,000

2,070,000

$25,628,600

$200,000

$1,921,400

$4,615,000

2,100,000 (50,000)

(50,000)

$200,000

$36,190,000

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PROBLEM 15.14 (CONTINUED) a. (continued) SECORD LIMITED Shareholders’ Equity December 31, 2023

Share Capital Preferred shares, $6 dividend, 1,000,000 shares authorized 325,000 shares issued and outstanding $ 3,625,000 Common shares, unlimited shares authorized 2,070,000 shares issued and outstanding 25,628,600 Total share capital 29,253,600 Contributed surplus 2,121,400 Total paid-in capital 31,375,000 Retained earnings 4,615,000 Accumulated other comprehensive income 200,000 Total shareholders’ equity $36,190,000

Preferred Shares Bal. $ 3,000,000 1. 625,000 $ 3,625,000

Number of Pref. Shares Bal. 300,000 1. 25,000 325,000

Common Shares Bal. $25,000,000 2. 1,000,000 371,400 $25,628,600

Number of Common Shares Bal. 1,000,000 2. 50,000 Bal. 1,050,000 3. X 2 Bal. 2,100,000 4. (30,000) Bal. 2,070,000

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PROBLEM 15.14 (CONTINUED) a. (continued) Contributed Surplus —Common Bal. $2,000,000 5. 78,600 $1,921,400

Retained Earnings Bal. $5,500,000 8. 1,950,000 6. 2,100,000 9. 1,035,000 $4,615,000

Contributed Surplus —Pref. Bal. $200,000 $200,000

Acc. Other Comp. Income Bal. $250,000 7. 50,000 $200,000

1. 2. 3. 4.

Jan. Feb. June July

1 1 1 1

5. 6. 7.

July 1 Dec. 31 Dec. 31

8. 9.

Dec. 31 Dec. 31

25,000 X $25 50,000 X $20 stock split: 1,050,000 shares X 2 30,000 X ($26,000,000 ÷ 2,100,000 sh.) = 30,000 X $12.38 (rounded) = $371,400 30,000 X ($15 – $12.38) = $78,600 Net income Other comprehensive income (loss) = $2,050,000 – $2,100,000 = ($50,000) 325,000 X $6 = $1,950,000 2,070,000 X $0.50 = $1,035,000

b. Common Shares (30,000 x $12.38) ............. Contributed Surplus ..................................... Cash (30,000 x $15) ............................. c.

371,400 78,600 450,000

There would be no effect on total shareholders’ equity. Common Shares (30,000 x $24.761) ............ 742,800 Contributed Surplus ............................. 292,800 Cash (30,000 x $15) ............................. 450,000 1 ($26,000,000 ÷ 1,050,000 sh.) = $24.76 rounded

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PROBLEM 15.14 (CONTINUED) d.

Other comprehensive income and accumulated other comprehensive income are not recorded under ASPE. Under ASPE, changes in retained earnings are presented in a statement of retained earnings, and changes in capital accounts are presented in the notes to financial statements.

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PROBLEM 15.15 a.

Dividends ............................................ 140,000 Cash .......................................... 140,000 (Cash dividend of $0.70 per share on 200,000 shares)

Dividends ............................................ 380,000 Common Shares ........................ 380,000 (Stock dividend of 5%, 10,000 shares, at $38 per share)

SHAREHOLDERS’ EQUITY Paid-in capital: Common shares Issued 210,000 shares1 Contributed surplus Total paid-in capital Retained earnings Accumulated other comprehensive income2 Total shareholders’ equity 1 200,000 x $10 + $380,000 = $2,380,000 2 ($3,350,000 – $3,200,000) + $1,100,000 = $1,250,000 c.

$ 2,380,000 4,300,000 6,680,000 23,680,000 1,250,000 $31,610,000

Continuity Schedule of Retained Earnings For the Year Ended December 31, 2023 Balance, January 1, 2023 Net income for 2023 Deduct dividends on common shares: Cash dividend Stock dividend (see note) Balance December 31, 2023

$21,000,000 3,200,000 24,200,000 $140,000 380,000

520,000 $23,680,000

Note: The 5% stock dividend (10,000 shares) was declared and distributed to shareholders of record at the close of business on December 31, 2023. For the purposes of the dividend, the shares were assigned a price of $38 per share based on the fair value of the shares at the dividend declaration date.

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PROBLEM 15.15 (CONTINUED) d. Gateway Corporation Statement of Changes in Shareholders' Equity For the year ended December 31, 2023

Balance, January 1 Net income Other comprehensive income Comprehensive income Issuance of common shares through stock dividend Cash dividend Balance, December 31

Common Shares Number of shares Share Capital 200,000 $ 2,000,000

Contributed Surplus $ 4,300,000

Retained Earnings $ 21,000,000 3,200,000

Accumulated Other Comprehensive Income $ 1,100,000 150,000

10,000

380,000

210,000

$ 2,380,000

$ 4,300,000

(380,000) (140,000) $ 23,680,000

LO 2,3 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

$ 1,250,000

Total $ 28,400,000 3,200,000 150,000 3,350,000 0 (140,000) $ 31,610,000

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Intermediate Accounting, Thirteenth Canadian Edition

CASE Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the front of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 15.1 NADIR INTERNATIONAL INC. Case Overview The company’s profits are suffering due to increased overseas competition and a general downturn in the North American economy. Management believes that it can improve its financial statements by “writing up” its long-term assets. The company is also seeking funding, creating an additional bias to make the company’s performance look better. The company has attempted to raise capital but has been unsuccessful due to the low value of its assets. Therefore, there is pressure to increase the net book value of the fixed assets. Management believes that these higher values reflect the fair value of the assets and are more relevant for users. GAAP is a constraint given that the company is looking to raise funds. As a private company, it may choose to follow ASPE or IFRS. Since the company is thinking of going public, it might be wise to follow IFRS to reduce the costs of switching accounting policies in future. Given the fact that the company is seeking funds, the auditor may want to ensure that the financial statements are transparent.

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CA 15.1 NADIR INTERNATIONAL INC. (CONTINUED) Analysis and recommendations Issue: The current book value of the assets does not support the company’s request for funding from various financial institutions. Therefore, management would like to reflect the assets at a higher value than what is reflected using historical costs. Revalue the assets Leave the asset value as is. - Under IFRS, the - Historical costs are more reliable. company may use - The company plans to buy new the revaluation equipment in any case (assuming method to revalue its that it can get funding) resulting in assets. the new equipment being reflected - This would be more at current values. reflective of the - More costly from a record keeping company’s perspective to use the revaluation economic reality method. since the assets - Once the revaluation method is would be adjusted to implemented it must be applied fair value. Rising prospectively, not just for the real estate prices current year with the goal of are not currently improving the carrying value of the reflected in the fixed assets. statements. - Under ASPE, a full financial - The bankers reorganization involves a deficit, generally make created by poor financial lending decisions performance, to be reclassified to based on fair value, share capital. The deficit should so this information is not be created by dividend more relevant. declaration. It would also involve a realignment of the company’s equity and non-equity interests. As there is no realignment of interests, financial reorganization under ASPE is not an option.

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CA 15.1 NADIR INTERNATIONAL INC. (CONTINUED) Recommendation: The revaluation method can only be used if the company is reporting under IFRS. If the company is currently reporting under ASPE, it would have to change to an IFRS reporting system. The time needed to change systems may not enable the company to obtain financing on a timely basis. Given the high costs of revaluing the assets, it may make more sense and be more meaningful to provide specific market valuations to the bankers.

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INTEGRATED CASES IC 15.1 SANDOLIN INCORPORATED Note: These issues should be ranked in order of importance but the case does not give sufficient quantitative information to do this. However, instructors may wish to discuss this in class. Revenues appear to be a key number, and therefore, issues that affect revenues may be more important. Case Overview SI is a global company with publicly traded shares; therefore, IFRS is a constraint. The company has recently undergone a restructuring. This is a good time to ensure assets are not overvalued since the markets expect write-offs in a restructuring situation. However, SI currently has a high credit rating and share price due to increasing revenues and the recent restructuring. The company would not want to jeopardize this. There are numerous stakeholders, this includes: • Credit rating agencies that will be looking for the company to reassess/substantiate its recent rating. • Investors and shareholders that will be looking at the financial statements to assess and confirm the company’s value. • Government will be looking at the financial statements to assess whether toll road revenues are excessive. Overall, management must be careful to present a fair representation of the value of the company (high value) without appearing to be charging excessive revenues for toll roads. Revenues appear to be a key factor.

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IC 15.1 SANDOLIN INCORPORATED (CONTINUED) Analysis and recommendations Issue: SI has recently restructured, laying off 5,000 employees and disabling several oil and gas wells. Present these items separately on the I/S - The markets are viewing the restructuring activities as a positive indicator of future performance. Therefore, SI should provide the details of the costs separately to give more information. - These items are non-recurring and should be segregated so that users may assess normalized earnings. Issue: SI recently raised its toll rate on a busy toll road that spans a major urban centre. The government claims that SI is prohibited from unilaterally raising the toll rates without prior government approval, which will not be forthcoming. SI’s lawyers do not agree with the government’s position based on a review of the contract with the government. Recognize an asset impairment Do nothing related to the toll road - If the company’s ability to raise - The company’s lawyers believe that tolls is restricted by the the company has a contractual right government, the asset value to raise revenues and are willing to changes. This change in contest this. condition signals a potential - Disclosure of the issue in the impairment, which must be financial statements may not be measured and disclosed. necessary if the information is - Full recognition of this potential available through the press or if the impairment may affect the company believes that the share price and credit ratings. government claim is unsubstantiated. - Reporting this problem will imply that future revenue streams are impaired and thus this may affect share prices and credit ratings. Solutions Manual 15.106 Chapter 15 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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IC 15.1 SANDOLIN INCORPORATED (CONTINUED Recommendation: Leave the assets as is and do not disclose on the basis that the lawyers believe that the company’s position is correct based on its contractual agreement with the government. Issue: SI engages in trades to reduce its exposure to fluctuating commodity prices. These deals are referred to as “round trip” trades. Several large trades involved purchases and sales with the same party for the same volume at substantially the same price. These transactions have been treated as sales and account for 40% of the increase in revenues. The company never takes possession of the commodity that is being bought and sold. Show gross revenues - These transactions account for 40% of the increased revenues. - If transaction was reflected at its net value this could affect SI’s credit rating and share prices. - SI is buying and selling energy contracts but appears to never take legal title of the goods traded, SI should confirm this is correct and establish this with its company lawyers.

Show net revenues - As traders, the economic substance of the transaction is what the company is earning on the trade (more specifically the commissions on the trade). - If SI never takes possession of the goods traded, it appears to be acting as an agent.

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IC 15.1 SANDOLIN INCORPORATED (CONTINUED Recommendation: Difficult to justify treating the “round trip” trade as sales unless legal title is taken of the energy traded. The company must show that it has the risks and rewards of ownership of the energy. Therefore, the trades should be reflected at the net value. Issue: SI purchased an engineering business prior to yearend. SI shares were issued to the vendor. The value of the shares exceeded the fair value of the engineering firm. The engineering firm provided SI with a one year note receivable for the difference. The note receivable will be forgiven if the engineering firm outperforms expectations. Currently the note receivable is recorded as an asset. Record note as an asset Record note as share reduction or not at all - The value of the - Alternatively, this represents a transaction should be contingency as the vendor determined and shareholders will owe SI an additional recorded at the amount if the engineering firm does transaction date. not exceed expectations. - Currently, the note - Recognize the contingency if represents a benefit to probable and measurable. This is SI that it has access to. difficult to measure at this point since - As the situation future profits are unknown. Therefore, changes, this needs to since the shares are already issued be reassessed. and currently have fair value, the note - If the note is no longer should be recorded. Given this is part repayable, the value of the acquisition price, SI may might be added to the consider recording the note as a cost of the investment contra account to the common shares since it really represents (share purchase receivable). additional consideration The excess payment in shares over the paid for the business. FV of the engineering company is - Improves SI’s balance similar to a contingent advance on sheet. future profits, so a deduction from the share capital would represent the substance of the transaction. Solutions Manual 15.108 Chapter 15 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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IC 15.1 SANDOLIN INCORPORATED (CONTINUED Recommendation: Record as an asset since it presently has future benefits.

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IC 15.2 WIND AND SOLAR Case Overview WSI is a new tech startup company that is experiencing cash flow difficulties. WSI underestimated its development costs and consumed all its bank financing prior to the completion of the wind turbines and solar panels. The bank has refused to advance more funds and there is a bank covenant requiring a 1:1 debt-to-equity ratio. Therefore, this will be a sensitive ratio. WSI entered into an agreement with WD to help finish the development of the turbines and solar panels. WD will advance the funds upfront for development costs in exchange for a percentage of the revenues generates by the windmills. There are two shareholders who are bound by a share agreement that has a buyout clause equal to 10 times the net income for the current period. At yearend, one shareholder wants to be bought out. The amount of the payout is a function of net income; therefore, this is also a sensitive number. The engineers are being paid with shares and may cash these in at the end of 2023. The amount of the payout will be based on a valuation of the company using the 2022 and 2023 net income. The bank will likely want to monitor the debt-to-equity ratio and the company’s financial conditions, therefore GAAP is a constraint. If the company plans to go public it may want to follow IFRS. Following IFRS now will save transition costs later. The auditor will need to consider all of these factors.

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IC 15.2 WIND AND SOLAR (CONTINUED) Analysis and recommendations Issue: WSI entered into a contract with Windy Developments to obtain the required financing to complete the development of the windmills and solar panels. Capitalize the interest costs Expense the interest costs - As a new company, WSI must - WSI does not know decide whether to capitalize whether it will be able interest on the financing to recover the full cost during construction of the of construction of the windmills. windmills from future - The interest is a cost incurred operations, so the during construction and a cost interest should not be that wouldn’t be incurred added to the asset during this period if the cost. windmills were acquired from - As WSI has received another party. funding up front from - Capitalizing the interest WD, interest income charges would affect net from investing any income, making it higher than surplus funds could go it otherwise would be, and through net income, increasing assets, retained offset by the cost of earnings, and equity. the funds to WSI and - However, this would increase netting the effect of the buy-out payment to the cost out to some Winston as well as to the extent. engineers. - Interest is the cost of - IFRS requires capitalization borrowed money. WSI (choice under ASPE). has borrowed money. - It does not seem appropriate Therefore, the to reduce net income by the financing cost should interest cost as no revenue be recognized in the has been generated against period incurred. which the expense could be deducted.

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IC 15.2 WIND AND SOLAR (CONTINUED) Recommendation: Capitalize interest given that there has been no revenues generated yet, and it is a directly attributable and legitimate cost of construction. Issue: WSI entered into an agreement with WD, whereby WD will advance the funds needed to build the windmills upfront. In return, WSI will pay WD a percentage of the revenues generated from the additional windmills once operational. Recognize the windmills as Do not recognize the windmills assets as assets - WD financed the development - WD is paying WSI to build and of the windmills, which are operate these windmills on owned and will be operated by behalf of WD. WSI. - Costs should be recognized - WSI will derive future benefits as cost of sales when through the operation of the revenues recognized. windmills, and it controls - This will decrease NI resulting access to the windmills. in decreased buyout and Therefore, the windmills are cash-out amounts. assets of WSI.

Recommendation: Treat the windmills as assets to be consistent with the treatment of the funds received for financing.

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IC 15.2 WIND AND SOLAR (CONTINUED) Issue: Currently several engineers are working for an equity stake in the company. The engineers are not being paid a salary but will be entitled to 10% of the 2023 share valuation. Recognize salary expense

Do not recognize as a salary expense - Engineers are working for - Engineers are buying into and being compensated by the company but instead of WSI. Therefore, this paying cash for their share should be accounted for as ownership, they are paying a salary expense. with services or sweat - This will result in a lower equity. NI. Therefore, lowering the - This is a nonmonetary amount of the shareholder transaction, but it is too buyout and the eventual difficult to measure the payout should the value of the shares at this engineers’ cash out. point. - The value could be measured by looking at the fair value of the salaries.

Recommendation: The services being provided by the engineers is clearly an expense that can be valued at the fair value of an engineer’s time. Therefore, treat as an expense since providing service. However, the company may want to consider categorizing as compensation expense versus salary expense.

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IC 15.2 WIND AND SOLAR (CONTINUED) Issue: Government contract The company has a contract with the government to provide power. The contract has a fixed upfront component and a guaranteed payout of $1,000,000. The government considers this to be a grant. Recognize as unearned revenue

Recognize the value as a government grant to offset cost of construction/other - There is a performance - In substance this is a obligation to deliver government grant to offset the electricity. However, the cost of building windmills. company has not satisfied - This should be booked as a the obligation until it reduction of the cost of the delivers electricity, or until windmills. the 2022/2023 period - This will affect future net ends. income as the depreciation - Treating the value as expense will be lower. unearned revenues may - This is partly a financing negatively affect the agreement, that is repayable in debt/equity ratio and may electricity. The company has breach the bank covenant. an obligation to deliver electricity.

Recommendation: It is more conservative to delay the recognition of revenues until the service (electricity) is provided. The company may treat this partly as a government grant (if electricity provided falls short of the minimum amount) and credit the value to the cost of the windmill.

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RESEARCH AND ANALYSIS RA 15.1BOMBARDIER INC. a. The following charts present Bombardier’s two classes of authorized shares at December 31, 2020. Preferred Shares Name # of shares # of shares authorized issued and (in outstanding millions) (in millions) Series 2* 12.000 5.812

Votes Rights to dividends per share if declared None Monthly, at a variable rate to a maximum as defined Series 3* 12.000 6.188 None From August 2017 to July 2022, fixed at a rate of 3.983% or $0.99575 /share per year, payable quarterly, after which a new fixed rate is determined with a floor set on the rate. Series 4* 9.400 9.400 None A fixed dividend of 6.25% or $1.5625/share per year, payable quarterly. *All series of preferred shares are cumulative and redeemable at stated rates. Series 2 and 3 are convertible under various conditions into other series of preferred, while Series 4 preferred are convertible under specific conditions into Class B subordinate voting shares of the company, or into an additional Series of preferred shares that may be issued in the future. Common Shares Class A, 3,592.000 multiple voting1

Class B, subordinate voting2

3,592.000

308.737

2,111.044

10 After payment of the priority dividend on the Class B shares, then equally on a per share basis between A and B shares, payable quarterly 1 In priority to holders of Class A shares, a non-cumulative dividend of $0.0015625/share per year, payable quarterly. After this, dividends declared are shared equally per share between the A and B Class shares.

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RA 15.1 BOMBARDIER INC. (CONTINUED) a. (continued)

Common Shares (continued) 1 Convertible at holder’s option, to one Class B subordinate voting share 2 Convertible at holder’s option into one Class A share, if acceptable to the

company’s controlling shareholder (the Bombardier family), or if controlling shareholder’s holdings fall below 50% of all outstanding Class A multiple voting shares. b. Bombardier Inc. began as a family-owned business that prospered and grew, eventually going public. In order to keep control within the family but be able to access large amounts of public funds to help it grow, a dual share structure was set up whereby the family ensured it had control by owning the majority of shares that gave them voting control, i.e., the Class A shares with 10 votes per share held. As can be seen above, the Class A shareholders have 3,087,369,290 votes while the Class B common, with six times the number of common shares held, have only 2,111,044,001 votes. There are still large public companies trading on the Toronto Stock Exchange that have a dual class share structure, but its use has been on the decline as corporate governance issues and shareholder rights (such as one share to one vote) have become increasingly important. There is a need for various classes of shares, such as preferred and common, and between those that pay a fixed dividend and a variable rate dividend in order to raise capital efficiently by providing financial products to a variety of investors with different risk preferences and cash flow needs. However, modern corporate governance practices do not support dual class shares where the voting rights put control and decision-making in the hands of a small group whose interests do not necessarily align with those of the remaining shareholders.

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RA 15.1 BOMBARDIER INC. (CONTINUED) c. Calculation of book value per Class A and B common share, December 31 (in US dollars): Shareholders’ equity of Bombardier Inc.’s equity holders Deduct preferred entitlement Net common entitlement Total number of Class A and B shares Book value per share Closing share price (average of Class A and B share price)

2020 ($9,325 million)

2019 ($7,667 million)

(347 million) ($9,672 million)

(347 million) ($8,014 million)

2,420 million

2,398 million

($4.00)

($3.34)

$0.65

$1.94

The market price per share is considerably higher than the book value per share (which is negative) because the book value is based on past events and the application of fairly conservative accounting standards. The market price per share is based on what the expectations are for the company’s future and the cash flows expected from future operations. [For use in part (f) below, the January 1, 2019 common equity was ($5,563) – $347 = ($5,910).]

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RA 15.1 BOMBARDIER INC. (CONTINUED) d. The information about the types of common share transactions, representing the number of shares of each class, is found in Note 33 to the financial statements:

Issued and fully paid, January 1, 2019 Less held in trust for the PSU and RSU equity-settled sharebased payment plan New Class B shares issued during 2019 Class A shares converted to Class B during 2019 Shares held in trust distributed Number of shares, end of 2019 Class A shares converted to Class B during 2020 New Class B shares issued during 2020 Shares held in trust distributed Number of shares issued and fully paid, December 31, 2020 Less held in trust for the PSU and RSU equity-settled sharebased payment plan

Class A shares 308,750,749

Class B shares 2,125,232,847 (60,541,394) 2,064,691,453 2,780,538

(3,820)

3,820

308,746,929 (10,000)

21,380,909 2,088,856,720 10,000 64,737 22,112,544

308,736,929

2,111,044,001

In general, the number of Class A shares has reduced slightly over the 2-year period through conversion to Class B shares. The net number of Class B shares has increased over the same period due mostly to the issuance of additional shares in 2019 and the distribution of shares held in trust in 2019 and 2020.

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RA 15.1 BOMBARDIER INC. (CONTINUED) e.

During 2020, the company declared dividends amounting to US$19 million on the preferred Series of shares and no dividends on the Class A and B common shares (Note 33). On a per-share basis in Cdn. $, this amounted to: Series 2 preferred $0.72 per share Series 3 preferred $1.00 per share Series 4 preferred $1.56 per share The company paid dividends, according to the statement of cash flow, of US$19 million, all of which related to the preferred shares. This information is disclosed in Note 33 and in the statement of cash flows. The company’s statement of changes in equity however shows dividend declaration to preferred shares of US$21 million but does not reconcile the different amounts.

Net income (loss) attributable to shareholders of Bombardier Inc. Less preferred dividends Income (loss) attributable to common Common equity – opening - see (c) above Common equity – closing – see (c) above Average common shareholders’ equity Return on common shareholders’ equity Total dividends paid to common Payout ratio Market share price Earnings per share—basic Price earnings ratio

December 31, 2020 US$ (868) M

December 31, 2019 US$ (1,797) M

(19) M (887) M (8,014) M (9,672) M (8,843) M 10.03% 0 0% $0.65 ($0.37) (1.76) times

(20) M (1,817) M (5,216) M (8,014) M (6,615) M 27.47% 0 0% $1.94 ($0.76) (2.55) times

2020 and 2019 have not been good years for Bombardier. The company has sustained losses over the last several years and its common equity has been negative since 2015. The losses combined with negative common equity produces a positive return on common shareholders’ equity. This figure is misleading and highlights the importance of looking at the underlying numbers to assess the company’s sustained losses resulting in negative equity. In addition, the company’s decrease from 27.47% in ROE to 10.03% would normally indicate a decline in performance. Given the negative numbers involved, the performance is an improvement because the loss in 2020 is smaller than in 2019. The sustained losses have meant that no dividends have been paid to common shareholders resulting in a 0% payout ratio for both 2019 and 2020. Solutions Manual 15.119 Chapter 15 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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RA 15.1 BOMBARDIER INC. (CONTINUED) f. (continued) The PE ratio is negative for both years due to negative EPS indicating negative earnings for both years. The company has experienced negative PE since 2014. Usually, companies that generate consistent negative PE ratios are not generating enough profit and run the risk of bankruptcy/insolvency. g. Bombardier’s strategy for managing its capital is to assess the creditworthiness of the corporation and achieve an investment grade profile. In 2020, the focus of the capital management strategy has been based on the sale of business transactions to deleverage and adapt to changes in the market resulting from the Covid-19 pandemic. While the overall strategy is still adapting based on this unprecedented time in the market, Bombardier is continuing to focus on restoring and growing earnings to achieve a lower debt to EBITDA multiple. Plans to achieve this center around cost reduction initiatives and adapting its infrastructure to market needs.

Bombardier management also closely monitors its net retirement benefit liability, particularly its effect on future cash flows. In managing its capital structure, the company may issue new debt or retire existing debt, reduce its pension fund liability, issue new or retire existing shares, and adjust dividend payments. It also monitors closely the bank covenants in place in support of its credit facilities to ensure that financial commitments are met. While the notes to the financial statements do not specifically define what the company means by “capital,” it appears it uses the term to refer to its capital structure in general. Between this and the metrics and strategies indicated, “capital” relates to the mix of debt and equity financing its resources and operations.

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RA 15.2 BANK OF MONTREAL AND ROYAL BANK OF CANADA

a. Year-end Balance of common shares ($ millions) Number of common shares outstanding Average carrying amount Closing market price on October 31, 2020 (as listed on TSX) Stock exchanges where common shares traded

Bank of Montreal (BMO) OCT 31, 2020

Royal Bank of Canada (RBC) OCT 31, 2020

$13,430

$17,499

645,889,396

1,423,861

$20.79

$12.29

$78.47

$92.22

Toronto Stock Exchange (TSX), New York Stock Exchange (NYSE)

Toronto Stock Exchange (TSX), New York Stock Exchange (NYSE), Swiss Exchange (SIX) TSX 1

Stock Exchange where TSX preferred shares are traded 1. Series C-2 Preferred shares of RBC are listed on the NYSE b. Authorized share capital: (Notes 16 and 20, respectfully) Preferred shares, in series Common shares

Unlimited number

Unlimited number, but limited in total dollar value issued Unlimited number

c. Both companies present summarized total shareholders’ equity information on the balance sheet by setting out two components of the bank’s equity: (i) the parent company bank’s shareholders’ interests in the net assets of the corporation, and (ii) the equity interests of the non-controlling shareholders in subsidiary companies controlled by the bank.

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RA 15.2 BANK OF MONTREAL AND ROYAL BANK (CONTINUED) c. (continued) The part (i) subtotal is broken down into share capital indicating separate balances for its preferred shares and common shares, retained earnings, and other components of equity (with BMO indicating accumulated other comprehensive income and contributed surplus). The part (ii) subtotal – the entitlement of equity interests held by non-parent company shareholders in the net assets of the consolidated entity is added to the part (i) subtotal to arrive at the total equity amount for the consolidated entity. Both banks also provide a statement of changes in equity, also broken down into two subtotals that add up to report the change in total equity. The subtotals are the primary changes in equity attributable to (i) the bank’s shareholders and (ii) the non-controlling interests in subsidiary companies controlled by the bank. BMO’s statement of changes covering the past three years is presented in a report format with separate explanation of the changes in each of the components of shareholders’ equity shown on the balance sheet. RBC presents its statement of changes in equity in a “landscape” table format covering a two-year period. The comparative presentation of the statements of income and of comprehensive income, and statement of cash flows for BMO are also for three years (two years for RBC), although both banks provide a comparative balance sheet for two years only. The three-year statement of changes in equity provides a succinct story of how the equity has increased over this period, and what components are primarily responsible for the changes.

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RA 15.2 BANK OF MONTREAL AND ROYAL BANK (CONTINUED) d. Dollar amounts in millions and numbers of shares in thousands. Bank of Montreal 2020 2019 Amount # of Amount # of $ shares $ shares

Amount $

# of shares

12,971

639,232

12,929

639,330

13,032

647,816

471

6,746

Issued under stock option plan

564

903

1,513,307

Repurchased for cancellation

(52)

(653)

(20)

(1,000)

(202)

(10,000)

Ending balance – common shares

13,430

645,889

12,971

639,232

12,929

639,339

Beg. balance – common shares Issued under shareholder dividend reinvestment and share purchase plan

2018

Royal Bank of Canada 2020 2019 Amount # of Amount # of $ shares $ shares

Amount $

# of Shares*

17,645

1,430,678

17,730

1,452,898

Issued under share-based plan

1,043

136

1,900

1,466

Purchased for cancellation

(97)

(7,860)

(126)

(10,251)

(187)

(15,335)

End. balance of common shares

17,628

1,423,861

17,645

1,430,678

17,635

1,439,029

Beg. balance – common shares

17,635

1,439,029

2018

*found in 2019 financial statements

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RA 15.2 BANK OF MONTREAL AND ROYAL BANK (CONTINUED) d. (continued) Over the past three years, both banks have had small numbers of common shares issued. These have been issued primarily under the companies’ dividend re-investment plans whereby shareholders can opt to have their dividends paid in additional common shares instead of in cash. The other reason was to issue shares under their stock option plans. f.

(See (e) presented below) The rate of return on common shareholders’ equity for each company for 2020 is presented below. (Note that the numbers used relate to the common shareholders of the bank.) Refer to the earnings per share notes (Note 23 for both banks). Royal Bank’s return on common shareholders’ equity is significantly higher than that of Bank of Montreal.

Net income attributable to shareholders (1) millions of C$ Less: Preferred dividends (2) Net income available to common shareholders (3) = (1) (2) Total shareholders' equity attributable to shareholders, beginning (4) Less: Preferred shares, including treasury shares (5) Common shareholders' equity, beginning (6) = (4) - (5) Total shareholders' equity, ending (7) Less: Preferred shares, including treasury shares (8) Common shareholders' equity, ending (9) = (7) - (8) Average common shareholders' equity (10) = [(6) + (9)] /2 Return on common shareholders' equity (11) = (3) / (10)

BMO 5,097 (247) 4,850

RBC 11,432 (269) 11,163

51,076

83,523

(5,348) 45,728 56,593 (6,598) 49,995 47,862 10.13%

(5,707) 77,816 86,664 (5,945) 80,719 79,268 14.08%

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RA 15.2 BANK OF MONTREAL AND ROYAL BANK (CONTINUED) e. The amount of cash dividends declared per share and the total amount by

which dividends affected shareholders’ equity are presented below for each bank. Cash dividends declared in fiscal 2020 Preferred cash dividend per share - class B series 25 Preferred cash dividend per share - class B series 26 Preferred cash dividend per share - class B series 27 Preferred cash dividend per share - class B series 29 Preferred cash dividend per share - class B series 31 Preferred cash dividend per share - class B series 33 Preferred cash dividend per share - class B series 35 Preferred cash dividend per share - class B series 36 Preferred cash dividend per share - class B series 38 Preferred cash dividend per share - class B series 40 Preferred cash dividend per share - class B series 42 Preferred cash dividend per share – class B series 44 Preferred cash dividend per share – class B series 46(1) Preferred cash dividend per share - series W Preferred cash dividend per share - series AA Preferred cash dividend per share - series AC Preferred cash dividend per share - series AE Preferred cash dividend per share - series AF Preferred cash dividend per share - series AG Preferred cash dividend per share - series AZ Preferred cash dividend per share - series BB Preferred cash dividend per share - series BD Preferred cash dividend per share - series BF Preferred cash dividend per share - series BH Preferred cash dividend per share - series BI Preferred cash dividend per share – series BJ Preferred cash dividend per share – series BK Preferred cash dividend per share – series BM Preferred cash dividend per share – series BO

Bank of Montreal

Royal Bank of Canada

0.45 0.52 0.96 0.91 0.96 0.90 1.25 58.50 1.21 1.13 1.10 1.21 1.28

1.05 0.95 0.98 0.96 0.95 0.96 0.93 0.91 0.85 0.90 1.23 1.23 1.31 1.38 1.38 1.20

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RA 15.2 BANK OF MONTREAL AND ROYAL BANK (CONTINUED) e. (Continued) Cash dividends declared in fiscal 2020 (continued) Preferred cash dividend per share – Series C-2

Bank of Montreal

Royal Bank of Canada 67.50 US$

Common cash dividend per share Total impact on shareholders’ equity (in millions) - Dividends declared on preferred - Dividends declared on common Total

$4.24

$4.29

$(247) (2,723) $(2,970)

$(268) (6,111) $(6,379)

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RA 15.3 CANADIAN TIRE CORPORATION LIMITED a. As at January 2, 2021, Canadian Tire had the following: Common shares authorized, 3,423,366; issued, 3,423,366 (see Note 26). All 100% of the authorized common shares are issued. Class A Non-voting shares authorized, 100,000,000; issued, 57,383,758. The number of shares issued represents approximately 57% of the authorized Class A shares. b. The Class A Non-voting shares have a stated fixed annual dividend of $.01 per share which is cumulative, and this dividend is a preferential dividend. After this preferential dividend is paid (current and any arrears) and the common have received a dividend at the same rate for the current year, the Class A shares participate equally and fully in dividends with common shares over and above this stated dividend rate. Although they do not vote, the Class A shareholders may attend most meetings and they are entitled to vote separately as a class to elect a specified number of directors. These features, which allow some voting privileges and the opportunity to share in earnings above a stated amount, make these preferred shares appear more like common shares than traditional preferred shares. This “residual equity” class description is further emphasized on dissolution where the common and non-voting class share equally per share in company assets available for distribution. On the other hand, the cumulative nature of the non-voting class for a specified minimum dividend and the restricted opportunity for them to vote on matters of general concern to the corporation indicate restrictions not usually associated with common shareholdings. (Note also that the common shares can be converted at any time into Class A Non-voting shares on a share per share basis.) c. The excess of the amount paid on re-acquisition over the average “cost” or carrying amount of the shares re-acquired, is charged first to related contributed surplus and then any remaining amount to retained earnings (Note 3 Accounting Policies). The journal entry made was (in millions of dollars): Retained earnings ............................................. 102.4 Share capital (Class A shares) ......................... 8.3* Cash ......................................................... 110.7 *This is the average “cost” or carrying amount of the shares when reacquired. Although there was a balance in Contributed Surplus of $2.9 million at the beginning of the current year, this must have been related to other types of transactions as the full excess payment was recognized in retained earnings in the current year.

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RA 15.3 CANADIAN TIRE CORPORATION LIMITED (CONTINUED) d. The average carrying amount of the Class A shares at the beginning of the 2020 fiscal year was $10.12 ($587.8 million / 58,096,958 shares). At the end of the 2020 fiscal year, the average carrying amount was $10.40 ($596.8 million/57,383,758 shares). The average cost of the shares at the time of repurchase is $10.1 (($110.7 - $102.4) / 818,302). The shares were repurchased at $135.28 ($110.7 million / 818,302 shares). A scan of the market price of the shares (CTC-A) shows that the opening market price of the shares was $139.74 and climbed throughout the year. This indicates that the repurchase price fell within the market prices during the year. The market price of the shares at closing on January 4, 2021 was $166.37, which is much higher than the average carrying amount per share at the beginning and at the end of the year. It appears that the shares must have been issued many years ago when the market prices were much lower and/or the shares have been subject to stock splits. e.

Note 4 indicates that the company has three general objectives in managing its capital: • ensuring sufficient liquidity to support its financial obligations and carry out its operating and strategic plans; • maintaining healthy liquidity reserves and access to capital; and • minimizing the after-tax cost of capital while taking into consideration current and future industry, market and economic risks and conditions. In addition, it has two objectives related to its bank’s capitalization: • to provide sufficient capital to maintain the confidence of investors and depositors, and • being appropriately capitalized as required by regulators and, in comparison with its peers. The company includes the following items in the definition of its capital under management: • total debt – made up of deposits, short-term borrowings, long-term debt including the current portion, and long-term deposits • redeemable financial instruments • share capital • contributed surplus • retained earnings

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RA 15.3 CANADIAN TIRE CORPORATION LIMITED (CONTINUED) e. (continued) Management monitors its capital in the following ways: • monitoring of key capital structure ratios: various debt-to-capitalization ratios, debt-to-earnings ratios, • ensuring the company’s ability to service its debt and other fixed obligations by the tracking of fixed-charge coverage ratios • monitoring key financial covenants included in existing debt agreements on an ongoing basis • monitoring its capital against guidelines set out by the Office of the Superintendent of Financial Institutions of Canada (banking – the Canadian Tire Bank makes up part of its operations). With the objective of maintaining its investment-grade rating from credit rating agencies, the company uses ratios approximating those used by the agencies and other market participants and monitors their performance against targeted ranges.

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RA 15.4 IMPACT OF DIFFERENT LEGAL SYSTEMS ON INTERNATIONAL GAAP Sample Solution Comparable, transparent, and reliable financial information is fundamental for the success of capital market operations. The rapid growth in the number, reach, and size of multinational corporations, foreign direct investments, cross-border purchase and sale of securities, as well as the number of foreign securities listings on the stock exchanges increase the need for comparable standards of financial reporting. However, because of various social and economic structures, different legal systems, and diverse cultures among countries, the accounting standards and practices in different countries vary widely. While the international accounting standards benefit investors and analysts, multinational corporations, stock exchanges, and other developing countries, some people have raised concerns that different legal systems around the world have made uniform accounting standards difficult to achieve for their ownership interests. However, International Accounting Standards take a “principles-based” approach rather than a “rules-based” approach and very clearly have the goal of reporting on economic resources, claims to those resources and changes in an entity’s net resources. Principles-based standards are expected to allow similar financial statement elements and transactions to be accounted for similarly, even in different countries, and enable accountants and auditors to judge more professionally whether what is recognized and measured reflects economic realities. IFRS incorporates standards for countries that experience rapid price changes and different economic conditions. In addition, the disclosure of specific information required by law in various countries can be accommodated within the notes or in information cross-referenced to the financial statements. There are few accounting requirements in IFRS that cover the accounting for share capital of entities. Most of the relevant information relates to disclosure of the terms and conditions of various categories of ownership interests. This can be accomplished regardless of the entity’s legal environment so that financial statement users can understand their rights and limitations.

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RA 15.5 ROGERS SUGAR INC. a. The following components make up the shareholders’ equity of Rogers Sugar Inc., and the explanations describe how each has changed over the two-year period ended October 3, 2020: Common shares: The number of common shares decreased by 1,348,541 shares whereas the dollar amount decreased by $1,070,000 in fiscal 2020. The major transactions affecting this account involved a large purchase and subsequent cancellation of shares (1,377,394 shares and a book value reduction of $1,320,000) for a total cost of $6,536,000. The company also issued shares for the conversion of debentures into common shares (28,853 shares were issued at a book value of $250,000).

Contributed surplus: Contributed surplus was increased by the amount of share-based compensation attributed to each reporting period ($168,000 in fiscal 2020 and $190,000 in 2019). Equity portion of convertible debentures: The company reports convertible debentures in its non-current liabilities on the statement of financial position. When convertible debentures are originally issued, some portion of their issue price is attributed to the conversion feature, and this portion is considered an item of equity. Rogers Sugar reports this as a component of its shareholders’ equity. The equity component did not change in 2020 or 2019. Accumulated Other Comprehensive Income (Loss): AOCI is presented as three columns in the Statement of Changes in Shareholders’ Equity: accumulated unrealized gain (loss) on employee benefit plans, accumulated cash flow hedge gain, and accumulated foreign currency translation differences. During 2020, the company reported an actuarial loss of $4,345,000 on its defined benefit pension plans (a loss of $14,708,000 in 2019). The accumulated cash flow hedge loss of $2,871,000 results from the application of IFRS 9. The accumulated foreign currency translation differences in 2020 is a gain of $54,000 attributed to the translation of foreign operations.

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RA 15.5 ROGERS SUGAR INC. (CONTINUED) a. (continued)

Deficit: A deficit is negative retained earnings. The company has experienced net losses and paid dividends in excess of net incomes over the years. The deficit balance increased in 2020 as dividends of $37,380,000 and share repurchases and cancellations of $5,216,000 exceeded net earnings of $35,419,000. In 2019, the balance in deficit increased as there was a loss of $8,167,000, dividends declared of $37,793,000, and share repurchases and cancellations of $523,000. Although it may look unusual that the excess over carrying amount of the shares was charged entirely against retained earnings/deficit when there is a balance in contributed surplus, this is likely due to the contributed surplus balance being accumulated from other types of transactions and not including any “surplus” from “gains” on repurchases and cancellations on shares in the past (see Note 22 that indicates that the contributed surplus arises from issuing share-based compensation). The company’s accounting policies note 3 discloses that “the excess of the purchase price over the carrying amount of the shares is charged to deficit.” Year Account titles ended Oct. 3, Common Shares 2020 Retained Earnings Cash Repurchase and cancellation 1,377,394 common shares Sep. 28, Common Shares 2019 Retained Earnings Cash Repurchase and cancellation 122,606 common shares.

Debit $

Credit $

1,320,000 5,216,000 6,536,000 of 117,000 523,000 640,000 of

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RA 15.5 ROGERS SUGAR INC. (CONTINUED) b. As described in Note 22 of the financial statements, Rogers Sugar Inc.’s management sets out the following objectives in regards to capital management. • To ensure there is proper capital investment in the manufacturing infrastructure in order to provide stability and competitiveness of the operations. This is achieved through annual investments in capital expenditures of approximately $20 million, and, on average, annual maintenance expenditures of $30 to $40 million. • To achieve stability in its dividend payments to shareholders. This is achieved by maintaining sufficient cash reserves and raising dividends to shareholders only after carefully assessing various factors of the Company in order to ensure sustainability of the dividends. • To maintain appropriate debt levels, including appropriate lines of credit to eliminate any financial constraints on the use of capital. The Company maintains an appropriate revolving line of credit for use in financing its normal operations during the year. The company estimates to use between $120 million and $200 million of its revolving credit facility to finance its normal operations during the year. It also monitors key ratios required in their debt covenants to ensure compliance with them. • When cash is available, to use it to repurchase shares or convertible debentures when the market values at which they are traded are below what the board of directors considers their fair value.

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RA 15.7 ROGERS SUGAR INC. (CONTINUED) c. Rogers Sugar declared a quarterly dividend of $0.09 per share, for an annual dividend of $0.36 per share in its year ended October 3, 2020, the same as in the previous year. The total dividends declared were $37,380,000 for the year ended October 3, 2020 ($37,793,000 in 2019). Dividends paid during 2020 totaled $37,501,000 ($37,804,000 in 2019) according to the statement of cash flows. The last quarterly dividend of $9,318,000 ($0.09 X 103,533,333 shares) is shown as Dividends payable to shareholders in Trade and other payables (Note 17) on the company’s statement of financial position ($9,440,000 in 2019). With earnings per share in fiscal 2020 of $0.34 per share and cash dividends of $0.36 per share, the pay-out ratio for the year ended October 3, 2020 is $0.36/$0.34 or 105.9%. For the year ended September 28, 2019, earnings per share were $(0.08). This makes the calculated pay-out ratio for that year $0.36/$(0.08) or(450.0)%%, which is typically something to be concerned about. A negative payout ratio means that the company had to rely on existing cash reserves to pay out a dividend rather than from income generated in the fiscal year. The statement of cash flows provides insight on how the company can pay out 105.9% and (450.0)% of earnings as dividends to shareholders. The company has a significant amount of expenses categorized as depreciation, which does not involve a cash outflow, leaving cash available for dividends. In addition, a significant amount of cash is generated from trade and other payables (the use of credit - $13,496,000). However, this would not be a sustainable way to generate cash in order to pay dividends. Overall, it appears that in 2020, the company generated significant cash from operations, which generally supports a company’s ability to pay dividends. In the previous fiscal year of 2019, dividends were paid despite a net loss. Of particular note, in the operations section of the cash flow statement there is an addback of $50,000,000 related to Goodwill impairment. This would explain the overall loss in the fiscal year. In addition, the company still generated significant cash from operations, which is likely why dividends were still paid.

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION: CHAPTERS 13-15 Cinefilm Response Sheet Part A - Movie Points Instructions Determine the appropriate journal entries and impact on the financial statements of the loyalty program under both the revenue approach and expense approach. Note that the revenue approach is the only option under IFRS. The expense approach is provided in this question for illustration purposes only. Complete the tables below. a.

Record the year-end journal entry to recognize the loyalty program under both the revenue and expense approach. Revenue Approach Expense Approach Service Revenue 171,600 Advertising Expense 51,480 Unearned Revenue 171,600 Estimated Loyalty Program Liability 51,480 Total MP Issued: 345,548 MP Redeemed: (176,064) 25,152x7 MP Outstanding: 169,484 MP Not Redeemed: (49,364) 345,548/7 MP to be Redeemed: 120,120 Movies to be Awarded: 17,160 (120,120/7) Movie Revenue: $171,160 (17,160 x $10) Movie Cost: 51,480 (17,160 x $3)

Determine the impact of the loyalty program journal entry under the revenue approach on the financial statement key metrics. Use the following words to describe the impact for each metric: positive, negative, no impact, not determinable. EPS Revenue Debt/Equity ROA

Recognition of loyalty program

Negative

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION (CONTINUED) Part B – Bond Derecognition Instructions Prepare the amortization table and journal entry for the derecognition of the bond and assess the impact on the financial statements’ key metrics. Complete the tables below. a.

Complete the amortization table below up to December 31, 2023. Beginning Cash Interest Value Interest Expense Amortization 31-Dec-21 31-Dec-22 31-Dec-23

$957,876

$50,000

$57,473

$7,473

$965,349

965,349

50,000

57,921

7,921

973,270

50,000

58,396

8,396

981,666

Record the journal entry to reflect the derecognition of the bond.

Bonds Payable 981,666 Cash Gain on Redemption of Bond

Ending Value

950,000 31,666

Determine the impact of the bond reacquisition journal entry on the financial statement key metrics. Use the following words to describe the impact for each metric: positive, negative, no impact, not determinable. EPS Revenue Debt/Equity ROA Reacquisition of bond

Positive

No impact

Positive

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION (CONTINUED) Part C – Share Reacquisition Instructions Complete the tables below. a.

Prepare the journal entry to record the reacquisition of the common shares.

Common Shares Contributed Surplus Retained Earnings Cash

5,040,000 ($24 x 210,000) 545,000 7,015,000 12,600,000 ($60 x 210,000)

Note: Contributed surplus is debited first, with the remaining debit going to retained earnings. ($228 million divided by 9.5 million = $24) b.

Determine the impact of the share reacquisition journal entry on the financial statement key metrics. Use the following words to describe the impact for each metric: positive, negative, no impact, or not determinable. EPS Revenue Debt/Equity ROA

Reacquisition of common shares

Positive

No impact

Negative

Positive

Part D – Dividend Payment Instructions Calculate the dividend per share for the common shareholders. Prepare your calculations below. Total dividend Preferred shares dividend (250,000 x $1) Common shares dividend

$714,500 250,000 464,500

Shares O/S

Dividend per share

9,290,000

9,500,000 - 210,000 9,290,000

Originally O/S Reacquisition Shares O/S

0.05

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MMXXII vii F2

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CHAPTER 16 COMPLEX FINANCIAL INSTRUMENTS Learning Objectives 1. Understand what derivatives are, how they are used to manage risks, and how to account for them. 2. Analyze and account for hybrid/compound instruments from an issuer perspective. 3. Describe and account for share-based compensation. 4. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. 5. Understand how derivatives are used in hedging and explain how to apply hedge accounting standards. 6. Account for share appreciation rights plans and performancetype plans. 7. Understand how options pricing models are used to measure financial instruments. 8. Describe and analyze required fair value disclosures for financial instruments.

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Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

BT Item

1. 2. 3. 4. 5 6.

1,4 1 1,4 1 1 1

C C AP AP AP C

1. 2. 3. 4. 5 6.

1 1 1 1 1 1,4

C AP AP AP AP AP

1. 2. 3.

1 1 1

AP AP AP

1,5

2,3

1. 3,6,7,8 AP

BT Item LO BT Item LO BT Item LO BT Brief Exercises 7. 2 C 13. 2 AP 19. 2,4 C 25. 6 C 8. 2 C 14. 2 AP 20. 3 C 26. 7 C 9. 2,4 C 15. 2 AP 21. 3 C 27. 8 C 10. 2,4 C 16. 2 AP 22. 3 AP 28. 5 C 11. 2,4 AP 17. 2,4 C 23. 4,6 AP 12. 2,4 AP 18. 2,4 C 24. 4,6 AP Exercises 7. 1 AP 13. 2 AP 19. 3 AP 25. 6 AP 8. 1,2,4 AP 14. 2 AP 20. 3 AP 26. 6 AP 9. 2,4 AP 15. 2 AP 21. 4,5 AP 10. 2,4 AP 16. 2 AP 22. 4,5 AP 11. 2 AP 17. 2 AP 23. 4,5 AP 12. 2 AP 18. 3 AP 24. 6 AP Problems 4. 1,4 C 7. 2,4 AP 10. 3 AP 13. 2,3,4,7 C 5. 2,3 AP 8. 2 AP 11. 4,5 AP 6. 1,2,3,4 AP 9. 2 AP 12. 4,5 AP Cases 2. 5 AN 3. 1,4 AP 4 1,4,5 AN Integrated Cases 2. 1,5 AN Research and Analysis 2. 1,5,8 AP 3. 1,5,8 AP

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CLASSIFICATION TABLE Topics

Brief Exercises

Exercises

Problems

1. Understanding derivatives and 1, 2, 3,4,5,6 account for them.

1, 2, 3, 4, 5, 6, 7, 8

1, 2, 3, 4, 6

2. Analyze and account for hybrid/compound instruments

7, 8, 9, 10, 11, 12, 13, 14, 15, 16,17, 18, 19

8, 9, 10, 11, 12, 13, 14, 15, 16, 17

5, 6, 7, 8, 9, 13

3. Share-based compensation

20, 21, 22

18, 19, 20

5, 6, 10, 13

4. Differences between ASPE and IFRS

1, 3,9, 10, 11 12, 17, 18, 19, 23, 24

6, 8, 9, 10, 21, 22, 23

4, 6, 7, 11, 12, 13

21, 22, 23, 28

11, 12

*5. Derivative instruments for hedging and hedge accounting *6. SARS

23, 24, 25

*7. Stock compensation plans and options pricing models *8. Fair value disclosures

24, 25, 26 13

*This material is dealt with in an Appendix to the chapter.

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ASSIGNMENT CLASSIFICATION TABLE (CONTINUED) NOTE: If your students are solving the end-of-chapter material using a financial calculator or an Excel spreadsheet as opposed to the PV tables, please note that there will be a difference in amounts. Excel and financial calculators yield a more precise result as opposed to PV tables. The amounts used for the preparation of journal entries in solutions have been prepared from the results of calculations arrived at using the PV tables unless stated otherwise in the question.

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Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Item E16.1 E16.2 E16.3 E16.4 E16.5 E16.6 E16.7 E16.8 E16.9 E16.10 E16.11 E16.12 E16.13 E16.14 E16.15 E16.16 E16.17 E16.18 E16.19 E16.20 *E16.21 *E16.22 *E16.23 *E16.24 *E16.25 *E16.26 P16.1 P16.2 P16.3 P16.4 P16.5 P16.6 P16.7 P16.8 P16.9 P16.10 *P16.11 *P16.12 *P16.13

Description Derivative transaction Derivative transaction Derivative transaction Derivative transaction Derivative transaction Purchase commitment Derivatives involving the entity’s own shares Various complex financial instruments Issuance and conversion of bonds Conversion of bonds Conversion of bonds Conversion of bonds and expired rights Conversion of bonds Conversion of bonds Conversion of bonds Issuance of bonds with detachable warrants Issuance of bonds with redemption feature Issuance and exercise of stock options Issuance, exercise, and termination of stock options Issuance, exercise, and termination of stock options Cash flow hedge Cash flow hedge Fair value hedge Share appreciation rights Share appreciation rights Share appreciation rights Call option contract – purchased Call option contract – written Put option contract – derivative instrument Derivatives involving entity’s own shares Entries for various financial instruments Loan, CSOP, and forward contract Correction of issuance of bond, calculate yield Issuance of notes with warrants Bonds, warrants, conversion rights Stock option plan Fair value hedge interest rate swap Cash flow hedge – futures contract Black-Scholes model

Level of Time Difficulty (minutes) Simple 10-15 Simple 10-15 Simple 10-15 Simple 10-15 Simple 10-15 Simple 10-15 Simple 10-15 Moderate 20-25 Moderate 20-25 Complex 30-35 Simple 10-20 Simple 10-15 Moderate 20-25 Simple 10-15 Complex 30-40 Simple 10-15 Moderate 25-35 Moderate 10-15 Simple 10-15 Simple

10-15

Moderate Moderate Complex Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Complex Complex Complex

15-20 15-20 20-25 15-25 15-25 25-30 15-20 15-20 15-20 15-20 35-40 30-35 35-40 25-30 30-35 30-35 35-45 40-50 40-50

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 16.1 The main issue that arises for instruments that require settlement in the entity’s own shares is whether the instrument should be presented as equity, a financial liability, or a financial asset. Generally, going back to basic principles is required to determine the appropriate presentation. However, there is some guidance that IFRS has noted in the standard: • “fixed for fixed principle” – where the number of shares and the consideration required to settle the instrument are both fixed, this will be presented as equity. An example of this is a written call option giving the holder the right to buy a fixed number of shares for a fixed amount of consideration with no choice for cash settlement. Purchased put or call options that give the entity the right to sell or buy a fixed number of shares for a fixed amount of consideration is equity, since there is no contractual obligation on the company’s part to pay cash. • An obligation to pay cash (or other assets) is required to be presented as a liability. A written put option where the holder has the right to sell a fixed number of shares to the company, or a forward contract to buy a fixed number of shares for a fixed amount of cash may obligate the entity to pay out cash. These will be recorded as financial liabilities. • A choice in settlement – Anytime there is a choice for cash settlement (or other assets) by either party, the instrument is a financial liability. (Only in cases where all the possible choices resulted in shares being issued would the instrument be recorded as equity.) Under ASPE, if the company can make a choice and avoid settling in cash or other assets, then this instrument would be recorded as equity. Contracts that will be net settled in cash or shares are financial assets or liabilities since either cash or a variable number of shares will be used for settlement. LO 1,4 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance Solutions Manual 16-7 Chapter 16 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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BRIEF EXERCISE 16.2 Saver Rio Ltd. should account for the call option at the cost to acquire it ($500) and record it as Derivatives – Financial Assets/Liabilities. Saver Rio Ltd. is not obligated to exercise the option and buy the shares. The investment would be measured at fair value at the reporting date with a gain or loss, if any, recognized in net income for the difference between the cost and the market value. This call option results in additional counterparty/credit risk (risk that the other party will fail to fulfill their side of the bargain) and liquidity risk (risk that Saver will not be able to come up with the money to exercise the contract if the contract is in the money). If the option was purchased on an exchange, the counterparty risk disappears. In addition, there is still a risk that the options will lose value (price risk). Note that since this is a purchased option, Saver has the right but not the obligation to exercise the option, although it would want to exercise it if the contract was in the money at the exercise date. LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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BRIEF EXERCISE 16.3 (a) This purchase commitment is an executory contract that can be settled on a net basis by paying cash as opposed to taking delivery of the apples. Under IFRS, because Daily Produce Ltd. intends on taking delivery of the apples, the contract is designated as ‘expected use’ and not accounted for as a derivative; rather, the transaction is recognized the day the delivery of the apples takes place. On April 1, 2023, Daily Produce records: Inventory ................................................. Accounts Payable...........................

1,500 1,500

(b) Under ASPE, a purchase commitment is generally accounted for as an unexecuted contract and is not recognized until the underlying non-financial item is delivered. Therefore, Daily Produce Ltd. would not account for the contract as a derivative; rather, the transaction would be recognized the day the delivery of the apples takes place. On April 1, 2023, Daily Produce records: Inventory ................................................. Accounts Payable...........................

1,500 1,500

(c) This contract results in a price risk for Daily Produce since it has locked in a price and the value of the apples may change. The contract fixes the cash flows however, so there is no cash flow risk. It also exposes the entity to a counterparty/credit risk (the risk that the supplier will not be able to fulfill the contract) and a liquidity risk (the risk that Daily Produce will not be able to come up with the funds to pay the supplier). LO 1,4 BT: AP Difficulty: S Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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BRIEF EXERCISE 16.4 (a) January 1, 2023 No journal entry necessary since the fair value of the forward contract would be $0. January 15, 2023 Derivatives – Financial Assets/Liabilities ... Gain or Loss on Derivatives ...........

40 40

(b) This contract results in a price risk (since Ginseng has agreed to pay a fixed price for the $US and the value of the $US may change), credit/counterparty risk (since the other party to the contract may not be able to fulfill its side of the bargain, which is delivering the $US), and liquidity risk (the risk that Ginseng will not be able to come up with the funds to settle its side of the contract, i.e., delivery of $C6,336) Note that the contract eliminates cash flow risk since the entity knows exactly what it will pay for the $US. LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

BRIEF EXERCISE 16.5 January 1, 2023 Derivatives – Deposits.............................. Cash ................................................

30 30

January 15, 2023 Derivatives – Financial Assets/Liabilities Gain or Loss on Derivatives ..........

40 40

LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.6 Wolfgang Ltd. is faced with a presentation issue: should the $1,000 cost of the option be treated as an investment, similar to the cost of an option to purchase the shares of another company? In this transaction, Wolfgang Ltd. has agreed to buy back a fixed number of the company’s own shares for a fixed amount of consideration. IAS 32 states that this type of “fixed for fixed” transaction would be presented as a reduction from shareholders’ equity and not as an investment. This is, effectively, the prospective retirement of shares (or acquisition of treasury shares, if that is permitted). LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 16.7 These bonds are considered to be a perpetual debt obligation. Jamieson is obligated to provide to the holder, payments of interest at fixed dates extending into the indefinite future, and a principal payment for the face value of the bond very far into the future. The bonds would be reported on Jamieson’s statement of financial position at the present value of the annuity of interest payments over the term of the bond, calculated at the market rate of interest (at the date of issue), ignoring the future value of the principal payment. Because the perpetual bond’s value is driven solely by the contractual obligation to pay interest, it would be classified as a long-term debt on the statement of financial position. It would not be remeasured annually unless designated under the fair value option, in which case it would be revalued at fair value and gains/losses booked to net income. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.8 Under the terms of the agreement with the preferred shareholders, it is highly likely that Verhage Limited will redeem the preferred shares before the dividend rate doubles after five years. Failure to do so would result in Verhage paying an extremely high dividend to the preferred shareholders. Verhage has little or no discretion to avoid paying out the cash to redeem the shares before the end of the fifth year and this likely obligation to deliver cash creates a liability. Consequently, the preferred shares should be classified as long-term debt on the statement of financial position. Because the preferred shares are classified as long-term debt on the statement of financial position, the dividends declared and paid to preferred shareholders would be classified as interest expense on the statement of income. It might be desirable to separate the amount of dividends (reported as interest expense) paid on the preferred shares from the interest paid on other debt. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 16.9 Under IFRS, the preferred shares would be recorded as a liability because the contingent settlement provision is based on an event outside the company’s control. However, under ASPE, the preferred shares would be accounted for as a liability only when it is highly likely that the firm’s net income will drop below $500,000 in a future fiscal period. If the triggering event is unlikely, then the preferred shares would be accounted for as equity. LO 2,4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.10 The solution is the same for IFRS and ASPE. When a preferred share provides for mandatory redemption by the issuer for a fixed or determinable amount at a fixed or determinable future date or gives the holder the right to require the issuer to redeem the share at or after a particular date for a fixed or determinable amount, the instrument meets the definition of a financial liability. Consequently, the preferred share should be classified as long-term debt on the statement of financial position. LO 2,4 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 16.11 (a) 1. Using Tables: The PV of the Using Table A.4 PV of an ordinary annuity of the interest payments of $100,000 ($1,000,000 x 10%) for 5 periods of 3.60478 = $360,478 + $1,000,000 X .56743 (table A.2), PV = $567,430). PV annuity 5 years, 12%, $100,000 $ 360,478 PV $1,000,000, in 5 years, 12% 567,430 PV of the debt component by itself $ 927,908 2. Using a financial calculator: PV $ ? Yields $927,904 I 12% N 5 PMT $ (100,000) FV $ (1,000,000) Type 0 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $927,904.476 Rounded $927,904 Solutions Manual 16-14 Chapter 16 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.11 (CONTINUED) (b) Under IFRS, the proceeds are allocated to the liability and equity components under the residual method, with the debt component measured first (generally at the present value of future cash flows). Total proceeds at par

$ 1,000,000

PV of the debt component by itself Incremental value of option

(927,904) $

72,096

Cash ............................................................ 1,000,000 Bonds Payable ...................................... 927,904 Contributed Surplus – Conversion Rights 72,096

(c) Under ASPE, the equity component may be measured at $0 as an accounting policy choice. In this case, the journal entry would be: Cash ............................................................ 1,000,000 Bonds Payable ...................................... 1,000,000 Alternatively, measure the component that is most easily measurable first (often the debt component), and apply the residual to the other component. This option is consistent with the required treatment under IFRS. LO 2,4 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 16.12 (a) Cash (500 X $1,000 X 1.03).................................. 515,000 Bonds Payable ............................................. 485,000 Contributed Surplus— Stock Warrants...... 30,000 Under IFRS, the residual method is applied whereby cash is allocated to the value of the debt instrument first, and the residual is allocated to equity. The debt value is calculated as follows: 500 x $1,000 x 0.97. This assumes that the warrants are accounted for as equity instruments. (b) Under ASPE (3856.20 and .21), one option is to measure the component that is most easily measurable first (often the debt component), and apply the residual to the other component. This option is consistent with the required treatment under IFRS, and the journal entry would be the same as under IFRS. In this case, the warrant is also easily measurable (500 x 10 x $2.50) so the entity could record the transaction as follows: Cash (500 X $1,000 X 1.03).................................. 515,000 Bonds Payable ............................................. 502,500 Contributed Surplus—Stock Warrants....... 12,500 Another option is to measure the equity component at $0 as an accounting policy choice. In this case, the journal entry would be: Cash (500 X $1,000 X 1.03)................................. 515,000 Bonds Payable ............................................

515,000

LO 2,4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.13 Bonds Payable ................................................... Common Shares .........................................

510,000 510,000

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 16.14 Loss on Redemption of Bonds.......................... Contributed Surplus—Conversion Rights ........ Bonds Payable ................................................... Common Shares ......................................... Cash.............................................................

14,000 30,000 489,100 519,100 14,000

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 16.15 Loss on Redemption of Bonds1 ........................ Contributed Surplus—Conversion Rights ........ Bonds Payable ................................................... Retained Earnings .............................................. Cash............................................................. 1 ($492,370-$489,100)

3,270 30,000 489,100 7,630 530,000

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 16.16 Preferred Shares1 ............................................... Contributed Surplus—Conversion Rights ........ Common Shares ......................................... 1 (10,000 x $9) - $9,000

81,000 9,000 90,000

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.17 (a)

A puttable share contains a written put option that requires the company to pay cash or other assets if the option is exercised. The holder has the right to exercise the option, which is beyond the company’s control. For these reasons, puttable shares are normally classified as a liability. However, under IFRS, the shares may be classified as equity if the shares are “in-substance” equity instruments. Because the puttable common shares entitle the holder to a pro rata share of Davison’s net assets upon liquidation, because the shares do not have preferred rank or dividend preference, and because there are no other common shares, Davison’s puttable common shares may be classified as equity under IFRS.

(b) Under ASPE, the criteria for classification of puttable shares as equity are similar to the IFRS criteria. Therefore, under ASPE, Davison’s puttable common shares may also be classified as equity. LO 2,4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.18 (a)

These are mandatorily redeemable preferred shares, which must be classified as a liability under IFRS. The mandatory redemption imposes a contractual obligation to deliver cash or other assets upon redemption, which represents a financial liability.

(b) Under ASPE, mandatorily redeemable preferred shares (also referred to as high/low preferred shares) are required to be classified as equity. (c)

This type of transaction involving preferred shares is labelled an “estate freeze” because the fair value of the business’s assets is frozen at a point in time (by freezing the redemption value of the preferred shares at a value equal to fair value of the business’s assets at the time of transition). The successive owners then purchase common shares in the new corporation at a nominal amount, which allows them to benefit from subsequent increases in the business’s value.

LO 2,4 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

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BRIEF EXERCISE 16.19 (a)

Under IFRS, a liability exists since the contingent settlement provision (based on the fair value of the company’s common shares) is based on an event outside the company’s control. The preferred shares are required to be classified as a liability.

(b) Under ASPE, the preferred shares would be classified as a liability only if the contingency is highly likely to occur. In this case, it is considered unlikely that Parker’s common shares will exceed a fair value of $100 per share, and therefore unlikely that the contingency will occur. The preferred shares would be classified as equity. LO 2,4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.20 Four common stock compensation plans are: 1. Compensatory stock option plans (CSOPs) 2. Direct awards of stock 3. Share appreciation rights plans (SARs) 4. Performance-type plans These different plans are used to compensate employees and especially management. It is generally agreed that effective compensation programs: 1. Motivate employees to high levels of performance. 2. Help retain executives and recruit new talent. 3. Base compensation on employee and company performance. 4. Maximize the employee’s after-tax benefit and minimize the employer’s after-tax cost. 5. Use performance criteria that the employee can influence. LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.21 The main difference between an employee stock option plan (ESOP) and a compensatory stock option plan (CSOP) is that with ESOPs, the employee usually pays for the options (either fully or partially). Thus, ESOP transactions are recognized as capital transactions (charged to equity accounts). The employee is investing in the company. CSOPs, on the other hand, are primarily seen as an alternative way to compensate particular, often senior employees for their services, like a barter transaction. The services are rendered by the employee in support of the act of producing revenues. Thus, CSOP transactions are recognized on the income statement (charged to an expense account). In addition, a company may use options as compensation in a particular purchase or acquisition transaction. It may also choose to issue options simply to raise cash. In such a case, the issue would be recorded as equity. LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 16.22 1/1/23

No entry

12/31/23

Compensation Expense1 ............ Contributed Surplus—Stock Options ............................ 1 [$63,000 = $126,000 X 1/2]

63,000

Compensation Expense ............. Contributed Surplus—Stock Options ............................

63,000

12/31/24

63,000

LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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*BRIEF EXERCISE 16.23 (a)

Under ASPE, a cash-settled plan is measured at intrinsic value. 2023:[3,700 X ($18 – $16)] X 50% = $3,700 2025:[3,700 X ($28 – $16)] – $3,700 = $40,700

(b)

Yes. Under IFRS, a cash-settled plan is measured at the fair value of the SARs plan, which is estimated using an options pricing model and incorporates both intrinsic value and time value.

LO 4,6 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

*BRIEF EXERCISE 16.24 (a) December 31, 2023 Compensation Expense1 ............................ Liability under Share Appreciation Rights Plans ................................ 1 ($150,000 X 50%)

(b) December 31, 2023 Compensation Expense2 ............................ Liability under Share Appreciation Rights Plans ................................ 2

75,000 75,000

50,000 50,000

(($30 – $20) X 10,000) X 50%

LO 4,6 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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*BRIEF EXERCISE 16.25 Performance-type plans award specified executives common shares (or cash) if specified performance criteria are attained during the performance period (generally three to five years). A performance-type plan’s compensation cost is measured by the fair value of shares (or cash) issued on the exercise date. The company must use its best estimates to measure the compensation cost before the date of exercise, and allocate the compensation cost over the performance period using the percentage approach. Under other compensatory plans, options are valued at the date of grant using an options pricing model such as Black-Scholes, and their value is allocated evenly over the period of required service. LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 16.26 Fair value is most readily determined where there is an active market with published prices. Where this is not the case, a valuation technique is used. For options, option pricing models are useful for calculating fair value. The inputs to the model include: 1. The exercise price. This is the price at which the option may be settled. It is agreed upon by both parties to the contract. 2. The expected life of the option. This is the term of the option. It is agreed upon by both parties to the contract. Some options may only be settled at the end of the term (known as European options) while others may be settled at points during the term (known as American options). 3. The current market price of the underlying stock. This is readily available from the stock market. 4. The volatility of the underlying stock. This is the magnitude of future changes in the market price. Volatility looks at how the specific stock price moves relative to the market. 5. The expected dividend during the option life. 6. The risk-free rate of interest for the option life. In general, government bonds carry a return that is considered to be the risk-free return. LO 7 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 16.27 IFRS requires fair value disclosures for financial instruments. Both the cost and the fair value of all financial instruments must be reported in the notes to the financial statements. This information helps financial statement users understand the fair value of the company’s financial instruments and the potential gains and losses that might occur in the future from these instruments. Companies should also disclose any relevant information that helps users determine the degree to which the company used fair values for its instruments and any relevant information used in measuring fair values. The more detailed information is necessary to help the investor assess the reliability of the fair value information, and because changes in the fair values of different financial instruments are reported differently in the financial statements, based on their type and whether the fair value option is employed. To make a distinction among the levels of reliability in valuing financial instruments, the IASB established a fair value hierarchy. Level 1 is the most reliable measurement because fair value is based on quoted prices in active markets for identical assets or liabilities. Level 2 is less reliable since it is based on quoted market prices for similar assets or liabilities. Level 3 is the least reliable as it uses unobservable inputs that reflect the company’s assumption as to the value of the financial instrument. Since it is difficult to reflect these levels of uncertainty in the financial statements, disclosure provides a framework for addressing the qualitative aspects related to risk and measurement. LO 8 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 16.28 Big Data has allowed for the availability of abundant amounts of data related to fuel prices. There are databases available of global fuel prices that outline location, type of fuel, reserve amount, price, etc. This information is actively available at a daily level of granularity. Air Canada and West Jet develop algorithms that assist in predicting future fuel prices. Each company has its own determination of the regression model, and therefore may have a completely different prediction and output of future fuel prices. These models can be combined with other datasets including variables such as weather, production, economic cycles, and even number of COVID-19 cases. Fuel demand fluctuated dramatically during COVID-19, thus impacting prices. One model may show prices increasing, and another may show prices decreasing. The accuracy of the model using Big Data would help each company mitigate its market risk against oil prices. LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 16.1 a.

The put option contract is entered into to protect from a potential loss on an investment. By purchasing the put option for SIT Ltd. shares, RIT Co. can protect itself against the risk of a decrease in the share price. RIT Co. is effectively locking in the share price at $100 per share and therefore its investment cannot fall below $500,000. This is a hedge.

RIT Co. would record an asset of $10,000 on the statement of financial position for the put option. The option is a derivative that will be recorded at FV-NI. When the share price falls, RIT Co. would revalue the put option and recognize a gain (through net income).

The accounting is transparent since the risk of loss in the value of the investment is offset by the potential for gain on the option. There is a hedge. The gains and losses on the investment will be offset by corresponding but opposite gains and losses on the put (through net income if ASPE is followed). Under IFRS, the result would be the same if the company were to use FV-NI accounting for the investment. The company has the option of using FV-OCI for the investment but then might want to use hedge accounting to reflect the hedge. The hedge accounting would allow the gains/losses on the investment to be booked through income. However, hedge accounting is costly and therefore if possible, the company would use FV-NI accounting for the investment right from acquisition.

LO 1 BT: C Difficulty: S Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.2 a.

January 1, 2023 No journal entry necessary since the fair value of the forward contract would be $0.

January 20, 2023

Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives ........... February 6, 2023 Gain or Loss on Derivatives1 ..................... Derivatives – Financial Assets/Liabilities ....................... 1 ($125 – $450) February 28, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives 2 ......... 2 ($360-$125) March 14, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives 3 ......... 3 ($700 – $360)

c. April 1, 2023 4 Cash ............................................................ Derivatives – Financial Assets/Liabilities .............. ………… Gain or Loss on Derivatives .............. 4 3 X ($41,000 – $40,000)

450 450

325 325

235 235

340 340

3,000 700 2,300

LO 1 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.3 a. January 1, 2023 Derivatives – Deposits ................................ Cash .................................................

b. January 20, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives ...........

450

February 6, 2023 Gain or Loss on Derivatives1 ..................... Derivatives – Financial Assets/Liabilities ................................. 1 ($125 – $450) February 28, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives 2 ......... 2 ($360-$125) March 14, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives 3 ......... 3 ($700 – $360)

c. April 1, 2023 4 Cash Derivatives – Financial Assets/Liabilities Gain or Loss on Derivatives Derivatives –Deposits 4 3 X ($41,000 – $40,000) + $65

450

325 325

235 235

340 340

3,065 700 2,300 65

LO 1 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.4 a. January 2, 2023 Derivatives – Financial Assets/Liabilities . Cash .................................................

b. March 31, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives 1 ......... 1 ($17,500 – $500)

500 500

17,000 17,000

The gain increases net income for the period by $17,000.

As no information is provided as to other investments or exposures that Jackson may have, it appears that the company has used the option for speculative purposes. Jackson appears not to be hedging to minimize the risk of a current or future transaction.

This derivative will expose the company to a price risk, as the price of the underlying is a variable that may change the value of the option. In addition, there is a credit/counterparty risk (the risk that the other party to the contract will not honour its side of the contract) and a liquidity risk (the risk that Jackson will not be able to honour its side of the contract). Since this is a purchased option, Jackson has the right but not the obligation to exercise the option. If the option is in the money, Jackson would want to exercise it.

LO 1 BT: AP Difficulty: S Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.5 a. April 1, 2023 Derivatives – Financial Assets/Liabilities . Cash .................................................

b. June 30, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives 1 .......... 1 ($10,000 – $175)

c. July, 1, 2023 2 FV-NI Investments ......................................... Gain or Loss on Derivatives ........................... Cash (700 X $27)....................................... Derivatives–Financial Assets/Liabilities. 2 700 X $38

175 175

9,825 9,825

26,600 2,300 18,900 10,000

d. Recall that the fair value of a call option is based on the intrinsic value and the time value. The option is a six-month option and it was exercised after three months. Because the option was exercised (with three months remaining), Petey would not be able to recover the time value portion of the option’s fair value. LO 1 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.6 a.

Under IFRS, this purchase commitment is an executory contract that can be settled on a net basis by paying cash as opposed to taking delivery of the oranges. However, because Fresh Juice fully intends to take delivery of the oranges, the contract is designated as ‘expected use’ and not accounted for as a derivative; rather, the contract is recognized on the day the delivery of the oranges takes place. Therefore, there are no journal entries required at either January 1 or January 31. A journal entry will be recorded when Fresh Juice actually takes delivery of the oranges.

If Fresh Juice does not intend to take delivery of the oranges, then the executory contract will be viewed as a derivative because it can be settled on a net basis. Therefore, the contract would be recorded at fair value. Because there was no cost to enter into the contract, there would be no initial entry on January 1. However, the contract will be marked to market and will change as the price of oranges change. Therefore, the following journal entry will be made on January 31: Gain or Loss on Derivatives1 ........................ Derivatives–Financial Assets/Liabilities . 1 (10,000 X ($0.50 – $0.49))

100 100

Under ASPE, this purchase commitment contract would not be accounted for as a derivative because this agreement is not exchange traded. Therefore, the contract would be recognized on the day the delivery of oranges takes place.

LO 1,4 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.7 a.

The derivative is considered a fixed-for-fixed derivative in an entity’s own shares as the option stipulates that the entity will purchase (buy back) a fixed number of shares for a fixed amount of consideration. IFRS states that this transaction should be presented as a reduction from shareholders’ equity and not as an investment. This is, effectively, the prospective retirement of shares (or acquisition of treasury shares, if that is permitted). Contributed Surplus – Stock Options ......... Cash ..........................................................

250 250

Because the option allows a choice in how the option will be settled, the instrument is a financial asset or liability (derivative) under IFRS unless all possible settlement options result in it being an equity instrument. In this case, one settlement option is the delivery of cash. Therefore, it will be classified as a financial asset (derivative).

LO 1 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.8

3. 4.

Type of financial instrument Financial derivative – forward contract

Non-financial derivative – exchange- traded futures This is not a financial instrument This is a purchase commitment (and therefore not exchange traded)

Contra equity - this is a purchased call option that is settleable only in the entity’s own equity instruments (fixed for fixed) Non-financial derivative – exchange- traded futures Liability. Increase in redemption amount makes it highly likely company will redeem, and imposes a liability to deliver cash or other assets at the time of redemption.

Timing of recognition When fair value fluctuates. Value at acquisition is $nil. When fuel prices fluctuate. Value at acquisition is $nil.

Measurement

PV of future cash flows

Net income

N/A

As these are not exchange traded and the company intends to take delivery of the steel, these are not recognized in the financial statements under either ASPE or IFRS. When options are purchased and cash is paid.

Not recognized unless onerous

N/A

Cash paid

N/A

Initial margin is similar to a bank account.

Cash deposited on margin

Net income

When shares are issued.

PV of future cash flows

Net income

PV of future cash flows

Gains or Losses Net income

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.8 (CONTINUED) Type of financial instrument Hybrid instrument. Warrants are written call options, and debt is a liability.

Timing of recognition When debt is issued.

Hybrid instrument – conversion option is a written call option and is equity since a fixed number of shares will be issued.

When debt is issued.

10. Liability – these are puttable shares and since the option to put the shares back to the company is beyond the control of the entity, they are liabilities unless certain specific conditions are met.

When instruments are issued.

Measurement IFRS – debt at PV of future cash flows and rest to equity ASPE – may allocate $0 to the warrant or may bifurcate the initial amount between debt and equity allocating the more easily measurable first with the residual to the other component IFRS – debt at PV of future cash flows and rest to equity ASPE– may allocate $0 to the conversion feature or may bifurcate the initial amount between debt and equity allocating the more easily measurable first with the residual to the other component Amount received

Gains or Losses Net income for debt component including interest and gains/losses upon extinguishment

Net income for debt component including interest and gains/losses upon extinguishment

LO 1,2,4 BT: C Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.9 1.

Fair value of bonds without warrants is $285,000 ($300,000 X .95) Cash ($300,000 X 1.04) ....................... 312,000 Bonds Payable ............................ Contributed Surplus—Stock Warrants

285,000 27,000

Under ASPE, the first option is to measure the component that is most easily measurable first (often the debt component), and apply the residual to the other component. The second option is to measure the equity component at $0. The entries under these two approaches are, respectively, as follows: Cash ($10,000,000 X .97) ............................9,700,000 Bonds Payable ............................ 9,300,000 Contributed Surplus— Conversion Rights ................. 400,000 Cash ($10,000,000 X .97) .................... Bonds Payable ............................

9,700,000 9,700,000

Under ASPE, the first option is to measure the component that is most easily measurable first, and apply the residual to the other component. Cash .................................................... 19,600,000 Bonds Payable ............................ 18,400,000 Contributed Surplus—Stock Warrants 1,200,000

Value of bonds plus warrants ($20,000,000 X .98) Value of warrants (200,000 X $6) Value of bonds

$19,600,000 1,200,000 $18,400,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.9 (CONTINUED) 3. (continued) The second option is to measure the equity component at $0. Cash .................................................... 19,600,000 Bonds Payable ............................ 19,600,000 4. a)

IFRS approach: Loss on Redemption of Bonds ....... Bonds Payable ................................. Contributed Surplus— Conversion Rights .......................... Common Shares.......................... Cash .............................................

65,000 9,925,000 270,000 10,195,000 65,000

ASPE approach: Loss on Redemption of Bonds1 ......... 30,000 2 Retained Earnings ............................. 35,000 Bonds Payable .................................... 9,925,000 Contributed Surplus— Conversion Rights ........................ 270,000 Common Shares.......................... 10,195,000 Cash ............................................. 65,000 1 $9,955,000 – ($10,000,000 – $75,000) 2 $65,000 – $30,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.9 (CONTINUED) 5.

Fair value of bonds without warrants ($500,000 X .95)

$475,000

Cash ($500,000 X 1.03) .......................... 515,000 Bonds Payable ............................... Contributed Surplus—Stock Warrants

475,000 40,000

The warrants are equity instruments since they are fixed for fixed. LO 2,4 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.10 a.

Cash1 ...................................................... Bonds Payable ($6,000,000 X .97) . Interest Payable2 ............................ Contributed Surplus— Conversion Rights .................... 2 1

5,970,000 5,820,000 90,000 60,000

($6,000,000 X 9% X 2/12) [($6,000,000 X .98) + $90,000]

Under IFRS, the bond discount is amortized using the effective interest method. Using either a financial calculator or Excel, the effective interest rate on the bonds is calculated as follows:

1. Using a financial calculator: PV I N PMT FV Type 1

$ 5,820,000 ?% 19.66671 $ (270,000) $ (6,000,000) 0

Yields 4.7378 %

(20 6-month periods less two months from April 1 to June 1)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.10 (CONTINUED) 2. Excel formula =RATE(nper,pmt,pv,fv,type)

Result: .0473783 rounded to 4.7378% Interest Payable .................................... Interest Expense .................................... Bonds Payable3 ............................... Cash ($6,000,000 X 9% ÷ 2) ............ 3

90,000 183,827 3,827 270,000

($5,820,000 X 4.7378% X 4/6) – ($6,000,000 X 4.5% X 4/6)

Note: The discount is amortized from the date of acquisition only. Therefore, the discount amortization for the 4 months ended October 1, 2023 is calculated using 4 months of interest at the yield rate and 4 months of cash interest.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.10 (CONTINUED) c.

Bonds Payable ($1,500,000 – $42,563) . 1,457,437 Contributed Surplus— Conversion Rights .......................... 15,000 Common Shares ........................ 1,472,437 Calculations: Discount related to 25% of the bonds ($180,000 X .25) Less discount amortized [($3,827 + ($5,820,000 + $3,827) X 4.7378% – $270,000)] X .25 Unamortized bond discount Actual proceeds when bonds sold Value of bonds only Value of conversion rights Proportion converted Value of rights converted

$45,000

2,437 $42,563 $5,880,000 5,820,000 60,000 _ _25% $15,000

April 1, 2024 1. Using a financial calculator PV I N PMT FV Type

$ ? 4.7378% 18 $ (270,000) $ (6,000,000) 0

Yields $5,829,743

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.10 (CONTINUED) d. (continued) Using Excel, the price of the bond on April 1, 2024 is calculated using formula = PV(rate, nper, pmt, fv, type

Result $5,829,742.948 Rounded $5,829,743

Bonds Payable ($5,829,743 X 25%) ...... 1,457,436 Contributed Surplus— Conversion Rights .......................... 15,000 Common Shares ........................ 1,472,436 Calculations: Value of conversion rights Proportion converted Value of rights converted

60,000 _ _25% $15,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.10 (CONTINUED) d. (continued)

Note: Unless otherwise noted, the pro-rata method is used in the text (since students do not always have financial calculators or computers available to do the calculations especially in exam and test situations). However, Excel provides a more accurate number of the carrying value of the bonds. e.

Under ASPE, there are two options in accounting for hybrid/compound instruments. The first option is to measure the component that is most easily measurable first (often the debt component), and apply the residual to the other component. This option is consistent with the required treatment under IFRS. If Daisy chooses this option, the journal entry to record the issuance of the convertible bonds on June 1, 2023 is the same as in part (a). The second option is to measure the equity component at $0. If Daisy chooses this option, the journal entry to record the issuance of the convertible bonds on June 1, 2023 is: Cash5 ...................................................... 5,970,000 Bonds Payable .............................. 5,880,000 4 Interest Payable ............................ 90,000 4 ($6,000,000 X 9% X 2/12) 5 [($6,000,000 X .98) + $90,000]

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.10 (CONTINUED) f.

The bondholders would only be motivated to convert bonds into common shares if they perceived an increase in the value of their investment, and if they would get common shares with a fair value higher than the fair value of the bonds that were given up in the conversion. The book value of what they gave up at the time of conversion is shown in the entry above as $1,472,436 for 30,000 common shares. This works out to slightly over $49 per share. The common shares are likely trading at an amount higher than $49 by a good margin. There should be an excess over the book value of $49 as the bondholders are giving up a steady cash inflow from the interest income obtained from the bonds in exchange for shares, which might not yield any dividends. This is especially true as continuing to hold the bonds provides a return in the form of interest, yet the option feature locks in the stock appreciation in favour of the holder – so the immediate opportunity for a gain must be considerable.

LO 2,4 BT: AP Difficulty: C Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.11 a.

Bonds Payable ($2,400,000 + $44,500) 2,444,500 Contributed Surplus— Conversion Rights ........................... 22,200 Preferred Shares ............................ 2,466,700

Loss on Redemption of Bonds ............ Bonds Payable ...................................... Contributed Surplus— Conversion Rights ............................ Preferred Shares ........................... Cash ...............................................

9,000 2,444,500 22,200 2,466,700 9,000

The primary advantages of bonds from the perspective of the bondholder are security and steady cash flows from the interest and the return of capital at the maturity date of the bonds. The advantages of preferred shares would be similar to bonds as to the cash flows from dividends received, particularly if the preferred shares are cumulative and the company has a strong history of dividend paying ability. While the bonds have a fixed maturity date, typically the preferred shares do not. The lack of a maturity date or a date at which the preferred shareholder can get the capital investment returned at a fixed amount might be perceived as a disadvantage. This might also be the perception because the issuing company has no plans to redeem the preferred shares, although this perceived disadvantage is alleviated significantly if the preferred shares are actively traded. The conversion from bonds might be precipitated by a rise in interest rates, causing the market value of the bonds to drop, leading to a lower return on investment if sold.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.11 (CONTINUED) c. (continued)

Other considerations might be that the dividend rate on the preferred shares outpaces the return of the bonds. Finally, the tax treatment of the revenue type (interest versus dividends) might be another motive for the conversion by bondholders; the effect of the dividend tax credit can increase the after-tax yield significantly for an individual, and inter-corporate dividends attract no net tax in a corporation. LO 2 BT: AP Difficulty: S Time: 20 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.12 a. Bonds Payable ...................................... 1,340,748 Contributed Surplus— Conversion Rights ........................... 175,000 Common Shares.............................

1,515,748

Premium as of July 31, 2023 for $5,000,000 of bonds Face value of bonds converted Carrying value of bonds converted

$362,990 5,000,000 $5,362,990

$1,250,000 $5,000,000 $1,250,000 $5,000,000

X $5,362,990 = $1,340,748

X $700,000 = $175,000

b. Contributed Surplus— Conversion Rights ........................... Contributed Surplus— Conversion Rights Expired 1 .... 1 ($700,000 – $ 175,000)

525,000 525,000

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.13 a.

Cash........................................................ 10,800,000 Bonds Payable ................................ 8,500,000 Contributed Surplus— Conversion Rights ................... 2,300,000 (To record issuance of $10,000,000 of 8% convertible debentures for $10,800,000. The bonds mature in 20 years, and each $1,000 bond is convertible into 5 common shares)

Bonds Payable (Schedule 1) ................. 2,595,000 Contributed Surplus— Conversion Rights ........................... 690,000 (2,300,000 X 30%) Common Shares ............................ 3,285,000 (To record conversion of 30% of the outstanding 8% convertible debentures after giving effect to the 2-for-1 stock split) Schedule 1 Computation of Carrying Value of Bonds Converted

Discount on bonds payable on January 1, 2023 $1,500,000 Amortization for 2023 ($1,500,000 ÷ 20) $75,000 Amortization for 2025 ($1,500,000 ÷ 20) 75,000 150,000 Discount on bonds payable on January 1, 2025 1,350,000 Bonds converted 30% Unamortized discount on bonds converted 405,000 Face value of bonds converted 3,000,000 Carrying value of bonds converted $2,595,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.13 (CONTINUED) c. Computation of Common Shares Resulting from Conversion Number of shares convertible on January 1, 2023: Number of bonds ($10,000,000 ÷ $1,000) Number of shares for each bond Stock split on January 1, 2025 Number of shares convertible after the stock split % of bonds converted Number of shares issued

10,000 X 5 50,000 X 2 100,000 X 30% 30,000

From the perspective of Hammond Corp., the conversion from bonds to common shares has the following advantages: 1. No obligation (or more flexibility) to pay dividends, as opposed to fixed cash outflows for interest payments, reducing financial risk. 2. No obligation to repay principal at maturity date of bonds. 3. Increased income from reduced interest costs (to be computed on an after-tax basis). 4. Depending on Hammond’s financial structure, the effect of the conversion might be a positive or negative effect on earnings per share. 5. Positive effect on debt to equity ratio.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.13 (CONTINUED) d. (continued) The disadvantages of the conversion to Hammond Corporation include: 1. Dilution of earnings for existing shareholders might make shareholders unhappy; offset at least in part by higher income because less interest is paid. Existing shareholders will conceivably pressure the company not to dilute their ownership (this may actually be unlikely, due to the fact that the conversion feature would have been fully disclosed since the initial issuance of the bonds, and the possibility of conversion would be fully reflected in the price of the shares). 2. Pressure from new shareholders for dividend payout.

Loss on Retirement of Bonds1 .......... Bonds Payable.................................... Contributed Surplus— Conversion Rights .......................... Retained Earnings ............................. Cash ............................................ 1 (3,000 x $870 - $2,595,000)

15,000 2,595,000 690,000 6,000 3,306,000

LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.14 Bonds Payable ...................................... 1,650,000 Contributed Surplus— Conversion Rights ................... 27,000 Common Shares.............................

1,677,000

Discount as of June 30, 2023 for $6,000,000 of bonds $500,000 Face value of all bonds 6,000,000 Carrying value of all bonds $5,500,000 Carrying amount of bonds converted: 1,800,000 $6,000,000

X $5,500,000 = $1,650,000

Carrying amount of rights exercised on conversion: $1,800,000 $6,000,000

X $90,000 = $27,000

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.15 a. 1.

December 31, 2024 Interest Expense .................................... Bonds Payable ($120,000 X 1/20).......... Cash ($6,000,000 X 7% X 6/12) ......

204,000 6,000 210,000

January 1, 2025 Bonds Payable ....................................... 406,400 Contributed Surplus— Conversion Rights1 .................. 8,000 Common Shares............................. 1 [1.04 less 1.02 = .02; 2% X $6 million X 6.667%] Total premium ($6,000,000 X .02) Premium amortized ($120,000 X 2/10) Balance

414,400

$120,000 24,000 $96,000

Bonds converted ($400,000 ÷ $6,000,000) 6.667% Related premium ($96,000 X 6.667%) $6,400 Face value of bonds redeemed 400,000 Carrying value of bonds redeemed $406,400

March 31, 2025 Interest Expense .................................... Bonds Payable ....................................... ($120,000 / 10 X 3/12 X 6.667%) Interest Payable2 ............................ 2 ($400,000 X 7% X 3/12) To accrue interest

6,800 200 7,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.15 (CONTINUED) a. 3. (continued) March 31, 2025 Bonds Payable ...................................... Contributed Surplus— Conversion Rights ............................. Common Shares ............................. To record conversion ............................ 3

406,200 8,000 414,200

Premium as of January 1, 2025 for $400,000 of bonds $6,400 ÷ 8 years remaining X 3/12 Premium as of March 31, 2025 for $400,000 of bonds Face value of bonds converted Carrying value of bonds converted

June 30, 2025 Interest Expense .................................... Bonds Payable4...................................... Interest Payable ($400,000 X 7% X 3/12) Cash6 .......................................

$6,400 (200 ) 6,200 400,000 $406,200

176,800 5,200 7,000 189,000

[Premium to be amortized: ($120,000 X 86.667%) X 1/20 = $5,200, or $83,2005 ÷ 16 (remaining interest and amortization periods) = $5,200] *6Total to be paid: ($5,200,000 X 7% ÷ 2) + $7,000 = $189,000 *5 Original premium 2023 amortization 2024 amortization Jan. 1, 2025 write-off Mar. 31, 2025 amortization Mar. 31, 2025 write-off

$120,000 (12,000) (12,000) (6,400) (200) (6,200) $83,200

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.15 (CONTINUED) b.

Bondholders would be motivated to hold off converting their investment in bonds into common shares to continue to take advantage of the security and steady cash flows from the interest and the return of capital at the maturity date of the bonds. Should the value of the common shares continue to climb higher, the opportunity to convert is still available until the conversion right expires. On the other hand, if the fair value of the common shares declines, the bondholder can continue to hold the bonds to their maturity and receive the face value of the bond, and collect interest payments to maturity. The risk in postponing the conversion lies in the volatility of the fair value of the common shares. If the bondholder does not convert when the common share fair value is high, the bondholder cannot realize a gain on the resale of the shares. Subsequently, if the fair value of the common shares declines, the bondholder will not be able to sell the bond at a substantial gain since the incentive to convert to common shares is now non-existent and the conversion right is worthless.

LO 2 BT: AP Difficulty: C Time: 40 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.16 a.

ASPE allows for two options: 1) to allocate the entire issuance to the debt component; or 2) to use the residual method. Residual method: The residual method under ASPE allows for the first allocation to be to the component that is more easily measurable, in this case, the equity component:

September 1, 2023 Cash ($5,304,000 + $117,000) ........................ 5,421,000 Bonds Payable1....................................... 5,252,000 1 Contributed Surplus—Stock Warrants 52,000 2 Interest Payable ..................................... 117,000 To record the issuance of the bonds 1

Schedule 1 Premium on Bonds Payable and Value of Stock Warrants Sales price (5,200 X $1,000 X 1.02) $5,304,000 Deduct value assigned to stock warrants (5,200 X 2 X $5) 52,000 Bonds payable $5,252,000 2

Schedule 2 Accrued Bond Interest to Date of Sale Face value of bonds Interest rate Annual interest

$5,200,000 9% $ 468,000

Accrued interest for 3 months – ($468,000 X 3/12)

$ 117,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.16 (CONTINUED) a. (continued) Allocation of zero to equity A second option is available under ASPE whereby the entire issuance is allocated to the debt.

September 1, 2023 Cash ($5,304,000 + $117,000) ........................ 5,421,000 Bonds Payable ........................................ 5,304,000 3 Interest Payable ..................................... 117,000 3

Schedule 1 Accrued Bond Interest to Date of Sale Face value of bonds Interest rate Annual interest Accrued interest for 3 months – ($468,000 X 3/12) b.

$5,200,000 9% $ 468,000 $

117,000

A lower debt to total assets ratio indicates better debt-paying ability and long-run solvency. Allocating the entire issuance to the debt component (and therefore zero to equity) results in a higher debt to total assets ratio compared to using the residual method. The creditor may also analyze that the underlying financial instrument is the same under each option, and that the company’s accounting choice is affecting this calculated ratio.

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.17 a.

Under ASPE, financial liabilities that are indexed to an entity’s performance are measured at the higher of the amortized cost and the amount owing at the SFP date given the feature. Therefore, the journal entry upon issuance is recorded at the issue amount. Cash ($1,000 x 100 x 1.03)....................... Bonds Payable................................

103,000 103,000

The bond amortized carrying amount should be compared to the potential cash outflow under the indexing feature to determine its year-end carrying amount.

Dec. 31, 2023

Amortized cost $102,400 ($103,000 – $6001)

Indexed feature

Higher of two options $102,400

$75,000 ($250 x 3 x 100)

Dec. 31, 2024

$101,800 ($102,400 – $600)

$105,000 ($350 x 3 x 100)

$105,000

Dec. 31, 2025

$101,200 ($101,800 – $600)

$135,000 ($450 x 3 x 100)

$120,0002

The amortization of the premium is calculated as follows: Bond Premium: $3,000 Years to Maturity: 5 Amortization per year: $600 2

Although the indexed feature calculates a redemption feature at $135,000, the bond agreement states that the bonds cannot be redeemed for more than $1,200 per bond. LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.18 a. 1/2/23

No entry (total compensation cost is $550,000)

12/31/23 Compensation Expense ....................... 275,000 Contributed Surplus—Stock Options 275,000 To record compensation expense for 2023 (1/2 X $550,000) 4/1/24

Contributed Surplus—Stock Options 21,389 Compensation Expense ................ 21,389 ($275,000 X 3,500/45,000) To record termination of stock options held by resigned employees

12/31/24 Compensation Expense ....................... 253,611 Contributed Surplus—Stock Options 253,611 To record compensation expense for 2025 (1/2 X $550,000) – $21,389 1/3/25

Cash (31,500 X $42) .......................... 1,323,000 Contributed Surplus—Stock Options . 385,000 ($550,000 X 31,500/45,000 or $507,222 X 31,500/41,500) Common Shares ........................ 1,708,000 To record issuance of 31,500 shares upon exercise of options at option price of $42

(Note to instructor: The fair value of the shares has no relevance in this entry or the following one.)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.18 (CONTINUED) a. (continued) 5/1/25

Cash (10,000 X $42) ................................ 420,000 Contributed Surplus—Stock Options ... 122,222 ($550,000 X 10,000/45,000 or $507,222 X 10,000/41,500) Common Shares .............................. 542,222 To record issuance of 10,000 shares upon exercise of remaining options at option price of $42

The pricing model may not take into account forfeitures because they cannot be reasonably estimated. The objective of offering stock options is to attract, motivate, and remunerate selected individuals in the organization. Including a reduction of the expected expenditure by an arbitrary amount of forfeitures is contrary to the goal and does not reflect management’s intention. Had forfeitures been included in the estimate at the time of the grant of the options, the total compensation expense would be proportionately reduced, based on management’s best estimate.

With an employee stock option plan (ESOP), the employee usually pays for the options (either fully or partially) and there may be a very large number of participants across the company. Thus, ESOP transactions are recognized as capital transactions (charged to equity accounts). The employee is investing in the company.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.18 (CONTINUED) c. (continued) A compensatory stock option plan (CSOP), on the other hand, is primarily seen as an alternative way to compensate particular, often senior employees for their services, like a barter transaction. The services are rendered by the employees in the act of producing revenues. Thus, CSOP transactions are recognized on the income statement (charged to an expense account). LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.19 a. 1/1/23 No entry 12/31/23 Compensation Expense .................. 840,000 Contributed Surplus— Stock Options ...................... ($1,680,000 X 1/2) 12/31/24 Compensation Expense .................. 840,000 Contributed Surplus— Stock Options ....................... 5/1/25

Cash (12,000 X $30) ......................... 360,000 Contributed Surplus— Stock Options1............................... 504,000 Common Shares ....................... 1 ($1,680,000 X 12,000/40,000)

840,000

864,000

12/31/26 Contributed Surplus— Stock Options ................................ 1,176,000 Contributed Surplus – Expired Stock Options2 ......... 1,176,000 2 ($1,680,000 – $504,000) b.

The market price of the Waldorf shares at the date of grant would likely be lower than the exercise price. The objective of issuing the stock options is principally to motivate employees to work at enhancing the market value of the company’s shares. The options have a service period, typically of more than one year. Consequently, the company would want to allow for an upward movement in the share price to justify the remuneration of key employees whose work would have led to the increase in the market value of the shares. If the market value of the shares at the date of grant was at or greater than the exercise price, the incentive would be substantially removed, and so the plan would be less effective.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.19 (CONTINUED) c.

The market price of the Waldorf shares at May 1, 2025 of $34 is not used in recording the exercise of the stock options. From an accounting perspective, the market price is not relevant. It is nonetheless relevant to the executives in making their decision to exercise their stock options. The market price is mentioned to indicate that the timing of the exercise is justified, or at least makes sense. The market price of the shares exceeds the cash paid. Executives exercising a stock option would have paid $30 and could resell the shares immediately for $34, for a gain of $4 per share.

During 2026 the market price of the shares likely fell below $30 per share. This would explain why no additional stock options were exercised, and were left to lapse, as there was no benefit to be gained by the executives in exercising them. They could not recover the cash required to exercise the stock option through the resale of the shares if the stock price was below the exercise price of $30 per share.

The executives holding the stock options might delay the exercise of the options to postpone the requirement of obtaining the necessary cash to exercise the option. Often executives must sell the shares obtained on the exercise of stock options to pay off bank loans secured to obtain the necessary cash required. Proceeds from the sale of the shares are also used for the payment of the personal income tax that is assessed on the income for tax purposes realized on the sale of the shares obtained through the exercise of stock options. The risk involved in delaying the exercise of the options is that the market price of the common shares may decline, making the options worthless.

LO 3 BT: AP Difficulty: S Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 16.20 a.

January 1, 2023 No entry

December 31, 2023 Compensation Expense .................. Contributed Surplus— Stock Options ..................... (2,500 X $8 X 1/4)

January 1, 2028 Cash (2,000 X $36) ........................... Contributed Surplus— Stock Options1............................... Common Shares ..................... 1 (2,500 X $8 X 2,000 / 2,500)

December 31, 2030 Contributed Surplus— Stock Options 2.............................. Contributed Surplus – Expired Stock Options .......... 2 (2,500 X $8 X 500 / 2,500)

5,000 5,000

72,000 16,000 88,000

4,000 4,000

LO 3 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.21 a. Step Action

Answer

Identify the hedged item.

Identify the hedging item.

The hedged item is the risk of cash flow uncertainty from the variable interest note. The hedging item is the interest rate swap.

Identify how the hedged item is being accounted for without hedge accounting.

Under ASPE, the note is recognized at amortized cost, with interest payments accrued as interest expense.

Identify how the hedging item is accounted for without hedge accounting. Locate where the recognized gains and losses for the hedged and hedging items are recognized (net income, OCI, or perhaps not at all).

The changes in the fair value of the swap are not recognized under ASPE.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.21 (CONTINUED) b. June 30, 2023 Note Interest paid $ 100,000 Cash received on swap Interest expense $ 100,000 1 [(5.7 % + 1%) X 6/12] 2 [(5.7 % + 1%) – 6%] X $100,000 X 6/12 December 31, 2023 Interest paid Cash received on swap Interest expense 3 4

Rate 3.35%1

Amount $ 3,350 (350)2 $ 3,000

Note $ 100,000

Rate 3.85%3

$ 100,000

Amount $ 3,850 (850)4 $3,000

[(6.7 % + 1%) X 6/12] [(6.7 % + 1%) – 6%] X $100,000 X 6/12

c. June 30, 2023 Interest Expense ......................................... Cash ...................................................... To record payment of interest Cash ............................................................. Interest Expense .................................. To record cash received on swap December 31, 2023 Interest Expense ......................................... Cash ...................................................... To record payment of interest Cash ........................................................ Interest Expense .................................. To record cash received on swap

3,350 3,350

350 350

3,850 3,850

850 850

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.21 (CONTINUED) d.

The interest rate swap is a cash flow hedge because the hedge is entered into to protect Thompson against variations in future cash flows caused by the changes in the prime interest rate. At the time of entering into the contract, Thompson had not yet incurred the interest charges for the note. The cash flows are therefore related to future interest payments. Consequently, the hedge cannot be a fair value hedge.

Under IFRS, the journal entries related to interest would be identical to those under ASPE as recorded as in part (c). In addition, the gain in the swap must be recorded in Other Comprehensive Income.

December 31, 2023 Derivatives – Financial Assets/Liabilities .............. 25,000 Gain or Loss on Derivatives ........................... 25,000 To increase the value of the contract Gain or Loss on Derivatives ................................... 25,000 Unrealized Gain or Loss - OCI ........................ 25,000 To record the “fix” under hedge accounting LO 4,5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.22 a. Step Action

Answer The hedged item is the risk of cash flow uncertainty from the note due to changes in the LIBOR rate of interest. The hedging item is the interest rate swap.

Identify the hedged item.

Identify the hedging item.

Under ASPE, the note is recognized Identify how the hedged at amortized cost, with interest item is being accounted for payments accrued as interest without hedge accounting. expense.

The swap is not recognized under Identify how the hedging ASPE; any interest received from the item is accounted for swap is accrued as a credit to without hedge accounting. interest expense.

Locate where the The changes in the fair value of the recognized gains and swap are not recognized under losses for the hedged and ASPE. Under IFRS, the swap is hedging items are recognized and revalued to fair recognized (net income, value at each reporting date with OCI, or perhaps not at all). gains/losses recognized in OCI.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.22 (CONTINUED) b. December 31, 2023 Note Interest paid $ 10,000,000 Cash paid on swap Interest expense $ 10,000,000 1 (6% – 5.8%) X $10,000,000 December 31, 2024 Note Interest paid $ 10,000,000 Cash received on swap Interest expense $ 10,000,000 2 (6.6% – 6%) X $10,000,000 c. December 31, 2023 Interest Expense ......................................... Cash .................................................... To record payment of interest Interest Expense ......................................... Cash .................................................... To record payment on swap December 31, 2024 Interest Expense ......................................... Cash .................................................... To record payment of interest Cash ............................................................. Interest Expense ................................ To record cash received on swap

Rate 5.8% 6%

Rate 6.6% 6%

Amount $ 580,000 20,0001 $ 600,000

Amount $ 660,000 (60,000)2 $ 600,000

580,000 580,000

20,000 20,000

660,000 660,000

60,000 60,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.22 (CONTINUED) d.

The interest rate swap is a cash flow hedge because the hedge was entered into to protect Yellowknife against variations in future cash flows caused by the changes in the LIBOR rate of interest. At the time of entering into the contract, Yellowknife had not yet incurred the interest charges for the note. The cash flows are therefore related to future interest payments. Consequently, the hedge cannot be a fair value hedge.

If the company follows hedge accounting under IFRS, the swap would be recognized, remeasured to fair value at each reporting date, and any gains and losses in fair value would be booked to OCI. As the interest cash flows actually occur, the gains/losses in OCI are transferred to net income.

In addition to the journal entries in part c. above, the gains and losses that result from the changes in the fair value of the swap must be recorded.

December 31, 2023 Gain or Loss on Derivatives ................................... 13,500 Derivatives – Financial Assets/Liabilities ...... 13,500 To decrease the value of the contract Unrealized Gain or Loss - OCI ................................ 13,500 Gain or Loss on Derivatives .......................... 13,500 To record the “fix” under hedge accounting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.22 (CONTINUED) f. (continued) December 31, 2025 Derivatives – Financial Assets/Liabilities .............. Gain or Loss on Derivatives ........................... To increase the value of the contract Gain or Loss on Derivatives ................................... Unrealized Gain or Loss - OCI ........................ To record the “fix” under hedge accounting

4,000 4,000

LO 4,5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.23 a. Step Action

Answer

Identify the hedged item.

The hedged item is the risk that the fair value of the fixed rate bond payable will increase due to declining interest rates.

Identify the hedging item.

The hedging item is the swap to receive a fixed rate and pay a variable rate of interest.

Identify how the hedged item is being accounted for without hedge accounting.

The note is recognized at amortized cost, with interest payments accrued as interest expense.

Identify how the hedging item is accounted for without hedge accounting.

The swap is a derivative that is recognized as FV-NI.

Locate where the recognized gains and losses for the hedged and hedging items are recognized (net income, OCI, or perhaps not at all).

The liability is revalued to fair value with gains and losses booked through income to offset the gains and losses recognized on the swap.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.23 (CONTINUED)

b. December 31, 2023 1 Interest Expense ........................................ Cash ...................................................... 1 ($1,000,000 X 7.5%)

75,000 75,000

c. December 31, 2023 Cash ............................................................ Interest Expense ..................................

13,000

d. December 31, 2023 Derivatives – Financial Assets/Liabilities . Gain or Loss on Derivatives ................

48,000

e. December 31, 2023 Unrealized Gain or Loss ............................ Bonds Payable ......................................

48,000

13,000

48,000

This is a fair value hedge because it relates to the risk that the fair value of the bond is increasing due to declining interest rates. Under IFRS fair value hedge accounting, the liability would be revalued to fair value with gains/losses being booked through income so that they offset the gains/losses on the swap. Fair value hedge accounting can be applied to this hedge because the exposure is from a recognized liability (the fixedrate bond payable). The company is concerned that interest rates will decline and therefore the bond will become onerous (fair value will increase).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.23 (CONTINUED) g.

Under ASPE, the first two entries would be recorded but the bond would not be revalued and the swap would not be recognized (nor remeasured).

LO 4,5 BT: AP Difficulty: C Time: 25 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.24 a. PreNumber Total Fair estab. Diffeof CompenValue Price rence Rights sation

2023 2024 2025 2026 2027

$36 $32 40 32 45 32 36 32 48 32

$4 8 13 4 16

Accrual Entry

Balance of Liability

40,000 $160,000 $40,000 $40,000 25% 40,000 320,000 120,000 160,000 50% 40,000 520,000 230,000 390,000 75% 40,000 160,000 (230,000) 160,000 100% 40,000 640,000 480,000 640,000

b. December 31, 2023 Compensation Expense ..................................... 40,000 Liability under Share Appreciation Rights Plans 40,000 December 31, 2026 Liability under Share Appreciation Rights Plans 230,000 Compensation Expense ............................. 230,000 December 31, 2027 Compensation Expense ..................................... 480,000 Liability under Share Appreciation Rights Plans 480,000

c. June 1, 2028 Liability under Share Appreciation Rights Plans 320,000 Cash [20,000 X ($46 – $32)] .......................... 280,000 Compensation Expense ………………………… 40,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.24 (CONTINUED) d.

If Barrett applies IFRS, the procedure is almost identical to the steps taken in part (a). The only difference is that the column headed up “Total Compensation” in the table would not be calculated at the intrinsic value of the SARs outstanding. Instead, this column would be completed by inserting the fair value of the SARs determined using an option pricing model. The procedure of how the total is applied to expense each year is the same as under ASPE.

Under ASPE, SARs plans are recognized at their intrinsic value at each financial statement date, and compensation expense is affected by the fair value of the company’s shares at each financial statement date. The fair value of the company’s shares may change due to events that were beyond the control or influence of the executive employee in the SARs program, and Barrett’s compensation expense may or may not reflect the value of the services provided by Murfitt in the year. As well, if the fair value of the company’s shares fluctuate significantly, compensation expense may also fluctuate significantly, and calculated profit may not be an accurate reflection of the company’s performance in the year. An investor should carefully consider the effects of the SARs program when analyzing Barrett’s profit.

LO 6 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.25 a.

Schedule of Compensation Expense - Share Appreciation Rights (200,000)

Date

12/31/24

Cumulative Compensation Recognizable

Percentage Accrued

$ 780,000

25%

12/31/25

50%

12/31/26

1,850,000

75%

12/31/27

1,400,000

100%

Compensation Accrued to Date

$ 195,000 (195,000) 0

Expense 2024

Expense 2025

Expense 2026

Expense 2027

195,000 (195,000)

1,387,500 12,500 $1,400,000

1,387,500 12,500

Compensation Expense .......................................................... Liability under Share Appreciation Rights Plans ..........

12,500

Liability under Share Appreciation Rights Plans .................. Cash [200,000 X ($19 – $12)] ...........................................

1,400,000

12,500

1,400,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.25 (CONTINUED) d.

The Schedule of Compensation Expense under ASPE is as follows. Cumulative Compensation Recognizable

Percentage Accrued

Fair Value

Preestablished Price

12/31/24

$15

$12

$ 600,000

25%

12/31/25

50%

12/31/26

1,800,000

75%

Date

12/31/27

1,400,000

100%

Compensation Accrued to Date

Expense 2024

Expense 2025

Expense 2026

Expense 2027

$ 150,000 150,000 (150,000) 0 1,350,000 50,000 $1,400,000

(150,000)

1,350,000 50,000

Compensation expense for 2025 reflects a drop in the fair value of the shares, but it does not reflect the drop in fair value of the shares to below the pre-established price of $12 per share. On December 31, 2025, a debit of $150,000 to Liability Under Share Appreciation Rights Plans and a credit of $150,000 to Compensation Expense would be recorded, resulting in a zero balance in Liability Under Share Appreciation Rights Plans. If fair value of the shares drops below the pre-established price of $12, the SARs are out-of-the-money and would not be exercised by the officers in the program. Thus, compensation expense should not reflect a drop in fair value of the shares to below the pre-established price of $12 per share. LO 6 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.26 a. Schedule of Compensation Expense - Share Appreciation Rights (50,000) Cumulative Pre-estaCompenPercenblished sation tage Price Recognizable Accrued

Date

Fair Value

12/31/23

$36

$32

$200,000

25%

12/31/24

350,000

50%

12/31/25

650,000

75%

12/31/26

200,000

100%

12/31/27

800,000

—

Compensation Accrued to Date

Expense 2023

Expense 2024

$50,000 $50,000 125,000 $125,000 175,000 312,500 487,500 (287,500) 200,000 600,000 $800,000

Expense 2025

Expense 2027

$312,500 $(287,500) $600,000

b. 2023 Compensation Expense .................................................................... Liability under Share Appreciation Rights Plans .....................

50,000

2026 Liability under Share Appreciation Rights Plans ............................ Compensation Expense .............................................................

287,500

2027 Compensation Expense .................................................................... Liability under Share Appreciation Rights Plans .....................

600,000

Expense 2026

50,000

287,500

600,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 16.26 (CONTINUED) c.

From the perspective of the employee, the characteristics of the SAR and the stock option are very different. Although both provide a form of compensation based on the increase in the fair value of the shares of the employer, the differences in the features are important to the employee. In the case of the exercise of stock options, the employee must provide cash and the options to obtain shares in the company. In order to recover the cash, the shares obtained from the stock option need to be sold. On the other hand, the employee need not pay any cash to the company in exercising a SAR. The latter seems more attractive on this basis alone.

Performance-type compensation plans award the executives common shares (or cash) if specified performance criteria are attained during the performance period (generally three to five years). An example of a performance-type plan is the award of cash if the return on assets or equity increases to meet a certain threshold. Other targets include growth in sales, growth in earnings per share (EPS), or a combination of these factors.

LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS Problem 16.1 Purpose—the student calculates and records the purchase and the transactions concerning a call option contract for shares over two accounting periods and also records the ultimate settlement of the call option.

Problem 16.2 Purpose—the student calculates and records the writing of a call option contract for shares over two accounting periods and also records the ultimate settlement of the call option.

Problem 16.3 Purpose—the student calculates and records the purchase and the adjustments concerning a put option contract for shares over two accounting periods and also records the ultimate write-off of the put option as the market value never falls below the strike price.

Problem 16.4 Purpose—the student analyzes a derivative that involves an entity’s own shares, and provides the alternative accounting treatment under ASPE and IFRS.

Problem 16.5 Purpose—to provide the student with an opportunity to prepare entries to properly account for a series of transactions involving the issuance and exercise of common stock rights and detachable stock warrants, plus the granting and exercise of stock options. The student is required to prepare the necessary journal entries to record these transactions and the shareholders’ equity section of the statement of financial position as at the end of the year.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 16.6 Purpose—to provide the student with an opportunity to analyze three separate financial instruments: 1) a financial liability (loan); 2) a compensatory stock option plan; and 3) a forward contract.

Problem 16.7 Purpose—to provide the student with the opportunity to experience a situation in which the initial recording of a convertible bond was incorrectly done in a prior year. Based on the incorrect treatment, the student must revise the accounting of the issuance of the convertible bond, and prepare a correcting entry after calculating the appropriate yield to apply to the calculation of the bond using the effective interest method. Finally, commentary on the effect of the correction on the debtto-equity ratio is required in the problem.

Problem 16.8 Purpose—to provide the journal entry of the issuance of a note payable sold together with a warrant. The incremental method applies in this case. The student must then prepare the related amortization table for the note and some adjusting journal entries.

Problem 16.9 Purpose—to provide the student with an opportunity to record the issuance of bonds with detachable warrants and conversion rights. Underwriting fees incurred in the issuance of the bonds are also recorded in the problem. The student must calculate the effective yield rate for the bonds, prepare an amortization table, and prepare journal entries for the issuance, conversion, and exercise of warrants. Finally, some analysis concerning the likely value of the shares issued in the conversion is discussed.

Problem 16.10 Purpose—to provide the student with an understanding of the entries to properly account for a stock option plan over a period of years. The student is required to prepare the journal entries when the stock option plan was adopted, when the options were granted, when the options were exercised, and when the options expired. Solutions Manual 16-82 Chapter 16 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) *Problem 16.11 Purpose—the student calculates and records the transactions concerning a fair value hedge interest rate swap, over two accounting periods, and also provides partial statement of financial position and statement of income disclosure at three points in time over the term of the swap.

*Problem 16.12 Purpose—the student calculates and records the transactions concerning a cash flow hedge concerning the purchase of gold, over two accounting periods, and also provides partial statement of financial position and statement of income disclosure at two points in time over the term of the futures contract.

*Problem 16.13 Purpose—the student explains why certain complex financial instruments require the use of the Black-Scholes model in measuring their fair values. The student discusses how these instruments are initially recorded and subsequently measured under IFRS and ASPE.

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SOLUTIONS TO PROBLEMS PROBLEM 16.1 a. July 7, 2023 Derivatives – Financial Assets/Liabilities ....... Cash ......................................................

b. September 30, 2023 Derivatives – Financial Assets/Liabilities ....... Gain or Loss on Derivatives1 .................. 1 ($1,780 – $480) c. December 31, 2023 Gain or Loss on Derivatives2 ............................. Derivatives–Financial Assets/Liabilities ...... 2 ($1,780 – $965) d. January 4, 2025 Cash [ 240 X ($85 – $80)] ................................... Gain or Loss on Derivatives ......................... Derivatives – Financial Assets/Liabilities ...... July 7, 2023 Sept. 30, 2023 Dec. 31, 2023 Balance

480 480

1,300 1,300

815 815

1,200 235 965

$ 480 1,300 (815) $965

The option is “in the money” at the exercise date since Hing Wa (the option holder) can purchase the shares for $80 when they are worth $85. LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 16.2 a. July 7, 2023 Cash .................................................................... Derivatives – Financial Assets/Liabilities .......

480

b. September 30, 2023 Gain or Loss on Derivatives ($1,780 – $480) ....... Derivatives – Financial Assets/Liabilities .......

1,300

c. December 31, 2023 Derivatives – Financial Assets/Liabilities .............. Gain or Loss on Derivatives ($1,780 – $965)

815

d. January 4, 2025 Derivatives – Financial Assets/Liabilities .............. Gain or Loss on Derivatives ................................ Cash [240 x ($85 – $80)] ...............................

965 235

July 7, 2023 Sept. 30, 2023 Dec. 31, 2023 Balance

480

1,300

815

1,200

$ 480 1,300 (815) $ 965

The option is “in the money” (for the holder) at the exercise date since the holder of the option can purchase the shares for $80 when they are worth $85. Hing Wa loses because they must sell the shares at a price below the current market value. LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.3 a.

July 7, 2023

Derivatives – Financial Assets/Liabilities ............. Cash ............................................................

480

September 30, 2023

Gain or Loss on Derivatives ($480 – $250) ......... Derivatives – Financial Assets/Liabilities ......

480

230 230

December 31, 2023

Gain or Loss on Derivatives ($250 – $100) ......... Derivatives – Financial Assets/Liabilities ......

150 150

d. January 31, 2024 Put option is not exercised as the market price of Mykia shares exceeds $50, the strike price. Gain or Loss on Derivatives ................................ 100 Derivatives – Financial Assets/Liabilities ......

July 7, 2023 Sept. 30, 2023 Dec. 31, 2023 Balance

100

$ 480 (230) (150) $ 100

LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.4 a.

The derivative is considered a fixed-for-fixed derivative in an entity’s own shares as the option stipulates that the entity will issue a fixed number of shares for a fixed amount of consideration. IFRS states that this transaction would be presented as a reduction from shareholders’ equity and not as an investment. This is, effectively, the prospective retirement of shares (or acquisition of treasury shares, if that is permitted). Contributed Surplus—Stock Options .... Cash ........................................

750 750

Because the option allows a choice in how the option will be settled, the instrument is a financial asset/liability (derivative) by default under IFRS unless all possible settlement options result in it being an equity instrument. If this call option contract allows both parties a choice to settle the option by either exchanging the shares or settling on a net basis, one settlement option is the delivery of cash, and the call option will be classified as a derivative.

ASPE is silent about the accounting for derivatives involving the entity’s own shares; however, the treatment of similar items would support presenting the option as a contra equity item because it clearly does not meet the definition of an asset. Therefore, the conclusion will not change.

LO 1,4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 16.5 a.

1. Memorandum entry made to indicate the number of rights issued including full details as to characteristics.

2. Cash .................................................. Bonds Payable ($200,000 x 0.96) Contributed Surplus— Stock Warrants .................. *

200,000

3. Cash 1................................................. Common Shares .......................

288,000

192,000 8,000

288,000

[(100,000 – 10,000) rights exercised] ÷ *[(10 rights/share) X $32 = $288,000 1

4. Contributed Surplus—Stock Warrants ..... 6,400 ($8,000 X 80%) Cash2 ....................................................... 48,000 Common Shares ............................

54,400

.80 X $200,000/$100 per bond = 1,600 *warrants exercised; 1,600 X $30 = $48,000 5. Compensation Expense3 ....................... Contributed Surplus – Stock Options .......................... 3 $10 X 5,000 options = $50,000

50,000 50,000

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PROBLEM 16.5 (CONTINUED) a. (continued) 6. For options exercised: Cash (4,000 X $30).................................. 120,000 Contributed Surplus—Stock Options ....... 40,000 (80% X $50,000) Common Shares ............................

160,000

For options lapsed: Contributed Surplus—Stock Options ....... 10,000 Compensation Expense4 ................

10,000

(Note to instructor: This entry provides an opportunity to indicate that a credit to Compensation Expense occurs when the employee fails to fulfill an obligation, such as remaining in the employ of the company, performing certain job functions, etc. However, if a stock option lapses because the share price is lower than the exercise price, then a credit to Contributed Surplus—Expired Stock Options occurs.) b. Shareholders’ Equity: Share Capital: Common Shares, authorized 1,000,000 shares, 314,600 shares issued and outstanding Contributed Surplus—Stock Warrants5 Retained Earnings Total Shareholders’ Equity 5 $8,000 – $6,400

$4,102,400 1,600 $4,104,000 750,000 $4,854,000

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PROBLEM 16.5 (CONTINUED) b. (continued) Calculations: Common Shares Number Amount At beginning of year From stock rights (entry #3 above) From stock warrants (entry #4 above) From stock options (entry #6 above) Total

300,000 9,000 1,600 4,000 314,600

$3,600,000 288,000 54,400 160,000 $4,102,400

Expiration of stock options does not make it incorrect to have recorded compensation expense related to the expired stock options, during the service period. The right to exercise the stock options was earned by the executive during the service period, and the company benefited from the executive’s services during the service period. Therefore, compensation expense was properly recorded in the service period (and need not be reversed in the event of expiration of the stock options). The accounting treatment resulted in recording of compensation expense in the year that related revenue was earned. If the executive had fulfilled the employment contract and the stock options expired, the following journal entry would be recorded for the expiration. Contributed Surplus— Stock Options .................................. Contributed Surplus – Expired Stock Options .............

10,000 10,000

LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.6 a.

Financial Instrument #1 This is a hybrid financial instrument. Under ASPE, the company can allocate the proceeds between the liability and the equity portion, or allocate 100% to the liability, as is required in this case. Under IFRS, the company must always measure the debt component first (generally at the present value of the cash flows), and assign the rest of the value to equity since it is a residual item. ASPE IFRS Debit Credit Debit Credit 5,000,000 5,000,000 5,000,000 4,567,072

Cash Notes Payable Contributed Surplus - Conversion Rights 432,928 To record issue of convertible debt 1. Using Tables: $5,000,000 X .78353 (table A.2) + $150,000 x 4.32948 (Table A.4) = $4,567,072. Interest Expense 150,000 228,354 Notes Payable 78,354 Interest Payable 150,000 150,000 To record interest expense for year $4,567,072 x 5% = $228,354 2. Using a financial calculator: PV $? I 5% N 5 PMT $ (150,000) FV $ (5,000,000) Type 0

Yields $4,567,052

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.6 (CONTINUED) a. (continued) 3. Using Excel formula =PV(rate,nper,pmt,fv,type)

Result: $4,567,052.333 Rounded $4,567,052

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.6 (CONTINUED) a. (continued) Financial Instrument #2: This is a compensatory stock option plan. The entries are the same under ASPE and IFRS. ASPE IFRS Debit Credit Debit Credit 550,000 550,000 550,000 550,000

Compensation Expense Contributed Surplus – Stock Options To record annual compensation expense related to CSOP Cash 250,000 250,000 Contributed Surplus – 55,000 55,000 1 Stock Options Common Shares 305,000 305,000 To record one employee exercising options and purchasing shares 1

$550,000 X 1/10

Financial Instrument #3: This is a forward contract. The entries are the same under ASPE and IFRS. No entry would be recorded when the contract was first entered into. The gain on December 31, 2023 is $0.01 x $7,000,000. ASPE Debit Credit 70,000

Derivatives – Financial Assets/Liabilities Gain or Loss on Derivatives To record gain on forward contract

70,000

IFRS Debit Credit 70,000 70,000

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PROBLEM 16.6 (CONTINUED) b.

Balances at December 31, 2023: Account Derivatives – Financial Assets Interest Payable Notes Payable Contributed Surplus – Stock Options Contributed Surplus – Conversion Rights

Balance under ASPE $ 70,000 Dr 150,000 Cr 5,000,000 Cr

Balance under IFRS $ 70,000 Dr 150,000 Cr 4,645,426 Cr

495,000 Cr

495,000 Cr 432,928 Cr

Note to instructor: It may be useful to illustrate the following “proof”: Notes Payable under IFRS Contributed Surplus – Conversion Rights Subtotal Less: Amortization to date of note discount Balance under ASPE

4,645,426 Cr 432,928 Cr 5,078,354 Cr (78,354) Dr 5,000,000 Cr

LO 1,2,3,4 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.7 a.

Entry at January 1, 2023 should have been: Cash ($1,000,000 X 1.07) ........................ 1,070,000 Bonds Payable ($1,000,000 X .97) ... Contributed Surplus— Conversion Rights........................

970,000 100,000

At the issuance of the convertible bond, the bookkeeper should have recognized the debt (bond) and conversion right (equity) components separately in the accounts. As the company is compliant with IFRS, the residual method, as illustrated in the corrected entry above, should have been used. Under IFRS, the debt component is measured first, with the residual value assigned to equity since it is a residual item. b.

ASPE does have an option to allow for the equity portion to be allocated zero, with all the proceeds being allocated to the debt component. If this option was available, the bookkeeper would be correct. However, this is an optional treatment and the correction noted in part (a) above is still in order as the company is a publicly accountable enterprise and must prepare financial statements in accordance with IFRS.

Using either a financial calculator or Excel, the effective interest rate on the bonds is calculated as follows: 1. Using a financial calculator: PV $ 970,000 I ?% N 6 PMT $ (100,000) FV $ (1,000,000) Type 0

Yields 10.70307 %

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.7 (CONTINUED) c. (continued) 2. Using Excel formula =RATE(nper,pmt,pv,fv,type)

Result: .107030746 rounded to 10.70307 %

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PROBLEM 16.7 (CONTINUED) d. Schedule of Bond Discount Amortization Effective Interest Method 10% Bonds Sold to Yield 10.70307% 10% 10.70307% Cash Effective Discount Date Paid Interest Amort. Jan. 1, 2023 Dec. 31, 2023 $100,000 $103,820 $3,820 Dec. 31, 2024 100,000 104,229 4,229 Dec. 31, 2025 100,000 104,681 4,681 Dec. 31, 2026 100,000 105,182 5,182 Dec. 31, 2027 100,000 105,737 2008 5,737 100,000 106,351 6,351 $600,000 $630,000 $30,000

Carrying Amount $970,000 973,820 978,049 982,730 987,912 993,649 1,000,000

e. January 1, 2025 Retained Earnings ($103,820 – $74,900) ............... Bonds Payable ($1,044,900 – $973,820) ............... Contributed Surplus— Conversion Rights...............................

28,920 71,080 100,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.7 (CONTINUED) f. December 31, 2024 Interest Expense .................................................... 104,229 Bonds Payable ............................................... 4,229 Cash ............................................................... 100,000

The debt to equity ratio, following the correction in part (e) above, will be substantially improved as $100,000 previously classified as part of debt is now correctly classified as equity. This will have a significant effect on the debt to equity ratio, as both the change to the numerator and the change to the denominator lead to a decrease in the ratio. The improvement in the ratio is reduced by the charge to Retained Earnings for the correction of the error in interest expense from 2023.

LO 2, 4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.8 a.

The entry for the issuance of the notes on January 1, 2023: 1. Using Tables: The present value of the note is: $1,100,000 X .59345 (factor for a single payment in 5 years at 11%) = $652,796 (Rounded by $1). 2. Using a financial calculator: PV $? I 11% N 5 PMT $ 0 FV $ (1,100,000) Type 0

Yields $652,796

3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $652,796.4609 Rounded to $652,796

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 16.8 (CONTINUED) a. (continued) January 1, 2023 Cash................................................................ 1,000,000 Notes Payable .......................................... Contributed Surplus—Stock Warrants... ... b.

The amortization note is:

schedule

for

the

652,796 347,204

zero-interest-bearing

Schedule for Interest and Discount Amortization— Effective Interest Method $1,100,000 note issued to yield 11% Cash Effective Discount Carrying Date Interest Interest Amortized Amount 1/1/23 $ 652,796 1 12/31/23 $0 $71,808 $ 71,808 724,6042 12/31/24 0 79,706 79,706 804,310 12/31/25 0 88,474 88,474 892,784 12/31/26 0 98,206 98,206 990,990 12/31/27 0 109,010* 109,010 1,100,000 Total $0 $447,204 $447,204 1

$652,796 X 11% = $71,808 $652,796 + $71,808 = $724,604 *rounded $1 c. December 31, 2023 Interest Expense ............................................. Notes Payable .......................................... 2

71,808 71,808

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PROBLEM 16.8 (CONTINUED) d. January 1, 2026 Cash (250,000 x $22)………… ........................ 5,500,000 Contributed Surplus – Stock Warrants3 ........... 86,801 Common Shares ...................................... 5,586,801 3 ($ 347,204 X 0.25 = $86,801) LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 16.9 a. September 30, 2023: Cash................................................................ 4,600,000 Bonds Payable ........................................ 4,200,000 Contributed Surplus— Stock Warrants1 ................................. 240,000 Contributed Surplus— Conversion Rights .............................. 160,000 1 ($4,000,000 / 1,000 X 20 warrants X $3) b.

Using either a financial calculator or Excel, the effective interest rate on the bonds is calculated as follows: 1.Using a financial calculator: PV $ 4,200,000 I ?% Yields 3.6436 % N 20 PMT $ (160,000) FV $ (4,000,000) Type 0

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PROBLEM 16.9 (CONTINUED) 2. Excel formula =RATE(nper,pmt,pv,fv,type)

Results: .036436077 rounded to 3.6436 %

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PROBLEM 16.9 (CONTINUED) c. Schedule of Bond Premium Amortization Effective Interest Method 8% Semi-annual Bonds Sold to Yield 7.2872% 4% 3.6436% Cash Effective Premium Carrying Date Paid Interest Amort. Amount Sept. 30, 2023 $4,200,000 Mar. 31, 2024 $160,000 $153,031 $6,969 4,193,031 Sept. 30, 2024 160,000 152,777 7,223 4,185,808 Mar. 31, 2025 160,000 152,514 7,486 4,178,322 Sept. 30, 2025 160,000 152,241 7,759 4,170,563 Mar. 31, 2026 160,000 151,959 8,041 4,162,522 Sept. 30, 2026 160,000 151,666 8,334 4,154,188 Mar. 31, 2027 160,000 151,362 8,638 4,145,550 Sept. 30, 2027 160,000 151,047 8,953 4,136,597 Mar. 31, 2028 160,000 150,721 9,279 4,127,318 Sept. 30, 2028 160,000 150,383 9,617 4,117,701

d. December 31, 2023 Interest Expense ............................................ Bonds Payable…………………………………. Interest Payable ....................................... 2 ($153,031 X 3/6 = $76,516) 2

March 31, 2025 Interest Expense ............................................. Interest Payable .............................................. Bonds Payable ................................................ Cash .........................................................

76,516 3,484 80,000

76,515 80,000 3,485 160,000

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PROBLEM 16.9 (CONTINUED) e. March 23, 2023: Cash .............................................................. Contributed Surplus— Stock Warrants ($240,000 X ½) ................. Common Shares ................................. 3

600,000 120,000 720,000

Number of warrants exercised: ($4,000,000 / $1,000 X 20 warrants X 1/2 = 40,000) Number of common shares issued: 40,000 warrants X 1 = 40,000 3 (40,000 X $15 = $600,000) f. September 30, 2028: Bonds Payable ................................................ 4,117,701 Contributed Surplus— Conversion Rights ..................................... 160,000 Common Shares ................................. g.

4,277,701

Number of common shares issued: ($4,000,000 / $1,000 X 80 common shares = 320,000) The bondholders would only be motivated to convert bonds into common shares if they perceived an increase in the value of their investment, and if they would get common shares with a market value higher than the fair value of the bonds that were given up in the conversion. Assuming the carrying amount of what they gave up at the time of conversion is equal to the fair value, the carrying amount is shown in the entry above as $4,277,701 for 320,000 common shares. This works out to slightly below $13.37 per share. Likely the common shares are trading at an amount higher than $13.37 by a good margin. There should be an excess over the carrying amount of $13.37 as the bondholders are giving up a steady cash inflow from the interest income obtained from the bonds in exchange for shares, which might not yield any dividends.

LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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PROBLEM 16.10 2023. No journal entry would be recorded at the time the stock option plan was adopted. However, a memorandum entry in the journal might be made on November 30, 2023, indicating that a stock option plan had authorized the future granting to officers of options to buy 70,000 common shares at $8 a share. 2024 No entry

January 2

December 31 Compensation Expense .................................. 209,524 Contributed Surplus—Stock Options ...... To record compensation expense attributable to 2024—22,000 options Pro-rata calculation: 2024 2025 President 15,000 13,000 Vice-President 7,000 7,000 Total options 22,000 20,000 Compensation Expense $ 209,5241 $ 190,4762 1 22,000 / 42,000 X $400,000 = $209,524 2 20,000 / 42,000 X $400,000 = $190,476

209,524

Total 28,000 14,000 42,000 $400,000

2025 December 31 Compensation Expense .................................. 190,476 Contributed Surplus—Stock Options ...... To record compensation expense attributable to 2025—20,000 options

190,476

Contributed Surplus—Stock Options ............... 209,524 Contributed Surplus—Expired Stock Options ..................................... To record lapse of president’s and vicepresident’s options to buy 22,000 shares

209,524

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PROBLEM 16.10 (CONTINUED) 2026 December 31 Cash (20,000 X $8) ......................................... 160,000 Contributed Surplus—Stock Options ............... 190,476 Common Shares .................................... To record issuance of 20,000 common shares upon exercise of options at $8

350,476

LO 3 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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*PROBLEM 16.11 a. Step Action

Answer

Identify the hedged item.

The hedged item is the risk that the fair value of the fixed-rate note payable will increase due to declining interest rates.

Identify the hedging item.

The hedging item is the swap to receive a fixed rate and pay a variable rate of interest.

Identify how the hedged item is being accounted for without hedge accounting.

The note is recognized at amortized cost, with interest payments accrued as interest expense.

Identify how the hedging item is accounted for without hedge accounting.

The swap is a derivative that is recognized as FV-NI.

Locate where the recognized gains and losses for the hedged and hedging items are recognized (net income, OCI, or perhaps not at all).

The liability is revalued to fair value with gains and losses booked through income to offset the gains and losses recognized on the swap.

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*PROBLEM 16.11 (CONTINUED) b. (1) December 31, 2023 No entry is required at the date of the swap because the fair value of the swap at inception is zero. (2) June 30, 2024 1 Interest Expense .......................................... Cash ...................................................... 1 ($10,000,000 X 8% X 6/12) (3) June 30, 2024 Cash ............................................................. Interest Expense2 ................................ 2 [$10,000,000 X (8% – 7%) X 6/12]

Swap receivable (8% X $10,000,000 X 1/2) .. Payable at LIBOR (7% X 10,000,000 X 1/2) . Cash settlement ............................................ (4) June 30, 2024 Gain or Loss on Derivatives ............................ Derivatives–Financial Assets/Liabilities .....

400,000 400,000

50,000 50,000 Interest Received (Paid) $ 400,000 (350,000) 50,000

200,000

(5) June 30, 2024 Notes Payable …………………………………… 200,000 Unrealized Gain or Loss ...........................

200,000

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*PROBLEM 16.11 (CONTINUED) c. Mister Corp. Statement of Financial Position (partial) December 31, 2023 Long-term liabilities Notes payable

$10,000,000

Income Statement (partial) For the Year Ended December 31, 2023 No items to report

d. Mister Corp. Statement of Financial Position (partial) June 30, 2024 Current liabilities Derivatives – Financial Liabilities $200,000 Long-term liabilities Notes payable

$9,800,000

Statement of Income (partial) For the Six Months Ended June 30, 2024 Interest expense ($400,000 – $50,000) Other revenues and gains: Unrealized gain – Notes payable Loss – Swap contract

$350,000

$200,000 (200,000) 0

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*PROBLEM 16.11 (CONTINUED) e.

Mister Corp. Statement of Financial Position (partial) December 31, 2024

Other assets Derivatives – Financial Assets

$60,000

Current liabilities Notes payable

$10,060,000

Income Statement (partial) For the Year Ended December 31, 2024 Income Statement Interest expense First six months Next six months Total

$ 350,000 [as shown in (c)] 375,0003 (see below) $ 725,000

Gain—Swap $ 60,000 Unrealized Loss—Notes Payable (60,000) Total $ 0 3

Swap receivable (8% X $10,000,000 X 1/2) Payable at LIBOR (7.5% X $10,000,000 X 1/2) Cash settlement Interest expense unadjusted June 30–December 31, 2024 Cash settlement

$ 400,000 375,000 $ 25,000

$ 400,000 (25,000) $ 375,000

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*PROBLEM 16.11 (CONTINUED) f.

Under ASPE, the first two entries would be recorded but the bond would not be revalued and the swap would not be recognized (nor remeasured).

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*PROBLEM 16.12 a. Step Action

Answer

Identify the hedged item.

Identify the hedging item.

The hedged item is the risk of cash flow uncertainty from the anticipated gold purchase. The hedging item is the futures contract.

Identify how the hedged item is being accounted for without hedge accounting.

The hedged item would be recorded at cost.

The futures contract is recognized as FV-NI. The gains and losses on the futures contract are accumulated in OCI until the inventory is purchased.

April 1, 2023

2. June 30, 2023 Derivatives-Financial Assets/Liabilities ............ Gain or Loss on Derivatives ..................... To increase the value of the contract Gain or Loss on Derivatives .............................. Unrealized Gain or Loss - OCI ................. To record the “fix” under hedge accounting

5,000 5,000

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*PROBLEM 16.12 (CONTINUED) 3. September 30, 2023 Derivatives-Financial Assets/Liabilities ............ Gain or Loss on Derivatives ...................... To increase the value of the contract Gain or Loss on Derivatives ............................... Unrealized Gain or Loss - OCI .................. To record the “fix” under hedge accounting

4. October 31, 2023 Raw Materials Inventory................................... Cash (500 ounces X $315)........................ To record purchase of raw materials

2,500 2,500

2,500 5,000 2,500 5,000

157,500 157,500

Accumulated Other Comprehensive Income ..... Raw Materials Inventory .................................... To record the “fix” under hedge accounting

157,500 7,500

Cash ................................................................ Derivatives-Financial Assets/Liabilities ...... To record settlement of contract

7,500

5. December 20, 2023 Accounts Receivable ....................................... Sales Revenue.......................................... To record credit sales Cost of Goods Sold1 ........................................ Finished Goods Inventory ......................... To record cost of goods sold 1 ($200,000 - $7,500)

157,500 7,500

7,500

350,000 350,000

192,500 192,500

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*PROBLEM 16.12 (CONTINUED) c. Statement of Financial Position (partial) June 30, 2023 Current assets Derivatives-Financial Assets/Liabilities

$5,000

Shareholders’ Equity Accumulated Other Comprehensive Income*

$5,000

Statement of Comprehensive Income (partial) For the Six Months Ended June 30, 2023 Other Comprehensive Income: Unrealized holding gain – Futures contract* *These amounts are net of taxes d.

$5,000

Statement of Comprehensive Income (partial) For the Year Ended December 31, 2023

Sales revenue Cost of goods sold ($200,0001 - $7,500) Gross profit (included in net income) Other comprehensive income: Unrealized holding gains on cash flow hedge* Realized gain on cash flow hedge transferred to net income OCI, year ended December 31, 2023

$350,000 192,500 $157,500 7,500 (7,500) -0-

Note that the $200,000 cost of goods sold includes the $157,500 paid for the gold. IFRS also permits the amount in OCI to be netted with the inventory asset when it is acquired. * this amount is net of taxes

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*PROBLEM 16.12 (CONTINUED) e.

Under ASPE and using hedge accounting, the futures contract would not be recognized in the accounts until the hedged item (the gold inventory) was acquired and recognized on the statement of financial position. The gold would be purchased at $315 per ounce (total $157,500) and the previously unrecognized future is settled with the company receiving $7,500 cash, which is credited against the inventory cost. This brings the inventory cost to $150,000, which reflects the locked-in price of $300 per ounce under the futures contract.

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*PROBLEM 16.13 a.

The Black-Scholes model is used to determine the fair value of options. Consequently, any financial instrument that is an option or has an option embedded in it, will require that some form of option pricing model be used. i.

ii.

iii.

Derivatives that are options used by companies to manage risk (hedging or speculation) will require the Black-Scholes model to determine the fair value; Convertible bonds issued by the entity have an option to convert embedded in the bond that must be separately measured; Compensatory stock option plans (CSOPs) are plans where employees are given stock options in the company as payment for employment services to be provided. The fair value of these plans must be determined using the Black-Scholes option pricing model.

Under IFRS, the following standards apply: i. ii.

iii.

Derivatives must be measured at fair value initially and at each subsequent reporting period. Convertible bonds contain both a liability and an equity component which are classified separately on the initial issuance of the bonds. Under IFRS, the residual method is used whereby the fair value of the debt component is measured first, and then any residual amount is allocated to the equity component. The amount classified to equity is not changed during the life of the bond, so does not need to be subsequently remeasured. CSOPs are measured at fair value at the time of the grant of the options to the employees. The fair value of the options must be determined using some option pricing model (generally the Black-Scholes option pricing model). This value is used to measure the compensation expense at the time of the grant and does not change throughout the life of the options.

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*PROBLEM 16.13 (CONTINUED) a. (continued) Under ASPE, the following standards apply to each of the above: i.

ii.

iii.

Derivatives generally must be measured at fair value both initially and at each subsequent reporting period. However, if the derivative is required to be settled in the company’s shares and the fair value of these shares cannot be readily determined, then the derivative is measured at cost. Convertible bonds contain both a liability and an equity component which should be classified separately. However, under ASPE, at the time of issuance, the company has a choice to either recognize the equity portion at zero (allocating all the proceeds on issue to the liability component) or determine the value of the component that is the more readily measurable first and then allocate any residual to the other component. The equity component does not change value throughout the life of the bond. CSOPs are measured at fair value at the time of the grant. The fair value of the options must be determined using some option pricing model (generally the Black-Scholes option pricing model). This value is used to measure the compensation expense at the time of the grant, and does not change throughout the life of the options.

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*PROBLEM 16.13 (CONTINUED) b.

The inputs into the Black-Scholes model include: i. ii. iii. iv. v. vi.

the exercise price, the expected life of the option, the current market price of the underlying shares, the volatility of the price of the underlying shares, the expected dividend during the life of the option, and the risk-free rate of interest over the life of the option.

The difficulty for private enterprises is in determining the volatility of the shares, since the entity’s shares are not publicly traded. However, the private company must still make an attempt to estimate what this volatility would be by looking at similar company shares in the market. The other input that is more difficult to determine is the current market price of the shares, since again, the shares are not publicly traded. For a public company, this information would be readily available.

Assuming all other inputs remain unchanged: i.

ii.

iii.

an increase in the risk-free rate will increase the fair value of the options granted since the time value of money has increased; a decrease in the volatility will decrease the fair value of the options granted since the likelihood of being able to exercise at higher prices is reduced; an increase in the expected life of the options will increase the fair value of the options since there is a longer time period before they need to be exercised which increases the time value component of the price.

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*PROBLEM 16.13 (CONTINUED) d.

The major differences between exchange-traded options and stock options granted under employee benefit plans are the following: i.

ii.

iii.

employee stock options have a vesting period during which they cannot be exercised and during which the options are forfeited if the employee leaves; employee stock options tend to have much longer periods to maturity (often up to 10 years from the date of grant) which normal exchange-traded options do not; new shares are issued by the company when the employee stock options are exercised; this is not the case with exchange-traded options where the shares are already issued and outstanding by the company.

As a result of these significant differences, some believe that the Black-Scholes formula is not the correct model to use. However, even given these weaknesses, it is still believed to be the best alternative available to estimate the fair value of options under employee stock option plans. LO 2,3,4,7 BT: C Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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CASES Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the front of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. *CA 16.1 AIR CANADA Case Overview The industry is a challenging one with many bankruptcies and significant competition. The company’s main expense is fuel, which accounts for a significant amount of total costs of the company. The need to manage this cost is critical to the viability of the business. Air Canada uses a hedging strategy to fix its fuel costs. Hedges are complex and there are operational risks (risks in implementing and managing the hedges). Analysis and Recommendations Issue: Whether to use hedge accounting for fuel risk management activities. Apply hedge accounting - The hedged item is the anticipated fuel purchases and the hedging items are the derivatives used to lock in the prices on those purchases. - From an economic perspective, these financial instruments will fix or cap the price for a significant percentage of fuel purchases, therefore this is an economic hedge.

Do not apply hedge accounting - Hedge accounting is optional. - There is a cost associated with applying hedge accounting (accountants must prepare documentation and assess effectiveness, which must be audited). - Hedge accounting has risks associated with its usage as the transactions and accounting are very complex.

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*CA 16.1 AIR CANADA (CONTINUED) Apply hedge accounting (continued)

Do not apply hedge accounting (continued) - Under IFRS, anticipated fuel purchases will - An alternative not be recognized in financial statements, would be to use but the hedging items (derivatives) would be note disclosures since they meet the accounting definition of to describe the derivatives. The derivatives will be measured existence of the at fair value at each reporting date and the hedge. resulting gains/losses will be reflected in net income. Even though there is an economic hedge in place with no further risk of loss, gains/losses would be reflected in net income and as a result, introduce volatility. This is not reflective of the fact that the company has taken steps to protect itself and eliminate the volatility associated with fuel prices from an economic perspective. - An alternative option is to use hedge accounting. Under this method, the gains/losses from the revaluation of the derivatives would be reflected in other comprehensive income, therefore shielding net income from volatility. The gains/losses would be reclassified to net income when the fuel is consumed in the operation of the business. This results in the remeasurement of fuel costs to reflect the locked-in prices. This would generally be treated as a cash flow hedge as it is a hedge of a future transaction and related cash flows. - The company will have to identify the hedging relationship and assess the effectiveness of the hedge on a regular basis in the note disclosures.

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*CA 16.1 AIR CANADA (CONTINUED) Recommendation: When hedging activity occurs, hedge accounting makes sense as it provides greater transparency and allows users to see the impact of the actions management has taken to protect the company. It should be noted that in 2020, Air Canada did not have any fuel hedging activity, likely because of the Covid-19 pandemic. Since air travel was at its lowest levels in history, there was very little usage of fuel, and fuel prices were at historical lows.

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CA 16.2 COACH CORPORATION Case Overview The company uses a performance-based compensation plan that is based on net income, making this a key metric. As a result, the subjective estimate of bad debt expense negatively affects the bonus that executives could receive in the current period. By decreasing the bad debt estimate, EPS would increase from 12% to 16.1%, significantly increasing bonuses. IFRS is a constraint since this is a public company. Analysis and Recommendations The subjectivity related to the estimate of bad debt expense affects executive compensation. If bad debt expense is calculated using best estimates, it should not be changed to enhance executive bonuses or as a result of a suggestion to do so by any of the executive group members. The Controller may face an ethical issue if she if feeling pressured by any members of the executive team to change the estimate of bad debt expense. Tse needs to remember that the accounting information should be neutral and unbiased. No changes should be made to the calculation of bad debt expense.

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CA 16.3 COPMIN INC. Case Overview: CopMin Inc. is a private enterprise that owns two mines and is involved in copper mining operations. It has recently negotiated and entered into two separate contracts for each mine. The first is a five year sales contract with a major customer, whereby, CopMin agrees to sell 75% of its annual production at a fixed price, with a 1% annual increase for inflation. Payment is received upon monthly delivery of product. In the second agreement CopMin has purchased a variety of option contracts to sell copper that is exchange traded. This has resulted in options on 60% of the mine’s production for 2023 and 40% of the production for 2024. The copper may be sold at a fixed price, or the contract can be settled on a net cash basis prior to expiry. There was a fee charged to buy these contracts. Analysis and Recommendations: a.

The first contract, for the Papula Mine, is a sales contract to deliver copper at a fixed price and a fixed volume (fixed by the annual production of the mine). This sale commitment is not traded on an exchange and is an executory contract. No money changed hands at the beginning of the contract and cash will be received as delivery is made. This contract cannot be net settled in cash since delivery of the copper must be made. In this case, the contract is treated as an unexecuted contract, meaning that it does not need to be measured at fair value at each reporting period. Instead, the sale is recorded at the fixed committed price when delivery of the copper is made. This is the same under both IFRS and ASPE.

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CA 16.3 COPMIN INC. (CONTINUED) a. (Continued)

The exchange-traded options for the Minera Mine are nonfinancial derivatives. The premium paid for the options is the fair value paid at the time the options are purchased. Under ASPE, even though the options are exchange traded, they are not futures contracts. Therefore, the contracts are initially recorded at fair value (amount paid) but not remeasured. Under IFRS, these options are non-financial derivatives that can be settled on a net basis. If the intent of the company is to make physical delivery of the copper, then the option can be designated as “expected use” and the company need not account for the options as a derivative instrument (FV-NI). The options would initially be recorded at fair value (amount paid) but would not be remeasured. Alternatively, if the company’s intent is to settle on a net cash basis at some time during the term of the options, then the option is treated as a derivative. As such, the options would be measured and reported at fair value at each reporting period.

If the sale commitment contract was able to be settled net in cash, rather than requiring the delivery of the copper, it would still be recorded when executed under ASPE since it is not an exchangetraded futures contract. However, under IFRS, the company would have to assess the likelihood of making delivery of the copper or settling on a net basis. If the company intends to deliver the copper, then the contract is designated as “expected use” and the sale can be recorded when the delivery is made. If the company intends to settle on a net basis, then the contract would be treated as a derivative and would be measured and reported at fair value at every reporting period.

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CA 16.4 SORON LIMITED Case Overview: Soron is a private company, so it may use IFRS or ASPE. Treatment of the derivatives under both standards will be reviewed. As the controller, Leon Price must ensure that the financial reporting is unbiased and provides useful information. The CEO has requested that Leon not show a loss in the financial statements when accounting for the derivatives. It is clear that the CEO is biased. Issue: Soron purchased 10,000 shares in a company that is publicly traded, but it also purchased exchange-traded options to sell these shares at a future date. Analysis and Recommendations: The investment in the publicly traded shares is recorded at fair value under both IFRS and ASPE. Under ASPE, the gain or loss on any changes in fair value is directly reported to current earnings. The option is a derivative, and it is measured at fair value at each reporting period, with the changes reported in the current earnings. This results in symmetric reporting and a netting of the gains and losses on the hedged item and the hedging item in the profit or loss for the period. There is no need to use hedge accounting under ASPE in this case. Under IFRS, the company has a choice to classify the investment as FV-NI or FV-OCI. The derivative must be recorded at fair value through profit or loss. If the company chooses to report the investment at fair value through profit or loss, then this would match the treatment of the option derivative. Similar to ASPE above, there would be no need for hedge accounting since the gains and losses on both the hedged item and the hedging item would be offset in the current earnings.

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CA 16.4 SORON LIMITED (CONTINUED) However, if the company chooses to report the investment at fair value through OCI, then there is a mismatch because changes in the derivative will be reported in the profit or loss for the period, whereas changes in the investment are reported in OCI. Consequently, the company could adopt fair value hedge accounting and designate the investment as the hedged item and the option as the hedging item. The gains and losses on the derivative would be recorded in OCI for the period and would be offset against the gains and losses on the investment. In this case, the company may want to use FV-NI accounting for the investment in the first place to avoid the complexities of hedge accounting. Issue: Soron recently sold goods on account to a US customer, residing in the US, in US currency, due in 6 months. To mitigate the loss on the exchange value of the sale, Soron also entered a forward contract to sell the same amount of U.S. dollars in six months. Analysis and Recommendations: Under IFRS and ASPE, the U.S. dollar receivable must be translated into the equivalent Canadian dollars at each reporting period. Any foreign exchange gain or loss is recognized in the profit or loss for the period. The forward contract, which is a derivative, must also be reported at fair value with the gains and losses reported to net earnings. This accounting treatment results in symmetric reporting of the gains and losses, showing a net impact in the current earnings. Therefore, no hedge accounting is required, and any gains and losses will offset.

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INTEGRATED CASES IC 16.1 ON-LINE DEALS Case Overview ODI is a growing online sales company specializing in the sale of hotel rooms and airline flights. ODI is currently privately held but is considering going public. GAAP is a constraint. The company has several financial instruments with covenants that require audited financial statements. Given that ODI is considering going public, it is prudent to use GAAP, and specifically IFRS. There may be a bias to make statements look better in order to increase initial share price of an IPO. Senior management is also compensated with stock options and will stand to benefit greatly from higher share prices. The auditor should be cautious and conservative due to the increased risk associated with going public. Analysis and Recommendations Issue: Revenues related to the sale of hotel rooms and airlines is recorded at fair value of the goods received and this is also the price that customers pay.

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IC 16.1 ON-LINE DEALS (CONTINUED) Record Gross Revenues Record Net Revenues - ODI should examine - It appears that ODI is whether it is acting as a providing a service by principal (e.g., selling things connecting sellers and for a profit) or as an agent. buyers. - In this case ODI is buying - Therefore, the revenue is a blocks of rooms or flights, type of commission and therefore, it has the risks should be shown on a net and rewards of ownership basis. and the company stands to - ODI should carefully analyze lose out if it does not sell the this, but it appears that for whole block of rooms or many of the items being sold flights. there is no risk of loss to the - ODI is acting as the principal firm. If the item is not sold, by selling assets that it has then the loss rests with the legal title to (ie. blocks of airline or hotel company, not rooms and flights). ODI.

Recommendation: ODI should carefully analyze the substance of the transactions given the multiple transaction types. It is safer to show revenues on a net basis until more information can be obtained regarding whether or not ODI takes legal title of the rooms/flights and whether the company is at risk of loss.

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IC 16.1 ON-LINE DEALS (CONTINUED) Issue: ODI has spent a significant amount of money refurbishing its website during the last year. To remain competitive, the website needs regular updates. Capitalize the website costs Expense the website costs - The website is a critical asset - It appears that the website that will provide future is critical to the business, economic benefit by providing and it is important to the platform by which ODI continuously invest in it. interacts with its customers. Therefore, this is an - Without this upgrade of the ordinary and ongoing cost website, ODI will lose sales of conducting business. and this will have a negative Even if it appears that the impact on future cash inflows. website is viewed as an - The website is owned and asset, particularly given the controlled by the company. problems in the past related to the hacking incident, ODI might want to write off or impair any costs capitalized and understand that costs being incurred going forward are only good until there is a breach. Computer hacking is a big risk in this business and as soon as the new security features are in place, new attempts at hacking may occur. Recommendation: Treat the costs for the refurbishment of the website as expenses, unless any of the refurbishments done are truly an upgrade or betterment from the original capabilities of the website.

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IC 16.1 ON-LINE DEALS (CONTINUED) Issue: Currently several customers are suing ODI in a class action lawsuit related to the data breach. The case goes to trial early next year and ODI’s lawyers believe that the company may be required to pay out a large settlement based on previous case settlements. Recognize the liability related to the Do not recognize the liability lawsuit related to the lawsuit - There is definitely an - It is very difficult to measure obligation or duty for ODI to the potential losses related deal with the data breach. to the lawsuit. - Both company founders were - Even though the lawyers aware of the potential risks believe that there are that contributed to the similar cases that have breach. The breach was in been unsuccessful, each part due to the company’s case is different. own computer problems. - ODI plans to sue SAI and Also, ODI made the choice to so the net losses may be contract with SAI. insignificant. - The company founders have publicly apologized and promised to make things right. This creates a constructive obligation. - The lawyers have noted that for similar companies and situations, there have been significant lawsuit losses, so a loss is likely.

Recommendation: Given the above analysis, ODI should accrue a liability related to the estimated losses that may result from this lawsuit.

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IC 16.1 ON-LINE DEALS (CONTINUED) Issue: In order to finance a new facility, ODI has issued financial instruments to a large institutional investor. Record the FI as Debt Record the FI as Equity - An obligation to deliver - The FI is legally equity since cash exists because of the it pays dividends and has no triggering event that due date. requires repayments when - It appears that this may be revenues reach and exceed permanent financing since two times historic revenue the triggering event is not levels. likely to happen. Revenues - This triggering event may are currently large because of be outside the control of the the accounting policy to company as it will depend recognize sales on a gross on sales from customers. basis. It makes more sense - The company will obviously to recognize revenue on a net have a goal to grow as basis and this will decrease large as possible and would revenues significantly and not limit growth just to make the target more difficult preclude the triggering to achieve (assuming the event from happening. target is based on the - This is a more conservative historically recognized gross view and given the revenues). significant and continuing - The level of revenues might growth within the industry, it be seen to be within the appears ODI’s growth is control of the company, inevitable. especially since it depends on an accounting policy choice and also on management’s decision regarding how much they would like to grow the company.

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IC 16.1 ON-LINE DEALS (CONTINUED) Recommendation: Record as debt, since there is a defined triggering event in which the principal must be repaid, despite the uncertainty of when that might happen. Issue: The company founders and senior management team are currently not taking a salary but are being paid with stock options. Recognize the stock options as Do not recognize the stock salary expense options as salary expense - Management salaries are - It is difficult to measure the a cost of doing business. value of the stock options - Management is providing a since this is a private service to the company company that is also fairly that must be captured. new. There is very limited Currently profits are company history. overstated since the - It may be difficult to management team measure both the value of appears to be working for the contribution and/or the “free”. value of the company.

Recommendation: The company should accrue the expense based on the value of the stock options. It is incumbent on the company to determine the value of the company in order to value the options properly.

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IC 16.1 ON-LINE DEALS (CONTINUED) Issue: ODI is building a company owned technology facility, as a selfconstructed asset. Capitalize construction costs Expense construction costs - ODI may capitalize costs - Jay and Wen are both such as salaries and other owners and employees of costs to build the facility. the company. Their The founders, Jay and compensation is an Wen have spent a ordinary cost of doing significant amount of time business. on the design, which adds - It may be difficult to future value and is directly separate the value that related to the construction they add to the business activity. every day from the value - The proper design of this they are adding to this facility is critical given the particular asset. recent data breaches. Jay and Wen have significant insight into the key risks of the company, including the risks associated with protecting customer information.

Recommendation: ODI should capitalize direct costs related to the construction of the asset such as direct materials, direct labour, etc. However, it may choose to either capitalize or expense the design costs related to Jay and Wen’s time.

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IC 16.2 SALTWORKS INC (SI) Case Overview SI is a salt mining company that has recently been approached by a public company that is interested in acquiring SI and they have placed a stipulation that SI’s financial statements be prepared in accordance with IFRS. This makes IFRS a constraint. The purchaser will use IFRS standards to evaluate and potentially acquire SI. The accountant needs to be transparent but may have a bias to make SI “look good” in order to maximize its value. Analysis and Recommendations Issue: Costs have been incurred to both drill and build SI’s two salt mines referenced to as Mines 1 and 2, with the potential to develop a third mine, Mine 3. Capitalize costs to drill and build Expense costs to drill and build the mines the mines - SI is allowed to capitalize - SI is unsure of the future exploration and evaluation benefit of the mines costs under IFRS 6. Costs (uncertainty as to value of that can be capitalized potential salt find). include studies, - This is especially the case exploratory drilling, for Mine 3 since SI is sampling, and those uncertain about the quality related to establishing of the salt and whether or technical feasibility and not there is a market for it. commercial viability. Continued

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IC 16.2 SI (CONTINUED) Capitalize costs to drill and build the Expense costs to drill and mines (continued) build the mines (continued) - Development costs must be analyzed under IAS 38 (intangible assets). For Mine 2 costs, it is more likely that these are developmental costs that may be capitalized if the following criteria are met: the mine is technically feasible, there is an intent to complete it, there is the ability to mine, there is an existing market for the output, there is availability of resources, and there is the ability to measure costs. While this case does not provide all this information, the company has certainly displayed intent to complete and assuming the salt is of the same quality as Mine 1, then a market exists for salt in Mine 2. The company appears to have the resources to carry on with the development. - If capitalized, the mine then must be tested for impairment.

Recommendation: Given the uncertainty related to Mine 3, it is likely best to expense those costs. However, the costs for Mine 2 may be capitalized, assuming the criteria for capitalization is met. More data may need to be gathered. Solutions Manual 16-137 Chapter 16 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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IC 16.2 SI (CONTINUED) Issue: SI has agreed to sell its logging rights for $400,000 to an independent third-party company, LC. SI has already received the cash. Recognize logging rights’ Defer logging rights’ revenues revenues - SI has been paid an up- The contract with LC provides front for access to the LC with access to the trees. property over three years. - Revenue received was Therefore, SI should not dependent upon how recognize the revenue over many trees were cut three years. SI’s performance down. obligation is to provide rights - SI granted immediate to cut for a three-year period. access to LC. LC may - LC has paid for the right to log the whole area cut down a certain number of immediately or over time. trees over this three-year - SI may want to expense period. Just because LC paid the replanting costs up front does not mean that against any revenue SI can recognize the recognized so that profits revenues up front. are not overstated. - It is unclear if the performance obligation is still satisfied if LC cannot access the trees because of the lack of a logging road. It appears LC acquired the rights before the logging roads were negotiated and that these rights are independent. - The cutting of the trees is creating an additional obligation to plant new trees.

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IC 16.2 SI (CONTINUED) Recommendation: Defer the revenues since this is more reflective of the economic reality. As trees are cut down, recognizing an obligation to replant as a constructive obligation also exists. Issue: SI agreed to share the cost of building the logging roads with LC. $1,000,000 in costs were incurred to build the roads, which have been subsequently washed out and must be rebuilt. SI plans to use these roads later on to for its mining efforts. Capitalize costs for the re-build Expense the costs for the re-build - The roads have a future - The roads are impaired value since the roads may since they have been be used after the logging is washed out and must be complete. rebuilt. - The weather derivative will - If hedge accounting is not cover losses. used (no information given as to whether it has been used or not) then the derivative would have been booked with gains being recognized in income (provided that the derivative was measurable). Thus, the gains and losses will offset.

Recommendation: The washed out roads are impaired and should be accounted for accordingly with a write down. The new road is an asset with future economic benefit and should be capitalized.

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IC 16.2 SI (CONTINUED) Issue: SI purchased a weather derivative contract to mitigate the risk of weather events and hedge against the effects of abnormal temperatures and precipitation. SI paid a premium of $100,000 for the contract. Under the terms of the contract, the counterparty will pay SI $500,000 if more than 250 mm of rain falls within a certain period (causing flooding). Analysis and Recommendation: SI needs to determine whether the contract meets the definition of a derivative. If so, then derivative accounting would be used as discussed in the previous point. This is likely the case as it is measurable. There is no mention of whether hedge accounting is used by SI or not. The company should consider using hedge accounting as long as the costs do not outweigh the benefits.

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RESEARCH AND FINANCIAL ANALYSIS RA 16.1 NUTRIEN a. Note 5 describes the various share based compensation plans that

include: Stock Options, Performance Share Units (PSUs), Restricted Share Units (RSUs), Deferred Share Units (DSUs), and a legacy plan that has been grandfathered. Stock Option Plans a) Who is eligible?

Officers and Eligible Employees

b) How often are they granted?

Annually

c) Vesting period

25% per year over four years

d) Expiry period / Term

Maximum term of 10 years

e) Settlement

PSUs a) Who is eligible?

Officers and Eligible Employees

b) How often are they granted?

Annually

c) Vesting period

d) Expiry period / Term

On 3rd anniversary grant date based on total shareholder return over a 3 year performance cycle, compared to average total shareholder return of a peer group of companies over the same period Not applicable

e) Settlement

Cash

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RA 16.1 NUTRIEN LTD. (CONTINUED) RSUs a) Who is eligible?

Eligible employees

b) How often are they granted?

Annually

c) Vesting period

d) Expiry period / Term

On 3rd anniversary of grant date and are not subject to performance conditions Not applicable

e) Settlement

Cash

DSUs a) Who is eligible?

Non-executive directors

b) How often are they granted? c) Vesting period

At the discretion of the Board of Directors Fully vested upon grant

d) Expiry period / Term

Not applicable

e) Settlement

Cash

For all the plans mentioned, the weighted average fair value of stock options granted was estimated at the date of the grant using the BlackScholes-Merton option-pricing model. A table is provided in Note 5 with the assumptions for 2020 and 2019. This is used to determine the compensation expense. b.Compensation expense is as follows (in millions of US dollars): Stock Options PSUs RSUs DSU’s TOTAL

2020 14 31 22 2 69

2019 19 65 18 2 104

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RA 16.1 NUTRIEN LTD. (CONTINUED) c.

As per Note 5, the following table summarizes the activity related to the stock option plans:

Outstanding – beginning of year Granted Exercised Forfeited or cancelled Expired Outstanding – end of year

Number of Shares Subject to Option 2020 2019

Weighted Average Exercise Price 2020 2019

9,191,480 2,293,802 (123,403) (34,506)

9,044,237 1,376,533 (451,574) (502,016)

56.88 42.23 42.24 57.45

58.41 53.54 42.73 86.53

(329,481)

(275,700)

75.92

76.59

10,997,892

9,191,480

53.59

56.88

As per Note 5, the following table shows the number of options outstanding and exercisable: Range of Exercise Prices

$37.84 to $41.60 $41.61 to $43.36 $43.37 to $45.40 $45.41 to $52.75 $52.76 to $78.86 $78.87 to $130.78 Total

Options Outstanding Number Weighted Weighted Average Average Remaining Exercise Life in Price Years 1,647,297 5 38.71 2,293,802 9 42.23 1,492,667 7 44.50 2,239,358 5 48.74 1,645,867 7 57.60 1,678,901 2 94.31 10,997,892 6 53.59

Options Exercisable Number Weighted Average Exercise Price 1,647,297 988,275 2,098,294 821,067 1,678,901 7,233,834

38.71 44.50 48.91 61.68 94.31 57.97

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RA 16.2 CANADIAN TIRE CORPORATION a.

Canadian Tire is exposed to several different business risks, each related to a specific business segment in which the company operates. Relative to the retail business segment: Seasonality risk refers to the risk associated with the sales of items that have a seasonal market in all three retail brands, and the demand of which can be affected by weather. Evolving Consumer Behaviour and Shopping Habits refers to how consumers are increasingly embracing online shopping and mobile e-commerce applications. The Management Discussion and Analysis references how Covid-19 accelerated this shift, requiring the business to quickly adapt to these changes. Supply chain disruption risk refers to the potential disruptions due to foreign supplier failures, geopolitical risk, labour disruption, or insufficient capacity at ports, and risks of delays or loss of inventory in transit. Conduct risk refers to level of risk associated with loss of brand name and reputation related to sourcing products from factories in less developed countries. Environmental risk refers to the risks associated with handling gas, oil, propane, and recycling materials such as tires, paint, oil, and lawn chemicals. This affects both the retail stores and the Petroleum operations. Commodity price and disruption risk affects the performance of its petroleum dealers as the commodity cost of oil fluctuates caused by global conditions. Market obsolescence risk is faced by the company’s clothing and apparel retailers as consumer fashion preferences change. Global sourcing risk affects Canadian Tire’s retail operations where the quality of foreignsourced goods and their satisfactory distribution are key to its business model. Relative to their real estate investment trust (REIT) business segment: External Economic Environment risks are those resulting from fluctuations or fundamental changes in the external environment that include economic conditions, market stability, industry, consumer behaviours, and competition amongst market participants. Key Business Relationship is a risk as it relates to the company’s relationship with CTC. There may be situations where there is conflict with CTC and its ability to meet its obligations. Financial risks involve the trading price of its publicly traded units, the distributions to its unitholders, and other various financial risks. Legal and Regulatory Compliance is the risk related to failing to comply with laws and regulations applicable to the business. Operations risks are related to direct or indirect losses associated with the operations of property, development, redevelopment, renovations, disasters, health crises, cyber incidents, climate change, business planning and talent shortages.

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RA 16.2 CANADIAN TIRE CORPORATION (CONTINUED) a. (continued) Relative to the financial services segment: Consumer credit risk is a significant risk associated with the company’s credit cards relating to whether customers will repay amounts owed to the company. Liquidity and funding risk refers to the company’s ability to meet its obligations as they come due and to obtain funding as needed at a reasonable rate. Interest rate risk means that changes in interest rates impact net interest income although a one percent change in interest rates is not considered to materially affect net interest income. Regulatory risk refers to the potential damage to its business, earnings, relationships, and reputation if it fails to comply with requirements of the regulatory bodies. Risks that are enterprise-wide in nature, termed “principal” risks: These risks include those associated with the external business environment and having operations in a global and domestic marketplace; for example, changes such as an economic recession, changes in political environments, demographics, and new technologies. Other principal risks relate to strategy, brands, people, technology innovation and investment, key business relationships, cyber, information, operations, financial, financial reporting, legal and litigation, and credit. In addition to the business risk exposures, Canadian Tire is exposed to financial risks associated with its use of financial instruments. These are spread across its business segments as well. Financial instrument risk comprises the risk exposure related to collectability of credit card receivables, and amounts owing from its dealer network and from derivative counterparties. It also refers to the collectability of its investment securities. This risk extends across all business segments. Liquidity risk reflects the risk that Canadian Tire may not be able to meet its obligations as they come due, also attributed to all business segments. Foreign currency risk is the risk associated with fluctuations predominantly in U.S. dollar exchange rates due to the company’s significant global sourcing for merchandise denominated in U.S. dollars. Interest rate risk is the risk associated with changes in interest rates that affect the company’s investments and any variable rate debt, including lease obligations. Again, all segments are affected by this type of risk.

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RA 16.2 CANADIAN TIRE CORPORATION (CONTINUED) b.

In Note 5 – Financial Risk Management, the company discloses how it manages the foreign currency and interest rate risks. To manage foreign currency risk, the company forecasts its U.S. dollar purchases and hedges them through foreign exchange contracts. In this way, it defers the effect of any sudden exchange rate movements, giving the company time to develop strategies to deal with any long-term change in rates. To manage interest rate risks, Canadian Tire uses interest rate swaps. The company’s policy is to maintain a minimum of 75% of its long-term debt, including lease obligations, at fixed rates. It has minimal interest rate exposure relative to its debt. However, there is exposure on the financial services GIC deposits, HIS account deposits, tax free savings accounts, and securitization transactions. These are partially offset by similar variable rate changes on the credit card receivables and investment rates available to its bank. The company has also entered into delayed start interest rate swaps as a hedge of future term deposit issues planned for 2021 to 2025.

As indicated in Note 3, the derivative instruments used by the company to hedge its risks are interest rate swap contracts (to hedge interest rate risk), forward exchange contracts (to hedge foreign currency risk), and equity derivative contracts (to hedge some of its future share-based payment expenses). As further explained in Note 3, the company uses cash flow hedges. Cash flow hedges are used for foreign currency contracts for future purchases of inventory-related items, and the changes in the fair values of the contracts are deferred in OCI, until the hedged transaction is complete, and the asset acquired. When the inventory is recognized, the value of the merchandise inventory is adjusted by the accumulated gains and losses on these foreign currency contracts in OCI.

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RA 16.2 CANADIAN TIRE CORPORATION (CONTINUED) d.

The derivatives (in $ million) are reported in the following notes to the financial statements: Where disclosed Note 8: Trade and Other Receivables (current assets)

Assets

Liabilities

$70.0

Note 10: Long-term and other assets Note 18: Trade and Other Payables (current liabilities)

$42.6

Note 24: Other long-term liabilities

_____

$10.4

Total

$112.6

$129.7

$119.3

Note 33 provides information describing how the derivatives were valued. Note 33.1 indicates that forward exchange contracts were measured at fair value by discounting the difference between the contracted forward price and the current forward price for the remaining time to maturity of the contract, using a risk-free rate. The fair value of interest rate swaps reflect the estimated amounts that will be received or paid if the company were to settle the contracts at the measurement date, and are determined by an external valuator using valuation techniques based on observable market input data. The fair value of the equity derivatives was calculated by taking into account changes in the underlying share prices, adjusted for a market interest rate specified by the contract. All the company’s financial instruments were assigned a Level 2 in the fair value hierarchy, except for Redeemable financial instruments, which were assigned a level 3. This means that the vast majority of inputs used in the measurements were based on market-related data observable for the instrument, although they were not quoted prices of identical instruments in an active market.

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RA 16.2 CANADIAN TIRE CORPORATION (CONTINUED) e.

Yes. After answering parts a through d above, it should be evident that data analytics would be an integral part of managing risks and utilizing derivatives effectively. To understand risks, a decision maker should incorporate information such as market data, market trends, economic factors, decision criteria, inputs, etc. that provide information regarding the nature of the risks in question, and the effectiveness of the derivatives available to manage those risks. For example, consider interest rate risk, and using interest rate swaps to manage those risks. There are many economic variables that should be considered to estimate how interest rates will change in the future. Using data analytics to help anticipate and predict those future changes will provide a more accurate prediction. In addition, the same logic would be applied to understand the effectiveness of the derivative required to manage those risks, in this case, interest rate swaps.

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RA 16.3 BROOKFIELD ASSET MANAGEMENT INC. a. IFRS 7 Financial Instruments: Disclosures: In Note 2(h) to its financial statements, Brookfield defines fair value, and what the company considers in estimating an asset or liability’s fair value. It also describes the three fair value hierarchical levels (Level 1, 2 and 3) and explains what differentiates one level from another. Note 2(o) sets out its accounting policies for derivative financial instruments and hedge accounting, including the purpose of their use in managing financial risks. Within Note 2(t) that addresses critical judgements and estimates, financial instruments are identified as requiring estimates and assumptions in the determination of their fair values. In Note 6, Fair Value of Financial Instruments, the company sets out: • The dollar amounts of its financial assets and financial liabilities reported on the balance sheet, indicating the measurement basis used for each type, and providing some detail about the various classifications. • A table listing the carrying amounts and the fair values of its financial assets and financial liabilities. • A description of its hedging activities, including its use of hedge accounting for both cash flow hedges and net investment hedges. • A summary of the company’s financial assets and financial liabilities carried at fair value, categorized by the fair value hierarchy levels. • A description of valuation techniques and key inputs used to determine Level 2 fair values; and similar input for Level 3 fair value measurements. • A reconciliation of the opening to closing fair value balances for financial assets and liabilities valued at Level 3 inputs.

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RA 16.3 BROOKFIELD (CONTINUED) b.

In Note 6, as at December 31, 2020, Brookfield reports US $41,335 million of financial assets and US $193,217 million of financial liabilities, at their carrying amounts in the financial statements. On the consolidated balance sheet, as at December 31, 2020, Brookfield reports total assets of US $343,696 million and total liabilities of US $221,054 million. Therefore, $41,335/$343,696or 12.0% of total assets are financial assets, and $193,217/$221,054 or 87.4% of total liabilities are financial liabilities. Based on these percentages, it appears that financial instruments are very significant to Brookfield’s financial position, particularly on the liability side. This is not surprising for companies financed with long-term debt because most liabilities are financial liabilities, by definition. The financial assets also make up a relatively significant proportion of total assets, and over half of these financial assets are made up of cash, cash equivalents, and accounts receivable. To assess the reliability of the measurements used for the company’s financial instruments, it is important to determine what measurement basis is used for each type of financial instrument. The following information is found in Note 6:

Type of financial instrument (in US $millions) Financial assets Financial liabilities

For financial instruments measured at fair value: Financial assets Financial liabilities

FV-NI $7,692 $7,346

Measurement Basis FV-OCI Amortized cost $8,861 $24,782 $-0$185,87 1

FV Measurement Level Level 1 Level 2 Level 3 $5,664 $8,520 $2,369 $75 $5,167 $2,104

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RA 16.3 BROOKFIELD (CONTINUED) b. (continued) It is assumed that an amortized cost measurement is a relatively reliable measure. US $16,553 million of the US $41,335 million of financial assets are measured at fair value, and US $5,664 million of this US $16,553 million are based on Level 1 measures which are prices in an active market. These are very reliable in nature. The Level 2 measures for financial assets (US $8,520 million) are based on discounted cash flow models, quoted market prices, aggregated market prices of underlying investments, observable yield curves, and other valuation methods based on observable market data. The remaining US $2,369 million of financial assets are based on the least reliable Level 3 estimates using a variety of valuation techniques with significant unobservable inputs such as future cash flows, discount rates, forward exchange rates, volatility measures, terminal capitalization rates, and investment horizons. Even assuming a significant 50% error rate in the Level 3 measurements, this would cause only a $2,369/2 or approximately US $1,184.5 million or 0.7% error in the total assets on the balance sheet. However, such an error might be more significant to net income. US $7,346 million of the US $193,217 million of the financial liabilities are measured using fair values, the remainder using the amortized cost approach. US $75 million of these are based on a Level 1 quality measure; US $5,167 million have a Level 2 and the remaining US $2,104 million are measured using Level 3 inputs. The types of Level 2 observable inputs and the Level 3 unobservable inputs are the same as those identified for the financial assets above. Again, significant errors in estimating the Level 3 fair values would not significantly affect total liabilities. In addition, because the same unobservable variables are used in valuing the Level 3 assets and the Level 3 liabilities, the net effect of such estimate errors would tend to net out and be even less significant to its financial position, although perhaps still significant to its performance. c.

Financial instruments affect the financial performance of the company in the following ways: interest and dividend revenue; interest expense; unrealized gains and losses from changing fair values on instruments measured at FVNI, including derivatives; realized gains and losses from financial instruments disposed of, including derivatives; unrealized gains and losses from changing fair values on instruments measured at FV-OCI, in this case to other comprehensive income (OCI); and credit gains and losses on receivables.

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RA 16.3 BROOKFIELD (CONTINUED) c. (continued) Brookfield reports the following key performance (2020) information (in US $ millions): Net income $707 and OCI of $2,313. Related to financial instruments are the following performance-affecting results: Fair value changes in income: gains and losses from changes in the fair value of financial instruments, including derivatives: (See Note 24) Financial contracts – gain686 Other fair value changes (may or may not be financial)- loss (1,052) Interest expense (on income statement)($7,213) Changes recognized in OCI (to be recycled to net income): including hedging activity: Financial contracts and power sales agreements($218) Marketable securities$285 Changes recognized in OCI (will not be reclassified to net income): Marketable securities$316

In Note 6, the company indicates that in 2020, there were unrealized gains of $916 million in FVOCI debt securities and $322 million of FVOCI equity securities. Gains transferred to net income from OCI on available-for-sale securities disposed of (Note 6) 7 Included above (but difficult to tie in) were unrealized net losses of $41 million and also included are gains of $28 million from the cumulative translation adjustment in OCI with respect to foreign currency contracts entered into for hedging purposes. (see Note 25).

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RA 16.3 BROOKFIELD (CONTINUED) c. (continued) Summary: the potential for revenues and expenses, and gains and losses on financial instruments appears to be significant in relation to the net income and OCI reported, and therefore, to the company’s financial performance. However, the quality of the amounts reported is fairly high and would not be as much of a concern, nor significant (as would many of the Level 3 measurements for the company’s fair-valued property, plant, and equipment, much of which is also carried at fair value). d.

Notes 6, 25, and 26 provide significant information about the financial risks to which Brookfield is exposed, how it uses derivatives for the most part to manage those risks, and the notional amount of the company’s derivative positions at the end of its fiscal year. The notes indicate that the company determines whether hedge accounting could be applied, and if so, designates a variety of hedging relationships as cash flow, fair value, or foreign currency exposure of a net investment in a foreign operation hedge. The following financial risks are identified: currency risk, interest rate risk, other price risk, as well as credit and liquidity risks. Currency risk: Brookfield is a global company, and deals in transactions in a variety of foreign currencies – British pounds, Australian dollars, Canadian dollars, European Union euros, Korean won, Chinese yuan, Brazilian reals, and Japanese yen, primarily. It manages these exposures using derivative contracts such as foreign exchange contracts, cross currency interest rate swaps, and foreign exchange options. Interest rate risk: With US $193,217 million of financial obligations at December 31, 2020, Brookfield is exposed to considerable fair value and cash flow risk, particularly associated with variable rate assets and liabilities. The company and its subsidiaries use interest rate swaps, swaptions, and interest rate cap contracts to mitigate these risks.

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RA 16.3 BROOKFIELD (CONTINUED) Other price risk: The major other market risk relates to natural gas prices because they are directly related to the electricity that the company sells. Brookfield enters into derivative contracts to hedge the sale of generated power using forward electricity sale derivatives and natural gas financial contracts. The company also uses equity derivatives to hedge its long-term share-based compensation arrangements. Credit risk: To protect against the non-payment by companies owing money to Brookfield and its subsidiaries, the company uses credit default swaps. Liquidity risk: By managing its exposures to the other risks, Brookfield is also reducing its risk of not being able to generate funds to pay its debts as they come due.

The derivatives used as cash flow hedges can be summarized as follows: • Energy derivatives to hedge the sale of power in the future and fix the cash flows from those sales • Interest rate swaps to hedge, that is, fix, the future cash flows related to their variable rate debt and assets • Equity derivatives to hedge long-term compensation arrangements, so that the cash needed to pay the compensation in the future will be available The net investment hedges are used to manage the company’s foreign currency exposures from its net investment in foreign operations. The derivatives used are: • Foreign exchange contracts and foreign currency denominated debt instruments. By holding net investments in foreign-based corporations, the company is exposed to changes in the value of those investments because of changes in the exchange rates. Changes in the FV of the FX contracts, therefore, will offset changes in the measurement of its net investments due to changes in the currencies.

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MMXXII viii F3

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CHAPTER 17 EARNINGS PER SHARE Learning Objectives 1. Understand why earnings per share (EPS) is an important number and how it should be presented, disclosed, and analyzed. 2. Calculate basic earnings per share. 3. Calculate diluted earnings per share. 4. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.

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Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

BT Item LO

1. 2. 3. 4. 5.

1 1 2 2 2

AP 6. C 7. AP 8. AP 9. AP 10.

2 2 2 2 2

AP 17. AP 18. AP AP

3 3

AP C

7. 2,3 AP 10. 2,3 AP 13. 2,3 8. 2,3 AP 11. 2,3 AP 14. 2,3 9. 2,3 AP 12. 2,3 AP Cases 3. Research and Analysis 4. 5. 6.

AP AP

4. 1,2,3 AP 5. 1 AP 6. 2 AP 2.

1. 2.

AP AP AP AP AP

AP AP C C C

1. 2. 3. 1.

3 3 3 3 4

5. 6. 7. 8.

C AP AP

BT Item LO 21. 22. 23. 24. 25.

1. 2 AP 2. 1,2,4 AP 3. 1,2,3,4 AP 4. 1,2 AP 1,2,3 1,2,4 1,2,3

2 2 2 2

BT Item LO BT Item LO Brief Exercises AP 11. 2 AP 16. 3 AP 12. 3 K 17. 3 AP 13. 3 AP 18. 3 AP 14. 3 AP 19. 2,3 AP 15. 3 AP 20. 3 Exercises AP 9. 3 AP 13. 3 AP 10. 3 AP 14. 3 AP 11. 3 AP 15. 3 AP 12. 3 AP 16. 3 Problems

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

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ASSIGNMENT CLASSIFICATION TABLE Topics

Brief Exercises Exercises Problems

1. General objectives, presentation, disclosure, and analysis.

1, 2

2, 3, 4

1, 2, 3, 4, 5, 9

2. EPS—simple capital structure.

3, 4, 5, 6, 1, 2, 3, 4, 7, 8, 9, 5, 6, 7, 8 10, 11, 17

1, 2, 3, 4, 6, 7, 8, 9, 10, 11, 12, 13, 14

3. EPS—complex capital structure.

12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22

9, 10, 11, 12, 13, 14, 15, 16, 17, 18

1, 3, 4, 7, 8, 9, 10, 11, 12, 13, 14

4. Differences between IFRS and ASPE.

2, 3

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ASSIGNMENT CHARACTERISTICS TABLE Item

Description

E17.1 E17.2 E17.3 E17.4 E17.5 E17.6 E17.7 E17.8 E17.9

Weighted average number of shares Weighted average number of shares EPS—Simple capital structure EPS—Simple capital structure EPS—Simple capital structure EPS—Simple capital structure EPS—Simple capital structure EPS—Simple capital structure EPS with convertible bonds, various situations EPS with convertible bonds EPS with convertible bonds and preferred shares EPS with convertible bonds and preferred shares EPS with convertible bonds and preferred shares EPS with convertible bonds with conversion and preferred shares EPS with convertible bonds and preferred shares EPS with options, various situations EPS with warrants EPS with contingent issuance agreement

E17.10 E17.11 E17.12 E17.13 E17.14 E17.15 E17.16 E17.17 E17.18 P17.1 P17.2 P17.3 P17.4 P17.5 P17.6 P17.7 P17.8 P17.9 P17.10 P17.11 P17.12 P17.13 P17.14

EPS concepts and effect of transactions on EPS EPS—simple capital structure EPS calculation involving put and call options Comprehensive EPS Comprehensive EPS Basic EPS—Two-year presentation Calculation of number of shares for basic and diluted EPS EPS with complex capital structure Comprehensive – using three-step method Comprehensive – using three-step method Simple EPS and EPS with stock options EPS with complex capital structure Comprehensive EPS Comprehensive EPS

Level of Time Difficulty (minutes) Moderate Moderate Simple Simple Simple Simple Simple Simple

15-20 15-25 15-20 20-25 15-20 15-20 20-25 10-15

Complex Moderate

20-25 20-25

Moderate

20-25

Moderate

10-15

Complex

35-40

Complex Moderate

30-35 25-30

Moderate Moderate Simple

20-25 15-20 10-15

Moderate Moderate

25-35 20-30

Moderate Moderate Complex Moderate Moderate

20-25 20-25 30-40 30-35 35-45

Moderate Complex Moderate Moderate Moderate Complex Moderate

30-35 40-45 35-40 30-40 25-35 30-35 25-35

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 17.1 (a) Earnings per share Income from continuing operations ($1,000,000/25,000) $40.00 Loss from discontinued operations, net of tax ($140,000/25,000) (5.60) Net income ($860,000/25,000) $34.40 (b) Common shareholders need to know how much of a company’s available income can be attributed to the shares they own. This helps them assess future dividend payouts and the value of each share. When the income statement presents discontinued operations, earnings per share should be disclosed for income from continuing operations, discontinued operations, and net income. These disclosures make it possible for users of the financial statements to know the specific impact of income from continuing operations on earnings per share, as opposed to a single earnings per share number that also includes the impact of income or loss from operations not expected to continue. LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.2 EPS is a highly visible measurement that is useful in evaluating management stewardship and predicting a company’s future value. Diluted EPS is particularly useful in understanding how currently existing situations may impact the future value of common shares. EPS may also be used in determining the valuation of common shares and in calculating the price earnings ratio. Comparing these measures for East Corporation and West Ltd. will help Rhonda make investment decisions. LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.3

$1,400,000 – (100,000 X $5) = $4.09 per share 220,000 shares

LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.4 $1,400,000 220,000 shares = $6.36 per share LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.5

$1,400,000 – (100,000 X $5) = $4.09 per share 220,000 shares Basic earnings per share would be the same as in BE17.3 because the dividends are deducted, whether declared or not, when the preferred shares are cumulative. This claim of the preferred shareholders must be satisfied prior to any payment of dividends to common shareholders, so these earnings are permanently unavailable to common shareholders. LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.6 Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

Jan. 1 – March 1 March 1 – Sep. 1 Sep. 1 – Dec 31

600,000 750,000 700,000

2/12 6/12 4/12

100,000 375,000 233,333 708,333

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.7

Event

Dates Outstanding

Shares Outstanding

Beginning balance Jan. 1–March 1 42,000 Issued shares March 1–July 1 62,000 Reacquired shares July 1–Dec. 31 52,000 Weighted average number of shares outstanding

Restatement

Fraction of Year

Weighted Shares

1.1 1.1 1.1

2/12 4/12 6/12

Restatement

Fraction of Year

Weighted Shares

3 3 3

2/12 4/12 6/12

21,000 62,000 78,000 161,000

7,700 22,733 28,600 59,033

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.8

Event

Dates Outstanding

Shares Outstanding

Beginning balance Jan. 1–March 1 42,000 Issued shares March 1–July 1 62,000 Reacquired shares July 1–Dec. 31 52,000 Weighted average number of shares outstanding LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.9

Event

Dates Outstanding

Shares Outstanding

Beginning balance Jan. 1–March 1 42,000 Issued shares March 1–July 1 62,000 Reacquired shares July 1–Dec. 31 52,000 Weighted average number of shares outstanding

Restatement

Fraction of Year

.5 .5 .5

2/12 4/12 6/12

Weighted Shares 3,500 10,333 13,000 26,833

LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.10 1.

(500,000 X 4/12) + (550,000 X 8/12) = 533,333

550,000 (The 50,000 shares issued as the stock dividend are assumed outstanding from the beginning of the year.)

LO 2 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.11

Event Beginning balance Issued shares Reacquired shares Stock dividend Issued shares

Dates Outstanding

Shares Outstanding

Restatement

Fraction of Year

Jan. 1–Mar. 1 Mar. 1–Jul. 1 Jul. 1–Oct. 1 Oct. 1–Dec. 1 Dec. 1–Dec. 31

100,000 112,000 107,000 128,400 146,400

1.2 1.2 1.2

2/12 4/12 3/12 2/12 1/12

Weighted average number of shares outstanding—unadjusted Stock split, February 1, 2024 Weighted average number of shares outstanding—adjusted Income per share before discontinued operations ($400,000 + $50,000 = $450,000; ($450,000 ÷ 261,000 shares) Discontinued operations loss per share, net of tax ($50,000 ÷ 261,000) Net income per share ($400,000 ÷ 261,000) LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Weighted Shares 20,000 44,800 32,100 21,400 12,200 130,500 2 261,000

$1.72 (.19) $1.53

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.12 Three-step process Step 1: Determine, for each dilutive security, the incremental per share effect if the security is exercised or converted. Step 2: Where there are multiple dilutive securities, rank the results from the lowest earnings effect per share to the largest; that is, rank the results from the most dilutive to least dilutive. The instruments with the lowest incremental EPS calculation will drag the EPS number down the most and are therefore most dilutive. Step 3: Beginning with the basic earnings per share based on the weighted average number of common shares outstanding, recalculate the earnings per share by adding the most dilutive per share effect from the first step. If the result from this recalculation is less than EPS in the prior step, go to the next most dilutive per share effect and recalculate the earnings per share. This process is continued as long as each recalculated earnings per share amount is smaller than the previous amount. The process will end when a particular security maintains or increases the earnings per share and is antidilutive. LO 3 BT:K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.13

$140,000 120,000 shares = $1.17 per share When common shares will be issued due to mandatory conversion of a financial instrument that is already outstanding, it is assumed that the conversion has already taken place for EPS calculation purposes (IAS 33.23). The numerator is not adjusted for the preferred dividend since it is assumed that they are converted to common shares (thus the preferred dividend is not paid out), and the denominator is presented as if the conversion took place at the beginning of the year, since the mandatorily convertible instrument was outstanding at that time. LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.14 Net income Weighted average number of shares adjusted for dilutive securities (115,000 + 19,0001) Diluted EPS 1 9,500 preferred shares X 2 upon conversion

$700,000 ÷ 134,000 $5.22

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.15 Net income $300,000 Adjustment for interest, net of tax [$80,000 X (1 – .25)] 60,000 Adjusted net income $360,000 Weighted average number of shares adjusted for dilutive securities (100,000 + 26,000) ÷ 126,000 Diluted EPS $2.86 Note: Basic earnings per share is $3.00 ($300,000/100,000). Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.16 Basic earnings per share is $3.00 ($300,000/100,000). Increase in diluted earnings per share numerator: Adjustment for interest, net of tax [$80,000 X (1 – .25)] = $60,000 Increase in diluted earnings per share denominator: Adjustment for dilutive securities = 10,000 Individual EPS calculation: $60,000 / 10,000 = $6.00 > $3.00 It is antidilutive and therefore excluded from the diluted earnings per share calculation. Note: Only one earnings per share number would be presented ($3.00) and it would be labelled as basic and diluted earnings per share. LO 3 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.17 Net income Adjustment for interest, net of tax [$922,685 X 8% X (1 – .30) X 8/12] Adjusted net income Weighted average number of shares adjusted for dilutive securities [900,000 + ($1,000,000 ÷ $1,000 X 120 X 8/12)] Diluted EPS

$550,000 34,447 $584,447

÷ 980,000 $0.60

Note: Basic earnings per share is $0.61 ($550,000/900,000). LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.18 Basic earnings per share is $0.39 ($350,000/900,000). Increase in diluted earnings per share numerator: Adjustment for interest, net of tax $922,685 X 8% X (1 – .30) X 8/12 = $34,447 Increase in diluted earnings per share denominator: Adjustment for dilutive securities $1,000,000 ÷ $1,000 X 120 X 8/12 = 80,000 Individual EPS calculation: $34,447 / 80,000 = $0.43 > $0.39 Antidilutive and therefore excluded from the diluted earnings per share calculation. Note: Only one earnings per share number would be presented ($0.39) and it would be labelled as basic and diluted earnings per share. LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.19 Number of common shares outstanding – basic

300,000

Additional shares – conversion of preferred shares (10,000 X 2 x 6/12)

10,000

Weighted average number of shares – diluted EPS

310,000

LO 2,3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.20 Proceeds from assumed exercise of 45,000 options (45,000 X $10) Shares issued upon exercise Treasury shares purchasable ($450,000 ÷ $15) Incremental shares outstanding (additional potential common shares) Diluted EPS =

$300,000 = 200,000 + 15,000

$450,000 45,000 30,000 15,000 $1.40

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.21 Purchased options will always be antidilutive since they will only be exercised when they are in the money and this will always be favourable to the company. Hence there are no incremental shares outstanding. They are therefore not considered in the calculation of diluted EPS (IAS 33.62). LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.22 Amount needed to buy 25,000 shares under put options (25,000 X $8) Shares issued in market to obtain $200,000 ($200,000 ÷ $7) Number of shares purchased under the put options Incremental shares outstanding (additional potential common shares)

$200,000

28,571 25,000 3,571

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.23 Purchased options will always be antidilutive since they will only be exercised when they are in the money. In this case, Redpath would exercise the option only if the option price were above the market price. They are therefore not included in the calculation of diluted earnings per share (IAS 33.62). LO 3 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 17.24 The put options are not in the money (exercise price < market price) in this case since the exercise price is $6 and the market price is $7. Therefore, these put options would be excluded from the calculation of diluted earnings per share. LO 3 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 17.25 ASPE does not require EPS calculations or disclosures; however, IFRS does require presentation of basic and diluted EPS, as well as EPS related to discontinued operations. If Flory decides to convert to IFRS standards, resources will need to be allocated to this important process. LO 4 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 17.1 a. Event

Dates Outstanding

Shares Outstanding

Beginning balance Jan. 1–April 1 300,000 Issued shares April 1–July 1 330,000 Stock dividend July 1–Nov. 1 363,000 Acquired shares Nov. 1–Dec. 31 353,000 Weighted average number of shares outstanding

Restatement

Fraction of Year

Weighted Shares

1.1 1.1

3/12 3/12 4/12 2/12

82,500 90,750 121,000 58,833 353,083

Restatement

Fraction of Year

Weighted Shares

.1 .1

3/12 3/12 4/12 2/12

7,500 8,250 11,000 3,833 30,583

b. Event

Dates Outstanding

Shares Outstanding

Beginning balance Jan. 1–April 1 300,000 Issued shares April 1–July 1 330,000 Reverse stock split July 1–Nov. 1 33,000 Acquired shares Nov. 1–Dec. 31 23,000 Weighted average number of shares outstanding LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.2 a.

7,150,000 shares Jan. 1, 2022–Sept. 30, 2022 (6,500,000 X 9/12) 4,875,000 Retroactive adjustment for stock dividend X 1.10 Jan. 1, 2022–Sept. 30, 2022, as adjusted 5,362,500 Oct. 1, 2022–Dec. 31, 2022 (6,500,000 X 1.1 X 3/12) 1,787,500 7,150,000 Another way to view this transaction is that the 6,500,000 shares at the beginning of 2022 must be restated for the stock dividend regardless of when during the year the stock dividend occurs.

7,150,000 shares Jan. 1, 2022–Sept. 30, 2022 (6,500,000 X 9/12) 4,875,000 Retroactive adjustment for stock dividend X 1.10 Jan. 1, 2022–Sept. 30, 2022, as adjusted 5,362,500 Oct. 1, 2022–Dec. 31, 2022 (6,500,000 X 1.1 X 3/12) 1,787,500 7,150,000 The weighted average number of common shares to use in calculating earnings per common share for 2022 is the same for the 2022 and 2023 comparative income statements, because the 3for-1 stock split occurred after the 2023 financial statements were issued.

9,025,000 shares Jan. 1, 2023–Mar. 31, 2023 (7,150,000 X 3/12) Apr. 1, 2023–Dec. 31, 2023 (9,650,000 X 9/12)

27,075,000 shares 2023 weighted average number of shares previously calculated Retroactive adjustment for stock split

1,787,500 7,237,500 9,025,000

9,025,000 X 3 27,075,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.2 (CONTINUED) e.

28,950,000 shares Jan. 1, 2024–Mar. 31, 2024 (9,650,000 X 3/12) Retroactive adjustment for stock split Jan. 1, 2024–Mar. 31, 2024, as adjusted Apr. 1, 2024–Dec. 31, 2024(9,650,000 X 3 X 9/12)

2,412,500 X 3 7,237,500 21,712,500 28,950,000

Another way to view this transaction is that the 9,650,000 shares at the beginning of the year must be restated for the stock split regardless of when during the year the stock split occurs. f.

Earnings per common share disclosures help both existing and potential investors determine the amount of income earned by each common share. In calculations of EPS, the weighted average number of shares outstanding provides the basis for the per-share amounts that are reported. When stock dividends or stock splits occur, calculation of the weighted average number of shares requires a restatement of the shares outstanding before the stock dividend or stock split, so that valid comparisons of EPS can be made between periods before and after the stock dividend or stock split. EPS is also used in the calculation of the price earnings ratio (market price of shares / EPS), which compares the market price of the company’s shares with income generated on a per-share basis. Market price of the company’s shares will generally adjust after issuance of a stock dividend or stock split. For calculation of the price earnings ratio to remain valid after a stock dividend or stock split, EPS should also be adjusted in the company’s financial statements to assume that the additional shares were outstanding since the beginning of the year in which the stock dividend or stock split occurred. This helps financial statement users determine the impact of financial transactions on the value of the common shares.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.2 (CONTINUED) g.

If the company was using ASPE, there would be no requirement to calculate EPS, or to report it on the face of the income statement.

LO 1,2,4 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

EXERCISE 17.3 a. Event

Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

Jan. 1 Issued shares Reacquired shares

Jan. 1–May 1 May 1–Oct. 31 Oct. 31– Dec. 31

210,000 218,000

4/12 6/12

70,000 109,000

204,000

2/12

34,000 213,000

b. Income per share before discontinued operations ($229,690 + $40,600 = $270,290; ($270,290 ÷ 213,000 shares) = Discontinued operations loss per share, net of tax ($40,600 ÷ 213,000) Net income per share ($229,690 ÷ 213,000)

$1.27 (.19) $1.08

c. Weighted average number of shares outstanding—unadjusted Stock split, January 31, 2024 Weighted average number of shares outstanding—adjusted Income per share before discontinued operations ($229,690 + $40,600 = $270,290; ($270,290 ÷ 639,000 shares) Discontinued operations loss per share, net of tax ($40,600 ÷ 639,000) Net income per share ($229,690 ÷ 639,000)

213,000 3 639,000 $0.42

(.06) $0.36

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.3 (CONTINUED) d.

Common shareholders need to know how much of a company’s available income can be attributed to the shares they own. This helps them assess future dividend payouts and the value of each share. When the income statement presents discontinued operations, earnings per share should be disclosed for income from continuing operations, discontinued operations, and net income. These disclosures make it possible for users of the financial statements to assess the specific impact of income from continuing operations on earnings per share, as opposed to a single earnings per share number, which also includes the impact of a gain or loss from irregular items.

It is possible to have simple and complex capital structures over different fiscal years of a corporation. For each accounting period a corporation would need to determine whether options, warrants, convertible debt, or convertible preferred shares were outstanding during the fiscal year. Issuance or redemption of such securities would lead to a change in the capital structure from simple to complex or vice versa and this would be reflected in the EPS disclosure.

If the company was using ASPE, there would be no requirement to calculate EPS, or to report it on the face of the income statement.

LO 1,2,3,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.4 a. Dates Outstanding

Shares Outstanding

Fraction of Year

Jan. 1–April 1 200,000 3/12 April 1–July 1 390,000 3/12 July 1–Oct. 1 490,000 3/12 Oct. 1–Dec. 31 530,000 3/12 Weighted average number of shares outstanding

Weighted Shares 50,000 97,500 122,500 132,500 402,500

b. Income before income tax and discontinued operations $680,000 Income tax (30%) 204,000 Income before discontinued operations 476,000 Discontinued operations gain of $97,000, net of applicable income tax of $29,100 67,900 Net income $543,900 c. Earnings per common share: Income before discontinued operations1 Discontinued operations gain net of tax2 Net income3

$1.03 .17 $1.20

$680,000 – income tax of $204,000 – preferred dividends of $60,000 (6% of $1,000,000) = $416,000 (income available to common shareholders) *1$416,000 ÷ 402,500 shares = $1.03 per share (income before discontinued operations gain) 22 $67,900 ÷ 402,500 shares = $.17 per share (discontinued operations gain, net of tax) 3 ($543,900 – $60,000 pref. div) ÷ 402,500 shares = $1.20 per share (net income)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.4 (CONTINUED) d. Weighted average number of shares outstanding— unadjusted Reverse stock split, February 10, 2024 Weighted average number of shares outstanding— adjusted Earnings per common share: Income before discontinued operations1 Discontinued operations gain net of tax2 Net income3

402,500 X 1/2 201,250

$2.06 .34 $2.40

$680,000 – income tax of $204,000 – preferred dividends of $60,000 (6% of $1,000,000) = $416,000 (income available to common shareholders) 1

$416,000 ÷ 201,250 shares = $2.06 per share (rounded to balance net income) (income before discontinued operations gain) 2 $67,900 ÷ 201,250 shares = $.34 per share (discontinued operations gain, net of tax) 3 ($543,900 – $60,000 pref. div) ÷ 201,250 shares = $2.40 per share (net income) e.

Logan is considered to have a simple capital structure because its capital structure does not include securities that could have a dilutive effect by lowering earnings per share. Logan does not have any potential common shares.

LO 1,2 BT: AP Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.5 a. Shares Outstanding

Restatement

Fraction of Year

Weighted Shares

Beginning balance Jan. 1–Feb. 1 580,000 Issued shares Feb. 1–Mar. 1 760,000 Stock dividend Mar. 1–May 1 836,000 Acquired shares May 1–June 1 636,000 Stock split June 1–Oct. 1 1,908,000 Issued shares Oct. 1–Dec. 31 1,968,000 Weighted average number of shares outstanding

1.1 X 3.0 1.1 X 3.0 3.0 3.0

1/12 1/12 2/12 1/12 4/12 3/12

159,500 209,000 418,000 159,000 636,000 492,000 2,073,500

Event

Dates Outstanding

$2,500,000 (Net income)

Earnings Per Share = 2,073,500 (Weighted Average Shares) = $1.21

Earnings Per Share =

$2,500,000 – $800,000 = $0.82 2,073,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.5 (CONTINUED) d.

Income from continuing operationsa Loss from discontinued operationsb (rounded) Net income Net income Add loss from discontinued operations Income from continuing operations a

$1.30 (.09) $1.21 $2,500,000 200,000 $2,700,000

$2,700,000 = $1.30 2,073,500

$(200,000) = $(.09) rounded to balance net income 2,073,500

The earnings process occurs continuously throughout the fiscal year. We must therefore recognize that the income for the year was generated from the capital available throughout the year, rather than the amount of capital from the common shares at any particular point in time. It is necessary to adjust the denominator of the EPS ratio to reflect the length of time during the year that the different amounts of capital from the different number of shares outstanding was available to finance the generation of earnings during the year.

LO 2 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.6 a. Dates Outstanding

Event

Shares Outstanding

Restatement

Fraction of Year

Weighted Shares

2 2 2

4/12 4/12 4/12

433,333 500,000 400,000 1,333,333

Beginning balance Jan. 1–May 1 650,000 Issued shares May 1–Sept. 1 750,000 Reacquired shares Sept. 1–Dec. 31 600,000 Weighted average number of shares outstanding Net income Preferred dividend (50,000 X $100 X 8%) Net income Weighted

applicable

average

to common

$5,500,000 (400,000) $5,100,000 shares

number of shares outstanding

$5,100,000 = 1,333,333 = $3.83

Had the stock split occurred on January 30, 2024, before the financial statements for the year ended December 31, 2023 were issued, the results of the calculation for the earnings per share would remain unchanged, as the effect of the stock split would be applied retroactively to the earliest comparative date for the periods disclosed in the financial statements.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.6 (CONTINUED) c.

If Esau did not declare or pay a preferred dividend in 2023, earnings per share for the year ended December 31, 2023 would remain unchanged at $3.83 (same as calculated in part (a)). This is because the preferred shares are cumulative, and if the dividend is not declared in the current year, an amount equal to the dividend that should have been declared, for the current year only, should be subtracted from net income.

If Esau declared and paid two years of dividends in arrears, along with the current year preferred dividend in 2023, earnings per share for the year ended December 31, 2023 would remain unchanged at $3.83 (same as calculated in part (a)). This is because dividends in arrears for previous years would have been included in the previous years’ calculations.

If the preferred shares are non-cumulative, and the current year preferred dividend was paid in 2023, earnings per share for the year ended December 31, 2023 would still be $3.83 (same as calculated in part (a)).

If the preferred shares are non-cumulative, and no preferred dividend was declared in 2023, earnings per share for the year ended December 31, 2023 would be $4.13 ($5,500,000 / 1,333,333).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.6 (CONTINUED) h.

A stock split (which only increases the number of shares outstanding) will result in a decreased market price per share, making the shares more affordable to the majority of potential investors. A current shareholder will likely favour the company’s declaration of a stock split, because if the company’s shares are made more affordable to the majority of investors, the shareholder’s shares will also be more marketable, and will likely increase in value as a result of the stock split.

LO 2 BT: AP Difficulty: S Time: 20 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.7 a. Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

January 1–April 1 500,000 3/12 April 1–December 31 1,500,000 9/12 Weighted average number of shares outstanding

125,000 1,125,000 1,250,000

b. Income data: Income before discontinued operations $5,000,000 Deduct $4 per share dividend on preferred shares 200,000 Income to common before discontinued operations 4,800,000 Deduct discontinued operations loss, net of tax 400,000 Income available for common shareholders $4,400,000 c. Earnings per common share: Income before loss from discontinued operations1 $3.84 2 Loss from discontinued operations, net of tax (.32) 3 Net income $3.52 1

$4,800,000 ÷ 1,250,000 shares = $3.84 per share (income before discontinued operations loss) 2 $400,000 ÷ 1,250,000 shares = $.32 per share (discontinued operations loss net of tax) 3 $4,400,000 ÷ 1,250,000 shares = $3.52 per share (net income)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.7 (CONTINUED) d. Earnings per common share: Income before loss from discontinued operations4 Loss from discontinued operations, net of tax5 Net income6

Dates Outstanding

Shares Outstanding

Restatement

Fraction of Year

Jan. 1–Apr. 1 500,000 1.1 3/12 Apr. 1–Sep. 1 1,500,000 1.1 5/12 Sep. 1–Dec. 31 1,650,000 4/12 Weighted average number of shares outstanding

$3.49 (.29) $3.20

Weighted Shares 137,500 687,500 550,000 1,375,000

$4,800,000 ÷ 1,375,000 shares = $3.49 per share (income before discontinued operations loss) 5 $400,000 ÷ 1,375,000 shares = $.29 per share (discontinued operations loss net of tax) 6 $4,400,000 ÷ 1,375,000 shares = $3.20 per share (net income) LO 2 BT: AP Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 17.8 a. Event

Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

Beginning balance Issued shares Reacquired shares

Jan. 1–April 1 April 1–Oct. 1 Oct. 1–Dec. 31

900,000 1,450,000 1,140,000

3/12 6/12 3/12

225,000 725,000 285,000

Weighted average number of shares outstanding—unadjusted Stock dividend, February 15, 2024 Weighted average number of shares outstanding—adjusted b. Net income Preferred dividend (280,000 X $50 X 7%)

1,235,000 1.05 1,296,750

$2,130,000 (980,000) $1,150,000

Earnings per share for 2023:

$1,150,000 Net income applicable to common shares Weighted average number of shares outstanding = 1,296,750 = $0.89

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EXERCISE 17.8 (CONTINUED) c.

Dividend arrears on preferred shares of prior years that are paid in the current year do not affect the calculation of earnings per share. The arrears are outstanding as at December 31, 2023, but the earnings per share calculation of the prior year has taken into account the reduction from income of one year’s entitlement for the preferred dividends, whether paid or not. This is the case because the preferred shares are cumulative. The December 31, 2023 notes to the financial statements would reveal, as a subsequent event disclosure, the details of the payment of the dividend arrears along with the declaration of the 5% stock dividend. The note would also mention why the effect of the stock dividend was included retroactively in the calculation of the weighted average number of shares outstanding for 2023.

As stated in (b), the annual dividend entitlement for dividends is taken as a deduction from income in the numerator of the EPS ratio each year (for that year only) whether the dividend is declared or not. The calculation of earnings per share will remain unchanged despite the fact that there are two years of dividend arrears.

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.9 a.

Revenues $75,000 Expenses: Other than interest $40,000 Bond interest ($50,000 X .08) 4,000 44,000 Income before income tax 31,000 Income tax (25%) 7,750 Income available to common shareholders (Net income) $ 23,250

Diluted earnings per share (see note): $23,250 + [(1 – .25) X ($4,000)] = $26,250 = $4.38 1,000 + (50 X 100) 6,000

Revenues Expenses: Other than interest Bond interest (50 X $1,000 X .08 X 3/12) Income before income tax Income tax (25%) Net income

$75,000 $40,000 1,000

41,000 34,000 8,500 $ 25,500

Diluted earnings per share: $25,500 + [(1 – .25) X ($1,000)] = $26,250 = $11.67 1,000 + (50 X 100 X 3/12) 2,250

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.9 (CONTINUED) d.

Revenues Expenses: Other than interest $40,000 Bond interest (50 X $1,000 X .08 X 6/12) 2,000 (40 X $1,000 X .08 X 6/12) 1,600 Income before income tax Income tax (25%) Net income

$75,000

43,600 31,400 7,850 $23,550

Diluted earnings per share (see note): $23,550 + [(1 – .25) X ($3,600)] = $26,250 = $4.38 [1,000 + (1,000 X 1/2)] + [4,000 + (1,000 X 1/2)] 6,000

Note: The answer is the same as (b). In both (b) and (d), the bonds are assumed converted for the entire year. Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. LO 3 BT: AP Difficulty: C Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.10 a.

(1) Number of shares for basic earnings per share. Dates Outstanding

Shares Outstanding

Fraction of Year

Jan.1–April 1 800,000 3/12 Apr.1–Dec. 31 1,200,000 9/12 Weighted average number of shares outstanding

Weighted Shares 200,000 900,000 1,100,000

(2) Number of shares for diluted earnings per share. Dates Outstanding

Shares Outstanding

Fraction of Year

Jan. 1–April 1 800,000 3/12 April 1–July 1 1,200,000 3/12 July 1–Dec. 31 1,224,000* 6/12 Weighted average number of shares outstanding *1,200,000 + [($600,000 ÷ $1,000) X 40]

(1) Earnings for basic earnings per share: After-tax net income (2) Earnings for diluted earnings per share: After-tax net income Add back interest on convertible bonds (net of tax): Interest (Schedule 1) $24,892 Less income tax (30%) 7,468 Total

Weighted Shares 200,000 300,000 612,000 1,112,000

$1,540,000 $1,540,000

17,424 $1,557,424

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.10 (CONTINUED) b. (continued) Schedule 1 – Interest expense calculation: Given that the convertible bonds are compound instruments, the amount of the debt and equity elements must be separated to calculate the interest expense to be added back, after tax, to the net income. The present value of the future cash flows of the bonds at an effective rate of 10% is $497,837, leaving $102,163 to be allocated to the conversion right from the total amount of cash received of $600,000.

Using a financial calculator: PV $ ? Yields $497,837 I 10% N 20 PMT $ (48,000) FV $ (600,000) Type 0

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.10 (CONTINUED) b. (continued) Excel formula: =PV(rate,nper,pmt,fv,type)

Result: $497,837.2354 Rounded: $497,837 The interest expense is therefore $497,837 X 10% X 6/12 = $24,892

[Note to instructor: In this problem, the earnings per share calculated for basic earnings per share is $1.40 ($1,540,000 ÷ 1,100,000) and the diluted earnings per share is $1.40 (technically $1.40056). As a result, only one earnings per share number would be presented and it would be labelled as basic and diluted earnings per share.] LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 17.11 a. Basic EPS: $7,500,000 ÷ 2,000,000 shares = $3.75 b. Potential dilution – if the convertible debentures had been converted on January 2, 2023: Additional income to common: Carrying amount of debentures: Interest expense, 2023: $3,920,000 X 7.2886% = 1 – tax rate (25%) = After-tax interest

$4M X .98 =

$3,920,000 $285,713 X .75 $ 214,285

Additional common shares: $4,000,000/$1,000 = 4,000 debentures Increase in diluted earnings per share denominator: 4,000 X 18 72,000 $214,285 72,000

= $2.98; $2.98 < $3.75 therefore is dilutive

Diluted Earnings per Share: $7,500,000 + $214,285 = $7,714,285 = $3.72 2,000,000 + 72,000 2,072,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.11 (CONTINUED) c.

If the convertible security were preferred shares, basic EPS would be calculated after deducting the preferred share dividend entitlement (for cumulative shares) and the preferred dividends declared (for non-cumulative shares). This would reduce the basic EPS below the amount in part (a) if there were any amount attributed to preferred shareholders. Note that there would be no tax implications on the payment of dividends. Next, the test would be done to see if the conversion of the preferred shares was, in fact, dilutive. If the relationship between the preferred entitlement divided by the increased number of common shares is greater than basic EPS, basic and diluted EPS would be the same number. If the relationship is less than basic EPS, then the numerator for basic would be increased by the preferred entitlement previously deducted. The denominator would be increased above the basic EPS denominator by the additional number of common shares that would be issued on conversion of the preferred shares.

Although the amount of interest is not actually saved immediately, the reduction of the expense decreases the amount of the net loss used in the EPS calculation. The corresponding amount of tax applicable to this savings will also reduce any income tax that is recovered from applying the current year’s loss back to any of the three previous taxable fiscal years or accrued as a future tax from carrying a smaller amount of loss forward. The accounting and tax consequences will be accrued and so the effect on EPS should also be included in the current year. Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the debentures separately.

LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.12 a.

Basic EPS = $200,000 ÷ 100,000 = $2.00 per share If bonds were converted to common: Interest savings (net of tax) ($4,000,000 X 6% X (1–.25)]

$180,000

Additional common shares $4,000,000 ÷ $1,000 = 4,000 bonds X 20 80,000 shares Effect of conversion: $180,000 ÷ 80,000 = $2.25 per additional share ($2.25 > $2.00) Therefore, these bonds would be anti-dilutive. Proof: Net income Add: Interest savings (net of tax) [$4,000,000X 6% X (1–.25)] Adjusted net income

$200,000 180,000 $380,000

Diluted EPS: $380,000 ÷ (100,000 + 80,000) = $2.11 Basic and diluted EPS (both) = $2.00

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.12 (CONTINUED) b.

Basic EPS: Income to common: $200,000 – $120,000* = $80,000 *The preferred shares are cumulative so they are entitled to a 6% dividend ($2 M X 6% = $120,000). Basic EPS: $80,000 ÷ 100,000 = $0.80 Effect of conversion of preferred shares: Additional income to common = $120,000 Additional common shares outstanding Shares assumed to be issued (20,0001 X 5) 1 $2,000,000 ÷ $100

100,000

Effect of conversion: $120,000 ÷ 100,000 = $1.20 per additional share ($1.20 > $0.80) Therefore, the preferred shares would be anti-dilutive. Proof: Income to common for basic EPS Add: dividend savings, if converted Adjusted net income for common

$120,000 80,000 $200,000

Diluted EPS: $200,000 ÷ (100,000 + 100,000) = $1.00 Therefore, both basic and diluted EPS = $0.80

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.13 a. Basic Earnings Per Share Income Dividends on preferred shares ($50,000 X 5%) Basic EPS

Income $400,000

EPS

60,000

$6.63

(2,500) $397,500

b. Step 1: Determine, for each dilutive security, the incremental per share effect if the security is exercised or converted. Individual earnings per share calculations are done for each potentially dilutive security to determine if the securities are in fact dilutive, when compared to basic earnings per share of $6.63. This is often known as an anti-dilutive test. Only dilutive securities will be used in the calculation of diluted earnings per share. The effect of conversion/exercise of each security will be applied to the calculation in the sequence of most dilutive to least dilutive, to arrive at the most diluted earnings per share result. For convertible preferred shares: Dividends avoided from conversion 5% X $50,000 shares = $2,500 divided by 1,000 additional common shares ($50,000 divided by par value $100 X two shares) = $2.50 < $6.63 For 10% convertible bonds: Maturity value Stated rate Interest expense 1 – tax rate (24%) After-tax interest

$100,000 X 10% 10,000 X .76 $ 7,600

$100,000/$1,000 = 100 bonds Increase in diluted earnings per share denominator: 100 X 25 2,500 Individual EPS calculation: $7,600 / 2,500 = $3.04 < $6.63 Solutions Manual 17.44 Chapter 17 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.13 (CONTINUED) b. (continued) Step 2: Rank the results from the lowest earnings effect per share to the largest; that is, rank the results from the most dilutive to least dilutive. Convertible preferred shares: 2.50 < $6.63 — Ranked most dilutive. 10% convertible bonds $3.04 < $6.63 — Ranked less dilutive than the convertible preferred shares. Step 3: Beginning with the basic earnings per share based on the weighted average number of common shares outstanding, recalculate the earnings per share by adding the most dilutive per share effect from the first step. If the result from this recalculation is less than EPS in the prior step, go to the next most dilutive per share effect and recalculate the earnings per share until a security maintains or increases the EPS, and is antidilutive. Diluted Earnings Per Share

Income

Basic Preferred shares

$397,500 2,500 400,000 7,600 $407,600

Bonds Diluted Earnings Per Share

EPS

60,000 1,000 61,000 2,500 63,500

$6.63

EPS

60,000

$6.55

6.56 $6.42

c. Basic Earnings Per Share Income Dividends on preferred shares ($50,000 X 14%)

Income $400,000

Basic EPS

$393,000

(7,000)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.13 (CONTINUED) c. (continued) Step 1: Individual earnings per share calculations are done for each potentially dilutive security to determine if the securities are in fact dilutive, when compared to basic earnings per share of $6.55. Only dilutive securities will be used in the calculation of diluted earnings per share. The effect of conversion/exercise of each security will be applied to the calculation in the sequence of most dilutive to least dilutive, to arrive at the most diluted earnings per share result. For convertible preferred shares: Dividends avoided from conversion 14% X $50,000 shares = $7,000 divided by 1,000 additional common shares ($50,000 divided by par value $100 X two shares) = $7.00 which is > $6.55. Any conversion of preferred shares is anti-dilutive and therefore excluded from the calculation of diluted earnings per share. Step 2: The bonds are dilutive but are the only remaining dilutive security and consequently, no ranking is needed. Step 3: Beginning with the basic earnings per share based upon the weighted average number of common shares outstanding, recalculate the earnings per share. Diluted Earnings Per Share

Income

Basic Bonds Diluted Earnings Per Share

$393,000 7,600 $400,600

Shares 60,000 2,500 62,500

EPS $6.55 $6.41

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. LO 3 BT: AP Difficulty: C Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.14 a.

Number of shares for basic earnings per share. Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

Jan. 1–April 1 60,000 3/12 1 April 1–Dec. 1 61,000 9/12 Weighted average number of shares outstanding

15,000 45,750 60,750

Number of additional common shares issued from the conversion of 40% of the convertible bonds = $100,000 / $1,000 par value X 40% = 40 bonds X 25 common shares based on the conversion ratio = 1,000 common shares b. Basic Earnings Per Share Income Dividends on preferred shares ($50,000 X 5%)

Income $402,2802

Basic EPS

$399,780

EPS

60,750

$6.58

(2,500)

Net income of $400,000 is increased by after-tax cost of interest saved on the 40% conversion of the bonds: $100,000 X 10% X 40% X 9/12 X (1 - 24%) = $2,280 c.

Individual earnings per share calculations are done for each potentially dilutive security to determine if the securities are in fact dilutive, when compared to basic earnings per share of $6.58. Only dilutive securities will be used in the calculation of diluted earnings per share. The effect of conversion/exercise of each security will be applied to the calculation in the sequence of most dilutive to least dilutive, to arrive at the most diluted earnings per share result.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.14 (CONTINUED) c. (continued) For convertible preferred shares: Dividends avoided from conversion 5% X $50,000 shares = $2,500 divided by 1,000 additional common shares ($50,000 divided by par value $100 X two shares) = $2.50 < $6.58 — Ranked most dilutive. For 10% convertible bonds: Maturity value Stated rate Interest expense 1 – tax rate (24%) After-tax interest Less amount saved from 40% conversion Numerator effect

$100,000 X 10% 10,000 X .76 7,600 2,280 $5,320

$100,000/$1,000 = 100 bonds Increase in diluted earnings per share denominator:

100 X 25 2,500

2,500 less number on conversion 750 (1,000 shares X 9/12) = 1,750 Individual EPS calculation: $5,320 / 1,750 = $3.04 < $6.63 Ranked least dilutive. Diluted Earnings Per Share

Income

Basic Preferred shares

$399,780 2,500 402,280 5,320 $407,600

Bonds Diluted Earnings Per Share

Shares 60,750 1,000 61,750 1,750 63,500

EPS $6.58 6.51 $6.42

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EXERCISE 17.14 (CONTINUED) d.

It is not a coincidence that the diluted earnings per share results remain the same, as the calculation of diluted earnings per share is meant to simulate the effect of conversion, answering the question: “What is the worst possible earnings per share?” It should therefore be the same as the actual EPS if all convertible securities are actually converted.

LO 3 BT: AP Difficulty: C Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.15 a.

Basic Earnings Per Share Net Income Dividends on preferred shares ($100,000 X 4%)

Income $50,000

Basic EPS

$46,000

EPS

10,000

$4.60

(4,000)

To determine the dilutive effect of the convertible instruments, an assumption (generally referred to as the if-converted method) is made that all of the convertible instruments (both the bonds and the preferred shares in this case) are converted at the earliest date that they could have been during the year. The effects of this assumption are twofold: (1) if the bonds are converted then there will be no interest expense (thus resulting in more income and income tax expense), and similarly if the preferred shares are converted there will be no preferred dividends paid, and (2) there will be additional common shares outstanding during the year.

c. Step 1: Determine, for each dilutive security, the incremental per share effect if the security is exercised or converted. Individual earnings per share calculations are done for each potentially dilutive security to determine if the securities are in fact dilutive, when compared to basic earnings per share of $4.60. Only dilutive securities will be used in the calculation of diluted earnings per share. The effect of conversion/exercise of each security will be applied to the calculation in the sequence of most dilutive to least dilutive, to arrive at the most diluted earnings per share result.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 17.15 (CONTINUED) c. (continued) For 7% convertible bonds: Maturity value of bonds Stated rate Interest expense 1 – tax rate (25%) After-tax interest that would have been saved

$200,000 X 7% 14,000 X .75 10,500

Increase in diluted earnings per share denominator: 200 X 40 = 8,000 additional shares Individual EPS calculation: $10,500 / 8,000 = $1.31 < $4.60 For convertible preferred shares: Dividends avoided from conversion 4% X $100,000 shares = $4,000 divided by 2,000 additional common shares (1,000 preferred shares X two shares) = $2.00 < $4.60 Step 2: Rank the results from the lowest earnings effect per share to the largest; that is, rank the results from the most dilutive to least dilutive. 1. 7% convertible bonds: $1.31 < $4.60 Ranked most dilutive. 2. Convertible preferred shares: $2.00 < $4.60 — Ranked least dilutive.

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EXERCISE 17.15 (CONTINUED) c. (continued) Step 3: Beginning with the basic earnings per share based upon the weighted average number of common shares outstanding, recalculate the earnings per share. Diluted Earnings Per Share Basic Bonds Preferred shares Diluted Earnings Per Share

Income $46,000 10,500 56,500 4,000 $60,500

Shares 10,000 8,000 18,000 2,000 20,000

EPS $4.60 3.14 $3.03

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately.

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EXERCISE 17.15 (CONTINUED) d.

When Hayward Corporation issued the 7% convertible bonds, the company’s interest rate on straight debt was higher than 7%. The convertible bonds were issued at par, meaning that the market rate of interest on the convertible bonds was equal to the stated rate of interest (7%). The conversion privilege entices the investor to accept a lower interest rate than would normally be the case on a straight debt issue, therefore the market rate of interest on the convertible bonds (7%) would be lower than the company’s interest rate on straight debt at the time of issuance.

LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 17.16 a.

Since the options are “in the money” (i.e., the exercise price is below the average market price), they will be dilutive and, therefore, are included in the calculation of diluted EPS. Diluted Shares assumed issued on exercise Proceeds (1,000 X $20 = $20,000) Treasury shares ($20,000/$25) Incremental shares

1,000 800 200

$150,000 Diluted EPS = 30,000 + 200 = $4.97

Diluted Shares assumed issued on exercise Proceeds = $20,000 Treasury shares ($20,000 / $25)

Incremental shares

1,000 800 200 X 2/12 33

$150,000

Diluted EPS = 30,000 + 33 = $4.99

The put options are not in the money (exercise price < market price) in this case since the exercise price is $15 and the market price is $25. Therefore, these put options would be excluded from the calculation of diluted earnings per share.

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EXERCISE 17.17 a.

The warrants are dilutive because the option price ($10) is less than the average market price ($23).

Basic EPS = $4.80 ($480,000 ÷ 100,000 shares)

Diluted EPS = $4.36 ($480,000 ÷ 110,174 shares) Proceeds from assumed exercise: (18,000 warrants X $10 exercise price) Treasury shares purchasable with proceeds: ($180,000 ÷ $23 average market price) Incremental shares issued: (18,000 shares issued less 7,826 purchased)

$180,000 7,826

10,174

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EXERCISE 17.18 a.

The contingent shares would have to be reflected in diluted earnings per share because the earnings level is currently being attained. Full disclosure of this contingent share issue would be provided in the notes to the financial statements. (IAS33.53)

Because the earnings level is not being currently attained, contingent shares are not included in the calculation of diluted earnings per share. Full disclosure of this contingent share issue would be provided in the notes to the financial statements. (IAS33.53)

If contingently issuable shares are issuable based on predetermined conditions (e.g., profit levels or performance of Paint Pro), they are included in the calculation of basic EPS when the conditions are satisfied. In part (a), the conditions for issuance of additional shares specifically require that Paint Pro achieve a certain level of net income in 2024; however, the level of net income is achieved in 2023, therefore the contingent shares must be included in the 2023 earnings per share calculations. Ultimately, Paint Pro may not achieve the required level of net income in 2024 (in which case, the additional shares would not be issued to Paint Pro’s shareholders in 2025). However, based on 2023 net income, it is probable that Paint Pro will achieve the required level of net income in 2024. Probable issuance of the additional shares is reflected in the 2023 earnings per share calculations, to maintain the relevance (predictive value), and representational faithfulness (neutrality) of the financial statements.

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TIME AND PURPOSE OF PROBLEMS Problem 17.1 Purpose—to provide the student with some familiarity with the applications of GAAP when dealing with earnings per share. The student is required to explain the general concepts of EPS in regard to a specific capitalization structure, and to discuss the proper treatment, if any, that should be given to a list of items in computing earnings per common share for financial statement reporting.

Problem 17.2 Purpose—the student calculates the weighted average number of common shares for computing earnings per share and prepares a comparative income statement including earnings per share data. In addition, the student explains a simple capital structure and the earnings per share presentation for a complex capital structure. The impact of EPS on financial statement analysis, and the differences between IFRS and ASPE are also included.

Problem 17.3 Purpose—to provide the student with some familiarity with the effect of put and call options on the diluted earnings per share calculation. A simple weighted average number of common shares outstanding is also included.

Problem 17.4 Purpose—building on the calculations of Problem 17.3, involving put and call options, the student continues with the same data and must arrive at basic and diluted earnings per share amounts, taking into account additional potentially dilutive securities.

Problem 17.5 Purpose—to provide the student with a comprehensive problem involving the calculation of the weighted average number of shares outstanding, disclosure of EPS for a discontinued operation, and the calculation of basic and diluted EPS. The student must also prepare the bottom portion of the statement of income in proper format, starting with the caption “Income before discontinued operations”.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 17.6 Purpose—to provide the student with an understanding of the proper calculation of the weighted average number of shares outstanding for two consecutive years. The student is also asked to determine whether the capital structure presented is simple or complex. A two-year comparative income statement with appropriate EPS presentation is also required.

Problem 17.7 Purpose—the calculation of the number of shares used to calculate basic and diluted earnings per share is complicated by a stock dividend, a stock split, and several issues of common shares during the year. The student must calculate the numerator for computing basic EPS.

Problem 17.8 Purpose—to provide the student with an understanding of the effect options and convertible bonds have on the calculation of weighted average number of shares outstanding with regard to basic EPS and diluted EPS. Preferred share dividends must also be calculated. Each potentially dilutive security is tested for potential dilution and, if found to be potentially dilutive, is used in most to least descending order, in the calculation of diluted earnings per share.

Problem 17.9 Purpose—to provide the student with a problem with multiple dilutive securities that must be analyzed to calculate basic and diluted EPS. Using the three-step method, the student must rank the potentially dilutive securities in the most to least dilutive order to arrive at the appropriate diluted earnings per share.

Problem 17.10 Purpose—to provide the student with a comprehensive problem with multiple dilutive securities that must be analyzed to calculate basic and diluted EPS using the three-step method. In this problem, a security initially appears to be dilutive but once ranked in the calculation of diluted earnings per share, the security ends up becoming antidilutive and must be excluded in the calculation of diluted earnings per share.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 17.11 Purpose—to provide the student with an understanding of the proper calculation of the weighted average number of shares outstanding during a period plus the procedures utilized in the “treasury stock method” for the calculation of EPS. The student is required to prepare a schedule illustrating the number of common shares outstanding and to calculate the EPS for a situation involving options outstanding since the beginning of the year.

Problem 17.12 Purpose—to provide the student with a problem with multiple dilutive securities that must be analyzed to calculate basic and diluted EPS. Each potentially dilutive security is tested for potential dilution and, if found to be potentially dilutive, is used in most to least descending order in the calculation of diluted earnings per share.

Problem 17.13 Purpose—to provide the student with a comprehensive problem with multiple dilutive securities that must be analyzed to calculate basic and diluted EPS. The student must first calculate the amount of interest expense taking into account a discount on some bonds available for conversion. The student must rank the potentially dilutive securities in the most to least dilutive order to arrive at the appropriate diluted earnings per share. Additional questions in this problem deal with the frequency of dividend payments.

Problem 17.14 Purpose—to provide the student with a comprehensive problem with multiple dilutive securities that must be analyzed to calculate basic and diluted EPS. The student must calculate the weighted average number of shares outstanding and must rank the potentially dilutive securities in the most to least dilutive order to arrive at the appropriate diluted earnings per share.

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Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 17.1 a.

Earnings per share, as it applies to a corporation with a capitalization structure composed of only one class of common shares, is the amount of earnings applicable to each common share outstanding during the period for which the earnings are reported. The calculation of earnings per share should be based on a weighted average of the number of shares outstanding during the period with retroactive recognition given to stock splits or reverse splits and to stock dividends. The calculation should be made for income from continuing operations, income (loss) from discontinued operations, and net income. Disclosure of earnings per share is made on the face of the income statement. Companies that report a discontinued operation must present per share amounts for this line item either on the face of the income statement or in the notes to the financial statements.

Treatments to be given to the listed items in calculating earnings per share are: 1.

Outstanding preferred shares with a par value liquidation right issued at a premium, although affecting the determination of book value per share, will not affect the calculation of earnings per common share except with respect to the dividends as discussed in #4. below.

The exercise of a common stock option results in an increase in the number of shares outstanding, and the calculation of earnings per share should be based on the weighted average number of shares outstanding during the period. The exercise of a stock option by the grantee does not affect earnings, but any compensation expense recorded relating to the granting of the options to the officers would reduce net income and earnings per share.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.1 (CONTINUED) 3.

The replacement of a machine immediately prior to the close of the current fiscal year will not affect the calculation of earnings per share for the year in which the machine is replaced. The number of shares remains unchanged and since the old machine was sold for its carrying amount, earnings are unaffected.

Dividends declared on preferred shares should be deducted from income from continuing operations and net income before computing earnings per share applicable to the common shares and other residual securities. If the preferred shares are cumulative, this adjustment is appropriate whether or not the dividends are declared.

Purchased call options will always be antidilutive for purposes of calculating diluted earnings per share. These options will only be exercised when they are in the money and this will always be favourable to the company. They will therefore be excluded for purpose of the dilution calculation.

Acquiring treasury shares will reduce the weighted average number of shares outstanding used in the EPS denominator.

When the number of common shares outstanding increases as a result of a 2-for-1 stock split during the year, the calculation should be based on twice the number of weighted average shares outstanding prior to the stock split. Retroactive recognition should be given for all prior years presented.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.2 a.

Weighted Average Shares

Total as at June 1, 2022 Issue of September 1, 2022 Total as at May 31, 2023 1.

Before Stock Dividend

After Stock Dividend1

1,000,000 500,000 1,500,000

1,200,000 600,000 1,800,000

May 31, 2024 1,800,000 X 12/12 =

1,800,000

1,200,000 X 3/12 = 1,800,000 X 9/12 = Total, May 31, 2023

300,000 1,350,000 1,650,000

Effect of the stock dividend is reflected in the May 31, 2023 weighted average number of shares for comparative purposes on the 2024 financial statements.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.2 (CONTINUED) b.

LORETTA CORPORATION Comparative Income Statement For the Years Ended May 31,

Income from continuing operations before income tax Income tax Income from continuing operations Loss from discontinued operations, less applicable income tax of $20,000 Net income Earnings per common share Income from continuing operations Loss from discontinued operations, net of tax Net income

2024

2023

$800,000 160,000 640,000

$1,200,000 240,000 960,000

80,000 $560,000

_ $960,000

$0.30

$.52

(0.04) $0.26

_ _ $.52

Weighted average number of shares

2024 $640,000 (100,000) 540,000 1,800,000

2023 $960,000 (100,000) 860,000 1,650,000

Income from continuing operations

$ 0.30

$ .52

Income from continuing operations Preferred dividend (1)

Loss from discontinued operations Weighted average number of shares Discontinued operations loss per share

$(80,000) 1,800,000 $ (0.04)

(1) Preferred dividends = 200,000 X $10 X .05 = $100,000 Solutions Manual 17.63 Chapter 17 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.2 (CONTINUED) Net income – Preferred dividend Weighted average number of shares Net income per share c.

2024 $ 460,000 1,800,000 $ 0.26

A corporation’s capital structure is regarded as simple if it consists only of common shares or includes no potentially dilutive securities. Loretta Corporation has a simple capital structure because it has not issued any convertible securities, warrants, or stock options, and there are no existing rights or securities that have a potentially dilutive effect on its earnings per common share.

A corporation having a complex capital structure would be required to make a dual presentation of earnings per share; i.e., both basic earnings per share and diluted earnings per share. This assumes that the potentially dilutive securities are actually dilutive. The basic earnings per share calculation uses only the weighted average of the common shares outstanding. The diluted earnings per share calculation assumes the conversion or exercise of all potentially dilutive securities.

EPS is useful in assessing management stewardship and predicting a company’s future value. Diluted EPS is particularly useful in understanding how currently existing situations may impact the future value of common shares. EPS may also be used in determining the valuation of common shares and in calculating the price earnings ratio.

IFRS requires the disclosure of basic and diluted earnings per share be made on the face of the income statement. Companies that report a discontinued operation must present per share amounts for this line item either on the face of the income statement or in the notes to the financial statements. ASPE does not have any requirements for calculation or presentation of EPS.

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PROBLEM 17.3 a. Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

Jan. 1 - June 30 July 1 - Dec. 31

1,000,000 1,100,000

6/12 6/12

500,000 550,000 1,050,000

$1,298,678 Basic EPS = 1,050,000 = Proceeds from assumed exercise of 10,000 call options (10,000 X $30)

$1.24

$300,000

Shares issued upon exercise Treasury shares purchasable ($300,000 ÷ $35) Incremental shares Incremental shares pro-rated to 6/12

10,000 8,571 1,429 714

$1,298,678 Diluted EPS = 1,050,000 + 714 =

$1.24

The put options are not in the money since the company would be able to buy the shares at $25, which is lower than the market price of $35. The put options are not included in the calculation of diluted earnings per share. The purchased call options are antidilutive since they will only be exercised when they are in the money and this will always be favourable to the company. They are therefore not included in the calculation of diluted earnings per share.

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PROBLEM 17.3 (CONTINUED) b. (continued) For purposes of calculating the individual earnings per share for the convertible bonds, to decide if there may be further dilution, the bonds are assumed to have been converted January 1, 2023. The income effect would be to add back the after-tax cost of the interest saved of $250,000 and the denominator effect is to increase the number of shares by 50,000 (100,000 shares X 6/12). This yields an EPS of $5.00 ($250,000 / 50,000) which is antidilutive and therefore excluded. c.

Earnings per common share: Basic earnings per share Diluted earnings per share

$1.24 $1.24

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. LO 1,2,3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

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PROBLEM 17.4 a. Basic Earnings Per Share Net Income Dividends on preferred (200,000 X $3) Basic EPS b.

Income $1,298,678

EPS

1,050,000

$0.67

(600,000) $698,678

Diluted Earnings Per Share calculations: For preferred shares: Dividends avoided from conversion $3 X 200,000 shares = $600,000 divided by 100,000 additional common shares pro-rated to 9 months = 75,000 additional shares = $8.00 > $0.67 Antidilutive and therefore excluded from the diluted earnings per share calculation. For 5% convertible bonds: Maturity value (10,000 X $1,000) Stated rate Interest expense 1 – tax rate (30%) After-tax interest

$10,000,000 X 5% 500,000 X .70 $ 350,000

$10,000,000/$1,000 = 10,000 bonds Increase in diluted earnings per share denominator: 10,000 X 9 the most advantageous rate to the holder 90,000 Individual EPS calculation: $350,000 / 90,000 = $3.89 > $0.67 Antidilutive and therefore excluded from the diluted earnings per share calculation.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.4 (CONTINUED) b. (continued) Diluted Earnings Per Share Basic (a) above

Income $698,678

Shares 1,050,000

EPS $0.67

$698,678

714 1,050,714

$0.66

Call options (see P17.3)

Earnings per common share: Basic earnings per share Diluted earnings per share

$0.67 $0.66

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.5 a. Weighted average number of shares: Beginning balance Jan. 1, 450,000 X 7/12 = Balance from July 31, to Dec. 31 600,000 X 5/12 = Total number of common shares to calculate basic earnings per share

262,500 250,000 512,500

b. Basic Earnings Per Share Income from continuing operations Dividends on preferred shares (20,000 X $3.00)

Income $1,300,000

Basic EPS

$1,240,000

EPS

512,500

$2.42

(60,000)

c. Individual earnings per share calculations are done for each potentially dilutive security to determine if securities are in fact dilutive when compared to basic earnings per share of $2.42. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive to arrive at the most diluted earnings per share result. In the ranking of securities, stock options will be used first if they are in the money (exercise price of $3 is below the average market price of $5). The warrants are not in the money as their exercise price of $7 is above the average market price of $5 and they are therefore ignored for purposes of calculating diluted earnings per share.

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PROBLEM 17.5 (CONTINUED) c. (continued) For Options: Use treasury stock method to determine incremental shares outstanding. Proceeds from exercise of options (20,000 X $3)

$60,000

Shares issued upon exercise of options Shares purchasable with proceeds (Proceeds ÷ Average market price) ($60,000 ÷ $5) Incremental shares outstanding For 4% convertible bonds: Maturity value Stated rate Interest expense 1 – tax rate (20%) After-tax interest

20,000

12,000 8,000

$1,000,000 X 4% 40,000 X .80 $ 32,000

$1,000,000/$1,000 = 1,000 bonds Increase in diluted earnings per share denominator: 1,000 X 25 25,000 Individual EPS calculation: $32,000 / 25,000 = $1.28 < $2.42 Diluted Earnings Per Share Basic Options Bonds Diluted Earnings Per Share

Income $1,240,000 1,240,000 32,000 $1,272,000

EPS

512,500 8,000 520,500 25,000 545,500

$2.42 2.38 $2.33

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.5 (CONTINUED) c. (continued) Basic EPS: Income before discontinued operations Discontinued operation loss Net Income Diluted EPS: Income before discontinued operations Discontinued operation loss Net Income 1 (rounded)

Income

EPS

512,500 512,500 512,500

$2.42 (0.39) $2.03

EPS

545,500 545,500 545,500

$2.33 (0.361) $1.97

$1,240,000 (200,000) $1,040,000 Income $1,272,000 (200,000) $1,072,000

d. Partial Income Statement Income from continuing operations Loss from discontinued operations (net of tax recovery) Net Income

$1,300,000 200,000 $1,100,000

Basic earnings per share: Income from continuing operations Discontinued operations loss Net Income

$2.42 (.39) $2.03

Diluted earnings per share: Income from continuing operations Discontinued operations loss Net Income

$2.33 (.36) $1.97

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. LO 1 BT: AP Difficulty: C Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.6 a.

Bryce Corporation has a simple capital structure since it does not have any potentially dilutive securities.

The weighted average number of shares that Bryce Corporation would use in calculating earnings per share for the fiscal years ended May 31, 2023, and May 31, 2024, is 1,600,000 and 2,200,000 respectively, calculated as follows:

2023: Event Beginning bal. New issue

2024: Event Beginning bal. New issue 1

Dates Outstanding

Shares Outstanding

Restatement

Fraction of Year

Weighted Shares

June 1–Oct. 1 Oct. 1–May 31

1,000,000 1,500,000

1.20 1.20

4/12 8/12

400,000 1,200,000 1,600,000

Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

June 1–Dec. 1 Dec. 1–May 31

1,800,0001 2,600,000

6/12 6/12

900,000 1,300,000 2,200,000

1,500,000 X 1.2

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PROBLEM 17.6 (CONTINUED) c. BRYCE CORPORATION Comparative Income Statements For Fiscal Years Ended May 31,

Income from operations Interest expense (1) Income before tax Income tax Income from continuing operations Discontinued operation loss, net of income tax of $180,000 Net income Earnings per share: Income from continuing operations Discontinued operations loss Net income

2023 $1,800,000 240,000 1,560,000 468,000 1,092,000

2024 $2,500,000 240,000 2,260,000 678,000 1,582,000

$ 1,092,000

420,000 $1,162,000

$0.65

$0.69 (0.19) $0.50

= $2,400,000 X .10 = $240,000 2023 a Income from continuing operations $1,092,000 Preferred dividend (2) (60,000) $1,032,000 Weighted average number of shares 1,600,000

2024 $1,582,000 (60,000) $1,522,000 2,200,000

(1) Interest expense

Earnings per share – basic b

$0.65

Discontinued operations loss Weighted average number of shares Weighted average number of shares

(2) Preferred div.

$0.69 $(420,000) 2,200,000 $(0.19)

= (No. of Shares X Par Value X Dividend %) = (20,000 X $50 X .06) = $60,000 per year

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the debt separately. LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 17.73 Chapter 17 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

a b

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PROBLEM 17.7 a.

The number of shares used to calculate basic earnings per share is 4,951,000, as calculated below.

Event

Dates Outstanding

Shares Outstanding

Restatement

Beginning balance, including 5% stock dividend Jan. 1–Apr. 1 2,100,000 2.0 Conversion of preferred shares Apr. 1–July 1 2,520,0001 2.0 Stock split July 1–Aug. 1 5,040,000 Issued shares for building Aug. 1–Nov. 1 5,340,000 Purchase of shares Nov. 1–Dec. 31 5,316,000 Total number of common shares to calculate basic earnings per share 1

Fraction of Year

Weighted Shares

3/12

1,050,000

3/12 1/12

1,260,000 420,000

3/12 2/12

1,335,000 886,000 4,951,000

400,000 shares of preferred stock X 1.05 (factor due to stock dividend) = 420,000 additional common shares

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 17.7 (CONTINUED) b.

The number of shares used to calculate diluted earnings per share is 5,791,000, as shown below. Number of shares to calculate basic earnings per share Convertible preferred shares—still outstanding (300,000 X 2 X 1.05) Convertible preferred shares—converted (400,000 X 2 X 1.05 X 3/12) Number of shares to calculate diluted earnings per share

4,951,000 630,000 210,000 5,791,000

The adjusted net income to be used as the numerator in the basic earnings per share calculation for the year ended December 31, 2023, is $10,350,000, as calculated below: Net income Preferred share dividends March 31 (700,000 X $3.00 X 3/12) $525,000 June 30, September 30, and December 31 (300,000 X $3.00 X 3/12 X 3) 675,000 Adjusted net income

$11,550,000

1,200,000 $10,350,000

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PROBLEM 17.8 The calculation of Camden Pharmaceutical Industries’ basic and diluted earnings per share for the fiscal year ended June 30, 2023, are shown below. a. Basic Earnings Per Share Net Income Dividends on preferred (25,000 X $4.25) Basic EPS

Income $1,500,000 (106,250) $1,393,750

EPS

1,000,000

$1.39

Individual earnings per share calculations are done for each potentially dilutive security to determine if the security is in fact dilutive when compared to basic earnings per share of $1.39. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive to arrive at the most diluted earnings per share result. In the ranking of securities, options will be used first if they are in the money (exercise price of $15 is below the average market price $20). For Options: Use treasury stock method to determine incremental shares outstanding. Proceeds from exercise of options (100,000 X $15) $1,500,000 Shares issued upon exercise of options Shares purchasable with proceeds (Proceeds ÷ Average market price) ($1,500,000 ÷ $20) Incremental shares outstanding

100,000

75,000 25,000

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PROBLEM 17.8 (CONTINUED) a. (continued) For 7% convertible bonds: Maturity value Stated rate Interest expense 1 – tax rate (30%) After-tax interest

$5,000,000 X 7% 350,000 X .70 $ 245,000

$5,000,000 / $1,000 = 5,000 bonds Increase in diluted earnings per share denominator: 5,000 X 50 250,000 Individual EPS calculation: $245,000 / 250,000 = $.98 < $1.39 Diluted Earnings Per Share

Income

EPS

$1,393,750

$1.39

Bonds

1,393,750 245,000

1,000,000 25,000 1,025,000 250,000

Diluted Earnings Per Share

$1,638,750

1,275,000

$1.29

Basic Options

1.36

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PROBLEM 17.8 (CONTINUED) b.

When calculating the interest assumed to have been saved by the conversion of bonds, the amortization of any premium or discount will be taken into account in the calculation. Premium amortization will reduce interest expense while discount amortization will increase interest expense relative to the cash amount of interest paid. Following the adjustment for any premium or discount amortization to the assumed interest savings, income tax must also be applied, before the net savings are added to the net income numerator in the diluted earnings per share ratio calculation. Note that when effective interest amortization of premium or discount is employed, the interest added back is the actual effective interest amount, net of tax, rather than the cash interest paid. Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately.

Preferred dividends were not declared in 2023; however, one year of dividends on the preferred shares was deducted from net income to arrive at net income available to common shareholders. This is because the preferred shares are cumulative, meaning that the annual dividend not paid in any given year must be made up in a later year before any profits can be distributed to common shareholders. If the company has cumulative preferred shares outstanding, the annual dividend is deducted from net income to arrive at net income available to common shareholders, even if the annual dividend is not declared, because common shareholders need to know how much of the company’s available income can be attributed to the shares that they own. Common shareholders refer to earnings per share information to help them assess future dividend payouts and the value of each common share. Therefore, the effect of cumulative dividends on preferred shares is included in basic and diluted earnings per share.

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PROBLEM 17.9 The calculations of Twilight Limited’s basic and diluted earnings per share for the 2023 fiscal year are shown below. a. Basic Earnings Per Share Net Income Dividends on preferred (600,000 x $.68)

Income $2,500,000

Basic EPS

$2,092,000

EPS

3,000,000

$0.70

(408,000)

b. Step 1: Determine, for each dilutive security, the incremental per share effect if the security is exercised or converted. Individual earnings per share calculations are done for each potentially dilutive security to determine if the securities are in fact dilutive when compared to basic earnings per share of $0.70. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive, to arrive at the most diluted earnings per share result. In the ranking of securities, options will be used first if they are in the money (exercise price of $8 is below the average market price of $14). For Options: Use treasury stock method to determine incremental shares outstanding. Proceeds from exercise of options (100,000 X $8) Shares issued upon exercise of options Shares purchasable with proceeds (Proceeds ÷ Average market price) ($800,000 ÷ $14) Incremental shares outstanding

$800,000 100,000

57,143 42,857

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PROBLEM 17.9 (CONTINUED) b. (continued) For 4% convertible bonds: Maturity value Stated rate Interest expense 1 – tax rate (25%) After-tax interest

$2,000,000 X 4% 80,000 X .75 $ 60,000

$2,000,000/$1,000 = 2,000 bonds Increase in diluted earnings per share denominator: 2,000 X 100 200,000 Individual EPS calculation: $60,000 / 200,000 = $0.30 < $0.70 For 6% convertible bonds: Maturity value Stated rate Interest expense – annual Pro-rated to seven months Interest expense 1 – tax rate (25%) After-tax interest

$3,000,000 X 6% 180,000 X 7/12 105,000 X .75 $ 78,750

$3,000,000/$1,000 = 3,000 bonds X 7/12 = 1,750 Increase in diluted earnings per share denominator: 1,750 X 100 175,000 Individual EPS calculation: $78,750 / 175,000 = $0.45 < $0.70 — Ranked third most dilutive. For preferred shares: Dividends avoided from conversion $0.68 X 600,000 shares = $408,000 divided by 600,000 additional common shares (one to one ratio) = $0.68 < $0.70 Solutions Manual 17.80 Chapter 17 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 17.9 (CONTINUED) b. (continued) Step 2: Rank the results from the lowest earnings effect per share to the largest; that is, rank the results from the most dilutive to least dilutive. 1. For options: most dilutive as no numerator effect. 2. For 4% bonds $0.30 < $0.70— Ranked most dilutive after options. 3. For 6% bonds: $0.45 < $0.70— Ranked third most dilutive. 4. For preferred shares: $0.68 < $0.70 — Ranked least dilutive. Step 3: Beginning with the basic earnings per share based on the weighted average number of common shares outstanding, recalculate the earnings per share by adding the most dilutive per share effect from the first step. If the result from this recalculation is less than EPS in the prior step, go to the next most dilutive per share effect and recalculate the earnings per share until a security maintains or increases the EPS, and is antidilutive. Diluted Earnings Per Share Basic (a) above Options 4% bonds 6% bonds Diluted Earnings Per Share Preferred shares

Income $2,092,000 2,092,000 60,000 2,152,000 78,750 2,230,750 408,000 $2,638,750

Shares 3,000,000 42,857 3,042,857 200,000 3,242,857 175,000 3,417,857 600,000 4,017,857

EPS $0.70 0.69 0.66 0.65 $0.66

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PROBLEM 17.9 (CONTINUED) b. (continued) The preferred shares, although initially appearing dilutive, ultimately would cause diluted earnings per share to become greater. The preferred shares are therefore excluded from the diluted earnings per share calculation. Diluted earnings per share remain $0.65. Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. c.

Preferred dividends were not declared in 2023; however, one year of dividends on the convertible preferred shares was deducted from net income to arrive at net income available to common shareholders in calculating basic earnings per share. This is because the convertible preferred shares are cumulative, meaning that the annual dividend not paid in any given year must be made up in a later year before any profits can be distributed to common shareholders. In calculating diluted earnings per share, the effect of converting the convertible preferred shares into common shares was considered (including elimination of the annual preferred share dividend), and it was determined that conversion of the preferred shares would not reduce diluted earnings per share. Therefore, the effect of converting the preferred shares was excluded from the calculation of diluted earnings per share, and the annual preferred share dividend was deducted from net income to arrive at net income available to common shareholders. Common shareholders need to know how much of the company’s available income can be attributed to the shares that they own, and they refer to earnings per share information to help them assess future dividend payouts and the value of each common share. Therefore, the effect of cumulative dividends on convertible preferred shares must be carefully considered in calculating basic and diluted earnings per share.

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PROBLEM 17.9 (CONTINUED)

If diluted EPS was not reported, a potential shareholder would only be presented with basic EPS, which would not reflect the significant adverse effect of conversion or exercise of all potentially dilutive securities. EPS is also used in the calculation of the price earnings ratio (market price per share / EPS), and diluted EPS should be presented on the company’s financial statements to provide a calculation of the diluted EPS for comparison to market price per share.

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PROBLEM 17.10 The calculations of Treeton Inc.’s basic and diluted earnings per share for the 2023 fiscal year are shown below. a. Basic Earnings Per Share Net Income Dividends on preferred (100,000 X $10)

Income $5,000,000

Basic EPS

$4,000,000

EPS

500,000

$8.00

(1,000,000)

b. Step 1: Determine, for each dilutive security, the incremental per share effect if the security is exercised or converted. Individual earnings per share calculations are done for each potentially dilutive security to determine if the security is in fact dilutive when compared to basic earnings per share of $8.00. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive, to arrive at the most diluted earnings per share result. In the ranking of securities, options will be used first if they are in the money (exercise price of $45 is below the average market price of $50). For Options: Use treasury stock method to determine incremental shares outstanding. Proceeds from exercise of options (100,000 X $45) $4,500,000 Shares issued upon exercise of options Shares purchasable with proceeds (Proceeds ÷ Average market price) ($4,500,000 ÷ $50) Incremental shares outstanding

100,000

90,000 10,000

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PROBLEM 17.10 (CONTINUED) b. (continued) For 4% convertible bonds: Maturity value Stated rate Interest expense 1 – tax rate (25%) After-tax interest

$30,000,000 X 4% 1,200,000 X .75 $900,000

$30,000,000/$1,000 = 30,000 bonds Increase in diluted earnings per share denominator: 30,000 X 25 750,000 Individual EPS calc.: $900,000 / 750,000 = $1.20 < $8.00 For preferred shares: Dividends avoided from conversion $10.00 X 100,000 shares = $1,000,000 divided by 150,000 additional common shares (1 to 1.5 ratio) = $6.67 < $8.00 Step 2: Rank the results from the lowest earnings effect per share to the largest; that is, rank the results from the most dilutive to least dilutive. 1. For options: most dilutive as no numerator effect. 2. For 4% bonds $1.20 < $8.00— Ranked most dilutive after options. 3. For preferred shares: $$6.67 < $8.00— Ranked least dilutive.

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PROBLEM 17.10 (CONTINUED) b. (continued)

Step 3: Beginning with the basic earnings per share based on the weighted average number of common shares outstanding, recalculate the earnings per share by adding the most dilutive per share effect from the first step. If the result from this recalculation is less than EPS in the prior step, go to the next most dilutive per share effect and recalculate the earnings per share until a security maintains or increases the EPS, and is antidilutive. Diluted Earnings Per Share Basic (a) above

Income $4,000,000

Shares 500,000

4,000,000 900,000 4,900,000 1,000,000 $5,900,000

10,000 510,000 750,000 1,260,000 150,000 1,410,000

Options 4% bonds Diluted Earnings Per Share Preferred shares

EPS $8.00

7.84 3.89 $4.18

The preferred shares, although initially appearing dilutive, ultimately cause diluted earnings per share to become greater. The preferred shares are therefore excluded from the diluted earnings per share calculation. Diluted earnings per share remains at $3.89.

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. LO 2,3 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 17.11 a.

The controller’s calculations are not correct in that the straight arithmetic average of the common shares outstanding at the beginning and end of the year is used. The weighted average number of shares outstanding should be calculated as follows: Dates Outstanding

Shares Outstanding

Fraction of Year

Weighted Shares

Jan. 1–Oct. 1 Oct. 1–Dec. 1 Dec. 1–Dec. 31

1,285,000 1,035,000 1,200,000

9/12 2/12 1/12

963,750 172,500 100,000

Weighted average number of shares outstanding

1,236,250

Net income for year

$3,374,960

$3,374,960 Earnings per share = = $2.73 1,236,250

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PROBLEM 17.11 (CONTINUED) b.

Basic earnings per share =

$3,374,960 = $2.73 1,236,250

$3,374,960 Diluted earnings per share = = $2.58 1,306,250 Calculation of weighted average number of shares adjusted for dilutive securities Number of shares under options outstanding Option price per share Proceeds upon exercise of options

140,000 X $10 $1,400,000

Shares issued upon exercise of options Market price of common shares: Average $20 Treasury shares that could be repurchased with proceeds ($1,400,000 ÷ $20) Excess of shares under option over treasury shares that could be repurchased (140,000 – 70,000)

140,000

Incremental shares Average number of common shares outstanding Weighted average number of shares adjusted for dilutive securities

70,000 1,236,250

70,000 70,000

1,306,250

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PROBLEM 17.12 The calculations of Polo Limited’s basic and diluted earnings per share for the 2023 fiscal year are shown below. a. Basic Earnings Per Share Net Income Dividends on preferred (4,000,000 X 6%) Basic EPS a.

Income $2,300,000 (240,000) $ 2,060,000

EPS

600,000

$3.43

Individual earnings per share calculations are done for each potentially dilutive security to determine if the security is in fact dilutive when compared to basic earnings per share of $3.43. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive, to arrive at the most diluted earnings per share result. In the ranking of securities, options will be used first if they are in the money (exercise price of $20 is below the average market price of $25). For Options: Use treasury stock method to determine incremental shares outstanding. Proceeds from exercise of options (75,000 X $20) $1,500,000 Shares issued upon exercise of options Shares purchasable with proceeds (Proceeds ÷ Average market price) ($1,500,000 ÷ $25) Incremental shares outstanding (additional potential common shares)

75,000

60,000 15,000

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PROBLEM 17.12 (CONTINUED) b. (continued) For 8% convertible bonds: Maturity value Stated rate Interest expense 1 – tax rate (30%) After-tax interest

$2,000,000 X 8% 160,000 X .70 $ 112,000

$2,000,000 / $1,000 = 2,000 bonds Increase in diluted earnings per share denominator: 2,000 X 30 60,000 Individual EPS calculation: $112,000 / 60,000 = $1.87 < $3.43 — Ranked most dilutive after options. For 6% convertible preferred shares: Dividends avoided from conversion 6% X $4,000,000 = $240,000 divided by ($4,000,000 / $100 par) or 40,000 preferred shares X 3 (one to three ratio) = 120,000 additional common shares = $2.00 < $3.43 — Ranked least dilutive. Diluted Earnings Per Share Basic (part a) Options Bonds Preferred shares

Income $2,060,000 2,060,000 112,000 2,172,000 240,000 $2,412,000

Shares 600,000 15,000 615,000 60,000 675,000 120,000 795,000

EPS $3.43 3.35 3.22 $3.03

Disclaimer: For simplicity, ignore the IFRS requirement to record the debt and equity components of the bonds separately. Solutions Manual 17.90 Chapter 17 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 17.12 (CONTINUED) c.

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PROBLEM 17.13 a.

Interest expense incurred in 2023 Less interest on 10% bonds issued at par ($5,000,000 X 10%) Remaining interest expense on 7.25% bonds

$1,178,200

Basic Earnings Per Share Net Income Dividends on $4.50 preferred (120,000 X $4.50) Dividends on $3.00 preferred (400,000 X $3.00) Basic EPS

EPS

1,700,000

$3.98

500,000 $678,200

Income $8,500,000 (540,000) (1,200,000) $6,760,000

Individual earnings per share calculations are done for each potentially dilutive security to determine if the security is in fact dilutive when compared to basic earnings per share of $3.98. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive, to arrive at the most diluted earnings per share result. For $4.50 convertible preferred shares: Dividends avoided from conversion of $4.50 preferred shares is $540,000 divided by (120,000 X 2) or 240,000 additional common shares = $2.25 < $3.98. — Ranked most dilutive. For $3.00 convertible preferred shares: Dividends avoided from conversion of $3.00 preferred shares is $1,200,000 divided by 400,000 additional common shares = $3.00 < $3.98. — Ranked third most dilutive after the $4.50 convertible preferred shares and the convertible bonds.

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PROBLEM 17.13 (CONTINUED) c. (continued) For 7.25% convertible bonds: Interest expense referred to in part (a) 1 – tax rate (30%) After-tax interest

$678,200 X .70 $ 474,740

$9,000,000/$100 = 90,000 bonds Increase in diluted earnings per share denominator: 90,000 X 2 180,000 Individual EPS calculation: $474,740 / 180,000 = $2.64 < $3.98 — Ranked second most dilutive after the $4.50 convertible preferred shares. d. Diluted Earnings Per Share Basic (part b) $4.50 preferred shares 7.25% bonds $3.00 preferred shares

Income $6,760,000 540,000 7,300,000 474,740 7,774,740 1,200,000 $8,974,740

Shares 1,700,000 240,000 1,940,000 180,000 2,120,000 400,000 2,520,000

EPS $3.98 3.76 3.67 $3.56

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PROBLEM 17.13 (CONTINUED) e.

The splitting of the annual dividend entitlement of both classes of preferred shares into quarters may be preferred by the shareholders. More frequent dividends enhance their cash inflows on investments. In the case of Jackie Enterprises Ltd., neither issuances nor conversions of preferred shares took place during 2023. Consequently, there is no impact on the calculation of diluted earnings per share for the year. Had any conversions taken place, the dividend entitlement would have been reduced proportionately, with a corresponding increase in the number of common shares outstanding from the date of conversion. However, since conversion is assumed to have occurred at the beginning of the year, the diluted EPS amount would not change regardless of when the conversion actually took place.

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PROBLEM 17.14 a. Restatement

Fraction of Year

Weighted Shares

Beginning balance Jan. 1–March 1 90,000 Issued shares March 1–June 1 120,000 Stock dividend June 1–Nov. 1 132,000 Acquired shares Nov. 1–Dec. 31 102,000 Weighted average number of shares outstanding

1.1 1.1

2/12 3/12 5/12 2/12

16,500 33,000 55,000 17,000 121,500

Basic Earnings Per Share Net Income Dividends on 4% preferred ($100,000 X 4%) Basic EPS

EPS

121,500

$1.20

Event

Dates Outstanding

Shares Outstanding

b. Income $150,000 (4,000) $146,000

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PROBLEM 17.14 (CONTINUED) c.

Individual earnings per share calculations are done for each potentially dilutive security to determine if the security is in fact dilutive when compared to basic earnings per share of $1.20. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive, to arrive at the most diluted earnings per share result. For the stock options: The stock options are not in the money and therefore are antidilutive. The exercise price of the options exceeds the average market price of the common shares for the 2023 fiscal year. The options are excluded for purposes of calculating diluted earnings per share. For 4% cumulative convertible preferred shares: Dividends avoided from conversion of 4% preferred shares is $4,000 divided by 15,000 additional common shares = $0.27 < $1.20 — Ranked most dilutive. For 6% convertible bonds: Interest expense 1 – tax rate (30%) After-tax interest

$6,000 X ,70 $4,200

Interest expense avoided from the conversion of the 6% bonds is $4,200 divided by 10,000 additional common shares = $0.42 < $1.20 — Ranked less dilutive than the 4% convertible preferred shares.

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PROBLEM 17.14 (CONTINUED) d. (continued Diluted Earnings Per Share Basic (part b) 4% preferred shares 6% bonds

Income $146,000 4,000 150,000 4,200 $154,200

Shares 121,500 15,000 136,500 10,000 146,500

EPS $1.20 1.10 $1.05

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CASE

Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the back of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 17.1 CANTON PRODUCTS INC. Case Overview Canton Products is a publicly traded company that would like to expand its listing to include the New York and London Stock Exchanges. As a result, IFRS is a constraint. The company is concerned about cash flows, and a declining share price that is negatively affecting the company’s ability to negotiate favourable interest rates with the bank. The share price is being influenced by the dilutive impact of potential common shares related to the outstanding convertible notes. This is driving the share price down and decreasing the company’s ability to borrow money at the lowest rates available. Investors will be concerned about the dilutive impact, while banks will be focused on share price. It is the role of the auditor to be transparent and conservative in reporting, especially given shareholder and investor focus on the dilutive impact of potential common shares.

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CA 17.1 CANTON PRODUCTS INC. (CONTINUED) Analysis and recommendations Issue: Canton needs to determine how to account for new potential common shares related to the new convertible debt issue. The company has exchanged old convertible senior subordinated notes for new ones. The old notes were convertible into 25 shares for each $1,000 note. The new notes have a net share settlement provision on conversion that requires Canton to pay the holders up to $1,000 in cash for each note, plus an excess amount that would be settled in shares at a fixed conversion price, which is 30 shares for each $1,000 note. Calculate DEPS under the ifconverted method - The new notes are similar to the old notes in substance and should be calculated under the “if-converted” method. - This will be dilutive since share price is above conversion price, or in the money. - This should be reviewed to ensure that this exchange was not done solely to manipulate DEPS.

Calculate DEPS under the “treasury stock” method - The new shares essentially contain an embedded option. - Since the share price does not exceed 20% of the conversion price this is not dilutive since the conditions for dilution have not been met.

Conclusion: It is more conservative to include the convertible notes within the DEPS calculation using the if-converted method.

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INTEGRATED CASES IC 17.1 TIZIANA’S FOODS LIMITED Case Overview TFL is currently a public company. Therefore, IFRS is a constraint. However, the company wants to return to being privately held. A private consortium has agreed to provide the funds for the share repurchase if the shares reach a certain trading value. It is not clear if this repurchase is likely or probable at this point. The consortium is a major user of the statements and will want transparency. If the company becomes privately held, it will have the choice to follow IFRS or ASPE. There is a bias by the company to ensure positive financial statement results in order to guarantee that the share price is not negatively affected. The controller will wish to present the company’s financial statements in the best light possible.

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IC 17.1 TIZIANA’S FOODS LIMITED (CONTINUED) Analysis and recommendations Issue: TFL needs to decide how to account for initial upfront deposits received for franchise fees. Most of these stores have not yet opened, but locations have been found. Recognize upfront deposit fees as Recognize upfront deposit revenues once locations are found, fees as revenues later over and deposits have been received time - Under the five-step revenue - Under the five-step model recognition process, there are of revenue recognition, separate performance there is a contract that obligations in the franchise has performance contract. Revenue would be obligations. Within the recognized when the contract there is an performance obligations are overall contract price. The complete. transaction price is to be - If selection of a site location is allocated to the considered a performance performance obligations, obligation, then a portion of the and revenue is to be revenue may be recognized. recognized when the - Research shows that it is highly performance obligations unlikely that losses by stores are complete. In this case, will occur given the choice of the performance location. Therefore, there is little obligations are not risk of loss. complete since the stores - Funds will be deposited in a are not yet open. trust fund by franchisees. This - In addition, the company will help ensure that a deal will has agreed to absorb the go through and that there will first five years of losses. be sufficient funds to run the In this case TFL still has a store. This lowers the overall risk of loss that may risk of franchise failure. eliminate any revenues earned in the current year.

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IC 17.1 TIZIANA’S FOODS LIMITED (CONTINUED) Recommendation: Defer recognition of revenues until the stores open, given that there is too much uncertainty up to that point and performance obligations are not complete.

Issue: TFL has agreed to issue shares to the franchisees if the stores are profitable in the first two years. TFL needs to determine if these additional potential shares for the franchisees should be recorded as part of the cost of sale of the franchise. Record potential shares as a Do not record a cost cost - If probable that stores will - It is too early to tell if the be profitable (and shares will be issued. measurable), TFL should Therefore, this is not record the cost in order to measurable. accurately reflect the - Research may not be selling price of the accurate. franchise. The research indicates that the stores will not suffer losses and franchisees have deposited funds into a trust account to ensure that stores will have sufficient operating capital. - This is more transparent. Recommendation: Do not record the costs yet, given that there is too much uncertainty. However, this must be disclosed in the notes to the financial statements.

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IC 17.1 TIZIANA’S FOODS LIMITED (CONTINUED) Issue: TFL needs to decide if the additional potential shares for the franchisees should be included in the calculation of diluted earnings per share as contingently issuable shares. Include shares in DEPS Do not include shares in DEPS - If probable that stores will - It may be too early to tell if be profitable, then TFL the shares will be issued. should include the shares Therefore, it is not in DEPS in order to include measurable. the impact of issuing - Research may not be shares to franchisees. accurate. Especially since the research shows stores will not suffer losses and franchisees have deposited funds, helping to ensure that stores will have sufficient operating capital. - This is more transparent. Recommendation: Do not include the shares in the DEPS calculation yet. There is too much uncertainty.

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IC 17.1 TIZIANA’S FOODS LIMITED (CONTINUED) Issue: TFL issues long term debt that is convertible into common shares. If the company goes private, it has agreed to repay 120% of the face value of the debt. Record as part debt and part Record as all debt and measure equity at either 100% or 120% - This would result in a - Ignoring the contingency compound instrument— related to going private, part debt and part equity. the conversion feature - The economic substance results in the company that provides the right to paying a variable number convert the debt to shares of shares. Therefore, this adds extra value. The is a debt instrument. TFL embedded call option will either repay the debt in should be accounted for cash or issue a variable separately. number of shares to make - This is more transparent. up the face value. - TFL is currently only - If the company goes thinking of going private. private, the debt is This is not necessarily automatically repayable at likely or probable at this 120%. stage. The company would - The extra premium is not only measure this as all payable until a decision is debt where the made to privatize the contingency is beyond company, and this has not control of company. yet happened. However, this is not the case since TFL has the final decision as to whether to go private or not.

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IC 17.1 TIZIANA’S FOODS LIMITED (CONTINUED) Recommendation: Record the debt as a liability since there is a contractual obligation to pay either cash or a variable number of shares. TFL should include full note disclosure and calculate and disclose diluted earnings per share.

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RESEARCH AND ANALYSIS RA 17.1 AIR CANADA a.

In note 15, the company provides the details of its calculations of basic and diluted earnings per share as follows:

Numerator Net Income Effect of convertible notes Remove anti-dilutive impact Adjusted numerator for diluted earnings (loss) per share Denominator Weighted -average shares Effect of potential dilutive securities Stock options Convertible notes Total potential dilutive securities Remove anti-dilutive impact Adjusted denominator for dilutive earnings (loss) per share Basic earnings (loss) per share Diluted earnings (loss) per share

2020 (millions)

2019 (millions)

($4,647) 216 (216) (4,647)

$1,476 0 0 1,476

282

268

1 28 29 (29) 282

4 0 4 0 272

($16.47) ($16.47)

$5.51 $5.44

In 2020 the basic earnings per share and diluted earnings per share are equal, and negative given the loss experienced by the company in that fiscal year. In 2019, there is a difference between basic and diluted earnings per share. Note 13 does provide detail about the share capital of Air Canada, but does not provide a calculation of the weighted average common shares. This amount is simply stated in Note 15. Notes 9 and 14 contain information about the convertible notes and stock options (respectively) that Air Canada has.

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RA 17.1 AIR CANADA (CONTINUED) b.

Note 15 states that the calculation of diluted earnings per share excludes outstanding options where the option exercise price was greater than the average market price. In order to be considered in the calculation of diluted earnings per share, the security must be dilutive. Options are only dilutive if they are considered to be “in the money”, where we can safely assume that a rational holder would exercise their right and subsequently have shares issued that would dilute the entity. Options that are not “in the money” would not be exercised by the holder as there would be a financial loss in doing so.

One main difference is the loss in 2020 compared to profit in 2019. However, the key difference in the calculation of diluted earnings per share between the two years is that in 2020 Air Canada had convertible notes that needed to be considered in the calculation whereas in 2019, it did not. In 2020 table, Air Canada included $216 million in the calculation of diluted earnings per share (interest cost savings if converted into equity), but then removed the amount on the next line as it was determined to be anti-dilutive. The individual calculation of this assessment was not included; however, a security must be disclosed as anti-dilutive if that is the case. This information is found in the numerator section of the calculation. In addition to this, under the denominator section, the convertible notes are highlighted again but this time as it relates to its effect on the weighted average common shares. If exercised, these convertible notes would have added 28 million shares to the weighted average common shares of the firm for 2020. Since these convertible notes would have been anti-dilutive as described already, the amount was removed. In 2019 section of the table, the denominator shows 4 million shares related to stock options considered as dilutive. In 2020, the 1 million identified was considered anti-dilutive as this amount was added into the “remove antidilutive impact” line on the table.

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RA 17.2 MOLSON COORS BREWING COMPANY a.

The company provides the following earnings per share information, in US$ per share on the face of its income statement.

Basic net income per share

2020 $(4.38)

2019 $1.12

Diluted net income per share

$(4.38)

$1.11

The company also shows the weighted-average shares outstanding (in millions): 2020 2019 Basic 216.8 216.6 Dilutive effect of share-based awards 0 0.3 Diluted 216.8 216.9 The company also provides disclosure at the bottom of the income statement to explain that anti-dilutive securities are excluded from computation of diluted EPS. b.

The company has a complex capital structure. This is evident from the fact that diluted earnings per share are reported on the statement of operations. In reviewing the consolidated balance sheet and the stockholders’ equity note 8, the company has the following types of authorized, issued, and outstanding shares: • • •

Preferred stock, at US$0.01 par value (although there are 25.0 million shares authorized, none have been issued) Class A and Class B common shares, both at US$0.01 par value No par value Class A Exchangeable and no par value Class B Exchangeable shares which can be converted at any time, at the holder’s option, into the corresponding common shares on a one-for-one basis.

As outlined in Note 8, the Class A and Class B and the Class A Exchangeable and Class B Exchangeable all have the same dividend rights and share equitably in the undistributed earnings. Consequently, the number of all these shares that are issued and outstanding are added together to determine the number outstanding for basic EPS, taking into consideration the weighting of changes made in the numbers during the year.

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RA 17.2 MOLSON COORS BREWING COMPANY (CONTINUED) b. (Continued) The company discloses 216.8 million weighted average shares in the consolidated statement of operations for 2020 and 216.9 million for 2019. Based on the following table, the weighted average number of shares used for basic EPS appears reasonable. Number of shares – in millions Class A Class B Class A exchangeable Class B exchangeable Treasury shares Shares outstanding, December 31 Weighted average number used for basic EPS in the financial statements

2020

2019 2.6 209.8 2.7 11.1 (9.5) 216.7

2.6 205.7 2.7 14.8 (9.5) 216.3

216.8

216.9

In 2020, the company exchanged 3.7 million shares of the Class B shares for common stock. However, this would have a nil effect on the calculation of total weighted average common shares. c.

As explained in Note 13, the company has only one share-based compensation plan; the MCBC Incentive Compensation Plan. Awards issued, related to Class B common stock, include RSUs, DSUs, PSUs, and stock options. RSUs are Restricted Stock Units; DSUs are Deferred Stock Units; and PSUs are Performance Share Units. Stock options may or may not have a dilutive effect on EPS. See part (d) for diluted earnings per share data.

As detailed on the consolidated statements of operations and supported in Notes 8 and 13, the company indicates that there are securities that had an anti-dilutive effect on earnings per share, but other than indicating how many share-based payments were awarded, there is no detail about which securities specifically are anti-dilutive. In millions of shares Weighted-average shares for basic EPS Dilutive effect of share-based awards Weighted-average shares for diluted EPS Anti-dilutive securities excluded from computation of diluted EPS

2020 216.8 0 216.8 2.7

2019 216.6 0.3 216.9 1.3

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RA 17.3 NON-GAAP FINANCIAL MEASURES a.

The pros of allowing alternate per share amounts to be included in the annual financial statements of companies are that such amounts may provide additional information that is useful to investors and other financial statement users. The practice of reporting cash flow per share in the financial statements was long established and well accepted in Canada, and many felt that discontinuing this practice was a disservice to financial statement users. Some argued that this would result in a loss of information, and others argued that it would result in less reliable information since it was likely that cash flow per share data would instead be reported elsewhere in the annual report where it would be unaudited and therefore less reliable. Other types of per share data that could be provided are operating earnings per share, assets per share, and equity per share. As long as the note disclosure provides the details of how the numerator and denominator are determined, this could provide useful information to shareholders. The cons of allowing alternate per share amounts to be included in the financial statements of companies are that there is a risk that such data will be used in place of earnings per share, which is a much more conceptually sound measure. Cash flow, in any of its various definitions, is not a residual amount and does not accrue to the common shareholder, which makes it conceptually weak when expressing an amount on a per share basis. There is also a problem with determining what cash flow amount to use as the numerator. There are many different practices for both calculation and presentation, and this lack of standardization can hinder comparability among financial statements and be potentially misleading to users. Analysts may not support the disclosure of other per share amounts mainly due to the lack of agreement on the numerator and the lack of conceptual basis for this measure.

Arguments to support comprehensive income per share: • As the accounting standards now define “income” to include other comprehensive income items such as unrealized gains and losses, conceptually, there is support for the disclosure of comprehensive income per share. • The current standards could easily be applied to comprehensive income, with few changes required. • Company share prices should recognize the effects of other comprehensive income items, so per share data could be used to properly reflect price-earnings multiples.

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RA 17.3 NON-GAAP FINANCIAL MEASURES (CONTINUED) b. (continued) •

The IASB is still studying ways in which they can conceptually differentiate between items that belong in net income (or profit) and those that belong below the line in OCI. To the extent that such conceptual differences cannot be clearly provided, users may find that EPS based on comprehensive income is a preferred indicator.

Arguments to support not reporting comprehensive income per share: • Other comprehensive income items relate to unrealized gains and losses that are not yet recognized as part of profit or loss for specific reasons. As the impact of these items on profit or loss will likely change once recognized, it would be premature to include them in a per share measure. In fact, there are some items that affect OCI but will or may never impact earnings such as revaluation surpluses and actuarial gains and losses on pensions. • How would comprehensive income per share be calculated – is it possible to eliminate some OCI items? What would be the treatment, for example, of revaluation surpluses and actuarial gains and losses? As noted above, these items will or may never impact profit or loss, so should they be eliminated in the calculation of comprehensive income per share? • Companies in similar industries may have very different other comprehensive income items depending on their involvement in hedging, foreign subsidiaries, and the accounting policies adopted for property, plant, and equipment, and pension plans. These differences could have a significant effect on per share calculations that have very little to do with operating profit. Consequently, when price-earnings multiples are calculated and compared, there might be significant differences, even when operations are very similar.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 17.3 NON-GAAP FINANCIAL MEASURES (CONTINUED) c. The Canadian Securities Administrators (CSA) defines a non-GAAP financial measure as one that “(a) depicts the historical or expected future financial performance, financial position or cash flow of an entity, (b) with respect to its composition, excludes an amount that is included in, or includes an amount that is excluded from, the composition of the most directly comparable financial measure disclosed in the primary financial statements of the entity, (c) is not disclosed in the financial statements of the entity, and (d) is not a ratio, fraction, percentage or similar representation…”. Such measures are often disclosed and discussed in press releases, management discussion and analysis documents, prospectus and marketing materials and on the company website. The CSA explain that their concern is that such disclosures might be misleading or confusing to users, especially where they are displayed more prominently than similar and related GAAP measures. The CSA Notice indicates a number of things an issuer must do to ensure investors are not misled, before it can include non-GAAP financial measures. This is broken out between historical and forward-looking information, with an excerpt provided below from the disclosure document. Non-GAAP financial measures that are historical information: •

An issuer must not disclose a non-GAAP financial measure that is historical information in a document unless certain conditions are met o (a) the non-GAAP financial measure is labelled using a term that ▪ (i) given the measure’s composition, describes the measure, and ▪ (ii) distinguishes the measure from totals, subtotals and line items disclosed in the primary financial statements of the entity to which the measure relates o (b) the non-GAAP financial measure is identified as a non-GAAP financial measure; o (c) the document discloses the most directly comparable financial measure that is disclosed in the primary financial statements of the entity to which the measure relates; o (d) the non-GAAP financial measure is presented with no more prominence in the document than that of the most directly comparable financial measure referred to in paragraph (c); o (e) in proximity to the first instance of the non-GAAP financial measure in the document, the document

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RA 17.3 NON-GAAP FINANCIAL MEASURES (CONTINUED) ▪

•

(i) explains that the non-GAAP financial measure is not a standardized financial measure under the financial reporting framework used to prepare the financial statements of the entity to which the measure relates and might not be comparable to similar financial measures disclosed by other issuers, ▪ (ii) discloses, directly or by incorporating it by reference as permitted under section 5, • (A) an explanation of the composition of the nonGAAP financial measure, • (B) an explanation of how the non-GAAP financial measure provides useful information to an investor and explains the additional purposes, if any, for which management uses the non-GAAP financial measure, • (C) a quantitative reconciliation of the non-GAAP financial measure for its current and comparative period, if disclosed under paragraph (f), to the most directly comparable financial measure referred to in paragraph (c), and that reconciliation is disclosed in the permitted format, and • (D) if the label or composition of the non-GAAP financial measure has changed from what was previously disclosed, an explanation of the reason for the change; o (f) if the non-GAAP financial measure is disclosed in MD&A or in an earnings release of the issuer, the non-GAAP financial measure for a comparative period, determined using the same composition, is disclosed in the document, unless it is impracticable to do so. For the purpose of clause (1)(e)(ii)(C), a quantitative reconciliation of the non-GAAP financial measure is in the “permitted format” if it o (a) is disaggregated quantitatively in a way that would enable a reasonable person applying a reasonable effort to understand the reconciling items, o (b) explains each reconciling item, and (c) does not describe a reconciling item as “non-recurring”, “infrequent”, “unusual”, or using a similar term, if a loss or gain of a similar nature is reasonably likely to occur within the entity’s 2 financial years that immediately follow the disclosure, or has occurred during the entity’s 2 financial years that immediately precede the disclosure.

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RA 17.3 NON-GAAP FINANCIAL MEASURES (CONTINUED) Non-GAAP financial measures that are forward-looking information: ▪ In this section, “equivalent historical non-GAAP financial measure” means a non-GAAP financial measure that is historical information and has the same composition as a non-GAAP financial measure that is forward-looking information; “SEC issuer” has the meaning ascribed to it in National Instrument 52-107 Acceptable Accounting Principles and Auditing Standards. ▪ An issuer must not disclose a non-GAAP financial measure that is forwardlooking information in a document unless all of the following apply: o (a) the document discloses an equivalent historical non-GAAP financial measure; o (b) the non-GAAP financial measure that is forward-looking information is labelled using the same label used for the equivalent historical non-GAAP financial measure; o (c) the non-GAAP financial measure that is forward-looking information is presented with no more prominence in the document than that of the equivalent historical non-GAAP financial measure; o (d) in proximity to the first instance of the non-GAAP financial measure that is forward-looking information in the document, the document discloses, directly or by incorporating it by reference as permitted under section 5, a description of any significant difference between the non-GAAP financial measure that is forward-looking information and the equivalent historical non-GAAP financial measure. ▪ Subsection (2) does not apply if the disclosure is made o (a) by an SEC issuer, and o (b) in compliance with Regulation G under the 1934 Act. d.

Canadian Pacific Railway Limited is a good example of a company that reports a non-GAAP earnings per share measure, as well as other non-GAAP measures as part of its earnings releases, but outside of its quarterly financial statements, complying well with the requirements of CSA Staff Notice 52-306 (revised): • Adjusted diluted earnings per share • Adjusted operating income • Adjusted net income • Adjusted operating ratio • Adjusted return on average shareholders’ equity • Free cash • Foreign exchange adjusted variance • Adjusted dividend payout ratio • Adjusted net debt to net income ratio

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RA 17.4 BCE INC. a.

The company provides per share data on the following: • Basic earnings per share on earnings attributable to common shareholders, and • Diluted earnings per share on earnings attributable to common shareholders. These are reported as basic net earnings per common share, and diluted net earnings per common share. As can been seen in the table below, basic and diluted earnings per share are equal and reported together as basic and diluted. As per Note 11, in 2020 there is only 0.1 million of assumed exercised stock options (0.6 million in 2019) added to weighted average common shares which has a negligible affect on the calculation of diluted EPS.

Basic and diluted net earnings per share from continuing operations from discontinued operations Basic and diluted net earnings per common share b.

2020

2019

$2.51 $0.25 $2.76

$3.34 $0.03 $3.37

As reflected in Note 29, the company has First Preferred shares outstanding from Series Q to AR. The dividend rates vary from using floating to fixed rates varying from a low of 2.75% to a high of 4.812%. The dividends are all cumulative. The company also has voting common shares outstanding. In 2020, total dividends declared amounted to $3,147 million (statement of changes in equity) and dividends paid to preferred shareholders of $132 million and to common shareholders of $2,975 (statement of cash flows) for a total of $3,107. The statement of cash flows also discloses cash dividends paid by subsidiaries to non-controlling interests of $53.

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RA 17.4 BCE INC. (CONTINUED) b. (Continued) The difference is reconciled in Note 31 – Additional cash flow information: Dividends payable, January 1, 2020 Cash flows from (used in) financing activities: Cash dividends paid on common and preferred shares Cash dividends paid by subsidiaries to non-controlling interests Total cash flows from (used in) financing activities excluding equity Dividends declared on common and preferred shares Dividends declared by subsidiaries to non-controlling interests Other Total non-cash changes Dividends payable, December 31, 2020

$729 (3,107) (53) (3,160) 3,147 53 (3) 3,197 $766

c. In millions of CDN. $ Net earnings Net earnings attributable to preferred shares (dividends declared) Earnings attributable to non-controlling interest Earnings attributable to common shareholders (i.e., of BCE)

2020 2,699

2019 3,253

(136)

(151)

(65)

(62)

2,498

3,040

The adjustments relate to two different interests: to the dividends declared on the preferred shares, and to the non-controlling interest. The preferred entitlement to earnings in the year must be deducted in order to determine the earnings that are available to common shareholders because the preferred, as the name suggests, have a preferential interest. Secondly, because part of the equity reported on the statement of financial position refers to the equity in the common shares of BCE’s subsidiary companies held by non-controlling shareholders of the subsidiaries, their entitlement must also be deducted in order to determine what the equity in net earnings is for the BCE common shareholders.

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RA 17.4 BCE INC. (CONTINUED) d. The tables below attempt to reconcile the weighted average number of shares for the two years for basic EPS (information from Note 29). In thousands of shares Actual shares outstanding Opening number of shares Shares issued under employee stock option plan Shares issued under deferred share plan (DSP) Shares issued under employee share plan (ESP) Ending number of shares

2020

2019

903,908

898,200

507

4,460

904,415

1,231 903,908

Calculation of weighted average number of shares outstanding 2020 Unweighted Weighted

January 1 to June 30 (X 6/12) Issued for stock option plan

903,908 507

451,954

June 30 to December 31 (X 6/12) Weighted average number calculated Weighted average number (Note 11) used in basic EPS calculations

904,415

452,208 904,162

904,300

The calculated weighted average above assumed the shares issued under the stock option plan were issued evenly over the year and were, therefore, outstanding for only half the year. The above assumptions appear reasonable because the weighted average number of shares calculated is similar to the actual weighted average number of shares used by the company (only 138 share variance) with any difference explained by increasing the proportion of the 2020 year the additional shares issued were outstanding.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 17.4 BCE INC. (CONTINUED) Calculation of weighted average number of shares outstanding 2019 Unweighted Weighted January 1 to June 30 (X 6/12) 898,200 449,100 Issued for stock option plan 4,460 Issued under DSP 17 Issued under ESP 1,231 June 30 to December 31 (X 6/12) 903,908 451,954 Weighted average number calculated 901,054 Weighted average number (Note 11) used in basic EPS calculations 900,800 For 2019, the same assumptions were made as for 2020. The weighted average number of shares calculated above again comes close to the numbers actually used by the company in Note 11. There is only a 254 share variance, with any difference being explained by increasing the proportion of the 2019 year the additional shares issued were outstanding.

As indicated in Note 11 on EPS, the assumed exercise of options has caused a dilutive effect: an additional .1 million shares in 2020 were added to the basic number of 904.3 million, and an additional .6 million shares in 2019 were added to the basic number of 900.8 million. The diluted EPS includes only the options that would be exercised for shares at a price lower than the average market price for the year (i.e., if they were “in the money”). All other options have been excluded on the basis that they would be anti-dilutive. That is, the exercise price was greater than the average market price for the year so that the company could buy back and reduce the number of outstanding shares with the proceeds received. The number of options that have been excluded were 10,783,936 in 2020 and 61,170 in 2019.

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Intermediate Accounting, Thirteenth Canadian Edition

TASK-BASED SIMULATION AND CUMULATIVE COVERAGE: CHAPTERS 16 and 17 Part A – Basic Earnings per Share

Net Income Available to C/S Weighted average number of Shares Basic EPS

$332,552 791,667 $ 0.42

Net income Dividends – Cum.Pref. Dividends - Non-Cum NI Available to C/S

482,552 (150,000) ______0_ 332,552

Beginning Beginning amount Reacquired Issued

Issued

Reacquired

Ending

Months

100,000

750,000 650,000 1,000,000

3/12 5/12 4/12

750,000 350,000

Weighted Shares 187,500 270,833 333,334 791,667

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Intermediate Accounting, Thirteenth Canadian Edition

TASK-BASED SIMULATION AND CUMULATIVE COVERAGE (CONTINUED) Part B – Diluted Earnings per Share Net Income Available to Common Shareholders

Weighted Average Number of Shares Outstanding

Basic NI Available to C/S Add: Preferred share dividend Interest on Convertible Bond, net of taxes Diluted NI Available to C/S

Basic weighted average Common Shares O/S Add: Convertible bond common shares Convertible preferred shares Stock options Diluted W-A Common Shares O/S

$332,552 0 0 (note 1) $332,552

Treasury Stock Method Proceeds from the exercise of 10,000 options (10,000 x 20) Shares issued upon exercise of options Treasury shares purchasable with proceeds ($200,000 / $30) Incremental shares outstanding (additional potential common shares) Diluted EPS

$0.26 ($332,552 / 1,295,000)

791,667 0 500,000 3,333 1,295,000

$200,000 10,000 6,667

3,333

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Intermediate Accounting, Thirteenth Canadian Edition

TASK-BASED SIMULATION AND CUMULATIVE COVERAGE (CONTINUED) Part B (continued) Note 1 – the convertible bond is anti-dilutive, and should be excluded Incremental Impact of Preferred Shares Dividend paid on the non-cumulative preferred shares $0 (no dividend paid) Income tax effect $0 (dividends are not tax deductible) Dividend payment avoided $0 Number of common shares issued, assuming conversion Per share effect: Incremental numerator effect: Incremental denominator effect: Total impact

500,000

$0 500,000 shares $0.00

Therefore, potentially dilutive. Incremental Impact of Convertible Bond Interest expense for the year Income tax effect Interest expense avoided (net of tax)

$8,688 2,172 $6,516

Number of common shares issued, assuming conversion Per share effect: Incremental numerator effect: Incremental denominator effect: Total impact

2,000

$6,516 2,000 shares $3.26 which is greater than basic EPS $0.42, so anti-dilutive

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TASK-BASED SIMULATION AND CUMULATIVE COVERAGE (CONTINUED) Part C – Stock Options Increase Change the term to four years

No impact

Not Determinable

Change the exercise price to $30 Change the riskfree rate to 5% Increase the assumed volatility of the company’s share price Issue Class C preferred shares, with noncumulative dividends

Decrease

X X X

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Intermediate Accounting, Thirteenth Canadian Edition

TASK-BASED SIMULATION AND CUMULATIVE COVERAGE (CONTINUED) Part D – Class A Preferred Shares Increase

Decrease

No impact

Change dividend to noncumulative dividend assuming that dividend is regularly paid

Make shares convertible into 200,000 common shares Change the dividend per share to $3 per share

Not Determinable

X X

Part E – Convertible Bond Retirement 1)

Bonds Payable Contributed Surplus – Conversion Rights Loss on Redemption of Bonds1 Retained Earnings2 Cash 1($145,990 – $152,500) 2 ($6,319 - $8,500)

145,990 6,319 6,510 2,181 161,000

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TASK-BASED SIMULATION AND CUMULATIVE COVERAGE (CONTINUED) Part E (continued) 2) Increase Basic EPS Net income available to common shareholders Weighted average shares outstanding Diluted EPS Net income available to common shareholders Weighted average shares outstanding

Decrease

No Impact

Not Determinable

X X

(antidilutive) X

For the impact on diluted EPS in future years of retiring the bond, the impact on Net income available to common shareholders could be either “not determinable” or “increase”. It would be “increase” if the retirement of the bonds means a higher net income because there is no longer any interest expense. Students could also answer “not determinable” because the use of company assets to retire the bonds could also indicate a loss of revenues that would cancel out the interest savings.

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Intermediate Accounting, Thirteenth Canadian Edition

MMXXII vii F2

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Intermediate Accounting, Thirteenth Canadian Edition

CHAPTER 18 INCOME TAXES Learning Objectives 1. Understand the importance of income taxes from a business perspective. 2. Explain the difference between accounting income and taxable income, and calculate taxable income and current income taxes. 3. Explain taxable and deductible temporary differences , determine their amounts, and calculate deferred tax liabilities and deferred tax assets. 4. Prepare analyses of deferred tax balances and record deferred tax expense. 5. Explain the effect of multiple tax rates and tax rate changes on income tax accounts, and calculate current and deferred tax amounts when there is a change in substantively enacted tax rates. 6. Account for tax loss carryover benefits, including any note disclosures. 7. Explain why the Deferred Tax Asset account is reassessed at the statement of financial position date, and account for the deferred tax asset with and without a valuation allowance account. 8. Identify and apply the presentation and disclosure requirements for income tax assets and liabilities, and apply intraperiod tax allocation. 9. Identify the major differences in accounting between IFRS and ASPE, and what changes are expected in the near future. 10. Apply the temporary difference approach (future income taxes method) of accounting for income taxes in a comprehensive situation.

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Intermediate Accounting, Thirteenth Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

BT Item

1. 2. 3. 4. 5.

1 2 2 2 2,3,4

C 6. AP 7. AP 8. AP 9. AP 10.

1. 2,3 C 8. 2. 2,3 C 9. 3. 2,3 K 10. 4. 2,3 AP 11. 5. 2,3,4 AP 12. 6. 2,3,4,8 AP 13. 7. 2,3 K 14. 1. 2,4,8 AP 2. 2,4,8 AP 3. 2,4,5,8 AP 4. 2,4,5,8,9 AP

5. 6. 7. 8.

1. 2,3,6,7 AN

5,6,8

BT Item LO BT Item LO Brief Exercises 2,4 AP 11. 3,4 AP 16. 6 2,4 AP 12. 4 AP 17. 6 3,4 AP 13. 4,5 AP 18. 6,7 3,4 AP 14. 3,5 AP 19. 6,7 3,4 AP 15. 6 AP 20. 8 Exercises 2,3,4,8 AP 15. 2,3,4,5 AP 22. 2,3,5,8,9 2,3,9,10 AP 16. 3,4,8 AP 23. 2,4,5,8 2,3,5,8,10 AP 17. 2,3,4 AP 24. 4,5 2,3,4,5 AP 18. 2,3,4 AP 25. 5,6 2,3,4,8 AP 19. 2,3,4,5,8 AP 26. 5,6,7,8 2,3,4 AP 20. 2,3,4,5 AP 27. 7 2,3,4 AP 21. 2,4,9 AP 28. 7 Problems 2,4,5,8 AP 9. 2,4,5,8,9 AP 13. 2,8 2,4,8 AP 10. 2,4,8 AP 14. 2,4,8 2,4,5,8 AP 11. 8,9,10 AP 15. 2,5,6,8 2,4,5,8 AP 12. 5,6,7,8 AP 16. 2,5,8 Cases 3. Research and Analysis 5,6,8 AP 4. 9 AN 5. 2,3,6, 7,8,9

BT Item

AP AP AP AP AP

21. 22. 23. 24.

8 8 8,9 9

AP AP AP AP

AP AP AP AP AP AP AP

29. 30. 31. 32. 33. 34. 35.

3,4,8,9 2,4,8,9 2,8,9 2,8,9 3,4,8,9 2,8,9 8,9

AP AP AP AP AP AP AP

AP AP AP AP

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

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Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CLASSIFICATION TABLE Topics

Brief Exercises

Exercises

Problems

1. Income taxes from a business perspective.

2. Difference between accounting income and taxable income, calculate taxable income.

2, 3, 4, 5, 6, 7

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23,32, 32, 33, 34

1, 2, 3, 5, 6, 7, 8, 9, 10, 11, 13, 14, 15

3. Taxable temporary differences, calculation of deferred/future income tax liabilities.

5, 8, 9

1, 2, 3, 4,6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 22, 23, 31

1, 2, 3, 5, 6, 7, 8, 9, 13, 14, 15

4. Deductible temporary differences, calculation of deferred/future income tax assets.

10, 11, 14

1, 2, 3, 5, 6, 7, 8, 9, 10, 11, 15, 16, 17, 18, 19, 20, 23, 31, 32

1, 2, 3, 5, 6, 7, 8, 9, 13, 14, 15

5. Deferred/future income tax balances.

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

5, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 22, 23, 24, 31, 32

1, 3, 4, 5, 6, 7, 8, 9, 10, 11, 13, 14, 15, 16

6. Multiple tax rates, tax rate changes.

13, 14

10, 11, 15, 19, 20, 22, 23, 24, 25, 26, 27, 28

2, 3, 4, 14, 16

7. Loss carrybacks.

15, 16, 17, 18, 19

25, 26, 27, 28

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ASSIGNMENT CLASSIFICATION TABLE (CONTINUED) Topics

Brief Exercises

Exercises

Problems 12, 15

8. Loss carryforwards.

16, 17, 18, 19

25, 26, 27, 28

9. Valuation of deferred/future tax asset.

18, 19

28, 29, 30

10. Presentation and disclosure of income taxes.

20, 21, 22, 23

6, 8, 9, 10, 12, 16, 22, 23, 32, 33, 34, 35

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15

11. Differences between IFRS and ASPE.

23, 24

8, 9, 10, 12, 16, 21, 22, 23, 28, 32, 33, 34, 35

1, 2, 3, 5, 6, 7, 8, 9, 10, 11, 14

8, 9, 10, 23, 28

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16

12 Temporary difference approach in a comprehensive situation

Please note: The simplifying assumption is made that unless told that a company follows ASPE, all companies in the end-of-chapter brief exercises, exercises, and problems follow IFRS and use the term “deferred” rather than “future” for the tax-related accounts.

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ASSIGNMENT CHARACTERISTICS TABLE Level of Difficulty

Item

Description

E18.1

Terminology, relationships, calculations, Moderate entries Identifying reversing and permanent Moderate differences Identifying reversing and permanent Simple differences; deferred tax liabilities and deferred tax assets Capital cost allowance schedule over 8 years Moderate One reversing difference through three years, Moderate one rate Intraperiod tax allocation–other comprehensive Moderate income Identifying reversing or permanent differences Simple and showing effects Two reversing differences, future taxable and Moderate deductible amounts, no beginning deferred taxes, one tax rate Two reversing differences, future taxable and Moderate deductible amounts, beginning deferred taxes, one tax rate Two reversing differences, future taxable and Moderate deductible amounts, beginning deferred taxes, change in tax rate Reversing and permanent differences, future Simple taxable amount, no beginning deferred taxes One reversing difference, future taxable Simple amounts, one tax rate, no beginning deferred taxes, One reversing difference, future taxable Simple amounts, one tax rate, no beginning deferred taxes One reversing difference, future taxable Simple amounts, one tax rate, beginning deferred taxes One temporary difference, future taxable Simple amounts, no beginning deferred taxes, change in rate Permanent and reversing differences, Simple calculate taxable income, entry for taxes One reversing difference, future deductible Simple amounts, one tax rate, no beginning deferred taxes

E18.2 E18.3

E18.4 E18.5 E18.6 E18.7 E18.8

E18.9

E18.10

E18.11 E18.12

E18.13

E18.14

E18.15

E18.16 E18.17

Time (minutes) 10-15 20-25 20-25

15-20 15-20 15-20 10-15 20-25

20-25

20-25 20-25

15-20

15-20 15-20

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ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Level of Difficulty

Time (minutes)

Item

Description

E18.18

One reversing difference, future deductible Simple 15-20 amounts, one tax rate, beginning deferred taxes One temporary difference, future taxable Moderate 20-25 amount becoming future deductible amount, one tax rate, change in rate One reversing difference, future deductible Moderate 20-25 amounts, no beginning deferred taxes, change in rate Depreciation, reversing difference over five Moderate 40-45 years, determining taxable income, taxes payable method Deferred tax liability, change in tax rate Complex 15-20 Two differences, no beginning deferred Simple 15-20 taxes, multiple rates One difference, multiple rates, beginning Simple 20-25 deferred taxes, change in rates Loss carryback and carryforward Moderate 20-25 Carryback and carryforward of tax loss Simple 15-20 Loss carryback and carryforward Complex 30-35 Loss carryback and carryforward using a Moderate 30-35 valuation allowance Deferred tax asset–different amounts to be Moderate 20-25 realized Deferred tax asset–different amounts to be Moderate 10-15 realized; valuation allowance Three differences, classification of deferred Simple 10-15 taxes. Intraperiod tax allocation–discontinued Moderate 25-30 operations Taxes payable method Simple 10-15 Taxes payable method Simple 10-15 Taxes payable method Moderate 15-20

E18.19

E18.20

E18.21

E18.22 E18.23 E18.24 E18.25 E18.26 E18.27 E18.28 E18.29 E18.30 E18.31 E18.32 E18.33 E18.34 E18.35

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ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Item

Description

P18.1

Three temporary differences and two permanent differences, opening balance, statement disclosure Six differences, three years, two tax rates, income and SFP reporting Four differences, one rate, reconciliation of balances and comparative statement disclosure, reconcile tax rate One temporary difference, tracked for four years, one permanent difference, change in rate Second year of depreciation difference, two differences, single rate, earnings per share Several differences, two years, reversing differences, one rate, discontinued operations and financial statements Two differences, two years, reversing differences, two assumptions, several rates and financial statements Three differences, several rates, two years and statement disclosure Two differences, two rates, future income expected Two differences, two years, calculate taxable income and pre-tax accounting income Five differences, one year, income and retained earnings reporting, and effective tax rate Losses carryback and carryforward expected to be realized and not expected to be realized Prior period error correction, recovery of prior year taxes, income statement and retained earnings statements disclosure One reversing difference, change in tax rate, calculation of effective tax rate, all entries and balance sheet presentation under ASPE

P18.2 P18.3

P18.4

P18.5 P18.6

P18.7

P18.8 P18.9 P18.10 P18.11

P18.12

P18.13

P18.14

Level of Difficulty

Time (minutes)

Moderate

30-35

Complex

45-50

Complex

50-60

Complex

50-60

Moderate

40-45

Complex

50-60

Complex

40-45

Complex

50-60

Moderate

25-30

Complex

40-50

Complex

50-60

Moderate

35-40

Moderate

35-40

Moderate

50-60

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Item P18.15

P18.16

Description Loss carryback with timing and permanent differences and a tax rate change. The tax benefit for only half of the loss carryforward can be recognized. Journal entries and tax reconciliation note required Changing tax rates, fair value accounting of investment properties and revaluation method including their impact on deferred tax balances

Level of Difficulty Complex

Time (minutes) 60-75

Moderate

20-25

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 18.1 (a)

Higher income tax expense results in lower profits.

(b) Higher income taxes paid decreases cash flow from operations. (c)

Considering only the effect of income taxes, Faber should register its company in Eastern Europe, where the company would be subject to a lower corporate income tax rate.

LO 1 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.2 2023 taxable income Tax rate 12/31/2023 income tax payable

$184,000 X 25% $ 46,000

LO 2 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.3 Accounting income Permanent difference – insurance expense

$156,000 5,000

Reversing difference: CCA > Depreciation Taxable income Current income taxes at 25%

161,000 (14,000) $147,000 $ 36,750

SFP Account PP & E

(Taxable) Temporary Difference (change in) ($14,000)*

Tax X Rate 25%

Deferred Tax (Liability) (change in) ($3,500)

*Carrying amount and tax base are not given in the exercise; only the net change in the temporary difference is given. Current Tax Expense ......................................... 36,750 Income Tax Payable ................................... To record current tax expense

36,750

Deferred Tax Expense........................................ Deferred Tax Liability ................................. To record deferred tax expense

3,500

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.4 (a) X(.25) = $200,000 taxes due for 2023 X = $200,000 ÷ .25 X = $800,000 taxable income for 2023 (b) Taxable income [from part (a)]................................ Excess of CCA over depreciation........................... Dividend income ...................................................... Unearned rent .......................................................... Accounting income for 2023 ...........................

$800,000 160,000 23,000 (60,000) $923,000

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.5 The $40,000 reversing difference that occurs in the first fiscal year of Mazur Corp. results in a taxable temporary difference at December 31, 2023. The carrying amount is greater than the UCC (tax base) by $40,000. $40,000 X 30% tax rate = $12,000 deferred tax liability. Stmt of Fin Pos Account

(Taxable) Temporary Difference

Tax X Rate

Deferred Tax (Liability)

PP & E

($40,000)*

30%

($12,000)

*Carrying amount and tax base are not given in the exercise; only the net difference is provided. LO 2,3,4 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.6

Accounting income Non-deductible insurance expense

$156,000 5,000

Divided by Accounting @ 25% Income $39,000 25.0% 1,250 $ 40,250

Effective tax rate ($40,250/$156,000)

0.8% 25.8% 25.8%

LO 2,4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.7 (a) Basic Calculations of Capital Cost Allowance, Amounts, and Balances:

Year 2023 2024

(A) CCA Base Rate $30,000 45% 16,500 30%

(B) CCA $13,500 4,950

(A – B) UCC $16,500 11,550

Carrying Amount $24,000 18,000

(C-B) Reversing Difference $(7,500) 1,050

2025 2026

11,550 8,085

30% 30%

3,465 2,426

8,085 5,659

6,000 6,000

12,000 6,000

2,535 3,574

2027

5,659

30%

1,698

3,961

6,000

4,302

(b)

Date 12/31/2023 12/31/2024 12/31/2025 12/31/2026 12/31/2027

Tax Base Carrying (UCC) Amount $16,500 $24,000 11,550 18,000 8,085 12,000 5,659 6,000 3,961 0

Deductible (Taxable) Temporary Difference $(7,500) (6,450) (3,915) (341) 3,961

Tax Rate 0.25

Deferred Tax Asset (Liability) $(1,875)

Deferred Tax Asset (Liability) before Adjustment $0

0.25 0.25 0.25 0.25

(1,613) (979) (85) 990

(1,875) (1,613) (979) (85)

LO 2,4 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Inc. in Deferred Tax Asset (Liability) $(1,875) 262 634 894 1,075

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.8 Balance Sheet Account

Tax Base

Carrying – Amount

Equip.

$136,000

$178,000

(Taxable) Temporary Tax = Difference X Rate $(42,000)

30%

Deferred Tax = (Liability) $(12,600)

LO 3,4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.9 Accounting income $ 275,000 Reversing difference: CCA > Deprec. (40,000) Taxable income 235,000 X 30% Income tax payable $ 70,500 Stmt of Fin Pos Account

(Taxable) Temporary Difference

Tax X Rate

Deferred Tax (Liability)

PP & E

($40,000)*

30%

($12,000)

*Carrying amount and tax base are not given in the exercise, only the net difference is provided. Current Tax Expense ......................................... 70,500 Income Tax Payable ................................... To record current tax expense

70,500

Deferred Tax Expense ........................................ 12,000 Deferred Tax Liability ................................. To record deferred tax expense

12,000

LO 3,4 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.10

Carrying Amount

Deductible Temporary Tax Difference X Rate

– (256,000)

$256,000

SFP Account

Tax Base –

Warranty Liability

Deferred Tax Asset

$64,000

25% =

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.11 Current tax expense for 2023 Deferred tax benefit for 2023 Deferred tax asset, 12/31/2023 Deferred tax asset, 12/31/2022

$70,000 $62,000 40,000

Total income tax expense for 2023

(22,000) $48,000

Current Tax Expense ........................................ Income Tax Payable .................................. To record current tax expense

70,000

Deferred Tax Asset............................................ Deferred Tax Benefit ................................... To record deferred tax expense

22,000

70,000

22,000

LO 3,4 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.12 Current tax expense for 2023 Deferred tax expense for 2023 Deferred tax liability, 12/31/2023 Deferred tax liability, 12/31/2022

$53,000 $52,000 35,000

Total income tax expense for 2023

17,000 $70,000

LO 4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.13 Year

Future taxable amount

Rate

Deferred tax liability

2024

$53,000

25%

$ 13,250

2025

310,000

25%

77,500

2026

352,000

30%

105,600 $196,350

The increase in the tax rate from 25% to 30% in 2026 would increase the deferred tax expense and liability in 2023 by $17,600 ($352,000 x 5%). LO 4,5 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.14 Deferred Tax Asset......................................... Deferred Tax Benefit1 ............................. 1 ($3,200,000 X 5%)

160,000 160,000

LO 3,5 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.15 Income Tax Receivable ................................... Current Tax Benefit1 ............................... 1 [$120,900 + ($160,000 X 30%) = $168,900]

168,900 168,900

LO 6 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.16 Income Tax Receivable ......................................... 138,000 Current Tax Benefit 1 ..................................... 138,000 1 ($460,000 X 30%) To recognize benefit of loss carryback Deferred Tax Asset................................................ 36,000 Deferred Tax Benefit2 ................................... 2 [($580,000 – $460,000) X 30%] To recognize benefit of loss carryforward

36,000

LO 6 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.17 (a) Income Tax Receivable .................................... 138,000 Current Tax Benefit1 .................................. 1 ($460,000 X 30%)

138,000

(b) Income Tax Receivable .................................... 138,000 Current Tax Benefit 2 .................................. 2 ($460,000 X 30%) To recognize benefit of loss carryback

138,000

Deferred Tax Asset........................................... 36,000 Deferred Tax Benefit .................................. To recognize benefit of loss carryforward

36,000

Deferred Tax Expense3 ....................................... 36,000 Allowance to Reduce Deferred Tax Asset to Expected Realizable Value .... 36,000 3 ($120,000 X 30%) To bring the Deferred Tax Asset account to its realizable value LO 6 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.18 (a) Current Tax Expense ......................................... Income Tax Payable ................................... To record current tax expense Income Tax Payable ........................................... Current Tax Benefit1 ................................... 1 ($25,000 X 30%) To record current tax benefit (b) Deferred Tax Expense......................................... Deferred Tax Asset ...................................... To record deferred tax expense

7,500 7,500

Allowance to Reduce Deferred Tax Asset to Expected Realizable Value.............. 7,500 Deferred Tax Benefit2 ................................ 7,500 2 ($25,000 X 30%) To bring the Deferred Tax Asset account to its realizable value LO 6,7 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.19 (a) Deferred Tax Expense........................................ 85,000 Deferred Tax Asset .....................................

85,000

(b) Deferred Tax Expense........................................ 85,000 Allowance to Reduce Deferred Tax Asset to Expected Realizable Value….

85,000

LO 6,7 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.20 Unrealized Gain or Loss - OCI ........................... FV-OCI Investments.................................... To record fair value adjustment

9,000

Deferred Tax Asset............................................. 2,700 Deferred Tax Benefit – OCI1 ....................... 1 ($9,000 X 30%) To record deferred taxes on fair value adjustment Net income Other comprehensive income: Unrealized loss on FV-OCI investments Less: Deferred tax benefit Comprehensive income

9,000

2,700

$60,000 $9,000 (2,700)

6,300 $53,700

LO 8 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.21 (a)

Income before income tax Income tax expense Current Deferred Net income

$230,000 $43,000 27,000

70,000 $160,000

(b) Effective tax rate = $70,000/$230,000 = 30.4% LO 8 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 18.22 Income from continuing operations before income tax Income tax expense Income from continuing operations Discontinued operations: Loss from discontinued operations Less: applicable income tax savings Net income 1 ($87,000 x 25%) 2($16,000 x 25%)

$ 87,000 21,7501 65,250 $16,000 4,0002

12,000 $ 53,250

LO 8 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.23 (a) Long-term liabilities Future tax liability

$52,000

(b) Long-term liabilities Deferred tax liability

$52,000

LO 8,9 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 18.24 Income Tax Expense .......................................... 36,750 Income Tax Payable ...................................

36,750

LO 9 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 18.1 a. b. c. d. e. f. g. h. i. j. k. l. m.

greater than less than 304,000 = ($76,000 divided by 25%) are not less than benefit; $15,000 $8,500 = [($100,000 X 25%) – $16,500] debit $59,000 = ($82,000 – $23,000) will not be benefit increase, increase temporary, reversing

LO 2,3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.2 a.

Reversing difference. The full estimated three years of warranty costs reduce the current year’s pre-tax accounting income, but they will reduce taxable income in varying amounts each respective year, as paid. Assuming the estimate for each warranty is valid, the total amounts deducted for accounting and for tax purposes will be equal over the three-year period for a given warranty. This is an example of an expense that in the first period reduces pre-tax accounting income more than taxable income and in later years, reverses. This type of temporary difference will result in future deductible amounts, which will give rise to the current recognition of a future income tax asset. Another way to evaluate this situation is to compare the carrying value of the warranty liability with its tax basis (which is zero). When the liability is settled in a future year, an expense will be recognized for tax purposes but none will be recognized for financial reporting purposes. Therefore, tax benefits for the tax deductions should result from the future settlement of the liability.

Reversing difference. While the change in value is included in income in the current year, it will not be taxable/deductible until sold. Therefore, it is a reversing difference.

Permanent difference. The difference is not due to different methods of depreciation, but due to different amounts accepted as “cost.” Since only the amount accepted originally as its tax cost can be amortized in the future, the difference is a permanent one. Gains recorded for accounting purposes at the disposition of the asset used on trade are deducted and losses are added to income to arrive at taxable income.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.2 (CONTINUED) a. (continued) 4.

Permanent difference. The investor’s share of earnings of an investee accounted for by the equity method is included in accounting income, while dividends received from taxable Canadian corporations are excluded from taxable income. The amount included in accounting income is a permanent difference deducted when computing taxable income.

Reversing difference. The write-down of the inventory is recognized for accounting purposes in the current year, but the loss is not allowed to be deducted for tax purposes until the inventory is sold. Hence, it is a reversing difference.

Permanent and reversing difference. Any loss from a litigation accrual would not be deductible for tax purposes until paid. This is a reversing difference arising in the year accrued. The portion of the loss that is expected to be a penalty, which cannot be used as a deductible expense for tax purposes, will be a permanent difference.

Reversing difference under IFRS only (ASPE does not allow the revaluation model to be used). This write-down of the properties will cause the deferred tax accounts to change, but the loss is not reported for current tax purposes. Once the land and buildings are actually disposed of, the taxable income will be impacted by difference between the original cost and the proceeds on disposal. (At this time, a portion of the difference may be shown as recaptured capital cost allowance on the building and a portion as capital gains for the land, but this will not be known until the actual sale proceeds are determined.)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.2 (CONTINUED) a. (continued) 8. Reversing difference – When the retirement obligation is settled, the full cash amount paid will be reflected as a reduction of taxable income. However, in the accounting records, this has been reported each year since the obligation was originally accrued, along with the gain on settlement in the final year. As a result, there will be an amount in the deferred tax asset with respect to this obligation. When the obligation is paid, this future tax asset will be reversed.

Deferred tax accounts The estimated warranty costs will be deductible in future periods and cause taxable income to be less than accounting income in the future. → Deferred tax asset (Classified as non-current, assuming the three-year warranty liability is classified as a non-current liability) under both IFRS and ASPE.

Holding/unrealized gains → will be taxable when realized → deferred tax liability Holding/unrealized losses → will be deductible when realized → deferred tax asset (Same treatment under ASPE and IFRS).

No related deferred tax accounts. Same treatment under ASPE and IFRS.

The impairment loss will be deductible in future periods and cause taxable income to be less than accounting income in the future. → Deferred tax asset (Classified as non-current under ASPE and IFRS).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.2 (CONTINUED) b. (continued) 6.

The penalty portion does not have related deferred tax accounts. The rest of it results in a deferred tax asset. (Classified as non-current under ASPE and IFRS).

This is not allowed under ASPE. Under IFRS, the loss will be deductible in future periods and cause taxable income to be less than accounting income in the future. → Deferred tax asset (or a reduction in the related future tax liability account) (Classified as non-current under IFRS).

The cash settlement of the retirement obligation results in the current taxable income being lower than the current accounting income. As such, there will be a reduction in the future tax asset account that has been increasing in previous years as the expense was recorded for accounting purposes but not yet for tax purposes. The related future tax asset should be eliminated with this settlement.

LO 2,3 BT: C Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.3 a. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

Reversing diff. Reversing diff. Permanent diff. Permanent diff. Reversing diff. Reversing diff. Permanent diff. Permanent diff. Permanent diff. Reversing diff. Reversing diff. Reversing diff. Reversing diff. Reversing diff.

b. Future deductible amounts Future deductible amounts No effect on future tax returns No effect on future tax returns Future taxable amounts Future taxable amounts No effect on future tax returns No effect on future tax returns No effect on future tax returns Future deductible amounts Unrealized gains: future taxable amounts Holding/unrealized losses: future deductible amounts Future deductible amounts Future taxable amounts

Deferred tax asset Deferred tax asset No deferred taxes No deferred taxes Deferred tax liab. Deferred tax liab. No deferred taxes No deferred taxes No deferred taxes Deferred tax asset Deferred tax liab. Deferred tax asset Deferred tax asset Deferred tax liab.

LO 2,3 BT: K Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.4 Capital Cost Allowance Schedule for Class 10, 30%. CCA UCC UCC, 01/01/2021 $ 0 Additions during 2021: 29,200 Disposals during 2021: 0 CCA, 2021: $29,200 X 30% X 1.5 $13,140 (13,140) UCC, 12/31/2021 $16,060 UCC, 01/01/2022 Additions during 2022: Disposals during 2022 (lesser of cost of $8,000 and proceeds of $7,000): UCC, before CCA CCA, 2022: $13,860 X 30% (net additions must be greater than zero for 1.5 year rule) UCC, 12/31/2022 UCC, 01/01/2023 Additions during 2023: Disposals during 2023: CCA, 2023: $5,000 X 30% X 1.5 $9,702 X 30% UCC, 12/31/2023

$16,060 4,800

(7,000) 13,860

$4,158

(4,158) $9,702 $9,702 5,000 0

$ 2,250 2,911

(5,161) $9,541

UCC, 01/01/2024 $9,541 Additions during 2024: 5,000 Disposals during 2024: 0 1 CCA, 2024: ($9,541 + $5,000) X 30% 4,362 (4,362) UCC, 12/31/2024 $10,179 1 2024 to 2027 inclusive, 1.5 rate reduced to 1.0 (that is, additions are not subject to the 1.5 year rule or the half-year rule for 2024-2027). Solutions Manual 18.29 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.4 (CONTINUED) UCC, 01/01/2025 Additions during 2025: Disposals during 2025: CCA, 2025: $10,179 X 30% UCC, 12/31/2025 UCC, 01/01/2026 Additions during 2026: Disposals during 2026: CCA, 2026: $7,125 X 30% UCC, 12/31/2026 UCC, 01/01/2027 Additions during 2027: Disposals during 2027: CCA, 2027: $4,987 X 30% UCC, 12/31/2027 UCC, 01/01/2028 Additions during 2028: Disposals during 2028: CCA, 2028: $5,000 X 30% X 0.51 $3,491 X 30% UCC, 12/31/2028

3,054

2,138

1,496

$10,179 0 0 (3,054) $7,125 $7,125 0 0 (2,138) $4,987 $4,987 0 0 (1,496) $3,491 $3,491 5,000 0

750 1,047

(1,797) $6,694

2028 forward, implement the half-year rule for net additions. The half-year rule is used irrespective of when in the year the purchase was made. LO 2,3 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.5 a.

Year

Amount of Temporary Difference Originating or Reversing during the Year

2023 $160,000 – $245,000 = $85,000 originating 2024 $139,000 – $121,000 = $18,000 reversing 2025 $131,000 – $125,000 = $6,000 reversing

Deductible Temporary Difference at Year-End

$85,000 67,000 61,000

Date

Future Deductible Amounts

Tax Rate

Deferred Tax Asset*

12/31/2023 12/31/2024 12/31/2025

$85,000 67,000 61,000

30% 30% 30%

$25,500 20,100 18,300

*The fact that the temporary difference will result in future deductible amounts is determined by the fact that in the year of origination, the temporary difference causes taxable income to exceed pre-tax accounting income. Therefore, in the period(s) of reversal, we can expect pre-tax accounting income to exceed taxable income.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.5 (CONTINUED) c. 2023 Current Tax Expense1 ............................................ 73,500 Income Tax Payable ....................................... 73,500 1 [Taxable income x income tax rate ($245,000 x 30%)] To record current tax expense Deferred Tax Asset................................................. Deferred Tax Benefit2 ..................................... 2 [$85,000 x 30%] To record deferred tax benefit

25,500 25,500

2024 Current Tax Expense3 ............................................ 36,300 Income Tax Payable ....................................... 36,300 3 [Taxable income x income tax rate ($121,000 x 30%)] To record current tax expense Deferred Tax Expense4 .......................................... Deferred Tax Asset ......................................... 4 [$20,100 - $25,500] To record deferred tax expense

5,400 5,400

2025 Current Tax Expense5 ............................................ 37,500 Income Tax Payable ....................................... 37,500 5 [Taxable income x income tax rate ($125,000 x 30%)] To record current tax expense Deferred Tax Expense6 .......................................... Deferred Tax Asset ......................................... 6 [$18,300-$20,100] To record deferred tax expense

1,800 1,800

LO 2,3,4 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.6 a. Unrealized Gain or Loss - OCI ........................... 28,000 FV-OCI Investments.................................... To record fair value adjustment Deferred Tax Asset............................................. 8,400 Deferred Tax Benefit – OCI1 ....................... 1 [($28,000 X 30%) – $0] To record deferred taxes on fair value adjustment b. FV-OCI Investments ........................................... 33,500 Unrealized Gain or Loss – OCI2 ................. 2 ($28,000 + $5,500) To record fair value adjustment

Deferred Tax Expense - OCI .............................. 10,050 Deferred Tax Asset ..................................... Deferred Tax Liability3 ................................ 3 ($5,500 X 30%) To record deferred taxes on fair value adjustment Balance, Dec. 31, 2024: ($5,500 X 30%) Balance before adjustment Adjustment to deferred tax asset/liability account and 2024 deferred tax expense - OCI

28,000

8,400

33,500

8,400 1,650

$(1,650) L 8,400 A $10,050

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.6 (CONTINUED) c. Hang Technologies Inc. Statement of Comprehensive Income For the Year Ended December 31, 2024 Net income $100,000 Other comprehensive income (loss) Unrealized gains (losses) on FV-OCI 33,500 Investments Less: Deferred tax (expense) benefit (10,050) Other comprehensive income (loss) 23,450 Comprehensive income $123,450

2023 $100,000 (28,000)

8,400 (19,600) $80,400

The company will report a deferred tax liability of $1,650 as a non-current liability. IFRS does not permit any deferred tax accounts to be reported in current assets or current liabilities.

LO 2,3,4,8 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.7 a.

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

ii i iii i ii ii i iii iii i i i

b. Add or deduct from accounting income deduct add add add deduct deduct add deduct deduct add add add

LO 2,3 BT: K Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.8 a. SFP Account Dec 31, 2023

Deductible (Taxable) Temporary Differences $50,000 (150,000)

Tax Carrying Base Amount PP & E $980,000 $930,000 Contract Asset/Liability* (50,000) 100,000 Deferred tax liability, December 31, 2023 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023

Tax Rate 25% 25%

Deferred Tax Asset (Liability) $ 12,500 (37,500) (25,000) 0 $( 25,000)

*For the completed-contract method, the construction asset/liability account reports only construction costs excluding any gross profit recognized under the percentage-of-completion method, net of billings. Completed contract is used for income tax returns. $100,000 - $500,000 + $350,000 = ($50,000)

b. Accounting income Reversing differences: Property, plant, and equipment: Depreciation expense Capital cost allowance ($1,100,000 – $980,000) Contract Asset/Liability: Gross profit—Percentage completion ($500,000 – $350,000) Gross profit—Completed contract method Taxable income Current income taxes at 25%

$195,000

$170,000 (120,000) (150,000) 0

50,000

(150,000) $95,000 $23,750

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.8 (CONTINUED) c. Current Tax Expense ......................................... 23,750 Income Tax Payable ................................... To record current tax expense Deferred Tax Expense........................................ 25,000 Deferred Tax Liability ................................. To record deferred tax expense d.

Income before income tax Income tax expense Current Deferred Net income

Long-term liabilities Deferred tax liability

23,750

25,000

$195,000 $23,750 25,000

48,750 $146,250

$25,000

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

Long-term liabilities Future tax liability

$25,000

LO 2,3,4,8 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.9 a. SFP Account Dec. 31, 2024

Deductible (Taxable) Temporary Differences $(20,000) (180,000)

Tax Carrying Base Amount PP & E $620,000 $640,000 Contract Asset/Liability * (60,000) a 120,000 Deferred tax liability, December 31, 2024 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2024 a $350,000 - $400,000 + $410,000 - $420,000 = $(60,000) * Completed contract is used for income tax returns. b. Accounting income Reversing differences: Property, plant, and equipment: Depreciation expense ($460,000 – $170,000) Capital cost allowance ($980,000 – $620,000) Contract Asset/Liability: Gross profit – Percentage completion ($440,000 – $410,000) Gross profit – Completed contract method Taxable income Current income taxes at 25%

Tax Rate 25% 25%

Deferred Tax Asset (Liability) $(5,000) (45,000) (50,000) (25,000) $(25,000)

$120,000

$290,000 (360,000)

(70,000)

(30,000) 0

(30,000) $20,000 $5,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.9 (CONTINUED) c. Current Tax Expense ......................................... Income Tax Payable ................................... To record current tax expense

5,000 5,000

Deferred Tax Expense........................................ 25,000 Deferred Tax Liability ................................. To record deferred tax expense

d. Income before income tax Income tax expense Current Deferred

25,000

2024 $120,000

2023 $195,000

5,000 25,000 30,000 $90,000

23,750 25,000 48,750 $146,250

2024

2023

Long-term liabilities Deferred Tax Liability

$50,000

$25,000

Net income

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP. f. Long-term liabilities Future tax liability

2024

2023

$50,000

$25,000

LO 2,3,9,10 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.10 a. Deductible SFP (Taxable) Account Tax Carrying Temporary Sep. 15, 2024 Base Amount Differences PP & E $980,000 $930,000 $50,000 a Contract Asset/Liability (50,000) 100,000 (150,000) Decrease in deferred tax liability due to decrease in tax rate a

Tax Rate Decrease 5% 5%

Decrease in Deferred Tax (Asset) Liability $(2,500) 7,500 $5,000

($350,000 - $400,000) September 15, 2024 adjustment to record the impact of the decrease in tax rate on the company’s net taxable temporary difference: Deferred Tax Liability ................................. Deferred Tax Benefit ...........................

5,000 5,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.10 (CONTINUED) b.

SFP Account Dec. 31, 2024

Deductible (Taxable) Temporary Differences $ (20,000) (180,000)

Tax Carrying Base Amount PP & E $620,000 $640,000 Contract Asset/Liability (60,000) 120,000 Deferred tax liability, December 31, 2024 Sept. 15 deferred tax liability before adjustment ($25,000 – $5,000) Incr. in deferred tax liability, and deferred tax expense for 2024

Tax Rate 20% 20%

Deferred Tax Asset (Liability) $(4,000) (36,000) (40,000) 20,000 $(20,000)

c. Accounting income Reversing differences: Property, plant, and equipment: Depreciation expense ($460,000 – $170,000) Capital cost allowance ($980,000 – $620,000) Contract Asset/Liability: Gross profit – Percentage completion ($440,000 – $410,000) Gross profit – Completed contract method Taxable income Current income taxes at 25% current rate

$120,000

$290,000 (360,000)

(70,000)

(30,000) 0

(30,000) $20,000 $5,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.10 (CONTINUED) d. Current Tax Expense ......................................... Income Tax Payable ................................... To record current tax expense

5,000 5,000

Deferred Tax Expense........................................ 20,000 Deferred Tax Liability ................................. To record deferred tax expense

20,000

e. Income before income tax Income tax expense Current Deferred * Net income

2024 $120,000

2023 $195,000

5,000 15,000 20,000 $100,000

23,750 25,000 48,750 $146,250

*Deferred tax expense for 2024 of $15,000 is comprised of a deferred tax benefit of $5,000 due to a decrease in tax rates effective September 15, 2024 and deferred tax expense of $20,000 due to differences in the period of recognition of certain expenses for accounting purposes versus for income tax purposes. f. Long-term liabilities Deferred Tax Liability

2024

2023

$40,000

$25,000

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.10 (CONTINUED) g.

Refer to last two columns in table in part (b) above.

Long-term liabilities Future tax liability

2024

2023

$40,000

$25,000

LO 2,3,5,8,10 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.11 a. Investment Income or Loss ............................... FV-NI Investments ...................................... To record fair value adjustment FV-OCI Investments ........................................... Unrealized Gain or Loss—OCI ................... To record fair value adjustment b.

2,000 2,000

4,000 4,000

All of Christina’s investments must be reported on the SFP at their fair value. The resulting difference between this and the tax base of the investments represents a temporary difference. The unrealized gain recognized is not taxable, and any unrealized loss recognized is not deductible, until the investments are sold at a gain or at a loss. The resulting taxable temporary difference must have the corresponding deferred tax recorded at the tax rate that Christina expects to pay (or recover in the case of a loss) on this gain or loss in future accounting periods. In this case the enacted rate is 30%; this rate needs to be applied to arrive at the amount of deferred taxes.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.11 (CONTINUED) c.

Tax Rate

Deferred Tax Asset (Liability)

30%

$ (750)

FV-NI Investments 60,000 58,000 2,000 30% FV-OCI Investments 71,000 75,000 (4,000) 30% Deferred tax liability, December 31, 2023 Deferred tax asset/liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023 1 (CCA is $10,000 X 30% X 1.5 = $4,500; $10,000 less CCA $4,500 = $5,500)

600 (1,200) (1,350) 0 $(1,350)

SFP Account Dec. 31, 2023 Equipment

Tax Base

Carrying Amount

Deductible (Taxable) Temporary Differences

$5,5001

$8,000

$ (2,500)

The deferred tax liability would be shown on the statement of financial position as a non-current liability in the amount of $1,350.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.11 (CONTINUED) d. Accounting income Less investment income or loss for FV-NI investments Permanent difference: 50% of meals and entertainment of $24,000 Reversing difference: Investment income or loss for FV-NI investments Depreciation expense Capital cost allowance ($10,000 x 30% x 1.5) Taxable income Current income taxes at 25%

$110,000 (2,000)

$108,000 12,000 120,000 2,000

$2,000 (4,500)

(2,500) $119,500 $29,875

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.11 (CONTINUED) e. Current Tax Expense ......................................... 29,875 Income Tax Payable ................................... To record current tax expense Deferred Tax Expense........................................ Deferred Tax Liability ................................. To record deferred tax benefit

150

Deferred Tax Expense—OCI1............................. Deferred Tax Liability ................................. 1 [($4,000 X 30%) – $0] To record deferred tax expense

1,200

29,875

150

1,200

LO 2,3,4,5 BT: AP Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.12 a.

The investments must be reported on the SFP at their fair value. The resulting difference between this and the tax base of the investments (cost of $314,450) represents a temporary difference. The unrealized gain recognized is not taxable, and any unrealized loss recognized is not deductible, until the investments are sold at a gain or at a loss. The resulting taxable temporary difference must have the corresponding deferred tax recorded at the tax rate that Henry expects to pay (or recover in the case of a loss) on this gain or loss in future accounting periods. In this case the enacted rate is 30% that needs to be applied to arrive at the amount of any deferred taxes.

b. SFP Account

Tax Base

FV-NI Invest.

$314,450

(Taxable) Carrying Temporary Tax – Amount = Difference X Rate $318,200

$(3,750)

30%

Deferred Tax (Liability) $(1,125)

c. Accounting income Reversing difference: Unrealized gain on FV-NI Investments Taxable income Current income taxes at 30% d. Current Tax Expense ......................................... 89,475 Income Tax Payable ................................... To record current tax expense Deferred Tax Expense1 ...................................... Deferred Tax Liability ................................. 1 ($1,125 – opening balance of $0) To record deferred tax expense

$302,000 (3,750) $298,250 $89,475

89,475

1,125 1,125

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.12 (CONTINUED) e.

Income before income tax Income tax expense Current Deferred Net income

$302,000 $89,475 1,125

Current liabilities: Income tax payable

$89,475

Long-term liabilities: Deferred tax liability

$ 1,125

90,600 $211,400

Under IFRS, all deferred tax assets and liabilities are reported as non-current items on a classified SFP. LO 2,3,4,8 BT: AP Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.13 a. Deductible (Taxable) Temporary Differences $(95,000)

SFP Deferred Tax Account Tax Carrying Tax Asset Dec. 31, 2023 Base* Amount* Rate (Liability) Equipment $(95,000) $0 30% $(28,500) Deferred tax liability, December 31, 2023 (28,500) Deferred tax liability before adjustment 0 Increase in deferred tax liability, and deferred tax expense for 2023 $(28,500) * Values not provided in this exercise ($25,000 + $30,000 + $40,000 = $95,000) Future years (Taxable) temporary differences Depreciation in excess of CCA Tax rate enacted for the year Deferred tax liability

Total

2024

2025

2026

$95,000

$25,000 30% $7,500

$30,000 30% $9,000

$40,000 30% $12,000

$28,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.13 (CONTINUED) b.

2023 $200,000 -0-

Accounting income Permanent differences: Reversing difference: CCA greater than depreciation Taxable income Current income taxes – 30% c. Current Tax Expense ...................................... Income Tax Payable ................................ To record current tax expense Deferred Tax Expense..................................... Deferred Tax Liability .............................. To record deferred tax expense d.

Income before income tax Income tax expense Current Deferred Net income

95,000 105,000 $31,500

31,500 31,500

28,500 28,500

$200,000 $31,500 28,500

60,000 $140,000

LO 2,3,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.14 a.

2024 Deductible (Taxable) Temporary Differences $(70,000)

SFP Account Tax Carrying Dec. 31, 2024 Base* Amount* Equipment $(70,000) 0 Deferred tax liability, December 31, 2024 Deferred tax liability before adjustment Decrease in deferred tax liability, and deferred tax benefit for 2024 *Values not provided in this exercise ($30,000 + $40,000 = $70,000)

Deferred Tax Tax Asset Rate (Liability) 30% $(21,000) (21,000) (28,500) $7,500

Future years (Taxable) temporary differences Depreciation in excess of CCA Tax rate enacted for the year Deferred tax liability

Total

2025

2026

$70,000

$30,000 30% $9,000

$40,000 30% $12,000

$21,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.14 (CONTINUED) a. (continued) 2025 Deductible (Taxable) Temporary Differences $(40,000)

SFP Account Tax Carrying Dec. 31, 2025 Base* Amount* Equipment $(40,000) 0 Deferred tax liability, December 31, 2025 Deferred tax liability before adjustment Decrease in deferred tax liability, and deferred tax benefit for 2025 *Values not provided in this exercise Future year (Taxable) temporary differences Depreciation in excess of CCA Tax rate enacted for the year Deferred tax liability

Total

2026

$40,000

$40,000 30% $12,000

$12,000

Deferred Tax Tax Asset Rate (Liability) 30% $(12,000) (12,000) (21,000) $ 9,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.14 (CONTINUED) b. Pre-tax accounting income Reversing differences – CCA < depreciation expense Taxable income Taxable income Enacted tax rate Current income tax expense c. 2024 Current Tax Expense ........................................ Income Tax Payable .................................. To record current tax expense Deferred Tax Liability ........................................ Deferred Tax Benefit.................................. To record deferred tax benefit

2025 Current Tax Expense ........................................ Income Tax Payable .................................. To record current tax expense Deferred Tax Liability ........................................ Deferred Tax Benefit.................................. To record deferred tax benefit

2024 $ 180,000

2025 $ 180,000

25,000 $ 205,000

30,000 $ 210,000

$ 205,000 X 30% $ 61,500

$ 210,000 X 30% $ 63,000

61,500 61,500

7,500 7,500

63,000 63,000

9,000 9,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.14 (CONTINUED) d. Income before income tax Income tax Current Deferred (benefit) Net income

Income before income tax Income tax Current Deferred (benefit) Net income

2024 $ 180,000 $ 61,500 (7,500)

54,000 $ 126,000 2025 $ 180,000

$ 63,000 (9,000)

54,000 $ 126,000

The net income is identical for 2024 and 2025. Although the temporary balances have changed, their changes were accrued at the expected tax rates in 2023. Subsequent reversals of balances in the temporary differences reduce the deferred tax liability account at the expected amounts each subsequent year. This trend in net income is not a coincidence. The net income remains constant due to the consistent amount of income before income tax.

LO 2,3,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.15 a.

2024 Deductible (Taxable) Temporary Differences $(70,000)

Deferred Tax Tax Asset Rate (Liability) 25% $(17,500) (17,500) (28,500) $ 11,000

Future years Total

2025

2026

(Taxable) temporary differences Depreciation in excess of CCA Tax rate enacted for the year

$70,000

$30,000 25%

$40,000 25%

Deferred tax liability

$17,500

$7,500

$10,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.15 (CONTINUED) a. (continued) 2025 Deductible (Taxable) Temporary Differences $(40,000)

SFP Account Tax Carrying Dec. 31, 2025 Base* Amount* Equipment $(40,000) 0 Deferred tax liability, December 31, 2025 Deferred tax liability before adjustment Decrease in deferred tax liability, and deferred tax benefit for 2025 *Values not provided in this exercise Future year Total (Taxable) temporary differences Depreciation in excess of CCA Tax rate enacted for the year Deferred tax liability

$40,000 $10,000

2026 $40,000 25% $10,000

Deferred Tax Tax Asset Rate (Liability) 25% $(10,000) (10,000) (17,500) $ 7,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.15 (CONTINUED) b. Pre-tax accounting income Reversing differences – CCA < depreciation expense Taxable income

2024 $ 180,000

2025 $ 180,000

25,000 $ 205,000

30,000 $ 210,000

Taxable income Enacted tax rate Current income tax expense

$ 205,000 X 30% $ 61,500

$ 210,000 X 25% $ 52,500

c. 2024 Current Tax Expense ......................................... Income Tax Payable ................................... To record current tax expense Deferred Tax Liability ......................................... Deferred Tax Benefit................................... To record deferred tax benefit 2025 Current Tax Expense ......................................... Income Tax Payable ................................... To record current tax expense Deferred Tax Liability ......................................... Deferred Tax Benefit................................... To record deferred tax benefit

61,500 61,500

11,000 11,000

52,500 52,500

7,500 7,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.15 (CONTINUED) d. Income before income tax Income tax Current Deferred (benefit) Net income

Income before income tax Income tax Current Deferred (benefit) Net income

2024 $ 180,000 $ 61,500 (11,000)

50,500 $ 129,500 2025 $ 180,000

$ 52,500 (7,500)

45,000 $ 135,000

LO 2,3,4,5 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.16 a. Accounting income Permanent differences: Non-deductible fines

$105,000 15,000 120,000

Reversing differences: Excess of CCA over depreciation Excess rent collected over rent earned Taxable income Current income taxes – 30%

(16,000) 24,000 $128,000 $38,400

b. SFP

Deductible (Taxable) Temporary Differences $(16,000)*

Tax X Rate 30%

Deferred Tax Asset (Liability) $(4,800)

Account PP & E Unearned rent revenue 24,000 30% 7,200 Deferred tax asset, Dec. 31, 2023 2,400 Deferred tax asset before adjustment 0 Incr. in deferred tax asset, and deferred tax benefit for 2023 $ 2,400 *Carrying amount and tax base are not given in the exercise, only the net difference is provided. c.

Current Tax Expense ...................................... Income Tax Payable ................................ To record current tax expense

38,400

Deferred Tax Asset1 ........................................ 7,200 Deferred Tax Benefit ............................... Deferred Tax Liability1 ............................ 1 or a net debit to Deferred Tax Asset of $2,400 To record deferred tax benefit

38,400

2,400 4,800

Because of a flat tax rate, these totals can be reconciled: ($24,000 – $16,000) X 30% = $2,400 OR $7,200 + $(4,800) = $2,400. Solutions Manual 18.60 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.16 (CONTINUED) d.

Income before income tax Income tax expense Current Deferred (benefit) Net income

$105,000 $38,400 (2,400)

36,000 $69,000

Accounting income Non-deductible fines

$105,000 15,000

@ 30% $ 31,500 4,500 $ 36,000

Effective tax rate ($36,000/$105,000)

Long-term assets Deferred tax asset

Divided by Accounting Income 30.0% 4.3% 34.3% 34.3%

$2,400

LO 3,4,8 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.17 a. Deductible (Taxable) Temporary Differences $150,000

SFP Account Tax Carrying Dec. 31, 2023 Base Amount Warranty liability 0 $(150,000) Deferred tax asset, December 31, 2023 Deferred tax asset before adjustment Increase in deferred tax asset, and deferred tax benefit for 2023

Deferred Tax Tax Asset Rate (Liability) 25% $37,500 37,500 0 $37,500

Future years Deductible temporary difference Warranty liability Tax rate enacted for the year Deferred tax asset

Total

2024

2025

2026

$150,000

$50,000 25% $12,500

$35,000 25% $8,750

$65,000 25% $16,250

$37,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.17 (CONTINUED) b.

2023 $135,000 -0-

Accounting income Permanent differences: Reversing difference: Warranty expense > warranty costs Incurred Taxable income Current income taxes – 25%

150,000 285,000 $71,250

c. Current Tax Expense ............................................. Income Tax Payable ...................................... To record current tax expense Deferred Tax Asset................................................. Deferred Tax Benefit....................................... To record deferred tax benefit

Income before income tax Income tax expense Current Deferred (benefit) Net income

71,250 71,250

37,500 37,500

$135,000 $71,250 (37,500)

33,750 $101,250

LO 2,3,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.18 a.

2024 Deductible (Taxable) Temporary Differences $100,000

SFP Account Tax Carrying Dec. 31, 2024 Base Amount Warranty liability 0 $(100,000) Deferred tax asset, December 31, 2024 Deferred tax asset before adjustment Decrease in deferred tax asset, and deferred tax expense for 2024

Deferred Tax Tax Asset Rate (Liability) 25% $25,000 25,000 37,500 $(12,500)

Future years Total

2025

2026

$100,000

$35,000 25% $8,750

$65,000 25% $16,250

Deductible temporary difference Warranty liability Tax rate enacted for the year Deferred tax asset

$25,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.18 (CONTINUED) a. (continued) 2025 Deductible (Taxable) Temporary Differences $65,000

SFP Account Tax Carrying Dec. 31, 2025 Base Amount Warranty liability 0 $(65,000) Deferred tax asset, December 31, 2025 Deferred tax asset before adjustment Decrease in deferred tax asset, and deferred tax expense for 2025 Future year Deductible temporary difference Warranty liability Tax rate enacted for the year Deferred tax asset

Total

2026

$65,000

$65,000 25% $16,250

$16,250

Deferred Tax Tax Asset Rate (Liability) 25% $16,250 16,250 25,000 $(8,750)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.18 (CONTINUED) b. Pre-tax accounting income Reversing difference – Warranty costs incurred > warranty expense Taxable income Taxable income Enacted tax rate Current income tax expense

2024 $ 155,000

2025 $ 155,000

(50,000) $ 105,000

(35,000) $ 120,000

$ 105,000 X 25% $ 26,250

$ 120,000 X 25% $ 30,000

c. 2024 Current Tax Expense ............................................. Income Tax Payable ...................................... To record current tax expense Deferred Tax Expense............................................ Deferred Tax Asset ......................................... To record deferred tax expense

2025 Current Tax Expense ............................................. Income Tax Payable ...................................... To record current tax expense Deferred Tax Expense............................................ Deferred Tax Asset ......................................... To record deferred tax expense

26,250 26,250

12,500 12,500

30,000 30,000

8,750 8,750

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.18 (CONTINUED) d. Income before income tax Income tax Current Deferred Net income

Income before income tax Income tax Current Deferred Net income

2024 $ 155,000 $ 26,250 12,500

38,750 $ 116,250 2025 $ 155,000

$ 30,000 8,750

38,750 $ 116,250

The net income is identical for 2024 and 2025. Although the temporary balances have changed, their changes were accrued at the expected future income tax rates in 2023. Subsequent reversals of balances in the temporary differences reduce the deferred tax asset account at the expected amounts each subsequent year. This trend in net income is not a coincidence. The net income remains constant due to the consistent amount of income before income tax.

LO 2,3,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.19 a. Investment Income or Loss ...................... FV-NI Investments ............................... To record fair value adjustment

2,000 2,000

As discussed in Exercise 18.12, the difference between the carrying amount ($40,000) and the tax base ($42,000) at December 31, 2024 is a temporary difference. The loss is not deductible until the investments are sold. The resulting deductible temporary difference must have the corresponding deferred tax recorded at the tax rate that Henry expects to recover on this loss in future accounting periods. In this case the enacted rate of 30% needs to be applied to arrive at the amount of any deferred taxes.

c. SFP Account

Tax Base

Deductible Carrying Temporary Tax – Amount = Difference X Rate

Deferred Tax Asset (Liability)

FV-NI Invest. $42,000 $40,000 $2,000 30% Balance before adjustment Adj. to deferred tax account, and deferred tax benefit for 2024

$600 (1,125) $1,725

d. Accounting income Reversing diff.: Unrealized loss on Invest. (FV-NI) Reversing diff.: 2023 Unrealized gain realized in 2024 Taxable income Current income taxes at 30%

$120,000 2,000 3,750 $125,750 $37,725

Current tax expense for 2024

$37,725

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.19 (CONTINUED) e. Current Tax Expense ......................................... 37,725 Income Tax Payable ................................... To record current tax expense Deferred Tax Asset1 ........................................... Deferred Tax Liability1........................................ Deferred Tax Benefit ................................... To record deferred tax benefit

37,725

600 1,125 1,725

Alternatively, if one SFP account—a Deferred Tax Asset/Liability account—is used, a debit balance indicating an asset and a credit balance indicating a liability, the entry would be: Deferred Tax Asset/Liability .............................. Deferred Tax Benefit ...................................

Income before income tax Income tax expense Current Deferred (benefit) Net income

Non-current assets Deferred tax asset

1,725 1,725

$120,000 $37,725 (1,725)

36,000 $84,000

$600

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.19 (CONTINUED) h. SFP Account

Tax Base

Deductible Carrying Temporary Tax – Amount = Difference X Rate

Deferred Tax Asset (Liability)

FV-NI Invest. $42,000 $40,000 $2,000 25% Balance before adjustment Adj. to deferred tax account, and deferred tax benefit for 2024 Current Tax Expense ......................................... 37,725 Income Tax Payable ................................... To record current tax expense Deferred Tax Asset1 ........................................... Deferred Tax Liability1........................................ Deferred Tax Benefit................................... To record deferred tax benefit

500 1,125

1,625

or Deferred Tax Asset/Liability ........................

37,725

1,625

LO 2,3,4,5,8 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

$500 (1,125) $1,625

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.20 a.

2024 Deductible (Taxable) Temporary Differences $100,000

SFP Account Tax Carrying Dec. 31, 2024 Base Amount Warranty liability $0 $(100,000) Deferred tax asset, December 31, 2024 Deferred tax asset before adjustment Decrease in deferred tax asset, and deferred tax expense for 2024

Deferred Tax Tax Asset Rate (Liability) 28% $28,000 28,000 37,500 $(9,500)

Future years Total

2025

2026

$100,000

$35,000 28% $9,800

$65,000 28% $18,200

Deductible temporary difference Warranty liability Tax rate enacted for the year Deferred tax asset

$28,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.20 (CONTINUED) a. (continued) 2025 Deductible (Taxable) Temporary Differences $65,000

SFP Account Tax Carrying Dec. 31, 2025 Base Amount Warranty liability $0 $(65,000) Deferred tax asset, December 31, 2025 Deferred tax asset before adjustment Decrease in deferred tax asset, and deferred tax expense for 2025 Future year Deductible temporary difference Warranty liability Tax rate enacted for the year Deferred tax asset

Total

2023

$65,000

$65,000 28% $18,200

$18,200

Deferred Tax Tax Asset Rate (Liability) 28% $18,200 18,200 28,000 $(9,800)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.20 (CONTINUED) b. 2024 $ 155,000

2025 $ 155,000

Pre-tax accounting income Reversing difference – Warranty costs incurred > warranty expense (50,000) Taxable income $ 105,000

(35,000) $ 120,000

Taxable income Enacted tax rate Current income tax expense

$ 120,000 X 28% $ 33,600

$ 105,000 X 25% $ 26,250

c. 2024 Current Tax Expense ....................................... Income Tax Payable ................................. To record current tax expense Deferred Tax Expense...................................... Deferred Tax Asset ................................... To record deferred tax expense 2025 Current Tax Expense ....................................... Income Tax Payable ................................. To record current tax expense Deferred Tax Expense...................................... Deferred Tax Asset ................................... To record deferred tax expense

26,250 26,250

9,500 9,500

33,600 33,600

9,800 9,800

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.20 (CONTINUED) d. Income before income tax Income tax Current Deferred Net income

Income before income tax Income tax Current Deferred Net income

2024 $ 155,000 $ 26,250 9,500

35,750 $ 119,250 2025 $ 155,000

$ 33,600 9,800

43,400 $ 111,600

LO 2,3,4,5 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 a.

Basic Calculations of Capital Cost Allowance, Amounts and Balances:

Year 2023 2024 2025 2026 2027

(A) Base $600,000 240,000 144,000 86,400 51,840

(B) CCA X 40 % X 1.5 $ 360,000 X 40 % 96,000 X 40 % 57,600 X 40 % 34,560 X 40 % 20,736 $568,896

(A – B) UCC $ 240,000 144,000 86,400 51,840 31,104

Carrying Amount $480,000 360,000 240,000 120,000 0

2025

2026

2027

b. 2023

2024

Accounting income Reversing difference

$ 340,000 $340,000 (240,000) 24,000

$340,000 $340,000 62,400 85,440

$ 340,000 99,264

Taxable income

$ 100,000 $364,000 X 30 % X 30 % $30,000 $109,200

$402,400 $425,440 X 30 % X 30 % $120,720 $127,632

$ 439,264 X 30 % $131,779

Income tax payable

(C – B) Reversing Difference $(240,000) 24,000 62,400 85,440 99,264

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 (CONTINUED) c. and d. 2023 Statement of Deductible Financial Position (Taxable) Account Tax Carrying Temporary Dec. 31, 2023 Base Amount Differences Property, plant, & equipment $240,000 $480,000 $(240,000) Deferred tax asset/liability, December 31, 2023 Deferred tax asset/liability before adjustment Increase in deferred tax liability, and deferred tax expense for 2023 Current Tax Expense1 ........................................ 30,000 Income Tax Payable ................................... 1 ($100,000 X 30%) part (b) To record current tax expense Deferred Tax Expense ........................................ 72,000 Deferred Tax Liability ................................. To record deferred tax expense

30,000

72,000

Deferred Tax Tax Asset Rate (Liability) 30% $(72,000) (72,000) 0 $(72,000)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 (CONTINUED) c. and d. (continued) 2024 Deductible (Taxable) Temporary Differences $(216,000)

SFP Account Tax Carrying Dec. 31, 2024 Base Amount Property, plant, & equipment $144,000 $360,000 Deferred tax liability, December 31, 2024 Deferred tax liability before adjustment Decrease in deferred tax liability, and deferred tax benefit for 2024 Current Tax Expense2 ........................................ 109,200 Income Tax Payable ................................... 2 ($364,000 X 30%) part (b) To record current tax expense Deferred Tax Liability ........................................ Deferred Tax Benefit ................................... To record deferred tax expense

109,200

7,200 7,200

Deferred Tax Tax Asset Rate (Liability) 30% $(64,800) (64,800) (72,000) $7,200

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 (CONTINUED) c. and d. (continued) 2025 Deductible (Taxable) Temporary Differences $(153,600)

SFP Account Tax Carrying Dec. 31, 2025 Base Amount Property, plant, & equipment $86,400 $240,000 Deferred tax liability, December 31, 2025 Deferred tax liability before adjustment Decrease in deferred tax liability, and deferred tax benefit for 2025 2025 Current Tax Expense3 ........................................ 120,720 Income Tax Payable ................................... 3 ($402,400 X 30%) part (b) To record current tax expense

120,720

Deferred Tax Liability ......................................... 18,720 Deferred Tax Benefit................................... To record deferred tax expense

18,720

Deferred Tax Tax Asset Rate (Liability) 30% $(46,080) (46,080) (64,800) $18,720

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 (CONTINUED) c. and d. (continued) 2026 Deductible (Taxable) Temporary Differences $(68,160)

SFP Account Tax Carrying Dec. 31, 2026 Base Amount Property, plant & equipment $51,840 $120,000 Deferred tax liability, December 31, 2026 Deferred tax liability before adjustment Decrease in deferred tax liability, and deferred tax benefit for 2026 2026 Current Tax Expense4 ........................................ 127,632 Income Tax Payable ................................... 4 ($425,440 X 30%) part (b) To record current tax expense

127,632

Deferred Tax Liability ......................................... 25,632 Deferred Tax Benefit................................... To record deferred tax expense

25,632

Deferred Tax Tax Asset Rate (Liability) 30% $(20,448) (20,448) (46,080) $25,632

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 (CONTINUED) c. and d. (continued) 2027 Deductible (Taxable) Temporary Differences $31,104

SFP Account Tax Carrying Dec. 31, 2027 Base Amount Property, plant, & equipment $31,104 $0 Deferred tax asset, December 31, 2027 Deferred tax liability before adjustment Increase in deferred tax asset, and deferred tax benefit for 2027 2027 Current Tax Expense5 ........................................ 131,779 Income Tax Payable ................................... 5 ($439,264 X 30%) part (b) To record current tax expense

131,779

Deferred Tax Liability ......................................... 29,779 Deferred Tax Benefit................................... To record deferred tax benefit

29,779

Deferred Tax Tax Asset Rate (Liability) 30% $9,331 9,331 (20,448) $29,779

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 (CONTINUED) e. 2023 Income Tax Expense .......................................... 30,000 Income Tax Payable ................................... ($100,000 X 30%) To record current tax expense

30,000

2024 Income Tax Expense .......................................... 109,200 Income Tax Payable ................................... ($364,000 X 30%) To record current tax expense

109,200

2025 Income Tax Expense .......................................... 120,720 Income Tax Payable ................................... ($402,400 X 30%) To record current tax expense

120,720

2026 Income Tax Expense .......................................... 127,632 Income Tax Payable ................................... ($425,440 X 30%) To record current tax expense

127,632

2027 Income Tax Expense .......................................... 131,779 Income Tax Payable ................................... ($439,264 X 30%) To record current tax expense

131,779

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.21 (CONTINUED) f. CCA, Depreciation and Income Taxes Payable 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 -

2023

2024 CCA

2025 Depreciation

2026

2027

Income Taxes payable

LO 2,4,9 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001, cpa-t007 CM: Reporting; DAIS

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.22 a. Future Years 2024 NonCurrent Future taxable amounts Tax rate Future tax liab.

2025 Noncurrent**

$2,400,000 $2,400,000 30% * 29% $ 720,000 $ 696,000

Total

$4,800,000 $1,416,000

*The prior tax rate of 30% is calculated by dividing the $1,440,000 balance of the future tax liability account at January 1, 2023, by the $4,800,000 temporary difference at that same date. **One-half of the instalment receivable is classified as a current asset and one-half is non-current. Nevertheless, under ASPE the future tax liability is all classified as noncurrent.

Similarly, under IFRS, all deferred tax balances are reported as non-current in a classified SFP. Therefore, the noncurrent deferred tax liability is reported as $1,416,000.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.22 (CONTINUED) c. (Taxable) SFP Temporary Tax Differences X Account Rate Receivable ($4,800,000)* several Deferred tax liability, as revised Deferred tax liability before rate adjustment Decr. in deferred tax liability, and deferred tax benefit for 2023 from tax rate change

Deferred Tax (Liability) $(1,416,000) (1,416,000) (1,440,000) $24,000

* see part (a) for the detailed calculations Deferred Tax Liability ......................................... 24,000 Deferred Tax Benefit ...........................

24,000

LO 2,3,5,8,9 BT: AP Difficulty: C Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.23 a.

Taxable income for 2023 Tax rate Income taxes payable for 2023

$520,000 30% $156,000

Current Tax Expense .............................. 156,000 Income Tax Payable ........................ To record current tax expense

2024 Future (taxable) deductible amounts Depreciation

Future Years 2025

((($(20,000) ) Warranty liability 200,000 Enacted tax rate 30% Net deferred tax asset (($ 54,000) Net deferred tax asset before adjustment Increase in deferred tax asset

2026

Total

$(30,000)

$(10,000) $( 60,000))

30% $(9,000)

25% $ (2,500)

$200,000

Deferred Tax Asset ................................. Deferred Tax Benefit ....................... To record deferred tax benefit b.

156,000

$ 42,500 0 $ 42,500

42,500 42,500

IFRS requires that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

Long-term Assets Deferred tax asset

42,500

LO 2,4,5,8 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.24 a. Future Years

Future taxable amounts Enacted tax rate Deferred tax liability

2024

2025

2026

$78,000 30% $23,400

$62,000 30% $18,600

$55,000 25% $13,750

2027

Total

$46,000 $241,000 25% $ 11,500 $ 67,250

SFP Account Prop., plant, & equip.

(Taxable) Temporary Differences $(241,000)*

Tax Rate several

Deferred tax liability, Dec. 31, 2023 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023

Deferred Tax (Liability) $(67,250) (67,250) (41,000) $(26,250)

*Carrying amount and tax base are not given in the exercise, only the net difference is provided. Deferred Tax Expense ................................ 26,250 Deferred Tax Liability ..........................

26,250

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.24 (CONTINUED) c. Future Years

Future taxable amounts Enacted tax rate Deferred tax liability

2024

2025

2026

2027

Total

$78,000 29% $22,620

$62,000 27% $16,740

$55,000 27% $14,850

$46,000 27% $12,420

$241,000

Statement of Financial Position Account Prop., plant, & equip.

(Taxable) Temporary Differences $(241,000)*

Tax Rate several

Deferred tax liability, revised balance Deferred tax liability before adjustment [part (b)] Decr. in deferred tax liability, and deferred tax benefit for 2024

$ 66,630

Deferred Tax (Liability) $(66,630) (66,630) (67,250) $620

*Carrying amount and tax base are not given in the exercise, only the net difference is provided. Deferred Tax Liability ......................................... Deferred Tax Benefit ...........................

620 620

Note to Instructor: The journal entry above is effective and should be made at the time the new rates were substantively enacted or, if financial statements are prepared only annually, it would be combined with other year-end adjustments for 2024 that record the income tax expense. LO 4,5 BT: AP Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.25 a. 2020 Current Tax Expense ..................................... 32,500 Income Tax Payable ($130,000 X 25%) .

32,500

2021 Current Tax Expense ..................................... 26,250 Income Tax Payable ($105,000 X 25%) .

26,250

2022 Income Tax Receivable ................................. 58,750 Current Tax Benefit1............................... *1 (25% X ($130,000 + $105,000))

58,750

This leaves $305,000 - $235,000 = $70,000 of tax losses available for carryforward. No entry can be made to record any tax benefit from the remaining $70,000 of tax losses because it is not more likely than not that the company will actually benefit from them. However, the existence of the $70,000 loss carryforward should be disclosed in a note. 2023 In 2023, the company earned $50,000 of taxable income and it can deduct $50,000 of the $70,000 tax loss carryforward from this. They report a taxable income amount in 2023 of $0-. Because they are still uncertain about being able to benefit from the remaining $20,000 of tax losses in the future, no entry is made to recognize the benefit in the year, but this amount must be disclosed in a note. Income tax expense in 2023 is $-0-. Alternatively, both a current tax expense of $50,000 X 30% = $15,000 and a current tax benefit from previously unrecognized tax losses available for carryforward of $50,000 X 30% = $15,000 could both be recognized and reported.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.25 (CONTINUED) b. 2020 Income (loss) before income tax Income tax expense – current Net income

$130,000 32,500 $97,500

2021 Income (loss) before income tax Income tax expense – current Net income

$105,000 26,250 $78,750

2022 Income (loss) before income tax Current tax benefit due to loss carryback Net loss

$(305,000) 58,750 $(246,250)

2023 Income (loss) before income tax Current tax expense Net income Or, alternatively: Income before income tax Current tax expense Current tax benefit from unrecognized tax losses carried forward Net income

$50,000 -0$50,000

$50,000 $15,000 (15,000)

-0$50,000

LO 5,6 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.26 2020 Current Tax Expense ($80,000 X 25%) ............... 20,000 Income Tax Payable ....................................

20,000

2021 Income Tax Receivable ...................................... 48,000 ($160,000 X 30%) Current Tax Benefit ($160,000 X 30%) ......

48,000

2022 The 2022 loss of $380,000 is carried back, $250,000 to 2019 and $80,000 to 2020, leaving $50,000 to carry forward. Income Tax Receivable ...................................... 95,000 Current Tax Benefit 1 .................................. 1 ($250,000 X 30% + $80,000 X 25%) To record benefit from loss carryback Deferred Tax Asset............................................. 12,500 Deferred Tax Benefit2 ................................. 2 ($50,000 X 25%) - $-0To record deferred benefit from loss carryforward 2023 Current Tax Expense ........................................ 20,000 Income Tax Payable .................................. 3 [25% X ($130,000 – $50,000 loss carryforward)] To record current tax expense

95,000

12,500

Deferred Tax Expense4 ...................................... 12,500 Deferred Tax Asset ..................................... 4 ($0 – $12,500) To record deferred tax expense 2024 Current Tax Expense ($145,000 X 25%) ............ 36,250 Income Tax Payable ...................................

20,000

12,500

36,250

LO 5,6,7,8 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 18.90 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.27 a.

2021 Current Tax Expense ($120,000 X 25%) ...... 30,000 Income Tax Payable ..............................

30,000

2022 Current Tax Expense ($90,000 X 25%) ........ 22,500 Income Tax Payable ..............................

22,500

2023 The 2023 loss of $280,000 is carried back, $120,000 to 2021 and $90,000 to 2022, leaving $70,000 to carryforward. Income Tax Receivable ................................ 52,500 Current Tax Benefit 1............................. To record benefit from loss carryback 1 [25% X $120,000] + [25% X $90,000] = $52,500 Future Tax Asset........................................... 21,000 Future Tax Benefit 2 .............................. To record deferred benefit from loss carryforward 2 30% X ($280,000 – $120,000 – $90,000) = $21,000 2024 Current Tax Expense ................................... 45,000 Income Tax Payable .............................. 3 [($220,000 – $70,000) X 30%] To record current tax expense

52,500 *

21,000

Future Tax Expense4 .................................... 21,000 Future Tax Asset ................................... 4 ($0 – $21,000) To record deferred tax expense

45,000*

21,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.27 (CONTINUED) b. 2023 Income (loss) before income tax Income tax benefit Current benefit due to loss carryback Future benefit due to loss carryforward Net loss 2024 Income (loss) before income tax Income tax Current tax expense Future tax expense Net income

$(280,000) $52,500 21,000 ( 73,500 $(206,500)

$220,000 $45,000 21,000

2023 Income Tax Receivable ................................ 52,500 Current Tax Benefit 5............................. To record benefit from loss carryback *5[25% X $120,000] + [25% X $90,000] = $52,500 Future Tax Asset........................................... 15,750 Future Tax Benefit 6 .............................. To record future benefit from loss carryforward 6 30% X ($280,000 – $120,000 – $90,000) = $21,000 $21,000 X 75% = $15,750 2024 Current Tax Expense .................................... 45,000 Income Tax Payable ............................... 7 [($220,000 – $70,000) X 30%] To record current tax expense

66,000 $154,000

52,500 *

15,750

Future Tax Expense8 ..................................... 15,750 Future Tax Asset .................................... 8 ($0 – $15,750) To record deferred tax expense

45,000

15,750

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.27 (CONTINUED) d. 2023 Income (loss) before income tax Income tax benefit Current benefit due to loss carryback Future benefit due to loss carryforward Net loss 2024 Income (loss) before income tax Income tax Current tax expense Future tax expense Net income

$(280,000) $52,500 15,750

68,250 $(211,750)

$220,000 $45,000 15,750

60,750 $159,250

Riley’s notes should include information about the unused tax loss carryforward ($70,000), as well as supporting evidence for recognized future tax assets of $15,750. Note: For tax planning purposes, if the corporation anticipates profitable years ahead, it may decide to not carry back its losses in order to take advantage of the higher rates for 2024 and beyond. The loss carryback is optional.

LO 7 BT: AP Difficulty: C Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.28 a. 2023 Income Tax Receivable ........................................ 52,500 Current Tax Benefit 1 .................................... 1 [25% X $120,000] + [25% X $90,000] = $52,500 To record benefit from loss carryback Future Tax Asset .................................................. 21,000 Future Tax Benefit 2 ...................................... 2 30% X ($280,000 – $120,000 – $90,000) = $21,000 To record future benefit from loss carryforward

52,500

21,000

Future Tax Benefit3 ............................................. 5,250 Allowance to Reduce Deferred Tax Asset to Expected Realizable Value .... 3 ($21,000 X 25%) To adjust future tax asset account to net realizable value

5,250

2024 Current Tax Expense .......................................... 45,000 Income Tax Payable ..................................... 4 [($220,000 – $70,000) X 30%] To record current tax expense

45,000*

Future Tax Expense5 ............................................ 21,000 Future Tax Asset........................................... 5 ($0 – $21,000) To record future tax expense Allowance to Reduce Deferred Tax Asset to Expected Realizable Value ...... 5,250 Future Tax Expense ................................... To adjust future tax asset account to net realizable value.

21,000

5,250

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.28 (CONTINUED) b. 2023 Operating loss before income tax Income tax benefit Current benefit due to loss carryback Future benefit due to loss carryforward Net loss 2024 Operating income before income tax Income tax Current tax expense Future tax expense Net income c. Long-term assets: Future Tax Asset

$52,500 15,750

68,250 $(211,750)

$220,000 $45,000 15,750

2023 $ 21,000

Less: Allowance to Reduce Future Tax Asset to Expected Realizable Value Future Tax Asset (net)

$(280,000)

60,750 $159,250

2024 -

(5,250)

15,750

Both the Future Tax Asset account and the Allowance to Reduce Future Tax Asset to Expected Realizable Value account should be adjusted for the change in the enacted tax rates for 2024. This adjustment should be recorded in the accounts as soon as it is known and can be measured.

As with ASPE, the deferred tax asset would be classified as a non-current asset on the SFP, however, a valuation allowance may not be used. Instead, the Future Tax Asset account would be $15,750.

LO 7 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.29 a.

Current Tax Expense .................................. 273,600 Income Tax Payable ............................ To record current tax expense

273,600

Taxable income Enacted tax rate Income tax payable

$912,000 X 30% $273,600

SFP Account Warranty Liabilities

Deductible Temporary Differences $300,000*

Tax Rate 30%

Deferred tax asset, Dec. 31, 2023 Deferred tax asset before adjustment Incr. in deferred tax asset, and deferred tax benefit for 2023

Deferred Tax Asset $90,000 90,000 81,000 $9,000

*Carrying amount and tax base are not given in the exercise, only the net difference Deferred Tax Asset ..................................... Deferred Tax Benefit ........................... To record deferred tax benefit

9,000 9,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.29 (CONTINUED) b.

(1.) 2023 Current Tax Expense .................................. 273,600 Income Tax Payable ............................ To record current tax expense

Deductible SFP Temporary Differences X Account Warranty Liabilities $300,000* Less amount not likely to be realized Deferred tax asset, Dec. 31, 2023 Deferred tax asset before adjustment Decr. In deferred tax asset and deferred tax expense increase for 2023

Tax Rate 30%

273,600

Deferred Tax Asset $90,000 (25,000) 65,000 81,000 $(16,000)

*Carrying amount and tax base are not given in the exercise, only the net difference Deferred Tax Expense ................................ 16,000 Deferred Tax Asset ............................. To record deferred tax expense

16,000

(2.) 2024 Deferred Tax Asset ..................................... 25,000 Deferred Tax Benefit ...........................

25,000

Note to instructor: This entry would be combined with other entries for the year that set up any deferred tax asset or liability for current year activity. LO 3,4,8,9 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.30 a. Current Tax Expense ......................................... 273,600 Income Tax Payable ................................... To record current tax expense Future Tax Asset ................................................ Future Tax Benefit 1 .................................... 1 ($90,000 – $81,000) To record future tax benefit

273,600

9,000 9,000

Future Tax Expense ............................................ 25,000 Allowance to Reduce Future Tax Asset to Expected Realizable Value ...... 25,000 To bring the deferred tax assets account to its realizable value b. Allowance to Reduce Future Tax Asset to Expected Realizable Value .............. 25,000 Future Tax Benefit ......................................

25,000

LO 2,4,8,9 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.31 a.

Temporary Difference

Resulting Deferred Tax Asset Liability

Related SFP Account

($275,000)

Plant Assets

Deprec. Litigation Loss

Instalment Sale Totals

Lawsuit Obligation

$91,000

_____ $91,000

(218,000) ($493,000)

Instalment Receivable

Long-term liabilities Deferred tax liability ($493,000 – $91,000)

$ 402,000

IFRS requires that all deferred tax assets and liabilities be reported as non-current items on a classified SFP. b. Long-term liabilities Future tax liability

$ 402,000

LO 2,8,9 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.32 a.

Calculation of current income tax expense:

Accounting income: Revenue Expenses Permanent differences: Non-taxable dividends Golf club dues Reversing differences: CCA > depreciation Litigation loss Taxable income Current income taxes for 2023 @ 30%

Income from Continuing Operations

Discontinued Operations

Total

$273,000 216,000 57,000

$118,000 110,500 7,500

$64,500

(1,700)

4,500

(3,700) _______ $56,100

5,100 $12,600

(3,700) 5,100 $68,700

$16,830

$3,780

$20,610

Calculation of deferred tax expense, continuing operations: Statement of (Taxable) Temporary Deferred Tax Financial Position Tax Differences X (Liability) Account Rate PP&E $(3,700)* 30% $(1,110) Deferred tax liability, Dec. 31, 2023 (1,110) Deferred tax liability before adjustment 0 Incr. in deferred tax liability, and deferred tax expense for 2023 for continuing operations $(1,110) *Carrying amount and tax base are not given in the exercise, only the net difference is provided.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.32 (CONTINUED) a.

Calculation of deferred tax expense, discontinued operations: Statement of Deductible Temporary Financial Position Tax Differences X Account Rate Litigation Liability $5,100* 30% Deferred tax asset, Dec. 31, 2023 Deferred tax asset before adjustment Incr. in deferred tax asset, and deferred tax benefit for 2023 – for Disc. Operations

Deferred Tax Asset $1,530 1,530 0 $1,530

*Carrying amount and tax base are not given in the exercise, only the net difference is provided.

b. Current Tax Expense ................................ Current Tax Expense – Discontinued Operations .................... Income Tax Payable ......................... To record current tax expense

16,830

Deferred Tax Expense ............................. Deferred Tax Liability ....................... To record deferred tax expense

1,110

3,780 20,610

1,110

Deferred Tax Asset .................................. 1,530 Deferred Tax Benefit – Discontinued Operations ............. 1,530 To record deferred tax benefit on discontinued operations

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.32 (CONTINUED) c. Income before income tax and discontinued operations Income tax Current tax Deferred tax Income from continuing operations Discontinued operations: Income from discontinuing operations Net of applicable income tax: Current tax $3,780 Deferred tax (benefit) (1,530) Net income

$57,000 $16,830 1,110

17,940 39,060

7,500

2,250

5,250 $44,310

Earnings per share: Income from continuing operations Income from discontinuing operations Net income

$3.91 0.52 $4.43

Non-current assets Deferred tax asset ($1,530 – $1,110)

$420

IFRS requires that all deferred tax assets and liabilities be reported as non-current items on a classified SFP. e. Non-current assets Future tax asset

$420

LO 2,8,9 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.33 a.

Income Tax Expense1 ................................. 89,475 Income Tax Payable ............................ 1 ($302,000 - $3,750) x 30%

Income before income tax Income tax expense Net income

Current liabilities: Income tax payable

89,475

$302,000 89,475 $212,525

$89,475

Additional disclosures would include a statement that the taxes payable method is being used and a brief description of what it entails, along with: 1. income tax expense or benefit included in determining income (loss) before discontinued operations; and the amount related to transactions recognized in equity; 2. a reconciliation of the actual tax rate or expense or benefit to the statutory amount for income (loss) before discontinued operations, with information about major reconciling items; 3. the amount of reserves to be included in taxable income in each of the next five years; and the amount of unused income tax credits and losses carried forward.

Henry is providing all of the necessary and relevant disclosure as mentioned in (d) above. Creditors can therefore interpret the effect of adopting the taxes payable method of accounting for the income tax accounts. Creditors will also understand Henry’s motivation in adopting this method. The benefits of the alternative method are likely exceeded by unnecessary and possibly excessive costs of providing the additional information.

LO 3,4,8,9 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.34 a. Accounting income Permanent differences : Non-deductible fines

$105,000 15,000 120,000

Reversing differences: Excess of CCA over depreciation Excess rent collected over rent earned Taxable income Income taxes – 30%

Income Tax Expense ...................................... Income Tax Payable ................................

(16,000) 24,000 $128,000 $38,400

38,400 38,400

Income before income tax Income tax expense Net income

$105,000 38,400 $66,600

Current assets Income tax receivable ($42,000 – $38,400)

$3,600

LO 2,8,9 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 18.35 a. Accounting income before adjustments Permanent difference: Add: 50% meals and entertainment Reversing difference: Less: CCA in excess of depreciation Taxable income Income tax expense @ 30% Income Tax Expense ...................................... Income Tax Payable ................................

$185,000 10,000 (25,000) $170,000 $51,000 51,000 51,000

b. Effective Tax Rate = $51,000/$185,000 Adjustment for permanent differences = ($10,000 x 30%)/$185,000 Adjustment for reversing differences = ($25,000 x 30%)/$185,000 Statutory Tax Rate * adjusted to eliminate rounding errors

27.5%* (1.6%) 4.1%* 30.0%

LO 8,9 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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TIME AND PURPOSE OF PROBLEMS Problem 18.1 Purpose—to test a student’s ability to differentiate between permanent and temporary differences, calculate, classify and record current and deferred taxes, as well as prepare a partial income statement and SFP. In this problem, the student deals with a single tax rate and opening balances to the deferred tax accounts related to a single temporary difference.

Problem 18.2 Purpose—to test a student’s ability to calculate and classify future taxes for five temporary differences, while dealing with an opening balance in the deferred tax asset account. Student must deal with three years and two tax rates and is required to draft the income statement for the year as well as arrive at SFP amounts with appropriate classifications.

Problem 18.3 Purpose—to provide the student with an understanding of how to calculate and properly classify deferred taxes when there are four types of temporary differences. A single tax rate applies. The student is required to calculate and classify deferred taxes. Also, the student must use data given to solve for both taxable income and pre-tax accounting income. Reconciliations of reversing differences and the resulting deferred tax accounts must be prepared in order to provide proper comparative SFP disclosures. Finally, the reconciliation of the effective tax rate is required.

Problem 18.4 Purpose—to provide the student with a situation where: (1) a temporary difference originates over a three-year period and begins to reverse in the fourth period, (2) a change in an enacted tax rate occurs first in a year prior to the year in which the amount of the cumulative temporary difference originates and then second in a year in which there is a change in the amount of cumulative temporary difference, (3) the amount of originating or reversing temporary difference must be calculated each year in order to determine the cumulative temporary difference at the end of each year, and (4) there is a permanent difference along with a temporary difference each year. Journal entries are required for the first year in one instance and then for each of four years, including the entry for the adjustment of deferred taxes due to the change in the enacted tax rate. The income statement disclosure is also required for one year.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 18.5 Purpose—to provide the student with an understanding of how future temporary differences for existing depreciable assets are considered in determining the future years in which existing temporary differences result in taxable or deductible amounts. The student is given information about pre-tax accounting income, one temporary difference, and one permanent difference. The student must calculate all amounts related to income taxes for the current year and prepare the journal entry to record them. In order to determine the beginning balance in a deferred tax account, the student must calculate deferred taxes for the prior year’s SFP. An income statement and SFP presentation is also required along with earnings per share disclosure.

Problem 18.6 Purpose—to provide the student with the opportunity to reconcile timing differences reversing over a two-year period stemming from several sources, but using a consistent tax rate. Discontinued operations are also dealt with in this problem. The production of entries, income statement, and SFP amounts are also a requirement in this challenging problem.

Problem 18.7 Purpose—to develop an understanding of the concept of future taxable amounts and future deductible amounts. Also, to develop an understanding of how reversing timing differences affect the calculation of deferred tax assets and liabilities when there are multiple tax rates enacted for the various periods affected by existing temporary differences. Different assumptions as to the likeliness of realization of deferred tax assets accrued from future deductible amounts are used and lead to a variety of entries and financial statement balances to be reported for two years.

Problem 18.8 Purpose—to provide the student with the opportunity to deal with several reversing differences reversing over a two-year period with several tax rates involved. The activity of some SFP accounts over the two-year period provide the necessary detail to trace the reversing timing differences. Reporting of comparative balances on the statement of income and SFP at the end each of the two years must also be provided. A good understanding of the accounting and tax treatment is required to handle this challenging problem.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 18.9 Purpose—to provide the student with an understanding of how the calculation and classification of deferred taxes are affected by the individual future year(s) in which future taxable and deductible amounts are scheduled to occur because of existing temporary differences. Two situations are given and the student is required to calculate, record, and classify the deferred taxes for each. A net deferred tax asset results in both cases.

Problem 18.10 Purpose—to test a student’s understanding of the relationships that exist in the subject area of accounting for income taxes. The student is required to calculate and classify deferred taxes for two successive years. The journal entry to record income taxes as well as a draft of the income tax expense section of the income statement are also required for each year. An interesting twist to this problem is that the student must calculate taxable income for two individual periods based on facts about the tax rate and amount of taxes paid for each period and then combine that information with data on temporary differences to calculate pre-tax accounting income.

Problem 18.11 Purpose—to test a student’s ability to calculate, record, and classify deferred taxes for three reversing differences and three permanent differences and to draft the income statement and a statement of retained earnings for the year. This problem also requires the reconciliation of the effective tax rate.

Problem 18.12 Purpose—to provide the student with a situation involving an actual net operating loss that can be partially offset by prior taxes paid using the carryback provision. Journal entries for the loss year and two subsequent years are required. The benefits of the loss carryforward are realized in the year following the loss year in one case and unexpected in another. Income statement presentations are required for the loss year where the benefits of the carryback and the carryforward are recognized and the year following the loss year where the benefits of the carryforward are realized and for the case where the loss carryforward is not expected.

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Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 18.13 Purpose—To challenge the student to deal with an error in a prior period in a company following ASPE and using the future/deferred income taxes method of accounting. The problem also includes reversing (CCA vs depreciation and allowance for expected credit losses) and permanent differences (income tax penalties and interest, and golf club dues). The student must consider refiling the prior year tax return as a result of the error and complete the statement of retained earnings with the after-tax impact of the error shown. The student must also prepare the journal entry for the error.

Problem 18.14 Purpose—To introduce the student to accounting for commercial real estate leases and deal with the reversing differences (prepaid rent and rent payable) as well as permanent differences (golf club dues and interest expense incurred to earn income not subject to tax). The student must deal with 2 years of information, calculate income tax expense and payable for 2 years, and journalize all tax entries for 2 years. Also required is the tax section of the income statement and comparative statements of financial position for 2 years.

Problem 18.15 Purpose—To provide the students with a challenging problem that requires them to think through a number of issues: loss carryback in a situation where the company’s accounting income and taxable income has differences due to timing and permanent differences, a change in tax rate, and a loss carryforward that cannot be recognized in its entirety. Students are asked to prepare entries and the income tax rate reconciliation note.

Problem 18.16 Purpose—to provide the student with three situations and require the discussion of the impact accounting policy choices for two situations and changing tax rates in one situation will have on deferred tax balances. Fair value accounting for investment properties and the revaluation method are included in this discussion.

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SOLUTIONS TO PROBLEMS PROBLEM 18.1 (a)

Year 2022 2023 2024 2025 2026

Basic Calculations of Capital Cost Allowance, Amounts, and Balances 2022 - 2026:

(A) CCA Base Rate $900,000 30% 630,000 20% 504,000 20% 403,200 20% 322,560 20%

(B) CCA $270,000 126,000 100,800 80,640 64,512

(A – B) UCC $630,000 504,0002 403,200 322,560 258,048

Carrying Amount $825,000 675,0001 525,000 375,000 225,000

(Taxable) Temporary Difference $(195,000) (171,000) (121,800) (52,440) 33,048

(C-B) Reversing Difference $(195,000) 24,000 49,200 69,360 85,488

Taxable temporary difference, Dec. 31, 2022 X tax rate = Deferred tax liability, Dec. 31, 2022 ($825,000 – $630,000) X tax rate = $58,500 Tax rate = 30% 1 2

$900,000 – $75,000 – $150,000 = $675,000 $900,000 – ($900,000 X 20% X 150%) – $126,000 = $504,000

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PROBLEM 18.1 (CONTINUED) a. (continued)

SFP Account Dec. 31, 2023 Property, plant, & equip.

Tax Base $504,0002

Carrying Amount $675,0001

Deductible (Taxable) Temporary Differences $(171,000)

Prepaid rent (2024 expense) -018,750 (18,750) Prepaid rent (2025 expense) -018,750 (18,750) Warranty liability -0(4,500) 4,500 Deferred tax liability, December 31, 2023 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023

1 2

$900,000 – $75,000 – $150,000 = $675,000 $900,000 – ($900,000 X 20% X 150%) – $126,000 = $504,000

Tax Deferred Rate Tax (see Asset below) (Liability) 30% $(51,300) 30% 30% 30%

(5,625) (5,625) 1,350 (61,200) (58,500) $(2,700)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.1 (CONTINUED) b. Accounting income Permanent differences: 50% of meals expense ($12,000 X 50%) Golf club fees Reversing differences: Depreciation Capital cost allowance Rent paid Rent expense Warranty expense Warranty payments Taxable income Current income taxes – 30%

$60,000 $6,000 9,000

150,000 (126,000) (56,250) 18,750 9,000 (4,500)

c. Current Tax Expense ................................... Income Tax Payable .......................... To record current tax expense

19,800

Deferred Tax Expense ............................... Deferred Tax Liability ......................... To record deferred tax expense

2,700

d. Income before income tax Income tax Current Deferred Net income

15,000 75,000

24,000 (37,500) 4,500 $66,000 $19,800

19,800

2,700

$60,000 $19,800 2,700

22,500 $37,500

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PROBLEM 18.1 (CONTINUED) e.

Statement of financial position, December 31, 2023 Long-term liabilities: Deferred tax liability [$56,925 + ($5,625 - $1,350)]

$61,200

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP. LO 2,4,8 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.2 a. For non-current deferred taxes: Future taxable amounts: CCA vs. depreciation Tax rate enacted for the year Deferred tax liability

Deferred Tax Asset (Liability) 2024 2025 2026 $(90,000) $(50,000) $(40,000) 30% 28% 28% $(27,000) $(14,000) $(11,200)

Future taxable amounts: Instalment accounts receivable Tax rate enacted for the year Deferred tax liability

2024

Future deductible amounts: Pension liability Tax rate enacted for the year Deferred tax asset Deferred tax liability

Total $(180,000) $(52,200)

2025 $(36,000) 28% $(10,080)

2026 $(36,000) 28% $(10,080)

Total $(72,000)

2024 $ 30,000 30% $ 9,000

2025 $ 20,000 28% $ 5,600

2026 $ 10,000 28% $ 2,800

Total $ 60,000

$(18,000)

$(18,480)

$(54,960)

$(20,160)

$ 17,400

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PROBLEM 18.2 (CONTINUED) a. (continued) Deferred tax asset (liability)___ Future deductible amounts: Unearned royalties Tax rate enacted for the year Deferred tax asset

2024 $ 76,000 30% $ 22,800

Future deductible amounts: Various accrued expenses Tax rate enacted for the year Deferred tax asset

2024 $ 24,000 30% $ 7,200

Future taxable amounts: Instalment accounts receivable Tax rate enacted for the year Deferred tax liability

2024 $ (36,000) 30% $ (10,800)

Deferred tax asset

$ 19,200

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PROBLEM 18.2 (CONTINUED) a. (continued) (Taxable) Deductible Temporary Differences

SFP Account Tax Carrying Dec. 31, 2023 Base Amount PP&E (table above) * * $(180,000) -0- $72,000 (72,000) Instal. accounts receivable -0- (60,000) 60,000 Pension liability Unearned royalties -0- (76,000) 76,000 Accrued liabilities -0- (24,000) 24,000 Instal. accounts receivable -036,000 (36,000) Deferred tax liability, December 31, 2023 Deferred tax asset before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023 * Amounts not given in the problem Deferred Tax Expense .................................. Deferred Tax Liability ............................

65,760 65,760

Tax Rate Mixed Mixed Mixed 30% 30% 30%

Deferred Tax Asset (Liability) $(52,200) (20,160) 17,400 22,800 7,200 (10,800) (35,760) 30,000 $(65,760)

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PROBLEM 18.2 (CONTINUED a. (continued) Non-current liabilities: Deferred tax liability ($54,960 – $19,2001) 1 ($22,800 + $7,200 - $10,800 = $19,200)

2023 $35,760

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

$180,000 tax due for 2023 ÷ 30% 2023 tax rate = $600,000 taxable income for 2023.

Accounting income for 2023: Assuming that the only differences between accounting income and taxable income relate to the reversing differences given, the 2023 reversing differences are: CCA > depreciation ($90,000 + $50,000 + $40,000) Instalment gross profit > taxable amount: ($36,000 + $36,000 + $36,000) Pension expense < pension contributions, 2023: Accumulated to Dec. 31, 2023 ($30,000 + $20,000 + $10,000) $60,000 2 Less accumulated to Jan. 1, 2023 (100,000) Reversing difference in year:

$(180,000)

(108,000)

(40,000)

Royalties received > royalty revenues Expenses incurred > expenses paid Total reversing differences, 2023

76,000 24,000 $(228,000)

Temporary deductible difference accumulated to January 1, 2023: $30,000 deferred tax asset ÷ 30% tax rate = $100,000

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PROBLEM 18.2 (CONTINUED) c. (continued) Calculation of accounting income, 2023: Accounting income Reversing differences Taxable income – see part (c)

$ X (228,000) $ 600,000

Therefore, accounting income: $600,000 + $228,000 =

$ 828,000

d. Income before income tax Income tax expense Current Deferred3 Net income

$828,000 $180,000 65,760

245,760 $582,240

This can be further divided into the deferred taxes caused by a change in the rate of tax and those caused by changes in the temporary differences themselves: Caused by change in rate of tax: Deferred tax asset, January 1, 2023 $100,000 @ 30% Deferred tax asset, January 1, 2023 $100,000 @ 30% for 2023, 2024, and 28% for 2025, 2023: $40,000 @ 30% $12,000 $30,000 @ 30% 9,000 $20,000 @ 28% 5,600 $10,000 @ 28% 2,800 Caused by changes in temporary differences: $65,760 – $600 =

$30,000

29,400 $ 600 $65,160

LO 2,4,8 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 18.118 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 18.3 a. Excess CCA over Deprec. Future taxable amounts Tax rate enacted for the year Deferred tax liability

2024 $ 37,500 25% $ 9,375

Unearned Rent Future deductible amounts Tax rate enacted for the year Deferred tax asset

SFP Account Tax Dec. 31, 2022 Base PP&E (table above) * Unearned Rent (table above) -0Unearned Rent (table above) -0Deferred tax liability, December 31, 2022

2025 $ 37,500 25% $ 9,375

2026 $ 37,500 25% $ 9,375

2023 $20,000 30% $6,000

2024 $20,000 25% $ 5,000

Carrying Amount * $(20,000) (40,000)

Deductible (Taxable) Temporary Differences $(150,000) 20,000 40,000

*Amounts not given in the problem

2027 $ 37,500 25% $ 9,375

2025 $20,000 25% $5,000

Tax Rate 25% 30% 25%

Total $ 150,000 $ 37,500

Total $60,000 $16,000

Deferred Tax Asset (Liability) $(37,500) 6,000 10,000 $(21,500)

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PROBLEM 18.3 (CONTINUED) b.

Calculation of effect of disposal of equipment on temporary differences: Original cost of disposed equipment Accumulated depreciation of disposed equipment Reduction in carrying amount of equipment Reduction in CCA pool (UCC) for proceeds Reversing difference in 2023

$ 105,000 (37,000) 68,000 90,000 22,000

CCA > depreciation, 2023 Excess of carrying amount over tax base, January 1, 2023 Excess of carrying amount over tax base, Dec.31, 2023 Carrying amount > tax base, equipment Future taxable amounts Tax rate enacted for the year Deferred tax liability Unearned Rent Future deductible amounts Tax rate enacted for the year Deferred tax asset

2024 $ 68,000 25% $ 17,000

2025 $ 68,000 25% $ 17,000

2024 $20,000 25% $5,000

$22,000 100,000 150,000 $272,000

2026 $ 68,000 25% $ 17,000

2025 $20,000 25% $ 5,000

2027 $ 68,000 25% $ 17,000

Total $40,000 $10,000

Total $ 272,000 $ 68,000

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PROBLEM 18.3 (CONTINUED) b. (continued)

(Taxable) Deductible Temporary Differences $(272,000) 20,000 20,000 75,000

SFP Account Tax Carrying Dec. 31, 2023 Base Amount PP&E (table above) * * Unearned Rent (table above) -0- $(20,000) Unearned Rent (table above) -0- (20,000) LT Investment * * Deferred tax liability, December 31, 2023 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023 *Amounts not given in the problem c.

Deferred Tax Expense .................................. 17,750 1 Deferred Tax Asset ..................................... 12,750 ($18,750 + $5,000 + $5,000 – op. bal. $16,000) Deferred Tax Liability1 ........................... 30,500 ($68,000 – op. bal. $37,500) 1 Alternately – net the two Deferred Tax Asset/Liability .................. 17,750 To record deferred tax expense Solutions Manual 18.121 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Tax Rate 25% 25% 25% 25%

Deferred Tax Asset (Liability) $(68,000) 5,000 5,000 18,750 (39,250) (21,500) $(17,750)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.3 (CONTINUED) c. (continued) Accounting income Permanent differences: Dividends received that are not taxable Late interest penalties on tax instalments

$633,000 ($15,000) 2,880

(12,120) 620,880

Reversing differences: Gain on disposal of equipment Impairment loss on investments Excess of rent revenue over cash received ($60,000 – $40,000) CCA > Depreciation

(20,000) (100,000)

Taxable income Current income taxes at 30% current rate

$553,880 $166,164

Current Tax Expense .................................... 166,164 Income Tax Payable ............................. To record current tax expense

(22,000) 75,000

166,164

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.3 (CONTINUED) d.

Statement of financial position classification: Long-term liabilities Deferred tax liability

2023

2022

39,250

21,500

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP. e. Income statement presentation: Income before income tax Income tax Current tax Deferred tax Net income

$633,000 $ 166,164 17,750

183,914 $449,086

f. @ 30% $189,900 (4,500) 864 $186,264

÷ Accounting Income 30.0% (0.7)% 0.1% 29.4%

(2,350) $183,914 Effective tax rate ($183,914 / $633,000) (rounded)

(0.4)% 29.0% 29.0%

Accounting income Non-taxable dividends Non-deductible penalties

$633,000 (15,000) 2,880

Net taxable temporary differences taxed at lower 25% rate: ($272,000 – $150,000) X 5% = $(6,100) $75,000 X 5% = 3,750

The effective tax rate differs from the statutory rate because there is no tax effect on the permanent differences, and because of the deferment of taxes to the future at a 25% rate rather than the current rate of 30%. LO 2,4,5,8,9 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 18.123 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.4 a.

Before deferred taxes can be calculated, the amount of the reversing differences originating (reversing) each period and the resulting temporary difference at each year-end must be calculated:

Accounting income Permanent difference Taxable income (given) Reversing difference for the year Tax rate enacted for the year Current income tax (% X taxable income) (Taxable) temporary Difference – beginning of year (Excess) CCA in year (Taxable) temporary Difference – end of year

2023 $ 460,000 40,000 500,000 299,000 ($201,000)

2024 $ 420,000 40,000 460,000 294,000 $(166,000)

2025 $ 390,000 40,000 430,000 304,200 $(125,800)

2026 $ 460,000 40,000 500,000 644,000 $144,000

25%

30%

$74,750

$88,200

$91,260

$193,200

$( 0) (201,000)

$(201,000) (166,000)

$(367,000) (125,800)

$(492,800) 144,000

$(201,000)

$(367,000)

$(492,800)

$(348,800)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.4 (CONTINUED) a. and b. 2023

SFP (Taxable) Account Tax Carrying Temporary Dec. 31, 2023 Base* Amount* Differences Property, plant, & equip. $(201,000) Deferred tax liability, December 31, 2023 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023 *Amounts not given in the problem 2023 Current Tax Expense .................................... 74,750 Income Tax Payable ............................. [(refer to table in part (a)] To record current tax expense

74,750

Deferred Tax Expense .................................. 50,250 Deferred Tax Liability ............................ To record deferred tax expense

50,250

Deferred Tax Tax Rate (Liability) 25% $(50,250) (50,250) 0 $(50,250)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.4 (CONTINUED) a. and (b) (continued) 2024 SFP (Taxable) Account Tax Carrying Temporary Dec. 31, 2024 Base* Amount* Differences Property, plant, & equip. $(367,000) Deferred tax liability, December 31, 2024 Deferred tax liability before adjustment ($50,250 + $10,050a) Incr. in deferred tax liability, and deferred tax expense for 2024 *Amounts not given in the problem

Deferred Tax Tax Rate (Liability) 30% $(110,100) (110,100) (60,300) ($49,800)

2024 Deferred Tax Expense ................................ 10,050 Deferred Tax Liability ............................ 10,050 [To record the adjustment for the increase in the enacted tax rate recorded when known: $201,000 × (30% – 25%)] a

Current Tax Expense .................................... 88,200 Income Tax Payable ............................. [(refer to table in part (a)] To record current tax expense Deferred Tax Expense .................................. 49,800 Deferred Tax Liability ............................ To record deferred tax expense

88,200

49,800

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.4 (CONTINUED) a. and b. (continued) 2025

SFP (Taxable) Account Tax Carrying Temporary Dec. 31, 2025 Base* Amount* Differences Property, plant, & equip. $(492,800) Deferred tax liability, December 31, 2025 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2025 *Amounts not given in the problem 2025 Current Tax Expense .................................... 91,260 Income Tax Payable ............................. [(refer to table in part (a)] To record current tax expense

91,260

Deferred Tax Expense .................................. 37,740 Deferred Tax Liability ............................ To record deferred tax expense

37,740

Deferred Tax Tax Rate (Liability) 30% $(147,840) (147,840) (110,100) $(37,740)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.4 (CONTINUED) a. and b. (continued) 2026

SFP (Taxable) Account Tax Carrying Temporary Dec. 31, 2026 Base* Amount* Differences Property, plant, & equip. $(348,800) Deferred tax liability, December 31, 2026 Deferred tax liability before adjustment Decr. in deferred tax liability, and deferred tax benefit for 2026 *Amounts not given in the problem 2026 Current Tax Expense .................................... 193,200 Income Tax Payable ............................. [(refer to table in part (a)] To record current tax expense

193,200

Deferred Tax Liability .................................... 43,200 Deferred Tax Benefit ............................. To record deferred tax benefit

43,200

Tax Rate 30%

Deferred Tax (Liability) $(104,640) (104,640) (147,840) $43,200

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.4 (CONTINUED) c. 2024 Income before income tax Income tax expense Current Deferred1 Net income 1 ($49,800 + $10,050)

$420,000 $88,200 59,850

148,050 $271,950

LO 2,4,5,8 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.5 a.

Basic Calculations of Capital Cost Allowance, Depreciation and Balances: (A) Year

Base

2022 $1,000,000 X 20 % X 1.5 2023 700,000 X 20 %

(B)

(A – B)

(C-B) Reversing

(C)

CCA

UCC

Deprec.

Carrying Amount

$300,000 140,000

$ 700,000 560,000

$125,000 125,000

$875,0001 $(175,000) 750,0002 (15,000)

Difference

$1,000,000 - $125,000 = $875,000 $1,000,000 - $125,000 - $125,000 = $750,000 (b) 2

2023

SFP (Taxable) Account Tax Carrying Temporary Dec. 31, 2023 Base Amount Differences Property, plant, & equip. $560,000 $750,000 $(190,000) Deferred tax liability, December 31, 2023 Deferred tax liability before adjustment ($175,000 X 30%) Incr. in deferred tax liability, and deferred tax expense for 2023

Deferred Tax Tax Asset Rate (Liability) 30% $(57,000) (57,000) (52,500) $(4,500)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.5 (CONTINUED) b. (continued) Calculation of current income tax expense: Accounting income Permanent difference – tax exempt interest

$ 1,400,000 (60,000) 1,340,000 15,000 1,325,000 $ 397,500

Reversing difference - [part (a)] Taxable income on regular operations Income tax expense and payable @ 30 % c. Current Tax Expense ................................... 397,500 Income Tax Payable............................. To record current tax expense Deferred Tax Expense ................................. Deferred Tax Liability ........................... To record deferred tax expense d.

Income before income tax Income tax expense Current Deferred Net income Earnings per share: Net income

397,500

4,500 4,500

$1,400,000 $397,500 4,500

402,000 $ 998,000

$9.98

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.5 (CONTINUED) e.

Net deferred tax liability at December 31, 2023. (See part (b)) Long-term liabilities Deferred tax liability

$57,000

LO 2,4,5,8 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.6 a. PP&E Bal. Dec. 31, 2022

UCC $ 960,000

Carrying Amount $ 1,256,000

For 2023 Bal. Dec. 31, 2023

(192,000) 768,000

(175,000) 1,081,000

(17,000) (313,000)

(5,100) (93,900)

Liability

For 2024 Bal. Dec. 31, 2024

(153,600) $ 614,400

(180,000) 901,000

26,400 $ (286,600)

7,920 $ (85,980)

Liability

Difference $ (296,000)

Tax 30% $ (88,800)

Deferred Tax Liability

Tax Base

Accrued Liability

Difference

Tax 30%

Deferred Tax

Bal. Dec. 31, 2022

$ 0

$ (199,500)

$199,500

$59,850

Asset

For 2023 Bal. Dec. 31, 2023 For 2024 Bal. Dec. 31, 2024

0 0 0 $-0-

131,500 (68,000) 68,000

(131,500) 68,000 (68,000) $ -0-

(39,450) 20,400 (20,400) $ -0-

Restructuring Liability

$ -0-

Asset

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.6 (CONTINUED) a. (continued) Deferred Gross Profit on Property Sale Bal. Dec. 31, 2022 For 2023 (net increase) Bal. Dec. 31, 2023 For 2024 Bal. Dec. 31, 2024

Tax Base $ -0-0-0-0-0-

Carrying Amount -0$46,800 46,800 (15,600) $31,200

Difference -0$ (46,800) (46,800) 15,600 $ (31,200)

Tax 30% -0$ (14,040) (14,040) 4,680 $ (9,360)

Deferred Tax

Liability Liability

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.6 (CONTINUED) b. Continuing operations: Accounting income Permanent differences: Non-deductible life insurance Non-taxable dividends Reversing differences: CCA & depreciation Restructuring charges Profit on property sale Taxable income Current income taxes – 30% Discontinued operations: Accounting income Permanent differences Reversing differences Taxable income Current income taxes – 30%

2023 $850,000

2024 $525,000

11,000 (3,250) 857,750

11,000 (3,500) 532,500

(17,000) (131,500) (46,800) 662,450 $198,735

26,400 (68,000) 15,600 506,500 $151,950

18,800 0 0 18,800 5,640

$0 0 0 0 $0

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.6 (CONTINUED) a. and c.

SFP Account Dec. 31, 2022

Tax Base PP&E $960,000 Restructuring Liability -0Future tax liability, December 31, 2022

SFP Account Dec. 31, 2023

Carrying Amount $1,256,000 (199,500)

Deductible (Taxable) Temporary Differences $(296,000) 199,500

Deductible (Taxable) Temporary Differences $(313,000) 68,000 (46,800)

Tax Carrying Base Amount PP&E $768,000 $1,081,000 Restructuring Liability -0(68,000) Deferred G/P on Sale (A/R) -046,800 Future tax liability, December 31, 2023 Future tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023

Tax Rate 30% 30%

Tax Rate 30% 30% 30%

Future Tax Asset (Liability) ($88,800) 59,850 $(28,950) Future Tax Asset (Liability) ($93,900) 20,400 (14,040) (87,540) (28,950) $(58,590)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.6 (CONTINUED) a. and c. (continued)

SFP Account Dec. 31, 2024

Deductible (Taxable) Temporary Differences $(286,600) -0(31,200)

Tax Carrying Base Amount PP&E $614,400 $901,000 Restructuring Liability -0-0Deferred G/P on Sale (A/R) -031,200 Deferred tax liability, December 31, 2024 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2024

Tax Rate 30% 30% 30%

Deferred Tax Asset (Liability) ($85,980) -0(9,360) (95,340) (87,540) $(7,800)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.6 (CONTINUED) c.

December 31, 2023

Current Tax Expense ............................................... 198,735 Current Tax Expense – Discontinued Operations ..... 5,640 Income Tax Payable ........................................ 204,375 To record current tax expense Deferred Tax Expense ............................................. Deferred Tax Liability ........................................ To record deferred tax expense

58,590 58,590

December 31, 2024 Current Tax Expense ............................................ Income Tax Payable ($506,500 X .30)........... To record current tax expense

151,950 151,950

Deferred Tax Expense .......................................... Deferred Tax Liability ..................................... To record deferred tax expense

7,800 7,800

d. SFP 2023 Long-term liabilities: Deferred tax liability ($93,900 + $14,040 – $20,400)

$87,540

SFP 2024 Long-term liabilities: Deferred tax liability ($85,980 + $9,360)

$95,340

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.6 (CONTINUED) e. Income Statement – 2023 Income from continuing operations before income tax Income tax expense Current $198,735 Deferred 58,590 Income from continuing operations Discontinued operations Gain on disposal of operations 18,800 Less applicable current income tax 5,640 Net income Income Statement – 2024 Income before income tax Income tax expense Current Deferred Net income

$850,000

257,325 592,675

13,160 $605,835

$525,000 $ 151,950 7,800

159,750 $365,250

LO 2,4,8 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.7 a.

Future taxable amounts increase future taxable income relative to pre-tax accounting income due to existing taxable temporary differences. Future deductible amounts decrease future taxable income relative to pre-tax accounting income due to existing deductible temporary differences. A deferred tax liability should be recorded for the future income tax consequences attributable to the future taxable amounts scheduled and a deferred tax asset should be recorded for the future tax consequences attributable to the future deductible amounts scheduled.

See next two pages for deferred taxes. Current Tax Expense .................................. 15,000 Income Tax Payable ............................. ($50,000 taxable income X 30%) To record current tax expense

15,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.7 (CONTINUED) b. (continued) Mixed rates

Future taxable amounts Tax rate enacted for the year Future tax (liability)

Future deductible amounts Tax rate enacted for the year Future tax asset

2024

2025

Future Taxes 2026

$(75,000) 28% ($21,000)

$(75,000) 26% ($19,500)

$(75,000) 24% ($18,000)

$(300,000)

2024

2025

2026 $2,400,000 24% $576,000

2027

Total $2,400,000

28% –

26% –

Balance (Taxable) Sheet Deductible Account Tax Carrying Temporary Dec. 31, 2023 Base* Amount* Differences Unknown* see table in (b) 0 0 $(300,000) Unknown* see table in (b) 0 0 2,400,000 Future tax asset, December 31, 2023 Future tax asset/liability before adjustment Incr. in future tax asset, and future tax benefit for 2023

2027

Total

Tax Rate Mixed 24%

$(76,500)

24% –

$576,000 Future Tax Asset (Liability) (76,500) 576,000 499,500 0 $499,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.7 (CONTINUED) b. (continued) Future Tax Asset .......................................... Future Tax Benefit................................. To record deferred tax expense.

499,500 499,500

I might be concerned that the company will not generate enough taxable income in the future from which to deduct the future deductible amounts. If this were the case, their future deductibility would not qualify as having asset value. To the extent that the deferred tax asset will not be realized, an allowance to reduce the deferred tax asset account to the expected realizable value should be created. It becomes a valuation account, which will then ensure that the asset is reduced to the realizable value for financial statement reporting purposes. The use of the allowance account is optional. An alternative approach would be to establish a deferred tax asset only for the portion of the future taxes estimated more likely than not to be realized.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.7 (CONTINUED) d. Future Tax Expense ............................................. 480,000 Allowance to Reduce Future Tax Asset to Expected Realizable Value ............ ($2,000,000 X 24% = $480,000)

480,000

e. 2026 Future deductible amounts Tax rate enacted for the year Future tax asset (net)

$600,000 24% $144,000

Future Taxes 2027

Total

$1,500,000 $2,100,000 24% $360,000 $504,000

Temporary difference – future deductible amount: Required balance (net above) Opening balance recorded in 2023 Required balance in allowance Allowance to Reduce Future Tax Asset to Expected Realizable Value ............ Future Tax Benefit2 ....................................... 2 ($480,000 – $72,000 = $408,000)

$504,000 576,000 $ 72,000

408,000 408,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.7 (CONTINUED)

Future Taxes 2026 2027

f. 2024 mixed rates

2025

Future taxable amounts Tax rate enacted for the year Future tax (liability)

$(75,000) 26% $(19,500)

$(75,000) 24% ($18,000)

$(75,000) 24% $(18,000)

$(225,000)

2025

2026 2027 $600,000 $1,500,000 24% 24% $144,000 $360,000

Total $2,100,000

Future deductible amounts Tax rate enacted for the year Future tax asset

26%

Balance (Taxable) Sheet Deductible Account Tax Carrying Temporary Dec. 31, 2024 Base* Amount* Differences Unknown* see table above 0 0 $(225,000) Unknown* see table above 0 0 2,100,000 Future tax asset, December 31, 2024 Future tax asset (net) before adjustment ($499,500 – $480,000) Incr. in future tax asset, and future tax benefit (net) for 2024 * Not given in the problem

Tax Rate mixed 24%

Total

$(55,500)

$504,000 Future Tax Asset (Liability) (55,500) 504,000 448,500 19,500 $429,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.7 (CONTINUED) f. (continued) Balance sheet classification Refer to tables in part (b) and (f) above.

Non-current assets Future tax asset (net of allowance)

2024

2023

$448,5002

$19,5001

Balance of Deferred Tax accounts December 31, 2023: Future tax asset $576,000 Less: Allowance to reduce future tax asset to expected realizable value-part (d) (480,000) 96,000 Less: Future tax liability (76,500) Net deferred tax asset – non-current $19,500 2

Balance of Deferred Tax accounts December 31, 2024: Future tax asset $576,000 Less: Allowance to reduce future tax asset to expected realizable value-part (e) (72,000) 504,000 Less: Future tax liability (55,500) Net deferred tax asset – non-current $448,500

If the company did not use the allowance method, the amounts reported for the future tax asset account would have been reported on the balance sheet as the same net amount as indicated above. If no allowance is used, only the realizable amount is recognized initially. LO 2,4,5,8 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.8 a.

2022 balances with mixed tax rates: Future taxable amounts: CCA vs. depreciation Tax rate enacted for the year Deferred tax liability

2023 $(17,500) 30% $(5,250)

Deferred Taxes 2024 2025 $(12,500) $(2,500) 29% 28% $(3,625) $(700)

Future deductible amounts Pension liability Tax rate enacted for the year Deferred tax asset

2023 12,000 30% $ 3,600

2024 12,000 29% $ 3,480

SFP Account Tax Carrying Dec. 31, 2022 Base Amount Property, plant, and equipment $67,500 $100,000 Warranty Liability -0- (20,500) Pension Liability -0- (38,800) Deferred tax asset, December 31, 2022 (1) from table above

Deductible (Taxable) Temporary Differences $(32,500) 20,500 38,800

2025 14,800 28% $ 4,144

Tax Rate

Total $(32,500) $ (9,575) Total 38,800 $ 11,224

Deferred Tax Asset (Liability)

Mixed $(9,575) (1) 30% 6,150 Mixed 11,224 (1) $7,799

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.8 (CONTINUED) a. (continued) SFP classification: Non-current assets: Deferred tax asset ($6,150 + $11,224 – $9,575)

$7,799

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

2023 future taxes – mixed tax rates

Future taxable amounts: CCA vs. Depreciation Tax rate enacted for the year Deferred tax liability

Deferred Taxes 2024 2025 $(12,500) $(2,500) 29% 28% $(3,625) $(700)

Future deductible amounts Pension liability Tax rate enacted for the year Deferred tax asset

2024 12,000 29% $ 3,480

2025 14,800 28% $ 4,144

Total $(15,000) $(4,325) Total 26,800

$ 7,624

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.8 (CONTINUED) b. (continued) Deductible (Taxable) Temporary Differences $(15,000) 23,480 26,800

SFP Account Tax Carrying Dec. 31, 2023 Base Amount Property, plant, & equipment * * Warranty Liability -0- (23,480) Pension Liability -0- (26,800) Deferred tax asset, December 31, 2023 Deferred tax asset before adjustment Incr. in deferred tax asset, and deferred tax benefit for 2023 * not given in the problem (1) from table above

Tax Rate Mixed 29% Mixed

Deferred Tax Asset (Liability) $(4,325) 6,809 7,624 10,108 7,799 $2,309

(1) (1)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.8 (CONTINUED) c. Calculation of current tax expense 2023: Accounting income Permanent difference – dividends Permanent difference – golf dues Reversing differences Warranty Expense Warranty Payments Pension Expense Recognized Tax Deductible Pension Payments Depreciation > CCA Taxable income Current income taxes @ 30% *($21,200 +$6,300 = $27,500)

$ 119,650 (5,800) 25,000 138,850 $30,480 (27,500)* 60,000 (72,000)

2,980 (12,000) 17,500 $147,330 $44,199

Current Tax Expense ........................................... 44,199 Income Tax Payable ..................................... To record current tax expense

44,199

Deferred Tax Asset .............................................. Deferred Tax Benefit..................................... To record deferred tax expense

2,309

d. Income statement presentation 2023: Income before income tax Income tax Current tax Deferred tax (benefit) Net income

$119,650 $ 44,199 (2,309)

41,890 $ 77,760

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.8 (CONTINUED) d.

(continued)

Statement of financial position classification: Non-current assets: 2023 Deferred tax asset $10,1081 Current liabilities: Income tax payable [$44,199 – (4 X $9,500)] 1 2

$6,199

2022 $7,7992

not given

$6,809 + $3,299 $6,150 + $1,649

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP. e.

Under ASPE, there would be no difference, except for a possible use of different terminology (future taxes instead of deferred taxes).

LO 2,4,5,8 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.9 Part 1 a. Mixed tax rates Alia 2024

2025

Future Years 2026 2027

Future taxable amounts Tax rate enacted for the year

$(600) 25%

$(400) 30%

$(200) 30%

$(2,400)

Deferred tax (liability)

$(150)

$(120)

$ (60)

$ (630)

2025

Future Years 2026 2027

2028

Total

2024 Future deductible amounts Tax rate enacted for the year Deferred tax asset

25% -

$3,600 30% $1,080

2028

Total

$3,600 30% -

$1,080

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.9 (CONTINUED) Part 1 (continued) a. (continued) Deductible (Taxable) Temporary Differences $(2,400) 3,600

SFP Account Tax Carrying Dec. 31, 2023 Base* Amount* Property, plant, and equipment Litigation liability Deferred tax asset (net), December 31, 2023 Deferred tax liability before adjustment Increase in deferred tax asset, and deferred tax benefit for 2023 * not given in the problem

Deferred Tax Tax Asset Rate (Liability) Mixed $(630) 30% 1,080 450 (1,000) $1,450

Alia will report a Deferred Tax Asset of $450 in non-current assets on the SFP.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.9 (CONTINUED) Part 1 (continued) b. Current Tax Expense1 .......................................... Income Tax Payable..................................... 1 ($8,000 X 25%) To record current tax expense

2,000 2,000

Deferred Tax Liability2 .......................................... 1,000 Deferred Tax Asset 2……………………………… . 450 Deferred Tax Benefit .................................... 1,450 To record deferred tax expense 2 Alternately: one debit to Deferred Tax Asset/Liability for $1,450

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.9 (CONTINUED) Part 2 a.

Mixed tax rates

Khoi

Future taxable amounts Tax rate enacted for the year Deferred tax (liability)

2024

2025

$(800) 25% $(200)

2024 Future deductible amounts Tax rate enacted for the year Deferred tax asset

25% –

2025

25% –

Future years 2026 $(800) 25% $(200) Future years 2026 $6,000 25% $1,500

2027

Total

$(800) $(3,200) 30% $(240) $(840)

2027

Total $6,000

30% –

$1,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.9 (CONTINUED) Part 2 (continued) a. (continued) Deductible (Taxable) Temporary Differences $(3,200) 6,000

SFP Account Tax Carrying Dec. 31, 2023 Base* Amount* Property, plant, and equipment Litigation liability Deferred tax asset, December 31, 2023 Deferred tax asset before adjustment Decrease in deferred tax asset, and deferred tax expense for 2023 *not given in the problem b. Current Tax Expense3 .......................................... Income Tax Payable..................................... 3 ($8,000 X 25%) To record current tax expense Deferred Tax Expense ......................................... Deferred Tax Asset ...................................... To record deferred tax expense

2,000 2,000

540 540

Tax Rate Mixed 25%

Deferred Tax Asset (Liability) $(840) 1,500 660 1,200 $540

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.9 (CONTINUED) c.

Part 1 – All SFP deferred tax accounts are presented as noncurrent, regardless of origin. Alia Corp. Statement of Financial Position (partial) December 31, 2023 Non-current assets Deferred tax asset

$450

Part 2 – All SFP deferred tax accounts are presented as noncurrent, regardless of origin. Khoi Corp. Statement of Financial Position (partial) December 31, 2023 Non-current assets Deferred tax asset d.

$660

Under ASPE, there would be no difference, except for a possible use of different terminology (future taxes instead of deferred taxes).

LO 2,4,5,8,9 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.10 a.

Basic Calculations of Capital Cost Allowance, Depreciation and Balances:

Year 2023 2024

(A) (B) Base CCA $400,000 X 25 % X 1.5 $ 150,000 250,000 X 25 % 62,500

(A – B) UCC $ 250,000 187,500

(C – B) Carrying Reversing Amount Difference $320,000 $(70,000) 240,000 17,500

b. 2023

SFP Taxable Account Tax Carrying Temporary Dec. 31, 2023 Base Amount Differences Property, plant, & equip. $250,000 $320,000 $70,000 Deferred tax liability, December 31, 2023 (shown as non-current) Deferred tax account before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023

Tax Rate 30%

Deferred Tax Liability $(21,000) (21,000) 0 $(21,000)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.10 (CONTINUED) c. Deferred Tax Expense .................................. 21,000 Deferred Tax Liability ........................... To record deferred tax expense

21,000

Current Tax Expense .................................... 105,000 Income Tax Payable ............................. (amount given in the problem) To record current tax expense

105,000

$105,000 tax due for 2023 ÷ 30% (2023 tax rate) = $350,000 taxable income for 2023.

Income before income tax Income tax expense Current Deferred Net income a

Pre-tax accounting income Excess CCA [from (a) above] Taxable income [from (c) above]

$420,000a $105,000 21,000

126,000 $294,000 $

X (70,000) $350,000

Solving for X; X - $70,000 = $350,000; X = $420,000 pre-tax accounting income.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.10 (CONTINUED) e.

2024

SFP Deductible Account Tax Carrying Temporary Tax Dec. 31, 2024 Base Amount Differences Rate Property, plant & equip. $187,500 $240,000 $(52,500) 30% Unearned Rev. – current -0- (75,000) * 75,000 30% Unearned Rev. – non-curr. -0- (75,000) * 75,000 30% Deferred tax asset, December 31, 2024(shown as non-current) Deferred tax liability before adjustment Incr. in deferred tax asset, and deferred tax benefit for 2024 *$150,000 unearned at end of 2024 divided by 2 years (2022 and 2023)

Deferred Tax Asset $(15,750) 22,500 22,500 29,250 (21,000) $50,250

f. Deferred Tax Asset ....................................... 29,250 Deferred Tax Liability .................................... 21,000 Deferred Tax Benefit ............................. To record deferred tax benefit

50,250

Current Tax Expense .................................... 84,000 Income Tax Payable ............................. 84,000 (amount given in the problem) To record current tax expense $84,000 tax due for 2024 ÷ 30% (2023 tax rate) = $280,000 taxable income for 2024. Solutions Manual 18.159 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.10 (CONTINUED) g.

$112,500d

Income before income tax Income tax expense Current Deferred (benefit) Net income

$84,000 (50,250)

Pre-tax accounting income Depreciation in excess of CCA [from (a) above] Excess rent collected over rent earned Taxable income [from (f) above]

33,750 $ 78,750 $

X 17,500 150,000 $280,000

Solving for X: X + $150,000 + $17,500 = $280,000 X = $112,500 pre-tax accounting income.

h. Refer to last column in tables of part (b) and (e) above. 2024 Non-current assets Deferred tax asset Long term liability Deferred tax liability

2023

$29,250*

$21,000

*($22,500 + $22,500 - $15,750) IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.10 (CONTINUED) i.

Under both IFRS and ASPE, when financial statements of several legal entities are consolidated into one for financial reporting purposes, the possibility exists that deferred tax accounts on the individual statements of financial position could be related to taxes from different jurisdictions. Since there is no right to offset taxes between jurisdictions, there is a possibility of having more than one account for deferred taxes reported on a SFP (one for each legal entity).

LO 2,4,8 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.11 a. Deductible (Taxable) Temporary Differences $3,000 (30,000) (20,000) 34,500**

SFP Account Tax Carrying Dec. 31, 2023 Base Amount Warranty liability -0(3,000) Contract asset/liability 270,000 300,000* Property, plant, & equipment 220,000 240,000 Land not given not given Deferred tax liability, December 31, 2023 Deferred tax liability before adjustment Incr. in deferred tax liability, and deferred tax expense for 2023 *(Construction costs $270,000 + Gross profit $30,000) **$46,000 X 75%

Tax Rate 30% 30% 30% 30%

Deferred Tax Asset (Liability) $900 (9,000) (6,000) 10,350 (3,750) 0 $(3,750)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.11 (CONTINUED) b.

Accounting income Permanent difference: Non-taxable dividends Non-deductible fines Non-deductible loss in land value $46,000 X 25% Reversing differences: Warranties: excess of expense over claims paid ($15,000 – $12,000) Property, plant, and equipment: excess of CCA over depreciation expense ($80,000 – $60,000) Contract asset/liability: Excess of reported construction profit over completed contract method ($30,000 – $0) Loss on land not deductible until future years Taxable income Current income taxes at 30%

Net income $64,000

Retained Earnings $(5,700)

Total $58,300

(1,400) 3,500

11,500

3,000

(20,000)

(30,000)

34,500 $65,100 $19,530

_______ $(5,700) $(1,710)

34,500 $59,400 $17,820

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.11 (CONTINUED) c. Current Tax Expense. .......................................... 19,530 Income Tax Payable ..................................... Retained Earnings (tax effect) ...................... To record current tax expense Deferred Tax Expense ........................................ Deferred Tax Liability .................................... To record deferred tax expense

17,820 1,710

3,750 3,750

d. Income statement presentation: Income before income tax Income tax expense Current Deferred Net income

$64,000 $19,530 3,750

23,280 $40,720

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.11 (CONTINUED) e. Statement of Changes in Equity Retained Earnings Balance January 1, 2023 Add: Net income Less: Financing charge Less applicable tax Balance December 31, 2023

Statement of Financial Position Current liabilities Income tax payable Long-term liabilities Deferred tax liability

-0$40,720 $(5,700) 1,710

(3,990) $36,730

$17,820 3,750

IFRS require that all deferred tax assets and liabilities be reported as non-current items on a classified SFP.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.11 (CONTINUED) g.

Accounting income Non-taxable dividends Non-deductible fines Non-deductible land writedown

$64,000 (1,400) 3,500 11,500

@ 30% 19,200 (420) 1,050

Divided by Accounting Income 30.0% (0.7)% 1.6%

3,450 23,280

5.4% 36.3%

Effective tax rate ($23,280 / $64,000) (rounded)

36.3%

The effective tax rate differs from the statutory rate in this case because of the effect of the permanent differences of dividends, fines, and 25% of the loss due to writedown of land. LO 8,10 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.12 a. 2022 Income Tax Receivable—2019 ............................ 6,250 ($25,000 X 25%) Income Tax Receivable—2020 ............................ 15,000 ($60,000 X 25%) Income Tax Receivable—2021 ............................ 24,000 ($80,000 X 30%) Current Tax Benefit....................................... To record benefit from loss carryback

45,250

Note: An acceptable alternative is to record only one Income Tax Receivable account for the amount of $45,250. Future Tax Asset .......................................... 13,500 Future Tax Benefit ................................ 13,500 ($210,000 – $25,000 – $60,000 – $80,000 = $45,000) ($45,000 X 30% = $13,500) To record future benefit from loss carryforward 2023 Current Tax Expense .................................... Income Tax Payable ............................. [($70,000 – $45,000) X 30%] To record current tax expense

7,500

Future Tax Expense ..................................... 13,500 Future Tax Asset ................................... ($13,500 – $0) To record future tax expense 2024 Current Tax Expense .................................... 22,500 Income Tax Payable ($90,000 X 25%) ..

7,500

13,500

22,500

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.12 (CONTINUED) b.

An income tax receivable account totalling $45,250 will be reported under current assets on the SFP at December 31, 2022. This type of receivable is usually listed immediately above inventory in the current asset section. This receivable is normally collectible within two months of filing the amendment to the tax returns reflecting the carryback. A future tax asset of $13,500 should also be classified as a non-current asset (all future tax assets/liabilities are classified as non-current). Also, retained earnings is increased by $58,750 ($45,250 + $13,500) as a result of the entries to record the benefits of the loss carryback and the loss carryforward. If Carly Inc. reports under IFRS, the deferred tax asset related to the loss carryforward would also be classified as a non-current asset on the SFP.

c. 2022 Income Statement Loss before income tax Income tax benefit Current benefit due to loss carryback $45,250 Future benefit due to loss carryforward 13,500 Net loss

$(210,000)

58,750 $(151,250)

d. 2023 Income Statement Income before income tax Income tax expense Current $7,500a Future 13,500 Net income a [($70,000 – $45,000) X 30%]

$70,000

21,000 $49,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.12 (CONTINUED) e. 2022 Income Tax Receivable—2019 ............................ 6,250 ($25,000 X 25%) Income Tax Receivable—2020 ............................ 15,000 ($60,000 X 25%) Income Tax Receivable—2021 ............................ 24,000 ($80,000 X 30%) Current Tax Benefit.......................................

45,250

Note: An acceptable alternative is to record only one Income Tax Receivable account for the amount of $45,250. Although its related possible income tax benefit is not recognized in the accounts, Carly Inc. has a tax loss carryforward of $45,000, which is required to be disclosed.

2023 Current Tax Expense .................................... Income Tax Payable ............................. [($70,000 – $45,000) X 30%]

7,500

2024 Current Tax Expense .................................... 22,500 Income Tax Payable ($90,000 X 25%) .. f.

7,500

22,500

2022: entry for current taxes – no change 2022: if a valuation allowance is used, the full income tax benefit and future tax asset related to the tax loss carryforward is recognized and then offset by the allowance, as follows. Future Tax Asset .......................................... 13,500 Future Tax Benefit ................................ ($45,000 X 30% = $13,500) To record future benefit from loss carryforward

13,500

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.12 (CONTINUED) f. (continued) Future Tax Expense ..................................... 13,500 Allowance to Reduce Future Tax Asset to Expected Realizable Value ($13,500 – $0) To bring future tax asset account to its realizable value

13,500

2023: entry for current taxes – no change 2023: because the tax loss carryforward has now been used, both the amount in the future tax account and in its allowance account must be removed, as follows:

Future Tax Expense .................................... 13,500 Future Tax Asset ................................ To adjust future tax asset account Allowance to Reduce Future Tax Asset to Expected Realizable Value ........ 13,500 Future Tax Benefit ................................ To bring future tax asset account to its realizable value

13,500

Alternatively, one entry could have been made: Allowance to Reduce Future Tax Asset to Expected Realizable Value ........ 13,500 Future Tax Asset ................................

13,500

2024: No change to part (e) entry.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.12 (CONTINUED) g. 2022 Income Statement Loss before income tax Income tax benefit Current benefit due to loss carryback Net loss

2023 Income Statement Income before income tax Income tax expense – Current a Net income a [($70,000 – $45,000) X 30%]

$(210,000) 45,250 $(164,750)

$70,000 7,500 $62,500

Using the valuation allowance instead of applying the reduction in value directly does not have any impact on cash flows. The use of the contra allowance simply permits the recording of the full benefits associated with all future deductible amounts in the asset account. This facilitates tracking for management purposes. It has no use for financial reporting purposes except, perhaps, for the transparency of the information. Readers can see the total possible benefits and the extent to which management has judged they will not be realized.

LO 5,6,7,8 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.13 a.

$135,000 x 30% = $40,500, deferred tax liability, December 31, 2022.

The prior period error has the following effect on the December 31, 2022 SFP: The land is understated by $40,000, retained earnings is understated by the $40,000 error in the expenses on the 2022 income statement and overstated by the income tax effect (30% of $40,000 = $12,000), and the income tax payable account is understated by $12,000. Land Retained Earnings To record correction entry for land Retained Earnings Income Tax Payable To recognize additional income tax payable on the amount deducted in error in 2022 (2022 tax return is amended)

40,000 40,000 12,000 12,000

c. Accounting income Add: Golf club dues Non-deductible interest costs Depreciation expense Excess of year’s bad debt expense over tax deductible amount Less: CCA Taxable income

$1,645,000 4,500 2,500 365,000 20,000 (300,000) $1,737,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.13 (CONTINUED) c. (continued) Asset / Liability

Tax Base

Property, plant, and equipment

$933,0001

Carrying Amount

Tax Deferred Rate Tax (Liability) Asset

$ (70,000) 30%

$ (21,000)

Allowance not given 20,000 30% for doubtful accounts Deferred tax liability, Dec. 31, 2023 Balance before adjustment Adjustment required to deferred tax liability, and deferred tax benefit, 2023

6,000

$1,352,000 + $16,000 – $365,000 = $1,003,000 not given

Deductible / (Taxable) Temporary Difference

Carrying amount, Dec. 31, 2022 Future taxable amount, Dec. 31, 2022 UCC, Dec. 31, 2022 2023 addition to class Less 2023 CCA UCC, Dec. 31, 2023

$(15,000) (40,500) $ 25,500 $1,352,000 ( 135,000) 1,217,000 16,000 (300,000) $ 933,000

Current tax expense = $1,737,000 x 30% = $521,100 Deferred tax expense = $25,500 (benefit) Total income tax expense = $521,100 - $25,500 = $495,600 Current tax expense Income tax payable To record current tax expense

521,100

Deferred tax liability Deferred tax benefit To record deferred tax benefit

25,500

521,100

25,500

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.13 (CONTINUED) d. Income Statement: Income before income tax Less: Income tax expense Current Deferred (benefit) Net income

$1,645,000 $521,100 (25,500)

Statement of Changes in Equity - Retained Earnings: Retained Earnings, January 1, 2023 As previously reported Correction of prior period error, net of income tax of $12,000 Restated balance, January 1, 2023 Add: Net income Retained Earnings, December 31, 2023

495,600 $1,149,400

$5,678,000 28,000 5,706,000 1,149,400 $6,855,400

LO 2,8 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.14 a.

2023: Deductible (Taxable) Temporary Differences $(89,000) 146,000

SFP Account Tax Carrying Dec. 31, 2023 Base Amount Prepaid Rent -0$89,000 Rent Payable -0- (146,000) Future tax asset, December 31, 2023 Future tax asset before adjustment Incr. in future tax asset, and future tax benefit for 2023

Future Tax Tax Rate 27% 27%

Asset (Liability) $(24,030) 39,420 15,390 0 $ 15,390

2024: Deductible (Taxable) Temporary Differences $(92,000) 133,000

SFP Account Tax Carrying Dec. 31, 2024 Base Amount Prepaid Rent -0$92,000 Rent Payable -0- (133,000) Future tax asset, December 31, 2024 Future tax asset before adjustment Decr. in future tax asset, and future tax expense for 2024

Future Tax Tax Rate 29% 29%

Asset (Liability) $(26,680) 38,570 11,890 15,390 $( 3,500)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.14 (CONTINUED) b.

2023: Accounting income Permanent differences: Golf club dues Interest incurred to earn exempt income

$884,000 $13,000 4,000

17,000 901,000

Reversing differences: Prepaid rent deductible when paid Accrued rent expense not yet deductible Taxable income Current income taxes at 28%

(89,000) 146,000 $958,000 $268,240

2024: Accounting income Permanent differences: Golf club dues Interest incurred to earn exempt income

$997,000 $11,000 6,000

17,000 1,014,000

Reversing differences: Excess of rent paid over rent expense recognized ($92,000 – $89,000) Excess of rent paid over rent expense recognized ($146,000 – $133,000) Taxable income Current income taxes at 29%

(3,000)

(13,000) $998,000 $289,420

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.14 (CONTINUED) c. 2023 Journal entries: Current Tax Expense ........................................... 268,240 Income Tax Payable ..................................... To record current tax expense Future Tax Asset .................................................. Future Tax Benefit ........................................ To record future tax expense

15,390 15,390

2024 Journal entries: Current Tax Expense ........................................... 289,420 Income Tax Payable ..................................... To record current tax expense Future Tax Expense ............................................. Future Tax Asset .......................................... To record future tax expense d. Income before income tax Income tax expense Current Future (benefit) Net income

268,240

289,420

3,500 3,500

2024 $997,000

2023 $884,000

289,420 3,500 292,920 $704,080

268,240 (15,390) 252,850 $631,150

Refer to last column in tables in part (a) above.

Non-current assets Future tax asset

2024

2023

$11,890

$15,390

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.14 (CONTINUED) f. @ 29% Accounting income Non-deductible dues Non-deductible interest Change in tax rate ($146,000 – $89,000) × (29% – 27%)

Divided by Accounting Income

$997,000 11,000 6,000

$289,130 3,190 1,740 294,060

29.0% 0.3% 0.2% 29.5%

57,000

(1,140) $292,920

(0.1%) 29.4% 29.4%

Effective tax rate ($292,920/$997,000)

The effective tax rate differs from the statutory rate because of the effect of the permanent differences of golf club dues and interest, and because of the effect of the change in tax rate during the year on the deferred tax accounts. LO 2,4,8 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.15 Prior-year tax rate: $616,000 / $2,200,000 = 28% Deductible Deferred Tax SFP (Taxable) Account Tax Carrying Temporary Tax Asset Dec. 31, 2023 Base* Amount* Differences Rate (Liability) PP&E before change $(2,200,000) 28% $(616,000) in tax rate Increase in deferred tax liability due to change in tax rate ($2,200,000 X 2%), and deferred tax expense adjustment (44,000) Deferred tax liability (related to PP&E), Dec. 31/23 ($660,000) * not provided; no change in amount of PP&E temporary difference since Dec. 31/22 SFP Account

Tax

Carrying

Deductible (Taxable) Temporary

Deferred Tax Tax

Dec. 31, 2023 Base* Amount* Differences Rate PP&E $(2,200,000) 30% Pension liability (24,000) 30% Warranty liability 31,000 30% Deferred tax liability, Dec. 31/23 Deferred tax liability before adjustment Decrease (net) needed in deferred tax liability, and net deferred tax benefit * not given in the problem. Solutions Manual 18.179 Chapter 18 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Asset (Liability) $(660,000) (7,200) 9,300 $(657,900) ( 660,000) $ 2,100

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.15 (CONTINUED) Calculation of loss for tax purposes and loss carryforward: Accounting loss Permanent differences: Development costs (50% X $150,000) Meals and entertainment (50% X $38,000) Reversing differences: Warranty expense Pension funding > expense Loss for income tax purposes Carryback to prior years Loss available for carryforward 50% realization probable Portion of loss to recognize as benefit Tax rate Deferred tax asset and benefit * ($87,000 – $111,000 = – $24,000)

($494,000) 75,000 19,000 31,000 (24,000)* (393,000) 123,000 (270,000) 50% (135,000) 30% ($40,500)

2023 Income tax journal entries: Income Tax Receivable ($123,000 x 28%)……. ... 34,440 Current Tax Benefit ...................................... To record benefit from loss carryback

34,440

Deferred Tax Expense……………………………... 44,000 Deferred Tax Liability (incr. in tax rate)…. ..... To record deferred tax expense for change in rates

44,000

Deferred Tax Liability …………………………. Deferred Tax Expense ……………………. To record deferred tax

2,100

Deferred Tax Asset ............................................. 40,500 Deferred Tax Expense .................................. To record deferred tax from loss carryforward

40,500

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.15 (CONTINUED) Instead of the three deferred tax entries above, one entry could have been made as follows: Deferred Tax Expense ………………………….. ... Deferred Tax Liability1 ……………………… .. 1 ($44,000 - $2,100 - $40,500)

1,400 1,400

Income statement (partial) Loss before income tax Income tax benefit (expense) Current – loss carryback Deferred Net income (loss) 2

$(494,000) $34,440 (1,400)2

33,040 $(460,960)

($40,500 – $44,000– $2,100 = $1,400)

Note to the financial statements: The deferred tax expense increased by $44,000 due to a change in the tax rate in 2023.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.15 (CONTINUED) Reconciliation – Statutory rate to effective rate:

Loss before taxes Non-deductible: Development costs Meals/entertainment Tax rate adjustment on reversing differences ($2,200,000 x 2% tax rate) ½ of loss carryforward recovery not probable Tax rate adjustment on loss carryback ($123,000 x 2% tax rate)

@ 30%

÷ Accounting loss

$494,000

$148,200

30.00%

75,000 19,000

(22,500) (5,700) 120,000

(4.55%) (1.15%) 24.30%

2,200,000

(44,000)

(8.91%)

135,000

(40,500)

(8.20%)

123,000

(2,460) $33,040

(0.50%) 6.69%

Effective tax rate ($33,040 / $494,000 = 6.69%)

6.69%

Haley Inc.’s effective tax rate differs from the statutory rate due to permanent differences that will never be subject to tax; a change in tax rate that impacts temporary differences that are being carried forward; not recognizing the deferred tax benefit of half of the loss carryforward; and recovery of prior-year income taxes at a tax rate different than the current year rate. LO 2,5,6,8 BT: AP Difficulty: C Time: 75 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 18.16 a. (1)

If Golden has taxable income in 2023 and offsets it with a loss carryforward from 2022, the 31% tax rate would be used when reducing the related deferred tax asset at December 31, 2023.

(2)

If Golden reports taxable income in 2023 and ends the year with a deferred tax liability, the 30% tax rate would be used in calculating the deferred tax liability at December 31, 2023. If Golden reports a taxable loss in 2023 that is not fully absorbed through a carryback (or if the entity elects not to carry the loss back), and future taxable income is expected to be more likely than not for 2024 and future years, Golden would use the 30% tax rate for its deferred tax asset from the tax loss carryforward.

Discussion: In determining the future tax consequences of temporary differences, it is helpful to prepare a schedule that shows in which future years existing temporary differences will result in taxable or deductible amounts. The appropriate enacted tax rate is applied to these future taxable and deductible amounts. In determining the appropriate tax rate, you must make assumptions about whether the entity will report taxable income or losses in the various future years expected to be affected by the reversal of existing temporary differences. So, you calculate the taxes payable or refundable in the future due to existing temporary differences. In making these calculations, you apply the provisions of the tax laws and enacted tax rates for the relevant periods. For future taxable (deductible) amounts, if taxable income is expected in the year that a future taxable (deductible) amount is scheduled, the enacted rate for that future year is used to calculate the related deferred tax liability (asset).

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PROBLEM 18.16 (CONTINUED) b.

If the company expects to recover the value of the asset through a sale in the next year, the proceeds on this sale will attract a different income tax rate. The deferred tax liability should be calculated based on the applicable tax rates to be paid. Given the above information, the deferred tax liability is calculated as follows: $1,200,000 will be recaptured and taxed at 30% = $360,000 $3,000,000 will be taxed as capital gains and attract a tax rate of 15% (as given in the question) = $450,000 Total deferred tax liability will be $810,000 ($360,000 + $450,000). Any change required to adjust the deferred tax liability will be reported in net income, as the fair value adjustment was reported in net income.

If this property was accounted for using the revaluation method, the same amounts would apply as calculated above. However, changes required to adjust the deferred tax liability account would be reflected in other comprehensive income, since the revaluation adjustment was reported via the other comprehensive income account.

LO 2,5,8 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

CASE Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the front of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 18.1 BAKER COMPANY LIMITED Case Overview GAAP is a constraint since the financial statements are being audited. As a private company, the company could use ASPE or IFRS. For the purposes of this analysis, differences between the two will be identified. The role of the auditor is to ensure transparency. Management is confident in the company’s ability to recover and continue to grow after the recession has abated. As a result, management may be biased to demonstrate this within the financial statements. Statement users include shareholders/investors who will also want transparency. Given the losses in 2025, they will be considering whether to not to divest. Analysis and Recommendations Issue: The auditor needs to decide whether the benefit from the losses should be recognized in the current financial statements. To the extent that taxes were paid in previous years, the losses would first be carried back to recover these taxes and a partial benefit could be recognized. However, the real issue is whether there is sufficient certainty to recognize the benefits that might be realized if the losses are carried forward. The benefits may be recognized if it is more likely than not that the benefits will be realized (under ASPE) or realization is probable (under IFRS). This ultimately depends on the existence of sufficient taxable income in the carryforward period to be able to utilize the losses and shelter future taxable income. Note that under ASPE, the entity has a choice to use the taxes payable method or future income taxes method.

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Intermediate Accounting, Thirteenth Canadian Edition

CA 18.1 BAKER COMPANY LIMITED (CONTINUED) Recognize the benefit of the Do not recognize the benefit of losses. the losses. - Management plans to - Determining if the benefits expand into new markets. are likely to be realized is Two new products are difficult when unfavourable scheduled to be introduced evidence exists. and there are sufficient - The unfavourable evidence customers lined up to includes a history of purchase the products, to marginal profits in 2023 the extent that the and 2024, followed by company is predicting at losses in 2025. The minimum a break-even net company is also still in its income using conservative formative years. It is not estimates. unusual for companies to - Given the company did not sustain losses in the startsuffer pre-recession losses up period. in its first two years, there - It might be argued that the is an indication that it must current state of the be doing something right. economy is unsettled. Since management has Unemployment is high and better insight into its own consumer spending has company and customers, increased significantly. The management might be in a fact that economists are better position to predict predicting that it might take the future than economists. two to three more years for - With numerous competitors consumer spending to declaring bankruptcy this recover creates additional may create new market uncertainty. opportunities and help - Using the taxes payable increase market share. method (ASPE), would only - This option would not be recognize tax receivables allowable under the taxes based on current and/or payable method (ASPE). refiled tax returns. Therefore, no future income tax assets would be recorded.

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Intermediate Accounting, Thirteenth Canadian Edition

CA 18.1 BAKER COMPANY LIMITED (CONTINUED) Recommendation: While management might be able to make a strong case for profitability, it is still a projection. Given that the economy appears to be recovering slowly, it would be more conservative/prudent to not recognize the benefit. The unrecognized benefits and expiry dates would be disclosed in the notes to the financial statements. If the company is profitable in 2026, the company could revisit the issue and recognize any remaining benefits of the losses at that time.

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Intermediate Accounting, Thirteenth Canadian Edition

INTEGRATED CASE IC 18.1 CAUCHY INC. (CI) Case Overview The controller has a potential bias towards increasing net income or showing profitability, since the company is looking for new investment share capital and may need to refinance its existing loans. The bank and potential investors are key users of the financial statements and will be relying on the statements to make decisions. This emphasizes the need to for transparency. IFRS is a constraint, since this is a public company trading on the TSX. Analysis and recommendations Issue: CI purchased 20% of the common shares of KL Corp. CI appointed one member to KL’s board of directors. CI is undecided whether it will hold onto this investment for the longer term. If there is a 25% or more increase in the share price, CI is willing to sell the shares. The original reason for entering into this transaction was to create a strategic alliance. CI is determining whether it should account for the shares using the Equity method or FV-NI or FV-OCI. IC 18.1 CI (CONTINUED)

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IC 18.1 CI (CONTINUED) Equity method

At fair value with gains and losses through income or OCI - A 20% ownership interest is - A 20% ownership interest is borderline but may imply inconclusive for significant significant influence. influence. - Representation on the - The investment is no longer Board may allow for being held for strategic significant influence, purposes. Specifically, particularly since this since the intent is to represents one of four sell/trade if share prices rise board positions. above certain point. - The original intent of the - If using FV-OCI, CI would share purchase was for revalue the investment to strategic purposes and to fair value and allocate the ensure a steady supply of gains/losses to OCI. high-quality raw materials. - If using FV-NI, CI would revalue the investment to fair value and allocate gains/losses to net income. - CI has the option to treat the investment as either FV-NI and/or FV-OCI since this is a publicly traded company.

Recommendation: CI could use any of the options; however, given the company’s intent to sell if the shares reach a certain price, CI should consider measuring the investment at fair value with gains/losses through income (easier approach).

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IC 18.1 CI (CONTINUED) Issue: CI purchased five-year bonds at a premium. The bonds are convertible to common shares of the issuing company. It is CI’s intent to hold onto these bonds to maturity, unless CI has a cash crunch, in which case it would sell the bonds. CI is determining whether it should account for the bonds using the Amortized cost method or FV-NI or FV-OCI.

Amortized cost

At fair value with gains and losses through income or OCI - It is CI’s intent to hold the - CI should use amortized bonds to maturity, unless it cost only if it is the experiences a cash crunch company’s objective to and needs to sell the collect contractual bonds. payments of principal and - The amortized cost method interest over the life of the requires the amortizing of bond. In this case, it is not the premium as an clear if this is the business adjustment to interest cost. model and thus the FV- CI may have to segregate OCI or FV-NI may be more the conversion option and appropriate. value it at fair value - If CI uses FV-OCI, CI (embedded derivative). would revalue the bonds to (This is generally beyond fair value and allocate the the scope of the text.) gains/losses to OCI. - If CI uses FV-NI, CI would revalue the bonds to fair value and allocate the gains/losses to net income. - CI has the option to treat the investment as either amortized cost or FV-NI or FV-OCI.

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IC 18.1 CI (CONTINUED) Recommendation: CI should account for the bonds using the FV-NI method. It is more transparent to value at FV-NI since the business model seems to indicate the investments are incidental to CI’s main business. Issue: CI completed a significant sale on credit to a new U.S. customer and recognized a non-refundable upfront fee as part of the contract as revenue. CI is providing its customer with market data at the beginning of the contract and ongoing market research services over the duration of the contract. CI is determining whether or not to recognize the nonrefundable fee as revenue. Recognize the upfront fee as Do not recognize the upfront fee revenue as revenue - If CI is following IFRS, - The market data being management needs to provided is a standalone determine if there are multiple product, but the customer performance obligations in may have the ability to reject the agreement and follow the quality of the data and proper revenue recognition deem it unusable for its practices. If using ASPE, purposes. management needs to - There is no mention of a determine the point in which refund policy. If the customer all benefits, risks, and demands a refund (which CI rewards have passed to the may grant as this issue is customer in order to silent from what is known recognize the revenue. about the contract) the - The market data portion of market data portion of the the contract should be contract may not be considered a separate considered a sale until the performance obligation as it end of the contract. is a standalone product. Therefore, it must have standalone value.

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IC 18.1 CI (CONTINUED)

- The ongoing market analysis and monitoring functions could also be considered a separate performance obligation. - There is objective and reliable evidence of undelivered items since CI issued renewal contracts to other customers this year. - There is persuasive evidence of a contract, since the deal is done and likely documented. - The amount is measurable since there are no material uncertainties. - Delivery of the market data happens at the beginning of the agreement, so it has likely already been given to the customer.

- CI could recognize the fee over time, for example using a the straight-line method (unless there is another pattern), if management believes that there are not separate performance obligations. - CI may use the percentageof- completion method.

Recommendation: As there appears to be separate performance obligations, if CI is using IFRS, revenue should be recognized based on the standalone value of the market data, with the balance of the contract value recognized as the market analysis is provided to the customer over the duration of the contract. If CI is using ASPE, management should recognize revenue as benefits are passed to the customer.

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Intermediate Accounting, Thirteenth Canadian Edition

IC 18.1 CI (CONTINUED) Issue: The receivable for this sale has been hedged using a forward contract to sell U.S. dollars at a fixed rate. The other half is hedged through a natural hedge since the company has some U.S. dollar payables. The auditor has requested CI to prepare some notes analyzing the need for hedge accounting for this transaction and explaining the risks associated with the sales transaction and hedge transactions. Hedge accounting No hedge accounting - The use of hedge accounting - Hedge accounting is optional. is meant to ensure that - Costs and complexity are gains/losses from hedging significant. instruments offset - No need to use hedge gains/losses from hedged accounting since gains and items in income in the same losses of the hedged item period. (U.S. AR) and hedging - Company can use if there is instrument (forward contract) a strategy designed and already offset each other practices put into place to (forward contract recognized, manage the risk. valued at fair value and - Modifies normal accounting gains/losses to net income by creating adjusting entries already. U.S. AR revalued to at the end of each period to spot rate with gains and the hedged item and the losses to net income). hedging instrument. - Natural hedge does not - Must identify the hedging require special accounting relationship between the since U.S. AP also revalued hedging instrument to spot rate with gains/losses (derivative) and the hedged to income. item. - Management must ensure and report on whether the hedging strategy of the company is effective on an annual basis.

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IC 18.1 CI (CONTINUED) Recommendation: There is no requirement to use hedge accounting. If management decides to use hedge accounting then, as the auditor suggests, note disclosure would need to be included with the financial statements. The note should include elements as per above. If management decides to not use hedge accounting, then no disclosure is required. In this case, if this transaction is the only derivative being used to manage risk, management should not opt into hedge accounting. Issue: CI has been subject to a one-time charge on a lawsuit. The company’s tax accountants have determined that the company will have a loss for tax purposes. CI is trying to determine whether it should recognize the benefit of a loss carryforward. Recognize the loss carryforward - This charge is due to a onetime loss and otherwise the company is expected to be profitable.

Do not recognize the loss carryforward - While there is an expectation of future profits, there always a level of uncertainty of whether there will be enough future profitability to realize the benefit of the losses.

Recommendation: Since the loss this year appears to be a one-time issue related to the one-time charge on a lawsuit and there is an expectation of future profit, it would be reasonable to recognize the benefit of the loss carryforward.

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Intermediate Accounting, Thirteenth Canadian Edition

RESEARCH AND ANALYSIS RA 18.1 DEFERRED TAX ASSETS and IAS 12 a.

According to IAS 12.24, 25, 27, and 28, income tax benefits associated with the ability to reduce income taxes in the future can be recognized as tax assets currently only if it is probable (more likely than not) that the entity will generate taxable income in the future against which those deductible temporary differences can be applied to reduce taxable income and future taxes. The benefits must be capable of being realized. Realization of the tax benefit of an existing deductible temporary difference or carryforward ultimately depends on being able to earn sufficient taxable income of the appropriate character (for example, ordinary income or capital gain, and within the same taxation authority) within the carryback, or, in Davida’s case, the carryforward period available under the tax law. If this is not “probable,” then the asset and associated reduction in the accounting loss cannot be recognized.

IAS 12.31 indicates that an entity should consider the guidance in paragraphs 35 and 36 when it has a history of recent losses similar to what Davida Limited has experienced. In such a case, in addition to having enough taxable temporary differences, there must be some convincing evidence in order to currently recognize the benefits and deferred tax asset. IAS 12.36 indicates what criteria should be considered in making judgements about whether future taxable income will be available. As per IAS 12.36, these criteria are:

a. whether the entity has sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, which will result in taxable amounts against which the unused tax losses or unused tax credits can be utilised before they expire; b. whether it is probable that the entity will have taxable profits before the unused tax losses or tax credits expire; c. whether the unused tax losses result from identifiable causes which are unlikely to recur; and d. whether tax planning opportunities are available to the entity that will create taxable profit in the period for the unused tax losses or unused tax credits to be utilised.

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RA 18.1 DEFERRED TAX ASSETS and IAS 12 (CONTINUED) c.

IAS 12.30 provides examples of types of tax-planning strategies that might be implemented to help ensure future taxable income will be available. These involve using tax regulations to the best advantage, particularly where an entity has choices. The examples provided can be summarized in the Canadian context as: (1) Accelerate taxable income amounts, by deferring the tax deductibility of certain expenses or speeding up the taxability of certain income items, in order to use carryforwards before they expire (2) Sell capital assets that have appreciated in value to recover past capital cost allowance claimed that will increase future taxable income, or change the nature of taxable or deductible amounts from ordinary income or loss to capital gain or loss (3) Switch from investments that generate non-taxable income to those that generate taxable income. In Davida’s situation, some of these tax-planning ideas are useful: •

• •

In the past, the company has deducted more capital cost allowance than depreciation expense in determining its taxable losses. This has resulted in the recognition of deferred tax liabilities and increased provisions for income taxes (reduced tax benefit) on the income statements. The effect has been to increase taxable losses available for carryforward. Management could approach the tax authorities for approval to refile and adjust past tax returns to eliminate any, and perhaps all, capital cost allowance claimed in the past. This would have the effect of reducing past taxable losses and the amount of loss carryforwards as well as increasing the undepreciated capital cost of the capital assets. An increased undepreciated capital cost will allow for more capital cost allowance to be claimed in the future. At a minimum, no capital cost allowance should be taken for the current year, thus increasing the current period taxable income. Davida should also perform a review of all its revenue and expense recognition policies, particularly for tax purposes, to determine if there are any that could legitimately be changed to recognize revenue earlier and expenses later.

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RA 18.1 DEFERRED TAX ASSETS and IAS 12 (CONTINUED) d. Whenever judgement must be exercised, such as assessing the likelihood of generating sufficient future taxable income so that a significant income tax asset and income tax benefit can be recognized, management and the board of directors should consider their users’ objectives and whether their decisions reflect economic reality. Ideally, they will choose a measure that is most relevant to stakeholders, to both existing and potential investors and creditors, and one that will faithfully represent the company’s financial position and financial performance. Unfortunately, sometimes these decisions are made based on how management perceives the company’s resulting financial statements, its financial position, and how its prospects will be interpreted by others. This latter approach presents difficulties for the following reasons: • •

•

It is contrary to the concepts underlying generally accepted accounting principles, the very clear intent of IAS 12, and the professional ethics of Davida’s financial management personnel and the board of directors. The interests of financial statement users sometimes conflict with one another. For example, current shareholders want the prospects to look as good as possible so they can sell their shares at a high price, while potential shareholders are interested in buying in at a reasonable price, probably on the low side. As a relatively new company, it is important that users know they can depend on the financial position and results reported. If there is any indication of overly aggressive accounting, Davida may be penalized in the future through higher costs of capital, as a risk component will get built into interest rates charged by creditors and prices paid for ownership capital. For all these reasons, the ethical, professional, and sustainable decision is to measure the likely availability of future taxable income applying judgement consistent with the objective of the IAS 12 requirements. Where management might be tempted to make less-than-ideal business decisions to attract a more advantageous tax treatment, such ethical dilemmas need to be resolved in terms of what is in the best long-run interests of the shareholders. Many of the tax planning ideas reflect only choices permitted under the tax legislation and have no effect on company operations. There are no ethical implications related to making these choices.

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RA 18.2 MAPLE LEAF FOODS INC. Note: all amounts are in thousands of Canadian dollars. a.

The amount of the income tax expense ($ in thousands) on the company’s Consolidated Statements of Net Earnings for 2020 was an expense of $46,596 and for 2019, an expense of $12,367. The company uses intraperiod tax allocation relating to its other comprehensive income (OCI) items. Items in OCI tend to be the result of unrealized gains and losses that will eventually attract income tax when realized. The tax expense/benefit, however, is associated with the events when recognized for accounting purposes. As shown in the Consolidated Statements of Other Comprehensive Income (Loss) ($ in thousands), in 2020, four such specific items were recognized, resulting in recognizing a net $19,964 related tax benefit in OCI; and in 2019, four items were also recognized, but attracted a net income tax expense of $76. In each of the four cases in the two years, the tax is reported along with the type of gain or loss reported. Note 7 provides the total tax dollar amount in summary for the items reported in OCI, but the Consolidated Statements of Other Comprehensive Income reports the amount of tax with each individual item. On the Consolidated Balance Sheets ($ in thousands), there are income taxes payable of $27,639, and $205 for the comparative date the previous year. This is in comparison with amounts reported on the Consolidated Statements of Cash Flows ($ in thousands) of net income taxes paid of $26,212 and $40,682 in 2020 and 2019, respectively. It should be noted that the references to income tax adjustments to net earnings in the top portion of the operating cash flows section of the cash flow statement, both current and deferred, merely add back/deduct the amounts reported on the statements of net earnings so that the company reports the actual amount of net income taxes paid/received as a separate line item below. Reporting the income taxes paid or received in a year is a required disclosure.

The income tax benefits reported using the statutory tax rates and effective tax rates for 2020 and 2019 are presented below using Note 7. There are minor differences between these two rates and the resulting benefits in each year because of offsetting amounts.

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RA 18.2 MAPLE LEAF FOODS INC. (CONTINUED) b. (continued) 2020

2019

$42,119

$23,228

(224)

(975) (10,460)

(1,910) 1,149

(1,240) 1,112

2,214

948

3,044

754

109 95

92 342

$46,596

(1,434) $12,367

($ in thousands) Income tax at applicable statutory rate Reduction in deferred tax (recovery) expense related to changes in tax rates Reduction for favourable tax audit resolution Reduction due to manufacturing and processing credit Increase due to share-based compensation Increase in due to non-deductible expenses and transactional costs Increases due to tax rate differences in other jurisdictions Increase due to non-recognition of income tax benefit of losses Increase in benefit due to “other” reasons Reduction due to adjustments to tax expense from prior periods Total income tax expense at effective rates

Canadian Statutory rate Effective Tax Rate: ($46,596/$159,873) ($12,367/$86,995)

26.3%

26.7%

29.1% 14.2%

The Company’s applicable statutory rate is the Canadian combined rate applicable in jurisdictions in which the Company operates. The causes of the increases and decreases in this tax rate and the resulting tax benefit are explained in the table above. As is indicated, the effective rates did not deviate too far from the statutory rates when all causes of various effects are considered in 2020. However, in 2019 there is a significant difference between the effective rate and the statutory rate. This is primarily due to the reduction in tax of $10,460 from a favourable audit resolution. c.

A schedule of the deferred tax balances reported on the 2020 Consolidated Balance Sheets, along with the causes and the related asset or liability with different tax and book values, is reported below using Note 7. Under IFRS, all deferred tax balances on the SFP are considered non-current. The same rules apply under ASPE effective January 1, 2020.

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RA 18.2 MAPLE LEAF FOODS INC. (CONTINUED) c. (continued) Amounts in $000 Amount

Balance Sheet item

Deferred Tax Assets Tax loss carryforwards

$64,469 No Balance Sheet account

Accrued liabilities

11,604

Employee benefits

50,609 Employee benefits (a liability)

Other

1,119 Not identified

Accounts payable and accruals, and provisions

$127,801

Deferred Tax Liabilities

Property and equipment Cash basis farming Goodwill and intangibles Total

$147,555 Property and equipment 24,491 Accounts receivable 51,601 Goodwill & intangible assets $223,647

Reported as a deferred tax asset Reported as a deferred tax liability

$14,070 As a non-current asset $109,916 As a non-current liability

Maple Leaf Foods, in Note 7, indicates that it has no unrecognized deferred tax assets at December 31, 2020. The company indicates that it has unrecognized deferred tax liabilities related to the unremitted earnings of subsidiaries and other investments. The reason provided for the non-recognition is that Maple Leaf Foods can control the distribution of any such amounts and it is not probable that such amounts will be distributed in the foreseeable future. Therefore, since there will be no future reversal of the temporary differences, no deferred tax liability has been recognized.

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RA 18.3 COMPARATIVE ANALYSIS a.

All three companies operate in the retail food industry. Loblaw and Empire operate grocery stores, drug stores, and real estate interests (Loblaw also has a financial services segment) in Canada, and Alimentation Couche-Tard (CoucheTard) mainly operates convenience stores in North America, Europe, and Asia.

A schedule of the total income tax provision for each company is presented below. All three companies included income tax provisions in current net earnings and other comprehensive income items. Intraperiod tax allocation was used by all three companies in the statement of comprehensive income.

(in millions of $) Year ended Total tax provision shown in statement of earnings Tax provision in other comprehensive income (i) Total income tax provision

Couche-Tard US$ April 25, 2021

Loblaw CAD$ January 2, 2021

Empire CAD$ May 2, 2020

653.6

431.0

219.9

33.1 _____ 686.7

(24.0) ____ 407.0

6.5 _____ 226.4

(i) Note – this was determined from each of the OCI items found either in the notes or on the statement of comprehensive income. No provisions were found in the retained earnings of any of the companies. c.

A schedule of the companies’ deferred income tax assets and liabilities as at their most recent balance sheet dates, along with the source of the underlying temporary differences, is presented below. One would expect companies in the same industry to have similar temporary differences and these three companies do have some major temporary differences in common. Although the companies use different wording to describe the underlying temporary differences and report in varying degrees of detail, there are major similarities for property and equipment, goodwill and intangibles, loss carryforwards, and for other liabilities (the expectation is that Couche-Tard’s “expenses deductible in future” are similar).

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RA 18.3 COMPARATIVE ANALYSIS (CONTINUED) c. (continued) (in millions of $) – Liabilities shown in brackets Property and equipment Investment Deferred (charges) credits (net) Goodwill and intangibles Asset retirement obligations Inventory Other Trade and other payables Other liabilities Fixed Assets Other assets Tax Loss carry forwards Employee future benefits Expense deductible in future Unrealized exchange gain (loss) Lease liabilities Right to use assets Revenues taxable during the following years Provisions Long-term debt Partnership deferral reserve Net deferred tax assets (liabilities)

CoucheTard US$ (1,014.3) (10.4) 88.1 (346.7) 102.5

Loblaw CAD$

Empire CAD$ (64.1) (39.1)

(1,510.0)

88.5 4.7 (3.6) 4.1 40.3

4.7

41.0 66.0 200.0 (553.0)

(21.7)

64.0

(4.8) 57.5 83.0

19.5 72.4 747.9 (693.2)

2,324.0 (1,899.0)

1,409.3 (1,233.1)

(1,267.0)

31.0 (1.9) 17.7 389.5

(16.8)

(1068.0)

Note: Amounts in the above table were found as follows: Couche-Tard numbers were determined by adding Deferred Asset & Deferred Liability numbers presented in Note 12, Loblaw numbers were found in Note 7, and Empire numbers were found in Note 14. d.

Yes, in many respects, one would expect the three companies to be subject to similar income tax legislation and tax rates, in that all three are Canadian- based companies. However, Loblaw and Empire operate in most provinces, while Couche-Tard operates mainly in Quebec and Ontario in Canada, as well as in many countries around the world. Therefore, Couche-Tard’s tax rates may be somewhat different. The three companies’ statutory rates and their effective tax rates are indicated below.

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RA 18.3 COMPARATIVE ANALYSIS (CONTINUED) d. (continued) Couche-Tard Statutory rate in Canada Difference due to different rates in other jurisdictions Effect of tax rate changes Permanent differences Non-deductible and nontaxable items Adjustment re prior periods Other Effective rate reported

26.50%

Loblaw

Empire*

26.6%

27.4%

(0.1%)

0.05%

0.3% 0.2% (0.4%) 26.6%

(0.78%)

(7.64%) 0.60%

19.46%

(0.26%) 26.4%

*Calculated % changes from dollar information

Couche-Tard is the only one of the three companies to experience a significant difference between its statutory rate (in Canada) and its effective tax rate. This is because Couche-Tard conducts business in a variety of countries and as a result experiences a wide variety of tax rates. Based on the (7.64%) difference due to tax rates in other jurisdictions, it appears that on average, the statutory rate in the countries that Couche-Tard operates in is lower than the Canadian rate. Most of the other differences between the statutory rates and effective rates appear to be very minor, and are due to the types of non-operating transactions that the companies engaged in during the year. e.

Loblaw discloses that it has unrecognized deferred tax assets of $167 million relating to deductible temporary differences ($14 million) and non-capital loss carryforwards ($153 million). While the losses expire in years ranging from 2029 to 2040, the deductible temporary differences do not expire. The reason provided for the non-recognition of the associated tax benefits as deferred tax assets is that it is considered not probable that future taxable income will be available to enable the company to use these benefits to reduce future income taxes payable. Couche-Tard indicated that deferred tax assets not recognized related to losses carried forward and deductible temporary differences totals $651.2 million. A significant amount of that total ($423.7 million) is expected to reverse through OCI. Per Note 3 in the Income Taxes section, Deferred Tax Assets are reviewed at each reporting period and are reduced to the extent that it is no longer probable that the benefit will be realized. Couche-Tard also indicates that some deferred income tax liabilities ($6,106.0 million) relating to the repatriation of the retained earnings of foreign subsidiaries have not been recognized because these amounts are not expected to materialize in the foreseeable future. These deferred tax liabilities relate to temporary differences. Empire indicates that all deferred tax assets have been recognized in the accounts.

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RA 18.4 IFRS AND ASPE a. (1) ASPE: Under ASPE, an adjustment must be made to the deferred tax liability account so that it is measured and reported at the amount at which the liability is expected to be settled, normally using those rates enacted at the reporting date. [Section 3465.51] Therefore, an adjustment of $30,000 ($1 million X the 3% increase in rates) is required to increase the deferred tax liability to the correct balance. The associated $30,000 adjustment to income tax expense is required to be reported with the current year’s deferred income tax expense in income before discontinued operations. [Section 3465.59 and .60] IFRS: Under IFRS, the increase in the deferred tax liability of $30,000 is identical because IFRS requires the deferred liability to be measured at the amount expected to be needed to settle the obligation to the tax authorities, using the tax rates that have been enacted or substantially enacted at the reporting date. [IAS12.47]. The treatment required for the corresponding increase in tax expense under IFRS is different from that indicated for ASPE. IAS 12.58(a) and .61A requires backward tracing; that is, for the deferred tax adjustment to be recognized directly in equity (in this case, retained earnings) if the original deferral was recognized in equity. (2) ASPE: Under ASPE, the building is required to be carried at amortized cost and will not be revalued to fair value. Therefore, the existing temporary difference of $0.8 million or [$6.5 million – ($8.0 million - $2.3 million)] remains, but the deferred tax liability related to this temporary difference must be adjusted for the same reasons as in part (1). The adjustment required, then, is an increase in the deferred tax liability of $24,000 or ($800,000 X 3%) [see Section 3465.51]. The associated increase in the deferred tax expense is reported in the current year’s deferred tax expense and in income before discontinued operations [see 3465.59 and .60]. IFRS: Under IFRS, the company has the option of accounting for the building at amortized cost, and the required adjustment in this case would be the same as indicated under ASPE. However, under IFRS, the company also has an option to account for the building using the revaluation method. Using this method, the increase in the fair value of $3.5 million ($10.0 million less $6.5 million) results in a “gain” that is reported in revaluation surplus, a component of OCI. There is now a total temporary difference of $4.3 million between the accounting value of the asset of $10.0 million and its tax base of $5.7 million ($8 million – $2.3 million).

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RA 18.4 IFRS AND ASPE (CONTINUED) a. (continued) (2) (continued) The related deferred tax liability on the reporting date would be: Balance before adjustment: 25% X ($6.5 million - $5.7 million) = $200,000 cr Increase due to 3% tax increase: 3% X ($6.5 million - $5.7 million) = 24,000 cr Deferred tax on revaluation gain in OCI: 28% X ($10 million - $6.5 million) = 980,000 cr Total = $1,204,000 cr Under this option, in addition to the $24,000 increase in the deferred tax liability account on the balance sheet and the deferred income tax expense on the income statement due to the 3% increase in the tax rate [see IAS 12.58], a revaluation gain of $3.5 million would be reported in OCI (revaluation surplus), net of a deferred income tax expense of $980,000 [see IAS 12.61A]. The deferred tax liability account increases by a total of $24,000 + $980,000 = $1,004,000. Tax expense components relating to the change in tax rates would be separately disclosed [see IAS 12.80(d)]. The deferred tax liability is reported on the statement of financial position as a non-current liability [see IAS 1.69]. (3) ASPE: While ASPE permits use of the taxes payable method or the temporary difference approach for reporting income taxes, LGS appears to have adopted the temporary difference (future income taxes) approach for its prior period adjustments and capital assets, and the same approach is assumed throughout these situations [see Section 3465.03]. However, the company has the option of reporting this investment at fair value through net income (FVNI) or at cost. If the equity investment is accounted for at cost, the investment’s carrying amount remains at $340,000, and no increase in value is reported in net income. Also, since the gain is only reported for tax purposes when realized, there is no effect on taxes payable in 2023. In addition, because the tax base and accounting value of the asset are the same at $340,000, there is no temporary difference and therefore no deferred tax liability.

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RA 18.4 IFRS AND ASPE (CONTINUED) a. (continued) (3) (continued) If the investment is adjusted to its fair value of $510,000, the resulting unrealized gain of $170,000 ($510,000 – $340,000) is reported in net income. The tax base of the investment is $340,000, the accounting value is $510,000, and therefore there is a temporary difference of $170,000. At a tax rate of 28%, the deferred tax liability account needs to be increased by $47,600 ($170,000 X 28%). This tax effect is reported as the deferred tax expense component of income tax expense on the 2023 income statement in income before discontinued operations [Section 3465.20, .51 and .59]. IFRS: Under IFRS, LGS must account for the investment at fair value through net income (FV-NI), since the investment was not acquired for contractual cash flows and it appears the shares were acquired for trading purposes. In this situation, the accounting for FV-NI is exactly the same as discussed for ASPE above [IAS 12.15, .46, .47, .58, and .77]. NOTE: Under ASPE, LGS is permitted to switch to the taxes payable method without the usual stipulations required for a change in accounting policy required under Section 1506.06(b) [Section 3465.03]. If the company changes to the taxes payable method, the effects of using the temporary difference/future income taxes method would be accounted for retrospectively. The effect would be the elimination of the existing deferred tax liability account and a reduction in income tax expense in each of the specific years the deferrals had been increased, adjusted through 2023’s opening retained earnings. For situations (1) to (3), none of the effects in the ASPE columns in the table below would be applicable.

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RA 18.4 IFRS AND ASPE (CONTINUED) b. ASPE Effect on Effect on deferred tax 2023 tax liabilities expense*

IFRS Effect on deferred tax liabilities

Effect on 2023 tax expense*

+$30,000 +$24,000

$-0+$24,000

N/A

+$1.004 million

+$24,000

$-0-

N/A

At FV +$47,600 +$47,600 +$47,600 *related to income before discontinued operations

+$47,600

Situation 1.3% tax increase 2.Cost method Revaluation method 3.Shares at cost

+$30,000 +$24,000

It appears the effects are relatively similar. The areas of difference relate to the fact that under ASPE, more adjustments are recognized in net income – in part (1) because of no backward tracing of changes in tax rates, and in part (2) because ASPE does not allow fair value changes to be recognized anywhere other than net income (does not allow the revaluation method or the FV-OCI method for investments and does not recognize OCI). A real difference would be experienced if LGS choses to use the taxes payable method, as there would be no adjustments on an ongoing basis under ASPE in the table above.

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RA 18.5 BASIC CONCEPTS AND PRINCIPLES a.

The following objectives of accounting for income taxes are identified in the introduction to IAS 12 Income Taxes: 1. To recognize the current and future tax consequences related to a. The carrying amounts of assets and liabilities recognized in the statement of financial position as those assets are realized and obligations are met, and b. The current accounting period transactions and events that have been recognized. 2. To report the current and future tax consequences of current period transactions, activities, and events, together with the type of transaction or event that gave rise to the tax effect. 3. To properly recognize and report information about the tax consequences related to unused tax losses and unused tax credits. 4. To appropriately present and disclose information related to income taxes in the financial statements.

The following basic principles are applied in accounting for income taxes at the date of the financial statements: 1. A current income tax liability or asset is recognized for the estimated taxes payable or refundable based on the tax return for the current year. 2. A deferred income tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carry-forwards using the enacted (or substantially enacted) tax rates expected to apply when the temporary differences reverse. 3. Current income tax expense, for the most part, is related to the recognition of revenues and expenses under tax rules. 4. Deferred tax expense is based on the changes required in the carrying amounts of the deferred tax assets and liabilities in the statement of financial position. 5. If necessary, and based on available evidence, deferred tax assets are adjusted to remove the potential tax benefits where it is not probable that they will be realized. 6. Income tax expense is “matched” with the related type of transaction that gave rise to the tax, such as with income before discontinued operations, discontinued operations, items of OCI, events recognized in retained earnings, and with types of capital transactions.

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RA 18.5 BASIC CONCEPTS AND PRINCIPLES (CONTINUED) c.

Under the future income taxes method (ASPE) or the temporary difference approach (IFRS) of accounting for income taxes, the deferred (or future) income tax outflows and inflows related to the realization of assets and the settlement of liabilities for their carrying amounts are recognized as deferred tax liabilities and deferred tax assets. (Note: we use the term deferred here and below for both IFRS and ASPE to simplify the discussion.) These deferred tax liabilities and deferred tax assets meet the definitions of liabilities and assets in the conceptual framework. Temporary differences between an asset’s or liability's carrying amount and its tax base or unused tax losses, may generate benefits in the future in the form of reduced tax payments or a recovery of taxes paid in the past. Temporary differences between an asset’s or liability's carrying amount and its tax base may require additional tax payments in the future as the asset is realized or liability is settled. This method is more effective in achieving the objective of financial reporting, communicating information that is useful to users. This method provides users with better measures of a company’s economic resources and obligations where there are income tax consequences associated with asset and liability recovery or settlement. In reporting deferred tax assets and liabilities, ASPE will report future tax assets or future tax liabilities as non-current. Similarly, under IFRS, all deferred tax assets and liabilities are also classified as non-current.

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RA 18.5 BASIC CONCEPTS AND PRINCIPLES (CONTINUED) d.

An asset represents a present economic resource (a right that has the potential to produce an economic benefit), the entity controls access to the resource, and it results from past transactions or events. Currently, there are two issues relating to the measurement and reporting of deferred tax assets: •

•

The cash effects related to the benefits of this asset will be received sometime in the future. As such, it should be discounted to approximate the present value of the benefit to be received. Also, the amounts of the future benefits are not assured, they are merely “probable,” and they are not single point estimates. Therefore, preferred measurements would use probabilities of likely outcomes to determine the best estimate of the economic resource. The extent to which the entity controls the asset is also in question. In the case of loss carryforward benefits where the company has not been profitable, the government does not owe the company this amount, and the realization of this deferred tax asset is highly dependent on a future event that may or may not happen. Consequently, the right is not “controllable.” It may be better thought of as merely a “conditional right to receive the benefits”. Using this strict definition, perhaps the deferred tax asset arising from the use of loss carryforwards should not be recorded.

A liability represents a present duty or responsibility that obligates the company to transfer an economic resource, giving it little discretion to avoid the obligation that results from a past transaction. Similar issues arise in looking at deferred tax liabilities within this definition: •

•

The amount of this liability may be paid sometime in the future. As such, it should be discounted to approximate the present value of the obligation that will be met in the future. In addition, there are a variety of different outcomes. As a result, it could be argued that the entity should estimate the amount and timing of the obligation under each of these different outcomes, determine the present values of each of these outcomes, and then estimate the probability of each outcome. It is also arguable as to whether this represents an enforceable obligation to an entity. The company does not yet owe these taxes. The amount of the deferred tax liability will depend on future taxable profits and when these temporary differences will reverse. For example, if a company continues to invest in property, plant, and equipment and the capital cost allowance claim is always greater than the depreciation for tax purposes, then it may be a long time (if ever) that any requirement for payment will arise. Consequently, the obligation is not presently enforceable. This liability represents a “conditional obligation to pay” given certain future events occur, and this is not a liability.

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RA 18.6 OPERATING and ACCOUNTING POLICIES a.

Accelerated depreciation, such as the double-declining balance method used for income tax purposes, allows a company to deduct substantial capital cost allowance (CCA) early in an asset’s life. Yearly CCA declines to a point where the accelerated CCA amount is lower than the depreciation expense calculated under the straight-line method. The reversing point occurs when the accelerated CCA matches the straight-line rate. Some companies are motivated to sell assets prior to this point to maximize the CCA benefit provided in terms of income taxes. As long as the company is growing, the company may receive a prolonged deferral of income taxes. This is possible because, while the proceeds received on sale of the old asset reduces the balance in the CCA class involved, it is replenished with the higher cost of the replacement asset, which can then start to be tax depreciated at a substantially higher amount.

b. The types of ethical implications related to the company’s aggressive deferral of income tax include those related to applying the tax legislation, Henrietta’s professional considerations as an accountant, and the general business ethics of the company. These need to be assessed by Henrietta because of the avoidance of current income taxes payable by the company. This is possible due to the tax deferral permitted by temporary differences caused by the difference in financial accounting principles and tax laws. The practice of selling off assets before the differences reverse and replacing them with new assets means that the company is transferring the obligation to pay taxes several years into the future. c.

Shareholders would be harmed by Mesa’s income tax practice. In order to maintain this policy, and using the mechanism described in (a) above, the company has to systematically acquire new assets at a cost higher than the previously disposed assets. To repurchase assets at a lower cost could also trigger recaptured CCA in some cases. This means that management is probably embarking on a short-term policy of improving its financial condition with a damaging cash management policy, along with potentially indebting itself and increasing the company’s solvency risk. It would also be important to understand whether there is a legitimate need for these new assets. This would be demonstrated by a decrease in the effectiveness of the company’s use of assets in declining return-on-assets and asset turnover ratios. Preconceived accounting outcomes should not drive corporate policies. In summary, Henrietta has to determine whether the business decisions are being made within too narrow an objective of reducing income tax cash flows, and whether this is detrimental to the company as a whole. It is important to also consider if this policy results in the company having a higher than necessary cost of capital.

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RA 18.7 OPERATING & ACCOUNTING POLICIES (CONTINUED) d. As a professional accountant that adheres to strong ethical standards, Henrietta is obligated to uphold objectivity and integrity in the practice of financial reporting. In addition, she has a duty to communicate her concerns about whether such a practice is in the best long-run interests of the company and its shareholders, as indicated above. If she thinks that this practice is unethical, then she needs to communicate her concerns to the highest levels of management within Mesa, including members of the Board and/or the Audit Committee. In this situation, it would appear that Mesa Inc. is simply trying to minimize its cash income tax payments, which probably would not be considered illegal or unethical. However, the practice is more than likely unsustainable. Current tax legislation permits taxpayers to arrange their affairs in order to pay the minimum amount of tax as long as it is done within tax rules and the spirit of the Income Tax Act. Henrietta should ensure that what the company is adhering to these requirements, and is in fact, acting in the best interests of the company. It would be important to review the legislation for indication of an overall objective related to the capital cost allowance system that might have precedence over the specific regulations. Henrietta should ensure that these transactions and policies would be considered acceptable by the CRA, and that they would not be considered as having the sole purpose of avoiding paying income taxes. Such activities that are structured to be within the rules but have no bona fide business purpose can be caught under GAAR (General anti-avoidance rules). These transactions, if considered unacceptable, could be re-assessed by the Canada Revenue Agency.

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The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

MMXXII viii F2

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CHAPTER 19 PENSIONS AND OTHER POSTEMPLOYMENT BENEFITS Learning Objectives 1. Understand the importance of pensions from a business perspective. 2. Identify and account for a defined contribution plan and distinguish between defined contribution and defined benefit plans. 3. Explain what the employer’s benefit obligation is, identify alternative measures for this obligation, and prepare a continuity schedule of transactions and events that change its balance. 4. Identify transactions and events that change benefit plan assets and a benefit plan surplus or deficit, and calculate the balance of the plan assets and the plan surplus or deficit. 5. Identify the components of defined benefit cost, and account for a defined benefit pension plan under IFRS and ASPE. 6. Account for defined benefit plans with benefits that vest or accumulate other than pension plans. 7. Identify the types of information required to be presented and disclosed for defined benefit plans, prepare basic schedules, and be able to read and understand such disclosures. 8. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. 9. Explain and apply basic calculations to determine current service cost, the defined benefit obligation, and past service cost for a one-person defined benefit pension plan.

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Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

BT Item

1. 2. 3. 4.

1 2,8 2 3

AP AP C AP

1. 2 AP 2. 2 AP 3. 3,4,5,7 AP 4. 3,4,5 AP 5. 3,4,5 AP 1. 2. 3.

2 AP 2,6 AP 3,4,5 AP

BT Item LO BT Item LO BT Item LO BT Brief Exercises 5. 4 AP 9. 5 AP 13. 4,5 AP 17. 5,9 AP 6. 4 AP 10. 5 AP 14. 5 AP 7. 4,5 AP 11. 5 AP 15. 6,8 AP 8. 5 AP 12. 5 AP 16. 5,9 AP Exercises 6. 4 AP 11. 3,4,5,6,8 AP 16. 5,6,8 AP 21. 3,4,5 AP 7. 3,4,5 AP 12. 3,4,5,7 AP 17. 3,4,5,6 AP 22. 3,4,5,6 C 8. 3,4,5 AP 13. 5,8 AP 18. 6 AP 9. 3,4,5,7 AP 14. 3,4,5,6 AP 19. 3,4,5,7 AP 10. 5,8 AP 15. 3,4,5,8 AP 20. 9 AP Problems 4. 3,4,5,7,8 AP 7. 2,3,4,5,7 AP 10. 2,3,4,5,7 AP 13. 2,3,4,5,6,8 AP 5. 2,3,4,5,8 AP 8. 5,8 AP 11. 2,3,4,5,7 AP 14. 3,9 AP 6. 2,3,4,5,7,8 AP 9. 3,4,5 AP 12. 2,3,4,5 AP 15. 6,8 AP Cases

1. 3,4,5,7,8AP Integrated Cases 1.

1. 3,4,5,7 AN 2.

Research and Analysis 3,4,5,7 AN 3. 1,3 AP 4.

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

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Intermediate Accounting, Thirteenth Canadian Edition

Topics

Brief Exercises

Pensions from a business perspective.

Exercises

Problems

Defined contribution and defined 2,3 benefit plans.

1, 2, 22

1, 2

Employer’s benefit obligation.

3, 4, 5,7,8,9, 3,4,5,6,7, 11,12,14,15, 9,10,11,12, 17,19,21 13,14

Transactions and events that change benefit plan assets. Plan’s surplus or deficit position.

5,6,7,13

3, 4, 5, 6, 7, 3,4,5,6,7,9, 8, 9,11,12, 10,11,12, 14,15,17,19, 13 21

Defined benefit expense and accounting for a defined benefit pension plan under IFRS and ASPE.

7,8,9,10,11 3,4,5,7,8,9,10 3, 4, 5, 6, 7, 12,13,14 11,12,13,14, 8, 9, 10, *16, *17 15,16,17,19 11,12 21,22

6. Defined benefit plans with benefits that vest or accumulate other than pension plans.

7. Presentation and disclosure.

14, 16, 17, 18, 22

2, 13, 15

3, 7, 9, 12, 19

4, 6, 7, 10, 11

8. Differences between IFRS and ASPE.

2, 15

10, 11, 13, 15, 16

4,5, 6, 8, 13, 15

*9. One-person plan.

16,17

*This material is dealt with in an Appendix to the chapter.

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ASSIGNMENT CHARACTERISTICS TABLE Item E19.1 E19.2 E19.3

Description

Defined contribution plan Defined contribution plan Continuity schedules and calculation of defined benefit expense E19.4 Preparation of pension work sheet E19.5 IFRS and ASPE: changes in pension accounts E19.6 Calculation of actual return E19.7 Calculation of actual return, gains and losses, defined benefit expense, and reconciliation E19.8 Preparation of pension work sheet E19.9 DBO and plan asset continuity schedules E19.10 Defined benefit expense, journal entries E19.11 Defined benefit expense, journal entries, work sheet, ASPE, IFRS and DAIS E19.12 Defined benefit expense, journal entries, disclosures, effect of ASPE policy choice E19.13 Defined benefit expense, IFRS and ASPE, reduced past service costs E19.14 Post-retirement benefit expense, surplus or deficit, and reconciliation E19.15 Defined benefit expense work sheet, ASPE, IFRS E19.16 Post-retirement benefit expense, calculation and entries, IFRS, ASPE E19.17 Post-retirement benefit work sheet E19.18 Post-retirement benefit reconciliation schedule E19.19 Pension calculations and disclosures E19.20 Calculation of current service cost and DBO *E19.21 Defined benefit expense, journal entries, work sheet, IFRS E19.22 Contributory plans, accounting for employer vs. accounting for benefit plan, funding, service cost

Level of Time Difficulty (minutes) Simple Simple Moderate

5-10 10-15 15-20

Moderate Moderate Simple Moderate

15-25 25-30 5-10 35-45

Moderate Moderate Simple Moderate

30-35 30-35 10-15 35-45

Moderate

25-30

Simple

10-15

Moderate

30-35

Moderate

20-30

Simple

10-15

Simple Simple Moderate Moderate Moderate

15-20 5-10 25-35 25-30 25-35

Moderate

20-30

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ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Item P19.1 P19.2 P19.3

Description

Journal entries for a long-term disability benefit Defined benefit plan for sabbatical leave IFRS - Three-year continuity schedules, entries, ASPE expense comparison, user interest P19.4 Three-year continuity schedules, ASPE and IFRS P19.5 ASPE versus IFRS – not using worksheet P19.6 One-year events, reconciliations, IFRS, and ASPE P19.7 Two-years - Defined benefit expense, journal entries, note disclosure, and worksheet, ASPE P19.8 One-year - calculation of expense and balance sheet account – and reconcile ASPE and IFRS P19.9 Choice of worksheet or schedule preparation – 3 years ASPE P19.10 Choice of worksheet or schedule preparation – 3 years IFRS P19.11 One-year pension events; contributory vs. noncontributory - IFRS P19.12 One-year contributory plan: work sheet, entries, reconciliation; effect of changes in DBO assumptions – IFRS and ASPE differences P19.13 Post-retirement benefit expense, continuity of DBO and plan assets *P19.14 Calculation of DBO and past service cost – oneperson plan P19.15 Treatment of a company’s sabbatical leave under IFRS and ASPE; information needed

Level of Time Difficulty (minutes) Moderate Complex Complex

20-25 35-45 45-55

Moderate

40-50

Complex Complex

40-50 30-35

Complex

45-55

Moderate

30-40

Moderate

35-45

Moderate

35-45

Moderate

20-30

Moderate

30-40

Moderate

30-35

Complex

40-45

Moderate

30-40

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 19.1 (a)

With $9 million in total assets less $9.8 million in total liabilities, the company’s SFP as at December 31, 2023 shows total shareholders’ equity of $(0.8 million). With annual defined benefit expense of $3 million in 2023, it appears that the pension plan may have contributed to a loss situation, as well as a decrease to retained earnings, which may have led to retained earnings becoming a deficit and shareholders’ equity becoming negative. The pension plan has a $2.3 million deficiency ($11.3 million obligation less $9 million plan assets) as at December 31, 2023, resulting in a net defined benefit liability of $2.3 million. Not enough information is provided to determine if the pension plan deficit increased during the year, but the overall deficit position of the plan is significant given the negative shareholders’ equity position of the company. The net defined benefit liability represents 23.5% ($2.3 million/$9.8 million) of total liabilities and will affect the company’s solvency ratios such as debt to total assets ratio.

(b) In addition to the cash contributions the company makes to the plan, the company incurs the cost of administering the plan, the opportunity cost of using the cash for other purposes in the business, and the potentially higher financing costs due to higher solvency risk as a result of the underfunded pension plan. LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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BRIEF EXERCISE 19.2 (a)

IFRS

Past service cost recognized immediately in expense Current service cost ($2,735,864 x 5%)............ Defined benefit expense for 2023

$845,350 136,793 $982,143

(b) ASPE Past service cost recognized immediately in expense Current service cost ($2,735,864 x 5%) ................ Defined benefit expense for 2023 .........................

$845,350 136,793 $982,143

There is no difference in defined benefit expense between IFRS and ASPE in this case. However, under ASPE, the past service cost would be considered a remeasurement that must be presented separately on the income statement. LO 2,8 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.3 A Defined Contribution Plan (DC) A defined contribution (DC) plan is a post-employment benefit plan that specifies how the entity’s contributions or payments into the plan are determined, rather than identifying what benefits will be received by the employee or the method of determining those benefits. For a DC pension plan, the amounts that are contributed are usually turned over to an independent third party or trustee who acts on behalf of the beneficiaries (the participating employees). The trustee assumes ownership of the pension assets and is responsible for their investment and distribution. The trust is separate and distinct from the employer. The ultimate risks and rewards of the DC pension plan rests with the employees as the employer’s involvement is essentially limited to making the annual contribution each year. Therefore, the accounting for a DC pension plan is relatively straight-forward. The employer’s obligation is dictated by the amounts to be contributed. A liability is reported on the employer’s SFP only if the required contributions have not been made in full, and an asset is reported if more than the required amount has been contributed. The annual benefit cost (i.e., the defined benefit expense) is simply the amount that the company is obligated to contribute to the plan.

A Defined Benefit (DB) Plan A defined benefit (DB) plan is any benefit plan that is not a defined contribution plan. It is a plan that specifies either the benefits to be received by an employee or the method of determining those benefits.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.3 (CONTINUED) Similar to a DC plan, the amounts that are contributed for a DB pension plan are usually turned over to an independent third party or trustee who acts on behalf of the beneficiaries. The ultimate risks and rewards of the DB pension plan rest with the employer since the employer must guarantee that a set retirement benefit will be paid to the employees. The benefits typically are a function of an employee’s years of service and compensation level in the years approaching retirement. To ensure that appropriate resources are available to pay the benefits at retirement, there is usually a requirement that funds be set aside during the service lives of the employees. Therefore, accounting for a DB pension plan is much more complex. The pension cost and defined benefit obligation depend on many factors such as employee turnover, mortality, length of service, and compensation levels, as well as investment returns that are earned on pension assets, inflation, and other economic conditions over long periods of time. Because the cost to the company is affected by a wide range of uncertain future variables, it is not easy to measure the defined benefit cost and liability to be recognized each period as employees provide services to earn their pension entitlement. Note: This is not intended to be a comprehensive discussion of all issues associated with the DB pension plan, but rather to highlight some of the key differences between a DB and DC pension plan. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.4 (in hundreds of thousands) Defined benefit obligation, opening balance Interest cost Current service cost Benefits paid to retirees Past service cost Defined benefit obligation, ending balance

$138 14 32 (12) 20 $192

LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 19.5 Ending plan assets Beginning plan assets Increase in plan assets Deduct: Contributions $170,000 Less: benefits paid (130,000) Actual return on plan assets

$1,753,000 1,359,000 394,000

(40,000) $ 354,000

LO 4 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.6 (in hundreds of thousands) Plan assets, opening balance Actual return on plan assets Contributions from employer Benefits paid to retirees

$150 17 30 (12)

Plan assets, ending balance

$185

Defined benefit obligation (BE 19.4) $(192) Plan assets at fair value 185 Plan’s surplus (deficit) $ (7) Since the defined benefit obligation exceeds the plan assets, the plan is in a deficit position. LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 19.7 Defined benefit obligation Fair value of plan assets Plan deficit, and net defined benefit liability, December 31, 2023

$3,400,000 2,420,000 $ 980,000

Note: the past service cost of $990,000 from the 2023 plan amendment has already been included in the defined benefit obligation since the plan was amended on December 31, 2023. The $990,000 past service cost from plan amendments must be reported separately on the statement of income or in the notes. LO 4,5 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.8 (in hundreds of thousands) Past service cost Current service cost Net interest cost 11% ($11 – $11)

$35 19 0

Defined benefit expense

$54

Remeasurement gain or loss (OCI): Actuarial loss on fund assets (11% X $100) - $9 Actuarial loss on DBO

2 15

Total remeasurement loss (OCI)

$17

Under IFRS, the pension plan results in total defined benefit expense and decrease in net income and retained earnings of $54, and total remeasurement loss (OCI) and decrease in accumulated other comprehensive income of $17. Combined, this reduces shareholders’ equity by $54 + $17 = $71. LO 5 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.9

Current service cost $58,000 1 Net interest/finance cost Defined Benefit Obligation ($210,000 x 10%) 21,000 Plan Assets – Opening ($200,000 x 10%) (20,000) Plan Assets – Contributions made evenly during the year ($77,000 x ½ x 10%) (3,850) (2,850) Defined benefit expense $55,150 1 The net interest/finance cost can also be calculated based on the DBO less average plan assets: [$210,000 - ($200,000 + ½ of $77,000)] x 10% = [$210,000 - $238,500] X 10% = ($2,850) Remeasurement (gain) or loss (OCI): Remeasurement gain on fund assets Actual return on fund assets $(25,000) Expected return on fund assets Plan Assets – opening ($200,000 x 10%) 20,000 Plan Assets – increase due to contributions made evenly during the year ($77,000 x ½ x 10%) __3,850 (1,150) 2 Actuarial loss on DBO 14,000 Net remeasurement loss (OCI) $12,850 2

The Actuarial gain on fund assets can also be calculated follows: ($25,000) – ($238,500 X 10%) = ($1,150) Under IFRS, the pension plan results in total defined benefit expense and a related decrease in net income and retained earnings of $55,150, and a remeasurement loss (OCI) and decrease in accumulated other comprehensive income of $12,850, for a total reduction in shareholders’ equity of $68,000. LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.10 Current service cost Net interest/finance cost1 Defined Benefit Obligation ($210,000 x 10%) Plan Assets – Opening ($200,000 x 10%) Plan Assets – Contributions made evenly during the year ($77,000 x ½ x 10%)

$58,000 21,000 (20,000) (3,850) (2,850)

Actuarial gain on fund assets $25,000 – ($238,500 X 10%) (1,150) Actuarial loss on DBO 14,000 Defined benefit expense $68,000 1 The net interest/finance cost can also be calculated based on the DBO less average plan assets: [$210,000 - ($200,000 + ½ of $77,000)] x 10% = [$210,000 - $238,500] X 10% = ($2,850) Under ASPE, the pension plan results in total defined benefit expense and a related decrease in net income and retained earnings of $68,000, for a total reduction in shareholders’ equity of $68,000. LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.11 IFRS RUI CORPORATION General Journal Entries

Items Balance, 1/1/23 Service cost Net interest/finance cost Remeasurement gain on plan assets Past service cost Contributions Benefits paid Expense entry Contribution entry Bal. 12/31/23

Remeasu- Annual rement Defined (Gain) Benefit Loss (OCI) Expense

Cash

Memo Record Net Def. Benefit Defined Liability/ Benefit Asset Obligation -0-

250,000 Dr

27,500 Dr

250,000 Cr 27,500 Cr

0 Dr

25,000 Cr

25,000 Dr

5,000 Cr

5,000 Dr 29,000 Dr.

29,000 Cr 20,000 Cr

5,000 Cr

Plan Assets

000 Dr29, 56,500 Dr ________ 51,500 Cr 20,000 Cr 20,000 Dr 31,500 Cr

LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

17,500 Dr

20,000 Dr 17,500 Cr

314,000 Cr

282,500 Dr

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.12 ASPE RUI CORPORATION General Journal Entries

Items Balance, 1/1/23 Service cost Net interest/finance cost Remeasurement gain on plan assets Past service cost Contributions Benefits paid Expense entry Contribution entry Bal. 12/31/23

Annual Defined Benefit Expense

Cash

Memo Record

Net Def. Benefit Defined Liability/ Benefit Asset Obligation -0-

Plan Assets

250,000 Cr 27,500 Cr

250,000 Dr

27,500 Dr 0 Dr

25,000 Cr

25,000 Dr

5,000 Cr 29,000 Dr. 20,000 Cr 000 Dr29, 51,500 Dr ________ 51,500 Cr 20,000 Cr 20,000 Dr 31,500 Cr

5,000 Dr 29,000 Cr 17,500 Dr

20,000 Dr 17,500 Cr

314,000 Cr

282,500 Dr

LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.13 Plan deficit, January 1, 2023 $1,100 - $1,000

100

Pension events during 2023: Current service cost

+90

Finance/interest cost on DBO1 6% X $1,100

+66

Actual return on plan assets1

-55

Contributions into plan Plan benefits paid (decreases both plan assets and DBO)

-92

Plan amendment, December 31, 2023 Plan deficit, December 31, 2023

No effect +40 $ 149

Or net interest/finance cost: 6% X 100 = +$6 increased by the actuarial loss on the assets of $55 – (6% X $1,000) = loss of +$5 = $11. Regardless of approach, the net effect is an increase in the deficit of $11. Proof (not required): DBO, Dec. 31/23: $1,100+$66+$90-$64+40

$1,232

Assets, Dec. 31/23: $1,000+$55+$92-$64

1,083

Plan deficit, December 31, 2023

$ 149

LO 4,5 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.14 Based on the actuarial report, there is a $41,300 ($398,000 $356,700) actuarial loss. (a)

Under IFRS, the entire $41,300 actuarial loss is recognized immediately as a 2023 remeasurement loss in other comprehensive income. Defined benefit expense reported in net income is not affected.

(b) Under ASPE, the entire $41,300 actuarial loss is also recognized as a remeasurement loss, but it is included immediately in 2023 defined benefit expense and deducted in determining net income. The amount of the remeasurement must be disclosed separately on the income statement or in the notes. LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.15 (a)

IFRS

Current service cost Net interest/finance cost ($65,500 - $48,000)

$130,000 17,500

Post-retirement benefit expense in net income

$147,500

Note: The remeasurement gain of $6,000 is reported in OCI under the assumption that the plan covers such benefits as life insurance and medical and dental benefits. If the plan covers benefits that had considerably less measurement uncertainty, the gain would be included in the benefit expense in net income. (b) ASPE Current service cost Net interest/finance cost ($65,500 - $48,000) Remeasurement gain on plan assets ($54,000 - $48,000) Post-retirement benefit expense in net income

$130,000 17,500 (6,000) $141,500

The remeasurement gain must be disclosed separately on the face of the income statements or in the notes to the financial statements. LO 6,8 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 19.16 (a)

Effect on 2023 net income of plan amendment for past service cost under ASPE:

Post-plan amendment benefit obligation Pre-plan amendment benefit obligation Past service cost to recognize in expense in 2023

$156,239 137,888 $ 18,351

Defined benefit expense will increase and net income will decrease by $18,351 in 2023 under ASPE. (The net interest/finance cost also increases as the weighted average balance of the DBO during the year increases by $18,351 for the whole year.) (b) If Saver applies IFRS instead of ASPE, the effect would be identical. Past service cost is one of the components of defined benefit expense that is included in net income. LO 5,9 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 19.17 (a)

Effect on 2023 net income of actuarial revaluation of the defined benefit obligation under ASPE:

Post-actuarial revaluation of benefit obligation Pre-actuarial revaluation of benefit obligation Remeasurement loss to recognize in 2023 expense

$156,239 137,888 $ 18,351

Defined benefit expense will increase and net income will decrease by $18,351 in 2023 under ASPE and would require separate disclosure. (The net interest/finance cost also increases as the weighted average balance of the DBO during the year increases by $18,351 for the whole year.) (b) If Saver applies IFRS instead of ASPE, the effect would be different. Under IFRS, the remeasurement loss is recognized in OCI directly, not as part of defined benefit expense in net income. (However, because the DBO still increases, the net interest/finance cost will also increase.) LO 5,9 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 19.1 a.

Pension Contributions Payable ..................... 29,300 Cash ......................................................... 29,300

Defined benefit expense for December 2023: $276,100 x 7% = $19,327

Current liability: Pension Contributions Payable ($276,100 X 5%) + $19,327 or ($276,100 x 12%)

$ 33,132

At December 31, 2023, all that remains payable is the amount withheld from employees in December and the required employer matching amount. LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

EXERCISE 19.2 a.

Defined Benefit Expense1 .............................. 135,000 1

([$2,000 x 40] + [$1,000 x 55]) = $135,000

Defined Benefit Expense1 ............................... 135,000 Pension Contributions Payable2 .................... 35,000 Cash ......................................................... 170,000 2

Employee contribution: ([$2,000 x 10] + [$1,000 x 15]) = $35,000 (the $35,000 would have been included as a payable at the time that the related Salaries and Wages Expense was calculated). LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.3 a.

Defined benefit obligation, 1/1/23 Interest cost ($2,000,000 X10%) Current service cost Past service Benefits paid Defined benefit obligation, 12/31/23

b. Plan assets, 1/1/23 Actual return on plan assets Contribution into plan Benefits paid Plan assets, 12/31/23 c.

Defined benefit expense, 2023 Current service cost Past service cost Net interest/finance cost ($2,000,000 – $1,600,000) x 10% Defined benefit expense for 2023

$2,000,000 200,000 235,000 50,000 (100,000) $2,385,000

$1,600,000 160,000 262,500 (100,000) $1,922,500

$235,000 50,000 40,000 $325,000

Defined Benefit Expense ............................. 325,000 Net Defined Benefit Liability/Asset...... 325,000 (Note: there are no actuarial gains or losses in 2023 related to the DBO or the plan assets, so there are no remeasurement gains or losses to recognize in OCI) Net Defined Benefit Liability/Asset ............. 262,500 Cash........................................................ 262,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.3 (CONTINUED) e.

Net defined benefit liability/(asset), 1/1/23 Contribution Defined benefit expense Net defined benefit liability/(asset), 12/31/23

$ 400,000 (262,500) 325,000 $ 462,500

Alternatively, the amount could also be reconciled as follows: Defined benefit obligation Plan assets at fair value DBO in excess of plan assets (plan deficit)

$(2,385,000) 1,922,500 $ (462,500 )

LO 3,4,5,7 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.4 a. Rebek Corporation Pension Work Sheet—2023 General Journal Entries Annual Defined Net Def. Benefit Benefit Expense Cash Liab/Asset Balance, 01/01/2023 Current service cost Past service cost Net interest/finance cost1 Contributions Benefits paid Expense entry Contribution entry

400,000 Cr. 235,000 Dr. 50,000 Dr. 40,000 Dr. _______ 325,000 Dr.

262,500 Cr. _______0 00,000 Dr. 262,500 Cr.

Memo Record Defined Benefit Obligation 2,000,000 Cr. 235,000 Cr. 50,000 Cr. 200,000 Cr.

Plan Assets 1,600,000 Dr.

100,000 Dr. 000,00

160,000 Dr. 262,500 Dr. 100,000 Cr. 000,000 Dr.

0 Dr. 2,385,000 Cr.

1,922,500 Dr.

325,000 Cr. 262,500 Dr. 462,500 Cr.

Balance, 12/31/2023 1$40,000 = ($2,000,000 - $1,600,000) X 10%

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.4 (CONTINUED) b.

Defined Benefit Expense ............................. 325,000 Net Defined Benefit Liability/Asset ...... 325,000 (Note: there are no actuarial gains or losses in 2023 related to the DBO or the plan assets, so there are no remeasurement gains or losses to recognize in OCI) Net Defined Benefit Liability/Asset ............. 262,500 Cash........................................................ 262,500

Calculation of plan surplus/deficit, December 31, 2023 Defined benefit obligation Plan assets at fair value Plan deficit

$(2,385,000) 1,922,500 $ (462,500)

LO 3,4,5 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.5 a.

Assumes the company applies IFRS and has a significant plan surplus and current period remeasurement gain prior to the following events in the current year:

Current service cost Actual return on plan assets is > expected based on DBO discount rate (assess only the impact of the difference between the actual return and the expected return here) Return on plan assets at the interest/discount rate Past service costs due to plan revision Liability actuarial gain Liability actuarial loss Employer contributions on last day of fiscal year Benefits paid to retirees on last day of fiscal year An increase in the average life expectancy of employees

Defined Benefit Obligation I NE

Pension Plan Assets NE I

Defined Plan Benefit Surplus Expense D I I NE

Remeasurement Gain (OCI) NE I

D I NE

NE NE I

I D I

NE NE NE

I D NE

b. Assuming the company uses ASPE instead of IFRS, all the answers to the DBO, plan assets, and plan surplus columns would not change. In the defined benefit expense column, differences will exist between the ASPE answer and the IFRS answer only where the remeasurement gain (OCI) is affected. This is because ASPE recognizes the items directly in defined benefit expense on the income statement, while IFRS splits the effects between the income statement expense account and its OCI account. When the last two IFRS columns are netted together, the net result is the same as the ASPE solution, although disclosed separately. LO 3,4,5 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 19.28 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.6 Calculation of Actual Return on Plan Assets Fair value of plan assets at 12/31/23 $1,586,875 Fair value of plan assets at 1/1/23 1,438,750 Increase in fair value of plan assets 148,125 Deduct: Contributions to plan during 2023 $212,500 Less: benefits paid during 2023 218,750 6,250 Actual return on plan assets for 2023 $ 154,375 LO 4 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.7 a.

Actual = (Ending – Beginning) – (Contributions – Benefits) Fair value of plan assets, December 31, 2023 $2,096 Deduct: Fair value of plan assets, January 1, 2023 1,360 Increase in fair value of plan assets in 2023 736 Deduct: Contributions $640 Less: benefits paid 160 Increase caused by contributions > benefits 480 Actual return on plan assets in 2023 $ 256

Calculation of the net defined benefit liability/asset on January 1, 2023: DBO, January 1, 2023 Deduct: FV of plan assets, January 1, 2023 Plan deficit and net defined benefit liability, January 1, 2023

$2,240 1,360 $ 880

Defined benefit obligation continuity schedule for 2023: DBO, January 1, 2023 Current service cost, 2023 Interest cost (10% X $2,240) Past service cost, Dec. 30/23 plan amendment Benefits paid in 2023 DBO, December 31, 2023

$2,240 320 224 380 (160) $3,004

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.7 (CONTINUED) d.

Defined benefit expense for 2023: Current service cost Net interest/finance cost: 10% ($2,240 - $1,360) Asset remeasurement gain: $256 – (10% x $1,360) Past service cost, 2023 plan amendment Defined benefit expense for 2023

$320 88 (120) 380 $668

Note: the past service cost would be considered a remeasurement that should either be presented separately on the income statement or in the notes. e.

Journal entries 2023: Defined Benefit Expense ................................ Net Defined Benefit Liability/Asset ......... To record defined benefit expense Net Defined Benefit Liability/Asset ................ Cash.......................................................... To record contribution to the pension fund

668 668

640 640

Comparison of asset surplus/deficit with amount reported on the balance sheet, December 31, 2023: Defined benefit obligation Plan assets Plan deficit

$(3,004) 2,096 $ (908)

Net defined benefit liability, Jan. 1/23 from (b) $ 880 Cr. Defined benefit expense recognized 668 Cr. Contributions made, 2023 640 Dr. Net defined benefit liability, Dec. 31/23 $ 908 Cr. LO 3,4,5 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.8 a. Berstler Limited Pension Work Sheet—2023 (ASPE) General Journal Entries

Items

Balance, Jan. 1, 2023 (a) Service cost (b) Net interest/finance cost (c) Asset remeasurement gain (d) Past service cost in year (e) Contributions (f) Benefits paid Expense entry—2023 Contributions entry—2023 Balance, Dec. 31, 2023

Annual Defined Benefit Expense

Cash

Net Defined Benefit Liability/ Asset

Memo Record

Defined Benefit Obligation

880 Cr. 320 Dr. 88 Dr. 120 Cr. 380 Dr.

2,240 Cr. 320 Cr. 224 Cr.

1,360 Dr. 136 Dr. 120 Dr.

380 Cr. 640 Cr. 160 Dr.

___668 Dr.

Plan Assets

000 Dr. 640 Cr.

668 Cr. 640 Dr. 908 Cr.

640 Dr. 160 Cr.

0,000____ Cr. 0,000____ Cr. 3,004 Cr. 2,096 Dr.

(b) $88 = ($2,240 - $1,360) X 10%; $224 = $2,240 X 10%; $136 = $1,360 X 10% (c) $120 = $2,096 – ($1,360 + $640 - $160 + $136)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.8 (CONTINUED) b.

Journal entries 12/31/23

Defined Benefit Expense ....................................... Net Defined Benefit Liability/Asset ................ To record defined benefit expense

668

Net Defined Benefit Liability/Asset ....................... Cash ................................................................. To record contribution to the pension fund

640

668

640

The $908 credit balance reported on the balance sheet as the net defined benefit liability represents the net obligation the company has at December 31, 2023 to the employees’ defined benefit pension plan. The company’s benefit obligations related to employee services provided to the company up to December 31, 2023 are $908 more than the fair value of the assets that have been set aside at that same date to meet those obligations. Therefore, it also represents the defined benefit plan’s deficit of $908.

LO 3,4,5 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.9 a.

Defined benefit obligation, 1/1/23 Past service cost, effective 1/1/23 Interest cost ($480,000 x 9%) Current service Benefits paid DBO, 12/31/23

$420,000 60,000 480,000 43,200 43,500 (35,000) $531,700

Plan assets, 1/1/23 Actual return on plan assets Contributions Benefits paid Plan assets, 12/31/23

$409,650 39,210 41,250 (35,000 ) $455,110

Defined benefit expense 2023: Current service cost Net interest/finance cost ($480,000 - $409,650) x 9% Remeasurement gain on assets: Actual return $(39,210) Included in net interest/finance cost above 9% x $409,650 36,868 Past service cost

$ 43,500 6,332

(2,342) 60,000 $107,490

Defined Benefit Expense ............................. 107,490 Net Defined Benefit Liability/Asset....... 107,490

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.9 (CONTINUED) d.

Net defined benefit liability, January 1, 2023 $ 10,350 Cr. 2023 defined benefit expense recognized 107,490 Cr. Funding contributions, 2023 41,250 Dr. Net defined benefit liability, December 31, 2023 $76,590 Cr.

Plan’s Surplus/Deficit DBO, 12/31/23 Plan assets, 12/31/23 Plan deficit, a net obligation, 12/31/23 Net defined benefit liability, 12/31/23 from (d)

$531,700 455,110 $ 76,590 $ 76,590 Cr.

In this case, the components making up the defined benefit expense should be disclosed separately, especially those related to past service costs and the difference between the actual return on the plan assets and the return calculated using the discount rate in the net interest/finance calculation. Users of financial statements analyze the reported income statement amounts as information useful in predicting the potential for future returns and cash flows. Therefore, information about any expenses that are not recurring in nature is relevant information because this may affect user predictions. Users recognize that the returns on plan assets in any one year will vary from the long-run expected returns used in the actuarial calculations, often by substantial amounts. Therefore, the difference between the actual return in any year and the discount rate (the asset gain in this case) is not considered to be a recurring item. In addition, plan amendments are not considered to be annually recurring costs. For this reason, these components of defined benefit expense, as well as other non-recurring items such as other actuarial gains and losses, are required to be separately disclosed. The remaining components of defined benefit expense are recurring in nature.

LO 3,4,5,7 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 19.35 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.10 a.

Calculation of defined benefit expense under IFRS: Service cost $65,000 Net interest/finance cost: ($500,000 - $400,000) X 8% 8,000 Defined benefit expense for 2023 $73,000 Remeasurement loss on assets: (8% X $400,000) - $17,000 actual return = $15,000 Defined Benefit Expense ................................ 73,000 Remeasurement loss (OCI) ............................ 15,000 Net Defined Benefit Liability/Asset ........ 88,000 To record defined benefit expense and remeasurement loss Net Defined Benefit Liability/Asset ................ 95,000 Cash ......................................................... 95,000 To record contributions to the pension fund

Calculation of defined benefit expense under ASPE: Service cost $ 65,000 Net interest/finance cost: ($500,000 - $400,000) X 8% 8,000 Remeasurement loss on assets: Using discount rate: 8% X $400,000 = $32,000 Actual return ( 17,000) 15,000 Defined benefit expense for 2023 $ 88,000 Defined Benefit Expense ................................ 88,000 Net Defined Benefit Liability/Asset ........ 88,000 To record defined benefit expense Net Defined Benefit Liability/Asset ................ 95,000 Cash ......................................................... 95,000 To record contributions to the pension fund

LO 5,8 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 19.36 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 19.11 a.

Defined benefit expense, 2023: Current service cost $ 63,000 Net interest/finance cost: ($255,000 + $140,400 - $297,000) X 10% 9,840 Asset remeasurement loss: At 10% discount rate (10% X $297,000) $(29,700) Actual return (8% X $297,000) 23,760 Asset remeasurement loss 5,940 Past service cost 140,400 $219,180 Defined Benefit Expense ................................ 219,180 Net Defined Benefit Liability/Asset ........ 219,180 To record defined benefit expense Net Defined Benefit Liability/Asset ................ 79,200 Cash ......................................................... 79,200 To record contributions to the pension fund

b. Net defined benefit asset, Jan. 1, 2023 Plan surplus ($297,000 plan assets less DBO of $255,000) 2023 defined benefit expense recognized Funding contributions, 2023 Net defined benefit liability, Dec. 31, 2023

$ 42,000 Dr. 219,180 Cr. 79,200 Dr. $ 97,980 Cr.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.11 (CONTINUED) c. Antoine Corporation Pension Work Sheet—2023

Items

General Journal Entries Annual Defined Net Def. Benefit Benefit Liability/ Expense Cash Asset

Balance, Jan. 1, 2023 (a) Past service cost 140,400 Dr. (b) Current service cost 63,000 Dr. (c) Net interest/finance cost 9,840 Dr. (d) Asset remeasurement loss 5,940 Dr. (e) Contributions 79,200 Cr. (f) Benefits paid 219,18021 Expense entry—2023 219,180 Dr. 000 Dr. Contributions entry—2023 79,200 Cr. Balance, Dec. 31, 2023

Memo Record Entries Defined Benefit Obligation

42,000 Dr.

255,000 Cr. 140,400 Cr. 63,000 Cr. 39,540 Cr.

43,200 Dr. 219,180 Cr. 79,200 Dr. 0,000______ Cr. 97,980 Cr. 454,740 Cr.

Plan Assets 297,000 Dr.

29,700 Dr. 5,940 Cr. 79,200 Dr. 43,200 Cr.

0,00 ___ Cr. 356,760 Dr.

(c) $9,840 = ($255,000 + $140,400 - $297,000) X 10%; $39,540 = ($255,000 + $140,400) X 10%; $29,700 = $297,000 X 10% (d) $5,940 = $29,700 – ($297,000 X 8%)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.11 (CONTINUED) d. Defined benefit obligation, Jan. 1/23 Past service cost, Jan. 1/23 Interest cost ($395,400 x 10%) Current service cost Benefits paid DBO, Dec. 31/23 (or see worksheet)

$255,000 140,400 395,400 39,540 63,000 (43,200) $454,740

Plan assets, Jan. 1/23 Actual return on plan assets ($297,000 x 8%) Contributions Benefits paid Plan assets, Dec. 31/23 (or see worksheet)

$297,000 23,760 79,200 (43,200) $356,760

Plan deficit, Dec. 31/23 (net obligation) Net defined benefit liability – part (b)

$ 97,980 $ 97,980 Cr.

The plan surplus/deficit and the balance sheet account should be the same amount because the same items and amounts that affect the DBO and plan assets also affect the defined benefit expense and contribution journal entries in the net defined benefit liability/asset account. The exception to this statement is the amount of benefits paid, as this does not affect either the net amount of the plan surplus/deficit, nor the balance sheet account. If you review all the other items that affect the DBO and the plan assets and identify them as debits and credits, you will see that the two entries made to the net defined benefit liability/asset contain the same debits and credits.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.11 (CONTINUED) f.

The only difference if Antoine Corp. reported under IFRS instead of ASPE is that the remeasurement loss would be reported in OCI instead of being included in defined benefit expense on the income statement. That is, its total defined benefit expense would be $219,180 - $5,940 = $213,240, and it would have a loss of $5,940 reported in OCI. Comprehensive income would remain the same, as the remeasurement loss is still included, but as a component of OCI instead of net income. Under ASPE, the past service cost would be considered a remeasurement that must be presented separately either on the income statement or in the notes. Aside from the corresponding changes in retained earnings and accumulated other comprehensive income, everything else would remain the same on the balance sheet.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.11 (CONTINUED) g.

LO 3,4,5,6,8 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001, cpa-t007 CM: Reporting and DAIS

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.12 a.

Defined benefit expense for 2023: Current service cost Net interest/finance cost: ($1,000,000 - $600,000) X 9% Asset remeasurement loss: Actual return on plan assets: Return based on discount rate above: (9% X 600,000) (54,000) Actual return on assets 53,000 Defined benefit expense for 2023

$ 56,000 36,000

1,000 $ 93,000

Defined Benefit Expense ................................ 93,000 Net Defined Benefit Liability/Asset ........ 93,000 To record defined benefit expense Net Defined Benefit Liability/Asset ................ 145,000 Cash ......................................................... 145,000 To record contribution to the pension fund

Defined benefit obligation, Jan. 1/23 Plan assets, Jan. 1/23 Plan deficit (net obligation), Jan. 1/23 and balance in the Net Defined Benefit Liability account at Jan. 1/23

$(1,000,000) 600,000 __________ $ (400,000)

Defined benefit obligation, Dec. 31/231 Plan assets at fair value, Dec. 31/232 Plan deficit, Dec. 31/23

$(1,146,000) 798,000 $ (348,000)

Defined benefit obligation 31/12/23: $1,000,000 + $56,000 + ($1,000,000 X 9% = $90,000) = $1,146,000 2 Plan assets 31/12/23: $600,000 + $53,000 + $145,000 = $798,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.12 (CONTINUED) c. (continued) Net defined benefit liability, Jan. 1/23 From 2023 defined benefit expense entry From 2023 contribution/funding entry Net defined benefit liability, Dec. 31/23 d.

$400,000 Cr. 93,000 Cr. 145,000 Dr. $348,000 Cr.

Income Statement: Defined benefit expense

$93,000

Balance Sheet: Long-term liabilities Net defined benefit liability

$348,000

Note X: The company sponsors a defined benefit pension plan covering the following group of employees and providing the following benefits. For the year ended December 31, 2023, the net expense recognized for the company’s pension plan is $93,000. This includes an asset remeasurement loss of $1,000. The present value of the defined benefit obligation at December 31, 2023, is $1,146,000 and the market value of the fund assets is $798,000. This results in a plan deficit of $348,000. The effective date of the most recently completed actuarial valuation of the defined benefit obligation was ____.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.12 (CONTINUED) e.

If Griseta Limited also had an actuarial valuation of its plan prepared for funding purposes, and had chosen instead to use a funding valuation accounting policy for reporting purposes, this would have affected the pension results as follows: • Defined benefit expense in parts (a) and (b) would have been reduced because the net interest/finance cost would have been reduced by 9% of ($1,000,000 - $875,000) or $11,250. Defined benefit expense would have been $93,000 – $11,250 = $81,750. • In part (c), the plan deficit at January 1, 2023 and the net defined benefit liability at the same date also would have been reduced by $125,000 to $275,000 because the DBO was only $875,000, not $1 million. The DBO, the plan deficit, and the net defined benefit liability would also be reduced at December 31, 2023 because of the lower opening balance and reduced interest cost recognized in expense. • In part (d), the defined benefit expense on the income statement, as indicated above, would be reduced to $81,750 and the balance sheet liability account would also be reduced by the total of the $125,000 lower opening balance and the $11,250 reduced defined benefit expense recognized in the year. • In part (d), an accounting policy note would be required to explain that the company has chosen to measure its defined benefit plan obligation using a funding basis valuation.

LO 3,4,5,7 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.13 a.

IFRS Defined benefit expense (benefit) 2023 – to net income: Current service cost $ 13,000 Past service cost (benefit) (34,000) Net interest/finance cost: 10% of ($239,000 - $34,000 - $155,000) 5,000 Defined benefit expense (benefit) $(16,000) (Note: excludes remeasurement loss that would be charged to OCI)

ASPE Defined benefit expense (benefit) 2023 – to net income: Current service cost $ 13,000 Past service cost (benefit) (34,000) Net interest/finance cost: 10% of ($239,000 - $34,000 - $155,000) 5,000 Asset remeasurement loss: (10% X $155,000) – $7,750 7,750 Defined benefit expense (benefit) $( 8,250) Under ASPE, the past service cost/(benefit) of ($34,000) as well as the asset remeasurement loss of $7,750 would be considered remeasurements that must be presented separately on the income statement or in the notes.

LO 5,8 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.14 a.

Current service cost Net interest/finance cost: 10% X ($110,000 - $42,000)

$ 57,000

Post-retirement benefit expense 2023

$63,800

6,800

Remeasurement loss on assets: (10% X $42,000) - $3,000 Actuarial loss on obligation Post-retirement benefit remeasurement loss (OCI)

$32,200

Plan assets, 1/1/23 Actual return on plan assets Contributions Benefits paid out Plan assets, 12/31/23

$42,000 3,000 22,000 (6,000) $61,000

$1,200 31,000

Defined post-retirement benefit obligation, 1/1/23 $110,000 Interest cost ($110,000 x 10%) 11,000 Current service cost 57,000 Actuarial loss 31,000 Benefits paid (6,000) Defined post-retirement benefit obligation,12/31/23 $203,000 Defined post-retirement benefit obligation Plan assets at fair value Plan deficit, 12/31/23

$(203,000) 61,000 $(142,000 )

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.14 (CONTINUED) d. Net post-retirement benefit liability, 1/1/231 Post-retirement benefit expense 2023 Remeasurement loss (OCI) Contributions (funding) during 2023 Net post-retirement benefit liability,12/31/23 1

$ 68,000 63,800 32,200 (22,000) $142,000

$110,000 - $42,000 = $68,000

There is no need to reconcile – these two have the same balance because the inputs that affect the balance of each are identical.

LO 3,4,5,6 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 19.15 a.

Balance Jan. 1, 2023 Current service cost Net interest /finance cost1 Remeasurement gain on plan assets2 Benefits paid Contributions Expense entry Contribution entry 2023 Balance Dec.31, 2023 1 2

General Journal Entry Annual Defined Net Defined Benefit Benefit Liab./ Expense Cash Asset 101,000 Dr. 40,000 Dr. 8,585 Cr.

Memo Record Defined Benefit Obligation 389,000 Cr. 40,000 Cr. 33,065 Cr.

Plan Assets 490,000 Dr.

33,400 Dr.

8,050 Dr. 33,400 Cr. 30,000 Dr.

428,665 Cr.

536,300 Dr.

8,050 Cr. 30,000 Cr. 23,365 Dr. 30,000 Cr.

23,365 Cr. 30,000 Dr. 107,635 Dr.

41,650 Dr.

$8,585 = 8.5% X ($389,000 - $490,000); $33,065 = 8.5% X $389,000; $41,650 = 8.5% X $490,000 $8,050 = $49,700 – (8.5% X $490,000)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.15 (CONTINUED) a. (continued) Defined Benefit Expense .................................... Net Defined Benefit Liability/Asset ............. To record defined benefit expense

23,365

Net Defined Benefit Liability/Asset .................... Cash .............................................................. To record contributions to the pension fund

30,000

23,365

30,000

If Yorke Inc. had chosen the accounting basis measure of the defined benefit obligation, the following adjustments would be necessary:

Defined benefit expense – Part (a) $23,365 Revised net interest/finance cost: 8.5% X ($490,000 - $490,000) = $0 Therefore, add back the amount in part (a) 8,585 Defined benefit expense for 2023 and the credit to the net defined benefit account would have been $31,950 The defined benefit obligation at December 31, 2023 would be higher than indicated on the worksheet by the additional $101,000 opening balance + 8.5% interest on the $101,000 difference: $428,665 + $101,000 + $8,585 = $538,250. Proof: $490,000 + (8.5% X $490,000) + $40,000 - $33,400 = $538,250 The net defined benefit asset would be reduced by the same amount as the defined benefit increased: $107,635 Dr. $101,000 Cr. - $8,585 Cr. = $1,950 Cr. Proof: $538,250 – $536,300 = $1,950 plan deficiency.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.15 (CONTINUED) c. If IFRS had been applied, the defined benefit expense would have been similar to the expense in part (b), except that the asset remeasurement gain would be excluded on the basis that it would be recognized in OCI. The expense reported in net income would be: Current service cost Net interest/finance cost: 8.5% of ($490,000 - $490,000) = Defined benefit expense

$40,000

Proof: Expense determined in part (b) Add back the asset gain

$31,950 8,050 $40,000

-0$40,000

LO 3,4,5,8 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.16 a. Current service cost Net interest/finance cost: 9% X ($1,822,500 - $1,597,500) Post-retirement benefit expense Remeasurement loss on plan assets: 9% X $1,597,500 Actual return on plan assets

$202,500 20,250 $222,750

$143,775 141,750 $ 2,025

Post-Retirement Benefit Expense ............... 222,750 Net Retirement Benefit Liability/Asset ................................. 222,750 To record post-retirement benefit expense Remeasurement Loss (OCI)......................... Net Retirement Benefit Liability/Asset ................................ To record remeasurement loss

2,025

Net Retirement Benefit Liability/Asset ........ Cash ................................................. To record contribution to the benefit plan

47,250

b. Current service cost Net interest/finance cost: 9% X ($1,822,500 - $1,597,500) Remeasurement loss on plan assets: 9% X $1,597,500 $ 143,775 Actual return on plan assets 141,750 Post-retirement benefit expense

2,025

47,250

$ 202,500 20,250

2,025 $ 224,775

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.16 (CONTINUED) b. (continued) Post-Retirement Benefit Expense ............... 224,775 Net Retirement Benefit Liability/Asset ................................. 224,775 To record post-retirement benefit expense Net Retirement Benefit Liability/Asset ........ Cash ................................................. To record contribution to the benefit plan

47,250 47,250

LO 5,6,8 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.17 Opsco Corp. Post-retirement Benefit Plan Worksheet – 2023 – IFRS General Journal Entry

Remeas. (Gain)/Loss (OCI) Opening balance Service cost Net interest/finance cost1 Remeasurement loss – asset2

Post Retirement Benefit Expense

Cash

Memo Record

Net Defined Benefit Liab/Asset 225,000 Cr.

202,500 Dr. 20,250 Dr.

Ending balance

1,822,500 Cr. 202,500 Cr. 164,025 Cr.

1,597,500 Dr.

47,250 Cr.

2,025 Dr.

143,775 Dr. 2,025 Cr. 47,250 Dr.

Benefits paid

Funding entry

Plan Assets

2,025 Dr.

Contribution

Expense entry

DBO

222,750 Dr.

90,000 Dr.

90,000 Cr.

2,099,025 Cr.

1,696,500 Dr.

224,775 Cr. 47,250 Cr.

47,250 Dr.

402,525 Cr.

1$20,250 = ($1,822,500 - $1,597,500) X 9%; $164,025 = $1,822,500 X 9%; $143,775 = $1,597,500 X 9% 2 Remeasurement loss – asset of $2,025 = ($1,597,500 X 9%) - $141,750

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.17 (CONTINUED) See work sheet on previous page.

Entries: Post-retirement Benefit Expense ................ 222,750 Net Retirement Benefit Liability/Asset ................................. 222,750 To record post-retirement benefit expense Remeasurement Loss (OCI)......................... Net Retirement Benefit Liability/Asset ................................ To record remeasurement loss Net Retirement Benefit Liability/Asset ........................................ Cash ................................................. To record contribution to the benefit plan

2,025 2,025

47,250 47,250

LO 3,4,5,6 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.18 a.

Defined post-retirement benefit obligation (Credit) Plan assets at fair value (Debit) Plan deficit and Net Retirement Benefit Liability/Asset

$(185,000) 130,000 $ (55,000)

The past service costs that arose on August 31, 2023 would already be included in the defined post-retirement benefit obligation balance at December 31, 2023. Therefore, it is not relevant to the calculation of the plan surplus or deficit at year end. The past service costs would also have been included in post retirement benefit expense for the year, and therefore it has already been credited to the Net Retirement Benefit Liability/Asset balance sheet account.

LO 6 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.19 a.

Defined benefit obligation, January 1, 2023: Let Jan. 1 DBO = X X + $94,000 + $253,000 - $140,000 = $2,737,000 Therefore, X = $2,530,000 Plan assets, January 1, 2023: Let Jan. 1 plan assets = Y Y + $130,000 + $92,329 - $140,000 = $2,278,329 Therefore, Y =

$2,196,000

Jan. 1, 2023 plan deficit =

334,000

This is also the net defined benefit liability at the same date. b.

Note A: Significant Accounting Policies Employee Benefit Pension Plan The company accrues its obligations under its employee defined benefit pension plan and the related costs, net of plan assets. The defined benefit obligation is measured using the projected benefit method. Note X: The company sponsors a defined benefit pension plan covering the following group of employees and providing the following benefits. Information about the company’s defined benefit pension plan is as follows: Defined benefit obligation: Balance at beginning of year Interest cost Current service cost Benefits paid Balance at end of year

$2,530,000 253,000 94,000 (140,000) $2,737,000

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EXERCISE 19.19 (CONTINUED) b. (continued) Plan assets: Fair value at beginning of year Actual return on plan assets Employer contributions Benefits paid

$2,196,000 130,000 92,329 (140,000)

Fair value at end of year

$2,278,329

Net defined benefit (liability)/asset: Defined benefit obligation Plan assets at fair value Plan deficit and net defined benefit liability Defined benefit expense: Current service cost Net interest/finance cost1 Defined benefit expense 1 $253,000 - $219,600

$(2,737,000) 2,278,329 $(458,671)

Remeasurement (Gain) Loss (OCI): Actuarial loss on fund assets2 Remeasurement (Gain) Loss (OCI) 2

$ 94,000 33,400 $127,400

$ 89,600 $ 89,600

$219,600 - $130,000

Reconciliation of the net defined benefit liability: Net defined benefit liability, Jan. 1 Defined benefit expense recognized Remeasurement loss recognized Less cash contributions to plan Net defined benefit liability, Dec. 31

$334,000 127,400 89,600 (92,329) $458,671

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.19 (CONTINUED) b. (continued) Other information to be disclosed includes assumptions that underlie the plan such as the discount rate, the rate of increase in compensation levels, what type of assets make up the pension fund assets, and the dates of the most recent actuarial revaluations. LO 3,4,5,7 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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*EXERCISE 19.20 a.

The employee’s expected final salary in 2041 would be calculated as follows: $40,000 X (1.04)26 = $110,899 (in 27 years there would be 26 raises)

Step 1: Calculate annual pension benefit on retirement from working in 2023: Annual pension benefit on retirement = 2.5% X $110,899 X 1 year = $2,772 per year of retirement Step 2: Discount the present value of the annuity of $2,772 for 21 years at 6% to December 31, 2041. Using PV tables: Present value of an annuity of $2,772 discounted at 6% for 21 periods: ($2,772 X 11.76408) = $32,610 Using a financial calculator: PV I N PMT FV Type

$ ? 6% 21 $ (2,772) $0 0

Yields $32,610

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*EXERCISE 19.20 (CONTINUED) b. (continued) Using Excel formula: =PV(rate,nper,pmt,fv,type)

Result: $32,610.02039 rounded to $32,610 Step 3: Discount the present value of the annuity in 2041 to its present value at 2023: Present value of $32,610 discounted at 6% for 18 years ($32,610 X .35034) = $11,425 (18 years = 2023 to 2038) Using a financial calculator: PV I N PMT FV Type

$ ? 6% 18 $ 0 $ (32,610) 0

Yields $11,425

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 19.20 (CONTINUED) b. (continued) Excel formula: =PV(rate,nper,pmt,fv,type)

Result: $11,424.71103 rounded to $11,425 The current service cost relative to this plan for 2023 would be $11,425. c.

Pension benefits earned from January 1, 2015 to December 31, 2023 = 2.5% X $110,899 X 9 years = $24,952 per year of retirement. Present value at December 31, 2041 of an annuity of $24,952 discounted at 6% for 21 periods(rounded): ($24,952 X 11.76408) =

$293,537

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*EXERCISE 19.20 (CONTINUED) c. (continued) Using a financial calculator: PV I N PMT FV Type

$ ? 6% 21 $ (24,952) $ 0 0

Yields $293,537

Excel formula: =PV(rate,nper,pmt,fv,type)

Result: $293,537.2399 rounded to $293,537 The defined benefit obligation represents the present value of this amount discounted at 6% for 18 years:

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 19.20 (CONTINUED) c. (continued) Present value of $293,537 discounted at 6% for 18 years (rounded) ($293,537 X .35034) = $102,838 Using a financial calculator: Yields $102,839 PV $ ? I 6% N 18 PMT $ 0 FV $ (293,537) Type 0 Excel formula: =PV(rate,nper,pmt,fv,type)

Result: $102,838.8654 rounded to $102,839 The defined benefit obligation at December 31, 2023 would be $102,839. LO 9 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 19.21 a.

Defined benefit expense: Current service cost Net interest/finance cost: 8% X ($1,030,000 - $950,000) Defined benefit expense – 2023

$86,000 6,400 $92,400

In addition, as needed for part (b): Remeasurement loss (OCI): Asset remeasurement loss Actual return on assets Return included in defined benefit expense 8% X $950,000 Actuarial loss on DBO

$56,000 76,000 $20,000 29,000 $49,000

Entries: Defined Benefit Expense.............................. Net Defined Benefit Liability/Asset....... To record defined benefit expense

92,400

Remeasurement Loss (OCI)......................... Net Defined Benefit Liability/Asset ...... To record remeasurement loss

49,000

92,400

49,000

Net Defined Benefit Liability/Asset ............. 175,000 Cash ......................................................... 175,000 To record contribution to the pension fund

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EXERCISE 19.21 (CONTINUED) c.

Defined Benefit Obligation: January 1, 2023 Current service cost Interest cost 8% X $1,030,000 Actuarial loss, end of year Benefits paid December 31, 2023 Plan Assets: January 1, 2023 Actual return Contributions into plan assets Benefits paid December 31, 2023 Plan deficit: January 1: $1,030,000 - $950,000 December 31: $1,152,400 - $1,106,000 Net defined benefit liability/asset: January 1, 2023 (= plan deficit), credit Expense entry, 2023, credit Remeasurement loss entry, credit Contribution entry, debit December 31, 2023, credit (same as plan deficit, December 31, 2023)

$1,030,000 86,000 82,400 29,000 (75,000) $1,152,400

950,000 56,000 175,000 (75,000) $1,106,000

$80,000 $46,400

$ 80,000 92,400 49,000 (175,000) $ 46,400

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EXERCISE 19.21 (CONTINUED) d. General Journal Entries Remeas. Gain/ Loss (OCI) Balance Jan. 1, 2023 Current service cost Net interest /finance cost1 Remeasurement loss on plan assets2 Actuarial loss Benefits paid Contribution Expense entry

Annual Defined Benefit Expense

Cash

Memo Record Net Defined Benefit Liab./ Asset 80,000 Cr.

Defined Benefit Obligation

950,000 Dr.

86,000 Dr.

1,030,000 Cr. 86,000 Cr.

6,400 Dr.

82,400 Cr.

76,000 Dr.

20,000 Dr.

20,000 Cr.

29,000 Dr.

29,000 Cr. 75,000 Dr. 175,000 Cr.

49,000 Dr.

Contribution entry 2023

Plan Assets

92,400 Dr.

75,000 Cr. 175,000 Dr.

141,400 Cr. 175,000 Cr.

Balance Dec.31, 2023

175,000 Dr. 46,400 Cr.

1,152,400 Cr.

1$6,400 = ($1,030,000 - $950,000) X 8%; $82,400 = $1,030,000 X 8%; $76,000 = $950,000 X 8% 2$20,000 = ($950,000 X 8%) - $56,000

LO 3,4,5 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

1,106,000 Dr.

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EXERCISE 19.22 a.

In a contributory pension plan, the employees bear part of the cost of the stated benefits whereas in a non-contributory plan, the employer bears the entire cost.

The employer is the organization sponsoring the pension plan. The employer incurs the costs and makes contributions to the pension fund. For the employer the accounting involves (1) allocating the cost of the pension plan to the proper accounting periods, (2) measuring the amount of pension obligation resulting from the plan, and (3) disclosing the status and effects of the plan in the financial statements. The pension plan itself is the entity that receives the contributions from the employer, invests and administers the pension assets, and makes the benefit payments to the pension recipients. For the plan, the accounting involves identifying receipts as contributions from the employer sponsor, tracking the income generated on the assets, and computing the amounts due to individual pension recipients. (NB: accounting for the benefit costs and obligations of the employer with respect to the plan is the topic of this chapter; accounting for the fund or plan is not.)

Relative to the benefit plan, the term “funded” refers to the fact that assets are accumulated over the period the employee provides service to the organization so that monies will be available to pay the benefits when they are due. The relationship between pension plan assets and the present value of expected future pension benefit payments earned by employees to the reporting date indicates the surplus or deficit position of the plan. Relative to the employer, the term “funded” has a similar meaning. Some plans are pay-as-you-go and others (i.e., funded plans) have assets set aside as the employees provide services.

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EXERCISE 19.22 (CONTINUED) c. (continued) Relative to the benefit plan, the net defined benefit liability or asset is what is reported on the balance sheet of the employer. This balance is usually the same as the surplus/deficit position of the plan. These terms are not used in conjunction with a defined contribution plan where the employer is responsible only for paying a fixed or calculated amount into the plan each year for each employee covered. In such a case, if the employer makes all required payments during the year as is required, the plan is always 100% funded, except, perhaps, at the reporting date when the last month’s contributions may still be outstanding. In this case, a regular account payable would be reported. The employer takes responsibility for nothing more than this. d.

Terms and their definitions as they apply to accounting for pension plans follow: 1. For both IFRS and ASPE, current service cost is the actuarial present value of benefits attributed by the pension benefit formula to employee services rendered during that period. The current service cost is expensed in the year. Also, for both IFRS and ASPE, past service cost represents the cost of the retroactive benefits granted (or pulled back) in a plan amendment (or initiation). Retroactive benefits are benefits granted (or pulled back) in a plan amendment (or initiation) that are attributed by the pension benefit formula to employee services rendered in periods prior to the amendment. These are included in defined benefit expense in the period awarded.

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EXERCISE 19.22 (CONTINUED) d. (continued) 1. (continued) Under ASPE, any past service cost (benefit) would be considered a remeasurement that must be presented separately either on the income statement or in the notes. 2. A remeasurement gain/loss refers to the difference between the actual return and the discount rate of return on the plan assets used in calculating the net interest/finance cost included in defined benefit expense under both ASPE and IFRS. An actuarial experience gain/loss refers to changes in actuarial assumptions (for example, changes in mortality rate, turnover rate, disability rate, and salary amounts) that cause a change in the defined benefit obligation. This would also involve a change in assumptions used by the actuary in calculating the DBO (for example, a change in the interest rate used to discount the pension cash flows). IFRS usually recognizes actuarial gains and losses and remeasurement gains and losses directly in OCI. However, for long-term defined benefit plans such as long-term service awards and unrestricted sabbaticals where the calculations are more straightforward, the remeasurement/actuarial gains and losses are taken directly to expense. Under ASPE, such gains or losses are recognized directly in defined benefit expense and, therefore, in net income. However, such gains and losses, along with any past service cost (benefit) recognized in the period, would be considered remeasurements that must be presented separately either on the income statement or in the notes.

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EXERCISE 19.22 (CONTINUED) e.

The basic concepts and measurement methodology for postretirement benefits that accumulate are the same as for pension benefits. The recognition and measurement criteria for the obligation and plan assets are the same, as is the actuarial valuation method, the attribution period, and the calculation of the current cost of benefits. However, under IFRS, a distinction is made between plans that are more uncertain and require more complex assumptions such as post-employment pension plans and health-care benefit plans, and other plans that have less uncertainty. Other plans with less measurement uncertainty include paid leave, sabbaticals, and long-term disability, all of which increase with length of service. For these types of plans, any remeasurement gains and losses must be recognized immediately in expense, and therefore, in net income, not OCI.

LO 3,4,5,6 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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TIME AND PURPOSE OF PROBLEMS Problem 19.1 Purpose—to provide the student with an opportunity to determine the appropriate accounting for the costs of a long-term disability benefit plan and prepare the journal entries.

Problem 19.2 Purpose—to provide a problem that requires calculation of the liability for a vested benefit plan for sabbatical leave. This is a challenging problem that requires the student to apply the principles of benefit plans to a new situation.

Problem 19.3 Purpose—to provide a problem that requires a comparison of IFRS and ASPE, and preparation of continuity schedules for defined benefit obligation, plan assets, and defined benefit expense for three years’ pension transactions, three years of general journal entries for the pension plan, and reconciliation schedules at the end of each year.

Problem 19.4 Purpose—to provide a problem that requires a detailed analysis and application of the reporting standards (and differences) for accounting for a defined benefit plan under both ASPE and IFRS.

Problem 19.5 Purpose—to provide a problem that requires a detailed analysis and application of the reporting standards (and differences) for accounting for a defined benefit plan between IFRS and ASPE, including making a recommendation to the company president.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 19.6 Purpose—to provide a problem that requires ASPE and IFRS calculations of the annual defined benefit expense, preparation of the pension journal entries, measurement of plan surplus/deficit, and reconciling it to the liability on the SFP. A supplementary question is asked about a liability gain/loss that is the result of a discontinued operation.

Problem 19.7 Purpose—to provide a problem that requires calculation of ASPE defined benefit expense, preparation of the pension journal entries, and note disclosure. Amounts required in the note disclosure must be calculated using information for two consecutive years. The calculations are complicated by missing information that must be deduced. The pension work sheet must also be prepared.

Problem 19.8 Purpose—to provide a problem that requires calculation of the IFRS and ASPE defined benefit expense and continuity of the defined benefit obligation, plan assets, and net defined benefit liability/asset for one year.

Problem 19.9 Purpose— to provide a problem that requires calculation of the ASPE defined benefit expense and continuity of the defined benefit obligation, plan assets, and net defined benefit liability/asset for three years, plus the option of providing a work sheet. Missing information must be deduced.

Problem 19.10 Purpose— to provide a problem that requires calculation of the IFRS defined benefit expense and continuity of the defined benefit obligation, plan assets, and net defined benefit liability/asset for three years, plus the option of providing a work sheet. Missing information must be deduced.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 19.11 Purpose—to provide a problem that requires the preparation of IFRS schedules to determine the plan surplus/deficit and to prove the balances obtained. A separate question is asked about how the results would differ if the plan were a contributory one.

Problem 19.12 Purpose—to provide an IFRS problem that requires preparation of a pension work sheet and journal entries for one year, as well as a question about how changing interest rates and increased rates of compensation would affect the results.

Problem 19.13 Purpose—to provide a problem that requires the calculation of IFRS postretirement benefit expense, the preparation of a continuity schedule for defined benefit obligation and plan assets, and a reconciliation for post-retirement benefit expense. In addition, the student is required to discuss differences in accounting for post-retirement benefits and pension benefits.

*Problem 19.14 Purpose—to provide a complex problem that requires the calculation of postretirement benefit obligations by factoring in changes to the discount rate and salary assumptions for a one-person plan. The student must also analyze the change in the DBO for a 1% increase and decrease in the discount rate and the past service costs given the revised assumptions.

Problem 19.15 Purpose−to provide the student with an opportunity to determine the appropriate accounting for a sabbatical benefit under ASPE and IFRS and to list the information needed to measure the costs and prepare adjusting entries.

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SOLUTIONS TO PROBLEMS PROBLEM 19.1 This is partly a defined benefit plan because the plan specifies the benefits to be received by employees – full salary for the first three months. To the extent that the insurance company assumes the risk for the long-term portion of the salary continuation plan for a fixed premium of $20,000, this portion of the benefit plan is a defined contribution plan. 2023: Payment of premium to insurance company: Long-term Disability Benefits Expense .......................... 14,000 Long-term Disability Benefits Payable ........................... 6,000 Cash ...................................................................... 20,000 Late October, 2023: Long-term Disability Benefits Expense .......................... 13,500 Long-term Disability Benefits Payable ................... 13,500 (based on the “event accrual” approach discussed in Chapter 13 – recognize full expense when the event occurs: ($4,500 X 3)) November 2023: Long-term Disability Benefits Payable ........................... 4,500 Cash ...................................................................... 4,500 December, 2023: Long-term Disability Benefits Payable ........................... 4,500 Cash ...................................................................... 4,500

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PROBLEM 19.1 (CONTINUED) 2024: January 2024 – payment of third month’s waiting period: Long-term Disability Benefits Payable ........................... 4,500 Cash ...................................................................... 4,500 Payment of premium to insurance company: Long-term Disability Benefits Expense .......................... 14,000 Long-term Disability Benefits Payable ........................... 6,000 Cash ...................................................................... 20,000 LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 19.2 a.

Because the professors have to engage in an activity that benefits the university while they are on sabbatical, their salary while on sabbatical is simply recognized as expense in the year they take it. No amount needs to be recognized over the 7-year period leading up to it.

b. The following calculations assume that none of the benefits vest prior to earning the full sabbatical.

Current salary

Salary when eligible1

$80,000 $90,093 90,000 101,355 110,000 123,878

Salary during sabbatical (80%)

Portion earned in current year (1/7)

Present value2

Number of professors

$72,074 $10,296 81,084 11,583 99,102 14,157

$6,847 7,7033 9,4154

55 40 55

Sabbatical amount earned in current year

$376,585 308,120 47,075 $731,780

Salary in 2023 X (1.02)6 2 A rate of 6% is assumed. Using a financial calculator: PV I N PMT FV Type

$ ? 6% 7 $ 0 $(10,296) 0

Yields $6,847

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PROBLEM 19.2 (CONTINUED) b. (continued) Excel formula: =PV(rate,nper,pmt,fv,type)

Result $6,847.428042 rounded to $6,847 3 4

($6,847 / 80,000 x $90,000) = $7,703 ($6,847 / 80,000 x $110,000) = $9,415

Since five of the professors in the $110,000 salary grouping will retire, they will not have worked the necessary seven years for the benefit to vest. Journal entry required: Compensation Expense ...................................... Liability for Compensated Absence..............

731,780 731,780

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PROBLEM 19.2 (CONTINUED) c. Liability for Compensated Absence ..................... Cash ............................................................

367,000 367,000

Note: This entry would be made proportionately for each pay period throughout the fiscal year during which the faculty members are paid while on sabbatical.

If the sick leave can be carried over into the next fiscal period and employees are eligible to receive a cash payment upon discharge, termination of employment, or retirement, (i.e., the benefits are vested) then the amounts related to sick leave represent a liability that should be accrued. However, if employees are only permitted to take the paid sick days if they are actually sick, difficulties in measuring the liability combined with the immateriality of the amount may mean that the university recognizes the expense as the sick days are actually taken.

If unused sick time is not eligible to be carried over, there is no future obligation and no entry is required.

LO 2,6 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 19.3 a. IFRS – 2023

General Journal Entries Rem. Gain/ Loss (OCI)

Defined Benefit Expense

Cash

Opening balance Service cost Net Int./Fin. Cost1 Asset Rem. Loss2 Contributions Benefits paid Expense entry Funding entry Total 1 2

Memo Record Net Defined Benefit Liab./Asset DBO 0 460,000 Cr.

36,800 Dr. 0 Dr.

36,800 Cr. 46,000 Cr.

6,900 Dr. 36,800 Cr. 6,900 Dr. 36,800 Dr. 36,800 Cr.

Plan Assets 460,000 Dr.

46,000 Dr. 6,900 Cr.

32,200 Dr.

36,800 Dr. 32,200 Cr.

6,900 Cr. 510,600 Cr.

503,700 Dr.

43,700 Cr. 36,800 Dr.

$0 = ($460,000 - $460,000) X 10%; $46,000 = $460,000 X 10%; $46,000 = $460,000 X 10% $6,900 = ($460,000 X 10%) - $39,100 Although not required, work sheets are provided for 2024 and 2025 below.

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PROBLEM 19.3 (CONTINUED) a. (continued) IFRS – 2024 Rem. Gain/ Loss (OCI)

Intermediate Accounting, Thirteenth Canadian Edition

General Journal Entries Defined Benefit Expense

Cash

Opening balance Past service cost 1/1/24 Service cost Net Int./Fin. Cost1 Asset Remeasurement Loss2 Contributions3 Benefits paid Expense entry Funding entry Total

Memo Record Net Defined Benefit Liab/Asset DBO 6,900 Cr. 510,600 Cr.

368,000Dr

368,000 Cr.

43,700 Dr. 37,490 Dr.

43,700 Cr. 87,860 Cr.

0 Dr. 112,700Cr 0 Dr. 449,190Dr

Plan Assets 503,700 Dr.

50,370 Dr. 0 Cr.

37,720 Dr.

112,700 Dr. 37,720 Cr.

343,390 Cr. 972,440 Cr.

629,050 Dr.

449,190 Cr. 112,700Cr 112,700 Dr.

1$37,490 = ($510,600 + $368,000 - $503,700) X 10%; $87,860 = $(510,600 + $368,000) X 10%; $50,370 = $503,700 X

10% 2$0 = ($503,700 X 10%) - $50,370 3$112,700 = $43,700 + $69,000

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PROBLEM 19.3 (CONTINUED) a. (continued) IFRS – 2025 Rem. Gain/ Loss (OCI)

Intermediate Accounting, Thirteenth Canadian Edition

General Journal Entries Defined Benefit Expense

Cash

Opening balance Service cost Net Int./Fin. Cost1 Asset Rem. Loss2 Contributions3 Benefits paid Actuarial loss on DBO4 Expense entry Funding entry

Memo Record Net Defined Benefit Liab/Asset DBO 343,390 Cr. 972,440 Cr.

59,800 Dr. 34,339 Dr.

59,800 Cr. 97,244 Cr.

7,705 Dr. 140,300Cr 114,816Dr. 122,521 Dr. 94,139 Dr.

48,300 Dr. 114,816 Cr.

Plan Assets 629,050 Dr.

62,905 Dr. 7,705 Cr. 140,300 Dr. 48,300 Cr.

216,660 Cr. 140,300 Cr. 140,300 Dr.

Total

419,750 Cr. 1,196,000Cr

1$34,339 = ($972,440 - $629,050) X 10%; $97,244 = $972,440 X 10%; $62,905 = $629,050 X 10% 2$7,705 = ($629,050 X 10%) - $55,200 3$140,300 = $59,800 + $80,500 4$114,816 = $1,196,000 – ($972,440 + $59,800 + $97,244 - $48,300)

776,250 Dr.

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PROBLEM 19.3 (CONTINUED) Continuity of Defined Benefit Obligation – 2023

Defined benefit obligation, 1/1/23 Current service cost Interest cost ($460,000 x 10%) Benefits paid out Defined benefit obligation, 12/31/23

$460,000 36,800 46,000 (32,200) $510,600

Continuity of Defined Benefit Obligation – 2024 Defined benefit obligation, 1/1/24 Past service cost, 1/1/24 Current service cost Interest cost ($878,600 x 10%) Benefits paid out Defined benefit obligation, 12/31/24

$510,600 368,000 878,600 43,700 87,860 (37,720) $972,440

Continuity of Defined Benefit Obligation – 2025 Defined benefit obligation, 1/1/25 Current service cost Interest cost ($972,440 x 10%) Benefits paid out Actuarial loss, end of year1 Defined benefit obligation, 12/31/25 1

$972,440 59,800 97,244 (48,300) 114,816 $1,196,000

$114,816 = $1,196,000 - $972,440 - $59,800 - $97,244 + $48,300

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PROBLEM 19.3 (CONTINUED) c.

Continuity of Fund Assets – 2023 Plan assets, 1/1/23 Actual return on plan assets Contributions Benefits paid out

$460,000 39,100 36,800 (32,200)

Plan assets, 12/31/23

$503,700

Continuity of Fund Assets – 2024 Plan assets, 1/1/24 Actual return on plan assets Contributions ($43,700 + $69,000) Benefits paid out

$503,700 50,370 112,700 (37,720)

Plan assets, 12/31/24

$629,050

Continuity of Fund Assets – 2025 Plan assets, 1/1/25 Actual return on plan assets Contributions ($59,800 + $80,500) Benefits paid out

$629,050 55,200 140,300 (48,300)

Plan assets, 12/31/25

$776,250

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PROBLEM 19.3 (CONTINUED) Defined benefit expense – 2023

Current service cost Net interest/finance cost: 10% ($460,000 - $460,000)

$ 36,800 -0$ 36,800

Defined benefit expense – 2024 Current service cost Net interest/finance cost: 10% ($878,600 - $503,700) Past service cost

$ 43,700 37,490 368,000 $449,190

Defined benefit expense – 2025 Current service cost Net interest/finance cost: 10% ($972,440 - $629,050)

$59,800 34,339 $94,139

Journal entries: 2023 Defined Benefit Expense ................................... 36,800 Remeasurement Loss (OCI)1 ............................. 6,900 Net Defined Benefit Liability/Asset ............. 43,700 To record defined benefit expense Net Defined Benefit Liability/Asset ..................... 36,800 Cash .......................................................... 36,800 To record contribution to the pension fund 1

$6,900 = ($460,000 X 10%) – $39,100

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PROBLEM 19.3 (CONTINUED) e. (continued) 2024 Defined Benefit Expense ................................... 449,190 Net Defined Benefit Liability/Asset ............. 449,190 To record defined benefit expense Net Defined Benefit Liability/Asset ..................... 112,700 Cash .......................................................... 112,700 To record contribution to the pension fund 2025 Defined Benefit Expense ................................... 94,139 Remeasurement Loss (OCI)2 ............................. 122,521 Net Defined Benefit Liability/Asset ............. 216,660 To record defined benefit expense Net Defined Benefit Liability/Asset ..................... 140,300 Cash .......................................................... 140,300 To record contribution to the pension fund 2

$122,521 = ($629,050 X 10%) – $55,200 + $114,816

Note: the remeasurement gains and losses taken to OCI do not get recycled into net income at a later date.

Reconciliation Schedule 2023 Defined benefit obligation Fair value of plan assets Defined benefit obligation in excess of plan assets (plan deficit), and net defined benefit (liability)/asset

(510,600) 503,700

$(6,900)

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PROBLEM 19.3 (CONTINUED) f. (continued) Reconciliation Schedule 2024 Defined benefit obligation Fair value of plan assets Defined benefit obligation in excess of plan assets (plan deficit), and net defined benefit (liability)/asset Reconciliation Schedule 2025 Defined benefit obligation Fair value of plan assets Defined benefit obligation in excess of plan assets (plan deficit), and net defined benefit (liability)/asset

$(972,440) 629,050

$(343,390)

$(1,196,000) 776,250

$(419,750)

Defined benefit expense – 2023 Current service cost Net interest/finance cost: 10% ($460,000 - $460,000) Asset remeasurement loss ($46,000 - $39,100)

$ 36,800 -06,900 $ 43,700

Defined benefit expense – 2024 Current service cost Net interest/finance cost: 10% ($510,600 + $368,000 - $503,700) Asset remeasurement loss ($50,370 - $50,370) Past service cost

$ 43,700 37,490 -0368,000 $ 449,190

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PROBLEM 19.3 (CONTINUED) g (continued) Defined benefit expense – 2025 Current service cost Net interest/finance cost: 10% ($972,440 - $629,050) Asset remeasurement loss ($62,905 - $55,200) Actuarial loss on DBO

$ 59,800 34,339 7,705 114,816 $ 216,660

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PROBLEM 19.3 (CONTINUED) g. (continued) ASPE – 2023

General Journal Entries Defined Benefit Expense

Cash

Opening balance Service cost Net Int./Fin. Cost1 Asset Remeasurement Loss2 Contributions Benefits paid Expense entry Funding entry

Memo Record

Net Defined Benefit Liab/Asset DBO 0 460,000 Cr.

Plan Assets 460,000 Dr.

36,800 Cr. 46,000 Cr.

46,000 Dr.

32,200 Dr.

6,900 Cr. 36,800 Dr. 32,200 Cr.

6,900 Cr. 510,600 Cr.

503,700 Dr.

36,800 Dr. 0 Dr. 6,900 Dr. 36,800 Cr. 43,700 Dr.

Total

36,800 Cr.

43,700 Cr. 36,800 Dr.

1$0 = ($460,000 - $460,000) X 10%; $46,000 = $460,000 X 10%; $46,000 = $460,000 X 10% 2$6,900 = ($460,000 X 10%) - $39,100

Although not required, all work sheets under ASPE have been provided. Defined benefit expense can be calculated as in the “Defined benefit expense” column in each work sheet.

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PROBLEM 19.3 (CONTINUED) g. (continued) ASPE – 2024

General Journal Entries Defined Net Defined Benefit Benefit Cash Expense Liab/Asset

Opening balance Past service cost 1/1/24 Service cost Net Int./Fin. Cost1 Asset Remeasurement Loss2 Contributions3 Benefits paid Expense entry Funding entry Total

Memo Record DBO

6,900 Cr. 510,600 Cr.

Plan Assets 503,700 Dr.

368,000Dr

368,000 Cr.

43,700 Dr. 37,490 Dr.

43,700 Cr. 87,860 Cr.

50,370 Dr.

37,720 Dr.

0 Cr. 112,700 Dr. 37,720 Cr.

343,390 Cr. 972,440 Cr.

629,050 Dr.

0 Dr. 112,700Cr 449,190Dr

449,190 Cr. 112,700Cr 112,700 Dr.

1$37,490 = ($510,600 + $368,000 - $503,700) X 10%; $87,860 = $(510,600 + $368,000) X 10%; $50,370 =

$503,700 X 10% 2$0 = ($503,700 X 10%) - $50,370 3$112,700 = $43,700 + $69,000 Solutions Manual 19.89 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 19.3 (CONTINUED) g. (continued) ASPE – 2025

General Journal Entries Defined Benefit Expense

Cash

Opening balance Service cost Net Int./Fin. Cost1 Asset Remeasurement Loss2 Contributions3 Benefits paid Actuarial loss on DBO4 Expense entry Funding entry

Memo Record

Net Defined Benefit Liab/Asset DBO 343,390 Cr. 972,440 Cr.

Plan Assets 629,050 Dr.

59,800 Cr. 97,244 Cr.

62,905 Dr.

59,800 Dr. 34,339 Dr. 7,705 Dr. 140,300Cr

48,300 Dr. 114,816 Cr.

114,816 Dr. 216,660 Dr.

Total

140,300Cr

7,705 Cr. 140,300 Dr. 48,300 Cr.

216,660 Cr. 140,300 Dr. 419,750 Cr.

1,196,000Cr

776,250 Dr.

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PROBLEM 19.3 (CONTINUED) h. Potential investors would be most interested in seeing the components of defined benefit expense so they can determine which components are recurring in nature. They would also be very interested in seeing the surplus or deficit position of the plan and how it changes from year to year. The higher the deficit, the higher the risk to investors. Another important disclosure would be the amount of cash that would likely have to be committed to fund the plan each year going forward. The estimates used in discount calculations would be useful as this can make a significant difference in the DBO, current service cost, and interest calculations involving pension plans. More of this information is required to be provided under IFRS. However, under ASPE, past service costs and remeasurement gains and losses on the plan assets and DBO are considered remeasurements that must be presented separately on the income statement or disclosed in the notes to the financial statements. Also, it is assumed that users of the financial statements of smaller private entities using ASPE have greater access to required information from management. LO 3,4,5 BT: AP Difficulty: C Time: 55 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 a.

ASPE: At January 1, 2023, note that the balance of the net defined benefit liability on the opening SFP will be equal to the plan surplus or deficit at that date. The net defined benefit liability, therefore, was $175,000 - $165,000 = $10,000 cr. 2023 Defined benefit obligation, 1/1/23 $175,000 Past service cost, 1/1/23 78,000 253,000 Interest cost ($253,000 x 7%) 17,710 Current service cost 35,000 Benefits paid (24,000) DBO, 12/31/23 $281,710 Plan assets, 1/1/23 Actual return on plan assets ($165,000 x 8%) Contributions—plan funding Benefits paid Plan assets, 12/31/23

Plan deficit, Dec. 31/23, and the balance of the Net Defined Benefit Liability at Dec. 31/23 [see proof in part (b)]

$165,000 13,200 44,000 (24,000) $198,200

$83,510

Defined benefit obligation, 1/1/24 Interest cost ($281,710 x 7%) Current service cost Benefits paid DBO, 12/31/24

2024 $281,710 19,720 47,250 (26,000) $322,680

Plan assets, 1/1/24 Actual return on plan assets ($198,200 x 6%) Contributions Benefits paid Plan assets, 12/31/24

$198,200 11,892 44,000 (26,000) $228,092

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 (CONTINUED) a. (continued) 2024 (continued) Plan deficit, Dec. 31/24, and the balance of the Net Defined Benefit Liability at Dec. 31/24 [see proof in part (b)]

$94,588

Defined benefit obligation, 1/1/25 Interest cost ($322,680 x 7%) Current service cost Benefits paid DBO, 12/31/25

2025 $322,680 22,588 52,500 (28,000) $369,768

Plan assets, 1/1/25 Actual return on plan assets ($228,092 x 7%) Contributions Benefits paid Plan assets, 12/31/25

$228,092 15,966 44,000 (28,000) $260,058

Plan deficit, Dec. 31/25, and the balance of the Net Defined Benefit Liability at Dec. 31/25 [see proof in part (b)]

$109,710

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 (CONTINUED) b.

Defined benefit expense 2023: Current service cost Net interest/finance cost: 7% ($253,000 - $165,000) Asset remeasurement gain: (7% X $165,000) – (8% X $165,000) Past service cost incurred in year

Defined benefit expense 2024: Current service cost Net interest/finance cost: 7% X ($281,710 - $198,200) Asset remeasurement loss: (7% X $198,200) – (6% X $198,200)

Defined benefit expense 2025: Current service cost Net interest/finance cost: 7% X ($322,680 - $228,092) Asset remeasurement loss: (7% X $228,092) – (7% X $228,092)

$ 35,000 6,160 (1,650) 78,000 $117,510

$47,250 5,846 1,982 $ 55,078

$52,500 6,622 -0$59,122

The SFP net defined benefit liability account balance as given in part (a) can be proved as follows: Opening balance + expense – contributions = ending balance 2023: 10,000 cr. + 117,510 cr. – 44,000 dr. = 83,510 cr. 2024: 83,510 cr. + 55,078 cr. – 44,000 dr. = 94,588 cr. 2025: 94,588 cr. + 59,122 cr. – 44,000 dr. = 109,710 cr. As expected, these also reflect the plan deficiency at each year end.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 (CONTINUED) c.

At January 1, 2023, note that the balance of the net defined benefit liability on the opening SFP will be equal to the plan surplus or deficit at that date. The net defined benefit liability, therefore, was $175,000 - $165,000 = $10,000 cr. 2023 Defined benefit obligation, 1/1/23 Past service cost, 1/1/23 Interest cost ($253,000 x 7%) Current service cost Benefits paid DBO, 12/31/23

$175,000 78,000 253,000 17,710 35,000 (24,000) $281,710

Plan assets, 1/1/23 Actual return on plan assets ($165,000 x 8%) Contributions—plan funding Benefits paid Plan assets, 12/31/23

$165,000 13,200 44,000 (24,000) $198,200

Plan deficit, Dec. 31/23, and the balance of the Net Defined Benefit Liability at Dec. 31/23 [see proof in part (d)]

$83,510

2024 Defined benefit obligation, 1/1/24 Interest cost ($281,710 x 7%) Current service cost Benefits paid DBO, 12/31/24

$281,710 19,720 47,250 (26,000) $322,680

Plan assets, 1/1/24 Actual return on plan assets ($198,200 x 6%) Contributions Benefits paid Plan assets, 12/31/24

$198,200 11,892 44,000 (26,000) $228,092

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 (CONTINUED) c. (continued) 2024 (continued) Plan deficit, Dec. 31/24, and the balance of the Net Defined Benefit Liability at Dec. 31/24 [see proof in part (d)]

$94,588

2025 Defined benefit obligation, 1/1/25 Interest cost ($322,680 x 7%) Current service cost Benefits paid DBO, 12/31/25

$322,680 22,588 52,500 (28,000) $369,768

Plan assets, 1/1/25 Actual return on plan assets ($228,092 x 7%) Contributions Benefits paid Plan assets, 12/31/25

$228,092 15,966 44,000 (28,000) $260,058

Plan deficit, Dec. 31/25, and the balance of the Net Defined Benefit Liability at Dec. 31/25 [see proof in part (d)]

$109,710

d. Defined benefit expense 2023: Current service cost Net interest/finance cost: 7% ($253,000 - $165,000) Past service cost incurred in year Remeasurement (gain) loss (OCI) 2023 Asset remeasurement loss (gain): (7% X $165,000) – (8% X $165,000)

$ 35,000 6,160 78,000 $119,160

$ (1,650)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 (CONTINUED) d. (continued) Defined benefit expense 2024: Current service cost Net interest/finance cost: 7% X ($281,710 - $198,200) Remeasurement (gain) loss (OCI) 2024 Asset remeasurement loss (gain): (7% X $198,200) – (6% X $198,200) Defined benefit expense 2025: Current service cost Net interest/finance cost: 7% X ($322,680 - $228,092) Remeasurement (gain) loss (OCI) 2025 Asset remeasurement loss (gain): (7% X $228,092) – (7% X $228,092)

$47,250 5,846 $ 53,096

$ 1,982

$52,500 6,622 $59,122

-0-

Note: the remeasurement gains and losses taken to OCI do not get recycled into net income at a later date. The SFP net defined benefit liability account balance as given in part (c) can be proved as follows: Opening balance + expense +/– remeasurement loss/gain – contributions = ending balance 2023: 10,000 cr. + 119,160 cr. – 1,650 dr. – 44,000 dr. = 83,510 cr. 2024: 83,510 cr. + 53,096 cr. + 1,982 cr. – 44,000 dr. = 94,588 cr. 2025: 94,588 cr. + 59,122 cr. +/–0 – 44,000 dr. = 109,710 cr. As expected, these also reflect the plan deficiency at each year end.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 (CONTINUED) e.

In part (b) under ASPE, all the changes in the DBO and plan assets get reported in net income, while under IFRS, the changes in the DBO and plan assets get split between the expense recognized in net income and the remeasurements recognized in OCI. Under IFRS, the remeasurements that are items likely to change (reverse) in the future are recognized in OCI, and not subsequently recycled to net income. ASPE does not recognize OCI in its financial statements, but does require disclosures of remeasurements similar to IFRS, although what is included in “remeasurements and other items” under ASPE differs from what is reported in OCI under the IFRS standard. One difference is the treatment of past service costs. Under both GAAPs, past service cost is included in defined benefit expense in the year of the plan amendment and is reported in net income. However, ASPE requires past service costs to be included in “remeasurements and other items” that are separately disclosed because such costs are not replicable (recurring each period). IFRS also reports past service costs in expense because it is not a remeasurement that is likely to reverse in the future. That is, separate disclosure treatment under ASPE and OCI treatment under IFRS are required for different reasons. The measure of expense over the three-year period, when changes to OCI are included, will total the same amount. However, on an annual basis, net income will be more variable under ASPE. In addition, under ASPE, the entity has an accounting policy choice of whether to use a funding valuation of the DBO or the accounting basis DBO. The funding basis measure of expense is often lower.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.4 (CONTINUED) e. (continued) Which method results in a better measure of expense over the threeyear period? Because both methods have the same effect on comprehensive income and on the balance sheet liability, it is difficult to give an opinion on which measure of expense is better. To the extent that the expense amount is taken into account in determining net income and earnings per share, the IFRS approach may be considered better because items that may change significantly in future periods are eliminated from the EPS measure. However, because analysts have full information of the various components under both approaches, they can determine the components that are recurring in nature. f.

As indicated in part (e), all the changes in the DBO and plan assets under ASPE get reported in net income, while under IFRS, the changes in the DBO and plan assets get split between the expense recognized in net income and the remeasurements recognized in OCI. However, the IFRS net income amount plus the OCI-reported amount add up to the same amount as is included in expense in ASPE’s net income. As a result, the net defined benefit liability/asset reported on the SFP and the plan surplus or deficit are exactly the same. Therefore, the measure is the same.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.5 a. IFRS Defined benefit expense Current service cost Net interest/finance cost (benefit) 8% x ($75,000 - $75,000); 8% X ($93,000 – $93,500); 8% X ($109,440 - $114,500) Past service cost Total

2023 12,000 0

2024 13,000 (40)

2025 14,500 (405)

75,000 87,000

0 12,960

0 14,095

(2,520)

1,160

(2,520)

1,160

93,500 15,000 10,000 (4,000) 114,500

114,500 16,000 8,000 (5,000) 133,500

Remeasurement (Gain) Loss (OCI) Asset remeasurement (gain) loss (500) (8% x $75,000) - $6,500; (8% X $93,500) $10,000; (8% X $114,500) - $8,000 Total (500) Plan Assets Opening balance Contributions ($75,000 original + $12,000) Actual return Benefits paid Ending balance

0 87,000 6,500 0 93,500

Defined Benefit Obligation Balance January 1 0 Past service cost, January 1 75,000 Current service cost 12,000 Interest cost $75,000 X 8%; $93,000 X 6,000 8%; $109,440 X 8% Benefits paid 0 Ending balance 93,000

93,000

109,440

13,000 7,440

14,500 8,755

(4,000) 109,440

(5,000) 127,695

Plan Surplus (Dr.) or Deficit (Cr.) Defined benefit obligation 93,000 CR 109,440 CR Plan Assets 93,500 DR 114,500 DR Plan surplus and Net Defined Benefit 500 DR 5,060 DR Asset on SFP

127,695 CR 133,500 DR 5,805 DR

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.5 (CONTINUED) b. ASPE: The following calculations are based on an accounting policy choice of using the accounting basis measure of the defined benefit obligation. Defined benefit expense Current service cost Net interest/finance cost (benefit) 8% x ($75,000 - $75,000); 8% X ($93,000 – $93,500); 8% X ($109,440 - $114,500) Asset remeasurement (gain) loss (8% X $75,000) - $6,500; (8% X 93,500) $10,000; (8% X $114,500) - $8,000 Past service cost Total

2023 12,000 0

2024 13,000 (40)

2025 14,500 (405)

(500)

(2,520)

1,160

75,000 86,500

0 10,440

0 15,255

0 87,000 6,500 0 93,500

93,500 15,000 10,000 (4,000) 114,500

114,500 16,000 8,000 (5,000) 133,500

Plan Assets Opening balance Contributions ($75,000 + $12,000) Actual return Benefits paid Ending balance

Defined Benefit Obligation Opening balance 0 Past service cost, 1/1/23 75,000 Service cost 12,000 Interest cost (8% X $75,000); (8% X 6,000 $93,000); (8% X $109,440) Benefits paid 0 Ending balance 93,000

93,000

109,440

13,000 7,440

14,500 8,755

(4,000) 109,440

(5,000) 127,695

Plan Surplus (Dr.) or Deficit (Cr.) Defined benefit obligation 93,000CR 109,440 CR Plan assets 93,500 DR 114,500 DR Plan surplus and Net Defined Benefit 500 DR 5,060 DR Asset on SFP

127,695 CR 133,500 DR 5,805 DR

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.5 (CONTINUED) c.

To: Ms. President From: CFO Please see the attached tables that set out the results of using IFRS and of using ASPE. The major difference between these methods (assuming an ASPE accounting policy choice of an accounting basis measure of the defined benefit obligation) is where some components of the pension cost are reported. In our case under IFRS, the difference between the return on plan assets at the discount rate and the actual return earned on the plan assets is recognized in OCI rather than in net income as it is under ASPE. The items recognized in OCI under IFRS are due to events that may reverse in the future and as a result, should not affect net income and earnings per share reported. Under ASPE, all events that change either the plan assets or the defined benefit obligation must be recognized and reported in net income. Other comprehensive income is not a feature of financial statements under ASPE. In addition, under ASPE, the past service cost would be considered a remeasurement that must be presented separately on the income statement or disclosed in the notes to the financial statements. In future years, there may be other situations, such as actuarial valuation adjustments, that are required to be reported in OCI. This is not something that is a choice of policy – it is a result of adopting IFRS. Other than these remeasurement items, the IFRS and ASPE effects are identical as you can see. The net effect is higher net income under ASPE when these remeasurement items are positive (gains) and lower net income when the remeasurements are negative (losses).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.5 (CONTINUED) c. (continued) Under ASPE, we do have an accounting policy choice, but I have used the policy that results in the ASPE reports being close to the IFRS reports, as you requested. The company could choose to use an actuarial measure for its defined benefit obligation that is prepared for funding purposes. Invariably however, this measure of the DBO is lower than the measure of the DBO for accounting purposes. While the accounting measure of the DBO would have the effect of increasing the plan surplus and the pension asset reported on our balance sheet, and reducing the net interest/finance cost component of the defined benefit expense, these numbers would not correspond as well with those reported under IFRS. Therefore, I recommend making the accounting policy choice to use the accounting measure of the defined benefit obligation. This will make the ASPE results as close as possible to the IFRSbased reports. LO 2,3,4,5,8 BT: AP Difficulty: C Time: 50 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.6 a.

Defined benefit obligation, Jan. 1, 2023 Add interest (8% X $1,430,000) Add current service cost Less benefit payments DBO, calculated, December 31, 2023 Liability loss (diff. of calculated vs. actual) Actuarial valuation of DBO, Dec. 31, 2023

$1,430,000 114,400 213,200 0 1,757,600 67,600 $1,825,200

Plan assets, Jan. 1, 2023 Actual return, 2023 Contributions: $213,200 + $106,600 Deduct payments to retirees Plan assets, Dec. 31, 2023

$1,040,000 80,600 319,800 ( 0 ) $1,440,400

Plan deficit, December 31, 2023

$ 384,800

Defined benefit expense for 2023: Current service cost Net interest/finance cost: 8% X ($1,430,000 - $1,040,000) Asset remeasurement loss: (8% X $1,040,000) - $80,600 Liability loss (see part (a) above)

$213,200 31,200 2,600 67,600 $314,600

(1) Journal Entries—2023: ASPE Defined Benefit Expense .................................. 314,600 Net Defined Benefit Liability/Asset ............ 314,600 To record defined benefit expense Net Defined Benefit Liability/Asset .................... 319,800 Cash ($213,200 + $106,600)..................... 319,800 To record contributions to the pension fund

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.6 (CONTINUED) c. (continued) (2) If Brawn Corp. applied IFRS, the journal entries would be: Defined Benefit Expense ($213,200 + $31,200) 244,400 Net Defined Benefit Liability/Asset ............ 244,400 To record defined benefit expense Remeasurement Loss (OCI) ($2,600 + $67,600) ...................................... 70,200 Net Defined Benefit Liability/Asset ............ 70,200 To record remeasurement loss Net Defined Benefit Liability/Asset .................... 319,800 Cash ($213,200 + $106,600)..................... 319,800 To record contributions to the pension fund Under IFRS, the asset remeasurement loss is recognized in OCI as is the liability loss, assumed to have been due to an actuarial revaluation of the defined benefit obligation. (This loss is not recycled back through net income.) The defined benefit expense recognized would be comprised only of the current service cost and the net interest/finance cost. d.

Net defined benefit liability, Jan. 1/23 $1,430,000 - $1,040,000 Defined benefit expense entry, 2023 Contributions entry, 2023 Net defined benefit liability, Dec. 31/23

$390,000 Cr. 314,600 Cr. 319,800 Dr. $384,800 Cr.

The plan deficit is also a credit balance of $384,800. These two numbers are identical because the inputs to their calculation are identical. Every item that affects the DBO and the plan assets is picked up in either the entry to recognize the expense or the entry to recognize the contributions to the plan. Because all the inputs are the same, their balances are identical. Solutions Manual 19.105 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.6 (CONTINUED) e.

The liability loss that relates to the disposal of the business segment is most likely a plan settlement with employees of that segment. It would be reported in the discontinued operations section of the income statement along with other gains/losses on the disposal of the segment and any part of the defined benefit expense that relates to the running of the discontinued operation in 2023. These are reported on a net-of-tax basis. Under ASPE, the cost of the plan settlement would be considered a remeasurement, requiring separate disclosure either on the income statement or in the notes to the financial statements. If Brawn Corp. applied IFRS instead of ASPE, and the liability loss related to a plan settlement with employees, the $67,600 loss would be an income statement item instead of an item of OCI. In this case, the loss would be reported the same way as under ASPE.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.7 a.

Calculation of defined benefit expense:

Current service cost Net interest/finance cost: ($600,000 - $360,0001) X 9% ($700,000 - $515,000) X 9%

2023

2024

($ 60,000) ( 21,600 )

($ 90,000) ( 16,650)

Asset remeasurement loss (gain): (9% X $360,0001) - $24,000 (9% X $515,000) – 47,000

( 8,400

(650) )$ 90,000) $106,000 Defined benefit expense ) 1 If the defined benefit obligation at January 1 was $600,000 and the net defined benefit liability at the same date was $240,000, the plan assets must have been $600,000 - $240,000 = $360,000 on January 1, 2023. b.

Journal Entries—2023 Defined Benefit Expense ................................... 90,000 Net Defined Benefit Liability/Asset ............ 90,000 To record defined benefit expense Net Defined Benefit Liability/Asset2 ................... 145,000 Cash ......................................................... 145,000 2 ($60,000 + $85,000) To record contributions to the pension fund Journal Entries—2024 Defined Benefit Expense .................................. 106,000 Net Defined Benefit Liability/Asset ............... 106,000 To record defined benefit expense Net Defined Benefit Liability/Asset3 ................... 145,000 Cash ......................................................... 145,000 3 ($90,000 + $55,000) To record contributions to the pension fund

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PROBLEM 19.7 (CONTINUED) c.

Intermediate Accounting, Thirteenth Canadian Edition

Manon Corporation Pension Work Sheet – 2023 and 2024 General Journal Entries

Items Balance, Jan. 1, 2023 (a) Service cost (b) Net interest/finance cost (c) Asset remeasurement loss (d) Company contributions (e) Benefits paid Expense entry, 12/31/23 Contribution entry, 2023 Balance, Dec. 31, 2023, Jan. 1, 2024 (f) Service cost (g) Net interest/finance cost (h) Asset remeasurement gain (i) Company contributions (j) Benefits paid Expense entry, 12/31/24 Contribution entry, 2024 Balance, Dec. 31, 2024

Annual Defined Benefit Expense

Cash

Net. Def. Benefit Liab/Asset 240,000 Cr.

60,000 Dr. 21,600 Dr. 8,400 Dr. 000,000 Dr. 90,000 Dr.

145,000 Cr. 000,000 Dr. 145,000 Cr.

90,000 Cr. 145,000 Dr. 185,000 Cr.

90,000 Dr. 16,650 Dr. 650 Cr.

Defined Benefit Obligation

Plan Assets

600,000 Cr. 360,000 Dr. 1 60,000 Cr. 54,000 Cr. 32,400 Dr. 8,400 Cr. 145,000 Dr. 14,000 Dr. 14,000 Cr. 0,000,000 Cr. 0,000,000 Cr. 700,000 Cr.

515,000 Dr.

90,000 Cr. 63,000 Cr.

145,000 Cr. 000,000 Dr. 106,000 Dr. 145000 Cr.

106,000 Cr. 145,000 Dr. 146,000 Cr.

46,350 Dr. 650 Dr. 145,000 Dr. 65,000 Dr. 65,000 Cr. 0,0 0,000,000 Cr. 00,000 Cr. 788,000 Cr. 642,000 Dr.

1Calculated as the difference between the Jan. 1, 2023 DBO and the net defined benefit liability balance at the same date.

(b) and (g) $21,600 = ($600,000 - $360,000) X 9%; $54,000 = $600,000 X 9%; $32,400 = $360,000 X 9%. $16,650 = ($700,000 - $515,000) X 9%; $63,000 = $700,000 X 9%; $46,350 = $515,000 X 9% (c) and (h) $8,400 = ($360,000 X 9%) - $24,000; $650 = ($515,000 X 9%) - $47,000 (d) and (i) $145,000 = $60,000 + $85,000; $145,000 = $90,000 + $55,000 (e) $14,000 calculated by using beginning and ending balances of DBO as provided or of plan assets, once its opening balance is determined. (j) $65,000 calculated by using beginning and ending balances of plan assets as provided.

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PROBLEM 19.7 (CONTINUED) d.

Note X: The company sponsors a defined benefit pension plan covering the following group of employees and providing the following benefits. For the year ended December 31, 2024, the net defined benefit expense for the company’s pension plan is $106,000. This is after allowing for an asset remeasurement gain of $650. The present value of the defined benefit obligation at December 31, 2024, is $788,000 and the fair value of the plan assets is $642,000 based on the fair market value on that date. This results in a plan deficit and net obligation of $146,000. The effective date of the most recently completed actuarial valuation of the defined benefit obligation was ______. (Calculations of the amounts in the above note are shown on the work sheet illustrated on the preceding page.)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.8 a.

Defined benefit expense under IFRS: Current service cost Net interest/finance cost: 6% ($510,000 + $240,000 - $320,000) Past service cost incurred, 20231

$ 107,500 25,800 240,000 $373,300

Under ASPE, the past service cost of $240,000 would be considered a remeasurement that must either be presented separately on the income statement or disclosed in the notes to the financial statements. b.

Defined benefit expense under ASPE: Current service cost Net interest/finance cost: 6% ($510,000 + $240,000 - $320,000) Asset remeasurement loss: (6% X $320,000) + $9,500 loss Actuarial loss on defined benefit obligation Past service cost incurred, 2023

$ 107,500 25,800

28,700 15,500 240,000 $417,500 c. Reconciliation of the difference between defined benefit expense recognized in net income under IFRS and ASPE: Defined benefit expense, IFRS - from (a) Add remeasurement losses recognized in OCI instead of net income: Asset loss: Return using discount rate $320,000 X 6% = $19,200 Actual loss 2023 = 9,500 28,700 Liability loss: actuarial loss, DBO 15,500 Total pension charge in comprehensive income under IFRS Total pension charge in net income under ASPE

$373,300

44,200 $417,500 $417,500

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PROBLEM 19.8 (CONTINUED) d.

Under both IFRS and ASPE, the net defined benefit liability/asset at January 1, 2023 would have been the same as the plan deficit at that date: Defined benefit obligation Fund assets Plan deficiency and balance of the net defined benefit liability, January 1, 2023

Net defined benefit liability, Jan. 1/23 Entries made to net defined benefit liability account, 2023: Defined benefit expense to net income Remeasurement loss to OCI Contributions to plan 2023: For current service cost For past service cost: 25% X $240,000 Net defined benefit liability, Dec.31/23

( 510,000) 320,000 $

190,000

ASPE

IFRS

$190,000 Cr.

417,500 Cr. -0-

373,300 Cr. 44,200 Cr.

107,500 Dr.

60,000 Dr.

$440,000 Cr.

There is no difference in the balance of this account reported on the SFP at December 31, 2023. This is because the funding is the same amount, and the same total amount is credited to the net defined benefit liability/asset account. These are the only entries that affect the balance of the net defined benefit liability account. In addition, the method of accounting for employee future benefits does not affect the DBO (assuming both approaches use an accounting based actuarial valuation) or the plan assets. Therefore, the plan surplus or deficit will also be identical, and this is reflected in the balance of the net defined benefit liability/asset account.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.8 (CONTINUED) e.

Under ASPE, BCL would be able to choose a funding basis measure for its actuarial valuation of the DBO. If this accounting policy choice had been made, it would also result in a cash flow of $167,500 as both the current year’s service cost ($107,500) and 25% of the past service cost ($60,000) as determined in part (d) are funded in the current year, in accordance with the actuary’s advice. As this was the first plan amendment BCL had made, there were no unfunded past service costs outstanding from previous years. However, under a funding basis, the cost of (present value of) benefits granted for current services and for past services might not take projected salaries into account to the same extent as an accounting basis actuarial valuation. This would affect the amount of the current service cost and past service costs for the company, thus resulting in potentially lower cash funding as well. Note to Instructors/Students: In reality, the funding would not likely vary with the accounting policy chosen. Often, pension funding is determined by minimum funding requirements set out in legislation, although the advice of the actuary and the cash position of the company can be important variables in the decision.

LO 5,8 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.9 a.

Continuity Schedule of Defined Benefit Obligation: 2023 Defined benefit obligation at beginning of year Current service cost Interest cost a,b Benefits paid out Net actuarial loss (gain) Defined benefit obligation at end of year

$7,029 = $63,900 X 11% $8,114 = $101,429 X 8%

Continuity Schedule of Plan Assets:

a b

2025

$ 0 $ 63,900 $ 101,429 55,000 85,000 119,000 0 7,029 8,114 0 (30,000) (35,000) 8,900) (24,500)) 84,500) $63,900 $101,429 $278,043

Plan assets at beginning of year Actual return on assetsa,b Benefits paid out Contributions Plan assets at end of year

2024

2023

2024

2025

$0 0 0 50,000) $50,000

$ 50,000 5,000 (30,000) 60,000 $85,000

$ 85,000 25,000 (35,000) 95,000) $170,000

$5,000 = $85,000 –$60,000 + $30,000 – $50,000 $25,000 = $170,000 – $95,000 + $35,000 – $85,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.9 (CONTINUED) c.

Defined benefit expense for 2023: Current service cost Actuarial loss on DBO Defined benefit expense Defined benefit expense for 2024: Current service cost Net interest/finance cost: 11% X ($63,900 - $50,000) Remeasurement asset loss (gain): (11% X $50,000) - $5,000 Actuarial gain on DBO Defined benefit expense Defined benefit expense for 2025: Current service cost Net interest/finance cost: 8% X ($101,429 - $85,000) Remeasurement asset loss (gain): (8% X $85,000) - $25,000 Actuarial loss on DBO Defined benefit expense

$55,000 8,900 $63,900

$85,000 1,529 500 (24,500) $62,529

$119,000 1,314 (18,200) 84,500 $186,614

Separate disclosure is made (usually in the notes) of the total of the components of defined benefit expense that are not recurring in nature. This would include the asset remeasurement gains and losses and actuarial gains and losses on the defined benefit obligation indicated above. Past service costs incurred would also be included in this total when they are recognized.

Kieso, Weygandt, Warfield, Wiecek, McConomy

PROBLEM 19.9 (CONTINUED) d.

Intermediate Accounting, Thirteenth Canadian Edition

Dela Corporation Pension Work Sheet—2023, 2024, and 2025 General Journal Entries Memo Record

ASPE

Items

Balance, Jan. 1, 2023 (a) Service cost (b) Net interest/finance cost (c) Actuarial loss, DBO (d) Contributions (e) Benefits paid Expense entry Funding entry, 12/31/23

Annual Defined Benefit Expense

Cash

Defined Benefit Obligation

0 Cr.

0 55,000 Cr. 0 8,900 Cr. 0,00,000 Cr. 0

50,000 Dr. 0

63,900 Cr. 50,000 Dr.

_______

______,0

13,900 Cr.

63,900 Cr.

50,000 Dr.

55,000 Dr. 0 8,900 Dr. 50,000 Cr. _____ 63,900 Dr. _____0 Dr. 08,0,0088,900 50,000 Cr.

Balances, Dec. 31, 2023 (f) Service cost (g) Net interest/finance cost (h) Asset remeasurement loss (i) Actuarial gain on DBO (j) Contributions (k) Benefits paid Expense entry Funding entry, 12/31/24 Balances, Dec. 31, 2024

Net Defined Benefit Liab/Asset

85,000 Dr. 1,529 Dr. 500 Dr. 24,500 Cr.

85,000 Cr. 7,029 Cr.

0 0

5,500 Dr. 500 Cr.

24,500 Dr. 60,000 Cr.

62,529 Dr. 0024,50,00

Plan Assets

___0 Dr. 60,000 Cr.

62,529 Cr. 60,000 Dr. 16,429 Cr.

30,000 Dr. ,00,0 r101,429 Cr.

(g)$1,529 = 11% X ($63,900 - $50,000); $7,029 = 11% X 63,900; $5,500 = 11% X $50,000 (h)$500 = (11% X $50,000) - $5,000

60,000 Dr. 30,000 Cr. 0 085,000 Dr.

Kieso, Weygandt, Warfield, Wiecek, McConomy

PROBLEM 19.9 (CONTINUED) d. (continued)

Intermediate Accounting, Thirteenth Canadian Edition

Dela Corporation Pension Work Sheet—2023, 2024, and 2025 General Journal Entries Memo Record

ASPE

Items

Annual Defined Benefit Expense

Balances, Dec. 31, 2024

00,00 Dr.

(l) Service cost (m) Net interest/finance cost (n) Asset remeasurement gain (o) Actuarial loss on DBO (p) Contributions (p) Benefits paid Expense entry Funding entry

119,000 Dr. 1,314 Dr. 18,200 Cr. 84,500 Dr

Cash

Net Defined Benefit Liab/Asset

Defined Benefit Obligation

Plan Assets

16,429 Cr.

101,429 Cr.

000 Cr. 85,000 Dr.

119,000 Cr. 8,114 Cr.

6,800 Dr. 18,200 Dr.

84,500 Cr. 95,000 Cr. 35,000 Dr.

186,614 Dr. 0,000 Dr. 95,000 Cr.

95,000 Dr. 35,000 Cr.

186,614 Cr. 95,000 Dr.

_ 000,0 Cr. 000 Cr. Balances, Dec. 31, 2025 108,043 Cr. 278,043 Cr. 170,000 Dr. (m) $1,314 = 8% X ($101,429 - $85,000); $8,114 = 8% X 101,429; $6,800 = $85,000 X 8% (n) $18,200 = (8% X $85,000) - $25,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.9 (CONTINUED) e.

Pension Reconciliation Schedule, December 31, 2025 Defined benefit obligation Plan assets Plan deficit

$(278,043) 170,000 $(108,043)

The net defined benefit liability account balance at December 31, 2025 is also $108,043 Cr.: Opening balance, Jan. 1/23 2023: Expense entry Funding entry 2024: Expense entry Funding entry 2025: Expense entry Funding entry Balance, Dec. 31/25

-063,900 Cr. 50,000 Dr. 62,529 Cr. 60,000 Dr. 186,614 Cr. 95,000 Dr. $ 108,043 Cr.

The net defined benefit liability account is the same as the fund deficiency because all items that affect the DBO and plan assets (and, therefore, the plan surplus or deficit), also affect the balance sheet account by being included in defined benefit expense and the funding. The only exception is the benefits paid which affects neither balance. f.

The only accounting policy choice the company has under ASPE is the choice of using a funding calculation for the actuarial valuation of its DBO or an actuarial valuation prepared for accounting purposes.

LO 3,4,5 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.10 a.

$7,029 = $63,900 X 11% $8,114 = $101,429 X 8%

Continuity Schedule of Plan Assets:

a b

2025

$ 0 $ 63,900 $ 101,429 55,000 85,000 119,000 0 7,029 8,114 0 (30,000) (35,000) 8,900) (24,500)) 84,500) $63,900 $101,429 $278,043

Plan assets at beginning of year Actual return on assetsa,b Benefits paid out Contributions Plan assets at end of year

2024

2023

2024

2025

$0 0 0 50,000) $50,000

$ 50,000 5,000 (30,000) 60,000 $85,000

$ 85,000 25,000 (35,000) 95,000) $170,000

$5,000 = $85,000 –$60,000 + $30,000 – $50,000 $25,000 = $170,000 – $95,000 + $35,000 – $85,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.10 (CONTINUED) c.

Defined benefit expense for 2023: Current service cost

$55,000

Although not part of defined benefit expense reported on the income statement, the actuarial loss on the liability of $8,900 is recognized in OCI as an actuarial loss. Defined benefit expense for 2024: Current service cost Net interest/finance cost: 11% X ($63,900 - $50,000)

$85,000 1,529 $86,529

Although not part of defined benefit expense reported on the income statement, the following net gain is recognized in OCI. Remeasurement asset loss (gain): (11% X $50,000) - $5,000 $ 500 Actuarial gain on DBO (24,500) $(24,000) Defined benefit expense for 2025: Current service cost $119,000 Net interest/finance cost: 8% X ($101,429 - $85,000) 1,314 $120,314 Although not part of defined benefit expense reported on the income statement, the following net loss is recognized in OCI. Remeasurement asset loss (gain): (8% X $85,000) - $25,000 $(18,200) Actuarial loss on DBO 84,500 $66,300 There is no standard disclosure required of the components of defined benefit expense included in net income, however, each item that affects the DBO and the plan assets is required to be separately disclosed. Solutions Manual 19.119 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

PROBLEM 19.10 (CONTINUED) d.

Intermediate Accounting, Thirteenth Canadian Edition

Dela Corporation Pension Work Sheet—2023, 2024, and 2025 General Journal Entries Memo Record

IFRS

Items

Balance, Jan. 1, 2023 (a) Service cost (b) Net interest/finance cost (c) Actuarial loss, DBO (d) Contributions (e) Benefits paid Expense entry Funding entry, 12/31/23

Remeasurement (Gain) Loss (OCI)

Annual Defined Benefit Expense

Cash

Defined Benefit Obligation

0 Cr.

0 55,000 Cr. 0 8,900 Cr. 0,00,000 Cr. 0

50,000 Dr. 0

63,900 Cr. 50,000 Dr.

_______

______,0

13,900 Cr.

63,900 Cr.

50,000 Dr.

55,000 Dr. 0 8,900 Dr. 50,000 Cr. 8,900 Dr.

_____ 55,000 Dr. _____0 Dr. 08,0,0088,9 50,000 Cr. 00

Net Defined Benefit Liab/Asset

85,000 Dr. 1,529 Dr.

85,000 Cr. 7,029 Cr.

500 Dr. 24,500 Cr.

0 0

5,500 Dr. 500 Cr.

24,500 Dr. 60,000 Cr.

24,000 Cr.

Plan Assets

86,529 Dr. ___0 Dr. 0024,50,00 60,000 Cr.

62,529 Cr. 60,000 Dr. 16,429 Cr.

(g)$1,529 = 11% X ($63,900 - $50,000); $7,029 = 11% X 63,900; $5,500 = 11% X $50,000 (h)$500 = (11% X $50,000) - $5,000

30,000 Dr. ,00,0

60,000 Dr. 30,000 Cr.

0,0 0 101,429 Cr. 0085,000 Dr.

Kieso, Weygandt, Warfield, Wiecek, McConomy

PROBLEM 19.10 (CONTINUED) d. (continued)

Intermediate Accounting, Thirteenth Canadian Edition

Dela Corporation Pension Work Sheet—2023, 2024, and 2025 General Journal Entries Memo Record

IFRS

Items

Remeasurement (Gain) Loss (OCI)

Annual Defined Benefit Expense

Balances, Dec. 31, 2024

00,00 Dr.

(l) Service cost (m) Net interest/finance cost (n) Asset remeasurement gain (o) Actuarial loss on DBO (p) Contributions (p) Benefits paid Expense entry Funding entry

119,000 Dr. 1,314 Dr.

Cash

Net Defined Benefit Liab./Asset

Defined Benefit Obligation

Plan Assets

16,429 Cr.

101,429 Cr.

000 Cr. 85,000 Dr.

119,000 Cr. 8,114 Cr.

18,200 Cr. 84,500 Dr.

84,500 Cr. 95,000 Cr. 35,000 Dr.

66,300 Dr.

6,800 Dr. 18,200 Dr.

120,314 Dr. 0,000 Dr. 95,000 Cr.

186,614 Cr. 95,000 Dr.

Balances, Dec. 31, 2025 108,043 Cr. (m) $1,314 = 8% X ($101,429 - $85,000); $8,114 = 8% X 101,429; $6,800 = 8% X $85,000 (n) $18,200 = (8% X $85,000) - $25,000

95,000 Dr. 35,000 Cr.

_ 000,0 Cr. 000 Cr. 278,043 Cr. 170,000 Dr.

Separate disclosure of the components of defined benefit expense are not required by IFRS, however, reconciliations of the opening to closing balances of the net defined liability/asset account, the DBO, and the plan assets are required. In this way, individual amounts affecting both net income and OCI are made apparent.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.10 (CONTINUED) e.

Pension Reconciliation Schedule, December 31, 2022 Defined benefit obligation Plan assets Plan deficit

$(278,043) 170,000 $(108,043 )

The net defined benefit liability account balance at December 31, 2025 is also $108,043 Cr.: Opening balance, Jan. 1/23 2023: Expense entry Remeasurement loss entry to OCI Funding entry 2024: Expense entry Remeasurement gain entry to OCI Funding entry 2025: Expense entry Remeasurement loss entry to OCI Funding entry Balance, Dec. 31/25

-055,000 Cr. 8,900 Cr. 50,000 Dr. 86,529 Cr. 24,000 Dr. 60,000 Dr. 120,314 Cr. 66,300 Cr. 95,000 Dr. $ 108,043 Cr.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.11 a.

Defined Benefit Obligation Balance, January 1, 2023 Plan amendment – past service cost (benefit) Current service cost 2023 Interest cost: 8% X ($1,250,000 - $45,000) Calculated balance Actuarial loss ($1,387,500 – $1,250,000 + $45,000 - $50,000 - $96,400) Balance per actuary, December 31, 2023 Plan Assets Balance, January 1, 2023 Contributions to plan Balance before actual return Actual return ($975,000 - $750,000 - $143,750) Balance, December 31, 2023 Defined Benefit Expense Current service cost Past service cost (benefit) Net interest/finance cost: 8% X ($1,250,000 - $45,000 - $750,000) Remeasurement (gain) loss (OCI) Actuarial loss – DBO Remeasurement (gain) loss on plan assets $81,250 – (8% X $750,000)

$1,250,000 (45,000) 50,000 96,400 1,351,400

36,100 $1,387,500

$ 750,000 143,750 893,750 81,250 $ 975,000

$ 50,000 (45,000) 36,400 $ 41,400 $ 36,100 ( 21,250) $ 14,850

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.11 (CONTINUED) a. (continued) Defined benefit obligation, December 31, 2023 Plan assets, December 31, 2023 Plan deficit, December 31, 2023 Net defined benefit liability, Jan.1, 2023 ($1,250,000 - $750,000) Defined benefit expense entry Net remeasurement loss - OCI entry Funding contribution in year entry Net defined benefit liability, Dec. 31, 2023

$1,387,500 975,000 $ 412,500

$ 500,000 Cr. 41,400 Cr. 14,850 Cr. 143,750 Dr. $ 412,500 Cr.

The plan deficit/surplus position and the balance of the net defined benefit asset/liability on the balance sheet are identical. They are the same because every transaction or event that changes the DBO and plan assets also affects the defined benefit expense, or net remeasurement gain/loss or contribution entry made to the net defined benefit asset/liability account. The only difference will be the amount of benefits paid out to retirees which reduces the DBO and plan assets by equal amounts, and therefore does not change the plan surplus or deficit. The net defined benefit asset/liability account is not affected by the benefit payments either.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.11 (CONTINUED) b. If Etienne’s plan was contributory, the employees would bear part of the cost of the pension plan, reducing the net defined benefit expense by the amount of the employee contribution. In a noncontributory plan, the employer bears the entire cost of the pension plan. The plan status as contributory versus noncontributory would not change any portion of the previous answers. For example, if, say, $2,000 had been received from the employees, the company would record an increase in cash of $2,000 and a reduction in defined benefit expense of $2,000. Therefore, in (a) above, the current service cost would already have been reduced by the $2,000 and the contributions into the plan assets would also include the $2,000 from the employees. Or, follow through if an incremental $2,000 were received after the numbers in (a) had been prepared. The effects would be: Increase in plan assets of $2,000 Decrease in plan deficit of $2,000 Decrease in defined benefit expense on income statement of $2,000 Decrease in net defined benefit liability on balance sheet of $2,000 In a contributory plan, the cash would be provided from the employer’s own account and a portion would come from amounts withheld from employee pay. The statement of cash flows would show a smaller net cash outflow for a contributory plan since the employees would be providing a portion of the cash funding to the plan. LO 2,4,5,7 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.12 a.

The pension work sheet for Beaton and Gunter Inc. for the year ended December 31, 2023 is presented on a following page. It is assumed that the company is following IFRS because it is a subsidiary of a multinational company that is a public company.

The journal entries required to reflect the accounting for Beaton and Gunter Inc.’s pension plan for the year ended December 31, 2023, are as follows: Defined Benefit Expense* .................................. 459,375 Remeasurement Gain (OCI) ...................... 40,625 Net Defined Benefit Liability/Asset ............. 418,750 To record defined benefit expense Net Defined Benefit Liability/Asset ..................... 493,750 Cash .......................................................... 493,750 To record contributions to the pension fund * In effect, when the payroll transaction took place, the employees contributed $81,250 as their share of the pension cost.

Pension Reconciliation Schedule—2023 Defined benefit obligation Plan assets at fair value Defined benefit obligation in excess of plan assets (plan deficit), and Net defined Benefit (liability)/asset

$(12,243,750)a 10,006,250b $(2,237,500)c

$12,243,750 = $11,375,000 + $425,000 + $568,750 - $756,250 + $631,250 $10,006,250 = $9,062,500 + $1,125,000 + $493,750 + $81,250 - $756,250 c $2,237,500 = ($11,375,000 - $9,062,500) + $500,000 - $575,000 b

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.12 (CONTINUED) d. If interest rates in the economy are falling, this will translate to a lower discount rate being used to calculate the DBO. This will increase the DBO and therefore also increase the pension plan’s deficit – the amount by which the pension plan is underfunded. In the future, the interest cost that is added to the DBO (and the net interest/finance cost component of defined benefit expense) will be reduced. If the rate of compensation increase is reduced, this would result in a decrease in the actuarial present value of the pension benefits earned to date based on projected salaries. As a result, the DBO decreases, which decreases the plan deficit. Both would be accounted for in OCI (as a Remeasurement Loss (OCI) or a Remeasurement Gain (OCI)).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.12 (CONTINUED) General Journal Entries

Items

Balance, Jan. 1, 2023 (a) Service cost (b) Net interest/finance cost (c) Asset remeasurement gain (d) Actuarial loss, liability (e) Employee contributions (f) Benefits paid (g) Contributions into plan Expense entry, 12/31/23 Net funding entry Balance, Dec. 31, 2023

Remeasurement (Gain) Loss – (OCI)

Annual Defined Benefit Expense

Cash

Memo Record Net Def. Ben. Liability/ Asset

2,312,500 Cr. 425,000 Dr. 115,625 Dr. 671,875 Cr. 631,250 Dr.

Defined Benefit Obligation

11,375,000 Cr. 425,000 Cr. 568,750 Cr.

Plan Assets A 9,062,500 Dr. 453,125 Dr. 671,875 Dr.

631,250 Cr. 81,250 Cr.

81,250 Dr.

_________

__________ 575,000 Cr. ___________

40,625 Cr.

459,375 Dr. 493,750 Cr.

418,750 Cr. 493,750 Dr. 2,237,500 Cr.

756,250 Dr. ___________

0 Cr. 12,243,750 Cr. 10,006,250 Dr.

00,000 Dr.

b. $115,625 = 5% X ($11,375,000 - $9,062,500); $568,750 = (5% X $11,375,000); $453,125 = 5% X 9,062,500 c. $671,875 = $1,125,000 – (5% X $9,062,500) LO 2,3,4,5 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

756,250 Cr. 575,000 Dr.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Twelfth Canadian Edition

PROBLEM 19.13 a.

Post-retirement benefit expense – 2023 Current service cost Net interest/finance cost ($3,439,800 - $2,780,000) X 7%

$273,000 46,186 $319,186

Continuity of Post-Retirement Benefit Obligation – 2023 Defined post-retirement benefit obligation, 1/1/23 Current service cost Interest cost ($3,439,800 x 7%) Benefits paid out Balance, 12/31/23

$3,439,800 273,000 240,786 (171,600) $3,781,986

Continuity of Fund Assets – 2023 Plan assets, 1/1/23 Actual return on plan assets Contributions Benefits paid out

$2,780,000 158,500 234,000 (171,600)

Balance, 12/31/23

$3,000,900

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.13 (CONTINUED) c.

Reconciliation Schedule 2023 Post-retirement benefit obligation (credit) Fair value of plan assets (debit) Post-retirement benefit obligation in excess of plan assets (plan deficit)* *Proof: Net Defined Post-retirement Liability, Jan.1 1 Expense recognized Asset remeasurement loss (OCI)2 Contributions by company Account balance December 31, 2023 1 2

$(3,781,986) 3,000,900 $ (781,086)

$659,800 cr 319,186 cr 36,100 cr 234,000 dr $781,086 cr

$3,439,800 - $2,780,000 $158,500 – (7% X $2,780,000)

Under ASPE, the post-retirement benefit expense would be the total of the IFRS-calculated expense plus the asset remeasurement loss: $319,186 + $36,100 = $355,286 There would be no change in part (b). The choice of GAAP to apply does not change the calculation of the defined benefit obligation or the plan assets. Because of this, and because the total of the credit entries to the net defined post-retirement liability account remain the same, there is also no difference in this account or the plan deficit. The only difference that might exist is if, under ASPE, the company has chosen a policy of using the funding basis measure of the benefit obligation instead of the accounting-based one. In this case, the DBO would be lower, as would be the interest cost related to the liability.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.13 (CONTINUED) e.

The basic concepts and measurement methodology for postretirement benefits that accumulate are the same as for pension benefits. The recognition and measurement criteria for the obligation and plan assets are the same, as is the actuarial valuation method, the attribution period, and the calculation of the current cost of benefits. In reality, few post-retirement medical and dental plans build up a significant amount of plan assets. This is because, unlike pension plans, the contributions into the plan are not tax deductible; the tax deduction occurs when the medical and dental payments are made on behalf of the retirees. With pension plans, the contributions made to the plan are tax deductible. IFRS, however, does make an exception for some long-term benefits where there is less uncertainty about the measurement of the future benefits. In cases such as those associated with long-term paid absences for long service leave, long-term disability benefits, etc., remeasurement gains and losses are recognized in expense on the income statement rather than in OCI.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 19.13 (CONTINUED) The following work sheet is not required but is provided to illustrate the similarities with accounting for pension benefits. General Journal Entries

Items

Remeasurement (gain) loss (OCI)

Net Postretirement Benefit Expense

Cash

Memo Record Post-retirement Benefit Liability/ Asset

Defined Post-retirement Benefit Obligation

Plan Assets

659,800 Cr. 3,439,800 Cr. 2,780,000 Dr. Balance, Jan. 1, 2023 ** 273,000 Dr.** 273,000 Cr. (a) Service cost ** 46,186 Dr. * 240,786 Cr. 194,600 Dr. (b) Net int/fin. cost 36,100 Dr. 36,100 Cr. (c) Remsmt. loss 234,000 Cr. 234,000 Dr. (e) Contributions 171,600 Dr. 171,600 Cr. (f) Benefits paid 36,100 Dr. 319,186 Dr.** 355,286 Cr. 000 00 Expense entry, 12/31 234,000 Cr. 234,000 Dr. ,000 Dr. 0,000 Dr. Contribution entry 781,086 Cr. 3,781,986 Cr. 3,000,900 Dr. Balance, Dec. 31/23 319,319 (b (b)$46,186 = 7% X ($3,439,800 - $2,780,000); $240,786 = 7% X $3,439,800; $194,600 = 7% X $2,780,000 (c)$36,100 = $158,500 – (7% X $2,780,000)

LO 2,3,4,5,6,8 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*PROBLEM 19.14 a.

Pension benefits earned to December 31, 2024 PV of annuity at Dec. 31, 2056 DBO at Dec. 31, 2024

Amounts using original assumptions

Amounts using revised assumptions

$9,000 1 75,455 3 11,692 5

$8,700 2 69,101 4 7,929 6

2% X $150,000 X 3 years = $9,000 2% X $145,000 X 3 years = $8,700 3 $9,000 X PV factor (6%, 12 years) = $9,000 X 8.38384 (Table A-4) = $75,455 4 $8,700 X PV factor (7%, 12 years) = $69,101 2

Using a financial calculator: PV I N PMT FV Type

$ ? 7% 12 $ (8,700) $ 0 0

Yields $69,101

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*PROBLEM 19.14 (CONTINUED) a. (continued) Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $69,101.37078 rounded to $69,101 5

$75,455 X PV factor (6%, 32 years) = $75,455 X 0.15496 (Table A-2) (rounded)= $11,692 6 $69,101 X PV factor (7%, 32 years) = $7,929 Using a financial calculator: PV I N PMT FV Type

$ ? 7% 32 $0 $ (69,101) 0

Yields $7,929

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*PROBLEM 19.14 (CONTINUED) a. (continued) Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $7,928.726668 rounded to $7,929 The DBO at December 31, 2024, using the revised assumptions would be $7,929. This represents an actuarial gain of $3,763 ($11,692 – $7,929) since the revised DBO is lower than the DBO calculated under the original assumptions.

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*PROBLEM 19.14 (CONTINUED) b.

Pension benefits earned to December 31, 2024 PV of annuity at Dec. 31, 2056 DBO at Dec. 31, 2024 DBO at Dec. 31, 2024 using 7% Change in DBO Percentage change

6% discount rate

8% discount rate

$8,700 72,939 1

$8,700 65,564 2

11,303 3 (7,929 ) $ 3,374

5,586 4 (7,929 ) $(2,343)

43% increase

30% decrease

$8,700 X PV factor (6%, 12 years) = $8,700 X 8.38384 (Table A-4) = $72,939 2 $8,700 X PV factor (8%, 12 years) = $8,700 X 7.53608 (Table A-4) = $65,564 3 $72,939 X PV factor (6%, 32 years) = $72,939 X 0.15496 (Table A-2) = $11,303 4 $65,564 X PV factor (8%, 32 years) = $65,564 X 0.08520 (Table A-2) = $5,586

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*PROBLEM 19.14 (CONTINUED) c.

Assuming the plan was 100% funded previously (DBO = Plan assets), the decrease in DBO would put the plan into a surplus position of $11,692 - $7,929 = $3,763. This also means that the balance sheet pension account would be a net defined benefit asset account of $3,763. This is the same under either ASPE or IFRS. Under ASPE, defined benefit expense for 2024 would be directly affected by the amount of the end-of-year liability actuarial gain. That is, defined benefit expense would be reduced by $3,763. Because of the reduction in the DBO, 2025’s defined benefit expense would also be reduced as the net interest/finance cost for inclusion in the defined benefit expense would now be a benefit. If IFRS was applied, the actuarial gain of $3,763 would be recorded in 2024 as a credit to remeasurement (gain) loss (OCI), and the defined benefit expense taken to net income would not be affected. However, in 2025, defined benefit expense will be reduced because of the same net interest/finance benefit reported in expense (as with ASPE).

Pension benefits earned to December 31, 2026 PV of pension earned at Dec. 31, 2056 DBO at Dec. 31, 2026 DBO, at Dec. 31/26 after prior service recognized DBO, at Dec. 31/26 before service recognized Past service cost incurred

Before credit for prior service

After credit for prior service

$14,500 1

$31,900 2

115,169 3 15,129 5

253,372 4 33,285 6 $33,285 (15,129) $18,156

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*PROBLEM 19.14 (CONTINUED) d. (continued) 1

2% X $145,000 X 5 years = $14,500 2% X $145,000 X 11* years = $31,900 * 11 years = 6 years past service cost before 2026 plus 5 years from 2022 to 2026. 2

Using a financial calculator:

PV I N PMT FV Type

$ ? 7% 12 $ (14,500) $ 0 0

Yields $115,169

Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $115,168.9513 rounded to $115,169

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*PROBLEM 19.14 (CONTINUED) d. (continued) 4

Using a financial calculator

PV I N PMT FV Type

$ ? 7% 12 $ (31,900) $ 0 0

Yields $253,372

Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $253,371.6929 rounded to $253,372

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*PROBLEM 19.14 (CONTINUED) d. (continued) 5

Using a financial calculator:

PV I N PMT FV Type

$ ? 7% 30 $0 $ (115,169) 0

Yields $15,129

Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $15,129.41952 rounded to $15,129

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*PROBLEM 19.14 (CONTINUED) d. (continued) 6

Using a financial calculator:

PV I N PMT FV Type

$ ? 7% 30 $0 $ (253,372) 0

Yields $33,285

Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $33,284.74921 rounded to $33,285 LO 3,9 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 19.15 a.

This benefit relates to a compensated absence. It is a defined benefit plan that is service related (the benefit is earned by the employee over a five-year period and then vests in the employee). Under both ASPE and IFRS, the company should accrue the cost of the benefit and the related liability over the five years in which the employee obtains full eligibility for benefits. Under ASPE, the company can measure the defined benefit obligation using the funding valuation method or an accounting-based measure, depending on the policy it has chosen for its defined benefit plans. All past service costs and actuarial gains and losses are recognized in expense as incurred, as is the actual return on any plan assets. IFRS, in addition to the current service cost, includes past service costs and a net interest or finance cost on its net defined benefit liability/asset in expense. Any actuarial and remeasurement gains and losses are also recognized in expense because the measurement uncertainty associated with this plan is relatively low. (For pension and post-retirement medical and dental plans, the calculations are complex and are more likely to reverse over time, so actuarial and remeasurement gains and losses for these type of plans are reported in OCI and not in expense.)

Under both ASPE and IFRS, the following information is needed or assumptions made: − employee turnover data: i.e., probability that some employees will not satisfy the minimum five-year service requirement. This information would not necessarily be needed by the assistant controller, but would be needed by the actuary. − projected salary in the sabbatical year. This information would not necessarily be needed by the assistant controller, but would be needed by the actuary.

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PROBLEM 19.15 (CONTINUED) b. (continued) − appropriate discount rate to use in discounting benefits to their present value and in determining the net interest/finance cost for the expense. Under ASPE, this discount rate can either be the yield on high-quality corporate bonds, or the settlement rate, both at the date of the most recent actuarial valuation. IFRS requires that the current reporting date yield on highquality corporate bonds be used. − valuation of the defined benefit obligation at the reporting date. − actual return on any plan assets supporting the obligation and the fair value of the plan assets at the reporting date. − the amount of company contributions into the plan assets, and the amount of benefits paid to plan beneficiaries. c.

Yes, the answer to part (a) would change. The accounting method described in (a) is based on the assumption that the employees are receiving compensation in the sixth year based on past services and that in the sixth year they are not providing active service to the company. If the company dictates their activities during the sabbatical year and the activities benefit the company, this would be considered active service. The sabbatical year would then not be a compensated absence, but rather a salary for active service even if the service is in alternative activities such as research and promotion. The company would then not need to accrue the costs of the compensated absence in the preceding years, and it would account for the payments in the sabbatical year in the same way as for regular salary payments. This treatment is the same under both IFRS and ASPE.

LO 6,8 BT: AP Difficulty: M Time: 40 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

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CASE Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the front of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 19.1 DELMAR MANUFACTURING INC. Case Overview: Delmar Manufacturing Inc. (DM) is operating in a stable environment, but the current income has been negatively affected by the cost of expansion and construction of a manufacturing facility in another province. The users of the financial statements in this situation include management and the pension committee of DM who will be reviewing the impact the pension accounting entries and presentation will have on the financial statements. There may be a greater preference for DM to adopt accounting standards that reduce the non-controllable volatility in net income. Since DM is a private company, it has the option to follow ASPE or IFRS. The company currently uses ASPE but has asked that the differences between ASPE and IFRS be included in the consultant’s report. Taking on the role of the consultant, an objective and transparent financial reporting objective needs to be adopted. Consideration of accounting changes in the future and the impact to DM is specifically requested. Analysis and Recommendations: Issue: Treatment of the specific pension components DM’s Net Defined Benefit Liability at the end of 2022 presented on the financial statements is net of the plan assets of $980,000. Therefore, the pension obligation must be $3,145,000*. Solutions Manual 19.144 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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CA 19.1 DELMAR MANUFACTURING INC. (CONTINUED) *(Defined benefit obligation $3,145,000 less plan assets $980,000 yields the Net Defined Benefit Liability of $2,165,000 on DM’s financial statements) IFRS – Changes in plan assets and DBO - Current service cost of $236,000 is recorded in defined benefit expense. - Past service costs*: the entire $96,000 is recognized in the 2023 defined benefit expense. - Net interest/finance cost included in defined benefit expense: the discount rate used to calculate the net interest on the net defined benefit liability for 2023 must be equivalent to the year-end yield on high-quality corporate bonds – in DM’s case, the 8% current yield.

ASPE – Changes in plan assets and DBO - Current service cost of $236,000 is recorded in defined benefit expense. - Past service costs*: $96,000 is recognized in the 2023 defined benefit expense, with separate disclosure in the income statement or notes.

- Net interest/finance cost included in defined benefit expense: there is a choice for the discount rate used to calculate the net interest on the net defined benefit liability for 2023: the same 8% yield on high-quality debt instruments could be used (as at the date of the actuarial valuation), or the settlement rate of 7% could be used. If the lower 7% rate is used to discount the DBO and to calculate the net interest/finance cost component of the expense, this would have the effect of increasing the present value of the DBO and the current and past service cost components, as well as the net defined benefit liability and the plan deficit. - Therefore, the 8% rate was used.

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CA 19.1 DELMAR MANUFACTURING INC. (CONTINUED) * The past service costs of $96,000 are assumed to be a plan amendment. If the PSC are considered a transfer of past service costs from the old plan to the new plan, they would decrease the pension liability of the old plan and increase the pension liability of the new plan for a net nil effect. IFRS – Changes in plan assets and DBO -

The net interest/finance cost for 2023 is calculated on the net defined benefit liability at Jan. 1, 2023 adjusted for changes due to contributions and benefit payments*: 8% X ($2,165,000 - $88,000/2) = $169,680. This amount is recognized as part of defined benefit expense.

ASPE – Changes in plan assets and DBO The net interest cost is calculated in the same manner as under IFRS, and is included in defined benefit expense.

*The benefit payments have no effect on this account as equal amounts reduce the plan assets and the obligation.

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CA 19.1 DELMAR MANUFACTURING INC. (CONTINUED) IFRS – Changes in plan assets and DBO - The asset remeasurement gain or loss must be determined as the difference between the 8% rate used above for the plan assets portion and the actual return earned on the plan assets: [8% X ($980,000 + $44,000) $16,500] = $65,420 loss. This is not included in defined benefit expense, but instead is recognized in OCI.

ASPE – Changes in plan assets and DBO - The asset remeasurement loss of $65,420 is the same under ASPE, but it is included in defined benefit expense in the year, with separate disclosure required either on the face of the income statement or in the notes.

- The actuarial loss – the total of $55,000 resulting from the change in assumptions and the $19,000 resulting from the change in expected and actual actuary costs are recognized directly in OCI. This totals $74,000. - The benefits paid of $34,000 do not affect defined benefit expense, nor do the contributions made into the plan.

Under ASPE – the actuarial losses totaling $74,000 are recognized as part of defined benefit expense. They, like the asset remeasurement loss, require separate disclosure. The benefits paid of $34,000 do not affect defined benefit expense, nor do the contributions made into the plan.

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CA 19.1 DELMAR MANUFACTURING INC. (CONTINUED) Issue: Presentation of the net defined benefit liability on the financial statements IFRS ASPE - The DBO represents the year- - The DBO represents the yearend valuation, and it is end valuation, and it is reduced by the fair value of reduced by the fair value of the plan assets at the same the plan assets at the same date. The net amount, the date. The net amount, the plan deficit in DM’s case, is plan deficit in DM’s case, is equal to the net defined equal to the net defined benefit liability reported on the benefit liability reported on the balance sheet. See the balance sheet. See the calculations below. calculations below. DBO January 1, 2023 ($2,165,000 + $980,000) Interest cost: 8% X $3,145,000 Current service cost Past service cost Benefits paid Actuarial losses ($55,000 + $19,000) December 31, 2023

$3,145,000 251,600 236,000 96,000 (34,000) 74,000 $3,768,600

Plan Assets January 1, 2023 Actual return Benefits paid Contributions into plan December 31, 2023

$ 980,000 16,500 (34,000) 88,000 $1,050,500

Plan deficit, December 31, 2023: ($3,768,600 - $1,050,500)

$2,718,100

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CA 19.1 DELMAR MANUFACTURING INC. (CONTINUED) Defined benefit expense components: Current service cost Past service cost Net interest/finance cost (see above) Defined benefit expense under IFRS

$236,000 96,000 169,680 501,680

Items shown in other comprehensive income (IFRS): Actuarial loss on liability $74,000 Asset remeasurement loss (see above) 65,420 139,420 Defined benefit expense under ASPE $641,100 Under ASPE, defined benefit expense on the income statement is the total of the two subtotals above, or $641,100. Under IFRS, defined benefit expense in net income is $501,680, and the remaining $139,420 is presented in OCI, outside of net income, but part of comprehensive income. There is no recycling of these remeasurement gains and losses (including the actuarial and experience gains and losses).

The net defined benefit liability is affected by these amounts as follows: $2,165,000 + ($501,680 + $139,420 or + $641,100) - $88,000 = $2,718,100. Note that the ending balance of the net defined benefit liability also equals the plan deficit at the end of the year.

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CA 19.1 DELMAR MANUFACTURING INC. (CONTINUED) The results of applying the two methods are very similar, with the major difference being where the volatile remeasurement gains and losses are reported. Under IFRS, net income will be far less volatile than it will be under ASPE, which includes all the changes in the DBO and plan assets. Under both ASPE and IFRS, the company would disclose the various components of the expense (and OCI under IFRS); and on the face of the income statement could present the expense as one number or segregate the benefit costs into their components. Recommendation: DM is private and can choose to follow either ASPE or IFRS. The major difference revolves around the volatility inherent in net income under ASPE, although there is plenty of opportunity to explain the components in the notes. ASPE would also allow the use of the lower settlement rate of 7% to discount the DBO and to calculate the net interest/finance cost component of the expense. This would have the effect of increasing the present value of the DBO and the current and past service cost components, as well as the net defined benefit liability and the plan deficit. Due to the additional cost of providing IFRS statements, including disclosures and reduced accounting policy choice options in areas other than pensions, the ability to explain the effect of the various components of pension cost to users of the financial statements, and the detrimental effects of using the settlement rate as the discount rate, it is recommended that DM continue using its present accounting standards and accounting policies.

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INTEGRATED CASE IC 19.1 MARTEL INDUSTRIES LIMITED Case Overview: Martel Industries is a public company, this is evident since the shares trade on national stock exchange. Therefore IFRS is a constraint. There may be some bias on the part of management to demonstrate strong stability on its statement of financial position given the company’s significant bank loans. The debt-to-equity ratio is a key ratio used by the bank to assess the company’s performance and is likely used in setting the cost of capital. The company is capital intensive given its large expenditures in exploration and development (therefore debt levels are likely to be very high). Additional users of the financial statements include: 1.

Investors that will likely want information about potential reserves and level of risk assigned to its assets

Environmentalists that will use the statements as evidence of whether the company is being environmentally responsible and not making excess profits at the expense of the environment

Since the funding for the new benefit plan is based on net income, any issue that affects net income will be a significant one, especially for the employees who are part of the plan. The controller will want to be transparent yet not expose the company to any additional risks from environmentalists nor increase the cost of capital.

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IC 19.1 MARTEL INDUSTRIES LIMITED (CONTINUED) Analysis and recommendations: Issue: Martel has built a railway system to transport the ore out of mine A. It is estimated that the rail cars have a useful life of 20 years and the tracks a useful life of 50 years. The mine itself is only expected to have a 10-year useful life, after which time it is expected to be abandoned. The company may or may not salvage the rail cars and tracks. Componentize the railway cars / Do not componentize the railway tracks cars / tracks - Martel should treat the - The mine will last 10 years. cars and tracks as Therefore, amortize its separate and amortize value over 10 years. them over a different - Costs to componentize period or using a different these assets is not worth it, method since they have meaning the costs exceed differing lives and usage. the benefits. - The mineral property - The mine is likely to be depreciation should be abandoned at the end of based on reserves and 10 years, so it is likely depletion, whereas the there is little residual value railway system in railway cars and tracks. depreciation should be based on usage. - The company may be able to salvage and sell the railway system at the end, or reuse it. - It is better to separate the equipment from the property as this is more transparent.

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IC 19.1 MARTEL INDUSTRIES LIMITED (CONTINUED) Recommendation: It is more transparent to separate out the significant components and depreciate separately. Martel should carefully assess the residual value of the cars and tracks at the end of the useful life of the mine, as this is likely to have a significant impact on the amount of annual depreciation. Issue: Martel’s geologists and engineers have been asked to estimate the reserves in Mine A. This has resulted in a wide range of values with the upper range estimated at 3 times the value of the lower range. The lower range estimates are based on proven reserves with the upper range values reflecting possible and probable values. Depletion to be: Based on a high estimate of reserves (3X higher so significant difference) - Lower depletion rate. - Difficult to estimate, however engineers and geologists have established the higher level reserves as probable and possible. This may be a better measure than the low-end estimate which is overly conservative.

Based on a low estimate of reserves - Higher depletion making this more conservative. - Significant uncertainty since engineers and geologists are not able to determine a concrete number, resulting in a wide range. - This figure can be adjusted as the mining activities progress.

Recommendation: A reasonable measure based on the expected value of the reserves would be a good neutral measure. This is a normal situation in the mining business. Alternatively, consider selecting a value that is based on the mid-range of the two extremes. Solutions Manual 19.153 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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IC 19.1 MARTEL INDUSTRIES LIMITED (CONTINUED) Issue: Mine B is currently in the exploration stage. Costs consist of geophysical studies, exploratory drilling, and sampling. There is significant uncertainty regarding the quality and quantity of commercial grade ore. The mine is in an unstable part of the world and requires a one time “fee” to the resource minister of the country’s government. All costs have been capitalized. Mine B exploration costs Capitalize exploration costs Expense exploration costs - Interest costs must be - Significant uncertainty capitalized, provided they are as to whether there is directly related to a productive sufficient commercial mine. grade gold ore that - All other costs related to exists. bringing the mine into - The one-time fee (a production are capitalized, bribe?) should likely be provided they are directly expensed if this is the related. normal cost of doing - Costs may include senior business in this type of management salaries. Senior environment. management needed to - May need to disclose. spend more time on this - Senior management project due to political salaries are a fixed instability in country. This was cost. This cost would directly related to getting the be incurred regardless mine ready. of the mine negotiation, - The company believes that the therefore, this is a mine will contribute to future normal ongoing cost of cash flows that it will have doing business. access to, otherwise it would not be spending the money on developing the property.

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IC 19.1 MARTEL INDUSTRIES LIMITED (CONTINUED) Recommendation: Overall, the company believes that the land is worth developing and the costs should be capitalized. Check with legal counsel about legality of paying amounts that might be considered bribes to individuals in developing countries, and the ethics of the transaction taking into account the company’s code of ethical behaviour.

Issue: Mine C has been producing copper for the past 2 years. The country where the mine is located has announced stricter regulations related to returning the land where the mine is located to its original condition. Management determines this cost to be material. Mine C Asset Retirement Obligation (ARO) Accrue ARO costs Do not accrue ARO costs - The costs must be accrued if - Martel will likely abandon likely and measurable. Martel is the mine. Therefore, the in the business of mining and expenditure on ARO not should be able to measure the probable. estimated cost of cleanup. - Not required by law yet; - It appears these costs are therefore, there is no legal measurable since management obligation. knows that the costs will be material. - Environmentalists would find this useful information. Therefore, full recognition would give it prominence and visibility. - Even if the mine was abandoned, Martel still has a responsibility to clean up the land.

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IC 19.1 MARTEL INDUSTRIES LIMITED (CONTINUED)

Recommendation: Determine whether the intended new legislation is retroactive and can be applied to environmental damage prior to the legislation date. This might indicate limits on the legal liability the company has. Also determine whether Martel has a constructive liability regarding the clean-up, based on the company’s past behaviour. If so, recognize the liability and the costs. Issue: Oil rigs require major maintenance every 2 years. This is a significant cost. Gas is stored in underground caves, and approximately 25% of it will never be sold and is used to pressurize the caves. Oil rigs Capitalize maintenance costs Expense maintenance costs - There is a future benefit to the - Cost versus benefit – it is maintenance costs, they are not worth it to capitalize required every 2 years and these costs since the therefore meet the definition of benefit is only extended to 2 an asset. Treat the major years. maintenance as a separate - More like an ongoing cost of asset component (like an doing business. These overhaul) and depreciate it costs are needed to over 2 years as the cost is maintain the equipment and significant. to keep it in good working - The cost of the pressurizing order. Different wells will gas is necessary for the incur these major storage facility, so it should be maintenance costs in capitalized and depreciated alternate years, so the costs over the life of the storage are smoothed out in this caves. way. - Inventory that can’t be sold should be written off.

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IC 19.1 MARTEL INDUSTRIES LIMITED (CONTINUED) Recommendation: It is better to expense the major maintenance costs as the company incurs such costs throughout the year for different wells. It is normal maintenance, with different wells incurring major costs in different years. As for the gas in the caves, capitalize the pressurizing quantities of gas as it is a necessary cost incurred to make the caves operational. Depreciate over the time the gas is used to pressurize the caves. Other issues: The ore piles at Mine A: Treat ore piles as inventory as they are work in process-type assets. Capitalize all necessary costs in getting the ore to the surface and assess for lower of cost and net realizable value due to the large quantities. Engineers and geologists can also test this ore for its quality, and an indication of the likely quality of the remaining ore reserves. Pension and other post-retirement benefits: • Details about the new post-retirement health benefit plan for the employees is needed. At this point, it appears to be a defined contribution plan. The benefit expensed is measured in the same way a bonus based on net income would be. • The actuarial gain from remeasurement of the net defined benefit liability would be shown net of any remeasurement gains or losses on the plan assets in other comprehensive income on a net of tax basis. • The company has two defined benefit plans for each of Mines A and B. The company is required to separately measure the benefit cost, defined benefit obligation, and plan assets for each funded benefit plan. As one plan results in a net defined benefit asset and the other plan results in a net defined benefit liability, the two plans must be shown separately and cannot be offset against each other. Solutions Manual 19.157 Chapter 19 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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RESEARCH AND ANALYSIS RA 19.1 BCE INC. a.

Note 26 breaks down the components of the post-employment benefit and obligations assets. The defined benefit (DB) pension plans at December 31, 2020 and 2019 were in a deficit position: December 31, 2020 (in $ millions) DB pension (in $ millions) plans Defined benefit obligations 27,149 Plan assets Plan status (deficit)

–

OPEB plans

Total

1,600

28,749

27,785

344

28,129

636

(1,256)

(620)

DB pension plans

OPEB plans

25,650

1,529

27,179

25,530

320

(120)

(1,209)

25,850 (1,329)

asset

December 31, 2019 (in $ millions) Defined benefit obligations Plan assets Plan asset(deficit)

status–

Total

The December 31, 2020 defined benefit pension plan is in a surplus position of $636 million. This is a $756 million improvement over the deficit position of $120 million in 2019 that appears to be primarily due to a significant increase in the amount of plan assets ($25,530 million in 2019, increasing to $27,785 in 2020), resulting from the actual return exceeding the expected return. The 2020 deficit in the other post-employment benefit (OPEB) plans increased by $47 million since the end of 2019 due to minor fluctuations in both the obligation and the plan assets.

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RA 19.1 BCE INC. (CONTINUED) b.

The reconciliation of the deficit status of these plans at December 31, 2020, to the amounts reported on the balance sheet is as follows:

(in $millions)

Dec. 31, 2020

Plan deficits Effect of asset limit Post-employment benefit liability (net)

$ (620) (65) $(685)

Reported in other non-current assets

1,277

Reported in non-current liabilities

(1,962)

Deficit status - net

$ (685)

Since the company has separate legal agreements with various fund trustees and various employee groups, the surplus position of one plan cannot be used to make good on a deficit position in another plan. In accounting, assets and liabilities are not netted against each other unless there is an automatic and legal right of offset between them. Therefore, the plans in a surplus position are reported together as an asset and those in a deficit position are added together and reported as a liability. The net of the reported asset and liability (a net liability) should be the same as the net deficit status of the plans. This is because all the entries made to the defined benefit liability/asset account are based on the changes to the plan assets and the DBO. c. The company’s 2020 returns for the pension plan assets were: (in $ millions) Expected return on plan assets Actual return on plan assets* *13.7%

$ 772 3,434

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RA 19.1 BCE INC. (CONTINUED) d.

The expense (service cost) reported by BCE in 2020 for its post-employment benefit plans is $269 million (net of capitalized amounts). The main components of this expense (in $ millions) were as follows: Current service cost – defined benefit pension plans Current service cost - OPEBs Defined contribution pension plan costs Plan amendment Less benefit plan costs capitalized Expense included in operating costs Total service costs recognized for post-employment benefit plans Net financing costs for post-employment benefit plans ($10 + $36) Expense recognized in net income for post-employment benefit plans

$ 219 2 113 334 (65) 269 269 46 $315

The overall expense is significantly more than what would be reported under ASPE. Under IFRS, BCE included $503 million of actuarial gains directly in OCI. (Note: $503 million is taken off the SCI and is net of tax of $184 million. This is reconciled with information from Note 26 which shows the addition to OCI of $687 million ($732 million - $45 million) which net of $184 million tax is $503 million.) Under ASPE, this amount would have to be recognized within the expense calculation in determining net income. As a result, there would have been an overall gain in 2020 if ASPE standards were used. e.

BCE reports that it provides pension and other benefit plans for its employees which include defined contribution pension benefits, defined benefit pensions, supplementary executive retirement benefits for eligible employees, healthcare and life insurance benefits, and worker compensation and medical benefits on behalf of former or inactive employees between the end of their employment and the beginning of their retirement.

The total cost (in $ millions) of these benefits would be: Those recognized in operating costs Those recognized in severance, acquisition and other costs Those capitalized in assets Total service costs recognized Add post-employment finance cost recognized Total costs capitalized or expensed Add costs associated with actuarial losses (gains) Total of all associated costs (gains)

$ 269 0 65 334 46 380 (503) ($123)

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Intermediate Accounting, Thirteenth Canadian Edition

RA 19.2 RESEARCH TOPIC – ENTITY COMPARISONS a.

Relevant rates used to calculate pension information: 2020 Air Canada

2020 Loblaw

2020 Nutrien

(Note 10)

(Note 25)

(Note 21)

Discount rate, for expense 3.20% 3.25% 3.35%* during year Discount rate, for DBO at 2.59% 2.50% 2.83% year end Rate of compensation 2.50% 3.00% 4.57% increase *Nutrien uses the rate that existed at the end of the previous year. b. The discount rates are relatively similar for the year-end DBO, and for the rate at which the benefit cost/expense was calculated for all three companies. However, the rate of compensation increase varies considerably. Air Canada’s rate of 2.50% is the lowest, Loblaw has an intermediate rate of 3.00%, while Nutrien has the highest at 4.57%. These differences will have a significant impact on the projected amount of the defined benefit obligation. Even with the apparently small differences in the rates used to measure the expense for the year, a small difference in the percentage can translate to a larger difference between rates. c.

The changes in the assumptions during the period covered in the notes of the companies’ financial statements are presented below.

Discount rate, for expense Discount rate, for DBO at year end Rate of compensation increase

Air Canada Decrease by 0.73% from 3.93% to 3.20% Decreased by 0.54% from 3.13% to 2.59% No change, remains at 2.50%

Loblaw Decrease by 0.75% from 4.00% to 3.25% Decreased by 0.75% from 3.25% to 2.50% No change, remains at 3.00%

Nutrien n/a Decreased by 0.52% from 3.35% to 2.83% Decreased by 0.09% from 4.66% to 4.57%

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Intermediate Accounting, Thirteenth Canadian Edition

RA 19.2 ENTITY COMPARISONS (CONTINUED) c. (continued) The most significant changes were in the discount rates used for the calculation of the benefit cost and for the defined benefit obligation at year end. All three entities changed the rate to varying degrees for the expense calculation and the year end DBO calculation. The decreases ranged from .52 to .75 percentage points. None of the changes in interest rates affect the plan assets, although the change in rate does affect the remeasurement gain or loss on plan assets as it affects the split between the actual return on plan assets and the return assumed in the discount rate. Only Nutrien changed the rate of compensation year over year by decreasing it since the previous year. d.

Air Canada (see Note 10) provides its employees with defined benefit and defined contribution pension benefits and other post-employment benefits such as those related to health, life, and disability. Assumptions stated include a discount rate of 3.2% for the period’s benefit cost and a 2.59% end-of-year rate for the DBO. Assumed annual health care cost increases are 5.0%, with cost trend rates declining to 4.5% by 2023. Loblaw provides post-retirement health care, life insurance, and dental benefits in addition to both defined benefit and defined contribution pension benefits. Assumptions stated include a 3.0% discount rate for the net defined benefit cost in the year, and a 2.5% rate for discounting the defined benefit obligations. Assumed annual health care cost growth rates are 4.5%, with cost trend rates remaining the same at the end of 2021 and thereafter. Nutrien assumes a 3.2% discount rate for the expense (the end of year rate for 2019) and a 2.66% rate for the obligation at year end. It offers its employees a number of post-retirement benefit plans, including those that provide pension benefits and those that provide health, disability, dental, and life insurance benefits. Nutrien assumes a growth in medical costs starting at 5.8% in 2020, moving to 4.5% by 2037. Another assumption necessary to use in the calculations is the mortality rate – that is, the life expectancy of the group covered by the plans. Nutrien provides the best, very thorough discussion of its assumptions related to this variable.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 19.2 ENTITY COMPARISONS (CONTINUED) e.

Below is the information on the defined benefit pension plan and postretirement benefit plans for the 2020 fiscal year end. Air Canada $ millions Defined benefit plans Plan (deficit) surplus Balance sheet account balance Difference

2,167 2,840 Dr. 1,515 Cr. 842 Dr.

Loblaw $ millions

Nutrien US $ millions

2 165 Dr. 166Cr. 1 Dr.

(360) 109 Dr. 15 Cr. 454 Cr.

= Additional minimum funding liability related to past service costs

Other employee benefits Plan (deficit) surplus Balance sheet account balance Difference

(1,562) 1,562Cr.

(163) 163 Cr.

n/a n/a

nil

n/a

There does not appear to be any mention of ESG goals or requirements in the description of the plan assets in any of the three company’s notes. This is primarily because the funds are managed by a plan administrator. Any performance metrics surrounding ESG would likely be found on the administrators’ financial reporting documents. However, organizations that use a plan administrator could certainly communicate that as an organization they are supportive of ESG goals-based investing. This may also be something that employees want to see more of.

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RA 19.3 RESEARCH TOPIC – RECENT CHANGES IN DEFINED BENEFIT PLANS The following summarizes what Canadian companies have been doing in recent years in response to rising post-employment health care costs and the risks that are associated with defined benefit pension plans. a.

Reduction or elimination of retiree future benefits: • Eliminating the plan is the most drastic response, and the one that is likely to cause the most significant employee discontent. Working with employees to reduce the overall benefits but keep the benefits most important to them could significantly reduce company costs and not alienate employees to the same extent. • Unilaterally reducing or eliminating post-retirement benefits may prompt retirees and/or active employees to bring a legal action against the employer. • Reserving the right to amend or terminate post-retirement benefits is expressly needed. • An employer may consider providing employees with a lump-sum payment in exchange for the elimination or reduction of post-retirement benefits.

Stricter eligibility requirements: • Imposing more stringent eligibility requirements with respect to new hires, such as hiring part-time employees who are not entitled to join the pension plan.

Capping of benefits and/or requiring employees to begin sharing the cost, or increasing the portion of the cost paid for by employees.

Switching to defined contribution plans or shared risk plans: • The risk of having sufficient resources at retirement is transferred to the employees from the employer sponsor. While the employees would be taking on more risk, the employer might make provisions to protect them against catastrophic expenses. New types of hybrid plans have been developed and adopted that have some of the attributes of defined benefit plans and some of the advantages of defined contribution plans. One example is a plan where employees are guaranteed the higher of what the actual results were in a defined contribution plan or a return of 2% on contributions.

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RA 19.3 RECENT CHANGES in BENEFT PLANS (CONTINUED) d. (continued) •

Employees could manage their share of the risk by adjusting future contribution and coverage levels to match their personal situation. • Many companies have implemented defined contribution plans for new employees, while retaining a defined benefit plan for existing employees. Other entities allow the defined benefit plan to continue to exist but allow no future benefits to be added to it; a new defined contribution plan is begun for the current period and moving forward for all employees. In this way, existing employees do not lose the benefits that have accumulated to the date the plans change.

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RA 19.4 CEILING TEST IAS 19, paragraph 64 and Section 3462, paragraph .067 in Part II of the CPA Canada Handbook both require the net defined benefit asset to be measured at the lower of the plan surplus and the asset ceiling. The requirements of both IFRS and ASPE are very similar. The asset ceiling is defined (in IAS 19, paragraph 8) as “the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan.” IFRIC 14 (entitled “IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction”) outlines its rationale and what calculations are needed for this test. ASPE Section 3462 sets out similar information. Since the surplus in the plan assets arguably belongs to the employees and not the company, limitations must be put on the amount of asset that a company can report when the funded status is a surplus. The standards explain in more detail what conditions must exist for a company to be able to show as an asset (related to the surplus of the pension plan) economic benefits available to the entity in the form of refunds or reductions in the future contributions that would otherwise be made to the plan. These future economic benefits can be recognized only under the condition that the entity has an unconditional right to realize these benefits at some point, either during the life of the plan or when the plan is settled. In general, the expected future benefit is comprised of the total of any withdrawable surplus and any reduction in future contributions that would otherwise be made. These are measured as the total of two components: • The present value of the expected future annual accruals for current service (for the existing number of employees), less the present value of required employee contributions and any minimum contributions required regardless of surplus position; and • The amount of plan surplus that can be withdrawn consistent with the existing plan and legal requirements. This calculation is based on the conditions prevailing at the reporting date. IFRIC 14 applies to all post-employment defined benefit plans and other long-term employee defined benefits covered by IFRS, and ASPE Section 3462.067 applies to all defined benefit plans covered by that standard.

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MMXXII ii F1

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Intermediate Accounting, Thirteenth Canadian Edition

CHAPTER 20 LEASES Learning Objectives 1. Understand the importance of leases from a business perspective. 2. Explain the conceptual nature, economic substance, and advantages of lease transactions. 3. Calculate the lease payment that is required for a lessor to earn a specific return. 4. Identify and apply the factors that are used to determine if a contract is or contains a lease under IFRS and whether leases are capital or operating leases under the ASPE classification approach. 5. Account for right-of-use assets by lessees under IFRS and capital leases under ASPE. 6. Determine the effect of, and account for, residual values and purchase options for a lessee’s right-of-use asset (IFRS) or a capital lease (ASPE). 7. Account for operating leases by lessees under ASPE (and short-term leases and low-value leases under IFRS) and compare the operating and capitalization methods of accounting by lessees. 8. Determine the statement of financial position presentation of right-of-use assets (and ASPE capital leases) and identify other disclosures required. 9. Identify and apply the criteria that are used to determine the type of lease for a lessor under the classification approach.

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Learning Objectives 10. Account for and report basic financing and manufacturer/dealer or sales-type leases by a lessor. 11. Account for and report financing and manufacturer/dealer or sales-type leases, with guaranteed residual values or a purchase option, by a lessor. 12. Account for and report operating leases by a lessor. 13. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. 14. Describe and apply the lessee’s accounting for sale-leaseback transactions and the accounting treatment for leases that involve real estate.

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Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

BT Item

Item

Brief Exercises 1. 4 AP 6. 5 AP 11. 6 AP 16. 4,11 AP 21. 14 AP 2. 4,7 AP 7. 3 AP 12. 6 AP 17. 4 AP 22. 14 AP 3. 4 AP 8. 5 AP 13. 6 AP 18. 11 AP 23. 14 AP 4. 4 AP 9. 5 AP 14. 9,10 AP 19. 11 AP 5. 4,7 AP 10. 6 AP 15. 9,10 AP 20. 14 AP Exercises 1. 4,5,8 AP 6. 3,4,6,8 AP 11. 4,7 AP 16. 4,7 AP 21. 14 AP 2. 4,8 AP 7. 4,6 AP 12. 3,11 AP 17. 9,10 AP 3. 4,5,6,11 AP 8. 4,5,8 AP 13. 9,10,11 AP 18. 14 AP 4. 6,9,10,11 AP 9. 4,5,9,10,13 AP 14. 5,6,9,11 AP 19. 14 AP 5. 3,5,8 AP 10. 4,7 AP 15. 3,10,11 AP 20. 14 AP Problems 1. 1,4,6,7 AP 6. 4,5,7,8,12 AP 11. 9 AP 16. 4,6 AP 21. 3,4,5,6,7,8 AP 2. 4,5,6 AP 7. 4,5,6,8 AP 12. 4,5,6,8,11 AP 17. 9,11,13 AP 22. 9,12 AP 3. 4,5,6,8 AP 8. 4,5,6 AP 13. 4,8,9,10,11 AP 18. 3,11,12 AP 23. 14 AP 4. 9,11 AP 9. 4 AP 14. 5,8 AP 19. 4,8 AP 24. 14 AP 5. 3,4,5,6,11,12 AP 10. 5 AP 15. 9,11 AP 20. 3,4,5,6,8,9 AP Cases 1.

8,12

AP 2.

2 8,12

AN 3. Research and Analysis AP 3. 8,12 AO 4.

1,2

AN 5.

2,4,8,13 AN

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

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Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CLASSIFICATION TABLE Topics

Brief Exercises

Exercises

*1. Rationale for leasing. *2. Lessees: classification of leases; accounting by lessees.

Problems 1

1, 2, 3, 4, 5, 6, 8, 9, 10, 11, 12, 13, 17

*3. Disclosure of leases.

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11,

1, 2, 3, 5, 6, 7, 8, 9, 10, 11, 12, 14, 16, 19, 20, 21,

1, 5, 6, 8,11

3, 6, 7, 12, 13, 14, 19, 20, 21

*4. Lessors: classification of leases; accounting by lessors.

14, 15, 16, 18, 19,

3, 4, 9, 12, 13, 14, 15, 16, 17

4, 5, 6, 11, 12, 13, 15, 16, 17, 18, 22

*5. Sale and leaseback.

20, 21

18, 19, 20

23, 24

*6. Real estate leases.

22, 23

*This material is dealt with in an Appendix to the chapter. NOTE: If your students are solving the end-of-chapter material using a financial calculator or an Excel spreadsheet as opposed to the PV tables, please note that there will be a difference in amounts. Excel and financial calculators yield a more precise result as opposed to PV tables. The amounts used for the preparation of journal entries in solutions have been prepared from the results of calculations arrived at using the PV tables, unless specified otherwise in the question.

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ASSIGNMENT CHARACTERISTICS TABLE Item

Description

E20.1

Lessee entries; right-of-use asset with executory costs Lessee entries; right-of-use asset with executory costs–different lease and fiscal years Type of lease, lessee entries with purchase option Lessor entries with purchase option Lessee calculations and entries, right-of-use asset, disclosure Amortization schedule and journal entries for lessee Amortization schedule, journal entries for lessees and comparison Journal entries and statements for lessee Lease payment calculation and lessee-lessor entries–sales-type lease Operating lease versus capital lease Lessee entries, operating lease Calculation of rental, amortization schedule, journal entries for lessor–differing lease and fiscal year Lessor entries, determination of type of lease, lease payment Calculation, spreadsheet application, financial statement amounts Lessor entries, financing lease with option to purchase, lessee right-to-use asset Rental amount calculation, lessor entries, disclosure– financing lease with unguaranteed residual value Accounting and disclosure for an operating lease– lessor Lessor entries–manufacturer/dealer or salestype lease Sale-leaseback–buyer and lessor entries Lessee-lessor, sale-leaseback Land lease, lessee and lessor Real estate lease

E20.2 E20.3 E20.4 E20.5 E20.6 E20.7 E20.8 E20.9 E20.10 E20.11 E20.12 E20.13 E20.14 E20.15 E20.16 E20.17 *E20.18 *E20.19 *E20.20 *E20.21 P20.1

Operating and capital lease alternatives, statement disclosure—lessee and rationale

Level of Time Difficulty (minutes) Moderate

45-50

Moderate

25-35

Moderate

30-40

Moderate Moderate

30-40 30-40

Complex

40-50

Moderate

25-30

Complex Moderate

30-40 30-40

Moderate Moderate Moderate

25-35 20-25 25-35

Moderate

30-40

Moderate

25-35

Complex

40-50

Simple

15-20

Moderate

15-20

Moderate Moderate Moderate Moderate

25-35 20-25 15-20 20-25

Complex

50-60

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ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Item P20.2

Description

Leasing alternative comparison—lessee, comparison including cash flows P20.3 Lessee entries and SFP, income and cash flow presentation; capital lease P20.4 Lessor entries and SFP, income and cash flow presentation; direct financing lease P20.5 Right-of-use asset and lease liability lease to lessee and operating lease to lessor; entries and financial statements P20.6 Right-of-use asset and lease liability lease to lessee; operating lease for lessor entries P20.7 Right-of-use asset and lease liability lease to lessee with purchase option P20.8 Right-of-use asset and lease liability lease to lessee – revision of estimate P20.9 SFP and income statement disclosure—lessee P20.10 P20.9 under IFRS P20.11 SFP and income statement disclosure—lessor P20.12 Right-of-use asset and lease liability lease to lessee P20.13 Lessee-lessor entries; SFP and cash flow presentation; sales-type lease P20.14 Lessee entries and SFP and cash flow presentation; right-of-use asset P20.15 Lessor calculations and entries; sales-type lease with unguaranteed residual value P20.16 Lessee calculations and entries; right-of-use asset with guaranteed and unguaranteed residual value with comparison P20.17 Lessor calculations and entries; sales-type lease with guaranteed and unguaranteed residual value, with disclosure, depreciation calculations for lessee P20.18 Lessee-lessor accounting for residual value P20.19 Contrasting capital and operating lease choice P20.20 Lease accounting and reporting – right-of-use asset to lessee and capital lease to lessor P20.21 Lease vs. purchase including financing options to purchase, IFRS and summaries—lessee P20.22 Lessor of P20.21 *P20.23 Sale and leaseback arrangement *P20.24 Sale and leaseback - theoretical

Level of Time Difficulty (minutes) Moderate

45-50

Moderate

45-50

Moderate

40-45

Complex

50-60

Complex

50-60

Moderate

40-45

Moderate

40-45

Moderate Moderate Moderate Moderate

30-40 30-40 30-40 40-50

Moderate

45-55

Moderate

25-35

Complex

45-50

Complex

40-50

Complex

50-60

Complex Moderate Complex

30-40 40-50 50-60

Complex

50-80

Moderate Complex Complex

35-45 40-45 40-45

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 20.1 (a)

IFRS: For right-of-use assets, the lessee uses the rate implicit in the lease whenever it can be reasonably determined; otherwise the incremental borrowing rate is used. In this case, the rate implicit in the lease is 9%. 1.

Using Table A.5 PV of an annuity due, 6 periods at 9% of 4.88965, the capitalized amount of the leased asset = $30,000 X 4.88965 = $146,689.50.

2. Using a financial calculator: PV I N PMT FV Type

$ ? 9% 6 $ (30,000) $0 1

Yields $146,689.54

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.1 (CONTINUED) (a) (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $146,689.54 rounded (b) ASPE: For capital leases, the lessee uses the lower of the lessee’s incremental borrowing rate and the rate implicit in the lease. In this case, the lower of the lessee’s incremental borrowing rate and the rate implicit in the lease is 8%. 1. Using Table A.5 PV of an annuity due, 6 periods at 8% of 4.99271, the capitalized amount of the leased asset = $30,000 X 4.99271 = $149,781.30.

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.1 (CONTINUED) (b) (continued) 2. Using a financial calculator: PV I N PMT FV Type

$ ? 8% 6 $ (30,000) $0 1

Yields $149,781.30

3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $149,781.30 rounded LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.2 Because the coffee machine leases represent low-value leases, they can be given the same treatment as operating leases under ASPE on the records of Turcotte. Low-value leases are permitted exceptions to the rule of treating all leases as right-of-use assets under IFRS 16. Assuming Turcotte elects to treat these as lowvalue leases: July 1, 2023 payment: July 1, 2023

Low-Value Lease Expense ..... Cash (50 x $40) ................

2,000 2,000

The entry would be the same under ASPE, as the leases do not meet the ASPE capitalization criteria (no reasonable assurance that ownership will transfer, there is no BPO, the lease term is 60% (3/5) of useful life (below the 75%) and the PV of the minimum lease payments is substantially less than 90% of fair value (payments of $240 vs. fair value of $350 prior to discounting to present value). LO 4,7 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.3 (a) Under IFRS, the lease would be set up by Lee as a right-ofuse asset as the lease does not qualify for a short-term or low-value exemption. (b) Under ASPE, the lease does not meet the transfer of ownership test, (there is no reasonable assurance that ownership will transfer, no BPO), or the economic life test [(5 years ÷ 8 years) < 75%] used for ASPE. However, it does pass the recovery of investment test. 1. Using Tables: The PV of the minimum lease payments ($32,000 X 4.31213 = $137,988) (or using the alternative methods 2 and 3 below) is greater than 90% of the fair value of the asset (90% X $140,000 = $126,000). Therefore, Lee should classify the lease as a capital lease. 2. Using a financial calculator: PV I N PMT FV Type

$ ? Yields $137,988.06 8% 5 $ (32,000) $0 1

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.3 (CONTINUED) (b) (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $137,988.06 rounded LO 4 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.4 (a)

IFRS: Under IFRS, the lease would be set up by Blane as a right-of-use asset as the lease does not qualify for a shortterm or low-value exemption.

(b) ASPE: The lease does not meet the transfer of ownership test, (there is no BPO or reasonable assurance that ownership will transfer), or the economic life test [(5 years ÷ 8 years) < 75%], or the recovery of investment test [($215,606.50 ÷ $250,000) < 90%] used for ASPE. Therefore, Blane should classify the lease as an operating lease. LO 4 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 20.5 (a)

Because the term of the warehouse lease is short (10 months), the lease payments will be accounted for by the lessee on a straight-line basis over the lease term, or by another systematic approach (similar to an operating lease under ASPE). Short-term leases of 12 months or less are allowable exceptions to the rule of treating all leases as rightof-use assets under IFRS 16.

(b) May 1, 2023 payment: May 1, 2023

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

14,500 14,500

(c) The entry would be the same under ASPE. LO 4,7 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.6 1. (Using Table A.5 PV of an annuity due and 5 periods at 6% of 4.46511, PV of minimum lease payments = $25,173 X 4.46511= $112,400.21.)

2. Using a financial calculator: PV $ ? Yields $112,400.10 I 6% N 5 PMT $ (25,173) FV $0 Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $112,400.10 rounded Right-of-Use Asset .......................................... Lease Liability .......................................... Cash..........................................................

112,400 87,227 25,173

LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.7 Using Excel or a financial calculator solve the payment amount: 1. Using Table A.5 PV of an annuity due, 5 periods at 6% of 4.46511, payment = $112,400 / 4.46511= $25,172.95. 2.Using a financial calculator PV $ 112,400 RATE 6% NPR 5 PMT ? Yields $25,172.98 FV $0 Type 1 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $25,172.98 rounded LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 20.8 Interest Expense ................................................ Lease Liability ............................................. [($150,000 – $25,561) X 10% X 8/12] To record interest

8,296

Depreciation Expense ........................................ 12,500 Accumulated Depreciation- Rightof-Use Asset ($150,000 X 1/8 X 8/12) ...... To record depreciation expense

8,296

12,500

LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 20.9 Interest Expense1 ............................................... 4,148 Lease Liability ($25,561 - $4,148) ...................... 21,413 Cash............................................................. 1 ($150,000 – $25,561) X 10% X 4/12 = $4,148

25,561

LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 20.10 Under IFRS, the probability-weighted expected value of the residual guarantee must be used in the present value calculation of the lease payments liability. Probability-weighted expected value $16,000 X 50% = $12,000 X 30% = $10,000 X 20% =

$8,000 3,600 2,000 $13,600

LO 6 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.11 (a) 1. Using tables: PV of rentals [PV of guar. RV

$28,000 X 4.88965 $17,000 X .59627

$136,910 10,137 $147,047

2. Using a financial calculator: PV I N PMT FV Type

$ ? 9% 6 $ (28,000) $ (17,000) 1

Yields $147,047

3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $147,047 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.11 (CONTINUED) (a) Continued Equipment under Lease ..................................... 147,047 Obligations under Lease ............................ Cash............................................................. To record inception of lease and first lease payment

119,047 28,000

(b) 1. Using tables: PV of rentals PV of guar. RV

$28,000 X 4.88965 $10,000 X .59627

$136,910 5,963 $142,873

2. Using a financial calculator: PV I N PMT FV Type

$ ? 9% 6 $ (28,000) $ (10,000) 1

Yields $142,873

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.11 (CONTINUED) (b) Continued 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $142,873 rounded Right-of-Use Asset ............................................. 142,873 Lease Liability ............................................. Cash............................................................. To record inception of lease and first lease payment

114,873 28,000

LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.12 Equipment under Lease ..................................... 136,910 Obligations under Lease ............................ Cash ........................................................... To record inception of lease and first lease payment 1. Using tables: PV of rentals

$28,000 X 4.88965

2. Using a financial calculator: PV $ ? I 9% N 6 PMT $( 28,000) FV 0 Type 1

108,910 28,000

$136,910

Yields $136,910

3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $136,910 rounded LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.13 Guaranteed residual value (BE20.11) Capitalization of lease Sept. 1, 2023: Equipment under Lease 147,047 Obligations under Lease

Depreciation Expense3 Accumulated Depreciation— Leased Equipment 3 ($147,047 – $17,000) ÷ 6

Equipment under Lease 119,047 28,000

Cash August 31, 2024: Interest Expense1 Obligations under Lease 1 ($147,047 - $28,000) x 9%

Unguaranteed residual value (BE20.12)

10,714 10,714

21,675 21,675

136,910

Obligations under Lease

108,910 28,000

Cash

Interest Expense2 Obligations under Lease 2 ($136,910 - $28,000) x 9%

9,802

Depreciation Expense4 Accumulated Depreciation— Leased Equipment 4 ($136,910 ÷ 6)

22,818

LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

9,802

22,818

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.14 The lease does not meet the transfer of ownership test, (there is no bargain purchase option or transfer of ownership), but it does meet the economic life test [(6 years ÷ 7 years) > 75%], and the recovery of investment test [($175,000 ÷ $175,000) > 90%] used for ASPE. Collectibility is reasonably assured with no additional costs. Therefore, Lai should classify the lease as a direct financing lease. 1. Using Tables: Lease payments receivable $201,444 [ (6 X $33,574) PV of rentals (5.21236 X $33,574) 175,000 Unearned interest $ 26,444 2. Using a financial calculator: PV $ ? Yields $(175,000) I 6% N 6 PMT $ 33,574 FV $0 Type 1 3.Excel formula =PV(rate,nper,pmt,fv,type)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.14 (CONTINUED) Lease Receivable ............................................... 201,444 Equipment Acquired for Lessee ................ Unearned Interest Income .......................... To record inception of lease

175,000 26,444

Cash .................................................................... 33,574 Lease Receivable ........................................ To record first lease payment

33,574

LO 9,10 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.15 The lease does not meet the transfer of ownership test, (there is no BPO or transfer of ownership), but it does meet the economic life test [(6 years ÷ 7 years) > 75%], and the recovery of investment test [($175,000 ÷ $175,000) >90%] used for ASPE. Collectibility is reasonably assured with no additional costs. Therefore, Lai should classify the lease as a sales-type financing lease (cost differs from FMV). Lease Receivable ............................................... 201,444 Sales Revenue ............................................ Unearned Interest Income ......................... To record inception of lease

175,000 26,444

Cost of Goods Sold ............................................ 137,500 Inventory ..................................................... To record cost of goods sold

137,500

Cash .................................................................... 33,574 Lease Receivable ........................................ Collection of first lease payment

33,574

Unearned Interest Income ................................. Interest Income1 .......................................... 1 [($175,000 – $33,574) X 6%] To record interest income

8,486 8,486

LO 9,10 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.16 (a)

The lease does not meet the BPO or transfer of ownership test, but it does meet the economic life test [(5 years ÷ 5 years) > 75%], and the recovery of investment test [($410,000 ÷ $410,000) > 90%] used for ASPE. Collectibility is reasonably assured with no additional costs. Therefore, Regina should classify the lease as a sales-type lease. 1. Using Tables [($95,930 X 4.03735) + ($40,000 X .56743)] = $410,000 (rounded) ($95,930 X 5) + $40,000 = $519,650 2. Using a financial calculator:

PV $ (410,000) Yields 12 % I ?% N 5 PMT $ 95,930 FV $ 40,000 Type 1 3. Excel formula =RATE(nper,pmt,pv,fv,type)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.16 (CONTINUED) (b) Lease Receivable ............................................... 519,650 Sales Revenue ............................................ Unearned Interest Income .......................... To record inception of lease

410,000 109,650

Cost of Goods Sold ............................................ 265,000 Inventory ..................................................... To record cost of goods sold

265,000

Cash .................................................................... 95,930 Lease Receivable ........................................ Collection of first lease payment

95,930

LO 4,11 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.17 (a)

IFRS: Quong should set up the lease as a right-of-use asset and lease liability as the lease would not qualify for a shortterm or low-value exemption.

(b) ASPE: The lease does not meet the transfer of ownership test, the bargain purchase test, or the economic life test [(4 years ÷ 8 years) < 75%], or the recovery of investment test [($116,025 ÷ $150,000) < 90%] used for ASPE. Therefore, Quong should classify the lease as an operating lease. LO 4 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.18 1. Using Tables: [($28,000 X 4.88965) + ($17,000 X .59627)] = $147,047 ($28,000 X 6) + $17,000 = $185,000

2.Using a financial calculator: PV $ ? Yields $(147,047) I 9% N 6 PMT $ 28,000 FV $ 17,000 Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $(147,047) rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.18 (CONTINUED) Lease Receivable1 .............................................. 185,000 Sales Revenue ............................................ Unearned Interest Income .......................... To record inception of lease 1 ($28,000 x 6) + $17,000

147,047 37,953

Cost of Goods Sold ............................................ 121,000 Inventory ..................................................... To record cost of goods sold

121,000

Cash .................................................................... 28,000 Lease Receivable ........................................ To record first lease payment

28,000

LO 11 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 20.19 Lease Receivable ............................................... 519,650 Cost of Goods Sold ($265,000 – $22,6971) ........ 242,303 Sales Revenue ($410,000 – $22,697) ......... Unearned Interest Income .......................... Inventory ..................................................... 1 ($40,000 X .56743) = $22,697 ($95,930 X 4.03735) = $387,303 ($95,930 X 5) + $40,000 = $519,650 To record inception of lease Cash .................................................................... 95,930 Lease Receivable ........................................ Collection of first lease payment

387,303 109,650 265,000

95,930

LO 11 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

*BRIEF EXERCISE 20.20 (a) Deferred profit on sale-leaseback = $200,000 – ($300,000 – $120,000) = $20,000 ASPE: Under ASPE, the deferred gain on sale is amortized on the same basis as the depreciation of the leased asset. In this case, amortization of the deferred gain on sale to be recorded at the end of 2023 is $8,000 ($20,000 X 2 ÷ 5 years). (b) IFRS: Under IFRS, the gain on rights transferred to Daye Ltd. to be recorded by Clark would be $6,000 ($20,000 X 30%). The remaining 70% would relate to the right to use the equipment retained by Clark. LO 14 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 20.21 Cash .................................................................... 65,000 Accumulated Depreciation - Vehicles ............... 26,000 Vehicles ($53,000 + $26,000) ...................... Deferred Profit on Sale-Leaseback............ To record sale of vehicle Vehicles under Lease......................................... 65,000 Obligations under Lease ............................ ($17,147 X 3.79079 – $1 rounding) To record inception of lease

79,000 12,000

65,000

Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $65,001 I 10% N 5 PMT $ (17,147) FV $ 0 Type 0 Depreciation Expense ........................................ Accumulated DepreciationVehicles under Lease ($65,000 X 1/5) .... To record depreciation expense

13,000

Deferred Profit on Sale-Leaseback ................... Depreciation Expense ($12,000 X 1/5) ....... To record amortization of deferred profit

2,400

13,000

Interest Expense ($65,000 X 10%) ..................... 6,500 Obligations under Lease.................................... 10,647 Cash............................................................. To record lease payment

2,400

17,147

LO 14 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 20.22 The lease meets the transfer of ownership test, (transfer of ownership), and also meets the economic life test [(25 years ÷ 25 years) > 75%], and the recovery of investment test [($370,000 ÷ $370,000) > 90%] used for ASPE. Therefore, should classify the lease as a direct financing lease for lessee and lessor. January 1, 2023: Land under Lease............................................ 120,000 Buildings under Lease .................................... 250,000 Obligations under Lease ......................... 339,123 Cash.......................................................... 30,877 To record inception of lease and first lease payment Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $ 370,000* I 7.5% N 25 PMT $ (30,877) FV $ 0 Type 1 *rounded

December 31, 2023: Interest Expense ................................................ Obligations under Lease ............................ [($370,000 – $30,877) X 7.5%] To record interest Depreciation Expense ........................................ Accumulated Depreciation – Leased Buildings ($250,000 / 25) ............ To record depreciation expense

25,434 25,434

10,000 10,000

LO 14 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 20.23 As land has an indefinite life, the useful life cannot be assessed (lease term ≥ 75% of useful life). Therefore, the land portion will be treated as an operating lease but the building, which has a useful life, will be treated as a capital lease. January 1, 2023 Buildings under Lease .................................... Obligations under Lease ......................... To record inception of lease Obligations under Lease1 ............................... Rent Expense (Land) ...................................... Cash.......................................................... 1 [($30,877 X $250,000 / $370,000) = $20,863] To record first lease payment

250,000 250,000

20,863 10,014

December 31, 2023: Interest Expense2 ............................................... 17,185 Obligations under Lease ............................ 2 [($250,000 – $20,863) X 7.5%] To record interest Depreciation Expense ........................................ 10,000 Accumulated Depreciation – Leased Buildings ($250,000 / 25) ........... To record depreciation expense

30,877

17,185

10,000

LO 14 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 20.1 a.

Assuming this is a manufacturer/dealer lease: Initial Measurement of Right-of-Use Asset and Lease Liability Contractual Rights and Obligations under Lease, Jan. 1, 2023 Annual lease payment: Yearly payment Executory costs Annual lease payment

$73,580.00 2,470.29 $71,109.71

1. Using tables: PV of lease payments $71,109.71 X 6.32825 = $450,000.00 2. Using a financial calculator: PV I N PMT FV Type

$ ? 12% 10 $(71,109.71) $0 1

Yields $450,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.1 (CONTINUED) a. (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $450,000 rounded 1/1/23

Right-of-Use Asset .......................... 450,000.00 Insurance Expense ......................... 2,470.29 Lease Liability ..................... 378,890.29 Cash ..................................... 73,580.00

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.1 (CONTINUED) b. MALEKI CORP. Lease Amortization Schedule (Lessee)

Date

Jan. 1, 2023 Jan. 1, 2024 Jan. 1, 2025 Jan. 1, 2026 Jan. 1, 2027 Jan. 1, 2028 Jan. 1, 2029 Jan. 1, 2030 Jan. 1, 2031 Jan. 1, 2032

Annual Pmt. Excl. Exec. Costs

Interest (12%) on Unpaid Liability

Reduction of Lease Liability

$71,109.71 $71,109.71 71,109.71 $45,466.83 25,642.88 71,109.71 42,389.69 28,720.02 71,109.71 38,943.29 32,166.42 71,109.71 35,083.32 36,026.39 71,109.71 30,760.15 40,349.56 71,109.71 25,918.20 45,191.51 71,109.71 20,495.22 50,614.49 71,109.71 14,421.48 56,688.23 71,109.71 7,618.92 63,490.79 $711,097.10 $261,097.10 $450,000.00

Balance of Lease Liability $450,000.00 378,890.29 353,247.41 324,527.39 292,360.97 256,334.58 215,985.02 170,793.51 120,179.02 63,490.79 0

c. 12/31/23 Depreciation Expense1 ................... 45,000.00 Accumulated Depreciation— Right-of-Use Asset ......... 45,000.00 1 ($450,000 ÷ 10) To record depreciation expense 12/31/23 Interest Expense ........................... Lease Liability ..................... To record interest

45,466.83 45,466.83

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.1 (CONTINUED) c. (continued) 1/1/24

Insurance Expense ....................... Lease Liability ............................... Cash ..................................... To record lease payment

2,470.29 71,109.71 73,580.00

12/31/24 Depreciation Expense ................... 45,000.00 Accumulated Depreciation— Right-of-Use Asset ......... 45,000.00 To record depreciation expense 12/31/24 Interest Expense ........................... Lease Liability ..................... To record interest d.

42,389.69 42,389.69

Note X: The following is a schedule of future lease payments under a contract-based lease liability expiring December 31, 2032 together with the balance of the lease liability. Year ending December 31 2025 2026 2027 2027 2029 2030 and beyond Total lease payments Less amount representing executory costs Less amount representing interest at 12% Balance of the lease liability

$73,580 73,580 73,580 73,580 73,580 220,740 588,640 19,763 568,877 215,630 $353,247

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.1 (CONTINUED) e.

LO 4,5,8 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001, cpa-t007 CM: Reporting and DAIS

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.2 1/1/23

Right-of-Use Asset .......................... 450,000.00 Insurance Expense1 ........................ 1,029.29 2 Prepaid Insurance ......................... 1,441.00 Lease Liability ..................... 378,890.29 Cash ..................................... 73,580.00 1 ($2,470.29 X 5/12) 2 ($2,470.29 X 7/12) To record lease payment

05/31/23 Depreciation Expense3 ................. 18,750.00 Accumulated Depreciation— Right-of-Use Asset .......... 18,750.00 3 ($450,000 ÷ 10 X 5/12) To record depreciation expense 05/31/23 Interest Expense 4 ......................... Lease Liability ..................... 4 ($45,466.83 x 5/12) To record interest

18,944.51

12/31/23 Insurance Expense ....................... Prepaid Insurance ............... To record expired insurance

1,441.00

18,944.51

1,441.00

Note: This entry could also be done at May 31, 2024 as a year-end adjusting entry. 1/1/24

Insurance Expense ....................... Prepaid Insurance ......................... Interest Expense 5 ......................... Lease Liability 6 ............................. Cash ................................. 5 ($45,466.83 – $18,944.51) 6 ($25,642.88 + $18,944.51) To record lease payment

1,029.29 1,441.00 26,522.32 44,587.39 73,580.00

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.2 (CONTINUED) 05/31/24

Depreciation Expense ................ 45,000.00 Accumulated Depreciation— Right-of-Use Asset .......... 45,000.00 To record depreciation expense

05/31/24

Interest Expense ......................... 17,662.37 Lease Liability ..................... 17,662.37 ($42,389.69 X 5/12) To record interest

12/31/24

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

1,441.00 1,441.00

Note: This entry could also be done at May 31, 2025 as a yearend adjusting entry. LO 4,5 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.3 a.

Initial Measurement of Right-of-Use Asset and Lease Liability Contractual Rights and Obligations under Lease, July 1, 2023, using 1. tables $20,066.26 X 4.23972 $85,075.32

Annual rental payment PV of annuity due of 1 for n = 5, i = 9% PV of periodic rental payments

$ 4,500.00 X .64993 $ 2,924.69

Bargain purchase option PV of 1 for n= 5, i = 9% PV of bargain purchase option

$85,075.32 + 2,924.69 $88,000.01

PV of periodic rental payments PV of bargain purchase option Net investment at inception of lease

2. Using a financial calculator: PV I N PMT FV Type

? 9% 5 $ (20,066.26) $ (4,500) 1

Yields $ 88,000.01

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.3 (CONTINUED) (a) (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $88,000.01 rounded b.

The lease would be set up as a right-of-use asset and lease liability under IFRS as it would not qualify for a short-term or low-value exemption.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.3 (CONTINUED) c.

This is a finance lease for the lessor for the following reasons: 1. The lease agreement has a purchase option that is reasonably certain to be exercised and 2. The PV of the minimum lease payments ($88,000) is equal to the fair value of the leased equipment allowing the lessor to recover all of its investment and earn a return on its investment in the leased equipment. The lease is a manufacturer/dealer lease as it gives rise to a profit (fair value of the assets of $88,000 exceed the cost of $60,000 by $28,000).

d. Russell Corporation (Lessee) Lease Amortization Schedule

Date 7/1/23 7/1/23 7/1/24 7/1/25 7/1/26 7/1/27 6/30/28 1

Annual Lease Payment Plus BPO $ 20,066.26 20,066.26 20,066.26 20,066.26 20,066.26 4,500.00 $ 104,831.30

Interest (9%) on Unpaid Liability

Reduction of Lease Liability

*$ 6,114.04* * 4,858.34* * 3,489.62* * 1,997.73* * 371.571 *$16,831.30*

$20,066.26 13,952.22 15,207.92 16,576.64 18,068.53 4,128.43 $88,000.00

Balance Lease Liability $88,000.00 67,933.74 53,981.52 38,773.60 22,196.96 4,128.43 0.00

Rounding error is $.01 cent.

e. 7/1/23

Right-of-Use Asset ......................... 88,000.00 Lease Liability ...................... 67,933.74 Cash ...................................... 20,066.26 To record inception and payment of lease

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.3 (CONTINUED) e. (continued) 12/31/23 Interest Expense1 .......................... Lease Liability ...................... 1 ($6,114.04 X 6/12 = ($3,057.02) To record interest

3,057.02 3,057.02

Depreciation Expense2 ................... 4,400.00 Accumulated Depreciation —Right-of-Use Asset ....... 4,400.00 2 ($88,000.00 ÷ 10 = ($8,800.00; $8,800.00 X 6/12 = $4,400) To record depreciation expense 7/1/24

Interest Expense3 .......................... 3,057.02 Lease Liability4 .............................. 17,009.24 Cash ..................................... 20,066.26 3 ($6,114.04 – $3,057.02) 4 ($20,066.26 – $3,057.02) To record lease payment

12/31/24 Interest Expense5 .......................... 2,429.17 Lease Liability ..................... 5 ($4,858.34 X 6/12 = ($2,429.17) To record interest 12/31/24 Depreciation Expense6 .................. 8,800.00 Accumulated Depreciation —Right-of-Use Asset .. 6 ($88,000.00 ÷ 10 years = ($8,800.00) To record depreciation expense

2,429.17

8,800.00

(Note to instructor: Because a purchase option was reasonably certain to be exercised, the leased asset is depreciated over its economic life rather than over the lease term.) LO 4,5,6,11 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 20-45 Chapter 20 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.4 a.

Note as determined in Exercise 20.3, part (c): This is a finance lease for the lessor for the following reasons: 1. The lease agreement has a purchase option that is reasonably certain to be exercised and 2. The PV of the minimum lease payments ($88,000) is equal to the fair value of the leased equipment allowing the lessor to recover all of its investment and earn a return on its investment in the leased equipment. The lease is a manufacturer/dealer lease as it gives rise to a profit (fair value of the assets of $88,000 exceed the cost of $60,000 by $28,000).

Gross investment = Minimum lease payments + any unguaranteed residual value The minimum lease payments associated with this lease are the periodic annual rents plus the proceeds from the exercise of the purchase option. There is no residual value relevant to the lessor’s accounting in this lease. Calculation:

5 X $20,066.26 = $100,331.30 + 4,500.00 Gross investment at inception $104,831.30 c.

The net investment equals the PV of the components of the gross investment calculation. Net investment calculation using 1. Tables: $20,066.26 Annual rental payment X 4.23972 PV of annuity due of 1 for n = 5, i = 9% $85,075.32 PV of periodic rental payments $ 4,500.00 X .64993 $ 2,924.69

Proceeds on exercise of purchase option PV of 1 for n = 5, i = 9% PV of purchase option

$85,075.32 + 2,924.69 $88,000.01

PV of periodic rental payments PV of purchase option Net investment at inception

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.4 (CONTINUED) c. (continued) 2.Using a financial calculator: PV $ ? Yields ($88,000.01) I 9% N 5 PMT $ 20,066.26 FV $ 4,500 Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $(88,000.01) rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.4 (CONTINUED) d. Herbert Leasing Corporation (Lessor) Lease Amortization Schedule

Date 7/1/23 7/1/23 7/1/24 7/1/25 7/1/26 7/1/27 6/30/27

Annual Lease Payment Plus PO

Interest (9%) on Net Investment

$ 20,066.26 20,066.26 *$ 6,114.04* 20,066.26 * 4,858.34* 20,066.26 * 3,489.62* 20,066.26 * 1,997.73* 4,500.00 * 371.571 $104,831.30 *$16,831.30* 1 Rounding error is $.01 cent. e. 7/1/23

Net Investment Recovery

$20,066.26 13,952.22 15,207.92 16,576.64 18,068.53 4,128.43 $88,000.00

Balance Net Investment $88,000.00 67,933.74 53,981.52 38,773.60 22,196.96 4,128.43 0.00

Cash .............................................. 20,066.26 Lease Receivable .......................... 84,765.04 Cost of Goods Sold ....................... 60,000.00 Sales Revenue ...................... 88,000.00 Unearned Interest Income ... 16,831.30 Inventory ............................... 60,000.00 To record lease and cost of goods sold

12/31/23 Unearned Interest Income ............ 3,057.02 Interest Income2 ................... 2 ($6,114.04 X 6/12 = $3,057.02) To record interest

3,057.02

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.4 (CONTINUED) e. (continued) 7/1/24

Cash ............................................... 20,066.26 Lease Receivable ................. 20,066.26 Collection of lease payment

7/1/24

Unearned Interest Income ............ Interest Income3 ................... 3 ($6,114.04 – $3,057.02) To record interest

3,057.02

12/31/24 Unearned Interest Income ............ Interest Income4 ................... 4 ($4,858.34 X 6/12 = ($2,429.17) To record interest

2,429.17

7/1/25

3,057.02

2,429.17

Cash ............................................... 20,066.26 Lease Receivable ................. 20,066.26 Collection of lease payment Unearned Interest Income ............ Interest Income5 ................... 5 ($4,858.34 – $2,429.17) To record interest

2,429.17

12/31/25 Unearned Interest Income ............ Interest Income6 ................... 6 ($3,489.62 X 6/12 = $1,744.81) To record interest

1,744.81

2,429.17

1,744.81

LO 6,9,10,11 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.5 a.

Initial Measurement of Right-of-Use Asset and Lease Liability Contractual Rights and Obligations under Lease, Jan. 1, 2024 1. Using a financial calculator: PV $ ? Yields $164,995 I 10.5% N 8 PMT $ (28,500) FV $ 0 Type 1 2. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $164,995 rounded b.

The lease would be set up as a right-of-use asset and lease liability under IFRS as it would not qualify for a short-term or low-value exemption.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.5 (CONTINUED) c.

Date

Jan. 1, 2024 Jan. 1, 2025 Jan. 1, 2026 Jan. 1, 2027 Jan. 1, 2028 Jan. 1, 2029 Jan. 1, 2030 Jan. 1, 2031 1

Xu Ltd. Lease Amortization Schedule (Lessee)

Annual Lease Payments

$28,500 28,500 28,500 28,500 28,500 28,500 28,500 28,500 $228,000

Interest (10.5%) on Unpaid Liability

$14,332 12,844 11,200 9,384 7,377 5,159 2,709 1 $63,005

Reduction of Lease Liability

$28,500 14,168 15,656 17,300 19,116 21,123 23,341 25,791 $164,995

Balance of Lease Liability $164,995 136,495 122,327 106,671 89,371 70,255 49,132 25,791 (0)

$ 1 rounding

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.5 (CONTINUED) d. 1/1/24

12/31/24

1/1/25

12/31/25

Right-of-Use Asset ..................... 164,995 Lease Liability ..................... Cash ..................................... To record inception and payment of lease

136,495 28,500

Depreciation Expense2 ............... Accumulated Depreciation— Right-of-Use Asset .......... 2 ($164,995 ÷ 8) To record depreciation expense

20,624 20,624

Interest Expense ......................... Lease Liability ..................... To record interest

14,332

Lease Liability ............................. Cash ..................................... To record lease payment

28,500

Depreciation Expense ................ Accumulated Depreciation— Right-of-Use Asset ......... To record depreciation expense

20,624

Interest Expense ......................... Lease Liability ..................... To record interest

12,844

14,332

28,500

20,624

12,844

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.5 (CONTINUED) e.

Xu Ltd. Statement of Financial Position (partial) December 31, 2025

Property plant and equipment Right-of-use asset Less accumulated depreciation

Current liabilities Lease liability Long-term liabilities Lease liability (Note X)

2024

$164,995 41,248 123,747

$164,995 20,624 144,371

28,500

106,671

122,327

Note X: The following is a schedule of future lease payments under contract-based lease liability expiring December 31, 2031 together with the balance of the lease liability. Year ending December 31 2026 2027 2028 2029 2030 2031 Total lease payments Less amount representing interest at 10.5% Balance of the lease liability

$28,500 28,500 28,500 28,500 28,500 28,500 171,000 48,673 $122,327

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.5 (CONTINUED) g.

When negotiating a lease arrangement, the lessor sets the lease payments receivable to obtain the appropriate return for the asset leased. The amounts arrived at are negotiable. In this case, the lessor likely tried to obtain an amount near to or exceeding the resale price of the equipment and arrived at annual payments in round amounts ($28,500). The PV of the minimum lease payment approximated the resale price without being exactly equal (99.4% in this case). This is a natural outcome from the negotiations process between the parties involved.

LO 3,5,8 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 20.6 a. Although no ownership transfer is included in the lease, this lease is a capital lease to the lessee because the lease term (five years) exceeds 75% of the economic life of the asset (six years). Also, the PV of the minimum lease payments exceeds 90% of the fair value of the asset ($75,654/$80,000 = 95%). 1. Using Tables: $18,143 Annual rental payment X 4.16986 PV of an annuity due of 1 for n = 5, i = 10% $75,654 PV of minimum lease payments 2. Using a financial calculator: PV $ ? Yields $75,654 I 10% N 5 PMT $ (18,143) FV $0 Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.6 (CONTINUED) b.

Date 1/1/23 1/1/23 1/1/24 1/1/25 1/1/26 1/1/27

LeBlanc Limited (Lessee) Lease Amortization Schedule

Annual Lease Payment

$18,143 18,143 18,143 18,143 18,143 $90,715

Interest (10%)1 on Unpaid Obligation

*$ 5,751* * 4,512* * 3,149* * 1,649 *$15,061*

Reduction of Lease Obligation

$18,143 12,392 13,631 14,994 16,494 $75,654

Balance of Lease Obligation $75,654 57,511 45,119 31,488 16,494 0.00

The implicit rate is known and is lower than the lessee’s incremental borrowing rate of 11%

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EXERCISE 20.6 (CONTINUED) c. 1/1/23

Equipment under Lease ................. 75,654 Obligations under Lease .... 57,511 Cash ..................................... 18,143 To record inception of lease and first lease payment During 2023 Insurance Expense ......................... Cash ..................................... To record payment of insurance Property Tax Expense .................... Cash ..................................... To record payment of property taxes

12/31/23 Interest Expense ............................. Obligations under Lease .... To record interest

1/1/24

900 900

1,600 1,600

5,751 5,751

Depreciation Expense2 ................... 15,131 Accumulated Depreciation —Leased Equipment ....... 2 ($75,654 ÷ 5 = $15,131 rounded) To record depreciation expense

15,131

Obligations under Lease ................ 5,751 Interest Expense ................. To record interest accrual reversing entry

5,751

Interest Expense ............................. Obligations under Lease ................ Cash ..................................... To record lease payment

5,751 12,392 18,143

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EXERCISE 20.6 (CONTINUED) c. (continued) During 2024 Insurance Expense ......................... Cash ..................................... To record payment of insurance Property Tax Expense .................... Cash ..................................... To record payment of property taxes

900 900

1,600 1,600

12/31/24 Interest Expense ............................. Obligations under Lease ... To record interest

4,512

Depreciation Expense ................... Accumulated Depreciation —Leased Equipment . To record depreciation expense

15,131

4,512

15,131

The lessor sets the annual rental payment as follows: 1. Using tables: Fair value of leased asset to lessor $80,000.00 Less: PV of unguaranteed residual value $7,000 X .62092 (PV of 1 at 10% for 5 periods) 4,346.44 Amount to be recovered through lease payments $75,653.56 Five periodic lease payments $75,653.56 ÷ 4.169863 $18,142.95 3 PV of annuity due of 1 for 5 periods at 10%

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EXERCISE 20.6 (CONTINUED) d. (continued) 2. Using a financial calculator: PV $ (80,000) I 10% N 5 PMT $ ? Yields $18,142.92 FV $ 7,000 Type 1 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $18,142.92 rounded

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.6 (CONTINUED) e.

Note X: The following is a schedule of future minimum lease payments under the capital lease expiring December 31, 2027 together with the balance of the obligation under capital lease. Year ending December 31 2025 2026 2027 Total minimum lease payments Less amount representing interest at 10% Balance of the obligation

$18,143 18,143 18,143 54,429 9,310 $45,119

LO 3,4,6,8 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20-7 a. 1. Using tables $18,143 X 4.16986 $75,654 4,346 $80,000

Annual rental payment PV of an annuity due of 1 for n = 5, i = 10% PV of minimum lease payments PV of $7,000 x .62092 due in 5 years, i = 10%

2. Using a financial calculator: PV $ ? Yields $80,000 I 10% N 5 PMT $ (18,143) FV $ (7,000) Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $80,000 rounded

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.7 (CONTINUED) b.

Date 1/1/23 1/1/23 1/1/24 1/1/25 1/1/26 1/1/27 1/1/28

c. 1/1/23

LeBlanc Limited (Lessee) Lease Amortization Schedule

Annual Lease Payment

$18,143 18,143 18,143 18,143 18,143 7,000 $97,715

Interest (10%) on Unpaid Obligation

*$ 6,186* * 4,990* * 3,675 2,228 2 636 $17,715*

Reduction of Lease Obligation

Balance of Lease Obligation $80,000 61,857 49,900 36,747 22,279 6,364

$18,143 11,937 13,153 14,468 15,915 6,364 $80,000

.00

Equipment under Lease ................. 80,000 Obligations under Lease .... 61,857 Cash ..................................... 18,143 To record inception of lease and first lease payment

12/31/23 Interest Expense ............................. Obligations under Lease .... To record interest

6,186

Depreciation Expense1 ................... 14,600 Accumulated Depreciation —Leased Equipment ....... 1 ($80,000 - $7,000) ÷ 5 = $14,600 To record depreciation expense

6,186

14,600

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.7 (CONTINUED) d. Guaranteed Residual value Capitalization of lease 1/1/23: Equipment under Lease Obligations under Lease Cash End of year 31/12/23: Interest Expense Obligations under Lease Depreciation Expense Accumulated Depreciation— Leased Equipment

Unguaranteed residual value (E20.6)

75,654

61,857 18,143

Equipment under Lease Obligations under Lease Cash

5,751

6,186

Interest Expense Obligations under Lease

15,131

14,600

Depreciation Expense Accumulated Depreciation— Leased Equipment

80,000

6,186

14,600

LO 4,6 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

57,511 18,143

5,751

15,131

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20-8 a.

When using this approach, the longest possible lease term that is “more likely than not” to occur, is used in the calculations of the discounted contractual lease payments liability. Because the payments under the renewal are 125% of the original lease payment ($135,000 X 125% = $168,750), two calculations need to be made. The first will be for the first term of the lease involving an annuity due of $135,000 for three years at 8%, the implicit rate in the lease, known to Cuomo. The second will be for the renewal option involving a single payment. 1. Using Tables $135,000 X 2.78326 $375,740.10

Annual rental payment PV of annuity due of 1 for n = 3, i = 8% PV of periodic rental payments

$ 168,750 X .79383 $133,958.81

PV of renewal option rental in 3 years PV of 1 for n = 3, i = 8% PV of renewal option rental

$375,740.10 +133,958.81 $509,698.91

PV of periodic rental payments PV of renewal option rental PV of contractual lease payments liability

2.Using a financial calculator: PV $ ? Yields $509,699.93 I 8% N 3 PMT $(135,000) FV $(168,750) Type 1 Solutions Manual 20-64 Chapter 20 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20-8 (CONTINUED) a. (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $509,699.93 rounded $509,700 b.

Cuomo Mining Corporation Lease Amortization Schedule Interest Annual (8%) Reduction Lease on Unpaid of Lease Payments Liability Liability

Balance of Lease Liability

Date Apr. 1 Apr. 1 Apr. 1 Apr. 1

2023 2024 2025 2026

$135,000 135,000 135,000 168,750 $573,750

$29,976 21,574 12,500 $64,050

$135,000 105,024 113,426 156,250

$509,700 374,700 269,676 156,250 0

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EXERCISE 20-8 (CONTINUED) c.

April 1, 2023 Right-of-use Asset............................... 509,700 Lease Liability............................. Cash ............................................ To record inception of lease and first payment December 31, 2023 Interest Expense .................................. Lease Liability............................. ($29,976 X 9 ÷ 12 = $22,482) To record interest

22,482 22,482

Depreciation Expense ......................... 95,569 Accumulated DepreciationRight-of-Use Asset ............... ($509,700 ÷ 4 years X 9 ÷ 12 = $95,569) To record depreciation expense April 1, 2024 Interest Expense ................................ Lease Liability...................................... Cash ............................................ 1 ($29,976 X 3 ÷ 12 = $7,494) To record lease payment 1

December 31, 2024 Interest Expense ................................ Lease Liability............................. 2 ($21,574 X 9 ÷ 12 = $16,181) To record interest 2

374,700 135,000

95,569

7,494 127,506 135,000

16,181

Depreciation Expense3 ........................ 127,425 Accumulated DepreciationRight-of-Use Asset ............... 3 ($509,700 ÷ 4 years = $127,425) To record depreciation expense

16,181

127,425

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EXERCISE 20-8 (CONTINUED) d.

Cuomo Mining Corporation Statement of Financial Position – Partial December 31, 2024

Property, plant, and equipment Right-of-use asset Accumulated depreciation4 Net

$509,700 (222,994) 286,706

Liabilities: Current liabilities: Lease Liability5

129,607

Long-term liabilities: Lease Liability ($285,8576 - $129,607) Total liabilities

156,250 $285,857

e. Income statement Depreciation expense Interest expense7

$127,425 23,675 $151,100

Depreciation expense 2023................. Depreciation expense 2024................. Total .....................................................

[$135,000 - ($21,574 X 3 ÷ 12 = $5,393*)] = $129,607 *rounded

($374,700 + $22,482 - $127,506 + $16,181) = $285,857

Refer to total interest expense in journal entries $7,494 + $16,181 = $23,675

$ 95,569 127,425 $222,994

LO 4,5,8 BT: AP Difficulty: C Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.9 a.

The lease would be set up by Flynn as a right-of-use asset under IFRS as the lease does not qualify for a short-term or low-value exemption. Although no ownership transfer is included in the lease, this lease is a capital lease to the lessor because the lease term (six years) exceeds 75% of the economic life of the asset (seven years). Also, the present value of the minimum lease payments exceeds 90% of the fair value of the asset ($144,000/$144,000 = 100%). This is a sales-type lease to Lavery since the lease is a capital lease to Flynn, the lessee, and because the collectibility of the lease payments is reasonably predictable, there are no important uncertainties surrounding the unreimbursable costs yet to be incurred by the lessor, and the fair value of the equipment ($144,000) exceeds the lessor’s cost ($111,000).

Calculation of annual rental payment: 1. Using time value of money tables. $144,000 – $6,000 X 0.596271 4.88972

$28,718

*1 2

PV of $1 at 9% for 6 periods PV of an annuity due at 9% for 6 periods

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.9 (CONTINUED) b. (continued) 2. Using a financial calculator: PV $ (144,000) I 9% N 6 PMT $ ? Yields $28,718 FV $ 6,000 Type 1 The lessee will use 10% rather than the lessor’s 9% as the implicit lease rate is unknown to the lessee. 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $28,718 rounded

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.9 (CONTINUED) c. 1/1/23

Right-of-Use Asset3 ............................. 137,582 Lease Liability............................. Cash ............................................ To record inception and payment of lease

108,864 28,718

PV of an annuity due at 10% for 6 periods ($28,718 X 4.79079)

Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $137,582 I 10% N 6 PMT $ (28,718) FV $ 0 Type 1 12/31/23 Depreciation Expense4 ....................... 22,930 Accumulated Depreciation – Right-of-Use Asset ....... 4 ($137,582 ÷ 6 years) To record depreciation expense Interest Expense5 ............................... 10,886 Lease Liability .......................... 5 ($108,864) X .10) To record interest

22,930

10,886

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.9 (CONTINUED) d. 1/1/23

Lease Receivable6 .......................... 178,308 Cost of Goods Sold ........................ 107,422 Sales Revenue ...................... 140,422 Inventory ............................... 111,000 7 Unearned Interest Income .. 34,308 To record inception of lease and cost of goods sold 6 ($28,718 X 6) + $6,000 7 $178,308 – $144,000

Since the residual value is not guaranteed, the present value of the residual value of $6,000 is excluded from both sales and cost of goods sold. Sales Revenue Less present value of residual value9

$144,000 3,578 $140,422

Cost of Goods Sold Less present value of residual value9

$111,000 3,578 $107,422

($6,000 X .5962710) 10 PV of $1 at 9% for 6 periods

1/1/23

Cash ............................................... Lease Receivable ................. Collection of lease payment

28,718 28,718

12/31/23 Unearned Interest Income ............ 10,375 11 Interest Income .................. 10,375 11 [($144,000 – $28,718) X .09] To record interest

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.9 (CONTINUED) e.

For Lavery Corp.—(the lessor): Under IFRS, the lease would receive the same treatment as under ASPE except the criteria need not include the two revenue recognition-based tests concerning collectibility and estimating unreimbursable costs. Instead of being referred to as a sales-type lease, the lease would be referred to as a manufacturer or dealer lease.

LO 4,5,9,10,13 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 20.10 Memorandum Prepared by: Date:

(Your Initials)

HOANG INC. December 31, 2023 Reclassification of Leased Auto As a Capital Lease While performing a routine inspection of the client’s garage, I found a 2022 automobile, which was not listed among the company’s assets in the equipment subsidiary ledger. I asked the plant manager about the vehicle, and she indicated that because the automobile was only being leased, it was not listed along with other company assets. Having accounted for this agreement as an operating lease, Hoang Inc. had charged $2,640 ($220 x 12) to 2023 rent expense. Following the examination of the lease agreement entered into with Quick Deal New and Used Cars on January 1, 2023, I determined that the automobile should be capitalized because its lease term (50 months) is greater than 75% of its estimated useful life (60 months). I advised the client to capitalize this lease at the present value of its minimum lease payments: $8,623 (the present value of the monthly payments), plus $1,277 (the present value of the guaranteed residual). The following journal entry was suggested: Vehicles under Lease .................................... Obligations under Lease ....................... To record inception of lease

9,900 9,900

To account for the first year’s payments as well as to reverse the original entries, I advised the client to make the following entry:

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EXERCISE 20.10 (CONTINUED) Obligations under Lease............................... Interest Expense1 .......................................... Rent Expense ......................................... Correction of error

1,535 1,105 2,640

Lease Amortization Schedule

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

Monthly Lease Payment

Interest (1%) Expense

Reduction of Lease Obligation

$220.00 220.00 220.00 220.00 220.00 220.00 220.00 220.00 220.00 220.00 220.00 220.00 $2,640.00

$99.00 97.79 96.57 95.33 94.09 92.83 91.56 90.27 88.97 87.66 86.34 85.00 $1,105.42

$121.00 122.21 123.43 124.67 125.91 127.17 128.44 129.73 131.03 132.34 133.66 135.00 $1,534.58

Balance of Lease Obligation $9,900.00 9,779.00 9,656.79 9,533.36 9,408.69 9,282.78 9,155.61 9,027.16 8,897.43 8,766.40 8,634.06 8,500.40 8,365.40

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EXERCISE 20.10 (CONTINUED) Finally, this automobile must be depreciated over its lease term. Using straight-line, I calculated monthly depreciation of $156 (the capitalized amount, $9,900, minus the estimated residual, $2,100, divided by the 50-month lease term). The client was advised to make the following entry to record 2023 depreciation: Depreciation Expense ........................... 1,872 Accumulated Depreciation-Vehicles........... 1,872 under Lease To record depreciation expense LO 4,7 BT: AP Difficulty: M Time: 35 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

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EXERCISE 20.11 a.

1. Using Tables. Calculation of PV of minimum lease payments: $13,668 X 4.169861 = $56,994 1

PV of an annuity due of 1 for 5 periods at 10%.

2. Using a financial calculator: PV $ ? Yields $56,994 I 10% N 5 PMT $ (13,668) FV $ 0 Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $56,994 rounded

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.11 (CONTINUED) b.

This is an operating lease to Wong since the lease term (5 years) is less than 75% of the economic life (7 years) of the leased asset. The lease term is 71.4% (5 ÷ 7) of the asset’s economic life. There is no bargain purchase option and the present value of minimum lease payments of $56,994 represent 72% of the fair value at September 1 of $79,000, falling short of the criteria of 90% to treat the lease as a capital lease.

c. September 1, 2023 Prepaid Rent ............................................... 13,668 Cash ................................................... December 31, 2023 Rent Expense1 ............................................ Prepaid Rent ..................................... 1 ($13,668 X 4 / 12 = $4,556)

13,668

4,556 4,556

September 1, 2024 Prepaid Rent ............................................... 13,668 Cash ...................................................

13,668

December 31, 2024 Rent Expense ............................................. 13,668 Prepaid Rent ......................................

13,668

Alternately, the September 1, 2024 payment can be recorded to rent expense, in which case no adjusting entry is needed at December 31, 2024. LO 4,7 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.12 a. 1. Using tables Fair value of leased asset to lessor $305,000.00 Less: PV value of unguaranteed residual value $45,626 X .56447 (PV of 1 at 10% for 6 periods) 25,754.51 Amount to be recovered through lease payments $279,245.49 Six periodic lease payments $279,245.49 ÷ 4.790791 1

$58,288

PV of annuity due of 1 for 6 periods at 10%

2. Using a financial calculator: PV $ (305,000) I 10% N 6 PMT $ ? Yields $58,288 FV $ 45,626 Type 1

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.12 (CONTINUED) a. (continued) 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $58,288 rounded

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.12 (CONTINUED) b.

Date 1/1/23 1/1/23 1/1/24 1/1/25 1/1/26 1/1/27 1/1/28 12/31/28

Matta Leasing Limited (Lessor) Lease Amortization Schedule Annual Lease Payment Plus URV

$ 58,288 58,288 58,288 58,288 58,288 58,288 45,626 $395,354 1 rounding of $1

Interest (10%) on Net Investment

Net Investment Recovery

$24,671 21,310 17,612 13,544 9,070 4,1471 $90,354

$ 58,288 33,617 36,978 40,676 44,744 49,218 41,479 $305,000

Balance of Net Investment $305,000 246,712 213,095 176,117 135,441 90,697 41,479 0

This is not a manufacturer’s lease to the lessor as the cost is equal to the FMV at the time of leasing.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.12 (CONTINUED) c. 1/1/23

Cash ............................................... 58,288 2 Lease Receivable ......................... 337,066 Equipment Acquired for Lessee 305,000 Unearned Interest Income .... 90,354 2 (58,288 x 5 + 45,626) To record inception of lease and collection of lease payment

31/10/23 Unearned Interest Income ............ Interest Income3 .................... 3 ($24,671 ÷ 12 X 10) To record interest

20,559

1/1/24

58,288

Cash ............................................... Lease Receivable .................. Collection of lease payment

20,559

58,288

31/10/24 Unearned Interest Income ............ 21,870 4 Interest Income .................... 4 ($24,671 ÷ 12 X 2) + ($21,310 ÷ 12 X 10) To record interest

21,870

d. Matta Leasing Limited Statement of Income (partial) For the Year Ended October 31,

Revenue Interest income

2024

2023

$21,870

$20,559

LO 3,11BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.13 a.

The lessor sets the annual rental payment as follows: 1. Using tables Fair value of leased asset to lessor1 $28,500.00 Less: PV of bargain purchase option $5,000 X .62029 (PV of 1 at 1% for 48 periods) 3,101.45 Amount to be recovered through lease payments $25,398.55 Forty-eight periodic lease payments $25,398.55 ÷ 38.35382 $662.22 1 2

Fair value of $29,500.00 less down payment of $1,000.00 PV of annuity due of 1 for 48 periods at 1%

2. Using a financial calculator: PV I N PMT FV Type

$ (28,500) 1% 48 $ ? $ 5,000 1

Yields $662.22

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.13 (CONTINUED) a. (continued) 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $662.22 rounded b.

The lease agreement has a BPO. The lease, therefore, qualifies as a capital lease from the viewpoint of the lessee. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. Due to the fact that the initial amount of net investment (which in this case equals the PV of the minimum lease payments, ($28,500 + the down payment of $1,000) exceeds the lessor’s cost ($21,200), the lease is a sales-type lease to the lessor.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.13 (CONTINUED) c.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.13 (CONTINUED) c. (continued)

* rounding by $.18

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EXERCISE 20.13 (CONTINUED) d.

A journal entry would be required on December 31, 2023 by Yogendran Corp. to accrue the interest in the amount of $254.76 related to payment no. 8, which is due January 1, 2024. Unearned Interest Income ....................... 254.76 Interest Income ...................................

254.76

The income to be reported on the statement of income of Yogendran Corp. for the fiscal year ended December 31, 2023 concerning this lease will be as follows: Sales revenue $29,500 Cost of goods sold 21,200 Gross profit 8,300 Interest income - lease 1,867 (Interest income represents the sum of the interest for the first 7 payments from the table above and an accrual of interest for the 8th payment)

At December 31, 2023, the SFP would have reported as a current asset the amount of the principal reduction that will be obtained in the next 12 months. Based on the table above the sum of the principal reduction for monthly payments 8 through 19 total $5,168. The remaining amount of the balance of the investment at December 31, 2023 ($25,476 less the current portion of $5,168) of $20,308 will be reported as a long-term lease receivable.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.14 a.

Calculation of annual payments

1. Using tables Cost (fair value) of leased asset to lessor Less: PV of residual value $13,000 X .82645 (PV of 1 at 10% for 2 periods) Amount to be recovered through lease payments Two periodic lease payments $124,256.15 ÷ 1.735541 1 PV of ordinary annuity of 1 for 2 periods at 10%

$135,000.00

(10,743.85) $124,256.15

$71,595.09

2. Using a financial calculator: PV $ (135,000) I 10% N 2 PMT $ ? Yields $71,595.24 FV $ 13,000 Type 0

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.14 (CONTINUED) a. (continued) 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $71,595 rounded Calculation of lease receivable Annual payments ($71,595 X 2) Residual value Lease receivable

$143,190 13,000 $156,190

Calculation of unearned interest income Gross investment by lessee Asset cost (fair value) Unearned interest income

$156,190 135,000 $ 21,190

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EXERCISE 20.14 (CONTINUED) b.

Castle Leasing Corporation should classify the lease as a finance lease because Castle is not a manufacturer or dealer and the lease meets the criteria for a capital lease (similar to the criteria discussed in part I below, but IFRS does not use numerical thresholds). Wai Corporation, the lessee, will treat the leased equipment as right-of-use asset (it does not meet the IFRS exception of being a short-term or low value lease)

For ASPE, a classification approach is used. A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized. Quantitative criteria are used. The lease is capitalized if any one of the following are applicable: 1. the term of the lease is greater than or equal to 75% of the remaining economic life of the asset, 2. the PV of the minimum lease payments is greater than or equal to 90% of the fair value of the asset, or 3. the transfer of title to the asset, perhaps represented by the presence of a bargain purchase option (n/a for this lease). The lease is a capital lease for Wai, the lessee as both criteria 1 (2/2 = 100%) and 2 (100% as shown in part (a) above) have been met. For Castle Leasing, the lessor, the lease would receive the same treatment as under IFRS, as the two ASPE revenue recognition-based tests concerning collectability and estimating unreimbursable costs are passed. Under ASPE, the lease would be considered a direct financing lease.

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EXERCISE 20.14 (CONTINUED) d.

CASTLE LEASING CORPORATION (Lessor) Lease Amortization Schedule

Date

1/1/23 12/31/23 12/31/24 e. 1/1/23

12/31/23

12/31/24

Annual Pmt. Interest Excl. Ins. on Net Costs Investment (10%)

$71,595 71,595

*$13,500 * 7,690 *$21,190

Net Investment Recovery

Net Investment

$58,095 63,905

$135,000 76,905 13,000

Lease Receivable1 ....................... 156,190 Equipment Acquired for Lessee Unearned Interest Income ... 1 ($71,595 x 2 + $13,000) To record inception of lease Cash ($71,595.09 + $5,000) ......... Insurance Expense............... Lease Receivable ................. Collection of lease payment

76,595

Unearned Interest Income .......... Interest Income ..................... To record interest

13,500

Cash ............................................. Insurance Expense............... Lease Receivable ................. Collection of lease payment

76,595

Unearned Interest Income .......... Interest Income ..................... To record interest

7,690

135,000 21,190

5,000 71,595

13,500

5,000 71,595

7,690

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.14 (CONTINUED)

f. 12/31/24

Cash ............................................. Lease Receivable ................ Collection of lease payment

13,000 13,000

Upon signing the lease, Wai Corporation, the lessee, should record a right-of-use asset and lease liability at the present value of the two lease payments of $71,595 each plus the present value of the option to purchase the equipment for $13,000, and therefore the same amount used by the lessor or $135,000. The lessee includes the option payment, as there is reasonable assurance that Wai will exercise the option to purchase.

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EXERCISE 20.15 a.

Part 1. Annuity Due: 1. Using Tables: Fair value of leased asset to lessor Less: PV of unguaranteed residual value $25,000 X .68058 (PV of 1 at 8% for 5 periods) Amount to be recovered through lease payments

$415,000.00

17,014.50 $397,985.50

Five periodic lease payments $397,985.50 ÷ 4.312131 $92,294.41 1

PV of annuity of 1 for 5 periods at 8%.

2. Using a financial calculator: PV $ (415,000) I 8% N 5 PMT $ ? Yields $92,294.46 FV $ 25,000 Type 3. Excel formula =PMT(rate,nper,pv,fv,type)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.15 (CONTINUED) a. Part 2. Ordinary Annuity: 1. Using Tables: Fair value of leased asset to lessor Less: PV of unguaranteed residual value $25,000 X .68058 (PV of 1 at 8% for 5 periods) Amount to be recovered through lease payments

$415,000.00

17,014.50 $397,985.50

Five periodic lease payments $397,985.50 ÷ 3.992712 $99,678.04 2

PV of annuity due of 1 for 5 periods at 8%

2.Using a financial calculator: PV I N PMT FV Type

$ (415,000) 8% 5 $ ? $ 25,000 0

Yields $99,678.02

3. Excel formula =PMT(rate,nper,pv,fv,type)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.15 (CONTINUED) b. 1.

URV = Unguaranteed Residual Value * Rounding .01 2.

* Rounding .11

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EXERCISE 20.15 (CONTINUED) c. 1/1/23

Equipment Acquired for Lessee... Cash ...................................... To record purchase of equipment

415,000 415,000

Cash ............................................... 96,294 4 Lease Receivable ......................... 394,178 Repairs and Maintenance Expense Unearned Interest Income ... Equipment Acquired for Lessee 4 [($92,294.46 x 4) + $25,000] To record lease during 2023

Repairs and Maintenance Expense 7,000 Cash ...................................... 7,000 To record annual repairs and maintenance payment

12/31/23 Unearned Interest Income ......... Interest Income .................. To record interest 1/1/24

during 2024

4,000 71,472 415,000

25,816 25,816

Cash ............................................... 96,294 Repairs and Maintenance Expense Lease Receivable ................. Collection of lease payment

4,000 92,294

Repairs and Maintenance Expense 7,000 Cash ...................................... 7,000 To record annual repairs and maintenance payment

12/31/24 Unearned Interest Income ......... Interest Income .................. To record interest

20,498 20,498

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EXERCISE 20.15 (CONTINUED) d.

Vick Leasing Inc. Statement of Financial Position (Partial) December 31, 2023 2023

Current assets Net investment in leases Non-current assets Net investment in leases Balance

256,228 $348,522

Reconciliation of net investment in leases: Beginning balance after first payment.......... Add accrued interest ...................................... Ending balance ...............................................

2023 $322,706 25,816 $348,522

$92,294

Note X: (on Vick Leasing Inc.’s 2024 financial statements) The company's net investment in a financing lease includes the following: Total lease receivable $301,882 Unearned interest income 45,654 $256,228 Future lease payments receivable under the financing lease are as follows: Year ending December 31 2025 $92,294 2026 92,294 2027 92,294 Total lease payments receivable 276,882 Unguaranteed residual value 25,000 $301,882 Vick Leasing would also need to disclose any contingent rental income in the year, the allowance for expected credit losses, and general information about their leasing arrangement with Rock River Inc.

LO 3,10,11 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 20-96 Chapter 20 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 20.16 a.

Because the term of the auger lease is short (6 months), the lease payments will be accounted for by Wong on a straightline basis over the lease term, or by another systematic approach (similar to an operating lease under ASPE). Shortterm leases of 12 months or less are allowable exceptions to the rule of treating all leases as right-of-use assets under IFRS. Pomerleau will account for the lease payments received as rent revenue. Because the jackhammer lease represents a low-value lease, it is treated similar to an operating lease under ASPE on the records of Wong. Low-value leases are also permitted exceptions to the rule of treating all leases as right-of-use assets under IFRS. Pomerleau will account for the lease payments received as rent revenue.

Wong Inc.:

July 1, 2023 payments: Prepaid Rent1........................... 16,800 Cash ................................. 16,800 1 (($2,500 x 6) + ($100 x 18)) = ($15,000 + $1,800) Dec. 31, 2023

Low-Value Lease Expense2 .... Short-Term Lease Expense3 ... Prepaid Rent ................... 2 ($100 x 6) 3 ($2,500 x 6)

Pomerleau Corp: July 1, 2023 collection: Cash ......................................... Unearned Rent Revenue . Dec. 31, 2023

Unearned Rent Revenue ......... Rent Revenue ..................

600 15,000 15,600

16,800 16,800 15,600 15,600

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EXERCISE 20.16 (CONTINUED) c.

SFP Wong Inc.: Current assets: Prepaid rent Short-term lease expense Low-value lease expense Pomerleau Corp.: Current liabilities: Unearned rent revenue Rent revenue

Statement of Income

$1,200 $15,000 600

$1,200

d. July 1, 2023 payment: Prepaid Rent ............................ Cash ................................. Dec. 31, 2023

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

$15,600

16,800 16,800 15,600 15,600

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.17 a.

(1) Calculation of gross investment: $24,736 X 6 = $148,416 (2) Calculation of unearned interest income: Gross investment Less: Fair value of machine1 Unearned interest income

$148,416 123,500* $ 24,916

1. Using Tables: 1 $24,736 X 4.99271 (PV factor of annuity due at 8% for 6 periods) 2. Using a financial calculator: PV I N PMT FV Type

$ ? 8% 6 $ 24,736 $ 0 1

Yields $123,499.68

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 20.17 (CONTINUED) a. 2 (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $123,499.68 rounded (3)

Net investment in lease: Lease receivable Less: Unearned interest income

$148,416 24,916 $123,500

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EXERCISE 20.17 (CONTINUED)

b. 1/1/23

Cash ..................................................... 24,736 Lease Receivable ................................ 123,680 Cost of Goods Sold ............................. 99,000 Sales Revenue ............................ 123,500 Inventory ..................................... 99,000 Unearned Interest Income ......... 24,916 To record inception of lease and cost of goods sold

12/31/23 Unearned Interest Income .................. Interest Income2 ........................ 2 [($123,500 – $24,736) X .08] To record interest

7,901 7,901

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*EXERCISE 20.18 a. Hein Corporation (Lessee)1 1/1/23 Cash .......................................... Accumulated Depreciation– Equipment ............................ Equipment ........................... Deferred Profit on SaleLeaseback ....................... To record sale of equipment Equipment under Lease ........... Obligations under Lease .... ($117,176.68 X 6.144572) To record lease back of equipment 2

720,000 340,000 980,000 80,000 720,000 720,000

PV of annuity of 1 for 10 periods at 10%

Excel formula =PV(rate,nper,pmt,fv,type) PV $ ? Yields $720,000 I 10% N 10 PMT $ (117,176.68) FV $ 0 Type 0 1 Lease should be treated as a capital lease because present value of minimum lease payments equals the fair value of the equipment. The lease term is greater than 75% of the economic life of the asset, and title transfers at the end of the lease. Throughout 2023 Repairs and Maintenance Expenses 11,000 Cash..................................... Payment of repairs and maintenance

11,000

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*EXERCISE 20.18 (CONTINUED) a. (continued) 12/31/23 Deferred Profit on Sale-Leaseback 8,000 3 Depreciation Expense ....... ($80,000 ÷ 10) To record amortization of deferred profit 3

8,000

The credit could also be to a gain account.

12/31/23 Depreciation Expense .............. Accumulated Depreciation - Leased Equipment ...... ($720,000 ÷ 10) To record depreciation expense

72,000

Interest Expense....................... Obligations under Lease4 ........ Cash..................................... To record lease payment

72,000.00 45,176.68

72,000

117,176.68

Note to instructor: 1. The present value of an ordinary annuity at 10% for 10 periods should be used to capitalize the asset. In this case, Hein would use the implicit rate of the lessor because it is lower than its own incremental borrowing rate and known to Hein. 2. The deferred profit on the sale-leaseback should be amortized on the same basis that the asset is being depreciated. Partial Lease Amortization Schedule

Date 1/1/23 12/31/23

Annual Lease Payment

$117,176.68

Interest (10%)

$72,000.00

Amortization 4

$45,176.68

Balance $720,000.00 674,823.32

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*EXERCISE 20.18 (CONTINUED) a. (continued)

1/1/23

Liquidity Finance Corp. (Lessor)5 Equipment Acquired for Lessee 720,000 Cash ................................... To record purchase of equipment

720,000

Lease Receivable .......................1,171,766.80 ($117,176.68 X 10) Unearned Interest Income……. 451,766.80 Equipment Acquired for Lessee 720,000.00 To record leaseback of equipment 12/31/23 Cash ............................................ 117,176.68 Lease Receivable .............. 117,176.68 Collection of lease payment Unearned Interest Income ......... Interest Income .................. To record interest

72,000 72,000

Lease should be treated as a direct financing lease by the lessor because the present value of the minimum lease payments equals the fair value of the equipment, and (1) collectibility of the payments is reasonably assured, (2) no important uncertainties surround the costs yet to be incurred by the lessor, and (3) the cost to the lessor equals the fair value of the asset at the inception of the lease.

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*EXERCISE 20.18 (CONTINUED) b.

The primary reason for Hein to enter into a sale and leaseback arrangement for its equipment is to borrow cash. This transaction is similar to the purchase of new equipment using capital leases, except that in this case, Hein is using an asset it owns and is familiar with. Hein wishes to obtain some leverage by borrowing funds for an amount that exceeds the carrying value of the asset at the time of the sale. Since the carrying value of the equipment on the books of Hein at the time of the sale represents the depreciated cost of the asset in use, this value is not intended to correspond to its fair value. Hein can continue with its intention to use the asset to the completion of its planned useful life. The sale and leaseback arrangement will not disturb this plan. Hein is taking advantage of the increase in value to obtain additional financing at preferential rates. Creditors will not view this action as a desperate measure since the gain on the sale is being deferred and amortized.

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*EXERCISE 20.19 a.

Sale-leaseback arrangements are treated as though two transactions were a single financing transaction if the lease qualifies as a capital lease. Any gain or loss on the sale is considered unearned and is deferred and amortized over the lease term (if possession reverts to the lessor) or the economic life (if ownership transfers to the lessee). In this case, the lease qualifies as a capital lease because the lease term (10 years) is 83% of the remaining economic life of the leased property (12 years). Therefore, at 12/31/23, all of the gain of $120,000 ($520,000 – $400,000) would be deferred and amortized over 10 years. Since the sale took place on 12/31/23, there is no depreciation for 2023.

A sale-leaseback is usually treated as a single financing transaction in which any profit on the sale is considered unearned and is deferred and amortized by the seller. However, the lease does not meet any of the criteria of a capital lease for the property sold: 1/14 < 75% of useful life, no ownership transfer, and $35,000 < 90% of FMV. In this case, the sale and the leaseback are accounted for as separate transactions. Therefore, the full gain of $60,000 ($480,000 – $420,000) is recognized.

In this case, Barnes Corp. would report a loss of $87,300 ($300,000 – $212,700) for the difference between the book value and lower fair value. The CPA Canada Handbook requires that when the fair value of the asset is less than the book value (carrying amount), a loss must be recognized immediately. In addition, rent expense of $72,000 ($6,000 per month X 12 months) should be reported as the lease does not qualify as a capital lease: 2/5 < 75% of useful life, no ownership transfer, and PV $115,753 < 90% of $212,700 ($191,430).

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*EXERCISE 20.19 (CONTINUED) d.

In this case, Dedresan would report a gain* relating to the spaces of the warehouse that are an in-substance sale to the buyer-lessor. There would be no interest or depreciation recorded in 2023 on the related financial liability and right-ofuse asset, since the date of the sale and leaseback is December 30, 2023. (*Note: the exact gain relating to the rights transferred is not calculated here because we do not have sufficient information. We would need to calculate the discounted present value of the lease payments for the 5-year lease period in order to determine the Right-of-Use Asset retained and the Gain on Rights Transferred).

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*EXERCISE 20.20 a. September 15, 2023 Prepaid Rent ....................................................... Cash............................................................. December 31, 2023 Rent Expense1 .................................................... Prepaid Rent ............................................... 1 ($30,000 X 3.5 / 12) = $8,750

30,000 30,000

8,750 8,750

b. The rental of land can only be accounted for as a capital lease by the lessee if the rental of the property contains a bargain purchase option or if the lease transfers ownership of the property to the lessee as land has an indefinite useful life. Since this is not the case here, the lease of the land has to be treated as an operating lease. In the case of equipment, the possibility of accounting for the lease as a capital lease is more likely to depend on the terms of the lease in relation to the capitalization criteria. c. September 15, 2023 Cash .................................................................... 30,000 Unearned Rent Revenue ............................ December 31, 2023 Unearned Rent Revenue .................................... Rent Revenue2 ............................................ 2 ($30,000 X 3.5 / 12) = $8,750

30,000

8,750 8,750

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*EXERCISE 20.21 a. 1. Using a financial calculator: PV $ ? Yields $ 390,224 I 7% N 15 PMT $ (30,000) FV $ (270,000) Type 1 2. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $390,224 rounded At the end of the lease term: Land: initial fair value x 1/3 x 2 ($450,000 / 3 x 2) Building: $450,000 X 2/3 x 40% ......................... Total at the end of 15 years ...............................

$300,000 120,000 $420,000

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*EXERCISE 20.21 (CONTINUED) b. March 30, 2023 Land under Lease 1 .............................................. 130,075 Buildings under Lease ......................................... 260,149 Cash............................................................... 30,000 2 Obligations under Lease ............................. 360,224 1 2 (1/3 X $390,224 = $130,075) To record inception of lease c. December 31, 2023: Interest Expense3 ............................................... Obligations under Lease ............................ 3 ($360,224 X 7% X 9/12 = $18,912) To record interest Depreciation Expense4....................................... Accumulated Depreciation— Leased Buildings………… ...................... 4 (($260,149 - $40,000) / 25 years X 9/12 = $6,604) To record depreciation expense March 31, 2024 Interest Expense 5 .............................................. Obligations under Lease..................................... Cash............................................................. 5 ($360,224 X 7% X 3/12) To record lease payment

18,912 18,912

6,604 6,604

6,304 23,696 30,000

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*EXERCISE 20.21 (CONTINUED) c. (continued) December 31, 2024: Interest Expense6 ............................................... 18,661 Obligations under Lease ............................ 18,661 6 [($360,224 - $23,696 + $18,912) X 7% X 9/12 = $18,661] To record interest Depreciation Expense7....................................... Accumulated Depreciation— Leased Buildings ................................... 7 (($260,149 - $40,000) / 25 years = $8,806) To record depreciation expense

8,806 8,806

LO 14 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

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TIME AND PURPOSE OF PROBLEMS Problem 20.1 Purpose—to provide an opportunity for the student to contrast two alternative means by which a business can acquire software for its business by using leasing. Along with preparing all the necessary calculations and journal entries, the student must also contrast the financial statement effect of the two different leasing alternatives. Finally, the qualitative considerations and the short- and long-term implications of each option must be outlined by the student.

Problem 20.2 Purpose—to provide an opportunity for the student to contrast two alternative means by which a business can acquire equipment and software for its business by using leasing. Along with preparing all the necessary calculations, the student must also contrast the financial statement effect of the two different leasing alternatives for the first year and for the overall term of the lease plus a renewal period under one option. Finally, the qualitative considerations and the short- and long-term implications of each option must be outlined by the student, emphasizing the effects on cash flow.

Problem 20.3 Purpose—to provide the student with a lease situation involving monthly payments made for a truck. The lease involves a right-of-use asset and lease liability for the lessee and a finance lease for the lessor. The lease has a residual value guaranteed by the lessee. Along with preparing all the necessary calculations and journal entries, the student must also prepare the SFP, the income and cash flow statements on a comparative basis, and any required note disclosures. They must also prepare the journal entry at the completion of the term of the lease involving the disposal of the truck and the lessee’s involvement concerning the guaranteed residual value.

Problem 20.4 Purpose—to provide the student with the lease situation described in Problem 20.3 but from the perspective of the lessor. The requirement for comparative financial statement disclosure is included in the problem.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 20.5 Purpose—to provide an opportunity for the student to contrast the entries and corresponding financial statements of the lessor and lessee when the conditions call for the accounting of the lease as a right-of-use asset and lease liability for the lessee but as an operating lease to the lessor. The odd result is that the asset is reported on both statements of financial position.

Problem 20.6 Purpose—to develop an understanding of the accounting treatment for a right-ofuse asset and lease liability for the lessee and operating lease for the lessor. The student is required to identify the type of lease involved, explain the respective reasons for their classification, and discuss the accounting treatment that should be applied for both the lessee and lessor. The student is also asked to record executory costs paid by the lessor and prepare the journal entries to reflect the first year of this lease contract for both the lessee and lessor and to discuss the disclosures required of the lessee and lessor. Included in this problem is a requirement to compare the factors and criteria for classification differences between IFRS and ASPE.

Problem 20.7 Purpose—to provide the student with a lease situation containing a purchase option and both an implicit and stated interest rate between which the student must choose. The lease involves a right-of-use asset for the lessee. The student must calculate the appropriate amount at which to capitalize the lease and, in a last requirement, given different interest rates, prepare the SFP and income statement presentation of this lease by the lessee.

Problem 20.8 Purpose— The lease involves a right-of-use asset for the lessee. Included in the instructions is a revision of estimate concerning the guaranteed residual value of the leased asset. Journal entries, adjusting entries, and a revised amortization schedule must also be prepared by the student.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 20.9 Purpose—to provide an understanding of how lease information is reported on the SFP and income statement for two different years in regard to the lessee. In addition, the year-end month is changed in order to help provide an understanding of the complications involved with partial periods. Included in this problem is a requirement to compare the factors and criteria for classification differences between IFRS and ASPE.

Problem 20.10 Purpose—repeat of P20.9 under IFRS.

Problem 20.11 Purpose—to provide an understanding of how lease information is reported on the SFP and income statement for two different years in regard to the lessor. In addition, the year-end month is changed in order to help provide an understanding of the complications involved with partial periods. Included in this problem is a requirement to compare the factors and criteria for classification differences between IFRS and ASPE.

Problem 20.12 Purpose—to develop an understanding of the accounting for leases where the lease involves a right-of-use asset for the lessee and the lease payments for the first half of the lease term differ from those for the latter half. The student is required to calculate for the lessee the discounted present value of the right-of-use asset and the related lease liability at the lease’s inception date. The student is also asked to prepare journal entries for the lessee.

Problem 20.13 Purpose—to develop an understanding of the accounting procedures involved in a sales-type leasing arrangement. The student is required to discuss the nature of this lease transaction from the viewpoint of both the lessee and lessor. The student is also required to prepare the journal entries to record the lease for both the lessee and lessor as well as illustrate the items and amounts that would be reported on the SFP and statement of cash flows at the end of the first year for the lessee and the lessor. Solutions Manual 20-114 Chapter 20 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 20.14 Purpose—to develop an understanding of the accounting for a lease that involves a right-of-use asset for the lessee. The student is required to prepare the lease amortization schedule for the entire term of the lease and the necessary journal entries for the lease through the first two lease payments. The student is also asked to indicate the amounts that would be reported on the lessee’s SFP and statement of cash flows. Finally, the student must contrast the financial statement reporting with that obtained for a new set of conditions leading to the treatment of the lease as an operating lease.

Problem 20.15 Purpose—to develop an understanding of the accounting treatment accorded a sales-type lease involving an unguaranteed and guaranteed residual value. The student is required to discuss the nature of the lease with regard to the lessor and to calculate the amount of the gross investment, the unearned interest income, the sale price, and the cost of goods sold. The student is also required to construct a 10-year lease amortization schedule for the leasing arrangement, and to prepare the lessor’s journal entries for the first year of the lease contract. Finally, disclosure of the net investment must be prepared.

Problem 20.16 Purpose—to develop an understanding of a capital lease for the lessor with an unguaranteed and guaranteed residual value, with and without a bargain purchase option. The lease involves a right-of-use asset for the lessee. The student explains why it is a capital lease and calculates the amount of the initial obligation. The student prepares a 10-year amortization schedule and all of the lessee’s journal entries for the first year under each of the different assumptions. Included in this problem is a requirement to prepare a table contrasting the entries when a guaranteed and unguaranteed residual value is present in the lease.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 20.17 Purpose—to develop an understanding of a sales-type lease with a guaranteed and unguaranteed residual value. The student discusses the classification of the lease and calculates the gross investment, unearned interest income, sales price, and cost of sales. The student prepares a 10-year amortization schedule and all of the lessor’s journal entries for the first year. The problem then goes on to require the student to calculate the amount of depreciation to be recorded by the lessee under conditions where the residual value is and is not guaranteed by the lessee. The financial statement disclosure requirements to the lessor must also be outlined based on these two conditions. Included in this problem is a requirement to compare the factors and criteria for classification differences between IFRS and ASPE.

Problem 20.18 Purpose—to develop an understanding of how residual values and direct costs in processing the lease affect the accounting for the lessee and the lessor. The student must understand both the accounting for a guaranteed and unguaranteed residual value and determine how large the residual value must be to have operating lease treatment. Included in this problem is a requirement to compare the factors and criteria for classification differences between IFRS and ASPE.

Problem 20.19 Purpose—to provide the student with the opportunity to contrast the financial implications of two alternative leases offered to a business with liquidity problems. The student must perform the necessary analysis to conclude as to how the leases would be accounted for under ASPE and provide a basis for the recommendation in a formal report. The student will need to eliminate some unnecessary minor factors (such as small differences in lease term dates) in order to quickly zero in on the essential issues surrounding the choices offered.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 20.20 Purpose—to provide the student with the opportunity to contrast the financial implications and reporting when a lease is treated as a capital lease by the lessor, on account of the involvement of a third party when a guaranteed residual value exists. The lease involves a right-of-use asset for the lessee. The student must prepare the entries and the financial statement disclosure of both parties in the lease agreement. This problem highlights the unsolved issue of the equipment not being reported on either SFP.

Problem 20.21 Purpose—to provide the student with the opportunity to contrast three different options to obtain a luxury vehicle, including: finance a purchase, lease and renew a lease, and lease and exercise the option to purchase. A fourth option must be prepared using the contract-based approach of IFRS. Several calculations, amortization schedules, and journal entries are also required in this problem. Finally, a summary for the first year’s SFP and income statement for all options as well as a summary of all expenses for the 5 years use of the vehicle must be summarized. Additional considerations in making choices must also be provided by the student.

Problem 20.22 Purpose—to provide the student with the lessor’s accounting of one of the options discussed in P20.21.

Problem 20.23* Purpose—to develop an understanding of how to handle a sale and leaseback transaction, including the preparation of the lessee’s journal entries. A second set of assumptions is used to arrive at a different conclusion, which is to account for the lease as an operating lease.

Problem 20.24* Purpose—to provide the student with an understanding of the theoretical reasons for the accounting treatment of a sale and leaseback of a building under ASPE and IFRS.

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SOLUTIONS TO PROBLEMS PROBLEM 20.1 a.

Option No. 1 - Precision Inc. Calculation of PV of minimum lease payments: The $5,000 option to buy the software at the end of the lease of five years is not considered a bargain purchase option in view of the $200 price offered by Graphic Inc. in Option No. 2. The lease payments are in the amount of $3,500 as the $1,000 annual licensing fee is an executory cost. 1. Using Tables: $3,500 X 3.790791 = $13,268 1

PV of an ordinary annuity of 1 for 5 periods at 10%

2. Using a financial calculator: PV $ ? Yields $13,268 I 10% N 5 PMT $ (3,500) FV $ 0 Type 0

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.1 (CONTINUED) a. (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $13,268 rounded Total lease payments: At inception of lease – January 1, 2023 PV of minimum lease payments Total

$12,000 13,268 $25,268

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.1 (CONTINUED) a. (continued) This is an operating lease to Interior Design Inc. since the lease term (5 years) is less than 75% of the economic life (8 years) of the leased asset. The lease term is 62.5% (5/8) of the asset’s economic life. There is no bargain purchase option and the PV of minimum lease payments of $25,268 represent 84% of the $30,000 fair value at January 1, 2024, falling short of the criteria of 90% to treat the lease as a capital lease under ASPE. Option No. 2 – Graphic Inc. Calculation of PV of minimum lease payments: The minimum lease payments in the case include the bargain purchase option of $200. The present value therefore is: PV of monthly payment 2 ............................................. PV of bargain purchase option of $200 3 ..................... PV of minimum lease payments ..................................

$27,104 124 $27,228

1. Using Tables: 2

PV of an annuity due of 1 for 5 periods at 10%. $6,500 X 4.16986 = $27,104 3 PV of a single payment of 1 for 5 periods at 10% $200 X .62092 = $124

2. Using a financial calculator: PV $ ? Yields $27,228 I 10% N 5 PMT $ (6,500) FV $ (200) Type 1

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PROBLEM 20.1 (CONTINUED) a. (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $27,228 rounded To Interior Design Inc., this lease is a capital lease because the terms satisfy the following criteria: 1.

Although as in Option No. 1, the lease term is not greater than or equal to 75% of the economic life of the leased asset (the lease term is 62.5% (5/8) of the economic life), there is a bargain purchase option.

The PV of the minimum lease payments is greater than or equal to 90% of the fair value of the leased asset; that is, the present value of $27,228 is 91% of the fair value of the leased asset of $30,000: ($27,228 / $30,000 = 90.76%)

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PROBLEM 20.1 (CONTINUED) b. January 1, 2024 Prepaid Rent ................................................ 12,000 Cash ...................................................

12,000

The first payment will be amortized straight-line over the term of the lease. December 31, 2024 Rent Expense (Software) ............................. 3,500 Operating Expenses ..................................... 1,000 Cash ................................................... 4,500 To record payment of rent and operating expenses December 31, 2024 Rent Expense (Software)4 ............................ Prepaid Rent ......................................... 4 ($12,000 / 5 = $2,400) To record expired rent

2,400 2,400

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PROBLEM 20.1 (CONTINUED) c. Interior Design Inc. Lease Amortization Schedule with Graphic Inc.

Date

1/1/24 1/1/24 1/1/25 1/1/26 1/1/27 1/1/28 1/1/29

Annual Lease Payment

$6,500 6,500 6,500 6,500 6,500 200 $32,700

Interest (10%) on Unpaid Obligation

*$2,073 * 1,630 * 1,143 607 18 *$5,471

Reduction of Lease Obligation

Balance of Lease Obligation $27,228 20,728 16,301 11,431 6,074 181 0

$6,500 4,427 4,870 5,357 5,893 182 $27,229

d. January 1, 2024 Software under Lease ................................... 27,228 Cash ..................................................... Obligations under Lease ....................... To record inception of lease and first lease payment

December 31, 2024 Interest Expense ...................................... Obligations under Lease ................... To record interest

6,500 20,728

2,073 2,073

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PROBLEM 20.1 (CONTINUED) d. (continued) December 31, 2024 Depreciation Expense .................................. 3,404 Accumulated Depreciation— Software under Lease ..................... 3,404 5 ($27,228 ÷ 8 years = $3,404) Use 8 years, as option to purchase will be exercised as it is a bargain price. To record depreciation expense 5

January 1, 2025 Obligations under Lease .......................... Cash ............................................... To record lease payment

6,500 6,500

Income statement effects: Rent expense ($3,500 + $2,400) Operating expenses Interest expense Depreciation expense Total expenses

Option No. 1 Operating Lease $5,900 1,000

_____ $6,900

Option No. 2 Capital Lease

$2,073 3,404 $5,477

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PROBLEM 20.1 (CONTINUED) e. (continued) Asset and liability balances Dec. 31, 2024 Current assets: Prepaid rent $9,600 Property, Plant, and Equipment: Software under lease Less: accumulated depreciation

$27,228 (3,404) $23,824

Current liabilities: Current portion of obligations under lease Long-term liabilities: Obligations under lease ($20,728 + $2,073) Less current portion Total liabilities: Total cash outflows during 2024* $16,500 *excluding the $1,500 upgrade and including the $1,000 licensing fee to Precision

6,500

22,801 (6,500) 16,301 $22,801 $6,500

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PROBLEM 20.1 (CONTINUED) f.

Among Interior’s paramount concerns will be ensuring that it continues to meet its debt to equity covenant. Since all financing is done with the bank, Interior Design Inc. may be perceived to be of high risk by the bank. Entering into the Precision Inc. lease (Option No. 1) would provide off–balance sheet financing, keeping the obligations under capital leases off the balance sheet. Equity would be reduced by the lease payments expensed each period. In contrast, the Graphic Inc. (Option No. 2) lease would increase Interior’s liabilities by the PV of the minimum lease payments. Interest expense each period and depreciation of the leased asset will decrease net income and therefore equity each period. To maintain their debt to equity covenant, Interior would probably choose the Precision lease (operating lease Option No. 1) to minimize debt on their SFP. The bank officials would be satisfied but nevertheless aware of the accounting treatment used to lead to the required result. Consequently, although Interior is complying with the covenant, the bank might apply other more stringent conditions to make up for the off–balance sheet financing or include the lease as a debt for their long-term assessment ratio calculations.

In the long term, Option No. 2 presents the better option. The software will be owned and used by Interior over the eight-year useful life of the asset, instead of the five-year term of lease under the operating lease, Option No. 1. The other immediate disadvantage to the operating lease option No. 1 is the large immediate (January 1, 2023) cash outflow required by the prepayment clause under the operating lease of $12,000. This payment could create an important liquidity problem over the term of the lease, especially in the first year.

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PROBLEM 20.1 (CONTINUED) g. (continued) The conclusion to be drawn from this study is that choices are often made by private businesses for reasons outside what makes economic sense overall. IFRS removes the distinction between operating and finance leases except for low-value asset leases or leases with terms of less than 12 months. This treatment, used by public companies and those companies following IFRS, eliminates the option to select leases in order to reduce or eliminate the presence of liabilities on the SFP.

Note to instructor: The two alternatives are not, strictly speaking, comparable in a capital budgeting sense as the difference in the purchase option leaves option 1 with a 5-year life and option 2 with an 8-year life. The present value of the purchase option in Option 1 (although a non-GAAP treatment) is needed to make the two options comparable (PV is $3,100). Option 2 is therefore superior in a present value sense. It is important to mention that comparing the accounting treatment without considering the impact on cash flows is inadequate when evaluating management’s decisions. LO 1,4,6,7 BT: AP Difficulty: C Time: 60 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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PROBLEM 20.2 a.

Memorandum Prepared by: TO: President of SWT Date:

(Your Initials)

I have summarized the information regarding the two leases for the customer service telecommunications and computer equipment. Both leases would result in the recording of right-of-use assets and lease liabilities. I have explained the reasons in the following chart, followed by my detailed calculations. Each lease arrangement is a purchase from an accounting standpoint, and accordingly, the costs that will affect the income statement each year include interest expense, depreciation expense, and any annual operating costs. The following table shows that Lease Two has less of an impact on income than Lease One in 2023, as well as on average over the number of years we will be using the leased equipment. As both leases provide SWT with similar equipment that meets our requirement, it is my recommendation that we sign Lease Two. From a cash flow standpoint, the lease payments of Lease One are made in advance every year, while Lease Two payments are made at the end of the year which gives us more liquidity. Please note that with Lease One, the equipment will not belong to us at the end of the lease term of five years, it will revert to the lessor, and we are required to guarantee the value at that time of $85,000. If we are interested in keeping the equipment, we can decide at the end of the lease term if we wish to purchase the equipment for $85,000; if we do not acquire it, we may be required to make up any deficiency in its fair value and this introduces considerable uncertainty. With Lease Two, we will acquire the equipment over the seven-year term of the lease and cash flows are clearly defined.

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PROBLEM 20.2 (CONTINUED) b.

Based on my analysis, I am recommending Lease Two. From a financial reporting perspective, the equipment and software we are leasing will be included in property, plant, and equipment and identified as a Right-of-Use Asset. The SFP will also show the balance of the lease liability.

Interest rate used in calculations Number of years of use by SWT

Lease One 10% - implicit rate unknown 5 years

Lease Two 8% - implicit rate known 7 years

PV of lease payments

$487,694 (1) rounded

$444,404 (2)

Type of lease

Finance (3)

Finance (4)

Total cash outflow from lease payments Average per year

$724,000 (5)

$742,500 (6)

$144,800

$106,071

$38,339 (7) $80,539 (9) $23,500 $142,378

$35,552 (8) $63,486 (10) $26,500 $125,538

Income statement effect first year Interest expense Depreciation expense Operating expenses Total expenses

Total income statement effect over life of lease and renewal Interest expense $118,806 (11) $112,596 (12) Depreciation expense $402,694 (13) $444,404 (14) Operating expenses $117,500 (15) $185,500 (16) Total expenses $639,000 $742,500 Average per year $127,800 $106,071 Refer to Appendix A for details of calculations referenced to the above.

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PROBLEM 20.2 (CONTINUED) Appendix A: (1)

$104,300 X 4.16987 $434,917.40 $85,000 X .62092 $52,778.20 $487,695.60

Annual rental payment PV of an annuity due 5 years at 10% (Table A.5) PV of lease payments Guaranteed residual value (or purchase price) PV of 1 in 5 years at 10% (Table A.2) PV of guaranteed residual value Total PV of lease payments

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator: PV $ ? I 10% N 5 PMT $ (104,300) FV $ (85,000) Type 1

Yields $487,695.28

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PROBLEM 20.2 (CONTINUED) Appendix A (continued) (2)

$111,000 X 3.99271 $443,190.81 $1,000 X 1.78326 1,783.26 X .68058 $1,213.65 $444,404.46

Annual rental payments ($137,500 – $26,500) PV, ordinary annuity 5 years at 8% (Table A.4) PV of lease payments Annual rental renewal period ($27,500 – $26,500) PV, ordinary annuity 2 years at 8% (Table A.4) PV of 1 in 5 years at 8% (Table A.2) PV of lease renewal payments Total PV of lease payments

(i) Using a financial calculator: PV $ ? I 8% N 2 PMT $ 1,000* FV $0 Type 0 * ($27,500 − $26,500)

Yields $1,783.26

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PROBLEM 20.2 (CONTINUED) Appendix A (continued) Excel formula =PV(rate,nper,pmt,fv,type)

(ii) Using a financial calculator: PV $ ? I 8% N 5 PMT $ 111,000* FV $ 1,783.26 Type 0 *($137,500 – $26,500)

Yields $444,404.47

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PROBLEM 20.2 (CONTINUED) Appendix A (continued) Excel formula =PV(rate,nper,pmt,fv,type)

(3) The lease would be set up by SWT as a right-of-use asset and lease liability under IFRS as the lease does not qualify for a short-term or low-value exemption lease. (4) The PV of the lease payments is equal to the fair value of the equipment. (5) Lease payments $104,300 x 5 + $85,000 = $606,500 Operating costs $23,500 x 5 = $117,500 Total $724,000

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PROBLEM 20.2 (CONTINUED) Appendix A (continued) (6) [($137,500 lease payments and operating costs) x 5] + [($27,500 x 2)] = $742,500 (7) ($487,694 – $104,300) x 10% = $38,339 (8) $444,404 x 8% = $35,552 (9) ($487,694 – $85,000) ÷ 5 years = $80,539 (10) $444,404 ÷ 7 = $63,486 (11) Cash outflows from lease (item 5) less PV lease payments (item 1) ($606,500 – $487,695 = $118,805) (12) Cash outflows from lease (item 6) less PV lease payments (item 2) ($557,000 – $444,404 = $112,596) (13) $487,694 – $85,000 = $402,694 or item 9 X 5 years (14) Capitalized amount of the lease or Item 10 X 7 years = $444,404 (15) $23,500 X 5 = $117,500 (16) $26,500 X 7 = $185,500 LO 4,5,6 BT: AP Difficulty: M Time: 50 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

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PROBLEM 20.3 a.

The lease would be set up by Hunter Ltd. as a right-of-use asset and lease liability under IFRS as the lease does not qualify for a short-term or low-value exemption lease. For Situ Ltd., the PV of the lease payments are 100% of FMV, providing evidence that the PV of the minimum lease payments approximates the fair value of the leased asset. Although the 3/5 years of lease may not provide “the substantial portion of the economic benefit” and although there is no transfer of ownership, the finance lease criteria have been met. Specifically, since the lessor Situ Ltd. is not a manufacturer or dealer (FMV = Carrying value), the lease is a direct finance lease.

Calculation of annual rental payment: (Hint when using a financial calculator: ensure that the compounding is done monthly, I/Y = 1) 1. Using a financial calculator: PV $ 20,691 I 1% N 36 PMT $ ? Yields ($600) FV $ (3,500) Type 1 This confirms that the interest rate used to calculate the lease payment was 12% or 1% per month. Alternatively, the RATE function could have been used directly. (The lease payments include the executory costs of $20 per month and are therefore in the net amount of $600.)

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PROBLEM 20.3 (CONTINUED) b. (continued) 2. Excel formula =PMT(rate,nper,pv,fv,type)

Result $600 rounded

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PROBLEM 20.3 (CONTINUED) c. Lease Amortization Schedule

Date Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May Jun. July Aug. Sep. Oct. Nov. Dec.

1 2023 1 2023 1 2023 1 2023 1 2023 1 2023 1 2023 1 2023 1 2023 1 2023 1 2023 1 2023 1 2024 1 2024 1 2024 1 2024 1 2024 1 2024 1 2024 1 2024 1 2024 1 2024 1 2024 1 2024

Monthly Lease Payment Plus RVG $ 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600 600

Interest (1%) on Unpaid Liability

$ 201 197 193 189 185 181 176 172 168 164 159 155 150 146 141 137 132 127 123 118 113 108 103

Reduction of Lease Liability $600 399 403 407 411 415 419 424 428 432 436 441 445 450 454 459 463 468 473 477 482 487 492 497

Balance Lease Liability $20,691 20,091 19,692 19,289 18,882 18,471 18,055 17,636 17,212 16,784 16,352 15,916 15,475 15,030 14,580 14,126 13,667 13,204 12,736 12,263 11,786 11,303 10,816 10,325 9,828

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PROBLEM 20.3 (CONTINUED) c. (continued) Lease Amortization Schedule

Date Jan. Feb. Mar. Apr. May Jun. July Aug. Sep. Oct. Nov. Dec. Jan.

1 2025 1 2025 1 2025 1 2025 1 2025 1 2025 1 2025 1 2025 1 2025 1 2025 1 2025 1 2025 1 2025

Monthly Lease Payment Plus RVG

Interest (1%) on Unpaid Liability

Reduction of Lease Liability

Balance Lease Liability

$600 600 600 600 600 600 600 600 600 600 600 600 3,500 $25,100

$98 93 88 83 78 73 67 62 57 51 46 40 361 $4,409

$502 507 512 517 522 527 533 538 543 549 554 560 3,464 $ 20,691

$9,326 8,819 8,308 7,791 7,269 6,741 6,209 5,671 5,127 4,579 4,025 3,465 0

Rounding $1 RVG = Residual value guarantee d. January 1, 2023 Right-of-Use Asset ........................................... 20,691 Insurance Expense........................................... 20 Lease Liability ........................................... Cash ......................................................... To record inception of lease and insurance payment

20,091 620

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.3 (CONTINUED) d. (continued) December 31, 2023 Interest Expense .............................................. Lease Liability ........................................... To record interest Depreciation Expense1 ..................................... Accumulated Depreciation—Rightof-Use Asset ........................................ 1 [$20,691 - $3,500] ÷ 3) To record depreciation expense January 1, 2024 Lease Liability .................................................. Insurance Expense........................................... Cash ......................................................... To record lease payment

155 155

5,730 5,730

600 20 620

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.3 (CONTINUED) e.

Hunter Ltd. Statement of Financial Position December 31, 2024

Property plant, and equipment Right-of-Use Asset Less accumulated depreciation

Current liabilities Lease Liability2 Long-term liabilities Lease Liability (Note X)* .

2023

$20,691 11,460

$20,691 5,730

9,231

14,961

6,462

5,802

3,465

9,828

(from table, payments from Jan. 1 to Dec. 1, plus accrued interest (2023) = $445 + $450 + $454 + $459 + $463 + $468 + $473 + $477 + $482 + $487 + $492 + $497 + $155; (2024) = $502 + $507 + $512 + $517 + $522 + $527 + $533 + $538 + $543 + $549 + $554 + $560 + $98) In 2024, the guaranteed residual value remains as a non-current portion of the lease liability as it is due on the anniversary date of the lease agreement. 3 from table

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.3 (CONTINUED) e. (continued) *(Note X): The following is a schedule of future payments under lease liability expiring December 31, 2025. 2024

Amount representing executory costs Amount representing interest Balance of liability

$7,440 3,500 10,940 (240) (774) $9,926

2023 $7,440 7,440 3,500 18,380 (480) (2,270) $15,630

From lease amortization schedule: Balance at December 31 Add accrued interest Balance

$9,828 98 $9,926

$15,475 155 $15,630

Amounts due in 2024 Amounts due in 2025 Amounts due in 2026

Hunter Ltd. Statement of Income For the Year Ended December 31,

Administrative expense Depreciation expense Insurance expense Other expenses Interest expense4 4

2024

2023

$5,730 240

1,496

2,140

from lease amortization schedule part (c)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.3 (CONTINUED) f. December 21, 2025 Interest Expense .............................................. Lease Liability5 ................................................. Accumulated Depreciation—Rightof-Use Asset ............................................. Loss on Lease .................................................. Right-of-Use Asset.................................... Cash ......................................................... 5 rounding $1 g.

36 3,465 17,190 300 20,691 300

Hunter Ltd. Statement of Cash Flows For the Year Ended December 31,

Indirect Format: Cash flows from operating activities Depreciation expense Increase (decrease) in lease liability for accrued interest Financing Activities: Lease payment 7 6 ($155 – $98) 7 from lease amortization schedule part (c)

2024

2023

$5,730

(57)6

155

(5,647)

(5,216)

Also show cash paid for interest of $1,553 and $1,984

In the notes to the financial statements: Non-cash Investing and Financing Activities: Purchase of Right-of-Use Asset

$20,691

Direct Format: Cash flows from operating activities Cash paid for interest Cash paid for insurance

$(1,984) (240)

$(1,553) (240)

LO 4,5,6,8 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 20-142 Chapter 20 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.4 a. January 1, 2023 Cash................................................................ Lease Receivable ($600 x 35 + $3,500) ......... Equipment Acquired for Lessee ............... Unearned Interest Income ....................... Insurance Expense ..................................

620 24,500 20,691 4,409 20

December 31, 2023 Unearned Interest Income ............................... Interest Income ..................................... To record interest

2,140 2,140

From amortization table (P20.3) Monthly ($201 + $197 + $193 + $189 + $185 + $181 + $176 + $172 + $168 + $164 + $159 + $155 – $1 rounding)

b. Situ Ltd. Statement of Income For the Year Ended December 31,

Revenue Interest income (leases)1

2024

2023

$1,497

$2,139

(240)

Other expenses (Recovery) of insurance expense 1

from lease amortization schedule part (c) of P20.3

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.4 (CONTINUED) b. (continued) Situ Ltd. Statement of Financial Position December 31, 2024

2023

$6,462

$5,802

3,464 $9,926

9,828 $15,630

Net investment in lease: 2024 Beginning balance ............................................ $15,475 Less recovery in year (see table P20.3) ........... (5,647) Ending balance ................................................ 9,828 Recoverable within 12 months ......................... (6,364) Non-current portion of net investment .............. $3,464

2023 $20,691 (5,216) 15,475 (5,647) $9,828

Reconciliation of balance: From lease amortization schedule P20.3: Balance at December 31 Add accrued interest Balance

$15,475 155 $15,630

Current assets Net investment in vehicle leases Non-current assets Net investment in vehicle leases Balance

$9,828 98 $9,926

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.4 (CONTINUED) c. Situ Ltd. Statement of Cash Flows For the Year Ended December 31,

Indirect Format: Cash flows from operating activities (Increase) decrease in interest receivable Investing Activities: Collected on investment in lease2 Increase in investment in lease (net) Direct Format: Cash flows from operating activities Cash collected for interest3 Cash paid for insurance expense

2024

2023

$57

$(155)

5,647

5,216 (20,691)

$1,553 (240)

$1,984 (240)

2Amounts are the same as Cash paid on lease – financing activity of 3

Hunter Ltd. P20.3 part (g) Amounts are the same as Cash paid for interest – operating activity of Hunter Ltd. P20.3 part (g)

LO 9,11 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.5 a.

The lease would be set up by Labonté Ltée. as a right-of-use asset and lease liability under IFRS as the lease is not eligible for a short-term or low-value exemption. For LePage, the collectibility of the lease payments is not reasonably predictable, and there are important uncertainties surrounding the costs yet to be incurred. Accordingly, the earnings process is not considered complete and, in spite of the fact that the fair value ($560,000) of the equipment exceeds the lessor’s cost ($420,000), the lease cannot be recorded as a salestype lease by LePage and must be recorded as an operating lease.

Calculation of annual rental payment: To calculate the amount of the payments using 1. Tables: ($560,000 + $2,500) - ($80,000 X .37594 1) 4.78448 2 1 2

$111,282

PV of $1 at 15% for 7 periods. PV of an annuity due at 15% for 7 periods.

2. Using a financial calculator: PV I N PMT FV Type

$ (562,500) 15% 7 $ ? $ 80,000 1

Yields $111,282

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.5 (CONTINUED) b. (continued) 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $111,282 c. 7/15/23

Right-of-Use Asset .......................... Lease Liability ........................... Cash .........................................

562,500 451,218 111,282

12/31/23 Depreciation Expense3 .................... 31,592 Accumulated Depreciation -Right-of-Use Asset .............. 3 ($562,500 - $80,000) ÷ 7 X 5.5/12 To record depreciation expense Interest Expense4 ............................ Lease Liability ........................... 4 ($451,218 X .15 X 5.5/12) To record interest

31,592

31,021 31,021

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.5 (CONTINUED) c. (continued) 7/15/24

Lease Liability ................................. Interest Expense5 ............................ Cash .................................... 5 ($451,218 X .15 X 6.5/12) To record lease payment

74,620 36,661

12/31/24 Depreciation Expense6 .................... Accumulated Depreciation -Right-of-Use Asset .............. 6 ($562,500 - $80,000) ÷ 7 To record depreciation expense

68,929

111,282

68,929

Interest Expense7 ............................ 28,024 Lease Liability ........................... 7 [($451,218 + $31,021 – $74,620) X .15 X 5.5/12] To record interest e. 7/15/23

Rental Equipment ........................... Inventory................................... To record rental equipment

420,000

Cash................................................ Unearned Rent Revenue .......... To record collection of rent

111,282

Rental Equipment ............................ Cash ......................................... To record capitalized legal costs

2,500

28,024

420,000

111,282

2,500

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.5 (CONTINUED) e. (continued) 12/31/23 Unearned Rent Revenue ................. Rent Revenue8......................... 8 ($111,282 X 5.5/12) To record rent

51,004 51,004

Depreciation Expense9 .................... 22,426 Accumulated Depreciation -Rental Equipment ............... 9 ($422,500 - $80,000) ÷ 7 X 5.5/12 To record depreciation expense 7/15/24

Unearned Rent Revenue ................. Rent Revenue10 ........................ 10 ($111,282 X 6.5/12) To record rent

60,278

Cash................................................ Unearned Rent Revenue .......... To record collection of rent

111,282

12/31/24 Depreciation Expense11 ................... Accumulated Depreciation -Rental Equipment ............... 11 ($422,500 - $80,000) ÷ 7 To record depreciation expense

48,929

12/31/24 Unearned Rent Revenue ................. Rent Revenue12 ........................ 12 ($111,282 X 5.5/12) To record rent

51,004

22,426

60,278

111,282

48,929

51,004

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.5 (CONTINUED) d. Labonté Right-ofUse Statement of financial position: Property, Plant, and Equipment: Right-of-use asset Rental equipment Less: Accumulated depreciation Current liabilities: Lease liability13 Unearned rent revenue Long-term liabilities: Lease liability13 Less: Current portion

Statement of income: Rent revenue Depreciation expense Interest expense

f. LePage Operating Lease

$562,500 (31,592) 530,908

$ 422,500 (22,426) 400,074

74,620 60,278

482,240 (74,620) 407,619

$ 31,592 31,021

$ 51,004 22,426

Includes interest accrued of $31,021

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.5 (CONTINUED) g.

Although it might seem odd that the same asset is reported on two different statements of financial position, the collection risks under which the lessor, LePage, is operating do not justify the recognition of income under a sales-type lease. There are too many uncertainties surrounding the related costs and collections under the terms of its lease with Labonté. Should Labonté default on the lease, LePage might have to rent the used equipment to another lessee or resell it as used inventory. It is also not unreasonable to consider that the residual value “guarantee” by Labonté should not be considered in the calculations (e.g., for depreciation) as that company’s financial situation may make them unable to “make good” on the guarantee.

LO 3,4,5,6,11,12 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.6 a.

The lease would be set up by Gumo Construction Inc. as a rightof-use asset and lease liability under IFRS as the lease does not qualify for a short-term or low-value exemption lease. Under IFRS, meeting any one or a combination of the following criteria normally indicates that the risks and rewards of ownership are transferred to the lessee, and supports classification as a finance lease to the lessor: 1. There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term. If there is a bargain purchase option in the lease, it is assumed that the lessee will exercise it and obtain ownership of the asset. 2. The lease term is long enough that the lessee will receive substantially all the economic benefits that are expected to be derived from using the leased property over its life. 3. The lease allows the lessor to recover substantially all its investment in the leased property and to earn a return on the investment. Evidence of this is provided if the present value of the minimum lease payments is close to the fair value of the leased asset. 4. The leased assets are so specialized that, without major modification and/or significant cost to the lessor, they are of use only to the lessee. None of these conditions have been met and so the lease is an operating lease for Synergetics Inc.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.6 (CONTINUED) b.

Under ASPE, the lease is an operating lease to the lessee and lessor because: 1. it does not transfer ownership, and it does not contain a bargain purchase option, 2. (6/12 years) does not cover at least 75% of the estimated economic life of the crane, and 3. the present value of the lease payments is not at least 90% of the fair value of the leased crane. $21,500 Annual Lease Payments X PV of annuity due at 7% for 6 years $21,500 X 5.10020 = $109,654, which is less than $144,000.00 (90% X $160,000) At least one of the three criteria would have had to be satisfied for the lease to be classified as other than an operating lease. The property is recorded as a rental property to the lessor and would be treated as a payment of rent by the lessee under the operating lease.

Lessee’s Entries February 1, 2023 Right-of-Use Asset...................................... 109,654 Lease Liability ..................................... Cash ................................................... To record inception of lease and first lease payment December 31, 2023 Interest Expense1 ....................................... Lease Liability ..................................... 1 ($88,154 X 7% X 11/12) To record interest Depreciation Expense2 ............................... Accumulated Depreciation— Right-of-Use Asset .................... 2 ($109,654 ÷ 6 X 11/12] To record depreciation expense

88,154 21,500

5,657 5,657

16,753 16,753

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.6 (CONTINUED) c. (continued) Lessor’s Entries February 1, 2023 Cash ............................................................... Unearned Rent Revenue......................... Collection of rent February 1, 2023 Prepaid Insurance........................................... Prepaid Expenses........................................... Cash or Accounts Payable ...................... To record prepayments December 31, 2023 Unearned Rent Revenue ............................ Rent Revenue3 .................................... 3 ($21,500 X 11/12) To record rent revenue

21,500 21,500

450 1,400 1,850

19,708 19,708

Insurance Expense ($450 X 11/12)............. Repairs and Maintenance Expense4 ........... Prepaid Insurance .............................. Prepaid Expenses .............................. 4 ($1,400 X 11/12) To record expired prepayments

413 1,283

Depreciation Expense5 ............................... Accumulated Depreciation— Rental Equipment ...................... 5 [($160,000 – $20,000) ÷ 12 X 11/12] To record depreciation expense

10,694

413 1,283

10,694

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.6 (CONTINUED) d. Gumo Right-ofUse Statement of financial position: Property, Plant, and Equipment: Right-of-use asset Rental equipment Less: Accumulated depreciation Current liabilities: Lease liability6 Unearned rent revenue

Synergistics Operating Lease

$109,654 (16,753) 92,901

$160,000 (10,694) 149,306

27,157 1,792

Long-term liabilities: Lease liability7 6 ( $21,500 + $5,657 accrued interest) 7 ($88,154 + $5,657- $27,157 = $66,654)

Statement of income: Rent revenue Depreciation expense Interest expense Insurance expense Repairs and maintenance expense

66,654

$ 16,753 5,657

$ 19,708 10,694 413 1,283

LO 4,5,7,8,12 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.7 a.

1. Using tables: $170,794 X 7.80169 $1,332,482

Annual payment PV of annuity due of 1 for n = 10, i = 6% PV of annuity payments

$300,000 X .55839 $167,518

PV of purchase option in 10 years PV of 1 for n = 10, i = 6% PV of purchase option ($1 rounding)

$1,332,482 + 167,518 $1,500,000

PV of periodic payments PV of purchase option Total PV

2. Using a financial calculator: PV I N PMT FV Type

? 6% 10 $( 170,794) $( 300,000) 1

Yields $1,500,000.66

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.7 (CONTINUED) a. (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $1,500,000 rounded b.

The vice-president is correct. The lease would be set up by Ramey Corporation as a right-of-use asset and lease liability under IFRS as the lease does not qualify for a short-term or lowvalue exemption lease. It would be foolish for Ramey not to exercise the option to purchase the airplane. Airplanes and their engines, when properly maintained, typically retain their value. The purchase option of $300,000 compares favourably to the residual value, which is estimated at $400,000 and will never fall below $275,000.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.7 (CONTINUED) b. (continued) In addition, the lease term of 10 years is far shorter than the 15 years of the useful life of the airplane. Since Ramey is already paying for the repairs and maintenance, it will benefit from this investment in the increased resale value of the airplane once the bargain purchase option is exercised. Ramey will consequently benefit from any appreciation in value of this asset, beyond the term of the lease. c.

Ramey Corporation Lease Amortization Schedule (Lessee)

Annual Lease Payments

Date

Jan. 1, Jan. 1, Jan. 1, Jan. 1, Jan. 1, Jan. 1, Jan. 1, Jan. 1, Jan. 1, Jan. 1, Jan. 1,

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033

$170,794 170,794 170,794 170,794 170,794 170,794 170,794 170,794 170,794 170,794 300,000 $2,007,940

Interest (6%) on Unpaid Liability

$79,752 74,290 68,500 62,362 55,856 48,960 41,650 33,901 25,688 16,981 $ 507,940

Reduction of Lease Liability

$170,794 91,042 96,504 102,294 108,432 114,938 121,834 129,144 136,893 145,106 283,019 $1,500,000

Balance of Lease Liability $1,500,000 1,329,206 1,238,164 1,141,660 1,039,366 930,934 815,996 694,162 565,018 428,125 283,019 0

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.7 (CONTINUED) d.

The leased aircraft will be reflected on Ramey Corporation’s SFP as follows: Property, Plant, and Equipment Right-of-use asset Less accumulated depreciation1

$1,500,000 81,667 $1,418,333

Current liabilities Lease liability2

$170,794

Long-term liabilities Lease liability

$1,238,164

1 2

[($1,500,000 - $275,000) ÷ 15] = $81,667 ($79,752 accrued interest + $91,042) = $170,794

The following items relating to the leased aircraft will be reflected on Ramey Corporation’s statement of income: Depreciation expense (Note A) Interest expense (from table) Repairs and maintenance expense Insurance expense

$81,667 79,752 36,900 34,000

LO 3,5,6,8 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.8 a.

The lease would be set up by Wagner Inc. as a right-of-use asset and lease liability under IFRS as the lease does not qualify for a short-term or low-value exemption. 1. 1. Using tables: PV of lease payments $545,000 X 5.62288* = $3,064,470 *Annuity due Table A.5 at 8% 2. Using a financial calculator: PV $ ? Yields $3,064,469.42 I 8% N 7 PMT $ 545,000 FV $ 0 Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $3,064,469 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.8 (CONTINUED) a. (continued) 2. Wagner Inc. Lease Amortization Schedule

Date July 1 2023 July 1 2024 July 1 2025 July 1 2026 July 1 2027 July 1 2028 July 1 2029

Annual Lease Payments $ 545,000 545,000 545,000 545,000 545,000 545,000 545,000

Interest (8%) on Unpaid Liability

Reduction of Lease Liability

$201,558 174,082 144,409 112,361 77,750 40,370

$545,000 343,442 370,918 400,591 432,639 467,250 504,630

Balance of Lease Liability $3,064,470 2,519,470 2,176,028 1,805,110 1,404,519 971,880 504,630 (0)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.8 (CONTINUED) a. (continued) 3. July 1, 2023 Right-of-Use Asset ................................ 3,064,470 Lease Liability .............................. Cash ............................................ To record inception of lease and first lease payment December 31, 2023 Interest Expense .................................. Lease Liability .............................. 2 ($201,558 X 6 / 12 = $100,779) To record interest 2

100,779 100,779

Depreciation Expense3 .......................... 218,891 Accumulated Depreciation – Right-of-Use Asset .................... 3 ($3,064,470 ÷ 7 years X 6/ 12 = $218,891) To record depreciation expense July 1, 2024 Interest Expense .................................. Lease Liability........................................ Cash ............................................ 4 ($201,558 X 6 / 12 = $100,779) To record lease payment 4

2,519,470 545,000

218,891

100,779 444,221 545,000

b. 1. Probability-weighted expected value of residual $400,000 X 60% = $240,000 $300,000 X 40% = 120,000 Probability-weighted value 360,000 Guaranteed value 450,000 Liability July 1, 2030 $90,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.8 (CONTINUED) b. (continued) 1. (continued) To calculate the present value of this additional cash outflow: Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $56,715 I 8% N 6 PMT $0 FV $ 90,000 Type 1 2. July 1, 2024 Right-of-use Asset ................................. Lease Liability ..............................

56,715 56,715

The carrying amount of the lease liability after the above entry is $2,232,743 (balance from the original amortization schedule $2,176,028 after the July 1, 2024 payment + $56,715)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.8 (CONTINUED) b. (continued) 3.

Wagner Inc. Lease Amortization Schedule—Revised July 1, 2024 Interest Annual (8%) Reduction Balance Lease on Unpaid of Lease of Lease Date Payments Liability Liability Liability $ 2,232,743 July 1 2025 $ 545,000 $ 178,619 $366,381 1,866,362 July 1 2026 545,000 149,309 395,691 1,470,671 July 1 2027 545,000 117,654 427,346 1,043,325 July 1 2028 545,000 83,466 461,534 581,791 July 1 2029 545,000 46,543 498,457 83,334 5 July 1 2030 90,000 6,666 83,334 (0) 5 one-dollar rounding

4. December 31, 2024 6 Interest Expense .................................. Lease Liability .............................. 6 ($178,619 X 6 ÷ 12 = $89,310) To record interest

89,310 89,310

Depreciation Expense7 .......................... 483,716 Accumulated Depreciation – Right-of-Use Asset .................... 7 ($2,902,2948 ÷ 6 years = $483,716) To record depreciation expense 8

Original entry for the asset Depreciation recorded in 2023 Change in estimate: residual value Depreciable balance

483,716

$3,064,470 (218,891) 56,715 $2,902,294

LO 4,5,6 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.9 a.

Interest expense (See schedule) Repairs and maintenance expense Depreciation expense ($150,690 ÷ 6)

$10,216 $2,500 $25,115

Property, plant, and equipment: Property under lease Accumulated depreciation Net property under lease

$150,690 (25,115) 125,575

Current liabilities: Obligations under lease

$30,500

Long-term liabilities: Obligations under lease

$99,906

Interest expense (See schedule) Repairs and maintenance expense Depreciation expense ($150,690 ÷ 6)

$8,492 $2,500 $25,115

4. Property, plant, and equipment: Property under lease Accumulated depreciation Net property under lease

$150,690 (50,230) 100,460

Current liabilities: Obligations under lease

$30,500

Long-term liabilities: Obligations under lease

$77,898

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.9 (CONTINUED) b.

Interest expense ($10,216 X 3/12) Repairs and maintenance expense ($2,500 X 3/12) Depreciation expense ($150,690 ÷ 6 = $25,115 X 3/12) Current assets: Prepaid expenses ($2,500 X 9/12 = $1,875)

$2,554 $625 $6,279

$1,875

Property, plant, and equipment: Property under lease Accumulated depreciation Net property under lease

$150,690 (6,279) 144,411

Current liabilities: Obligations under lease ($20,284 + $2,554)

$22,838

Long-term liabilities: Obligations under lease

$99,906

Interest expense [($10,216 – $2,554) + ($8,492 X 3/12) = $7,662 + [$2,123 = $9,785] Repairs and maintenance expense Depreciation expense ($150,690 ÷ 6)

$9,785

$2,500 $25,115

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.9 (CONTINUED) b. (continued) 4.

Current assets: Prepaid expenses ($2,500 X 9/12 = $1,875)

$1,875

Property, plant, and equipment: Property under lease Accumulated depreciation Net property under lease *($6,279 + $25,115 = $31,394)

$150,690 (31,394*) 119,296

Current liabilities: Obligations under lease1 1 $22,008 + ($8,492 X 3/12)

$24,131

Long-term liabilities: Obligations under lease

$77,898

LO 4 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.10 a.

Interest expense (See schedule) Repairs and maintenance expense Depreciation expense ($150,690 ÷ 6)

$10,216 $2,500 $25,115

Property, plant, and equipment: Right-of-use asset Accumulated depreciation Net right-of-use asset

$150,690 (25,115) 125,575

Current liabilities: Lease liability1

$30,500

Long-term liabilities: Lease liability

$99,906

($20,284 + $10,216 accrued interest) = $30,500

Interest expense (See schedule) Repairs and maintenance expense Depreciation expense ($150,690 ÷ 6)

4. Property, plant, and equipment: Right-of-use asset Accumulated depreciation Net right-of-use asset

$8,492 $2,500 $25,115

$150,690 (50,230) 100,460

Current liabilities: Lease liability2 $30,500 Long-term liabilities: Lease liability $77,898 2

($22,008 + $8,492 accrued interest) = $30,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.10 (CONTINUED) b.

Interest expense ($10,216 X 3/12) Repairs and maintenance expense ($2,500 X 3/12) Depreciation expense ($150,690 ÷ 6 = $25,115 X 3/12)

Current assets: Prepaid expenses ($2,500 X 9/12 = $1,875) Property, plant, and equipment: Right-of-use asset Accumulated depreciation Net right-of-use asset Current liabilities: Lease liability3 Long-term liabilities: Lease liability 3

$2,554 $625 $6,279

$1,875

$150,690 (6,279) 144,411 $22,838

$99,906

($20,284 + $2,554 accrued interest) = $22,838

Interest expense [($10,216 – $2,554) + ($8,492 X 3/12) = $7,662 + [$2,123 = $9,785] Repairs and maintenance expense Depreciation expense ($150,690 ÷ 6)

$9,785

$2,500 $25,115

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.10 (CONTINUED) b. (continued) 4.

Current assets: Prepaid expenses ($2,500 X 9/12 = $1,875)

$1,875

Property, plant, and equipment: Right-of-use asset Accumulated depreciation Net right-of-use asset ($6,279 + $25,115 = $31,394)

$150,690 (31,394) 119,296

Current liabilities: Lease liability4

$24,131

Long-term liabilities: Lease liability

$77,898

[$22,008 + ($8,492 X 3/12 accrued interest)] = $24,131

LO 5 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.11 a.

Interest income

$10,216

Current assets: Lease receivable Unearned interest income Net investment in lease

$30,500 (0) $30,500

Non-current assets: Lease receivable ($183,000 – $30,500 – $30,500) Unearned interest income ($32,310 – $10,216) Net investment in lease

$122,000 (22,094) $99,906

Interest income

$8,492

Current assets: Lease receivable Unearned interest income Net investment in lease

$30,500 (0) $30,500

Noncurrent assets: Lease receivable ($183,000 – $30,500 – $30,500– $30,500) Unearned interest income ($32,310 – $10,216 – $8,492) Net investment in lease

$91,500 (13,602) $77,898

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.11 (CONTINUED) b.

Interest income ($10,216 X 3/12 = $2,554)

Current assets: Lease receivable Unearned interest income ($10,216 – $2,554) Net investment in lease Noncurrent assets: Lease receivable ($183,000 – $30,500 – $30,500) Unearned interest income ($32,310 – $10,216) Net investment in lease

Interest income [($10,216 – $2,554) + ($8,492 X 3/12) = $7,662 + $2,123]

Current assets: Lease receivable Unearned interest income ($8,492 – $2,123) Net investment in lease Noncurrent assets: Lease receivable ($183,000 – $30,500 – $30,500 – 30,500) Unearned interest income ($32,310 – $10,216 – $8,492) Net investment in lease

$2,554

$30,500 (7,662) $22,838

$122,000 (22,094) $99,906 $9,785

$30,500 (6,369) $24,131

$91,500 (13,602) $77,898

LO 9 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.12 a.

YIN TRUCKING CORPORATION Schedule to Calculate the Discounted Present Value of Terminal Facilities and the Related Obligations January 1, 2023

1. Using Tables: Present value of first 10 payments: Present value of an annuity due for 10 years at 6% ($900,000 X 7.80169) Present value of last 10 payments: Present value of an annuity due for 10 years at 6% ($320,000 X 7.80169) Discounted to January 1, 2029 ($2,496,541 X .558395)

$7,021,521

2,496,541

1,394,056 Present value of bargain purchase option of ($1,000,000 X .31180) Present value of terminal facilities and related obligations

311,800 $8,727,377

(Note to instructor: For the last ten periods, the present value of an annuity due for 20 periods less the present value of an annuity due for 10 periods can be used as follows: ([12.15812 – 7.80169] X $320,000 = $1,394,056 rounded).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.12 (CONTINUED) a. (continued) Present value (at end of first ten years) of the next ten-year annuity of $320,000 is $2,496,541 (rounded down $1) 2. Using a financial calculator: PV $? Yields $2,496,541 I 6% N 10 PMT $ (320,000) FV $ 0 Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $2,496,541 (rounded down $1)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.12 (CONTINUED) a. (continued) Calculate the present value of single amount of $2,496,541 for ten years at 6% and obtain $1,394,056 (rounded up $1) 2. Using a financial calculator: PV $ ? Yields $1,394,055 I 6% N 10 PMT $ 0 FV $ (2,496,541) Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $1,394,055 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.12 (CONTINUED) a. (continued) Calculate the PV of single amount of $1,000,000 for twenty years at 6% and obtain $311,805 2 .Using a financial calculator: PV I N PMT FV Type

$ ? 6% 20 $ 0 $ (1,000,000) 1

Yields $311,805

3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $311,805 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.12 (CONTINUED) b.

Partial Amortization Schedule (Annuity Due Basis)

Annual Lease Executory Interest Date Payment Costs1 at 6% 1/1/23 — — — 1/1/23 $1,048,000 $148,000 $ 0 1/1/24 1,048,000 148,000 468,000 1/1/25 1,048,000 148,000 442,080 1/1/26 1,048,000 148,000 414,605 1 $125,000 + $23,000

Reduction of Lease Liability — $900,000 432,000 457,920 485,395

Balance Lease Liability $8,700,000 7,800,000 7,368,000 6,910,080 6,424,685

January 1, 2023 Right-of-Use Asset ......................................... 8,700,000 Prepaid Expenses .......................................... 125,000 Prepaid Insurance .......................................... 23,000 Lease Liability ......................................... 7,800,000 Cash ........................................................... 1,048,000 To record inception of lease and first lease payment December 31, 2023 Depreciation Expense .................................... Accumulated Depreciation—Rightof-Use Asset ($8,700,000 ÷ 40)....... To record depreciation expense

217,500 217,500

Interest Expense ............................................ Lease Liability ......................................... To record interest

468,000

Property Tax Expense .................................... Insurance Expense......................................... Prepaid Expenses................................... Prepaid Insurance................................... To record expired prepayments

125,000 23,000

468,000

125,000 23,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.12 (CONTINUED) c.

Yin’s SFP at December 31, 2023 would show the following: Property, plant, and equipment Right-of-use asset Accumulated depreciation

$8,700,000 217,500 8,482,500

Current liabilities: Lease liability2

900,000

Long-term liabilities: Lease liability

7,368,000

($432,000 + accrued interest $468,000)

d. January 1, 2023 Buildings under Lease .................................... Prepaid Expenses .......................................... Prepaid Insurance .......................................... Obligations under Lease ......................... Cash .......................................................

8,700,000 125,000 23,000 7,800,000 1,048,000

December 31, 2023 Depreciation Expense3 ................................... 217,500 Accumulated Depreciation—Leased Buildings 3 ($8,700,000 ÷ 40) Interest Expense ............................................. Obligations under Lease .......................... To record interest

468,000

Property Tax Expense ..................................... Insurance Expense......................................... Prepaid Expenses................................... Prepaid Insurance................................... To record expired prepayments

125,000 23,000

217,500

468,000

125,000 23,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.12 (CONTINUED) d(continued) Yin’s SFP at December 31, 2023 would show the following: Property, plant, and equipment Buildings under lease Accumulated depreciation Current liabilities: Current portion of obligations under lease Long-term liabilities: Obligations under lease

$8,700,000 217,500 8,482,500

900,000 7,368,000

LO 4,5,6,8,11 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.13 a.

The lease should be treated as a capital lease by Lee Industries, requiring the lessee to capitalize the leased asset. The lease qualifies for capital lease accounting by the lessee because: (1) title to the engines transfer to the lessee, and (2) the lease term is equal to the estimated life of the asset. While no mention is made of the amount of the fair value of the leased asset at January 1, 2023, it is reasonable to assume that it would be above the cost to manufacture the engines. Lor is in business to manufacture and sell its products, so Lor would want to recover the sales price of the engines, not just their cost. The present value of the minimum lease payments (see below) is $4,500,000 and the assumption is that this is the selling price and fair value of the engines. The transaction represents a purchase financed by instalment payments over a 10-year period. For Lor the transaction is a sales-type lease because a manufacturer’s profit accrues to Lor. This lease arrangement also represents the manufacturer’s financing of the transaction over a period of 10 years. Lease Payment Receivable Payment per period Periods Lease receivable 1. Using Tables: Present Value of Lease Payments $620,956 X 7.246891 1

$ 620,956 X 10 $6,209,560

$4,500,000

Present value of an annuity due at 8% for 10 years

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.13 (CONTINUED) a. (continued) 2.Using a financial calculator: PV I N PMT FV Type

$ ? Yields $4,499,998.53 8% 10 $ (620,956) $ 0 1

3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $4,499,998.53

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.13 (CONTINUED) a. (continued) Unearned Interest Income Lease receivable Less: Present value of lease payments Unearned interest income

$6,209,560 4,500,000 $1,709,560

Dealer Profit Sales revenue (present value of lease payments) Less cost Profit on sale

$4,500,000 3,900,000 $ 600,000

Equipment under Lease ............................. 4,500,000 Obligations under Lease .................... 3,879,044 Cash ................................................ 620,956 To record inception of lease and first lease payment

Lease Receivable .................................... 6,209,560 Cost of Goods Sold.................................. 3,900,000 Sales Revenue ................................. 4,500,000 Inventory .......................................... 3,900,000 Unearned Interest Income ................ 1,709,560 To record inception of lease and cost of goods sold Cash ........................................................ Lease Receivable............................. Collection of lease payment

620,956 620,956

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.13 (CONTINUED) d.

Lee Industries Lor Inc. Lease Amortization Schedule

Date 1/1/23 1/1/23 1/1/24 1/1/25

Annual Lease Payment/ Receipt 620,956 620,956 620,956

Interest Income/ Expense at 8%

Reduction in Present Value of Lease

Present Value of Lease

620,956 310,632 335,483

4,500,000 3,879,044 3,568,412 3,232,929

310,324 285,473

Lessee (December 31, 2023) Interest Expense ...................................... 310,324 Obligations under Lease .................. To record interest Lessor (December 31, 2023) Unearned Interest Income ....................... 310,324 Interest Income ................................ To record interest e.

310,324

LEE INDUSTRIES INC. Statement of Financial Position December 31, 2023

Property, plant, and equipment: Equipment under lease $4,500,000 Less accumulated depreciation1 450,000 $4,050,000

Current liabilities: Obligations under lease2 Long-term liabilities: Obligations under lease2

$620,956 *

3,568,412

**1$4,500,000 ÷ 10 = $450,000 * 2 taken from amortization schedule above

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.13 (CONTINUED) e. (continued) LOR INC. Statement of Financial Position December 31, 2023

Assets: Current assets: Net investment in leases

$ 620,956

Noncurrent assets: Net investment in leases

$3,568,412

Amounts taken from amortization schedule

The transaction securing the equipment using the capital lease would not be reported on the statement of cash flows for the year ended December 31, 2023 of Lee, the lessee. This is a non-cash financing and investing transaction to Lee. These transactions would be described in the notes to the respective financial statements. The only cash transaction between the parties during 2023 is the January 1, 2023 lease payment in the amount of $620,956. This transaction is an operating activity inflow to Lor and is a financing outflow to Lee. For Lee, the annual depreciation for 2023 would be an adjustment to determine cash flow from operations under the indirect approach. For Lor, the operating cash flows would be included in the adjustments to net income under the indirect approach and would be shown as part of cash collected from customers under the direct approach.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.13 (CONTINUED) g.

Note X: (on Lee’s financial statements:) The following is a schedule of future minimum lease payments under the capital lease expiring December 31, 2032 together with the balance of the obligations under capital leases. Year ending December 31 2024 2025 2026 2027 2028 2029 and beyond Total minimum lease payments Less amount representing interest at 8% Balance of the obligations

$620,956 620,956 620,956 620,956 620,956 2,483,824 5,588,604 1,709,560 $3,879,044

Note Y: (on Lor’s financial statements:) The company's future minimum lease payments receivable under the sales-type lease and the net investment in lease are as follows: Year ending December 31 2024 2025 2026 2027 2028 2029 and beyond Total minimum lease payments receivable Unearned income Net investment in lease

$620,956 620,956 620,956 620,956 620,956 2,483,824 $5,588,604 1,399,236 $4,189,368

LO 4,8,9,10,11 BT: AP Difficulty: M Time: 55 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.14 a. 1. Using Tables: PV of monthly payment of $41,000 X 4.169871 ................. $170,964* PV of residual value of $4,000 X .620922 .......................... 2,484 PV of minimum lease payments ........................................ $173,448 1 (PV factor for annuity due for 5 years at 10%) 2 (PV factor for $1 for 5 years at 10%) *rounded by $1 2. Using a financial calculator: PV $ ? Yields $ 173,448.17 I 10% N 5 PMT $ (41,000) FV $ (4,000) Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $173,448.17 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.14 (CONTINUED) b. Dubois Steel Corporation (Lessee) Lease Amortization Schedule (Annuity Due Basis)

Date

Annual Lease Payment

Interest (10%) on Unpaid Liability

Reduction of Lease Liability

Balance of Lease Liability

1/31/23 1/31/23 1/31/24 1/31/25 1/31/26 1/31/27 1/31/28

— $41,000 41,000 41,000 41,000 41,000 4,000

—

— $41,000 27,755 30,531 33,584 36,942 3,636

$173,448 132,448 104,693 74,162 40,578 3,636 0

$ 0 13,245 10,469 7,416 4,058 364

c. January 31, 2023 Right-of-Use Asset........................................ 173,448 Lease Liability ....................................... Cash ..................................................... To record inception of lease and first lease payment

December 31, 2023 Depreciation Expense3 ................................. 22,713 Accumulated Depreciation— Right-of Use Asset ....................................... 3 ($173,448 ÷ 7 X 11/ 12) To record depreciation expense

132,448 41,000

22,713

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.14 (CONTINUED) d. (continued) December 31, 2023 Interest Expense ......................................... 12,141 Lease Liability ....................................... 4 ($13,245 X 11 / 12) To record interest 4

January 31, 2024 Interest Expense ........................................... 1,104 Lease Liability5.............................................. 39,896 Cash ..................................................... 5 ($27,755 + $12,141) To record lease payment During year Insurance Expense ..................................... Repairs and Maintenance Expense ............ Cash ................................................... . To record payment of insurance and repairs

December 31, 2024 Depreciation Expense6 ............................. Accumulated Depreciation— Rightof-Use Asset ................................. 6 ($173,448 ÷ 7) To record depreciation expense December 31, 2024 Interest Expense ..................................... Lease Liability ................................... 7 ($10,469 X 11 ÷ 12) To record interest 7

12,141

41,000

XXX XXX XXX

24,778 24,778

9,597 9,597

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.14 (CONTINUED) e. (continued) January 31, 2025 Interest Expense ($10,469 - $9,597)............. 872 8 Lease Liability .............................................. 40,128 Cash ..................................................... 8 ($9,597 + $30,531) To record lease payment f.

41,000

Dubois Steel Corporation Statement of Financial Position December 31, 2024 Property, plant, and equipment: Right-of-use asset $173,448 Less: Accumulated depreciation 47,491 $125,957

Current liabilities: Lease liability Long-term liabilities: Lease liability

$40,128 74,162

The transaction securing the right-of-use asset would not be reported on the statement of cash flows for the year ended December 31, 2023. This is non-cash investing and financing transaction, which should be described in the notes to the financial statements. The first lease payment would appear as a cash outflow in the financing activities section of the statement. When using the direct method for the operating activities of the cash flow statement, no amounts need to appear. (More specifically, since no cash had been paid relating to 2023 interest on the lease, the amount of interest expense relating to the lease would be adjusted to interest paid ($0). Therefore, no amount would appear on the statement of cash flows). On the other hand, using the indirect method, adjustments to net income would include the adding back of depreciation expense in the amount of $22,713 and the increase in the lease liability for accrued interest in the amount of $12,141.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.14 (CONTINUED) h.

Based on these new facts, the lease would still be accounted as a right-of-use asset and lease liability, although at a lower amount by the present value of the option to buy of $4,000.

LO 5,8 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.15 a. 1. Using tables: Annual lease payment Present value of an annuity due of $1 for 10 periods discounted at 8% Present value of the 10 rental payments Add present value of estimated residual value of $15,000 in 10 years at 8% ($15,000 X .46319) Initial present value 2. Using a financial calculator: PV $ ? Yields $188,120 I 8% N 10 PMT $ (25,000) FV $ (15,000) Type 1

$ 25,000 7.24689 181,172

6,948 $188,120

3. Excel formula =PV(rate,nper,pmt,fv,type)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.15 (CONTINUED) b.

The lease is a sales-type lease because: (1) the lease term is greater than or equal to 75% of the asset’s estimated economic life, (2) collectibility of payments is reasonably assured and there are no further costs to be incurred, and (3) CHL Corporation realized an element of profit aside from the financing charge. 1. Gross investment is $265,000 (10 annual lease payments of $25,000 each, plus the unguaranteed residual value of $15,000). 2. Unearned interest income, $76,880, is the gross investment of $265,000 less $188,120, the initial present value of the investment, calculated in part (a): 3. Sale price is $181,172 (the present value of the 10 annual lease payments); i.e., the initial PV of $188,120 minus the PV of the unguaranteed residual value of $6,948. 4. Cost of goods sold is $98,052 (the $105,000 cost of the asset less the present value of the unguaranteed residual value of $6,948).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.15 (CONTINUED) c.

CHL CORPORATION (Lessor) Lease Amortization Schedule Annuity Due Basis, Unguaranteed Residual Value

Beginning of Year Initial PV 1 2 3 4 5 6 7 8 9 10 End of 10

Annual Lease Payment Plus Residual Value (a) — $ 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 15,000 $265,000

Interest (8%) on Net Investment (b) — — *$ 13,050* * 12,094* * 11,061* * 9,946* * 8,742* * 7,441* * 6,036* * 4,519* * 2,881* * 1,1101 *$76,880*

Net Investment Recovery (c) — $ 25,000 11,950 12,906 13,939 15,054 16,258 17,559 18,964 20,481 22,119 13,890 $188,120

Net Investment (d) $188,120 163,120 151,170 138,264 124,325 109,271 93,013 75,454 56,490 36,009 13,890 0

Rounding error is $1. (a) Annual lease payment required by lease contract. (b) Preceding balance of (d) X 8%, except beginning of first year of lease term. (c) (a) minus (b). (d) Preceding balance minus (c).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.15 (CONTINUED) d. Beginning of Lease Year 1 Lease Receivable ............................................... 265,000 Cost of Goods Sold ............................................ 98,052 Sales Revenue ........................................... Inventory ..................................................... Unearned Interest Income .......................... To record inception of lease and cost of goods sold Selling Expenses ................................................ Cash ........................................................... To record payment of initial direct costs

7,000

Cash .................................................................. Lease Receivable ....................................... Collection of lease payment

25,000

181,172 105,000 76,880

7,000

25,000

End of fiscal year – 5 months after signing lease Unearned Interest Income .................................. 5,438 2 Interest Income .......................................... 2 ($13,050 X 5/12) To record interest

5,438

12 months after signing lease Unearned Interest Income .................................. Interest Income3.......................................... 3 ($13,050 X 7/12) To record interest

7,612

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.15 (CONTINUED) e.

The balance of the net investment should be the net investment of $163,120 plus the interest earned to the end of the year of $5,438, for a total of $168,558. This should be reported as follows: Current portion4 Non-current portion5 Total ($188,120 – $25,000 + $5,438) 4

Lease receivable Less unearned payment ($13,050 – $5,438) Current portion 5 Non-current: Total lease receivable Less unearned ($76,880 – $13,050)

$17,388 151,170 $168,558 $25,000 7,612 $17,388 $215,000 63,830 $151,170

Assuming the $15,000 residual value was guaranteed by the lessee, this would change the initial entry for the sale to be as follows:

Lease Receivable ............................................... 265,000 Cost of Goods Sold ............................................ 105,000 Sales Revenue ........................................... Inventory ..................................................... Unearned Interest Income .......................... To record inception of lease and cost of goods sold

188,120 105,000 76,880

The sales revenue and cost of goods sold would not need to be reduced by the present value of the estimated residual value calculated in part (a) of $6,948.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.15 (CONTINUED) g.

1. Using Tables: The present value of minimum lease payments would be equal to the estimated selling price of $210,482. The annual lease payment would equal $X, and the factor for the present value of an annuity due (Table A.5) at 8% for 12 periods is 8.13896. To obtain a present value of minimum lease payments of $210,482, the annual payment would = (X x 8.13896), so the annual payment would be $25,861. 2. Using a financial calculator: PV $ 210,482 I 8% N 12 PMT $ ? FV $ Type 1

Yields $25,861

3. Excel formula =PMT(nper,pmt,pv,fv,type)

Result: $25,861 rounded LO 9,11 BT: AP Difficulty: C Time: 50 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.16 a.

For ASPE, a classification approach is used. A lease that transfers substantially all the benefits and risks of property ownership should be capitalized. For the lessee, quantitative criteria are assessed to determine the nature and classification of the lease such as: 1. the term of the lease is greater than or equal to 75% of the remaining economic life of the asset, 2. the PV of the minimum lease payments is greater than or equal to 90% of the fair value of the asset, or 3. the presence of a bargain purchase option.

It will be classified as a capital lease for Provincial Airlines Corp. because the lease term is 75% or more of the asset’s economic life (10/12 years = 83%). This is sufficient even though the present value of the minimum lease payments does not exceed 90% of the fair value of the leased asset. ($181,172 / $210,482 < 90%).

The lease would be set up by Provincial Airlines Corp. as a rightof-use asset and lease liability under IFRS as the lease does not qualify for a short-term or low-value exemption.

Initial Obligations Under Leases: 1. Using Tables: Minimum lease payments ($25,000) X PV of an annuity due for 10 periods at 8% (7.24689) 2. Using a financial calculator: PV $ ? I 8% N 10 PMT $ (25,000) FV $ 0 Type 1

$181,172

Yields $181,172

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.16 (CONTINUED) d. (continued) 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $181,172 rounded

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PROBLEM 20.16 (CONTINUED) e.

Provincial Airlines Corp. (Lessee) Lease Amortization Schedule (Annuity due basis and URV)

Beginning of Year

Initial PV 1 2 3 4 5 6 7 8 9 10

Annual Lease Payment

Interest (8%) on Unpaid Obligation

Reduction of Lease Obligation

(a) — $25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 $250,000

(b) — — *$12,494* * 11,493* * 10,413* * 9,246* * 7,985* * 6,624* * 5,154* * 3,567* * 1,852 *$68,828*

Lease Obligation (d) $181,172 156,172 143,666 130,159 115,572 99,818 82,803 64,427 44,581 23,148 0

(a) Annual lease payment required by lease contract. (b) Preceding balance of (d) X 8%, except beginning of first year of lease term. (c) (a) minus (b). (d) Preceding balance minus (c).

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PROBLEM 20.16 (CONTINUED) f.

Lessee’s journal entries:

Beginning of the Year Equipment under Lease ................................... 181,172 Obligations under Lease ........................... Cash ......................................................... To record inception of lease and first lease payment End of the Year Interest Expense .............................................. Obligations under Lease ........................... To record interest Depreciation Expense ...................................... Accumulated Depreciation— Leased Equipment ($181,172 ÷ 10) ....... To record depreciation expense g.

156,172 25,000

12,494 12,494

18,117 18,117

Refer to the calculations and table of P20.15 for the amounts using the guaranteed residual value in the calculations of payments made by the lessee Provincial Airlines Corp.

Beginning of the Year Equipment under Lease ................................... 188,120 Obligations under Lease ........................... Cash ......................................................... To record inception of lease and first lease payment

163,120 25,000

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PROBLEM 20.16 (CONTINUED) g. (continued) End of the Year Interest Expense .............................................. Obligations under Lease ........................... To record interest Depreciation Expense1 ..................................... Accumulated Depreciation—Leased Equipment ............................................ 1 [($188,120 - $15,000) ÷ 10] To record depreciation expense h.

13,050 13,050

17,312 17,312

The residual value of $45,000 will not be included in calculation of the present value of the minimum lease payments. Rather, the bargain purchase option of $15,000 will be the future outflow in the calculations below. The bargain purchase option will permit depreciation of the equipment over its economic life of 12 years. Using a financial calculator: PV $ ? I 8% N 10 PMT $ (25,000) FV $ (15,000) Type 1

Yields $188,120

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.16 (CONTINUED) h. (continued) Excel formula =PV(rate,nper,pmt,fv,type)

Result: $188,120 rounded Beginning of the Year Equipment under Lease ................................... 188,120 Obligations under Lease ........................... Cash ......................................................... To record inception of lease and first lease payment

163,120 25,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.16 (CONTINUED) h. (continued) End of the Year Interest Expense ............................................. Obligations under Lease ........................... 2 [($188,120 - $25,000) X 8%] To record interest 2

Depreciation Expense3 ..................................... Accumulated Depreciation—Leased Equipment ........................................... 3 [$188,120 ÷ 12]) To record depreciation expense

13,050 13,050

15,677 15,677

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PROBLEM 20.16 (CONTINUED) i. Guaranteed residual value Capitalization of lease: Equipment under Lease Obligations under Lease Cash

188,120

End of year: Interest Expense Obligations under Lease

13,050

Depreciation Expense Accumulated Depreciation— Leased Equipment

Unguaranteed residual value 181,172

163,120 25,000

Equipment under Lease Obligations under Lease Cash

12,494

13,050

Interest Expense Obligations under Lease

18,117

15,667

Depreciation Expense Accumulated Depreciation— Leased Equipment

15,667

LO 4,6 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

156,172 25,000

12,494

18,117

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PROBLEM 20.17 a.

Present value of minimum lease payments: 1. Using Tables: 1. Present value of annual payments of $50,000 made at the beginning of each period for 10 years, $50,000 X 6.75902 (PV of an annuity due at 10%)

$337,951

2. Present value of guaranteed residual value, $15,000 X .38554 (PV of $1, 10 years at 10%) Present value of minimum lease payments

5,783 $343,734

2. Using a financial calculator: PV $ ? Yields $343,734 I 10% N 10 PMT $ (50,000) FV $ (15,000) Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

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PROBLEM 20.17 (CONTINUED) b.

Jennings needs to determine that the risks and benefits of ownership of the leased property are transferred. These factors include: 1. There is reasonable assurance that the lessee will obtain ownership of the leased property. In this case, the residual value is guaranteed by the lessee. 2. The lessee will benefit from most of the asset use due to the length of the lease term, which is substantially all of the leased property's economic life. 3. The lessor recovers substantially all its investment and earns a return on that investment. Jennings is a manufacturer and consequently the signing of the lease involves the sale of inventory and the financing of the customer’s purchase. The lease is therefore a manufacturer or dealer lease to Jennings. 1. Gross investment: Lease payments of $50,000 made at the beginning of each year for 10 years Guaranteed residual value due at the end of 10 years Gross investment 2. Sale price is the same as the present value of minimum lease payments 3. Unearned interest income: Gross investment Less: Fair value of the X-ray machine Unearned interest income 4. Cost of goods sold is the cost of manufacturing the X-ray machine

$500,000 15,000 $515,000 $343,734 $515,000 343,734 $171,266

$210,000

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PROBLEM 20.17 (CONTINUED) c.

JENNINGS INC. (Lessor) Lease Amortization Schedule (Annuity due basis, guaranteed residual value)

Beginning of Year Initial PV 1 2 3 4 5 6 7 8 9 10 End of 10

Annual Lease Payment Plus Residual Value $ 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 15,000 $515,000

Interest Net (10%) on Net Investment Investment Recovery — *$ 29,373* * 27,311* * 25,042* * 22,546* * 19,801* * 16,781* * 13,459* * 9,805* * 5,785* * 1,3631 *$171,266*

$ 50,000 20,627 22,689 24,958 27,454 30,199 33,219 36,541 40,195 44,215 13,637 $343,734

Net Investment $343,734 293,734 273,107 250,418 225,460 198,006 167,807 134,588 98,047 57,852 13,637 0

Rounding error is $1.

Lessor’s journal entries:

Beginning of the Year Lease Receivable ............................................... 515,000 Cost of Goods Sold ............................................ 210,000 Sales Revenue ........................................... Inventory ..................................................... Unearned Interest Income .......................... To record inception of lease and cost of goods sold Selling Expenses .................................................. 14,000 Cash/Accounts Payable ................................ To record payment of initial direct costs

343,734 210,000 171,266

14,000

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PROBLEM 20.17 (CONTINUED) d. (continued) Cash..................................................................... 50,000 Lease Receivable ......................................... Collection of lease payment End of the Year Unearned Interest Income .................................... 29,373 Interest Income ............................................. To record interest e.

50,000

29,373

At December 31, the end of the first year of the lease, Jennings Inc. will report on the income statement the sales revenue amount of $343,734 and cost of goods sold of $210,000, indicating gross profit from the sale of the X-ray equipment in the amount of $133,734. They will also report the interest income on the lease of $29,373 and selling expenses of $14,000. The SFP would report the current portion of the lease receivable of $50,000 and the non-current portion of $415,000, reduced by the current portion of the unearned interest income on the lease in the amount of $27,311 and the non-current portion for $114,582. For the statement of cash flows, using the indirect format for the cash flow from operations, there will be an adjustment of an addition to income for the reduction of inventory of $210,000 and an addition for the net increase in unearned income of $141,893 ($171,266 – $29,373). For investing activities, the statement will show a net increase in lease payments receivable of $465,000 ($515,000 – $50,000). In addition, interest received in cash should be reported either under operating activities or under investing activities, separately from the principal lease payment.

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PROBLEM 20.17 (CONTINUED) e. (continued) For note disclosure, the list of required and desirable disclosures would include the total future minimum lease payments receivable, unguaranteed residual values, unearned finance income, executory costs included in minimum lease payments, contingent rentals taken into income, lease terms, and the amounts of minimum lease payments receivable for each of the next five years.

Since the implicit rate in the lease of 10% is known to the lessee, SNC Medical Centre, the interest rate used by SNC will be the same as that of the lessor, Jennings Inc. Consequently, the machinery will be capitalized at the amount of $343,734, the present value of the minimum lease payments as calculated in (a) above. The depreciation of the machinery will be based on the term of the lease as SNC has guaranteed the residual value. The depreciation expense will therefore be $32,873 (($343,734 $15,000) / 10 years).

If the residual value of the X-ray machine not been guaranteed, the amount of the sale and the cost of goods sold recorded would have been reduced by the present value of the residual value in the amount of $5,783 ($15,000 X .38554 for PV of $1, for 10 years at 10%). Using a financial calculator: PV $ ? Yields $5,783 I 10% N 10 PMT $ 0 FV $ 15,000 Type 1

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.17 (CONTINUED) g. (continued) Using Excel formula =PV(rate,nper,pmt,fv,type)

Result: $5,783 rounded From the perspective of the lessor, the entries concerning the recording of the lease receivable do not change, except as noted above, since the lessor assumes the residual value will be recovered whether or not that amount is guaranteed by the lessee. Consequently, the amount of interest accrued at the end of the year will be the same amount as given in (c). The financial statements of the lessor remain unaffected with the exception of the reduction of $5,783 for the sales revenue and cost of goods sold amounts on the income statement.

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PROBLEM 20.17 (CONTINUED) g. (continued) From the perspective of the lessee, the amount used to capitalize the machinery will exclude the residual value, since the lessee does not guarantee that amount. Using the same variables as in (a) above but excluding the residual value yields an amount of $337,951. The depreciation expense will therefore be $33,795 ($337,951 / 10 years). h.

Had Jennings been using ASPE, quantitative factors would apply. The lease is a sales-type lease because: (1) the lease term is for 83% (10 ÷ 12) of the economic life of the leased asset, (2) the present value of the minimum lease payments exceeds 90% of the fair value of the leased property, (3) the collectibility of the lease payments is reasonably predictable and no uncertainties exist as to unreimbursable costs yet to be incurred by the lessor, and (4) the lease provides the lessor with manufacturer’s profit in addition to interest income.

LO 9,11,13 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 20.18 a.

Green Finance Corporation, the lessor, needs to determine that the risks and benefits of ownership of the leased property are transferred. These factors include: • There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term. If there is a purchase option in the lease, Green needs to determine that it is reasonably certain that the purchase option will be exercised by the lessee. • The lease term is long enough that the lessee will receive substantially all the economic benefits that are expected to be derived from using the leased property over its life. This criterion appears to have been met since the lease is for 8 years (vs. an economic life of 10 years). • The lease allows the lessor to recover substantially all its investment in the leased property and to earn a return on the investment. Evidence of this is provided if the present value of the minimum lease payments is close to the fair value of the leased asset. • The leased assets are so specialized that, without major modification and significant cost to the lessor, they are of use only to the lessee. Green would treat the lease as a finance-type lease. In this case, the lease would be set up by Lanier Dairy Ltd. as a right-of-use asset and lease liability under IFRS as the lease does not qualify for a short-term or low-value exemption lease.

1. Using tables: $30,000 X 6.582381 $23,000 X .627412 1 2

= $197,471.40) = 14,430.43) = $211,901.83

PV factor of annuity due at 6% for 8 years PV factor of $1 at 6% for 8 years

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.18 (CONTINUED) a. (continued) 2. Using a financial calculator: PV $ ? Yields $211,901.93 I 6% N 8 PMT $ (30,000) FV $ (23,000) Type 1 3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $211,901.93 rounded b. May 30, 2023 Lessee: Right-of-Use Asset .......................................... Lease Liability .......................................... Cash ........................................................ To record inception of lease and first payment

211,902 181,902 30,000

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PROBLEM 20.18 (CONTINUED) b. (continued) May 30, 2023 Lessor: Lease Receivable3 .......................................... Equipment Acquired for Lessee ............... Unearned Interest Income ....................... 3 ($263,000 = 8 X $30,000 + $23,000 for residual value) To record inception of lease Cash................................................................ Lease Receivable .................................... Collection of lease payment

263,000 211,902 51,098

30,000 30,000

December 31, 2023 Lessee: Interest Expense4 ............................................ Lease Liability .......................................... 4 ($181,902 X .06 X 7/12) To record interest Depreciation Expense5 .................................... Accumulated DepreciationRight-of-Use Asset ............................... 5 [($211,902 – $23,000) ÷ 8 X 7/12] To record depreciation expense

6,367 6,367

13,774 13,774

December 31, 2023 Lessor: Unearned Interest Income ............................... Interest Income ........................................ To record interest

6,367 6,367

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PROBLEM 20.18 (CONTINUED) c. May 30, 2024 Lessee: Lease Liability ($30,000 - $4,547) ................... Interest Expense6 ............................................ Cash ........................................................ 6 [($211,902 – $30,000) X .06 X 5/12] To record lease payment Lessor: Unearned Interest Income ............................... Interest Income ........................................ To record interest Cash................................................................ Lease Receivable .................................... Collection of lease payment d.

30,000

4,547 4,547

30,000 30,000

(1) and (2) are both $197,471, as the lessee has no obligation to pay the residual value. Using a financial calculator: PV $ ? I 6% N 8 PMT $ (30,000) FV $ 0 Type 1

25,453 4,547

Yields $197,471.44

In the case of (1), the amount of the net investment at the inception of the lease would be $211,902 + $1,200 or $213,102. For (2) and (3), both would be $211,902, as the estimated residual value exists whether or not it is guaranteed.

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PROBLEM 20.18 (CONTINUED) f.

The present value of the residual would have to be at least 10% of the fair value of the leased asset or 10% X $211,902 = $21,190.20. The future value of this lump sum (n=8, i=6) = $21,190.20 X 1.59385 or $21,190.20/.62741, both of which = $33,774. Using a financial calculator: PV $ 21,190 I 6% N 8 PMT $ 0 FV $? Type 1

Yields $33,773.64

Excel formula: =FV(rate,nper,pmt,pv,type)

Result: $33,773.64 rounded

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PROBLEM 20.18 (CONTINUED) g.

Lanier would determine if the risks and benefits are transferred with the lease. There are three criteria to test. If the lease satisfies one or more of them, it is a capital lease. The lease does not meet the first criterion – title does not transfer and there is no BPO. The lease meets the second criterion – the lease term of 8 years is more than 75% of the equipment’s 10-year economic life. The lease also meets the third criterion – the present value of the minimum lease payments ($211,902) is greater than 90% of the fair value of the equipment. All three criteria are met and therefore, the lease is classified as a capital lease.

LO 9,11,12 BT: AP Difficulty: C Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 20.19 Memorandum Prepared by: Date:

(Your Initials)

Fram Fibreglass Corp. (FFC) Assessing Leasing Proposals Industrial Development Bank (IDB) vs. Municipal Finance Corp. (MFC) The purpose of this memorandum is to outline the analysis and recommendations concerning leasing alternatives obtained from IDB and MFC. The objective is to lease equipment with a current selling price of $50,000 for a term of 5 years. Both proposals require that the equipment be returned to the lessor at the end of the term. Both lease terms start and end at approximately the same dates. The terms of the leases differ in other respects, which will result in alternate accounting treatments on the books of FFC. MFC – proposal: To FFC, this lease is a capital lease because the terms satisfy the following criteria: 1. The present value of the minimum lease payments is roughly equal to the fair value of the leased asset; that is, the present value of $50,002 (see below) is 100% of the fair value of the leased asset. 2. The lease fails in the second criteria concerning the presence of a bargain purchase option. 3. The lease also fails the third capitalization criteria in that the lease term is not greater than or equal to 75% of the economic life of the leased asset; that is, the lease term is 71% (5/7) of the economic life of the equipment. Note that in this case, since there is no interest rate mentioned in the lease proposal, FFC must impute the company’s incremental borrowing rate of 15%. Solutions Manual 20-218 Chapter 20 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 20.19 (CONTINUED) Using a financial calculator: PV $? I 15% N 5 PMT $ (11,681) FV $ (10,000) Type 1

Yields $ 50,002

IDB - proposal: IDB is providing an operating lease to FFC since the lease term (5 years) is less than 75% of the economic life (7 years) of the leased asset. The lease term is 71.4% (5 ÷ 7) of the asset’s economic life. There is no bargain purchase option and the present value of minimum lease payments of $44,330 (see below) represents 88.7% of the fair value at April 23, 2023 of $50,000, falling short of the criteria of 90% to treat the lease as a capital lease. Using a financial calculator: PV $ ? I 12% N 5 PMT $ (10,980)1 FV $ 0 Type 1 1

Yields $ 44,330

Rental payment of $12,000 less $1,020 in executory costs.

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PROBLEM 20.19 (CONTINUED) Let us contrast the charges to the income statement for a typical lease year as well as look at the cash outflows (direct method) and SFP balances at the end of the first lease year. The table below assumes a 12-month period from the inception of the lease to eliminate any differences caused by different start dates. MFC Capital Lease Statement of financial position: Property, Plant, and Equipment: Equipment under lease Less: Accumulated depreciation

IDB Operating Lease

50,000 (8,000) (1) 42,000

Current Liabilities Current portion of obligations under lease Long-term liabilities Obligations under lease Less: Current portion Statement of income: Rent expense Depreciation expense Interest expense Other operating costs

Statement of cash flows: Cash paid for lease

11,681 (2) 44,067 (11,681) (2) 32,386 $ 10,980 $ 8,000 5,748 300 $ 16,048

1,020 $12,000

$ (11,981)

$ (12,000)

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PROBLEM 20.19 (CONTINUED) (1) ($50,000 - $10,000) / 5 (2), (3), and (4) – See amortization schedule MFC Lease Lease Amortization Schedule

Date May. 1, 2023 May. 1, 2024 May. 1, 2025 May. 1, 2026 May. 1, 2027 May. 1, 2028 Apr. 30, 2028

Annual Payment Excl. Exec. Costs $ 11,681.00 11,681.00 (2) 11,681.00 11,681.00 11,681.00 10,000.00 $ 68,405.00

Interest (15%) On Unpaid Obligation

$5,747.85 4,857.88 3,834.41 2,657.42 1,307.44 $18,405.00

Reduction of Lease Obligation

$11,681.00 5,933.15 6,823.12 7,846.59 9,023.58 8,692.56 $50,000.00

Balance of Lease Obligation $50,000.00 38,319.00 32,385.85 25,562.73 17,716.14 8,692.56 -

* final interest amount rounded by $3.56 to balance

Based on the analysis above, my recommendation is for FFC to choose the operating lease with IDB because: 1. Although the cash outflows are practically identical, the charges to the income statement are 17% lower with the operating lease. 2. Given the current financial situation of FFC concerning liquidity, the capital lease would adversely affect the current ratio. 3. Additional debt on the SFP will not be viewed well by FFC’s creditors if the capital lease alternative offered by MFC were selected. Choosing this alternative would be violating the stipulation of Royal Montreal Bank that FFC not increase the debt-to-equity ratio above the current levels.

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PROBLEM 20.19 (CONTINUED) Note to Instructor: Some students will treat this as a capital budgeting problem and compare the present value of the cash flows of the two alternatives. It may be useful when assigning the problem to remind the students to write the report based on financial reporting considerations. LO 4,8 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 20.20 a.

For the purpose of calculating the lease payment that will yield a 12% return to Galt, the residual value guaranteed by a third party will be included in the calculations below: 1. Using tables: Fair value of leased asset to lessor Less: PV of guaranteed residual value $100,000 X .45235 (PV of 1 at 12% for 7 periods) Amount to be recovered through lease payments Five periodic lease payments $369,765 ÷ 5.11141 PV of annuity due of 1 for 7 periods at 12%.

$415,000

45,235 $369,765 $72,341.10

2.Using a financial calculator: PV I N PMT FV Type

$ (415,000) 12% 7 $ ? $ 100,000 1

Yields $72,341.15

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PROBLEM 20.20 (CONTINUED) a. (continued) 3. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $72,341.15 rounded

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PROBLEM 20.20 (CONTINUED) b. Galt Manufacturing Ltd. (Lessor) Lease Amortization Schedule

Date 5/2/23 5/2/23 5/2/24 5/2/25 5/2/26 5/2/27 5/2/28 5/2/29 5/2/30

Annual Lease Payment Plus RV

$ 72,341 72,341 72,341 72,341 72,341 72,341 72,341 100,000 $606,387

Interest (12%) on Net Investment

$41,119 37,372 33,176 28,476 23,213 17,317 10,714 $191,387

Net Investment Recovery

$ 72,341 31,222 34,969 39,165 43,865 49,128 55,024 89,286 $415,000

Balance of Net Investment $415,000 342,659 311,437 276,468 237,303 193,438 144,310 89,286 0

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PROBLEM 20.20 (CONTINUED) c. 5/2/23

Cash ................................................... 72,341 Lease Receivable1................................. 534,046 Cost of Goods Sold ............................... 327,500 Sales Revenue ............................. 415,000 Inventory ...................................... 327,500 Unearned Interest Income ............ 191,387 1 ($72,341 X 6) +$100,000 To record inception of lease and cost of goods sold

12/31/23 Unearned Interest Income ..................... 27,413 Interest Income2 .......................... 2 [($415,000 – $72,341) X .12 X 8/12] To record interest 5/2/24

5/2/24

Unearned Interest Income ..................... 13,706 Interest Income3 .......................... 3 [($415,000 – $72,341) X .12 X 4/12] To record interest Cash ..................................................... 72,341 Lease Receivable ....................... Collection of lease payment

12/31/24 Unearned Interest Income ..................... 24,915 Interest Income4 .......................... 4 [($415,000 – $72,341 - $31,222) X .12 X 8/12] To record interest 5/2/25

5/2/25

Unearned Interest Income ..................... 12,457 Interest Income5 .......................... 5 [($415,000 – $72,341 - $31,222) X .12 X 4/12] To record interest Cash...................................................... 72,341 Lease Receivable ....................... Collection of lease payment

27,413

13,706

72,341

24,915

12,457

72,341

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.20 (CONTINUED) d. As at and for the period ended December 31, 2023 Statement of Financial Position: Current assets Net investment in leases $ 72,341 Noncurrent assets (investments)6 6

297,731

($342,659 + $27,413 - $72,341 current)

Income Statement: Sales revenue Cost of goods sold Gross profit Interest income

$ 415,000 327,500 87,500 27,413

Statement of Cash Flows: Operating Activities: Cash received for lease

$ 72,341

The lease would be set up by Mulholland Corp. as a right-of-use asset and lease liability under IFRS as the lease does not qualify for a short-term or low-value exemption lease: Using a financial calculator: PV $ ? Yields $369,764 I 12% N 7 PMT $ 72,341 FV $0 Type 1

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.20 (CONTINUED) f. Mulholland Corp. Lease Amortization Schedule (Lessee) Annual Lease Payments

Date

May 2, 2023 May 2, 2024 May 2, 2025 g. 5/2/23

$72,341 72,341 72,341

Interest (12%) on Unpaid Liability

Reduction of Lease Liability

Balance of Lease Liability

$72,341 36,650 41,048

$369,764 297,423 260,773 219,725

$35,691 31,293

Right-of-Use Asset .......................... Lease Liability ............................ Cash .......................................... To record inception of lease

During 2023: Repairs and Maintenance Expenses Cash .......................................... Payment for repairs

369,764 297,423 72,341

10,000 10,000

12/31/23 Interest Expense7 ............................ Lease Liability ............................ 7 ($35,691 X 8/12) To record interest

23,794

12/31/23 Depreciation Expense8 ................... Accumulated DepreciationRight-of-Use Asset..................... 8 ($369,764 ÷ 7 X 8/12) To record depreciation expense

35,216

23,794

35,216

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.20 (CONTINUED) g. (continued) Fiscal year ended December 31, 2024: During 2024: Repairs and Maintenance Expenses 14,400 Cash .......................................... Payment for repairs 5/2/24

Lease Liability ................................. Interest Expense9 ............................ Cash .......................................... 9 ($35,691 X 4/12) To record lease payment

60,444 11,897

12/31/23 Interest Expense10 ........................... Lease Liability ............................ 10 ($31,293 X 8/12) To record interest

20,862

12/31/24 Depreciation Expense 11 .................. Accumulated DepreciationRight-of-Use Asset..................... 11 ($369,764 ÷ 7) To record depreciation expense

52,823

72,341

20,862

52,823

Fiscal year ended December 31, 2025: During 2025: Repairs and Maintenance Expenses 14,950 Cash .......................................... Payment for repairs 5/2/25

Lease Liability ................................. Interest Expense12 ........................... Cash .......................................... 12 ($31,293 X 4/12) To record lease payment

14,400

14,950

61,910 10,431 72,341

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.20 (CONTINUED) h. As at and for the period ended December 31, 2023 Statement of Financial Position: Property, Plant, and Equipment: Right-of-use asset $ 369,764 Less: Accumulated depreciation __35,216 334,548 Current Liabilities Lease liability 72,341 Long-term liabilities Lease liability13 248,876 Statement of Income: Depreciation expense Repairs and maintenance expenses Interest expense Statement of Cash Flows: Operating Activities: indirect Depreciation expense Increase in lease liability for interest accrued Financing Activities: Cash paid for lease 13

$ 35,216 10,000 23,794

35,216 23,794 $ (72,341)

($297,423 + $23,794 - $72,341 current)

When both companies follow IFRS, the asset is on the SFP of the lessee, where it belongs in an economic sense.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.20 (CONTINUED) j.

Because Mulholland Corp. is now assumed to follows ASPE, it would account for the lease as an operating lease since: Using a financial calculator: PV $ ? Yields $369,764 I 12% N 7 PMT $ 72,341 FV $0 Type 1 The lease term (7 years) is less than 75% of the economic life (10 years) of the leased asset. The lease term is 70% (7 ÷ 10) of the asset’s economic life. There is no bargain purchase option and the present value of minimum lease payments of $72,341 represents 89% ($369,764 / $415,000) of the $415,000 fair value at May 2, 2023, falling short of the criteria of 90% to treat the lease as a capital lease. Fiscal year ended December 31, 2023: During 2023: Repairs and Maintenance Expenses Cash .......................................... Payment for repairs

5/2/23

Prepaid Rent .................................. Cash .......................................... Payment for rent

12/31/23 Rent Expense 14 .............................. Prepaid Rent................................. 14 ($72,341 X 8/12) To record expired rent

10,000 10,000

72,341 72,341

48,227 48,227

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.20 (CONTINUED) j. (continued) Fiscal year ended December 31, 2024: During 2024: Repairs and Maintenance Expenses Cash .......................................... Payment for repairs 5/2/24

5/2/24

14,400 14,400

Rent Expense 15 .............................. Prepaid Rent................................. 15 ($72,341 X 4/12) To record expired rent

24,114

Prepaid Rent .................................. Cash .......................................... Payment for rent

72,341

12/31/24 Rent Expense 16 .............................. Prepaid Rent................................. 16 ($72,341 X 8/12) To record expired rent

24,114

72,341

48,227 48,227

Fiscal year ended December 31, 2025: During 2025: Repairs and Maintenance Expenses Cash .......................................... Payment for repairs 5/2/25

5/2/25

14,950 14,950

Rent Expense17 ............................... Prepaid Rent................................. 17 ($72,341 X 4/12) To record expired rent

24,114

Prepaid Rent .................................. Cash ........................................ Payment for rent

72,341

24,114

72,341

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.20 (CONTINUED) j. (continued) As at and for the period ended December 31, 2023 Statement of financial position: Current assets: Prepaid rent $ 24,114 Statement of Income: Rent expense Repairs and maintenance expenses

$ 48,227 10,000

Statement of cash flows: Operating Activities: Cash paid for lease

$ (72,341)

In this set of circumstances, the equipment is on neither the lessor’s (Galt’s) nor the lessee’s (Mulholland’s) statements of financial position. The equipment should likely be on the SFP of the lessee as they have avoided recording the lease as a capital lease by involving a third party in the guaranteed residual value. In this case, the present value of minimum lease payments represents 89% of the fair value of the asset. This is very close to the 90% capitalization criteria guideline. The 90% criterion is not an absolute rule and therefore accountants should look beyond the numbers to the substance of the transaction to determine the accounting treatment of the lease; in this case, capitalization of the lease may be a more meaningful presentation. LO 3,4,5,6,8,9 BT: AP Difficulty: C Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 a.

Option 1: 1. Using a financial calculator: PV I N PMT FV Type 1 7%÷4

$79,000 1.75%1 20 ? $0 0

Yields $4,715.61

2. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $4,715.61 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) a. Option 1: (continued) 2. Sanderson Inc. Instalment Note Payable Amortization Schedule Effective Note Interest Principal Payment (1.75%) Reduction 1/1/23 1/4/23 1/7/23 1/10/23 1/1/24 1/4/24 1/7/24 1/10/24 1/1/25 1/4/25 1/7/25 1/10/25 1/1/26 1/4/26 1/7/26 1/10/26 1/1/27 1/4/27 1/7/27 1/10/27 1/1/28

$4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61 4,715.61

$ 1,382.50 1,324.17 1,264.82 1,204.43 1,142.99 1,080.47 1,016.85 952.12 886.26 819.25 751.06 681.68 611.09 539.26 466.17 391.81 316.14 239.15 160.81 81.10 $15,312.13

$3,333.11 3,391.44 3,450.79 3,511.17 3,572.62 3,635.14 3,698.76 3,763.48 3,829.35 3,896.36 3,964.55 4,033.92 4,104.52 4,176.35 4,249.43 4,323.80 4,399.47 4,476.46 4,554.79 4,634.50

Carrying Amount $79,000.00 75,666.89 72,275.46 68,824.67 65,313.50 61,740.88 58,105.73 54,406.98 50,643.49 46,814.15 42,917.79 38,953.24 34,919.32 30,814.80 26,638.45 22,389.02 18,065.22 13,665.75 9,189.30 4,634.50 0.00

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) a. Option 1: (continued) 3. January 1, 2023 Vehicles ...................................................... 79,000.00 Notes Payable..................................... 79,000.00 April 1, 2023 Interest Expense ......................................... 1,382.50 Notes Payable ............................................ 3,333.11 Cash ................................................... December 31, 2023 Interest Expense ......................................... 1,204.43 Interest Payable .................................. To record interest

4,715.61

1,204.43

December 31, 2023 Depreciation Expense ............................... 13,800.00 Accumulated Depreciation – Vehicles . 13,800.00 under Lease [($79,000 – $10,000) ÷ 5] To record depreciation expense b.

Option 2: 1. BMW Canada calculates the lease payments using a two-step approach. The first step involves the calculation of the lease payments for the original lease period of 36 months beginning January 1, 2023. For this lease, the recoverable amount of 50% of the fair value of the car on January 1, 2023 is used for the future value, at the end of the three-year period.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. Option 2: (continued) 1. Using a financial calculator: PV $(79,000) I 0.5%2 N 36 PMT ? Yields $ 1,392.21 3 FV $39,500 Type 1 2 6% ÷ 12 3 ($79,000 X 50% = $39,500) 2. Excel formula =PMT(rate,nper,pv,fv,type)

Result: $1,392.21 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. Option 2: (continued) The second step is the calculation of the lease payments for the lease renewal period of 24 months beginning January 1, 2026. Although the fair value of the car at January 1, 2028 of $10,000 is not guaranteed, it is used in the calculation of the lease amortization schedule by the lessor, BMW Canada. As well, although there is a small probability that Sanderson will incur additional kilometre charges for exceeding the limits set in the lease, these penalties are not included in the calculation. Excel formula =PMT(rate,nper,pv,fv,type) PV $(39,500) I 0. 5833%4 N 24 PMT ? Yields $1,371.12 FV $10,000 Type 1 4 7% ÷ 12 2. The lease is an operating lease to Sanderson because: a) it does not transfer ownership, nor does it contain a bargain purchase option, b) it does not cover at least 75% of the estimated economic life of the car, (3 ÷ 8 = 37.5%) and c) the present value of the lease payments of $45,992* is not at least 90% of the fair value of the car.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. Option 2: (continued) Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? * Yields $45,992.17 I .5% N 36 PMT $ 1,392.21 FV 0 Type 1 At least one of the three criteria would have had to be satisfied for the lease to be classified as other than an operating lease. 3. ASPE assumes that the risks and benefits of ownership are normally transferred to the lessee, and the lessee should classify and account for the arrangement as a capital lease if any one or more of the following criteria is met: a) There is reasonable assurance that the lessee will obtain ownership of the leased property, including through a bargain purchase option. b) The lessee will benefit from most of the asset benefits due to the length of the lease term. In addition, a numerical threshold is included: this is usually assumed to occur if the lease term is 75% or more of the leased property's economic life. c) The lessor recovers substantially all of its investment and earns a return on that investment. In addition, a numerical threshold is included: this is usually assumed if the present value of the minimum lease payments is equal to 90% or more of the fair value of the leased asset.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. (continued) Including the renewal period, Sanderson is using the car for 5 of its 8 years of economic life. This translates to 62.5% and so the 75% threshold is not reached. There is no option to bargain purchase option during the initial or renewal terms of the lease with BMW Canada. The present value of the minimum lease payments paid by Sanderson Inc. is $71,730.00 calculated as follows, in a three-step approach: The first step is for the renewal period of 2 years: Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $30,800.16 I 0.5833%5 N 24 PMT 1,371.00 FV $ 0 Type 1 5 7 % ÷ 12 The second step is to calculate the present value of the amount arrived in the first step back to January 1, 2023 for a period of 3 years.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. (continued)

Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $25,738.00 I 0.5%* N 36 PMT 0 FV $ 30,800.16 Type 1 * 6% ÷ 12 The third step is for the calculation of the present value of the initial lease payments by Sanderson Inc. 3. (continued) Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $45,992.17 I 0.5%* N 36 PMT $1,392.21 FV $ 0 Type 1 *6% ÷ 12

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. (continued)

Add the present value of the lease renewal to the present value of the initial lease Present value of the minimum lease payments Rounded to $71,730

$25,738.00 45,992.17 $71,730.17

Present value of the minimum lease payments divided by the fair value of the asset $71,730 ÷ $79,000 = 90.8% and so the lease is a capital lease to Sanderson Inc. 4. Sanderson Inc. Lessee Lease Amortization Schedule Interest Reduction Lease on Unpaid of Lease Obligation Payment (.5%) Obligation

Date Jan. Feb. Mar Apr. May June July

1, 1, 1, 1, 1, 1, 1,

2023 2023 2023 2023 2023 2023 2023

$1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21

$351.69 346.49 341.26 336.00 330.72 325.41

$1,392.21 1,040.52 1,045.72 1,050.95 1,056.21 1,061.49 1,066.80

Balance of Lease Obligation $71,730.00 70,337.79 69,297.27 68,251.55 67,200.59 66,144.39 65,082.90 64,016.10

Kieso, Weygandt, Warfield, Wiecek, McConomy

PROBLEM 20.21 (CONTINUED) b. 4. (continued) Lease Date Aug. 1, Sep. 1, Oct 1, Nov. 1, Dec. 1, Jan. 1, Feb. 1, Mar 1, Apr. 1, May 1, June 1, July 1, Aug. 1, Sep. 1, Oct 1, Nov. 1, Dec. 1, Jan. 1, Feb. 1, Mar 1, Apr. 1, May 1, June 1, July 1, Aug. 1, Sep. 1, Oct 1, Nov. 1, Dec. 1, Jan. 1,

2023 2023 2023 2023 2023 2024 2024 2024 2024 2024 2024 2024 2024 2024 2024 2024 2024 2025 2025 2025 2025 2025 2025 2025 2025 2025 2025 2025 2025 2026

Payment 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21

Intermediate Accounting, Thirteenth Canadian Edition

Interest on Unpaid Obligation (.5%) 320.08 314.72 309.33 303.92 298.48 293.01 287.51 281.99 276.44 270.86 265.25 259.62 253.95 248.26 242.54 236.79 231.02 225.21 219.38 213.51 207.62 201.70 195.74 189.76 183.75 177.71 171.63 165.53 159.40 153.41

Reduction of Lease

Balance of Lease

Obligation 1,072.13 1,077.49 1,082.88 1,088.29 1,093.73 1,099.20 1,104.70 1,110.22 1,115.77 1,121.35 1,126.96 1,132.59 1,138.26 1,143.95 1,149.67 1,155.42 1,161.19 1,167.00 1,172.83 1,178.70 1,184.59 1,190.51 1,196.47 1,202.45 1,208.46 1,214.50 1,220.58 1,226.68 1,232.81 (153.41)

Obligation 62,943.97 61,866.48 60,783.61 59,695.31 58,601.58 57,502.38 56,397.68 55,287.46 54,171.69 53,050.33 51,923.38 50,790.78 49,652.53 48,508.58 47,358.91 46,203.50 45,042.30 43,875.31 42,702.47 41,523.77 40,339.18 39,148.67 37,952.20 36,749.75 35,541.29 34,326.79 33,106.21 31,879.53 30,646.72 30,800.13

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. (continued) 4. (continued) Lease Date Jan. 1, Feb. 1, Mar 1, Apr. 1, May 1, June 1, July 1, Aug. 1, Sep. 1, Oct 1, Nov. 1, Dec. 1, Jan. 1, Feb. 1, Mar 1, Apr. 1, May 1, June 1, July 1, Aug. 1, Sep. 1, Oct 1, Nov. 1, Dec. 1,

2026 2026 2026 2026 2026 2026 2026 2026 2026 2026 2026 2026 2027 2027 2027 2027 2027 2027 2027 2027 2027 2027 2027 2027

Payment 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 1,371.00 $83,023.56

Interest on Unpaid Obligation (.5%) 171.67 164.67 157.64 150.56 143.44 136.28 129.08 121.83 114.55 107.22 99.84 92.43 84.97 77.47 69.92 62.33 54.70 47.02 39.30 31.53 23.72 15.86 7.85 $11,293.56

Reduction of Lease

Balance of Lease

Obligation 1,371.00 1,199.33 1,206.33 1,213.36 1,220.44 1,227.56 1,234.72 1,241.92 1,249.17 1,256.45 1,263.78 1,271.16 1,278.57 1,286.03 1,293.53 1,301.08 1,308.67 1,316.30 1,323.98 1,331.70 1,339.47 1,347.28 1,355.14 1,363.15

Obligation 29,429.13 28,229.80 27,023.48 25,810.12 24,589.67 23,362.11 22,127.39 20,885.47 19,636.30 18,379.85 17,116.06 15,844.91 14,566.33 13,280.31 11,986.77 10,685.70 9,377.03 8,060.73 6,736.75 5,405.05 4,065.58 2,718.29 1,363.15 0.00

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) b. (continued) 5. January 1, 2023 Vehicles under Lease ............................. 71,730.00 Obligations under Lease ..................... 70,337.79 Cash ................................................... 1,392.21 To record inception of lease and first lease payment

February 1, 2023 Obligations under Lease ............................. 1,040.52 Interest Expense ......................................... 351.69 Cash ...................................................

1,392.21

December 31, 2023 Interest Expense ......................................... Obligations under Lease ..................... To record interest

293.01 293.01

Depreciation Expense ................................. 12,346.00 Accumulated Depreciation —Vehicles under Lease ........................................ 12,346.00 [($71,730 - $10,000) ÷ 5] To record depreciation expense

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) c.

Option 3: 1. Under this option, Sanderson Inc. must treat the lease as an operating lease as none of the criteria for treatment as a capital lease is met. 2. January 1, 2023 Rent Expense ............................................. 1,392.21 Cash ...................................................

1,392.21

December 31, 2023 Rent Expense ............................................. 1,392.21 Rent Payable ......................................

1,392.21

3. 1. Using a financial calculator: PV $39,500 I 2%* N 8 PMT ? Yields $5,392.14 FV $0 Type 0 * 8% ÷ 4

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) c. Option 3: (continued) 2 Using Excel formula =PMT(rate,nper,pv,fv,type)

Result: $5,392.14 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) c. Option 3: (continued) 4. Sanderson Inc. Instalment Note Payable Amortization Schedule

Date 1/1/26 1/4/26 1/7/26 1/10/26 1/1/27 1/4/27 1/7/27 1/10/27 1/1/28

Payment $5,392.14 5,392.14 5,392.14 5,392.14 5,392.14 5,392.14 5,392.14 5,392.14

Effective Interest (2%) $790.00 697.96 604.07 508.31 410.64 311.01 209.38 105.73 $3,637.10

Principal

Carrying

Reduction

Amount $39,500.00 34,897.86 30,203.68 25,415.62 20,531.80 15,550.29 10,469.16 5,286.41 0.00

$4,602.14 4,694.18 4,788.06 4,883.82 4,981.50 5,081.13 5,182.75 5,286.41

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) c. (continued) 5. January 1, 2026 Cash ........................................................... 39,500.00 Notes Payable..................................... 39,500.00 Vehicles ...................................................... 39,500.00 Cash ................................................... 39,500.00 April 1, 2026 Interest Expense ......................................... 790.00 Notes Payable ............................................ 4,602.14 Cash ................................................... December 31, 2026 Interest Expense ......................................... Interest Payable .................................. To record interest

5,392.14

508.31 508.31

Depreciation Expense ............................... 14,750.00 Accumulated Depreciation – Vehicles . 14,750.00 [($39,500 – $10,000) ÷ 2] To record depreciation expense

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) d.

Under IFRS the probability-weighted expected value of the excess mileage penalty must be used in the present value calculation of the lease rights and obligations. $0 X 75% 10,000 kilometres X 25 cents X 10%= 20,000 kilometres X 25 cents X 15%= Probability-weighted amount

$250 750 $1,000

Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $835.64 I 0.5%* N 36 PMT $0 FV $ 1,000 Type 0 * 6% ÷ 12 Consequently, the capitalized amount of the right-of-use asset and the lease liability increases by $835.64. The same lease amortization schedule for Option 2, item 4, except that the carrying amount at the inception will be $71,730.00 + $835.64 = $72,565.64 and a payment of $1,000 is made January 1, 2026.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) d. (continued) Lease Amortization Schedule —IFRS

Date

Lease Payment

Interest Reduction on Unpaid of Lease Liability Liability

Balance of Lease Liability $72,565.64

Jan. 1/23

$1,392.21

71,173.43

Feb. 1/23

1,392.21

$355.87

1,036.34

70,137.09

Mar. 1/23

1,392.21

350.69

1,041.52

69,095.56

Apr. 1/23

1,392.21

345.48

1,046.73

68,048.83

May 1/23

1,392.21

340.24

1,051.97

66,996.86

Jun. 1/23

1,392.21

334.98

1,057.23

65,939.64

Jul. 1/23

1,392.21

329.70

1,062.51

64,877.13

Aug. 1/23

1,392.21

324.39

1,067.82

63,809.30

Sept.1/23

1,392.21

319.05

1,073.16

62,736.14

Oct. 1/23

1,392.21

313.68

1,078.53

61,657.61

Nov. 1/23

1,392.21

308.29

1,083.92

60,573.69

Dec. 1/23

1,392.21

302.87

1,089.34

59,484.35

Jan. 1/24

1,392.21

297.42 $3,922.66

1,094.79

58,389.56

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) d. (continued) January 1, 2023 Right-of-Use Asset.................................... 72,565.64 Lease Liability ..................................... 71,173.43 Cash ................................................... 1,392.21

February 1, 2023 Lease Liability ............................................. 1,036.34 Interest Expense ......................................... 355.87 Cash ................................................... December 31, 2023 Interest Expense ......................................... Lease Liability ..................................... To record interest

1,392.21

297.42 297.42

Depreciation Expense................................ 12,513.13 Accumulated Depreciation- ................. Right-of-Use Asset ........................... 12,513.13 [$72,565.64-$10,000) ÷ 5] To record depreciation expense

Assuming the entries in part (d), the $1,000 payment is the last payment on the amortization schedule, and it will be a combination of the final payment on the principal outstanding and interest on the outstanding obligation since the last payment date. Assuming the entries in part (b), the penalty would be recognized as a loss when it can first be estimated reliably.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) f. Option 1

Option 2

Option 3

Statement of financial position Assets: Property, plant, and equipment Right-of-use asset Vehicles Vehicles under lease Accumulated depreciation Net

IFRS

$72,566 $79,000 (13,800) 65,200

$71,730 (12,346) 59,384

(12,513) 60,053

Liabilities: Current liabilities: Interest payable Rent payable

1,204

Instalment note payable – current Obligations under lease – current Lease liability

14,418

1,392

13,852

13,505

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) f. (continued) Option 1 Long-term liabilities: Instalment note payable Obligations under lease Lease liability Total liabilities Income statement - 2023 Depreciation expense Rent expense Interest expense

g. Total expense - 5 years Depreciation expense Auto expense (excess km.) Rent expense Interest expense

Option 2

Option 3

______ 70,029

45,042 ______ 58,894

_____ 1,392

$13,800

$12,346

IFRS 16

54,407

5,176 $18,976

Option 1 $69,000 (1)

15,312 (2) $84,312

Option 2 $61,730 1,000 11,294 $74,024

3,871 $16,217

(3)

(4)

46,277 59,782 $12,513

$16,707 _______ $16,707

Option 3 $29,500

(5)

50,120

(6)

3,637 $83,257

(7)

3,923 $16,436

IFRS $62,565

(8)

11,459 (9) $74,024

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.21 (CONTINUED) g. (continued) (1) (2) (3) (4) (5) (6) (7) (8) (9)

Annual depreciation X 5 or Cost $79,000 less residual value $10,000 Refer to instalment note table Option 1 part 2 Annual depreciation X 5 or capitalized amount $71,730 less residual value $10,000 Refer to lease amortization schedule Option 2 part 4 Annual depreciation $14,750 X 2 or Cost $39,500 less residual value $10,000 Monthly rental of $1,392.21 X 36 months Refer to instalment note table Option 3 part 4 Annual amortization X 5 = $62,565 or capitalized amount $72,565 less residual value $10,000 Same as item 4 of $11,294 plus the interest on the penalty of $835.64 (difference between present value of $835.64 and future value of $1,000.00) = $11,459

Not coincidently, the total expenses under Option 2 are equal to those for the accounting using IFRS in part (c). The main difference in the choices can be found in the choice between purchase Option 1 or lease Option 2. Option 3 is somewhat of a hybrid between Options 1 and 2 but what it has most in common with Option 1 is that the vehicle is purchased. Although the purchase option results in the highest total expense for five years, (Option 1 and 3) it also provides the highest potential for a gain from the sale of the vehicle at the end of the useful life, as the residual value employed in the calculations at lease inception might be a conservative estimate. The second major consideration is the difference in the way in which income tax will be applied to the different alternatives, particularly since the asset is a luxury vehicle and there are limits on deductibility under the Income Tax Act. Finally, cash flow consideration and financial ratios that are of particular interest to the creditors and investors of Sanderson Inc. should be taken into account.

LO 3,4,5,6,7,8 BT: AP Difficulty: C Time: 80 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.22 a.

The lease is an operating lease to BMW Canada. The lease 1. does not transfer ownership, nor contain a purchase option, 2. does not cover a major part of the estimated economic life of the car, (3 ÷ 8 = 37.5%) and 3. the PV of the lease payments of $45,992* is considerably less than the fair value of the car (58%). Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? * Yields $45,992.17 I .5% N 36 PMT $ 1,392.21 FV 0 Type 1 At least one of the three criteria would have had to be satisfied for the lease to be classified as other than an operating lease. The property is recorded as a rental property to BMW and will be treated as a payment of rent by the lessee under the operating lease.

b. January 1, 2023 Cash ..................................................... Rent Revenue ...............................

1,392.21 1,392.21

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.22 (CONTINUED) c.

1. BMW Canada – Lessor Lease Amortization Schedule

Date Jan. Feb. Mar Apr. May June July Aug. Sep. Oct Nov. Dec. Jan. Feb. Mar Apr. May June July Aug. Sep. Oct Nov. Dec.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2023 2024 2024 2024 2024 2024 2024 2024 2024 2024 2024 2024 2024

Lease Payment Plus URV

Interest on Net Investment (.5%)

$1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21 1,392.21

$388.04 383.02 377.97 372.90 367.80 362.68 357.53 352.36 347.16 341.94 336.69 331.41 326.10 320.77 315.42 310.03 304.62 299.18 293.72 288.23 282.71 277.16 271.58

Net Balance Investment of Net Recovery Investment $79,000.00 $1,392.21 77,607.79 1,004.17 76,603.62 1,009.19 75,594.43 1,014.24 74,580.19 1,019.31 73,560.88 1,024.41 72,536.47 1,029.53 71,506.95 1,034.68 70,472.27 1,039.85 69,432.42 1,045.05 68,387.38 1,050.27 67,337.10 1,055.52 66,281.58 1,060.80 65,220.78 1,066.11 64,154.67 1,071.44 63,083.23 1,076.79 62,006.44 1,082.18 60,924.26 1,087.59 59,836.67 1,093.03 58,743.65 1,098.49 57,645.15 1,103.98 56,541.17 1,109.50 55,431.67 1,115.05 54,316.61 1,120.63 53,195.99

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PROBLEM 20.22 (CONTINUED) c. 1. (continued) Lease Payment Date Plus URV Jan. 1 2025 1,392.21 Feb. 1 2025 1,392.21 Mar 1 2025 1,392.21 Apr. 1 2025 1,392.21 May 1 2025 1,392.21 June 1 2025 1,392.21 July 1 2025 1,392.21 Aug. 1 2025 1,392.21 Sep. 1 2025 1,392.21 Oct 1 2025 1,392.21 Nov. 1 2025 1,392.21 Dec. 1 2025 1,392.21 Jan. 1 2026 Jan. 1 2026 1,371.00 Feb. 1 2026 1,371.00 Mar 1 2026 1,371.00 Apr. 1 2026 1,371.00 May 1 2026 1,371.00 June 1 2026 1,371.00 July 1 2026 1,371.00 Aug. 1 2026 1,371.00 Sep. 1 2026 1,371.00 Oct 1 2026 1,371.00 Nov. 1 2026 1,371.00 Dec. 1 2026 1,371.00 Jan. 1 2027 1,371.00 Feb. 1 2027 1,371.00 Mar 1 2027 1,371.00 Apr. 1 2027 1,371.00

Int. on Net Balance Net Investment of Net Invest.(.5%) Recovery Investment 265.98 1,126.23 52,069.76 260.35 1,131.86 50,937.90 254.69 1,137.52 49,800.38 249.00 1,143.21 48,657.17 243.29 1,148.92 47,508.24 237.54 1,154.67 46,353.57 231.77 1,160.44 45,193.13 225.97 1,166.24 44,026.89 220.13 1,172.08 42,854.81 214.27 1,177.94 41,676.88 208.38 1,183.83 40,493.05 202.47 1,189.74 39,303.31 196.70 196.70 39,500.00 1,371.00 38,129.00 222.42 1,148.58 36,980.42 215.72 1,155.28 35,825.14 208.98 1,162.02 34,663.12 202.20 1,168.80 33,494.32 195.38 1,175.62 32,318.71 188.53 1,182.47 31,136.23 181.63 1,189.37 29,946.86 174.69 1,196.31 28,750.55 167.71 1,203.29 27,547.26 160.69 1,210.31 26,336.95 153.63 1,217.37 25,119.59 146.53 1,224.47 23,895.12 139.39 1,231.61 22,663.50 132.20 1,238.80 21,424.71 124.98 1,246.02 20,178.69

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.22 (CONTINUED) c. (continued) 1. (continued) Lease Int. on Net Payment Net Investment Date Plus URV Invest.(.5%) Recovery May 1 2027 1,371.00 117.71 1,253.29 June 1 2027 1,371.00 110.40 1,260.60 July 1 2027 1,371.00 103.04 1,267.96 Aug. 1 2027 1,371.00 95.65 1,275.35 Sep. 1 2027 1,371.00 88.21 1,282.79 Oct 1 2027 1,371.00 80.73 1,290.27 Nov. 1 2027 1,371.00 73.20 1,297.80 Dec. 1 2027 1,371.00 65.71 1,305.29 Jan. 1 2028 10,000.00 54.67* 9,945.33 *Rounded $13,968.89

Balance of Net Investment 18,925.39 17,664.79 16,396.84 15,121.49 13,838.69 12,548.42 11,250.62 9,945.33 0.00

2. The lease is a manufacturer’s or dealer’s lease to BMW Canada. The present value of the unguaranteed residual value is calculated as follows using two steps: The first step is for the renewal period of 2 years: Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $8,734.39 I 7% N 2 PMT 0 FV $ 10,000 Type 1 The second step is to calculate the present value of the amount arrived in the first step back to January 1, 2023 for a period of 3 years. Solutions Manual 20.259 Chapter 20 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.22 (CONTINUED) c. (continued) 2. (continued) Excel formula =PV(rate,nper,pmt,fv,type) Using a financial calculator: PV $ ? Yields $7,333.56 I 6% N 3 PMT 0 FV $ 8,734.39 Type 1 Consequently, the sale price is $79,000.00 less the present value of the unguaranteed residual value of $7,333.56 or $71,666.44, which is > 90% of FMV (90% x 79,000 = 71,100). This indicates a finance lease under IFRS. The cost of goods sold is $70,000 less the present value of the unguaranteed residual value of $7,333.56 or $62,666.44. The amount of the lease payments receivable is the sum of the lease payments under the initial lease and the renewal lease calculated as follows: 36 payments @ 1,392.21 = 24 payments @ 1,371.00 = Unguaranteed residual value Total receivable

$50,119.56 32,904.00 10,000.00 $93,023.56

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.22 (CONTINUED) c. (continued) 3. January 1, 2023 Cash .......................................................... 1,392.21 Lease Receivable ...................................... 91,631.35 Cost of Goods Sold.................................... 62,666.44 Sales Revenue ................................... 71,666.44 Inventory ............................................ 70,000.00 Unearned Interest Income .................. 14,023.56 February 1, 2023 Cash .......................................................... 1,392.21 Lease Receivable...............................

1,392.21

December 31, 2023 Unearned Interest Income ......................... 4,319.51 Interest Income ..................................

4,319.51

LO 9,12 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.23* a. 1. Using tables: PV of rentals [PV of RV

$838,380 X 9.36492 $1,000,000 X .14864

2. Using a financial calculator PV $ ? I 10% N 20 PMT $ (838,380) FV $ (1,000,000) Type 1

$7,851,362 148,640 $8,000,002

Yields $8,000,005

3. Excel formula =PV(rate,nper,pmt,fv,type)

Result: $8,000,005 rounded

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.23* (CONTINUED) a. (continued) Partial Lease Amortization Schedule Annual Lease Interest Payment (10%) Amortization

Date 6/29/23 6/29/23 6/29/24 b. 6/29/23

6/29/23

$838,380 838,380

$716,162

$838,380 122,218

Balance $8,000,000 7,161,620 7,039,402

Cash........................................... 8,000,000 Buildings .............................. 9,500,000 Accumulated Depreciation -Buildings ........................... 3,321,4291 Deferred Profit on SaleLeaseback ........................ 1,821,429 1 ($9,500,000 - $2,000,000) / 35 X 15.5 years) To record sale of building Buildings under Lease ................ 8,000,000 Obligations under Lease ....... 7,161,620 Cash ..................................... 838,380 To record inception of lease and first lease payment

12/31/23 Deferred Profit on Sale-Leaseback 45,536 2 Depreciation Expense ............ 2 ($1,821,429 ÷ 20 X 6/12) To record amortization of deferred gross profit 2

45,536

The credit could also be to a gain account.

The deferred profit on the sale-leaseback should be amortized on the same basis that the asset is being depreciated.

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PROBLEM 20.23* (CONTINUED) b. (continued) Maintenance, insurance, and property taxes would also have been paid during the year. 12/31/23 Depreciation Expense3 ................... 150,000 Accumulated Depreciation -Leased Buildings ............... 3 (($8,000,000 - $2,000,000) ÷ 20 X 6/12) To record depreciation expense 12/31/23 Interest Expense4 ........................... Obligations under Lease.......... 4 ($7,161,620 X 10% X 6/12) To record interest

358,081

6/29/24

480,299 358,081

Obligations under Lease............. Interest Expense ............................. Cash ........................................ To record lease payment

150,000

358,081

12/31/24 Deferred Profit on Sale-Leaseback 91,071 5 Depreciation Expense ............ 5 ($1,821,429 ÷ 20) To record amortization of deferred gross profit 12/31/24 Depreciation Expense6 ................... 300,000 Accumulated Depreciation -Leased Buildings ................ 6 (($8,000,000 - $2,000,000) ÷ 20) To record depreciation expense

838,380

91,071

300,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.23* (CONTINUED) 12/31/24 Interest Expense7 ........................... Obligations under Lease.......... 7 ($7,039,402 X 10% X 6/12) To record interest

351,970 351,970

The lease must now be recorded as an operating lease as it is no longer a capital lease because: (1) the lease term is for 60% (12 ÷ 20) of the economic life of the leased asset and (2) the present value of the minimum lease payments is 79% ($6,283,709 / $8,000,000) of the fair value of the leased asset and (3) there is no longer a bargain purchase option. Maintenance, insurance, and property tax expenses would also be incurred. The PV value of the minimum lease payments: Using a financial calculator: PV $ ? I 10% N 12 PMT $ (838,380) FV $ 0 Type 1

6/29/23

Yields $ 6,283,709

Cash................................................ 8,000,000 Buildings ................................... 9,500,000 Accumulated Depreciation -Buildings8 .............................. 3,321,429 Deferred Profit on SaleLeaseback .............................. 1,821,429 8 ($9,500,000 - $2,000,000) / 35 X 15.5 years) To record sale of building

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.23* (CONTINUED) c. (continued) 6/29/23 Prepaid Rent ................................... Cash ..................................... To record rent payment

838,380

12/31/23 Rent Expense .................................. Prepaid Rent.............................. To record expired rent

419,190

12/31/23 Deferred Profit on SaleLeaseback .................................. Rent Expense9 ........................... To adjust deferred profit 9 ($1,821,429 / 12 X 6/12)

838,380

419,190

75,893 75,893

6/29/24 Rent Expense10 ................................ Prepaid Rent.............................. To record expired rent

419,190

6/29/24 Prepaid Rent10 ................................. Cash .......................................... To record rent payment

838,380

12/31/24 Rent Expense ................................... Prepaid Rent.............................. To record expired rent

419,190

12/31/24 Deferred Profit on SaleLeaseback ................................... Rent Expense11 ......................... To adjust deferred profit 11 ($1,821,429 / 12) 10

419,190

838,380

419,190

151,786 151,786

Note to instructor: these two entries could be combined.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.23* (CONTINUED) d.

The net assets amount (or equity) on the SFP of North Central will be very similar after the completion of the sale and leaseback as it was before. Any excess of the capitalized amount of the building over the carrying value at the time of the sale (i.e., the gain) will be deferred and amortized over the term of the lease, or the life of the asset. Eventually this gain will be realized to equity. Over the term of the lease, the additional costs related to the borrowing will affect equity, but this is no different than if a loan had been obtained in exchange for a mortgage obligation.

LO 14 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.24* a.

Truttman was motivated to sell and leaseback its used building to generate some cash flow, possibly for working capital. The interest rate offered by the leasing company was most likely favourable from the point of view of Truttman, in comparison to other sources of financing.

The comparison of the fair value of the used building and the present value of the lease payments as well as the comparison of the remaining useful life and lease term will be relevant under ASPE. A lease may be categorized as a capital lease if, at the date of the lease agreement, it meets any one of three criteria under ASPE. As the lease has no provision for Truttman to reacquire ownership of the building, it fails the criteria of transfer of ownership at the end of the lease under ASPE; there is no purchase option. Truttman’s lease payments, with a present value equalling 85% of the building’s fair value, fails the criterion for a present value equalling or exceeding 90% of the building’s fair value for ASPE. Under ASPE, the final criterion is whether its term allows the lessee to substantially use the building for its economic useful life. In this case, 73% is below the 75% threshold and therefore the criteria would not be met. In this case, under ASPE the lease would be classified as an operating lease. Under ASPE, the profit on sale of a property sold and leased back under an operating lease arrangement is deferred and amortized in proportion to the rental payments over the time that it is expected the lessee will use the assets. The lease would be set up by Truttman as a right-of-use asset and lease liability under IFRS, as the lease does not qualify for a short-term or low-value exemption lease.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.24* (CONTINUED) c.

Operating lease treatment under ASPE: Truttman should account for the sale portion of the sale-leaseback transaction at October 31, 2023, by increasing cash for the sale price for $13 million, decreasing building (and related accumulated depreciation) by the carrying amount of $10 million, and recognizing a deferred gain on sale of $3 million for the excess of the sale price over the building’s carrying amount. The deferred gain will be recognized over the term of the lease. If the sale price is $1 million greater than the fair value, the total gain deferred would be $4 million. All of the gain is deferred and amortized over the operating lease term. The operating lease payments are then recorded as an expense as made. To the extent that, after the transfer, the seller-lessee continues to use the same asset it has transferred, the sale-leaseback is really a form of financing, and therefore it is reasonable that no gain or loss is recognized on the transaction. In substance, the seller-lessee is simply borrowing funds. On the other hand, if the seller-lessee gives up the ownership risks and benefits associated with the asset, the transaction is clearly a sale, and gain or loss recognition is appropriate.

Capital lease treatment under ASPE: Truttman would account for the sale portion of the sale-leaseback transaction at October 31, 2023, by increasing cash for the sale price of $13 million, decreasing building (and related accumulated depreciation) by the carrying amount of $10 million, and recognizing a deferred gain on sale of $3 million for the excess of the building’s sale price over its carrying amount. The deferred gain will be recognized on the same basis as depreciation of the leased asset. At the same time, a capital leased asset and an offsetting capital lease obligation will be recognized at the present value of the lease payments.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 20.24* (CONTINUED) d. (continued) At the end of the year, December 31, 2023, Truttman would recognize interest expense on the obligation at the effective interest rate and depreciation expense on the building (depreciated over the term of the lease). Accrued interest on the obligation for the period from November 1, to December 31, 2023, will appear in the current liabilities section of the SFP along with the principal portion of the first lease payment due October 30, 2024. The remaining portion of the principal to be repaid beyond 2024 will be reported as a non-current liability. Assuming the operating section of the December 31, 2023, cash flow statement is prepared using the indirect method, the gain on the sale of the building, the depreciation expense and the increase in the interest payable (for the accrual recorded for the lease at the end of the year) will be added back to income. Finally, the capital lease and the related obligation under capital lease from the leaseback transaction are a non-cash financing and investing transaction that will not appear on the face of the cash flow statement but will be reported in the notes to the financial statements. LO 14 BT: AP Difficulty: C Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

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CASES Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the back of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 20.1 CROWN INC. Case Overview CI’s management team has a financial reporting bias; they do not want to increase the debt that is presently on the balance sheet. They are specifically concerned with the debt-to-equity ratio and do not wish to erode it any further. Since the company appears to have other debt, the creditors will be key users. They will want objective information and will be concerned with the debt-to-equity ratio to assess how leveraged the company is, and thereby assess the company's ability to repay debt. As a private company, CI is can apply ASPE, but may choose to apply IFRS. Note that the company wants to know the differences between IFRS and ASPE. As the auditor you will want transparent financial statements. Analysis and Recommendations Issue: Crown Inc. is motivated to ensure that its debt-to-equity ratio is not further eroded. As a result, it would prefer to structure the lease with Anchor Limited as an operating lease versus a capital / finance lease. The controller must determine how to classify this lease for ASPE purposes.

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CA 20.1 CROWN INC. (CONTINUED) Analysis: - There is no evidence that the legal title passes to CI at the end of the lease. - There is no BPO since the purchase option allows CI to purchase at the FV. - The term of the lease is only 12 years, which is less than 75% of the economic life of 20 years. - The PVMLP is as follows: ▪ $150,000 X 7.16073 = $1,074,110 ▪ $1,074,110/$1,900,000 = 56.5% which is less than 90% Therefore, this lease initially appears to be an operating lease. However, given that the asset is manufactured specifically for CI and there is no other possible use for the machine, AL likely does not want the machine back. It would appear that under ASPE the lease is a capital lease that represents a purchase in substance by CI. This is reinforced by the understanding that CI would either renew the lease or exercise the purchase option. The written agreement should not be reviewed in isolation but rather within the context of the reporting environment (management bias) and also considering the additional unwritten agreement to purchase. This classification depends on the transfer of the risk and rewards of ownership. In this case, both the auditor and the client know that the substance is such that the lease has been used as an alternative financing option to obtain off-balance-sheet financing. However, the client will argue that under ASPE it is an operating lease given that it does not meet the criteria of a capital/finance lease if the numerical thresholds are used as a benchmark. Under IFRS the lease would be set up as a right-of-use asset as the lease does not qualify for a short-term or low-value exemption. As such, it would increase the amount of debt and would worsen the debtto-equity ratio.

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CA 20.1 CROWN INC. (CONTINUED) Minor differences from the perspective of the lessee include: - Discount rates – ASPE requires the use of the lower of the implicit rate (IR) and incremental borrowing rate (IBR) if the IR is known, whereas IFRS requires the use of IR if it is known (otherwise IBR). Recommendation: As an auditor there is an overriding concern that the financial statements are fairly presented. Therefore, this requires that the substance of all transactions is appropriately reflected in the financial statements. In this case the evidence supports the fact that this is a capital/finance lease under ASPE. Given this, the auditor should argue to capitalize the lease, especially since the amounts are material. Under IFRS, the machine under lease would be accounted for as a Right-of-Use Asset.

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CA 20.2 KELLY’S SHOES Case Overview It is not clear whether GAAP is a constraint, however, users will likely want GAAP financial statements since they provide more useful information. Landlords will want to see the financial statements to help negotiate the restructuring, while creditors and shareholders would also be interested in transparent statements. Management would want to present a realistic picture of the company’s situation. However, there may be a bias to make the situation look worse than it is to support a better negotiating position. Differences between IFRS and ASPE are provided as requested. Analysis and Recommendations Issue: Kelly is currently insolvent and must determine how to account for the payment to the landlords (three months rent bonus). It is not clear as to whether these are operating or capital leases. The termination of a capital lease would result in the removal of assets/liabilities with a gain/loss recognized.

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CA 20.2 KELLY’S SHOES (CONTINUED) Analysis: Accrue bonus payment costs - If it is likely that the costs would be incurred and measurable, then as per IAS 37, present the obligation as a result of a past transaction, with probable outflow that is measurable (essentially the same as ASPE). - In this case, the leases are non-cancellable (past transaction) and therefore, it is likely that costs would be incurred to break the leases. - In order to accrue, the amount would need to be measurable. This would depend on the stage that negotiations were in.

Do not accrue bonus payments (expense) - Measurement may be an issue since each landlord might make a different decision or negotiate a different deal. - Some landlords may even be willing to provide financial support in the form of reduced rent to the company to keep the stores open as long as possible. However, the company cannot accrue this type of benefit until it is received. (contingency accounting). - An exit plan by the company does not necessarily create an obligation.

Recommendation: It would appear that the negotiations were at a very preliminary stage and that some landlords might have been willing to offer inducements/ concessions to the company. However, the outcome was not yet determinable and recognition would not be recommended. This would be further supported since, even if it were argued that the reduced costs were likely, it is difficult to measure them. At the one end of the spectrum, the landlords could require that the full commitment to the end of the lease be honoured. At the other end, the landlords might agree to a lesser amount, i.e., the company would pay rent until a new tenant is found.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RESEARCH AND ANALYSIS RA 20.1 KINAXIS INC. (a) Based on the following, Kinaxis does enter into lease arrangements. Consolidated Statement of Financial Position (USD thousands) 2020 Non-current assets: Right-of-use assets $15,722 (2019 - $8,671) Current liabilities: Lease obligations $4,554 (2019 - $2,288) Non-current liabilities: Lease obligations $12,065 (2019 - $6,818) Consolidated Statement of Cash Flows Operating activities Depreciations of property and equipment and right-of-use assets $14,335 (2019 - $11,908) Financing activities Payment of lease obligations ($3,742) (2019-($2,674))

(b) The most notable wording is found in the last paragraph of Note 3(g). Kinaxis indicates that any leases that are 12 months or less (short-term) and are of low value are recognized as an expense on a straight-line basis. This is consistent with the exemption that exists under IFRS, and not ASPE. Another indication that the company is using IFRS rather than ASPE is that there is no wording that describes how a lease agreement is tested against set criteria in order to capitalize the lease agreement rather than expense. ASPE sets out criteria whereas IFRS provides guidance to capitalize all leases except for the low value and short-term agreements. Lastly, the term “right-of-use” is commonly used IFRS terminology whereas ASPE would typically use “equipment under lease” or “leased equipment”. In addition, note 2 (a) clearly outlines the basis of preparation of the financial statements as IFRS.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 20.1 KINAXIS INC. (CONTINUED) (c) As per Note 7, Kinaxis has the following categories in its right-of-use assets (USD thousands): Offices $7,317 Data Centres $8,405 Kinaxis offers cloud-based subscription software as a service to its customers. To deliver this type of service, hardware that falls under the description of Data Centres would be critical in the effective delivery of this service. This type of equipment can be very expensive, so leasing might be a better option than purchasing as the cost may be lower. As well, these assets would need to be regularly refreshed. By structuring this as a lease, Kinaxis can give the equipment back to the lessor at the end of the term, and lease new and more up to date equipment. Having the latest equipment that provides these kinds of services would be important to meet customer expectations. The company leases its office space as its note disclosure for property, plant and equipment does not show any buildings. The company is relatively young and growing rapidly. In this situation, it is advantageous to lease office space rather than purchase buildings. This allows the company to grow quickly and expand in several different markets without the encumbrance of owning office buildings. (d)As of December 31, 2020, lease financing accounts for 11.33% [($4,554 + $12,065) / ($131,859 + $14,794)] of total liabilities. This is slightly misleading due to the fact that current liabilities include deferred revenues of $94,275. When only considering long term liabilities, long term lease obligations make up 81.55% ($12,065 / $14,794) of total long-term liabilities. Considering the business model that Kinaxis uses, this is what an analyst might expect to see. For 2019, lease financing accounts for 7.55% [($2,288 + $6,818) / ($106,731 + $13,910)] of total liabilities. The large increase in leases came from business combinations and expansion of its office spaces in 2020 in Ottawa, Ontario. 2020 Return on total assets: Profit / Total Assets = 13,730 / 428,410 = 3.20% Total debt to equity: Total Debt / Total Equity = 146,653 / 281,757 = 52.05%

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 20.1 KINAXIS INC. (CONTINUED) 2019 Return on total assets: Profit / Total Assets = 23,331 / 350,743 = 6.65% Total debt to equity: Total Debt / Total Equity = 120,641 / 230,102 = 52.43% Return on total assets deteriorated in 2020 from 2019 results. Total debt to equity remained consistent year over year. The main reason for the difference is due to the acquisition of two subsidiaries in 2020. The asset base of the company increased in 2020 from 2019 due to Goodwill booked on the consolidated statements. As these were new/recent acquisitions, it may be that the synergies anticipated have not yet resulted in a corresponding increase to net income.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 20.2 LOBLAW COMPANIES LIMITED (a) Loblaw is both a lessee and a lessor. As a lessee, the company leases some of its retail stores, distribution centres, corporate offices, vehicles, and IT equipment. Note 28 categorizes these as “Property” and “Other”. As a lessor, the company engages in financing type leases related to properties that are sub-leased to third parties. The company also reported operating lease income in 2020 (included in “Other” in Note 18). Consolidated Balance Sheet (millions) Non-current Assets Right of Use Assets $7,207* *Note 28 provides a breakdown of this: $9,168 cost less $1,961 depreciation Current Liabilities Lease Liabilities due within one year $1,379 Non-current Liabilities Lease Liabilities $7,522

SG&A (as per Note 28) contains the following (millions): Short-term leases $25 Variable lease payments $389 Sales & Leaseback transactions - Loss of $1 Finance Interest Income $4 Impairment losses $5 Operating Lease Income $25

(b) Consolidated Statements of Cash Flows (millions): Operating Activities Depreciation and Amortization (value related to leases only)* $965 Impairment (value related to leases only)* $17 Interest received from finance leases $4 *amounts found in Note 28 Investing Activities Lease payments received from finance leases $9

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Intermediate Accounting, Thirteenth Canadian Edition

20.2 LOBLAW COMPANIES LIMITED (CONTINUED) Financing Activities Cash rent paid on lease liabilities – Interest $369 Cash rent paid on lease liabilities – Principal $1,024

(c) 2020 Debt to Assets: $24,751 / $35 870 = 69.00% 2019 Debt to Assets: $24,988 / $36,309 = 68.82% 2020 Return on Assets: $1,192 / $35,870 = 3.32% 2019 Return on Assets: $1,131 / $36,309 = 3.11% Based on the above, there are very few changes/differences year over year. As it relates to leases, there also appears to be little change year over year in the values reported. (d) Students should answer this question using the following section from Note 28: “The Company also has owned and leased properties that are leased and subleased to third parties, respectively. The subleases are primarily related to medical centers and ancillary tenants within stores.” Student responses could include but are not limited to: • Demographics o Existing consumer base may be an aging population o Increasing number of newcomers needing medical care • Consumer Behaviour / Buying Trends o Diversification of services and product offerings demanded by clients o Clients wanting one-stop shopping o Products / Services that are complimentary to Loblaw’s core offering • Profit maximization o Profit potential associated with offering new services / products is less than the profit derived from subleasing the space

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Intermediate Accounting, Thirteenth Canadian Edition

RA 20.3 RESEARCH AN AUTOMOBILE LEASE (a) The terms and conditions associated with the lease of a vehicle generally include: 1. Lease costs which include a) leased vehicle price, which include price of accessories, dealer installed options, freight and pre-delivery inspection, and all applicable taxes such as federal air conditioning tax, provincial gas consumption tax, tire tax, etc., but excludes HST/GST and PST; b) optional extended warranty; c) optional life insurance; d) optional disability insurance; e) other (specify); f) less cash down payment; g) less trade-in allowance (net of amount owing on trade-in); and h) less end value of vehicle, to arrive at the amount to be amortized. (See item 8 below) 2. Total lease charges, representing interest, and annual lease rate, stated as a percentage (the latter being provided in the majority of cases). 3. The lease term, expressed in the number of months. 4. Amount of monthly payments (annuity due) including: a) number of monthly payments, b) base monthly payment, c) plus GST or HST, d) plus PST (where applicable), to arrive at the total monthly payment. 5. Total of monthly payments arrived at by multiplying the monthly payment by the number of monthly payments. 6. Summary of amounts due on delivery including: a) net cash down payment, b) net trade-in allowance, c) GST, PST or HST d) vehicle licence fee, e) registration fee, f) other (specified), g) first monthly payment, and h) refundable security deposit.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 20.3 RESEARCH AN AUTOMOBILE LEASE (CONTINUED) (a) (continued) 7. Specification concerning the kilometre charge for kilometres driven beyond a set limit negotiated and specified in the lease to fit the customer’s particular needs. 8. Lease end purchase based on the estimated fair market value of the vehicle at the end of the term of the lease. This option price would have HST (or GST and PST) added as well as licence fee, registration fee, and charges related to certification of the vehicle. 9. Other conditions of the lease include: a) insurance; b) maintenance repairs and operating expenses; c) taxes, registration and other charges; d) excess wear clauses; e) fines, liens and encumbrances; f) early termination clauses; g) defaults; h) warranties; i) guarantees; and j) clauses concerning modification or relocation of the vehicle. (b) The cash flows associated with the lease include the amounts specified under the amounts due on delivery of the vehicle (item 6 of part (a) above); the monthly payments under the lease, as calculated above; and the “lease end purchase” (described in item 8 above), should the lessee choose the option price at the end of the term of the lease, to purchase the vehicle. (c) An initial purchase is often the better choice. In the car lease, all of the risks associated with ownership are passed on to the lessee. The amount provided as the option price to purchase the vehicle at the end of the term of the lease is a conservative amount arrived at by the lessor to reduce the risk to them from the realization of the value of the vehicle through resale or through an additional lease transaction, should the option to purchase not be exercised.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 20.4 ASPE – IFRS and LEASES (a) The current ASPE and IFRS standards require the following: Retail outlet leases: Based on the lease terms and conditions for the retail outlets as explained by Louise Bren, these leases all appear to be operating leases under ASPE. Leases that are operating leases are recognized and reported in the following manner under ASPE: the monthly lease payments and variable rental payments are all expensed as incurred (except any lease inducements over the term of the lease should be taken into account and the total rent should be recognized evenly over the term of the lease). As the company builds historical results, some part of the variable rentals could be accrued if a reasonable estimate of annual sales can be made in advance of reaching the point at which the variable rent kicks in. Under IFRS, the retail outlet leases will be set up as right-of-use assets as the leases do not qualify for a short-term or low-value exemption. The variable rental payments should be estimated in advance and measured using expected values and then included in the lease payments as part of the initial lease liability recognized. Manufacturing and office building lease: The information provided indicates that the building lease has been assessed against the capitalization criteria under ASPE and found to qualify as an operating lease. Under IFRS, the manufacturing and office building lease would be considered a finance lease and would be set up as a right-of-use asset as it does not qualify for a short-term or low-value exemption.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 20.4 ASPE – IFRS and LEASES (CONTINUED) (b)

To: Louise Bren, Subject: Lease concepts and accounting under IFRS. Under IFRS, which uses the contract approach, all lease contracts are examined in terms of transferring the right to use a specific asset from the lessor to the lessee and taking on an associated obligation to make a series of payments into the future to pay for this right. This differs from ASPE where leases are divided into those that are in-substance transfers of ownership and the asset itself (finance leases) and those that are merely executory contracts where neither party has performed except over time (operating leases). Under IFRS, all lease contracts (except a few minor ones, which for practicality are excluded) are viewed as transferring the right to use the asset (recognized as a right-of-use asset) to the lessee in return for a contractual obligation to make cash lease payments (a lease liability). Therefore, most leases, whether recognized as finance or operating leases previously, will be accounted for as right-of-use assets and lease obligations under IFRS. In addition, there are some changes in the amounts that will be capitalized, measured at their expected values, as right-of-use assets and recognized in the lease liabilities. These include: • Variable rental payments related to changes in construction cost indices, consumer prices indices, etc. • Amounts likely to be paid at the end of the lease relative to any residual value deficiencies (as compared to the guaranteed amount of any residual value under existing IFRS and ASPE) • Amounts of purchase options that are reasonably certain to be exercised (as compared to the amount of bargain purchase options only) • The term of the lease (over which the payments will be made and the present values of the obligation and asset are measured) will be the non-cancellable term plus any additional terms that are reasonably certain to extend the lease under IFRS • The discount rate to be applied is the rate implicit in the lease, if determinable, otherwise the discount rate is the lessee’s incremental borrowing rate. This differs from the ASPE requirement to use the lower of the two rates.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 20.4 ASPE – IFRS and LEASES (CONTINUED) (b) (continued) Your financial statements are likely to differ under IFRS in the following ways: Retail outlet leases: A liability for the contractual lease obligation will be recognized and amortized using the effective interest method and the appropriate discount rate over the lease term. As payments are made, the obligation will be reduced and interest expense will be recognized. The capitalized value of the lease payments are also recognized as assets, most likely in property, plant and equipment. After “acquisition,” the assets will be depreciated to depreciation expense in the income statement, consistent with policies used for similar owned assets. The payments made under the contract are recognized as partial repayments of the obligation and partially as interest expense on the income statement. Decisions will need to be made about the following variables: 1. What lease term should be used? With a five year lease that is renewable for another five years, you will have to determine the likelihood of exercising the option to renew these leases, and this has to be decided when the original lease is signed. The term may be 10 years for the current retail leases – the initial term and the renewal period. 2. What payments should be included and capitalized? In this case, the monthly payments and the variable rent payments would be included in determining the value of the right-of-use asset and the lease liability. The value for the variable rental payments would be determined using probability weighted expected values over the term of the lease. The value of these variable payments, as well as the likelihood of lease term extensions, would have to be reassessed at each reporting period, with any changes reflected in the asset and liability accounts. 3. What discount rate should be used? IFRS is clear that the rate implicit in the lease should be used to discount the cash flows. However, if it is not clear from the retail leases what rate is used by the lessor, Sporon’s incremental borrowing rate should be used.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 20.4 ASPE – IFRS and LEASES (CONTINUED) (b) (continued) Manufacturing and office building lease: Although this lease may currently be assessed as meeting the criteria to be accounted for as an operating lease under ASPE, the accounting for it is clear under IFRS. The lease contract results in acquiring the rights to use the building and this is recognized as a right-of-use asset to Sporon and as a lease liability. The right-of-use asset (building) should be capitalized on the same basis as the retail leases and be depreciated over the term of the lease plus any extensions expected. The liability should be reduced as payments are made, and the interest portion is expensed to the income statement. The impact on the statement of comprehensive income, therefore, relates to non-recognition of rent expense and the substitution instead of depreciation expense and interest expense. Over time, these annual charges would likely average out to close to the rental amounts previously recognized in income. As far as the statement of cash flows is concerned, there will be a significant difference. Instead of the rent expense on the income statement and the cash paid for rent on the cash flow statement being very similar in amount every year, now the statement of cash flows will show: • No deduction from operating income for rent expense or a use of operating cash flows • In the operating cash flow section: depreciation taken on the right-ofuse assets will be added back to the net income, reported as a noncash expense (or would not appear on the cash flow statement if the direct method is used) • In the financing cash flow section: the cash payments that reduced the lease liability in the year will be deducted as an outflow • The cash interest paid in the year is permitted to be deducted either as an operating cash flow or a financing cash flow, depending on Sporon’s accounting policy choice for interest • New leases entered into will be disclosed as non-cash investment and financing activities This would cause the operating cash flow to be higher than under ASPE in that much of the cash paid is now recognized as a financing outflow instead of an operating outflow.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 20.4 ASPE – IFRS and LEASES (CONTINUED) (c) Appendix: The contract based approach of IFRS will be more useful to users as entities currently are not recognizing operating lease obligations (that meet the definition of liabilities), nor the asset values associated with the contractual right to use specific assets. Under IFRS, the finance (or capital) and operating lease distinction would basically disappear and most leases would qualify for recognition as assets and liabilities by the lessee. This would affect the following basic ratios. Profitability Profit margin

Return on assets

Return on equity

The ratio will be lower in the earlier years and higher in the later years under IFRS lease treatment because 1) operating leases recognize lease expenses evenly during the lease term; and 2) interest expense and amortization expenses are higher in the earlier years and lower in the later years. Lower: Assets, the denominator, would increase by the value assigned to the right-of-use assets. The net income will be lower in the early years due to the higher interest and amortization expenses. As a result, the return on assets will be lower. Over time, this will increase as the asset and liability are reduced and net income is higher with the lower amounts charged for interest and amortization expenses. Lower: The return (net income) would decrease in the early years and retained earnings in equity would increase at a slower rate for the same reasons noted above.

Risk Debt-to-equity Times interest earned

Solvency Operating cash flows to total debt

Higher: Debt would increase by the contractual lease liability amount recognized. EBIT may increase because, although there is an amortization expense, it may be lower than the rent expense that would disappear. However, the denominator, interest expense, would increase as well. So it is difficult to assess the overall impact without further details. As cash outflows for the principal balance of the lease obligation would be reported under ”financing activities”, the cash flow from operating activities would be higher. At the same time, the amount of total debt, which is the denominator of this ratio, would increase by the lease liability and later get smaller as the obligation gets repaid. So it is difficult to assess the exact impact without further details.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

MMXXII vii F2

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

CHAPTER 21 ACCOUNTING CHANGES AND ERROR ANALYSIS Learning Objectives 1. Identify and differentiate among the types of accounting changes and explain how to account for them. 2. Identify economic motives for changing accounting methods and interpret financial statements where there have been retrospective changes to previously reported results. 3. Identify differences in accounting between IFRS and ASPE. 4. Correct the effects of errors and prepare restated financial statements.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4.

1 1 1 1,3

1. 2. 3. 4. 5 6.

1 1 1 1,2 1,3 1,3

1. 2. 3. 4.

1 1 1 1,4

1,2

1. 2.

1 1

BT Item LO BT Item LO BT Item LO Brief Exercises C 5. 1 AP 9. 1 C 13. 1 C 6. 1,3 C 10. 1 AP 14. 1 AP 7. 1 AP 11. 1 C 15. 1 C 8. 1,3,4 AP 12. 1 C 16. 1 Exercises C 7. 1,4 AP 13. 1,4 AP 19. 1,4 AP 8. 1 AP 14. 1,3 AP 20. 1,4 AP 9. 1 AP 15. 1,3,4 AP 21. 1,4 AP 10. 1 AP 16. 1,4 AP 22. 1 C 11. 1 AP 17. 1,4 AP 23. 1 C 12. 1 AP 18. 1,4 AP 24. 1 Problems AP 5. 1,4 AP 9. 1,4 AP 13. 1 C 6. 1,3 AP 10. 1,3 AP 14. 1,4 AP 7. 1,3,4 AP 11. 1,4 AP 15. 1,4 AP 8. 1,3,4 AP 12. 1 AP 16. 1,4 Integrated Cases AP 2. 1,2 AN Research and Analysis AN 3. 3 AP 4. 1,2 AP . AP

BT Item LO BT C 17 C AP AP

AP 25. AP 26. AP AP AP AP

1 2

AP C

AP 17. 1,3 AP AP 18. 1,2 C AP AP

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

Problems

1. Differentiate among change in policy, change in estimate, and errors.

1, 2, 3, 4, 12, 15, 16

1, 2, 3, 4, 5, 6, 7, 13

1, 2, 3, 4, 5, 6, 7, 8, 9, 11 12,13,14, 18

2. Change in accounting policy.

5, 6, 13

2, 8, 9, 10, 14, 15

1, 6, 7, 10, 11,18

3. Correction of an error.

3, 7, 8

2, 3, 4, 7, 10, 11, 12, 16, 17, 18, 19, 20, 21

1, 2, 3, 4, 5, 6, 7, 8, 9, 11, 12, 13, 14, 15, 16, 18

4. Change in estimate.

9, 10, 11, 14

4, 7, 12, 16, 22, 23, 24

2, 3, 4, 5, 6, 7, 8, 9, 11, 14, 18

4, 26

2, 10, 11, 17, 18

Topics

5. Motivations for change. 6. Differences between IFRS and ASPE.

4, 8

5, 6

6, 7, 10, 17

7. Correct errors and restate financial statements.

7, 8, 17

7, 12, 16, 17, 18, 19, 20, 21

4, 5, 7, 8, 9, 11, 14, 15, 16

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Intermediate Accounting, Thirteenth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Item E21.1 E21.2 E21.3 E21.4 E21.5 E21.6 E21.7 E21.8 E21.9 E21.10 E21.11 E21.12 E21.13 E21.14 *E21.15 E21.16 *E21.17 *E21.18 *E21.19 *E21.20 *E21.21 E21.22 E21.23 E21.24 E21.25 E21.26 P21.1 P21.2 P21.3 P21.4 P21.5

Description Various accounting changes Changes and methods of accounting, journal entries Long-term contracts Change in estimate, error correction Accounting for accounting changes Various accounting changes Change in estimate, error, financial statements Accounting change—inventory Change in policy—measurement model for investment property Various changes in policy—inventory methods Error correction entries Error and change in estimate—depreciation Disposal of assets Construction accounting change Accounting for investments Error and change in estimate—depreciation Error analysis and correcting entries Error analysis and correcting entries Error analysis Error analysis Error analysis Accounting changes—depreciation Depreciation changes Change in estimate—depreciation Change in estimate—depreciation Political motivations for policies Error corrections and changes in policy Accounting changes and disclosure requirements Change in estimate, policy, and error correction with tax effect Change in estimate and error correction Comprehensive accounting change in estimate and error analysis problem

Level of Time Difficulty (minutes) Moderate 25-30 Moderate 20-25 Simple Moderate Simple Moderate Complex Moderate Complex

10-15 20-30 20-25 20-30 40-50 25-30 40-50

Moderate Moderate Simple Moderate Moderate Complex Simple Simple Moderate Moderate Moderate Moderate Moderate Moderate Moderate Simple Simple Moderate Moderate

20-35 20-25 15-20 15-20 15-20 20-25 15-20 10-15 20-25 25-30 25-30 10-15 15-20 25-30 10-15 10-15 15-20 25-30 25-35

Moderate

30-35

Moderate Moderate

30-35 30-35

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ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Level of Time Difficulty (minutes)

Item

Description

P21.6 P21.7

Error analysis and changes in policy Complex Effect of changes in policy, estimate and error, Complex financial statements, and note disclosure Comprehensive accounting change and error Complex analysis problem, with statement of retained earnings and notes Effect of changes in policy and estimate, Complex financial statements Change in policy (FIFO to average cost), Complex income and retained earnings statement Accounting changes, with statement of Moderate changes in equity and notes Error corrections Moderate Error analysis with tax effect Moderate Error analysis and correcting entries Complex Error analysis and calculation of corrected net Moderate income Error analysis and correcting entries Complex Economic motives for selection of accounting Moderate policies and ethical considerations Accounting changes and ethical considerations Moderate

P21.8

P21.9 P21.10 P21.11 P21.12 P21.13 P21.14 P21.15 P21.16 P21.17 P21.18

45-50 50-60 45-55

50-60 50-60 20–30 25-30 20-25 50-60 30-40 50-60 25-30 20–30

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 21.1 1.

The change to a three-year remaining life for the purpose of computing depreciation on production equipment is a change in estimate due to a change in conditions.

This is an expense classification change arising from a change in the use of the building for a different purpose. Thus, it is not a change in policy, a change in estimate, or the correction of an error.

The change to expensing preproduction costs (writing the costs off in one year as opposed to several years) is a change in estimate due to a change in conditions. The change in estimate relates to the value used in the base in the allocation. Preproduction costs are included as part of development costs and may be capitalized under IFRS as long as certain criteria are met (IAS 38.59).

LO 1 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.2 1.

Both FIFO and weighted average cost are acceptable cost formulas under ASPE; thus, this item is a change in accounting policy.

This oversight is a mistake that should be corrected. Such a correction is considered a change due to error.

Both the completed-contract method and the percentage-ofcompletion method are acceptable alternatives under ASPE. However, they are not interchangeable. The company must choose the method that best relates the revenues recognized to the work performed. In general, the completed-contract method is only used where performance consists of one act or the progress towards completion is not measurable (3400.18). Thus, such a change is a change in accounting estimate.

LO 1 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 21.3 Accumulated Depreciation 1 ................................ 90,000 Deferred Tax Liability ................................... 27,000 Retained Earnings [$90,000 X (1 – 30%)] .... 63,000 1 ($165,000 – $75,000) Note that this is considered to be a correction of an accounting error. LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 21.4 a.

ASPE supports the position that an accounting error, by its definition and nature, can be traced to a specific prior year, and that only by using full retrospective restatement can accounting changes lead to comparable information. If full retrospective restatement is not used, the years before the change will contain errors and the current and following years will present financial statements without errors. In addition, partial retrospective restatement to the carrying amounts at the beginning of the earliest period (this could even be the current year) for which restatement is possible would result in “catch-up” adjustments, such as the adjustment of the opening balance of retained earnings for error correction that may not be clear enough for the financial statement users to understand. As consistency is considered essential in providing meaningful trend data and for determining other financial relationships that are necessary to evaluate a business, partial retrospective or even prospective restatement could cause confusion for the users and a loss of confidence by investors.

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.4 (CONTINUED) b. International Accounting Standard (IAS) 8, on the other hand, specifically requires that when an enterprise retrospectively applies a new accounting policy or corrects a prior period error, it should distinguish information that 1. provides evidence of circumstances that existed on the date(s) at which the transaction, other event, or condition occurred; and 2. would have been available when the financial statements for that prior period were authorized for issue from other information.

When retrospective restatement would require making a significant estimate for which it is impossible to distinguish these two types of information, or when the effects of the retrospective application cannot be determined, it is impracticable to correct the prior period error retrospectively. When an enterprise becomes aware of its accounting error but the correction is impracticable, the best thing it can do to achieve the objective of financial statements—communicating information that is useful to users—would be to provide partial retrospective or prospective treatment. Also, this approach can be supported when an entity may find that data from specific prior periods may only be available at a cost that exceeds the benefits achieved. LO 1,3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.5 Inventory ............................................................... 228,000 Income Tax Payable ..................................... 68,400 Retained Earnings [$228,000 X (1 – 30%)] .. 159,600

Note to instructor: CRA generally requires a company to use the same inventory costing method for tax purposes as for financial reporting purposes. Therefore, Talbert would have additional tax payable on the increased income reported rather than a deferred tax liability. LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.6 a.

ASPE allows a choice of one of two accounting treatments for development phase costs: 1.

Capitalize the costs as internally generated intangible assets when certain criteria are met, and expense all other costs that do not meet the certain criteria; or Expense all costs.

In the past, Chang capitalized development costs as long as the certain criteria for capitalization of internally generated intangible assets were met, which is consistent with the first option above. Therefore, the change to expensing development costs as they are incurred is not a change due to correction of an error. If the change to expensing development costs as they are incurred is due to a change in conditions (for example, if the reason for the change is that the future benefits associated with the development costs have become doubtful), the change is a change in estimate. If the change to expensing development costs as they are incurred is not due to a change in conditions, the change may be treated as a voluntary change in accounting policy. A voluntary change in accounting policy is acceptable if the change results in the financial statements presenting “reliable and more relevant” information about the effects of the transactions, events, or conditions on the entity’s financial position, financial performance, or cash flows. However, ASPE also permits a voluntary change in accounting policy without having to meet the “reliable, but more relevant” test, by allowing voluntary changes between or among alternative ASPE methods of accounting and reporting for certain items, including development phase costs.

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.6 (CONTINUED) b.

Under IFRS, development phase costs should be capitalized as internally generated intangible assets when certain criteria are met, and all other costs that do not meet the certain criteria for capitalization should be expensed. Therefore, Chang must continue its current treatment of capitalizing development costs as long as the certain criteria for capitalization of internally generated intangible assets are met. There would be no change in accounting or reporting treatment of development phase costs to report.

LO 1,3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 21.7 Equipment............................................................ Depreciation Expense ($145,000 ÷ 5) ................. Accumulated Depreciation – Equipment1 .. Deferred Tax Liability2 ................................. Retained Earnings3 ...................................... 1 $145,000 ÷ 5 X 3 years = $87,000 2 ($145,000 – $58,000) X 30% = $26,100 3 ($145,000 – $58,000) X (1 – 30%) = $60,900

145,000 29,000 87,000 26,100 60,900

Assumes income was reported accurately for tax purposes in all years. LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 21.8 a.

BAKER CORPORATION Statement of Retained Earnings December 31, 2023

Retained earnings, 1/1/23, as previously reported Correction of depreciation error, (net of tax of $125,000) Retained earnings, 1/1/23, as adjusted Add: Net income Deduct: Dividends Retained earnings, 12/31/23 b.

$2,000,000 (375,000) 1,625,000 800,000 2,425,000 195,000 $2,230,000

If Baker were to follow IFRS, the error correction would be accounted for in the same way, except that Baker would have to prepare a Statement of Changes in Shareholders’ Equity, as required under IFRS, rather than a Statement of Retained Earnings. In addition, Baker would have to provide an opening Statement of Financial Position for the earliest comparative period reported and adjusted basic and fully diluted earnings per share (EPS) as a result of the error correction.

LO 13,4 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 21.9 No entry is required to record the change in estimate. In CPA Canada Handbook, Part II, Section 1506, a revision of depreciation policy due to changes in the expected pattern of benefits is identified as a change in estimate, and this is accounted for prospectively, not retrospectively. Since the change was made at the beginning of the year, the new accounting policy would be applied to 2023 and prospective years. LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.10 Depreciation Expense1........................................ Accumulated Depreciation – Equipment ...

19,000 19,000

Carrying amount: = $60,000 – 2 X [($60,000 – $18,000) / 7] = $48,000 1

New annual depreciation:

 $48,000 – $10,000  = $19,000    4–2 LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 21.11 There would be no further change in reported income and EPS for 2023 since the 2023 net income has already been calculated using the new depreciation method. There would be no adjustment to opening retained earnings for any previous year since changes in estimate are accounted for prospectively. There would also be no journal entry to adjust the accounting records for accumulated depreciation due to the change in method since a change from one depreciation method to another due to a change in the pattern of consumption is considered a change in estimate, not a change in accounting policy (IAS 8.32). LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.12 The change is not a change in accounting policy. Although it appears that the company changed its accounting policy regarding claiming CCA, this is a change in tax accounting. Since this is not a change in accounting policy, no retroactive adjustment is required to prior years’ financial statements. Rather than having a large loss carryforward, for which Wong could accrue a future tax asset, Wong will have timing differences on its property, plant, and equipment that will eventually reverse and will be treated as future tax assets until realized. LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: CPA: cpa-t001 cpa-t006 CM: Reporting and Tax

BRIEF EXERCISE 21.13 The change is not a change in accounting policy. Although it appears that the company changed its accounting policy regarding recording amortization expense on the licence, it is not a change in accounting policy because a different policy is being applied to transactions, events, or conditions that differ in substance from those that were previously in place or that had previously occurred. BBF will need amortize the licence over the remaining two and one-half years of useful life, which is the period of remaining benefit. December 31, 2023 Amortization Expense ($100,000 / 2.5) ................... 40,000 Accumulated Amortization- Licenses ............ 40,000 To record amortization. Each year BBF will need to review the licence for any signs of impairment and record impairment losses if necessary. LO 1 BT: C Difficulty: S Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.14 a.

The change in the percentage rate used from 2% to 3% for calculating the year-end accrual for warranty expense is a change in estimate and is treated prospectively. Since the entry for 2023 has already been recorded, no additional entry is required.

LO 1 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 21.15 a.

The decision by the board of directors to declare a dividend is not a change in accounting policy. Although the intention may be to declare dividends on a quarterly basis, this decision can be changed at any time.

b. Dividends (100,000 x $.50) ...................................... 50,000 Dividends Payable ........................................... 50,000 To record dividends declared. LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 21.16

LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*BRIEF EXERCISE 21.17

a. b. c. d. e.

2022

2023

Overstated Overstated Understated Overstated No effect

Understated Overstated Overstated Understated Overstated

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 21.1

Item Change

Type of Change

Restatement of Prior Years in Comparative Financial Statements

This appears to be a voluntary change in an accounting policy, which is allowed under ASPE. ASPE allows voluntary changes in accounting policy between alternative ASPE methods of accounting for income taxes, without having to meet the “reliable, but more relevant” test. Therefore, there is no requirement to disclose why the change was made or why it is relevant.

Yes

This is a change in an accounting estimate.

This may represent a change in an accounting policy or a change in an estimate. If it is a change in the accounting policy to expense all development costs from now on, then under ASPE, there is no requirement to disclose why the change was made or why it is more relevant. ASPE allows voluntary changes in accounting policy between alternative ASPE methods of accounting for development costs, without having to meet the “reliable, but more relevant” test. Retrospective application would be required and prior years would be adjusted. However, it may be that the conditions for these particular development costs have changed. This would mean that the estimated future benefits arising from these capitalized development costs have changed (declined), which would be a change in estimate and treated prospectively. Disclosure would be required if material.

Yes

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.1 (CONTINUED) Item Change

Type of Change

Restatement of Prior Years in Comparative Financial Statements

This is treated as a change in classification. Like an error correction, prior years in comparative financial statements would also have to be restated.

Yes

This is an error correction.

Yes

This is a change in estimate due to a change in the pattern of benefits.

Under ASPE, the company has a choice to report subsidiaries as consolidated, or use either the equity method or the cost method. ASPE allows voluntary changes in accounting policy between alternative ASPE methods of accounting for investments in subsidiary companies, without having to meet the “reliable, but more relevant” test. Therefore, there is no requirement to disclose why the change was made or why it is more relevant. This is a voluntary change in an accounting policy and requires retrospective application.

Yes

Not a change in accounting policy. Simply, a change in tax accounting; done prospectively.

This change should not have any impact on the financial statements. Cost of goods sold and ending inventory should be the same regardless of whether the periodic or perpetual inventory method was used.

n/a

10.

A change in accounting policy that results from Yes/No* applying a primary source of GAAP. * The treatment would be specified in the transitional provisions of the new accounting pronouncement.

LO 1 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.2 a.

1. Change in estimate – prospectively. 2. Change in estimate – prospectively. 3. Accounting error correction – full retrospective application. 4. Change in accounting policy – full retrospective application.1 1

GAAP specifies that changes in policy should be accounted for retrospectively with full application to prior periods. In certain cases, it may be impracticable to determine estimates for prior periods, in particular if it is impossible to assess circumstances and conditions in prior years that need to be known in order to develop those estimates. Partial retrospective or prospective application would then have to be used.

Event #3: Equipment ....................................................... 220,000 Depreciation Expense2 ................................... 47,500 Accumulated Depreciation - Equipment ($47,500 X 2) ......................................... 95,000 3 Retained Earnings ................................. 120,750 4 Deferred Tax Liability ............................ 51,750 2 ($220,000 – $30,000)/4 = $47,500 3 ($220,000 – $47,500) X (1 – 30%) = $120,750 4 ($220,000 – $47,500) X 30% = $51,750

Note to Instructor: The Deferred Income Tax effect for the current year is not included in the above entry as noted in the question.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.2 (CONTINUED) b. (continued) Event #4: Retained Earnings .......................................... 10,500 Income Tax Payable ($15,000 X 30%) ............ 4,500 Inventory .................................................. 15,000 Changes for 2020 and 2021 have not been included since inventory changes are counterbalancing and their impact on opening 2023 retained earnings is nil.

Note to Instructor: Also note that the CRA generally requires a company to use the same inventory costing method for tax as it uses for financial reporting purposes. Therefore, the effect of the change in inventory costing method will result in a current tax amount, not a deferred tax asset or liability. LO 1 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.3 a.

The net income to be reported in 2023, would be computed as follows: Income before income tax $700,000 Income tax: Current (30% X $480,000) $144,000 Deferred [30% X ($700,000–$480,000)] 66,000 210,000 Net income $490,000

Construction in Process ................................ 200,000 Future Tax Liability ................................. 60,000 1 Retained Earnings ................................. 140,000 1 ($200,000 X (1 – 30%) = $140,000)

A current ratio of 0.95 indicates that the company has a lower amount of current assets than current liabilities as at the end of 2023. The entry in part (b) will result in an increase in current assets (with a debit to construction in process), and a proportionately smaller increase in current liabilities (with a credit to future tax liability). (Note that under ASPE, a future tax asset or liability must be classified as current or noncurrent based on the classification of the asset or liability underlying the temporary difference.) After recording the entry in part (b), the company’s current ratio will appear higher. The error correction had no impact on the company’s actual liquidity position, yet the error correction will cause the company’s current ratio to appear higher. A creditor should review the notes to the financial statements describing the error correction and recognize the effect of the correction on the company’s current ratio. A creditor may also note that other aspects of the company’s liquidity position should be analyzed for a more detailed assessment of the company’s short-term ability to pay its maturing obligations.

LO 1 BT: AP Difficulty: S Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.4 a.

Patent: This is a change in estimate. The change would be applied to the current year and prospectively. Land and Building: This is a correction of an error. The adjustment would be applied retrospectively. This would include restating all prior period financial statements presented for comparative purposes, adjusting the opening balance of retained earnings for the earliest period presented, presenting an opening statement of financial position for the earliest comparative period reported, and reporting adjusted basic and fully diluted earnings per share (EPS) as a result of the error correction.

b. Amortization of Patent: Amortization Expense ....................................... 91,000 Accumulated Amortization—Patents........ 91,000 Amortization recorded in 2021 and 2022: ($525,000 – $115,000) / 10 years X 2 years = $82,000 Annual amortization incorporating this change: ($525,000 – $170,000 – $82,000) / 3 years (2023 to 2025) = $91,000 Land and Building – error correction entry: Buildings ........................................................ 200,000 Land ........................................................ 200,000 Depreciation Expense1 .................................. 7,500 Retained Earnings ......................................... 18,750 Accumulated Depreciation – Buildings ($7,500 X 3.5) ..................... 26,250 1 ($200,000 – $50,000) / 20 years = $7,500 / year Solutions Manual 21-25 Chapter 21 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 21.4 (CONTINUED) c.

Change in Estimate (Patent): The nature and amount of the change should be disclosed. Amortization expense for the patent has been increased by $50,000 ($91,000 – $41,000) for the current and future years due to a change in estimated useful life and residual value. Correction of Error (Land and Building): The disclosure should enable users to understand the effects of the error on the financial statements. It should include a statement of the nature of the error, the amount of the correction for each prior period presented, the amount related to periods prior to those presented, the amount of the correction made at the beginning of the earliest prior period presented, and a statement that comparative information has been restated. Depreciation expense has been increased by $7,500 for both 2023 and 2022 (include previous years if included in comparative statements). This has decreased net income by $7,500 for both 2023 and 2022 and earnings per share by $XXX in each year.

If management determines assets’ useful lives and residual values as part of the year-end process, it is likely that the conditions leading to these changes would have occurred during the year. In this case, the change in estimate would be applied to 2023 going forward. If management determines that the factors leading to the change in estimate occurred at or after year end, the changes would be applied to 2024 going forward. In this exercise, it appears that depreciation and amortization expense is recorded once a year. Since the controller uses the adjustment process to revise the estimate of useful life and residual value, it would be appropriate to reflect the change to 2023 going forward.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.4 (CONTINUED) e.

Impairments of depreciable assets frequently involve a revision of estimates of useful life and residual value, but changes in estimates do not necessarily come from impairments of assets. Under IFRS, impairment tests for limited-life intangibles are done at the end of each reporting period. The controller would need to review the patent for impairment, and if events or changes in circumstances indicate that the carrying amount of the patent may not be recovered, the controller would need to compare the patent’s carrying amount to its recoverable amount (the higher of value in use and fair value less costs to sell). If the recoverable amount is less than carrying amount of the patent, the impairment loss would be the excess of the patent’s carrying amount over its recoverable amount. Under ASPE, impairment tests are done when there may be evidence of impairment. The controller would need to review the patent for impairment, and if events or changes in circumstances indicate that the carrying amount of the patent may not be recovered, the controller would need to compare the patent’s carrying amount to its recoverable amount (the undiscounted future cash flows from use and ultimate disposal). If the recoverable amount is less than the carrying amount of the patent, the patent is impaired. The impairment loss would be the excess of the patent’s carrying amount over its fair value. In this exercise there is no indication that the changes in estimates are due to impairment. Consequently, the changes would be accounted for as a change in estimate.

LO 1,2 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.5 a. and b.

Accounting treatment under IFRS:

1. 2. 3. 4. 5.

a. Accounting treatment P R P NA* P

6. 7. 8. 9. 10.

P R P P R

b. Type of change Change in estimate Accounting error correction Change in estimate Change in policy Not an accounting change – selection of policy for first time. Change in estimate Accounting error correction Change in estimate Change in estimate Accounting error correction

*The accounting treatment would be specified in the transitional provisions of the new source of GAAP. If not specified, then apply retrospectively. Note that the only two approaches that are permitted for reporting changes are retrospective and prospective treatment. When new or revised sources of primary GAAP are adopted, recommendations are usually included that specify how an entity should handle the transition. These are called transitional provisions. Under IFRS, when there is a retrospective change, an opening statement of financial position must be provided for the earliest comparative period provided and adjusted basic and fully diluted earnings per share (EPS) must be reported. Under IFRS, the entity should report information about new standards that have been issued but are not yet effective and have not yet been applied. IFRS also requires that the entity disclose information about measurement uncertainty, including sensitivity of carrying amounts to changes in assumptions. Solutions Manual 21-28 Chapter 21 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.5 (CONTINUED) c.

Accounting treatment under ASPE (if different than part (a) for IFRS): For corrections of errors, ASPE assumes that the impact on each specific prior period is measurable, and therefore only allows full retrospective restatement. IFRS acknowledges that the full impact of the error may not be determinable and allows partial retrospective restatement in these circumstances. Under ASPE, when there is a retrospective change, there is no requirement to provide an opening statement of financial position, or to report adjusted basic and fully diluted earnings per share (EPS). Under ASPE, there is no requirement to report information about new standards that have been issued but are not yet effective and have not yet been applied. There would be no differences to the accounting treatment for the various items between IFRS and ASPE, however some items have special considerations worth noting. (5) IAS 23 requires that interest be capitalized for qualifying assets, whereas ASPE still permits a choice between capitalization and expense, provided that the company is consistently applying the policy. Given that this is the first time the entity has constructed a building for its own purposes, capitalization of the related interest is not an accounting change, but rather selection of a policy for the first time.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.5 (CONTINUED) c. (continued) (9) Under IFRS, if the outcome cannot be reliably measured, recoverable revenues equal to costs are recognized (sometimes referred to as the zero-profit method). No gross profit is recorded until the contract is completed and the gross profit can be reliably measured. IFRS does not allow use of the completed contract method. Under ASPE, the completed-contract method is allowed as a default method for long-term contracts where the percentage complete cannot be reliably measured. Under the completed contract method, revenue would only be recorded when the contract is completed. d.

Under IFRS, one of the following two situations is required for a change in an accounting policy to be acceptable: 1. The change is required by a primary source of GAAP. 2. A voluntary change results in the financial statements presenting reliable and more relevant information about the effects of the transactions, events, or conditions on the entity’s financial position, financial performance, or cash flows. ASPE provides for further situations where an accounting policy change may be made without having to meet the “reliable and more relevant” criteria noted above. It allows the following voluntary changes in policy to be made:

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.5 (CONTINUED) d. (continued) 3. Between or among alternative ASPE methods of accounting and reporting for investments in subsidiary companies, and in companies where the investor has significant influence or joint control; for expenditures during the development phase on internally generated intangible assets; for defined benefit plans; for accounting for income taxes; and for measuring the equity component of a compound financial instrument. These further situations, allowed under ASPE as an acceptable change in accounting policy, relate to standards where accounting policy choices have to be made. These changes are treated as voluntary changes, but they do not have to meet the “reliable and more relevant” hurdle required of other voluntary changes. Although not specifically stated in the actual standard, it is assumed that once that choice has been made, the same policy is followed consistently. LO 1,3 BT: C Difficulty: S Time: 25 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.6 1.

The change to the units-of-production method from straightline is a change in estimate. The change is applied prospectively, but the company would require note disclosure of the impact on current and future earnings.

The conditions have changed and the future estimated benefit for these costs is now questionable. The change to expensing development costs is a change in estimate due to a change in conditions. Under IFRS, this is a prospective change, and note disclosure of the impact on current and future earnings is required. However, under ASPE, this could also be seen as a change in policy if the company will continue to expense development costs consistently. If this is the case, then the change in policy would be applied retrospectively, and Yates would not need to provide justification as to whether or not this is a more relevant treatment for reporting purposes.

This oversight is a mistake that must be corrected. Such a correction is considered a correction of an error of a prior period. Retrospective application is required under both IFRS and ASPE and note disclosure should include the nature of the error and its impact on the current and prior periods. Under IFRS, an opening statement of financial position is required for the earliest comparative period presented and adjusted basic and fully diluted earnings per share (EPS) as a result of the error correction would be reported.

This change is not one of the three types mentioned. Neither the method of accounting for certain receivables nor the method of accounting for income taxes (inter-period allocation) was changed. The only change is for tax reporting purposes.

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EXERCISE 21.6 (CONTINUED) 5.

In this case, no reason is provided for the change. The justification for the change will determine the appropriate accounting treatment. If the nature of the change is to provide more relevant information, then this would be treated as a voluntary change in accounting policy. The change would be applied retrospectively and comparative information would be restated as if the average cost method had been used for all prior periods. Under IFRS, an opening statement of financial position would also be required for the earliest comparative period presented and adjusted basic and fully diluted earnings per share (EPS) as a result of the change in policy would also be reported. However, if the reason for the change is due to changed circumstances, for example if the type and composition of inventory items has materially changed, the change would be treated as the application of accounting standards to a new situation and would be accounted for on a prospective basis. The change may also be due to a change in estimate, for example if the inventory flow pattern is different from what was previously estimated, and then the change would be accounted for on a prospective basis.

LO 1,3 BT: C Difficulty: M Time: 30 min. AACSB: Ethics CPA: CPA: cpa-t001 cpa-e001 Reporting and Ethics

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EXERCISE 21.7 a.

Preparation of comparative financial statements Analysis of change from sum-of-the-years-digits to straightline Depreciation for 2022 using sum-of-the-years-digits Cost of depreciable assets ................................. Depreciation in 2022 ($90,000 X 4/10) ................ Carrying amount at December 31, 2022 .............

$90,000 36,000 $54,000

Depreciation for 2023 using sum-of-the-years-digits Cost of depreciable assets ................................. Depreciation in 2022 ($90,000 X 4/10) ................ Depreciation in 2023 ($90,000 X 3/10) ................ Carrying amount at December 31, 2023 .............

$90,000 36,000 27,000 $27,000

Depreciation for 2023 using straight-line depreciation Carrying amount at December 31, 2022 ............. Estimated useful life ............................................ Depreciation for 2023 ($54,000 ÷ 3) ....................

$54,000 3 years $18,000

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EXERCISE 21.7 (CONTINUED) a. (continued) MERRICK INC. Income Statement For the Years Ended December 31 2023

2022 Restated see note XX

Sales Cost of goods sold Gross profit Operating expenses Net income

$340,000 180,000 160,000 79,000 $81,000

Earnings per share

$4.05

$270,000 162,000 108,000 50,000 $58,000 $2.90

a. Cost of goods sold – 2023: balance before change $200,000, less 2022 ending inventory overstatement error $20,000 = $180,000 b. Operating expenses – 2023: balance before change $88,000, less 2023 depreciation using sum-of-the-yearsdigits $27,000, plus 2023 depreciation using straightline $18,000 = $79,000 c. Earnings per share – 2023: net income $81,000 / 20,000 common shares outstanding = $4.05 d. Cost of goods sold – 2022: balance before change $142,000, plus 2022 ending inventory overstatement error $20,000 = $162,000 e. Earnings per share – 2022: net income $58,000 / 20,000 common shares outstanding = $2.90 Note to instructor: Additional disclosures would be necessitated as indicated in the chapter.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.7 (CONTINUED) a. (continued) MERRICK INC. Statement of Changes in Equity For the Year Ended December 31, 2023

Balance, January 1, 2022 ............. Net income 2022 (restated) overstatement ................... Less: Dividends............................ Balance, December 31, 2022, as restated.............................. Net income 2023 ........................... Less: Dividends........................... Balance, December 31, 2023 .......

Share Capital

Retained Earnings

Total

$30,000

$72,000

$102,000

58,000 (25,000)

105,000 81,000 (30,000) $156,000

135,000 81,000 (30,000) $186,000

30,000

$30,000

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EXERCISE 21.7 (CONTINUED) a. (continued)

MERRICK INC. Statement of Financial Position As at December 31, 2023

As at December 31, 2022

As at January 1, 2022

Restated see note XX

Assets Cash Inventory Plant assets, net

$60,000 107,000 36,000 $203,000

Liabilities and Shareholders’ Equity Accounts payable $17,000 Share capital 30,000 Retained earnings 156,000 b $203,000

$34,000 108,000 54,000 $196,000

$61,000 30,000 105,000 $196,000

$38,000 112,000 $150,000

$48,000 30,000 72,000 $150,000

a. Plant assets, net – 2023: balance before change $27,000, plus 2023 depreciation using sum-of-the-years-digits $27,000, less 2023 depreciation using straight-line $18,000 = $36,000 b. From part a. c. Inventory – 2022: balance before change $128,000, less 2022 ending inventory overstatement error $20,000 = $108,000 d. From part a.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.7 (CONTINUED) a. (continued)

Note to instructor: Additional disclosures would be necessitated as indicated in the chapter.

Most likely accounting treatment of change in depreciation method under various circumstances: • If the change is due to changed circumstances, for example, if the usage of the new assets is better reflected by straight-line depreciation or a changed pattern of expected benefits, then the change would be treated prospectively. • If the change is due to a change in primary GAAP, the transitional provisions of the new policy would specify the acceptable treatment.

LO 1,4 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.8 a.

Retained earnings, January 1, as reported.......... Cumulative effect of change in accounting principle to weighted average cost1 ................. Retained earnings, January 1, as adjusted ......... 1

2020 $160,000 (13,000) $147,000

[ – $8,000 (2018) – $5,000 (2019)]

Retained earnings, January 1, as reported.......... Cumulative effect of change in accounting principle to weighted average cost2 ................. Retained earnings, January 1, as adjusted .........

2023 $590,000 (15,000) $575,000

[– $8,000 (2018) – $5,000 (2019) – $5,000 (2020) + $10,000 (2021) – $7,000 (2022)] 2

Retained earnings, January 1, as reported.......... Cumulative effect of change in accounting principle to weighted average cost3 ................. Retained earnings, January 1, as adjusted ......... 3

2025 $780,000 (9,100) $770,900

[–$15,000 at 12/31/2022 + $5,900 (2023)]

2021 Net Income ............................. $130,000

2022 2023 $293,000 $310,900

LO 1 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.9 a.

For the years ended December 31, 2022 and 2023, the land was originally measured and reported on the SFP at its cost of $1,000,000 with no effects reported in net income (as there is no depreciation on land). GOLDEN PROPERTIES CORPORATION STATEMENT OF FINANCIAL POSITION (partial) AS AT DECEMBER 31, 2022

Land, at cost Retained earnings, ending balance

2021

$1,000,000 $0 230,000 189,000

GOLDEN PROPERTIES CORPORATION INCOME STATEMENT (partial) FOR THE YEAR ENDED DECEMBER 31,

2022 Gain (loss) in value of investment property Net income Earnings per share

2021

$0 $0 $41,000 $73,000 $0.41 $0.73

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EXERCISE 21.9 (CONTINUED) b.

The entry required on January 1, 2023 to restate opening Retained Earnings is: Retained Earnings ..................... Investment Property..............

20,000 20,000

The opening Retained Earnings in 2023 would have to be decreased by $20,000 for the change in fair value of the investment property up to December 31, 2022 (equal to the fair value holding loss in 2022 of $20,000. The entry required on December 31, 2023 to recognize the fair value holding gain is: Investment Property .................. Gain or Loss on Investment Property

70,000 70,000

An unrealized gain would have to be recognized in 2023 for the increase in fair value of the investment property in 2023 (equal to the fair value holding gain in 2023 of $70,000). This is a considered an acceptable change in accounting policy since changing the measurement model will provide more relevant information. Thus, it is accounted for retroactively as a change in accounting policy.

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EXERCISE 21.9 (CONTINUED) c.

The previous financial statements would be restated as follows to include the change in fair value of the investment property in net income and related presentation on the SFP: GOLDEN PROPERTIES CORPORATION STATEMENT OF FINANCIAL POSITION (partial) As at As at December December 31, 2023 31, 2022

As at January 1, 2022

Restated see note XX

Investment property - Land, at fair value Retained earnings, ending balance 4 5

$1,050,000

$980,000

292,0004

210,0005

189,000

$210,000 + $70,000 + $12,000 = $292,000 $230,000 - $20,000 = $210,000

GOLDEN PROPERTIES CORPORATION INCOME STATEMENT (partial) FOR THE YEAR ENDED DECEMBER 31, 2023

2022 Restated see note XX

Gain (loss) in value of investment property Net income Earnings per share

$70,000 $82,000 $0.82

$(20,000) $21,000 $0.21

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.9 (CONTINUED) d.

The fair value model results in more relevant information on the SFP, because the investment property is revalued to fair value every year. An investor may be better able to assess the current economic position of the company with this information. However, the fair value model increases the risk of bias in the financial statements, because the fair value model uses a fair value amount that is not necessarily supported by a transaction with commercial substance. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date,” and independent valuators and market-related evidence are used to the extent possible, but it may be necessary to use other methods. An investor in Golden should be aware that the fair value amount that is applied in the fair value model requires a degree of professional judgement in calculation and application, and that the determination of fair value can have a material affect on the SFP as well as the income statement. The cost model results in more neutral information on the financial statements, because the land is valued at cost. An investor in Golden should note that the change to the fair value model results in restated earnings per share for 2022 of $0.21, which is $0.20 less than originally reported earnings per share for 2022 of $0.41. On the other hand, the change to the fair value model results in earnings per share for 2023 of $0.82, which is $0.70 more than what earnings per share would have been for 2023 if Golden continued to apply the cost model.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.9 (CONTINUED) d. (continued) Under the fair value model, earnings per share may be impacted significantly by gains (losses) in the value of investment property. However, gains (losses) that are a result of fair value assessments require a degree of professional judgement in their calculation, and are affected by market conditions at the time of determination. So, they are not necessarily a reflection of the entity’s financial performance in the period. LO 1 BT: AP Difficulty: C Time: 50 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.10 a.

Inventory1 ............................................................. 8,000 Retained Earnings2 ...................................... 2

2020 *2021 *2022 1

$2,000 5,000 1,000 $8,000

8,000

($26,000 – $24,000) ($30,000 – $25,000) ($28,000 – $27,000)

Cost of Goods Sold could be used if the inventory is already adjusted at year-end. Note that the change in the ending inventory (and in ending retained earnings) each year must have been as follows to result in the income increases shown:

Dec. 31/20 ($0 + $2,000) Dec. 31/21 ($2,000 + $5,000) Dec. 31/22 ($7,000 + $1,000) Dec. 31/23 ($8,000 + $4,000)

+$2,000 +$7,000 +$8,000 +$12,000

Information shown in comparative form as follows:

Net income (Note A)

2023

2022

2021

2020

$34,000

$28,000

$30,000

$26,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.10 a. (continued) Note A: (ignoring income taxes) In 2023, inventory has been calculated using the first-in, firstout cost formula. In prior years, inventory had been calculated using the weighted average cost formula. The new method of inventory costing was adopted to provide more relevant financial statement information and has been applied retrospectively to inventory valuation of prior years. The impact of the change is an increase in ending inventory of $12,000 (increase in 2022 of $8,000), decrease in cost of goods sold of $4,000 (decrease in 2022 of $1,000), increase in net income of $4,000 (increase in 2022 of $1,000), an increase of opening retained earnings of $8,000 (increase of $7,000 in 2022) and an increase in earnings per share of $X (increase in 2022 of $X). b. Inventory3 ............................................................. 19,000 Retained Earnings4 ...................................... 19,000 4

2020 *2021 *2022 3

$ 6,000 9,000 4,000 $19,000

($26,000 – $20,000) ($30,000 – $21,000) ($28,000 – $24,000)

Cost of Goods Sold could be used if the inventory is already adjusted at year-end.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.10 b. (continued) Note that the change in the ending inventory (and in ending retained earnings) each year must have been as follows to result in the income increases shown: Dec. 31/20 ($0 + $6,000) Dec. 31/21 ($6,000 + $9,000) Dec. 31/22 ($15,000 + $4,000) Dec. 31/23 ($19,000 + $8,000)

Net income

+$6,000 +$15,000 +$19,000 +$27,000

2023

2022

2021

2020

$34,000

$28,000

$30,000

$26,000

Note A: (ignoring income taxes) In 2023, inventory has been calculated using the first-in, firstout cost formula. In prior years, inventory had been calculated using the last-in, first-out cost formula. The change is required in order to comply with CPA Canada Handbook, Part II, section 3031, and the new standard has been applied retrospectively. The impact of the change is an increase in ending inventory of $27,000 (increase in 2022 of $19,000), decrease in cost of goods sold of $8,000 (decrease in 2022 of $4,000), increase in net income of $8,000 (increase in 2022 of $4,000), an increase of opening retained earnings of $19,000 (increase of $15,000 in 2022) and an increase in earnings per share of $X (increase in 2022 of $X). LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.11 a. 1.

Accumulated Depreciation—Machinery.......... 15,000 Depreciation Expense ............................... 5,000 Retained Earnings ..................................... 10,000

Depreciation taken Depreciation (correct) 1

2021-2022

2023

*$150,0001 * 140,000* *$ 10,000*

$75,000 70,000 $ 5,000

$450,000 X 1/6 X 2

Salaries and Wages Expense .......................... 47,000 Retained Earnings ..................................... 47,000

Current Tax Expense ........................................ 81,000 Retained Earnings ..................................... 81,000

Goodwill ............................................................ 225,000 Amortization Expense............................... 50,000 Retained Earnings ($50,000 X 3.5 years) . 175,000 In addition, impairment.

the

company

should

test

goodwill

for

No entry necessary.

Retained Earnings ............................................ 63,000 Loss on Impairment .................................. 63,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.11 (CONTINUED) b.

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

c. 1.

Error correction Error correction Error correction Error correction Change in accounting policy Error correction

Accumulated Depreciation—Machinery.......... 15,000 Depreciation Expense ............................... Retained Earnings ..................................... Deferred Tax Liability ................................

5,000 7,500 2,500

Salaries and Wages Expense .......................... 47,000 Retained Earnings..................................... 35,250 Income Tax Payable .................................. 11,750

Current Tax Expense ........................................ 81,000 Retained Earnings1 ................................... 81,000 1

Since the full $81,000 was charged to Retained Earnings, the same amount is reversed without factoring in the income tax effect.

Goodwill ............................................................ 225,000 Amortization Expense............................... 50,000 2 Retained Earnings ................................... 131,250 3 Deferred Tax Liability .............................. 43,750 2 ($50,000 X 3.5 years X (1 – 25%)) 3 ($50,000 X 3.5 years) X 25% In addition, the company should test goodwill for impairment.

No entry necessary.

Retained Earnings ............................................ 47,250 Income Tax Payable ......................................... 15,750 Loss on Impairment ................................. 63,000

LO 1 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: CPA: cpa-t001 cpa-t006 CM: Reporting and Tax Solutions Manual 21-49 Chapter 21 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.12 December 31, 2023 Retained Earnings ($550,000 X 9/55) ........................ Accumulated Depreciation— Machinery........... To correct for the omission of depreciation expense in 2021.

90,000 90,000

Cost of machine $550,000 Less: Depreciation prior to 2023 2020 ($550,000 X 10/55) $100,000 2021 ($550,000 X 9/55) 90,000 2022 ($550,000 X 8/55) 80,000 270,000 Carrying amount at January 1, 2023 $280,000 Depreciation for 2023: $280,000 ÷ 7 = $40,000 Depreciation Expense ................................................ Accumulated Depreciation— Machinery........... To record depreciation expense for 2023.

40,000 40,000

LO 1 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.13 a. December 31, 2023 Loss on Disposal of Assets ($180,000 + $60,000) .. 240,000 Loss on Discontinued Operations ................... 240,000 To correct for error in recording of disposal

The assets have been disposed of and would not appear on the SFP at December 31, 2023. The change in the treatment would not affect the ending balance of the assets disposed of or the tax liabilities at December 31, 2023.

c. Income before income taxes1 ............................. $1,620,000 Income taxes2 ...................................................... 405,000 Net income........................................................... $1,215,000 1 2

($1,860,000 – $240,000) = $1,620,000 ($465,000 - $60,000) = $405,000

LO 1,4 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.14 a. Contract Asset/Liability .................................. 125,000 Retained Earnings1 .................................. 125,000 To record gross profit for prior years 2021 and 2022 1 ($1,575,000 - $1,450,000) b. Contract Asset/Liability .................................. Revenue from Long-Term Contracts ...... To record revenues. Construction Expenses ................................ Contract Asset/Liability .......................... To record construction expenses.

530,000 530,000

500,000 500,000

c. Contract Asset/Liability1 ................................. 155,000 2 Deferred Tax Liability ............................. 38,750 Retained Earnings3 .................................. 116,250 To record gross profit for prior years 2021 to 2023. 1 ($2,105,000 - $1,950,000) 2 ($155,000 x 25%) 3 ($155,000 - $38,750) LO 1,3 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.15 a.

The voluntary change is a change in accounting policy. A voluntary change in accounting policy is acceptable if the change results in the financial statements presenting “reliable and more relevant” information about the effects of the transactions, events, or conditions on the entity’s financial position, financial performance, or cash flows. Prior years’ financial statements would need to be adjusted.

ASPE also permits a voluntary change in accounting policy similar to IFRS as noted in part (a).

c. FV-NI Investments ........................................... Investment Income or Loss1 ........................... Retained Earnings ($225,413 - $224,500) ....... Bond Investment at Amortized Cost ...... 1 ($228,938 – $226,700 - $913)

226,700 1,325 913 228,938

Assets

Bonafacio Holdings Ltd. Statement of Financial Position December 31, 2023

Non-current assets: Bond investment at amortized cost

$228,938

2022

$225,413

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.15 (CONTINUED) e.

Assets Current assets:

Bonafacio Holdings Ltd. Statement of Financial Position December 31, 2023

FV-NI investments

$226,700

2022 (restated) $224,500

LO 1,3,4 BT: AP Difficulty: C Time: 25 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.16 a. December 31, 2023 Retained Earnings .................................................. 80,000 Accumulated Depreciation—Equipment ....... 80,000 (To correct for the omission of depreciation expense in 2020) ($1,200,000 / 15 years = $80,000 depreciation per year) No extra entry is necessary to record the change from one depreciation method to another since a change from one depreciation method to another is a change in estimate, and changes in estimates are treated prospectively. The adjusting entry to be made for depreciation, based on a prospective application of double-declining-balance (DDB) is: Depreciation Expense ............................................ 160,000 Accumulated Depreciation—Equipment ....... 160,000 To record depreciation expense. DDB rate: (100% ÷ 11 years remaining) X 2 = 18.18182% $1,200,000 – (4 X $80,000) = $880,000 $880,000 X 0.1818182 = $160,000

b. December 31, 2023 Retained Earnings .................................................. 60,000 Deferred Tax Asset ($80,000 X 25%) ..................... 20,000 Accumulated Depreciation—Equipment ....... 80,000 (To correct for the omission of depreciation expense in 2020) As above (see part a), with the same depreciation entry. LO 1,4 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.17 1.

Salaries and Wages Expense ........................ Salaries and Wages Payable ..................

12,500 12,500

Salaries and Wages Expense ........................ 33,800 Salaries and Wages Payable .................. 33,800

Prepaid Insurance ($8,760 X 10/12) ............... Insurance Expense .................................

7,300 7,300

Sales Revenue ................................................ 70,500 [$1,480,500 ÷ (1.00 + .05) X 5%] Sales Tax Payable ................................... 70,500 To record sales tax on revenue Sales Tax Payable........................................... 60,000 Sales Tax Expense .................................. 60,000 To adjust balances to actual

LO 1,4 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.18 a.

Supplies Expense ($6,700 – $3,400) ........ Supplies ............................................. To record supplies used.

3,300

Salaries and Wages Expense1 ................. Salaries and Wages Payable ............ To accrue salaries and wage expense. 1 ($6,200 – $4,900)

1,300

Interest Income ($7,300 – $6,750) ............ Interest Receivable............................

550

Insurance Expense2 .................................. Prepaid Insurance ............................. 2 ($108,000 – $42,000)

66,000

Rent Revenue ($72,000 ÷ 2) ...................... Unearned Rent Revenue ...................

36,000

Depreciation Expense3 ............................. Accumulated Depreciation – Equipment....................................... 3 ($47,500 – $4,750)

42,750

Retained Earnings .................................... Accumulated Depreciation – Equipment.......................................

18,500

3,300

1,300

550

66,000

36,000

42,750

18,500

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.18 (CONTINUED) b. 1.

Retained Earnings .................................... Supplies ............................................. To record supplies used.

3,300

Retained Earnings .................................... Salaries and Wages Payable ............ To accrue salaries and wage expense.

1,300

Retained Earnings .................................... Interest Receivable............................

550

Retained Earnings .................................... Prepaid Insurance .............................

66,000

Retained Earnings .................................... Unearned Rent Revenue ...................

36,000

3,300

1,300

550

66,000

36,000

Retained Earnings .................................... 42,750 Accumulated Depreciation - Equipment 42,750

Same as in (a).

Items 1 to 4 are adjusting entries as part of the accounting cycle. The situations presented could have occurred as oversights by the accounting staff in the adjustment process. The normal adjustment process however would normally capture these situations.

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.18 (CONTINUED) c. (continued) For salaries and wages payable and interest receivable, the fact that the opening balances were not changed does not imply an error. Cash receipts of interest and cash disbursements for salaries and wages were posted to the income statement, rather than cleared from the opening balances. This means that interest income and salaries and wages expense are currently overstated. The opening balance needs to be closed to Interest Income / Salaries and Wages Expense, and the year-end accrual recorded. This can be accomplished in a compound entry by adjusting the opening balance to the required ending balance. For item 4, the company is likely using the alternative form of recording its unearned rent revenue by posting the full amount to rent revenue. Therefore, the adjusting entry has to reduce the rent revenue account and post the corresponding amount to the unearned rent revenue account. Items 5 and 6 however, are accounting errors.

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.18 (CONTINUED) c. (continued) For items 1 to 5, since the proper adjustments are posted to the books of account in the current year, no disclosure is necessary. The financial statements will reflect the correct amounts. Under part (b) with the books closed, if the financial statements are not yet issued, the adjustments could be factored into the financial statements as part of the financial statement preparation process. No special presentation or note disclosure would be required. If the financial statements have been issued, the correction would flow into the subsequent financial statements and would be treated as corrections of errors in a prior period. Opening retained earnings would be adjusted. Under IFRS, an opening statement of financial position would be required for the earliest comparative period presented and adjusted basic and fully diluted earnings per share (EPS) as a result of the error correction would be reported. Note disclosure would be required, detailing the nature of the errors and the line items in the financial statements affected. Item 6 is an error in a prior period and would be treated as detailed above. Under IFRS, Lindy would also report information about new standards that have been issued but are not yet effective and have not yet been applied, and information about measurement uncertainty, including sensitivity of carrying amounts to changes in assumptions. LO 1,4 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.19 a.

Effect of errors on 2023 net income: $10,700 understatement Calculations – Effect on 2023 net income: Over (under) statement Overstatement of 2022 ending inventory (and 2023 beginning inventory) Understatement of 2023 ending inventory Expensing of insurance premium in 2022 ($66,000 ÷ 3) Failure to record gain on disposal of fully depreciated machinery in 2023 Total effect of errors on net income (understated)

$ (9,600)) (8,100) 22,000 (15,000) $(10,700))

Effect of errors on working capital: $45,100 understatement Calculations – Effect on working capital: Over (under) statement Understatement of 2023 ending inventory Expensing of insurance premium in 2022 (prepaid insurance) Cash from disposal of fully depreciated machinery unrecorded Total effect on working capital (understated)

$( (8,100)) (22,000) (15,000) $(45,100)

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.19 (CONTINUED) c.

Effect of errors on retained earnings: $47,400 understatement Calculations – Effect on retained earnings: Over (under) statement Understatement of 2023 ending inventory Overstatement of depreciation expense in 2022 Expensing of insurance premium applicable to 2025 in 2022 Failure to record disposal of fully depreciated machinery in 2023 Total effect on retained earnings (understated)

$( (8,100)) ( (2,300)) (22,000) (15,000) $(47,400)

NEILSON TOOL CORPORATION Statement of Retained Earnings For the Years 2023 and 2022 2023

2022 (restated)

Retained earnings, January 1, as previously reported Less: Effect of error in inventory in previous year Add: Depreciation error in previous year Add: Error in insurance Retained earnings, January 1, as restated Net income Dividends Retained earnings, December 31

$1,607,000

$1,250,000

(9,600) 2,300 44,000

1,643,700 385,700 (45,000) $1,984,400

1,250,000 458,700 (65,000) $1,643,700

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*EXERCISE 21.19 (CONTINUED) d. (continued) 1 2

Net income for 2023 = $375,000 + $10,700 understatement. Net income for 2022 = $422,000 – $9,600 + $2,300 + $44,000

Correction of error: The financial statements must be restated for all prior periods. Opening retained earnings are adjusted. The required disclosure includes a description of the errors, the effect of the correction of the errors on the financial statements of the current and prior periods, and the fact that the financial statements of prior periods that are presented for comparative purposes are restated. More specifically, the amounts of the corrections to each line of the financial statements presented for comparative purposes, as well as the amounts of the corrections made at the beginning of the earliest prior period, are presented. Retrospective restatement enhances the consistency and more specifically, the comparability of the financial statements.

LO 1,4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.20 a. Income before tax Corrections: Sales erroneously included in 2022 income Understatement of 2022 ending inventory Adjustment to bond interest expense1 Repairs erroneously charged to the Equipment account Depreciation recorded on improperly capitalized repairs (10%)3 Corrected income before tax 1

2023

$101,000

$77,400

(38,200)

38,200

8,640 (1,450)

(8,640) (1,552)

(8,500)

(9,400)

850 $62,340

1,705 $97,713

Bond interest expense for 2022 and 2023 was computed as follows:

2022 2023 4

2022

Carrying Amount of Bonds

Stated Interest

Effective Interest

$235,000 236,450

$15,000 15,000

**$16,4504 ** 16,552**

$235,000 X 7%

Difference between effective interest at 7% and stated interest (6%): 2022: $1,450 2023: 1,552 3

Erroneous depreciation taken in 2023: on 2022 addition (($8,500 - $850) x 10%) on 2023 addition ($9,400 x 10%) Total excess depreciation 2023

$ 765 940 $1,705

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.20 (CONTINUED) b. 1.

Retained Earnings ...................................... 38,200 Sales Revenue ..................................... 38,200

Assuming the incorrect opening inventory is still in the Inventory account: Inventory .................................................... 8,640 Retained Earnings ............................... 8,640 To record correction of beginning inventory. Note: If, contrary to the assumption in the problem, the Inventory account had been adjusted during the 2023 year as a result of interim inventory counts in order to prepare interim financial statements, or if the ending inventory had been counted at year end and an adjusting entry had already been made to recognize cost of goods sold: Cost of Goods Sold…………………………… 8,640 Retained Earnings ……………………….. 8,640 To record adjustment to cost of goods sold.

Retained Earnings ...................................... Bonds Payable ....................................

1,450

Interest Expense ......................................... Bonds Payable .................................... For the 2023 interest.

1,552

1,450

1,552

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.20 (CONTINUED) b. (continued) 4.

Retained Earnings ...................................... Equipment............................................ To correct for error.

8,500

Accumulated Depreciation - Equipment ... Retained Earnings ............................... To adjust the 2022 error on equipment.

850

Repairs and Maintenance Expense ........... Equipment............................................ To record correction of error.

9,400

Accumulated Depreciation - Equipment ... Depreciation Expense ......................... To adjust the 2023 error on equipment.

1,705

8,500

850

9,400

1,705

Quality of earnings refers to how solid the earnings numbers are. High quality earnings numbers are unbiased, reflective of the underlying business fundamentals, and sustainable. Prior to the correction of several errors in reported net income for 2022 and 2023, Hawks Corp. reported before-tax income of $101,000 and $77,400 in 2022 and 2023, respectively. After correction of the errors, Hawks Corp.’s corrected income before tax was $62,340 and $97,713 in 2022 and 2023, respectively. An investor may assess that Hawks Corp. has low quality earnings because the company’s reported earnings may be significantly biased and have a higher margin of potential misstatement. As a result, the shares of Hawks Corp. may be discounted in the capital markets.

LO 1,4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 21.21 Effect on Net Income 2022 Item (1)

OverUnderstatement statement

No Effect

X X

(3) (5)

No Effect

(2) (4)

2023

X X

LO 1,4 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.22 a.

Depreciation to date on the equipment: Double-declining depreciation 2020 (2/5 X $465,000) 2021 (2/5 X $279,000) 2022 (2/5 X $167,400)

Cost of equipment ............................... Depreciation to date ............................ Carrying amount (Dec. 31, 2022) ........

$186,000 111,600 66,960 $364,560 $465,000 364,560 $100,440

Depreciation for 2023: $(100,440 – $15,000) ÷ (5 – 3) = $42,720 Depreciation Expense .................................... 42,720 Accumulated Depreciation—Equipment . 42,720

b. Depreciation to date on building: $780,000 / 30 years = $26,000 per year $26,000 X 3 years = $78,000 depreciation to date Cost of building ................................... Depreciation to date ............................ Carrying amount (Dec. 31, 2022) ........

$780,000 78,000 $702,000

Depreciation for 2023: $702,000 ÷ (40 – 3) = $18,973 Depreciation Expense .................................... 18,973 Accumulated Depreciation—Buildings ... 18,973 LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.23 a.

Calculation of depreciation for 2023 on the building:

Cost of building Less: Depreciation prior to 2023 2019 ($1,200,000 – $0) X .051 2020 ($1,200,000 – $60,000) X .05 2021 ($1,200,000 – $117,000) X .05 2022 ($1,200,000 – $171,150) X .05 Carrying amount, January 1, 2023 1

$1,200,000 $60,000 57,000 54,150 51,443

222,593 $ 977,407

Double-declining-balance rate = (1 ÷ 40) X 2 = 5%

Depreciation expense for 2023: $25,761 [($977,407 – $50,000) ÷ 36 (=40 – 4) years] Depreciation Expense ................................... 25,761 Accumulated Depreciation—Buildings .

25,761

Calculation of depreciation for 2023 on the equipment:

Cost of equipment Less: Accumulated depreciation [($130,000 – $10,000) ÷ 12] X 4 years Carrying amount, January 1, 2023

$130,000 40,000 $ 90,000

2023 Depreciation expense = ($90,000 – $5,000) / (15 – 4) = $7,727

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.23 (CONTINUED) c.

Zui’s auditor must ensure that the changes in estimate are due to new and better information being provided/gathered, and not due to an attempt to manipulate earnings. Changes in estimate should result either from an assessment of the present status of the assets, or from changes in the expected future benefits of the assets. It may be difficult to estimate useful lives, residual values, and patterns of expected future benefits; however, Zui’s auditor must attempt to incorporate the best estimates and support the best estimates with evidence. Zui’s auditor must look for, and management must provide, supporting documentation for the changes. Each reporting period, management must revisit all estimates and refine them, and Zui’s auditor must review the information and exercise professional scepticism.

LO 1 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 cpa-t004 CM: Reporting and Audit

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.24 a.

The change in estimate would be applied in 2023. The amount of depreciation expense for 2023 would be calculated as a change in estimate. Income before depreciation and income tax Depreciation expense1 Income before income tax Income tax (30%) Net income

$300,000 250,000 50,000 15,000 $35,000

Cost of assets = $125,000 X 8 years = $1,000,000 Carrying amount = $1,000,000 – ($125,000 X 2) = $750,000 Depreciation expense = $750,000 X 2/62 = $250,000 2 The remaining useful life is 6 years (8 years less the 2 years already depreciated).

b., c., d. There would be no adjustment to opening retained earnings for any previous year since changes in estimate are accounted for prospectively. There would also be no journal entry to adjust the accounting records. The depreciation for 2023 of $250,000 would be recorded. LO 1 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.25 a.

No entry necessary. Changes in estimates are treated prospectively.

Depreciation Expense1 ..................................... Accumulated Depreciation—Equipment . 1

Original cost Accumulated depreciation [($510,000 – $10,000) ÷ 10] X 7 Carrying amount (1/1/23) Estimated residual value Remaining depreciable basis Remaining useful life (15 years – 7 years) Depreciation expense—2023

19,375 19,375

$510,000 (350,000) 160,000 (5,000) 155,000 ÷ 8 $ 19,375

LO 1 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.26 1.

Management incentive plans. In many large companies, management remuneration packages provide a salary, cash bonuses based on net income or other performance variables, and stock incentives based on share price performance. Common shares are offered to managers based on share price performance to try to align the longterm interests of the firm’s shareholders and managers. The cash bonus is often based on a percentage of income once a target is reached. In some cases, once net income rises above a certain ceiling, no further bonus is paid. This practice provides a great incentive to keep income between the target and the ceiling. That is, managers of units with income above the ceiling would be motivated to pick accounting policies that carry forward “surplus” earnings to the next period.

Lending covenants. Long-term lending contracts often include covenants to protect the lender from observable actions by the borrower that are against the lender’s interests, such as additional borrowing or excessive dividend payments. Covenants are often based on ratios such as working capital, times interest earned, debt to equity, and so on. Violation of a debt covenant puts the borrower in default of the loan contract; the lender can demand repayment or, more commonly, renegotiate terms and conditions, including interest rates. Firms affected by these covenants may try to select accounting policies that improve critical ratios.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.26 (CONTINUED) 3.

Political motivation. Is it possible to report too much income? If a firm is politically visible (usually because of size, the nature of the business, or because of a governmentawarded monopoly), high levels of return are potentially undesirable. High profits attract attention and may create enough dissatisfaction and political unrest to cause the government to regulate some aspect of the business or intervene in another fashion. Such firms would rather minimize reported accounting income at levels that provide (barely) satisfactory levels of return to creditors and investors.

Taxation. Reduction of income to lower tax payments is an obvious motivation for accounting policy choice. Remember, though, that there are extensive provisions in the Income Tax Act requiring the use of certain accounting methods for tax purposes, regardless of the accounting policy choice made for external reporting; thus, firms may have little room to manoeuvre.

Contracts. Legal agreements often refer to data (numbers) in (audited or unaudited) financial statements. For instance, an agreement may specify that “net income” is to be allocated in a variety of ways or that “book value” of equity (or a multiple thereof) is to be used to establish a buy-out price when a partner retires or a new partner is admitted. In these circumstances, there is considerable contractual motivation to manipulate income and book value. How can the contracting parties make sure that manipulation does not lead to inappropriate valuation? Specifying that GAAP must be followed is a first step. However, there are areas of accounting policy where GAAP allows for acceptable alternative methods.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 21.26 (CONTINUED)

Note to Instructor: Numerous other factors may be acceptable. Student responses will vary; the objective is to provoke debate on personal, political, and ethical motivations for accounting policy choice and for students to understand that there may be motivators other than “fair presentation”. LO 2 BT: C Difficulty: S Time: 20 min. AACSB: Ethics CPA: CPA: cpa-t001 cpa-e001 Reporting and Ethics

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS Problem 21.1 Purpose—to provide a problem that requires the student to: (1) prepare correcting entries for two years’ unrecorded sales commissions and three years’ inventory errors, and (2) prepare entries for two different changes in accounting policy. The student is also required to discuss alternative accounting treatments for the changes.

Problem 21.2 Purpose—to provide the student with an opportunity to understand different types of accounting changes. The student is required to explain the differences using three cases and describe the disclosure requirements for each case.

Problem 21.3 Purpose—to provide a problem that requires the student to: (1) account for a change in estimate, (2) record a correction of an error, and (3) account for a change in accounting policy. The student is also required to account for the tax effect of the changes.

Problem 21.4 Purpose—to provide a problem that requires the student to: (1) account for a change in estimate, (2) record a correction of an error, and (3) account for a change in accounting principle. The student is also required to compute corrected/adjusted net income amounts.

Problem 21.5 Purpose—to provide a problem that requires the student to account for two changes in estimate, record a correction of an error, and account for a change in circumstances. The student is also required to calculate corrected/adjusted net income amounts.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 21.6 Purpose—to develop an understanding of the entries required for changes in accounting policies, changes in estimates, and accounting errors. This comprehensive problem involves all types of changes. The entries for books open and books closed are required. The student is also required to discuss the type of change involved and how it would be accounted for.

Problem 21.7 Purpose—to develop an understanding of the effect that errors, changes in policies, and changes in estimates have on the financial statements. The student is required to prepare the journal entries to record a change in accounting principle, a change in estimate, and an error. The student must also prepare restated comparative financial statements and note disclosure. This problem also includes the tax effects for the three items. This is a comprehensive and complex problem.

Problem 21.8 Purpose—to develop an understanding of the journal entries and the reporting that are necessitated by an accounting change or correction of an error. The student is required to prepare the entries to reflect such changes or errors and recalculate net income and earnings per share for a two-year period. The student is also required to prepare comparative statements of retained earnings for a two-year period and to provide note disclosure.

Problem 21.9 Purpose—the student is required to compute a list of items for the amounts that would appear on comparative financial statements after adjustment for a correction of an accounting error and a change in estimate. Comparative revised financial statements must also be prepared including the related income tax implications.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 21.10 Purpose—The student is required to prepare a comparative statement of income and retained earnings for five years assuming a change in policy in inventory costing with an indication of the effects on earnings per share for the years involved. The student must also prepare a comparative statement of retained earnings for a two-year period assuming full and partial retrospective application. The student is also required to identify the comparative SFP accounts affected by the change in policy.

Problem 21.11 Purpose—this case describes several proposed accounting changes for which the student is required to identify whether the change involves an accounting policy, accounting estimate, or correction of an error. The company in this question follows IFRS. A revised statement of changes in equity is also required along with a discussion of the note disclosure.

Problem 21.12 Purpose—to provide a problem that requires the student to analyze eleven transactions and to prepare adjusting or correcting entries for these transactions.

Problem 21.13 Purpose—to help a student understand the effect of errors on income and retained earnings. The student must analyze the effect of six errors on the current year’s net income and on the next year’s ending retained earnings balance. The tax effect of the errors must also be considered.

Problem 21.14 Purpose—to develop an understanding of the effect that errors have on the financial statements and the way to record their corrections. The student is required to prepare journal entries to correct the accounting records, a comparative schedule portraying the corrected net income for the two-year period involved with this error analysis, and a schedule portraying the corrected opening retained earnings.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 21.15 Purpose—to develop an understanding of the effect that errors have on the financial statements. The student is required to prepare a schedule portraying the corrected net income for the years involved with this error analysis. The student is also required to prepare journal entries to correct the errors and prepare a schedule to show the corrected opening retained earnings balance for the years involved.

Problem 21.16 Purpose—to develop an understanding of the correcting entries and income statement adjustments that are required for accounting errors. This comprehensive problem involves many different concepts, such as consignment sales, bonus computations, warranty costs, and bank funding reserves. The student is required to prepare the necessary journal entries to correct the accounting records and a schedule showing the revised income before taxes for each of the three years involved.

Problem 21.17 Purpose—to allow the student to see the impact of accounting changes on income and to examine an ethical situation related to the motivation for change.

Problem 21.18 Purpose—to provide the student with an understanding of how changes in accounting can be reflected in the accounting records for a company following IFRS. This case involves several situations for which the student is required to indicate the appropriate accounting treatment. The student must also identify any ethical issues and suggest appropriate action.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 21.1 1.

Retained Earnings [$6,200 X (1 – 25%)] ............. Income Tax Receivable ...................................... Sales Commissions Payable ....................... Sales Commission Expense........................

4,650 1,550 3,800 2,400

Cost of Goods Sold ($24,000 + $9,000).............. 33,000 Income Tax Payable ................................... 6,000 Retained Earnings [$24,000 X (1 – 25%)] ... 18,000 Inventory ..................................................... 9,000 Income Overstated (Understated) 2021 Beginning inventory Ending inventory

$(21,000) $(21,000)

2022

2023

$21,000) (24,000 ) $ (3,000 )

$24,000 9,000 $33,000

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

7,500 7,500

Equipment cost ............................................ $160,000 Depreciation before 2023 ........................... (70,000) Carrying amount ......................................... $ 90,000 Depreciation to be taken ($90,000/(8 – 2)) Depreciation recorded ................................ Difference ...................................................

$ 15,000 22,500 $ 7,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.1 (CONTINUED) 4.

This is a change in circumstances as the company couldn’t reliably measure the revenue in past years and now it can. The change is a result of experience with the project and improved ability to estimate the costs to completion and therefore the percentage completed, and so the change would be applied on a prospective basis. The company has already recorded net income using percentage of completion, so no further entry is required.

LO 1 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 cpa-t006 CM: Reporting and Tax

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.2 The first case, the incorrect calculation of the current portion of longterm debt, is related to an error correction. Under IFRS, the company must use the full retrospective method to correct errors by 1) restating the comparative amounts for the prior period(s) presented in which the error occurred and 2) restating the opening balances of assets, liabilities, and equity for the earliest period presented if the error took place before that period. The company must also present an opening statement of financial position for the earliest comparative period presented. In the year of the correction, the company should disclose 1. the nature of the error. 2. the amount of the correction to basic and fully diluted earnings per share and to each line item on the financial statements presented for comparative purposes. 3. the amount of the correction made at the beginning of the earliest prior period presented. The second case is also considered to be an error correction. Prior period errors are omissions or misstatements and are caused by the misuse of, or failure to use, reliable information that existed and could reasonably have been found and used in the preparation and presentation of those financial statements. IFRS requires that a liability be classified as current if it is expected to be settled in the entity’s normal operating cycle, if it is held primarily for trading, or if it is due within 12 months from the end of the reporting period (without an unconditional right to defer settlement for at least 12 months from the end of the reporting period). Assuming that the company’s “operating cycle” has always been approximately 18 months (i.e., no recent event occurred to cause a change in the company’s operating cycle), using one year to classify current and non-current assets is failure to use reliable information to prepare financial statements. The steps to take and disclosures to include are the same as in the first case.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.2 (CONTINUED) In the third case, although it appears that the company changed its accounting policy regarding its operating cycle, it is not a change in accounting policy. This is because a different policy is being applied to transactions, events, or conditions that differ in substance from those that were previously occurring. In other words, using one year to classify assets and liabilities was appropriate when the company’s business involved short-term contracts. Now, the circumstances have changed due to the implementation of the company’s strategic plan, and the average life of the company’s contracts has now grown to about two years. Thus, the new policy, using its “operating cycle” for classification, is appropriate for the changed circumstances. The company should disclose the nature of the new policy so that readers understand what new circumstances caused the change in classification, and what impact it is expected to have on the financial statements. LO 1 BT: C Difficulty: M Time: 35 min. AACSB: Communication CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.3 a. (1) Litigation Expense ...................................................... 50,000 Litigation Liability ................................................ 50,000 (2) Loss on Impairment .................................................. 14,850 Allowance for Expected Credit Losses ................ 14,850 1 ($19,800 ÷ 2%) X 1.5% = $14,850 1

(3) Land ........................................................................... 70,000 Accumulated Depreciation—Equipment2 .................... 56,000 Depreciation Expense......................................... 14,000 Retained Earnings .............................................. 42,000 Equipment .......................................................... 70,000 2 $70,000 ÷ 5 = $14,000 per year; $14,000 X 4 years = $56,000 (4) There would be no adjustment to opening retained earnings for any previous years since changes in estimate are accounted for prospectively. The books are still open for 2023, so the depreciation expense for 2023 will be revised for that year only to the straight-line method. Accumulated Depreciation—Buildings ........................ 29,925 Depreciation Expense3 ....................................... 29,925 3 ($63,175 – $33,250) Carrying amount of the building at January 1, 2023: Cost less accumulated depreciation to Dec. 31/22 = $1,400,000 - $70,000 - $66,500 = $1,263,500 Remaining useful life from Jan. 1/23 = 38 years Correct Depreciation Expense, 2023 (straight-line basis) = $1,263,500 ÷ 38 = $33,250

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.3 (CONTINUED) a. (continued) (5) Accumulated Depreciation—Equipment ..................... 8,000 Depreciation Expense......................................... ($75,000 – $5,000) ÷ 5 = $14,000 per year ($75,000 – [$14,000 X 3] – $3,000) ÷ 5 = $6,000 ($14,000 – $6,000 = $8,000)

8,000

(6) No entry required. This is an error in classification. No amounts or items are missing in the financial statements.

b. Note to Instructor: Corrections to Deferred Income Tax are only necessary when a retrospective adjustment is being made and where the item involves a temporary difference between accounting and taxable income. The entry below assumes that the income tax entry for 2023 income taxes will be made subsequently. Item 3 is the only entry that would be different from the entries in Part a. (3) Land .................................................................70,000 Accumulated Depreciation—Equipment ...........56,000 Deferred Tax Liability ($42,000 X 25%) .............. Depreciation Expense......................................... Retained Earnings [$42,000 X (1 – 25%)] ........... Equipment ..........................................................

10,500 14,000 31,500 70,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.3 (CONTINUED) c.

1. This item is an adjustment to the current year financial statements. It is not an error in a prior year’s financial statements and does not require retrospective adjustment. 2. This is a change in estimate – prospective treatment. 3. This is an error in a prior year – retrospective treatment. 4. This is a change in estimate – prospective treatment, but requiring a change in the current year as adjustments have already been recorded. 5. This is a change in estimate – prospective treatment, but requiring a change in the current year as adjustments have already been recorded. 6. This is a SFP change in classification. No journal entry and no adjustment to opening retained earnings are required. However, comparative financial information will need to be restated to properly reflect the change in classification. A note indicating the nature of the adjustment would be included.

LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.4 a.

Cost of equipment ............................................ Less: Residual value ........................................ Depreciable cost .............................................. Depreciation to 2023 2020 ($80,000/10) ......................... 2021 ($80,000/10) ......................... 2022 ($80,000/10) ......................... Depreciation in 2023 Cost of equipment ......................... Less: Depreciation to 2022 ........... Carrying amount (January 1, 2023) Less: Residual value .................... Depreciable cost ...........................

$85,000 5,000 $80,000

$ 8,000 8,000 8,000 $24,000 $85,000 24,000 61,000 3,000 $58,000

Depreciation in 2023 $58,000/4 = $14,500 Depreciation Expense ........................................ 14,500 Accumulated Depreciation—Equipment ..... 14,500 2.

Cost of Building ...................................... Less: Depreciation to 2022 2021 ........................................... 2022 ........................................... Carrying amount (Jan 1, 2023) ... Less: Residual value.................. Depreciable cost .........................

$300,000 60,000 48,000 192,000 30,000 $162,000

Depreciation in 2023 ($162,000/8) = $20,250 Depreciation Expense ...................................... 20,250 Accumulated Depreciation—Buildings ...... 20,250

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.4 (CONTINUED) a. (continued) 3. Depreciation Expense ........................................ 13,000 Accumulated Depreciation—Machinery ...... 13,000 ($120,000 – $16,000) ÷ 8 To record depreciation expense. Accumulated Depreciation—Machinery ............. Retained Earnings ...................................... To record correction of depreciation recorded.

3,000 3,000

Depreciation recorded in 2021: ($120,000 ÷ 8) X 6 ÷ 12 = $7,500 Depreciation that should be recorded in 2021: ([$120,000 – $16,000] ÷ 8) X 6 ÷ 12 = $6,500 Depreciation recorded in 2022: ($120,000 ÷ 8) = $15,000 Depreciation that should be recorded in 2022: ($120,000 – $16,000) ÷ 8 = $13,000 Depreciation taken

Depreciation that should be taken

Difference

2021

$7,500

$6,500

$1,000

2022

15,000

13,000

2,000

$22,500

$19,500

$3,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.4 (CONTINUED) b. HOLTZMAN COMPANY LIMITED Income Statement (partial) For the Years 2023 and 2022 2023 Income before depreciation expense .......... Depreciation expense1 ................................ Net income ................................................. 1

Depreciation Expense Equipment ............................................ Buildings .............................................. Machinery ............................................

2022

$300,000 47,750 $252,250

$310,000 69,000 $241,000

2023

2022

$ 14,500 20,250 13,000 $ 47,750

8,000 48,000 13,000 $ 69,000

LO 1,4 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.5 a.

No entry is necessary. A change in estimate is accounted for prospectively in the current and future years. Since the change was made at the beginning of the year, 2023 would have been correctly recorded.

No entry is necessary as long as Kendrick did not recognize depreciation expense of $54,000 in 2023. At January 1, 2023, the asset’s carrying amount was $1,200,000 – ($108,000 + $120,000) = $972,000. The correct amount of depreciation for 2023 is ($972,000 – $120,000)/18 years = $47,333. If $54,000 has been recognized, the following entry is needed: Accumulated Depreciation—Buildings ......... 6,667 Depreciation Expense ....................................

6,667

A change in estimate is accounted for prospectively in the current and future years. A revision of depreciation policy due to changes in the expected pattern of benefits is treated as a change in estimate. 3.

Accumulated Depreciation—Machinery ........... [($20,0001 – $18,0002) X 3½ years] Retained Earnings .................................... Depreciation Expense .............................. 1 2

7,000 5,000 2,000

$160,000 ÷ 8 = $20,000 ($160,000 – $16,000) ÷ 8 = $18,000

Amortization Expense ($4,500 / 3) ................... Deferred Development Costs ...................

1,500 1,500

This is not a change in policy. Since the amounts were not material in previous years, this is a new policy applied due to changed circumstances.

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PROBLEM 21.5 (CONTINUED) b.

Calculation of 2023 depreciation expense on the equipment: 2020 to 2022 depreciation [($130,000 – $10,000) ÷ 10] $12,000 Cost of equipment Accumulated depreciation ($12,000 X 3 years) Carrying amount, 1/1/2023

$130,000 36,000 $94,000

$94,000 – $6,000 $88,000 2023 deprec. expense: = = $22,000 4 7–3

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PROBLEM 21.5 (CONTINUED) c.

KENDRICK CORPORATION Comparative Net Income Calculation For the Years 2023 and 2022

Income before depreciation expense and before effects of changes Depreciation of equipment – item 1 Depreciation of building – item 21 Depreciation of machine – item 3 Development costs – item 4 Net income

2023

2022

$600,000 (22,000) (47,333) (18,000) (1,500) $511,167

$420,000 (12,000) (108,000) (18,000) $282,000

Calculation of 2023 depreciation expense on the Building – item 2: Cost of building Accumulated depreciation ($120,000 + $108,000) Carrying amount, 1/1/2023 2023 depreciation expense:

$1,200,000 228,000 $972,000

$972,000 – $120,000 $852,000 = 18 20 – 2 = $47,333

Quality of earnings refers to how solid the earnings numbers are. High quality earnings numbers are unbiased, reflective of the underlying business fundamentals, and sustainable. Kendrick has made the necessary changes in 2023 to properly reflect the changes that have occurred in the operations of the business concerning the use of equipment, buildings, and the treatment of development costs. Except for the correction of an error, Kendrick’s earnings quality is strong.

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PROBLEM 21.6 a. and b. (1) Retained Earnings ...................................................... 52,000 Allowance for Doubtful Accounts ........................ 47,000 Accounts Receivable .......................................... 5,000 This is a correction of an error. The company must apply retrospective application in order to correct the presentation of receivables and bad debt expense in its comparative financial statements for 2022 and 2023. (2) The company is changing from a non-GAAP method to a GAAP method, and this should be treated as a correction of an error (a retrospective change). The following solution takes the view that this is an accounting error that is applied to the 2021 and 2022 years. As at October 1, 2022, the company should account for the change in useful life as a change in estimate--prospectively. Accounts needing correction as at October 1, 2022: Accumulated Depreciation and Retained Earnings, representing the difference in depreciation expense between CCA and the straight-line method: Depreciation taken (CCA): $35,000 – $20,825 = $14,175 Depreciation (straight-line): $35,000 ÷ 10 X 2 = .. 7,000 $ 7,175 The 2023 accounts have to be adjusted through Retained Earnings because the books for fiscal 2023 have been closed. Accounts needing correction as at September 30, 2023: Accumulated Depreciation and Retained Earnings, representing the Depreciation Expense (straight-line method) for the year ended September 30, 2023 using a remaining (and revised) useful life of 5 years: Solutions Manual 21-93 Chapter 21 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 21.6 (CONTINUED) a. and b. (continued) (2) (continued) Net carrying amount of asset, October 1, 2023 now = $35,000 - $7,000 = $28,000 Revised depreciation rate = $28,000 ÷ 5 years = $5,600/year Entry needed to adjust years ended September 30, 2021, 2022, and 2023: Accumulated Depreciation – Equipment .................. Retained Earnings ........................................... $7,175 - $5,600 = $1,575 (3) Equipment ............................................................... Retained Earnings ........................................... To record correction of purchase of equipment. Retained Earnings ................................................... Accumulated Depreciation—Equipment........... ($3,000 / 3) To record correction for depreciation expense.

1,575 1,575

3,000 3,000

1,000 1,000

This is a correction of an error. Since the error affects only 2023, no retrospective application is necessary.

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PROBLEM 21.6 (CONTINUED) a. and b. (continued) (4) Supplies ..................................................................... 1,500 Retained Earnings ..............................................

1,500

This is a correction of an error. Retrospective application is required for the 2022 balance in supplies. Since this is a counter-balancing error, no journal entry is required, but the opening balance in supplies of $1,000 will need to be adjusted on the comparative financial statements. (5) FV-NI Investments ..................................................... 3,000 Retained Earnings ..............................................

3,000

This is a correction of an error. c.

As a privately held entity, Maglite may choose to follow either ASPE or IFRS. Under IFRS, Maglite would account for the securities as FV-NI (or FV-OCI). Under ASPE, the trading investment must be accounted for using the fair value through net income (FV-NI) model. Given that these are being traded (and assuming that the company did not make an irrevocable election to use FV-OCI for any equity investments), the entity would likely use FV-NI under IFRS and there would be no difference in the treatment between IFRS and ASPE.

d. (1) Retained Earnings .................................................... 30,000 Bad Debt Expense ..................................................... 22,000 Allowance for Doubtful Accounts ........................ 47,000 Accounts Receivable .......................................... 5,000 1 Beginning balance in the allowance for doubtful accounts. 1

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PROBLEM 21.6 (CONTINUED) d. (continued) (2) If two entries are made: Accumulated Depreciation - Equipment2 ................... 7,175 Retained Earnings .............................................. To record correction for depreciation expense. 2 ($35,000 – $20,825) – 2 X ($35,000/10) Depreciation Expense3 ............................................... 5,600 Accumulated Depreciation - Equipment .............. 3 ($35,000 – $7,000) / 5 To record depreciation expense.

7,175

5,600

(3) Equipment .................................................................. 3,000 Office Expense ................................................... 3,000 To record correction of purchase of equipment. Depreciation Expense ................................................ 1,000 Accumulated Depreciation—Equipment.............. 1,000 ($3,000 / 3) To record depreciation expense. (4) Supplies ..................................................................... 1,500 Supplies Expense ............................................... Retained Earnings ..............................................

500 1,000

(5) FV-NI Investments...................................................... 3,000 Investment Income or Loss .................................

3,000

LO 1,3 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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PROBLEM 21.7 a. Item #1 Equipment .................................................................. 9,200 Future Tax Liability (30% X $9,200) .................... Retained Earnings (70% X $9,200)..................... To record effect of change in accounting policy. Depreciation Expense ($9,200 / 5) ............................. 1,840 Retained Earnings ($1,840 X 70%) ............................ 1,288 Future Tax Liability ($3,680 X 30%) ........................... 1,104 Future Tax Benefit ($1,840 X 30%)..................... Accumulated Depreciation - Equipment ............. ($1,840 X 2 years) To record expenses related to change in accounting policy. Item #2 Depreciation Expense ............................................... 8,000 Deferred Development Costs.............................. To correct for error.

2,760 6,440

552 3,680

Future Tax Liability ($8,000 X 30%) ........................... 2,400 Future Tax Benefit .............................................. To record taxes on correction of error. 1

8,000

2,400

A loss on impairment account could also be debited.

Item #3 Retained Earnings ...................................................... 21,000 Future Tax Asset ($30,000 X 30%) ............................ 9,000 Revenue from Long-Term Contracts................... 30,000 To correct for error. Future Tax Expense ($30,000 X 30%) ....................... 9,000 Future Tax Asset ................................................ To record taxes on correction of error.

9,000

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PROBLEM 21.7 (CONTINUED) b.

Assets

Dewitt Corp. Statement of Financial Position December 31 2023 2022 (restated)

Current assets Long-term assets

$ 192,300 319,520 $ 511,820

177,400 318,360 495,760

133,000

155,208 50,000 157,552 495,760

$ 1

Liabilities & Equity Current liabilities Long-term Liabilities Share capital Retained earnings

1&2

$ 117,000 165,256 50,000 179,564 $ 511,820

Long-term assets:

Beginning balance Item #1: Add: capitalized interest on equipment Less: Accumulated depreciation on capitalized interest on equipment Item #2: Deferred dev. costs Ending balance

2023 322,000

2022 311,000

9,200

(3,680) (8,000) $319,520

(1,840) $318,360

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PROBLEM 21.7 (CONTINUED) b. (continued) Current assets – 2022: Beginning balance of $168,400 + $9,000 (deferred tax asset related to item #3) = $177,400. Classified as current since it is related to Unearned Revenue, a current liability account of Dewitt Corp. 3

4&5

Long-term liabilities:

Beginning balance Item #1: Future tax liability 2023: $2,760 – $1,104 = $1,656 2022: $2,760 – $552 = $2,208 Item #2: Future tax liability reversal on change in estimate Ending balance

2023 $166,000

2022 $153,000

1,656 2,208 (2,400) $165,256

$155,208

Current liabilities – 2022: Beginning balance of $103,000 + $30,000 (Unearned revenue on deposit related to item #3) = $133,000. 6

7&8

Retained earnings:

Beginning balance Item #1: Change in policy net of tax ($9,200 X [1 – 30%]) Less: Amortization on revised cost of equipment net of tax 2023: $1,840 X 2 X [1 – 30%] 2022: $1,840 X [1 – 30%] Item #2: Deferred dev. costs net of tax ($8,000 X [1 – 30%]) Item #3: Reversal of contract revenue in 2021 net of tax ($30,000 X [1 – 30%]) Ending balance

2023 $181,300

2022 $173,400

6,440

(2,576) (1,288) (5,600)

$179,564

(21,000) $157,552

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PROBLEM 21.7 (CONTINUED) b. (continued) Dewitt Corp. Income Statement Year Ended December 31 2023 Revenues Expenses Income tax (30%) Net income Earnings per share Dividends declared per share

$ 505,000 387,840 117,160 35,148 $ 82,012 $8.20

1 2

$6.00

2022 (restated) $ 460,000 377,840 82,160 24,648 $ 57,512 $5.75

$2.50

Revenues – 2023: Beginning balance of $475,000 + $30,000 (Revenue on long-term contract item #3) = $505,000. 1

2&3

Expenses:

Beginning balance Item #1: Depreciation on capitalized interest Item #2: Additional depreciation or loss on deferred dev. costs Ending balance

2023 $378,000

2022 $376,000

1,840

8,000 $387,840

$377,840

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PROBLEM 21.7 (CONTINUED) b. (continued) 4&5

Current tax expense:

Beginning balance Item #1: Reversal of timing difference on additional depreciation expense Item #2: Reversal of timing difference on deferred dev. costs Item #3: Reversal of timing difference on long-term contract revenue Ending balance

2023 $29,100

2022 $25,200

(552)

(2,400) 9,000 $35,148

$24,648

Dewitt Corp. Statement of Retained Earnings Year Ended December 31 2023 Retained earnings, January 1, as previously reported Add: Adjustment for the cumulative effect on prior periods of the change in accounting policy, net of income tax of $2,208 (2022: $2,760) Less: Correction of error on revenue, net of tax of $9,000 Retained earnings, January 1, as restated Net income Less: Dividends declared Retained earnings, December 31

$ 173,400

2022 (restated) $

139,600

5,152

6,440

(21,000)

157,552 82,012 (60,000) $ 179,564

125,040 57,512 (25,000) 157,552

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PROBLEM 21.7 (CONTINUED) b. (continued) Opening balance of retained earnings – 2022: Ending balance of $173,400 – $58,800 (Net income) + $25,000 (dividends declared) = $139,600. 1

Adjustment due to change in policy – 2023: Capitalized interest net of tax of $9,200 X [1 – 30%] less additional depreciation expense for 2022 of $1,840 X [1 – 30%] = $5,152. 2

Adjustment due to change in policy – 2022: Capitalized interest of $9,200 X [1 – 30%] = $6,440 (net of tax). 3

Correction of error – 2023 and 2022: Contract revenue of $30,000 X [1 – 30%] = $21,000. 4

Dividends declared – 2023 and 2022: 2023: Dividends per share $6.00 X 10,000 shares = $60,000 2022: Dividends per share $2.50 X 10,000 shares = $25,000 5&6

Note A – Change in Accounting Policy on Capitalization of Interest In 2023, the company changed its accounting policy regarding the capitalization of interest. Interest on self-constructed assets will be capitalized as part of the cost of these assets. This change was done to provide more relevant presentation of the company’s financial information and to be consistent with other companies in the reporting entity on a consolidated basis. The change has been applied retrospectively with restatement of comparative information to 2021, when interest was incurred. The effect of this change on income of prior periods was to increase 2022 depreciation expense by $1,840 and decrease net income of 2022 by $1,288. Earnings per share for 2022 has also decreased by $0.13.

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PROBLEM 21.7 (CONTINUED) c. (continued) Note B – Error in Revenue Recognition of Prior Periods The company recognized as revenue a down-payment received in 2021 prior to completion of the related contract. This contract was completed in 2023. There was no impact on 2022 income statement items. This error has been corrected and the comparative balance sheet and statement of retained earnings information has been restated to reflect the correction of this error. There are no current tax implications for this error. d.

1. Under IFRS, IAS 23 requires capitalization of borrowing costs. Private entities that choose to apply ASPE have the choice of either capitalizing or expensing the interest costs for relevant PP&E assets. Thus, under IFRS, if Dewitt previously expensed the interest costs and now decides to capitalize the interest costs, rather than being a change in policy, the change to a generally accepted accounting method is considered the correction of an error and retrospective application with restatement would be applied (similar to the accounting treatment of a change in accounting policy) to the extent practicable to do so. 2. No difference in accounting treatment between IFRS and ASPE. Under IFRS, assuming the capitalization criteria are met, development costs must be capitalized (which they were in this case). 3. No difference in accounting treatment between IFRS and ASPE.

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PROBLEM 21.8 a.

Depreciation Expense .................................. 108,108 Accumulated Depreciation—Buildings .. 108,108 Computations: Cost of Asset A ........................................ Less: Depreciation prior to 20231 ............. Carrying amount, January 1, 2023 ........... 1

$540,000 162,000 $378,000

($540,000 ÷ 10) X 3

The DDB rate is calculated as 100% ÷ 7 X 2 = 28.6%2 Depreciation for 2023: $378,000 X 28.6% = $108,108 2 rounded [Note to instructor: Another equally correct approach is the following: $378,000 ÷ 7 X 2 = $108,000] 2.

Depreciation Expense ................................... 25,800 Accumulated Depreciation—Machinery ... 25,800 Calculations: Original cost Accumulated depreciation (1/1/23) $12,000 X 4 Carrying amount (1/1/23) Estimated residual value Remaining depreciable base Remaining useful life (9 years—4 years taken) Depreciation expense—2023

$180,000 48,000 132,000 3,000 129,000 ÷ 5 $ 25,800

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PROBLEM 21.8 (CONTINUED) a. (continued) 3.

Equipment .................................................... 160,000 Accumulated Depreciation—Equipment ... 64,000 (4 X $16,000) Retained Earnings ................................... 96,000 To correct for error. Depreciation Expense ................................... 16,000 Accumulated Depreciation—Equipment ... 16,000 To record depreciation expense.

Bad debt expense and allowance for doubtful accounts: The change in the percentage rate used from 6.5% to 8% for calculating the year-end balance for the allowance for doubtful accounts is a change in estimate and is treated prospectively. Since the entry for 2023 has already been recorded, no additional entry is required. b.

Restated net income and earnings per share: 2023 Net income Earnings per common share

2022

$195,092 1 $354,000 2 $1.95

$3.54

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PROBLEM 21.8 (CONTINUED) b. (continued) Calculations: 1 Income before depreciation expense (2023) Depreciation for 2023 Asset A Asset B Asset C Other Assets Income after depreciation expense 2

*Income before error correction (2022) Error correction—Depreciation Asset C Income after error correction

$400,000 $108,108 25,800 16,000 55,000 (204,908) $195,092 $370,000 (16,000) $354,000

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PROBLEM 21.8 (CONTINUED) c.

FLANAGAN INC. Comparative Statement of Retained Earnings For the Years Ended December 31

Balance, January 1, as previously reported Plus: Adjustment due to error in recording Asset C (Note B) Balance, January 1, as restated Add: Net income Balance, December 31

2023

2022 (restated)

$570,0002

$200,000

96,000 666,000 195,092 $861,092

112,0001 312,000 354,000 $666,000

Amount expensed incorrectly in 2019 ...................... $160,000 Depreciation to be taken to January 1, 2022 ($16,000 X 3) ...................................................... 48,000 Prior period adjustment for income ........................... $112,000

Opening balance of $200,000 + unadjusted income for 2022 of $370,000.

Note A – Change in Depreciation Method In 2023, the company changed its depreciation method for certain capital assets from the straight-line basis to the double-declining basis, due to a change in the pattern of benefits received from the assets. The change has been applied prospectively.

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PROBLEM 21.8 (CONTINUED) d. (continued) Note B – Error in Depreciation Expense of Prior Periods The company expensed a capital asset purchased in 2019. Depreciation was not recorded for 2019 and subsequent periods. This error has been corrected and the comparative information has been restated to reflect the correction of this error. Depreciation expense of $16,000 has been recorded for each of 2022 and 2023. Net income and earnings per share have decreased by $16,000 and $0.16, respectively for both of the years presented. e.

Changes in policy, changes in estimates, and corrections of errors will not have any impact on current period cash flows and will not change the totals for any of the three sections of the current period statement of cash flows or the net increase or decrease in cash and cash equivalents. If the statement is prepared on an indirect basis, the changes will be reflected in the net income figure and in the depreciation expense. Since the change affects both net income and depreciation expense, the adjustment to determine cash flow from operations will offset the expense, and the same total cash from operating activities will be achieved. The changes will not have any impact on a current period statement of cash flows prepared on the direct basis. However, there will be a change in the cash flow statement in the year of the error for the situation described in part 3. While there will be no net change in the amount of cash for 2019, the expenditure was originally recognized as an expense, and therefore as an operating outflow in 2019, whereas the corrected cash flow statement for 2019 will indicate that the $160,000 was an investing outflow. The change in estimate is applied on a prospective basis only and will not affect the statement of cash flows for prior periods.

LO 1,3,4 BT: AP Difficulty: C Time: 55 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting Solutions Manual 21-108 Chapter 21 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 21.9 a.

This change is considered the correction of an error – from a non-GAAP method to a GAAP method. 1. Accumulated depreciation at: December 31, 2022: $21,474,950 [balance before change (using CCA) ($22,946,000) less excess of CCA over straight-line depreciation for financial statement purposes ($1,365,000 + $106,050)] December 31, 2023: $22,186,000 [balance before change (using CCA) ($23,761,000) less excess of CCA over straight-line depreciation for financial statement purposes ($1,575,000)] 2. Deferred tax liability (long-term) at: December 31, 2022: $441,315 [tax effect (30%) of excess of CCA over straight-line depreciation for financial statement purposes ($1,365,000 + $106,050)] December 31, 2023: $472,500 [tax effect (30%) of excess of CCA over straight-line depreciation for financial statement purposes ($1,575,000)] 3. Selling, general, and administrative expenses for the year ended: December 31, 2022: $18,384,487 [balance before change (using CCA) ($18,411,000) less 25% of excess of CCA over straight-line depreciation for financial statement purposes for 2022 (.25 X $106,050 = $26,513)]

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PROBLEM 21.9 (CONTINUED) a. (continued) 3. (continued) December 31, 2023: $19,715,312 [balance before change (using CCA) ($19,540,000) less 25% of excess of CCA depreciation over straight-line depreciation for financial statement purposes for 2023 (.25 X $103,950 = $25,988) plus increase in loss on impairment for 2023 (.0025 X $80,520,000 = $201,300)] 4. Current portion of income tax expense for the year ended: December 31, 2022: $1,906,800 December 31, 2023: $1,471,500 [Total income tax of $1,480,500 less deferred tax expense of $9,000 (decrease in Deferred Tax Asset from 2022 to 2023 [$234,000 – $225,000]) = $1,471,500] 5. Deferred portion of tax expense (benefit) for the year ended: December 31, 2022: $31,815 [tax rate (30%) times excess of CCA over straight-line depreciation for financial statement purposes for 2022 ($106,050)] December 31, 2023: ($20,205) (benefit) [balance before change (using CCA) of $9,000 plus tax rate (30%) times excess of CCA over straight-line depreciation for financial statement purposes for 2023 ($103,950) less 30% times increase in loss on impairment for 2023 ($201,300)]

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PROBLEM 21.9 (CONTINUED) b. SHARMA CORPORATION Condensed Statement of Financial Position As at December 31, 2023 Assets Current assets Plant assets, at cost Less: Accumulated depreciation Other long-term assets

$28,138,700 45,792,000

22,186,000 a.1 14,996,000 b $66,740,700 Liabilities and Shareholders’ Equity Current liabilities $21,124,000 Long-term debt 15,341,110 c Share capital 11,620,000 Retained earnings 18,655,590 d $66,740,700

As at December 31, 2022

As at January 1, 2022

Restated see note XX

$29,252,000 43,974,000

$28,454,000 42,568,000

21,474,950 14,414,000 $66,165,050

21,064,000 14,048,000 $64,006,000

$23,650,000 14,304,315 11,620,000 16,590,735 $66,165,050

26,603,200 13,715,500 11,620,000 12,067,300 $64,006,000

a. Current assets – 2023: balance before change $28,340,000 less additional allowance for expected credit losses, $201,300 = $28,138,700 a. 1 Accumulated depreciation before adjustment $23,761,000 less adjustment $1,575,000 = $22,186,000 b. Other long-term assets – 2023: balance before change $15,221,000 less deferred tax asset balance before change, $225,000 = $14,996,000; 2022: $14,648,000 less $234,000 = $14,414,000; 2021: $14,282,000 less $234,000 = $14,048,000.

g b

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PROBLEM 21.9 (CONTINUED) b. (continued) c. Long-term debt – 2023: balance before change (using CCA) $15,154,000 plus deferred tax liability, $472,500 less deferred tax asset balance before change, $225,000 less additional deferred tax asset, $60,390 = $15,341,110 d. Retained earnings – 2023: balance before change $17,694,000 plus reduction in accumulated depreciation 2023 and previous years, net of tax, [$1,575,000 X (1 – 30%) = $1,102,500] less additional allowance for expected credit losses, net of tax [($201,300 X 70%) = $140,910] = $18,655,590 e. Long-term debt – 2022: balance before change (using CCA) $14,097,000 plus deferred tax liability, $441,315 less deferred tax asset balance before change, $234,000 = $14,304,315 f. Retained earnings – 2022: balance before change (using CCA) $15,561,000 plus reduction in accumulated depreciation for 2022 and previous years, net of tax, [($1,365,000 + $106,050) X (1 – 30%) = $1,029,735] = $16,590,735 g. Accumulated depreciation – January 1, 2022: balance before change (using CCA) $22,429,000 less excess of CCA over straight-line depreciation for previous years $1,365,000 = $21,064,000 h. Long-term debt – January 1, 2022: balance before change (using CCA) $13,540,000 plus deferred tax liability (tax effect 30% of excess of CCA over straight-line depreciation for previous years $1,365,000 = $409,500) less deferred tax asset balance before change, $234,000 = $13,715,500 i. Retained earnings – January 1, 2022: 2022 ending balance of $16,590,735 (from adjusted SFP) less adjusted net income for 2022, $4,523,435 [unadjusted net income for 2022, $4,449,200 plus reduction in accumulated depreciation for 2022, net of tax, ($106,050) X (1 – 30%) = $74,235] = $12,067,300

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PROBLEM 21.9 (CONTINUED) b. (continued) SHARMA CORPORATION Income Statement For the Years Ended December 31 2023

2022 Restated see note XX

Net sales Cost of goods sold Selling, general, and administrative expenses Other expense, net Income before income tax Income tax: Current Deferred (benefit) Net income

$80,520,000 54,769,038 25,750,962 19,715,312 6,035,650 (1,198,000) 4,837,650

1,471,500 (20,205) a.5 1,451,295 $3,386,355

$78,920,000 52,994,463 25,925,537

18,384,487 m 7,541,050 (1,079,000) 6,462,050 1,906,800 31,815 1,938,615 $4,523,435

j. Cost of goods sold – 2023: balance before change (using CCA) $54,847,000 less reduction in depreciation using correct calculations, $103,950 X 75% = $54,769,038 k. Selling, general, and admin. – 2023: balance before change $19,540,000 less reduction in depreciation using correct calculations, $103,950 X 25% plus additional loss on impairment, $201,300 = $19,715,312 l. Cost of goods sold – 2022: balance before change (using CCA) $53,074,000 less reduction in depreciation using correct calculations, $106,050 X 75% = $52,994,463 m. Selling, general, and admin. – 2022: balance before change $18,411,000 less reduction in depreciation using correct depreciation calculations, $106,050 X 25% = $18,384,487

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PROBLEM 21.9 (CONTINUED) b. (continued) a. 5 Change in Deferred tax asset account from 2022 to 2023 as given ($234,000 - $225,000) = $9,000 dr.; Capital Cost Allowance amount $103,950 X 30% = $31,185 dr.; and loss on impairment of accounts receivable $201,300 x 30% = $60,390 cr. Total $20,205 credit. SHARMA CORPORATION Statement of Changes in Equity For the Year Ended December 31, 2023 Share Capital Balance, December 31, 2021, as previously reported $11,620,000 Plus: Adjustment for the cumulative effect on prior periods of the error correction, net of tax Balance, January 1, 2022, as restated Net income 2022 (restated) Balance, December 31, 2022, as restated Net income 2023 Less: Dividends Balance, December 31, 2023

Retained Earnings

Total

$11,111,800 $22,731,800

955,500

11,620,000

12,067,300 4,523,435

23,687,300 4,523,435

11,620,000

16,590,735 28,210,735 3,386,355 3,386,355 (1,321,500) (1,321,500) $18,655,590 $30,275,590

$11,620,000

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Sales—net Cost of goods sold Beginning inventory Purchases Ending inventory Total Gross profit Administrative expenses Income before taxes Income taxes (30%) Net income Retained earnings– beginning: As originally reported Adjustment (See note1 and schedule) As restated Retained earnings – ending Earnings per share (100 shares)

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.10 KIMMEL INSTRUMENT CORPORATION Statement of Income and Retained Earnings For the Years Ended May 31 2019 $13,964

2020 $15,506

2021 $16,673

2022 $18,221

2023 $18,898

950 13,000 (1,124 ) 12,826 1,138 700 438 131 307

1,124 13,900 (1,091 ) 13,933 1,573 763 810 243 567

1,091 15,000 (1,270 ) 14,821 1,852 832 1,020 306 714

1,270 15,900 (1,480 ) 15,690 2,531 907 1,624 487 1,137

1,480 17,100 (1,699 ) 16,881 2,017 989 1,028 308 720

1,206

1,461

1,981

2,650

3,725

(35 ) 1,171 $ 1,478

17 1,478 $ 2,045

64 2,045 $ 2,759

109 2,759 $ 3,896

171 3,896 $ 4,616

3.07

5.67

7.14

11.37

7.20

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PROBLEM 21.10 (CONTINUED) a. (continued) 1

Note to instructor: The adjustments are simply the cumulative difference in income between the two inventory methods, net of tax. For example, the negative $35 in 2019 reflects the difference in ending inventories in 2018 ($1,000 – $950) times the after-tax rate of 1 - 30% = 70%. In 2020, the difference in income of $52 between the two methods in 2019 is added to the negative $35 to arrive at a $17 adjustment to the beginning balance of retained earnings in 2020. In 2023, the Company changed its method of pricing inventory from the first-in, first-out (FIFO) to the average cost method in order to more fairly present the financial operations of the company. The financial statements for prior years have been restated to retrospectively reflect this change, resulting in the following effects on net income and related per share amounts: Increase in

Net income Earnings per share

2019

2020

2021

2022

2023

$ 52 $0.52

$ 47 $0.47

$ 45 $0.45

$ 62 $0.62

$ 61 $0.61

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PROBLEM 21.10 (CONTINUED) a. (continued) Schedule of Income Reconciliation and Retained Earnings Adjustments 2019–2023 2018

2019 $1,000 950 50 15 $ 35

2020 $1,100.00 1,124.00 (24.00) 7.20 $ (16.80)

Ending Inventory FIFO Average Cost Difference Tax Effect (30%) Effect on Income2

$1,000 950 50 15 $ (35)

$1,100 1,124 (24) 7.20 $16.80

$1,000.00 $1,115.00 1,091.00 1,270.00 (91.00) (155.00) 27.30† 46.50† $ 63.70† $ 108.50†

Net Effect on Income

(35) $

51.80

46.90†

16.80

63.70† $

Beginning Inventory FIFO Average Cost Difference Tax Effect (30%) Effect on Income1

Cumulative Effect on Beginning Retained Earnings

2021 2022 $1,000.00 $1,115.00 1,091.00 1,270.00 (91.00) (155.00) 27.30† 46.50† $ (63.70)† $ (108.50)†

2023 $1,237.00 1,480.00 (243.00) 72.90† $ (170.10)

$1,237.00 1,480.00 (243.00) 72.90† $ 170.10†

$1,369.00 1,699.00 (330.00) 99.00 $ 231.00

44.80

108.50†

$ 170.10†

61.60

$ 231.00

*1Larger (smaller) beginning inventory has negative (positive) effect on net income. 2 Larger (smaller) ending inventory has positive (negative) effect on net income. † The tax effects are rounded up to the next whole dollar in the problem. Therefore, the net effects on income and retained earnings are effectively rounded down to the next whole dollar. Solutions Manual 21-117 Chapter 21 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

60.90†

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PROBLEM 21.10 (CONTINUED) b. KIMMEL INSTRUMENT CORPORATION Calculation of Corrected Retained Earnings For the Years Ended May 31 2023 2022 (restated) Retained earnings, June 1, as previously stated $3,725 $2,650 Adjustment for the cumulative effect on prior periods due to change in inventory costing method from FIFO to average cost $243 $155 Less applicable tax (30%) 72 171 46 109 Retained earnings, June 1, as restated 3,896 2,759 Net income 720 1,137 Retained earnings, May 31 $4,616 $3,896

2021 (restated)

$1,981

$91 27

64 2,045 714 $2,759

c. 2023

2022

2021

Inventory: FIFO basis Average cost basis Change, incr. (decr.)

$1,369 1,699 $ 330

$1,237 1,480 $ 243

$1,115 1,270 $ 155

Income Tax Payable

$99

$72

$46

Retained earnings: FIFO basis Average cost basis Change, incr. (decr.)

$4,384 4,616 $ 232

$3,725 3,896 $ 171

$2,650 2,759 $ 109

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PROBLEM 21.10 (CONTINUED) c. (continued) Note to instructor: CRA generally requires a company to use the same inventory costing method for tax purposes as for financial reporting purposes. Therefore, Kimmel would have additional tax payable on the increased income reported rather than a deferred tax account. d.

Retrospectively restating the financial statements of a prior year requires information that may, in many cases, be impracticable to obtain, even though the cumulative effect can be determined. For partial retrospective application, if the effect of a change in policy can be determined for some of the prior periods, the change in policy is applied retrospectively with restatement to the carrying amounts of assets, liabilities, and affected components of equity at the beginning of the earliest period for which restatement is possible (CPA Canada Handbook: 1506.15 and IAS 8. 25 and .26). This could be only the current year. An adjustment is made to the opening balances of the equity components for that earliest period, similar to the adjustments in the full restatement. Note that it is not appropriate to apply hindsight in developing measurements that need to be used. Measurements must be based on conditions that existed and were known in the prior period.

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PROBLEM 21.10 (CONTINUED) d. (continued) If the company were allowed to apply partial retrospective application, calculation of corrected retained earnings would be as follows: KIMMEL INSTRUMENT CORPORATION Calculation of Corrected Retained Earnings For the Years Ended May 31 2023 Retained earnings, April 1, as previously stated Adjustment for the cumulative effect on prior periods due to change in inventory costing method from FIFO to average cost Less applicable tax (30%) Retained earnings, April 1, as Restated Net income Retained earnings, May 31

$243 72

2022 (not restated)

$3,725

$2,650

171

3,896 720 $4,616

2,650 1,075 $3,725

Also, note that IFRS requires that a statement of changes in shareholders’ equity be prepared and that an opening statement of financial position be provided for the earliest comparative period provided when there is a retrospective change. On the other hand, ASPE allows for either a statement of retained earnings or a statement of changes in equity, and there is no requirement in the standards to provide an opening statement of financial position for the earliest comparative period when there is a retrospective change.

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PROBLEM 21.10 (CONTINUED) e.

Changing the method of costing inventory from FIFO to weighted average cost results in higher net income and earnings per share for 2019 to 2023, with the largest increases in net income and earnings per share resulting in the most recent years (2022 and 2023). A potential investor who may analyze the company’s profitability, and compare the company’s net income to the net income reported by competitor companies, should consider the effects of the change when assessing the subject company’s reported financial performance. Other measures of the company’s profitability may also be analyzed for a more detailed assessment of the company’s ability to generate profit in the future.

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PROBLEM 21.11 a. and b. 1.

Uncollectible accounts receivable. This is a change in accounting estimate, not a correction of an error, since it was not known in 2021 that Michael would go bankrupt. Restatement of prior periods is not required.

This is a change in an accounting estimate. Restatement of opening retained earnings is not required.

This is a new method for a new class of assets. No change is involved.

Adoption of the revaluation method is a voluntary change in an accounting policy, as required by IAS 16 for property, plant, and equipment. IAS 8 paragraph 17 indicates that the initial application of the revaluation model is dealt within IAS 16, not IAS 8. As a result, IAS 16 allows prospective treatment since it would be difficult to go back and determine fair values at previous dates. Consequently, for this specific change, the entity can apply this change prospectively and retrospective application is not required. However, the company is still required to disclose why it believes that the revaluation model is reliable and more relevant than the cost model. This change in policy is applied prospectively. Therefore, there would be a restatement of the opening balances at January 1, 2023. The entry required at January 1, 2023, would be the following: Land ($900,000 – $750,000) .................... 150,000 Deferred Tax Liability ($150,000 X 30%) 45,000 Revaluation Surplus (OCI) ............ 105,000

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PROBLEM 21.11 (CONTINUED) a. and b. (continued) 5.

As this is a correction of an error, the change must be applied retrospectively. Because FV-OCI investments affect other comprehensive income, a restatement of the AOCI (not retained earnings) in equity is required. The journal entry would be as follows:

Deferred Tax Liability ($200,000 X 30%) ........ 60,000 Accumulated Other Comprehensive Income ...................................................... 140,000 FV-OCI Investments .......................... 200,000

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PROBLEM 21.11 (CONTINUED) c.

Contents of the statement of changes in equity for 2023 would be the following:

Balance January 1, 2022 Comprehens ive income – as restated Balance – December 31, 2022 as restated Balance – January 1, 2023 as restated Comprehens ive income 2023 Balance December 31, 2023

Share Capital

Retained Earnings

Accumulated Other Comprehensive Income

$1,000,000

$2,500,000

$650,000

$4,150,000

910,000

335,000 *

1,245,000

1,000,000

3,410,000

985,000

5,395,000

1,000,000

3,410,000

985,000

5,395,000

1,350,000

150,000

$105,000

1,605,000

$4,760,000

$1,135,000

105,000

$7,000,000

$1,000,000

Revaluation Surplus

Total

*Comprehensive income for 2022 is restated for the overstatement in the fair value of the FV-OCI investment: $475,000 – $140,000 = $335,000

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PROBLEM 21.11 (CONTINUED) d.

For the error correction for item 5, the company needs to report the impact of the change on 2022’s comprehensive income and restate the opening balances of 2023 for the investment, the related deferred tax liability, and the AOCI in equity. Disclosures should be made that enable users of the financial statements to understand the effect of any changes on the financial statements so that the statements remain comparable to those of other years and of other entities. IFRS also requires reporting of the nature of the error, the effect of the correction on both basic and fully diluted earnings per share for each prior period presented, and an opening statement of financial position for the earliest period presented. For item 1, which is a change in estimate, disclosure is required if it is material for the current period. In this case, it might be argued that the amount is material and requires disclosure of the amount and its impact on the current earnings. IFRS also requires reporting of the nature and amount of any change that is expected to affect future periods, unless it is impracticable to estimate its effect. For item 2, the change in an estimate impacts both the current and future earnings and therefore the nature and amount of the change on the current year needs to be disclosed. If the future impact can be estimated then this should also be disclosed. If this is impracticable to estimate, this fact is disclosed. The accounting policy note would also disclose use of the straight-line method of depreciation. For item 3, this is a new transaction so the accounting policy is being applied on this transaction for the first time. This is required to be disclosed in the summary of significant accounting policies.

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PROBLEM 21.11 (CONTINUED) d. (continued) For item 4, the note disclosure for this change in policy would state that it is being applied prospectively, so there is no impact on prior years, and the changes are made to the opening balances at January 1, 2023. The company would also have to explain why it believes that the revaluation model is reliable and more relevant than the cost model. There would also be a note in the summary of significant accounting policies describing the revaluation model. Finally, the note on the land requires disclosure of the effective date of the revaluation, whether an independent valuator was used, the methods and assumptions used to determine the fair value and the level applied in the fair value hierarchy, the carrying amount of the land that would have been recognized under the cost model, and the revaluation surplus and changes to it during the year. Finally, under IFRS, the entity should report information about new standards that have been issued but are not yet effective and have not yet been applied. IFRS also requires that the entity disclose information about measurement uncertainty, including sensitivity of carrying amounts to changes in assumptions. LO 1,4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: CPA: cpa-t001 CM: Reporting

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PROBLEM 21.12 (1) Inventory .................................................................... 34,000 Retained Earnings .............................................. 34,000 (2) No entry, as ending inventory has not yet been recorded. However, the count amount should be adjusted (reduced by $17,400) before making the entry to record year-end inventory. This is an example of a correction that could be found when checking the cut-off procedures in connection with the count. (3) Cash........................................................................... Accounts Receivable ..........................................

6,200 6,200

(4) Depreciation Expense ................................................ 7,600 Accumulated Depreciation—Vehicles .................

7,600

(5) Accumulated Depreciation—Equipment ..................... 32,000 Equipment .......................................................... 29,300 Gain on Disposal of Equipment .......................... 2,700 (6) Litigation Expense ...................................................... 400,000 Litigation Liability ................................................ 400,000 (7) Depreciation Expense ................................................ Equipment .................................................................. Repairs and Maintenance Expense .................... Accumulated Depreciation—Equipment..............

8,000 64,000 64,000 8,000

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PROBLEM 21.12 (CONTINUED) (8) Investment Income or Loss ........................................ 19,000 FV-NI Investments ......................................... 19,000 (9) Salaries and Wages Payable ($18,000 – $11,600)..... Salaries and Wages Expense .............................

6,400

(10) Insurance Expense ($21,000 ÷ 3)............................... Prepaid Insurance ($21,000 ÷ 3 X 1.5) ....................... Retained Earnings ..............................................

7,000 10,500

(11) Amortization Expense ($48,000 ÷ 12) ........................ Retained Earnings ...................................................... Accumulated Amortization—Trademarks ............

4,000 4,000

6,400

17,500

8,000

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PROBLEM 21.13 Net Income for 2022

Retained Earnings 12/31/23

Item

Understated

Overstated

Understated

Overstated

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

$14,100 11,813 0 33,000 0 12,600

0 0 $18,000 0 21,000 0

0 $ 8,438 0 33,000 0 0

0 0 $ 9,000 0 10,500 0

Explanations: 1.

Net income would be understated in 2022 because interest income is understated. Net income would be overstated in 2023 because interest income is overstated. The errors, however, would counterbalance (wash) so that the Statement of Financial Position (Retained Earnings) would be correct at the end of 2023. The amount of understatement in 2022 would be $18,800 X (1 – 25%) = $14,100.

Depreciation expense in 2022 should be $2,250 for this machine. Since the machine was bought on July 1, 2022, only one-half of a year of depreciation should be taken in 2022 ($18,000/4 X 1/2 = $2,250). The company expensed $18,000 instead of $2,250 so net income is understated by $15,750 X (1 – 25%) = $11,813 in 2022. An additional $4,500 of depreciation expense should have been taken in 2023. At the end of 2023, retained earnings would be understated by $11,250 ($15,750 – $4,500) net of taxes of 25% = $8,438.

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PROBLEM 21.13 (CONTINUED) Explanations: (continued) 3.

GAAP requires that all research costs be expensed when incurred. Net income in 2022 is overstated $24,000 ($36,000 research costs capitalized less $12,000 amortized) X (1 – 25%) = $18,000. By the end of 2023, only $12,000 of the research costs would remain as an asset. Therefore, retained earnings would be overstated by $12,000 ($36,000 research costs – $24,000 amortized) X (1 – 25%) = $9,000.

The security deposit should be a long-term asset, such as refundable deposits. The $9,000 of last month’s rent is also an asset, such as prepaid rent. The net income of 2022 is understated by $44,000 ($35,000 + $9,000) X (1 – 25%) = $33,000 because these amounts were expensed. Retained earnings will continue to be understated by $33,000 until the last year of the lease. The security deposit will then be refunded, and the last month’s rent should be expensed.

$14,000 or one-third of $42,000 should be reported as income each year. In 2022, $42,000 was reported as income when only $14,000 should have been reported. Because $28,000 too much was reported, the net income of 2022 is overstated by $28,000 X (1 – 25%) = $21,000. At the end of 2023, $28,000 should have been reported as income, so retained earnings is still overstated by $14,000 ($42,000 – $28,000) X (1 – 25%) = $10,500.

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PROBLEM 21.13 (CONTINUED) Explanations: (continued) 6.

The ending inventory would be understated since the merchandise was omitted. Because ending inventory and net income have a direct relationship, net income in 2022 would be understated by $16,800 X (1 – 25%) = $12,600. The ending inventory of 2022 becomes the beginning inventory of 2023. If beginning inventory of 2023 is understated, then net income of 2023 is overstated (inverse relationship). The omission in inventory over the two-year period will counterbalance, so retained earnings at the end of 2023 will be correct.

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PROBLEM 21.14 a.

JACOBSEN CORPORATION Adjusting Journal Entries December 31, 2023 1.

Allowance for Expected Credit Losses1 ....... 5,000* Loss on Impairment ............................. To reflect reduction in loss experience rate. 1 $1,000,000 X (2% – 1½%)

5,000

Investment Income or Loss2 ......................... 13,000 FV-NI Investments ............................ 13,000 To reduce trading securities to fair value. 2 $78,000 – $65,000

Retained Earnings....................................... 8,900 Cost of Goods Sold ..................................... 4,700 Inventory.............................................. 13,600 To adjust for overstatements in opening and closing Inventories.

Equipment ................................................... 30,000 Depreciation Expense ................................. 2,500 ([$30,000 – $5,000] ÷ 10) Retained Earnings ............................... 27,500 ($30,000 – $2,500) Accumulated Depreciation— Equipment3 ...................................... 5,000 To correct posting of equipment purchase as expense in 2022. 3 $2,500 X 2 Accumulated Depreciation—Equipment ...... 17,500 Equipment ........................................... 14,700 Gain on Disposal of Equipment ........... 2,800 To correct the recording of the disposal of equipment.

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PROBLEM 21.14 (CONTINUED) a. (continued) 5.

Prepaid Insurance ....................................... 2,350 Insurance Expense ($4,700 ÷ 4) ................. 1,175 Retained Earnings4 .............................. 4 ($4,700 – $1,175) To adjust for nonrecognition of prepaid expense in 2022.

3,525

No entry is required. The items will be properly reclassified as part of the financial statement preparation.

JACOBSEN CORPORATION Computation of Corrected Net Income For the Years Ended December 31, 2023 and 2022

2023 Reported income Change in accounts receivable loss experience rate from 2% to 1½% Loss on FV-NI investments Ending inventories overstated: December 31, 2022 December 31, 2023 Misposting of equipment purchase Decrease in operating expenses—2022 Incr. in depreciation expenses—2023 Misposting of proceeds of equipment sold Recognition of prepaid insurance Corrected net income

2022

$220,000 $195,000 5,000 (13,000)

—

8,900 (13,600)

(8,900)

27,500 (2,500) 2,800 3,525 (1,175) $206,425 $217,125

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PROBLEM 21.14 (CONTINUED) c.

JACOBSEN CORPORATION Calculation of Corrected Retained Earnings At January 1, 2023

Retained earnings, January 1, Change in accounts receivable loss experience rate from 2% to 1½% Loss on FV-NI investments Ending inventories overstated: December 31, 2022 Misposting of equipment purchase Decrease in operating expenses—2022 Recognition of prepaid insurance Retained earnings, January 1, restated

$247,000 — — (8,900) 27,500 3,525 $269,125

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PROBLEM 21.15 a.

Net income, as reported Rent received in 2022, earned in 2023 Wages not accrued, 12/31/21 Wages not accrued, 12/31/22 Wages not accrued, 12/31/23 Inventory of supplies, 12/31/21 Inventory of supplies, 12/31/22 Inventory of supplies, 12/31/23 Corrected net income b. 1.

2022

2023

$29,000 (1,300) 1,100 (1,500)

$37,000 1,300

(1,300) 740 000,000 $26,740

Retained Earnings .............................................. Rent Revenue .............................................

1,300

Salaries and Wages Expense ............................. Salaries and Wages Payable ...................... To accrue salaries and wages expense.

940

Retained Earnings .............................................. Salaries and Wages Expense ..................... To correct for prior-year error.

1,500

Supplies .............................................................. Supplies Expense ....................................... To record supplies on hand.

1,420

Supplies Expense ............................................... Retained Earnings....................................... To correct for prior-year error.

740

1,500 (940) (740) 1,420 $39,540

1,300

940

1,500

1,420

740

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PROBLEM 21.15 (CONTINUED) c.

Retained earnings, Jan. 1 as reported Rent received in 2022, earned in 2023 Wages not accrued, 12/31/21 Wages not accrued, 12/31/22 Wages not accrued, 12/31/23 Inventory of supplies, 12/31/21 Inventory of supplies, 12/31/22 Inventory of supplies, 12/31/23 Retained earnings, Jan. 1 as restated

2022

2023

$95,000

$124,000 (1,300 )

(1,100) (1,500) 1,300 740 000,000 $95,200

$121,940

For 2022, reported net income of $29,000 divided by total net sales revenue of $1,200,000 results in a profit margin of 2.4%, and corrected net income of $26,740 divided by total net sales revenue of $1,200,000 results in a profit margin of 2.2%. For 2023, reported net income of $37,000 divided by total net sales revenue of $1,100,000 results in a profit margin of 3.4%, and corrected net income of $39,540 divided by total net sales revenue of $1,100,000 results in a profit margin of 3.6%. An investor who analyzed Kitchener’s profitability based on reported net income may have noted a change in profit margin from 2.4% to 3.4% in 2022 and 2023, whereas the actual change in profit margin (based on corrected net income) was from 2.2% to 3.6% in 2022 and 2023, signalling stronger improvement in profitability than originally reported. The investor may also note that errors in net income often affect multiple periods, and that other measures of the company’s profitability may also need to be analyzed for a more detailed assessment of the company’s ability to generate profit in the future.

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PROBLEM 21.16 a. INTEQ CORPORATION Schedule of Revised Income Before Income Tax For the Years Ended March 31, 2021, 2022, and 2023 CALCULATIONS 2021 1. Income before tax, as reported 2. Elimination of profit on consignments: Billed at 130% of cost Cost Profit error 3. To correct C.O.D. sale 4. Adjustment of warranty expense: Sales per books Correction for consignments Correction for C.O.D. sale Corrected sales Normal warranty expense, one-half of 1% Less costs charged to expense Additional expense 6. Bad debt adjustments: Normal bad debt expense, one-quarter 1% of sales Less previous write-offs Additional expense 7. Adjustment for contract financing 8. Adjustment for commissions

$ ÷ $

6,500 130 % 5,000 1,500

2022

2023

$ ÷ $

1,500

5,590 130 % 4,300 1,290

$940,000 (6,500) 0000,0 $933,500

$1,010,000 6,500 6,100 $1,022,600

$1,795,000 (5,590 ) (6,100 ) $1,783,310

4,668 760 3,908

5,113 1,670 3,443

2,334 750 1,584

2,557 1,320 1,237

$ $

8,917 3,850 5,067

4,458 3,850 608

5. Adjustment for bonus, one-half of 1% of income before tax and bonus Revised income before income tax

$1,400 – $800

$800 – $1,120

SUMMARY Increases (Decreases) in Income 2021 2022 2023 $71,600

$111,400

$103,580

(1,500)

1,500 6,100

(1,290 ) (6,100 )

(3,908)

(3,443 )

(5,067 )

(1,584) 3,000 (1,400) 66,208

(1,237 ) 3,900 600 1 118,820

(608 ) 5,100 (320 )2 95,295

(331) $65,877

(594 ) $118,226

(476 ) $94,819

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.16 (CONTINUED) b.

INTEQ CORPORATION Journal Entries March 31, 2023 Sales Revenue ........................................................ 5,590 Inventory on Consignment ...................................... 4,300 Cost of Goods Sold ......................................... Accounts Receivable ...................................... To adjust for consignments treated as sales, 3/31/23. Sales Revenue ........................................................ Retained Earnings .......................................... To adjust for C.O.D. sales not recorded, 3/31/22.

6,100

Warranty Expense .................................................. Retained Earnings ($3,908 + $3,443) ..................... Warranty Liability ............................................ To set up allowance for warranty expense.

5,067 7,351

Retained Earnings ($331 + $594) ........................... Salaries and Wages Expense................................. Salaries and Wages Payable.......................... To set up accrued bonus payable to manager.

925 476

Retained Earnings ($1,584 + $1,237) ..................... Bad Debt Expense .................................................. Allowance for Doubtful Accounts .................... To set up allowance for uncollectible accounts.

2,821 608

4,300 5,590

6,100

12,418

1,401

Cash (held by bank) ................................................ 12,000 Finance Expense ............................................ Retained Earnings ($3,000 + $3,900)............. To record finance charge reserve held by bank.

3,429

5,100 6,900

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.16 (CONTINUED) b. (continued) Sales Commission Expense ................................... Retained Earnings ($1,400 – $600) ........................ Sales Commission Payable ............................ To adjust for accrued commissions.

320 800 1,120

LO 1,4 BT: AP Difficulty: C Time: 60 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.17 a.

BAYBERRY CORPORATION Projected Income Statement For the Year Ended December 31, 2023 ______________________________________________________ Sales $29,000,000 Cost of goods sold $14,000,000 a Depreciation 1,600,000 Operating expenses 6,400,000 22,000,000 Income from operations 7,000,000 b Investment Income or Loss 1,000,000 Income before tax and bonus 8,000,000 President’s bonus 1,000,000 Income before income tax 7,000,000 Provision for income tax Current $ 1,800,000 c Deferred 300,000 2,100,000 Net Income $ 4,900,000 Conditions met: 1. 2. a

Income before bonus and tax > $8,000,000. Payable for income taxes does not exceed $2,500,000.

Depreciation for the current year in the initial projected statements includes $600,000 for the old equipment and $2,000,000 for the robotic equipment. If the robotic equipment is changed to straight-line, its depreciation is only $1,000,000 and the total is $1,600,000. By urging the board of directors to change the classification of Securities A and D to securities recorded using the fair-value through net income (FV-NI) model, income is increased by a $1,000,000 recognition of a holding gain. The holding gain on the securities is not currently taxable as it is not realized.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.17 (CONTINUED) b.

Students’ answers will vary. Changing the first-year election of depreciation back to the straight-line method is unethical if this method does not provide the most relevant information for the users of the financial statements. GAAP requires company management to select the depreciation method that best represents the pattern in which the entity receives the asset’s benefits. Since this is the first time the company has used robotic equipment, it may be difficult for corporate officers to challenge the choice of depreciation policy because of lack of knowledge about the pattern of use of the assets. The change would not be unethical depending on the rationale used by the corporate decision makers. It could only be justified on the basis that all production equipment, including the new robotic equipment, provides equal benefits over time. Considering the immediate need for cash of $1,000,000 for the president’s bonus and $1,800,000 for income taxes, there may be a need to sell some of the securities. Therefore, the transfer of $3,000,000 of investment securities (FV-OCI) to securities accounted as FV-NI may also be appropriate. Note that under IFRS, no reclassifications are permitted between these categories except on the rare occasion that there is a change in the entity’s business model. (Under ASPE, the fair value option designation is irrevocable; otherwise the issue is not addressed.) It is naive to believe that corporate officers do no planning for year-end (or interim) financial statements. The slippery slope arises with manipulation of financial statements. The reclassification of the selected securities clearly manipulates the income to the benefit of the president. The reclassification of the securities is not within IFRS guidelines.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.17 (CONTINUED) b. (continued) IFRS clearly states that transfers in or out of the trading classification should not be done. Since the investments were purchased during the year, management could argue that the classification was not specified until year end. The ethics of this decision are questionable as classification is based on the intent of management at the time of the purchase. Any auditor would automatically bring this transaction to the attention of the board of directors. Some stakeholders and their interests are: Stakeholder President CFO Board of Directors Shareholders

Employees

Creditors

Interests Personal gain of $1,000,000 bonus. Placed in ethical dilemma between the interests of the president and the corporation. May be subject to the manipulations of the President for his personal gain. Increased income from higher (paper) income may increase demand for dividends. Lower income from bonus may decrease cash available for dividends. President takes approximately 20% of net income for himself. This could have been used to start a pension plan for all of the employees. The increased income before tax represents a 16.7% inflation of the economic income of the corporation. This may lead to unreliable assessments as to creditworthiness.

In discussing the merits of these decisions, the impact of the changes on the benefits of the users on a long-term basis need to be considered.

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PROBLEM 21.17 (CONTINUED) c.

There usually are no cash flow implications to changes in policy. In this case however, the change in policy triggers a bonus to the president. If this bonus is paid out before year-end, the change in policies would generate a cash outflow from operations of $1,000,000. The bonus would typically be paid in 2024.

If the company were to follow ASPE instead of IFRS, the only difference would be that the investment securities would not be permitted to be classified as FV-OCI, since there is not an FV-OCI option under ASPE. As a result, management would not be able to “cherry-pick” the investments with holding gains for the intention to reclassify them as securities (FV-NI) in order to have the holding gains appear in net income while the holding losses appear in other comprehensive income. Instead, all holding gains and losses would be required to be presented in net income under ASPE. All other items would be treated similarly under both IFRS and ASPE.

LO 1,3 BT: AP Difficulty: M Time: 30 min. AACSB: Ethics CPA: CPA: cpa-t001 cpa-e001 Reporting and Ethics

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PROBLEM 21.18 Memorandum to: Ali Reiners, Controller From: Accountant Subject: Accounting treatment of various issues at Luftsa Corp. Here are my recommendations on the various issues you have brought to my attention. If you have further questions or wish to discuss these issues, please do not hesitate to contact me. 1.

This situation is an adoption of a new accounting policy. In previous years, the loyalty points award program was immaterial. Now however, the item has become material and the appropriate accounting policy is to identify the performance obligations related to the loyalty points award program, allocate and defer a portion of revenue to the performance obligations, and recognize the related revenue when (or as) Luftsa satisfies the performance obligations. The accounting policy can be applied prospectively starting January 1, 2023. Note disclosure is appropriate to describe this new policy and its impact on the current and future periods, if practicable to estimate.

In this situation, the company is changing its policies to use components for depreciation and the revaluation model. Luftsa has determined that it was not practicable to determine the impact of depreciation on components on prior years since the information was not available, so the policy change cannot be applied retrospectively. Additionally, the revaluation model may be implemented prospectively even though it is also a change in policy. IAS 8 paragraph 17 indicates that the initial application of the revaluation model is dealt with in IAS 16, not IAS 8. As a result, IAS 16 allows prospective treatment since it would be difficult to go back and determine fair values at previous dates.

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PROBLEM 21.18 (CONTINUED) 2. (Continued) The note disclosure would state why the company believes that these policies provide reliable and more relevant information. The company would also be required to note the impact on the opening balances as the company adopts the revaluation model for the assets at January 1, 2023 – that is the change to the assets, deferred taxes, and the revaluation surplus. Finally, the company should also disclose the impact on the depreciation and taxes for the current period with the adoption of these two new policies. 3.

This situation is considered a correction of an error. The general rule is that careful estimates that later prove to be incorrect should be considered changes in estimates. Where the estimate was obviously computed incorrectly because of lack of expertise or in bad faith, the adjustment should be considered an error. Changes due to error should employ the retrospective approach by: a.

Restating, via a prior period adjustment, the beginning balance of retained earnings for the statements of the current period. Correcting all prior period statements presented in comparative financial statements. The amount of the error related to periods prior to the earliest year’s statement presented for comparative purposes should be included as an adjustment to the beginning balance of retained earnings of that earliest year’s statement. In addition, an opening balance sheet must be presented for the earliest comparative period.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.18 (CONTINUED) 3. (continued) There are ethical issues involved in this situation. These involve the honesty and integrity of Rosentiel’s financial reporting practices versus the corporation’s and the division controller’s profit motives. Understating inventory obsolescence would overstate the division’s net income. Such a practice distorts Rosentiel’s operating results and misleads users of the financial statements. This practice is unethical and must be reported to Luftsa’s Board of Directors. In addition, the result of these practices is that excess bonuses may have been paid to the divisional controller, at the expense of other divisional controllers whose results would not have looked favourable in comparison. 4.

No adjustment is necessary— depreciation methods may be chosen that best reflect the pattern of use for any assets.

This situation is considered a change in estimate because new events have occurred that call for a change in estimate. The accounting change is made prospectively. Note disclosure would describe the impact of the change on the current earnings, and any impact that is practicable to estimate for the future.

Even though this situation looks like a change in estimate, the facts of the case indicate that the estimates were not revised based on better information, but rather revised incorrectly due to bad faith by the divisional manager. This situation is considered a correction of an error. The accounting treatment would be the same as discussed in point 3.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 21.18 (CONTINUED) 6. (continued) As well, there are ethical issues involved in this situation that relate to the honesty and integrity of Harper’s financial reporting practices and the divisional manager’s profit motives. Shortening the life of assets from 10 to 6 years may be evidence that depreciation expense during the first five years were understated. Such a practice distorts Harper’s operating results and misleads users of Harper’s (and ultimately Luftsa's) financial statements. If this practice is intentional, it is unethical. In addition, the result of these practices is that excess bonuses may have been paid to the divisional manager. This situation should be reported to the highest levels of management within Luftsa (the Board of Directors). LO 1,2 BT: C Difficulty: M Time: 30 min. AACSB: Ethics and Communication CPA: CPA: cpa-t001 cpae001 Reporting and Ethics

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INTEGRATED CASES Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the back of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. IC 21.1 TEMPLE LIMITED

Case Overview: Temple Ltd is a mature company in the real estate development business. The company’s property investments are valued at historical costs, which is having a negative effect on the company’s debt-toequity ratio. Temple would like to expand its investment into the Bahamas; however, it is concerned about the market’s reaction to the increase in debt given its current ratio of 5:1. The financial statement users include investors and creditors, specifically Lendall Bank. IFRS is a constraint since the company is publicly traded. Analysis and recommendations - Using fair values to value real estate assets is acceptable under IFRS. It provides greater transparency and more relevant information since the significant capital assets (investment properties) would be presented at a value that is much closer to the cash flows the property expects to generate. - Gains and losses are booked through comprehensive income under the revaluation method. This would be reflected in the statement performance and provide better information. Changes in the fair value of its investment properties are what management works toward, and on which management performance is likely compensated.

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IC 21.1 TEMPLE LIMITED (CONTINUED) - IAS 8 indicates that a voluntary change in accounting policy should only be made if the resulting information is reliable and more relevant. IAS 40.1 indicates that this could not be substantiated for a move from fair value to the cost basis, so a reader might assume that the reverse—from cost to fair value— could be justified. - Although Temple is required, at a minimum, to disclose the fair value of its investment properties in the notes to the financial statements, changing the measurement treatment to fair value is preferred and has a relatively low cost because the fair values are already being determined for the lending request. This change would provide more reasonable inputs into the debt/equity ratio. The bank is then better able to assess the ability of Temple to handle additional debt. Recommendation: Memo: Anticipated Capital Market Reaction to Increased Debt Levels Temple Limited should measure its investment properties at fair value. The company is expanding, and the non-current assets are currently recorded at historical cost on the financial statements. This does not reflect, the current value of these assets, specifically the investment properties. Temple is a public company with shares trading on the TSX; therefore, IFRS is required. Under IFRS, the company may use cost or fair value to measure these assets. The company is looking to finance an expansion, yet its debt-to-equity ratio is already high at 5:1. This ratio is likely due to the fact that the asset values do not reflect current values. Any additional loans will further erode the debt-toequity ratio.

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IC 21.1 TEMPLE LIMITED (CONTINUED) Investors and creditors (specifically Lendall Bank) would appreciate statements that reflect more current values and risk (reflect the hidden value). This will allow the financial statement users to make more informed decisions. If fair value is used to measure the assets and the statements are audited, the bank will be able to rely on the values. Use of fair value is the most transparent and relevant way to measure Temple’s assets. Gains and losses will be booked through income, showing how the company is performing in terms of its investments in its properties. Although this should not be the sole reason for adopting fair value measurement, the impact of switching is that the debt-to-equity ratio will be lower as the revaluation gains will flow through comprehensive income to become part of Temple’s equity.

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IC 21.2 SUNLIGHT EQUIPMENT MANUFACTURER Case Overview SEM is a BBQ manufacturing company that recently became unprofitable due to higher consumer interest rates and a slowing economy. In response to this, the company fired its CEO and hired a turnaround specialist, Agneta. Her compensation is structured in part as a bonus based on year-end financial results. There may be a reporting bias since Agneta may opt to make the numbers look better to earn her bonus. Net income is a key number since the bonus is based on this. A bias may also exist since she wants to pay her sales staff a bonus based on sales as part of the turnaround strategy. The slowdown in the economy may also put pressure on the financial statements, the company may want to make the numbers look better. Since SEM is a private company, the company has the choice to prepare the statements according to IFRS or ASPE. It has elected to use IFRS. Therefore, IFRS is a constraint. Users of the financial statements will want transparency to assess how the company is performing in the economic downturn and to assess how Agneta is performing. As the auditor you must be aware of these pressures on financial reporting.

Analysis and recommendations Issue: A new sales policy has been implemented that requires a 20% down payment unless the customer doubles their order in which case the down payment is waived. This new policy has been restricted to customers with excellent credit history. As a result, sales are up 20%. However, this figure might be inflated.

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IC 21.2 SUNLIGHT EQUIPMENT (CONTINUED) Recognize revenue upon receipt of the deposit - The 20% cash down payment will help ensure collectibility. Note also that only customers with excellent credit history have been allowed to purchase under the new policy. This assures that the transaction meets the definition of a contract under IFRS 15 (collection probable). - The transaction is measurable since there is a contract in place that stipulates the amount of the down payment and returns are unlikely given that only customers with excellent credit history are purchasing. - Legal title to the BBQs has been transferred. Therefore, it may be argued that the performance obligation has been settled.

Defer recognition until payment is assured - There is only a 20% cash down payment and in many cases, if customers’ orders double, the down payment is waived. Therefore, it could be argued that collectibility is an issue. Customers may have ordered double just to avoid the down payment but may not be able to sell that many BBQs. Any unsold BBQ’s may be returned after year end. Note that under IFRS 15, if collection is not assumed to be probable, IFRS 15 is not applicable and revenue recognition is delayed. - Measurability is also an issue since the customer does not have to pay until the BBQs ae sold to the end user or a third party. Given this, it is questionable as to whether this is a sale or a consignment arrangement. - Economic substance over legal form should be adhered to. SEM should record revenue at the point when control over the BBQs passes to the customer. SEM still has significant risks and rewards of ownership, since the BBQs that are not sold by the customer revert to SEM.

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IC 21.2 SUNLIGHT EQUIPMENT (CONTINUED) Recognize revenue upon receipt Defer recognition until payment of the deposit is assured - Physical possession remains with SEM, since BBQs are stored on SEM premises. SEM has not even shipped them. This is similar to a bill and hold arrangement, and may be evidence that the significant risks and rewards still rest with SEM. Recommendation: Defer recognition of revenues until collectability is ensured, this is a more conservative approach. Issue: SEM has purchased a new customized inventory tracking system. However, the company installing the system became insolvent prior to completing the install. SEM has not been able to find another company to finish the project. Capitalize the costs related to the incomplete installation - The new system has/will have future benefit since it will help track inventory. In the past, this has been a source of lost profits. - SEM owns the new system and will be able to use it once it is complete. - Agneta is confident that she will be able to find another software company to complete the installation.

Expense the costs related to the installation - The software company SL has gone bankrupt and is not able to finish the software – thus there is no future benefit. This is a sunk cost. - Without the project being completed, SEM has no access to potential future benefits.

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IC 21.2 SUNLIGHT EQUIPMENT (CONTINUED) Capitalize the costs related to the incomplete installation

Expense the costs related to the incomplete installation - Agneta may not want to admit failure, because it will affect her bonus and the perception about how she is performing in terms of turning the company around. - Expensing the costs may result in the presentation of a loss on the Income Statement.

Recommendation: Expense the costs to date since there is significant uncertainty as to future benefit given that the installation may not be able to be completed.

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IC 21.2 SUNLIGHT EQUIPMENT (CONTINUED) Issue: Agneta’s bonus has been accrued based on the increased sales. Accrue bonus for Agneta and sales staff - The payment for Agneta is likely as she has a reputation as a turnaround specialist and has put new policies in place to turn the company around that include new sales policies, a new remuneration structure, and a new inventory tracking system. - The bonus is measurable since it is defined. SEM must achieve a combined two-year profit of $5,000,000. The company has been profitable in the past. - It is more conservative to accrue.

Do not accrue - SEM is currently in a breakeven situation, it may not reach the $5,000,000 profitability threshold by the end of year two. The future is uncertain. - SEM appears to have created income by overly aggressive sales policies and changes in accounting policies. Note that the software acquisition is a large loss. - This is a condition involving uncertainty that will only be resolved when the company hits the two-year profit target.

Recommendation: Do not accrue the bonus. The current net income is overstated and should be restated.

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IC 21.2 SUNLIGHT EQUIPMENT (CONTINUED) Issue: Depreciation methods were changed from the double declining balance method to straight line. The rationale for the change is that the use of the double declining balance method was arbitrary and that SEM’s competitors use the straight-line method. - This must be viewed with a certain amount of skepticism. SEM may have changed this just to make net income higher. - Just because competitors use straight-line, it does not justify SEM changing its depreciation method. The method chosen should match the pattern of use. The fact that the machinery is most productive when it is new would support the double-declining balance method. - Straight-line would be arbitrary and unjustifiable. Recommendation: SEM should not change the method of depreciation. There is no evidence to support this change.

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RESEARCH AND ANALYSIS RA 21.1 EMPIRE COMPANY LTD a. Note 3 (AB) to Empire’s financial statements describes standards, amendments, and interpretations that have been communicated by the IASB, but have not yet been adopted by the company in its financial reporting. This provides the user with the ability to anticipate these relevant changes to reporting in future financial reporting documents. In May 2020, the IASB issued a package of narrow-scope amendments to three standards, which are: a. IFRS 3 – Business Combinations b. IAS 16 – Property, Plant and Equipment c. IAS 37 – Provisions, Contingent Liabilities and Contingent Assets In addition, the IASB put forward Annual Improvements to IFRS Standards for 2018 – 2020. The company is still assessing the impacts of the above as of the financial statement reporting date. In January 2020, the IASB issued Classification of Liabilities as Current or Non-Current as amendments to IAS 1. These are also considered narrow scope changes that only affect presentation of values, not the amount or timing of recognition. The company is still assessing the impacts of the above as of the financial statement reporting date.

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RA 21.1 EMPIRE COMPANY LTD (CONTINUED) b. Note 2 provides disclosures about the most significant critical judgements and estimates affecting the financial statements made by management. Some of the more significant assumptions, and the possible effect on the financial reports if a different assumption had been made, were as follows: • Inventories: Inventory is valued at the lower of cost and estimated net realizable value. Significant estimation and judgement is required in determining; estimated inventory provisions associated with vendor allowances and internal charges, estimated inventory provisions due to spoilage and shrinkage, and inventories valued at retail and adjusted to cost. • Impairment of non-financial assets: Assumptions are used in assessing impairment of these types of assets. Management will estimate recoverable amounts for each asset of CGU based on the higher of value in use and fair value less disposal costs. There is estimation uncertainty related to future operating results and discount rates. • Leases: In determining the value of lease liabilities and right-ofuse assets, assumptions are made on discount rates and lease term expectations. • Income taxes: Estimates are required for future earnings, and the timing and reversal of temporary differences to determine current and deferred income taxes. In addition, the company makes judgements in the interpretation of tax rules in the jurisdictions for which it operates. • Provisions: Estimates and assumptions are made of future cash flows and discount rates as it relates to an obligation. • Vendor allowances: The company has agreements with vendors that include volume-based allowances and discounts. Estimates and judgements are required when the receipt of these allowances are conditional on specified conditions occurring. This includes estimates of achieving agreed upon volume targets.

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RA 21.1 EMPIRE COMPANY LTD (CONTINUED) • Employee future benefits: Accounting for the cost of defined benefit pension plans and other post-retirement benefits requires assumptions. Actuarial assumptions are used, and sensitivity analysis is performed in the measurement of these obligations. • Business acquisitions: The company applies judgement on the recognition and measurement of assets and liabilities acquired, along with estimates of future cash flows and applicable discount rates. Given the varied types of estimates and judgements, it is difficult for a reader to estimate the impact of variations on the decisions of management. Readers can link the areas of judgement to specific financial statement items and gauge the impact based on the relative importance of the item to the financial results. Note disclosures also provides additional information. For example, Note 18 provides details of the estimates and assumptions for employee future benefits. A sensitivity analysis is also provided. Note 14 details the current and deferred income tax expense and deferred tax assets and liabilities. c. The accounting standards require the information identified in part (b) because different accounting methods, different judgements, and different estimates result in different numbers being reported on the balance sheet and income statement. Different numbers used by investors and creditors lead to different decisions. This disclosure provides the users of the statements with information about the reliability of the accounting values, the risk that other measures may be just as appropriate, and underscores the extent to which accounting measures are estimates. The disclosures make the financial statements more representationally faithful (complete) and more relevant for prediction purposes in making resource allocation decisions.

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RA 21.2 THOMSON REUTERS CORPORATION a.

The company included the change in accounting policies in Note 1 of the financial statements. The note references a change in accounting standards in 2019 (note that these are 2020 statements, but include 2019 comparative values): Effective January 1, 2019, the company adopted IFRS 16, Leases, which introduced a single lease accounting model that eliminated the distinction between operating and finance leases for lessees. This is a change in accounting policy mandated by a change in a primary source of GAAP.

b. As indicated above, the change identified was mandated based on a change in a primary source of GAAP. As stated in Note 1, the change was adopted using the modified retrospective method. As a result of this approach, there was a cumulative effective of $11 million, which was recorded as an adjustment to retained earnings at January 1, 2019. The change can be seen in the statement of changes in shareholders’ equity as an adjustment to opening retained earnings for 2019 only, identified on a line titled as “Impact of IFRS 16”, with a subtotal line after it titled, “Balance after IFRS 16 adoption”. This change increases total retained earnings and total equity. The statements include a note for leases (Note 27), however, since the change relates to January 1, 2019, and these are 2020 financial statements, there is no discussion of the change in the note. c. Thomson Reuters only has one disclosure related to accounting standards policy changes, as discussed above. However, upon review of the notes of the financial statements, it appears that the company did make an amendment to its Pension plan (Note 26), which may be considered a change in estimates. Note 28, Supplemental Cash Flow Information, indicates that this resulted in a gain of $119 million.

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RA 21.3 AIR CANADA a. As per Note 2 (CC), there are several revised accounting standards that are applicable to Air Canada in this reporting cycle, and they are all in regard to Interbank Offered Rate Reform (IBOR). In August 2020, the IASB published amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4, and IFRS 16. These amendments address issues that arise from the implementation of IBOR reform, where IBOR’s are replaced with other benchmark rates. Air Canada is adopting the amendments as of January 1, 2021 and is currently assessing the impacts to debt and lease contracts as a result of the change away from IBOR to other alternative rates. As at December 31, 2020, Air Canada estimates that the amount of debt and lease contracts that will be subject to IBOR reform is $1,718 million USD LIBOR. In addition, there are debt and air-craft leases impacted by rate benchmarks in multiple jurisdictions in the amounts of $1,007 million Canadian Dollar Offer Rate (CDOR) and $5 million Japanese Yen TIBOR. b. Note 3 identifies what judgements and accounting estimates were critical to the preparation of the financial statements. The company explains that these are recognized by management as components that could materially affect the amounts recognized on the financial statements. They are affected by internal and external environmental factors and may change with various circumstances. The judgements with the most significant effect on the financial statement numbers are related to:

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RA 21.3 AIR CANADA (CONTINUED) Impairment Considerations on Long-Lived Assets: Management carries out impairment tests by comparing the carrying value of an asset or CGU to its recoverable amount. The recoverable amount requires management to make a number of significant market participant assumptions, including assumptions related to cash flows, discount rates, and future growth rates. Employee Future Benefits: Actuarial valuations are used for accounting purposes, which are driven by estimates and assumptions. These estimates and assumptions are on variables such as discount rates, future compensation values, and mortality rates. These longterm assumptions are subject to significant uncertainty, which could cause variations in reported values. Income Taxes: Based on the Covid-19 pandemic, management is faced with significant uncertainty as it relates to estimating future income potential. In order to record deferred tax assets, there needs to be reasonable certainty that there will be future income in order to realize the benefits associated with the losses. Due to the uncertainty of future income, starting in the second quarter of 2020, management has foregone the recognition of deferred tax assets related to unused losses or other deductible temporary differences. Aeroplan Loyalty Program: The loyalty program requires management to make several assumptions and estimates to arrive at appropriate financial statement values. These estimates and assumptions center around estimated travel values (ETVs) of Aeroplan points, and breakage. Breakage represents the estimated number of points that are not expected to be redeemed. The resulting amounts contribute to the recognition of deferred revenue, which is currently valued at $3,256 million Canadian as at December 31, 2020, which is a significant balance relative to other line items on the financial statements. A sensitivity analysis is provided in the note as a small change in the assumptions could cause a material impact on revenue.

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RA 21.3 AIR CANADA (CONTINUED) Depreciation and Amortization Period for Long-Lived Assets: Estimates are made about the expected useful life and the expected residual values of these assets. Estimates and assumptions are evaluated at least annually as they have a significant impact on the financial statements. A sensitivity analysis is provided in the note disclosure to communicate this significance. Any changes to these estimates are generally applied on a prospective basis. Maintenance provisions: Provisions are made to fulfill lease obligations agreements on an aircraft’s condition. Provisions are based on estimates of aircraft utilization, expected future maintenance costs, the time at which maintenance is expected to occur, expected changes in discount rates on the present value of future cash flows, changes in inflation, and the possibility of lease extensions. c. The disclosure in Note 1 describes the effect Covid-19 has had on the airline industry as it relates to airline traffic, and the corresponding decline in revenue and cashflows. The travel restrictions imposed by governments globally is specifically highlighted. The high level of uncertainty as to when the pandemic might end has created similar uncertainty for management in its ability to predict and plan for future operations. There is limited visibility regarding when government restrictions will change surrounding travel, Covid-19 testing requirements, vaccination rates, consumer spending and willingness to travel, etc. for not only the Canadian market, but internationally as well.

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RA 21.3 AIR CANADA (CONTINUED) Note 1 makes two references to the accounting impacts of Covid-19. First, there is specific mention of additional detail provided in Note 17, which includes information on financing activities and other actions taken in response to the Covid-19 crisis. This note provides a detailed account of the financial instruments of the company along with risk management strategies. Given that management highlights significant uncertainty in the future for the business, it makes sense that risk management strategies to address this uncertainty is included in the disclosures. Secondly, management directs the reader to Note 3, where management discusses considerations related to critical accounting estimates and judgements. An example of one of these items is Income Taxes, which is highlighted above. Given the uncertainty surrounding future profitability, management did not recognize certain deferred tax assets in 2020.

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MMXXII vii F2

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CHAPTER 22 STATEMENT OF CASH FLOWS Learning Objectives 1. Understand cash and cash equivalents as well as the business importance of cash flows, and describe the purpose and uses of the statement of cash flows. 2. Identify the major classifications of cash flows and explain the significance of each classification. 3. Prepare the operating activities section of a statement of cash flows using the direct versus the indirect method. 4. Understand the basic steps in the manual preparation of a statement of cash flows. 5. Prepare a statement of cash flows using the direct method. 6. Prepare a statement of cash flows using the indirect method. 7. Prepare a complex statement of cash flows using both the direct and indirect methods. 8. Identify the financial presentation and disclosure requirements for the statement of cash flows. 9. Read and interpret a statement of cash flows. 10. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. 11. Use a work sheet to prepare a statement of cash flows.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item 1. 2. 3. 4.

LO 1 1,10 1 2,10

BT Item C AP AP AP

5. 6. 7. 8.

BT Item LO

2 2 2,8 2,5,8

Brief Exercises AP 9. 3,10 AP 13. 5,8,10 AP 17. K 10. 3,10 AP 14. 3 AP 18. AP 11. 5 AP 15. 3 AP AP 12. 5 AP 16. 6 AP

1. 1,6,8,9 AP 6. 2,5,6,8 AP 11. 2. 2,10 AP 7. 1,2,6,8,10 AP 12. 3. 2,5,6,8 AP 8. 2,8 AP 13. 4. 2,5,6,10 AP 9. 2,5,6,8 AP 14. 5. 2,6 AP 10. 2,8 C 15. 1. 7,8,9 AP 2. 4,6,8,9 AP 3. 1,4,7,8,9 AP

4. 5. 6.

1, 2,9

7,8 1,7,8 4,9,10

AP AP AP

2,8,10 3,9 3 5,6,8,9 3,5,8,9

7. 7,9 8. 6,10 9. 4,10 Cases

Item LO

BT Item

C 16. 3,6,8 AP 21. AP 17. 5,6,8,9 AP 22. AP 18. 3 AP 23. AP 19. 3 AP AP 20. 3,9 AP

7 11

AP AP

3 11 11

AP AN AP

AP 10. 4,7,10 AP 13. 2,6,8,9 AP AP 11. 1,7,10 AP AP 12. 7,8 AP

Integrated Cases 1. 1.

1, 2,9 2,3,8

AN 2.

Research and Analysis 3,9 AN 3. 9 AN 4.

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

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ASSIGNMENT CLASSIFICATION TABLE Topics 1. Cash and cash equivalents. Cash flows from a business perspective and uses of the statement of cash flows.

Brief Exercises Exercises 1, 2, 3 1, 7

Problems 1, 2, 3, 5, 6, 11

2. Classifying operating, investing, and financing activities.

4, 5, 6, 7, 8

2, 3, 4, 5, 6, 7, 8, 9, 10, 11

6, 8, 9, 10

3. Direct and indirect methods of preparing operating activities.

9, 10, 14, 15

12, 13, 15, 16, 18, 19, 20, 21

2, 8, 11,

5. Statement of cash flowsdirect method.

8, 11, 12, 13

3, 4, 6, 9, 14, 15, 17

5, 12

6. Statement of cash flowsindirect method.

1, 3, 4, 5, 6, 7, 9, 14, 16, 17

7. More complex statement using both methods.

7, 8, 17

8. Presentation and disclosure.

1, 3, 7, 8, 9, 10, 11, 14, 15, 16, 17

1, 2, 3, 4, 5, 6, 11, 13

9. Interpret a statement of cash flows.

2, 4

1, 12, 14, 15, 17, 20

1, 2, 4, 5, 7, 12, 13

10. Differences between IFRS and ASPE.

9, 10, 13

2, 4, 7, 11

6, 8, 9, 10, 11

11. Using a work sheet*

22, 23

1, 3, 4, 7

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ASSIGNMENT CHARACTERISTICS TABLE Item

Description

E22.1

Preparation of statement from transactions, and explanation of changes in cash flow Classification of transactions and calculation of cash flows Statement of cash flows–direct and indirect methods Statement presentation of transactions– investment using equity Partial statement of cash flows– indirect method Analysis of changes in capital asset accounts and related cash flows Statement presentation of transactions— indirect method Statement presentation of transactions– equity accounts Partial statement of cash flows–finance leases Classification of major transactions and events Classification of transactions Preparation of operating activities section— direct method Cash provided by operating activities, write off, and recovery of accounts receivable Statement of cash flows–direct and indirect methods Statement of cash flows–direct and indirect methods Statement of cash flows–direct and indirect methods Statement of cash flows–indirect and direct methods Preparation of operating activities section— indirect method Statement of cash flows—direct method Accounting cycle, financial statements, cash account, and statement of cash flows Conversion of net income to operating cash flow—indirect method Work sheet analysis of selected transactions

E22.2 E22.3 E22.4 E22.5 E22.6 E22.7 E22.8 E22.9 E22.10 E22.11 E22.12 E22.13 E22.14 E22.15 E22.16 E22.17 E22.18 E22.19 E22.20 E22.21 *E22.22

Level of Time Difficulty (minutes) Moderate

40-45

Moderate

25-35

Moderate

15-20

Moderate

15-20

Moderate

20-25

Moderate

30-35

Moderate

20-30

Moderate

15-20

Moderate

20-25

Simple

10-15

Simple Simple

10-15 20-30

Simple

15-20

Moderate

30-40

Moderate

30-40

Moderate

20-30

Moderate

35-40

Simple

15-20

Moderate Moderate

30-40 40-50

Moderate

20-30

Moderate

10-15

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ASSIGNMENT CHARACTERISTICS TABLE (CONTINUED) Item

Description

*E22.23 P22.1

Work sheet preparation SCF, direct method and reconciliation and comments SCF, indirect method Both methods including cash and cash equivalents Operating activities section—direct method and SCF—indirect method, and draft overall comments SCF, direct method and reconciliation and comments Equity transactions reported on the SCF SCF, indirect method, and net cash flow from operating activities, direct method and comments Operating activities section—indirect method SCF FV-OCI investment transactions, both formats All financial statements from account activities involving investments SCF, both methods and analysis Prepare SFP from cash flow and income statements SCF, indirect method with summary on highlights concerning cash activities, and related questions

P22.2 P22.3 P22.4

P22.5 P22.6 P22.7

P22.8 P22.9 P22.10 P22.11 P22.12 P22.13

Level of Time Difficulty (minutes) Moderate Complex

45-55 50-55

Moderate Complex

40-45 45-50

Moderate

40-50

Moderate

45-60

Moderate Moderate

30-35 30-40

Moderate

20-30

Moderate

20-25

Moderate

30-35

Moderate Complex

40-45 50-55

Moderate

50-60

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 22.1 (a)

A business should have positive cash flows to finance expansion, pay dividends, and remain solvent during economic downturns. Alvarado may have a positive cash balance and a solid current ratio as at the date of the company’s most recent SFP, as well as a history of profitability; however, Alvarado’s bank manager will also want to assess the business’s ability to generate positive cash flows from operations for the period. This will confirm its ability to finance the upcoming expansion and decrease the risk involved in lending to Alvarado.

(b) The statement of cash flows provides information about the business’s sources and uses of cash during the period, and helps investors and creditors assess the business’s earnings quality. With the information on the statement of cash flows, Alvarado’s bank manager can assess the business’s ability to generate cash to pay its maturing debt, increase productive capacity, and distribute a return to its owners. The statement of cash flows also allows Alvarado’s bank manager to assess the quality of Alvarado’s reported profitability by comparing cash flow from operations to accrual basis net income. (For example, if accrual basis net income is much greater than cash flow from operations, the company’s reported net income may be judged to be of lower quality, or less reflective of economic reality). LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.2 (a)

$228,000 ($108,000 + $120,000) Under IFRS, preferred shares acquired close to their maturity date may be included in cash equivalents. Legally restricted cash balances are not included in cash equivalents. They are reported separately in current assets or noncurrent assets, depending on the date of availability of the cash or of the expected disbursement.

(b) $108,000 Under ASPE, cash equivalents exclude all equity investments. Legally restricted cash balances are not included in cash equivalents. They are reported separately in current assets or noncurrent assets, depending on the date of availability of the cash or of the expected disbursement. LO 1,10 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.3 (a) Cash in bank Petty cash Investment in Canada 60-day treasury bills Temporary bank overdraft, chequing account Cash and cash equivalents

June 30 2023 $12,100 700

June 30 2022 $9,460 525

22,000

(13,800) $21,000

(1,000) $ 8,985

Net Increase

$12,015

(b)

LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.4 (a)

IFRS

Cash flow from investing activities Proceeds from sale of land Purchase of FV-NI investment Proceeds from sale of bonds Interest received Dividends received Purchase of investments in bonds, reported at amortized cost Net cash provided by investing activities

$180,000 (15,000) 415,000 11,000 4,000 (61,000) $534,000

(b) ASPE Cash flow from investing activities Proceeds from sale of land Purchase of FV-NI investment Proceeds from sale of bonds Purchase of investments in bonds, reported at amortized cost Net cash provided by investing activities

$180,000 (15,000) 415,000 (61,000) $519,000

LO 2,10 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 22.5 Cash flow from financing activities Proceeds from issuance of common shares Proceeds from issuance of bonds payable Payment of bank loan principal Dividends paid Purchase of company’s own shares Net cash provided by financing activities

$200,000 410,000 (20,000) (170,000) (47,000) $373,000

LO 2 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.6 (a) (b) (c) (d) (e) (f) (g) (h)

D A R-F A R-I R-I, D P-F P-I

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

P-I A D R-F N D R-F

(p) (q) (r) (s) (t) (u) (v)

P-F R-I, A P-F N N A P-I

LO 2 BT: K Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 22.7 (a)

Land .......................................................... 149,000 Common Shares .................................

(b)

No effect

(c)

In the notes to the financial statements: Non-cash Investing and Financing Activities: Purchase of land through issuance of common shares

149,000

$149,000

LO 2,8 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 22.8 Financing activities: Repayment of lease liability ...................................

$(2,330)

In the notes to the financial statements: Non-cash Investing and Financing Activities: Purchase of machinery under right-of-use lease

$85,000

LO 2,5,8 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.9 (a) Cash flows from operating activities Cash received from customers ($205,000 – $17,000) $188,000 Cash paid To suppliers ($120,000 + $11,000 – $13,000) $118,000 For operating expenses ($50,000 – $21,000) 29,000 For income taxes ($15,000 – $2,000) 13,000 160,000 Net cash provided by operating activities $ 28,000

(b)

The amount of taxes paid need not be disclosed under ASPE.

LO 3,10 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 22.10 (a) Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $21,000 Increase in accounts receivable (17,000) Increase in inventory (11,000) Increase in accounts payable 13,000 Increase in taxes payable 2,000 Net cash provided by operating activities

$20,000

8,000 $28,000

(b) The amount of taxes paid need not be disclosed under ASPE. LO 3,10 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.11 Sales revenue Less: Sales returns and allowances Less: Sales discounts Add: Decrease in accounts receivable Cash received from customers

$420,000 (10,000) (1,000) 13,000 $422,000

LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 22.12 Cost of goods sold Add: Increase in inventory Purchases Deduct: Increase in accounts payable Cash paid to suppliers

$550,000 23,000 573,000 8,000 $565,000

LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.13 (a)

Current Income tax expense 2023 Deferred tax expense 2023 Changes in related SFP accounts: Income tax payable Deferred tax asset Deferred tax liability Income taxes paid

Dec. 31 2023

Dec. 31 2022

Effect on Cash $(2,500) (50)

$ 1,200 300

$ 1,400 –

(200) (300)

1,950

1,600

350 $(2,700)

Under IFRS, income taxes paid are required to be disclosed, and generally are shown as an operating activity. (b) Under ASPE, companies are encouraged to disclose income taxes paid, but income taxes paid are not required to be disclosed separately. (c)

LO 5,8,10 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.14 (a) Cash flows from operating activities Cash received from customers Cash paid for expenses ($60,000 – $1,540) Net cash provided by operating activities

$90,000 58,460 $31,540

(b) Cash flows from operating activities Net income Increase in net accounts receivable1 Net cash provided by operating activities 1 $29,000 – $1,740 = $27,260 $20,000 – $1,200 = $18,800 ($27,260 – $18,800) = $8,460

$40,000 (8,460) $31,540

LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 22.15 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense Unrealized losses on FV-NI investments Increase in accounts payable Increase in accounts receivable Decrease in deferred tax asset Increase in inventory Net cash provided by operating activities

$46,000

$17,000 3,000 9,300 (11,000) 2,000 (7,400)

12,900 $58,900

LO 3 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 22.16 Cash flows from operating activities Net loss Adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation expense Increase in accounts receivable Net cash provided by operating activities

$(56,000)

$67,000 (8,100)

58,900 $ 2,900

LO 6 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 22.17 Cash flow from investing activities Loan advanced for note receivable Interest collected on note receivable1 Net cash used by investing activities 1 ($900 - $300) = $600

$(30,000) 600 $(29,400)

LO 7 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

*BRIEF EXERCISE 22.18 (a)

(b)

(c)

(d)

Net Income (Operating)............................. Retained Earnings ...............................

207,000

Retained Earnings (Dividends) ................ Dividends Paid (Financing).................

60,000

Equipment ................................................. Purchase of Equipment (Investing)....

114,000

Sale of Equipment (Investing) .................. Accumulated Depreciation—Equipment . Equipment ............................................ Gain on Disposal of Equipment (Operating) .....................................

13,000 32,000

207,000

60,000

114,000

40,000 5,000

LO 11 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 22.1 a.

STRONG HOUSE INC. Statement of Cash Flows For the Year Ended December 31, 2023

Cash flows from operating activities Net income $42,000 Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense (a) $13,550 Gain on disposal of investment in bonds (b) (500) 13,050 Net cash provided by operating activities 55,050 Cash flows from investing activities Purchase of land (c) (5,500) Proceeds on sale of investment in bonds (d) 15,500 Net cash provided by investing activities 10,000 Cash flows from financing activities Dividends paid (e) Payments to retire bonds payable (f) Proceeds from issuance of common shares (g) Net cash used by financing activities

(19,000) (10,000) 20,000 (9,000)

Net increase in cash Cash balance, January 1, 2023 Cash balance, December 31, 2023

56,050 10,000 $66,050

Non-cash investing and financing activities Issuance of bonds for equipment

$32,000

Supplemental disclosures of cash flow information: Cash paid during the year for: Interest Income taxes

$4,150 19,500

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EXERCISE 22.1 (CONTINUED) b. Dear Mr. Brauer: Enclosed is your statement of cash flows for the year ended December 31, 2023. I would like to take this opportunity to explain the changes that occurred in your business as a result of cash activities during 2023. (Please refer to the attached statement of cash flows.) The first category shows the net cash flow that resulted from all of your operating activities. Operating activities are those activities engaged in for the routine conduct of business, involving most of the transactions used to determine net income. Therefore, the cash inflow from operations that affects this category is net income. However, this figure must be adjusted, first for depreciation (item a)—because this expense did not involve a cash outlay in 2023—and second for the $500 gain on the disposal of your bond investment (item b). The gain must be subtracted from this section because it was included in net income, but it is not the result of an operating activity—it is an investing activity. The second category, cash flows from investing activities, results from the acquisition/disposal of plant assets and investments including the purchase of another entity’s debt such as bonds or loans and notes. Your purchase of land (item c) as well as the sale of your investment in bonds (item d) represents your investment activities during 2023, the purchase being a $5,500 outflow and the sale being a $15,500 inflow. Cash flows arising from the issuance and retirement of debt and equity are properly classified as “Cash flows from financing activities.” These inflows and outflows generally include the long-term liability and equity items on the SFP. Examples of your financing activities which resulted in cash flows are the payment of dividends (item e), the retirement of your bonds payable (item f), and your issuance of common shares (item g). Solutions Manual 22.18 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

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EXERCISE 22.1 (CONTINUED) b. (continued) Note that, although $32,000 worth of bonds were issued for the purchase of equipment, the transaction has no effect on the change in cash from January 1, 2023 to December 31, 2023 and so it does not appear on the face of the statement of cash flows but in the notes to your financial statements. I hope this information helps you to better understand the enclosed statement of cash flows. If I can further assist you, please let me know. Sincerely, c. STRONG HOUSE INC. Statement of Financial Position (condensed) December 31, 2023 Assets Cash Current assets other than cash Bond investment at amortized cost Plant assets (net) Land

$66,050 34,000 25,000 (1) 75,950 (2) 44,000 (3) $245,000

Liabilities and Equity Current liabilities Long-term notes payable Bonds payable Common shares Retained earnings

$14,500 30,000 54,000 (4) 100,000 (5) 46,500 (6) $245,000

(1) $40,000 – $15,500 + $500 (2) $57,500 – $13,550 + $32,000 (3) $38,500 + $5,500 (4) $32,000 + $32,000 – $10,000 (5) $80,000 + $20,000 (6) $23,500 + $42,000 – $19,000 Solutions Manual 22.19 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

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EXERCISE 22.1 (CONTINUED) d.

The statement of cash flows used to be called the statement of changes in financial position because it used to report the sources of increases and decreases in working capital. It also included all transactions affecting the entity’s assets and capital structure, regardless of whether or not the transactions involved cash flows. The former statement did not focus on cash, but on working capital. The improvements that were achieved in the changes to the current statement of cash flow have proven useful to users and involve communicating more relevant information in the assessment of performance. Relevance has been enhanced by providing information to assess the liquidity and solvency as well as the company’s earnings quality. In addition, the statement helps users predict future cash flows and assess management’s ability to generate cash from operating activities, instead of using net income as the main measure of performance. The statement of cash flows is less susceptible to earnings management than the statement of comprehensive income, which has more subjective accruals and deferrals.

LO 1,6,8,9 BT: AP Difficulty: M Time: 45 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

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EXERCISE 22.2 a.

1. Operating activities: Cash received from customers Sales revenue Less: Increase in accounts receivable Cash received from customers

$295,000 (10,000) $285,000

2. The approach is to prepare a T-account for property, plant, and equipment. Property, Plant and Equipment 12/31/22 147,000 Equipment from exchange of B/P 20,000 Paid for purchase of PP&E ? 45,000 Equipment sold 12/31/23 177,000

Payments= $177,000 + $45,000 – $147,000 – $20,000 = $55,000 The purchase of property, plant, and equipment is an investing activity. Note that the acquisition of property, plant, and equipment in exchange for bonds payable would be disclosed as a non-cash investing and financing activity and the details of this exchange would be provided in a note to the financial statements.

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EXERCISE 22.2 (CONTINUED) a. (continued) 3. The approach is to set up a T-account for accumulated depreciation. Accumulated Depreciation 67,000

Equipment sold

12/31/22

33,000

Depreciation expense

78,000

12/31/23

Accumulated depreciation on equipment sold = $67,000 + $33,000 – $78,000 = $22,000 The entry to reflect the sale of equipment is: Cash (proceeds from sale of equipment) ($45,000 + $14,500 – $22,000) 37,500 Accumulated Depreciation 22,000 Property, Plant, and Equipment Gain on Disposal of Equipment

(force) (above) 45,000 (given) 14,500 (given)

The proceeds from the sale of equipment of $37,500 are reported as investing activities inflow. 4. The cash dividends paid can be determined by analyzing T-accounts for retained earnings and dividends payable.

Dividends declared

Retained Earnings 91,000 ? 31,000 104,000

12/31/22 Net income 12/31/23

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.2 (CONTINUED) a. (continued) 4. (continued) Dividends declared = $91,000 + $31,000 – $104,000 = $18,000

Cash dividends paid

Dividends Payable 5,000 18,000 ? 8,000

12/31/22 Dividends declared 12/31/23

Cash dividends paid = $5,000 + $18,000 – $8,000 = $15,000 Because of the choice made by Pavicevic Ltd., the cash paid for dividends will appear in the operating activities as a cash outflow of $15,000. 5. The amount of the redemption of bonds payable is determined by setting up a T-account.

Redemption of B/P

Bonds Payable 146,000 20,000 ? 149,000

12/31/22 Issuance of B/P for PP&E 12/31/23

The problem states that the bonds were issued at par and so the redemption of bonds payable is the only change not accounted for.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.2 (CONTINUED) a. (continued) 5. (continued) Redemption of bonds payable = $146,000 + $20,000 – $149,000 = $17,000 Financing activities include all cash flows involving nonoperating liabilities and shareholders’ equity items. Therefore, redemption of bonds payable is considered a financing activity outflow. 6. The approach is to set up a T-account for FV-NI Investments. 12/31/21

Investments purch. 12/31/23

FV-NI Investments 49,000 17,000 3,000 ? 41,000

Investments sold Unrealized loss

Proceeds on sale of FV-NI investments sold = $17,000 + $5,000 = $22,000 The entry to reflect the sale of investments is: Cash (proceeds—sale of investments) FV-NI Investments Investment Income or Loss

22,000

(above) 17,000 (given) 5,000 (given)

The proceeds from the sale of FV-NI investments of $22,000 are reported as operating activities inflow.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.2 (CONTINUED) a. (continued) 7. To solve for the amount of the purchase of FV-NI investments, use the “T” account for the FV-NI investments above. ($41,000 + $17,000 + $3,000 – $49,000 = $12,000) The purchase of FV-NI investments of $12,000 is reported as operating activities outflow.

Had Pavicevic Ltd. been following ASPE, there would be no choice on how to classify interest and dividends paid in the statement of cash flows. The dividends paid (item 4) of $15,000 would be reported as a financing activity. Under ASPE, financing activities include all cash flows involving non-operating liabilities and shareholders’ equity items.

LO 2,10 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.3 a. 2023 May

1 Cash ....................................................... 22,500 Accumulated Depreciation-Equipment 31,0001 Gain on Disposal of Equipment ....... 1,500 Equipment ......................................... 52,000 1 $52,000 – $21,000

June 15 Accumulated Depreciation-Equipment Loss on Disposal of Equipment ........... Equipment .........................................

5,500 500

Sept. 1 Equipment.............................................. Cash ...................................................

7,700

6,000

7,700

Dec. 30 Notes Receivable................................... 75,000 Gain on Disposal of Land ................. Land ...................................................

30,000 45,000

31 Depreciation Expense ........................... 16,600 Accumulated Depreciation-Equipment

16,600

b. Indirect method: Operating activities: Depreciation expense $16,600 Loss on disposal of equipment 500 Gain on disposal of equipment (1,500) Gain on disposal of land (30,000) Investing activities: Sale of equipment Purchase of equipment

22,500 (7,700)

Note X:Significant non-cash investing and financing activities: A mortgage note receivable of $75,000 was obtained from the sale of land.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.3 (CONTINUED) c.

Direct method: Operating activities: None of the operating activity items in part (b) above would be shown separately on the statement of cash flows using the direct approach. Investing activities: Sale of equipment Purchase of equipment

22,500 (7,700)

(Note: investing activities are unchanged from (b) above) Note X:Significant non-cash investing and financing activities: A mortgage note receivable of $75,000 was obtained from the sale of land. d.

At first glance it might appear as if the total operating activities using the two formats would differ. In fact, they would not. For the indirect method, the four adjustments remove the effect of the items from net income (the starting point of the indirect method). These four items are listed to adjust accrual net income to cash from operating activities. Under the direct method, the four items listed would not be relevant.

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EXERCISE 22.4 a.

Reconciliation of transactions to investment account: Balance Jan. 1, 2023 Purchase of additional shares Jan. 2, 2023 Add share of Black income for 2023 (40% x $33,000) Less dividends received from Black in 2023 (40% X $14,000) Balance Dec. 31, 2023

$422,000 65,000

Operating activities: Equity income of Black Inc. Investing activities: Cash received for dividends Cash paid for Black Inc. shares

Direct

Indirect $(13,200)

$ 5,600 (65,000)

5,600 (65,000)

Operating activities: Direct Cash received for dividends $ 5,600 Equity in income of Black Inc. in excess of dividends received (note 1) Investing activities: Cash paid for Black Inc. shares (65,000)

Indirect

13,200 (5,600) $494,600

(note 1) Investment income from Black Inc. Dividends received from Black Inc. Net

$ (7,600) (65,000) $(13,200) 5,600 $ (7,600)

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EXERCISE 22.5 Tanaka Limited Statement of Cash Flows (partial) For the Year Ended December 31, 2023 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $16,800 Loss on disposal of equipment 5,800 Dividends paid Net cash provided by operating activities Cash flows from investing activities Purchase of equipment 1 Proceeds on sale of equipment 2 Net cash used by investing activities 1 2

$ 40,000

22,600 (15,000) 47,600

(110,000) 25,000 (85,000)

($62,000 + $48,000) = $110,000 [($56,000 – $25,200) – $5,800] = $25,000

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EXERCISE 22.6 a. 1. Using tables: - Regular annuity Present value of the payments in the future $25,000 X 3.16986

$79,246.50

2. Using a financial calculator: PV I N PMT FV Type

? 10% 4 ($25,000) $0 0

Yields $79,246.64

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $79,246.63616 Rounded $79,246.64

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.6 (CONTINUED) a. (continued) Present value of remaining four payments $79,246.50 Add initial payment 25,000.00 Total present value $104,246.50 Alternately, use annuity due calculations: 1. Using tables: - Annuity due Present value of the payments $25,000 X 4.16987

$104,246.75

2. Using a financial calculator: PV ? Yields $104,246.64 I 10% N 5 PMT ($25,000) FV $0 Type 1 3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $104,246.6362 Rounded $104,246.64 Solutions Manual 22.31 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

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EXERCISE 22.6 (CONTINUED) b. 1.

Land (new) ..................................................... Cash ......................................................... Land (old) ................................................. Gain on Disposal of Land ....................... To record exchange of land

91,000

Land ............................................................... Cash1 ........................................................ 1 ($58,000 – $91,000 + $60,000) To record purchase of land

27,000

Accumulated Depreciation—Equipment ..... Cash ............................................................... Equipment ................................................ Gain on Disposal of Equipment.............. To record disposal of equipment

10,000 1,000

Accumulated Depreciation—Equipment ..... Loss on Disposal of Equipment................... Equipment ................................................ To record equipment discarded

2,300 700

Equipment ..................................................... Cash2 ........................................................ 2 ($67,500 – $10,000 – $3,000 + X = $62,000) To record purchase of equipment

7,500

Depreciation Expense3 ................................. Accumulated Depreciation—Equipment 3 ($24,000 – $10,000 – $2,300 + X = $15,200) To record depreciation

3,500

3,000 60,000 28,000

27,000

10,000 1,000

3,000

7,500

3,500

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.6 (CONTINUED) b. (continued) 3.

Right-of-Use Asset...................................... 104,247 Lease Liability........................................ 104,247 To record right-of-use asset and lease liability Lease Liability ............................................. Cash ....................................................... To record lease payment

25,000

Interest Expense4 ........................................ Interest Payable ..................................... 4 [($104,247 – $25,000) X 10% X 6/12] To accrue interest expense

3,962

Depreciation Expense5 ............................. Accumulated Depreciation— Right-of-Use Asset ............................ 5 ($104,247 X 6/12 divided by 5 years) To record depreciation

10,425

25,000

3,962

10,425

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.6 (CONTINUED) c. 1.

d. 1. 2.

3. e.

Investing activities: Payment on exchange of land Purchase of land

(3,000) (27,000)

Investing activities: Proceeds from sale of equipment Purchase of equipment

1,000 (7,500)

Financing activities: Payment under right-of-use lease Increase in interest payable (lease liability)

(25,000) 3,962

Gain on disposal of land Gain on disposal of equipment Loss on disposal of equipment Depreciation expense on equipment Depreciation expense on right-of-use asset

(28,000) (1,000) 700 3,500 10,425

Separate disclosure is required of changes in liabilities arising from financing activities, including changes arising from cash flows and non-cash changes. This disclosure is meant to assist users in their evaluation of such changes. Companies are encouraged, but not required, to provide a reconciliation of items such as long-term borrowings and lease liabilities: disclosing opening balances, cash-flow related changes, non-cash changes, and a reconciliation of the closing balances of these financing-related items.

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EXERCISE 22.7 1.

Equipment cost Accumulated depreciation ([$40,000  10] X 6) Carrying amount at date of sale Sale proceeds Loss on disposal

$40,000) 24,000) 16,000) (5,300) $10,700)

The loss on disposal of plant assets is reported in the operating activities section of the statement of cash flows. It is added to net income to arrive at net cash provided by operating activities. The sale proceeds of $5,300 are reported in the investing section of the statement of cash flows as follows: Proceeds from sale of equipment 2.

Shown in the financing activities section of a statement of cash flows as follows: Sale of common shares

$5,300

$410,000

The write off of the uncollectible accounts receivable of $27,000 is not reported on the statement of cash flows. The write off reduces the Allowance for Expected Credit Losses balance and the Accounts Receivable balance. It does not affect cash flows.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.7 (CONTINUED) 4.

The net loss of $10,000 should be reported in the operating activities section of the statement of cash flows. Depreciation of $22,000 is added to income in the operating section of the statement of cash flows. The gain on disposal of land is deducted from income (loss) in the operating activities section of the statement of cash flows. The proceeds from the sale of land of $39,000 are reported in the investing activities section of the statement of cash flows. These four items might be reported as follows: Cash flows from operating activities Net loss Adjustments to reconcile net income to net cash provided by operations1: Depreciation expense Gain on disposal of land Loss on disposal of equipment

$(10,000)

22,000 (9,000) 10,700

Either net cash used or provided depending upon other adjustments. Given only the adjustments, the “net cash provided” would be used. Cash flows from investing activities Proceeds from sale of land

$39,000

The purchase of the Canadian Treasury bill is not reported in the statement of cash flows. This instrument is considered a cash equivalent and is therefore included in cash and cash equivalents.

The impairment loss on goodwill does not involve cash and would have caused a reduction of net income. It is reported in the operating activities section of the statement of cash flows. It is added to net income in arriving at net cash provided by operating activities.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.7 (CONTINUED) 7.

The patent amortization of $18,000 is reported in the operating activities section of the statement of cash flows. It is added to net income in arriving at net cash provided by operating activities.

The exchange of common shares for an investment in TransCo Corp. is reported as a “non-cash investing and financing activity” in the notes to the financial statements. It is shown as follows: Non-cash investing and financing activities Purchase of investment by issuance of common shares

$900,000

The accrual of an unrealized loss does not involve cash and would have caused a reduction of net income. It is reported in the operating activities section of the statement of cash flows. It is added to net income in arriving at net cash provided by operating activities.

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EXERCISE 22.8 a.

Net income: Retained earnings, end of year Add: Cash dividends – preferred Stock dividend Retained earnings available for dividends Less: beginning balance Retained Earnings Net income (derived)

$300,000 6,250 14,000 320,250 240,000 $ 80,250

Cash flows from financing activities: Preferred dividends paid $(6,250) Payments on repurchase of common shares (28,500) ($160,000 + $14,000 – $142,000 – $3,500 Contributed Surplus) Stock dividends do not involve cash.

Because Mandrich Inc. is using IFRS, it could choose to classify the $6,250 preferred dividends paid as operating cash flows.

Net income: Retained earnings, end of year Add: Stock dividend Retained earnings available for dividends Less: beginning balance Retained Earnings Net income (derived)

$300,000 14,000 314,000 240,000 $ 74,000

The preferred dividends paid on term preferred shares are treated as interest expense and cause net income to be lower by $6,250. LO 2,8 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.9 a. 1. Using tables: - Regular annuity Present value of the payments in the future $545,000 X 4.62288

$2,519,469.60

2. Using a financial calculator: PV I N PMT FV Type

? 8% 6 ($545,000) $0 0

Yields $2,519,469.42

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $2,519,469.417 Rounded to $2,519,469.42 Present value of remaining six payments Add initial payment Total present value

$2,519,469.42 545,000.00 $3,064,469.42

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.9 (CONTINUED) a. (continued) Alternately, use annuity due calculations: 1. Using tables: - Annuity due Present value of the payments $545,000 X 5.62288 2. Using a financial calculator: PV ? I 8% N 7 PMT ($545,000) FV $0 Type 1

$3,064,469.60

Yields $3,064,469.42

3. Using Excel: =PV(rate,nper,pmt,fv,type)

Result: $3,064,469.417 Rounded $3,064,469.42

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.9 (CONTINUED) b. July 1, 2022 Right-of-Use Asset .............................. Lease Liability............................. To record right-of-use asset

3,064,470

Lease Liability...................................... Cash ............................................ To record lease payment

545,000

3,064,470

545,000

December 31, 2022 Interest Expense ................................ 100,779 Interest Payable .......................... 100,779 1 ($3,064,470 – $545,000) x 8% = $2,519,470 x 8% = $201,558 ($201,558 X 6/12 = $100,779) To accrue interest expense 1

Depreciation Expense2 ........................ 218,891 Accumulated Depreciation— Right-of-Use Asset ............ 2 ($3,064,470 ÷ 7 years X 6/12 = $218,891) To record depreciation expense July 1, 2023 Interest Expense .................................. Interest Payable ................................... Lease Liability...................................... Cash ............................................ To record lease payment

218,891

100,779 100,779 343,442 545,000

December 31, 2023 Interest Expense ................................ 87,041 Interest Payable .......................... 87,041 3 ($2,519,470 – $343,442) x 8% = $2,176,028 x 8% = $174,082 ($174,082 X 6/12 = $87,041) To accrue interest expense 3

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EXERCISE 22.9 (CONTINUED) b. (continued) Depreciation Expense4 ........................ Accumulated Depreciation— Right-of-Use Asset ............ 4 ($3,064,470 ÷ 7 years = $437,781) To record depreciation expense

437,781 437,781

c. Wagner Inc. Statement of Cash Flows – Partial For the Year ended December 31, 2023 2022 Cash provided by (used in) Operating activities – Direct Method Payments of interest ........................... $(201,558) -0Cash provided by (used in) Financing activities Repayments of lease liability .............. (343,442) $(545,000) Net decrease in cash................................... $(545,000) $(545,000)

Note X: During 2022, Wagner Inc. signed finance leases to acquire a fleet of trucks for the amount of $3,064,470. d.

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EXERCISE 22.10 (1) a.

Not a cash transaction, but activity is an operating activity (2) a. Not a cash transaction, but activity is an operating activity because of the choice made by management (3) a. Operating activity (4) b. Investing activity (5) a. Operating activity (6) d. A significant non-cash investing or financing activity (7) e. Not a cash transaction or activity (8) c. Financing activity because of the choice made by management (9) a. Operating activity (10) d. A significant non-cash investing or financing activity (11) b. Investing activity (12) b. Investing activity because of the policy choice made by management (13) b. Investing activity for the disposition of the vehicles (14) a. e. Not a cash activity or transaction that is reported on the cash flow statement, but the activity itself would be an operating activity as management regards dividends paid as an operating activity. The decision to issue the dividend as a stock dividend instead of a cash dividend would be an operating-type decision.

Please note: The Instructions ask you to determine what type of activity each transaction is, not where each transaction is reported on the cash flow statement. Because the cash flow statement summarizes the cash flows associated with all the transactions and events that take place in the accounting period, it is important to be able to identify the type of activity each underlying transaction is. This dictates the type of cash flow related to each.

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EXERCISE 22.10 (CONTINUED) For instructors who prefer to answer this question from the perspective of how each transaction is reported on a cash flow statement, the following solution applies: (1) a.

Operating activity (indirect method only with offsetting adjustments to income) (2) e. None of these options (3) a. Operating activity (4) b. Investing activity (5) a. Operating activity (6) d. Non-cash investing or financing activity (7) e. None of these options (8) c. Financing activity because of the choice made by management (9) a. Operating activity (10) d. Non-cash investing or financing activity (11) b. Investing activity (12) b. Investing activity because of the policy choice made by management (13) a. b. Operating activity for the gain on disposal (indirect method only) and investing activity for the proceeds from sale (14) e. None of these options LO 2,8 BT: C Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 22.11 a. 1. 2.

(3) (4)

3. 4.

(5) (3)

5. 6.

(1) (5)

7. 8. 9. 10. 11. 12. 13.

(4) (1) (4) (5) (1) (1) (2)

14. 15. 16. 17.

(2) (1) (5) (4)

18.

(6)

19.

(6)

Investing activity. Financing activity for redemption cash paid; (1 or 2) operating add to income any loss and deduct from income any gain resulting from the redemption. Significant non-cash investing and financing activity. Investing activity for any cash proceeds received from the sale; (1 or 2) operating add to income any loss and deduct from income any gain resulting from the sale. Operating—add to net income. Significant non-cash investing activity; (1 or 2) If any gain is recorded on the exchange, deduct from income in operating activities and add back any loss. Financing activity. Operating—add to net income. Financing activity. Significant non-cash investing and financing activity. Operating—add to net income. Operating—add to net income. Operating activity because of the choice made by management. Operating—deduct from net income. Operating—add to net income. Significant non-cash investing and financing activity. Financing activity for principal paid on lease liability; financing activity for interest paid; operating add to income for the interest expense. None of these options; part of cash and cash equivalents. Operating activity already reflected in the income statement so no adjustment to income is required.

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EXERCISE 22.11 (CONTINUED) a. (continued) 20. 21. 22. 23.

24.

25.

(2) (4) (4) (4)

Operating—deduct from net income. Financing activity. Financing activity. Financing activity because of the choice made by management; operating add to income for the interest expense. (3) (2)Investing activity because of the choice made by management; operating deduct from net income for the interest earned. (6) None of these options; part of cash and cash equivalents.

b. The following answers would be different under ASPE: 17.

23.

24.

25.

(4)

Financing activity for principal paid on lease obligation; operating activity for interest paid, no adjustment to income is required when using the indirect method. (6) Operating activity if recognized in net income; if already reflected in the income statement, no adjustment to income is required when using the indirect method. (6) Operating activity already reflected in the income statement so no adjustment to income is required when using the indirect method. (3) Investing activity.

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EXERCISE 22.12 a. Malouin Corp. Partial Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Cash received from customers $797,000 (a) Cash paid To suppliers $486,000 (b) For income taxes 60,500 (c) 546,500 Net cash provided by operating activities $250,500 (a)

(b)

(c)

Computation of cash received from customers: Service revenue Add: Decrease in accounts receivable Add: ($54,000 – $35,000) Cash received from customers Computation of cash paid to suppliers: Operating expenses per income statement Deduct: Increase in accounts payable Deduct: ($44,000 – $31,000) Cash paid to suppliers

$778,000 19,000 $797,000

$499,000 (13,000) $486,000

Computation of cash paid for taxes: Income tax expense per income statement Add: Decrease in income tax payable Add: ($8,500 – $6,000) Cash paid for income taxes

$58,000 2,500 $60,500

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EXERCISE 22.12 (CONTINUED) b.

Current cash debt coverage ratio in 2023 Current cash debt coverage ratio = Net cash provided by operating activities / Average current liabilities = $250,500 / [($31,000 + $8,500) + ($44,000 + $6,000)] / 2 = 5.6 Current cash debt coverage ratio is a measure of the company’s ability to pay off its current liabilities in a specific year from its operations. An increase in the company’s current cash debt coverage ratio from 4.5 to 5.6 is an improvement and a sign of better liquidity in 2023. A creditor is interested in analyzing the company’s liquidity (short-term ability to repay maturing obligations) and current cash debt coverage ratio to help determine the level of credit risk associated with lending to the company. A creditor may interpret the increase in current cash debt coverage ratio as an indication that it is less likely that the company will experience difficulty in meeting its current liabilities as they come due, and that the credit risk associated with lending to the company in the short-term has decreased.

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EXERCISE 22.13 Allowance for Expected Credit Losses ....... Accounts Receivable ............................. To record write-off

5,000

Accounts Receivable .................................... Allowance for Expected Credit Losses To reinstate account previously written off

3,500

Cash ............................................................... Accounts Receivable ............................. Collection on account

3,500

Loss on Impairment ...................................... Allowance for Expected Credit Losses To record accrual of loss on impairment

4,400

5,000

3,500

4,400

Cash provided by (used in) operations — Direct Method Cash received from customers................

$3,500

Cash provided by (used in) operations — Indirect Method Loss on impairment would already be included in net income as an expense of $4,400 .................. $(4,400) Changes in non-cash working capital: Decrease in accounts receivable net of net write-offs (1)....................... Net increase in cash...................................... (1) Accounts receivable: Accounts receivable written-off............ Reinstated A/R (recovery of loss on impairment) .................................. Collection of accounts recovered ........ Allowance for expected credit losses: Accounts receivable written-off............ Recovery of loss on impairment........... Accrual of loss on impairment.............. Decrease in accounts receivable, net

7,900 $3,500 $(5,000) 3,500 (3,500)

$5,000 (3,500) (4,400)

$(5,000)

(2,900) $(7,900)

LO 3 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 22.49 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

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EXERCISE 22.14 a. Tuit Inc. Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Cash received from customers (1) $331,150 Cash paid to suppliers for goods (2) $139,000 Cash paid for other operating expenses (3) 28,000 Cash paid to and on behalf of employees (4) 65,000 Cash paid for interest 11,400 Cash paid for taxes (5) 6,125 249,525 Net cash provided by operating activities 81,625a Cash flows from investing activities Proceeds on sale of equipment (6) Purchase of equipment (7) Net cash used by investing activities

8,000 (44,000)

Cash flows from financing activities Principal payments on short-term loans Principal payments on long-term loans Dividends paid Net cash used by financing activities

(2,000) (9,000) (6,000)

Net increase in cash Cash, January 1, 2023 Cash, December 31, 2023

(36,000)

(17,000) 28,625 25,000 $ 53,625

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.14 (CONTINUED) a. (continued) Computations: (1) Cash received from customers Sales revenue Less: Increase in accounts receivable Cash received from customers (2)

(3)

(4)

(5)

$338,150 (7,000) $331,150

Cash paid to suppliers for goods Cost of goods sold Less: Decrease in inventory Purchases Less: Increase in accounts payable Cash paid to suppliers for goods

$165,000 (20,000) 145,000 (6,000) $139,000

Cash paid for to and other onoperating behalf of expenses employees Operating expenses Less: Salaries and wages expense Depreciation expense (8) Add: Increase in prepaid rent Cash paid for other operating expenses

$120,000 (69,000) (24,000) 1,000 $28,000

Cash paid to and on behalf of employees Salaries and wages expense Increase in salaries and wages payable Cash paid to and on behalf of employees

$69,000 (4,000) $65,000

Income taxes paid Income tax expense Decrease in income tax payable Income taxes paid

$4,125 2,000 $6,125

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.14 (CONTINUED) a. (continued) (6)

Calculation of proceeds from sale of equipment: Cost of equipment sold $ 20,000 Accumulated depreciation of equipment sold (70%) (14,000) Carrying amount of equipment sold 6,000 Gain on disposal of equipment 2,000 Proceeds on sale of equipment $ 8,000

(7)

Calculation of cost of new equipment purchased: Equipment Jan. 1, 2023 Equipment Dec. 31, 2023 Net increase in equipment Cost of equipment sold Cost of equipment purchased during year

$ 130,000 154,000 24,000 20,000 $ 44,000

Calculation of depreciation expense: Accumulated depreciation Jan. 1, 2023 Accumulated depreciation of equipment sold Accumulated depreciation Dec. 31, 2023 Depreciation expense for the year

$ (25,000) 14,000 35,000 $ 24,000

(8)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.14 (CONTINUED) b. Tuit Inc. Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $24,000 Impairment loss, goodwill 30,000 Gain on disposal of equipment (2,000) Increase in accounts receivable (7,000) Decrease in inventory 20,000 Increase in prepaid rent (1,000) Increase in accounts payable 6,000 Increase in salaries and wages payable 4,000 Decrease in income tax payable (2,000) Total adjustments Net cash provided by operating activities Cash flows from investing activities Proceeds on sale of equipment Purchase of equipment Net cash used by investing activities

8,000 (44,000)

Cash flows from financing activities Principal payments on short-term loans Principal payments on long-term loans Dividends paid Net cash used by financing activities

(2,000) (9,000) (6,000)

Net increase in cash Cash, January 1, 2023 Cash, December 31, 2023

$9,625

72,000 81,625

(36,000)

(17,000) 28,625 25,000 $53,625

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.14 (CONTINUED) b. (continued) Supplemental disclosures of cash flow information: Cash paid during the year for: Interest Income taxes c.

$11,400 $6,125

Because Tuit Inc. follows ASPE, there is no choice on how to classify interest and dividend payments in the statement of cash flows. Companies that adopt IFRS do have some choice. Under IFRS, interest paid and received and dividends paid and received can be recognized as operating cash flows. Alternatively, interest paid can be recognized as a financing outflow while interest and dividends received can be recognized as investing inflows. A choice is permitted for dividends paid: a financing outflow as a return to equity holders, or an operating outflow as a measure of the ability of operations to cover returns to shareholders.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.14 (CONTINUED) d.

Tuit Inc.’s operating activities generate significant positive cash flow, which supports the company’s investing and financing activities. The company is using the significant cash generated from its operations to expand by purchasing equipment and to repay creditors and pay dividends to shareholders, which is a sign of a mature, successful company. The company is expanding by purchasing equipment, likely due to high forecasted demand for the company’s product(s). The only item of concern is the $20,000 decrease in inventory, a substantial amount as revealed in the statement prepared using the indirect format. The company repaid creditors and paid dividends to shareholders, and still generated a significant increase in net cash and cash equivalents in 2023. An investor who is interested in investing in mature, successful companies may view Tuit Inc. favourably, and decide to invest in the company.

LO 5,6,8,9 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.15 a.

Both the direct method and the indirect method for reporting cash flows from operating activities are acceptable in preparing a statement of cash flows. However, accounting standards encourage the use of the direct method. Under the direct method, the statement of cash flows reports the major classes of cash received and cash disbursed, and discloses more information; this may be the statement’s principal advantage. Under the indirect method, net income on the accrual basis is adjusted to the cash basis by adding or deducting non-cash items included in net income, thereby providing a useful link between the statement of cash flows and the income statement and SFP.

The Statement of Cash Flows for Guas Inc. for the year ended May 31, 2023, using the direct method, is presented below.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.15 (CONTINUED) b. (continued) Guas Inc. Statement of Cash Flows For the Year Ended May 31, 2023 Cash flows from operating activities Cash received from customers $1,326,600 Cash paid To suppliers for goods for resale $795,700 To suppliers for other operating expenses 26,600 To and on behalf of employees 218,800 For interest 64,600 For income taxes 65,400 1,171,100 Net cash provided by operating activities 155,500 Cash flows from investing activities Purchase of plant assets Cash flows from financing activities Proceeds from issuance of common shares Dividends paid Principal payment of mortgage Net cash used by financing activities Net increase in cash Cash, June 1, 2022 Cash, May 31, 2023

(44,000)

4,750 (78,000) (25,000) (98,250) 13,250 20,000 $33,250

Note 1: Schedule of non-cash investing and financing activities: Issuance of common shares for plant assets

$51,000

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.15 (CONTINUED) b. (continued) Supporting calculations: Collections from customers Sales revenue Less: Increase in accounts receivable Cash collected from customers

$1,345,800 19,200 $1,326,600

Cash paid to suppliers for goods for resale Cost of goods sold Less: Decrease in inventory Increase in accounts payable Cash paid for goods for resale

$814,000 10,300 8,000 $795,700

Cash paid for other operating expenses Other expenses Add: Increase in prepaid expenses Cash paid for other operating expenses

$24,800 1,800 $ 26,600

Cash paid to and on behalf of employees Salaries and wages expense Add: Decrease in salaries and wages payable Cash paid to and on behalf of employees Cash paid for interest Interest expense Less: Increase in interest payable Cash paid for interest

$207,800 11,000 $218,800

$66,700 2,100 $64,600

The calculation of the cash flow from operating activities for Guas Inc. for the year ended May 31, 2023, using the indirect method, is presented below.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.15 (CONTINUED) c. (continued) Guas Inc. Statement of Cash Flows (partial) For the Year Ended May 31, 2023 Cash flows from operating activities Net earnings $141,100 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $26,000 Decrease in inventory 10,300 Increase in accounts payable 8,000 Increase in interest payable 2,100 Increase in accounts receivable (19,200) Increase in prepaid expenses (1,800) Decrease in salaries and wages payable (11,000) 14,400 Net cash provided by operating activities $155,500 d.

Under IFRS, a choice is permitted for dividends paid: a financing flow as a return to equity holders, or an operating flow as a measure of the ability of operations to cover returns to shareholders. However management views these specific flows, once the choice is made, it is applied consistently from period to period.

The dividend payout ratio for the year ended May 31, 2023 can be easily calculated using amounts reported on the statement of cash flows. The dividend payout ratio is 55% [$78,000 (dividends paid) divided by $141,100, (net earnings)]. From the perspective of a shareholder, this would be a positive ratio, as shareholders are recipients of this return on investment. The company’s operations generated the cash required to pay this dividend, which is a positive sign that the company may be able to sustain payment of dividends in the future.

LO 3,5,8,9 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 22.16 a. NORTH ROAD INC. Statement of Cash Flows Year Ended December 31, 2023 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense $ 58,700 Gain on disposal of equipment (3,750) Gain on disposal of investment in land (5,000) Increase in accounts receivable (53,800) Increase in inventory (19,250) Increase in accounts payable 4,420 Decrease in accrued liabilities (6,730) Net cash provided by operating activities

(25,410) 66,070

Cash flows from investing activities Proceeds from sale of land investments (1) Proceeds from sale of equipment Purchase of equipment (2) Net cash used by investing activities

(52,950)

$91,480

27,500 10,550 (91,000)

Cash flows from financing activities Issuance of notes payable 70,000 Payment of cash dividends (3) (37,670) Net cash flows provided by financing activities

32,330

Net increase in cash Cash, January 1 Cash, December 31

45,450 47,250 $92,700

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.16 (CONTINUED) a. (continued) Note X:Significant non-cash investing and financing activities: Equipment with a cost of $50,000 was exchanged for common shares. Supplemental disclosures of cash flow information: Cash paid during the year for: Interest Income taxes

$ 2,940 39,000

(1) Investments in land Jan. 1, 2023 Investments in land Dec. 31, 2023 Decrease in investments in land Gain on disposal of investment Proceeds from sale of investment

$107,000 84,500 22,500 5,000 $27,500

(2) PP&E Dec. 31, 2023 PP&E Jan. 1, 2023 Increase in PP&E Purchase through issuance of shares Cost of equipment sold Purchase of PPE for cash

$290,000 205,000 85,000 (50,000) 56,000 $ 91,000

(3) Retained earnings Dec. 31, 2023 Add: net income Retained earnings Jan. 1, 2023 Dividends paid

$(175,600) 91,480 121,790 $ 37,670

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.16 (CONTINUED) b. NORTH ROAD INC. Cash Flow Statement Year Ended December 31, 2023 Operating Activities Cash collections from customers Cash payments to suppliers Cash payments for operating expenses Cash payments for interest Cash payments for income taxes Net cash provided by operating activities

(1) (2) (3)

$243,700 (114,290) (21,400) (2,940) (39,000) $66,070

Calculations: (1)

(2)

(3)

Cash receipts from customers Sales revenue ....................................................... Less: Increase in accounts receivable ............... Cash payments to suppliers Cost of goods sold ................................................ Add: Increase in inventory .................................. Less: Increase in accounts payable .................... Cash payments for operating expenses Operating expenses .............................................. Add: Decrease in accrued liabilities ...................

$297,500 (53,800) $243,700 $99,460 19,250 (4,420) $114,290 $14,670 6,730 $21,400

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.16 (CONTINUED) c.

If North Road Inc. followed ASPE, it would not have the choice in the classification of the payment of dividends on the statement of cash flows. Dividends paid would have to be classified as financing outflows. Because North Road Inc. followed IFRS, a choice was permitted for dividends paid: a financing flow as a return to equity holders, or an operating flow as a measure of the ability of operations to cover returns to shareholders. However management views these specific flows, once the choice is made, it is applied consistently from period to period.

LO 3,6,8 BT: AP Difficulty: M Time: 30 min. AACSB None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.17 a. Tobita Limited Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ($1,200 – $1,170) Gain on disposal of investments (FV-NI) Increase in accounts receivable Decrease in inventory Proceeds from sale of FV-NI investments 1 Increase in accounts payable Decrease in accrued liabilities Net cash provided by operating activities

$945

$ 30 (80) (450) 300 200 300 (50)

Cash flows from investing activities Purchase of plant assets 2 Net cash used by investing activities

(130)

Cash flows from financing activities Issuance of common shares 3 Reduction in mortgage payable Dividends paid4 Net cash used by financing activities

130 (150) (260)

Net increase in cash Cash, January 1, 2023 Cash, December 31, 2023 1 ($1,420 – $1,300) + $80 gain 3 ($1,900 – $1,700) – $70

250 1,195

(130)

(280) 785 1,150 $1,935

($1,900 – $1,700) – $70 ($1,900 – $2,585) + $945 income

2 4

Non-cash investing and financing activities Issuance of common shares for plant assets Cash paid for interest during the year Cash paid for income taxes Solutions Manual 22.64 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

$70 20 405

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.17 (CONTINUED) b. Tobita Limited Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Cash received from customers1 $6,450 Add proceeds from sale of FV-NI investments 200 2 Less: Cash paid to suppliers for goods (4,100) 3 Cash paid for operating expenses (930) Cash paid for interest (20) Cash paid for income taxes (405) (5,255) Net cash provided by operating activities

1,195

Cash flows from investing activities Purchase of plant assets Net cash used by investing activities

(130)

Cash flows from financing activities Issuance of common shares Reduction in mortgage payable Dividends paid Net cash used by financing activities

130 (150) (260)

(130)

Net increase in cash Cash, January 1, 2023 Cash, December 31, 2023 Non-cash investing and financing activities Issuance of common shares for plant assets $1,300 + $6,900 – $1,750 = $6,450 $4,700 + $1,600 – $1,900 + $900 – $1,200 = $4,100 3 ($910 – $30) – $200 + $250 = $930 1

(280) 785 1,150 $1,935

$70

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.17 (CONTINUED) c.

Companies that adopt IFRS do have some choice. Under IFRS, interest paid and received and dividends paid and received can be recognized as operating flows. Alternatively, interest paid can be recognized as a financing outflow while interest and dividends received can be recognized as investing inflows. A choice is permitted for dividends paid: a financing outflow as a return to equity holders, or an operating outflow as a measure of the ability of operations to cover returns to shareholders.

There is an alarming trend that is flagged by the indirect format of the statement of cash flows illustrated above. Tobita decreased its inventory 16% while at the same time increasing its accounts payable 33%. Attention should be paid to the possibility of inventory stockouts or poor relationships developing with suppliers for nonpayment of accounts within payment terms. The direct format of the statement of cash flows does not highlight this change, although the trends could be noticed from a comparison of balances taken from the SFP.

LO 5,6,8,9 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.18 Malouin Corp. Partial Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Net income $137,000 Adjustment to reconcile net income to net cash provided by operating activities: Depreciation expense $66,000 Loss on disposal of equipment 14,000 Unrealized loss—FV-NI investments 4,000 Decrease in accounts receivable 19,000 Increase in accounts payable 13,000 Decrease in income tax payable (2,500) 113,500 Net cash provided by operating activities $250,500 LO 3 BT: AP Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.19 a. Huang Corp. Statement of Cash Flows (partial) For the Year Ended December 31, 2023 Cash flows from operating activities Cash received from customers (a) Less: Cash paid to suppliers for goods (b) Cash paid for operating expenses (c) Cash paid for interest (d) Cash paid for income taxes (e) Net cash provided by operating activities (a)

$549,600 $227,500 271,500 15,100 27,600

541,700 $ 7,900

Sales revenue Deduct: Increase in accounts receivable, net of write offs Cash collected from customers

$557,400

(b)

Cost of goods sold Deduct: Decrease in inventory Purchases Deduct: Increase in accounts payable Cash paid to suppliers for goods

$253,000 (16,000) 237,000 (9,500) $227,500

(c)

Selling expenses Administrative expenses Less depreciation expense Less loss on impairment Cash paid to suppliers of services

$138,000 140,000 (1,500) (5,000) $271,500

(d)

Interest expense Deduct: Decrease in unamortized bond discount netted with the liability Cash paid for interest

$15,600

Income tax expense Add: Decrease in income taxes payable Deduct: Increase in deferred income tax liability Cash paid for income taxes

$20,200 8,100 (700) $27,600

(e)

(7,800) $549,600

(500) $15,100

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.19 (CONTINUED) b.

$549,600 -$227,500

Cash received from customers (a)

Less: Cash paid to suppliers for goods (b)

Less: Cash paid for operating expenses (c)

Less: Cash paid for interest (d)

Less: Cash paid for income taxes (e)

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.19 (CONTINUED) b. (Continued) $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 -$100,000 -$200,000 -$300,000

-$400,000

Series1

Cash received from customers (a)

Less: Cash paid to suppliers for goods (b)

Less: Cash paid for operating expenses (c)

Less: Cash paid for interest (d)

Less: Cash paid for income taxes (e)

$549,600

-$227,500

-271,500

-15,100

-27,600

LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.20 a. Sept.

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

31,000

Equipment ........................................ Cash...........................................

17,280

Prepaid Rent ($680 X 3) ................... Cash...........................................

2,040

31,000

17,280

2,040

No entry

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

1,142

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

1,690

10 Office Expense ................................. Cash...........................................

430

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

5,120

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

600

19 Retained Earnings ........................... Cash (5,000 X $1.00) .................

5,000

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

980

21 Salaries and Wages Expense .......... Cash...........................................

600

1,142

1,690

430

5,120

600

5,000

980

600

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.20 (CONTINUED) a. (continued) Sept. 28

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

2,110

Telephone Expense ......................... Office Expense ................................. Cash...........................................

135 85

Sept. 1 Sept. 9 Sept. 20

Bal. Sept. 30 b. Sept. 30

Cash 31,000 Sept. 2 1,690 Sept. 4 980 Sept. 10 Sept. 18 Sept. 19 Sept. 21 Sept. 29 7,500

2,110

220

17,280 2,040 430 600 5,000 600 220

Depreciation Expense1 .................... Accumulated DepreciationEquipment ............................. 1 ($17,280 – $1,500) ÷ 5 X 1/12 To record deprecation expense

263

Salaries and Wages Expense .......... Salaries and Wages Payable .... To accrue salaries and wages expense

300

Supplies Expense2 ........................... Supplies..................................... 2 ($1,142 – $825) To adjust for supplies used

317

Rent Expense ................................... Prepaid Rent ............................. To adjust prepaid rent

680

263

300

317

680

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.20 (CONTINUED) b. (continued) Sept. 30

Utilities Expense .............................. Accounts Payable ..................... To accrue utilities expense

195 195

c. A.S. Design Limited Adjusted Trial Balance September 30, 2023 Cash Accounts Receivable ($5,120 – $980 + $2,110) Supplies Prepaid Rent Equipment Accumulated Depreciation-Equipment Accounts Payable ($1,142 – $600 + $195) Salaries and Wages Payable Common Shares Retained Earnings3 Service Revenue ($1,690 + $5,120 + $2,110) Rent Expense Supplies Expense Salaries and Wages Expense ($600 + $300) Telephone Expense Utilities Expenses Office Expense ($430 + $85) Depreciation Expense

Debit $7,500 6,250 825 1,360 17,280

Credit

$ 263 737 300 31,000 5,000 8,920 680 317 900 135 195 515 263 $41,220

$41,220

As this is the first year of operations, there is no opening balance for retained earnings, and until the year is closed, the only entry is for the distribution of dividends.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.20 (CONTINUED) d. A. S. Design Limited Income Statement For the Month Ended September 30, 2023 Service revenue Expenses: Rent expense $680 Supplies expense 317 Salaries and wages expense 900 Depreciation expense 263 Telephone expense 135 Utilities expenses 195 Office expense 515 Total expenses Net income

$8,920

3,005 $5,915

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.20 (CONTINUED) d. (continued) A. S. Design Limited Statement of Financial Position As at September 30, 2023 Assets Current assets Cash Accounts receivable Supplies Prepaid rent Current assets Property, plant, and equipment Equipment Accumulated depreciation Total assets

$ 7,500 6,250 825 1,360 15,935 17,280 263 17,017 $32,952

Liabilities Current liabilities Accounts payable Salaries and wages payable Current liabilities Shareholder’s Equity Common shares Retained earnings4 Total shareholder’s equity Total liabilities and shareholder’s equity 4

737 300 1,037

31,000 915 31,915 $32,952

$5,915 – $5,000

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EXERCISE 22.20 (CONTINUED) e. A. S. Design Limited Statement of Cash Flows For the Month Ended September 30, 2023 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Increase in supplies Increase in prepaid rent Increase in accounts payable Increase in salaries and wages payable Net cash used in operating activities

$5,915

$263 (6,250) (825) (1,360) 737 300

Cash flows from investing activities Purchase of equipment Cash flows from financing activities Issuance of common shares Payment of cash dividends Net cash provided by financing activities

(7,135) (1,220)

(17,280)

31,000 (5,000)

Net increase in cash Cash, September 1, 2023 Cash, September 30, 2023

26,000 7,500 0 $7,500

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EXERCISE 22.20 (CONTINUED) f. A. S. Design Limited Statement of Cash Flows – Partial For the Month Ended September 30, 2023 Cash flows from operating activities Cash received from customers (1) Less: Cash paid to suppliers for goods and services (2) Cash paid for salaries and wages Net cash used in operating activities

$2,670 $3,290 600

Computations: (1) Cash received from customers Service revenue Less: Increase in accounts receivable Cash received from customers (2)

Cash paid to suppliers for goods and services Total expenses Less: Depreciation expense Less: Salaries and wages expense

3,890 $(1,220)

$8,920 (6,250) $2,670

Less: Increase in accounts payable Add: Increase in supplies Add: Increase in prepaid rent

$3,005 (263) (900) 1,842 (737) 825 1,360

Paid to suppliers for goods and services

$3,290

The statement of cash flows balance at September 30, 2023 corresponds to the balance at September 30, 2023 for the cash account, arrived at in part (a) to the exercise. The operating activities section using the direct format in (f) more closely resembles the activity in the cash account as the amounts of the entries correspond (when aggregated) to the amounts appearing as increases and decreases in the cash account.

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.20 (CONTINUED) h.

If this were an established company, it might be considered alarming (in the indirect format of the statement of cash flows prepared in part (e) above), that operating cash flows are well below net income levels. Typically, the amount of net cash provided by operating activities exceeds the amount for net income, for established companies. This is mainly due to the adjustment to income for non-cash items for expenses such as depreciation. In the case of A. S. Design Limited, increases in its accounts receivable and prepaid rent exceed the amount of the income. Prepaid rent does not represent a potential collection risk but accounts receivable certainly do. However, as a company that is just beginning to grow its business, this is often the case and is to be expected as cash resources are invested in inventories, receivables, and other necessary working capital. The direct format of the statement of cash flows does not highlight this issue, although the same situation could be noticed from a comparison of balances on the SFP.

LO 3,9 BT: C Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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EXERCISE 22.21 a. Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable $1,500 Decrease in inventory 1,400 Decrease in accounts payable (300) Net cash provided by operating activities b. Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $(3,000) Decrease in inventory 3,200 Increase in accounts payable 4,400 Net cash provided by operating activities c. Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $(20,000) Increase in inventory (12,000) Increase in accounts payable 7,000 Net cash provided by operating activities d. Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable $1,500 Increase in inventory (3,900) Decrease in accounts payable (3,900) Net cash provided by operating activities

$32,000

2,600 $34,600

$32,000

4,600 $36,600

$32,000

(25,000) $7,000

$32,000

(6,300) $25,700

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Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 22.21 (CONTINUED) e. Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable $2,500 Decrease in inventory 1,100 Increase in accounts payable 2,000 Net cash provided by operating activities

$32,000

5,600 $37,600

LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 22.22 1.

Bonds Payable ............................................ 300,000 Contributed Surplus—Conversion Rights 9,000 Common Shares .................................... 309,000 (Non-cash investing and financing activity)

Net income (Operating) .............................. 410,000 Retained Earnings ................................. 410,000

Depreciation Expense (Operating) ............ Accumulated Depreciation—Buildings

90,000

Investment in Associate1... ......................... Investment Income or Loss (Operating) ............................. 1 ($123,000 X 28% = $34,440)

34,440

Accumulated Depreciation —Equipment .......................................... Equipment ................................................... Gain on Disposal of Equipment (Operating) ...................... Purchase of Equipment (Investing)......

90,000

34,440

30,000 10,000 6,000 34,000

Retained Earnings ...................................... 123,000 Dividends Payable ................................. 123,000 (Non-cash financing activity)

LO 11 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 22.23 Cosky Corporation WORK SHEET FOR PREPARATION OF STATEMENT OF CASH FLOWS For the Year Ended December 31, 2023 Acct. Reconciling TransAcct. Bal. At actions during 2023 Bal. at end of end of 2022 2023 Debits Debit Credit Cash $ 21,000 (17) $ 4,500 $16,500 FV-NI investments 19,000 (2) $ 6,000 25,000 Accounts receivable 45,000 (3) 2,000 43,000 Prepaid expenses 2,500 (4) 1,700 4,200 Inventory 65,000 (5) 16,500 81,500 Land 50,000 50,000 Buildings 73,500 (10) 51,500 125,000 Equipment 46,000 (11) 7,000 53,000 Machinery 39,000 39,000 Patents _______ (12) 15,000 15,000 Total debits $361,000 $452,200

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 22.23 (CONTINUED)

Credits Accounts payable Short-term notes payable (trade) Accrued liabilities Allowance for expected credit losses Accumulated depreciation—buildings Accumulated depreciation—equipment Accumulated depreciation—machinery Mortgage payable Bonds payable Common shares Retained earnings Total credits

Acct. Reconciling TransAcct. Bal. At actions During 2023 Bal. At end of end of 2022 2023 Debit Credit $ 16,000 (6) $10,000 $ 26,000 6,000 (7) $ 2,000 4,000 4,600 (8) 1,600 3,000 2,000 (3) 200 1,800 23,000 (13) 7,000 30,000 15,500 (13) 3,500 19,000 20,500 (13) 1,500 22,000 53,400 (14) 19,600 73,000 62,500 (16) 12,500 50,000 106,000 (15) 44,000 150,000 51,500 (9) 15,000 (1) 36,900 73,400 $361,000 $452,200

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Intermediate Accounting, Thirteenth Canadian Edition

*EXERCISE 22.23 (CONTINUED) Debit Statement of Cash Flows effects Operating activities Net income Depreciation expense Decrease in accounts receivable (net) Increase in prepaid expenses Increase in inventory Purchase of FV-NI investments Increase in accounts payable Decrease in notes payable Decrease in accrued liabilities Investing activities Purchase of building Purchase of equipment Purchase of patents Financing activities Dividends paid Issuance of mortgage payable Proceeds from issuance of shares Payments to retire bonds Totals Decrease in cash Totals

(1) (13) (3)

(6)

(14) (15)

(17)

LO 11 BT: AP Difficulty: M Time: 55 min. AACSB: None CPA: cpa-t001 CM: Reporting

Credit

36,900 12,000 1,800 (4) (5) (2)

1,700 16,500 6,000

(7) (8)

2,000 1,600

(10) (11) (12)

51,500 7,000 15,000

(9)

15,000

19,600 44,000 _______ (16) 124,300

12,500 128,800

4,500 $128,800

_______ $128,800

10,000

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Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS Problem 22.1 Purpose—to provide the student with a comprehensive set of financial statements and supporting notes to arrive at a statement of cash flows using the direct method. The student must first analyze some of the changes in the SFP amounts to calculate the activity of accounts. The indirect format of the cash flow from operating activities is then required, along with the preparation of a memo to the president including comments explaining the cash crunch experienced by the entity.

Problem 22.2 Purpose—to develop an understanding of the procedures involved in the preparation of a statement of cash flows. The student is required to prepare the statement using the indirect method, provide the necessary disclosure notes, and present an alternative treatment for the payment and collection of interest. Comments highlighting the investment strategy of the business as well as assessing the company’s liquidity position are required in the problem.

Problem 22.3 Purpose—to provide a comprehensive problem involving the preparation of a statement of cash flows. The student is required to prepare the statement using the indirect method. The student must also calculate the net cash flows from operating activities using the direct method. Long-term investments accounted for using the equity method are included in this problem. The original instructions have the student report the change in cash and cash equivalents, including temporary bank overdrafts. At the end of the problem, the student must discuss the effect of excluding or including cash equivalents from cash and cash equivalents.

Problem 22.4 Purpose—to develop an understanding of both the direct and indirect methods. The student is first asked to prepare the statement of cash flows using the indirect method. In addition, the student is asked to calculate the net cash flows from operating activities using the direct method and then provide overall comments about cash activities including a discussion of the payout ratio.

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Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 22.5 Purpose—to develop an understanding of the procedures involved in the preparation of a statement of cash flows. The student is required to prepare the statement using the direct method, including a reconciliation schedule and must then provide short comments summarizing the cash flow activities. FV-NI investments are included in this problem. Choices of classifications under IFRS are also included in this problem.

Problem 22.6 Purpose—to provide the student with the opportunity to analyze the effects of several different transactions on several equity accounts. The student is required to prepare entries for the transactions and is then asked to prepare the corresponding captions on a partial statement of cash flows using the indirect method as well as to prepare any necessary additional disclosure notes. This is not a long problem but it requires a thorough understanding of the equity transactions including the recording of property dividends involving an FV-OCI Investment.

Problem 22.7 Purpose—to develop an understanding of the procedures involved in the preparation of a statement of cash flows. The student is required to prepare the statement using the indirect method. The student also must calculate the net cash flow from operating activities using the direct method. As a final task, the student must take on the role of a member of an investment club, preparing a report of the cash activities of the company for the club’s consideration.

Problem 22.8 Purpose—to give the student the opportunity to prepare the operating activities of the cash flow statement, using the indirect format from the description of several items and transactions occurring during the year. Since the whole statement is not being prepared the student needs to distinguish which items do or do not affect the operating activities section of the statement. Since some of the transactions described are not simple, the task is not simple either.

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Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 22.9 Purpose—to provide the student with the opportunity to analyze the effects of transactions on the accounts: FV-OCI Investments and Accumulated Other Comprehensive Income. Once the entries and the reconciliation are prepared for the activity of these two accounts for the year, the student is asked to prepare the corresponding captions on the statement of cash flows using both the direct and the indirect methods. This is not a long problem but it requires a thorough understanding of the accounting of FV-OCI investments.

Problem 22.10 Purpose—to provide the student with the opportunity to analyze the effects of several transactions affecting investment and related accounts over a two-year period. The student must prepare partial statements of income, comprehensive income, changes in accumulated other comprehensive income, and financial position. After the preparation of selected journal entries, a partial statement of cash flows is required, using both the direct and indirect methods. Finally, some comparisons between IFRS and ASPE are discussed. Although this question involves only investments, it is thorough in all aspects of financial statement presentation and disclosure.

Problem 22.11 Purpose—to develop an understanding of the procedures involved in the preparation of a statement of cash flows. The student is required to prepare the statement using the indirect method. The student also must calculate some specific captions appearing in the net cash flow from operating activities using the direct method and must then reconcile the amounts in total to the cash obtained from operating activities arrived at using the indirect method. Investments accounted for by the equity method have been included in this problem. The cash flow is reporting cash and cash equivalents in this problem.

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Intermediate Accounting, Thirteenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 22.12 Purpose—to provide the student with a comprehensive problem in a style that the student has likely not encountered in the past. From a set of financial statements including the statement of income, the statement of cash flows, prepared using the indirect format, and the opening balances from the SFP, the student must calculate the ending balances for SFP. By working from this new perspective, the student has the opportunity to practice reconciling all changes to the SFP that are ultimately reported on the other financial statements provided. This should be a challenging problem for most students.

Problem 22.13 Purpose—to develop an understanding of the procedures involved in the preparation of a statement of cash flows, including a schedule of non-cash investing and financing activities. The student is required to prepare the statement using the indirect method, and consider the proper treatment of an unusual item. A memorandum of the highlights of the cash flow activity for the year is also required. In the last part, the student is asked to determine how operating, investing, and financing sections of the statement of cash flows will change under various situations.

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Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO PROBLEMS PROBLEM 22.1 a. Jeopardy Inc. Consolidated Statement of Cash Flows For the Year Ended April 30, 2023 ($000 omitted) Cash flows from operating activities Cash received from customers (1) $84,476 Cash received for interest 1,310 Payments for goods (2) 58,748 Payment for other operating expenses (3) 10,204 Payments to and on behalf of employees (4) 26,633 Interest paid 1,289 Income taxes paid (5) 0 Net cash used in operating activities Cash flows from investing activities Purchase of capital assets Purchase of other investments Proceeds from sale of property plant and equipment Payments for franchise fees (6) Net cash used in investing activities Cash flows from financing activities Proceeds from bank term loans Repayments of bank term loans (7) Proceeds from issuance of shares Proceeds from sale of warrants Net cash provided by financing activities Decrease in cash and cash equivalents Cash and cash equivalents, May 1, 2022 Cash and cash equivalents, April 30, 2023

$85,786

96,874 (11,088)

(2,290) (1,516) 250 (2,686) (6,242)

2,200 (1,200) 14,393 899 16,292 (1,038) (2,541) $ (3,579)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.1 (CONTINUED) a. (continued) Cash and cash equivalents consist of cash on hand and balances with banks, 60-day treasury bills, and temporary bank overdraft. Cash and cash equivalents included in the statement of cash flows comprise the following SFP accounts (amounts in thousands of dollars): 2023 2022 Cash and 60-day treasury bills $ 3,265 $ 3,739 Bank overdraft (6,844) (6,280) Total cash and cash equivalents $ (3,579) $ (2,541) (1) Cash received from customers Operating revenue Less: increase in accounts receivable Cash received from customers

$ 89,821 (5,345) $ 84,476

(2) Cash paid to suppliers for goods Cost of goods sold Add: increase in inventory Add: decrease in accounts payable Cash paid to suppliers for goods

$ 52,766 4,522 1,460 $ 58,748

(3) Cash paid for other operating expenses General and administrative expenses Less: decrease in prepaid expenses Cash paid for other operating expenses

10,415 (211) $ 10,204

(4) Cash paid to and on behalf of employees Salaries and wages expense Add: decrease in salaries and wages payable Cash paid to and on behalf of employees

$ 26,624 9 $ 26,633

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.1 (CONTINUED) a. (continued) (5) Income taxes paid/collected Income tax benefit Add: increase in deferred tax asset Add: increase in income tax receivable Cash paid/received for income taxes

$(2,775) 2,630 145 $ –

Reconciliation of Property Plant and Equipment (net): Opening Balance Additions – given Ending Balance – given Loss on disposal – given Proceeds on disposal – given Depreciation expense – force

$45,700 2,290 (37,332) (394) (250) 10,014

Total depreciation and amortization recorded Less depreciation for capital assets (above) Amortization for franchises

$10,220 (10,014) $ 206

(6) Reconciliation of Franchises (net): Opening Balance Amortization recorded (above) Ending Balance – given Additions – force

$ 1,911 (206) (4,391) $(2,686)

(7) Reconciliation of Bank Loans: Opening Balance New loans during the year - given Ending Balance – given Repaid during the year ($100 X 12)

$3,200 2,200 (4,200) $1,200

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.1 (CONTINUED) a. (continued) (7) (continued) Reconciliation of Share Capital: Opening Balance Proceeds from sale of shares – given Proceeds from sale of warrants – given Ending Balance

$ 62,965 14,393 899 $ 78,257

b. Jeopardy Inc. Consolidated Statement of Cash Flows (partial) For the Year Ended April 30, 2023 ($000 omitted) Cash flows from operating activities Net loss Adjustments to reconcile net loss to net cash used in operating activities: Depreciation expense $10,014 Amortization expense 206 Loss on impairment of goodwill 12,737 Loss on disposal of capital assets 394 Loss on equity investment 2,518 Increase in accounts receivable (5,345) Increase in inventory (4,522) Increase in income tax receivable (145) Decrease in prepaid expenses 211 Decrease in accounts payable and accrued liabilities (1,469) Increase in deferred tax asset (2,630) Net cash used in operating activities

$(23,057)

11,969 $(11,088)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.1 (CONTINUED) c.

Memo to President Jeopardy Inc. is experiencing a severe cash crunch despite having acceptable liquidity ratios and several non-cash expenses on its income statement. The following is a list of factors that have contributed to this problem: 1. There are disturbing trends in the management of working capital. This is evidenced from the operating activities of the statement of cash flows prepared using the indirect format. Jeopardy had significant increases in accounts receivable and inventory (combined increase of $9,867,000), while at the same time a reduction in accounts payable of $1,469,000 was achieved. This represents a deterioration amounting to $11.3 million in working capital position in one fiscal year. 2. Significant purchases of long-term investments, reported at amortized cost were made during the year ($1,516,000), although investments did generate some cash from interest. We should look carefully at the rates of interest earned on these investments, compared to the rates of interest paid on our debt. 3. Although the company recorded income tax benefits on the income statement from its losses, and corresponding additions to deferred tax assets on the statement of financial position ($2,630,000), we were unable to recover in cash any taxes paid in the past. The carry back of losses was disallowed because of the continued losses incurred in the past. 4. The majority of the cash obtained from selling shares and warrants to shareholders was consumed in operating activities. Closer attention to costs will be required to restore profitability and corresponding positive cash flows from operations.

LO 7,8,9 BT: AP Difficulty: C Time: 50 min. AACSB: Analytic and Communication CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.2 a. Mann Corp. Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Net earnings Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense (1) Loss on disposal of equipment (2) Investment income from associate (3) Increase in accounts receivable Increase in inventory Decrease in accounts payable Decrease in income tax payable Net cash provided by operating activities

$240,000

$181,000 2,000 (22,000) (79,700) (42,600) (61,000) (9,000)

Cash flows from investing activities: Proceeds from sale of equipment Loan to TMC Corp. Principal collected of loan receivable Net cash used by investing activities

42,000 (285,000) 33,500

Cash flows from financing activities: Increases in bank loan Dividends paid (4) Net cash used by financing activities

69,700 (85,000)

(31,300) 208,700

(209,500)

(15,300)

Net decrease in cash Cash, January 1, 2023 Cash, December 31, 2023

(16,100) 44,400 $28,300

Non-cash investing and financing activities: Right-of-use asset acquired with lease liability

$270,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.2 (CONTINUED) a. (continued) Additional disclosures: During the year Mann Corp. had the following operating cash flows relating to interest: Interest paid on operating line of credit and right-of-use lease: $14,900 Interest collected on loans to TMC Corp. 9,400 Income taxes paid during the year 151,000 (1) Calculation of depreciation expense: Original cost of equipment sold Carrying amount of equipment sold Accumulated depreciation of equipment sold Accumulated depreciation Jan. 1, 2023 Accumulated depreciation Dec. 31, 2023 Depreciation expense

$ 70,000 (44,000) 26,000 (1,010,000) 1,165,000 $ 181,000

(2) Calculation of loss on disposal of equipment: Proceeds on sale of equipment Carrying amount of equipment sold Loss on disposal of equipment

$ 42,000 (44,000) $ 2,000

(3) Calculation of undistributed earnings of Bligh Corp. Net income of Bligh Corp. Percentage owned by Mann Corp. Investment income from Associate

$ 88,000 25% $ 22,000

(4) Calculation of dividends paid: Increase in retained earnings for the year Net earnings for the year Decrease in dividends payable Dividends paid during the year

$175,000 (240,000) (20,000) $ ( 85,000)

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.2 (CONTINUED) b. ('000 $) Prop., plant, and equipment Accumulated depreciation

Depreciation expense Loss on disposal of equipment Proceeds on sale of equipment Non-cash right-of-use lease

2023 $ 3,066.4 (1,165.0) $ 1,901.4

2022 $2,866.4 (1,010.0) $1,856.4

change

$ 181 2 42 225 (270) $(45)

At first glance, a financial statement reader of the cash flow statement might come to the quick conclusion that all the cash flows generated from operations were used up in investing activities; this is really not the case. The cash generated from operations is almost exactly the same as the cash used in investing activities. This makes it appear as if Mann Corp. is leaving itself very little cash to allow it any flexibility in dealing with future cash demands. The reconciliation brings to light the noncash financing/investing transaction of the right-of-use asset and right-of-use lease of $270,000. This can then be easily compared with the amount of the depreciation on property, plant, and equipment recorded during the year. This comparison is often used to assess if management is properly dealing with the timely replacement of aging capital assets.

Since Mann Corp. follows IFRS, interest paid and received can be recognized as operating flows on the basis they are included in determining net income. Alternatively, interest paid could be a financing outflow while interest received could be considered an investment flow. Once the choice is made, it is applied consistently from period to period.

$45

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.2 (CONTINUED) d. (continued) Had Mann Corp. classified interest paid as financing activities, and interest received as investing activities, those amounts would need to become adjustments to the operating activities section of the statement of cash flows prepared using the indirect format as they were included in net earnings. The amounts are small (interest paid $14,900 and interest received $9,400) and would increase the cash flows from operations by $5,500. Correspondingly, the investing activities net outflow of cash would decrease by $9,400 and financing activities outflow would increase by $14,900. These changes are minor and would not impact conclusions reached concerning Mann’s liquidity position and ability to generate cash. e.

Mann Corp. has very low cash positions at its SFP dates. It also appears as if some large current liabilities must be paid, in amounts that are far larger than the amount of cash on hand. That being the case, Mann remains able to meet these obligations because it has secured a line of credit which has an upper limit of $600,000. It is never the intention of management to use the line of credit to the limit, but rather use it for the short-term financing of operating needs. The balances of the term line at the SFP dates are not unreasonable when compared to other important balances such as the amount of accounts receivable. In fact, the accounts receivable are likely securing the operating line of credit.

LO 4,6,8,9 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

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PROBLEM 22.3 a.

Preliminary calculations and reconciliations: A. Reconciliation of long-term investment in associate at equity: Opening balance $400,000 Equity in earnings of associate 62,000 Dividends received (derived) (44,000) Ending balance $418,000 B. Reconciliation of investment income: Total investment income on income statement Less: Equity in earnings of associate Interest income on investments (derived)

$90,000 (62,000) $28,000

C. Reconciliation of equipment: Opening balance Original cost of equipment sold Ending balance Purchases of equipment (derived)

$640,000 (46,000) (632,000) $(38,000)

D. Reconciliation of accumulated depreciation equipment: Opening balance $(135,000) Accumulated depreciation of equipment sold 32,000 Ending balance 160,000 Depreciation expense for year (derived) $57,000 E. Carrying amount of equipment sold Proceeds on sale of equipment (derived) Loss on disposal

$(14,000) 3,000 $(11,000)

F. Reconciliation of common shares: Opening balance Preferred shares converted to common shares Shares issued during year (derived) Ending balance

$666,000 18,000 62,000 $746,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.3 (CONTINUED) a. (continued) G. Reconciliation of retained earnings: Opening balance Add net income Cash dividends declared (derived) Ending balance

$294,000 195,000 (51,000) $438,000

H. Reconciliation of dividends payable Opening balance Add dividends declared (G) Cash dividends paid (derived) Ending balance

$50,000 51,000 (81,000) $20,000

Laflamme Inc. Statement of Cash Flows For the Year Ended December 31, 2023 Cash Flows from Operating Activities Net income $195,000 Dividends received from associate (A) 44,000 Adjustments to reconcile net income to net cash provided by operating activities: Loss on disposal of equipment $11,000 Depreciation expense – buildings 40,000 Depreciation expense – equipment (D) 57,000 Amortization expense – patent 5,000 Amortization of bond discount 4,000 Investment income from investment in associate (62,000) Increase in accounts receivable (77,000) Decrease in prepaid insurance 19,000 Increase in inventory (48,000) Decrease in supplies 4,000 Increase in accounts payable 15,000 Decrease in income tax payable (9,000) Increase in accrued liabilities 16,000 (25,000) Net cash provided by operating activities 214,000 Solutions Manual 22.99 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

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PROBLEM 22.3 (CONTINUED) a. (continued) Cash Flows from Investing Activities Purchase of land Purchase of building Purchase of equipment (C) Proceeds from sale of equipment Net cash used in investing activities Cash Flows from Financing Activities Proceeds from issuance of preferred shares1 Proceeds from issuance of common shares (F) Repayment of long-term notes principal Dividends paid (H) Net cash used in financing activities

$(40,000) (30,000) (38,000) 3,000 (105,000)

24,000 62,000 (40,000) (81,000) (35,000)

Increase in cash and cash equivalents Cash and cash equivalents balance Dec. 31, 2022 Cash and cash equivalents balance Dec. 31, 2023

74,000 8,000 $82,000

Cash and Cash Equivalents: Cash Cash equivalents Temporary bank overdrafts

2022 $56,000 45,000 (93,000) $8,000

2023 $46,000 36,000 0 $82,000

Note X: During the year the Laflamme Inc. obtained land having a fair value of $100,000 in exchange for its preferred shares.

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PROBLEM 22.3 (CONTINUED Supplemental disclosures of cash flow information: Cash paid during the year for: Interest* $91,000 Income taxes** $105,000 1

(Increase of $106,000 less Note X non-cash financing— investing above of $100,000 + $18,000 converted = $24,000)

*Interest paid: Interest expense Amortization of bond discount **Income taxes paid: Income tax expense Decrease in income tax payable

$95,000 (4,000) $91,000 $96,000 9,000 $105,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.3 (CONTINUED) b. Laflamme Inc. Statement of Cash Flows For the Year Ended December 31, 2023 Cash Flows from Operating Activities Cash received from customers (1) Cash received from interest (B) Cash received from dividends (A) Payments to suppliers for goods for resale (2) Payment for other operating expenses (3) Payments to and on behalf of employees (4) Interest paid (5) Income taxes paid (6) Net cash provided by operating activities 1. Cash collected from customers: Sales revenue Increase in accounts receivable 2. Payments to suppliers for goods for resale: Cost of goods sold Increase in inventory Increase in accounts payable 3.

Payment for other operating expenses Operating expenses Less: Depreciation expense – buildings Depreciation expense – equipment Amortization expense – patent Decrease in prepaid insurance Increase in accrued liabilities Decrease in supplies

$922,000 28,000 44,000 (347,000) (25,000) (212,000) (91,000) (105,000) $214,000

$999,000 (77,000) $922,000 $314,000 48,000 (15,000) $347,000 $166,000 (40,000) (57,000) (5,000) (19,000) (16,000) (4,000) $25,000

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PROBLEM 22.3 (CONTINUED) b. (continued) 4. Payments to and on behalf of employees: Sales commission expense Salaries and wages expense

5. Interest paid: Interest expense Amortization of bond discount 6. Income taxes paid: Income tax expense Decrease in income tax payable

$108,000 104,000 $212,000

$95,000 (4,000) $91,000 $96,000 9,000 $105,000

Laflamme does have some choice because it follows IFRS. Under IFRS, interest paid and received and dividends paid and received can be recognized as operating flows. Alternatively, interest paid can be recognized as a financing outflow while interest and dividends received can be recognized as investing inflows. A choice is permitted for dividends paid: a financing outflow as a return to equity holders, or an operating outflow as a measure of the ability of operations to cover returns to shareholders.

Had the cash equivalents not been included in the balance of cash and cash equivalents, transactions of purchases and maturities of principal of these investments would have been treated as investing activities on the statement of cash flows. Had the temporary bank overdrafts not been included in the balance of cash and cash equivalents, transactions of loans and cash advances by the bank and repayments of these loans would be treated as financing activities on the statement of cash flows.

LO 1,4,7,8,9 BT:AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 22.4 a. Jensen Limited Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense1 Gain on FV-NI investments Loss on disposal of equipment Increase in accounts receivable (net) Purchase of FV-NI investments 2 Proceeds on sale of FV-NI investments Increase in inventory Decrease in deferred income tax expense Increase in accounts payable Decrease in accrued pension liability Increase in income tax payable Net cash provided by operating activities

$76,000

$20,000 (24,000) 3,000 (17,500) (5,000) 50,000 (14,000) 4,500 12,500 (2,500) 2,000

29,000 105,000

Cash flows from investing activities Purchase of equipment3 Proceeds on sale of equipment4 Net cash used by investing activities Cash flows from financing activities Payment of long-term notes payable Dividends paid5 Proceeds on issuance of common shares6 Net cash used by financing activities Net increase in cash Cash, January 1, 2023 Cash, December 31, 2023

(12,000) 3,000 (9,000) (8,000) (74,000) 15,000 (67,000) 29,000 51,000 $80,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.4 (CONTINUED) a. (continued) $21,000 + $4,000 – $14,000 + $37,000 – $28,000 = $20,000 2 $80,000 – $37,000 + $11,000 + X = $59,000 (X = $5,000) 3 $70,000 + $10,000 – $20,000 – $48,000 = $12,000 4 $10,000 – $4,000 – $3,000 = $3,000 5 $92,000 – $76,000 – $90,000 = $(74,000) 6 $300,000 – $15,000 – $20,000 – $250,000 = 15,000

Non-cash investing and financing activities Issuance of common shares for land Issuance of common shares for equipment

$15,000 20,000

Additional disclosures: During the year Jensen Limited had the following operating cash flows relating to interest and income taxes: Interest paid $10,000 Income taxes paid 38,500 b. Net Cash Provided by Operating Activities Cash received from customers (1) Cash paid to suppliers for goods and services (2) Cash paid for other operating expenses (3) Cash paid to and on behalf of employees (4) Cash paid for purchase of FV-NI investments Cash proceeds on sale of FV-NI investments Interest paid Income taxes paid (5) Net cash provided by operating activities (1) Cash received from customers Sales revenue Less increase in accounts receivable Cash received from customers

$940,500 $474,800 144,000 213,200 5,000 (50,000) 10,000 38,500

835,500 $105,000

$ 960,000 (19,500) $ 940,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.4 (CONTINUED) b. (continued) (2) Cash paid to suppliers for goods Cost of goods sold Deduct: direct labour Deduct: pension expense Add: increase in inventory Deduct: increase in accounts payable Payment to suppliers for goods for resale

$ 600,000 (115,000) (11,700) 14,000 (12,500) $ 474,800

(3) Cash paid for other operating expenses Operating expenses Deduct: salaries and wages expense Deduct: pension benefits expense Deduct: depreciation expense Deduct: loss on impairment Paid to suppliers for other operating expenses

$ 250,000 (76,000) (8,000) (20,000) (2,000) $ 144,000

(4) Cash paid to and on behalf of employees Direct labour Salaries and wages expense Pension benefits expense Add: decrease in accrued pension liability Cash paid to and on behalf of employees

$ 115,000 76,000 19,700 2,500 $ 213,200

(5) Income taxes paid Income tax expense Deduct: decrease in deferred tax asset Deduct: increase in income tax payable Income taxes paid

$ 45,000 (4,500) (2,000) $ 38,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.4 (CONTINUED) c.

In spite of a very large dividend paid during the year that was almost as large as net income, the company managed to generate significant amounts of cash from operations and from the sale of some of its investments. The issuance of additional common shares helped finance the purchase of equipment and the acquisition of land.

The dividend payout ratio for the year ended December 31, 2023 can be easily calculated using amounts reported on the statement of cash flows. The payout ratio is 97% [$74,000 (dividends paid) divided by $76,000, (net income)]. From the perspective of an investor, this might be a welcomed ratio, as investors are recipients of this extremely high return on investment. On the other hand, paying out more dividends than the cash flow from operations might be worrisome, and a shareholder should not expect this level of payout to continue. The $50,000 proceeds on the sale of investments might be part of the reason for such a large payout this year, but again, this is not usually a replicable (continuing type of) cash flow. It would be unrealistic to expect the company to sustain this additional source of cash in the future.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.5 a. Ashley Limited Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Cash received from customers (1) Dividends received Proceeds on sale of FV-NI investments1 Cash paid to suppliers for goods (2) Cash paid for other operating expenses (3) Cash paid to and on behalf of employees (4) Income taxes paid (5) Interest paid Net cash provided by operating activities Cash flows from investing activities Proceeds from sale of land2 Purchase of equipment Net cash used by investing activities Cash flows from financing activities Proceeds from issuance of common shares Principal payment on long-term debt Dividends paid3 Net cash used by financing activities

$1,163,450 2,400 14,000 (753,000) (160,350) (88,000) (25,400) (41,750) $111,350

58,000 (125,000) (67,000)

22,500 (10,000) (19,450)

Net increase in cash and cash equivalents Cash and cash equivalents January 1, 2023 Cash and cash equivalents, December 31, 2023

(6,950) 37,400 (12,000) $25,400

Decrease in FV-NI investments $10,000 + gain of $4,000 Decrease in land of $50,000 + gain of $8,000 3 Opening $114,600 + NI $58,850 – Closing $154,000 = $19,450 2

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.5 (CONTINUED) a. (continued) Cash and cash equivalents consist of cash on hand and balances with banks, and temporary bank overdrafts. Cash and cash equivalents included in the statement of cash flows comprise the following SFP accounts: Cash Temporary bank overdraft Total cash and cash equivalents

2023 $ 25,400 – $ 25,400

2022 – $ (12,000) $ (12,000)

(1) Sales revenue Add decrease in accounts receivable Cash received from customers

$1,160,000 3,450 $1,163,450

(2) Cash paid to suppliers for goods and services Cost of goods sold Add increase in inventory Less increase in accounts payable Cash paid to suppliers for goods for resale

$748,000 7,000 (2,000) $753,000

(3) Cash paid for other operating expenses Selling expenses Administrative expenses Less decrease in prepaid rent Add increase in prepaid insurance Add increase in supplies Cash paid for other operating expenses

$ 39,200 124,700 (5,000) 1,200 250 $160,350

(4) Salaries and wages expense Less increase in salaries and wages payable Cash paid to and on behalf of employees

$92,000 _(4,000) $88,000

(5) Income tax expense Less increase in deferred tax liability Add decrease in income tax payable Income taxes paid

$29,400 (5,000) 1,000 $25,400

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.5 (CONTINUED) a. (continued) Cash Flows from Operating Activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Amortization expense Gain on disposal of land Proceeds from sale of FV-NI investments Investment Income Decrease in prepaid rent Decrease in income tax payable Increase in salaries and wages payable Decrease in accounts receivable Increase in inventory Increase in prepaid insurance Increase in supplies Increase in accounts payable Increase in deferred tax liability Net cash provided by operating activities b.

$58,850

$35,500 5,000 (8,000) 14,000 (4,000) 5,000 (1,000) 4,000 3,450 (7,000) (1,200) (250) 2,000 5,000

52,500 $111,350

Because Ashley Limited follows IFRS, it has some choice. Under IFRS, interest paid and received and dividends paid and received can be recognized as operating flows. Alternatively, interest paid can be recognized as a financing outflow while interest and dividends received can be recognized as investing inflows (except for dividends received from investments held for trading which have to be included in operating activities). A choice is permitted for dividends paid: a financing outflow as a return to equity holders, or an operating outflow as a measure of the ability of operations to cover returns to shareholders.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.5 (CONTINUED) c.

Memo Ashley has managed to generate sufficient cash from operations in the current year to overcome a cash and cash equivalent deficiency while at the same time making substantial investments in equipment and paying out dividends of 33% of net income for the year. Additional increases in cash came from the sale of land and FV-NI investments as well as further investments from shareholders through the issuance of shares.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.6 a. Item 1. Common Shares (5,000 x $34.20)................... Contributed Surplus (Common Shares) ........... Retained Earnings ........................................... Cash (5,000 X $47.40) ............................. Item 2. Land ................................................................ Cash ........................................................ Common Shares ...................................... Item 3 Unrealized Gain or Loss – OCI1 ...................... FV-OCI Investments ................................ To record fair value adjustment

171,000 22,700 43,300 237,000

240,000 33,000 207,000

3,650 3,650

Original cost of shares ............................ $68,400 Fair value adjustment to beg. of year ........ (2,350) Carrying amount beg. of year .................... 66,050 Fair value date of declaration..................... 62,400 (8,000 x $7.80) Fair value adjustment required .................. $3,650 Retained Earnings ........................................... Accumulated Other Comprehensive Income2 2 (Reclassification $2,350 + $3,650) To reclassify holding loss

6,000 6,000

Retained Earnings ........................................... 62,400 Dividends Payable ................................... 62,400 To record property dividends declared – directly to Retained Earnings Dividends Payable........................................... FV-OCI Investments ................................ To distribute property dividend payable

62,400 62,400

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.6 (CONTINUED) a. (continued) Item 4. Retained Earnings3 ......................................... 85,752 Common Stock Dividends Distributable ... 85,752 3 (43,200 X 5% X $39.70) To record declaration of stock dividends directly to retained earnings Common Stock Dividends Distributable .......... Common Shares ...................................... To record distribution of stock dividend Item 5. Land ................................................................ Contributed Surplus - Donated Land........ Item 6. Share Subscriptions Receivable ...................... Cash ($385,000 X 10%) .................................. Common Shares Subscribed4 .................. 4 (10,000 X $38.50) Item 7. Interest Expense ............................................. Dividends Payable ...................................

85,752 85,752

42,000 42,000

346,500 38,500 385,000

3,800 3,800

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.6 (CONTINUED) b. Cash provided by (used in) operations Changes in non-cash working capital: Dividends payable, term preferred shares

3,800

Cash provided by (used in) investing activities Purchase of land (Note X)........................

(33,000)

Cash provided by (used in) financing activities Collection of subscription for shares ........ Common shares repurchased ..................

38,500 (237,000)

Note X: During the year Gao Limited purchased land with a fair value of $240,000 in exchange for cash of $33,000 and 5,000 common shares. Additional disclosures: A property dividend in the amount of $62,400, charged to retained earnings, was declared and distributed to preferred shareholders. A 10% stock dividend for $85,752 was declared and distributed to the common shareholders. During the year, a shareholder donated land at an appraised value of $42,000. c.

If Gao’s investment in Trivex was accounted for using the fair value through net income model, the changes in fair value would have been included in net income, instead of being reported in other comprehensive income. There would be no accumulated other comprehensive income on the SFP at October 31, 2023, and therefore no reclassification entry would be needed following the declaration of the property dividend. As for the statement of cash flows, the amounts reported would not change, but the captions and descriptions would change to FV-NI, instead of FV-OCI.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.6 (CONTINUED) d.

If Gao were using ASPE, it would not be allowed to follow the FVOCI model and the process would follow the description in requirement c.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.7 a. Net Cash Flow from Operating Activities Cash received from customers (1) Net cash received on FV-NI investment transactions (2) Cash paid to suppliers for goods (3) $380,750 Cash paid for other operating expenses (4) 165,175 Cash paid for interest 3,000 Income taxes paid (5) 37,500 Net cash provided by operating activities (1) Cash received from customers Sales revenue Less increase in accounts receivable 1 Cash received from customers 1

$627,850 16,250

(586,425) $ 57,675

$ 640,000 (12,150) $ 627,850

$67,500 – $60,000 – $2,250 + $1,500 + $5,400 expense

(2) Net cash received on FV-NI investment transactions Proceeds from sale of FV-NI Investments Purchase of FV-NI investments ($40,500 - $24,750 - $23,250) Net cash received on FV-NI investment transactions

$23,750 (7,500) $16,250

(3) Cash paid to suppliers for goods Cost of goods sold Add: increase in inventory Deduct: increase in accounts payable Cash paid to suppliers for goods for resale

$ 380,000 6,000 (5,250) $ 380,750

(4) Cash paid for other operating expenses Operating expenses Deduct: increase in accrued liabilities Deduct: depreciation expense Deduct: loss on impairment Cash paid for other operating expenses

180,450 (1,250) (8,625) (5,400) $ 165,175

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.7 (CONTINUED) a. (Continued) (5) Income taxes paid Income tax expense Add: decrease in income tax payable Income taxes paid

$ 37,000 500 $ 37,500

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.7 (CONTINUED) b. Secada Inc. Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on disposal of machinery Investment loss Net cash received on FV-NI investments Increase in accounts receivable (net) Increase in inventory Increase in accounts payable Increase in accrued liabilities Decrease in income taxes payable Net cash provided by operating activities Cash flows from investing activities Purchase of machinery1 Addition to buildings Proceeds from sale of machinery2 Net cash used by investing activities Cash flows from financing activities Principal payments on long-term note payable Dividends paid3 Net cash used in financing activities Net increase in cash Cash, January 1, 2023 Cash, December 31, 2023

$37,750

$ 8,625 800 1,000 16,250 (6,750) (6,000) 5,250 1,250 (500)

19,925 57,675

(15,000) (11,250) 2,200 (24,050)

(5,000) (25,375) (30,375) 3,250 33,750 $37,000

$18,750 – $3,750 – $30,000 = $15,000 $3,000 – $800 = $2,200 3 $32,000 – $37,750 + $25,000 – $44,625 = $(25,375) 1 2

Interest paid Income taxes paid

$3,000 37,500

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.7 (CONTINUED) c.

Memo Fellow investment club members: The following is a short summary of the highlights from a cursory review of the operations of Secada Inc., which the club is considering for investment. From an investor’s perspective, we are interested in the profitability, financial stability, and dividend-paying ability of Secada. Based on the performance for the year ended December 31, 2023, Secada has demonstrated an extremely strong dividend-paying ability. The company was able to distribute 67% of the net earnings as cash dividends ($25,375 ÷ $37,750). This is a very high dividend payout ratio. Over and above the cash dividends paid out, Secada also distributed a 20% stock dividend. Although this dividend did not provide cash to the shareholders, it did allow them to receive additional common shares, which they can choose to sell. The statement of cash flows demonstrates some positive trends, particularly in the cash flows generated from operations. Secada managed to increase its cash position by the end of the fiscal year, while making some substantial investments in machinery and in buildings, although the company sold almost half of its long-term investments.

LO 7,9 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic and Communication CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.8 a. Cash flows from operating activities Net income Adjustments to reconcile net income to to net cash provided by operating activities: Depreciation expense Loss on disposal of equipment (1) Investment income (2) Proceeds from sale FV-NI investments (2) Decrease in accounts receivable Income from investment accounted using the equity method (7) Dividends received from investment accounted using the equity method (8) Net cash provided by operating activities

$245,000

$48,000 16,500 (5,500) 20,000 5,000 (8,100) 840

76,740 $321,740

Other comments: No. 1 the proceeds from the sale of the equipment will be shown as cash received from investing activities, but the loss on disposal of $16,500 ($23,500 – $7,000) must be an added back to income. No. 2 the proceeds of sale of FV-NI investments is shown as a cash inflow of $20,000 (sale of 100 Lontel Corporation shares at $200 per share) and the investment income of $5,500 is deducted from net income, both in the operating section. No. 3 does not affect the statement of cash flows as it does not affect cash. No. 4 is a non-cash expense (Loss on Impairment) in the income statement. Loss on impairment is not handled separately when using the indirect method. It is part of the change in net accounts receivable.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.8 (CONTINUED) a. (continued) No. 5 is a significant non-cash investing and financing activity. No. 6 depreciation is added to income when using the indirect method. No. 7 and 8 the equity pick-up of $8,100 (30% of $27,000) is deducted and the dividends received of $840 (30% of $2,800) are added to net income. Another alternative is to net the Company’s pro-rata share of the dividend against the income from equity method amount reported in the cash flows from operating activities. No. 9 is not shown on a statement of cash flows. No. 10 dividends of $2,500 on term preferred shares properly represent cash outflows in the operating activities, included in the calculation of net income, while the remaining dividends of $7,500 would be shown as outflows in the financing activities section of the statement of cash flows. b.

If Neilson Corp. was following IFRS, there would be some choice available on the treatment of dividends and interest paid or received. Under IFRS, interest paid and received and dividends paid and received can be recognized as operating flows. Alternatively, interest paid can be recognized as a financing outflow while interest and dividends received can be recognized as investing inflows. An exception is for interest and dividends received from investments held for trading which must be shown in operating activities. A choice is permitted for dividends paid: a financing outflow as a return to equity holders, or an operating outflow as a measure of the ability of operations to cover returns to shareholders. However, management views these specific flows, once the choice is made, it is applied consistently from period to period.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.9 a.

FV-OCI Investments .................................. 2,100 Unrealized Gain or Loss—OCI1 ............ 1 ($40,000 – $37,900) To record fair value adjustment to date of sale Cash .......................................................... 40,000 FV-OCI Investments ............................. To record sale of investment

2,100

40,000

Retained Earnings2 .................................... 300 Accumulated Other Comprehensive Income 2 ($40,300 – $40,000) To reclassify holding loss

300

b. Reconciliation of transactions to Fair Value through Other Comprehensive Income (FV-OCI) Investments account: Balance Jan. 1, 2023 at fair value (cost $40,300 – unrealized loss to date $2,400) Unrealized gain to date of sale ($40,000 – $37,900) Proceeds from sale of investment Purchase of new shares as investment Unrealized gain to December 31, 2023 Balance Dec. 31, 2023 at fair value

$37,900 2,100 (40,000) 23,600 400 $24,000

Reconciliation of transactions to Accumulated Other Comprehensive Income: Balance Jan. 1, 2023 - unrealized loss ($37,900 - $40,300) Unrealized gain to date of sale ($40,000 – $37,900) Transfer to Retained Earnings realized loss Unrealized gain to December 31, 2023 (new invest.) Balance Dec. 31, 2023

$(2,400) 2,100 300 400 $ 400

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.9 (CONTINUED) c.

Operating activities: Cash received for dividends

Direct $200

Indirect

Investing activities: Proceeds from sale of fair value through other comprehensive income investments Purchase of fair value through other comprehensive income investments

$40,000

(23,600)

If MFI Holdings Inc.’s investments were accounted using the fair value through net income (FV-NI) model, the amounts reported on the SFP would remain the same, but their descriptive captions would change accordingly. All the investment income, including the dividends received, would have been included in net income. The changes in fair value would also have been included in net income, instead of being reported in Other Comprehensive Income. There would be no Accumulated Other Comprehensive Income on the SFP. There would therefore be no need to reconcile the activity to the Accumulated Other Comprehensive Income as given in part (a) of the question. As for part (b) of the question, the amounts in the statement of cash flows for the dividends received and loss on disposal would not change, but the descriptive captions for the proceeds from sale and purchase would change to FV-NI, instead of FV-OCI, and would be included as operating activities.

If MFI Inc were to follow ASPE, it would not be allowed to follow the FV-OCI model.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.10 a. SAMSON INC. Statement of Financial Position December 31, 2023 Long-term Investments FV-OCI Investments

2022

$ 872,245 $883,400

Shareholders’ Equity Accumulated other comprehensive income (loss)

$10,278

$(10,100)

b. SAMSON INC. Income Statement For the Year Ended December 31, 2023 Other revenues and gains Dividend revenue

$37,500

SAMSON INC. Statement of Comprehensive Income For the Year Ended December 31, 2023 Net income (including items above) Other comprehensive income: Unrealized gains on FV-OCI investments during year ($4,350 + $19,620) Reclassification adjustment for realized gains Other comprehensive income Comprehensive income

$23,970 (3,592) 20,378 $ x + 20,378

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.10 (CONTINUED) b. (continued) SAMSON INC. Statement of Changes in Accumulated Other Comprehensive Income For the Year Ended December 31, 2023 Accumulated other comprehensive income (loss), January 1, 2023 Other comprehensive income, 2023 Accumulated other comprehensive income (loss), December 31, 2023

$(10,100) 20,378 $ 10,278

c. June 30, 2023 Cash ............................................................... 37,500 Dividend Revenue ................................... Dividends received from Anderson Corp. August 15, 2023 FV-OCI Investments ....................................... 4,350 Unrealized Gain or Loss - OCI ................ Fair value adjustment for the 3,000 shares sold Cash ............................................................... 70,605 FV-OCI Investments ................................ Sale of 3,000 Anderson Corp. shares Accumulated Other Comprehensive Income ... 3,592 Retained Earnings................................... Reclassification adjustment to transfer realized holding gain to Retained Earnings without recycling November 3, 2023 FV-OCI Investments ....................................... 35,480 Cash ....................................................... Purchase of 2,000 shares of Anderson Corp.

37,500

4,350

70,605

3,592

35,480

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.10 (CONTINUED) d. Operating activities: Cash received for dividends

Direct $37,500

Indirect

Investing activities: Proceeds from sale of FV-OCI investments Purchase of FV-OCI investments

$70,605 $70,605 (35,480) (35,480)

Samson could have adopted the practice of classifying the dividends received as investing cash flows, so long as that classification was followed consistently from year to year. e.

If Samson Inc.’s investments were accounted for using the fair value through net income model, the amounts reported on the SFP would remain the same, but their descriptive captions would change accordingly. All of the investment income, including the dividends received would have been included in net income. The changes in fair value would have been included in net income as well as the gain on the disposal of the investments, instead of being reported in Other Comprehensive Income, net of tax. There would be no Accumulated Other Comprehensive Income on the SFP. As for part (d) of the question, the cash flow statement would not change in amounts reported, but the descriptive captions would change to FV-NI, instead of FV-OCI, and would be shown as operating activities instead of investing activities.

(f)

If Samson Inc. were to follow ASPE, it would not be allowed to follow the FV-OCI model.

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.11 a.

Davis Inc. should be reporting in the statement of cash flows the change in cash and cash equivalents. Cash equivalents are shortterm, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of change in value. The balances of cash and cash equivalents for Davis Inc. at the fiscal year ends follow.

Cash Investments – 30-day term deposits Total cash and cash equivalents

March 31 2023 2022 $ 5,200 $4,400 20,000 6,200 $25,200 $10,600

Davis Inc. will be explaining the increase in cash and cash equivalents of $14,600 ($25,200 – $10,600).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.11 (CONTINUED) b. Davis Inc. Statement of Cash Flows (Partial) For the Year Ended March 31, 2023 Cash flows from operating activities Net income $72,650 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $7,500 Amortization of patents 1,500 Amortization of bond discount 750 Gain on retirement of bonds (16,600) Unrealized gain on FV-NI investments (3,000) Equity in earnings of Jessa Ltd. (12,500) Dividends received from Jessa Ltd. 2,000 Increase in accounts receivable (2,800) Increase in inventory (6,200) Decrease in prepaid expenses 150 Increase in prepaid rent (4,000) Decrease in accounts payable (1,400) Decrease in salaries and wages payable (800) Decrease in income tax payable (16,500) Increase in interest payable 1,500 Increase in accrued pension liability 1,600 Increase in future tax liability 10,300 (38,500) Net cash provided by operating activities $ 34,150

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.11 (CONTINUED) c. 1. Cash payments to and on behalf of employees Salaries and wages expense Less: increase in pension liability Add: decrease in salaries and wages payable Cash paid to and on behalf of employees

$ 64,500 (1,600) 800 $ 63,700

2. Cash paid for other operating expenses Administrative expenses Rent expense Less: decrease in prepaid expenses Add: increase in prepaid rent Cash paid for other operating expenses

$ 21,000 18,000 (150) 4,000 $42,850

3. Cash received from customers Sales revenue Less: increase in accounts receivable Cash received from customers

$450,000 (2,800) $447,200

4. Income taxes paid Income tax expense Add: decrease in income tax payable Less: increase in future tax liability Income taxes paid

$ 30,200 16,500 (10,300) $ 36,400

5. Cash payments to suppliers for goods Cost of goods sold Add: increase in inventory Add: decrease in accounts payable Payments to suppliers for goods

$260,000 6,200 1,400 $267,600

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 22.11 (CONTINUED) c. (continued) 6. Interest paid Bond Interest expense Less: increase in interest payable Less: bond discount amortization Interest paid d.

The sum of the cash flows arrived at in part (c) using the direct method has one item omitted to arrive at net cash provided from operating activities. This omission is for the dividends received from Davis’ investee Jessa Ltd. in the amount of $2,000. Cash received from customers Payments to suppliers for goods Cash paid for other operating expenses Cash paid to and on behalf of employees Interest paid Income taxes paid Cash received from dividends Cash provided from operating activities

$ 6,750 (1,500) (750) $ 4,500

$447,200 (267,600) (42,850) (63,700) (4,500) (36,400) 32,150 2,000 $ 34,150

Davis follows ASPE and so does not have a choice. Companies that adopt IFRS do have some choice. Under IFRS, interest paid and received and dividends paid and received can be recognized as operating flows. Alternatively, interest paid can be recognized as a financing outflow while interest and dividends received can be recognized as investing inflows. Dividends paid can be operating or financing outflows.

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PROBLEM 22.12 a. SORKIN CORPORATION Statement of Financial Position Accounts Comparative December 31, 2023 and 2022 ($ in millions) 2023 Cash (from statement of cash flows) $87 FV-NI investment (2) 30 Accounts receivable ($194 – $4) 190 Inventory ($200 + $5) 205 Prepaid expenses ($12 – $2) 10 Investment in associate (1) 130 Land ($150 + $46 note 1 of statement of cash flows) 196 Buildings and equipment (3) 412 Accumulated depreciation (4) (97) Patents 60 Accumulated amortization-patents (30) Goodwill ($60 – $20) 40 Total assets $1,233

2022 $ 21 – 194 200 12 125 150 400 (120) 60 (28) 60 $1,074

Accounts payable ($65 – $15) Salaries and wages payable ($11 – $5) Bond interest payable ($4 + $4) Income tax payable ($14 – $2) Deferred tax liability ($8 + $3) Lease liability Bonds payable ($250 – $60 + $3) Notes payable Preferred shares Common shares (5) Contributed surplus (6) Retained earnings (7) Total liabilities and equity

$65 11 4 14 8 – 250 – – 495 – 227 $1,074

$50 6 8 12 11 82 193 23 75 513 3 257 $1,233

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PROBLEM 22.12 (CONTINUED) a. (continued) 1.

Opening balance Investment in associate Investment income from associate Stoker Dividends received from Stoker Balance December 31, 2023

$125 11 (6) $130

2. Opening balance FV-NI investment Purchased for cash Unrealized gain FV-NI for 2023 Balance December 31, 2023

$25 5 $ 30

3. Opening balance Buildings and equipment Right-of-Use Asset acquired with lease Equipment cost lost in flood Balance December 31, 2023

$400 82 (70) $ 412

4. Opening balance Accumulated depreciation Acc. depreciation of equipment lost in flood (below) Depreciation expense on income statement Balance December 31, 2023

$(120) 42 (19) $(97)

Equipment cost lost in flood Loss recorded Proceeds obtained from damaged equipment Acc. depreciation of equipment lost in flood

$70 (18) (10) $42

5. Opening balance Common shares Stock dividend (4 M shares X $7.50 per share) Shares repurchased Balance December 31, 2023

$495 30 (12) $ 513

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PROBLEM 22.12 (CONTINUED) a. (continued) – $(9) 12 $3

6. Opening balance Contributed surplus Price paid for shares repurchased Weighted average original cost of shares Balance December 31, 2023 7. Opening balance Retained earnings Net income Dividends paid (none payable) Stock dividend – see item 5 above Balance December 31, 2023 b.

$227 67 (7) (30) $257

SORKIN CORPORATION Statement of Cash Flows – Operating Activities For the Year Ended December 31, 2023

Cash flows from operating activities Cash receipts from customers (1) Cash receipts for dividends (2) Purchase of FV-NI Investments (see part a) Payments to suppliers for goods (3) Payments for operating expenses (4) Payments to and on behalf of employees (5) Payments for interest (6) Income taxes paid (7) Cash provided by operating activities

$414 6 (25) (178) (20) (70) (21) (26) $80

1. Sales revenue Decrease in accounts receivable

$410 4

$414

2. Investment income from associate Income from equity investment Receipt of dividend from associate

$11 (11) 6

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PROBLEM 22.12 (CONTINUED) b. (continued)

3. Cost of goods sold Increase in inventory Decrease in accounts payable

$158 5 15

$178

4. Administrative expenses Decrease in prepaid expenses

22 (2)

$20

5. Salaries and wages expense Decrease in salaries and wages payable

$65 5

$ 70

6. Bond interest expense Increase in bond interest payable Amortization of bond discount

$28 (4) (3)

$ 21

7. Income tax expense Increase in deferred tax liability Decrease in income tax payable

$27 (3) 2

$ 26

If the seller of the land does not at the same time become the creditor (by taking back a note for example) in the sale of the land, then a third party, in this case the mortgage company, would have become the creditor. A separate and additional transaction would have been recorded for the borrowing of $23 million in cash from the mortgage company. That financing transaction would be reported on the statement of cash flows directly as an inflow of cash from financing activities. Entering into a financing arrangement at the same time as buying property is often confused as being combined. This is due to the fact that the cash transactions involved flow through the trust account of the lawyer handling the conveyance of the property. In the case of Sorkin Corporation, only two entities were involved. Consequently, handling the transaction with a note disclosure for the non-cash portion of the transaction is appropriate.

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PROBLEM 22.13 a.

Seneca Corporation Statement of Cash Flows For the Year Ended December 31, 2023

Cash flows from operating activities Net income (1) Adjustments to reconcile net income to net cash provided by operating activities: Loss on disposal of equipment (2) Gain from flood damage Depreciation expense (3) Amortization of patents Investment Income Increase in accounts receivable (net) Increase in inventory Increase in accounts payable Interest paid included in earnings Proceeds on sale of FV-NI investments Dividends paid Net cash provided by operating activities

$16,700

$ 2,650 (1,000) 3,950 1,250 (3,300) (1,950) (1,500) 1,100 2,200 5,800 (6,000)

Cash flows from investing activities Proceeds on sale of equipment Purchase of equipment Proceeds from flood damage to building Net cash provided by investing activities

2,600 (17,000) 23,000

Cash flows from financing activities Payment of interest Payment of short-term note payable Net cash used by financing activities

(2,200) (600)

3,200 19,900

8,600

Increase in cash Cash, January 1, 2023 Cash, December 31, 2023 Supplemental disclosures of cash flow information: Cash paid during the year for: Income taxes 5,600

(2,800) 25,700 13,000 $38,700

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PROBLEM 22.13 (CONTINUED) a. (continued) Non-cash investing and financing activities: Retired note payable by issuing common shares Purchased equipment by issuing note payable Supporting Computations: 1. Ending retained earnings Beginning retained earnings Net income

$10,000 15,500 $25,500 $21,700 (5,000) $16,700

Cost of equipment sold Accumulated depreciation (50% X $10,500) Carrying amount of equipment sold Proceeds from sale of equipment Loss on disposal of equipment

$10,500 (5,250) 5,250 (2,600) $ 2,650

Accumulated depreciation on equipment sold Decrease in accumulated depreciation Depreciation expense

$5,250 (1,300) $3,950

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PROBLEM 22.13 (CONTINUED) b. 2023 Buildings Accumulated depreciation Equipment Accumulated depreciation

Depreciation expense Loss on disposal of equipment Gain on flood damage Proceeds on sale of equipment Purchase of equipment Proceeds on disposal of building Non-cash purchase of equip.

$35,500 (2,000) $33,500

2022 $27,700 (5,700) 13,500 (3,300) $32,200

change

$1,300

$3,950 2,650 (1,000) 2,600 (17,000) 23,000 14,200 (15,500) $(1,300)

The cash generated from operations ($19,900) exceeds the cash generated from investing activities ($8,600). This makes it appear as if Seneca is not reinvesting into the business to replace aging capital assets. The reconciliation on the other hand takes into account the non-cash investing and financing transaction of the equipment of $15,500. Although some of the replacements of assets were necessitated by the flood damage, Seneca has demonstrated the ability to obtain the financing to acquire the necessary capital assets.

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PROBLEM 22.13 (CONTINUED) d.

A portion of the net income came from the gain recorded on the destruction of the building from a flood. The proceeds from the insurance claim totalling $23,000 were classified as investing activities, and the gain had to be deducted from income to arrive at cash flows from operating activities. Proceeds from the sale of the investments, interest paid, and depreciation expense were added to net income to arrive at cash flow from operating activities. These three items were the main reason that cash flows from operating activities was higher than net income. Cash flows from investing activities provided another large cash increase for the year, as assets sold or destroyed were not all replaced. The only significant outflow of cash for investments was related to purchases of equipment. Some refinancing from debt to equity took place as well, as there was non-cash financing of further acquisitions of equipment. Outstanding dividends from the previous year were paid.

Under IFRS, interest paid and received and dividends paid and received can be recognized as operating flows. Alternatively, interest paid can be recognized as a financing outflow while interest and dividends received can be recognized as investing inflows. An exception is made for dividends received from trading investments which must be classified as operating activities. A choice is permitted for dividends paid: a financing outflow as a return to equity holders, or an operating outflow as a measure of the ability of operations to cover returns to shareholders. However management views these specific flows, once the classification choice is made, it is applied consistently from period to period. The IASB is proposing that interest and dividends paid (typically cash outflows) would be categorized as financing activities, and interest and dividends received (typically cash inflows) would be categorized as investing activities on the statement of cash flows. In the case of Seneca, its current classification practice would not change for interest paid. The current categorization of dividends paid as an operating activity would need to change to a financing activity.

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PROBLEM 22.13 (CONTINUED) f.

(1) For a severely financially troubled firm: Operating: Probably a small cash inflow or a cash outflow. Investing: Probably a cash inflow as assets are sold to provide needed cash. Financing: Probably a cash inflow from debt financing (borrowing funds) as a source of cash at high interest cost. (2) For a recently formed firm that is experiencing rapid growth: Operating: Probably a cash outflow. Investing: Probably a large cash outflow as the firm expands. Financing: Probably a large cash inflow to finance expansion. For Seneca, excluding the unusual transaction of the flood, the company is more likely type (2), a company experiencing growth.

At first glance, an investor might come to the quick conclusion that Seneca’s net cash flow provided by operating activities ($19,900) is greater than Seneca’s accrual basis net income ($16,700), and that the net cash flow provided by operating activities does correspond to the amount of accrual basis net income that the company has reported. Seneca’s reported net income, which is affected by estimates and management’s choice of accounting policies, may be judged to be of lower quality and perhaps less reliable. However, upon analyzing Seneca’s net cash flow provided by operating activities, the investor may note that a significant return to shareholders (dividends paid of $6,000) is classified as an operating activity and that the amount was not deducted in the company’s calculation of accrual basis net income. The investor may conclude that Seneca’s quality of earnings may be reasonable, with a lower margin of potential misstatement.

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CASE Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer at the end of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 22.1 PAPADOPOULOS LIMITED (PL) Case Overview PL is Canadian retail merchandiser in its second year of operations and is currently considering an expansion into the U.S. PL will need financing to support this expansion. The bank is the main user of the financial statements and will use them to determine whether a loan for expansion will be granted. In the past, PL has prepared its statements for income tax purposes only. ASPE financial statements will enhance credibility and reliability. The statement prepared by Tonya does not conform with ASPE and must be redrafted.

Recommendations and Analysis Prior to addressing any issues, the cash flow statement must be redrafted. It has been prepared and presented as follows:

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CA 22.1 PAPADOPOULOS (CONTINUED) Papadopoulos Limited Statement of Cash Flows For The Year Ended December 31, 2023 Cash flows from operating activities: Cash received from customers Cash received for interest Payments for goods Payments for operating expenses Payments for interest Net cash used in operating activities Cash flows from investing activities: Proceeds from disposal of term deposit Purchase of property, plant, and equipment Purchase of investment Net cash used in investing activities Cash flows from financing activities: Proceeds from shareholder loan Proceeds from financing Cash provided by financing activities Net increase in cash

$350,000 10,000 (250,000) (90,000) (30,000) (10,000)

$100,000 (150,000) (55,000) (105,000) 150,000 50,000 200,000 $ 85,000

An assessment of the statement includes the following observations: The operating activity section of the statement indicates that more cash is required to maintain operations. This is concerning and will be viewed negatively by the bank, since internally generated cash from operations is what the company would be using to repay any loan granted. The large payments for inventory (goods) may be indicator of potential working capital management issues. Also, if the term deposit had a maturity of three months or less when it was acquired, it would likely be better classified as affecting cash equivalents, not investing activities. If this was the case, the company would actually show an overall net decrease in cash of $15,000.

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CA 22.1 PAPADOPOULOS (CONTINUED) This is only the second year of operations, the company is profitable, and the cash required for operations is not large. The bank may be somewhat flexible, provided the loans from shareholders do not require repayment in the future. The company is liquidating what appears to be non-essential assets (term deposit) and using the money to buy productive assets to be used to generate income. Excess cash has also been invested. Both of these activities will be viewed positively and is an example of good management (i.e., it will maximize return on excess cash by investing). However, the excess cash is only present due to the shareholder loan. The dependence on shareholder loans is preferable to external borrowing since the shareholders (all family) may be more flexible if the company cannot make interest and principal repayments on time. In conclusion, based on the redrafted statement of cash flows, it is unlikely that the bank would approve a request for financing from PL. It is unlikely that PL will be viewed favourably by the bank primarily because it is a new company and the cash flow from operations is negative. The only reason there is excess cash is a direct result of the shareholder loan.

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INTEGRATED CASES IC 22.1 EARTHCOM INC. Case Overview Earthcom is a publicly traded company that currently works in the telecommunications industry and has had a major service disruption. The company is having difficulty restoring services and is experiencing threats of lawsuits from unhappy customers. Since it is a public company, IFRS is a constraint. The shares are declining in value as a result of the service disruption, which is due to the loss of one of the company’s major assets. The CFO has resigned; therefore, there is pressure on the remaining company executive team to make things look more positive (potential for bias). The auditors will need to ensure that the assets/income are not overstated. The controller needs to provide transparency during this time of crisis. Conservatism would be the safest route, especially since the share price has already plummeted.

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IC 22.1 EARTHCOM INC. (CONTINUED) Analysis and recommendations Issue: One of PL’s main underground telecommunications lines has been cut. PL can not find the source of the problem and is having difficulty fixing the problem. Do not recognize the line as impaired - The company is in the process of doing a substantial amount of work to recover the services. Once this is done, the asset would retain its value. - There is no reason to believe that the company will not be able to find the problem. - A note disclosure would suffice.

Recognize the line as impaired - The severed line represents an event that reduces the potential future benefits of the asset. - PL cannot provide services to customers. Therefore, it is not able to generate future benefits. - Customers have currently lost service. - The company is uncertain as to how long it will take to restore service (if at all). PL does not have a backup plan. - PL stands to lose customers over this, and many customers are threatening to sue. - The company is already restoring other lines using better and newer technology and so these older lines will likely be obsolete and be used less as time goes on.

Recommendation: It is too early to tell if the asset is indeed impaired. Full note disclosure should suffice at this point. Care should be taken at the next quarter with this valuation since by then the company will have a better idea as to the feasibility of restoring service.

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IC 22.1 EARTHCOM INC. (CONTINUED) Issue: PL has to decide on how to treat the amounts spent on lawyers and consultants regarding the severed line. Capitalize costs - Without these expenditures, significant goodwill will be lost. - Many customers may also leave the company, this is an opportunity to show how the company deals with a crisis.

Expense the costs - The expenditures do not add any future value. - This is really just maintaining the company’s existing reputation. - Internally generated goodwill may not be capitalized.

Recommendation: It is more conservative to expense the costs since these costs just really maintain the status quo and provide damage control. Issue: PL must determine how to account for expenditures incurred to track down the problem and identify where the line was cut. Capitalize costs Expense - PL may argue that the work - Money being spent is to being done is creating an restore service and put PL’s asset with future benefits. assets back into use. This will allow the company to - These costs are not an asset, deal with similar problems in i.e., the costs will not a much more expedient way necessarily make the service in the future. better or enhanced. - As long as this has future - With high tech equipment, benefit, as described above, maintenance of the then it should be accounted technology is an ongoing cost for as an asset. of doing business. There is always a risk that the technology will fail or become outdated. The company must keep on top of this on an annual basis. Solutions Manual 22.145 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

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IC 22.1 EARTHCOM INC. (CONTINUED) Recommendation: Certain costs may add value (mapping) and may be capitalized. Those costs that are being spent just to restore capacity to prior levels are maintenance costs and must be expensed. Issue: How to present and account for the funds spent on upgrading old telecommunications lines. The auditors have questioned PL’s choice to capitalize these costs and have suggested that these costs should be expensed. Capitalize/treat as investing Expense/treat as operating activity on the statement of cash activity on the statement of cash flows flows - PL must be able to - All significant assets such as demonstrate that these these degrade over time and expenditures will provide need to be maintained. future benefit. - This is merely part of the - This sounds like it is a major ordinary ongoing activities of upgrade and given the fastthe company to maintain the paced technology service potential of its assets. requirements within the - This will show as an industry it could be argued operating activity on the cash that this is an asset. flow statement as this is a - PL may need to treat these normal ongoing cost of doing as separate components for business that will likely recur depreciation purposes if the annually or frequently due to amount is significant and the the high-tech nature of the expected life and usage assets. differs between the lines. - This will show as an investing activity on the cash flow statement as the company is investing in its future.

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IC 22.1 EARTHCOM INC. (CONTINUED) Recommendation: PL may be able to argue that these costs be capitalized due to changes in technology. Therefore, capitalization and presentation as an investing activity is acceptable. Issue: Customers are threatening to sue PL due to the disruption in service. Accrue costs - The company will want to settle quickly to minimize uncertainty in the marketplace especially since PL’s CEO stepped down, leaving the company without a leader. - PL may want to accrue a reasonable amount for settlement so that it can hire a new CFO and move forward and deal with the crisis.

Do not accrue costs - Too early to be able to assess probability and measurement.

Recommendation: Too early to tell at this point. Therefore, do not recognize. There is no lawsuit. The news will likely already be in the marketplace via newspapers, etc. The company can best deal with this by putting a new CFO in place (not really a financial reporting issue).

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RESEARCH AND ANALYSIS RA 22.1 DOLLARAMA INC. a. A comparison of the major categories of sources and uses of cash for fiscal year end 2021 and 2020 is provided below (expressed in thousands). (CDN$ in thousands) Net cash from operating activities Net cash used in investing activities Net cash used in financing activities Net increase (decrease) in cash Cash beginning of the year Cash at end of year

2021 $889,082 (264,525) (275,877) 348,680 90,464 $439,144

2020 $732,508 (199,313) (493,102) 40,093 50,371 $90,464

Cash generated from operations for the year as at January 31, 2021 is a net cash inflow of $889,082 and for the previous fiscal year ended February 2, 2020, the net cash inflow was $732,508. Cash provided from operating activities is significantly higher than total comprehensive income of $531,728 and $573,276 respectively. A review of the major adjustments used to reconcile net income to cash flow from operations explains why there is such a difference: Adjustments to the 2021 net earnings included an increase of $269,633 relating to (noncash) depreciation, whereas at the 2020 year end, the adjustment was $242,785. Other significant adjustments to net income, in order to turn net income into a cash number from an accrual one, include: deferred income taxes that contributed $15,843 and $15,015 respectively (consistent year over year), and share of equity accounted investments of ($19,654) and ($10,263) respectively. Another major component of adjustments includes the changes in operating working capital. Changes in operating working capital consisted of net cash inflows of $55,531 by year end 2021,whereas these changes consisted of net cash outflows of $84,356 by year end 2020. Note 18 shows the following breakdown of changes in non-cash working capital:

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RA 22.1 DOLLARAMA INC. (CONTINUED)

(CDN$ in thousands) Accounts receivable Prepaid expenses

2021 $14,06 1

2020 $1,222

386

5,639

Prepaid income taxes

1,777

Inventories Accounts payable and accrued liabilities

(7,164)

Income taxes payable

12,744

(42,26 2) (12,60 0) (36,35 5) (84,35 6)

33,727

55,531

This illustrates that operating working capital resulted in cash outflows for all items except for inventory in 2021, which is fairly typical. In addition to an outflow of inventory at fiscal year end 2020, there was a cash outflow in accounts payable and accrued liabilities. Interesting to note that overall in 2021, there was a cash inflow from working capital accounts while there was a net cash outflow for 2020, which is mainly attributed to a large outflow for inventories. Net cash used in investing activities increased from a net cash outflow of $199,313 in 2020 to $264,525 in 2021. This change is explained by additional cash payments in 2021 for: acquisition of equity-accounted investments of $97,281, additional property plant and equipment $140,040, and additions to intangible assets $27,797. Net cash used by financing activities decreased to $275,877 in 2021 from $493,102 in 2020. This change is primarily due to fewer repurchase and cancellation transactions of common shares in 2021; $87,042 compared to $327,155 in the previous year. A note of interest would be the $300,000 in and out under financing activities. It would appear that Dollarama refinanced debt, likely for more favourable interest arrangements / terms. b.

Dollarama uses the indirect method to report operating cash flows in the statement of cash flows. The indirect approach is useful in giving the user information about how the net earnings or losses of the company translate into cash.

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RA 22.1 DOLLARAMA INC. (CONTINUED) The indirect method provides adjustments to net income (loss) and arrives at a single cash flow from operations line. It does provide a useful link between the statement of cash flows and the income statement and balance sheet. This format is the most commonly used format for public companies and has the advantage of being a familiar format to users. In contrast, the direct approach would provide more detailed information on the various sources of cash flows in operations and provide more predictive value and more transparency to users. c.

Finance costs are shown as part of operating activities, but in an indirect manner. Finance costs of $95,646 in 2021 ($100,605 in 2020) were incurred as shown on the Statement of Net Earnings and Comprehensive Income. These costs are included in the starting point on the statement of cash flows in net income of $564,348 and $564,039 respectively. In addition, there are noncash financing costs on long term debt added back to net income of ($356) in 2021 and $1,138 in 2020. Dividend payments of $54,770 in 2021 ($54,144 in 2020) are shown as cash outflows in financing activities. Summary of significant accounting policies (Note 3), subsection Property, plant and equipment indicates that the company includes directly attributable borrowing costs in the cost of property, plant and equipment.

d. The debt to total assets ratio is a solvency ratio that measures the percentage of total assets provided by creditors. It provides a measurement of whether a company could add to its debt financing if needed.

Total assets Total debt Debt to total assets

2021 $4,223,746 3,888,892

2020 $3,716,456 3,808,652

92.1%

102.5%

Dollarama’s high debt to assets ratio is indicative of higher risk and lower solvency. Dollarama has many non-liquid assets including goodwill, right-ofuse assets, property, plant and equipment, intangible assets, and equityaccounted investments. The company also has a significant amount of longterm debt along with capitalized lease liabilities. The company’s solvency has improved from one year to the next but is still relatively high. However, the statement of cash flows shows year over year cash inflows from operating activities, and increasing cash on hand year over year. While overall, this solvency is not a good sign for investors, cash generated is increasing. Based on the financing activities section of the cash flow statement, other than dividend payments, the only significant cash outflow for liabilities is going towards lease payments, and little to none towards long term debt repayments. Solutions Manual 22.150 Chapter 22 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited

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RA 22.1 DOLLARAMA INC. (CONTINUED) The other significant source of cash outflows is the repurchase of common shares. In the short term, this contributes to appreciation of share price on the secondary market, however it is not a long-term sustainable practice if debt is not being paid down.

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RA 22.2 BOMBARDIER INC. a. Bombardier Inc. manufactures and sells state-of-the-art trains and airplanes. As a result, they have a long manufacturing and cash cycle. As described in note 2: • Revenues from long-term contracts related to designing, engineering, or manufacturing specifically designed products (including rail vehicles, vehicles overhaul, and signaling contracts) and service contracts are recognized using the percentage-of-completion method. The percentageof-completion method is calculated by actual costs incurred to the total costs for the entire contract. Revenue is recognized only to the extent that the expenses incurred are expected to be recovered when the contract outcome cannot be measured reliably. • Revenues from the sale of new aircraft are recognized when the aircraft has been delivered, as this is the point in time that risks and rewards of ownership have been transferred, the amount of revenue can be measured reliably, and collection of the related account receivable is reasonably assured. All costs incurred or to be incurred in connection with the sale, including warranty costs and sales incentives, are charged to cost of sales or as a deduction from revenues at the time revenue is recognized. • Sales of goods and services sometimes involve the provision of multiple components. In these cases, the Corporation determines whether the contract or arrangement contains more than one unit of accounting. When certain criteria are met, such as when the delivered item has value to the customer on a standalone basis, the recognition criteria are applied to the separate identifiable components of a single transaction to reflect the substance of the transaction. Conversely, two or more transactions may be considered together for revenue recognition purposes, when the commercial effect cannot be understood without reference to a series of transactions as a whole. Revenue is allocated to the separate components based on their relative fair value. • Revenues from sale of pre-owned aircraft and spare parts are recognized when the goods have been delivered, risks and rewards of ownership have been transferred to the customer, the amount of revenue can be measured reliably, and collection of the related receivable is reasonably assured. As can be seen from the above, there may be significant timing differences between the time that cash is received on a sale or from billings and subsequent collections on long-term construction contracts and the time revenue is recognized. In addition, there will also be significant differences in timing as to when cash payments are made for costs and when contract expenses are reported in net income.

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RA 22.2 BOMBARDIER INC. (CONTINUED) b. The schedule below shows the net income (loss) and operating cash flows for each year. In US$ millions Net income (loss) Net cash flow from operating activities Difference increase (decrease) Year over year percentage change in income Year over year percentage increases (decreases) in operating cash flows 1

2020 2019 $(568) $(1,607) (2,821) (2,253)

2018 2 $318

2017 $(525)

597 279

531 1,056

(680) 927

65%1 (315%)

12%

The percentage change was restated as a positive amount. Given that the underlying numbers are losses, a decrease in a loss is a positive change. Numbers from 2017 and 2018 were obtained from the 2018 annual report.

c. In US$ millions Net income (loss) Impairment charges Income (loss) without impairment charges Net cash flow from operating activities Difference between Income (loss) without impairment and Cash flow Year over year percentage change in income (without impairment) Year over year percentage increases (decreases) in operating cash flows

2020 2019 $(568) $(1,607) 42 1,574

2018 $318 11

2017 $(525) 51 (474)

(526)

(33)

329

(2,821)

(680)

597

(2,295)

(647)

268

(1,494%)1

169%

(315%)

12%

Note 8 to the 2020 financial statements for special items lists impairment charges for ACLP investments in 2020 as nil and $1,578 in 2019. Note 21 lists impairment charges (reversal) to PPE of $7 in 2019 (although the statement of cash flows shows this as a reversal of $4) and $42 in 2020. When excluding impairment in net earnings, the percentage difference from one year to the next shows significant deterioration from 2018 to 2020. Large impairment charges in 2019 caused significant variation in the percentage change of net losses and operating cash flows.

531 1,005

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RA 22.2 BOMBARDIER INC. (CONTINUED) d. The schedule below highlights the causes of additional significant differences between net income (loss) and operating cash flows. Note 35 in 2020 financial statements and Note 34 in 2019 financial statements provides information for major differences in the non-cash balances. In US$ millions Net income (loss) Amortization Impairment charges Gains on disposals (PPE & investments) Total of other non-cash items Changes in non-cash balances Net cash flow from operating activities Changes in non-cash balances (see Note 35 in 2020 and 34 in 2018) Trade and other receivables

2020 $(568) 510 42 (1,289) 0

2019 $(1,607) 422 1,574 (740) 148

(1,516) ($2,821)

(477) ($680)

2020

2019

2018 $318 272 11 (636) 644 (12) $597 2018

$396

($345)

$(317)

Inventories Contract Assets Contract Liabilities

682 (736) (945)

(976) 141 1,186

(841) (306) 1,222

Other financial assets and liabilities, net

(442)

(11)

380

151 (583) 57 (110) 14 ($1,516)

(75) 414 (707) 53 (157) ($477)

183 759 (579) 69 (582) ($12)

Other assets Trade and other payables Provisions Retirement benefits liability Other liabilities Net change in non-cash balances

As can be seen from the above schedule, there are significant changes in inventories, accounts payable, contract assets and liabilities, trade and other payables, provisions, and other liabilities. All these accounts are impacted by the timing of recognizing revenue (and related costs) and cash receipts from customers and payments for expenses. These large variations each year indicate that cash flows from operating activities are very different from reported earnings.

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RA 22.2 BOMBARDIER INC. (CONTINUED) e.

As seen from the above analysis, predicting cash flows will be extremely difficult given the large variations from year to year, with little correlation to net income (loss) trends. In this case, a direct approach might be more helpful, given that the cash flows from customers and payments to suppliers and employees would be more transparent. Using the indirect approach, it is not possible to calculate the cash receipts and cash payments from normal operating activities.

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RA 22.3 CORBY SPIRIT AND WINE LIMITED a.

The amounts of cash inflows and outflows at the sub-total level for the fiscal years ended June 30, 2021 and 2020 are presented below. In thousands of Canadian dollars Net cash from operating activities Net cash used in investing activities Net cash used in financing activities Net increase in cash Cash beginning of the period Cash at end of the period

2021

2020

$40,911

$49,542

(15,443)

(23,491)

(25,468)

(26,051)

The major difference in the statement of cash flow for Corby’s is the nil balance of cash at the beginning and end of each fiscal year as well as the nil change in cash for the fiscal year. Instead of holding cash, Corby participates in cash pooling arrangements along with other related companies administered by Citibank. The income generated from the high levels of cash is greater than the financial expenses incurred in the year. Transactions involving increases or decreases in cash held in the cash management pool are treated as an investing activity on the statement of cash flows. The deposits in cash management pools on the consolidated balance sheets went from $81,681 in 2020 to $94,399 in 2021. This reflects an increase of $12,718. This amount is shown as part of investing activities. b.

Corby has few tangible capital assets. A large portion of non-current assets are intangible assets. Consequently, there is not a large need for cash to be used for investing activities. The net cash outflows from investing activities of 2020 relate mainly to deposits in cash management pools and additions to property plant and equipment. Consistent with the reduced levels of investment in capital assets is the absence of long-term debt for financing on the balance sheet. No debt was obtained or repaid in 2020 and 2021. Dividends paid make up the majority of cash used in financing activities, with the remaining going towards lease payments.

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RA 22.3 CORBY SPIRIT AND WINE LIMITED (CONTINUED) c. In thousands of Canadian dollars

2021

Classification

Note 21: Interest income Note 21: Interest expense on lease liabilities Note 21: Net financial impact of pensions

$633 (126)

Operating Operating

(454)

Operating

509 (23,914)

Operating Financing

Interest received Dividends paid

The IASB is proposing that interest and dividends paid (typically cash outflows) would be categorized as financing activities, and interest and dividends received (typically cash inflows) would be categorized as investing activities on the statement of cash flows. In the case of Corby, its current classification practice would change. As can be seen in the table, all interest income and expense items are included in the operating section. If this change were to go through, the interest income would be moved to the investing activities section, and the interest expense items would be categorized under financing activities. The current categorization of dividends paid as a financing activity would remain unchanged. If Corby was in the business of providing financing to customers, the disclosure of interest and dividends would depend on the classification of the related income and expenses in its statement of profit or loss. d. in thousands of Canadian dollars Dividends paid Dividends as a % of cash from operating activities Net earnings Dividend payout ratio

2021

2020

$23,914

$24,483

58.5%

49.4%

$30,591

$26,652

78.2%

91.9%

The payout ratio is extremely high, although it has decreased from 2020 into 2021. Corby is controlled by Hiram Walker and Sons Ltd. that is in turn a wholly owned subsidiary of Pernod Richard, SA, a French limited company that controls the majority of the voting shares of Corby. Consequently, to the extent that cash is generated from the Corby business, Pernod Richard is in a position to determine and control the amount of dividends paid out.

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MMXXII vii F3

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CHAPTER 23 OTHER MEASUREMENT AND DISCLOSURE ISSUES Learning Objectives 1. Understand the importance of disclosure from a business perspective. 2. Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes. 3. Describe the disclosure requirements for major segments of a business. 4. Describe the requirements and accounting problems associated with interim reporting. 5. Discuss the accounting issues for related-party transactions. 6. Identify the accounting issues relating to subsequent events and those faced by unincorporated businesses. 7. Identify the major considerations relating to bankruptcy and receivership. 8. Identify the major disclosures found in the auditor’s report. 9. Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis. 10. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.

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Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

BT Item

1. 2. 3. 4. 5 6.

1 2 2 2 2 3

C C C C C C

1. 2. 3.

2 2 2

C C C

1. 3 AP 2. 2,10 C 3. 6 AP 1.

1,4

4,5

1. 2.

3,8 5,6

AP AP

BT Item LO BT Item LO BT Item LO Brief Exercises 7. 3 AP 13. 5 AP 19. 7 C 25. 9 8. 3 AP 14. 5 AP 20. 8 C 26. 3,9 9. 3 AP 15. 5 AP 21. 8 C 10. 4 K 16. 5 C 22. 9 AP .11. 4,10 C 17. 6,10 C 23. 9 AP 12. 5,10 AP 18. 6 C 24. 9 C Exercises 4. 3 AP 7. 6 C 10. 2,8 C 13. 2,9 5. 5 AP 8. 6 K 11. 9 AP 14. 2,9 6. 5 AP 9. 7,8 C 12. 9 AP 15. 9 Problems 4. 2 C 7. 2,6 C 10. 6 AP 5. 2 C 8. 2 C 11. 9 AP 6. 3 C 9. 2 AP Cases 2. 3. Integrated Cases 2. 1,2 AN 3. Research and Analysis 3. 4 AP 5. 4 AP 6. 6,7,9 AN 7. 10 4. 4 AP

BT AP AP

AP AP AP

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Summary of Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

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ASSIGNMENT CLASSIFICATION TABLE Topics

Brief Exercises

Exercises Problems

Disclosure from a business perspective.

Full disclosure principle 2, 3, 4, 5 and accounting policy notes.

1, 2, 3, 10 2, 3, 4, 5, 7, 8

Segment reporting; diversified firms.

6, 7, 8, 9, 25

54.

Interim reporting.

10, 11

Related-party transactions.

12, 13, 14, 15, 16

5, 6

Subsequent events.

17, 18

7, 8,

2, 3, 7, 11

5.7.

Bankruptcy and receivership

Auditor’s report.

20, 21

9, 10

4, 5

Financial statement analysis.

22, 23, 24, 25, 26

11, 12, 13, 12 14, 15

1, 6, 9

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ASSIGNMENT CHARACTERISTICS TABLE Item

Description

Level of Time Difficulty (minutes)

E23.1 E23.2 E23.3 E23.4 E23.5 E23.6 E23.7 E23.8 E23.9 E23.10 E23.11 E23.12 E23.13 E23.14 E23.15

Disclosure Illegal acts Accounting policies Segmented reporting Related-party transaction Related-party transaction Subsequent events Subsequent events Receivership and bankruptcy Auditor’s report Percentage analysis Percentage analysis Percentage analysis Ratio analysis Analysis of given ratios

Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Complex Moderate Moderate Moderate

15-20 15-20 10-15 10-15 20-25 20-25 15-20 10-15 10-15 10-15 20-25 35-45 15-20 20-25 20-25

P23.1 P23.2 P23.3 P23.4 P23.5 P23.6 P23.7

Segmented reporting General disclosures Subsequent events Disclosures required in various situations Disclosures required in various situations Segment reporting—theory Disclosures, conditional and contingent liabilities General disclosures, inventories, property, plant, and equipment Segment reporting Subsequent events Ratio analysis and projections

Moderate Moderate Complex Moderate Moderate Simple Simple

25-30 30-40 40-50 20-25 30-35 20-25 25-30

Simple

10-20

Moderate Moderate Complex

30-35 20-25 50-60

P23.8 P23.9 P23.10 P23.11

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 23.1 Full disclosure is essential to the proper functioning of capital markets because the information provided in financial statements and the accompanying notes to financial statements is used by investors in making investing decisions. Investors rely on this information to compare the performance of similar companies and to assess the relative risks and returns of different investments. Full disclosure of all material information helps ensure that investors make investing decisions based on faithfully representative information. Full disclosure also specifically supports relevance, the ability to use the financial information to predict future cash flows and to confirm that information in the future. Private companies generally have fewer disclosure requirements because many private entities have less complex business transactions and the stakeholders of private companies (such as shareholders) tend to have greater access to information about the entity. Overall, increased disclosure requirements for public companies helps ensure economic resources are allocated efficiently and that capital markets function properly. LO 1 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.2 a.

The increased likelihood that the company will suffer a costly strike requires no disclosure in the financial statements. The possibility of a strike is an inherent risk of many businesses. It, along with the risks of war, recession, etc., is in the category of general news and reporting on such a general contingency is beyond the scope of financial reporting.

A note to the financial statements should provide a description of the discontinued operation in order that the financial statement user has some understanding of the nature of this item and its effect on financial performance and position. The reason for the disposition should also be included in the note.

Gain contingencies and contingent assets are not recorded in the accounts. However, contingent assets that may materially affect a company’s financial position should be disclosed where an inflow of economic benefits is probable. In most situations, an asset would not be recognized until the claim settlement occurs, at which time the related asset is no longer a contingent asset, and its recognition is appropriate.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.3 The reader should recognize that the firm has an obligation for lease payments of approximately $6,711,000 for each of the next three years. In certain situations, this information is very important in determining: (1) the ability of the firm to use additional lease financing, and (2) the nature of maturing commitments and the amount of cash expenditure involved. Off–balance-sheet financing is common and the investor should be cognizant that the company has a commitment even though it is not reflected in the liability section of the SFP. The rental income from the subleases also provides useful information concerning the company’s ability to generate revenues and to cover, in part, the cash flow commitment in the three-year period. LO 2 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.4 The reader should recognize that there are dilutive securities outstanding and that the overall impact on earnings per share (EPS) must be compared to recent and current EPS to be meaningful. In addition, the purchase of shares enabled the company to increase its EPS. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 23.5 I disagree with the president. Although Uddin may have had a longstanding practice to distribute dividends in a consistent and timely fashion over the years, this practice is at the discretion of the board of directors and could change at any time. Shareholders know the limitation of dividends and would likely be confused concerning any entitlement should a statement concerning dividends appear in the list of accounting policies of the company. The dividend payments are a practice of the business and not a policy, in the sense of an accounting policy to the financial statements. The additional section of the Management Discussion and Analysis (MD & A) to the annual report will contain such management statements. The MD & A is intended to allow stakeholders to view the company through the eyes of management. The MD & A is not audited. LO 2 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.6 It should be emphasized that because a company discloses its segmented results, this does not relieve the necessity for providing consolidated results as well. Sometimes individuals become confused because they believe that using segmented reporting means that consolidated statements should not be presented. There is a need to provide both types of information. The consolidated results provide information on overall financial position and profitability, while the segmented results provide information on the specific details that comprise the overall results. Segmented information is needed in part because (a) sales and earnings of individual segments are needed to forecast consolidated profits because of the differences among segments in growth rate, risk, and profitability, and (b) segmented reports disclose the nature of a company’s businesses and the relative size of the components, which aids in evaluating the company’s investment worth. LO 3 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 23.7 Total revenues: $600 + $650 + $250 + $375 + $225 + $200 + $700 = $3,000 Revenue threshold: $3,000 X 10% = $300 Therefore, Gamma, Kennedy, Red Moon, and Nuhn meet this test and are reportable segments under IFRS. Note that the revenue employed in this calculation includes both sales to external customers and intersegment sales or transfers, not consolidated revenue. Segmented reporting is not required under ASPE. LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.8 Greater of a or b (in absolute terms) compared to operating profit or loss: a. Segments reporting a loss: (40) + (20) = (60) x 10% = $6 b. Operating profits: $90 + $25 + $50 + $34 + $100 = $299 Operating profits threshold: $299 X 10% = $29.9 Therefore, Gamma, Kennedy (loss), Red Moon, Tsui, and Nuhn meet this test and are reportable segments under IFRS. LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 23.9 Segment assets: $500 + $550 + $400 + $400 + $200 + $150 + $475 = $2,675 Segment assets threshold: $2,675 X 10% = $267.5 Therefore, Gamma, Kennedy, RGD, Red Moon, and Nuhn meet this test and are reportable segments under IFRS. LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.10 The accounting problems related to the presentation of interim data include: (a) Changes in accounting policies or methods. (b) The difficulty of allocating costs, such as income tax, pensions, etc., to the proper quarter. (c) Presentation of earnings per share (EPS) figures (basic and diluted). (d) Seasonality. (e) Auditor’s involvement in interim reports. LO 4 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.11 Seasonality affects interim reports when wide fluctuations in profits occur because off-season sales do not absorb the company’s fixed costs. These costs often tend to remain fairly constant regardless of sales or production. Revenues are recognized when the performance obligations are satisfied and expenses must be recognized and accrued when they are incurred according to IFRS. Companies can only defer recognition of costs or revenues when it is appropriate to do so. Deferral of costs is not appropriate unless the costs meet the definition of an asset. (Note: ASPE does not contain any guidance for reporting segmented information or interim reporting.) It is difficult to completely overcome the problem of seasonality, but disclosure as to the nature of the seasonality factors that face the business and the pattern of revenues and expenses (including comparative data) may help users of the financial statements understand whether seasonality is an adverse issue in any particular case. The effects of seasonality would be the same for companies following IFRS and ASPE, except that the level of disclosure would be enhanced for those using IFRS. LO 4,10 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.12 (a)

ASPE: Land .......................................................... Cash ....................................................

390,000 390,000

This is a related-party transaction. The transaction is not considered to be in the normal course of operations of the company. Since the land is acquired from the company president (assuming the president is not a significant shareholder) there is a change in ownership of the land. As well, the amount of the exchange is supported by an independent appraisal. The transaction is therefore measured at the exchange amount. Disclosure of the transaction would include a description of the relationship, a description of the transaction and amount, measurement basis, and any amounts due to the company president. However, if the president is a significant shareholder, and especially if the president holds a controlling interest and this is a noncash transaction, a different conclusion may be reached as to how the transaction should be valued, as there is no beneficial change in ownership in the assets.

(b) The major difference between ASPE and IFRS is that IFRS does not mandate remeasurement of a related-party transaction. LO 5,10 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.13 This is a related-party transaction since the same individual owns the two companies. Since the transaction is not in the normal course of business, there is no commercial substance, and there is no beneficial change in ownership in the assets, the transaction would be recorded at the carrying amounts of the assets involved. Fibreright Corp. Equipment (new) .................................................... 15,100 Accumulated Depreciation–Equipment1 ............... 9,000 Equipment (old) ............................................. 20,000 Contributed Surplus...................................... 4,100 1 ($20,000 - $11,000) Frederick Corp. Equipment (new) .................................................... 11,000 Accumulated Depreciation–Equipment2 ............... 19,900 Retained Earnings .................................................. 4,100 Equipment (old) ............................................. 35,000 2 ($35,000 - $15,100) Under ASPE, certain related-party transactions must be remeasured to the carrying amount of the underlying assets or services that were exchanged. This is the case if the transaction is not in the normal course of business, there is no substantive change in ownership, and/or the exchange amount is not supported by independent evidence. Transactions that are in the normal course of business that have no commercial substance must also be remeasured, and where the transaction is also a nonmonetary transaction, no gain or loss should be recognized. Note however, that IFRS does not mandate remeasurement of related-party transactions. LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.14 This transaction is a nonmonetary exchange. Since the equipment performs different functions, the transaction would be considered to have commercial substance. The transaction would therefore be measured at the exchange amount. Fibreright Corp. Equipment (new) .................................................... 20,800 Accumulated Depreciation–Equipment1 ............... 9,000 Equipment (old) ............................................. 20,000 Gain on Disposal of Equipment ................... 9,800 1 ($20,000 - $11,000) Frederick Corp. Equipment (new) .................................................... 20,800 Accumulated Depreciation–Equipment2 ............... 19,900 Equipment (old) ............................................. 35,000 Gain on Disposal of Equipment ................... 5,700 2 ($35,000 - $15,100) LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.15 If the shareholder owned only 40%, there is a presumption that there has been a substantive change in ownership. A change in ownership is considered substantive where an unrelated party has gained or given up > 20% interest in the item exchanged. In the case of a substantive change in ownership, the transaction would be recorded in the same way as in BE23.14. Fibreright Corp. Equipment (new) .................................................... 20,800 Accumulated Depreciation–Equipment1 ............... 9,000 Equipment (old) ............................................. 20,000 Gain on Disposal of Equipment ................... 9,800 1 ($20,000 - $11,000) Frederick Corp. Equipment (new) .................................................... 20,800 Accumulated Depreciation–Equipment2 ............... 19,900 Equipment (old) ............................................. 35,000 Gain on Disposal of Equipment ................... 5,700 2 ($35,000 - $15,100) LO 5 BT: AP Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 23.16 Cruton and Bigelow are related parties. Transactions between related parties are disclosed to ensure the users of the financial statements understand the basic nature of some of the transactions. Because it is often difficult to separate the economic substance from the legal form in related-party transactions, disclosure is used extensively in this area. Purchase of a substantial block of the company’s common shares by Bigelow, coupled with the use of a Bigelow affiliate to act as food broker, suggests that disclosure is needed. LO 5 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.17 (a)

IFRS (1) The flood loss ($80,000) is an event that provides information about conditions that did not exist at the SFP date but are subsequent to that date. It does not require adjustment of the financial statements. (2) Under IFRS, the subsequent period ends when the financial statements are authorized for issue. Because the liability was settled before the financial statements are authorized for issue by the board of directors, the financial statements should include adjustment of the liability. As a result, pretax income will decrease by $50,000. The settlement of the liability is the type of subsequent event that provides additional evidence about conditions that existed at the SFP date, so the financial statements should be adjusted accordingly.

(b) ASPE (1) The flood loss would not require adjustment of the financial statements, for the same reasons as stated above. (2) Under ASPE, the subsequent event period generally ends when the financial statements are complete. The date is a matter of judgement, taking into account management structure and procedures followed in completing the statements. If it is judged that the statements were complete on March 10, 2024, the settlement of the liability would not require adjustment of the financial statements. However, if it is judged that the statements are complete on March 17, 2024 (the date the statements are authorized for issue), pretax income will decrease by $50,000 as a result of the adjustment of the liability. LO 6,10 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.18 (a) “Subsequent events” are of two types: (1) Those that provide additional evidence about conditions that existed at the SFP date, affect the estimates used in preparing financial statements, and therefore, result in needed adjustments. (2) Those that provide evidence about conditions that did not exist at the SFP date but arose subsequent to that date and do not require adjustment of the financial statements but whose effects may be significant enough to be disclosed with appropriate figures or estimates shown. (b) 1. (i) Adjust the financial statements directly as the condition existed on the financial position date. 2. (ii) Disclosure. 3. (ii) Disclosure. 4. (ii) Disclosure. 5. (iii) Neither adjustment nor disclosure necessary. 6. (iii) Neither adjustment nor disclosure necessary. 7. (i) Adjust the financial statements directly as the condition existed on the financial position date. 8. (iii) Neither adjustment nor disclosure necessary. LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

BRIEF EXERCISE 23.19 The Nortel employees eligible to receive pension funds would be unsecured creditors in the bankruptcy. This explains why employees needed to take legal action to participate in the final distribution of remaining funds. Although the employees were promised that contributions to the pension fund would be made by Nortel as described and documented in employment agreements, these agreements were not guaranteed, nor secured using assets. LO 7 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

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BRIEF EXERCISE 23.20 The auditor expresses an unmodified opinion when the client’s financial statements present fairly, in all material respects, the client’s financial position, results of operations, and cash flows, on the basis of an examination made in accordance with Canadian Auditing Standards (generally accepted auditing standards), and the statements are in conformity with generally accepted accounting principles (IFRS or ASPE) and include all informative disclosures necessary to ensure the statements are not misleading. The auditor expresses a qualified opinion when he/she must take exception to the presentation of one or more components of the financial statements, but the exception or exceptions are not serious enough to negate an expression of an opinion or to express an “adverse” opinion. LO 8 BT: C Difficulty: S Time: 10 min. AACSB: Audit CPA: CPA: cpa-t001 cpa-t004 CM: Reporting and Audit

BRIEF EXERCISE 23.21 The first half of the annual report provides potential investors with management’s view of the performance and future plans of the business. This non-financial portion of the annual report is not audited. When outlining key audit matters in the auditor’s report, the auditor is bringing specific attention to those areas in the financial statements which, in the auditor’s view, represent the higher risk of misstatement or highest degree of judgement used by management in the preparation of the financial statements. A potential investor would be well advised to relate the key audit matters to the statements made by management in the non-financial portion of the annual report and make their own assessment concerning the potential risks associated with any investment. LO 8 BT: C Difficulty: M Time: 15 min. AACSB: Audit CPA: CPA: cpa-t001 cpa-t004 CM: Reporting and Audit

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BRIEF EXERCISE 23.22 Percentage (common-size) vertical analysis is as follows:

Net sales Cost of goods sold Gross profit Selling, general and administrative expenses Profit before tax

2023 100% 70% 30%

2022 100% 69% 31%

2021 100% 65% 35%

25% 5%

20% 11%

16% 19%

The company’s profit before tax declined in 2022 due to higher cost of goods sold as a percentage of net sales (compared to 2021). The profit before tax also declined in 2022 vs. 2021 due to the increased selling, general, and administrative expenses as a percentage of net sales. Although the company’s gross profit stabilized in 2023, the company’s expenses relative to net sales are increasing, resulting in further declining profit before tax. LO 9 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 23.23 a.

Total assets for each of the three years are as follows: 2021 = $400,000 2022 = $430,000 2023 = $520,000 Vertical analysis calculations for the three years is set out below: 2023 2022 2021 Current assets Non-current assets Current liabilities Non-current liabilities Common shares Retained earnings

23.1% 76.9% 13.5% 31.7% 28.8% 26.0%

18.6% 81.4% 20.9% 24.4% 26.8% 27.9%

25.0% 75.0% 16.3% 37.5% 25.0% 21.2%

Horizontal analysis calculations for 2023 vs. 2022 follows:

Current assets Non-current assets Current liabilities Non-current liabilities Common shares Retained earnings

2023

2022

$120 400 70 165 150 135

$80 350 90 105 115 120

Diff. $40 50 (20) 60 35 15

% Change 50% 14% (22)% 57% 30% 13%

LO 9 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 23.24 Referring to the research study discussed in chapter 23, some limitations of the financial statement analysis done in BE 23.22 are as follows: 1. Uncertainty about the nature and role of the financial statements. For example, the composition of selling, general, and administrative expenses is uncertain, and it is uncertain whether the income statements have been audited. This may lead users to misinterpret and/or place inappropriate reliance on the information. 2. Uncertainty about the nature of business operations portrayed. For example, the company’s type of business activities and the economic environment that the company operates in are unknown. 3. Uncertainty due to limitations of financial statement measurements and disclosures. The measurements in the income statements are not well understood, because there are no additional disclosures about the accounting policies and practices followed. 4. Uncertainty about management’s motives and intentions. Management’s choices in determining the accounting policies and methods may be motivated by a need to maximize bonuses over time, for example. Many financial statement elements are measured and reported at historical cost which can lead to distortions in assessing performance. Other important limitations of financial statement analysis include that estimated items (such as depreciation expense and bad debt expense which may be included in selling, general, and administrative expenses) may be significant, and that achieving comparability with other companies in the same industry may be difficult.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 23.24 (CONTINUED) Beyond the limitations and factors described above for financial analysis, there are additional limitations that apply to ratio analysis. These limitations include: 1. Many ratios use financial statement balances at a single point in time. Due to seasonality or other factors, the point in time selected is not representative of the normal balance during the operating cycle of the business. 2. Ratios can be manipulated. By timing certain transactions immediately before or after the financial statement date, balances used in ratios can be significantly changed. Making a payment early on outstanding accounts payable will improve a current ratio, assuming the ratio is over 1 prior to the payment. 3. Other considerations in the timing of transactions may cause large changes in balances that are not representative of the reality of the situation. An example would be management timing of the purchase of depreciable assets immediately before the end of the fiscal year to allow claiming a half year of capital cost allowance for tax purposes. 4. Some ratios compare current performance from the income statement with historical cost from the SFP. The historical cost of some long-lived assets may have changed substantially due to inflation. 5. Some businesses that have purchased goodwill are compared to other businesses who have internally developed goodwill that is not capitalized. 6. Businesses that operate as proprietorships or partnerships instead of corporations have, by definition, excluded expenses in operations, including income taxes and the salaries of owners who produce the revenue. LO 9 BT: C Difficulty: C Time: 20 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance Solutions Manual 23-24 Chapter 23 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 23.25 Ratio Current Ratio Quick Ratio Days Payables Outstanding

2025 2.17 0.54 39.54

2024 2.11 0.59 34.98

2023 2.00 0.66 N/A

Current Ratio = Current Assets / Current Liabilities 2023: $7,300 / $3,650 = 2.00 2024: $7,800 / $3,700 = 2.11 2025: $8,250 / $3,800 = 2.17 Quick Ratio = Quick Assets / Current Liabilities 2023: ($600 + $500 + $1,300) / $3,650 = 0.66 2024: ($700 + $500 + $1,000) / $3,700 = 0.59 2025: ($650 + $500 + $900) / $3,800 = 0.54 Days Payables Outstanding = Average Trade Accounts Payable Average Daily Cost of Goods Sold 2024: ($1,700 + $1,750) / 2 = 34.98 ($18,000 / 365) 2025: ($1,550 + $1,700) / 2 = 39.54 ($15,000 / 365) The company shows a positive trend in the current ratio. However, the quick ratio shows deterioration in the quality of the current assets. The two ratios combined show that the increasing liquidity in the current ratio is created from less liquid assets such as inventory and prepaid expenses. These current assets are less liquid than other current assets.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 23.25 (Continued) The days payables outstanding ratio shows an increasing time period for the company to pay off its current liabilities from approximately 35 days in 2024 to almost 40 days in 2025. If the company’s creditors normally have credit terms of 30 days, this shows a disturbing trend, especially when combined with the deterioration in the quick ratio. LO 9 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

BRIEF EXERCISE 23.26 Although colour would enhance the presentation of the following graph, this sample answer is provided as a guide.

Revenues of Industry Segments

Gamma

Nuhn, $700 , 23%

Gamma, $600 , 20%

Kennedy RGD Red Moon

Tsui, $200 , 7%

Suh

Kennedy, $650 , 22%

Tsui Nuhn

Suh, $225 , 8% Red Moon, $375 , 12%

RGD, $250 , 8%

LO 3,9 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

SOLUTIONS TO EXERCISES EXERCISE 23.1 Providing additional information to financial statement users to make the information comparable to other companies in the same industry, while useful, should not be included in the notes to the financial statements. The notes to the financial statement are intended to explain and help interpret the information that is presented in the financial statements. The controller’s suggested additional disclosure would report “as if” financial results and inventory position had Cambosa prepared its financial statements under an alternate set of policies and assumptions (known as “pro-forma”). This pro-forma information is not a reflection of the actual policies and performance of the business and should be excluded from the financial statements. The discussion of the comparison of results to others in the industry and the impact of FIFO versus LIFO on performance and position could be mentioned in the president’s letter to the shareholders or elsewhere in the annual report such as in the unaudited Management Discussion and Analysis. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.2 a.

Some examples of illegal acts (the violation of laws and regulations) may include: • paying bribes or “kickbacks” to secure business for the entity • criminal activities committed by the company or its employees on behalf of the company • violations of laws and regulations that affect financial statement amounts or disclosures, such as the tax laws • violations of laws and regulations that have a fundamental effect on the entity’s industry and its operations, such as violating pollution control and environmental laws for a chemical company.

Generally, illegal acts, if detected by authorities, are likely to give rise to criminal penalties, often including some form of financial liability. As a result, when an illegal act occurs and an accountant or auditor fails to detect it, a material liability may be omitted from the financial statements (as, arguably, all illegal acts are material). Another possibility is that the potential liability fails to satisfy the requirements of an accrual, in which case note disclosure of the contingency will incorrectly be omitted from the financial statements. In addition, revenues and expenses derived from an illegal act, if material in relation to the financial statements, should be disclosed.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.2 (CONTINUED) c.

Factors that could indicate that the inherent risk of violation of laws and regulations is greater than normal include the following: • violations of laws and regulations by the entity in the current or previous years • recent, well-publicized violations of laws and regulations by other companies in the industry • laws and regulations that are new or unusually complex • lack of experience on the part of management in interpreting or applying specific laws and regulations • active monitoring by regulators or other groups

LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.3 As the auditor of Sharma Ltd., I disagree with the controller’s proposal to change the accounting policy of revenue recognition to the completed-contract method on the basis that it is the policy used in submitting income tax returns. ASPE only allows the completedcontract method in those cases where management is unable to arrive at a reasonable estimate of the costs for completion on contracts or where the earning pattern suggests a single act is to be completed. If Sharma insisted on using the completed-contract method, there would be a violation of GAAP and a modified auditor’s report would be issued by the auditor. A qualification for revenue recognition would be referred to in the auditor’s report. If Sharma were using IFRS, it could not use the completed-contract method of revenue recognition. The method in IFRS corresponding to the results of the completed-contract method in ASPE is the zeroprofit method. In addition, under IFRS 15, revenue can only be recognized over time if (i) the customer receives and consumes the benefit as the seller performs, (ii) the customer controls the asset or (iii) the company does not have an alternate use for the asset. For the same reasons as in ASPE, a qualified auditor’s report would be suggested, but likely never issued as management would likely agree to a method allowable under IFRS 15. Sharma would likely abandon the suggestion in order to obtain an unmodified auditor’s report for its financial statements.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.4 a.

Revenue test: 10% X $398,000 = $39,800 Segments A ($140,000), B ($40,000), and D ($190,000) meet this test.

Operating profit test: 10% of the greater of (in absolute terms) segments with a loss or segments with profit: Loss segments: $5,000 + $2,000 = $7,000 Profitable segments: $25,000 + $8,000 + $500 = $33,500 (greater of above x 10%): 10% X $33,500 = $3,350 Segments A ($25,000), B ($8,000), and C ($5,000 absolute amount) meet this test.

Identifiable assets test: 10% X $351,000 = $35,100. Segments A ($240,000), C ($36,000), and D ($49,000) meet this test.

LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.5 a.

Maffin Corp.: Buildings ........................................................... Retained Earnings ............................................. Contributed Surplus ......................................... Cash ..........................................................

700 100 200 1,000

The transaction is not in the normal course of operations for the two companies and there is arguably no material change in the ownership interest in the building. The transaction would therefore be measured at its carrying amount. The adjustment to contributed surplus / retained earnings is considered to be a capital payment by Maffin Corp. and a capital receipt by Grey Inc. Grey Inc.: Cash ................................................................... Accumulated Depreciation–Buildings1 ............ Contributed Surplus ................................ Buildings ................................................. 1 ($25,000 - $700) b.

Maffin Corp.: Cash ................................................................... Gain on Disposal of Buildings ................ Buildings .................................................

1,000 24,300 300 25,000

1,100 400 700

A gain of $400 on sale of the building is recognized as income by Maffin Corp. It is not appropriate to reverse the original credit of $300 made to equity and recognize a gain in Grey Inc. now that Maffin Corp. has sold the building. c.

If Maffin could purchase the building at an amount less than the carrying amount on Grey’s financial statements, consideration should be given to whether the value of the building is impaired and should be written down in Grey’s books prior to transfer at the reduced carrying amount.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.5 (CONTINUED) d.

Maffin Corp.: Buildings ........................................................... Cash ..........................................................

1,000 1,000

The transaction is in the normal course of operations for the two companies and there is commercial substance. It is therefore appropriate for Grey to recognize a gain of $300. Maffin would record the building at the exchange amount. Grey Inc.: Cash ................................................................... Accumulated Depreciation–Buildings2 ............ Gain on Disposal of Buildings ................ Buildings .................................................. 2 ($25,000 - $700) Maffin Corp. – Sale of building in 2024 Cash ................................................................... Gain on Disposal of Buildings ................ Buildings .................................................. e.

1,000 24,300 300 25,000

1,100 100 1,000

Option 1: Transaction measured at carrying amount:

2023: Maffin Corp. – No impact on the income statement Grey Inc. – No impact on the income statement 2024: Maffin Corp. – Gain Total income for 2023 and 2024

$0 0

400 $ 400

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.5 (CONTINUED) e. (continued) Option 2: Transaction measured at exchange amount: 2023: Maffin Corp. – No impact on the income statement Grey Inc. – Gain of $300 2024: Maffin Corp. – Gain of $100 Total income for 2023 and 2024

$0 300

100 $ 400

Regardless of the method used, the combined income for the consolidated reporting unit will be the same. The purchase and sale of the building between Maffin and Grey become cancelled in the process of eliminating intercompany balances. The transaction with the “unrelated” external party provides the objective measurement of the gain to the reporting unit. However, Grey, and to the lesser extent, Maffin, are required to report to certain of their users as separate reporting units. In this case, the measurement of intercompany transactions becomes important in accurately reflecting economic substance. We can see that under option two, a portion of the gain ($300) is earned by Grey and the remainder is earned by Maffin, whereas under option one, the entire amount of the gain is earned by Maffin. The method of reporting will have an impact on the income of each company. LO 5 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.6 a.

The transaction is not in the normal course of operations and the transaction has commercial substance: Verez Limited: Machinery (new) ................................................ Accumulated Depreciation–Machinery1 .......... Retained Earnings ............................................. Machinery (old)......................................... 1 ($7,000 - $900) Consior Inc.: Machinery (new) ................................................ Accumulated Depreciation–Machinery2 ............ Contributed Surplus................................. Machinery (old)......................................... 2 ($6,000 - $700)

700 6,100 200 7,000

900 24,300 5,300 200 6,000

Since the transaction is not in the normal course of operations for the two companies and there is no change in the ownership interest in the machinery, the transaction is measured at its carrying amount. b. The transaction is not in the normal course of operations and the transaction does not have commercial substance: The entries are the same as for part (a). Since the transaction is not in the normal course of operations for the two companies and there is no change in the ownership interest in the machinery, the transaction is measured at its carrying amount regardless of whether the transaction has commercial substance or not. A related-party transaction that is not in the normal course of operations requires additional support for the substance of the transaction in order for the exchange amount to be used for financial reporting purposes. This is considered to occur when a change in the ownership interests in the item transferred is substantive and the exchange is supported by independent evidence. Solutions Manual 23-36 Chapter 23 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.6 (CONTINUED) b. (continued) In this case, the exchange amount is more representative of the economic reality of the transaction than the carrying amount and is sufficiently reliable to be used for financial reporting purposes. c.

The transaction is in the normal course of operations and the transaction has commercial substance: Verez Limited: Machinery (new) ................................................ Accumulated Depreciation–Machinery3 .......... Gain on Disposal of Machinery ............... Machinery (old) ........................................ 3 ($7,000 - $900) Consior Inc.: Machinery (new) ................................................ Accumulated Depreciation–Machinery4 .......... Gain on Disposal of Machinery ............... Machinery (old) ........................................ 4 ($6,000 - $700)

1,000 6,100 100 7,000

1,000 5,300 300 6,000

As long as the amount of the exchange is supported by independent evidence, the transaction is recorded at the exchange amount and a gain or loss is recorded on each company’s income statement. d.

The transaction is in the normal course of operations and the transaction does not have commercial substance: The entries are the same as for part (a). A nonmonetary transaction that does not have commercial substance would be measured at the carrying amount. In such a case, the adjustment to retained earnings is considered a capital payment by Verez and a capital receipt by Consior.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.6 (CONTINUED) e.

Under ASPE, certain related-party transactions must be remeasured to the carrying amount of the underlying assets or services that were exchanged. This is the case if the transaction is not in the normal course of business, there is no substantive change in ownership, and/or the exchange amount is not supported by independent evidence. Transactions that are in the normal course of business that have no commercial substance must also be remeasured, and where the transaction is also a nonmonetary transaction, no gain or loss should be recognized. Under IFRS, if there is no commercial substance (as is the case for b and d) we should measure at the carrying amount (per IAS16.24) For b and d the journal entries would be as follows: Verez Limited: Machinery (new) ................................................ Accumulated Depreciation–Machinery5 .......... Machinery (old) ........................................ 5 ($7,000 - $900) Consior Inc.: Machinery (new) ................................................ Accumulated Depreciation–Machinery6 .......... Machinery (old) ........................................ 6 ($6,000 - $700)

900 6,100 7,000

700 5,300 6,000

For scenario a and c, the entries would be recorded as in part c. LO 5 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.7 a.

(1) The issuance of common shares is an example of a subsequent event which provides evidence about conditions that did not exist at the SFP date but arose subsequent to that date. Therefore, no adjustment to the financial statements is recorded. However, this event should be disclosed in the notes, a supplemental schedule, or even through pro-forma financial data as the issuance of the shares is dilutive for the existing shareholders. (2) The changed estimate of tax payable is an example of a subsequent event that provides additional evidence about conditions that existed at the SFP date. The income tax liability existed at December 31, 2023, but the amount was not certain. This event affects the estimate previously made and should result in an adjustment of the financial statements. The correct amount ($1,200,000) would have been recorded at December 31 if it had been available. Therefore, Jason should increase the income tax expense in the 2023 income statement by $200,000. In the SFP, income tax payable should be increased and retained earnings decreased by $200,000.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.7 (CONTINUED) b.

The income tax payable as at December 31, 2023 should be increased to $1.2 million because the information about the increased estimate is available before the financial statements are considered authorized by the board of directors for issue (March 10, 2024). In the time between December 31, 2023 and March 10, 2024, the company is preparing to issue its financial statements and annual report, including preparing the necessary adjusting entries to ensure that all material transactions are reflected in the financial statements. Accordingly, an additional accrual of $200,000 dated December 31, 2023 should be recorded to reflect the additional income tax expense for 2023. Investors would rely on the financial statements in assessing the company’s performance, making their investing decisions and predicting future cash flows. Therefore, investors would support increasing the estimate of income tax payable as at December 31, 2023 so that they may make their decisions based on financial statements that are relevant, faithfully representative, complete, and free from material error.

The accounting treatment and answers provided in (a) and (b) would not change had Jason Corporation followed ASPE.

LO 6 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.8 1. a. 4. b. 7. b.1 10. c. 2. c. 5. c. 8. b. 11. a. 3. b. 6. c. 9. a. 12. b. 1 Assuming the customer represents 10% or more of the revenues LO 6 BT: K Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

EXERCISE 23.9 Under normal circumstances, Dedrisan could take on new debt at unfavourable terms to continue operations. Being in default of some loan covenants does not necessarily mean that Dedrisan is no longer a going concern and can no longer operate. Nevertheless, in this case, due to the nature of the unusually large loss, Dedrisan’s ability to continue and realize on its assets is deemed impossible. Dedrisan cannot obtain refinancing and cannot continue operations, so it is no longer a going concern. To obtain an unmodified opinion from the auditor, Dedrisan would have to use a liquidation approach rather than the historical cost principle in the preparation of the financial statements. Simply providing disclosure in the financial statement notes of the going concern issues would be insufficient to avoid an adverse opinion. The measurement issues are too pervasive and severe for the proper interpretation of the financial condition of the business. Dedrisan should advise key stakeholders of its situation and should begin the process of preparing a proposal for receivership. Depending on the amount of the debt, Dedrisan can choose to utilize the Companies’ Creditors Arrangement Act (CCAA). Under CCAA, Dedrisan can obtain short-term protection while preparing an offer to creditors for partial payment. If Dedrisan does not start the process, the creditors may start the process and appoint a receiver who would be given full discretion in managing Dedrisan’s assets and operations. LO 7,8 BT: C Difficulty: M Time: 15 min. AACSB: Audit CPA: CPA: cpa-t001 cpa-t004 CM: Reporting and Audit

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.10 a.

The major assets of law firms are its professionals. No major capital investments are needed for operations. Consequently, law firms are generally self-financed from the capital investment of the partners of the firm and operating capital is provided by banks providing lines of credit secured by accounts receivable. Because of the delay in revenue recognition, a creditor such as the bank would not be worried about the qualified auditor’s report. Rather, the modified accrual method reduced the bank’s risk as it has caused one of the assets of the firm to be valued as nil. The work in process that remains unbilled is a source of revenue for the following year.

The balances of work in process can be used to determine the relative size of unbilled work from year to year. To the extent that work in process remains unbilled at the end of each fiscal year, it does render the financial information difficult to measure as to period to period performance. As long as the amount of work in process remains relatively the same in amount, and major variances are taken into account, the comparability between years should not be significantly affected.

LO 2,8 BT: C Difficulty: M Time: 15 min. AACSB: Audit CPA: CPA: cpa-t001 cpa-t004 CM: Reporting and Audit

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.11 a.

Horizontal percentage analysis is as follows: MACKAY CORPORATION Statement of Financial Position December 31, 2023

Assets Cash Accounts receivable Investments-FV-NI Inventory Plant assets (net) Intangible assets Liabilities and Equity Accounts payable Long-term debt Share capital Retained earnings

2023

2022

Difference

% change

$285,000 142,000 133,000 355,000 442,000 113,000 $1,470,000

$292,000 181,000 132,000 401,000 465,000 143,000 $1,614,000

$(7,000) (39,000) 1,000 (46,000) (23,000) (30,000) (144,000)

(2.4%) (21.5%) 0.8% (11.5% (4.9%) (21.0%) (8.9%)

$267,000 64,000 326,000 813,000 $1,470,000

$337,000 152,000 326,000 799,000 $1,614,000

(70,000) (88,000) -014,000 $(144,000)

(20.8%) (57.9%) 1.8% (8.9%)

MACKAY CORPORATION Income Statement Year Ended December 31, 2023

Net sales Cost of goods sold Gross profit Selling, general, and administrative expenses Other expenses, net Income before income tax Income tax Net income

2023

2022

Difference

% change

$805,000 527,000 278,000

$781,000 530,000 251,000

$24,000 (3,000) 27,000

3.1% (0.6%) 10.8%

140,000 118,000 20,000 6,000 $14,000

111,000 110,000 30,000 9,000 $21,000

29,000 8,000 (10,000) (3,000) $(7,000)

26.1% 7.3% (33.3%) (33.3%) (33.3%)

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.11 (CONTINUED) a. (continued) The company’s liquidity has improved as evidenced by the 21.5% decrease in accounts receivable despite the 3.1% increase in net sales (which signals improved cash collections), as well as the 20.8% decrease in accounts payable. The company’s solvency has improved significantly, as evidenced by the 57.9% decrease in long-term debt. However, the company’s profitability has declined as evidenced by the 33.3% decrease in net income. The decrease in net income appears to be due to a significant 26.1% increase in selling, general, and administrative expenses. Net sales and gross profit increased only by 3.1% and 10.8% respectively, resulting in a decrease in net income. b. Vertical percentage analysis is as follows: Net sales Cost of goods sold Gross profit Selling, general, and administrative expenses Other expenses, net Income before income tax Income tax Net income

2023

2022

100.0% 65.5% 34.5% 17.4% 14.7% 2.4%

100.0% 67.9% 32.1% 14.2% 14.1% 3.8%

0.7% 1.7%

1.1% 2.7%

The company’s cost of goods sold as a percentage of net sales decreased, resulting in higher gross profit as a percentage of net sales. However, the company’s operating expenses including selling, general, and administrative expenses, and other expenses as a percentage of net sales increased. The company experienced increased net sales, yet the company’s operating expenses relative to net sales increased significantly, resulting in decreased net income. c.

Two profitability ratios include: 1) Gross profit margin, which shows an improvement and 2) Profit margin which shows deterioration in profit.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.11 (CONTINUED) d.

Referring to the research study discussed in chapter 23, some limitations of the financial statement analysis done in parts (a) and (b) are as follows: 1. Uncertainty about the nature and role of the financial statements. For example, the composition of selling, general, and administrative expenses and other expenses is uncertain, and it is uncertain whether the financial statements have been audited. This may lead users to misinterpret and/or place inappropriate reliance on the information. 2. Uncertainty about the nature of business operations portrayed. For example, the company’s type of business activities and the economic environment that the company operates in are unknown. 3. Uncertainty due to limitations of financial statement measurements and disclosures. The measurements in the income statements are not well understood, because there are no additional disclosures about the accounting policies and practices followed. 4. Uncertainty about management’s motives and intentions. Management’s choices in determining the accounting policies and methods may be motivated by a need to maximize bonuses over time, for example. Other important limitations of financial statement analysis include that estimated items (such as depreciation expense and bad debt expense which may be included in selling, general, and administrative expenses) may be significant, and that achieving comparability with other companies in the same industry may be difficult.

LO 9 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

EXERCISE 23.12 a. Assets Cash Accounts receivable Equipment (net) Goodwill Liabilities and Equity Accounts payable Long-term debt Share capital Retained earnings

Service revenue Contract labour Administrative expenses Travel expenses Marketing expenses Depreciation expense Other expenses Total expenses Income from operations Interest expense Income before taxes Income taxes Net income

2023 9.4% 29.6% 44.4% 16.6% 100.0%

2022 8.0% 29.0% 48.9% 14.1% 100.0%

2021 8.0% 27.6% 47.5% 16.9% 100.0%

14.4% 55.4% 10.1% 20.1% 100.0%

13.7% 63.1% 10.2% 13.0% 100.0%

13.1% 65.7% 12.2% 9.0% 100.0%

2023 100.0% 55.0% 45.0% 8.5% 5.8% 1.9% 0.9% 0.6% 17.7% 27.3% 3.8% 23.5% 10.1% 13.5%

2022 100.0% 55.2% 44.8% 9.7% 7.1% 2.8% 1.1% 0.5% 21.2% 23.6% 3.7% 19.9% 8.6% 11.3%

2021 100.0% 55.4% 44.6% 9.2% 6.2% 2.8% 1.2% 0.7% 20.1% 24.6% 4.5% 20.2% 8.5% 11.7%

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EXERCISE 23.12 (CONTINUED) b. Assets Cash Accounts receivable Equipment (net) Goodwill Liabilities and Equity Accounts payable Long-term debt Share capital Retained earnings

2023 $1,200 3,800 5,700 2,125

2022 $790 2,850 4,800 1,385

$12,825

$9,825

$1,850 7,100 1,300 2,575

$1,350 6,200 1,000 1,275

$12,825 2023 $10,900 5,990 4,910 930 630 210 100 60 1,930 2,980 410 2,570 1,100 $1,470

Change 410 950 900 740 $3,000

As a % 51.9% 33.3% 18.8% 53.4% 30.5%

$9,825

500 900 300 1,300 $3,000

37.0% 14.5% 30.0% 102.0% 30.5%

2022 $8,150 4,500 3,650 790 580 230 90 40 1,730 1,920 300 1,620 700 $920

Change $2,750 1,490 1,260 140 50 (20) 10 20 200 1,060 110 950 400 $550

As a % 33.7% 33.1% 34.5% 17.7% 8.6% (8.7)% 11.1% 50.0% 11.6% 55.2% 36.7% 58.6% 57.1% 59.8%

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EXERCISE 23.12 (CONTINUED) c.

The first key strategy in growing the consulting operations is the management and control of the financial relationship between fees earned from customers and the amounts paid for contract labour. Tran Consulting Ltd. has managed to control contract labour costs in relation to service revenue, at around 55% throughout the three-year period. [refer to part (a)]. The second critical activity for the consulting business is managing cash flows. Close attention must be paid to cash flows, particularly those involved in the timing of collection of accounts receivable versus the payment of accounts payable made up mainly of amounts payable for contract labour. The growth rate from 2022 to 2023 in the accounts payable of 37.0% has outpaced the growth of accounts receivable of 33.3% which is a good sign for cash flow management. [refer to part (b)]. The financing of the growth of the business is the third important key to success. In the case of Tran, [refer to part (b)] from 2022 to 2023, revenue has increased 33.7% and long-term debt increased 14.5%. In addition, we can see increases in share capital (30.0%) and goodwill (53.4%), which leads us to conclude that some of the growth in sales came from the acquisition of another business during 2023. The growth in revenue (33.7%) outpaced the increase in direct investments from shareholders (30%) and increases in long-term debt (14.5%). This allows Tran to continue on its path to further growth for the future, possibly by additional acquisitions if the opportunity arises. A fourth trend that is noticeable in the substantial increase in retained earnings of 102% from 2022 to 2023 [refer to part (b)]. This growth provides a substantial portion of the financing of operations. This increase comes from a very healthy 59.8% growth in net income [refer to part (b)] coupled with the very reasonable level of dividends that are being paid out.

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EXERCISE 23.12 (CONTINUED) c. (continued) Finally, cost control is the fifth key trend to investigate. Ignoring income taxes and interest costs, the growth in income from operations as a percentage of total service revenue has been dramatic. While in 2021 the percentage was 24.6%, this percentage reached 27.3% in 2023 [refer to part (a)]. Administrative expenses, as a percentage of revenue are declining, as are marketing expenses [refer to part (a)]. Cost controls allowed Tran to increase its profit margin from 11.7% in 2021 to 13.5% in 2023 [refer to part (a)]. LO 9 BT: AP Difficulty: C Time: 45 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 23.13 2021 $8,150 920 9,525

2022 $10,900 1,140 11,625

2023 $12,600 1,380 13,740

Percentage increase from previous year 2020 2021 Sales 14.0% 25.4% Net income 18.8% 21.1% Total assets 7.9% 12.9%

2022 33.7% 23.9% 22.0%

2023 15.6% 21.1% 18.2%

Sales Net income Total assets

2019 $5,700 640 7,820

2020 $6,500 760 8,440

Bar Chart

Percentage Change in Sales, Net Income and Total Assets of Tarzwell Limited 2020 - 2023 40% 35% 30% 25%

20% 15% 10% 5% 0% Sales

Net income 2020

2021

2022

Total assets 2023

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EXERCISE 23.13 (CONTINUED) Line Chart:

Percentage Change in Sales, Net Income and Total Assets of Tarzwell Limited 2019 - 2023 40% 35% 30% 25% 20% 15%

10% 5% 0% 2020

2021 Sales

2022 Net income

2023

Total assets

LO 2,9 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 23.14 a. 1.

Current cash debt coverage =

Net cash provided by operating activities Average current liabilities

2022:

$102 ($80 + $82) / 2

= 1.26 times

2023:

$119 ($80 + $85) / 2

= 1.44 times

Cash debt coverage =

Net cash provided by operating activities Average total liabilities

2022:

$102 ($165 + $170) /2

= .61 times

2023:

$119 ($240 + $165) / 2

= .59 times

Earnings per share =

2022:

$50 70

= $0.71

Net income minus preferred dividends Weighted average shares outstanding 2023:

$72 70

= $1.03

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EXERCISE 23.14 (CONTINUED) a. (continued) 4.

Price earnings ratio =

2022:

= 17.5 times

Times interest earned =

2022:

$ 12.41 $0.71

2022:

$102 - $20 $102

2023:

$16.50 $1.03

= 16.0 times

Income before interest charges and taxes Interest charges

$62 + $6 = 11.3 times $6

Free cash flow to operating cash flows =

Market price per share Earnings per share

2023:

$90 + $10 $10

= 10 times

Net cash provided by operating activities - capital expenditures and dividends Cash flow from operations

= 80.4%

2023:

$119 - $30 $119

= 74.8%

b. 1. Current cash debt coverage ratio 2. Cash debt coverage ratio 3. Earnings per share 4. Price earnings ratio 5. Times interest earned ratio 6. Free cash flow to operating cash flows

Improved Deteriorated slightly Improved Deteriorated Deteriorated Deteriorated

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EXERCISE 23.14 (CONTINUED) c.

The focus of an investor would be on two ratios: The earnings per share (EPS) and the price earnings (P/E) ratio. The EPS would be seen as improving, but so would the P/E ratio. From the perspective of an investor, the P/E ratio is a measure of risk. A decline in the ratio from 2022 to 2023 would be seen as an improvement, due to a reduction of risk.

LO 2,9 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

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EXERCISE 23.15 a.The acid-test ratio is the current ratio with the subtraction of inventory and prepaid expenses (the latter is generally insignificant relative to inventory) from current assets. Any divergence in trend between these two ratios would therefore be dependent upon the inventory account. Inventory turnover has declined sharply in the three-year period, from 4.91 to 3.72. During the same period, sales have increased 5 percent. The decline in inventory turnover is therefore not due to a decline in sales. The apparent cause is that investment in inventory has increased at a faster rate than sales, and this has accounted for the divergence between the acid-test and current ratios. b. Financial leverage is the use of borrowed funds (debt) to increase the return earned by investors, such as the shareholders of a business, and is measured by looking at the relationship between the amount of debt and the amount of shareholders’ equity. For example, if a company can borrow $1,000 at an interest cost of 6% and put that $1,000 to work and earn 10%, the excess 4% return goes to the shareholders without their having to invest any additional funds of their own. But consider the situation for the shareholders if the $1,000 borrowed and invested earns only 3%! Too much debt can be injurious to a company. With increased debt comes increased requirements for regular interest and principal payments, and bankruptcy risk increases. In the Robbins situation, financial leverage has definitely declined during the three-year period. This is shown by the steady drop in the long-term debt-to-total-assets ratio, and the total-debt-to-total-assets ratio. Apparently, the decline of debt as a percentage of this firm’s capital structure is accounted for by a reduction in the long-term portion of the firm’s indebtedness. This reduction of leverage accounts for the decrease in the return on equity ratio. This conclusion is reinforced by the fact that net income to sales and return on total assets have both increased. Solutions Manual 23-55 Chapter 23 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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EXERCISE 23.15 (CONTINUED) c.

The company’s investment in plant and equipment has decreased during the three-year period 2021–2023. This conclusion is reached by using the sales to fixed assets (fixed asset turnover) and sales as a percent of 2021 sales ratios. Because sales have grown each year, (3% in 2022 and 5% by 2023), the sales to fixed assets could be expected to increase unless fixed assets grew at a faster rate. The sales to fixed assets ratio increased at a faster rate than the 3 percent annual growth in sales; therefore, investment in plant and equipment must have declined.

Both the inventory and accounts receivable turnovers have deteriorated substantially during 2022 and 2023. Unless the decline in the receivables turnover can be attributed to a change in the terms of payment negotiated with customers, Robbins should not be experiencing this decline with the increase in sales. Expressed as a number of days these ratios further demonstrate the seriousness of the decline in activity during 2022 and 2023.

2021 Number of days to collect receivables 365 = 41.7 8.75

2023 Number of days to collect receivables 365 = 56.9 6.42

Number of days sales in inventory 365 = 74.3 4.91

Number of days sales in inventory 365 = 98.1 3.72

total days Increase in number of days Increase as a %

116

155 39 34.5%

Further attention will need to be paid to the management of these two important current assets. LO 9 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance Solutions Manual 23-56 Chapter 23 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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TIME AND PURPOSE OF PROBLEMS Problem 23.1 Purpose—to provide the student with an understanding of rules for segment reporting. The student must determine which of five segments are subject to segment reporting rules and describe the required disclosures.

Problem 23.2 Purpose—to provide the student with various disclosure issues from previous chapters including subsequent events and changes in accounting policies and estimates. The student must describe the appropriate disclosure for a variety of situations. Comparison between IFRS and ASPE treatments are also included.

Problem 23.3 Purpose—to provide the student with SFP reporting issues. The student must prepare a corrected SFP with proper disclosure. The issues involve various errors, changes in estimates, and subsequent events. The student must also describe any required note disclosure related to the items in the SFP. This problem provides a good overview of issues from previous chapters.

Problem 23.4 Purpose—to provide the student with an understanding of the necessary information that should be disclosed in the financial statements and notes. The student is required to evaluate the facts of four items concerning the company’s operations and to discuss any additional disclosures in the financial statements and notes that the auditor should recommend with respect to these items.

Problem 23.5 Purpose—to provide the student with an understanding of the conditions under which note disclosures are necessary. The student is required to analyze four sets of circumstances and to either prepare the respective note where deemed to be necessary or provide an explanation of the reason for not making a note disclosure. One item involves the going concern assumption and the topic of bankruptcy.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 23.6 Purpose—to provide the student with an understanding of segment reporting. The problem explores why a company did not have to prepare certain segment information. In addition, the student is asked to determine why geographical area information should be provided.

Problem 23.7 Purpose—to provide the student with an understanding of the types of disclosures that are necessitated under certain circumstances. This assignment involves three independent situations dealing with such concepts as site remediation, a self-insurance contingency, and the discovery of a probable loss subsequent to the date of the financial statements. The student is required to discuss the accrual treatment, the type of disclosure necessary, and the reasons why such disclosure is appropriate for each of the three situations.

Problem 23.8 Purpose—to provide the student with an understanding of the necessary information that must be disclosed in the financial statements with regard to certain asset classifications. The student is required to discuss each of the respective disclosures for inventories and property, plant, and equipment in the audited financial statements issued to the shareholders.

Problem 23.9 Purpose—to provide the student with an understanding of segment reporting requirements, including providing explanations as to which segments are reportable.

Problem 23.10 Purpose—to provide the student with an understanding of the proper accounting for subsequent event transactions. Bankruptcy, issue of debt, strikes, and other typical subsequent event transactions are presented.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED) Problem 23.11 Purpose—to provide the student with an understanding of several key ratios. In addition, the student is asked to identify and explain what other financial reports or financial analysis might be employed. Also, the student is to determine whether the company can finance the plant expansion internally and whether an extension on the note should be made. This question provides an extensive coverage of ratio analysis.

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SOLUTIONS TO PROBLEMS PROBLEM 23.1 a.

Determination of reportable segments: (1) Revenue test: 10% X $790,0001 = $79,000. Segments B ($80,000) and C ($580,000) both meet this test. 1

$40,000 + $80,000 + $580,000 + $35,000 + $55,000

(2) Operating profit test: Total from profit segments ($11,000 + $75,000 + $4,000 + $7,000) = $97,000 exceeds total from loss segments (10,000) 10% X ($11,000 + $75,000 + $4,000 + $7,000) = $9,700. Segments A ($11,000), B ($10,000 absolute value), and C ($75,000) all meet this test. (3) Identifiable assets test: 10% X $710,0002 = $71,000. Only segment C ($500,000) meets this test. 2

$35,000 + $60,000 + $500,000 + $65,000 + $50,000

Disclosures required by IFRS 8:

External Revenues Intersegment Revenues Total Revenues Cost of Goods Sold Operating Expenses Total Expenses Operating Profit (Loss) Identifiable Assets Liabilities

Other

Totals

$40,000 0 40,000 19,000 10,000 29,000 11,000 $35,000 $22,000

$(60,000 20,000 (80,000 (50,000 (40,000 (90,000 (10,000 ) $(60,000 $ 31,000

$480,000 100,000 580,000 270,000 235,000 505,000 75,000 $500,000 $443,000

$ 90,000 0 90,000 49,000 30,000 79,000 11,000 $115,000 $ 41,000

$670,000 120,000 790,000

87,000 $710,000 $537,000

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Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.1 (CONTINUED) b. (continued)

Reconciliation of revenues Total segment revenues Revenues of immaterial segments Elimination of inter-segment revenues Revenues from reportable segments

$790,000 (90,000) (120,000) $580,000

Reconciliation of profit or loss Total segment operating profit Profits of immaterial segments Profits from reportable segments

$ 87,000 (11,000) $ 76,000

Reconciliation of assets Total segment assets Assets of immaterial segments ($65,000 + $50,000) Assets from reportable segments

$710,000 (115,000) $595,000

Reconciliation of liabilities Total segment liabilities Liab. of immaterial segments ($12,000 + $29,000) Liabilities from reportable segments

$537,000 (41,000) $496,000

One of the major arguments against providing segment information is that competitors will then be able to determine the profitable segments and enter that product line themselves. If this occurs and the other company is successful, then the present shareholders of Franklin Corporation may suffer. This question should illustrate to the student that the answers are not always black and white. Disclosure of segments undoubtedly provides some needed information, but some disclosures desired by external parties may be confidential.

LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

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PROBLEM 23.2 a. 1. This is a change in estimate and should be applied to the calculations for 2023 on a prospective basis. If the impact of the change on depreciation expense is material, note disclosure explaining the change in estimate and the effect on earnings is required. 2. Since income tax is self-assessed by companies, additional assessments of prior years’ amounts occasionally happen. This is considered a revision of an estimate and the additional amount of income tax is expensed in 2023. If the additional income tax stems from an error in the preparation of the tax return, such as unreported revenues or over-estimation of deductions, the assessment would be treated as an accounting error. A prior year’s accounting error is recorded as an adjustment to opening retained earnings. Comparative financial statement amounts are restated and note disclosure explaining the nature of the error and the statement items adjusted and restated would be included. 3. The overstatement of 2022 officers’ salaries is an accounting error. Any impact on 2023 expenses would be corrected in the current year and the opening balance of retained earnings would be adjusted net of any related income tax effect. Comparative financial statement amounts and earnings per share amounts are restated and note disclosure explaining the nature of the error and the statement items adjusted would be included. 4. The stock dividend reduces retained earnings on the date of declaration. Therefore, it would be shown on the 2023 statement of changes in shareholders’ equity. Since the stock dividend is not issued before year-end, there would also be a Stock Dividend Distributable balance included in the Share Capital section of Shareholders’ Equity.

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PROBLEM 23.2 (CONTINUED) a. (continued) 4. (continued) Earnings per share would be adjusted as if the shares had been outstanding throughout the year 2023 and any EPS figures provided for earlier periods would also have to be restated for comparative purposes. This is a requirement even if the stock dividend was distributable in the new year. As long as it is before the financial statements are issued, these adjustments are required. 5.

This is a voluntary change in accounting policy as a result of switching to a policy that provides reliable and more relevant information. Daniel will need to record an adjustment to opening retained earnings for the change in policy, net of any related income tax effect, and restate the comparative statements. Note disclosure is required explaining the change in policy and the reason for the change. The method of applying the change (full or partial retrospective) must be disclosed as well as the impact of the change on individual statement items.

The guarantee should be (and should have been) disclosed in the notes to the financial statements as a significant commitment. Bonbee Inc. has defaulted on an interest payment and Daniel has stated that it will pay the defaulted interest to the bondholders on January 15, 2024. This is a subsequent event that provides evidence of a condition that existed at year end, and if Bonbee does not pay the interest by January 15, 2024, the interest should be shown as a current liability and an expense or loss charged to income (with a receivable set up if it is considered that an asset exists in terms of collectibility from Bonbee). If Daniel considers the possibility of having to honour the principal amount of the bonds of Bonbee likely and measurable, then a loss and liability should be accrued in the 2023 financial statements.

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PROBLEM 23.2 (CONTINUED) a. (continued) 6. (continued) If the probability of additional loss is not determinable, Daniel may still have to disclose the risk of additional loss. In either case, Daniel will have to examine the underlying cause of Bonbee’s missed interest payment to determine the likelihood of the guarantee being enforced against Daniel. 7. The accounting treatment depends on Daniel’s legal counsel’s evaluation of the likelihood of loss on appeal. If the company’s legal counsel estimates that it is not probable or undeterminable that Daniel will lose the appeal then no accrual is required. This position would be doubtful however since the company has already been found to be in breach of contract. The company would have to accrue the loss and liability. Additional note disclosure would be required to describe the liability and whether any unaccrued additional exposure to loss exists. b.

Under ASPE, most of the treatment given under IFRS would be the same with a few exceptions: For the stock dividend under item 4, the declaration of the dividend would be reported in the statement of retained earnings instead of the statement in changes in shareholders’ equity. For the change in accounting policy, under item 5, ASPE does not require the entity to meet the test of providing more relevant and reliable information. Lastly, for the accrued damages from the lawsuit under item 7, the threshold for recognition under ASPE would be “likely,” instead of “probable,” making it a more conservative assessment for recognition.

LO 2,10 BT: C Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 23-64 Chapter 23 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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PROBLEM 23.3 a. SAMSON CORPORATION Statement of Financial Position As at December 31, 2023

Assets Current assets Cash ($571,000 – $400,000) $ 171,000 Accounts receivable ($480,000 + $30,000) $ 510,000 Less allowance for expected credit losses 30,000 480,000 Notes receivable 162,300 Inventory (FIFO) at LC&NRV 645,100 Prepaid expenses 47,400 Total current assets $1,505,800 Long-term investments Investments in land Cash surrender value of life insurance Cash restricted for plant expansion

185,000 84,000 400,000

669,000

Property, plant, and equipment Plant and equipment (pledged as collateral for bonds) ($4,130,000 + $1,430,000) 5,560,000 Less accumulated depreciation 1,430,000 4,130,000 Land 446,200

4,576,200

Goodwill Total assets

252,000 $7,003,000

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PROBLEM 23.3 (CONTINUED) a. (continued) Liabilities and Shareholders’ Equity Current liabilities Accounts payable Income taxes payable Dividends payable Salaries and wages payable Unearned revenue Interest payable ($750,000 X 8% X 8/12) Total current liabilities Long-term liabilities Notes payable (due 2025) 8% bonds payable (due 2028; secured by plant and equipment)1 Total liabilities Shareholders’ equity Common shares, unlimited authorized 184,000 shares issued and outstanding Retained earnings2

$ 510,000 145,000 200,000 275,000 489,500 40,000 $1,659,500

157,400 705,939

863,339 2,522,839

1,840,000 2,490,161

Accumulated other comprehensive income 150,000 Total shareholders’ equity 4,480,161 Total liabilities and shareholders’ equity $7,003,000

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PROBLEM 23.3 (CONTINUED) a. (continued) 1

To find the effective interest rate on the note: ($750,000 x 93.4 = $700,500) Using a financial calculator: PV $ 700,500 I ? Yields 9.73% N 5 PMT $(60,000) FV $(750,000) Type 0 Using Excel formula: =RATE(nper,pmt,pv,fv,type)

Result: .097290274 rounded to 9.73 %

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PROBLEM 23.3 (CONTINUED) a. (continued) Interest expense = $700,500 X 9.73% X 8/12 = $45,439 Interest payable = $750,000 X 8% X 8/12 = $40,000 $45,439 – $40,000 = $5,439 amortization of discount for 2023 Carrying amount of bonds payable: $700,500 + $5,439 = $705,939 2 Retained earnings $2,810,600 Salaries and wages expense omitted (275,000) Interest expense omitted (45,439) $2,490,161 Additional comments: 1.

The information related to the competitor should be disclosed because this innovation may have a significant effect on the company. The value of the inventory is overstated because of the need to reduce selling prices. This factor along with the net realizable value of the inventory and the specially designed new plant should be disclosed. Consideration should be given as to whether or not Samson is a going concern under these circumstances or whether any of Samson’s product lines and the associated plant assets (where the fixed costs may only be partially recovered) have suffered impairment.

The pledged assets should be described in the SFP as indicated or in a footnote.

The error in calculating inventory will have been offset, so no adjustment is needed in the SFP. The comparative income statement and statement of changes in shareholders’ equity for 2022 will need to be restated to reflect the correction of this error. If 2021 is also disclosed on the income statement, it too will need to be corrected for cost of goods sold. If 2021 is a period covered in the statement of shareholders’ equity, it will need to be restated as well.

Salaries and wages payable is included as a liability and retained earnings are reduced, ignoring income tax effects.

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PROBLEM 23.3 (CONTINUED) a. (continued) 5.

The fact that the gain on sale of plant assets was credited directly to retained earnings has no effect on the SFP presentation; the income statement and statement of changes in shareholders’ equity will need to be corrected, ignoring any tax effects.

The plant and equipment account should be separately disclosed and depreciation calculated on each item individually; accumulated depreciation should be also split out on the SFP or in the financial statement notes. However, the information to divide the accounts was not given in this problem.

Accrued interest on the bonds ($750,000 X 8% X 8/12 = $40,000) was not recorded. Interest expense will reduce retained earnings ($700,500 X 9.73% X 8/12 = $45,439). The related discount ($45,439 – $40,000 = $5,439) will increase the carrying amount of the bonds and will be amortized over the life of the bonds.

The company needs to include a summary of accounting policies in its notes, detailing its accounting policies for inventory (FIFO), depreciation method for plant and equipment (straight-line), revenue recognition policy, and any other policies used.

The inventory needs to be reported at the lower of cost and net realizable value.

10. There is no adjustment needed for the change in the percentage of sales used for estimating the loss on impairment of receivables. This change is treated as a change in an accounting estimate. 11. The uninsured damage to the plant would require disclosure if it is significant (but it would not result in an adjustment to the financial statements).

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PROBLEM 23.3 (CONTINUED) b.

Management has the primary responsibility for the preparation, integrity, and objectivity of the company’s financial statements. If management wishes to present information in a certain way, it may do so. If the auditor objects because GAAP is violated, some type of audit report exception will be required.

LO 6 BT: AP Difficulty: C Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.4 Item 1 The staff auditor reviewing the loan agreement misinterpreted its requirements. Retained earnings are restricted in the amount of $420,000, which was the balance of retained earnings at the date of the agreement. The nature and amount of the restriction should be disclosed in the SFP or a note to the financial statements. It should be noted that the dividends paid since the inception of the loan agreement are below net income, therefore the company is meeting the retained earnings restriction requirement. Item 2 Unless cumulative preferred dividends are involved, no recommendation by the auditor is required. Dividend policy is understood by readers of financial statements to be discretionary on the part of the board of directors. The company need not commit itself to a prospective dividend policy or explain its historical policy in the financial statements, particularly since dividend policy is to be discussed in the president’s letter. If cumulative preferred dividends are omitted, this should be disclosed in the notes to the financial statements. Item 3 A competitive development of this nature is normally considered to be the second type of subsequent event, one that provides evidence with respect to a condition that did not exist at the date of the SFP, but in some circumstances the auditor might conclude that Radiohead’s poor competitive situation was evident at year-end. In any event, the development should be disclosed to users of the financial statements because the economic recoverability of the new plant is in doubt and Radiohead may incur substantial expenditures to modify its facilities. Because the economic effects probably cannot be determined, the usual disclosure would be in a note to the financial statements. (Only if circumstances were such that it was concluded that this condition did exist at year-end should the financial statements for the year ended December 31, 2023 be adjusted for the ascertainable economic effects of this development). Consideration should be given as to whether the going concern assumption is appropriate in these circumstances. Solutions Manual 23-71 Chapter 23 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.4 (CONTINUED) Item 4 The lease agreement with ANS Tooling Inc. meets the criteria for a capital lease because it contains a bargain purchase option (a 25-year-life building can be purchased at the end of 10 years for $1). The PV of the annuity due of $600,000 for 10 years at 9% is $4,197,148. This amount is almost exactly the fair value of the building at the inception of the lease. The lessee, Radiohead, must capitalize the leased asset and the related obligation in its SFP at the appropriate discounted amount of the future rental payments under the lease agreement. The lessee must disclose: (1) the gross amount of the leased asset and the accumulated depreciation thereon, (2) the future minimum lease payments as at the latest SFP date, in the aggregate and for each five succeeding fiscal years and the amount of imputed interest necessary to reduce the lease payments to present value, (3) a general description of the lease arrangement, and (4) the existence of and the terms of the purchase option. The income statement should contain a charge for depreciation of the leased asset plus the interest charge instead of rent expense. LO 2 BT: C Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.5 a.

The auditor might recommend the following notes be appended to the financial statements in regard to item 2 and item 3. Note A. In 2023, depreciation of plant assets is calculated by the straight-line method. In prior years, depreciation was calculated using an accelerated method. The new method of depreciation was adopted to better represent the pattern of benefit provided by these assets and has been applied prospectively effective January 1, 2023. The change in accounting estimate has not affected prior year comparative amounts. Other Observations 1 The change in method of calculating depreciation for all capital assets represents a change in accounting estimate and as such is accounted for on a prospective basis. 2. Accordingly, the new method should be reflected in the currentyear financial statements, and the financial statements included for comparative purposes should not be restated. Note B. The Canada Revenue Agency (CRA) is examining the federal income tax return, filed by the Corporation’s domestic subsidiary for the year 2021. The CRA has questioned the amount of a deduction claimed for a loss sustained by the subsidiary in 2021. The examination by the CRA has not progressed to the point that would indicate the extent of the subsidiary’s liability, if any. The Company believes that it will not be subject to any substantial consolidated income tax liability with respect to this matter.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.5 (CONTINUED) a. (continued) Note C. The company’s wholly owned subsidiary, Row Inc. is currently involved in an investigation of alleged questionable acts, and possibly illegal acts, on the part of its officers and employees. An investigation is underway and no conclusion has yet been reached by the RCMP investigating the matter. Row Inc. is vigorously defending itself. The company has guarantees in place for Row Inc.’s bank loans outstanding. Any adverse consequences stemming from the outcome of this matter will not significantly affect the operations of the company and appropriate provisions have been put into place and charged to income in the current fiscal year. Comments and assumptions concerning Note C: The issues surrounding Row Inc.’s bribery charges are of a different nature than the previous 3 items in this question. The issues in this case reside with the wholly owned subsidiary and not directly with Khim Inc. It is assumed that the amounts of the loan guarantees are not going to jeopardize the future operations of Khim. Khim will not be involved in Row’s bankruptcy except as an unsecured creditor. As the owner of Row, Khim has limited liability over the other unpaid debts of Row following bankruptcy. Based on Row’s legal counsel’s opinion, Khim’s investment in Row should be written off immediately. The liabilities for the amounts owed on bank loans guaranteed by Khim need to be accrued along with the recording of a corresponding loss on Khim’s income statement. There is no need to issue a modified auditor’s report on the part of the auditor as all of these adjustments and disclosures have been made to the consolidated financial statements.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.5 (CONTINUED) b.

Item 1. Non-accounting matters such as management changes and pending proxy fights are not disclosed unless such information is needed for the proper interpretation of the financial statements. The president should be informed that notes are an integral part of the financial statements and as such should be limited to information that relates to the financial statements. Furthermore, there is no certainty that a proxy fight will materialize and, hence, in view of the uncertainty, no reason for note disclosure. Disclosure of events that have no relevance to those matters essential to proper interpretation of the financial statements frequently creates doubt as to the reasons for disclosure and inferences drawn could be misleading. Information about the pending proxy fight might be included in the president’s letter to the shareholders, which is usually an integral part of a company’s annual report.

LO 2 BT: C Difficulty: M Time: 35 min. AACSB: Audit CPA: CPA: cpa-t001 cpa-t004 CM: Reporting and Audit

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.6 a.

Some companies have only one dominant product or service and therefore it is impossible to provide segmented data in a meaningful fashion. Dominant means that a given segment has 90% of all the sales, profit, and identifiable assets of the company. In this case, segmented data are not provided, but the industry in which the dominant segment operates must be identified.

Reporting sales by geographical area is extremely important. Countries have widely differing political and economic risk profiles, which may affect earnings’ prospects. Less stable geographic areas should be evaluated carefully, whereas more stable areas may require less analysis and attention.

Note to Instructor: The IASB requires that financial statements include selected information on a single basis of segmentation. The method chosen is sometimes referred to as the management approach. The management approach is based on the way that management segments the company for making operating decisions, which is made evident by the company’s organization structure. As this approach focuses on information about the components of the business that management looks at in making its decisions about operating matters, the components are referred to as operating segments rather than geographic or industry segments. LO 3 BT: C Difficulty: S Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.7 a.

Situation 1 A loss and a liability must be recorded because information is available prior to the issuance of the financial statements that indicates it is likely that a liability had been incurred at the date of the financial statements. Under ASPE, where a range of possible amounts is determined, and no one amount within the range is more likely than another, the bottom of the range is usually accrued with the amount of the remaining exposure disclosed in the notes. The guidelines (Sec. 3110 Asset retirement obligations) for recognition, measurement, and disclosure of this site restoration obligation must be followed. Situation 2 Even though: (1) there is a probable loss on the contract, (2) the amount of the loss can be reasonably estimated and (3) the likelihood of the loss was discovered prior to the date of authorization of the financial statements, the fact that the contract was entered into subsequent to the date of the financial statements precludes accrual of the loss contingency in financial statements for periods prior to the incurrence of the loss. However, the fact that a material loss has been incurred subsequent to the date of the financial statements but prior to their authorization for issuance by the board of directors means the loss should be disclosed in a note in the financial statements. The disclosure should contain the nature of the contingency and an estimate of the amount of the probable loss or a range into which the loss will probably fall.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.7 (CONTINUED) a. (continued) Situation 3 The fact that a company chooses to self-insure the contingency of injury to others caused by its vehicles is not enough of a basis to accrue a loss contingency that has not occurred at the date of the financial statements. An accrual or “reserve” cannot be made for the amount of insurance premium that would have been paid had a policy been obtained to insure the company against this particular risk. A loss contingency may only be accrued if prior to the date of the financial statements a specific event has occurred that will impair an asset or create a liability and an amount related to that specific occurrence can be reasonably estimated. The fact that the company is self-insuring this risk should be disclosed by means of a note to alert the financial statement reader to the exposure created by the lack of insurance. b.

If the contract is a non-cancellable purchase contract that will probably result in a significant loss to the company, the unavoidable costs of completing the contract are higher than the benefits expected from receiving the contracted goods or services. This is known as an onerous contract. ASPE does not require a loss and a liability to be recognized if the company has entered into an onerous contract, although Canadian practice has been to recognize the loss and the liability. Before a contract takes effect, no asset or liability is recognized because it is an executory contract (meaning that neither party has fulfilled its part of the contract). However, if the contract is non-cancellable and a probable loss related to the contract would be unavoidable, the loss and the liability should be recognized. A user of the financial statements would support recognizing the loss and the liability in the period that a probable loss becomes evident, so that they may make their decisions based on financial statements that are relevant, faithfully representative, and complete.

LO 2,6 BT: C Difficulty: S Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.8 a.

Leopard Corporation, must disclose the following information regarding inventory under IFRS: 1. 2. 3.

5. 6. 7.

The dollar amount assigned to inventory. The method of inventory costing; e.g., FIFO, weighted average, or specific identification. The basis of valuation: i.e., cost or lower of cost and net realizable value; if an amount other than cost is presented, then cost should still be presented by stating the amount of cost or by stating the amount of the valuation allowance. The composition of the inventory, identifying the value of raw materials, work-in-process, finished goods, and manufacturing supplies. Inventory pledged as collateral for loans. The amount of inventory recognized as expense during the accounting period. Details about the carrying amount of inventory carried at fair value less costs to sell, and details about inventory writedowns and reversals of writedowns, such as information about what led to the reversal of any writedowns. Considerable additional information is required for biological assets and agricultural produce at the point of harvest, such as a reconciliation of opening to ending account balances. IAS 1 requires the disclosure of any judgements used in applying accounting policies as well as sources of estimation uncertainty in measuring financial statement elements.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.8 (CONTINUED) a. (continued) The following information must be disclosed for property, plant, and equipment: An entity’s gross carrying amount of property, plant, and equipment, investment property, and biological assets. 2. Changes in the gross carrying amount and in the accumulated depreciation and impairment. 3. The nature and circumstances relating to impairment losses (and any reversal, if applicable). 4. How net income is affected by the changes related to depreciation, impairment, and impairment reversals. 5. The policies, models, and choices made in measuring PP&E, such as depreciation rates and methods, and government grants. 6. The existence and amounts of restrictions related to the assets. 7. The effects related to each of continuing and discontinued operations. 8. Changes in assets as a result of fair value remeasurements. 9. The carrying amount and other details of capital assets that are not being used because they are under construction or held for sale. 10. Cash inflows and outflows associated with the exploration and evaluation of mineral resources. 11. The fair value of investment property assets. 12. The level of fair value hierarchy used to measure fair value less costs of disposal for assets or cash-generating units where an impairment loss has been recognized or reversed during the period. 13. Any outstanding related contingencies. 1.

The information regarding inventory and property, plant, and equipment will be disclosed in the body of the financial statements and in the notes, which are an integral part of the statements.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.8 (CONTINUED) b.

The full disclosure principle calls for reporting any financial facts that are significant enough to influence the judgement of an informed user of the financial statements. While providing information that is not detailed enough is problematic, providing too much information, including information that would not make a difference in a user’s decision, is equally problematic. A user of the financial statements would want the company to provide relevant information that is detailed enough to disclose matters that would make a difference in their decisions and condensed enough to make the information understandable. The name of the supplier that each asset was purchased from and the current location of each asset would not normally make a difference in a user’s decision. Providing this information may result in information overload, where the user may be unable to digest or process the relevant information effectively.

LO 2 BT: C Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.9 To:

Timothy Chow, Accountant

From:

Student

Date:

Current date

Subject: Determination of reportable segments for Vu Corporation International The following comments assume that the information provided to me represents the company’s operating segments defined according to IFRS 8.5. Please note that “Corporate” cannot be defined as an operating or reportable segment because it does not generate revenues, but only serves to incur common costs that are not allocated out to each segment. I also assume that you have applied the qualitative tests to these segments and determined that none of them has the same basic economic characteristics that would suggest combining some of them into reportable segments. The next step, then, is to apply the quantitative threshold requirements. I have analyzed the information and determined that the funeral, the cemetery, and the limousine segments should be reported separately. The remaining two—the floral, and catering segments—can be combined under the category of other with the corporate data indicated as unallocated. To make this determination, I applied three criteria put forth by the IFRS 8 to the information provided from 2023. Meeting any one of the three criteria makes the segment reportable. First, a segment must be reported separately if its revenue is greater than or equal to 10 percent of the enterprise’s combined revenue. This is the case with both the funeral and the cemetery segments, as revenue for both is greater than $41,600 (10 percent of combined revenue).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.9 (CONTINUED) Second, a segment is considered significant enough to be reported separately if its absolute operating profit or operating loss is 10% of the greater of: (a) the combined operating profit of all segments without an operating loss or (b) the combined operating loss of all segments that incurred a loss. Combined operating profit for all profitable segments totals $ 77,000 + $36,000 = $113,000 while the loss arises from the corporate segment so it will not be considered. The funeral, cemetery, and limousine segments all meet this requirement by exceeding the threshold of $11,300. Thus, all three must be separately reported. Third, a segment must be reported separately if its identifiable assets are greater than or equal to 10 percent of the combined identifiable assets for all operating segments. Again, the funeral and the cemetery segments meet this test. Note that the floral and catering segments meet none of the above criteria, so they are not reported separately, yet are combined to enable a reconciliation of segment data to consolidated amounts. The unallocated Corporate data will also be needed to complete the reconciliation. When reporting segment information, you must include the profit as well as the total assets and liabilities for each. Additional information by segment is required only if the amounts are regularly reviewed by the chief decision-maker/management in their review and assessment of the segments. These include revenues from external customers, intersegment revenues, interest revenue and expense, depreciation, amortization, material items, equity method investment income, income tax expense or benefit revenues, operating profit (loss), identifiable assets, liabilities, depreciation and amortization expense, other significant noncash items, and the amount of capital expenditures. Reconciliations of segment revenues, operating profits and losses, and assets and liabilities to the totals reported on the consolidated financial statements must be provided.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.9 (CONTINUED) Please note that other entity-wide disclosures are also required, even if a company determines that it operates in only one segment: how the segments were determined, the amount of revenue from external customers (not applicable in your case), Canadian and foreign revenues, capital assets, and goodwill. I do not expect that you have any major customers that account for more than 10% of your total revenue, as that would also be a required disclosure. I hope that this information helps you in determining future reportable segments. If you have any other questions, please contact me. LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.10 1.

The financial statements should be adjusted for the expected loss pertaining to the full accounts receivable of $300,000 as the subsequent collection of $40,000 will be disqualified. Such adjustment should reduce accounts receivable to its realizable value as at December 31, 2023.

Report the fire loss in a note to the SFP and refer to it in connection with the income statement, since earnings power is presumably affected. Provide any details of insurance coverage for the loss.

Strikes are considered general knowledge and therefore disclosure is not required. Auditors, however, would encourage note disclosure in all cases.

This case is a difficult problem. If this event is of the second type that provides evidence with respect to conditions that did not exist at December 31, 2023, then appropriate disclosures should indicate that: (a) Recovery of costs invested in plant and inventory is in doubt. (b) The company may incur additional costs to modify the existing facility. (c) Due to this situation, future economic events cannot be determined. If it is the first type of subsequent event and the condition existed at December 31, 2023, then the financial statements must be adjusted. The provisions of accounting for contingencies would govern if amounts could not be estimated. It should be emphasized in class that no right answer exists for this problem. Judgement must play a major role in determining the adjustment or disclosure necessary for this transaction. Consideration should be given whether the going concern assumption is appropriate under the circumstances.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.10 (CONTINUED) 5.

Adjust the inventory figure as at December 31, 2023 as required by a market price of $2.00 instead of $1.40, applying the lower of cost and net realizable value principle. The actual quotation was a transitory error and no purchases had been made at this quotation.

Report the action of the new share issue in a note to the financial statements, as this has relevance to the users, particularly existing shareholders.

This is a subsequent event that provides evidence about conditions that did not exist at the SFP date. The decline in value, if material in effect on Bouvier’s financial statements, would be disclosed in the notes to the financial statements. The loss would not be recorded in the December 31, 2023 financial statements.

LO 6 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 a.

BRADBURN CORPORATION Financial Analysis Current ratio =

Current assets Current liabilities

2022: $320,000 = 2.02 to 1 $158,500

2023:

$403,000 = 2.46 to 1 $164,000

Current assets: 2022: $12,500 + $132,000 + $125,500 + $50,000 = $320,000 2023: $18,200 + $148,000 + $131,800 + $105,000 = $403,000 Current liabilities: 2022: $6,000 + $61,500 + $91,000 = $158,500 2023: $9,000 + $76,000 + $79,000 = $164,000

Quick ratio =

2022:

Current assets – inventories Current liabilities

$270,000 = 1.70 to 1 $158,500

Receivables turnover =

2023:

$298,000 = 1.82 to 1 $164,000

Net sales Average trade receivables

$3,000,000 ($131,800 + $125,500) / 2

= 23.3 times

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 (CONTINUED) a. (continued) 4.

Inventory turnover =

2023:

Net sales Average total assets

$3,000,000 = 1.67 times ($1,852,000 + $1,740,500) / 2

Gross profit percentage =

2022:

$1,530,000 = 19.7 times ($50,000 + $105,000) / 2

Asset turnover =

2023:

Cost of goods sold Average inventory

$1,275,000 $2,700,000

= 47.2%

Profit margin on sales =

2022:

$346,500 $2,700,000

= 12.8%

Gross profit Net sales 2023:

$1,470,000 = 49.0% $3,000,000

Net income Net sales 2023:

$427,000 $3,000,000

= 14.2%

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 (CONTINUED) a. (continued) 8.

Return on assets =

2022:

$346,500 ($1,688,500 + $1,740,500) / 2

= 20.2%

2023:

$427,000 $1,740,500 + $1,852,000) / 2

= 23.8%

Return on equity =

Net income Average total assets

Net income minus preferred dividends Average common shareholders’ equity

2022:

$346,500 = 22.5% ($1,499,000 + $1,582,000) 1 / 2

2023:

$427,000 = 26.1% ($1,582,000 + $1,688,000) 2 / 2

$1,300,000 +$282,000

10. Earnings per share =

2022:

$1,300,000 + $388,000

Net income minus preferred dividends Weighted average shares outstanding

$346,500 = $2.67 130,000

2023:

$427,000 = $3.28 130,000

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 (CONTINUED) a. (continued) 11. Payout ratio =

2022: 3

Cash dividends Net income

$130,0003 = 37.5% $346,500

2023: 4

130,000 shares x $1

12. Debt to total assets =

$260,0004 $427,000

130,000 shares x $2

Total debt Total assets

2022:

$6,000 + $61,500 + $91,000 $1,740,500

= 9.1%

2023:

$9,000 + $76,000 + $79,000 $1,852,000

= 8.9%

13. Free cash flow to operating cash flows =

Net cash provided by operating activities capital expenditures and dividends Cash flow from operations

2022:

$350,000 - $110,000 - $130,0006 $350,000

= 31.4%

2023:

$459,000 - $128,000 - $260,0005 $459,000

= 15.5%

130,000 shares X $2

= 60.9%

130,000 shares X $1

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 (CONTINUED) a. (continued)

14.

Common shareholders’ equity Number of common shares outstanding at SFP date

Book value per share =

2022: 7

$1,582,0007 = $12.17 130,000

$1,300,000 +$282,000

15. Percent Changes

Sales

2023:

$1,688,0008 = $12.98 130,000

$1,300,000 + $388,000

Amounts Percent Increase (000s omitted) 2023 2022 $3,000 $2,700 $300 = 11.11% $2,700

Cost of goods sold

1,530

1,425

$105 $1,425

= 7.37%

Operating expenses

860

780

$80 $780

= 10.26%

Gross margin

1,470

1,275

$195 $1,275

= 15.29%

Net income

427

346.5

$80.5 $346.5

= 23.23%

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 (CONTINUED) b.

Other financial reports and financial analyses that might be helpful to the commercial loan officer of Hibernia Bank include: 1. The Statement of Cash Flows would provide further information beyond the amount of cash provided by operating activities; the other sources and uses of cash for the acquisition of non-current assets and long-term debt requirements. 2. Projected financial statements for 2024 including a projected Statement of Cash Flows. In addition, a review of Bradburn’s comprehensive budgets might be useful. These items would present management’s estimates of operations for the coming year. 3. A closer examination of Bradburn’s liquidity by calculating some additional ratios, such as day’s sales in receivables and day’s sales in inventory. 4. An examination of the extent that leverage is being used by Bradburn. 5. Details concerning the due dates of the notes receivable because of their large size in both fiscal years.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 (CONTINUED) c.

If the percentage changes experienced in fiscal year for sales and cost of goods sold and operating expenses continue for each of the next 2 years, Bradburn Corporation should be able to finance the plant expansion from internally generated funds as shown in the calculations presented below. (000 omitted) 2023 2024 2025 $3,000.0 $3,333.3 $3,703.7 Sales Cost of goods sold Gross margin Operating expenses Income before tax Income tax (30%)1 Net income

1,530.0 1,470.0 860.0 610.0 183.0 $ 427.0

Add: Depreciation Deduct: Dividends Note repayment ($148 - $70) Funds available for plant expansion Plant expansion Excess funds 1

1,642.7 1,690.6 948.2 742.4 222.7 $ 519.7

1,763.7 1,940.0 1,045.5 894.5 268.4 $ 626.1

110.0 (260.0) (78.0) 291.7

118.2 (260.0)

(150.0) $ 141.7

(150.0) $ 334.3

484.3

Calculated as 30% of income before tax in each year.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

PROBLEM 23.11 (CONTINUED) c. (continued)

Assumptions given: for 2024 and 2025

for 2025

Sales increase at a rate of 11.11%. Cost of goods sold increases at rate of 7.37% Other operating expenses increase at the same rate experienced from 2022 to 2023; i.e., at 10.26%

There are no other significant non-cash expenses. Loan extension is granted.

Hibernia Bank should probably grant the extension of the loan, if it is really required, because the projected cash flows for 2024 and 2025 indicate that an adequate amount of cash will be generated from operations to finance the plant expansion and repay the loan. In actuality, there is some question whether Bradburn needs the extension because the excess funds generated from 2024 operations might cover the $70,000 loan repayment. However, Bradburn may want the loan extension to provide a cushion because its cash balance is low. The financial ratios indicate that Bradburn has a solid financial structure. If the bank wanted some extra protection, it could require Bradburn to restrict cash dividends for the next two years to the 2023 amount of $2.00 per share.

LO 9 BT: AP Difficulty: C Time: 60 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

CASE Note: See the Case Primer on the Student website, as well as the Summary of the Case Primer in the inside back cover of the text. Note that the first few chapters in volume 1 lay the foundation for financial reporting decision making. CA 23.1 HOLTZMAN ENTERPRISES INC. Case Overview: Holtzman Enterprises has authorized the issue of bonds that will negatively affect the financial statement ratios once the bonds are issued. The Treasurer is concerned about the ratios, which may also negatively affect the share price. - Financial statement users include both debtors and creditors, and they will want financial statement transparency. IFRS is a constraint given that the shares trade on the local stock exchange. Analysis and recommendations: - Issue: Holtzman is trying to determine whether it should delay the issuance of the bonds until the following year. Specifically, should Holtzman delay the transaction just because it does not like the impact on the financial statements? - Technically, no. If the company has done an analysis from an economic or strategic perspective and has decided that it needs the money now, financial reporting should not be a determining factor. The accounting should be neutral. On the other hand, if Holtzman does not really need the money, then there is no real loss to the company to defer the issue.

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CA 23.1 HOLTZMAN ENTERPRISES INC. (CONTINUED) Recommendation: - Holtzman should look at the cost to the company of deferral of the issue (economic costs and other costs). If there are real costs, then it may be best not to delay the issue. Holtzman must weigh the costs of deferral with the costs of showing more debt on the balance sheet.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

INTEGRATED CASES IC 23.1 PENRON LIMITED Case Overview Penron is in the business of selling oil and gas and derivatives. Even though the company is expanding, it appears to be spinning off its “nonessential assets”. Penron has signaled to the marketplace that it believes that it will meet its projected growth targets, and, as a result, there may be pressure to manipulate the financial statements to meet these goals. There are numerous financial statement users that include: - The bank is a key user of the statements since the company has guaranteed the LPL debt and LPL otherwise does not seem to have any cash flows. - The analysts are also key users and will be looking for information to support whether they should tell their clients to buy or sell Penron shares. The analysts will be looking for signals such as declines in revenues or profits. The pension plan is also a key stakeholder since it is investing significant amounts of money into the company’s shares. The plan would be looking at the stability and solvency of the company. There is an additional potential bias for management to overstate earnings since they own stock options. It appears that many of the executives may leave next year. Therefore, they may be interested in producing short-term profits (versus longer term).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.1 PENRON LIMITED (CONTINUED) - Finally, the Class A shares are mandatorily redeemable if management resigns and so they stand to gain if the share price is higher, or if the company financial statements appear strong. - The auditor must be very cautious since there appears to be multiple opportunities for biased information. IFRS is a constraint since this is a public company.

Analysis and Recommendations Issue: How to account for some of its pipelines to LPL Corporation, which is also owned by the President of Penron. This is a related party transaction since LPL is owned by the president of the company. Additional disclosures are required. IFRS does not require remeasurement of related party transactions; however, this information is relevant to the users, especially given the magnitude of the transactions and significance to the bottom line. IFRS also recommends disclosure of the nature of the relationship; a description of the transaction; the recorded amounts of the transaction; the measurement basis that was used; amounts due from or to related parties and the related terms and conditions; contractual obligations with related parties; contingencies involving related parties (such as the guarantee of the LPL loan); and management compensation and the controlling individual of LPL. Recommendation: The sale of the pipelines to LPL is a related-party transaction. This should be disclosed in the notes. In order to increase transparency, additional information about the transaction should also be disclosed.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.1 PENRON LIMITED (CONTINUED) Issue: Penron has issued Class A shares to certain company executives. The Class A shares share in earnings similarly to other common shares and have no preferential rights. However, the shares are mandatorily redeemable if a triggering event occurs, specifically the resignation or termination of the executive. Record the shares as a liability

Record the shares as equity or part debt/part equity - The shares are liabilities in - The shares are equity-like substance since they have a since they represent residual mandatory redemption ownership interests in terms of feature. In this case, the asset and dividend shares must be redeemed if distribution. the executive(s) resign. At this - The shares have no point, the company will have preferential rights and do not to pay the shares out and this oblige the company to pay creates a liability or obligation cash. to pay cash. - The legal form is equity and - The probability of the more importantly, the shares triggering event must be are equity in substance since, assessed. At year end, it except for the triggering event, appears likely that many of they represent a residual the executives will leave since interest in nature. their benefits vest and there is a concern that they will resign. - Thus, the obligation to pay cash is probable.

Recommendation: It is more conservative to treat at least part of the instrument as a liability since Penron is required to pay if the triggering event occurs.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.1 PENRON LIMITED (CONTINUED) Issue: Penron is currently undertaking the redevelopment of its website to create transactional engagement with its customers. Capitalize the website costs Expense the website costs - Once in development stage, - All costs in the planning costs should be capitalized if stages should be expensed the related hardware and due to the uncertainty software expenses have attached to possible future future benefits. revenues. In this case, the - Development of graphics company has not decided would be seen as an integral whether to go ahead with this part of the software and new business model. should be capitalized. - The benefit of any content is - Costs incurred to develop uncertain and should be content should be capitalized expensed. since this will have future - Content will likely change benefits, in other words lasting every year. Therefore, is an beyond the next year. ongoing cost of doing business. Recommendation: Expense these costs since this is more conservative and would better reflect the uncertainty of future revenues.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.1 PENRON LIMITED (CONTINUED) Issue: Penron guaranteed the bank loan for LPL to purchase some of Penron’s pipelines that are no longer in use. LPL is a new company and is owned by the president of Penron. LPL is a new company and repayment of the loan may be questionable. Disclose guarantee of bank loan Accrue guaranteed bank loan - The company has - LPL is a company that has guaranteed the LPL loan. been established just before Since LPL is a new the deal for the sale of the company, Penron may not pipelines was signed. As be able to quantify the such, it has very few assets likelihood that it will have to and may have difficulty pay the LPL loan. making the payments on the - The question is also one of bank loan. measurement. Given the - IFRS requires accrual if the early stages of the obligation is probable and arrangement, it is unlikely ASPE requires accrual if it is that the company will be able likely. to measure the potential - Measurement may also differ cost. under ASPE versus IFRS as noted above. Recommendation: LPL is a new company with no history. Since the arrangement is so recent it may not be possible to assess the likelihood of default by LPL. Penron should disclose the guarantee in the notes to the financial statements.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.2 FRANGIPANI LTD. (FL) Case Overview Frangipani is a new privately owned technology start-up company. A significant amount of money is currently being used for research and development activities and cash is tight. Financial statement users include: - The government who has sponsored a bank loan issued to the company will be interested in long term viability and cash flows. Loan covenants include annual reporting and the requirement to maintain a debt to equity of 1:1. Therefore, this is a key ratio. Family members who own preferred shares and will be interested in a return on investment and management stewardship. The shares are redeemable by the holder if the company shows no profit. - Scientists who are “paid” share appreciation rights in lieu of a salary. They will be interested in FL’s performance and the net value of the company. - The accountant will want the financial statements to be transparent but the owner may want to present financial statements that are favorable. The company has decided to use ASPE (although the company has the option to follow IFRS as an accounting policy choice). Analysis and recommendations Issue: The share appreciation rights (SARs) issued to the scientists in lieu of salary may be settled in cash or a variable number of shares at the option of the company.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.2 FL (CONTINUED) Record SARs as debt - Whether FL settles in cash or through a variable number of shares, this is still an obligation to give the same amount of value. - Under ASPE, the company may argue this is debt since it will be settled with cash or a variable number of shares (see accounting for financial instruments).

Record SARs as part debt/part equity or all equity - There is no obligation to deliver cash since FL may settle in shares. Under ASPE, the company may argue all equity since the settlement method is at the option of the company.

Recommendation: There is significant judgement required here and therefore, whichever presentation is chosen (debt, equity or part debt/part equity), the company should provide appropriate note disclosures. Issue: If FL can develop its new process within three years the government loan would be forgivable (that is, repaid in the form of preferred shares).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.2 FL (CONTINUED) Record as a grant (equity) Record as a loan - Normally, this would be - The loan is with the bank even treated as a grant and be though the government is recognized as an offset to sponsoring it. Therefore, it is a costs incurred. However, this liability to the bank. is not completely forgivable as - Certain conditions must be the government would take met for the loan to be preferred shares in the forgivable and those have not company. Therefore, the yet been met. There are transaction would be credited complications as someone to equity. else may patent the process - The company needs to meet first (technology stolen?). certain conditions for the loan - In addition to this, the to be forgivable including company must maintain a completing the project within debt-to-equity ratio of 1:1 three years. FL is very close otherwise the debt is to patenting the process. repayable. Recommendation: It is more reasonable to represent this obligation as debt due to the significant uncertainty surrounding the patenting of the new technology. The loan would need to be repaid if the new process is not completed within 3 years. Issue: FL has sold preferred shares to Frank’s family members. The shares are redeemable for common shares at the option of the company and redeemable for cash at the option of the shareholder if the company does not make a profit.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.2 FL (CONTINUED) Record as debt Record as equity - The shares are redeemable at - The is no obligation to pay the option of the shareholder if cash since the preferred the company is not profitable. shares may be redeemed for Under ASPE, the company common shares at the option would assess the probability of the company. of this happening. The issues - The shares are only discussed here will have a redeemable at the option of significant impact on the the holder if a profit is not amount of profit recognized so made. This may be the case care must be taken to ensure this year. unbiased reporting. Recommendation: Under ASPE, the company would assess the likelihood of generating a profit. If this is not likely, then recognize the preferred shares as debt. Issue: The advertising revenues are non-refundable and paid in advance. A significant amount of pre-paid advertising revenues were received just before year end. Recognize revenues upfront Recognize revenues over time - Advertising is for the - Advertising services are provided month and nonover time. Therefore, recognize refundable. Therefore, it the revenues over time as well. is earned by the end of the - The company commonly displays month at latest. advertising for the entire year. - Ensure that the entity does not succumb to pressure to recognize advertising revenues early due to the preferred shares becoming payable in cash if the company does not make a profit.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.2 FL (CONTINUED) Recommendation: Advertising revenues should be recognized over time as services provided over time. This would reflect the substance of the transaction (expected to provide advertising for a year) not just the legal form (only required to provide it for a month). Issue: FL has had significant technology breakthroughs during the year; however, when the company went to file its patent it discovered that someone else had already filed a patent for this technology. With investigation, FL realized its idea had been stolen by someone on FL’s discussion forums. FL will pursue legal action against this induvial and FL’s lawyer believes that he can successfully prove theft of the intellectual property. Capitalize the development costs

Expense, write-off, or writedown the development costs - The technology appears to be - The company has not feasible since the company is close to quite reached the stage submitting a patent application. where technical feasibility Similarly, the costs are known or is established. close to being known. - The technology was - There is intent to produce given that stolen before the patent this is the main goal of the company. was filed. Therefore, it - While there is no information available may have no future to support this, it does appear that value. there is a market for solar powered - Under ASPE, the vehicles in general. company may choose to - There are resources available through expense development a government sponsored loan and costs even if the criteria investors. for capitalization are met. - Presenting the development costs as - This would reduce an asset shows that the company is bookkeeping costs and investing in its future. be less complex. - The lawyer is confident that he can prove the theft of the IP, so its value is not compromised.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

IC 23.2 FL (CONTINUED) Recommendation: It is only okay to recognize the development costs as an asset if the conditions have been met for capitalization, which may be overly aggressive at this stage of development. The company is confident that it can prove theft of the intellectual property. FL should also check with the lawyers, given that this will affect the viability of the company. Going concern issue - Ensure full disclosure since it appears that the idea has been stolen and FL may not be able to bring to market. - If this is the case, the government loan is not forgiven, and preferred shares may be redeemable (if FL does not generate a profit).

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RESEARCH AND ANALYSIS RA 23.1 AIR CANADA AND INTERNATIONAL AIRLINES GROUP a.

(1)

Air Canada commented on the following list of items in its Note 2 on basis of presentation and summary of significant accounting policies:

Basis of measurement Principles of consolidation Passenger and cargo revenues Capacity purchase agreements Aeroplan loyalty program Other revenues Employee benefits Employee profit sharing plans Share-based compensation plans Maintenance and repairs Other operating expenses Financial instruments Foreign currency translation Income taxes Earnings (Loss) per share Restricted cash

Aircraft fuel inventory and spare parts and supplies inventory Property and equipment Interest capitalized Leases Intangible assets Goodwill Impairment of long-lived assets Non-current assets (or disposal groups) held for sale Provisions Special items Segment reporting Government grants Accounting standards and amendments Issued but not yet adopted

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 23-1 AIR CANADA AND INTERNATIONAL AIRLINES GROUP (CONTINUED) a. (continued) (2)

IAG commented on the following list of items in its Note 2 on significant accounting policies:

Basis of preparation Reclassification Presentation of results Going concern Consolidation Segmental reporting Foreign currency translation Property, plant and equipment Intangible assets Impairment of non-financial assets Investments in associates and joint ventures Financial instruments Employee benefit plans Taxation Inventories Cash and cash equivalents

Share based payments Provisions Revenue recognition Customer loyalty programmes Exceptional items Government grants Critical accounting estimates, assumptions, and judgements Estimates Judgements New standards, amendments and interpretations

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 23.1 AIR CANADA AND INTERNATIONAL AIRLINES GROUP (CONTINUED) b.

Many of the items discussed in the notes on accounting policies are similar, although the information may be organized differently. For example, Air Canada has a separate policy note on “Interest capitalized” while International Airlines Group (IAG) includes information about its interest capitalization policy in the section on “Property, plant and equipment.” The similarity is to be expected as both companies are in the airline industry. The policies that are listed separately are similar, and those related to this industry include revenue recognition, both for passenger and cargo revenue and for loyalty programs, foreign currency translation, inventories, and property and equipment. Some policies would be common to all businesses such as cash and cash equivalents, financial instruments, goodwill, and taxation. Other policies relate more to the size and structure of the businesses, such as aircraft fuel inventory, spare parts, and basis of consolidation. Notable differences in the accounting policies separately identified in Air Canada’s notes are restricted cash, capacity purchase agreements, maintenance and repairs, and earnings per share. IAG separately identifies share-based payments and judgements.

Under Note 2AA in its Basis of Presentation and Summary of Significant Accounting Policies, Air Canada states that it operates only one reportable segment based on how financial information is produced internally for the purposes of making operating decisions. In Note 20, Air Canada provides information on passenger revenues and cargo revenues by geographic region: for Canada, US transborder, Atlantic, Pacific and Other. Further, the note explains how the company associates revenue with a specific region. IAG is a group of airlines/businesses. In Note 4, the company breaks out revenue between passenger, cargo, and other across 5 reporting segments, along with associated expenses. In addition, there is a line that presents external revenue that is characterized as Inter-Segment Revenue. The segments reported are British Airways, Iberia, Vueling, Aer Lingus, and Other Group companies. In this Note, IAG also provides a geographical analysis of the revenue earned by the group, as well as assets by area. The geographic areas shown are; UK, Spain, USA, and Rest of world. For comparative purposes, this note provides information for the current and previous fiscal year. Since Air Canada only has one significant reportable segment, the information has limited use. The note disclosure for IAG is more useful since the disclosures provide the user insights into the various businesses/brands with the overall group. Both companies provide a geographic analysis, which allows the user to understand if revenue is outperforming in one region vs. another by revenue type.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 23.1 AIR CANADA AND INTERNATIONAL AIRWAYS GROUP (CONTINUED) d.

Air Canada’s independent auditors are PricewaterhouseCoopers LLP, who conducted the audit in accordance with Canadian generally accepted auditing standards, including its ethical requirements. In addition, they require that the audit be planned and carried out to support the audit opinion about whether the statements are free of material misstatement. Air Canada’s auditors did not reference particular regulations but did refer to the role of management and what the auditor’s responsibility is. IAG’s independent auditors are Ernst & Young, S.L., who conducted the audit in accordance with ethical requirements and prevailing audit regulations in Spain. In IAG’s case, the name of the senior statutory auditor on the audit assignment was identified with the name of Ernst & Young, S.L. in the signature line section. With Air Canada, the name of the engagement partner was identified in a sentence before the signature line. The audit report indicates the role and responsibilities of management (directors) and auditors. Air Canada’s audit report is addressed to the company’s shareholders, while IAG’s report is addressed to the shareholders of the parent company. Air Canada’s financial statements were prepared in accordance with International Financial Reporting Standards as issued by the IASB. IAG’s financial statements were prepared in accordance with International Financial Reporting Standards as adopted by the European Union. Both the IAG and the Air Canada auditors’ report present multiple sections including: Key audit risks, Management’s responsibility for the financial statements, and Auditor’s responsibility for the audit of the financial statements. This structure is based on an updated format. The resulting audit report contains significantly more information, which typically includes the following sections: • The opinion paragraph at the top of the auditor’s report; • Basis for opinion • Use of the report • Conclusions relating to going concern • Overview of the audit approach which includes: o Key audit matters; o Audit scope; and o Materiality • Other information • Matters on which we are required to report by exception • Responsibilities of directors for the financial statements

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 23.1 AIR CANADA AND INTERNATIONAL AIRWAYS GROUP (CONTINUED) • • • •

Auditors’ responsibilities for the audit of the financial statements Explanation as to what extent the audit was considered capable of detecting irregularities, including fraud Other matters auditors are required to address Signature and the name of the audit firm as well as the personal name of the engagement audit partner

In both cases, management is responsible for preparing the financial statements. Air Canada’s management is responsible for their “fair presentation in accordance with IFRS” and for the internal controls necessary to ensure statement presentation that is free from material misstatement, whether due to fraud or error. Similarly, the directors of IAG’s parent company are responsible for the preparation of the financial statements so that they give “a true and fair view…in accordance with IFRS-EU” and for the internal controls to ensure statements are free from material misstatement, whether due to fraud or error. Both Air Canada’s management and the directors of IAG’s parent company are also responsible for assessing the Company or the Group’s ability to continue as a going concern. Both companies’ audit reports explain what an audit involves. Although worded differently and in a different order, the explanations are very similar.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 23.2 THOMSON REUTERS CORPORATION a. As described in Note 31, the company had the following related party transactions: • The company is owned 66% by Woodbridge at December 31, 2020. The two companies enter into transactions in the ordinary course of business with each other for goods and services during the year, however, the transactions are not material to the Company’s results of operation or financial condition. • The company owns a 45% interest in Refinitiv. The Reuters News portion of the company’s business supplies news and editorial comments to Refinitiv for a minimum amount of revenues through October 1, 2048. Items reported in this note are summarized as follows o In 2020 and 2019, the company recorded $336 million of revenues under this agreement. As part of the agreement, Refinitiv may also license the “Reuters” brand for its products or services. For the year ended December 31, 2020, the company recorded $24 million in income in “Other operating gains, net” ($23 million in 2019). o The two companies also agreed to provide certain operational services to each other, including technology, administrative services, and property leases. In 2020, Thompson Reuters reported as a contra expense to Refinitiv transactional services and property leases in the amount of $8 million and $23 million respectively ($26 million and $39 million in 2019). Conversely, Refinitiv recorded an expense in 2020 of $15 million for transactional services and $13 million for property leases ($52 million and $34 million respectively in 2019). o As of December 31, 2020, the company owed $59 million ($79 million in 2019) to Refinitiv for non-cancellable leases, while Refinitiv owed the company $15 million ($56 million in 2019) for non-cancellable lease agreements. o As of December 31, 2020, the consolidated statement of financial position included a receivable from Refinitiv $112 million ($135 million in 2019) and a payable to Refinitiv of $100 million ($102 million in 2019) related to transactions between the two companies. • The company also entered into normal course of business service transactions with its own associates and joint ventures but these are not material to the company’s results of operation or financial condition. In addition, the company discloses the cost of the compensation paid to its key management personnel (executive officers) and directors who are considered related parties. This amounted to salaries and other benefits of $41 million and share-based payments of $16 million.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 23.2 THOMSON REUTERS (CONTINUED) b.

In general, the information was useful and mostly adequate. The nature of the relationship was provided, along with disclosure of the specific related party. The amount of the transactions and the reasons for the transactions were also provided. Even though this is not required by IFRS, users would appreciate knowing whether the amounts reflect fair values, although users may assume that company statements about transactions being conducted in the normal course of business means they were at fair value. Finally, for some of the transactions, if the amounts were insignificant, the amounts were not disclosed. From a user perspective, even these “minor” details would be helpful since, by their nature, related party transactions may not occur under normal market and business conditions.

Note 32 provides details of the subsequent events, which are summarized below: • On January 29, 2021, the company and private equity funds affiliated with Blackstone (ownership behind Refinitiv) sold its interest in Refinitiv to LSEG in an all share transaction. As of the closing date, the company indirectly owned approximately 82.5 million of LSEG shares, which as of January 28, 2021 had a total market value of approximately $9.8 billion. The company’s interest in LSEG shares is held through an entity jointly owned with Blackstone’s consortium. As part of the agreement the consortium (the company and Blackstone) have agreed to a lock up (restrict insiders being able to sell shares) through January 29, 2023. The company expects a pre-tax gain of approximately $8.5 billion in the first quarter of 2021. • In February of 2021, a $1.62 per common share annualized dividend was approved by the board of directors. A quarterly dividend of $0.405 per share was paid by the board on March 17, 2021 to shareholders of record of March 5, 2021. As disclosed under Note 1 under general business description, the directors approved the statements on March 3, 2021, making this the cut-off date for what is considered a subsequent event.

Kieso, Weygandt, Warfield, Wiecek, McConomy

Intermediate Accounting, Thirteenth Canadian Edition

RA 23.2 THOMSON REUTERS (CONTINUED) d.

(i) Thomson Reuters’ MD&A is organized under the following sections: • Executive summary, an overview of the business • Results of operations, a comparison of current with prior year results • Liquidity and capital resources, a cash flow and debt discussion • Outlook, trends, priorities, and a three-year financial outlook, including risks and assumptions • Related party transactions, discussion of transactions with controlling shareholder “Woodbridge” • Subsequent events • Changes in accounting policies • Critical accounting estimates and judgments made by management in applying accounting policies • Additional information, such as other required disclosures • Appendix, supplemental information and discussion

(ii)The sections of the MD&A dealing with related party transactions is identical, almost on a word-for-word basis, to Note 31 “Related party transactions” in the financial statements. In fact, Note 31 also contains a section on the compensation of key management personnel that is not included in the same section of the MD&A. The subsequent events section of the MD&A, again, is almost word-for-word the same as Note 32 “Subsequent events” in the financial statements. No new information or management insights have been provided in these two sections of the MD&A over and above what is in the financial statements. In a period when standard setters are concerned with disclosure overload and the length of the financial information in the annual reports, this repetition seems to be a waste of time and space. If there were additional management insights about what was provided in the GAAP financial statements, the information would be more useful. If this isn’t possible, then the MD&A should merely refer to the appropriate note in the financial statements.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 23.3 NESTLÉ SA a. IAS 34.20 requirements Statement of financial position: -at end of current interim period & -at end of immediately preceding financial year Statements of profit or loss and other comprehensive income: -for the current interim period & -cumulatively for the current year to date & -for the comparable interim period, both current and year-to-date for the preceding year Statement of changes in equity: -cumulatively for the current year to date & -for the comparative year-to-date of the preceding year Statement of cash flows: -current year to date & -for the comparative year-to-date of the preceding year

Nestlé’s reports -at June 30, 2021 -at December 31, 2020 For the 2 separate statements: -6 months ended June 30, 2021 -(see note below) -6 months ended June 30, 2020 -(see note below)

-January 1 to June 30, 2021 -January 1 to June 30, 2020

-6 months ended June 30, 2021 -6 months ended June 30, 2020

Note: Nestlé has provided all the required financial statements except it appears that the company does not produce quarterly financial reports, only half-yearly reports. Therefore, the current interim period (six months) and the cumulative to date period are the same six-month period. It should be noted that IFRS does not require interim financial statements to be provided, but if interim statements are provided, IAS 34 covers what should be reported. It is usually a regulatory body that dictates that interim statements are required and how often. Most Canadian public companies are required to prepare quarterly financial statements. If Nestlé issued quarterly statements, it would also have prepared a statement of profit and loss and statement of comprehensive income for the three months ended June 30, 2021 and the same statements for the three months ended June 30, 2020.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 23.3 NESTLÉ SA (CONTINUED) b. Note 1 on accounting policies, basis of preparation, indicates that the company has followed IAS 34 in preparing the interim financial statements and that they should be read in conjunction with the previous annual year-end financial statements, i.e., for the year ended December 31, 2020. The company has used the same accounting policies and conventions as it did for its 2020 fiscal year-end report, except for some changes in presentation and standards (noted as follows): • •

Changes in presentation – analyses by segment. Nestle Health Science, and Nespresso are being presented as reportable segments. Detail is provided in Note 3. Changes in accounting standards: o In May 2020, IASB issued an amendment to IFRS 16 that deals with Covid related rent concessions, and whether to consider these concessions as lease modifications. In March 2021, the IASB extended the duration of this amendment to June 30, 2022. The amendment was applied and there was no material impact to the statements. o Interest Rate Benchmark reform became effective January 1, 2021, but there was no material impact to the statements.

The other notes include information on the following : • •

• • • •

Note 2 – Information about acquisitions and disposals that might modify the scope of consolidation and information about assets held for sale. Note 3 – Provides segmented information for the six-month period January 1 to June 30, 2021 and comparative information for the period January 1, to June 30, 2020, on the basis of geographic regions and by type of product. In addition, a reconciliation of segment operating profits to the consolidated operating profit is provided. Note 4 – Discusses seasonality and indicates that the results for the group do not show seasonal variations or cyclical patterns. Note 5 – Provides a detailed breakdown of “Net other trading income (expenses)” and “Net other operating income/(expenses)”. Note 6 – Provides information about what makes up the share of associates’ profits, primarily the group’s ownership of L’Oreal, as well as the results of joint ventures Note 7 – Information on cash flow before changes in operating assets and liabilities. Shows the operating profits and adjustments for the non-cash items included in profit for the year, which are part of the reconciliation of net income to operating cash flow in the statement of cash flows.

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Intermediate Accounting, Thirteenth Canadian Edition

RA 23.3 NESTLÉ SA (CONTINUED) •

• • •

•

Note 8 – Provides disclosure about share repurchases and cancellations during the interim period and the total number of shares outstanding as of June 30, 2021. In addition, the note provides information on dividends paid and declared during the interim period. Note 9 – Provides the details on financial instruments: the amounts valued using level 1, level 2 and level 3 approaches to valuation, and the relationship between carrying amounts and fair values. Note 10 – Provides information about the bonds issued and redeemed during the period. Note 11 – Discusses impact of Covid-19: Covid-19 has had a significant impact on the world and business operations. Nestle has included estimates of net incremental effects by function for January 1, 2021 to June 30, 2021 and comparatively for the same period in 2020. Note 12 – Events after the balance sheet date: As at July 28, 2021, no subsequent events that warrant either a modification of the value of the assets and liabilities or an additional disclosure.

No, Note 1 indicates that this information is unaudited.

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RA 23.4 REPORTING INTERIM EXPENSES a.

Given that Kersee is a Canadian publicly traded (publicly accountable) company, it must report under IFRS. IFRS generally favours the discrete view for interim reporting. This means that Kersee should report its operating results for the quarter as if the quarter were an entirely separate reporting period. However, there are some issues, such as the determination of income tax expense for the interim period, that require some aspects of an integral approach.

b. The company’s revenue and expenses would be reported as follows on its quarterly report prepared for the first quarter of the 2023 fiscal year: Sales Cost of goods sold ($36,000,000 + $245,000) Variable selling expenses Fixed selling expenses Advertising Other ($1,500,000 – $500,000)

$60,000,000 36,245,000 2,000,000 2,000,000 1,000,000

Since revenue and expenses are defined as changes in assets and liabilities that result in a change in net assets, the definitions of assets and liabilities that are used for annual reporting decisions are also used for interim reports. At March 31, 2023, the cost of the inventory on hand must be determined and then the lower of cost and net realizable value measurement criterion is applied. Therefore, sales and cost of goods sold receive the same treatment as if this were an annual report. The inventory variance cannot be deferred as an asset even though the company believes it will reverse before the third quarter, because this is what the required GAAP treatment would be at year end. Consequently, the inventory carrying amount must be reduced to the lower cost amount and cost of goods sold is increased by the amount of the unfavourable price variance of $245,000. With respect to the advertising costs, if the costs would not be recognized as an asset (i.e., deferred) at year end, then this treatment is not permitted at the interim period end. The decision here is based on the nature of the advertising expenses. If the $2,000,000 covered a weekly advertisement in the media from January 1 to December 31, 2023, then 75% of this cost qualifies as an asset at March 31 – as a prepaid expense, and the company’s accounting treatment is correct. However, if the expenditure covered the cost of a “Superbowl” advertisement for example, it is too difficult to determine what future benefits, if any, remain for the next three quarters. Therefore, the full $2,000,000 would be expensed in the first quarter. Generally advertising expenses are expensed entirely due to the difficulty in determining the amount, if any, of the future benefits. Consequently, without further information being provided, the full advertising expense should be expensed. Solutions Manual 23-119 Chapter 23 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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RA 23.4 REPORTING INTERIM EXPENSES (CONTINUED) b. (continued) Costs and expenses other than product costs should be charged to expense in interim periods as incurred or allocated among interim periods, based on decisions about their related assets and liabilities. Consequently, the fixed selling costs not related to the television advertising should be reported as an expense to the extent that the costs incurred do not result in an asset at March 31. The sales recognized should follow regular revenue recognition principles, based on changes in assets and liabilities, at March 31. The variable selling expenses are also based on the same criteria that would exist if the situation had occurred at December 31. c.

IAS 34 on Interim Financial Reporting (and paragraphs 38 and 38A of IAS 1) requires the following minimum financial information to be disclosed to its shareholders in its quarterly reports: • • • • • • •

a condensed statement of financial position at March 31, 2023 and at December 31, 2022 showing comparative information a condensed statement of comprehensive income (profit or loss and other comprehensive income) for the three months ended March 31, 2023 showing comparable information for the three months ended March 31, 2022 a condensed statement of changes in equity for the year-to-date three months ended March 31, 2023 showing comparable information for the same year-todate period ending March 31, 2022 a condensed statement of cash flows for the year-to-date three months ended March 31, 2023 and comparable information for the same year-to-date period ending March 31, 2022 selected explanatory notes basic and fully diluted earnings per share for the three months ended March 31, 2023 and comparable information for the 2022 comparative period On a year-to-date basis, provide information about: o The fact that the accounting policies applied are the same as those for the most recently completed annual financial statements; or if this is not so, a description of the nature and effect of the changes o Any seasonality or cyclicality of interim operations o Any assets, liabilities, equity, net income or cash flows that are unusual in size, nature or incidence o Any changes in estimates of amounts reported previously or in prior interim periods of the current year o Any issues, repurchases and repayments of debt and equity securities o Dividends paid for ordinary (common) and other shares o Specific segmented reporting information o Subsequent events not reflected in the interim financial statements

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RA 23.4 REPORTING INTERIM EXPENSES (CONTINUED) c. (continued) o The effects of changes such as acquisitions, mergers, discontinued operations and other events that change the composition of the entity o Fair value disclosures for financial instruments by specific parts of IFRS 13 on fair value measurement and IFRS 7 on financial instrument disclosures • A statement that the interim report is in compliance with IFRS

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RA 23.5 INTERIM REPORTING – RECOGNITION AND MEASUREMENT a.

Acceptable. The use of estimated gross profit rates to determine the inventory and cost of goods sold is acceptable for interim reporting purposes as long as the method and rates utilized are reasonable. The company should disclose the method employed and any significant adjustments that result from reconciliations with annual physical inventory. (See IAS 34.41 on the use of estimates.)

Not acceptable. Even though pension costs are identifiable with a time period rather than with the sale of a product or service, the pension expense for the interim period is to be calculated using actuarial estimates of costs. In addition, any one-time adjustments for significant market fluctuations, curtailments, settlements and any other events must be included in the interim period. To do otherwise would require the recognition of a pension “asset” or pension “liability,” neither of which exists at the interim period end. Consequently, the full gain or loss on settlement should be recognized in the quarter in which the settlement occurred (IAS 19.110 and IAS 34.37 and 39).

Acceptable. Any loss in inventory value should be reported when the decline occurs. Any recoveries of the losses on the same inventory in later periods should be recognized as gains (recovery of loss) in the later interim periods of the same fiscal year. However, the gains should not exceed the previously recorded losses.

Not acceptable. Gains on the sale of investments would not be deferred if they occurred at year-end. This is because to do so, the company would have to report a liability “deferred gain on sale of investments.” This does not qualify as a liability, therefore, it must be a revenue. Consequently, the gain should not be deferred at the company’s interim reporting date; it should be reported in the quarter the gain was realized. (See IAS 34.28 and 37.)

Acceptable. The annual audit reflects the additional reliability on the financial reports of the whole year’s activities, so the audit fee is an expense of each quarter and the company accrues a liability representing an obligation related to the current quarter’s portion of the annual fee. A constructive obligation accrues throughout the year, so companies are encouraged to make quarterly estimates of these items that usually result in year-end adjustments. Therefore, this expense can be estimated and accrued over the four quarters.

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RA 23.5 RECOGNITION AND MEASUREMENT (CONTINUED) f.

Not acceptable. Revenue from products sold should be recognized as earned during the interim period on the same basis as followed for the full year. Because the company normally recognizes a sale when shipment occurs, it should recognize the revenue in the second quarter and not defer recognition to a future period. To do so would require the recognition of a liability (deferred sales) in relation to the sale, and no obligation exists to the customer or anyone else at the end of the interim period. This would be an inconsistent application of a key company accounting policy and violate generally accepted accounting principles for revenue recognition.

Not acceptable. Goodwill impairment losses cannot be reversed. (See IAS 36.124 and IAS 34.28.)

Not enough information. A bonus can be accrued in the interim period if the bonus is a legal or constructive obligation, and if a reasonable estimate can be made of the amount. In this case, if the company is obligated to pay the bonus if the share price at December 31, 2023 is above the target price, and if there is sufficient historical and budget data to indicate that the company’s earnings and share price grow with each quarter of the year and are highly correlated, an accrual of the bonus would be acceptable, based on the June 30, 2023 share price. A case can be made for accruing a bonus liability at June 30, 2023 based on the income earned for the first two quarters. This would be similar to accounting for a change in estimate. However, if past history indicates that the share price fluctuates widely throughout the year, and is not necessarily correlated with reported earnings, there may be no basis on which to measure and accrue an obligation and expense. The share price is outside of management’s control.

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RA 23.6 GOING CONCERN MAGNUM GOLDCORP INC. a.

As explained in Note 1 of its financial statements, Magnum is engaged in the acquisition and exploration of mineral resource properties. As per Note 2 under “Statement of compliance”, the company uses IFRS as its reporting standard.

b. LIQUIDITY RATIOS Current ratio Current assets Current liabilities Current cash debt coverage

Net operating cash flows Average current liabilities

ACTIVITY RATIOS Receivables turnover

Net sales Average trade receivables

Asset turnover

Net sales Average total assets

$5,062 $394,836 ($40,022) $(394,836 366,705)/2 0 (579 + 1,196)/2 0 (3,098,850 3,112,108)/2

0.013 (0.105) +

0.0 0.0 +

PROFITABILITY RATIOS Profit margin on Net income sales Net sales Return on assets

Return on common equity Earnings (Loss) per share

(97,535) 0 Net income (97,535) Average total assets (3,098,850 3,112,108)/2 Net income to common SH (97,535) Average common equity (2,704,014 2,745,403)/2 Income to common SH (97,535) Common shares o/s (wt’d 15,049,709

Price earnings ratio

aver.) Market price per share Earnings per share

Payout ratio

Cash dividends/Net income

Book value per share

Common SE Outstanding shares

0.065* (0.01) n/a – no dividends paid 2,704,014 15,049,709

n/a (0.03) + (0.036) + (0.01) (6.50) n/a 0.18

*The share price can be found outside of the financial statements by searching the stock price history on any major finance / stock reporting website.

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RA 23.6 GOING CONCERN MANGNUM GOLDCORP INC. (CONTINUED) b. (continued) SOLVENCY/COVERAGE RATIOS Debt to total assets Total debt Total assets Times interest earned

Income before int. & taxes Interest charges

Cash debt coverage

Operating cash flow Avg. total liabilities

$394,836 $3,098,850 (97,535) + 19,110 19,110 ($40,022) (394,836+366,705)/2

0.128 (4.10) (0.11)

With a current ratio of 0.013 and a negative current cash debt coverage ratio, the analysis indicates that Magnum will struggle to meet its current commitments as they come due. The current assets are extremely minimal, and practically negligible compared to the current liabilities. No profits were generated therefore profitability ratios cannot be calculated or are not useful and would produce a negative answer. The company also has a negative EPS, has paid no dividends, and has negative retained earnings (deficit). Combined with year over year net losses, these are indications of a struggling company. In addition, the solvency ratios indicate that the company is not generating sufficient income to cover its interest commitments (a negative interest coverage ratio). However, the company has very little debt relative to total (long term) assets. The traditional ratios clearly indicate that the company is in serious financial difficulty. A more detailed analysis of the underlying amounts is required in evaluating the company.

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RA 23.6 GOING CONCERN MAGNUM GOLDCORP INC. (CONTINUED) c.

The auditors, Crowe MacKay LLP, provided an unmodified opinion. The auditor agrees with how the statements were presented which indicates Magnum has followed the accounting principles outlined by IFRS. As a public accounting firm, Crowe MacKay has an obligation to act independently of the company when performing the audit. The auditor did make mention of the going concern issue, and pointed readers to Note 1 of the financial statements. Note 1 is titled Nature of Operations and Going Concern. In this note, there are two notable subsections; Going concern and Covid-19 Public Health Crisis. Management indicates in the note that the financial statements have been prepared on the assumption that the company is a going concern. However, the note goes on to state that while management believes the company will be successful in the future, there are several conditions that cast significant doubt on the company’s ability to continue as a going concern. These conditions are summarized as follows: • Significant operating losses • Unable to self-finance operations in the long-term • Working capital deficit • No source of operating cash flows • No assurances that sufficient funding will be available to conduct further exploration and development. Despite these conditions, management indicates that it is confident that it will be able to secure additional funding to continue operations and that the assets on the financial statements, while indicating that there are several factors that impact recoverability, are able to be realized to satisfy liabilities and commitments in the normal course of business. In addition, there is a disclosure describing the effects of the Covid-19 public health crisis on the operations of the business. These conditions contribute to the uncertainty as it relates to the company’s ability to continue as a going concern. Considering the ratio analysis completed above, in combination with this assessment, it is called into question as to whether this company is appropriately assessed as being able to continue as a going concern without some form of external commitment to fund the normal operations of the business. While management indicates that it is confident this can be achieved, there is little evidence to confirm this assertion by only completing a superficial review. It is possible that existing investors have committed to provide funding should the need arise.

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RA 23.6 GOING CONCERN MAGNUM GOLDCORP INC. (CONTINUED) d.

The company uses historic cost measurement, except for certain financial instruments and stock-based compensation which are measured at fair value. If the company were not a going concern, the primary measurement basis would be a liquidation value such as net realizable value. Considering the balance sheet, the following changes would be likely: Current assets: prepaid expenses would have to be remeasured into the cash that could be generated from any possible refunds (its net realizable value), but the remaining current assets are likely close to their cash value. Long-term assets: exploration and evaluation assets and reclamation deposit would have to be restated at liquidation value. Liabilities: no changes, except for the addition of liabilities from penalties or cancellation of contracts. Shareholders’ equity: The losses from the write-down of the prepaid expenses and restatement of long-term assets would directly affect the accumulated deficit, as would the additional liabilities, if applicable.

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION: CHAPTERS 18-23 Eastern Publishers Ltd. a.

Determine whether the lease for the 3D printer satisfies any of the criteria for capital lease classification under ASPE. The implicit rate embedded in the lease is equal to EPL’s incremental borrowing rate of 10%. Not Met Not Met Determinable Economic life test1 X 2 Recoverability test X Specialized asset test X Ownership transfer test X

1 (2 divided by 5 years) is less than 75% 2 (the present value of the two annual lease payments of $14,525 is less than 90% of

the fair value of $150,000 b.

Assess the impact on the 3D printer lease classification based on the following changes in key assumptions. Operating Capital Not Lease Lease Determinable EPL can purchase the lease at the end of the two years for $50,000 which reflects its expected market value. X The useful life of the printer is two years. X

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION (CONTINUED) c.

Identify whether each revenue and expense line item identified below is a temporary difference (taxable or deductible), permanent difference, or not a difference between GAAP and the Income Tax Act. Taxable Deductible Temporary Temporary Permanent Not a Difference Difference Difference Difference Lease expense X Depreciation X Meals and entertainment X Warranty X

Calculate the current and future tax expense for EPL. Be sure to review the details of the pre-tax income calculation.

Current Tax Expense Accounting income for 2023 Permanent Differences: 50% of meals and entertainment

$1,940,620

39,000

Reversible Differences: Add: Depreciation Deduct: CCA Add: Warranty expense

250,000 (750,000) 37,500

Taxable income for 2023

$1,517,120

Current tax expense for 2023

$530,992

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION (CONTINUED) d. (continued) Future Tax Expense Balance Sheet Account

Tax Base

Carrying Amount

(Taxable) Deductible Temporary Difference ($500,000)

Tax Rate

Deferred Tax Asset (Liability)

.35

$(175,000)

.35

13,125 (161,875) -0$(161,875)

Plant and $4,250,000 $4,750,000 equipment Warranty -037,500 37,500 Net future tax liability, December 31, 2023 Net future tax liability, December 31, 2022 Increase in future tax liability account, and future tax expense for 2023

Determine the impact of the following items on the presentation of EPL’s operating cash flows in the statement of cash flows assuming that the indirect method has been adopted. Add back

Deduction

No impact

Depreciation expense X Warranty X Gain on disposal of asset X Meals and entertainment expense X

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION (CONTINUED) f.

Identify where the following items would be located on the statement of cash flows assuming that the direct method is used for operating activities.

Depreciation expense

Not Presented X

Current tax expense

Operating

Investing

Financing

Lease expense X Gain on disposal of asset

Assume that the wages and benefits expense includes $5,000 related to a defined contribution pension plan for a key manager. The $5,000 was determined as 10% of the key manager’s earnings. In the table below, indicate whether certain information discovered in March 2024 would be considered a change in policy, change in estimate, or accounting error.

New Information Pension contribution percentage is increased to 15% of total wages. The key manager is given credit for the past three years of service at a related company. The pension contribution was calculated based on the key manager’s annual salary of $50,000. The manager was also paid a discretionary bonus of $1,000.

Change in Policy

Change in Estimate X

Accounting Error

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CUMULATIVE COVERAGE AND TASK-BASED SIMULATION (CONTINUED) h.

Assume that the new information revealed in March 2024 is during the subsequent events period. In the table below, indicate how the information should be treated in the 2023 year-end financial statements.

New Information

Note Disclosure

Recognition in Financial Statements

Pension contribution percentage is increased to 15% of total wages. The key manager is given credit for the past three years of service at a related company. The pension contribution was calculated based on the key manager’s 2023 annual salary of $50,000. The manager was also paid a discretionary bonus of $1,000 in 2023.

No Impact X

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MMXXII vii F2